Bank OZK (OZK) Q1 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Bank OZK First Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I'd now like to turn the conference to your speaker today, Tim Hicks. Please go ahead, sir.

Good morning. I am Tim Hicks, Chief Administrative Officer and Executive Director of Investor Relations 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; Greg McKinney, Chief Financial Officer; and Brannon Hamblen, President and COO of our Real Estate Specialties Group. We will now open the lines up for your questions. Let me ask our operator, Joelle, to remind our listeners how to queue in for questions. Joelle?

Thank you. [Operator Instructions] And our first question comes from Ken Zerbe with Morgan Stanley. Your line is now open.

Good morning, Ken.

Good place to start. In terms of the…

Ken, we can’t hear you.

It looks like his line is disconnected. Our next question comes from Timur Braziler with Wells Fargo. Your line is now open.

Hi. Good morning.

Good morning.

Maybe we can start on your commentary that you used certain qualitative overlays to increase allowance in excess of the Moody's methodology. Just wondering if you can expand on what some of those overlays might be and which portfolios they were applied to?

Greg, do you want to take the CECL question?

Yes, I will George. Good morning, Timur. As we looked at our model results and we were using the Moody's forecasts that were published on March 27. And while a lot of that was around the – our focus is around the base case forecast, we did look at the alternative scenarios both more and less severe. And as we began to evaluate at least certain portions of results coming out of the various models that feed into our CECL engine, we certainly felt like that the magnitude and velocity of deterioration in the economy we saw in the last 30 or so days of the quarter really did not get fully reflected into some of those model results. So what we did was we looked at certain portfolios and we looked at a number of portfolios across the Bank, but we looked at those really in a more severe stress scenario. So we would have taken them – what might the results look like in a more of a downturn, more severe downturn relative to the baseline forecast that was kind of the base forecast for us. And what might those results look like that gave us some kind of boundaries of where we thought some of the outer reaches of projected losses through the models would suggest over the life of the portfolios. And then we use that to then inform various overlays and qualitative adjustments to our model output. So we ended up with several different qualitative overlays over various aspects of the portfolio and various product lines within the portfolio. George, I don't know if you want to comment on any specifically lines of business or aspects of the portfolio, but we did feel like that we needed to adjust where appropriate some of the model output to really fully reflect the velocity of change we saw in economic circumstances over the last 30 days of the quarter.

Yes, I think you did a good job describing it, Greg. I would comment that two of the overlays that we used increased the allowance allocations generated by two of the models. And then the other – I think there were four overlays. It may have been five, but I think it was four that were related to specific subsets of different portfolios within different model. So we tried to get it right and be appropriately conservative. Obviously, it's a very dynamic economic situation we are in and unprecedented in many respects. So the model – the guys building the models, I'm sure, at Moody's are striving to keep up and fine-tune those models to be appropriately sensitive and not excessively sensitive to all the economic dynamics. So we took a good look at it, and I think, made a good set of decisions on how to overlay those models.

Okay. That's helpful. And then looking at the deferral activity as of March 31, it seems relatively in check. I'm just wondering how that's trended post quarter end. And if you can give deferrals by category within the hotel, the office and the indirect and RV portfolio, please?

I don't think we can give you a breakdown on that by product type. We have that information, but I don't have that. Tim, do you want to comment on the deferrals in general?

Yes, happy to. Timur, the numbers that we gave in the management comments were actually as of the end of the day, April 22. So those are the fairly current numbers. So 1,675 loan had deferrals totaling $356 million, so roughly 2% of our total loan portfolio. A good number of those are from our indirect lending portfolio and consumer – obviously, it's a consumer portfolio. I don't have the specific numbers around those right now. But as far as the count goes, the largest majority of the count is coming from the indirect portfolio.

Okay. And then last one for me, realizing that the LTVs across all your different portfolios are quite low and realizing that it's a fluid situation, I'm just wondering is there any way to estimate what the LTVs could look like in the office and hotel books specifically? And then just going forward with the CECL implementation, how punitive will it be for future provision if there is a near-term spike in LTV or is there enough flexibility in the model that you can look out longer term?

Brannon, why don't you recap where we are on LTVs on those portfolios based on the most recent appraisals and then comment on that? And I may add a comment to that as well. But Brannon I'm going to defer you on the first response.

Sure. Timur, good to talk to you today and as we always do include in our comments, good detail on where LTVs are across our different portfolios and geographies, and those have maintained same levels that you've seen recently. As it relates to what those look like in the future. I would just say it's really too soon to know, I mean obviously with some of the stress that we'll see, there'll be influence on revenues, there'll be influence on cap rates, and those all affect values, but the degree to which those are affected, honestly, it really is just too soon to know. Obviously, as well as you noted the models do look to LTV as a significant influencer over the results there. I think all I would say there is with our very conservative LTVs, we would expect to show in those models as well as one could. Again, it's just too soon to know how fast and how far and then what recovery looks like.

I completely agree, Timur. And I would point out that our RESG hotel portfolio is 52% of cost and 40% of most recent appraisal. As Brannon said that 40% will undoubtedly come up given the stress that sector is facing as those properties get reappraised, but when you're 40% loan-to-value starting out, you've got a lot of room for degradation and still be in good shape. Our office portfolio, which I think was the other when you mentioned at March 31, we have 39% - I'm sorry, 49% of cost and 38% of the price value on the office portfolio. So I would just echo Brannon's comments, the significantly low leverage points that we're starting out with portfolio gives us a lot of room and that's why we've been conservative and worked really hard to keep those leverage points down, it's for just the sort of scenario, economic scenario that we find ourselves in today. It gives us a lot of comfort.

Good color. Thank you.

Thank you. Our next question comes from Ken Zerbe with Morgan Stanley. Your line is now open.

Thanks. Can you guys hear me okay?

Yes, Ken. Sorry, we lost you earlier.

No worries at all. George, when we think about all the moving parts in the RESG portfolio like specifically loan growth and loan spreads, is the next year or so going to be a net positive or a net negative for Ozarks in RESG versus the trajectory you may have been on near prior to the whole pandemic?

I think it's going to be a net positive. We've seen a slowdown in refinancing activity, of course, it's unfortunate that part of that slowdown is attributable to work being stopped on projects temporarily while a lot of cities are in shelter-in-place mode. That's hard on our project sponsors, but it does have a counter-intuitive benefit for us and that the loans stay on our books longer. So the slower rate of pay-downs is actually beneficial to us in a margin and yield perspective. Clearly, there'll be some competitors that have already and will probably longer term pull back from this space. That lets us have a little more bargaining power in structuring transactions and pricing transactions. So I think those are positives that outweigh the negatives. Clearly credit costs are going to be higher, not that we feel like there is significant credit exposure in RESG portfolio, we feel very good about that. But I would say on balance, we view it as a net positive for that portfolio. Brannon, you're in the hot seat at RESG as the President there every day. Do you agree with that or?

No, absolutely. Ken, I would say that as it relates to the balances in the growth, all as George said. As it relates to yield, I mean you're already seeing pullback in the realm of the competition, and we're already pressing in and trying to gain advantage there by not just holding, but improving our LTV, LTC entry points and moving our spread in a positive direction. So again, a lot of things changing rapidly, but as we look forward, I would agree with George, I see this as a positive.

Got it. And then in terms of your deposit costs, is there anything structurally different about your portfolio versus someone else's portfolio that might keep your interest bearing deposit costs much higher than peers over the next, I don’t know, say few quarters or years or so, or is it possible to bring that down much more toward sort of the industry average?

Ken, we certainly expect our deposit cost to continue to come down, and I think Tim commented on that in his part of the management comments document that we expect it to come down pretty much throughout the remainder of the year. And we're working hard to do that. Our real estate heavy portfolio is a little different than a bank that is a C&I-driven bank. If you're a C&I-driven bank, your borrowers are going to have about as many deposits with you as they do lines of credit and loan balances in many cases. If you're a real estate-driven bank as we are, you depositors are different for the most part than your customers because $100 million real estate doesn't have a project – doesn't have a $100 million of deposits. So $100 million line of credit customer may have a $100 million deposit, so it's a very different dynamic. So our deposit book is very much driven by our branch network, which is very retail and dependent upon online competition and local competition, and for some customers, online competition is relevant for others, it's just local competitors. So we're driven by that. But we do see our cost of deposits coming down steadily if rates stay where they are over the course of the year. And we've given you some guidance in the management comments about our CD book and how that is priced and how that matures out over the next several quarters. So you can look at that and get some indication.

Great. Thank you, George.

Thank you. Our next question comes from Arren Cyganovich with Citi. Your line is now open.

Thank you. I was hoping you could give us a little bit more feel for how your interaction works with the developers on the construction side when they're obviously going to be struggling as they can't work on their projects and how much kind of cash flow and support that you have from them during an extended period of stoppage? And what kind of actions you are doing to help kind of work with them to make sure that the projects get finished?

Yes. Well, of course, everyone likes to avoid supply chain disruption and project stoppage because it does create some inefficiencies and runs up cost in the process. The structures that we have in place with our sponsors included on any project where we've got construction completion guarantee. And that completion guarantee basically says in simple terms that they're going to complete the project on time, on budget and if they're not on budget, if there are gaps in the cap stack, the development cost overruns or project delays that increase carry and interest costs that they are on the hook for those. So the vast majority of our sponsors will have the financial wherewithal. We would anticipate to meet those obligations to rebalance. So if there is a couple of million dollars more interest carrier or taxes or insurance that accrued while the project has stopped for 60 or 90 days, and before it gets restarted there is additional cost incurred in restarting and that is contractually an obligation of the sponsor. And we would expect the sponsors in the vast majority of cases to manage that without any assistance from us. There are also contingencies and funds built at the end of these project budgets that in many cases will cover some portion or all of that. So when you start a large complex construction project, you assumed some things are going to go differently than planned, and you build some contingencies in the budget to allow for that. And there will be some request that we will get from sponsors where they will ask us, and we will feel capable of doing so to accommodate their request to help them with some cost and carry for a period of time when their operations are shutdown or the construction is shutdown. We'll do that in a very judicious manner. We are not going to do a modification that we think in any way jeopardizes our loan and we're going to expect sponsors to come to the table and participate in those requests as well. So that we're just not providing carry for the delayed period or something. So it's a very intense subject of negotiation and discussion, but our sponsors understand their obligations and honor them and we don't really see that is probably in many cases if any resulting in a problem for us.

Thank you. That's very helpful. I like the disclosure you put in, I thought those were really helpful on page 28 of the hotel portfolio. It looks like the bulk of these are LTVs below 60%. It looks like all, but one. Maybe you could talk a little bit about the support you're seeing from your hotel sponsors and the – I guess, like the real risk here is that, in case the CRE value falls below and then just give the keys back to you. That would be, I suppose the biggest risk that you're – at such a low valuations there, it seems like a pretty low probability event. But maybe you could just talk a little bit about the hotel portfolio?

Well, we share your point of view that that's a low probability in most cases because of the significant sponsors’ equity contribution and the significant price value beforehand. We also acknowledged that that sector along with everything in the travel and leisure sector is pretty hard hit right now. And most of these properties, if you're completing a property today, you're probably not starting operations, you're probably just mothballing that project for a month or two or three till economic conditions become better to restart it. And a lot of sponsors who started operations with project and we're a few months into it, we're still incurring operating costs in excess of revenue and just elected to shutdown and we'll restart those projects in a few months when conditions normalize. So there are issues there that will push those loan-to-values up because you'll have a period of restarting operations. But again, we thank all that is pretty manageable with our very low leverage on those portfolios, the quality of the projects and the quality of the sponsors. But a lot of these guys will be starting over their ramp up and business build up to a point that they can stabilize the property at kind of a full stabilization rate of revenue and get an optimal permanent exit for it. Brannon, you're close to this every day. You might want to add some comments or do you have any additional thoughts on that?

No, I would just echo and emphasize, our entire portfolio was really built for times like these and we've kept our leverage low 40% on our hospitality portfolio. We've got across the board really strong sponsorship and that influenced behavior with the amount of equity that we've got in these deals and supported that with solid structuring. George mentioned completion guarantees earlier and those sorts of things. There will be some challenges here, roughly half of the portfolio though is still under construction. And one could argue that having not already spent those ramp up dollars in the past, they've still got those in the budget and prepared very well there. And so one could argue that those that haven't opened yet are somewhat of an advantage from that point of view. But in any event, I would echo what George said. We're in a good spot right now. We're hopeful about what it looks like going forward. There'll be some re-ramp time involved, but we're very well positioned and very close contact with all these sponsors to understand the issues as we go forward.

Yes. And I would add one final comment. Most of our hotel credits are to people that are established veteran hotel operators and that's not all of our customers, but it's the vast majority. And I think those guys are going to handle this current situation in a business as usual, sort of crisis management situation that a lot of those guys have operated hotels through 9/11, they’ve operated hotels through hurricanes, they've operated hotels through floods, they’ve operated hotels through recession, including the great recession. So if you – the hotel business is a business that is subject to quite a bit of volatility and the veteran operators are going to realize that they need to continue to support their project and stick with it and the value is not gone even though their hotel might be shutdown right now, and they'll get that built back in a few quarters when they get to resume operations and began to ramp up occupancy in RevPAR again. So I think the fact that we're dealing with that quality of sponsorship on the vast majority of these projects is a big plus.

Thank you, George.

Thank you. Our next question comes from Jennifer Demba with SunTrust. Your line is now open.

Thank you. Good morning. George, just wondering what you're seeing in terms of deferral requests or other trends in the Marine and RV portfolio today?

We've talked a lot about that portfolio being not high quality portfolio and we have had a number of requests there, but it's in the single-digit percentages of the portfolio. Tim, do you have that number?

Yes, I do. From a dollar perspective, about 3.7% of the indirect portfolio currently has a deferral as of today.

We share a lot of data with peer banks and so forth and we've been asked by a lot of people that are – it's been commented to us that our deferral rates seem to be lower than what other banks are experiencing. And we're certainly honoring deferral requests per the federal banking guidelines for customers where their business is shutdown are their – they’ve lost employment or otherwise are adversely impacted by the COVID-19 pandemic. But we feel like our portfolio that portfolio relative to other similar Marine RV portfolio, the RESG portfolio, whatever portfolio you're talking about, we feel like we have maintained a conservative level of underwriting that has us with borrowers in most cases who are capable of withstanding these sort of turbulent times and don't need deferral assistance to do so. So I think that's why our loan deferral rates are better. I think we just got a relatively good portfolio is consistent with our historically better than average credit performance compared to the industry.

Thanks, George.

Thank you.

Thank you. Our next question comes from Matt Olney with Stephens. Your line is now open.

Hey, great. Thanks for taking my question.

Hey, Matt.

On the deposit cost, the commentary mentioned there were two public fund entities that were replaced at the end of the quarter for a much cheaper deposits. I'm curious what kind of rates were those entities receiving? And when were they replaced? Just trying to get a better idea of the savings between those entities and the FHLB that was added?

They were replaced. Tim, do you remember was that late February or early March or somewhere in there.

Right at the end of February.

Okay. End of February. And those deposits were expensive deposits. And really the replacement was not so much related cost as it was to concentration. If you look at our 10 largest depositors now in the Bank, I think that number is probably an aggregate less than 10% of our total deposits. If you go back a year, year and a half ago, the largest deposit customers, 10 largest deposit customers were high-teens percentage. So we basically cut our concentration among our 10 largest deposit customers in about half and gotten that down to a really core group of customer. So this has been one of the goals that we've had internally is to really reduce concentrations at deposits and diversify our deposit funding sources much more broadly, which we've done to add some duration to those deposits just to take out periods of volatility and deposits. If you've got big chunky deposits and somebody decides to move or you don't want to pay the rate, somebody insist on getting paid, then that leads to a noticeable shift in your deposit balances. So we really wanted to get that book much more diversified and add some duration to just add a lot of stability to it. At the same time that we've been increasing our cash positions and investment security positions and a liquidity position. So we're much more liquid and much more diversified on the deposit side than we were two years ago or a year ago. And we view that as positive. We spend a little money to do it. That's slowed our rate to decrease in deposit costs in some cases, but we've gone in several instances for qualitative factors over margin improvement in the short run. And I think that will serve us well in the long run.

Okay. Thank you for the commentary. And then on the investment security side, it sounds like you were opportunistic towards the end of the quarter. Can you tell us more about what you were buying, the average yield? And were you buying these at a discount? Thanks.

We found a situation that was very short lived and short lived because the Federal Reserve did a great job of repairing the plumbing of the financial markets really quickly with a lot of the liquidity and asset purchase programs. But there was a situation that developed for a lot of tax exempt, mutual funds, money market funds, debt funds, whatever. Suddenly we're having calls and had to liquidate their assets. So they were liquidating because they needed money and market was disrupted. They were liquidating, in a lot of cases, their best quality, shortest-duration securities that they could liquidate. And we really bought two categories of assets and these opportunities are long down. As I said, the Fed fixed the market so quickly that we really only had about less than 10 days to actually look at opportunities and harvest them here. So what we bought was really two things. There's a variable rate demand note market. That's the sort of modern day replacement for what a decade ago was auction rate securities, and it's much more protected market and auction rate securities. But because these money funds were more liquidating assets, they were pulling out of that. So you had a situation where really quickly bonds that should have been trading at 20, 30, 40 basis points in yield went to a 5%, 6%, 7%, 8% yield, it's per week at a time. So we made several hundred million of purchases in that market. Those things have worked their way back down to pretty much market appropriate rates now. So that was a short lived phenomenon. The other area that we had a chance to pick up and we picked up about $400 million or so of really short AA and AAA munis that are super high quality and majority of those have already been pretty refunded. So they're pre-re and treasuries with the trustee waiting for the date that they can be called. So these are bonds from a few months to probably the longest or a couple of years, but most of them are within 18 months and in or a year. So you basically got treasury, U.S. treasury securities backing these AA, AAA-rated munis. And these are bonds that would normally trade around 1% level or slightly above or slightly below. And that market's backed and you could buy those bonds at two, two and a half, three, three and a half, I think we've involved some in the fours and yields there. So they're short-term bonds and highly liquid, super high quality, pledgeable at Federal Reserve, pledgeable to the Federal Home Loan Bank, pledgeable to a lot of state public funds entities. So using $700 million or $800 million of our cash to buy these didn't impair our liquidity at all because they're highly liquid and pledgeable and all sorts of different places for advances. So it was a pretty easy decision to make to do that and that will help our margin a little bit because we took that out of money that after the Fed cuts was sitting in our Fed account at 10 basis points earning yield and put that in something yielding quite a bit more even if just for a short period of time. So kudos to the Fed on doing an absolutely marvelous job of fixing the plumbing of the financial market, so that was only less than a 10-day opportunity and darn them for doing it. At the same time, we would have enjoyed continuing to harvest those opportunities that the market stayed disrupted a little longer.

And just to clarify, George, when you say these were short-term opportunities, are these securities essentially still on the balance sheet at the Bank or most of them now moved on?

Yes. The variable rate demand notes had largely returned to a normalized yield level. Just really as of this week, they've kind of been drifting back down to what would have been an appropriate yield level. So we'll have to make a decision if we want to stay in those longer term, they're a one-week commitment at a time. That's about half of what we bought. The other half is a stuff that will roll out over the next two years and most of it in the next one year. We've talked a bit about our desire to maintain more liquidity and higher quality liquidity and certainly, we've built that up over the last year including the last quarter. So we could have gone in and the markets were disrupted farther out in duration and on bonds that were not pre-refunded, but still high quality bonds. We could've gone out farther in duration and little farther down the quality scale and probably really captured some very profitable opportunities there. But we tempered our – capitalizing on this opportunity by our desire to really keep a lot of liquidity on balance sheet and really short high quality liquidity that we could liquify several different directions if we needed to. All that's just an appropriate response to the turbulent economic conditions caused by the COVID-19 pandemic.

Thank you.

Thank you.

Our next question comes from Michael Rose with Raymond James. Your line is now open.

Hi, guys. Thanks for taking my questions. Just wanted to touch on the commentary in the prepared remarks around the dividend. I don't know if this was touched on already, but it said you may not look to increase it. You guys have been obviously, good stewards of capital over time, keeping high levels for these periods of stress. Can you just talk about thoughts on the dividend, potentially a buyback sometime down the road? And how you would expect to deploy some of that capital on the other side of this? Thanks.

Tim, you want to talk about that?

Yes, happy to. Thanks, Michael for question. Obviously, we've got a very strong capital levels. Our capital, if you look at Tier 1 leverage, our capital is, if not the highest among the highest as of 3/31 was the highest as of 12/31 of the largest 100 banks in the U.S. Obviously, we've got strong core earnings as well. We've increased our dividend every quarter, for the last 39 quarters, increased our dividend every year since going public. Really what we said in the comments, Michael was that we may continue to increase it, but if we do, we would expect the Board to slow the rate of increase from our track record from the last several quarters, which has been a penny increase every quarter. We'll just have to evaluate situations at the time and make a decision of whether they want to increase and by what amount. But our core earnings and capital levels will support – certainly support our current dividend level and certainly some level of increase from there.

Okay. One follow-up question. This is always one of my favorite charts. On 21, you have the tables, the RESG losses over time. On the one hand, the loss experience has been really good and we obviously know that, appreciate all the data you guys have provided over the years on loan-to-costs and loan-to-values. But I guess the pushback would be, you guys are doing much larger loans than you did back when RESG was getting going. And then during the last – during the great financial crisis, George, can you just kind of help us, again, I know you've done this in the past, but help us feel comfortable with the quality of your sponsors and how that translates to maybe some perceived risk around size of exposure by credit? Thanks.

Yes. Well, again, a sponsor who's going to do a $1 billion project or $600 million or $700 million project or a $2 billion project that's going to result in a loan of a couple of hundred million, $300 million, $400 million, $500 million, $600 million, $700 million. Those sort of projects are done by sponsors who have a substantial experience, capabilities that's been demonstrated on smaller projects. Real estate developer doesn't come in and typically start out with a $1 billion project and then you sort of have to grow your way into that capability. So the projects that we do that are much larger projects are typically done by your most sophisticated, most capable proven sponsors. They tend to be the best quality assets because fewer banks or other lenders are capable of doing those projects with excellence, it tends to narrow down the competitive field to do that. And our expertise in commercial real estate lending, I think distinctive capabilities that we have in that regard are worth enough for our sponsors to call on us to do those sort of projects. So we feel we get the best sponsorship, the best assets and the best deal structures. And that's pretty evident in our – if you look at another table in the slide deck where our loan-to-value is shown by a project type, the bigger the projects, typically, we tend to get a little bit lower loan-to-value on those projects. For example, our largest project is in the book is 43% of a cost and 39% of a price value. So we think those are our best assets, best structure, best leverage and in many cases, in the portfolio. As far as that being a large concentration for us, what I would tell you is, today, the largest single loan we've got is about 80% of our legal loan limit. More or less, that's not an exact number, but a close approximation and then you get down to 70%, sort of for the next one. If you go back to 2008, 2009, 2010 time period, we had a number of loans that were at or within a couple of percentage points of being at our full legal loan limit. So our concentrations, while they seem like big numbers now because our capital is multiple times what it was many multiples of what it was a decade ago or 20 years ago. We've always done large loans relative to our capital account and we're actually more diversified, less concentrated now than we've probably been at any point in my 41-year history of being Chairman, CEO of the company. So we feel very good about those loans. And we think the quality of those credits, the quality of the sponsorship, the quality of the assets, the structure and the leverage on the transactions will prove over time what good projects and good investments they are far. So we feel very good about it. Brannon, do you want to add anything to that since they're all your lines?

No. I think you hit the nail on the head. I think, the quality of the sponsorships and the structures and that low leverage brings in more often in these big deals a second really material capital source in the mezz loans that are behind us, and I don't know, call it a third of our loans. So that would be the only thing I'd add is that you kind of get a two for one in those situations of really strong, very well capitalized groups that add a lot of credit quality in our opinion to those large loans.

Good point.

Okay. One just final quick follow-up. As we think about RESG on the other side of the pandemic at some point, RESG historically been a very high growth business for you. Do you think it's structurally changed where we're not going to need as much space going forward and we're not going to have to build as much stuff x population growth? I guess, have the dynamics of the business changed enough where this becomes a very mature business? Or is there still enough on the other side of this you think that this will be an elevated growth driver for you guys? Thanks.

Yes. That's a really good question, Michael. And I'll give you my answer and let Brannon weigh in on his perspective on that. But clearly, you have periods in the CRE cycles or environment where you have more need for product and then you have periods where you have less need for a product. And I think it's very likely that in the aftermath of the pandemic care that we'll have a period where there'll be less need for all types of product and then economic conditions will evolve and you'll suddenly have situations where you need more apartments, you need more hotels, you need more office and it maybe different needs than existed before, but you will have a need. And then also against that backdrop, people are going to continue to develop properties because properties age and become less desirable unless obsolete and people can build a new product that has modern fresh amenities and features to it that makes it more desirable than the old stale product that is out there. And that's one of the keys of our RESG business. A lot of times, you're building – financing an office building or a hotel or apartments and there are already office building hotels and apartments in that market. But some of those have become less desirable because they're dated and they're stale and the features, the amenities, the look and condition of those properties are no longer desirable. If we were a permanent lender, you have to worry about the fact that your assets are constantly becoming obsolete because the world is constantly changing. If you're a construction and development lender, we just got to make sure that our sponsors are building product that's going to meet the evolving expectations needs and wants of users of that product going forward. So our product is always the newest, freshest, best in the market. If our sponsors are building the right product, it's our job to make sure we don't finance them if they're not building product that has a high market acceptance. Your permanent lenders on the other hand, are the guys that had the challenge. Wow, this was a great product a decade ago or two decades ago, but it's become obsolete. And in one of our recent experiences that’s been well publicized, a shopping center in South Carolina, you saw that. That was a situation where we had a permanent loan and that property just became functionally obsolete because we changed this in the retail space, 97% of RESG portfolio is construction and development loans. And those are all fresh data they are at properties. So I think we're extremely well positioned for an environment where for a few years you might have a need for less new products. I think the other dynamic that's going to apply into that is, I think a lot of folks that have gotten into the CRE space and financing are going to decide, wow, this is not as easy as RESG, Bank OZK made it look. Maybe we shouldn't be doing this. And I think you'll have some folks back out of the space permanently, which will let us get a bigger share of the pie with less competition.

Great. Thanks for taking all my questions guys.

Thank you.

Thank you. Our next question comes from Brock Vandervliet with UBS. Your line is now open.

Thanks very much. I think you guys are to be congratulated in your deferment policies. I think too many of the banks have just kind of airdrop these things and it's good to see a lender who's more judicious. On the RESG issue, I feel like, I get the stoppage – the construction stoppage. I think here in New York state, they've stopped all construction. It doesn't seem like it's a big deal at all. It seems like the ultimate pain point though is take out financing, where to your point, George, longer-term, some of these things may not be viable, but I would worry about projects that are coming in the near-term, do those pencil anymore for the takeout financing if they've got a big slug of retail or even office. It seems like much of the world maybe somewhat changed, can you talk about the risk to the takeout in the near-term? Maybe this is a question for Brannon.

Brannon, do you want to take that?

Yes, let me take that Brock. Good question. And somewhat tied to the previous question and the answer, which I felt like George did a good job of hitting on that. I think as prognosticators, sometimes, we look out at change and view it too positively or too negatively. And with or without COVID, you've got the risk of changing tastes and preferences and the aging of product, et cetera, et cetera. But with the rate of innovation, the markets are increasingly efficient at seeing – adapting to require change and the finance markets follow. And I think, obviously as it relates to retail, we have over time drastically reduced the amount of exposure that we have in that property type. I think, we're down to 0.6% in our retail portfolio. And there's obviously some in our mixed use portfolio, but much smaller, more amenity type situations. And in the office market, as long as I've been in this business 30 years now, people have been having different opinions about what’s the right configuration is and how much should we have, should we have open space. And those opinions are always changing and people were trying something new and it results in a new direction. But the fact of the matter is I think that people are going to need office space. There is a time required for conversion to the latest and greatest need. And look, in the past few weeks, the CMBS world has obviously had its struggles, but it's showing signs of life and folks trying to – the issuers trying to do deals. So there is no question that ultimately that permanent finance will be our takeout. But this is really reminiscent of the great recession and where we were. And as George noted, it was a different portfolio. There were smaller projects, but a lot is similar and as much as our leverage was all right then. It's phenomenal now and our ability to wait till those markets recover, which we believe they ultimately will. We actually view as potentially positive with respect to balances on book longer. And all the things that we've noted numerous times before with respect to who we're doing this business with and their inclination to protect their significant equity position and plus the fact that they're just good people that do the right thing, we feel like…

Sorry, have you disclosed calendar of completions like what we should be kind of having our eyes on here?

I don't believe we've disclosed anything with respect to that Brock.

And Brock, we have a lot of completions. You can look at the cadence slide that we've got in our – that shows originations and payoffs, and most of the 2017 originations, a large percent of those are either recently completed or will complete this year. So you can look at that and infer a pretty good estimate of completion. But that's not the real question. The question is, is the quality of those assets and the viability of those assets. I mentioned earlier in response to an earlier question, you may have been in queue and not heard it. But I was asked, the question is on balance. Do we think this environment is good for RESG or bad for RESG? And I said on balance, it's good because we lack keeping loans on the books longer. We would – you've heard us complain over the last several years about the fact that the velocity of payoffs got faster and faster and faster and that was cutting into our returns on individual loans. So if the secondary market is disrupted for a few months or a few quarters or a year or two, and those loans stay on the books longer term, we're fine with that, because we've got very low leverage on those loans and we've got very good rates on them. We've got the construction loan rates. So if you can have construction loan, our construction loan leverage, roughly 50% of cost or 51%, whatever it is, or low 40s of a price value on an asset and keep it on the books for an extra six months or a year or 18 months, I doubt we'll get to keep it in at 18 months, but six months or a year extra and earn our construction rates of interest on that. That's really good because the permanent lender that will take them out will charge a much lower rate and we'll give them 1.5x to 2.5x as much leverage is we have on the asset. So if we've got a $100 million loan, the permanent loan is going to be $150 million, $200 million, $225 million, $250 million and at a lower rate than our loans. So if that market is disrupted and it lets us earn our interest for another six, 12 months, that's a positive for us at our leverage.

Got it. Okay. All right. Thanks for the color.

Thank you.

Thank you. Our next question comes from Stephen Scouten with Piper Sandler. Your line is now open.

Hey, thanks for taking the question guys.

Hi, Steve.

I'm just curious, quickly, I know you talked about some of your peers maybe thinking your percentage of deferrals were less than theirs. And I'm just wondering, how much of the deferral process was you all doing outbound calling versus customer requests that were inbound? It seems like some of the higher numbers we're seeing from banks are due to a lot of outbound calls attempting to put loans in deferral, if that makes any sense.

We have not engaged an outbound call and we've been responding to customer inquiries. And as I said earlier, if a customer's lost their job or their business has been shutdown or they've otherwise legitimately been affected by the COVID-19 situation, we're very receptive to within the guidelines established by the federal bank regulators, being accommodated to help those guys with the payments over the next few months. On the other hand, you don't want to do that unless there's a legitimate need to do that. Because, the reality is if you're interest rates, say is 5% on the loan and – or say, it 6% and you're deferring six-month payments, well, that's 2.5% or 3% increase in your loan amount. That's a modest increase in your credit exposure profile. But it is an increase in your credit exposure nonetheless. So you don't want to do it unless it's a legitimate case to do it because otherwise it just slightly degrades your credit quality profile.

Yes. Makes sense. I'm curious, you guys have obviously over time done such a great job of taking advantage of disruptions in the market. And obviously you talked about the muni investments that were, unfortunately, or fortunately, I guess, to the market take short-lived. But I'm wondering what else you guys are seeing in terms of opportunistic ways to deploy the capital that you all have probably rightly been holding for just such of these opportunities.

Well, I do think a lot of business opportunities in the RESG world are coming back our way. We are in a situation where in most product types we're able to get better pricing. Now that better pricing is, is simply a reflection of the fact that we're having to put up more credit reserves using CECL, and applying CECL in a very difficult economic environment has resulted from the COVID-19 pandemic. You're going to put up higher reserves for them. We saw that materially in the quarter just ended. So you've got to get your loan pricing up to reflect the fact that you're having to post higher reserves on all of these credits. So we've done that. The market conditions have allowed us the opportunity to do that. Hopefully, some of these reserves that we're posting in this environment will ultimately in future years prove to not be needed, and we can recapture some of those. But right now, you're having to post the reserves for them, so you've got to get the pricing for that. So I think we're already seeing some element of pricing come back our way, some element of business volume come back our way in some areas. The counter to that is in other areas, we're seeing folks that have continued to amp up the aggression on price and quality to the point that we're out of the market, such as our Marine RV business, where the competition is just gone to a point that we can't – we're pricing deals there, but we're not in the market and we can't get our risk adjusted returns based on where our competitors are playing. So we're sidelined in that market for all practical purposes, for what I suspect is going to be several quarters.

Got it. And then maybe just last thing, I'm curious if you could give some detail, I know you said, pricing is improving a little bit, like you said, some of that's due to credit build up that has to occur, that kind of where you're able to put LIBOR floors on new production today versus maybe where that is on the unfunded book even just to give us a feel for it those funded loans will fund a similar rate to what's on balance sheet now. And then any color you can give to that RESG pipeline into 2Q, you intimated that it was still pretty strong, but may weaken in the back half of the year. So I was wondering if you could frame that up at all.

Yes. Well, let me take you to figure 14 of the management comments document which is I thought Jay Staley, who worked on as far as – I thought Jay did a brilliant job in depicting where our floors are on all of our loans here and how they respond in an up and down environment. So 53% of our funded balance are at their floor, 65% of the total commitments are at their floors, as of March, 31. Now a couple of things that I'll give you a little color on that will help with that is a lot of our RESG loans, I think Tim and Brannon would probably tell you about 65% more or less, and I’ll say two-third roughly of our RESG loans are monthly adjustable as opposed to daily adjustable. So those loans weren't at their floor on March 31, but probably hit their floor on April 1 when the monthly adjustment occurred. So that is a little explanation that probably needs to go with that. But you can see in a down 25-bp environment, 59% and 70%, respectively, would be at their floors. And again, part of that is due to not just the timing of those adjustments on the RESG loans being predominantly on the first of the month, but the other factor is as LIBOR kind of flared out in March, which was helpful to us and will be helpful to us throughout the month of April. And you've had LIBOR coming down recently pretty nicely every day unfortunately, and that will cause us to trip more of those floors just as LIBOR adjust without any further movement in other market rate. But you can see where the floors are as rates rise. I think that table is very helpful. If you study it just a little bit, I thought Jay did a great job in putting that together for us.

Yes, for sure. And as it pertains to framing up the 2Q pipeline maybe various versus other quarters.

Well, the pipeline is very good going into Q2, and as we say in any quarter you've got to get it closed and booked, but we're feeling pretty good about that pipeline going into Q2. It's hard to know what the second half of the year looks like. We do expect some of the prepayments that we would have expected in first half of the year to occur in Q3 and Q4 because I think some of the permanent lenders who pulled back away from some deals in Q1 just kind of in shock and awe at what was going on, will get their bearings in market and those guys are not going to – these are big companies and big investors in the CRE space on a fairly continuous basis. I think they just pulled back temporarily to get their bearing. So we expect we'll have more significant payments late in the year, particularly probably in Q4 now. So the timing of that sort of moved in our favor, but I think we still get a lot of prepayments in the back half of the year. And then originations. It's hard to know, you've seen on the one hand sponsors pulled back from projects because of uncertainty, or they're concerned that they can't make their equity returns that they want in the new economic conditions and at the same time, we've seen a lot of competitors pull back. So we've had calls from people that we lost business to other competitors based on significant rate differential they are calling and saying our lender dropped us in the grease a week before closing or at the closing table, and we've still got our equity intact. We want to go forward with this project, we believe in it, we know we turned you guys down on your quote, but we'd like to come back and revisit that issue. So you're seeing some projects get put on the shelf, you're seeing some projects come back our way from competitors and that's why we pulled our loan guidance for the rest of the year because we're just not sure how all that plays out with everything else that's going on in the economy. But we're hopeful it's too soon to really call how that plays out in Q3 and Q4.

Got it. Really helpful color. Thanks for the time.

Thank you.

Thank you. Our next question comes from Evan Lisle with Janney Montgomery. Your line is now open.

Hey. Good morning, guys. Yes, this is Evan on for Brian Martin this morning.

Glad to have you, Evan.

Glad to be here. Just a couple of quick questions for you. I think firstly focusing on your PPP loans. I know you gave a little color on the number of funded loans in the balance, just was curious looking forward what quarters you expect to realize those numbers.

That's a good question. I don't know that we know that. That's how PPP program has come about really quickly. And when they launched it with quite a bit of unanswered questions, and it took a few days and over the weekend they really got get enough of those questions answered for most of us banks do feel comfortable going forward with program. The second phase of that's probably started today, I don't know, it might have started already whenever the President signs the bill and the SBA opens up their E-Tran pipeline. Again, we've got another almost 2,000 loans that are fully documented and papered and ready to submit and our labs team has built a submission piece of software that will allow us to load those loans in about two to three minutes each as opposed to what normally would be a 60 to 90 minute process for loading those loans on to the SBA system. So we realize it's going to be a race for our customers to get the final dollars in that. So we're working really hard to make sure that we execute really well, but it's important for our customers. That's important for our communities. So we really want to do a good job for them in that. When these actually get forgiven and paid off that's anybody's guess, it's going to be a huge process and we think a lot of those might get paid off in pretty short order. But it's going to – we've never done this before. So we'll see how it works out.

Okay. That's helpful. I guess next shifting to the margin. I was just curious about how much of that emergency cut in 1Q was reflected in the reported margin, given that LIBOR getting churn in line with Fed funds throughout much of this quarter. I guess when do you expect the full cut to be reflected?

I think much of it. Most of it was reflected in our last month of the quarter's numbers. I think, it will pretty much all get reflected into Q2, and I want Tim to comment on this. He may have a little bit different perspective and color. With that said though, it's going to take us really through the end of the year and probably through the first quarter of next year to get substantially all of the deposit cost cuts in there. The Fed's really fast action, they cut 225 basis points in three quarters and 150 bps of it in short order here in March. We did not adjust deposit cost nearly as fast as loan yields went down. So I think you'll see a pretty much all get baked into loan yields in Q2, what's not already baked into Q1, but it will take us through the end of the year to get most and then substantially all of it through the end of the first quarter of next year on the deposit side. Tim, is that your same view on that or do you have different color on that?

No, I agree with that, George. And I'll – Evan, I’ll point you to figure 40 on page 32. We mentioned earlier in the call that we will give you some breakout of our CD book by quarter and by rate and so obviously we've got a good opportunity to reprice that book down significantly and that will help drive some of those deposit cost decreases in Q2, Q3, Q4 and into Q1 of next year.

All right. Thank you. Yes, that's helpful. And then I guess just last question for me. Earlier in the call, you touched briefly on the indirect RV and marine book given that is in our shrink mode. Are there any sub-segments that you're more concerned on from a credit standpoint? Any color would be helpful there?

No, we're not – the past dues in our portfolio and all are continuing to behave very well. Obviously, it is consumer portfolio and when you have, I don't know what do we had, close to $30 million initial jobless claims in the last six weeks and you've got thousands and thousands and thousands, tens of thousands, probably hundreds of thousands of business to shutdown across the country that will have some impact on a consumer portfolio. But our decision to let that market just move away from us on pricing and credit is not a result of any conditions and the existing portfolio, it's just a mathematical fact that with some of our competitors has been very aggressive on price and others being very aggressive on credit that we just didn't feel like we could be competitive at risk-adjusted returns that had us in the game. So we're pricing the products, the way we think it needs to be priced. But that's got us out of the market. So hopefully, the market will come back our way. We've got a great team there. We feel super confident in our team's ability to execute our business strategy if competitive conditions will allow us to do so. So we're hopeful the market will come back our way over the next few quarters there.

Okay, awesome. And then just circling back to my first question on the PPP loans, just a housekeeping item, what's a good average rate to use for fees on that?

Probably in the 3s.

Okay, awesome. Well, I appreciate the color. And that's all for me.

All right. Thank you.

Thank you. I am not showing any further questions at this time, I would now like to turn the call back to George Gleason for closing remarks.

All right. Thank you, guys all for joining the call today. We appreciate the great questions and your continued interest in Bank OZK. We look forward to talking with you in about 90 days. Stay safe, stay well. Have a good rest of the day. Thank you. That concludes our call.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.