Bank OZK (OZK) Earnings Call Transcript & Summary

All right, everyone. We're going to get started. I'm very pleased to have Bank OZK with us today. Based in Little Rock, Arkansas, the company operates a traditional banking operation throughout the Southeast, along with its Real Estate Specialties Group, or RESG, as it's known, across the United States. And with us today from the company is Chief Administrative Officer, Tim Hicks; along with Brannon Hamblen, who heads up the RESG group. And with that, I will turn it over to Tim. Thank you.

Thank you, Michael. Good morning, everybody. Glad to be here again. It's a great conference, and glad to be here. I'm going to start, go through a few slides, and I'll hand it off to Brannon, let him go through a few slides in RESG, and then I'll wrap it up with another few slides. Forward-looking statements on Slide 2. Slide 3, for those of you guys that don't -- aren't familiar with us, we are a bank, mostly centered in the Southeast, but have several national lending businesses. Total assets of $23.6 billion at year-end. Return metrics, 1.87% return on average assets last year. And you can see the return on equity metrics there. 254 locations across 10 states, mostly in the Southeast, but we do have 1 branch in New York. That includes our Real Estate Specialties Group team and an operating branch there. We have 3 loan production offices in California, 2 of those are Real Estate Specialties Group related and 1 of them is related to our indirect lending team that we'll talk about more as well. Have a deep and talented management team, including all 2,800 employees plus that we have across our bank. Obviously, George Gleason, Chairman and CEO, shares an anniversary with this conference. This is his 41st year as Chairman and CEO of the company. Greg McKinney is our Chief Financial Officer. He's been here for 17 years. You'll see a lot of these executives have been here for 10 or more years. I've been here 11 years. Brannon has been with us for 12 years. John Carter, 11 years. Cindy Wolfe, Chief Banking Officer for the last 2 years. Cindy has been with us for 22 years in a lending role and running our North Carolina operations, and then moved back 2 years ago to our headquarters and took over the Chief Banking Officer role. She's doing great things, has hired a lot of several key members in our retail banking office that is doing great things across our footprint from a retail standpoint. And so John and Alan kind of run the lending side. Alan Jessup is Chief Lending Officer of Community Banking. We don't talk about Trust and Wealth Management a lot, but Jennifer Junker has been here for 5 years. We've had a great success underneath her. She's continued to generate strong earnings and record level of fee income from that group and then several others listed here and then several others not listed here. Just really a great management team. We have a great management team. You end up having great results. And we've -- that chart, net income chart, shows you that 19 out of 23 years as a public company, we've had record net income. 2019 was one of those years. We had 40 -- $425.9 million of net income last year, which was a record for us. 2018 would have been a record, but 2017, we had a onetime gain from the tax law change that resulted in a $50 million gain for us. That made that bar stand up pretty tall. But without that onetime gain, we would have had record earnings over the last 3 years. So obviously, 2020 has a lot of challenges, some of which we don't control, like the Fed cutting rates by 50 basis points. So we were not expecting. At the beginning of this year, we were assuming we'd have a flat rate environment. We'll talk about in a little bit how we protect on the downside. We do have -- a lot of our loans are -- 74% of our non-purchased loans are variable. But all of those loans, 99% of those loans have floors, and we'll talk about our floors that we have in those loans as well. Again, compared to the industry, very favorable return metrics, especially on return on assets. We have been continuing to build our capital levels. So our average, our return on average equity, attainable equity has come down to the pack, but not because of earnings. It's more from a fact that we've been retaining capital that we'll talk about in a few slides as well. But again, great earnings, record earnings last year and great ROA metrics as well. 90-plus percent of our revenue comes from net interest income. Obviously, as the Fed was increasing rates, that resulted in a lot of record years of quarterly -- or record quarters of net interest income, depicted there by the blue bars. The gray bars are years that -- quarters that do not have records. We are trying every day to get back to turning the tide on this and turning it to records. Obviously, loan growth is a big component of that and rates is another component of that. That as rates are coming down, that puts a lot of pressure on our margins. So we've got to offset that with growth this year. As Brannon we'll talk about in a little bit, we're dealing with a lot of payoffs at our Real Estate Specialties Group, which is going to impact our loan growth for 2020, but should set us up well for future years from that perspective. So cost of interest-bearing deposits is another area that we're focused on, and I'll highlight some of the things we're doing in that in a few slides as well. Again, more charts on yield. So the top chart there is nonpurchased loan yields. You'll see, obviously, the balances have been increasing. Average balances have been increasing each quarter, but the margin has been coming down as the Fed started decreasing rates at the end of last year. And obviously, just announced today that they're decreasing rates again. Our purchase portfolio, which is about a little -- about 7% of our loan portfolio. Total loan portfolio has been declining. The yields on that has been pretty stable in the mid- to low 6% range, but the balance has been declining, and we would expect that to continue to decline this year, similar pace to what it has declined in previous years. This is a chart at the bottom here that shows you the loans that are variable that have floors. So at year-end, 74% of our funded balance of nonpurchased loans and 42% of funded balance of purchased loans had variable rates. 99% of those had floors on our nonpurchased loans. At year-end, 47% of those were at their floor at 12/31/19. You go 2 bars later and show where it says down 50 basis points would indicate that 60% of our total commitments would be at their floors. So this does help, from our perspective, on the downside for nonpurchased loan yields. Our nonpurchased variable rate loans are highly tied to LIBOR. So where LIBOR goes, those yields go that direction as well, but this does provide some resistance. The floors do provide some resistance to that decline. That 60 basis point -- 60 percentage points, again, was at 12/31, the portfolio as of 12/31/19. Not only did the rate, the index come down over the last few days, the portfolio mix has shifted too. So as we get towards some of our 2016 and 2017 origination loans paying off this year and replaced by loans that are funding up and originated this year, that will actually increase that percentage as well. Our investment portfolio, the yield has been pretty stable, but the balances have been declining. Obviously, it's not a lot of attractive yields in the bond market right now. So I don't know that we have bought a bond since fourth quarter of 2018. So you're seeing that balance decline a little bit and going into interest-earning cash. For the most part, we would like for our bond portfolio to be a larger percentage of our earning assets, but we need to see an environment where we can expand, and we saw that in the fourth quarter of '18, but have not seen good opportunities since then. This is a chart on our core spread, which we describe as the difference between our yield on nonpurchased loans and our cost of interest-bearing deposits. We've talked about as the Fed increases, the yields on our loans increase. As Fed decreases and LIBOR decreases, that the yield decreases. At the same time, our cost of interest-bearing deposits, although lagging, does -- has been decreasing in the last 2 quarters. We would expect that to continue in the next several quarters. Last quarter, we had a 12 basis point decrease in cost of interest-bearing deposits, 6 basis points the quarter before. Some of that is coming from repricing of CDs. We have about $2.1 billion in Q1 that is being repriced of our CD book. So that will reprice. We have another $2 billion-plus that will reprice in the second quarter. In addition, we do have public funds, institutional funds that are priced off of the Fed funds that will reprice tomorrow for those that are repriced off of the Fed funds. So we will get some benefit there as well. In addition to what I mentioned, Cindy Wolfe and some of her team members are working on just generating a lot of improvements within our retail deposit branch. Customer experience is improving. So of course, we continue to work every day on improving our core deposits, which we think we're having good success on, which will hopefully continue to drive down that cost of interest-bearing deposits. Net interest margin as a whole compares favorably to the industry. We still have a very favorable comparison there. Asset quality is another area where we do well as compared to the industry, 9 basis points of net charge-offs. Last year, on nonpurchased loans, again, over our history as a public company, we've never had a year where our net charge-offs are greater than the industry as a whole. Even in the downturn, you can see we did have elevated charge-offs, but much lower than the industry, and those has -- went down quickly. So we had very good asset quality throughout our history, and we do not sacrifice when we make loans. And I mean that's priority #1, is making sure we have good credit quality within our portfolio and every one of our earning asset engines. Next several charts just show you how favorable those nonperforming loans and nonperforming asset ratios are compared to the industry and various other charts that show our asset quality is very good. And if you look at this chart which shows you our nonperforming assets as compared to our capital levels, our nonperforming assets are only 1.11% of our total capital, near all-time lows there. Efficiency ratio. Our efficiency ratio did increase slightly last year, 40.3% compared to 37.9% the year before. Still among the best in the industry. We are expecting -- we've really never managed that from the expense side. If you looked at our expense balances each year, they increase. We really try to generate favorable efficiency ratio from generating great returns and great revenue in each of our business units, and RESG is an important component of that. We expect noninterest expenses to increase in 2020. We are investing in making our bank a better bank. We're investing in a lot of different areas, not only in technology but risk and compliance and other areas that will allow us to be a much bigger bank than we are today. So we are investing in the future and how we can become a much bigger bank in the future. I'm going to hand it over to Brannon to let him talk through Real Estate Specialties Group, which is one of our largest -- is our largest earning asset engine, and then he'll hand it back to me.

Thanks, Tim. Yes. So RESG has been around since early 2003. We're currently 110 employees, give or take, with loan production offices in Manhattan, Atlanta, Dallas, L.A. and San Francisco that I'll cover their respective parts of the country. Predominantly construction ground up, construction lending, with some bridge lending mixed in as well. As Tim noted, all 100% floating rate debt. Today, we are less as a ratio of the total due to a lot of success in some of our other lending verticals. But still, today, 58% of the funded nonpurchased loan balances, 89% of the unfunded balances and on a weighted basis, 71% of the commitment of the funded -- unfunded balances of the bank. Our story has been increasingly about low leverage. As you can see today -- or I should say, at 12/31, 50.1% LTC, 41.8% LTV. Today versus where we were this time last cycle have definitely focused on that piece of it and have stayed true to it. The other sort of unique features of our lending unit are really the sponsor -- the quality of sponsorship, the quality of project and our defensive loan structuring, which, to Tim's point about asset quality, is a primary focus of ours. And as a result, over our 17-year history, have had average charge-offs of only 14 basis points. Some graphs on Q4 and the full year of 2019 in terms of our origination and all fundings and repayments. As Tim noted, the good times of 2015, '16 and '17 are coming back to us into some repayment volume on a more current basis, but that's actually -- there's silver lining in that as well. But we did actually increase our funded balances for 2019. So at the end of the day, positive results for us there. This slide is really a key slide, I think, to focus on. A lot has been made of our rapid growth and slowdown and then repayment challenges, headwinds that we faced in recent years. But we view this as demonstrating the strength of our story. At the end of the day, construction debt wants to be repaid on average in our portfolio, 34 to 36 months. That will start to extend a little bit, I would say, as the average size of our deals and the projects we're financing are larger and take longer to develop and ultimately execute. But as you can see, we did have strong growth, '15, '16 and '17. '18, as we've discussed, significant entries in the market in terms of nonbank capital. Really in late '17, we started to see that. And as things evolve in '18, some rapid changes in terms of the leverage points and structures and pricing. We were holding our ground in 2018. And you can see the significant reduction in origination. But in 2019, adjusted some of our pricing, not our structure, not our leverage, we've held true to that, maintained our asset quality. But still generated, I think, it was 37% additional growth to $6.48 billion in new originations in 2019. The dark bar represents the remaining outstanding balances. The green represents what's been repaid each year. As you can see, we've had significant repayments for our legacy portfolio, but it's performed really as we would want it to, as we would expect it to. Very little in the older origination years. And as we'll see on the next slide, all but one at very safe leverage point. So to the right, you can see a record year for payoffs at $5.67 billion. But our third best year in originations in the bottom chart at $6.48 billion. So -- and with respect to the future, we, at least coming into this year, thought we would meet or slightly exceed 2019 origination. Still feel good about where we are today. There's a little uncertainty, as we all know, but we're hopeful it's short term, and we return to the optimistic view that we had coming into the year. The infamous bubble chart. I think a lot of you will be familiar with, if you're not, demonstrating our average LTV -- not average, actually, our individual LTV on each loan that we've originated, that is still on our books. At the top, the large $57.5 million sole substandard credit on our book represents really an anomaly as were the charge-offs that we had in Q3 2018. This is the second home lot and home development out near Tahoe. As we've said in the past, today, we expect to recover all principal and interest on the loan, but it is a thin margin. So if things remain as they are, we should see that ultimately have a good outcome, but we watch it closely every quarter. Right now, we're having slightly above average of volume out there, so we feel good about where it is today. But we'll see how that goes as time marches on. But the rest of our portfolio, the older, smaller dots here back in older vintage origination year is very low leverage. We've maintained -- all of our loans are below 65% LTV and plan to stick to that discipline. This gives you a breakdown of our portfolio, really, as it relates to loan size. One of the great things about the previous graph Tim showed you in terms of our steadily increasing capital balances, our lending limit is increasing with that. It does give us the ability, not just to do larger loans, but to do more projects with our best sponsors in our best markets on our best projects. While we have, as you can see, done some larger loans above $300 million, still the vast majority of what we do is sort of in that $100 million to $200 million range. On average, about $75 million loan commitment. Regardless of the size of the deal, we stay very consistent with respect to loan-to-cost and loan-to-value across, as demonstrated there. This is another way to represent the consistency across property type, on the left, across MSA, on the right. So pretty consistent origination loan-to-cost and loan-to-value across property type and MSA.

I'll go through a few of our other verticals. Obviously, Community Banking is what we've done for the longest time, obviously, is our oldest and most established growth engine. We do have several specialty verticals. About 8 or 9 different verticals within Community Banking that we refer to as our specialty lending channels. Obviously, the bar chart down at the bottom has shown that we've had good growth. We expect in 2020 that the growth in these Community Banking as a whole, including all these verticals, will do -- will be better in 2020 than it is and was in 2019. A lot of these different verticals have hired folks in the last year or so and are really hitting their stride. So they've got good plans for 2020 to continue to expand what they've been doing. They actually had a really good fourth quarter, probably the best quarter they've had in several quarters. So hoping that, that trend continues. Obviously, the Community Banking space is super competitive, and -- which is one of the reasons we've decided to emphasize our specialty lending verticals within that group to be able to compete on expertise that we have in those verticals and relationships we have in those verticals. Indirect RV & Marine is a business that came from one of our acquisitions in 2016. This is a great business. We are very positive on this business. They focus on super prime, high prime consumer segments, high net worth individuals, average credit score of 790 and above. Over 50% of the portfolio has a 800 credit score or above. You can see the breakdown by loan size. The average loan size is about $90,000. They had a lot of good growth in '17 and '18 as they were expanding their dealer network. That dealer network has leveled off a little bit. We would expect that dealer network to continue to grow into 2020, but not at the same pace it did in '17 and '18. We feel really good about this business. This team, our 30-year veterans, the leadership. And this team of 30-year veterans, they were at a large bank during the downturn. And while they were at that bank, focused -- their focus was across the credit spectrum, across auto, indirect auto, marine and RV. They found, while they were there, that the super prime, high prime, RV, marine customer performed very well during the downturn, and that's why we decided to focus on that segment. And again, our net charge-off ratio has been very good. And then we watch on a daily basis the 30-day plus past due ratio. We've kept that ratio very low. But from a credit quality standpoint, we feel good about this business and return standpoint as well. So that's been a great addition to our team as well. This breaks down the growth in various business units. And we said, for 2020, we do expect some good, decent growth in 2020 on a nonpurchased funded balance growth, although we do expect it to be slightly or be below what we experienced in 2019. The makeup of that growth will depend on a lot of different things. We do expect indirect lending in RV & Marine to be lower than it was in 2019, but we expect Community Banking to be greater than it was in 2019. Obviously, this growth that we've had in indirect lending and growth we've had in the Community Banking verticals has resulted in our concentration ratios, and our growth in capital has resulted in our concentration ratios in CRE and construction to come down over time. We feel good about this. Feel good about being able to be where we were previously. Obviously, asset quality is the main focus for us. And if RESG in a year or 2 or 3 grows at the levels that it did previously and these ratios go back to where they were, we're fine with that too. But this does show you the result of some of the diversification efforts that we've had over the last couple of years. Slide on our loan-to-deposit ratio and the deposit mix. Obviously, our loan-to-deposit ratio has stayed in that mid-90% range. It's gone anywhere from 89% to 99% over the last few years. And we've, obviously, got -- through our 250 locations, we got a great ability to grow our balance sheet as needed, and we just typically manage to that mid-90% loan-to-deposit ratio to fund that growth. We do have a labs team, a fintech within our bank. They've been named one of the best fintechs to work for for the last 3 years. It's a great team. It's a growing team. They do a lot of things for us internally as well as externally. They've built a proprietary platform for Real Estate Specialties Group, that is a data platform that is really pipeline to pay off management for Real Estate Specialties Group. They're doing a lot of other things internally as well for us. Again, we mentioned the strong capital levels. Those levels have increased. We've got great retained earnings levels. Our growth has moderated some, but had solid, solid growth resulting in strong capital levels. And the tangible book value per share continues to increase, $26.88 as of the end of the year. Had good growth from a tangible book value perspective. And increased our dividends each year as a public company, and currently, as of 2019, at a 28% payout ratio. We would expect that payout ratio to increase slightly in 2020. So very committed to continue to increase our dividends and obviously have a pretty decent dividend yield right now. So Michael?

We have about 2 minutes for questions. Anyone? [indiscernible] Can you maybe make a comment about your guidance around [ production back ] in a little bit stronger than last year. It seems like you mentioned uncertainty. Is that something that is just a conjecture? Or is this something that you actually start to see in some of your clients getting a little bit more cautious?

So we're still seeing good business activity right now. I would say that's more -- coming into the year, everybody was very positive about the year. The one sort of uncertainty out there was the election. I think right now, with what's going on, that we're all hopeful that's just a pause to see what's going on, and then we sort of recapture that optimism through the end of the year. Right now, the first half of the year looks like we thought it would look.

One more. I would be remiss if I didn't ask the [indiscernible] question. I know you guys talked about [indiscernible]. Based on capital performance, [ it looks ] really good. Have those conversations accelerated? Is there some talk about it now based where the stock is?

We continue to talk about it. Obviously, as a -- over the 21-plus years as a public company, we have never done a buyback. We're very committed to our long-term strategy. We -- if you look over that time period, there have been times where we've had more capital than we've needed in that particular year. Our Board's hope is that we find ways to leverage that capital and use that capital. So no real change in our viewpoint there, Michael. It does continue to get discussed at our quarterly Board meetings. And certainly, at times like this when we're trading at a below book value valuation, those conversations become very, very active. But again, right now, our Board is committed to our long-term strategy of using that capital. And it's -- we do have more capital than our peers, but are still generating good returns and good earnings metrics, and that's really what we're focused on is how do we grow our business, and having capital allows RESG to have good growth and provides us opportunities in the future.

And I also got one more. I know you guys don't really [ give more of the ] guidance, but appreciate it [indiscernible]. What can you do on the liability side to offset some of the pressure from CDs?

Yes. First, it will be the CD repricing. Obviously, that will be impacted. But we do have about 20% of our deposit base that is public funds and wholesale deposits that will be repriced as well. We do have about 11% of our deposit base that is brokered as some of that is short-term CDs, anywhere from 6- to 11-month CDs. And the CD promotions we're doing today are anywhere from 9 to 11 months, so that will -- shortening the term. If you went back a year ago, the CD specials we were doing were probably 12 to 15 months. So we've decreased the promotional rates on CDs, but also shortened the duration, which will allow us to another opportunity to reprice those quicker. And then, again, always looking to grow core deposits as much as we can.

Anyone? All right. Thank you so much.

Thank you.

Thank you.