Banking On Value – Bank OZK (OZK)

Following the failure of First Republic (FRC), regional bank stocks have come under renewed pressure. In The Prudent Speculator’s latest special report, Banking on Value – Revisited, I discuss the latest goings on and separate fact from fiction. I also offer actionable advice from our Value Investing perspective, including three additional undervalued stock selections to go along with the one featured below.

A FORBES AMERICA BEST BANK

Little-Rock based Bank OZK
OZK
is a regional bank that conducts banking operations with over 240 offices in eight states including Arkansas, Georgia, Florida, North Carolina, Texas, New York, California and Mississippi, and had $29 billion in total assets as of Q1 2023.

Believe it or not, in that quarter, OZK announced that net income was a record $165.9 million, a 29% increase from the $128.0 million for the first quarter of 2022. Diluted EPS were a record $1.41, up 38% from the $1.02 posted in the year-ago period.

Concerning deposits, management released the following statement, “Most of our deposits are generated through our network of 229 retail branches in Arkansas, Georgia, Florida, North Carolina, and Texas. Because of the substantial ‘retail’ nature of our deposit base, the majority of our deposits are insured (67% at March 31, 2023) and, in the case of public funds and certain other deposits, collateralized (12% at March 31, 2023). As of March 31, 2023, our average account balance was approximately $37,000. The diversity of our deposit base is an important factor in the stability of our deposits, as demonstrated in the quarter just ended.”

Bank OZK favors a strategy of growth through the slow building and acquisition of individual branches rather than the consolidation of entire banks. CEO George Gleason has stated this strategy makes culture assimilation easier, likely contributing to the impressive efficiency ratio that OZK consistently sports. OZK is significantly exposed to commercial and industrial lending, a typically more volatile segment of banking, but it has been able to produce above average net interest margin while experiencing mild loan losses (relative to peers) throughout its history.

And here is what Mr. Gleason recently had to say on the all-important subject of commercial real estate:

There is a lot of chatter out there about commercial real estate. And I would make two points in regard to that. And one point is that our portfolio is new construction and we referenced this in the management comments. These are properties that have the newest state-of-the-art features, the newest amenities and attributes that sponsors are building brand new because it’s what renters or purchasers of those buildings or units are wanting. And as a result, our property tend to be the best, most highly marketable properties in the market.

So we’re still doing office buildings, and I know there’s a lot of noise around office buildings. But we are still seeing good leasing activity on the office parts of our portfolio. And it’s not because the world is out there running to buy office space and there is a giant competition to rent office space, but it’s because we’ve got the best properties and markets or sub-markets and the transactions that we’ve done makes sense. And there is demand for those. Now is leasing slower than it was four years ago or five years ago or three years ago before COVID? Yes, it is. We’ll give you that. But we are seeing decent leasing velocity and loans on office buildings paid off because the office buildings are leasing up and moving on, it is slower, but they are getting there.

The second thing I would tell you is there’s a lot of conversation about CMBS

CMBS
and the wave of maturities and all property types office gets talked about a lot coming from CMBS. And that’s not our market and those are not our type of properties. I understand that there is going to be some challenges in commercial real estate from CMBS loans that have a 3% or 4% interest rate that are maturing and now are going to refinance at a 7% or 8% interest rate or maybe even higher. That’s going to put a lot of those projects into ditch. A lot of those projects will still work though because over the ensuing five years or seven years or 10 since that loan was originated and put into CMBS, there has been substantial amortization on that loan and substantial increases in rent. But those are older properties. They’re not new state-of-the-art properties. They are not going to buy and large benefit from a flat to quality sort of attributes that there are developers of new properties enjoy. So they’re going to be harder to lease up, if they’re not already leased than a new state-of-the-art properties that has all the desirable amenities that people want to be in.

And the current employment environment where employers are trying to get employees to come back to work, they desperately want them to come back to work. For the most part, they are trying to get them to come back to work. The quality of the office environment is critically important in that regard. If you got really nice offices that people like and they have the amenities and the attributes that people want and going to the office is a pleasant experience because you like where you work, that is — that’s a valuable tool in recruiting people. Our sponsors who are building these new state-of-the-art office buildings understand that. And if you’ve got an old B-grade building, you’re probably looking to get out of that, that’s not our customer. You’re probably looking to get out of that building and get into a place where you can recruit better talent, even though your cost per square foot is going to go up a lot to be in that nicer building. So we think we’re very well positioned in this market.

Apologies for the lengthy quote, but it is important in understanding the rationale for why I think the current dividend yield of 4.3% and forward P/E ratio below 6 make OZK an attractive overlooked bargain.