Good day, and thank you for standing by. Welcome to the Bank OZK First Quarter 2024 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 recorded. I would now like to hand the conference over to your speaker today, Jay Staley, Director of Investor Relations and Corporate Development. Please go ahead.

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; Cindy Wolfe, Chief Operating Officer. We will now open up the lines for your questions. Let me now ask our operator, Abigail, to remind our listeners how to queue in for questions.

Thank you. At this time, we will conduct the question-and-answer session. One moment for our first question. Our first question comes from the line of Stephen Scouten with Piper Sandler. Please proceed with your question.

Yes. Thanks everyone. Appreciate the time. Great quarter here again. I really appreciate the addition of Figure 30 in the management comments showing the loan floors and how that helps protect the NIM. I'm curious if you guys have done any sort of sensitivity around that to kind of frame up the magnitude of potential change that could happen there on a quarterly or yearly basis as we continue to be in this higher for longer environment and you add new loans. I mean you talked a lot about that, but I'm wondering if there's a way to frame up the magnitude of benefit moving forward.

Stephen, we don't disclose anything on that, but our regular ALCO runs provide that information to management. We feel very good about our position there. Obviously, as we stated in the management comments, higher for longer at current rates is an excellent scenario for us. It gives us time to reset that floor. It also keeps repayments at a fairly muted level, both of which are very helpful for our net interest income perspective. Obviously, as we also noted, higher for longer is hard on some of our borrowers. So we believe any incremental credit costs are far outweighed in that flat-rate scenario by the additional net interest income that we earn. So we view that as a net positive for higher for longer. Obviously, we are pleased that expectations for cutting rates seem to be getting reduced a little. We view that as a scenario that will be constructive for us at a later date when we've had more opportunities to reset floors. We would just assume the Fed stay where they are and cut rates mid to late next year if they do cut rates. If the tail risk of higher rates comes into play, that would be very beneficial for our net interest margin, but that incremental benefit would probably be offset by the higher provision expense that our models would roll out. So hopefully, that's helpful to you.

It is very helpful. As I examine Figure 17, which illustrates the different sizes of credit within RESG, it appears that especially this quarter, but actually over the past few quarters, the new additions have predominantly come from the lower end of that range, particularly in the $0 to $125 million segment. I'm interested to know if this is a deliberate strategy to concentrate on smaller, more detailed credit functions or if there's another reason behind it.

We're still open to any good piece of business of any size. I think it reflects that equity is finding probably more opportunities to put together deals that make sense to them, and hence, we're seeing requests for loans toward that smaller segment. There are some larger transactions in the pipeline that may or may not close at some point in time. But yes, the deal sizes we're seeing from the sponsors are probably leaning a little smaller than what we have in the past, reflecting what makes sense in the economy for the sponsors today.

Got it. And then lastly for me, we’re seeing a lot of negative headlines around office. You guys are pretty well insulated from a loan-to-cost perspective and the newness of your projects. I'm wondering if you could speak to the dynamic you're seeing from a capital supply perspective, similar to what you guys were able to do in the Great Financial Crisis, where if a loan had issues, other mezz providers or sponsors were able to step in. Are you seeing overall strength in terms of willingness to step in on distressed products and overall capital in the system?

Sure. Your question is focused on our existing portfolio, but the dynamics on the new side of the product are significant as well. There are a lot fewer new projects going up across several property types; returns are much harder for equity, leading to fewer deals coming to market. However, a strong data proposition exists for products built in 2015 and later, as they have better prospects for capital flows. The quality of the projects significantly enhances the likelihood that you'll see supportive capital for existing products in our portfolio. We've had a number of situations over the last year where that has been evident. Expect more situations like that over the next 12 to 24 months, though it's dependent on project quality and experienced sponsorship.

Fantastic. Great color. Appreciate the time, guys, and great to see the continued NII growth. Well done.

Thank you.

One moment for our next question. Our next question comes from Catherine Mealor with KBW. Please proceed with your question.

Thanks. Good morning. I want to just get a little bit of color on extensions. I know we talked about that last quarter and you're continuing to see clients ask for short-term extensions as we wait for rates to be cut. In a higher for longer scenario, what's your gut on how that trend continues and what that could do to the size of your balance sheet? Is there any way to quantify the size of your portfolio that you've seen take some kind of extension or modification over the past few quarters?

Catherine, we have all that data, but I don't have it on my fingertips, and we haven't disclosed it. I would tell you, it's a business as usual sort of situation. I think we probably commented last quarter that on extensions, we are typically maintaining or even improving the economics. Our fees are what they would normally be for a bright extension, or higher; we're trying to reset floors and getting that done in the vast majority of those extensions, and improving the capital structure and reserves. We haven't done any extension yet that in the past would have been considered a TDR. These have all been flat to improved economics for us as these have extended. So we think there's a very constructive environment for this, with most of our sponsors stepping up and supporting their projects until interest rates get to a better place.

Great, and then maybe a question on the margin, if I could. Can you quantify the incremental cost of new deposits that were added this quarter? And how close we might be to a peak in deposit rates? It feels like there’s still a lot of growth coming in CDs, and there's a thought that your deposit costs might peak a few quarters later than some of your peers. Just curious how close we are to that gap closing as we reach peak deposit rates?

Yes. Our incremental cost of deposits in Q1 was less than in Q4. Expectations at the beginning of the year indicated rates would cut leading to lower deposit pricing. The balance has somewhat stabilized from where we saw it in January to where it was in Q4. We have said, for many quarters, that we expect continued escalation in pricing for several quarters post the last Fed increase. We’re nearing the point where we've got a couple of quarters before our CDs roll over from lower rates to higher rates, but that rate of change will be at a decreasing rate.

Great. That makes sense. Thank you.

One moment for our next question. Our next question comes from Matt Olney with Stephens. Please proceed with your question.

Hey, great. Thanks, guys. The management commentary references that in 2025 and 2026, we could see higher levels of RESG repayments, which makes sense given higher rates now and expectations for lower rates eventually. I'm trying to appreciate the level of RESG loans that are currently eligible to be repaid but have not yet been paid down. Is the best way to think about that just looking at Figure 12 and looking at the RESG loans with a vintage in 2020 or earlier and just assuming those are currently eligible and awaiting lower rates?

Age is probably a key indicator there, so that's a reasonable way to look at it, Matt.

Okay. And if we see those paydowns for RESG over the next few years, management commentary mentioned increased diversification in the next few years. I'm curious how you think about loan mix longer term. RESG is now 65% of the non-purchased loans. Some investors believe that RESG is the best in the business in that niche, but think it shouldn't be such a dominant part of a bank. How do you view RESG in terms of a longer-term portfolio portion?

We've said many times we agree that RESG is the best in the business. We have built an excellent team and business model at the Real Estate Specialties Group that generates excellent returns with below-average risk. Our strategic plan includes maintaining RESG's growth while adhering to its stringent credit quality. Our company’s value increases with diversification, allowing for sustainable revenue growth that is not overly reliant on any one area. I would like to see RESG grow to represent 50% of our business. We’re focusing on growing other lines to ensure that collectively they equal or exceed RESG, which will be a multi-year process but is essential.

Thank you.

Thanks for the question.

One moment for our next question. Our next question comes from Michael Rose with Raymond James. Please proceed with your question.

Hey, good morning guys. Thanks for taking my question. Nice step down in expenses this quarter. I know you reiterated the kind of mid-single digit growth outlook. Can you just size the opportunity for you guys and maybe what the expectations are for additions and how we should expect that to impact the run rate as we move through the year? I’m trying to get a sense of the cadence of how opportunistic you'll be?

We're going to be very opportunistic and already have been. Tim, through last quarter, we hired around 40 net new people. Over the last four quarters, we've added between 110 and 120 net new people. I wouldn’t be surprised to see us adding around 40 people or so each quarter going forward. Many banks have pulled back, and there's real talent out there to be acquired. We see value in adding those team members. In the short run, it may mute our ability to increase EPS and net income because these new hires may not produce revenue for several quarters. However, talent is essential for our long-term success. We're very focused on this and see many opportunities.

So George, are the additions going to be across the business lines, or will it be focused on more of the branch and community type lending personnel?

It's really across all business lines. For example, the corporate and institutional banking group that we're building under Brannon will involve asset-based lending, equipment finance, capital solutions, and fund finance. We're adding leadership talent from larger banks dedicated to credit quality and profitability, which aligns with our goals. We're also looking to add business bankers in the retail team and expand our branches. Our consumer banking efforts are ramping up, especially with recent mortgage applications we've started taking. We're doing what we need to do to grow safely and profitably moving forward.

That's helpful. And just to follow up, I saw that you guys are not going to be doing buybacks at this point. It sounds like the efforts are focused on growing your businesses. Anything else we should consider in terms of why the Board decided not to have a buyback in place, given the stock's trading position?

Hi, Michael, yes, you saw our comments there. We're primarily focused on organic growth this year. So we don’t have any plans for stock buybacks given the growth we had last year and the expectations we have for growth this year. We'll ask our Board in the future when we're ready, but there's no reason to have a buyback if we don't plan to use it.

Great. Would you say that you're more confident in the ability to grow EPS and PPNR or NII this year at a record rate, than you were back in January, just given the strong first quarter?

Michael, we're going to invest some money, and there are a lot of uncertainties about the economy. I would take a cautious outlook on that. The guidance we gave in our January call was that we expected our EPS and net income for the full year of 2024 to set records over 2023. We had records every year in 2023, coming off a strong Q4 2022. Starting out this year solid is encouraging. We're continuing our hard work and have confidence in our full-year guidance for 2024, although it may not be linear.

Great. Thanks for taking my questions.

Thank you.

One moment for our next question. Our next question comes from Manan Gosalia with Morgan Stanley. Please proceed with your question.

Hey, good morning.

Good morning.

I appreciate the new disclosure on the loan floors. I think you might have mentioned this, but those floors should keep migrating higher in a higher for longer rate environment. Is that correct?

Yes, definitely.

Okay. And how do you think about the dynamic between capital market exits in these loan floors as we move through the next couple of years? Would some of these loans exit rather than remain on their floors?

Brannon, do you want to answer Manan's question?

Certainly. Our borrowers prefer lower interest rates; however, the decision to exit a loan depends on various factors such as where the project is in its construction or lease-up phase and where they think rates will go. Our construction loans have minimum interest requirements, meaning borrowers will be less inclined to exit early unless there’s a compelling reason to do so. Those fully completed projects may efficiently move to permanent financing once they complete their minimum interest requirements.

Manan, let me add some detail on that, and Brannon can agree or disagree. Our construction loans may find it difficult to transition mid-construction, with variations depending on state regulations. Additionally, our loans require borrowers to pay a minimum interest amount. Thus, even if rates peak, many loans will remain on our books until the minimum interest has been met unless an extraordinarily compelling reason to exit early arises. For fully completed projects that have met their minimum interest requirements, they are more vulnerable to refinancing when rates drop below market rates. This transition for these loans is expected. Lastly, we have seen beneficial pricing for the minimum interest, ensuring we achieve a floor return on our capital allocation.

Indeed, we have successfully improved the floors, along with the minimum interest calculations. So it's crucial to mention that this is a well-managed aspect of our portfolio.

For those unfamiliar, the minimum interest is not designed to be punitive; rather, it helps ensure returns on capital allocation, given our typical loan structure.

That's very helpful. Thank you for the thorough answers. Pivoting, you mentioned that distressed transactions are starting to pick up. What do you believe will drive that number higher moving forward?

Let me clarify that the distressed transactions we're discussing are not within our portfolio but rather observed across the market. Brannon, can you provide additional insight on potential triggers that would increase the ratio of capital entering the distressed realm?

Certainly, it’s a nuanced issue. In the multifamily segment, market dynamics have to align for stronger activity. There’s a good prospect for capital to flow into sub-markets that evidence quick adjustments in cap rates—much more so than in office spaces. Interest rates played a significant role in deterring leveraged investments, particularly where institutions are hesitant to expand portfolios in distressed product types. A great deal remains to be seen regarding occupancies in older buildings, which many investors are watching closely. With much capital raised—while currently waiting—interest rate certainty and market clarity for office products will drive stronger engagement in the near term.

That's great. Thank you.

One moment for our next question. Our next question comes from Timur Braziler with Wells Fargo. Please proceed with your questions.

Hi, good morning.

Good morning.

Looking at the deposit trends in a higher for longer environment. I know you guys were able to bring down some deposit pricing in January. It sounds like half of that was brought back just with the current higher for longer environment. Regarding net interest margin and the linked quarter decline there at a decelerating pace, can we see NIM compressed at a decelerating pace going forward, or might the deposit dynamics, push margin compression to accelerate?

If we stay in a higher for longer environment at current rates, assuming the tail risk of Fed rate increases don't materialize and cuts don't happen near-term, we anticipate a relatively flat cost of interest-bearing deposits a couple of quarters out.

Got it. And then maybe on the way down, if rates drop, will the ability to reprice time deposits lower be formulaic, or will there be unique factors affecting this?

Formulaic is a good way to describe it. We’ve begun gradually rolling over maturing deposits, with expectations picking up in May and June. Our retention rates on maturing CDs have been better than anticipated, making that process more predictable.

Great. Thanks. Regarding substandard credits, the Seattle office that was newly mentioned this quarter, was it one of those loans from last quarter? And can you give broader expectations on your exposure in the Pacific Northwest?

Yes. The Seattle office we downgraded to substandard was indeed one we mentioned previously. That market has seen certain areas more challenged than others. While the work-from-home trend has affected the entire office sector, we've been cautious in our involvement in that region, focusing on areas with positive trends.

Okay, great. And lastly, any update on the Chicagoland loan, which has been extended to October? How would you handicap that being resolved in advance of that date?

We have made considerable progress on those specific assets. The team continues to explore options and is showing commitment by putting up $8 million to engage potential partners. While it’s too early to guarantee success, we view it as a positive indication of their seriousness. We see it as an opportunity for growth, as well as a sign of commitment.

One moment for our next question. Our next question comes from Ben Gerlinger with Citi. Please proceed with your question.

Hey, good morning everyone.

Good morning, Ben.

Most of the questions I was thinking have been addressed to some extent. But from your guidance and considering the pace of growth this year, is the strong deposit growth this quarter a leading indicator that Q2 could also be strong, or did Q1 perhaps pull forward some loan growth?

I don't think we can comment on a rushing change of quarters. We've indicated that the results of our performance can vary quite a bit from quarter to quarter. With deposits, we see aspects being steadier on a more linear basis, while origination and pay-off activities could swing. We expect stability in deposit growth.

Got you. And regarding the ratios on your balance sheet, do you have targets for your loan-to-deposit ratio from a high-level perspective?

Historically, we've maintained a loan-to-deposit ratio in the low to mid-90%. We don't anticipate a significant change in that balance. We project out funding needs and adjust deposit-gathering initiatives accordingly.

One moment for our next question. Our next question comes from Brian Martin with Janney Montgomery Scott. Please proceed with your question.

Hey, good morning guys. Just any commentary on the headcount that you've added? Are these new teams, or is it more of an addition to existing businesses?

We've not lifted entire teams out; these have been individual hires. We've brought in some great talent that aligns with our corporate philosophy. We've begun structuring the mortgage business, having started taking originations recently. We're strategically focusing on growing our team with high-quality individuals.

I appreciate that. And regarding the reserve build, how do you foresee reserve levels here, given the heavy lifting you've already done?

As mentioned, higher rates put pressure on borrowers, which impacts provisioning. If rates decrease, we would anticipate a lower level of provision. Capital levels will remain stable, supported by strong earnings retention, with slight growth expected in our risk-based capital ratios as we progress through the year.

That's helpful. Thank you.

One moment for our next question. Our next question comes from Brandon King with Truist. Please proceed with your question.

Just one for me, following up on the commentary around getting to that 50% RESG mix for the total loan portfolio. Do you think you need M&A to get there?

No, I believe we can achieve it organically. M&A could potentially accelerate our growth, but it isn't a requirement.

Okay. That's all I had. Thank you.

Thank you.

One moment for our next question. Our next question comes from Samuel Varga with UBS. Please proceed with your question.

Good morning everyone.

Good morning.

Last quarter, you mentioned how the Fed fund cuts expectations made negotiating floors a bit more challenging. Since then, with that expectation shifting, has it become easier to negotiate higher floors?

It has not made it easier for negotiations. Customers generally feel we're at the peak of rates and are looking for relief; that makes negotiations difficult.

Understood. Thanks for that color. Regarding valuation adjustments you’ve seen, do you believe this is adequately baked into Moody’s scenarios, or could an allowance increase be necessary?

We've acquired scrutiny on our valuations, and our appraisal services push back any questionable assumptions. Our allocations are appropriate for the Moody models and based on several economic uncertainties on our customers. We've had a significant ACL increase since the Fed raised rates, aligning with the higher target rates.

Understood. Thank you for the thorough answers.

That concludes the question-and-answer session. At this time, I would like to turn the call back to Chairman and CEO, George Gleason for closing remarks.

Thank you so much for joining the call. We look forward to talking with you and providing an update in about 90 days. Have a great quarter. Thank you.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.