OZRK - Bank of the Ozarks

[Green King]

I would also point something out to those who have said they are aggressive because they'll make loans others wont.  I worry that in many cases lending today is rule-based and regulatory driven.  I think that there are probably many areas of lending with very good economics that traditional big banks won't touch because it doesn't fit into their rules-based box now.

 

I think this strikes the heart of the debate. Is there a way to pick loans like we pick stocks? Will their concentrated book lead to disaster or better risk-adjusted returns?

 

When researching the RESG team, I noticed the prevalence of direct RE investment or development experience. I don't believe you tend to see this in large banks, where they approach underwriting like investors who believes the efficient market hypothesis. Their track record investing in CRE loans is another sign they know what they are doing. At any rate, what really got me comfortable was speaking to developers and sifting through a large sample of their development projects to assess the MOS.

 

Right but the odd thing is what's the deal with all the anecdotal evidence of aggressive loans and Ozark's alleged willingness to write any business. Something doesn't square

 

You can only see who has been swimming naked when the tides comes up. So far it has not happened.

[rawraw]

I understand where the shorts are coming from. But I reviewed many of OZRK's CRE loans and I am comfortable with the underlying development projects in the sample reviewed.

 

In NYC, the margins on high-end development projects are attractive. It does not cost significantly more to develop a high-end condo, but the price is much higher. This likely changes, but at the moment high margins create a degree of MOS for developers and OZRK. I think this is why OZRK and the developers are so aggressive while most of the industry is tightening their standards.

 

I also bought in the mid-30's last summer. But it is harder to get involved now. The price-to-book (~2.3x) is back to historical norms, so you really have to believe in management or the growth drivers (e.g. organic growth, acquisitions, interest rates, de-reg, tax cuts).

Can you explain what you mean by reviewing their loans?  Are you talking about the various press releases that disclose their bridge loans or something else?

 

While I agree in general with Oddballstocks approach to banks (he is pointing out a lot of things that should be pointed out), I think OZRK is an exception to these rules.  Unfortunately I can't publicly discuss the reasons why but atbed seems pretty up to speed on the stock.  This is a very unique bank and some of the typical rule of thumbs aren't as useful here.

 

But one of the things that makes OZRK attractive is the wide range of beliefs on the stock (as evidenced in this thread).  A year ago, the beliefs were much narrower and made the stock much more expensive.  These doubts have brought the multiple down, which I assume is why it is being posted here.  I always wondered why it wasn't discussed in 1H16 when it was really cheap.

[SlowAppreciation]

I would also point something out to those who have said they are aggressive because they'll make loans others wont.  I worry that in many cases lending today is rule-based and regulatory driven.  I think that there are probably many areas of lending with very good economics that traditional big banks won't touch because it doesn't fit into their rules-based box now.

 

I think this strikes the heart of the debate. Is there a way to pick loans like we pick stocks? Will their concentrated book lead to disaster or better risk-adjusted returns?

 

When researching the RESG team, I noticed the prevalence of direct RE investment or development experience. I don't believe you tend to see this in large banks, where they approach underwriting like investors who believes the efficient market hypothesis. Their track record investing in CRE loans is another sign they know what they are doing. At any rate, what really got me comfortable was speaking to developers and sifting through a large sample of their development projects to assess the MOS.

 

Right but the odd thing is what's the deal with all the anecdotal evidence of aggressive loans and Ozark's alleged willingness to write any business. Something doesn't square

 

You can only see who has been swimming naked when the tides comes up. So far it has not happened.

 

I don't disagree with this.

 

But just to play devil's advocate... they seemed to do pretty well during the financial crisis. How much farther could the tide go out?

[Green King]

I understand where the shorts are coming from. But I reviewed many of OZRK's CRE loans and I am comfortable with the underlying development projects in the sample reviewed.

 

In NYC, the margins on high-end development projects are attractive. It does not cost significantly more to develop a high-end condo, but the price is much higher. This likely changes, but at the moment high margins create a degree of MOS for developers and OZRK. I think this is why OZRK and the developers are so aggressive while most of the industry is tightening their standards.

 

 

As pointed out by oddballstocks given their loan growth over the last 4 years and correct me if i am wrong but I think loan sampling will likely be a false signal (confirmation bias) than anything else. Due to loan growth (loans they just made that had not yet shown its true character yet) and acquisitions (loans they didn't make) I am simply expressing my doubt.

[Green King]

I would also point something out to those who have said they are aggressive because they'll make loans others wont.  I worry that in many cases lending today is rule-based and regulatory driven.  I think that there are probably many areas of lending with very good economics that traditional big banks won't touch because it doesn't fit into their rules-based box now.

 

I think this strikes the heart of the debate. Is there a way to pick loans like we pick stocks? Will their concentrated book lead to disaster or better risk-adjusted returns?

 

When researching the RESG team, I noticed the prevalence of direct RE investment or development experience. I don't believe you tend to see this in large banks, where they approach underwriting like investors who believes the efficient market hypothesis. Their track record investing in CRE loans is another sign they know what they are doing. At any rate, what really got me comfortable was speaking to developers and sifting through a large sample of their development projects to assess the MOS.

 

Right but the odd thing is what's the deal with all the anecdotal evidence of aggressive loans and Ozark's alleged willingness to write any business. Something doesn't square

 

You can only see who has been swimming naked when the tides comes up. So far it has not happened.

 

I don't disagree with this.

 

But just to play devil's advocate... they seemed to do pretty well during the financial crisis. How much farther could the tide go out?

 

Impossible to know growth can hide many problems. That is is why oddballstocks looked at the reserves after looking at the loan growth. Remember the subprime subprime mortgage crisis or SNL ? you make good loans first but in small quantity than you growth from the financial proof of that. The new loans are not the same as the old ones. Also in real world it cannot be as good as the old ones. Due to size, since size eventually will slow down all growth.

 

Good loans require regional dominance.

Long term relationships.

Underwriting culture. 

Smart people (there are more banks than bankers)

Structural advantages.

Capacity to suffer so as no one be influenced by Gresham's law.

 

[oddballstocks]

Green King hit on some good points.  Growth and leverage = incredible returns when times are good, but look out below when the economy changes.

 

In terms of looking at actual loans.  You can do this, it requires a lot of time, programming experience and some creativity, think UCC filing..

[Lowlight]

I'll start by saying that I haven't done in depth research on OZRK due to my working in the banking industry and having limited interest in adding to my natural long.  Views within the banking industry are obviously more skeptical of OZRK than in the investment community.  A strategy of buying banks across a very wide geographic area in order to fund a centralized CRE platform lending throughout the US doesn't scream conservatism.  Depositors from a recently acquired bank probably have no real tangible association with OZRK today.  A low cost deposit base is what makes banks attractive today.  Banks have yet to be forced to reprice their liabilities (deposits).  When that happens, customer retention won't be so high across the board.  I question the company's ability to translate low cost deposits from a target into low cost deposits for OZRK.  On top of the deposit beta, there is a natural deposit decay rate that should only speed up for an acquirer.  Couple that with huge unfunded liabilities, and you see why OZRK is forced to be an acquirer.  Their loan growth cannot be funded organically or through wholesale funds.  While their CRE track record appears to 'speak for itself' as an analyst has said, the company was much smaller 5-10 years ago, likely had a better core deposit franchise, and was dealing with an improving market in certain commercial areas in the country. I tell people that you shouldn't confuse a bond fund with genius in a declining interest rate environment.  The same holds true for a CRE lender in a declining CAP rate environment.  I may be wrong on OZRK, but the price to book and the strategy should cause one to do their own homework and not get caught up in analysts re-rating the stock over and over again.

[atbed]

I understand where the shorts are coming from. But I reviewed many of OZRK's CRE loans and I am comfortable with the underlying development projects in the sample reviewed.

 

In NYC, the margins on high-end development projects are attractive. It does not cost significantly more to develop a high-end condo, but the price is much higher. This likely changes, but at the moment high margins create a degree of MOS for developers and OZRK. I think this is why OZRK and the developers are so aggressive while most of the industry is tightening their standards.

 

I also bought in the mid-30's last summer. But it is harder to get involved now. The price-to-book (~2.3x) is back to historical norms, so you really have to believe in management or the growth drivers (e.g. organic growth, acquisitions, interest rates, de-reg, tax cuts).

Can you explain what you mean by reviewing their loans?  Are you talking about the various press releases that disclose their bridge loans or something else?

 

While I agree in general with Oddballstocks approach to banks (he is pointing out a lot of things that should be pointed out), I think OZRK is an exception to these rules.  Unfortunately I can't publicly discuss the reasons why but atbed seems pretty up to speed on the stock.  This is a very unique bank and some of the typical rule of thumbs aren't as useful here.

 

But one of the things that makes OZRK attractive is the wide range of beliefs on the stock (as evidenced in this thread).  A year ago, the beliefs were much narrower and made the stock much more expensive.  These doubts have brought the multiple down, which I assume is why it is being posted here.  I always wondered why it wasn't discussed in 1H16 when it was really cheap.

 

I highly respect the work of many board members, including Mr. Tobik's. So I cringe as I am about to say I believe OZRK is an exception to the rule.

 

When I reviewed their loan book, I pulled property information from a database like ACRIS. Most of my work was focused on NYC. I then researched each project one by one. Press releases helped, but I also used resources like CBRE, co-star and contacts that I have in NYC property development. The aim was to figure out the capital structure above OZRK and estimate the value of the finished property.

 

At the end of the day, you will only invest if you trust this management team. My research helped get me comfortable with what they say on the calls. They are indeed the senior lender. I also got comfortable with their reported loan-to-cost and felt their loan-to-value was understated. The latter depends heavily on a developer's ability to execute. If a developer can, then some their expected profit adds to the margin of safety. I realize that this line of thinking can get an industry in trouble, but the average lender is tightening while OZRK pushes the pedal to the metal. This looks so aggressive because bad CRE loans have caused so many bank failures.

 

Furthermore, some would pass on specific projects that OZRK has financed. Every developer has a different risk tolerance and will not feel comfortable with the assumptions needed to get a project past their IRR hurdle. Pricing on a new-build condo 2-3 years out is inherently difficult to call. In some ways, the difference between the all in cost of the project and the current price/the expected realizable price is the developer's margin of safety. So I understand why some developers are hesitant to underwrite a deal if they need 5-10% higher pricing to exceed their IRR. Maybe the more conservative developer is right. Maybe the more aggressive developer is right. I don't know. Either way, the developer's MOS is also OZRKs.

 

By helping some smaller developers scale up, OZRK is taking more risk. Hopefully they are establishing relationships in the process, and doing so at the right time. Time will tell.

 

 

[Guest Schwab711]

Agree with Green King and Oddball.

 

Would OZRK investors today have invested in C1 Financial, Community & Southern, and ICBA? The combined loan books of these entities are almost the same size as pre-2014 OZRK. Going forward, large CRE/condo development loans and these portfolios seem to be the drivers.

 

I can think of a few ways you could show zero or near-zero NPLs. As an example, if rates are declining and you can sell loans at the first sign of non-performance without showing losses and you could make yourself look better at underwriting than you really are. All without breaking any rules. Purchased loan accounting is an encouraged cookie-jar that only shows its true colors over the long-run. We'll see how the last few years of M&A really were in time. OZRK is more of a black box than most banks their size in my opinion.

 

I don't understand how a community bank in Arkansas ended up with 10% of their loan book in NYC RE development loans and another 10% in similar loans in Dallas and LA. Why aren't mortgage originations keeping up with branch expansion? The number of ~1% loans is too much risk for me. This is all led to OZRK being in my too-hard pile.

 

Finally, what the heck is a community bank in Arkansas doing lending ~$125m in the Cayman Islands!?

 

This is what I think of when people talk about NYC condo developments:

http://money.cnn.com/2005/05/19/real_estate/re2005_boomtown_0506/

 

Interesting stuff on ALLL and purchased loan accounting:

http://scholarship.law.unc.edu/cgi/viewcontent.cgi?article=1100&context=ncbi

http://www.alll.com/wp-content/uploads/2015/01/Accounting-for-Purchased-Loans-Easier-Said-Than-Done.pdf

[Lowlight]

I'd be interested in whether the CRE lenders of the most recent three acquired banks were retained.  Given the focus on centralized, large scale CRE development lending, it's likely they were not.  If I'm right, OZRK has little

chance of driving growth out of the acquired banks.  To justify the multiples of book paid for these targets, they have to further scale the CRE division, effectively forcing themselves to become more concentrated.  I for one like the idea of concentration, but not in a levered vehicle like a bank, which naturally has very limited returns on assets, and needs leverage to earn a reasonable ROE. 

 

One thing I used to find odd was their concentration in Arkansas muni bonds, especially long dated bonds.  That just seemed to be another sign that they had little concern for liquidity.  Despite their rather obvious need to pay huge premiums for deposits...

[Green King]

I understand where the shorts are coming from. But I reviewed many of OZRK's CRE loans and I am comfortable with the underlying development projects in the sample reviewed.

 

In NYC, the margins on high-end development projects are attractive. It does not cost significantly more to develop a high-end condo, but the price is much higher. This likely changes, but at the moment high margins create a degree of MOS for developers and OZRK. I think this is why OZRK and the developers are so aggressive while most of the industry is tightening their standards.

 

I also bought in the mid-30's last summer. But it is harder to get involved now. The price-to-book (~2.3x) is back to historical norms, so you really have to believe in management or the growth drivers (e.g. organic growth, acquisitions, interest rates, de-reg, tax cuts).

Can you explain what you mean by reviewing their loans?  Are you talking about the various press releases that disclose their bridge loans or something else?

 

While I agree in general with Oddballstocks approach to banks (he is pointing out a lot of things that should be pointed out), I think OZRK is an exception to these rules.  Unfortunately I can't publicly discuss the reasons why but atbed seems pretty up to speed on the stock.  This is a very unique bank and some of the typical rule of thumbs aren't as useful here.

 

But one of the things that makes OZRK attractive is the wide range of beliefs on the stock (as evidenced in this thread).  A year ago, the beliefs were much narrower and made the stock much more expensive.  These doubts have brought the multiple down, which I assume is why it is being posted here.  I always wondered why it wasn't discussed in 1H16 when it was really cheap.

 

I highly respect the work of many board members, including Mr. Tobik's. So I cringe as I am about to say I believe OZRK is an exception to the rule.

 

When I reviewed their loan book, I pulled property information from a database like ACRIS. Most of my work was focused on NYC. I then researched each project one by one. Press releases helped, but I also used resources like CBRE, co-star and contacts that I have in NYC property development. The aim was to figure out the capital structure above OZRK and estimate the value of the finished property.

 

At the end of the day, you will only invest if you trust this management team. My research helped get me comfortable with what they say on the calls. They are indeed the senior lender. I also got comfortable with their reported loan-to-cost and felt their loan-to-value was understated. The latter depends heavily on a developer's ability to execute. If a developer can, then some their expected profit adds to the margin of safety. I realize that this line of thinking can get an industry in trouble, but the average lender is tightening while OZRK pushes the pedal to the metal. This looks so aggressive because bad CRE loans have caused so many bank failures.

 

Furthermore, some would pass on specific projects that OZRK has financed. Every developer has a different risk tolerance and will not feel comfortable with the assumptions needed to get a project past their IRR hurdle. Pricing on a new-build condo 2-3 years out is inherently difficult to call. In some ways, the difference between the all in cost of the project and the current price/the expected realizable price is the developer's margin of safety. So I understand why some developers are hesitant to underwrite a deal if they need 5-10% higher pricing to exceed their IRR. Maybe the more conservative developer is right. Maybe the more aggressive developer is right. I don't know. Either way, the developer's MOS is also OZRKs.

 

By helping some smaller developers scale up, OZRK is taking more risk. Hopefully they are establishing relationships in the process, and doing so at the right time. Time will tell.

 

A bank's MOS is not the same as the lender's MOS. This is why President Trump got rich and his lenders went bankrupt and had to be acquired by Citi Bank. P/L on loans are a logarithmic functions and not a linear one especially in Condos check their pricing action during crisis. Logarithmic functions make normal Margin of safety a ineffective tool, This is why many value investors went bust buying financials too early.

 

Also kudos for doing so much leg work on this one i have learned a lot from your responses and this thread.

[rawraw]

Thanks for the reply, very interesting. 

 

@oddballstocks, I know you can look at the property for loans from filings, but that isn't what I consider loan review. Probably just a mixup in definition of terms. Seems atbed learned a lot about the underwriting via channel checks.

 

Atbed, Have you met management before or only have heard the discussion on the calls? 

 

 

[atbed]

Thanks for the reply, very interesting. 

 

@oddballstocks, I know you can look at the property for loans from filings, but that isn't what I consider loan review. Probably just a mixup in definition of terms. Seems atbed learned a lot about the underwriting via channel checks.

 

Atbed, Have you met management before or only have heard the discussion on the calls?

 

I haven't met them personally.

[atbed]

I understand where the shorts are coming from. But I reviewed many of OZRK's CRE loans and I am comfortable with the underlying development projects in the sample reviewed.

 

In NYC, the margins on high-end development projects are attractive. It does not cost significantly more to develop a high-end condo, but the price is much higher. This likely changes, but at the moment high margins create a degree of MOS for developers and OZRK. I think this is why OZRK and the developers are so aggressive while most of the industry is tightening their standards.

 

I also bought in the mid-30's last summer. But it is harder to get involved now. The price-to-book (~2.3x) is back to historical norms, so you really have to believe in management or the growth drivers (e.g. organic growth, acquisitions, interest rates, de-reg, tax cuts).

Can you explain what you mean by reviewing their loans?  Are you talking about the various press releases that disclose their bridge loans or something else?

 

While I agree in general with Oddballstocks approach to banks (he is pointing out a lot of things that should be pointed out), I think OZRK is an exception to these rules.  Unfortunately I can't publicly discuss the reasons why but atbed seems pretty up to speed on the stock.  This is a very unique bank and some of the typical rule of thumbs aren't as useful here.

 

But one of the things that makes OZRK attractive is the wide range of beliefs on the stock (as evidenced in this thread).  A year ago, the beliefs were much narrower and made the stock much more expensive.  These doubts have brought the multiple down, which I assume is why it is being posted here.  I always wondered why it wasn't discussed in 1H16 when it was really cheap.

 

I highly respect the work of many board members, including Mr. Tobik's. So I cringe as I am about to say I believe OZRK is an exception to the rule.

 

When I reviewed their loan book, I pulled property information from a database like ACRIS. Most of my work was focused on NYC. I then researched each project one by one. Press releases helped, but I also used resources like CBRE, co-star and contacts that I have in NYC property development. The aim was to figure out the capital structure above OZRK and estimate the value of the finished property.

 

At the end of the day, you will only invest if you trust this management team. My research helped get me comfortable with what they say on the calls. They are indeed the senior lender. I also got comfortable with their reported loan-to-cost and felt their loan-to-value was understated. The latter depends heavily on a developer's ability to execute. If a developer can, then some their expected profit adds to the margin of safety. I realize that this line of thinking can get an industry in trouble, but the average lender is tightening while OZRK pushes the pedal to the metal. This looks so aggressive because bad CRE loans have caused so many bank failures.

 

Furthermore, some would pass on specific projects that OZRK has financed. Every developer has a different risk tolerance and will not feel comfortable with the assumptions needed to get a project past their IRR hurdle. Pricing on a new-build condo 2-3 years out is inherently difficult to call. In some ways, the difference between the all in cost of the project and the current price/the expected realizable price is the developer's margin of safety. So I understand why some developers are hesitant to underwrite a deal if they need 5-10% higher pricing to exceed their IRR. Maybe the more conservative developer is right. Maybe the more aggressive developer is right. I don't know. Either way, the developer's MOS is also OZRKs.

 

By helping some smaller developers scale up, OZRK is taking more risk. Hopefully they are establishing relationships in the process, and doing so at the right time. Time will tell.

 

A bank's MOS is not the same as the lender's MOS. This is why President Trump got rich and his lenders went bankrupt and had to be acquired by Citi Bank. P/L on loans are a logarithmic functions and not a linear one especially in Condos check their pricing action during crisis. Logarithmic functions make normal Margin of safety a ineffective tool, This is why many value investors went bust buying financials too early.

 

Also kudos for doing so much leg work on this one i have learned a lot from your responses and this thread.

 

Happy to provide my two cents. This board has been very helpful. Thank you and everyone for sharing thoughts

 

[thepupil]

not particularly new or additive, but just another data point that can be interpreted either way.

 

https://www.wsj.com/articles/banks-retreat-from-apartment-market-1487678401

 

Other developers are turning to smaller regional banks, such as  Bank of the Ozarks Inc., which can command higher rates, according to Willy Walker, chief executive of  Walker & Dunlop Inc., whose main business is making loans to apartment owners.

[atbed]

https://www.wsj.com/articles/manhattan-residential-real-estate-market-heats-up-1489575600

 

[Larry]

Q1 results out.

 

Company Release - 4/11/2017 7:00 AM ET

 

LITTLE ROCK, Ark.--(BUSINESS WIRE)-- Bank of the Ozarks, Inc. (NASDAQ: OZRK) today announced that net income for the first quarter of 2017 was a record $89.2 million, a 72.6% increase from $51.7 million for the first quarter of 2016. Diluted earnings per common share for the first quarter of 2017 were a record $0.73, a 28.1% increase from $0.57 for the first quarter of 2016.

 

The Company’s annualized returns on average assets, average common stockholders’ equity and average tangible common stockholders’ equity for the first quarter of 2017 were 1.93%, 12.80% and 17.17%, respectively, compared to 1.98%, 14.00% and 15.59%, respectively, for the first quarter of 2016. The calculation of the Company’s return on average tangible common stockholders’ equity and the reconciliation to generally accepted accounting principles (“GAAP”) are included in the schedules accompanying this release.

 

George Gleason, Chairman and Chief Executive Officer, stated, “We are very pleased to report our excellent results for the first quarter of 2017, including quarterly records in net income, diluted earnings per common share and trust income, $612 million growth in the funded balance of non-purchased loans and leases, $1.19 billion growth in the unfunded balance of non-purchased loans and leases, a 4.88% net interest margin, a 35.0% efficiency ratio and excellent asset quality.”

[atbed]

Q1 results out.

 

Company Release - 4/11/2017 7:00 AM ET

 

LITTLE ROCK, Ark.--(BUSINESS WIRE)-- Bank of the Ozarks, Inc. (NASDAQ: OZRK) today announced that net income for the first quarter of 2017 was a record $89.2 million, a 72.6% increase from $51.7 million for the first quarter of 2016. Diluted earnings per common share for the first quarter of 2017 were a record $0.73, a 28.1% increase from $0.57 for the first quarter of 2016.

 

The Company’s annualized returns on average assets, average common stockholders’ equity and average tangible common stockholders’ equity for the first quarter of 2017 were 1.93%, 12.80% and 17.17%, respectively, compared to 1.98%, 14.00% and 15.59%, respectively, for the first quarter of 2016. The calculation of the Company’s return on average tangible common stockholders’ equity and the reconciliation to generally accepted accounting principles (“GAAP”) are included in the schedules accompanying this release.

 

George Gleason, Chairman and Chief Executive Officer, stated, “We are very pleased to report our excellent results for the first quarter of 2017, including quarterly records in net income, diluted earnings per common share and trust income, $612 million growth in the funded balance of non-purchased loans and leases, $1.19 billion growth in the unfunded balance of non-purchased loans and leases, a 4.88% net interest margin, a 35.0% efficiency ratio and excellent asset quality.”

 

"I know when someone cuts their prices 3% or 8% on the listing prices on condos and that gets a big article in Barron’s or Investor’s Business Daily or The Wall Street Journal or Crain’s or some place, it tends to freak folks out. But the reality is we are typically in the 40s to 50% loan to cost and the 40s to 50% loan to value on those projects. And somebody cuts their prices 4% or 8%. There is still – the sponsors are still making a profit. They may not be making as much profit if they were getting full list price, but they are still making a profit. The mezzanine lenders are still getting paid off. We are still getting paid off.

 

One can read these headline articles about while prices came down 4%, or I read one the other day that said sales of condos in this part of New York were taking 103 days on the market versus 89 days a year ago. And that’s true, but that hardly is prices. Yes, if you are selling, you’d rather have your money 2 weeks earlier than not, but a 2-week extension and time on the market. And it’s – these are relatively modest issues that seem to get a disproportionate amount of attention. So, one has to really look at the data and the analytics and make smart decisions based on that and not get carried away by headline that says all of the properties are down 4% from where they are a year ago and they are all in the market 14 days longer than they were a year ago and the sponsor is making an 18% return instead of a 22% return on its money. So keep it in perspective."

 

https://seekingalpha.com/article/4061815-bank-ozarks-ozrk-ceo-george-gleason-q1-2017-results-earnings-call-transcript?part=single

[Green King]

don't you think it is odd the stock didn't rally with these great numbers?

[Guest Schwab711]

 

One can read these headline articles about while prices came down 4%, or I read one the other day that said sales of condos in this part of New York were taking 103 days on the market versus 89 days a year ago. And that’s true, but that hardly is prices. Yes, if you are selling, you’d rather have your money 2 weeks earlier than not, but a 2-week extension and time on the market. And it’s – these are relatively modest issues that seem to get a disproportionate amount of attention. So, one has to really look at the data and the analytics and make smart decisions based on that and not get carried away by headline that says all of the properties are down 4% from where they are a year ago and they are all in the market 14 days longer than they were a year ago and the sponsor is making an 18% return instead of a 22% return on its money. So keep it in perspective."

 

https://seekingalpha.com/article/4061815-bank-ozarks-ozrk-ceo-george-gleason-q1-2017-results-earnings-call-transcript?part=single

 

This is wrong and almost seems misleading considering he has run the bank for 30 years or something. In general, construction loans have relatively fixed costs and variable revenue. Lets assume it is 90 cents of costs for every $1 of revenue, which gives 10 cents of profit or 10% margin. If prices decline 4%, then 96 cents of revenue produces 6 cents of profit, or a 40% decline in profits. If 10% margin equated to a 22% return then a 6% margin equates to a 13.2% return. That's a decline 8.8% and not 4%. We also know there has to be leverage on these projects or OZRK wouldn't be loaning money. Construction/Development projects probably (hopefully) have 1x-3x leverage (25% to 50% equity).

 

A 4% decline in prices can substantially effect investment returns on RE development projects. Good underwriting would assume some variability in projected prices. Construction loans generally have the issue that decisions are primarily made for financial reasons, as opposed to mortgages where the buyer genuinely wants to live in the dwelling. There is nothing wrong with with positive spin but Gleason's comment is plain untrue.

[Larry]

Just finished the transcript. Gleason seems to be very confident with their real estate loans:

 

For decades, our focus has been on real estate lending and we are one of the largest and most active CRE lenders in the country. Our track record, including our record through great recession, speaks for itself. Our significant expertise and the conservatism we employ in our CRE lending are significant factors in our asset quality. Many people tend to lump everyone involved in CRE transactions in the same category without distinguishing between equity mezzanine lender and senior secured lender priorities and without distinguishing between high quality, low-leverage portfolios and lower quality, high-leverage portfolios. In almost every transaction we do, we are the sole senior secured lender, which means that in the event of a default, every penny of equity and every penny provided by mezzanine lender would be lost before we lose even $0.01 of interest or principal. Simply stated, we have the lowest risk position in the capital stack. Likewise, our extremely low loan to cost and loan to value ratios are probably more conservative than just about every other CRE lender in the country. Accordingly, we believe our CRE portfolio may be the lowest risk CRE portfolio in the industry.

 

From SA transcript: https://seekingalpha.com/article/4061815-bank-ozarks-ozrk-ceo-george-gleason-q1-2017-results-earnings-call-transcript?part=single

[atbed]

 

One can read these headline articles about while prices came down 4%, or I read one the other day that said sales of condos in this part of New York were taking 103 days on the market versus 89 days a year ago. And that’s true, but that hardly is prices. Yes, if you are selling, you’d rather have your money 2 weeks earlier than not, but a 2-week extension and time on the market. And it’s – these are relatively modest issues that seem to get a disproportionate amount of attention. So, one has to really look at the data and the analytics and make smart decisions based on that and not get carried away by headline that says all of the properties are down 4% from where they are a year ago and they are all in the market 14 days longer than they were a year ago and the sponsor is making an 18% return instead of a 22% return on its money. So keep it in perspective."

 

https://seekingalpha.com/article/4061815-bank-ozarks-ozrk-ceo-george-gleason-q1-2017-results-earnings-call-transcript?part=single

 

This is wrong and almost seems misleading considering he has run the bank for 30 years or something. In general, construction loans have relatively fixed costs and variable revenue. Lets assume it is 90 cents of costs for every $1 of revenue, which gives 10 cents of profit or 10% margin. If prices decline 4%, then 96 cents of revenue produces 6 cents of profit, or a 40% decline in profits. If 10% margin equated to a 22% return then a 6% margin equates to a 13.2% return. That's a decline 8.8% and not 4%. We also know there has to be leverage on these projects or OZRK wouldn't be loaning money. Construction/Development projects probably (hopefully) have 1x-3x leverage (25% to 50% equity).

 

A 4% decline in prices can substantially effect investment returns on RE development projects. Good underwriting would assume some variability in projected prices. Construction loans generally have the issue that decisions are primarily made for financial reasons, as opposed to mortgages where the buyer genuinely wants to live in the dwelling. There is nothing wrong with with positive spin but Gleason's comment is plain untrue.

 

I don't disagree with most of what you said. However, I don't think his comments are false either. For what it is worth, I believe the 4% drop he quoted is a fall in the developer's IRR from 22% to 18%. Profit margins for condo developments in Manhattan are much much higher than 10%. This profit margin has to be lost as well before OZRK loses money.

 

 

[Green King]

 

One can read these headline articles about while prices came down 4%, or I read one the other day that said sales of condos in this part of New York were taking 103 days on the market versus 89 days a year ago. And that’s true, but that hardly is prices. Yes, if you are selling, you’d rather have your money 2 weeks earlier than not, but a 2-week extension and time on the market. And it’s – these are relatively modest issues that seem to get a disproportionate amount of attention. So, one has to really look at the data and the analytics and make smart decisions based on that and not get carried away by headline that says all of the properties are down 4% from where they are a year ago and they are all in the market 14 days longer than they were a year ago and the sponsor is making an 18% return instead of a 22% return on its money. So keep it in perspective."

 

https://seekingalpha.com/article/4061815-bank-ozarks-ozrk-ceo-george-gleason-q1-2017-results-earnings-call-transcript?part=single

 

This is wrong and almost seems misleading considering he has run the bank for 30 years or something. In general, construction loans have relatively fixed costs and variable revenue. Lets assume it is 90 cents of costs for every $1 of revenue, which gives 10 cents of profit or 10% margin. If prices decline 4%, then 96 cents of revenue produces 6 cents of profit, or a 40% decline in profits. If 10% margin equated to a 22% return then a 6% margin equates to a 13.2% return. That's a decline 8.8% and not 4%. We also know there has to be leverage on these projects or OZRK wouldn't be loaning money. Construction/Development projects probably (hopefully) have 1x-3x leverage (25% to 50% equity).

 

A 4% decline in prices can substantially effect investment returns on RE development projects. Good underwriting would assume some variability in projected prices. Construction loans generally have the issue that decisions are primarily made for financial reasons, as opposed to mortgages where the buyer genuinely wants to live in the dwelling. There is nothing wrong with with positive spin but Gleason's comment is plain untrue.

 

I don't think his comments are patently false. For what it is worth, I believe the 4% drop he quoted is a fall in the developer's IRR from 22% to 18%. The profit margin for condo developments in Manhattan is much much higher than 10%.

 

please source on margin and article. TIA

 

This doesn't confirm with any of the numbers. No position long popcorn.

http://www.cnbc.com/2017/02/17/toll-brothers-big-sale-is-a-warning-manhattan-condo-market-is-cracking.html

 

[Guest Schwab711]

 

One can read these headline articles about while prices came down 4%, or I read one the other day that said sales of condos in this part of New York were taking 103 days on the market versus 89 days a year ago. And that’s true, but that hardly is prices. Yes, if you are selling, you’d rather have your money 2 weeks earlier than not, but a 2-week extension and time on the market. And it’s – these are relatively modest issues that seem to get a disproportionate amount of attention. So, one has to really look at the data and the analytics and make smart decisions based on that and not get carried away by headline that says all of the properties are down 4% from where they are a year ago and they are all in the market 14 days longer than they were a year ago and the sponsor is making an 18% return instead of a 22% return on its money. So keep it in perspective."

 

https://seekingalpha.com/article/4061815-bank-ozarks-ozrk-ceo-george-gleason-q1-2017-results-earnings-call-transcript?part=single

 

This is wrong and almost seems misleading considering he has run the bank for 30 years or something. In general, construction loans have relatively fixed costs and variable revenue. Lets assume it is 90 cents of costs for every $1 of revenue, which gives 10 cents of profit or 10% margin. If prices decline 4%, then 96 cents of revenue produces 6 cents of profit, or a 40% decline in profits. If 10% margin equated to a 22% return then a 6% margin equates to a 13.2% return. That's a decline 8.8% and not 4%. We also know there has to be leverage on these projects or OZRK wouldn't be loaning money. Construction/Development projects probably (hopefully) have 1x-3x leverage (25% to 50% equity).

 

A 4% decline in prices can substantially effect investment returns on RE development projects. Good underwriting would assume some variability in projected prices. Construction loans generally have the issue that decisions are primarily made for financial reasons, as opposed to mortgages where the buyer genuinely wants to live in the dwelling. There is nothing wrong with with positive spin but Gleason's comment is plain untrue.

 

I don't think his comments are patently false. For what it is worth, I believe the 4% drop he quoted is a fall in the developer's IRR from 22% to 18%. The profit margin for condo developments in Manhattan is much much higher than 10%.

 

I wasn't trying to imply that those were standard margins, I was just trying to provide an example. I understood that Gleason was referring to the IRRs earned by developers. If we are discussing the concepts of ratios (which is all a percentage is) then it really doesn't matter what metric we refer to. I was just trying to keep my example as simple as possible.

 

A little off-topic but for back of the envelope valuation/return calculations, stock appreciation + dividend yield is roughly equal to total return over a one year period. Technically, it's precisely wrong. For most situations (like in person conversations) over a one year period the error is so small that it really doesn't matter. However, that simple formula only provides a close approximation over short time frames. The delta between the actual and estimated returns increases when discussing longer periods. It becomes essentially unusable over several-year periods. The situation and time frame dictates when it is acceptable to use approximate vs. exact formulas when discussing ratios or deltas. In Gleason's case, I think his use of approximation was inappropriate, all things considered.

 

The reason we have phrases like "operating leverage" is because various income line items move disproportionately with changes in revenue. As I mentioned, for any business where costs are generally fixed and revenues are generally variable, relative changes in revenue lead to substantially greater changes in profit (both up and down). It's just a consequence of that type of business model. All business models have certain 'operating leverage' tendencies.

 

IRRs measure an entirely different ratio than profit margins and revenue delta. All will likely have different denominators. Only in limited special situations would all of these ratios move in lock-step. It would be extremely unusual for a 4% change in revenue to equate to a 4% change in returns (regardless of what 'return' metric we are measuring - for example purposes it really doesn't matter). I don't need to know specifics to know Gleason is wrong.

 

Just to clarify, I'm not trying to say anything other than what I'm saying. There's no need to read into it anymore than literally what I wrote. I have no idea how good their underwriting is. I'm not trying to imply anything about their underwriting. I don't know what their buffer or margin of safety is on loans like this. I don't know what the average margins or returns for developers are. All I know is Gleason is wrong about that particular example.

[atbed]

 

One can read these headline articles about while prices came down 4%, or I read one the other day that said sales of condos in this part of New York were taking 103 days on the market versus 89 days a year ago. And that’s true, but that hardly is prices. Yes, if you are selling, you’d rather have your money 2 weeks earlier than not, but a 2-week extension and time on the market. And it’s – these are relatively modest issues that seem to get a disproportionate amount of attention. So, one has to really look at the data and the analytics and make smart decisions based on that and not get carried away by headline that says all of the properties are down 4% from where they are a year ago and they are all in the market 14 days longer than they were a year ago and the sponsor is making an 18% return instead of a 22% return on its money. So keep it in perspective."

 

https://seekingalpha.com/article/4061815-bank-ozarks-ozrk-ceo-george-gleason-q1-2017-results-earnings-call-transcript?part=single

 

This is wrong and almost seems misleading considering he has run the bank for 30 years or something. In general, construction loans have relatively fixed costs and variable revenue. Lets assume it is 90 cents of costs for every $1 of revenue, which gives 10 cents of profit or 10% margin. If prices decline 4%, then 96 cents of revenue produces 6 cents of profit, or a 40% decline in profits. If 10% margin equated to a 22% return then a 6% margin equates to a 13.2% return. That's a decline 8.8% and not 4%. We also know there has to be leverage on these projects or OZRK wouldn't be loaning money. Construction/Development projects probably (hopefully) have 1x-3x leverage (25% to 50% equity).

 

A 4% decline in prices can substantially effect investment returns on RE development projects. Good underwriting would assume some variability in projected prices. Construction loans generally have the issue that decisions are primarily made for financial reasons, as opposed to mortgages where the buyer genuinely wants to live in the dwelling. There is nothing wrong with with positive spin but Gleason's comment is plain untrue.

 

I don't think his comments are patently false. For what it is worth, I believe the 4% drop he quoted is a fall in the developer's IRR from 22% to 18%. The profit margin for condo developments in Manhattan is much much higher than 10%.

 

It would be extremely unusual for a 4% change in revenue to equate to a 4% change in returns (regardless of what 'return' metric we are measuring - for example, purposes it really doesn't matter). I don't need to know specifics to know Gleason is wrong.

 

I respectfully disagree. It will depend on the specific project, but a 4% change in revenue will roughly reduce IRR by 4%.  I'll take a stab at explaining it directionally. I think you need to divide the reduction in total return by the weighted average life of the project. In your example of $100 sales and $90 costs, the ROA is 11.1% with no price reduction and 6.6% with a 4% price reduction.

 

10/90 = 11.1%

6/90 = 6.6%

 

Let's assume the profit margin already accounts for interest expense. If we assume 50% leverage, then ROE is:

 

10/45 = 22.2%

6/45 = 13.3%

 

Commercial real estate projects typically have a 3-4 year life. However, not all cash is spent at the beginning. For example, banks typically withhold funds until milestones are met. Some money is spent at 0 (i.e. land acquisition). Construction costs are spread out and could be paid out at 6 months, 12 months, 18 months, etc... This is why RE funds like to use IRR. It accounts for these irregular cash flows.

 

If we assume a weighted average life of capital = 2 years, we can take the 9% ROE differential and divide by 2. That gets you to about 4.5%. It'll be lower if we use a compound interest equation. Of course, this is extremely rough math. Coming up with exact assumptions regarding timing and amounts, running that through an XIRR model equation would be more accurate.

 

But I agree with you, IRR ain't perfect. An 18% IRR doesn't equate to an 18% annualized return. So it can't tell us the profit margin he generally sees across the portfolio. Gleason perhaps could have explained it better to the layman, but I don't think he was trying to misrepresent the situation.