Earnings Call Transcript - OZK Q3 2025

Operator, Operator

Good day, and thank you for standing by. Welcome to the Bank OZK Third Quarter 2025 Earnings Conference Call. Please be advised that today's conference is being recorded. 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. Please go ahead.

Jay Staley, Managing Director of Investor Relations and Corporate Development

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. 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 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 Jake Munn, President, Corporate and Institutional Banking. 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.

Operator, Operator

Our first question comes from Stephen Scouten from Piper Sandler.

Stephen Scouten, Analyst

So George, you and Brannon and your whole team obviously know these real estate markets better than any of us. I'm wondering from the heightened fear peak of like 2023 to today, if you could give some commentary on how 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, the attractiveness of each of those, how they're trending? And additionally, maybe on these 2 new loans that moved to substandard, how we can think about when the ACL 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. So just kind of understanding some of the puts and takes as those loans migrate.

George Gleason, Chairman and CEO

Let me address the last part of your question and then I'll hand it over to Brannon for broader insights on what we are observing. We had three loans transition from substandard to substandard nonaccrual, one of which incurred a significant charge-off that highlighted our exposure. We already set aside a substantial reserve for it in the prior quarter, but it still resulted in a charge-off. This illustrates when a reserve on a loan turns into a charge-off, which occurs when it becomes clear that we are moving forward with a liquidation or another resolution, rather than treating it as an ongoing loan. Regarding the Chicago project, when we moved it from special mention to substandard nonaccrual, we recognized the charge-off and adjusted its value to what we view as a liquidation amount for that asset. The third asset you mentioned was also moved from special mention to substandard, and we've placed a significant reserve on that one, reflecting a broad range of possible outcomes. The sponsors are actively pursuing a promising lease opportunity and possibly others that I am not aware of, but they do have one solid lease prospect that is well along in the process. They are also looking into ways to recapitalize that project and move forward. I expect we will have more clarity on this by the end of the next quarter or into Q1. Having gone through some of the analyst responses to our latest release, it seems there is a general consensus that our asset quality is mixed. I would agree that this is a fair assessment. We did see those three migrations along with a few charge-offs, but none were unexpected as they were all classified as substandard or special mention. On the positive side, we successfully sold our largest foreclosed asset, Lincoln Yards land in Chicago, at the book value it was recorded at. This was a significant success. Additionally, our second and third largest other real estate owned (OREO) assets as of June 30 are now under contract, with expected closings this quarter, and we anticipate neutral to positive gains on sale if those close, although we can never be completely certain until they do. Overall, I believe we are effectively managing the resolution of credits that come into the foreclosed asset category, which is encouraging. Furthermore, our combined total of special mention, substandard, and foreclosed assets actually decreased slightly during the quarter, indicating stable asset quality from that perspective. On page 29 of our management comments, we have consistently emphasized the importance of sponsor support since the onset of the COVID-19 pandemic. This quarter, we experienced exceptional sponsor support with 41 loans reaching maturity that were extended and modified, resulting in nearly $70 million of additional reserves being posted. We collected $13.5 million in fees and saw over $80 million in unscheduled loan paydowns, along with $14 million in curtailed unfunded balances. Some of these figures are among the highest we've recorded in the last 13 quarters. While we did witness three loans migrating in terms of risk rating, which is always less than ideal, they had been identified as credits previously. We also had several strong examples of sponsor support through our modifications and extensions. Lastly, I’d like to note the significant liquidity entering the commercial real estate space, evidenced by the record level of RESG paydowns this past quarter. We have anticipated elevated levels of RESG paydowns for several quarters now, and this latest quarter reached a new peak. This trend reflects an increased willingness among sponsors to explore refinance options. That encapsulates my perspective on credit quality, and I’ll let Brannon share what he's observing at the ground level regarding project trends.

Brannon Hamblen, President

Thank you, George, and Stephen, for the question. Generally, what George described shows ongoing improvement in real estate markets. Our main focus is on residential real estate, specifically multifamily units and condos, which have been performing very well. Regarding office and industrial spaces, we are pleased to see continued leasing activity in various projects across the country. In some markets, high-demand areas have filled their top-tier Class A office spaces. The trend of moving toward higher quality properties is evident everywhere. While it takes longer for office leases to transition compared to apartments, we are encouraged by the positive movement happening in several markets. In industrial real estate, leasing remains strong, and our appraisals reflect current market conditions, whether they indicate robust leasing or weaker activity. We are satisfied with our investment basis in projects that may not be leasing as quickly as others. The strength in office spaces is starting to positively affect the life science sector, where there is a lack of premium office options available for tenants. Life science sponsors, facing slower demand, are now open to courting traditional office tenants in their projects. While life science leasing has not reached the same level as office leasing, we are beginning to see an influence from office space dynamics in projects designated for life science. Overall, George's points represent signs of recovery in commercial real estate. We might be seeing a revival in the easing cycle that will alleviate some pressures on sponsors and real estate projects, impacting tenants and businesses. The capital markets are responding to these dynamics, with numerous loans being originated, many of which are aimed at our projects. This quarter's payoffs are a significant indication of these trends.

Stephen Scouten, Analyst

Yes. 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, it feels like you 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. And it seems like a lot of that is getting past the wall of these older vintage repayments in RESG. But just kind of if you could comment further on that, it sounds like mid-single-digit growth expected in '26, meaningfully more expected in '27. So I don't know if you can frame that up at all, but it feels like loan growth and fee income growth, you're both pretty bullish on as we get into '27. And just any additional commentary there would be great.

George Gleason, Chairman and CEO

Yes, Stephen, you accurately grasp our perspective on the future. Clearly, 2022 was a landmark year for RESG, with originations amounting to $13.8 billion. We've consistently shared that data in our management comments document, specifically on page 13, figure 13, which illustrates that journey. We've also informed our stakeholders that most of these loans operate on a 3- to 4-year lifecycle. Therefore, it's expected that we will see a notable increase in RESG payoffs in 2025, likely towards the end of that year. This trend was evident in the recent quarter as well. By 2026, as these loans approach their 3- to 4-year milestone, the payoffs will continue. We were aware, while celebrating the impressive originations of 2022, that we needed to prepare for significant challenges in 2025 and 2026. This understanding motivated our efforts to enhance our CIB group, diversifying and bolstering its origination capabilities to facilitate a seamless transition of growth from RESG during the anticipated payoff wave to another unit delivering comparable quality, such as the historically low net charge-off numbers we see in RESG. In hindsight, I would say that we might have benefited from launching CIB a year earlier. However, we initiated it when we had the right resources ready, and it’s working out well. I foresee the RESG repayment wave persisting through 2026, reflecting the natural payoff cycle from those 2022 originations. Naturally, there will also be some older and newer loans paying off next year, with a few of the 2022 loans pushing into 2027. Next year is poised to be significant for payoffs, if everything aligns as expected. Meanwhile, CIB is expanding, and we've substantially increased staffing there. I believe they will drive our growth for the coming year. We also anticipate continued growth in our high-quality indirect marine and RV business, along with our commercial banking sector. With the anticipated RESG payoff wave, we project a mid-single-digit loan growth rate for next year. Once the payoff wave settles and RESG starts contributing positively to growth instead of managing payoffs, we expect all our growth drivers to play essential roles. This will lead us to a well-rounded growth trajectory in 2027 and beyond. At that stage, we envision a more balanced portfolio with significant contributions from RESG, CIB, and the commercial banking indirect segment, each playing a substantial role. This diversification will enhance asset quality, reduce concentration risk affecting our valuation, and foster growth. We feel optimistic and believe we've set ourselves up effectively for future growth. We anticipate a mid-single-digit growth rate in the upcoming year, which many banks would consider a positive outcome. We're feeling confident about our position.

Stephen Scouten, Analyst

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. Is that right on how that accounting would generally work at a high level?

George Gleason, Chairman and CEO

Yes. And the CIB guys are very cognizant of that. And they're focused on opportunities that not only meet our high asset quality and returns but also have high utilization rates because we're very sensitive from our history with RESG where we've 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. 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. So they are actually working to weed out some of our older legacy business in those books that has a very low utilization rate in preference to new business that's very high-quality new business, but it's going to have a higher utilization rate and less unfunded. So we're focused on that as part of the strategy.

Brannon Hamblen, President

Yes. And George, to piggyback off of that, 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. 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. 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. 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. 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.

Operator, Operator

Our next question comes from the line of Manan Gosalia from Morgan Stanley.

Manan Gosalia, Analyst

So I appreciate all the comments on the credit for the RESG side. Can you talk a little bit about the CIB side, maybe what you're hearing, what you're seeing in the portfolio, especially given the recent headlines in the asset-backed lending, corporate banking, sponsor finance, fund finance portfolios. Can you just talk a little bit about what you're seeing there?

George Gleason, Chairman and CEO

Jake, do you want to take that?

Jake Munn, President, Corporate and Institutional Banking

Sure. Good morning, Manan. It's great to hear from you. In terms of quarter-over-quarter results, we achieved record origination growth for CIB, launching nearly 24 new relationships and upsizing about six. This is very encouraging. Management comments will reflect some impacts on our overall net figures due to strategic realignments and the active capital markets this quarter, where we set records for bond and high-yield issuances. This situation has slightly affected our outstanding growth, but on the positive side, through our loan syndications and Corporate Services group, we've started to see additional fee income from our capital markets initiatives, which is exciting. Overall, we had a successful quarter for CIB. The ABLG group led the charge alongside CBSF and our new Natural Resources Group. Additionally, our fund finance and lender finance groups also made significant contributions. We're pleased with the ongoing diversification and consistent growth we are experiencing, along with the added fee income from our collaboration with CIB's LSCS. You mentioned the NDFI space and our lender finance group. We're focused on developing a wholesale banking infrastructure that emphasizes diversification. With the introduction of new business lines and upcoming initiatives that should complement our existing offerings, our exposure to lender finance will continue to decrease as a share of the overall portfolio. It's important to clarify that most of our NDFIs are in the lender finance group led by Jim Lyons, who is part of our experienced team that was formerly known as EFCS. We've sharpened our focus here, ensuring strong deep underwriting, compliance, oversight, and maintaining a credit-focused mindset in this area. Our approach differs from many in the market who have faced challenges recently. We prioritize single lender opportunities and select 2 bank club deals, allowing us tighter control and a thorough assessment of the underlying companies. We thoroughly vet each investment against the bank's risk assessment framework to ensure alignment with our standards. We also evaluate their policies and procedures to confirm proper loan monitoring, complemented by third-party examinations and appraisals to ensure the validity and valuation assumptions for our loans. Since entering this space in 2019, our loan portfolio has grown, but at a slower rate compared to other business lines. We remain committed to this segment, but it's worth noting that, over time, it will likely become less significant as we diversify into more C&I business lines. George, do you have anything to add?

George Gleason, Chairman and CEO

Yes. 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. And this goes back to our long-standing relationships with a lot of the debt funds that do commercial real estate lending. And we compete with those guys. A lot of times, if they win a unitranche deal, they'll bifurcate it into a senior mezz and we're the senior lender and they're the mezz, 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. 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. 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 mezz in the transaction. So that's a big chunk of our NDFI loans. We feel really good about that. It's business we've been doing for many years with an exemplary track record. And in CIB, we are looking at the portfolios of the lenders that we're leveraging. As Jake said, our attachment points are very low in those. It gives us a lot of comfort, 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 one of these situations was on there, and he said, frankly, we just need to do better underwriting. And 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 doing very diligent underwriting on these things. And Jake really emphasized that talking about a lot of our deals we're single lender or small group lenders so that we're able to really influence that and dig in there and look at the underlying portfolios in great detail. 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.

Paschall Hamblen, President

Yes. And George, to build on that, it's important to highlight the NDFI opportunities, especially when examining our lender finance book. For example, we can consider BDCs and how they assess their investments, particularly regarding concentration risk, making sure that most of their loans are senior secured and properly structured. We also evaluate the industries they focus on. In previous earnings calls, we noted that CIB acknowledges there are certain industries currently facing higher risks or intense competition, which has led some to stretch their loan structures, making us somewhat uncomfortable. We observe this in the consumer, auto, health care, venture capital, and tech sectors. Many BDCs and other entities we categorize as NDFIs are targeting these areas, which is fine if that's their choice. However, similar to how we approach direct loans at Bank OZK, when lending to an NDFI, we assess the industries they are investing in to ensure alignment with our overall credit philosophy.

George Gleason, Chairman and CEO

Yes. And that conservatism and thorough underwriting is evident in our pull-through rates. Jake, what are we running now kind of pull-through rate.

Jake Munn, President, Corporate and Institutional Banking

Great point, George. We're still sub-15%. Yes. So when we look at that quarter-over-quarter, we're still being very selective on the opportunities that we're pursuing. 85% of the deals that come across our desk we're passing on primarily from a credit structuring standpoint, from a yield standpoint, the market has gotten very competitive, and we've said that quarter-over-quarter. And we're choosing to pick the spaces, pick the markets that make sense to us, 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.

George Gleason, Chairman and CEO

Yes, we are looking for Corporate and Investment Banking to account for 30% to 40% of our loan book over the next several years. Even if it represents just 3% or 4%, we will be paying close attention to it. We anticipate that it will become a significant part of our loan portfolio, and we expect it to be competitive with our Real Estate Services Group in terms of volume. We are committed to doing this correctly.

Operator, Operator

Our next question comes from the line of Matt Olney from Stephens.

Matt Olney, Analyst

I wanted to switch gears a little bit, and I appreciate the commentary around the margin and the guidance for the NII in the fourth quarter. Very helpful, and that all makes sense. Just want to understand your expectations of when that margin could stabilize. If we go back a year ago, 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 1Q and then stabilized in 2Q of this year. So call it a quarter or two lag after the Fed paused, we saw the NIM stabilize. So just looking for any color on when you expect the margin to stabilize as it relates to Fed cuts.

George Gleason, Chairman and CEO

Yes, I'm happy to address that. If Cindy were here today, she would tell you that our main interest-bearing deposit product is a 7-month CD special. We have other maturities, but over 80% of our CD issuance is in that 7-month timeframe right now. Our variable rate loans usually reprice around the time of a Fed cut, with those CDs repricing about 7 months later. This is a good example of why there's roughly a 2-quarter lag. You might see a slight compression in spread for a couple of quarters after a Fed cut until the deposit pricing adjusts. We expect to see this in the upcoming quarter with the September Fed cut and possibly one or two more cuts. Therefore, we'll be pursuing those loan yields for a couple of quarters while adjusting our deposit costs until the Fed stops, and then a couple of quarters after that, we should catch up. However, another important aspect is the floor rates on our variable rate loans. As of September 30, 22% of those loans were at their floor. If the Fed cuts another quarter, 36% will be at their floor, and if there's a 50 basis point cut, that will increase to 41%. As we reach those percentages, those floor rates significantly slow down or halt the repricing of a portion of our variable rate loans, allowing us to make up for that margin differential more quickly. Based on the current floors, I would estimate that it will take a couple of quarters of compressed margins following Fed cuts to catch up. However, if there are 3, 4, or 5 more Fed cuts, we'll start to see significant benefits and shorten that catch-up period, as many of those loans will no longer adjust downward.

Matt Olney, Analyst

Okay. That all makes sense. Appreciate the color there. And just to also go back and clarify a comment from a few minutes ago around 2026 and 2027. I think we all appreciate the RESG paydowns are going to be elevated in '26 and continued expense build-out next year as well. 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 the income growth could be more material. Is that a fair interpretation of your commentary?

George Gleason, Chairman and CEO

Yes, I think that's an accurate interpretation. We believe we can achieve record net interest income and record EPS next year. It will require a lot of effort, and the year-over-year gains might be relatively modest, similar to this year as we continue to build our infrastructure for the future and begin to absorb many of these payoffs. However, we are generating positive numbers year-over-year and expect to do the same next year, with the significant benefits of our investments anticipated to materialize in 2027 and beyond.

Operator, Operator

Our next question comes from the line of Catherine Mealor from KBW.

Catherine Mealor, Analyst

One follow-up to the margin question was about the floor impact and how it will limit the betas as we experience further cuts. Additionally, how do we account for the mix change with pricing at CIB yielding lower than the RESG book and its potential effect on loan yields in the next couple of years?

George Gleason, Chairman and CEO

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. We do get some fees and 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. So net-net, I think CIB's revenue-generating capability is not far off RESG's on a pound per pound basis. And 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. We will not have as much unfunded loan commitments on that portfolio and the diversification and elimination of our CRE concentration will let us be a little more judicious in our allocations of capital. So I think on an ROE basis, CIB will help us be actually improve our return on equity, even if on an ROA basis, there's a slight deterioration in ROA because I think it will allow us to be much more judicious in the use of our capital.

Jake Munn, President, Corporate and Institutional Banking

And Catherine, just to help there. As a reminder, 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 bond tips and other capital markets fees. 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. And so 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. And then as a reminder, too, in 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, they're 2-bank club or if they're syndications, we're the admin agent, we're leading deals now or we're the JLA, 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 and both a cross-sell standpoint and then also just an upfront fee and arranger fee, et cetera, standpoint. And 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.

George Gleason, Chairman and CEO

Yes. And the one item that Jake and I both neglected to mention that's really super important is our deposit opportunities for noninterest deposits, noninterest-bearing deposits or low interest-bearing deposits, low-cost deposits through CIB is really an important part of the return on equity equation on that book of business. 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 CIB type of book. So that's a big part of the equation as well.

Catherine Mealor, Analyst

Okay, that's great. My follow-up is that there has been a lot of movement in credit, and I agree it was a mixed quarter regarding credit. However, it was reassuring to see that the overall level of credits remained basically unchanged. Some credits came in, and some went out, but the total level stayed steady. So, the big question is, what might still be left to bring into special mention in your portfolio? Can you provide some insight into any migrations within your past credits? Are you observing stabilization there, or is there anything specific you are monitoring? Additionally, how should we view the potential impact of lower rates on the health of your RESG book and the inflow into special mention, considering that lower rates might improve the creditworthiness of some of those projects?

George Gleason, Chairman and CEO

Yes, that's an important question. The RESG portfolio primarily consists of variable rate loans, many of which have floor rates that we haven't reached on several loans. As a result, many of our sponsors stand to gain from any further rate cuts by the Federal Reserve. A lower interest rate environment also opens up more opportunities for these sponsors to secure permanent loans or bridge financing at more favorable terms. Consequently, Fed rate cuts could slightly accelerate the repayment rate of RESG loans, which is advantageous for our loan quality and beneficial for our clients. However, it might not be as positive for the repayment aspect. Ultimately, all these loans will be repaid eventually, so we welcome the opportunity for our customers to achieve a successful exit if the market conditions are favorable. In terms of what we monitor, our team actively reviews every loan in our portfolio daily. This diligent oversight is fundamental to the success we've enjoyed throughout our company’s history and over the 28 years since going public, during which we've consistently outperformed the industry's charge-off ratios. We're committed to effectively managing our loans. Regarding indicators of potential migration to problematic loans, we look at declines in value, unfavorable market conditions, and leasing issues. These factors are summarized in our management comments, especially related to sponsor support. The key question is whether our sponsors will continue to back their projects until they can lease or sell them. We maintained that when the COVID pandemic began, we believed most sponsors would persist in supporting their projects until conditions normalized. We've reiterated this expectation every quarter since the Fed raised interest rates 13 quarters ago. There are some exceptions, as fatigue and the availability of resources can limit sponsors' capabilities to support projects over extended periods. While we've observed a few such cases, they remain limited. When this occurs, these loans may be categorized as special mention or substandard, potentially moving into the OREO book for liquidation. Nonetheless, we continue to anticipate that the vast majority of our sponsors will remain committed to their projects until they reach a successful conclusion, given their strong sponsorship, quality assets, and significant investments in these projects. Some may eventually tire in their ability to support, but we are prepared for various potential scenarios in this area.

Paschall Hamblen, President

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

George Gleason, Chairman and CEO

Brannon, do you want to talk about life science?

Brannon Hamblen, President

Yes, Catherine, it's good to speak with you. I mentioned earlier that the industry has experienced a lot of product delivered but less demand for its space. There are still challenges ahead, and some projects will need more time to reach their goals. However, we are noticing a shift in how that space is intended to be used. As we've stated repeatedly, it definitely has the flexibility to accommodate a typical office user. With the improvement in demand for office space, we are seeing increasing interest in life science space from typical office users. This is one of the positive developments we're observing in that area. Things might not always go according to plan, but ultimately, the goal is to have a user in the space who is willing to pay rent. Our costs for these life science deals position us well to transition to an office use, in particular, which can be executed successfully. As you've consistently heard from us, we have secured substantial funding for these loans, and the cost to build out office tenant space is generally lower than that for life science tenants. Given these dynamics, while it would be ideal for all spaces to be filled with life science tenants, we are encouraged by the office market's demand, which is directing prospective tenants toward the high-quality assets that we have financed.

Operator, Operator

Our next question comes from the line of Janet Lee from TD Cowen.

Sun Young Lee, Analyst

I understand we will have more clarity in the fourth quarter and January, but regarding the Boston office loan that is now classified as substandard accruing, is it reasonable to expect that they will secure one-third of the building for that potential tenant? Is this expectation how your reserve for this loan is determined? Given the size of the loan, I would appreciate any additional insight on the likely outlook for this loan in your current situation.

George Gleason, Chairman and CEO

Yes. We certainly don't want to get ahead of our sponsor here in their negotiations. They are working hard on leasing. They're also evaluating how to recapitalize that project for a longer runway. 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, and we'll see how that plays out over the next couple of quarters.

Sun Young Lee, Analyst

Got it. Switching topics to loan origination, the third quarter showed one of the lowest levels. In your management commentary, you mentioned expectations for higher origination volumes in the fourth quarter and likely beyond. Can you clarify how the third quarter is an outlier and why we can expect improvements in the fourth quarter and afterwards, especially since you noted that RESG commitments are expected to decline, which appears to be driven by payoff activities? I would appreciate any insights you can provide.

George Gleason, Chairman and CEO

Yes. You are 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. You can never say that for sure. We'll be glad to put up another quarter of results and prove that. Hopefully, we will. What I can tell you is we've already originated in the first 2 weeks or so of the current quarter, about half the origination volume or a little more that we originated in the whole quarter last quarter. So those transactions, I think there are 3 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. 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. 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. 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. 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.

Operator, Operator

Our next question comes from the line of Brian Martin from Janney.

Brian Martin, Analyst

Most of my questions have been addressed. However, George, I have been switching between calls. Can you discuss the potential expansion of the CIB group? Are there additional teams, people, or verticals that you are considering adding? I would appreciate some insight into your thoughts on the growth outlook for this unit. Also, you've mentioned before the potential for fee income, given that it currently represents a small portion of revenue. Over time, where do you envision that fee income percentage in relation to total revenue as you move forward?

George Gleason, Chairman and CEO

Yes. We have a fantastic leadership team in our CIB group. It's not just Jake, but the whole leadership team working with him. They are effectively recruiting top-tier veteran talent and are being very deliberate about it while actively engaging in the market. Jake, I would like you to unmute and share more details on this.

Jake Munn, President, Corporate and Institutional Banking

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. I want to emphasize here in third quarter, we're looking at the management comments. You can see quarter-over-quarter, we're up $575 million in outstandings. If we were to look on a commitment basis, so that would be your outstandings plus your unfunded, we're up $1.19 billion. That's our net number. And I wanted to point that out again, from an origination standpoint, these teams are really starting to hit their stride across the board. Our natural resources group, led by George McKean, and Moni and Arth, that team has really taken off and putting together some nice opportunities for us. CBSF continues to grow. We have identified our leader out in Atlanta, John, and he's joined us, and he's building up our presence in that part of the country for us and our footprint. We've identified our leader and brought on within CBSF out in Nashville. He's got great experience and comes from a very large institution. We're excited to have him here, and we'll continue to build the team there as well. And so the CBSF and the diversification and 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. In addition to that, Mike Sheff's ABLG group has continued to expand. We just hired a gentleman up in New York, and we'll continue to focus on when we find the right people in the right spot that fit the OZK credit culture and overall culture. We're going to find those people. We're going to source them. We're going to bring them in and give them all the support they need to be successful, and we're seeing that in our ABLG group. Our lender finance group, as previously mentioned, led by Jim Lyons, is doing a fantastic job. 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 that we refused to give on. Our fund finance group, Parul and team is really doing a nice job and is going through that legacy book of business, as mentioned, and optimizing it. So we're proud of her and what she's doing and our portfolio management and operations group, which is really the backbone and more than 50% of our CIB staff continues to do a 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. If we look at the overall gross 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. And so again, some of that delta between the net and the gross 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 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, but that resulted in a little bit of a chip off of our overall growth for third quarter. As we look into fourth quarter, we're very cautiously optimistic. We feel nice about what we're doing. We have teams in place and executing at a high level. We had over a dozen names that were originated in third quarter that will be booked here really in October and then going into November, too. So we anticipate fourth quarter being strong as well. And we continue to look at opportunities for additional business lines, as you asked. That makes sense for what we do that are natural complementary kind of bolt-ons 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. I think you're going to see continued growth and momentum there, and we're very excited about it.

George Gleason, Chairman and CEO

Yes. Let me add that Jake is managing the expansion of his team based on a metric that Brannon and I are tracking. This metric focuses on volume and revenue generation. As his volume and revenue increase, he can hire additional team members. We are specifically bringing on very experienced and well-compensated senior individuals. This investment is costly, but it reflects the expertise and relationships they have developed over many years. We are taking a disciplined approach, ensuring we achieve positive leverage before adding more personnel. Jake is expanding the team responsibly, and we are focused on building a professional organization. We believe that by 2027, this team will be functioning at full capacity, and we will have increased staffing to create numerous growth opportunities across a diverse range of business segments. CIB is actively working on diversifying our portfolio, which is an added advantage.

Jake Munn, President, Corporate and Institutional Banking

Yes. Looking at CIB as a whole, it includes over 40 to 45 unique industries, demonstrating significant diversification within its structure and business lines. I want to highlight that as we hire, we adopt a different approach compared to our competitor banks. Many other banks enter a market by hiring 10 to 20 people, allowing them years to establish their book and repay for the initial hiring surge. In contrast, we take a methodical approach; before bringing on the next person, the existing team covers the costs. This strategy helps us keep a close eye on expenses and maintain an efficient ratio as we grow, ensuring we don't overextend ourselves.

Operator, Operator

At this time, I would now like to turn the conference back over to George Gleason, Chairman and CEO, for closing remarks.

George Gleason, Chairman and CEO

Thank you guys all for being on the call today. We greatly appreciate it. We look forward to talking with you in about 3 months. Thank you. Have a great day.

Operator, Operator

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