Bank of the Ozarks at Raymond James U.S. Bank Conference

Sep 06, 2017 AM CDT
OZRK.OQ - Bank of the Ozarks
Bank of the Ozarks at Raymond James U.S. Bank Conference
Sep 06, 2017 / 03:25PM GMT 

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Corporate Participants
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   *  George G. Gleason
      Bank of the Ozarks - Chairman, CEO & President
   *  Tim Hicks
      Bank of the Ozarks - Chief Administrative Officer and Executive Director of IR

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Conference Call Participants
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   *  Michael Edward Rose
      Raymond James & Associates, Inc., Research Division - MD, Equity Research

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Presentation
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 Michael Edward Rose,  Raymond James & Associates, Inc., Research Division - MD, Equity Research   [1]
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 Hi, everyone. We're going to get started. My name is Michael Rose. I'm one of the bank analysts here. I'm very pleased to have Chairman and CEO George Gleason from Bank of the Ozarks. We've got about 30 minutes. We're going to do -- I'm going to do between -- somewhere between 5 and 10 questions, and then we'll open up to the audience for some questions. So I guess we'll just get going.

 Maybe because it's top of mind, George, and you guys do have exposure in some of the impacted areas in Texas and in potentially some of the impacted areas in Florida, maybe you can just give your thoughts on the hurricane and what the bank has done and how you're preparing.

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [2]
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 Yes. Be happy to do so. Of course, we do have substantial operations in Houston, San Antonio and Austin. Those operations fared amazingly well. If you watch the -- CNN or other weather channel reports on what was going on down there, it was a horrible disaster, no doubt, but we got really, really fortunate. We have 34 people in Houston. We had no injuries to any of our people. A couple of them had water in their homes. A couple of them had problems with flooded vehicles and so forth but very minor injuries or issues there.

 We have 4 branches in Houston. Three of those were unaffected. We're operational. I think we reopened those on Thursday of last week. We had one where a roof hatch -- the -- a live roof access was blown off by the storm, so we had water in the ceiling of the branch just from rain, not flood. And that was repaired and that was operational, I think, Friday afternoon. So from a branch and personnel point of view, we got about as fortunate as you can possibly get given the magnitude of that storm.

 We immediately started, as our people went back to work, contacting our customers. We have a large contingent of RESG loans in the Metro Houston area. Those loans -- the collateral for those loans suffered only minor but no damage. Most of them were no damage. We had a few that were minor damaged to the extent that our customers were even debating if they would bother filing an insurance claim on it.

 We have 133 assets in our indirect marine RV and auto lending portfolio, the auto portfolio being an inherited portfolio. We have confirmed that at least 132 of those 133 assets have insurance in force. So we haven't been able to contact all those customers yet but no indication of problems there.

 On the community banking side, we do have a couple of homes that is collateral that were flooded and a couple of businesses that had water in. We're not sure of the insurance status on those yet. But in the grand scheme of things, relatively minor stuff from a very severe event with Hurricane Harvey. So we're feeling super good about that. And of course, our San Antonio and Austin assets operations were largely unaffected. They had a lot of rain and some wind but no damage there at all.

 Talked with our guys this morning, spent quite a bit of time on the phone with our guys in Florida who are battening down for Hurricane Irma. No definite direction on where that's going, but Florida certainly looks like it's in the target zone for Hurricane Irma. The good news is we have hurricane wind insurance on all of our major assets we finance in Florida. And as I'm sure some of you in the room live in Florida, as you know, Floridians routinely buy flood insurance if they're in coastal areas, even if they're not in a designated flood hazard zone. Irma doesn't look like a flood event. It's such a fast-moving storm. It looks like a wind event. So we feel like we're pretty well prepared for that. But we're doing the normal precautionary things, our business resilience and disaster recovery. People are already at work on Florida, preparing for effective dealing with any aftermath from that storm.

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Questions and Answers
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 Michael Edward Rose,  Raymond James & Associates, Inc., Research Division - MD, Equity Research   [1]
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 Great. Maybe we can move on to probably the question that everyone wants me to ask, which is, you guys had a former executive leave the company a few weeks ago, and wanted to see how -- from your point of view how the growth outlook at Real Estate Specialties Group may change. And maybe you can talk about some of the other executives there that you've recently highlighted in your slide deck that are going to play improved roles or elevated roles and how they have played into the sourcing and deal development in recent years.

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [2]
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 Yes. Be happy to do that. Dan Thomas worked for us for 14 years, and Dan did an excellent job in one of the -- he did a lot of really good things for us. One of the best things he did for us was build a really exceptional team at Real Estate Specialties Group. So when Dan left, we went from 108 employees to 107 employees in RESG. And really, while you hate to lose any important, high-performing individual from your company, the fact of the matter is, we've got a very deep team there, and I don't expect it to have a significant impact on our volume. In our recent slide deck, we did expand on that information on Page 15 of the slide deck. We've got 33 people in originations, which was principally where Dan focused his energy. We have 3 managing directors of originations. Tucker Hughes, who's based in Dallas, tucker started his career more than a decade ago with RESG in Dallas. Went to Austin, opened our Austin office. When we had to restart the LA office after an initial false start out there, he went to Los Angeles, built our team in that office and built our team in the San Francisco office, and then came back to Dallas within the past year as part of our long-term plan for him. So Tucker is a very strong individual in the originations side. He is supported by the team in Dallas, the team in Austin, the team in Los Angeles, which is headed by Jason Choulochas, and the team in San Francisco headed by Mason Ross. So strong origination capabilities there in the Northeast and New York. Rich Smith is a Managing Director of originations. Rich has a very strong team. As you know, New York is our largest market, and a large measure of our success is credited to Rich and his team. They work with him, Dave Sarner and Chris Lawton and [Sean Marino] and others there. And then in Atlanta, we serve the Southeast with Greg Newman. And while Greg is based in Atlanta, Florida is our largest market. Of course, he does business all over the Southeast from Tennessee and the Carolinas and Alabama and Mississippi and Georgia, but Florida is the biggest part of that.

 So we have a very strong origination team. We're continuing to see great volume. We approved over $1 billion of loans in our Loan Committee meetings in August. That's a very good month. Last year, we originated for the full year of 2015 about $8.3 billion, $8.2 billion, I believe. We think we're on track to originate somewhere between $8.5 billion and $10 billion in total originations this year. So we really don't see any significant impact on our volume, and it's just because we've got such a broad team. And as RESG has grown over the years, the impact of any one individual has lessened as we've got a lot more folks handling originations and handling customer relationships.

 We also detailed on Page 15 Wes Hardin supported by Jay Gyer and Anna Carrillo in Credit & Closings. So Wes, a long-term member of the team. John Fox, who heads our legal division there, and John has 4 other practicing attorneys who work with him. So 5 practicing lawyers on the legal side of RESG. Of course, we use outside counsel for all closings, but the coordination and the oversight of outside counsel is handled by that very capable in-house legal team. And then Brannon Hamblen, who is supported by Cliffton Hill and Juan Gonzales and a couple of other team leads, runs Asset Management. That's a team of 47 people for us. So strong and deep team. They are doing a great job and it's steady, on course business as usual, literally, at RESG.

 Six of these individuals are now direct reports of mine: Tucker Hughes, Rich Smith and Greg Newman in Originations; and then John Fox in legal; Wes Hardin in Closing & Credit; and Brannon Hamblen in Asset Management.

 It's interesting that about, oh, 1.5, 2 months before Dan's resignation, I've made a conscious decision to devote a lot more of my time to RESG for the next 2.5 years and had already told several of my executive officers and several of our key directors that I was going to do what I've done probably a half dozen other times in the history of the company, and that's do a mass handoff of direct reports and shift my focus elsewhere to RESG. And some of you will recall from the July conference call that I announced Tim Hicks' promotion to Chief Administrative Officer. Tim Hicks took over 3 of my direct reports. John Carter, who's our Director of Community Banking, took over one direct report. Darrel Russell, our long-term Chief Credit Officer, took over one direct report. And Tyler Vance our Chief Operating and Chief Banking Officer took over one direct report. So I've just given up 6 direct reports and, in a very timely, fortuitous, coincidental manner, picked up 6 new direct reports. So I had already taken actions to create a mass schedule of bandwidth to spend a lot more time with RESG, and that turned out to be even more timely than I thought it was when I was doing that.

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 Michael Edward Rose,  Raymond James & Associates, Inc., Research Division - MD, Equity Research   [3]
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 That's a really good overview of the team and how you're going to be spending, it sounds like, the majority of your time. Maybe just following up on RESG. It was about 68% of your non-purchased loan growth in the second quarter. Do you have a target here? And you have several other growth initiatives that you detailed over time. Can you describe what those are and what the optimal business mix is for you as you optimize your capital return profile?

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [4]
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 Yes. Let me say first sort of as a prelude to answering that question that we expect Real Estate Specialties Group to continue to grow and to be a bigger and bigger part of our business in dollar terms. I mentioned we had closed just over $8 billion of loans last year. We expect it to beat that number noticeably this year. We would expect to beat that number in '18 and beat it again in '19. So we expect RESG will grow, and I've said many times that it is our best unit in every aspect of what we do. It's our best underwritten loans, our best documented loans, our most precisely closed loans, our lowest leveraged, best sponsors, best projects, best serviced loans to Brannon Hamblen's Asset Management team. So they're our best credits in every respect. And accordingly, we've told those guys, grow as much as you can grow, be as big as you can be and don't worry about what that does to the ratios.

 On the other hand, we realized that our company is more valuable if we have a more diversified portfolio of earning assets. And we can be more capital efficient in the way we use our capital if we have other sources, product lines of earning assets in that mix. So what we have set as a goal of commercial real estate lending, ultimately being about 57% of our business and about 43% of our business coming from non-CRE loan types. And we're doing a good job in getting more traction in those other non-CRE loan types. This is not in any way a reflection and shouldn't be interpreted as a reflection we're not fully committed to our exceptional value-added equation we provide in the CRE space. We're totally committed to that. We just think our company is worth more if we diversify and do other lines of business where we also deliver value to our customers and get a good risk-adjusted return for our shareholders. So we're doing that, and then we've seen positive traction in those other areas of growth in the first 2 quarters of this year. We expect that will continue.

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 Michael Edward Rose,  Raymond James & Associates, Inc., Research Division - MD, Equity Research   [5]
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 Okay. One of the major topics, I think, for investors as of late has been the flattening yield curve and also rising deposit betas. Can you talk about how that impacts your ability to continue to improve your core spread? And then separately, can you talk about loan pricing trends? And any sort of upward pressure you've seen on deposit pricing in your markets?

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [6]
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 Okay. Well, let me talk about deposit pricing. We have not moved any of our administered rates yet in response to the 4 Fed rate increases. And that may be surprising, but the reality is we didn't move any of those rates the last 4 Fed rate cuts because we were already as low as we could go when the Fed was at 1 1/4% coming down. So it's played out about the same in reverse. Now our deposit -- our cost of interest-bearing deposits have gone up, and they've gone up really for 2 reasons. One is, in -- across all of our markets, we have a lot of relationships where the deposits are bid or are on an RFP basis. And if those relationships recycle and the Feds raise rates 2, 3, 4 times since they were last repriced, then those RFPs, those bid situations are going to go up. So we've seen that across our footprint. More significantly, we have about 46 or 47, I can't remember the exact number. Tim may be in the room and he gets a shot at that if he...

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 Tim Hicks,  Bank of the Ozarks - Chief Administrative Officer and Executive Director of IR   [7]
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 47.

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [8]
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 47. Thank you, Tim. We have 47 of our 240-something deposit offices in spin-up mode. And basically, if you look, we're in 156 cities, excluding New York City, with deposit offices. We have about 4% share of the branches in those 156 cities, but we have about 1.5%, we estimate, of the deposits in those cities. Well, we'll know that number more precisely when the Fed comes out with their data in another month or 2. But you can look at that and say, all these guys are terrible bankers. Look, they've only got a 1.5% share and they've got 4% of the deposit infrastructure. But what has happened is we've made our 15 acquisitions over the last 8 years. We acquired a tremendous amount of deposit infrastructure that we, frankly, didn't need when we acquired it. We just couldn't loan the money fast enough to use all the deposits that we have the capability to drive through those branches. So what we did is focus our staff on generating core checking, savings and money market accounts and let all the hot money run off, and we just sort of went to the bottom of the market in those markets, which is where we're priced in the vast majority of our markets today. As we've needed more deposits, we've done an analysis to basically look at branches and groups of branches that would market together, logically associated branches, and we've adjusted our rates up more aggressively in certain branches. And we've done that based on a part scientific, mathematical calculation and in part an objective calculation that basically is designed to make sure that we grow deposits in the markets where we can grow the most deposits at the lowest cost of funds when you factored in the cost of cannibalizing our existing deposits in those markets. So we've been very effective at adding deposits as we need them. We think we've got about $20 billion or more of deposit capacity in our existing branch network that we can extract with incremental pricing and marketing in those markets. So people ask all the time, well, what's your target loan-to-deposit ratio? And Tim put a slide in his most recent slide deck that shows that over the last 6 or 7 years, our loan-to-deposit ratio has been consistently between 89% and 99% with the exception of Q4 of 2015 when we were trying to stay under $10 billion and we asked a bunch of deposits to move for a few weeks at the end of the year. So basically, we were running about 93%, 94%, 95% loan-to-deposit ratio. So what I tell people all the time is if we were going to have a really puny growth quarter on loans and our non-purchased loans were going to grow $500 million, we would expect to have about a 94%, 95% loan-to-deposit ratio. And if we were going to have a very robust quarter where loans were going to -- non-purchased loans were going to grow $2 billion, we would expect to have about a 94% to 95% loan-to-deposit ratio because we just adjust our spin-up strategy, pricing and marketing to drive the behavior on deposit growth that we need to drive to fund our loan growth. And we've got the capacity to do that up to, we think, about $20 billion-plus growth in our balance sheet currently. So with all that said, yes, our cost of interest-bearing deposits has gone up. But over the last 5 quarters, if you look at it, we've been able to increase by, I don't know, 10, 25 basis points or so over that period of time the core spread, which for us our core spread that we measure is our yield on non-purchased loans and leases, the loans we originate versus our cost of interest-bearing deposits. We've had a 5-quarter trend of improving that spread. That's a key metric for us going forward, and we're going to work hard to improve that. And to answer your initial question, does a flat yield curve help or hurt in that, obviously a flat yield curve hurts in that. The vast majority of our loans are variable rate loans, and those are priced off prime and LIBOR. So they're priced off the short end of the curve. But to the extent that we originate fixed-rate loans in our consumer and small business lending book or indirect marine and RV book, those are priced off longer-term rates. So the flat curve definitely hampers us in that regard. The question you didn't ask, and that is Fed action, clearly we're going to have more success improving our core spread if the Fed continues to increase the Fed funds target rate. We'll have a difficult time continuing to improve our core spread if the Fed does not increase the Fed funds target rate. So we -- a steepening yield curve would be beneficial to us. Further Fed action would be beneficial to us. Unfortunately, both those things are outside of my control, just like hurricanes. So we just deal with it as it comes.

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 Michael Edward Rose,  Raymond James & Associates, Inc., Research Division - MD, Equity Research   [9]
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 Maybe just one more for me before I open up to the audience. Where do you see the company in 3 to 5 years? And do you see the ability to further improve returns given increasing costs as you get larger? And then maybe if you layer in how you get to a sub-30% efficiency ratio. I would assume that C1 Labs are C1. I think the Ozarks Labs (sic) [Ozark Labs] now plays into that.

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [10]
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 Thank you. Thanks, yes. Clearly, technology is an important part of the future, and we're working on rolling out our first de novo [II] branches, which we'll roll out in '18 or '19. Those branches are heavily technology-dependent. They are branches really designed to go in large MSAs, top 100, top MSAs that -- where we can serve a customer base of 600,000 or 700,000 people to 1.5 million people with just a pair or a tree of branches. So a very low brick-and-mortar intensity, very high technology intensity business model. And one of the key ingredients that made C1 Bank in Florida an important acquisition for us was their C1 Labs unit, which was 8 or 9 people when we announced that there. We've grown it, I think, to 23 people today. We would expect to continue to grow it in smaller increments as we go forward, but it is critically important to developing the technology and the mobile banking apps and other things that we really need to give us a competitive edge on the retail side of the business, which we think is going to be absolutely critical in the next 10 to 15 years not just to our financial sales to -- but to survival in an industry that's going to massively change in how customers interact with their bank. You can see lots of science with that changed now, but this is just beginning. So that's very important to us. We would think that over the next 5 years organically, we would more than double the size of our company, approaching a $50 billion number out there 5 years or so -- 5 or 6 years hence and that our number of physical facilities would increase from something on the order of 251, I think, we are today to somewhere around 290. Now we'll close some facilities that will become obsolete in the evolving banking industry. So there might be 10 or 20 closures. There might be 50 or 60 de novo II and other branch additions in that equation. But clearly, if you can think about that and say, well, if I go from 250 branches to 290 branches, that's a, what is that, a 16% increase in our number of branches with a more than doubling or 150% growth in our earning assets. Clearly, that is an important leverage in us achieving our long-term goals for a sub-30% efficiency ratio.

 Now I will tell you we're not doing ourselves any favor on getting our efficiency ratio lower this year, and that's because we're spending a lot of money building out the risk management infrastructure, not just enterprise risk management, the longer-view compliance, internal audit, cybersecurity, business resilience. All the elements that we're building now, we're building the infrastructure to be a $40 billion or $50 billion bank, and it is causing me to lose what little hair I have and proving to be a really big job, but we're well along in the process of that. And as we begin that next big push of growth forward, we feel like we're going to be much better off to have all that infrastructure in place now than trying to build it over the next 5 years. And so we're trying to get ahead of the curve on that. That is putting some pressure on our non-interest expense this year and our efficiency ratio, which is -- has been still very good in the mid-30s. But we think longer term, we can get to a sub-30%.

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 Michael Edward Rose,  Raymond James & Associates, Inc., Research Division - MD, Equity Research   [11]
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 We may have time for one question. Anybody want to ask? Yes, sir.

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 Unidentified Analyst,    [12]
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 Yes, 2 questions around the real estate. Of the $8 billion that you're (inaudible), how much is running off? What's your net growth? And secondly, are you prepared for this LIBOR (inaudible)?

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [13]
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 Well, I'll answer the last question first. All of our loans have in them a provision that allows that if LIBOR ceases to exist, that there is a formulaic methodology to shift to another index that we would select for those loans. Of course, we're 4 to 5 years away from the end of LIBOR. We've assumed that the LIBOR world may get messy before it actually comes to an end. So we've recently changed our language in our loan documents to say that if in our judgment LIBOR either becomes unavailable or ceases to function in a reasonable manner, that we can shift in our election to an alternate index and establishes a formulaic process for how you would establish that index. So that's the interim step. We think over the next year or 2 there will become more clarity as to where the industry is going and what's a market term for what the replacement for the LIBOR looks like going forward, and we'll start shifting to that as that becomes clearly accepted and understood by the industry. The first question you asked about prepayments of loans, our problem -- our challenge has not been getting loan applications, getting loan applications approved that meet our standards or getting them closed. We've been generating tremendous volume. As I say, we expect in our RESG unit to well eclipse last year's origination volume this year. But it's been difficult to turn that into growth because at our leverage, the prepayment velocity on our loans is really, really fast. So we have incurred typically in most quarters well in excess of $1 billion of prepayments and payoffs, and that's a positive reflection of the quality of what we're doing and acceptance of it in the market. If we were financing projects that weren't going to lease or weren't going to sell or weren't going to perform, nobody would want to finance them. But frankly, most of our assets are getting paid off at or shortly after CO now -- certificate of occupancy. So we're not enjoying the long life of those assets that we would have enjoyed 3 or 4 years ago when permanent lenders would have said -- or permanent buyers would have said, well I want to see this project perform 3 months or 6 months or 1 year before I put a permanent loan on it. The outlets for permanent financing or permanent sales of property are so efficient right now that they're taking our assets off books really, really fast. So that's our job.

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 Michael Edward Rose,  Raymond James & Associates, Inc., Research Division - MD, Equity Research   [14]
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 Unfortunately, that's all the time we have. So George, thank you very much.

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [15]
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 Thank you, guys. Appreciate it. Thank you.




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