Bank Ozk (OZK) 2024 Q2 法說會逐字稿

Good day, everyone, and thank you for standing by. Welcome to Bank Ozk second quarter 2024 earnings conference call. (operator Instructions) Please be advised that today's conference is being recorded. I would now like to hand the conference over to the Director of Investor Relations, Jay Staley. Please proceed.

Good morning. I'm Jay Staley, Director of Investor Relations and Corporate Development for Bank Ozk. Thank you for joining our call this morning and participating in our question-and-answer session. In today's Q&A session, we may make forward-looking statements about our expectations, estimates and outlook for the future.

Please refer to our earnings release, management comments and other public filings for more information on the various factors and risks that may cause actual results or outcomes to vary from those projected in or implied by such forward-looking statements.

Joining me on the call to take your questions are George Gleason, Chairman and CEO; Brannon Hamblen, President; Tim Hicks, Chief Financial Officer; and Cindy Wolfe, Chief Operating Officer. We will now open up the lines for your questions. Let me now ask our operator [Karmen] to remind our listeners how to queue in for questions.

Thank you. Yes. (Operator Instructions) Matt Olney, Stephens.

Hey, thanks. Good morning, everybody.

Morning, Matt.

So want to start off I guess on that San Diego life science project and the additional capital that you disclosed in the management commentary. And any color on why the amount, the $87 million that was included. I mean, presumably, I guess the new capital partners have some type of intrinsic value there, assuming the project. Any color on how we arrived at $87 million?

Matt, our loans all include reserve replenishment requirements that are subject to a calculation in our reasonable judgment, and that was simply a mathematical calculation based on our judgment for the part of the loan documents. So it was a regularly scheduled reserve replenishment that was required to come from additional equity. And there was no magic to do. It was just a mathematical calculation.

Okay. Thanks for that. And then I guess just kind of following up there, the $87 million, did it come in the form of additional collateral? Or did the new mass partner take out the original equity sponsor? Just any more details behind the transaction that took place.

The original equity sponsors fully engaged in the transaction and pursuing it. The mass partner is fully engaged in the transaction and pursuing it. Came in the form of cash by wire transfer, it's almost all capital contributions due into an account in the bank where it's held as a reserve for future interest and expenses on the deal side.

I mean, very standard deal. There was no drama or no, nothing unique about. It was a standard replenishment of reserves. If the analysts wrote the research on the report on this had bothered to ask us any questions about it regarding, what's your capital structure like? Who's in it? Are they going to continue to support it and so forth?

We could have explained. We have two very strong parties in this transaction. We are in a lot of business with the mass lender and the answer is, the strongest of the two partners by far their capability to support the project financially as well as executed if they had to is clear cut. But the sponsor is fully engaged in this.

They're proceeding with the transaction, the equity part -- the mass partners is needed but, this thing should have gotten the attention it deserved. It's a great asset, five great buildings and probably one of the best locations on the West Coast with a very strong, very capable sponsor capital partner group supporting it. And if it takes two years to lease or three years to lease or five years to lease, those guys will get to the finish line on it. I'm confident that is certainly our view of it.

If we had been asked questions about it, I think we could have avoided all the drama and unnecessary publicity about this project because it's an excellent asset. And as we said in our management comments, we're given full disclosure on that buyer. We consider it a high-quality asset and we don't expect to discuss it again.

Okay. I appreciate that and appreciate all the good disclosures on that project. I guess one of the questions that I'm getting from investors are just trying to understand the circumstances that would result in a construction loan to be graded below past rated, and not necessarily for any specific project, just more broadly if the construction loan is still under its interest reserve period, but the lease ups are behind plan or something is behind plan, the project. Help us just appreciate the circumstances that would drive that construction loan to be below past rate.

Well, Matt, that's kind of depend on a totality of circumstances. Number one, we're always looking at the strength and quality of sponsorship and capital partners and their investment and their commitment to continue to support a project that may be maturing a little more slowly than was originally expected. So sponsorship, quality of sponsorship capabilities. So sponsorship are certainly number one.

And number two is just the long-term expected prognosis and outcome on that project. It's not particularly alarming to us that a project delivers without leasing. The question that really drives our evaluation of a project is number one, the sponsors have the will and the capability to support a project till you have a successful outcome.

And number two, if the project of the quality and nature that you're going to have a successful outcome, whether it's this year or next year, three or four years down the road, and if you've got sponsors, you have the motivation and the capacity to carry it and the project is going to ultimately have a successful outcome, then you certainly have a positive view of the project. And the San Diego project certainly fits that criteria.

You know, the motivation that drives our customers to support their project is largely dependent upon the tremendous investments they have. And the projects, if you've got, our average loan to cost on our portfolio, I think is 51%. Jay, is that where we are now?

And our average loan to value is 42%, 43% even with all the reappraisals in this cycle that's still where we on a weighted average loan to cost, loan to value basis. When you've got 50% of the cost of a project invested is equity pref, equity or mass, your subordinated members who have the capital structure. You have a cap. The very nature of the cap stack, you have an inherent motivation to defend that investment.

For example, you know, our loan on the San Diego project is a $0.5 billion. The capital partners in that equity and mass have over a billion dollars committed to that project. They are not going to walk away from a billion dollar investment lightly.

So the second part of the test is, is the project capable of having a successful execution? Now there's a lot of noise in the CRE world today about projects that are just totally dead. And those are projects that are principally older projects that are in bad locations have 50- or 60- or 30- or 40-year old designs and are not built to current standards.

So the combination of our low leverage and the fact that we've got ground-up new construction that is built to modern standards, modern needs, modern expectations from tenant and buyers so that our sponsors have won a huge incentive because of their big investment and, two, our motivation to continue to support it because our projects will ultimately lease or sale and be successful.

The other thing I would tell you about that is, we talk a lot and we've said this since the Fed started raising rates that we expected the vast majority of our sponsors would continue to support their projects until economic conditions normalized, our property performance reached a stabilized state, and that's certainly true.

What I would point out to you while we have a handful of substandard loans and a handful of special mention loans in the RESG portfolio, all of those loans are current, and the sponsors remain engaged in working towards solutions on those projects. And the only two instances [we pay at worse] sponsors have given up on a project or the two pieces of OREO we have.

So every one of our substandard credits is current and performing in the sense that it's not past due and we put one of them on non-accrual because we wrote it down, and what caused us to do that is some noise from the sponsors about their commitment on that small project to continue to support it. So that we consider the most challenged project we've got.

But even with that, the sponsors have made their monthly interest payment out of their pocket. They're smart and they continue to work to try to craft a path forward that will salvage some of their investment, keep our loan current. We wrote it down. We classified it because we take a pretty conservative, proactive view on these things, but it's still a current loan.

Okay. Thanks for all the color. I'll be back in queue.

Alright. Thank you, Matt.

Catherine Mealor, KBW.

Hi, thanks. Good morning.

Hi. Good morning, Kath.

Why don't we just on paydowns, which were accelerated this quarter? I know that you mentioned there were two larger loans that paid down. But just any thoughts on what do you think that will look like for the back half of the year? Are there any larger credits that you foresee coming in or was it kind of large level, an anomaly, we will kind of get back to more like $800 million to $1 billion kind of pace that we've seen recently in the back half of the year?

Catherine, we were happy this quarter to have included in all of our prior quarterly discussions about paydowns, the comments that paydown may vary significantly from quarter to quarter and may have a significant impact in one quarter or another. So true to that form, you've seen a wide dispersion in paydowns and the first two quarters of this year, $790 million in Q1, $1.840 million in Q2.

We have telegraphed for some time that we expected a higher level of RESG repayments in the future. And that future showed its first signs of manifesting in the quarter just ended. I think when we'll really see a greater acceleration of paydowns quarter to quarter will be when the Fed starts reducing rates and probably a couple of cuts into that initiative. You will really begin to see some projects move.

My best guess, and I'm going to lean heavily on our long-standing comment that repayments can vary significantly from quarter to quarter. But my best guess is that Q1 and Q2 of this year sort of frame a range within which our Q3 and Q4 repayments will fall.

I'd be very surprised if we I had over $1.84 billion in repayments in Q3 or Q4 because I don't think the Fed's going to move rates until September, December, and I think really getting more big quarters of paydowns has probably going to be dependent upon getting some rate movements.

So I think Q1 was low, Q2 was higher, Q3 and Q4, probably fall somewhere in the middle of those is our current best guess.

That makes sense. And then as we think about paydowns accelerating next year and trying to refill that bucket, I know there's a lot of momentum in your CIB business, and that's now $2 billion or about 7% of loans. Can you just talk a little bit about your outlook for that business? What size loans are you typically doing or you expect to do? And maybe how fast would you expect this business to grow over the next couple of years to refill, potentially get a decline in RESG balances?

Yeah. I am going to ask Brannon Hamblen, who's on the line with us to comment on CIB and the importance of that handoff for continued growth in our balance sheet in future years. So, Brannon?

Yeah. You bet, George. Catherine, thanks for the question. Great question. A topic that you have heard us talk more about, will see us talk more about in the future. And as George indicated, there's a great sort of transition in front of us as RESG repayments start to come in. And this is something we've been working on for a while, and the latest hires and expansion of the team that we made are really just the latest evolution of a strategy that we've been working on for quite some time.

The CIB team, as we've said, is made up of several different sort of sub-business lines and three of those were in place, ABLG and Equipment Finance most recent as the last couple of years. And those teams have really started to hit their stride. But we've also added some new team members. We've had some phenomenal opportunities to have some folks join our team that are really incredibly talented, incredibly connected, great performance already, you know, in their respective careers, and they've got a credit mindset that's really well suited to our priorities, which, as you know, are always quality and yield ahead of growth.

But they have, as you can see, demonstrated the ability to achieve all three. As it relates to sort of the size of credits. It's a lot like RESG and that we have a pretty good spread in terms of the size of the credits. The loans aren't as big as some of the RESG loans, but it's not uncommon to sort of live in that, call it $30 million to $100 million, and $150 million range. We'll have some that will be bigger but they're solid credits, highly monitored credits that we expect to have very good credit quality on.

And, as we said -- you noted 7% of the funded portfolio as $2.1 billion. They actually originated over $500 million in the quarter just ended. So as we see the repayments likely accelerate as George said, in the near future, we believe we've orchestrated what should be a pretty smooth handoff sort of passing of the loan growth baton, if you will, from RESG to CIB in a very beneficial manner.

I think we've got a great shot at timing that, almost optimal manner. So we're extremely excited about the opportunity there to grow and diversify our book.

Right. Thank you.

Manan Gosalia, Morgan Stanley.

Hi, good morning.

Morning, Manan.

You noted that sponsors have a lot of motivation to support the properties, given how much you have invested at the bottom of the cap stack. And I'm assuming that if the property is taking time to lease, it also stays on your books for longer.

So I guess my question is, you know, what does the borrower do in the meantime? Is it an interest-only loan until it repays? Do they bring in more reserves? Can you explain what risk mitigants you bake in when loans are extended, and they essentially stay on the books for longer?

Yes. Happy to do so, Manan. What I would tell you is our portfolio management today through this cycle has not resulted in any concessions by us on any of those loans that would constitute one of those loans having been a TDR, troubled debt restructuring, if we were in the old accounting world where there were TDRs.

So we're sensitive to make sure that we're not becoming equity lock in our handling of the transaction if it takes time to work these things out. So we continue to maintain market rights on those, current rights on those, in many cases, we're improving the terms. The sponsors typically have to pay standard or upsized fees to extend those loans. And we require replenishment of reserves as we deem appropriate and in many cases are getting that principal paydowns on those loans.

So equity is equity. Equity has equity responsibilities where the senior secured loan, we don't have equity responsibilities. So the equity has to do the equity lifting on these things. But as I said, where needed our sponsors if done that with the exception of the two sponsorship groups that we have, those OREO properties [paying there].

So, yes, loans may stay on the books longer, but those loans are structured in a way that we feel good about them staying on the books longer or making substantial profits on those. And as long as the sponsors are doing the right thing on those credits, we're happy to have those loans on the books.

I will you a good example. Our longest standing classified asset in the RESG portfolio, just the project out, the development out, near Lake Tahoe that we had some nice progress on that in the last quarter with a sponsor selling the club amenities that development project had reached the point that of maturation that it was a time and the opportunity was there to sell those club amenities that resulted in $11.1 million paydown on our loan.

I believe, and I haven't looked at this probably since the beginning of the year, but I believe that over the life of that loan, our sponsors have paid us $30 million-something in interest and fees on that loan, which is roughly about the same as our $32.3 million funded balance.

So while we would prefer to not have a classified loan on the books long term, if the sponsor is doing the right thing and working the project and paying the interest and paying the fees and performing on the loan, we're going to do the right thing and work with the sponsor.

Again, we would prefer to not have a classified asset on the books for a long time. But our principles of do the right thing always mean that we got to do the right thing for our sponsors. The sponsors got a project that's got challenges. They are rising up and doing the equity responsibilities to meet those challenges. Then we got to be fair and reasonable and work with the sponsor on our originally agreed terms to get that project to a successful conclusion.

We're going to do the senior lender buying. They got to do the equity responsibilities. So we got to be fair and raised more with them and that's profitable for us to do it even if we would prefer to not have the classified assets problem.

That's great color. Thank you. Maybe as a follow up on NII, I noticed the proportion of NII coming from interest reserves has been ticking up slightly. Can you talk a little bit more about that dynamic? Is that indicative of more stress in general in the CRE market? Or is it just a function of longer staying on the books for a longer time, while rates are higher? Can you just walk us through how that works?

I'd say it is not a function of any stress at all whatsoever. Money coming from interest reserves sounds like, oh, my gosh, you know, you're burning down your reserve. But here here's the deal. When you put together a loan, Manan, you have a capital stack on that loan and sources and uses of funds on that loan from day one.

So interest over the period of construction, though the life of the construction of a loan is built into that. You know, you've got your land costs, you've got your hard construction cost, you've got your closing costs and fees, your tenant improvement and leasing commissions, your interest reserve, your tax reserve your -- all the costs that go into the cap stack. We want the sponsors to put all of their equity in before we put ours.

So if we say to the sponsor, okay, you're going to fund 50% of the cost of this $200 million project, we want all your $100 million to come in parts while there is no interest at the beginning. So all the sponsors money has kind of come into the land and the architects' fees and closing costs and the title policy.

In the beginning, initial construction, and then we start funding the last $100 million of the loan. Well that's going to construction. But that's when all of your interest is going to a curve. So all of the interest on these loans is typically in our budget, not because we're subsidizing the project by carrying the interest, but we made the sponsor put in all of their equity upfront.

Now we can be really stupid and not structure the loan in an intelligent manner and say, okay, sponsor, you put in $85 million of your $100 million upfront and then when it comes time to pay the interest, write checks for the other $15 million, that's the interest. But then what if the sponsor doesn't write your checks or what if he doesn't have the $15 million?

So we get all the sponsor money upfront because that's the smart, safe way to do it. And that means all the interest reserve is in our loan. So as all those loans, that big record volume of originations we have in 2022 funds up, more interest is being funded from interest reserves than before. It doesn't mean anything about weakness in those credits. It just means that we're smart in a way we structure these loans.

We make sure we've got the equity or the equity in first so that there's no doubt about the equity coming in later. And that means the interest reserve is built on our loan. It is not in any way a sign of weakness. Our loan is also structured so that if we get to the end of construction and the project is not leasing or selling or refinancing as quickly, then the sponsor has an obligation to replenish those interest reserves.

And that's happening with virtually every loan extension modification renewal. Those sponsors having to put more equity into the project to replenish those reserves to carry it longer because we've got built into our budget enough interest typically to carry it through construction and what was expected to be stabilization of the project if it takes longer to get to stabilization. Then the sponsor has to write additional checks to carry it. And that's an equity responsibility, not a lender responsibility.

Got it. That's very helpful. Thanks so much.

Okay. Thank you.

Michael Rose, Raymond James.

Hey, good morning, everyone.

Good morning.

Good morning. Thanks for taking my questions. I just wanted to go back to the Life Science credit, not to beat a dead horse here, but I think one of the things that I heard from investors, which is kind of the spec nature of that project in particular, and I just wanted to get a sense for -- if you have some sort of proportion of loans or percentage of loans that the projects are somewhat spec in nature because that's I think, relative to your history, somewhat contrary to what you typically do were there is a lot of analytical work done.

You're pretty sure of the lease stuff, even in the condo stuff, getting some more difficult challenges. Good projects and good markets. And is that a concern that we should be worried about? It's certainly a question I'm getting. Would just love some general commentary there. Thanks.

No, I don't think it's a concern you should be worried about at all, and it's not any sort of change in our business strategy. Large parts of what we have done over the 23-year history of RESG are unleased properties. The very first loan that we made was on a totally unleased property. So it's inherent in our business model and it's reflected in the 8 basis points annualized net charge-off ratio of that portfolio over the 23-year history.

Now we love leasing, and we love it when transactions come to us and have pre-leasing. But the vast majority of the transactions we've always done have not had significant pre pre-leasing. And now, back when we did retail and retail was -- if you got back to 2010 or so, retail, '11 retail was probably 20% or 30% of our portfolio there. Pre-leasing was inherent in all of those deals because you don't build a shopping center spec. You've got leases lined up.

Condos in Miami. You almost always have a high level of presales. And in most cases, when you close a loan, enough presales to repay your loan with 30% to 50% deposits down. Condos in New York. Since you're offering circular has to be approved and go through a process with the state government there and that process typically doesn't happen until you're midway through construction or further.

You typically have zero presales on a New York condo project, and if you do get to a point of having presales, you've typically got 10% or 20% deposits instead of the 30% to 50% deposits in Miami. These things vary all over the country by product type and geography. We know what market is, we know how business is done in all sorts of markets across country, and our loans sponsorship structure, capitalization, leverage points are all designed to be appropriate mitigants to those who ask.

So there's no degradation or shift in the way we're underwriting or thinking about things. This is what we've always done, and we feel very good about that.

That's very helpful. And maybe just as a follow-up, certainly appreciate the focus on CIB and then kind of in the other areas of the portfolio. Is the ramp up there and maybe what we're kind of expecting for paydowns, is this all to help drive the CRE concentration ratio below 300% over time? I know there's been a big regulatory focus there.

We've actually seen some capital raises to address those issues from some sales, some acquisitions as well. Some sales of banks as well. But how should we think about that for you guys? I know you guys have always kind of operated above the 300%, 100%. And kind of is the goal over time to migrate below those thresholds? Thanks.

The goal is to diversify our balance sheet. And you know, Michael, I so appreciate that question. Thank you for asking that. You know, we have built a level of expertise and understanding of commercial real estate in our Real Estate Specialties Group that is exceptional in my view and highly differentiated from the way most folks understand and think about commercial real estate. We have established ourselves as the leader in that field among banks and really among all the lenders, including the debt funds.

I think we enjoy a great deal of respect for what we do and a clear understanding within the real estate community that we're different than other people. And we're very conservative, but we deliver a level of execution and expertise that is worth paying for, even with our conservative view on project.

So we have built a very high-performing business with Real Estate Specialties Group and we want to continue to let that group grow and seize every opportunity that meets our conservative, high-quality underwriting standards. But we also realize that I mean, our performance metrics, look at our ROAA, look at our efficiency, look at our return on equity, look at our [Ask], look at all of our numbers, we ought to be trading at a two or three multiple premium to peers because our financial performance consistently over the time we've been public, consistently has been at the top of the industry.

We're not getting that premium. We know, we're not getting that premium because there are a whole bunch of folks that don't understand the unique expertise and capabilities and conservative approach we take to commercial real estate. And yes, commercial real estates are complicated business, and it can be risky if you don't do it in an extremely disciplined manner. And we are extremely disciplined.

We don't want to lose that extraordinary business we built. But we also realize if we let RESG grow to its full potential, and we grow other high-quality businesses around it, so it goes from being what at peak was 70% of the funded balance or our loans to over the next several years, 50% of the funded balance of our loans because Indirect, Marine and RV and CIB and Community Banking lines of business, Consumer Lines business and our Community Banking World all grow that that's going to let us achieve the multiple. the two or three premium multiple, that ought to have based on our company's performance as opposed to suffering a two or three multiple discount, because we're the foster child for CRE, even though we do it differently than everybody else.

So the answer to your question is yes, we wanted to diversify. We're not specifically focused on getting below the 300%, 100% threshold. That will probably be a natural product though of diversification. It's not the goal. It's just a byproduct of diversifying our balance sheet so that we can get the multiple that our shareholders deserve for the high-quality performance we put out.

Thanks for all the comments. I appreciate it.

Alright. Thank you, Michael.

Stephen Scouten, Piper Sandler Companies.

Hey, good morning, everyone. So I know there's been a couple of questions around the CIB already and Brannon, I appreciate your color to Catherine's question. But specifically seeing the commentary around -- within the expense commentary of aggressive hiring within that segment, can you give me a view for what that looks like in terms of how many people you might have there now and how large you want to build that team? And kind of, if as we saw this quarter, we started to reach that handoff point where CIB and Indirect & Marine are going to continue to exceed RESG contributions here near term?

Yeah. Well, I would tell you, on the Indirect & Marine, we've targeted that to be between 10% and 15% of our portfolio. We're bouncing along for a while, long while about 11% of total portfolio. I think it bounced up to like 12% in the quarter just ended. So that's going to stay in that 10% to 15% range. It may be get to 13%, you know who knows?

But we're not adding a lot of people there. We are adding a few, but they're just marginal incremental staff additions. We had, as Brannon mentioned, a nucleus of folks and fund finance and asset-based lending and equipment finance that was -- I don't know, or 8 or 10 people who were doing those lines of business for us. And I would guess our head count in the last six months, Brannon is approaching 30 or so people in those...

George? Yeah, it's probably a little north of there. But they've been really finding great opportunities to bring on, Stephen, across not just your sort of origination side, but they have, as I said, a very like mindset around credit. They really take a strategic and calculated approach to how they're focused on what they're lending on, who they're lending to, how that can be built into cross-sell opportunities across the organization, and how they can manage the loans, which are all senior in nature that are all stressed for downside when they're originated, but how they can manage those with a great sort of portfolio management group as well.

So you brought up RESG. There is really a lot of similarities in the way that infrastructure is being built, how it's being built for defensive structuring and underwriting on the front side, but also, it's a very significantly monitor portfolio. It's not a cove light kind of platform, but really digging in deep the front, middle, all the way to the end of the loan life cycle.

So, yeah, they've been hiring, made some great hires on the origination side, but also some strong hires on the portfolio management side. And as you know, from the way, we've run RESG and really the organization since George bought it, it's been quality, quality, quality and make sure that portfolio is populated with the right kind of credits and managed the right way throughout and sustainable and scalable. And these guys are well along the path to doing that.

Okay. And so just to clarify, had that kind of significant expansion you guys mentioned in the major comments, already occurred? Or it's kind of ongoing, like it's expanded a lot already, but it will continue to expand from a headcount perspective?

We've gone from the original nucleus of folks -- we had probably around 8 or 10 people in that area. 8 or 10 high-quality people, I would tell you that. We're building in and around, under and over that group because it is a great group that we had. But there were, I don't know, 8 or 10 people, might be 12 at the max where, as Brannon said, probably north of 30 people now. And that group will continue to grow. We'll end up with 40 and then 50 and then 60 and then more people. They are probably, by this time next year, I would guess we will have continued to grow that and be in that 50- to 60-person range there.

And these are highly skilled people that are not cheap. And that's why Tim, as we're having success hiring people and more frankly, we're having more success, hiring more highly skilled, quality people than we thought possible. And that's why Tim's having to catch his expense guidance up a couple of percent growth rate because we're finding more high-quality people than we thought we could.

And you guys have heard me speak at length about people are critical to our business and high quality, talented, smart, experienced people are essential to our business. And we're in an unusual window here with a lot of banks having pulled back due to add a lot of talent. So it's time to harvest that talent, get those guys on the team and tour those businesses further, while we can add the excellent talent.

Yeah. That's fantastic. And then on the capital side, and I know some of these larger repayments obviously opened up some capital and you announced the share repurchase. I would presume that leaves to be more opportunistic?

And then can you talk how that would maybe stand against potential M&A as another ability to deploy capital and also diversify the balance sheet? It feels like we might be on the precipice of a big pickup in M&A. So just kind of wondering how you guys are thinking about that given your strong track record there?

Well, first, if any FDIC transactions occur, we would love to have an opportunity on those. And you probably noted the one sizable deal that's occurred this year, we were in the better group on that. And we'll continue to look very favorably on opportunities to acquire failed bank transactions if there are. And that is always a preferred way. We've got a great track record and history doing that. So that would be the preferred way. But Tim, you want to comment a little more on stock repurchases, capital and regular way M&A?

Yeah. Thanks, Stephen. Certainly, yeah, a lot of positive things on capital this quarter. We haven't really talked about so far on this call how good a quarter it was as far as earnings, you know, a seventh consecutive record earnings really -- is an amazing track record. And you saw during this quarter with the additional repayments and so our unfunded balance go down just really the power of that earnings on capital. So when we have less growth than we've had in recent quarters, you saw our risk-based capital ratios expand nearly 30 basis points.

So that does open up opportunities. Felt like having a share repurchase authorization in place was prudent to be able to utilize that when there's lower growth at times. M&A to your point is another way to use capital. We've been active at times, and we'll certainly continue to look at M&A in a very disciplined manner. Certainly a lot of banks out there that have mark to market adjustments that would need to be considered if you are looking at M&A.

So, but we, as George alluded to, we've already been active in looking at FDIC deals this year and certainly would be active if any other showed up as well. So as you said, we've tried to be very prudent in how we manage our capital. And it was nice to see the earnings power that we had and our growth in risk-based capital ratios and our TCE was up. TCE ratio was up during the quarter, our tangible book value over 12 months has been up $5.18. Another good track record there. So a lot of positive things happening in this quarter.

Great. That's all super helpful. Appreciate the time.

Timur Braziler, Wells Fargo.

Hi, good morning. I wanted to ask my first question maybe a little bit more of a nuanced question as to the interplay of internal risk ratings when leasing trends don't match kind of expectations that were set at the underwriting. Is there anything happening below or beneath the scenes when leasing kind of doesn't match underwriting expectations? Yeah, I'll leave it there.

Well, that's a great question. And the answer is, yes, reappraisals or internal valuations of loans reflect changes in leasing expectations. And if the expectation is that leasing is not going to just take longer but occur at lower rates or with higher [fee or calls] that is built into the NOI of those projects. So those factors do find their way into risk ratings.

Over the eight quarters now that the Fed is first raised rates and then for the last two or three quarters, kept them at very high levels, you've -- we've seen a migration of risk ratings within our portfolio. We have 72 risk ratings in the portfolio and a lot of those are pass ratings. A lot of them are low pass ratings and then you get to, you know, the more verified special mention and substandard ratings.

But there's been a migration from one pass category to another pass category or past category to a low pass category that you've not seen. And that's just a reflection of higher for longer creates challenges for our sponsors and the projects. You have seen the evidence of those risk ratings while we don't disclose, you know, those 72 risk ratings.

You've seen the evidence of that migration and the fact that over the last eight quarters, our reserve for credit losses has almost doubled from $300 million to $574 million. So that's a $274 million increase in our ACL after the modest charge-offs we've experienced. Granted, a chunk of that was for portfolio growth, but you can see the qualitative migration and the fact that that reserve percentage has gone from a 0.83% of total loans and commitments to 1.19% of total loans and commitments over a period of time.

So that 36 basis points increase in the ACL percentage as a percentage of total loans funded, nonfunded reflects the migration that has occurred in those risk ratings of that portfolio. Again, we feel very good about the portfolio. As we said in January, we expect charge-offs this year to be higher than last year, but still well below industry average that continues to be our expectation.

That's not an indication of, you know, any sort of serious weakness in the portfolio. It is just a reflection of the fact that the high interest rates cause stress and some of that stress that's going to translate through into losses. Now for the first six months of the year, our six-month charge-off ratio is just minutely up over last year's net charge-off ratio, but that could drift higher in the second half of the year.

But again, that's why we built $274 million in additional ACL over the last eight quarters is the expectation. There would be some credit deterioration.

Great, thanks. And I guess as a follow up, looking at the life science sector specifically, I think some of the cyclical pressures there and some of the recent projects that have come online and have been kind of widely noted. I guess maybe what are your expectations for broader life sciences? Do you need reversal of some of these cyclical trends in order to lease up some of these projects? Or I guess what's the availability to convert some of the existing office space to suit other industries outside of life sciences?

Well, one of our clients, when I was on the West Coast a couple of months ago, who does life science showed me a very interesting graph that was -- it's not our materials. So we've not reproduced it and shared it. But it showed the venture capital and IPO money going into the life science industry over like the last two or three years.

And there was a steady flow of funds and of the space when interest rates began to rise and venture capital funding slowed. And then in the wake of Silicon Valley Bank, there was a significant slowdown in venture capital funding in the IPO market when there were stops, 15-, 16 months ago that there was going to be a banking crisis that was going to have some sort of systemic impact. IPO market sort of dried up as well.

And you had a significant period of time there where there was very, very little new money flowing in the life science space from venture capital and IPOs. And starting late last year, September October that began to click up a little bit. And this chart I was looking at and again, this was a couple of months ago, but it was a steady monthly progression of increase in money flowing into the life science space to people who do that business, who operate those businesses from venture capital and IPOs.

And you've also seen there have been several announced acquisitions of smaller life science companies by bigger life science companies. Those are the things that drive the demand for life science space. So when I was on the West Coast, San Francisco and Seattle a couple of months ago, the clients, they are who do life science, were very encouraged by the uptick in tenant inquiries in recent months caused by the fact that funding is returning to that space after a [hideous] funding for that space last year.

So we've seen a little bit of that translate into leases. We've heard quite a bit of chatter from different life science sponsors suggesting that they're seeing a meaningful uptick in interest in space. So I think it's way premature to talk about repurposing life science space for conventional office or other purposes.

It is re-purpose-able for conventional office easily. And one of the clients that we met with when I was in San Francisco, had a, you know, national credit tenant, quality tenant looking at an entire building that they had built for life science. It was not a life science tenant, but tenant liked the building, liked the location. It fit the needs for their people. So they were in contention along with several other buildings as a solution for the space needs for that tenant.

There was not a life science tenant, even though the building was built to part purpose-built life science standards. So it is convertible, but I think you're going to see, you know, a significant improvement in leasing over the next 12 months or so in the life science space because capital is returning to that space. And certainly, the aging of not only our US but the world population, the increased focus on health care at the government level, there are just a lot of factors that are favorable long-term factors for the life science industry side. I think you're going to see improved leasing conditions by a year.

Great. Thanks for the color, George.

Okay. Thank you. I appreciate it.

Samuel Varga, UBS.

Good morning.

Good morning, Samuel.

I wanted to just switch back to payoffs just for a second. I'm hoping to sort of dive a little bit into your view of the industry. Is there a -- I mean, thinking about the permanent market and receiving these projects as they pay off, are there certain types of buildings or industries that are sort of more ready from a permanent market perspective? Or there is no real trend that you can see yet at this point?

Can I take that, George?

Yeah. Go ahead, Brannon.

So yeah. We've been tracking our repayments to try to understand, Samuel, exactly the answer to that question, and we're starting to actually see some movement there in terms of how much is being refinanced, how much is actually being paid off from sale, what's going on there. And actually, in the first quarter, all of our repayments were coming from refinance opportunities.

But in the second quarter, we actually had a pretty good number. I think, of the 17 payoffs that we had, we actually had a couple of it sold and of course, our condo projects sell out. And then we actually had permanent financing. I'm guessing it's temporary, but some folks just pay us off without debt. But we did have 11, I think of those were refi by a third party.

In most cases, is going to be more of a bridge solution. The interest rate levels are still at a place where, as we said before, our sponsors are carefully monitoring what's going on there. And everyone realizes we've been strong along over the last eight, nine months around visions of rate reductions that would spur that refinance market.

But I mean, at the end of the day, we're still seeing good refinance activity in our projects. I think most of it, though, is going to be more at the bridge level, still floating rate, still short term, where they can move on to a more desirable, or for them profitable, long-term financing. There is long-term financing going on out there, but I don't think a lot of it is fitting our portfolio.

Yeah, Brannon, I would add to that. Where we are seeing a lot of really permanent long-term financing is in the multi space because you're Fannie and Freddie financing is a very stable, very cost-effective source of financing. So that's where we're seeing a lot of people really sell some assets away permanently. I think you would agree with that, Brannon.

Yeah. The multi-family is definitely the place that that happens.

Yeah. But there's a lot of bridge financing coming into the sponsors.

Got it. Thanks for all the color on that. And then just my follow-up is around loan yields. I'm trying to get a better sense of the rest of the originations that are currently funding up so far? Are those due to spreads, roughly approximate the book's average spread over [still for]? Or is there a difference there?

And then just as an addition to that, too, on the indirect side, as you add sort of an extra percentage points, let's say, of the loan book into that portfolio, what are the book yields on those and are those floating rate as well?

I'll tell you.

Go ahead, Brannon.

I'll take the RESG, George and you can dive into Indirect. A lot of the yield, this spread data is going to be determined by what types of projects you're doing and how you're working hard, market in market out. The guys are doing a phenomenal job. Really of about the same time, originating at lower leverage, still getting strong spreads and of course, our condo loans, which George discussed earlier, we view is some of our safest lending opportunities, given the strong presales, especially in the Southeast, in Miami more particularly where Greg has continued to see a lot of opportunity.

You tend to get strong spreads on that product type. So depending on how the book is weighted in terms of different product types, it'll move. But I believe generally, and I hadn't done a real thorough comparison on that. But I think the spreads today are comparing favorably to what we've got on the book.

Sam, you there? Samuel?

Yes, I'm here.

What's the on the Indirect?

Do you have any further questions?

Yeah. I was just wondering if you can give some color on the Indirect book yield and where those originations that are coming in? Are those also floating rates or are there some components there?

The indirect stuff is always all fixed. The RESG stuff is always all variable. I can't give you any color on the Indirect, really. I don't think it has moved very much in the last 90 days from where we were. And now we continue to see a fairly even steady slower business there.

Understood. Thanks for the color.

Thank you.

Brian Martin, Janney Montgomery Scott.

Most of mine have been answered. But just a follow-up that last one which I was going to ask. It sounds like the yields on -- as you kind of have this transition or handoff, the yields on the RESG portfolio versus the yields on the CIB portfolio are similar. Is that fair or how to think about that as you transition from one to the other, depending on how things play out there. Is that that is generally consistent or is there some significant differences there

We are going to have a lower nominal yields, Brian, on the CRB portfolio. The lower fees for the most part are on portfolio. The mitigating factor there is we get meaningful deposits with some of those CRB opportunities and treasury management opportunities as well as some other business opportunities.

So I think if you look at it on a pure yield basis, you would say, why you're giving up a lot to and you're going to dilute your yields. If you look at it on a return on equity basis and you factor in all of the costing and benefits, including deposits, treasury management so forth. I think we end up fairly close to the same place, but just from a pure nominal yield, yeah, there's going to be some long-term dilution to our headline margin number from via.

Got it. Okay. That's helpful. And makes sense. And you get there, the diversification with that as well. So and then maybe just the other one, just on -- the margin this quarter was a little bit held up a little bit better than seemed like we were looking for. Just kind of wondering if we do see a potential rate cut here in the back half. If you could just kind of remind us your kind of near-term outlook or you get into the next two to four quarters on NIM that would be great.

Yeah, what I would tell you and I think we alluded to this in the management comments, you know, higher level of repayments in Q2 contributed to a little bit higher level of kind of minimum interest, accelerated, deferred amortization or deferred origination fees and so forth. So Q1 was probably on the low side of average, and these are such variable things. It's hard to say what average is.

But you know, we felt like Q1 was probably low $2 million or $3 million. Q2 may have been high a couple of million dollars. So there was a little noise basis point or through sort of noise in those numbers, but not anything too big. The RESG portfolio is variable, right? We've talked a lot about the floors in figure 29 of the management comment document. We gave you the evolution of those floor rates over the last six months, which we've made some significant progress there.

For when the Fed does start lowering rates since all of our ESG's portfolio is variable, those will start heading down within a month after the Fed cuts right, and most of them are tied to a one-month term [Sulphur]. So, you know, they'll anticipate that reduction and most of them just on the 1 or the 11 of the month.

So I believe a few days, depending on when the Fed cuts rates lag between a Fed impact and so forth. So what we've been trying to do to mitigate that is, one, get those floor rates up, as I mentioned, but, two, we've been trying to shorten the duration of our deposit book and Sandy and Artie currently our Chief Deposit Officer, have done a really good job of that.

So had the Fed started cutting a year ago or a month after they peaked, rates, we would have seen a pretty good reversal on loan yields and a long duration adjustment of three or four quarters on our deposit book. We've got most of that deposit book adjustment gone from near term to one quarter and significantly more in the second quarter. So we're getting that lined up pretty well in anticipation of a Fed reduction. We'll see. We will give up some margin in the short run for a quarter or two, but we've mitigated that impact quite a bit over the last few quarters.

That's super helpful. So thank you for taking the questions.

Alight. thank you.

Matt Olney, Stephens.

Yeah, thanks for taking a follow up. The two large RESG repayments in the 2Q that were disclosed. I think you said one was in New York, one in Chicago. I know that some of the larger projects at RESG had been published by local real estate publications and some investors like to track these larger projects. So curious if you care to disclose which two projects these are that were repaid in the second quarter?

Well, yeah, I think they're pretty prominently disclosed in market out there. So well, I'm always reticent about talking about specific projects. The big New York projects was the ex-sale high-rise condo project on the Upper West Side. They are around 66th Street in New York, [Gary Bernadette] ex-sale project, a group we've done a lot of business with, and they have just done a brilliant execution on that project.

And to give you an idea, that was an $840 million total commitment. We were funded up to $511 million expecting to find up close to the max $840 million, but then they were expected to TCO, the bottom half of that building and start closing on condo sales and that.

So we would have had substantial paydowns on that project in Q3, probably in Q4 this year. They would have materially reduced our loan just from condo sales on the bottom half of the project. But they found a refinance opportunity that met some of their needs better than staying in our loans.

So they refinanced that away from us with our appreciation for having gotten to do the construction financing at appreciation for that long-term relationship. The project in Chicago was JDLs, one Chicago project, which beautifully elegant project, exceptionally done, great execution. We had funded up to our maximum $475 million buyout and that had begun to pay down from closing of condo sales.

So we were down to $376 million if I think was fully or nearly fully funded at the max and then started paying down from condo sales. Another just excellent project with excellence execution from our customers side.

Appreciate that.

All right. Thank you.

Thank you. I will pass it back to George Gleason for final comments.

Alright. Thank you. There being no more questions, so we thank you so much for your participation and we look forward to talking with you in another 90 days and reporting another good quarter's results. So thank you so much. Have a great day.

And thank you all for participating and you may now disconnect.