OZRK - Bank of the Ozarks

[Shooter MacGavin]

Hi all - My first post here on COBF. Figured I'd jump right into a battleground stock. Everything that has been said about sound banking principles is correct: deposit costs matter, low defaults are important, liquidity is key, construction loans have a bad history, etc. etc. But I do think we ought to consider the context.

 

1. Before the GFC and today are two totally different scenarios. Anyone who has bought a home recently or sought a business loan probably can attest to this. Yet, watching for CRE/Resi bubbles has become kind of a national sport. Probably because that's what happened LAST time. I believe Peter Lynch called it the 'penultimate preparedness', preparing for the last crisis (more popularly, fighting the last battle). A 'normal' recession (unlike GFC) doesn't cause mass defaults on any and all CRE loans and run on banks (though, understandably, that memory is fresh from 08-09). Elevated defaults? Sure. But run-on-the-bank-triggering defaults? I doubt it.

 

2. OZRK was quite opportunistic in buying up banks AFTER the GFC. This was actually a good time to buy banks. So growth through acquisitions, generally disliked in the banking industry (correctly, IMO), was not a problem here. For those who take an interest in FDIC-loss share accounting, you'll notice that OZRK accounted for each failed bank acquisition conservatively and the disclosure was amazing so you could actually see it.

 

3. In whole-bank acquisitions, they mostly issued stock when their stock was valued higher than what they acquired. This is what Singleton did when TDY was valued much higher in the 60s than target companies. It was all disclosed and well executed so investors could follow along. From a capital allocation standpoint, it makes sense. It was opportunistic and when the premium multiple faded, they stopped acquiring. So management wasn't chasing growth. Now that OZK stock is lower, Gleason is talking about ways to buy it back (potentially). Again, opportunistic, and shows management sensibility.

 

4. OZRK didn't just come out well through the GFC, but also survived the 80s and the 90s banking crises. To think that Gleason remained disciplined from 1979 to 2009 and then lost his mind seems a stretch.

 

5. As to Holdco-merger, this is not uncommon. Why spend money and be under Fed regulation if you don't have to be. Some of the FRB regs are ridiculous and I don't see any problem in avoiding them legally if they can. Other banks without federal charter are large banks such as First Republic, Signature, and small banks such as Farmers And Merchants Bank of Long Beach, a "value investor" favorite. (put that in quotes because of the whole thing about all investing being value investing, etc.). Also, just because they steered clear of the Fed does not mean there's only state regulation. The FDIC is still a regulator and is not a pushover.

 

6. I have also read the short-thesis comment about showing low GFC losses by acquiring banks (i.e. acquiring loans faster than you are losing money to show low NCO ratios). But, if we take out purchased loans and then recalculate the ratios, OZRK's NCOs were still better than industry. Also, as noted above, the marks on acquired loans were conservative.

 

7. Last call, they talked about slowing down a little in CRE because they were seeing some not-so-good-lending in the space. So it seems management isn't totally blind to the possibility of a slow-down eventually.

 

8. Finally, to be short at this level means the stock really has to fall to 5x earnings or zero. Maybe if CRE problems do come, their numbers could take a hit. Perhaps the stock could take a hit. But to bet on a zero seems extreme to me.

 

9. Now being on COBF, I suppose I must talk about Buffett. If you go back to the 1969-71 reports, you'll see they owned a bank called Illinois National Bank. Readers on this forum ought to be very familiar with the situation there. Time deposits were over 50% of the mix. Efficiency ratio was very low and ROAs were high at 2% v/s 0.5% industry back then. Not that there's a comparison but just to show that not ALL of these are headed for the trash heap.

 

I was a little unsure about making my first post on a battleground stock. But it did seem a very interesting name so figured I'd chime in. Nice to meet everyone. Hoping to hear some feedback. Thanks!

 

Great first post.  Well articulated.  Welcome to the board!

[NBL0303]

I second Shooter's comment. That was one hell of a first post.

[AdjustedEarnings]

There was a question in today's OZK presentation at Barclays about the loans they make without recourse. The company's response was pretty good I felt. It's around minute 37 of the webcast:

 

https://event.webcasts.com/viewer/event.jsp?ei=1210225

 

 

 

[rjstc]

Hi all - My first post here on COBF. Figured I'd jump right into a battleground stock. Everything that has been said about sound banking principles is correct: deposit costs matter, low defaults are important, liquidity is key, construction loans have a bad history, etc. etc. But I do think we ought to consider the context.

 

1. Before the GFC and today are two totally different scenarios. Anyone who has bought a home recently or sought a business loan probably can attest to this. Yet, watching for CRE/Resi bubbles has become kind of a national sport. Probably because that's what happened LAST time. I believe Peter Lynch called it the 'penultimate preparedness', preparing for the last crisis (more popularly, fighting the last battle). A 'normal' recession (unlike GFC) doesn't cause mass defaults on any and all CRE loans and run on banks (though, understandably, that memory is fresh from 08-09). Elevated defaults? Sure. But run-on-the-bank-triggering defaults? I doubt it.

 

2. OZRK was quite opportunistic in buying up banks AFTER the GFC. This was actually a good time to buy banks. So growth through acquisitions, generally disliked in the banking industry (correctly, IMO), was not a problem here. For those who take an interest in FDIC-loss share accounting, you'll notice that OZRK accounted for each failed bank acquisition conservatively and the disclosure was amazing so you could actually see it.

 

3. In whole-bank acquisitions, they mostly issued stock when their stock was valued higher than what they acquired. This is what Singleton did when TDY was valued much higher in the 60s than target companies. It was all disclosed and well executed so investors could follow along. From a capital allocation standpoint, it makes sense. It was opportunistic and when the premium multiple faded, they stopped acquiring. So management wasn't chasing growth. Now that OZK stock is lower, Gleason is talking about ways to buy it back (potentially). Again, opportunistic, and shows management sensibility.

 

4. OZRK didn't just come out well through the GFC, but also survived the 80s and the 90s banking crises. To think that Gleason remained disciplined from 1979 to 2009 and then lost his mind seems a stretch.

 

5. As to Holdco-merger, this is not uncommon. Why spend money and be under Fed regulation if you don't have to be. Some of the FRB regs are ridiculous and I don't see any problem in avoiding them legally if they can. Other banks without federal charter are large banks such as First Republic, Signature, and small banks such as Farmers And Merchants Bank of Long Beach, a "value investor" favorite. (put that in quotes because of the whole thing about all investing being value investing, etc.). Also, just because they steered clear of the Fed does not mean there's only state regulation. The FDIC is still a regulator and is not a pushover.

 

6. I have also read the short-thesis comment about showing low GFC losses by acquiring banks (i.e. acquiring loans faster than you are losing money to show low NCO ratios). But, if we take out purchased loans and then recalculate the ratios, OZRK's NCOs were still better than industry. Also, as noted above, the marks on acquired loans were conservative.

 

7. Last call, they talked about slowing down a little in CRE because they were seeing some not-so-good-lending in the space. So it seems management isn't totally blind to the possibility of a slow-down eventually.

 

8. Finally, to be short at this level means the stock really has to fall to 5x earnings or zero. Maybe if CRE problems do come, their numbers could take a hit. Perhaps the stock could take a hit. But to bet on a zero seems extreme to me.

 

9. Now being on COBF, I suppose I must talk about Buffett. If you go back to the 1969-71 reports, you'll see they owned a bank called Illinois National Bank. Readers on this forum ought to be very familiar with the situation there. Time deposits were over 50% of the mix. Efficiency ratio was very low and ROAs were high at 2% v/s 0.5% industry back then. Not that there's a comparison but just to show that not ALL of these are headed for the trash heap.

 

I was a little unsure about making my first post on a battleground stock. But it did seem a very interesting name so figured I'd chime in. Nice to meet everyone. Hoping to hear some feedback. Thanks!

 

Very good!

[Spekulatius]

There was a question in today's OZK presentation at Barclays about the loans they make without recourse. The company's response was pretty good I felt. It's around minute 37 of the webcast:

 

https://event.webcasts.com/viewer/event.jsp?ei=1210225

 

The webcasts wouldn’t start for me, but I think something else must have been said there, and the answers weren’t very satisfactory, since the stock is down 2% today.

[AdjustedEarnings]

There was a question in today's OZK presentation at Barclays about the loans they make without recourse. The company's response was pretty good I felt. It's around minute 37 of the webcast:

 

https://event.webcasts.com/viewer/event.jsp?ei=1210225

 

The webcasts wouldn’t start for me, but I think something else must have been said there, and the answers weren’t very satisfactory, since the stock is down 2% today.

 

The stock move appears unrelated. Looks like it was down even before the event started. I felt the answer was pretty good about how they work around doing recourse loans. And the fact that it's not something new but something they've done for a long time now and are experienced in structuring it properly.

[Shooter MacGavin]

here's the crux of the debate on this board addressed by George Gleason here.  On a side note - I also took a look at Corus Bank's 10ks from 2005-2009 and read through the Treasury auditor's report post-mortem.  I don't want to detail my findings here but the Corus of 2006 is very different from the Ozarks of today. The Corus analogy is interesting but it's really a reach, in my opinion.  I'm not even a banks analyst but I can see some glaring flags (with perfect hindsight of course) from Corus's financial reports in 2005 and 2006.

 

 

Matthew John Keating Barclays Bank PLC, Research Division – Director & Senior Analyst

Yes. I had a question around competitive advantage. And so, I actually did some research on where you guys fit in within the construction lending market. And what I discovered is that you basically fulfill a need for nonrecourse financing, where the large money center as well, et cetera, don't necessarily provide that financing. And the mezz lenders are effectively too expensive. And there's kind of 2 lenders in the market, you and another that satisfy that need. So I just want to talk about that, if that's true and then as a source of competitive advantage. And then the other question I had was around the concentration of risk in deals. So the deals you're doing today are much larger than you were doing x years ago, right? And so when you're doing a shopping center in Florida and it's $300 million or plus, just talk a little bit how you've managed the chunkier aspects of that relative to your total capital position.

 

George G. Gleason Bank OZK – Chairman & CEO

Yes. I'd be happy to do so. I've been Chairman and CEO for 39 years, and the bank has historically, from the very beginning, done full legal limit loans to customers we like, on projects we like. And I will tell you, in my 39-plus year history, we've been profitable continuously, so we've never lost money. So that willingness to take significant positions in a single credit and put our full legal loan limit to work on a single credit is nothing new. And we've managed that over 39 years where it's never hurt us. So I think that's important to understand. The second thing I would tell you is your question is based on an improper premise that were taking more concentrated positions than we ever have in the past. And I will give you an example. Going into the last economic downturn, the Great Recession, we had a number of loans on our books that were full legal limit loans to those customers. The largest loan that we've got on the books today is less than half of our legal loan limit. So while that loan today maybe 6 or 7x the size loan that we made 10 years ago, the reality is that, it's a fraction of the percentage of our capital account that it was. So if you look at our loans, the capital were less concentrated today than we were 10 years ago and were less concentrated, I think, over 1 year ago and 2 years ago and 3 years ago. But we do make large loans. And that is based on the fact that we believe those are the best quality transactions and the best quality customers. Now a lot of our loans are nonrecourse as to principal. But on every loan that we have been involves construction, we have a completion guarantee, wherein the sponsor or the owner of the sponsor, some upper-tier entity is giving us a guarantee that the project will be completed on time, on budget, lean-free, essentially. And as a result of that in the 15-year history of Real Estate Specialties Group, we have not had a single loan, not one loan, wherein we've gotten at the end of the project and we've not had the project completed with the funds that remained in the loan. So that requires a very effective completion guarantee structure, where your sponsor's going to cover cost overruns and do it immediately. It requires a very effective asset management servicing structure, where you identify issues that will create budget problems early on in the process, where you still got the leverage to require the sponsor to fix that. And it requires sponsors of high quality and projects of high quality. So we've been very successful in totally avoiding that risk. We also have, in every loan that we do that doesn't have a full principal recourse, we have a carve-out guarantee, our multiple carve-out guarantees. And those guarantees are much more rigorous than the typical banks' carve-out guarantees. And it basically limits our sponsors from putting the entity in bankruptcy or filing an act of responsive plating in bad faith and a foreclosure action. The carve-out guarantee is basically intended to control sponsor bad behavior. They're sometimes referred to as bad boy guarantees, because if you have a problem credit, you don't want the sponsor to be able to delay you or diminish the value of your collateral and can then commit ways to steal deposits, allow environmental contamination, not pay the utilities, not pay the insurance...

[topofeaturellc]

Why do you think it is that other Banks, with better funding bases don't want to be in that business?

[Shooter MacGavin]

Why do you think it is that other Banks, with better funding bases don't want to be in that business?

 

what do you mean by "better funding bases" and which banks are you referring to?

 

I can't speak for them but in my view, as a noveau non-bank analyst here is my take. As a category, if you're a big box bank that relies on credit committees and box checking and form filling and lazy credit analysis and regulators telling you what limits you need to pass stress tests - you got burned badly during the great recession.  All the BofA's of the world with the "better funding bases" showed how well their credit process works during a crisis.  The only reason it wasn't worse is because their >1T in asset size provides a natural diversification.  Forget about stress tests- contrast their charge off rates with OZK under actual real world stress - The great recession.  And then grade their credit process. You got particularly burned if you were in construction lending because as a category they had some of the worst charge-off ratios and default rates during the great recession, so it's natural to "as a rule" stay away.

 

But this is like asking "why do you think fidelity or Blackrock doesn't own 10% Fiat Chrysler (assuming it a great investment which i think it is)?" because they lost money on auto stocks...who cares? In my view, they have a subpar investment process with risk committees and investment committees which basically leads to index hugging. The big asset managers have rules about concentration (no position larger than 2%-3%, no sector concentration larger than xyz%) just like the wells fargo and BofA's of the world have a subpar lending process with layers of bureaucracy and credit committees that is driven by box checking exercises. They're all just so large and diversified that they rely on that to keep them out of trouble instead of actually doing good work.

 

This is not a knock on Fidelity/BofA/Blackrock analysts.  There's plenty of really talented, smart individuals at these firms and you have to be to get a job there.  But some that i've spoken with will tell you their process hinders them from delivering great results.  It's the same idea.

 

The punchline is for me as it relates to OZK - if they've got a credit process and business judgment driven by a superb banker based on common sense and has proven to work through 40 years of credit cycles, who cares why others aren't doing it?  The others -  on average - aren't very good anyway. Gleason isn't plain "lucky" either.  Bob Wilmers was a phenomenal banker too and M&T's charge off rates were comically low during the crisis. So was Ron Hermance at Hudson City Bank (may they both rest in peace), which M&T eventually bought.  In other words, good ol' fashioned credit analysis and common sense works fine.  The trouble is most banks don't use common sense.

 

[topofeaturellc]

I mean go ahead and believe that. History says everyone who plays in this market, in this way, goes bust.  The pay off profile of a loan is very different from an equity.  As a value equity guy, so long as you can tolerate the vol ( which Fido et Al. often can't) you live for another day. Unfortunately loans are selling puts.  If they don't cash flow, you have to take marks against your capital.

 

The idea that all of these Banks avoid a high risk adjusted roa strategy because they are dumb or lazy - it's kind of crazy. Look at how much market share these guys have taken in new entrant markets - they don't know the players how can the have an underwriting advantage?  This game had been seen before, is just history rhyming.

[Shooter MacGavin]

I mean go ahead and believe that. History says everyone who plays in this market, in this way, goes bust.  The pay off profile of a loan is very different from an equity.  As a value equity guy, so long as you can tolerate the vol ( which Fido et Al. often can't) you live for another day. Unfortunately loans are selling puts.  If they don't cash flow, you have to take marks against your capital.

 

The idea that all of these Banks avoid a high risk adjusted roa strategy because they are dumb or lazy - it's kind of crazy. Look at how much market share these guys have taken in new entrant markets - they don't know the players how can the have an underwriting advantage?  This game had been seen before, is just history rhyming.

 

Well I guess that's what makes a market.  You're taking the view that anyone who has more than small exposures to construction loans is going bust simply because other banks have pared back. I'm taking the view that credit underwriting matters and that just like with equities, every dollar lent can either have a poor or great structure which determines if you get paid.

 

Using an extreme example to illustrate the point - let's imagine a bank that has 100% book of construction financing worth $100 in one neighborhood.  You're saying that no matter what , over time , that bank is going to go bust simply because of its concentration.  I would say a bank that lent that money against $100 worth of cash as collateral locked away in a safe is going to be fine. The credit structure matters.

 

Going back to OZK, their loan book is currently more conservative and more diversified that it was in 2006-2007 in a less over supplied market and their RESG group which does the construction lending only ever had 4 bps of charge offs in 15 years through the great recession with less conservative underwriting!  Yet, effectively what you're saying is they somehow lost their minds and are purposely trying to blow themselves up, and don't see what you do, no matter how much they try and explain why their underwriting standards are even more conservative.

 

We can agree to disagree.

[Broeb22]

There is nothing new when it comes to finance.

 

Do you believe that no other banks have said “Gee, I want to get in on this super profitable lending?”

 

All it would take is someone hiring an OZK banker and saying, “do what you did there”.

 

Unless you think Gleason is some kind of Michael Milken who has some legitimate edge (although Milken had other not so legitimate edges), there are not very many examples of what you’re describing, Shooter.

 

The base rate of people in finance who said “this time is different” and were actually right is probably vanishingly low.

 

The two I can think of were true sea change type of moments: Efficient Market Theory, which became applied as index investing, and again, Michael Milken’s ideas that debt in highly leveraged firms, or originally fallen angels, was actually a good bargain sitting in plain sight. This idea was further pushed with the advent of private equity (based on Modigliani and Miller and enabled by Milken).

 

I’m not an expert on the history of finance, but is there any research supporting the claim that construction lending is somehow less risky than it appears?

[Guest Schwab711]

Banks with over-concentrated C&I books tend to lose large amounts of money at some point because C&I demand is usually not geographically diverse, if you make one loan - all projects look good so you become concentrated by vintage in boom times, and due to the variable structure of C&I loans and (in OZK's case - variable structure of their funding base), the banks heavy in this lending can become over-leveraged to a growing economy.

 

Right now, economically many think the good times will never end. We have all the ingredients for medium sized bank failures. I don't think it makes sense to look at OZK from this lense though. They have a lot of capital and it will take capital controls to stop Asian money from pouring in to US cities. OZK does have actual asset/liability issues no one on this board seems to want to talk about. OZK's NIM is compressing and has been for many quarters. They are on pace to hand out $1b/yr in RV/boat loans to avoid earnings contraction.

[NBL0303]

OZK does have actual asset/liability issues no one on this board seems to want to talk about. OZK's NIM is compressing and has been for many quarters.

 

Thanks for your thoughts Schwab - I would love to hear more about the asset/liability issues you were referencing. Were you talking about the RV/Boat loans and their wholesale deposits - or are there other additional asset/liability issues you were referencing as well? Either way, I would love to hear more thoughts on them.

[Shooter MacGavin]

There is nothing new when it comes to finance.

 

Do you believe that no other banks have said “Gee, I want to get in on this super profitable lending?”

 

All it would take is someone hiring an OZK banker and saying, “do what you did there”.

 

Unless you think Gleason is some kind of Michael Milken who has some legitimate edge (although Milken had other not so legitimate edges), there are not very many examples of what you’re describing, Shooter.

 

The base rate of people in finance who said “this time is different” and were actually right is probably vanishingly low.

 

The two I can think of were true sea change type of moments: Efficient Market Theory, which became applied as index investing, and again, Michael Milken’s ideas that debt in highly leveraged firms, or originally fallen angels, was actually a good bargain sitting in plain sight. This idea was further pushed with the advent of private equity (based on Modigliani and Miller and enabled by Milken).

 

I’m not an expert on the history of finance, but is there any research supporting the claim that construction lending is somehow less risky than it appears?

 

Sorry, i'm really not sure what you're saying here about Michael Milken so I'll just defer.

[oddballstocks]

Banks with over-concentrated C&I books tend to lose large amounts of money at some point because C&I demand is usually not geographically diverse, if you make one loan - all projects look good so you become concentrated by vintage in boom times, and due to the variable structure of C&I loans and (in OZK's case - variable structure of their funding base), the banks heavy in this lending can become over-leveraged to a growing economy.

 

Right now, economically many think the good times will never end. We have all the ingredients for medium sized bank failures. I don't think it makes sense to look at OZK from this lense though. They have a lot of capital and it will take capital controls to stop Asian money from pouring in to US cities. OZK does have actual asset/liability issues no one on this board seems to want to talk about. OZK's NIM is compressing and has been for many quarters. They are on pace to hand out $1b/yr in RV/boat loans to avoid earnings contraction.

 

And that alone is mind blowing.  Think of who the marginal borrower is for an RV or boat. It's someone who is buying a toy when times are good, a toy that depreciates like an anchor.  The depreciation curve of an RV or boat is straight down and then plateaus.

 

You have two issues with these loans, the cash flow isn't guaranteed. A person will default on their RV before their car, because they have to have a car to make an income, the RV is a toy.  Second is there's little recovery value. When people start to default on these autotrader and craigslist is filled with people trying to dump further depressing the prices.

 

If you talk to bankers you'll usually hear "sure I'd make an RV or boat loan to one of my customers as an add-on, but I'd never want to be in that business."

 

Smart money is waiting out the hot markets. I spoke to someone who specializes in ag-land financing, the ultimate boom/bust market. He said "we know our customers will blow up, we expect it, so we structure our loans to make sure we never lose a cent when they do." I asked what his clients were doing now "selling land and sitting on their hands waiting for the new money to blow up before buying back in."

 

The problem in banking is that things are concentrated, and are dominos. Employment falls, people work less, they start to default and it causes a cascade throughout the community.  There is a psychological aspect as well, when things are bad those with money refuse to spend.

 

I used to give a talk on banking. My main thesis was that banking is a commodity business, your cost (deposits) is the same as competitors, your revenue (lending rate) is the same as competitors and there are two things that set apart winning banks: expense control, and avoiding losses.  If you have the same average rates, the same average expenses and you avoid losses you viewed as a genius.  A bank is a levered bond fund, there is not much additional upside from taking on a risky loan vs avoiding it.  In a bull market this is impossible to see, but it's plain when the tide goes out.

 

The S&L's in AZ and CA thought they had a better mousetrap as well in the 1980s when they were making loss-proof land loans on future development too.

[s8019]

 

You have two issues with these loans, the cash flow isn't guaranteed. A person will default on their RV before their car, because they have to have a car to make an income, the RV is a toy.  Second is there's little recovery value. When people start to default on these autotrader and craigslist is filled with people trying to dump further depressing the prices.

 

If you talk to bankers you'll usually hear "sure I'd make an RV or boat loan to one of my customers as an add-on, but I'd never want to be in that business."

 

 

If it a recourse loan and an expensive RV or boat is just a tip of the affluent customer wealth, it should be ok. It's a consumer loan really and if you manage to sell consumer loans to affluent customers at good rates - what's not to like? Non recourse RV loans are obviously a train wreck but I don't know who on earth would do business in such loans. OZK management does not look that stupid.

 

Anyway, what is their competitive advantage in RV loans? They found a dearth of capital in this segment?

[Spekulatius]

 

You have two issues with these loans, the cash flow isn't guaranteed. A person will default on their RV before their car, because they have to have a car to make an income, the RV is a toy.  Second is there's little recovery value. When people start to default on these autotrader and craigslist is filled with people trying to dump further depressing the prices.

 

If you talk to bankers you'll usually hear "sure I'd make an RV or boat loan to one of my customers as an add-on, but I'd never want to be in that business."

 

 

If it a recourse loan and an expensive RV or boat is just a tip of the affluent customer wealth, it should be ok. It's a consumer loan really and if you manage to sell consumer loans to affluent customers at good rates - what's not to like? Non recourse RV loans are obviously a train wreck but I don't know who on earth would do business in such loans. OZK management does not look that stupid.

 

Anyway, what is their competitive advantage in RV loans? They found a dearth of capital in this segment?

 

Just from what I see a lot of RV or boat owners aren’t affluent. Maybe OZK clients are ( I have no idea) but if you are affluent, you probably don’t borrow to buy this to begin with, or get a cheap loan from a credit union.

[Shooter MacGavin]

Banks with over-concentrated C&I books tend to lose large amounts of money at some point because C&I demand is usually not geographically diverse, if you make one loan - all projects look good so you become concentrated by vintage in boom times, and due to the variable structure of C&I loans and (in OZK's case - variable structure of their funding base), the banks heavy in this lending can become over-leveraged to a growing economy.

 

Right now, economically many think the good times will never end. We have all the ingredients for medium sized bank failures. I don't think it makes sense to look at OZK from this lense though. They have a lot of capital and it will take capital controls to stop Asian money from pouring in to US cities. OZK does have actual asset/liability issues no one on this board seems to want to talk about. OZK's NIM is compressing and has been for many quarters. They are on pace to hand out $1b/yr in RV/boat loans to avoid earnings contraction.

 

And that alone is mind blowing.  Think of who the marginal borrower is for an RV or boat. It's someone who is buying a toy when times are good, a toy that depreciates like an anchor.  The depreciation curve of an RV or boat is straight down and then plateaus.

 

You have two issues with these loans, the cash flow isn't guaranteed. A person will default on their RV before their car, because they have to have a car to make an income, the RV is a toy.  Second is there's little recovery value. When people start to default on these autotrader and craigslist is filled with people trying to dump further depressing the prices.

 

If you talk to bankers you'll usually hear "sure I'd make an RV or boat loan to one of my customers as an add-on, but I'd never want to be in that business."

 

Smart money is waiting out the hot markets. I spoke to someone who specializes in ag-land financing, the ultimate boom/bust market. He said "we know our customers will blow up, we expect it, so we structure our loans to make sure we never lose a cent when they do." I asked what his clients were doing now "selling land and sitting on their hands waiting for the new money to blow up before buying back in."

The problem in banking is that things are concentrated, and are dominos. Employment falls, people work less, they start to default and it causes a cascade throughout the community.  There is a psychological aspect as well, when things are bad those with money refuse to spend.

 

I used to give a talk on banking. My main thesis was that banking is a commodity business, your cost (deposits) is the same as competitors, your revenue (lending rate) is the same as competitors and there are two things that set apart winning banks: expense control, and avoiding losses.  If you have the same average rates, the same average expenses and you avoid losses you viewed as a genius.  A bank is a levered bond fund, there is not much additional upside from taking on a risky loan vs avoiding it.  In a bull market this is impossible to see, but it's plain when the tide goes out.

 

The S&L's in AZ and CA thought they had a better mousetrap as well in the 1980s when they were making loss-proof land loans on future development too.

 

i'm not trying to be facetious, I promise. As some Yokel newbie myself, that doesn't know anything about banks, i'd love to know who you consider the smart money is.

 

as a newbie, I would look to things I thought were obvious to figure out who the smart money in banking is.  let's see- Top tier economic performance as measured by book value compounded per share plus dividends, lower leverage, consistently lower charge off, profitable during greatest credit crisis since great depression, intelligent owner-operator that compounded personal stake close to 800,000% (if you assume 2% dividends, his split adjusted cost basis is $0.01). 40 year career in banking, never once lost money.  Says all the right things.  Full disclosure of loan books. That doesn't sound like dumb money to me.  But maybe it is.  So who's the smart money?

 

Clearly in your mind, OZK is unable to see all the risks you see.  I know for a fact they've heard of Corus Bank. So if not OZK, then who is the smart money that you can point us to and by what goalposts are you measuring them ?

 

[oddballstocks]

Banks with over-concentrated C&I books tend to lose large amounts of money at some point because C&I demand is usually not geographically diverse, if you make one loan - all projects look good so you become concentrated by vintage in boom times, and due to the variable structure of C&I loans and (in OZK's case - variable structure of their funding base), the banks heavy in this lending can become over-leveraged to a growing economy.

 

Right now, economically many think the good times will never end. We have all the ingredients for medium sized bank failures. I don't think it makes sense to look at OZK from this lense though. They have a lot of capital and it will take capital controls to stop Asian money from pouring in to US cities. OZK does have actual asset/liability issues no one on this board seems to want to talk about. OZK's NIM is compressing and has been for many quarters. They are on pace to hand out $1b/yr in RV/boat loans to avoid earnings contraction.

 

And that alone is mind blowing.  Think of who the marginal borrower is for an RV or boat. It's someone who is buying a toy when times are good, a toy that depreciates like an anchor.  The depreciation curve of an RV or boat is straight down and then plateaus.

 

You have two issues with these loans, the cash flow isn't guaranteed. A person will default on their RV before their car, because they have to have a car to make an income, the RV is a toy.  Second is there's little recovery value. When people start to default on these autotrader and craigslist is filled with people trying to dump further depressing the prices.

 

If you talk to bankers you'll usually hear "sure I'd make an RV or boat loan to one of my customers as an add-on, but I'd never want to be in that business."

 

Smart money is waiting out the hot markets. I spoke to someone who specializes in ag-land financing, the ultimate boom/bust market. He said "we know our customers will blow up, we expect it, so we structure our loans to make sure we never lose a cent when they do." I asked what his clients were doing now "selling land and sitting on their hands waiting for the new money to blow up before buying back in."

The problem in banking is that things are concentrated, and are dominos. Employment falls, people work less, they start to default and it causes a cascade throughout the community.  There is a psychological aspect as well, when things are bad those with money refuse to spend.

 

I used to give a talk on banking. My main thesis was that banking is a commodity business, your cost (deposits) is the same as competitors, your revenue (lending rate) is the same as competitors and there are two things that set apart winning banks: expense control, and avoiding losses.  If you have the same average rates, the same average expenses and you avoid losses you viewed as a genius.  A bank is a levered bond fund, there is not much additional upside from taking on a risky loan vs avoiding it.  In a bull market this is impossible to see, but it's plain when the tide goes out.

 

The S&L's in AZ and CA thought they had a better mousetrap as well in the 1980s when they were making loss-proof land loans on future development too.

 

i'm not trying to be facetious, I promise. As some Yokel newbie myself, that doesn't know anything about banks, i'd love to know who you consider the smart money is.

 

as a newbie, I would look to things I thought were obvious to figure out who the smart money in banking is.  let's see- Top tier economic performance as measured by book value compounded per share plus dividends, lower leverage, consistently lower charge off, profitable during greatest credit crisis since great depression, intelligent owner-operator that compounded personal stake close to 800,000% (if you assume 2% dividends, his split adjusted cost basis is $0.01). 40 year career in banking, never once lost money.  Says all the right things.  Full disclosure of loan books. That doesn't sound like dumb money to me.  But maybe it is.  So who's the smart money?

 

Clearly in your mind, OZK is unable to see all the risks you see.  I know for a fact they've heard of Corus Bank. So if not OZK, then who is the smart money that you can point us to and by what goalposts are you measuring them ?

 

Not the bank, but the business owners who take advantage of the cycle.  The landlords who are saying "a 2% yield isn't worth it" and waits, but then buys in size when they're at 10% in a distressed sale.

 

I hope for you they've invented a better mousetrap. If they have built a new lossless model to banking we all profit because every bank will copy this new mousetrap and will start to originate loans that have zero risk and never go bad.  And if not I'll profit as well because they'll go belly-up.

 

Ideally I'd like to find a basket of 5-10 banks that have similar risk profiles to OZRK and buy cheap puts on all of them.  The longer we are from a recession the more brazen banks like this become, which means the greater chance they stub their toe and fail.  I'm sure Corus never thought they'd fail, or the thousands of banks in 2008, or the thousands in the late 1980s, or really any bank that failed.

 

All is well until it suddenly isn't.

 

On the RV loans. I agree that most of their borrowers are probably not affluent either.  I've attended a few RV shows.  Models aren't priced OTD, they're priced in payment value per month.  You want into a unit and there's a giant sign "Only $103 a month"

 

I love reading this thread, but I feel like I'm recycling my old material over and over.  This is a situation where I'm confident in my analysis.  It's really interesting to see who's on the other side of the trade.  Some compounders and owner-operator investors.  Which makes me more comfortable in my analysis.

 

I fully admit that if we get a very small recession that OZRK will figure out a way to sail through.  If the US is like Australia and we don't have a recession for another 10-15 years these guys are going to grow enormously and the quality of loans really won't matter at all.  I don't think the US has escaped the business cycle, but maybe we finally have.

 

This looks like a duck, quacks like a duck, walks like a duck, but maybe it really is a cow..

 

Payout on the options is 75:1, so it's cheap to bet on this.  Time will tell who is right.

 

[Shooter MacGavin]

Banks with over-concentrated C&I books tend to lose large amounts of money at some point because C&I demand is usually not geographically diverse, if you make one loan - all projects look good so you become concentrated by vintage in boom times, and due to the variable structure of C&I loans and (in OZK's case - variable structure of their funding base), the banks heavy in this lending can become over-leveraged to a growing economy.

 

Right now, economically many think the good times will never end. We have all the ingredients for medium sized bank failures. I don't think it makes sense to look at OZK from this lense though. They have a lot of capital and it will take capital controls to stop Asian money from pouring in to US cities. OZK does have actual asset/liability issues no one on this board seems to want to talk about. OZK's NIM is compressing and has been for many quarters. They are on pace to hand out $1b/yr in RV/boat loans to avoid earnings contraction.

 

And that alone is mind blowing.  Think of who the marginal borrower is for an RV or boat. It's someone who is buying a toy when times are good, a toy that depreciates like an anchor.  The depreciation curve of an RV or boat is straight down and then plateaus.

 

You have two issues with these loans, the cash flow isn't guaranteed. A person will default on their RV before their car, because they have to have a car to make an income, the RV is a toy.  Second is there's little recovery value. When people start to default on these autotrader and craigslist is filled with people trying to dump further depressing the prices.

 

If you talk to bankers you'll usually hear "sure I'd make an RV or boat loan to one of my customers as an add-on, but I'd never want to be in that business."

 

Smart money is waiting out the hot markets. I spoke to someone who specializes in ag-land financing, the ultimate boom/bust market. He said "we know our customers will blow up, we expect it, so we structure our loans to make sure we never lose a cent when they do." I asked what his clients were doing now "selling land and sitting on their hands waiting for the new money to blow up before buying back in."

The problem in banking is that things are concentrated, and are dominos. Employment falls, people work less, they start to default and it causes a cascade throughout the community.  There is a psychological aspect as well, when things are bad those with money refuse to spend.

 

I used to give a talk on banking. My main thesis was that banking is a commodity business, your cost (deposits) is the same as competitors, your revenue (lending rate) is the same as competitors and there are two things that set apart winning banks: expense control, and avoiding losses.  If you have the same average rates, the same average expenses and you avoid losses you viewed as a genius.  A bank is a levered bond fund, there is not much additional upside from taking on a risky loan vs avoiding it.  In a bull market this is impossible to see, but it's plain when the tide goes out.

 

The S&L's in AZ and CA thought they had a better mousetrap as well in the 1980s when they were making loss-proof land loans on future development too.

 

i'm not trying to be facetious, I promise. As some Yokel newbie myself, that doesn't know anything about banks, i'd love to know who you consider the smart money is.

 

as a newbie, I would look to things I thought were obvious to figure out who the smart money in banking is.  let's see- Top tier economic performance as measured by book value compounded per share plus dividends, lower leverage, consistently lower charge off, profitable during greatest credit crisis since great depression, intelligent owner-operator that compounded personal stake close to 800,000% (if you assume 2% dividends, his split adjusted cost basis is $0.01). 40 year career in banking, never once lost money.  Says all the right things.  Full disclosure of loan books. That doesn't sound like dumb money to me.  But maybe it is.  So who's the smart money?

 

Clearly in your mind, OZK is unable to see all the risks you see.  I know for a fact they've heard of Corus Bank. So if not OZK, then who is the smart money that you can point us to and by what goalposts are you measuring them ?

 

Not the bank, but the business owners who take advantage of the cycle.  The landlords who are saying "a 2% yield isn't worth it" and waits, but then buys in size when they're at 10% in a distressed sale.

 

I hope for you they've invented a better mousetrap. If they have built a new lossless model to banking we all profit because every bank will copy this new mousetrap and will start to originate loans that have zero risk and never go bad.  And if not I'll profit as well because they'll go belly-up.

 

Ideally I'd like to find a basket of 5-10 banks that have similar risk profiles to OZRK and buy cheap puts on all of them.  The longer we are from a recession the more brazen banks like this become, which means the greater chance they stub their toe and fail.  I'm sure Corus never thought they'd fail, or the thousands of banks in 2008, or the thousands in the late 1980s, or really any bank that failed.

 

All is well until it suddenly isn't.

 

On the RV loans. I agree that most of their borrowers are probably not affluent either.  I've attended a few RV shows.  Models aren't priced OTD, they're priced in payment value per month.  You want into a unit and there's a giant sign "Only $103 a month"

 

I love reading this thread, but I feel like I'm recycling my old material over and over.  This is a situation where I'm confident in my analysis.  It's really interesting to see who's on the other side of the trade.  Some compounders and owner-operator investors.  Which makes me more comfortable in my analysis.

 

I fully admit that if we get a very small recession that OZRK will figure out a way to sail through.  If the US is like Australia and we don't have a recession for another 10-15 years these guys are going to grow enormously and the quality of loans really won't matter at all.  I don't think the US has escaped the business cycle, but maybe we finally have.

 

This looks like a duck, quacks like a duck, walks like a duck, but maybe it really is a cow..

 

Payout on the options is 75:1, so it's cheap to bet on this.  Time will tell who is right.

 

Yes.  We have probably hashed this thing to death, so I think this will be my last post on this topic.  But thank you for your perspectives. 

 

"Some compounders and owner-operator investors.  Which makes me more comfortable in my analysis."

 

On this particular point, i personally have never cared who the other investors are in a stock.  It doesn't affect my investment decision.  I too have gone back looking for the smoke through Corus Bank's 10-ks and Audit reports of Corus and other banks and FDIC data and transcripts for OZK and Corus etc etc.  I spread the loan portfolio's of Corus vs OZK in 2004-2009 and 2004- 2018 respectively.  I have seen glaringly red flags (admittedly since I know to look for it) in Corus's financial statements 2004,2005,2006 statements that are very different from OZK.

 

Anchoring on the banks that you're aware of that blew up due to construction lending and then going back and looking for more banks that have construction lending exposure and saying they too will likely blow up seems logical but it isn't. Ultimately, it's a multi factor problem where you should isolate how predictive the factor such as, construction lending exposure, is vs subprime mortgages exposure, vs. auto exposure etc has been historically for all banks. How predictive is one credit structure is vs. another. etc?  It's probably a very tough exercise. There's different credit profiles, different collateral, different structures.  Though I don't know, I would speculate that it's not the type of loan (construction, auto, mortgage) but the creditworthiness/financial wherewithal of the borrower, and terms of the loan, that are the most important predictive factors. And then of course asset/liability duration and liquidity structures, and expected ROE per loan and leverage from the bank's POV.  I don't have the brainpower/patience for this exercise, but it seems more logical.

 

Incidentally, I wonder how much money was lost on pure mortgage lending through the great recession and SNL crisis vs. construction lending.  I don't know the answer but I suspect mortgages in total dollars far surpass construction loans. 

[havingheart]

Does anybody know if there are any other banks that are considered "reaching for yield in this environment"?  Just looking for reference points in comparison to OZK.  TIA!

[John Hjorth]

oddballstocks [Nate],

 

Why not let the whole thing "go" here on CoBF [instead of replying, on and on, to no avail]? - As always, time will tell who's right. [ ;- ) ]

[bizaro86]

John, while there is always a point where no good comes from further discussion, a discussion with thoughtful and intelligent proponents on both sides is often extremely useful for uncovering the truth. That is why that system is nearly universally used by the courts.

 

While I'm probably not smart enough to make money on OZRK  (long or short) I'm definitely learning from the exchange here.

 

So just appreciation to those on both sides, and encouragement to continue what has been a great discussion, imo.

[havingheart]

Chiming in that I appreciate Nate's replies as well.  Many of the old admired posters came and went, but Nate's always been more than generous with his inputs/ideas over the years.

 

Anyways, OZK is interesting because of the lack of consensus.  Hopping onto a consensus view on cobf has resulted in rather disappointing results for me in my experience.