Bank OZK : 2nd Quarter 2021 Earnings Release Conference Call

Bank OZK

Transcript of the Second Quarter 2021 Conference Call

July 23, 2021, 10:00 am

Note: Administrative communications of the operator and other greetings and social exchanges of no substantial import have been omitted from this transcript.

Good morning, I am Tim Hicks, Chief Credit & Administrative Officer 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;
• Greg McKinney, Chief Financial Officer; and
• Cindy Wolfe, Chief Banking Officer.

To make the most efficient use of the time we have for this call, we'd ask that you please limit your questions to one or two at a time, and then re-enter the queue for any follow-up questions, if needed. We will now open up the lines for your questions. Let me now ask our operator, to remind our listeners how to cue in for questions.

Ken Zerbe - Morgan Stanley

I was hoping we can start off, George, I think in your sort of prepared written remarks, you talked about total loan growth and RESG potentially starting to grow again in fourth quarter. I know payoffs have been just such a headwind over the last several years. Are the comments designed to say that, or suggest that, payoffs could actually start to slow in fourth quarter? Could we really be seeing a turnaround that those are starting to end in a big way?

George Gleason

Ken, no, I don't think that's the proper interpretation. I think payoffs will continue to be high. And I think the more appropriate interpretation is to think about origination volumes beginning to increase in a meaningful way. I spent six weeks on the road during the second quarter, visiting the vast majority of our major RESG markets and almost all of our origination team members out there. We had scores of customer meetings and interactions and were looking at projects. So we're pretty optimistic about our ability to begin to achieve higher origination volumes that will offset the elevated repayments that we are experiencing now because we're getting repayments that naturally would have occurred last year, but for delays from the COVID pandemic plus repayments that would naturally have occurred this year.

We originate construction and development loans. So repayments are going to be a common part of the business. Now obviously, we've got a higher level of accumulated repayments this year than normal just because of the COVID related delays in project completion, construction, sales, leasing, refinancing last year. But we're going to continue to have to originate more to offset the fact that all of our loans in that construction and development book pay off.

So we're focused on growth. We've got a great franchise. Our franchise has proven itself now through the Great Recession, proving itself through the pandemic. Our customers know they can count on us and rely on us that we're always going to be there for them. And I think we've got a chance to really grow our business over the next several years. And the six weeks on the road during this last quarter that I spent with our origination teams out there certainly suggest that late 2021, 2022, 2023, we can take our RESG business to a more significant level than we've taken it in the past because the opportunities seem to be there. And of course, Brannon's going to go on the road and do a lot of the same sort of networking that I did in coming quarters. And I think all of that work with our origination team is going to help produce an increasing volume of business, certainly next year, and hopefully, we'll see some of that begin to filter through in Q4.

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Ken Zerbe

And then just my one follow-up question, in terms of the net interest margin, obviously, you said you had a very good increase there. And it seems that some of it may have been driven by unusually high minimum interest collections, et cetera, but also lower deposit costs. When you think about the NIM on a go-forward basis from here, should we expect the lower deposit costs to continue to drive the NIM higher? Or how should we think about the trajectory of net interest margin?

George Gleason

I would suggest that we're at or near a peak on the NIM probably in the near term. We commented in our management comments that we're originating loans at lower rates than the rates that were earned on loans last quarter. That is unfortunately a part of this very liquid low rate environment in which we find ourselves. Yields on all sorts of financial instruments and loans are lower than they were and probably lower than they should be, but it is part of the environment. So as loans roll off, we're not able to replace those yields with equal yields.

We are being diligent to not sacrifice our credit standards and structure standards that we've adhered to for a long time that are the hallmark of our great asset quality. But we are having to get more aggressive on price to not only replace assets that are rolling off but also grow assets. So growth is important. Pricing is a bit negotiable in here.

So loan yields are probably almost certainly headed lower.

We've got room -- Cindy can talk about this later in detail. We've got room to continue to lower our deposit cost for a while to some extent. And I think there'll be some pressure on core spread and some pressure on NIM.

We did benefit in the quarter just ended from a very good level of minimum interest and loan fees. And I noticed several of the research reports on our results noted that we didn't quantify that. And the reason we didn't quantify that is it's hard to know what's normal. In some quarters that's $9 million or $10 million, some quarters that's $3 million or $4 million, and it bounces around all over the place. We were on the high end of the range this quarter. We could be on the low, the middle or the high end of the range for the next few quarters. It just depends on a lot of things that are hard to know when particular loans pay off and is it this quarter or next quarter and so forth. So we didn't quantify. We were on the high end of that. So that naturally alone will have some pressure on loan yields in Q3. And the key is going to be our ability to continue to offset that pressure with reducing deposit costs and the guys are doing a real nice job there. Long term, Ken, growth is the key.

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Timur Braziler - Wells Fargo Securities

George, maybe just following up on your last comment that long-term growth is the key. It seems like RESG, Indirect RV & Marine, ABL, CBSG, all converge in '22. I guess what does the near-term growth rate look like in 2022? And then once RESG is fully normalized with payoffs kind of stabilizing and originations starting to pick up again, what does that growth rate look like?

George Gleason

Timur, I'll let Brannon Hamblen address that because Brannon is our President, but he oversees RESG and our Corporate and Business Specialties Group and our new asset-based lending group. So he's got a pretty good perspective firsthand on most of that. So Brannon, do you want to take that?

Brannon Hamblen

Picking a normalized growth rate is a little bit of a fine point to make. But what I would tell you is from RESG's perspective, and George alluded to this, we're seeing very good pipeline activity. We're very strong there and our conversion, our wins of what's available out there is starting to pick up. So I'm expecting the back half of the year for originations in RESG to be definitely moving in the right direction and back toward and beyond what we'd historically done. You guys know it's a construction loan portfolio and what you close today when you've got 50% average loan-to-cost, it takes a while to get those dollars out the door.

We've included again, the graph on Page 7 of the management comments, it really gives you a sense of what's left from the legacy portfolio that's outstanding and therefore, what's left to pay down. So back to Ken's earlier question, you get a real sense of what that cycle is going to look like. So we'll still have some payoffs, but I'm seeing really good growth opportunities in the -- on the origination side that will start to -- and we've obviously weren't sitting on our hands in 2019 and 2020. So some of those loans starting to hit with funding will help as well to offset at least in part, these payoffs that will keep coming in the velocity that you see on page 7 of management comments, following the originations and the natural life cycle.

In our new asset-based lending group, I'm excited, again, as I mentioned last quarter about the addition of that team and that team is growing or adding incrementally and look forward to having, we think, some really solid players in probably Texas and Georgia markets first is what we think is going to happen there. And Mike Sheff, who leads that group is in addition to building the team and the infrastructure toward originating its first loan is very active in the market as well. And I expect that those guys will start to originate probably the first closings in Q4 or early Q4, possibly get one in Q3, but the opportunities that they're seeing out there in the geography that they're covering, I'm feeling good about those guys really contributing to our growth. They'll start at a moderate

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pace, but I think gather steam pretty good towards the back half of 2022 and keep going in 2023. I think there's good potential for originating some really solid credits in that world.

And our CBSG group is, as we noted, going to have some headwinds early on, but they're building a base and getting competitive and originating some new stuff with new borrowers there. So we'll see that accelerate as well. So Timur, it's hard to circle a number, but I can tell you that the outlook is positive across all three of those groups. And I think RESG is the big driver there. We're looking forward to getting back to what we've seen in previous years there. We think that the volume is there, and we're out there trying to haul it in and having some good success now.

George Gleason

Timur, I would add that we are gaining in a very steady and consistent manner of traction with our indirect lending group and the new business model that we rolled out about a year ago now, or almost a year ago there in that unit, and we really like the way that's performing. We're going to, we think, be able to protect our asset quality while paying lower premiums and getting better spreads now given where rates are, we may get better spreads, but that might not translate into better rates right now just because of how low everything is.

And our community bank is also getting some traction, I think. So growth will continue to be a challenge in outstanding, certainly through Q3. I hope that we'll have a positive growth number in Q4. And I think, as Brannon said, there's a lead time between getting these things closed and beginning to get funding on them. But I think we ought to see a steady progression in our total outstanding balances and earning assets from loan side throughout '22 and into the future. And I think we got all these units going in the right direction. The business model has certainly been proven. And I think we've got really good prospects of stepping up to a higher level of origination volume across the company, more diversified also than it's ever been before.

Timur Braziler

And then my follow-up. In the release you had indicated that you're seeing fewer origination opportunities in large urban markets such as New York that are meeting your standards. Is that still a few number of deals that are coming online? Or are you starting to see some deals come online that aren't necessarily checking your credit box or other standards?

George Gleason

Well, we always see a lot of deals that don't fit our credit box. But I would tell you, I was in a lot of our major markets, I was in New York, I was in Boston, I was in Chicago, I was in Miami, I was in the Tampa St. Pete area,

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