Bank OZK Q3 FY2023 Earnings Call

Good day, and thank you for standing by, and welcome to the Bank of OZK Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would like to introduce your host for today's call, Jay Staley, Director of Investor Relations and Corporate Development. You may begin.

Good morning. I'm Jay Staley, 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. 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; Brannon Hamblen, President; Tim Hicks, Chief Financial Officer; and Cindy Wolfe, Chief Operating Officer. We will now open up the line for your questions. Let me now ask our operator, Justin, to remind our listeners how to queue in for questions.

And our first question comes from Stephen Scouten from Piper Sandler Companies. Your line is now open.

Hey, good morning, everyone. Great quarter here. I'm curious, it looks like in the management comments that you're guiding to a pretty strong origination growth in the fourth quarter. And I'm wondering if you could give some comments there. I would assume that's occurring as some of your competitors may be pulled back from the space? And obviously, that's been a time when you guys have done really well. So, just curious, kind of, if that's what's happening today and kind of where you're seeing the pickup in origination category-wise?

Brannon, do you want to take that one?

Be happy to. Stephen, great to talk to you. Thanks for the question. That is in part some of the explanation. It's been an interesting year as we've seen generally a slowdown in the number of projects that we've seen that would differ from region to region. As we've said a number of times through the year, the Southeast region has remained strong, certainly relative to other regions. And even during certain periods of time in the Southeast. So we continue to see very good activity in that region and over into Texas and the Southwest. But yes, despite the slowdown in the number of deals that are out there, there's also been a pullback from some of our competitors out there. And we have, as time gone on, continued to press down on leverage, trying to expand on spread. So all the time, we stay very true to our disciplined approach to origination. But with, in many cases, fewer competitors out there, we are able to still close a number of deals, great deals with improved leverage and pricing metrics. So in terms of the continued theme, multifamily and industrial would be where we are seeing a lot of activity. We are closing other types of loans. I think I've mentioned a couple of times over the last few quarters that our Atlanta office that covers the Miami market is seeing a lot of opportunity in condos in the Miami markets. So we'll see some opportunity there. But multifamily and industrial has been, for the most part, the big movers. We've had some good mixed usage in there as well, but those are where we're seeing a lot of opportunity.

Great. And Brannon, I appreciate that. You spoke to spread there. What are you seeing on new loan spreads kind of relative to the incremental funding cost? And I guess you would feel based on that growth that you're getting paid well and compensated well on this new loan production?

Absolutely. We've talked about how our spreads differ pretty materially depending on the product type. But I would say that we're ranging from sort of mid-3s to up into the 4s depending on the product type and where it is.

Okay. And then just last thing for me. Obviously, the RESG loans are staying on the books for longer. I'd assume this has been driving some of the, what I see as conservatism around the loan loss reserve, but how do you guys kind of speak to that pushback maybe from some market participants and say like, these loans staying around longer is a bad thing, not a good thing even though you're earning more money?

Well, and George can weigh in on this one as well. I think I would first point out that we've had more payoffs than we have had originations this year. So as you can see from the numbers we reported, it's not a significant increase, but they have been up every quarter-over-quarter and evidence of other capital out there in the market. They're paying off with refis. They're paying off with sellouts or sales of income properties from developer to a new owner, and we've even had some situations where the borrower came into a lot of cash and just paid us off in that method. But as you noted, we don't mind having the earning balances on our book and are getting paid well for those loans. So look, with rates doing what they've done, we've known we would have a slower repayment volume, but it has been, and repayment volume continues to be. There's still people in the market with capital. So we're not surprised, and I would say on the whole, pleased to see the payoffs continue to come in at the numbers that they do.

Stephen, I want to clarify for our listeners who may not price loans regularly. Brannon mentioned that our spreads in the RESG portfolio typically range from the mid-300s to the 400s, which refers to a spread over 30-day terms SOFR, our main index. I just want to highlight that when we discuss spreads, we are specifically referencing this index. Brannon also pointed out that our leverage points have been decreasing. Over the last two years, our loan-to-value and loan-to-cost ratios have generally trended down, and we are likely down by 5 to 10 percentage points on leverage compared to what was originated two years ago, which is very positive for credit quality. I echo Brannon's sentiment that we are pleased to retain loans on our books longer. Sponsors are usually quick to refinance to cheaper permanent loans, but currently, they are hesitant and are carefully considering their refinancing options. This is resulting in our higher yield construction loans staying on our books for an extended period. Our low leverage points make us very happy to hold these loans longer.

Yep. Makes sense to me. Appreciate the color and congrats on all the success, again.

Thank you.

Thank you. And one moment for our next question. And our next question comes from Manan Gosalia from Morgan Stanley. Your line is now open.

Hey, good morning. So maybe just as a follow-up to that question. As we think about growth in funded balances over the next few quarters, I think this quarter, you had about $1.4 billion increase. Is that a good run rate to consider as we go through 2024?

I don't know that we're willing to lock in on that guidance. Manan, we expect good growth over the next year, but we're not giving specific guidance on that for the year yet or for the quarter. We’ll probably in our January call give some specific growth guidance on total loan expected growth in 2024. We expect it to be nice growth this year, but I'm not ready to lock in on a number yet.

All right. Fair enough. And then just on credit, it feels like a good quarter on credit. As we compare the properties that were reappraised this quarter versus last quarter, you had much less LTV migration into some of the high LTVs. Was there something fundamentally different about the properties reappraised this quarter versus last?

No. It's just the normal cycle of what was due for maturity extension, renewal, reappraisal, and there was nothing unique about that. Brannon and his teams at RESG continue to do an excellent job of getting paydowns on a lot of these loans where we would have had an upward migration in the loan-to-value based on a reappraisal as part of an extension process. We continue to get quite a few paydowns from sponsors on those that bring the loan to values back out standing closer to the loan-to-value at the time of underwriting. That just reflects the strength of the sponsors and the quality of the assets.

Got it. And anything different you're seeing on the credit side? Some of your peers have been increasing their NPLs on commercial real estate and also the criticized assets. I know your business is different, but I was just wondering if you're seeing anything different in the areas where you're operating?

No, I'm not, and I'll let Brannon address that. But the reality is that the quality of our sponsorship, the quality of our new construction projects, combined with the low leverage loan-to-value, loan-to-cost metrics on these projects has contributed to the excellent performance of our portfolio so far during this cycle. We continue to think that those are fundamental ingredients, great sponsorship, great state-of-the-art new assets, low loan-to-value, and low loan-to-cost, that will continue to help our portfolio perform very well on a relative basis to the industry going forward.

Great. Thank you.

And thank you. And one moment for our next question. And our next question comes from Timur Braziler from Wells Fargo Securities. Your line is now open.

Hi, good morning. I have a three-part question following up on Stephen's question. Just on loans staying on longer within the RESG. I guess, can you, a, put a number around just how much longer these loans are sticking on balance sheet versus a normal time? B, is there a contractual limit for how long these loans could stay in construction status? And then, c, how much of a cliff or a headwind to growth should we expect as the refi market reengages and paydowns normalize, whether that's in '25 or '26, whenever that might be?

The duration for which a loan remains in construction status while waiting for a better exit or trying to time the market is difficult to predict, as it varies significantly from one loan to another. Brannon shared some statistics earlier about the recent loan payoffs, including how many have refinanced or sold. He will provide that information, which may help clarify your question, even if it doesn’t fully answer it. You are correct that loans expected to pay off in a normal cycle might not do so this quarter because sponsors are choosing to wait for what they believe will be better conditions for permanent loans. When market sentiment improves over the next quarter, year, or 18 months, we anticipate many payoffs. Our teams across asset-based lending, equipment and structured finance, and commercial banking understand the importance of growing and diversifying our business to have the capacity to originate new volumes that will replace those assets once we experience a wave of payoffs. We are enhancing our infrastructure, as I mentioned in our last conference call, and actively adding skilled team members from banks reducing their origination staff. We have several positive developments in the works that I believe will support our continued growth in our balance sheet and loan balances, even amidst significant payoffs in the future. We are already looking one, two, or three years ahead regarding those volumes and planning accordingly. Our success in managing our portfolio and performance metrics right now is a result of our forward planning from two, three, and four years ago, where we prepared for rising rates and changing economic conditions. This has been particularly effective with our variable rate loans, which have floors, and our low loan-to-value structures. All these strategies are yielding positive results now. As we navigate this phase of the cycle, we are also looking ahead to future changes in the balance sheet and preparing now to maintain a steady upward trend over the coming years.

Great. Thank you for that color.

We have had 53 loan repayments year-to-date, if I counted correctly. Out of those, 32 were paid off through a third-party refinance. One borrower transitioned from a land loan to a new construction loan. Additionally, 15 loans were repaid from condo sellouts and a few industrial property sales. We've also seen pure cash repayments from a sponsor with significant cash reserves. Meanwhile, four projects were stopped by the sponsors, leading them to pay off the remaining small balances at closing. Historically, our average loan duration has varied, sometimes being longer or shorter than it is currently, but our trends now align with the current market environment. As George mentioned, securing a lower rate while locking in for an extended period is crucial, and overall, this is unfolding as we anticipated, allowing us to generate returns while these loans are on our balance sheet.

Great. Thanks for the color. And then just one follow-up on the credit side. You mentioned just now land loans and conversations around going vertical. Maybe just provide some commentary as to what you're seeing in the land portfolio and some of the updated conversations you're having with sponsors about their decision to go vertical?

Yeah, there's a mix there. We gave you some pretty good color, I think, on the land portfolio and the appraisal stats that we included in our comments in terms of we had, I think, four different land appraisals that were completed that showed stable to declining LTVs at the end of the day. And as we've noted in the past, a significant portion of our land portfolio is as, you said, initial shorter-term land loan with the thought that the sponsor once they have plans drawn up and costs sort of circled would move forward. And we are, as I said, seeing some of those move forward. But I also mentioned we had four that did not move forward. So we're still in a period where just like with refinances moving forward with a construction loan in today's rate environment, some of the economic uncertainty certainly makes one think two, three, and four times for moving forward, and we're seeing some of those decisions, say, what we're going to wait. The deal has just not got enough room in it for us to want to move forward. And at the same time, we're seeing a number that are going to move forward. And that's whether that's land loan situations that we have that move vertical or outside our portfolio. I think there's some, you can deduct some information from our thoughts about originations in Q4. So again, it depends on the market. It depends, it all comes down to the return that one can make and versus the cost that it takes to develop, and there's more room in certain markets and product types than there are in another. So it's a mixed bag there.

Great. Thanks for taking my questions.

And thank you. And one moment for our next question. And our next question comes from Catherine Mealor from KBW. Your line is now open.

Thanks, good morning.

Good morning.

I just wanted to switch over to the funding side of the conversation. Just ask about how you're thinking about funding growth as we look through '24, it's really nice CD growth. Of course, that's coming in at a higher cost. How do you think about kind of the, if let's say, Fed funds stay stable from where we are today, where do you think ultimately the blended kind of cost of funding peaks for you as you continue to reprice a 5%, 5.5% pace as you grow CDs?

Well, Catherine, I want to highlight that our team is performing exceptionally well in managing deposits, and we're seeing solid growth in this area. Like many banks, we're facing a trend where higher rates on CDs and other investment options are attracting funds away from non-interest-bearing accounts and lower interest accounts. We've had significant success in increasing our CD deposits, and we anticipate this will continue, although it will lead to some upward pressure on our deposit costs, as we've discussed since our April call last year. As the Federal Reserve raises rates, deposit costs will also rise. Given that CDs have staggered maturities, the effects of recent Fed rate hikes will be felt in about three to four quarters when those CDs come up for repricing. Thus, we are aware of this upward trend and have indicated that some of the impressive expansion we've seen in the last four or five quarters will begin to reverse. Our net interest margin and core spreads widened last quarter as loans reprice faster than deposits, but we expect to give back some of that improvement going forward. It's uncertain what the Fed's next steps will be, and they likely don’t have a clear direction either. However, deposit pricing is on the rise as we reprice CDs initially set at lower rates in the past few quarters. I'm confident our team is effectively funding our balance sheet in a cost-efficient manner, especially given our growth. We feel very positive about our progress, and I commend Cindy, Drew, and the rest of our deposit team, along with our retail branch staff, for their outstanding work.

You've been one of the few banks able to increase net interest income as your net interest margin has remained stable, coupled with significant growth. However, I expect that we may see a decline this year as the cost of deposits catches up with the industry. Nonetheless, we anticipate an inflection point in the coming quarters. Given the increased origination volume and robust growth, is it possible we could still achieve several more quarters of actual dollar net interest income growth?

It remains to be seen. In the last quarter's conference call, Tim and I mentioned that we expected to experience a decline in our net interest margin in the third quarter, which we would need to counterbalance with growth in average earning assets. It was a close competition in terms of whether we could achieve positive growth in net interest income. This quarter, we increased net interest income by about $10 million compared to the second quarter of this year, so the growth in assets outpaced the decrease in net interest margin. We achieved record net interest income. Moving forward, it will likely be uncertain on a quarter-to-quarter basis to determine which factor will dominate. We are striving to improve our margin as much as possible, while also pursuing growth that aligns with our quality and pricing standards. We hope to maintain this upward trajectory in future quarters, but I cannot predict the outcome at this time.

If you don't mind just one clarifying question on the credit comment earlier. On criticized and watch list loans, you did not see any change to that this quarter. Is that correct?

Tim, do you have that?

I don't have those specific numbers, Catherine, but no significant increase that we haven't already talked about. Obviously, in our management comments, we talked about the one loan at RESG, the hotel loan that did have a small charge-off of $3.7 million. That loan did go from performing to non-performing, but that was already a substandard loan. It was just substandard accrual going to substandard nonaccrual. So no other significant movement into risk rating classifications.

Okay. Great. Thanks for the clarification.

And thank you. And one moment for our next question. And our next question comes from Matt Olney from Stephens. Your line is now open.

Hey, thanks. Good morning. I want to ask more about loan floors within the RESG portfolio. I think on the past calls, you talked about the mix of residential loans is an important dynamic because the new originations have more significant level of loan floors than the older vintages. Any updated thoughts or color you can provide with respect to residential and loan floors?

Well, every quarter when we have older loans pay off, and we've talked about that volume. Those floors typically are much lower than the floors on newly originated loans. So our favored desired scenario is that the Fed is at or within a quarter of the end of their tightening cycle and that they stay at these rates for two years or longer. Because if the Fed does that, then we get a chance to recycle the vast majority of RESG loans from lower floors to higher floors which will be very helpful to us in a down rate environment. So every time we hear the market beginning to embrace the concept, the Fed's mantra of higher for longer is likely to be a reality. It brings a smile to my face because that's our best scenario for profitability.

Okay. Appreciate the commentary. And I guess, switching over to the capital. I guess with the growth this year, you've been able to deploy some of the excess capital. I think you estimated that CET1 ratio is around 10.7%. Would love to get some updated thoughts around capital thresholds and what's the lower band you'd be comfortable operating in, in the current environment. And I guess, specifically, would you be comfortable allowing that CET1 ratio to drop below 10%?

Matt, thanks for the question. Yeah. I mean as you noticed during the quarter, we had significant loan growth, and an ROA in excess of 2%, and that allowed us to capitalize the vast majority of that growth. We did have a small decline in CET1 ratio, but still feel like we have very strong levels of capital. We've seen a significant increase in unfunded over the past year, significant increase in funded that has used some of our capital through organic loan growth. But I don't see the pace of decline being the same pace that we've had over the past year. And would anticipate that our growth in earnings would help capitalize whatever growth we have on the balance sheet. So you've not seen us go below 10% in CET1. And so if we have a quarter or two of further declines and work our way back up over time, that would be generally my thought at this point.

And then, Tim, I guess, the second part of that would be around the stock buyback. Obviously, no activity in the third quarter, but I think we're now with these valuations where you were more active in the first part of the year. So any updated thoughts around the buyback from here? Thanks.

Yeah. I mean you saw in our comments, we are focused on loan growth, and we'll continue to be focused on our organic growth. We continue to deliver, for the last four quarters, we've had a return on tangible common equity of over 17%. Our tangible book value per share has increased year-over-year at 14.5%. So if you go back to 2021, 2022, 2023, I think we've done a really good job of managing our capital. In 2021, we took advantage of the low rates and issued a lot of really low-rate capital at that point over the coming years when we had slower growth, we used that capital to buy back our stock. I think we ended up buying back nearly 13% of our shares outstanding when we started the program. And then now this year, we've had a lot of great organic loan growth, and so we pulled back on the share repurchases. So I think we've managed the capital levels, the share repurchase just how we wanted to, and we've got good prospects for meaningful growth going forward and want to be focused on that as opposed to focus on share repurchases. However, we do expect sometime in 2024 still have another authorization when values of our stock are very compelling, we would continue to be active at the right price.

Yeah.

Okay. Thanks for taking my questions, guys.

And thank you. And one moment for our next question. And our next question comes from Brian Martin from Janney Montgomery Scott LLC. Your line is now open.

Hey, good morning.

Good morning.

Going back to the margin, George, you mentioned the dollars of NII and the outlook. In the past, after the Fed stops, the margin tends to hit its low point after about a quarter or two. Is that still your perspective on how things might unfold here, considering the pricing on new originations? Do you think the margin might bottom out in the next few quarters and then stabilize? Is that the correct way to view it?

Brian, what I would tell you in that regard, if we get just to a flat Fed environment, say, in '24 and there's no Fed moves either way, our CD issuance is laddered throughout every quarter when we issue new CDs, it's a very laddered book, but there's a small chunk in the seven-month time frame and a really big chunk in the 13-month time frame. So the 13-month CDs will basically mean that when the Fed is done, and market rates have stabilized, you'll still see that final tail of our deposit book repricing 13 months after the last Fed move. So it's really probably a four-quarter phenomenon to get to. If the Fed is stopped, it's probably four quarters of rising deposit cost to get to a point where deposit costs are stabilized and full effects are in there.

Got you. Okay. That makes sense. And then as far as where we exited on the cost of interest-bearing deposits for the month of September, would you have that or?

I don't have it, but I have someone here that probably has it. Cindy, do you have that?

Yes, I do. So September was 3.67% compared to 3.48% for the quarter.

Thanks, Cindy. I have a couple of questions regarding the expenses for the quarter. I noticed a decline and would like to hear your thoughts on the guidance for the full year. Given the decline this quarter, how do you view the investments you are making and what you've detailed in the management comments? Looking ahead to next year, should we anticipate a slowdown in net expense growth considering the investments made this year, while still expecting continued growth in those investments?

Tim, please.

Yeah, Brian, yeah, if you look through the expense lines, you would see some pretty significant increases in salary and benefits. You'd see significant increases in the FDIC insurance given the rate increase on that impacted the entire industry and then, of course, our growth in deposits, and then our advertising has certainly been elevated. So those have generated a bigger growth rate this year over year compared to what I would expect next year for thinking year-over-year. However, on expenses, what we focus on is how do we grow our bank, how do we invest in growing our bank, invest in our people. So we are super focused on expenses, but we're more focused on ways to grow our bank. And we try to do that in the most efficient way possible. But we've got good prospects for growth. George has talked about good prospects for adding new teams throughout the coming quarters. So that's really our focus. And, but on the rate of increase year-over-year, I don't expect '24 to be at the same rate of increase that we had in '23.

Got you.

And I would comment that the fact that third quarter noninterest expense was a few hundred thousand dollars below the second quarter. That's a countertrend anomaly I would expect, and Tim, you can comment on this. I would expect noninterest expense to generally go up every quarter going forward.

Yes. I would agree with that being an anomaly. We're growing.

Got you. Okay. I know if I saw that. And then how about just on the RESG front, kind of you talked about the payoffs still being somewhat muted here. I mean, is it likely that we see, I guess, some pickup next year? I mean talking about how long the loans are on the books and the payoff cycle, I mean should we expect the, some of the payoffs that don't occur this year to spill into next year? Is that the right way to be thinking about this?

Certainly, it's accurate to expect that some payoffs that would typically occur in a standard interest rate environment this year may instead take place next year or the following year. I anticipate a modest increase in payoff volume next year, but this will rely on market conditions and interest rates. Overall, I foresee a somewhat improving trend. However, I should clarify that referring to it as an improvement can be misleading; for those wanting payoffs, it represents progress, but for those benefiting from the substantial earnings generated from them, it isn't necessarily positive. Each payoff in this environment brings mixed emotions. It's encouraging to see people successfully transition to the secondary market or sell projects when desired, but we also dislike the loss of spread income. Both sides have their advantages and disadvantages.

Got you. Regarding RESG, the fundings have consistently increased each quarter this year due to strong originations in 2022. Is the current year-to-date funding level sustainable considering the record originations from last year and the ongoing funding? As we look ahead to 2024, we might not maintain the same pace as in the third quarter, but can we expect a similar blended level year-to-date?

The exceptional origination volume achieved by our RESG team in 2022 is driving significant fundings in 2023, and this trend will carry into 2024. I refer you to the cadence chart we have included in our management comments, which provides a visual representation of what has been funded from the 2022 portfolio and what is yet to be funded. As we have mentioned frequently, these loans typically fund mostly within one to two years after origination and are paid off three to four years post-origination.

Got you. Okay, thanks for taking the questions and the next quarter.

Thank you very much.

And thank you. And one moment for our next question. And our next question comes from Brody Preston from UBS. Your line is now open.

Hey, good morning, everyone.

Good morning.

I wanted to start maybe just a question for Cindy, just on the deposit costs. Have you guys had to increase your new offering rates at all during the quarter? And if so, could you kind of give us an indication as to how much?

Sure. We increased slightly during the quarter from our 13-month went from 5.50% to 5.60% and that was as a result of a little bit of movement in the competitive space.

And Brody, that is APY that you report to the customers, so the actual rate is probably more like went from like 5.30% something to 5.40% something, high 5.30s to 5.40s on the actual rate.

Thank you for that. I have a question for Tim. I would like to understand the loan yields better; the beta decreased significantly this quarter on a quarterly basis. What was the reason for that? Was it due to new production at lower yields, or do any of the RESGs have rate caps in effect during the quarter?

Some of the RESG loans include rate caps as part of their structure, with a third-party serving as the counterparty, which means we do not participate in that aspect. Therefore, we benefit from all rate increases, and our yields are not capped. I would need to check the SOFR changes from Q2 to Q3 to determine any impact, but generally, the increase was lower quarter-over-quarter compared to other quarters. There are no caps from an RESG standpoint, and we’ve noted that payout volume has been lower, which can sometimes lead to minimum interest. There are additional associated fees, and the results were likely at the lower end of the normal range while still remaining within that range, which may have had some influence.

I think the biggest factor is just the slowing rate of Federal Reserve rate increases. Our loan yields are variable rate, and they mostly adjust either daily or monthly. So as the Fed has slowed the rate of increases, the rate of increase in our loan yields has slowed proportionally.

Got it. I wanted to move back to RESG. I really appreciate you guys giving us the stats on the refis, on the pay downs and all that stuff. I want to ask, Brannon, did you take a look back as to how that compared to kind of year-to-date trends from prior periods? How that mix kind of looked between like straight payoffs versus third-party exits or anything like that?

Brody, I would be guessing if I told you that. The guess would be probably more refis, but I don't know what the pure mix was. We started paying a little bit more attention to that recently. I think we got a question last quarter, and we're all incredibly curious here. So we did have those stats ready for you, but I'd be stepping out there too far to tell you how much I think that's different. But I felt like roughly well over 50% of the payoffs coming from refi was a pretty positive result in today's world.

Got it. Can I ask you about the land loan in OREO? I'm sorry if someone already asked about it; I thought I didn't hear anyone mention it. It's the big one in there, and I believe you have it under a sale process. I understand you need to be careful with that process from a confidentiality standpoint, but you mentioned it was subject to standard due diligence. Do you have an idea of how far along you are in the due diligence process at this point?

Yeah. Let me address that. We've got, at September 30, we had a total of six pieces of foreclosed real estate. They're in five different states, and we were very pleased to have gotten three of those, and it just so happened it was the three largest of those six under contract. So 99% of our OREO balances are under contract for sale. As you mentioned, Brody, all of those are subject to standard due diligence and closing conditions and requirements, as is always the case. Each of those three contracts would clear our book value. Each of them is scheduled to close sometime before March 31 of 2024, and we'll see what happens. Sometimes contracts close, sometimes they don't close. But typically, people don't go to the time trouble and legal expense to put them under contract unless they intend to close them. So we're very pleased about that. In fact, that all of them clear our book balance and it’s the vast majority of our OREO is a good thing. These contracts all have various provisions about confidentiality in them as is customer in these contracts. So we're going to limit our commentary on it to that general comment at this time.

Got it. I appreciate that detail. And then I did want to also ask just getting the quarterly appraisal data is very helpful. And I just kind of tried to quickly aggregate it last night. And I guess when I looked at it, it's about 50 projects that you reappraised year-to-date. At least that you've disclosed and that's like $4.7 billion. So either way you cut it, that's about like 14% to 15% of your commitments either from a number or a dollar perspective? Is that kind of normally what we should expect it to be on a pace to reappraise 20% per year?

Yeah. I mean it's going to depend on what loans are maturing and coming up for extension, either as-of-right extension because our as-of-right extension provisions usually have a loan-to-value requirement in them, or what are coming up for extension that don't have an as-of-right when we're going to get an appraisal. Or what's a loan that is getting some attention on our part that we feel like we need to reappraise. So there are a variety of reasons you get an extension or get an appraisal. But there's nothing unusual. Let me say it that way. There's nothing unusual about the volume. It's just the normal way we would do that. Now if you factor in the originations over the last 12 quarters, that's another 25% of the portfolio. So what that tells you is something 40% to 50% of the portfolio has a fresh appraisal within the last 12 months on it, which is probably pretty typical.

Got it. Okay. I appreciate that. Suffice to say, though, based on the stats we can see, George, it's about 15% has been reappraised so far on our end and the average change in the loan-to-value is a little less than 3%?

Yeah. And again, I would point out that that average change of 3% is after substantial paydown. We get an appraisal if the loan-to-value is materially different than what it was at origination or doesn't meet the as-of-right extension requirements. Our sponsors in many cases are coming to the table with paydowns on those loans to reduce them back in line with our extension criteria requirements. So the 3% is a really good number, but it's a result of appraisals plus paydowns and that are reducing those balances to a lower loan-to-value.

Got it. And then the last question for me is about the significant shift in the interest rate environment that everyone is aware of. Given that 2021 was a major origination year with rates still at zero, how did you approach the assumption of cap rates? Can you share any insights on the assumed exit cap rate when you underwrote these projects and how you stressed that in your analysis? Also, how does that compare to the current environment today?

We focus on debt service coverage, looking at increments of 100 basis points, increasing up to 500 basis points based on our loan and the project's projected performance. We align our expectations with the sponsors' projections, examining various scenarios from 100 to 500 basis points. Additionally, we assess exit refinance market conditions and current secondary market rates for similar increments. We also evaluate cap rates for the property type, applying stress scenarios of 100 to 500 basis points. Our approach accounts for significant interest rate stress, particularly with the Fed raising the target rate by 525 basis points from its previous low. This methodology has proven to be effective and suitable for the current market conditions. If a project doesn’t pass our stress tests, we adjust the leverage to make it viable, which explains our high equity position and low leverage in our projects, reflecting the market risk we account for, including interest rate risk. Interestingly, while cap rates have increased, certain property types like apartments, industrial, and life sciences haven't risen at the same rate as the Fed's increases. The changes in cap rates during the Fed's 525 basis point hike have been less than that amount. It will be intriguing to see if cap rates will align more closely with the Fed's actions in the future. This will largely depend on whether we remain in an environment with a Fed funds target rate between 5.25% and 5.5%, and whether long-term rates will adjust to the high 4s or low 5s range. If that situation persists for a couple of years, we might see cap rates catching up. However, for now, cap rates appear to reflect a sentiment that future rates may drop, which is providing some support to property valuations.

George, what do you just say about the cap rates? You said you stress them up 300, 400 basis points. Does that mean that even in that scenario, when you underwrite that loan when you stress the cap rates to that degree, does the loan still perform and pay off when you kind of get to that left tail type event?

Yes. On the cap rate stress, as best I can remember, I don't think we have closed a loan that wouldn't tolerate 500 basis points cap rate stress and still cover our loan. There may have been a handful of exceptions to that in the 300-something loans in the RESG portfolio. But the vast majority of them can tolerate that kind of stress on the cap rates.

Got it. I appreciate that. I lied. I'll sneak in one more. Do you have to know what the reserve on the office portfolio is at this point?

No. Nobody here knows that broken out specifically.

Got it. Awesome. Well, thank you very much for taking my questions, everyone. I appreciate it. Have a great rest of the day.

And thank you. And at this time, I see no further questions. I'll turn the call back over to Chairman and CEO, George Gleason for closing remarks.

All right. Thank you, guys. We appreciate you joining the call. Thanks for the good questions. We look forward to talking with you in about 90 days. Have a great rest of the quarter. Thank you.

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