Earnings Call Transcript - OZK Q4 2025

Operator, Operator

Good day, and thank you for standing by. Welcome to Bank OZK Fourth Quarter and Full Year 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. 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; Cindy Wolfe, Chief Operating Officer; Tim Hicks, Chief Financial Officer; and Jake Munn, President, Corporate and Institutional Banking. We'll now open up the lines for your questions. Let me now ask our operator, Shannon, to remind our listeners how to queue in for questions.

Operator, Operator

Our first question comes from the line of Stephen Scouten with Piper Sandler.

Stephen Scouten, Analyst

I wanted to start with one kind of around the loan sale in the quarter and kind of your outlook on credit, net charge-offs and such. And maybe wondering what could lead you all to potentially lean further into the potential loan sales like you had on that one credit this quarter? And kind of given the commentary and the management comments around 2027 loss trends and a belief that those will improve, what gives you confidence to that end in that kind of positive outlook as we get beyond the CRE cycle?

George Gleason, Chairman and CEO

Yes. Great question. Thank you, Stephen. I appreciate it. Brannon, do you want to talk about the loan sale first, and then I'll take the second part of his question.

Brannon Hamblen, President

Absolutely, Stephen. Good morning. Great to have you, great to have the question. Appreciate it. Yes. We would be happy to say that contrary to some speculation that was out there, we sold that loan at par. We collected all our outstanding principal, all our accrued interest on the note sale, but I would reiterate what we said in our comments, Stephen, that the note sale does not reflect any change in our strategy. We've sold our ESG loans from time to time in the past in this particular case, and I would say that our note sales historically have been sort of one-off unique cases. In this case, there was an overlap between the project that secured that loan and multiple situations where the sponsor there and its equity partners were no longer willing to or able to support those projects. And that would include the large land development in Lincoln Yards that we sold in the third quarter, the Lincoln Yards life science project that's classified as standard non-accrual. So it's a particular fact pattern. It doesn't happen often. It's not a change in strategy. It's just the normal course of business as those occur.

George Gleason, Chairman and CEO

All right. And Stephen, on the other question you asked, we've given guidance in our management comments that we expect our 2026 results to look a lot like our 2024 and 2025 results in various respects. We've also detailed in considerable length in the comments there, the challenging environment that our sponsors have been operating in for a number of years. And that should be no surprise to anyone because we've talked about it, particularly at length over the last 14 quarters as we have built that ACL up, and we've depicted that ACL build in a chart in figure 23 of our management comments. So there was a build based on the expectation that the longer this challenging cycle drags on for our sponsors, the more likely it would be that individual sponsors on some individual projects would run into trouble and either choose to no longer support their projects or become unable to support their projects. And we've seen that over the last couple of years. And I think we've managed that really well and the ACL build was a prudent preparation for the environment we're in. I think we're getting towards the later stages, really in the later stages of the CRE cycle. We're seeing a lot of green shoots out there on leasing and property sales, we're seeing a lot of refinances because of the surge in credit availability, liquidity that has really manifested itself in the sector in the last couple of quarters. And obviously, the 100 basis points of Fed fund rate reductions in the last four months of 2024 and the 75 basis points of additional Fed fund rate reductions in the last four months of last year are providing some relief to sponsors on the interest cost. So we're not all the way through the cycle, but we think 2026 is pretty near the end of working through that cycle. And we think we see a decided upturn in not just improvements in the conditions for our sponsors, but also new volume and so forth. There's been a real constraint on new origination volume in recent years, and a lot of that is just the lack of equity and the fact that the market needed to balance supply and demand. We're seeing that come more and more into balance in various markets on various product types across the country. So we think our guidance is good, and we're very optimistic about 2027. We think 2026 is another year like 2025 where we're just working through the environment with our sponsors.

Stephen Scouten, Analyst

I understand, that's very helpful. I have one more question regarding the potential for fee income growth. While it hasn't traditionally been a significant part of OZK's income, it seems there are favorable trends due to the investments in CIB. I'm interested in how that could evolve not only in 2026 but also going forward. Do you believe there are long-term opportunities for growth in fee income, potentially leading to a multi-year growth pattern?

George Gleason, Chairman and CEO

Stephen, we're early in the process. So we haven't talked about it a lot. But clearly, if you read our comments closely, not only do we want to continue to achieve this diversification in our earning assets, which is well in tow and clearly evident. But we also want to see longer term. And you won't see huge strides in this in the short term. But longer term, we want to see fee income become a much larger part of our revenue. So we're so early in it. We've not talked about it a lot. We've given some general hints about it. But perhaps Jake could comment on CIB and then I'll comment on a couple of other items. Jake, do you want to talk about the fee income pieces of what you're doing?

Jake Munn, President, Corporate and Institutional Banking

Yes, happy to, George. I appreciate it, Stephen. Good question there. As you all know, we've discussed on previous earnings calls, our loan syndication and Corporate Services business line within CIB was planted about 18 months ago and continues to build. Those services provide kind of shared services bank-wide, including our capital markets program. It includes our interest rate hedging program, our loan syndications desk, our permanent placement solutions and also includes some foreign exchange capabilities and some additional capabilities in cities that George alluded to that we'll be rolling out here over the course of the next couple of quarters. All of that will continue to grow in line with CIB. CIB is their primary customer base for those shared services. But that being said, we're starting to see some nice penetration, for instance, with the interest rate hedging providing caps to our RESG customers, whether that be that or swaps that we're providing to some of our community bank customers. We are starting to see some nice growth and lift there through LSCS and some of those noninterest income initiatives that we're rolling out.

George Gleason, Chairman and CEO

Thank you, Jake. Outside of CIB, we're entering or about to start our third year in the mortgage business. The rollout was slow initially, but we gained traction in the last year and expect to continue to improve. Mortgage lending fee income from originating loans, which many banks resell in the secondary market, is becoming a good source of fee income for us. We are also focusing on expanding our trust and wealth business, moving beyond our traditional fiduciary trust services to grow both areas. Additionally, we've launched a private banking business, currently small, where we are collaborating with a select group of customers to refine our offerings and ensure we are providing the quality service they expect. This presents a good revenue opportunity. We are also making significant efforts to enhance our treasury management services, as many of our CIB customers have specific needs that we hadn't addressed for our smaller commercial bank customers in the past. We've invested heavily in hiring, technology, and resources to support these new business lines. You should see some incremental improvements in our noninterest income in 2026, with the most significant impact expected in 2027 and beyond.

Operator, Operator

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

Manan Gosalia, Analyst

So I wanted to start on credit. You called out uncertainties, particularly in office and life sciences in the management comments. Can you give us some more color on what you're seeing there? I guess, especially on the life sciences side, how long do you think it will take for the life sciences market to rebound? What you're hearing from sponsors? How have those conversations changed? And if you could also remind us on the levels of protection that are built into some of the larger life sciences loans.

George Gleason, Chairman and CEO

Brannon, you want to comment on life science and office as well, if you would like to?

Brannon Hamblen, President

Absolutely. Thank you for the question. As we've mentioned before, we've encountered varying results across different projects and markets. Some have thrived, while others have progressed slowly. The segments are certainly dealing with significant challenges due to various macroeconomic factors, including funding cuts from the NIH and their effect on demand for space over the past few years, along with a notable decrease in venture capital activity. On a positive note, there hasn't been a surge in speculative life science developments nationwide, although there have been projects that have begun with pre-leasing. We observe tenants expanding, presenting a mixed picture in these outcomes. Fortunately, there are no new supplies exacerbating the situation, and despite softer demand in some markets, it is slowly impacting the existing supply. It will take time for recovery. Certain markets are experiencing notable demand driven by capital investment in AI, which is beginning to influence Life Science as well, especially in areas lacking traditional office spaces. Life science offers a viable alternative for these users. While there are both success stories and challenges, we are seeing gradual absorption. This process requires time. As George mentioned, we've anticipated these developments for a while and have prudently managed our Asset Classification and Leverage (ACL) accordingly. We have entered transactions with low leverage and strong backing, and many sponsors continue to provide support. Some sponsors, however, are no longer able or willing to back these projects, and we have transparently reported on this. Ultimately, the life science market will need more time to stabilize, but we are encouraged by the ongoing support in the meantime. The office sector has been a positive narrative for us. We are particularly satisfied with the trends in several office markets within our portfolio, especially for projects that experienced limited activity over the past year and a half, which are now starting to benefit. Office leases typically span 5 to 10 years, making it a slow process for any market’s lease portfolio to evolve. Additionally, we are noticing continued incremental improvements from the return to office trend. As tenants reassess their needs and make leasing decisions, the emphasis on quality spaces, which we have discussed before, is still very evident. We observed significant leasing activity across several of our projects in various markets during the fourth quarter and are monitoring additional leases approaching execution soon. Overall, it has been a strong quarter for office leasing across many of our projects and markets, with more positivity anticipated based on current observations. Furthermore, the office sector is displaying considerable liquidity. Reviewing the past year, it was clear that office projects ranked second to multifamily in terms of payoffs. This trend has remained consistent in the last six months as well. Therefore, we have consistently witnessed good market liquidity, particularly in credit, which supports refinance activity. In summary, we have seen favorable results on the office front not just from a leasing perspective but also in terms of capital investment.

George Gleason, Chairman and CEO

And to put an emphasis on Brannon's point about the liquidity returning to the office space, I think we had four office projects refinance in the last quarter. One of our mixed-use projects that refinanced out had a significant office component within it. Some of the office projects we've seen refinance in the last year, a lot of them, in fact, have had no leasing. The liquidity is there, and people recognize the value in these high-quality buildings. The fact that the supply-demand metrics are normalizing, and these things that have been slow to lease are getting to the point that leases are very likely to be in the near term. That's providing some support for the space and a lot of liquidity and new investment in refinancing product that is out there. And similarly, in some markets around the country, you're beginning to not have the office available in the market that's built that meets the needs of some of the sponsors. And that really is providing an opportunity for life science projects to fill with space that's office-use space or another alternative-use space. And Brannon mentioned, particularly in the San Francisco Silicon Valley area, AI is driving a lot of demand for that space and creating buyers that are kicking the tires and walking and looking at some of the projects we've got in the life science space there for AI usage. So the environment is getting more constructive in a noticeable way.

Manan Gosalia, Analyst

Got it. So your conversations with the sponsors there on the life sciences side kind of indicate that they're in for the long haul. They're willing to support the properties for more time. And any thoughts on, I guess, the protections that are built into some of the larger life sciences loans that you have out there?

George Gleason, Chairman and CEO

We are reliant on sponsor support, and every sponsor and project is unique. The overall sentiment has improved somewhat. Our team recently met with the leadership of our largest life science loan, and although I wasn’t in that meeting, the feedback was that it was very positive and constructive. They outlined plans and commitments to enhance the project's leasing and activity levels, so we are cautiously optimistic. However, not every life science project may reach a successful outcome with its current sponsors and capital partners, and there may be a few setbacks. In this cycle, we have had four RESG assets go into foreclosure or for which we acquired title in satisfaction of debt, although we didn’t actually foreclose on any of them. Last year, we liquidated three of these assets, one in the third quarter and two in the fourth quarter. One of the projects, which had been under contract for several years, resulted in the sponsor paying us $12 million in extension fees and forfeiting earnest money. Overall, this involves a relatively small number of projects. I want to clarify a misconception; it was reported that we took a charge-off on the Los Angeles land, which is incorrect. We moved it to OREO at book value, and the decrease in its carrying value is due to forfeited earnest money, not a charge-off. We believe it is properly valued now. We currently have four loans in non-accrual status, indicating a small number of RESG assets where sponsors have been unable or unwilling to support the asset. On a positive note, we've provided detailed information on this for the last 14 quarters. Last quarter, we had 49 loans granted term extensions, which involved $56.7 million in reserve deposits, $7.6 million in modification fees, and $45.1 million in unscheduled principal paydowns. Over the last 14 quarters since interest rates began to rise, this has resulted in $1.3 billion in additional equity contributions, $866 million in reserve deposits, and $429 million in unscheduled principal paydowns. While I don’t have the exact fee number, it amounts to tens of millions in fee income. This indicates that about 95% of our RESG loans are receiving solid support from their sponsors. There may be some additional fallout before the end of this cycle, which we have anticipated by increasing our allowance for credit losses from $300 million to $632 million. We feel well-prepared for this scenario and have been managing and liquidating assets effectively in cases where sponsors have stepped back. We are positioned to navigate the remainder of this cycle successfully.

Operator, Operator

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

Brian Martin, Analyst

Thanks for all the commentary thus far. Maybe just in terms of it doesn't sound like much in the way of additional sponsors likely to maybe not be supporting these based on kind of your commentary. But just in terms of the resolution of the current level of non-performings, can you talk about maybe the timeline in terms of any big chunks you expect to see get resolved in time frames, just kind of how you expect to work some of that down as you go forward?

George Gleason, Chairman and CEO

Well, on the Boston property, for example, the sponsor on that project would have done an extension renewal and put up their part of the required capital to do that. Their two equity partners in that transaction really decided that they were not going to put up more capital until they got a lease, and our rule is you pay, you stay. You don't pay, you don't stay. So when they asked us to give them nine months or so, six months, whatever to work through the lease without making any payments on the loan, we just said that's not the way we operate. If you want time, you have to pay for the time. If you don't pay for the time, then we're going to move to resolve the asset. So the resolution of that asset can occur several ways. Number one is the sponsor in that transaction is out trying to put together new equity partners to continue with the successful outcome of that project. We're hopeful they'll be successful, but we're also dual-tracking our acquiring title to that property so that if they're not successful, we're ready to take that asset over and continue to move that asset forward in a constructive way. So obviously, if they raise new capital, that could get resolved, and our view on that could change dramatically and quickly. On the flip side, if we have to take that over, then we'll look for opportunities to sell it. If we can get a favorable price on a sale, we would sell it. If not, we'll lease it up and then sell it when we get it into better shape. I would comment also on that property. There was some commentary out there that the lease situation has blown up and gone. That is not our understanding of the situation. The sponsor continues to be actively engaged with the prospective tenant. The prospective tenant, our understanding is they just delayed their process for about six months and instead of making a decision early in the year, expect to make a decision mid-year, third quarter, or so forth. And I think our building is still in kind of the inside lane on the opportunity there to work out a lease with that sponsor. It's still early, but that activity is still ongoing, and we're working with the sponsor, and whether we acquire title or the sponsor recaps, we'll work very collaboratively with the sponsor. We have a good relationship with the sponsor. We'll work very collaboratively to make sure that those ongoing leasing efforts are maximized the opportunity. The office building that's on non-accrual in Santa Monica, we're pursuing opportunities that would result in a sale of that asset fairly quickly. The Chicago life science deal, the sponsor is working on a short sale opportunity on that. We've written it down based on our understanding of the financial metrics of that short sale. If they accomplish that, then we could be paid off quickly over the next couple of quarters, however long it takes to close that. If they don't accomplish that sale at a price that's satisfactory to us, then we'll take that property and sell it. The Baltimore land, we've talked about at length in previous conversations. We're working on a potential sale of that property right now. We're also working to continue to work with the current sponsor on our taking title and continuing to integrate our development and liquidation of that property with the other developments that the sponsor successfully achieved in that area. So it's hard to know when these things actually come to fruition. There are multiple paths that each of them could take, but we're working those things diligently, and sometimes you resolve things fairly quickly. The three pieces of OREO we sold last year that were RESG assets, all those were resolved in a pretty short time frame for sale. The flip side of that is the one we've still got there while we've made a lot of money on extension fees over the last couple of years with that and got a nice paydown on our carrying value of that OREO through the forfeited earnest money. We worked on that thing two to three years with that prospective buyer. And it didn't come to fruition. And now we're back in the market with it. So some of them will work out fairly quickly. Some of them, for one reason or another, will take a bit longer to work out. We try to be very constructive about the way we approach these things. And I'll give you a good example. Our oldest substandard accrual asset in the RESG portfolio is that development near Lake Tahoe, California. And that thing has been substandard accrual since 2019 and was special mention for some number of quarters, I believe. But before that, I don't remember when it went on special mention. But you hear the adage a lot of times about problem assets. And the old adage that everybody seems to quote is, "Your first loss is your least loss." Well, a lot of times, maybe a majority of the times, first loss is your least loss. But as we looked at that asset, we said, "The sponsor's not going to put new capital in this, but the sponsor remains engaged." We can work out an opportunity here where we don't have to put new money in it, but we can work with the sponsor and help them chart a path to a successful resolution of that. So instead of blowing that asset up in 2019 when it went on substandard and probably taking a 10 or 20 or million dollar loss on it, we worked with the sponsor, developed a plan to address that. And we've earned $43 million in interest and fees on that loan. And our total commitment today is $43 million. And our outstanding balance is about $34 million on that. So we've earned more in interest and fees than our outstanding balance on that loan. And there's a very high probability that we get through that all the way to payoff with a successful resolution of that asset, earning money all the way and never taking a loss on that. So you've got to be thoughtful and constructive in the way you approach these and understand what the assets are and understand how to maximize the value from them.

Brian Martin, Analyst

Got you. Maybe just let me ask one follow-up before I leave. The margin came in better than expected this quarter. I’m wondering if you could provide some insights on that considering the rate cuts that have already taken place and how you view the margin in a relatively stable environment. Also, any comments from Tim regarding the outlook for the buyback would be appreciated.

George Gleason, Chairman and CEO

Tim, you want to take the buyback first, and you're welcome to take the margin if you want to as well.

Tim Hicks, Chief Financial Officer

Thank you, Brian. We initiated a new buyback authorization on July 1 and have always planned to be opportunistic with it. In the fourth quarter, as our stock was trading below tangible book value, we found that to be a compelling opportunity. We purchased 2.25 million shares at an average price of $44.45, which was significantly below our current tangible book value. This acquisition positively impacted both our earnings per share and tangible book value. We still have nearly $100 million remaining in this authorization and will act opportunistically if we continue trading in similar price ranges. We could potentially utilize the entire amount this quarter before it expires at the end of June, depending on our stock performance. Additionally, we increased our dividend, marking the 62nd consecutive quarter of growth, along with an improvement in our capital ratios. Our tangible common equity rose by 35 basis points during the quarter, even while buying back $100 million of common stock. Combined, our preferred and common dividends amount to about $55 million. We are pleased with our ability to enhance capital ratios, increase capital in dollar terms, and return substantial capital to our shareholders during the quarter. Regarding our margin, it held up relatively well throughout the quarter. Most of our RESG loan rates reset on the tenth of the month, which did not fully capture the recent SOFR declines. There were still multiple basis points left from SOFR's decrease between the December and January resets. We also benefited from the effective management of our deposit costs by Ottie and the deposit team. Although we faced a headwind with two fewer days in the first quarter impacting net interest income, we have provided an estimated range for Q1 net interest income. Our deposit team will continue to focus on optimizing our deposit costs. Overall, we are satisfied with our margin performance in Q4 and will keep working diligently to manage it in the future.

Operator, Operator

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

Sun Young Lee, Analyst

Starting off with credit. So you've mentioned that your 2026 trends on credit would be similar to what you experienced in 2025. You probably have a better line of sight into your credit and the situations with sponsors. So just to level set, are we expecting a similar range of net charge-offs that you experienced in 2025 into 2026? So call it 50 basis points. And if I were to extrapolate the NCO expectations for 2026 into what you would be willing to do on your provision and allowance for loan losses, it's more than doubled over the past three years. So, do you plan that you would draw down on your reserves in anticipation of any potential credit losses in 2026, given that you've built reserves for so long for a few years, or similar to what you did for full year 2025, you would be taking a similar amount of provision for whatever expected credit losses are for '26?

George Gleason, Chairman and CEO

Great question. And Janet, I would start off by telling you we're going to do the right thing, whatever that is. And that will depend on where the global economy goes, where the U.S. economy goes, where the quality metrics and risk ratings of our portfolio go. So if we need to build a reserve further, which is probably not my base case, but if we need to do that, we'll do that. We're going to do the right thing, whatever the economy and the models and the risk ratings tell us is the appropriate thing. We talk about this at length in the management comments. We've prudently built the reserve. So when we incurred the charge-offs that we incurred in the quarter just ended, a large part of that was already provided for. So we were able to absorb that and still run with all the models and put up all the reserves we needed to put up. And we carefully looked at that and rolled all those numbers forward and really validated that our decisions in that regard were correct. So I would anticipate that if the economy plays out as we think it does and as this CRE cycle sort of winds down in 2026 and early 2027, as we think it will, that ACL percentage may continue to do what it did in the fourth quarter. And that has come down modestly as we absorb losses that we've provided for the likelihood and potential of. And we'll see where that goes based on where the economy goes and how the portfolio performs. But I think we were very prudent. The risk events build over time. Clearly, just the prolonged series of challenges that our CRE sponsors have faced going all the way back really to the COVID pandemic. For our purposes today, mostly from the last 14 quarters when the Fed started raising rates and sponsors were dealing with the aftereffects of COVID and inflation and work from home and all of that and then got into a higher rate scenario, it was a challenging time. As I said in the management comments, we think we are really in the late stages of working through that. If that bears out, then that reserve ACL percentage could continue to ease lower over the next year.

Sun Young Lee, Analyst

Got it. That's helpful, color. And I know it's hard to exactly comment on this, but I'll still try. So when you say 2026 will be similar to 2025, working through some of the credits in the latter cycle of CRE, is your expectation that you're going to see more of the migration into substandard non-accrual from special mention and maybe substandard accrual into the non-accrual category within that classified and criticized asset that you have, which have been pretty stable overall over the past year? Or are you anticipating more of the new credits that could be migrating over to the classified and criticized category over time? So basically, do you have a line of sight into some of the potential credits that could be migrating into special mention or substandard overall, or more of a potential credit migration within that classified category into non-accrual based on what you're seeing now?

George Gleason, Chairman and CEO

Well, a lot to unpack there. So let me start with this. The special mention category tends to be a fluid category. A lot of times, if we're having a very challenging extension modification negotiation with a customer, a loan may get into special mention while we're involved in that negotiation because our challenges to the customer may be, "You got to put up X dollars in reserves. We want to pay down on this. You've got to make these other enhancements and changes to protect our position." The customer may resist that because they've got other things they're dealing with too. And those negotiations may become very challenging and intense. And usually, we get those resolved in a favorable manner. So a loan that is in the midst of intense negotiation and we're unsure how that's going to play out may find itself in special mention. And then a lot of those get resolved. We get a nice paydown. We get reserves reposted. We earn a nice fee on the extension. It's kind of put back into a very healthy state, and it migrates back out into some level of pass rating. Then you have loans that migrate in that you're not successful in negotiating that, or maybe there was an issue with it that caused it to be in special mention, and that doesn't work out well. That will migrate into substandard or substandard accrual, and we'll give you more disclosure on that. So the special mention is not just a stepping stone to substandard. Loans come in that and go back out the other way, back into a pass status as well. And that happens very frequently. So there's a fair amount of churn in the special mention category. I would repeat what we said in the management comments. We've had a handful of sponsors who have been unable or unwilling to continue to support their project over the last 14 quarters, particularly the last couple of years. We expect that our experience in 2026 is going to be similar to our experience in 2024 and 2025. So sort of giving you a couple of years to look at as a comparison for our expectations for 2026. So I think we very likely will have a handful of additional sponsors who give up on projects. We have an ACL built for that expectation. And it's a case-by-case basis. And in dealing with sponsors, you're not just dealing with the sponsor, but you're also dealing with the sponsor's capital partners in a lot of these cases. So there are multiple variables at play, and we're really good at working through those. We have a great team that works through these negotiations and arrangements. I feel very good about that. But I think we've given you as good a guidance as we can give you at this point in time.

Operator, Operator

Our next question comes from the line of Jordan Ghent with Stephens.

Jordan Ghent, Analyst

I just had a question on kind of the capital. It looks like you guys have $350 million in sub-debt that moves from fixed to floating this coming October. I think you guys have previously said you could redeem in whole or part beginning in October. If that's still the case, and then with that, how does that affect your buyback up until that point?

Tim Hicks, Chief Financial Officer

Jordan, you’re correct. We do have subordinated debt transitioning from fixed to floating on October 1. We haven't decided what our course of action will be regarding that yet. We will make a decision when necessary, but it’s premature to comment at this stage. Regarding our buybacks, we possess significant capital, as evidenced by our CET1 ratio increase. Although we haven't extensively discussed our earnings on this call, we generated nearly $700 million, nearly matching last year's record earnings. This earning capacity provides us with ample capital opportunities. In certain years, we can expect robust growth, while in others, it may be in the mid-single digits. During those mid-single-digit years, with anticipated earnings levels, we will elevate our capital levels and seek opportunities to utilize that capital, similar to our actions in the last quarter. It’s too soon to provide insights on the subordinated debt. We've maintained subordinated debt for the last decade, and Tier 2 capital is integrated into our capital structure, reflecting our long-term strategy to hold a substantial amount of Tier 2 capital.

Jordan Ghent, Analyst

Got it. And then maybe just one more. Last quarter, you guys guided for loan balances to move lower in the fourth quarter in 2024, 2025. We didn't see this in management comments. Could you provide any commentary on what's going to happen maybe in the near term or kind of the trends you're seeing?

George Gleason, Chairman and CEO

Tim, you want to take that or I'll be happy to.

Tim Hicks, Chief Financial Officer

Sure, we provided loan guidance for the year. In the first quarter, we expect to see positive results and not experience a quarter like the fourth quarter. The payoff velocity can fluctuate, but I anticipate that our growth will occur in the middle to late part of the year. The first quarter should still show positive growth, but there may be some payoffs that could shift the results slightly. Overall, I believe our growth will continue throughout the year, with stronger performance anticipated in the second, third, and fourth quarters compared to the first quarter.

George Gleason, Chairman and CEO

Yes, I agree with that. Our guidance for mid-single-digit loan growth this year is likely to be more concentrated in the last three quarters rather than the first quarter. We experienced a significant number of payoffs that we anticipated in Q1.

Operator, Operator

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

Catherine Mealor, Analyst

One follow-up on the credit conversation. As we look at the special mention category, and I know, George, you talked about how this is a fluid category where loans come in and out. But it was interesting to see that a number of the loans that are in special mention were highlighted on the appraisal chart, Figure 29. And it feels like a couple of them have pretty LTVs that are nearing 100. And so just curious if you could provide any commentary on some of those larger office special mention loans. And are there maturity dates coming up near term, or are there things that we should be aware of in the next couple of quarters that could perhaps drive some of those to move into substandard?

George Gleason, Chairman and CEO

Well, in respect for our sponsors, we really try to not talk about loans that we don't need to talk about, and special mention loans fall in that category, so I don't know that we have a lot to really add on that, Catherine. There's a balancing act between being totally transparent and providing full and accurate disclosure to our investors, and then going beyond that and providing disclosure we don't need to provide that's challenging, detrimental to our sponsors, so I don't have a lot of comment on that. Those loans we feel like are appropriately risk-rated special mention. That risk rating is reflective of the appraised values on them. We've talked a lot about how fluid and in and out our special mention is, so if those loans merited a substandard rating, we would have them substandard rated. If they merit a substandard rating in the future, we'll rate them there at the appropriate time. And we think special mention is correct. We gave you those notations there because we didn't want to convey the impression that, gosh, we had loans that were higher loan-to-value loans that we had gotten an appraisal that said the loan-to-value on it is a lot higher than where it previously was. And we weren't taking that into account in the risk ratings on them. So I think we're doing the appropriate and proper thing, prudent thing on those loans.

Catherine Mealor, Analyst

Got it. No, that's clear. I appreciate that. And then maybe another question. It might be the same answer, but I'll try it. But any update on the larger life science line out in San Diego, the RaDD property, just any leasing update or anything that you can? It's been a few quarters since we've had an update on that. Just curious if there's anything you can provide on that larger credit.

George Gleason, Chairman and CEO

Yes. I'll let Brannon comment on that. When I mentioned meeting with the management team about our largest loan in Dallas, that was in reference to that loan. Brannon, I know you don't want to go into too many details, but could you share your insights on it?

Brannon Hamblen, President

Sure, Catherine. Thanks for the question. I would like to emphasize what George mentioned about sponsorship and management. They've brought in new leadership with significant experience in the segment. Over the past couple of years, the sponsor has invested a considerable amount of capital into that project. The company and its capital partners recently completed a capital raise of around $900 million. They have the financial capacity and the necessary expertise. We had a productive meeting, although there hasn't been much leasing activity executed yet. There are several proposals out, mainly related to the office space. I won't go into too much detail about the leasing aspect, but this new management team is quite impressive. Their plan is very grounded, and they are actively involved on a daily basis. The exciting part now is the activation phase, as tenants are finalizing their improvements and will soon open. We are optimistic about their commitment to the project and confident that they will successfully attract tenants to the asset.

Operator, Operator

Our last question comes from the line of Timur Braziler with Wells Fargo.

Timur Braziler, Analyst

My first question's on the Boston property. It looks like in the third quarter, the reappraisal was done on an as-stabilized basis and implied a level that was much higher in Q4, where it looks the appraisal was done now on an as-is basis. Can we just maybe talk through kind of what transpired between Q3 and Q4 that drove the more punitive appraisal?

George Gleason, Chairman and CEO

Well, it was the same appraisal, and it was using the as-stabilized versus the as-is value. And our approach on this is we use as-stabilized value when the sponsor is engaged in the project, supporting the project, and the expectation is that the project is going to achieve stability. If the sponsor is, in this case, then indicates that they're not going to continue to support the project and contribute capital and keep it current and keep it performing, then, as I said earlier, you pay, you stay. You don't pay, you go. And we're going to take property, then we shift to a liquidation value or an as-is value of the property. So we detail that in the footnote at the bottom of Figure 26, all of those substandard assets because sponsor support seems unlikely or is clearly not going to happen. All those substandard non-accrual assets are reflected at as-is values. The assets that continue to have sponsor support are reflected as as-stabilized value. So to specifically nail down the point, you asked what was the change. The change was we expected the sponsor when we were talking in October would continue to support the project to some degree. And they seem to be close to a resolution and a favorable resolution on the pending lease project because the prospective tenant extended their timeline to make a decision on their lease by six months plus or minus. The sponsor indicated they were not going to continue to support the project without a lease, or the capital partners did. The sponsor was still willing to support, but not the two capital partners. That lack of support and the elongated timeline on the lease decision led to the change in our appraisal selection for that asset.

Timur Braziler, Analyst

Okay. Got it. And then maybe just one more on the allowance. George, you had made the comment in one of the earlier questions on kind of working through the environment. I'm just wondering, in terms of allowance and the ability to maybe drive that lower, is that just working through the existing known problems? And I'm just wondering to the extent that we do get additional risk migration into categories beyond special mention, is that going to warrant additional allowance actions, or do you feel like the existing reserve that's in place today is going to be sufficient to work through whatever issues might surface over the course of the next 12 to 18 months?

George Gleason, Chairman and CEO

The ACL reflects our expectations for all of the current portfolio for the life of those loans. That's what CECL is all about. You calculate your expected loss for the life of those loans, so we have an expected level of migration that is embedded within that ACL. Even before, early in the interest rate raising cycle, we were building the ACL because of expectations. If this trend continues and goes on long enough, there will be some losses that will result. And obviously, the longer the cycle went on and the higher interest rates went, and then all of the other various macroeconomic challenges and uncertainties and impacts that occurred, that resulted in that full ACL build to a $680 million level where it stood at September 30. The environment is getting slightly more constructive, and we're resolving some of those specific losses by taking charge-offs on them and resolving them in the last quarter. So that's why the ACL came down. So based on our current expectation, there will be some migration in the portfolio. We don't know what specific loans are going to migrate, but we've got probability analysis basically on every loan, a probability of default or loss-given default. Some that we have loss reserves for will never become an issue, which will free up those reserves. Some that we have a loss reserve on will possibly migrate adversely and will need more reserve. But on average, I think we're in a really good position. And that's what your ACL does. It reflects your expectations for the whole portfolio. And you do it on a loan-level basis and sum all that up. But some of the vast majority of those reserves are not going to be needed for the specific loans they're on, but other things will get migrated to a more adverse status, and you'll need some of that reserve that's freed up from others to meet that. So it's an average process.

Operator, Operator

Thank you. I would now like to turn the call back over to George Gleason for closing remarks.

George Gleason, Chairman and CEO

All right, guys. Thank you so much. We appreciate all your time today, your interest in OZK. We look forward to talking with you in about 90 days. Have a great rest of the day. Thank you.

Operator, Operator

This concludes today's conference. Thank you for your participation. You may now disconnect.