OZRK - Bank of the Ozarks

[s8019]

The comparison to Penn Square is mostly about wholesale funding to grow project lending at super high rates.  If you think about it lending on O&G reserves and lending on prospective real estate projects isn't actually that different.  You put the money upfront beting on cash to amortize the loan from the liquidation of the asset.

 

Fundamentally it comes down to how good a job you did of getting positive selection on the projects, because you know one day it all rolls, and you just want to survive. Ordinarily the guy growing faster than everyone else isn't the guy with positive selection. And then you double down on that because of how it's funded.  Ie if you had deposits and capital maybe you survive, but if you're deposits run its over.

 

I think comparison to Penn Square may be misleading. Penn Square never really bothered with collateral and it used an origination model. OZK claims that they have LTC of 50% and LTV of 43% (in 2016 for example) and they keep their own loans on their book as far as I understand.

 

What I dont understand is how do they manage to find those loans in a pretty competitive commodity industry. Did they invent some better mousetrap or something? I would understand why it may have been the case in 2009-2012 as they were the only Bubba Gump Shrimp company in town. However speaking of 2018 - i don't get it.

[topofeaturellc]

PS claimed it had collateral in the form of reserves.  It was only after the thing imploded was that lie revealed.

 

And retaining the loans makes the quality of the funding even more Paramount.  But yeah I agree IF this thing ends up imploding it's more Anglo-Irish than Penn Square, and I think your last paragraph is where the controversy lies.  How it's funded and how they retain the risk don't matter if you think they've got a better mousetrap, just hard to see how given bank lending is a commodity for the customers.  If they really had a less risky book you'd also see it in lower than peer asset yields, but I don't think that's the case here.

 

[Spekulatius]

The comparison to Penn Square is mostly about wholesale funding to grow project lending at super high rates.  If you think about it lending on O&G reserves and lending on prospective real estate projects isn't actually that different.  You put the money upfront beting on cash to amortize the loan from the liquidation of the asset.

 

Fundamentally it comes down to how good a job you did of getting positive selection on the projects, because you know one day it all rolls, and you just want to survive. Ordinarily the guy growing faster than everyone else isn't the guy with positive selection. And then you double down on that because of how it's funded.  Ie if you had deposits and capital maybe you survive, but if you're deposits run its over.

 

I think comparison to Penn Square may be misleading. Penn Square never really bothered with collateral and it used an origination model. OZK claims that they have LTC of 50% and LTV of 43% (in 2016 for example) and they keep their own loans on their book as far as I understand.

 

What I dont understand is how do they manage to find those loans in a pretty competitive commodity industry. Did they invent some better mousetrap or something? I would understand why it may have been the case in 2009-2012 as they were the only Bubba Gump Shrimp company in town. However speaking of 2018 - i don't get it.

 

I wonder how the LTV is calculated. OZK provides loans to developers and typically they don’t have they much equity. The original bear case for OZK is that they provide reckless financing to developers in boom/bust cities like NYC and Miami. I am hearing that residential RE in Manhattan has slowed down a lot.

 

That’s not the reason why the stock has been weak recently - the reason is pressure on the NIM. I believe OZK funding model makes it more vulnerable to rises in interest rates, because their funding cost rise instantaneously, unlike a ban with a lot of commercial or retail deposits. USB also reported on more competition in construction loans and they are known to be a very responsible lender.

 

Anyways, I had a small put position and sold for about double. I am inclined to renew my bet with longer dating puts, because I think RE has slowed and the coastal markets that OZK lends to are affected the most.

[Shooter MacGavin]

The comparison to Penn Square is mostly about wholesale funding to grow project lending at super high rates.  If you think about it lending on O&G reserves and lending on prospective real estate projects isn't actually that different.  You put the money upfront beting on cash to amortize the loan from the liquidation of the asset.

 

Fundamentally it comes down to how good a job you did of getting positive selection on the projects, because you know one day it all rolls, and you just want to survive. Ordinarily the guy growing faster than everyone else isn't the guy with positive selection. And then you double down on that because of how it's funded.  Ie if you had deposits and capital maybe you survive, but if you're deposits run its over.

 

I think comparison to Penn Square may be misleading. Penn Square never really bothered with collateral and it used an origination model. OZK claims that they have LTC of 50% and LTV of 43% (in 2016 for example) and they keep their own loans on their book as far as I understand.

 

What I dont understand is how do they manage to find those loans in a pretty competitive commodity industry. Did they invent some better mousetrap or something? I would understand why it may have been the case in 2009-2012 as they were the only Bubba Gump Shrimp company in town. However speaking of 2018 - i don't get it.

 

I wonder how the LTV is calculated. OZK provides loans to developers and typically they don’t have they much equity. The original bear case for OZK is that they provide reckless financing to developers in boom/bust cities like NYC and Miami. I am hearing that residential RE in Manhattan has slowed down a lot.

 

That’s not the reason why the stock has been weak recently - the reason is pressure on the NIM. I believe OZK funding model makes it more vulnerable to rises in interest rates, because their funding cost rise instantaneously, unlike a ban with a lot of commercial or retail deposits. USB also reported on more competition in construction loans and they are known to be a very responsible lender.

 

Anyways, I had a small put position and sold for about double. I am inclined to renew my bet with longer dating puts, because I think RE has slowed and the coastal markets that OZK lends to are affected the most.

 

I think all banks that rely on deposits in a rising rate have will have a rising cost of funding.  If OZK needs to raise rates to bring deposits, so do the other banks.  In fact, 79% of OZK's loans are variable so actually, they'll be better off in a rising rate environment.

 

on the LTV, I'm not sure.  But they talk more to loan-to-cost at the inception of the loan.  That part is easy. 

 

If the loan to cost is ~50%, i just don't see how they can lose money across a broad portfolio of similar loans.  I'm not a banks analyst though so would love someone smarter on this subject to enlighten me.

 

if the projects across the portfolio cost $100, and the loan is senior secured with no other lender, and they lend $50, once the sponsors equity is in for the land and first 50% of construction costs, then how do they lose money? if the land/costs are immediately impaired on a single project by 50%, they'll still not lose money.  Across a broad porftolio? I just don't see it.

 

I don't know about the other areas, but short of a disaster, the land value is not going to be impaired in Manhattan.

[bizaro86]

I think it's pretty likely the land cost is included in the cost basis theyre lending on. So the cost could be land plus permitting plus a big hole plus mobilizing a giant crane. Some of the costs aren't independently recoverable.

[s8019]

 

That’s not the reason why the stock has been weak recently - the reason is pressure on the NIM. I believe OZK funding model makes it more vulnerable to rises in interest rates, because their funding cost rise instantaneously, unlike a ban with a lot of commercial or retail deposits. USB also reported on more competition in construction loans and they are known to be a very responsible lender.

 

 

In this case i would say that you should short all CRE lenders, especially the weaker ones with less margin of saftey (thinly capitalized, with higher LTV etc. - they are the first dominoes to fall). OZK is actually quite the contrary - one of the strongest lenders, at least on paper, so it should be much more resilient to any downturn. Provided of course that they really have this fantastic cherry picking ability to attract the most capitalized borrowers at higher than market rates.

[topofeaturellc]

Land value is just a levered exposure to the underlying project. Land prices in any market can very easily cyclically decline

 

The issue with being wholesale funded isn’t about rates, it’s about liquidity.  If the asset side starts to look weak people won’t extend wholesale deposits, and cre lending business can’t just shut down loan growth, you’ve got to be able to let the developer pull down the loan through completion or you’ll end up with an even bigger haircut.  So you end with a liquidity crisis.

[s8019]

it's more Anglo-Irish than Penn Square

 

 

I was thinking about that. There are some similarities. However Anglo was a bunch of crazy speculators who didn’t mind underwriting 100% LTV loans. OZK is obviously much more cautious.

 

Interestingly, Anglo management made a decision to reduce it’s participation in the developer loans in 2004. They knew it was too risky. The problem was that they didn’t have the guts to actually implement it. Just one last loan, just one last fat paycheck.

 

So if OZK is ready to walk the walk I would expect them to shrink its CRE book considerably in the next couple of years. Otherwise it means that they bow to the pressure in the top of cycle market and hence the bank is priced way too optimistically.

 

[Spekulatius]

it's more Anglo-Irish than Penn Square

 

 

I was thinking about that. There are some similarities. However Anglo was a bunch of crazy speculators who didn’t mind underwriting 100% LTV loans. OZK is obviously much more cautious.

 

Interestingly, Anglo management made a decision to reduce it’s participation in the developer loans in 2004. They knew it was too risky. The problem was that they didn’t have the guts to actually implement it. Just one last loan, just one last fat paycheck.

 

So if OZK is ready to walk the walk I would expect them to shrink its CRE book considerably in the next couple of years. Otherwise it means that they bow to the pressure in the top of cycle market and hence the bank is priced way too optimistically.

 

Has anyone ever seen a bank that stopped writing risky loans by by themselves without pressure from the outside (regulators etc)? I don’t recall any, either banks have good underwriting or bad one, but rarely ever a bank changes from being a bad underwriter to a good one without undergoing some “transformation”.

[Shooter MacGavin]

it's more Anglo-Irish than Penn Square

 

 

I was thinking about that. There are some similarities. However Anglo was a bunch of crazy speculators who didn’t mind underwriting 100% LTV loans. OZK is obviously much more cautious.

 

Interestingly, Anglo management made a decision to reduce it’s participation in the developer loans in 2004. They knew it was too risky. The problem was that they didn’t have the guts to actually implement it. Just one last loan, just one last fat paycheck.

 

So if OZK is ready to walk the walk I would expect them to shrink its CRE book considerably in the next couple of years. Otherwise it means that they bow to the pressure in the top of cycle market and hence the bank is priced way too optimistically.

 

Has anyone ever seen a bank that stopped writing risky loans by by themselves without pressure from the outside (regulators etc)? I don’t recall any, either banks have good underwriting or bad one, but rarely ever a bank changes from being a bad underwriter to a good one without undergoing some “transformation”.

 

With all due respect, how are you so sure OZK is making risky loans?  It seems to be that this based is on a premise that every single CRE loan is risky no matter the terms.  I'm willing to consider that they are making risky loans, but I'd love for you to highlight why. Just saying that OZK is making risky CRE loans seems to be the default position here but I have not seen any evidence that is true given that the loans are written with 50% LTC. 

 

Is it possible to underwrite construction loans that wouldn't be very risky? for example with a high interest, and low LTV and senior secured , with high quality borrowers who have a track record of development?

 

Look at the subprime auto lenders like CACC.  They know they've got high risk borrowers.  They price accordingly and collateralize their loans with the vehicle and the minute something goes south, they repo the car.  They make money hand over fist.  They made money in 2008/2009 too.  So did Ozark.  The evidence is that they are great at credit underwriting and understanding the collateral. 

 

Gleason has signed off on every single loan in the RESG during the past 14 years.  Did a banker of 38 years who has compounded the stock at a 20% CAGR for 20 years with the lowest charge off rates in the industry, now worth $235M and who made money in 2008/2009 and runs a well capitalized, efficient bank suddenly forget how to underwrite? what is he missing? 

[Shooter MacGavin]

 

I've been short them a while, and will continue to be so until they blow up.

 

Check out Penn Square Bank, similarities are scary.  There is nothing new in lending, and if you look on RE boards investors are shocked at the terms OZRK will take, they are the suckers at the table.

 

I'm short via options, I continue to roll them forward.  The carry cost is a few grand a year for about $100k of exposure.

 

Thank you for your thoughts, I'm going this route as well.  How far out are your puts generally? And how far out-of-the-money?

 

The longest dated they have are six months, so I buy those and every 3-6 months I re-up.

 

I'm buying the puts with a strike of $30.  This is binary to me.  A majority of their loans are construction loans and they have a TON of outstanding commitments for more construction lending.

 

It doesn't take a genius to see what happens here.  $9b in construction loans, and $9b in commitments for construction lending, with $3b in equity capital.  With a 20% default rate on construction loans they're sunk.  The thing is for a bank their size you don't even need that.  At a 10% default rate they're in receivership territory because the FDIC doesn't let banks get to $0.  And if you look at construction lending default rates during the crisis 10% isn't outlandish, it's fairly normal and in some places on the low side.

 

This presumes they have zero problems in any other area of their portfolio.  Which based on what I've seen I don't think will be the case.

 

 

They're on the record as saying they don't care about regulators and they just want loan volume.  This is dry tinder piled on dry tinder, all we need is a spark.

 

This is late to this post, but your math here is off. A portfolio wide 20% default rate is unheard off even during the great recession by your own admission. But the bigger error is that you are not considering the recovery due to collateral. You should be looking at the charge-off net of recovery, not just the default rates if you want to figure out how impaired the bank will be.  The incurred loss is a function of both the default and the recovery given default.  There is a reason lenders are secured.  Secured debt is cheaper because it's safer.  But rather than me explaining this to you, let Warren from the 1990 Berkshire Annual report:

Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks. The disarray was appropriate: Month by month the foolish loan decisions of once well-regarded banks were put on public display. As one huge loss after another was unveiled - often on the heels of managerial assurances that all was well - investors understandably concluded that no bank's numbers were to be trusted. Aided by their flight from bank stocks, we purchased our 10% interest in Wells Fargo for $290 million, less than five times after-tax earnings, and less than three times pre-tax earnings.

 

      Wells Fargo is big - it has $56 billion in assets - and has been earning more than 20% on equity and 1.25% on assets. Our purchase of one-tenth of the bank may be thought of as roughly equivalent to our buying 100% of a $5 billion bank with identical financial characteristics. But were we to make such a purchase, we would have to pay about twice the $290 million we paid for Wells Fargo. Moreover, that $5 billion bank, commanding a premium price, would present us with another problem: We would not be able to find a Carl Reichardt to run it. In recent years, Wells Fargo executives have been more avidly recruited than any others in the banking business; no one, however, has been able to hire the dean.

 

      Of course, ownership of a bank - or about any other business - is far from riskless. California banks face the specific risk of a major earthquake, which might wreak enough havoc on borrowers to in turn destroy the banks lending to them. A second risk is systemic - the possibility of a business contraction or financial panic so severe that it would endanger almost every highly-leveraged institution, no matter how intelligently run. Finally, the market's major fear of the moment is that West Coast real estate values will tumble because of overbuilding and deliver huge losses to banks that have financed the expansion. Because it is a leading real estate lender, Wells Fargo is thought to be particularly vulnerable.

 

      None of these eventualities can be ruled out. The probability of the first two occurring, however, is low and even a meaningful drop in real estate values is unlikely to cause major problems for well-managed institutions. Consider some mathematics: Wells Fargo currently earns well over $1 billion pre-tax annually after expensing more than $300 million for loan losses. If 10% of all $48 billion of the bank's loans - not just its real estate loans - were hit by problems in 1991, and these produced losses (including foregone interest) averaging 30% of principal, the company would roughly break even.

 

      A year like that - which we consider only a low-level possibility, not a likelihood - would not distress us. In fact, at Berkshire we would love to acquire businesses or invest in capital projects that produced no return for a year, but that could then be expected to earn 20% on growing equity. Nevertheless, fears of a California real estate disaster similar to that experienced in New England caused the price of Wells Fargo stock to fall almost 50% within a few months during 1990. Even though we had bought some shares at the prices prevailing before the fall, we welcomed the decline because it allowed us to pick up many more shares at the new, panic prices.

 

 

Now going back to OZK, on a single project the odds of it being half constructed and abandoned are low in my opinion. They claim the sponsors are 85 of the top 100 developers. Just from a cursory search and convo with others in the know, borrowers include O' Connor Properties, Goldman, Blackstone.  So the sponsors, who are well-capitalized and have a history won't let their equity just go to zero because occupancy rates go down. The construction should get done. The bigger risk is that over supply can lead to under occupancy vs. what was projected.

 

Let's assume a 95% occupancy was targeted on a single project, and 65% occupancy is the result after 3 years.  In which case, the project is impaired by ~32%. Well in this case, OZK is still going to get full recovery on it's loan in the event of a default because if they don't get paid, they liquidate the collateral for 65% of the cost.

 

 

 

 

[bizaro86]

it's more Anglo-Irish than Penn Square

 

 

I was thinking about that. There are some similarities. However Anglo was a bunch of crazy speculators who didn’t mind underwriting 100% LTV loans. OZK is obviously much more cautious.

 

Interestingly, Anglo management made a decision to reduce it’s participation in the developer loans in 2004. They knew it was too risky. The problem was that they didn’t have the guts to actually implement it. Just one last loan, just one last fat paycheck.

 

So if OZK is ready to walk the walk I would expect them to shrink its CRE book considerably in the next couple of years. Otherwise it means that they bow to the pressure in the top of cycle market and hence the bank is priced way too optimistically.

 

Has anyone ever seen a bank that stopped writing risky loans by by themselves without pressure from the outside (regulators etc)? I don’t recall any, either banks have good underwriting or bad one, but rarely ever a bank changes from being a bad underwriter to a good one without undergoing some “transformation”.

 

With all due respect, how are you so sure OZK is making risky loans?  It seems to be that this based is on a premise that every single CRE loan is risky no matter the terms.  I'm willing to consider that they are making risky loans, but I'd love for you to highlight why. Just saying that OZK is making risky CRE loans seems to be the default position here but I have not seen any evidence that is true given that the loans are written with 50% LTC. 

 

Is it possible to underwrite construction loans that wouldn't be very risky? for example with a high interest, and low LTV and senior secured , with high quality borrowers who have a track record of development?

 

Look at the subprime auto lenders like CACC.  They know they've got high risk borrowers.  They price accordingly and collateralize their loans with the vehicle and the minute something goes south, they repo the car.  They make money hand over fist.  They made money in 2008/2009 too.  So did Ozark.  The evidence is that they are great at credit underwriting and understanding the collateral. 

 

Gleason has signed off on every single loan in the RESG during the past 14 years.  Did a banker of 38 years who has compounded the stock at a 20% CAGR for 20 years with the lowest charge off rates in the industry, now worth $235M and who made money in 2008/2009 and runs a well capitalized, efficient bank suddenly forget how to underwrite? what is he missing?

 

Inverting that, if you were a top 100 developer with a strong track record of success, getting funding for a project at a low LTV, wouldn't you hope that your balance sheet, contacts, and track record would be getting you a better loan than a high interest one from Ozarks?

[s8019]

 

 

Has anyone ever seen a bank that stopped writing risky loans by by themselves without pressure from the outside (regulators etc)? I don’t recall any, either banks have good underwriting or bad one, but rarely ever a bank changes from being a bad underwriter to a good one without undergoing some “transformation”.

 

 

 

I think the long thesis reflected in valuation is that it’s not a typical run of the mill bank which just got lucky. It’s an unusual bank that have pretty high underwriting standards and focus on quality which they are not going to compromise. At the same time they were a very decisive post crisis first mover into heavily underbanked segments. They cut the red tape and quickly lend money to where they can find attractively priced risk. That’s why people are ok with paying a premium valuation for otherwise pretty commodity and cyclical business I guess.

 

It may be true, I don’t know. Let’s suppose it is true. In the current situation in the US market I would expect less and less underbanked segments. Too much liquidity is chasing too few yield opportunities. I’m really interested to know how can it be otherwise? Am I missing something?

 

So if Ozark is not going to compromise it’s underwriting standards it should find a lot of difficulties in attracting new business.

 

However in this case we should see that they let the existing loans to expire and sit on cash or else go to some other sectors where risk is underpriced (if there are any left).

 

Alternative bull thesis may be that they just keep some sort of magic and continue to attract the least risky deals at a fat interest margin even in overbanked markets. However it is difficult to believe it. There are 6000 banks in the US. Whatever magic Ozark is doing (quicker approval process etc.) it is not a rocket science. They should have a swarm of imitators by now then.

 

 

 

 

[oddballstocks]

Shooter..

 

As an investor we can justify any thing we want.  But I'd posit that there is more than meets the  eye here.  You can do a LOT of DD if you want, you can pull ALL of their borrowers, you can see who they deal with, you can talk to regulators.

 

I brought up Penn Square, and this is very similar. In both cases you're lending on some future expected output, from an oil well, or from the completion of a future construction project.  There is no cash flow until the project is complete.

 

Charge-offs and recoveries happen after the bank has failed.  A bank is required to mark loans as standard, sub-standard, impaired etc.  Their regulator requires them to put away loan loss reserves in anticipation of future problems.  Note, none of these loans are "bad", sometimes they are required to reserve when it's "good".  With the new accounting rules you need to over-reserve for defaults early.  It's up to a regulator to determine the reserves, so if everything is good it might be low, but if things start to look bad they will require additional reserves above and beyond.

 

The bank now is completely different from the bank in the past, the one that made it through the Great Recession by outrunning their losses by buying failed banks.  They are lending to speculative projects.  Want proof? Look at some of their projects, look at who they're lending to.  The bank has roughly doubled in the last three years.

 

The math is back of the envelope, because when you're a house of cards there are a lot of ways for it to fall.  The liquidity crisis is the most likely.  Deposits walk out the door, and there is nothing to call in.  Developers don't run flush with cash, and finishing a half finished shopping mall requires extra capital.

 

You can detail out some scenarios where reserves have to be boosted and suddenly profits become a loss very quickly.  They are dramatically under-reserved given their risk profile.

 

Then you have the CEO who claims they've invented a better mouse trap, and that it can't fail, and that they aren't worried about risk.  A bank is a levered bond fund, and management succeeds by managing risk.  In good times (like the last decade) everyone is a genius, becuase we're in a risking market.  The fact that they haven't blown up doesn't mean anything.

 

As I mentioned above, talk to some regulators.  Look deeply into why they switched from the Fed to the state level.  I've give you a hint, the Fed's don't like what they're doing, and if you're the biggest bank in the state there is a lot of regulatory capture and no teeth.

 

Also worth noting that the marquee names are some of the worst development type projects.  Typically a large investor will attach their name, bring in outside capital and keep almost no skin in the game.  They are the first to walk away.  You want banks with local developers where everything is on the line for them.

 

Let's look at worse case scenario here.  The economy hits a recession and there's a downturn in residential and commercial activity.  This is inevitable, maybe not this year, but in 1/3/5/10 years, at some point we will have a recession again.  They are extremely heavy in construction and unfinished projects.  The developers don't have money, and there's no buying demand so they stop building.  Ozarks stops receiving cash on those loans.  Now they foreclose and own a bunch of half finished projects.  They have two choices, the first is to sell the project as-is.  It's some dirt pushed around and a bunch of concrete casing for a building.  What does that go for during a recession?  Who is the buyer?  Loan to cost doesn't matter here anymore.

 

Or second, they realize the only way to recover money is to finish, so they extend the loan to a developer, giving them more cash to finish up.  Now any safe margin on the project (and I'd argue there aren't safe margins right now) is gone.  Now they've made a bet that things recover and it all goes back to a boom quickly.

 

In both cases their issue is time.  They have to finish or liquidate faster than their rate of deterioration.  If they can do this and somehow unload billions in dead construction projects at par then they can make it.

 

The thing banks don't have in a crisis is time.  Deposits walk quickly, and that funding gap HAS to be filled.  Filing lawsuits to foreclose take time.  When you are known as the lender who will lend on anything I'd posit that there is a lot of air in the portfolio.  You don't find that out until a crisis either.

 

This to me is like a person who walks a tight rope across Niagara Falls.  They've never fallen and so they believe they'll never fall in the future.  The problem is as they've become successful they've developed a bit of a drinking problem.  At some point drinking and walking a tight rope don't go well together.  We just don't know the when.

 

Check out some books on the S&L crisis.  Or check out Dead Bank Walking, it hits on some of this, and peels back what happens in the board room too.

 

I get the long thesis.  They have magic, they have a new mouse trap, earnings are growing, they're compounding, Gleason is a genius.  And that thesis is sound as long as we don't have a recession again.

 

For anyone short the longer this goes on the better.  For two reasons, they aren't learning any lessons, they're adding to their risk profile as they go, and they don't have an adult keeping them in check.  And second the longer this happens the less anyone thinks their could be a failure, so puts and borrow are cheap.

 

 

[Shooter MacGavin]

it's more Anglo-Irish than Penn Square

 

 

I was thinking about that. There are some similarities. However Anglo was a bunch of crazy speculators who didn’t mind underwriting 100% LTV loans. OZK is obviously much more cautious.

 

Interestingly, Anglo management made a decision to reduce it’s participation in the developer loans in 2004. They knew it was too risky. The problem was that they didn’t have the guts to actually implement it. Just one last loan, just one last fat paycheck.

 

So if OZK is ready to walk the walk I would expect them to shrink its CRE book considerably in the next couple of years. Otherwise it means that they bow to the pressure in the top of cycle market and hence the bank is priced way too optimistically.

 

Has anyone ever seen a bank that stopped writing risky loans by by themselves without pressure from the outside (regulators etc)? I don’t recall any, either banks have good underwriting or bad one, but rarely ever a bank changes from being a bad underwriter to a good one without undergoing some “transformation”.

 

With all due respect, how are you so sure OZK is making risky loans?  It seems to be that this based is on a premise that every single CRE loan is risky no matter the terms.  I'm willing to consider that they are making risky loans, but I'd love for you to highlight why. Just saying that OZK is making risky CRE loans seems to be the default position here but I have not seen any evidence that is true given that the loans are written with 50% LTC. 

 

Is it possible to underwrite construction loans that wouldn't be very risky? for example with a high interest, and low LTV and senior secured , with high quality borrowers who have a track record of development?

 

Look at the subprime auto lenders like CACC.  They know they've got high risk borrowers.  They price accordingly and collateralize their loans with the vehicle and the minute something goes south, they repo the car.  They make money hand over fist.  They made money in 2008/2009 too.  So did Ozark.  The evidence is that they are great at credit underwriting and understanding the collateral. 

 

Gleason has signed off on every single loan in the RESG during the past 14 years.  Did a banker of 38 years who has compounded the stock at a 20% CAGR for 20 years with the lowest charge off rates in the industry, now worth $235M and who made money in 2008/2009 and runs a well capitalized, efficient bank suddenly forget how to underwrite? what is he missing?

 

Inverting that, if you were a top 100 developer with a strong track record of success, getting funding for a project at a low LTV, wouldn't you hope that your balance sheet, contacts, and track record would be getting you a better loan than a high interest one from Ozarks?

 

 

I'm not a banks guy at all, but I used to work in ABL.  My perspective is that not everyone is good at everything.  Lending is very specialized, just like investing.  You have aircraft lessors, experts in shipbuilding financing, factoring, etc etc.  You need expertise in a market.  These guys can answer your question far better.  And btw, some of them think Ozarks is too aggressive!

 

https://www.wallstreetoasis.com/forums/bank-of-the-ozarks-real-estate-specialties-group

 

[NBL0303]

 

I'm not a banks guy at all, but I used to work in ABL.  My perspective is that not everyone is good at everything.  Lending is very specialized, just like investing.  You have aircraft lessors, experts in shipbuilding financing, factoring, etc etc.  You need expertise in a market.  These guys can answer your question far better.  And btw, some of them think Ozarks is too aggressive!

 

https://www.wallstreetoasis.com/forums/bank-of-the-ozarks-real-estate-specialties-group

 

Thanks for posting that link Shooter. As a shareholder Bank of the Ozarks, some of the quotes on that link you posted don't worry you at all, or at least raise the possibility that they are a risky lender?

 

Here is a sample of quotes just from the first few posts on that link:

 

"Ricky Rosay RERank: King Kong|  banana points 1,570

Second @IRRelevant. Have worked on a deal with them recently for spec office development...one of the only banks willing to lend with partial recourse on a project with minimal pre-leasing. All other banks required 50%+ preleasing, lower proceeds, crazy recourse provisions."

 

"brosephstalin RERank: King Kong|  banana points 1,902

If Ozarks doesn't do your construction deal you're in trouble. ...Clearly their deal flow is getting so heavy they need more analysts - not surprised. The big question is how long they'll stay afloat. We're taking bets in the office on how soon they're going under."

 

"GothamGuy RERank: Senior Monkey|  banana points 71

Just to add: Speak to anyone in the market about construction financing -- especially mezz -- and BOTO will come up again and again...and again. Clearly, they are taking on deals that other lenders are passing on."

[Shooter MacGavin]

Shooter..

 

As an investor we can justify any thing we want.  But I'd posit that there is more than meets the  eye here.  You can do a LOT of DD if you want, you can pull ALL of their borrowers, you can see who they deal with, you can talk to regulators.

 

I brought up Penn Square, and this is very similar. In both cases you're lending on some future expected output, from an oil well, or from the completion of a future construction project.  There is no cash flow until the project is complete.

 

Charge-offs and recoveries happen after the bank has failed.  A bank is required to mark loans as standard, sub-standard, impaired etc.  Their regulator requires them to put away loan loss reserves in anticipation of future problems.  Note, none of these loans are "bad", sometimes they are required to reserve when it's "good".  With the new accounting rules you need to over-reserve for defaults early.  It's up to a regulator to determine the reserves, so if everything is good it might be low, but if things start to look bad they will require additional reserves above and beyond.

 

The bank now is completely different from the bank in the past, the one that made it through the Great Recession by outrunning their losses by buying failed banks.  They are lending to speculative projects.  Want proof? Look at some of their projects, look at who they're lending to.  The bank has roughly doubled in the last three years.

 

The math is back of the envelope, because when you're a house of cards there are a lot of ways for it to fall.  The liquidity crisis is the most likely.  Deposits walk out the door, and there is nothing to call in.  Developers don't run flush with cash, and finishing a half finished shopping mall requires extra capital.

 

You can detail out some scenarios where reserves have to be boosted and suddenly profits become a loss very quickly.  They are dramatically under-reserved given their risk profile.

 

Then you have the CEO who claims they've invented a better mouse trap, and that it can't fail, and that they aren't worried about risk.  A bank is a levered bond fund, and management succeeds by managing risk.  In good times (like the last decade) everyone is a genius, becuase we're in a risking market.  The fact that they haven't blown up doesn't mean anything.

 

As I mentioned above, talk to some regulators.  Look deeply into why they switched from the Fed to the state level.  I've give you a hint, the Fed's don't like what they're doing, and if you're the biggest bank in the state there is a lot of regulatory capture and no teeth.

 

Also worth noting that the marquee names are some of the worst development type projects.  Typically a large investor will attach their name, bring in outside capital and keep almost no skin in the game.  They are the first to walk away.  You want banks with local developers where everything is on the line for them.

 

Let's look at worse case scenario here.  The economy hits a recession and there's a downturn in residential and commercial activity.  This is inevitable, maybe not this year, but in 1/3/5/10 years, at some point we will have a recession again.  They are extremely heavy in construction and unfinished projects.  The developers don't have money, and there's no buying demand so they stop building.  Ozarks stops receiving cash on those loans.  Now they foreclose and own a bunch of half finished projects.  They have two choices, the first is to sell the project as-is.  It's some dirt pushed around and a bunch of concrete casing for a building.  What does that go for during a recession?  Who is the buyer?  Loan to cost doesn't matter here anymore.

 

Or second, they realize the only way to recover money is to finish, so they extend the loan to a developer, giving them more cash to finish up.  Now any safe margin on the project (and I'd argue there aren't safe margins right now) is gone.  Now they've made a bet that things recover and it all goes back to a boom quickly.

 

In both cases their issue is time.  They have to finish or liquidate faster than their rate of deterioration.  If they can do this and somehow unload billions in dead construction projects at par then they can make it.

 

The thing banks don't have in a crisis is time.  Deposits walk quickly, and that funding gap HAS to be filled.  Filing lawsuits to foreclose take time.  When you are known as the lender who will lend on anything I'd posit that there is a lot of air in the portfolio.  You don't find that out until a crisis either.

 

This to me is like a person who walks a tight rope across Niagara Falls.  They've never fallen and so they believe they'll never fall in the future.  The problem is as they've become successful they've developed a bit of a drinking problem.  At some point drinking and walking a tight rope don't go well together.  We just don't know the when.

 

Check out some books on the S&L crisis.  Or check out Dead Bank Walking, it hits on some of this, and peels back what happens in the board room too.

 

I get the long thesis.  They have magic, they have a new mouse trap, earnings are growing, they're compounding, Gleason is a genius.  And that thesis is sound as long as we don't have a recession again.

 

For anyone short the longer this goes on the better.  For two reasons, they aren't learning any lessons, they're adding to their risk profile as they go, and they don't have an adult keeping them in check.  And second the longer this happens the less anyone thinks their could be a failure, so puts and borrow are cheap.

 

Oddballstocks,

 

I appreciate your comments. I'm not really trying to defend OZK even though I'm long. But what I'm trying to do is test my thesis, because banks aren't my forte.

 

In terms of the default rates on construction loans, I'm going to have to walk back my comments from earlier.  You're right.  They default rates were absurd during the crisis and the charge off rates we're high too.  So you absolutely have are right to raise a flag here.

 

https://www.newyorkfed.org/medialibrary/media/research/banking_research/quarterlytrends2018q1.pdf?la=en

 

In terms of getting rid of the bank holding company status, from what I see, I don't find it particularly egregious but maybe I'm being naive.  I spoke to someone I know very well who works for one of the largest banks in the world and who works adjacent to their CCAR group.  If you don't need the fed discount window, and you don't want to be subject to their capital holding requirements based on arbitrary rules, and you don't want to spend 1000 man hours every year and pay CCAR consultants a ton of money to game the stress tests, then why have a bank holding company structure?  US banking is one of the most over-regulated industries in the developed world. Banks have to deal with a ridiculous amount of federal regulators who all give them conflicting mandates and then state regulators to boot.  I too used to work at a bank. The compliance rules are nonsensical in a lot of cases and I would argue they don't necessarily protect society or investors etc. Some of it is a costly box checking exercise.

 

https://www.marketplace.org/2018/03/19/economy/divided-decade/what-balkanization-fragmented-financial-regulatory-system

 

If you came across something else which is a reg flag, which it sounds like you did, would you mind sharing? or at the very least please PM me?  I'm being sincere. I'm open to this idea that OZK is a ticking time bomb.

 

Here is the question ultimately that I'm trying to figure out.

 

Are you (to the entire forum who are negative on this name) negative on OZK because they are heavily weighted in construction loans?  If that's the case, then are you just assuming that construction loans always make bad loans? or is it specific to something OZK is doing?  In other words, what sin is OZK committing? is it just over-indexing construction loans or is it that they're behaving stupidly? or to ask it another way, if there was a lender that was specializing in construction loans, how should they make loans intelligently in a way that Ozark isn't?

 

Thank you.

[Shooter MacGavin]

 

I'm not a banks guy at all, but I used to work in ABL.  My perspective is that not everyone is good at everything.  Lending is very specialized, just like investing.  You have aircraft lessors, experts in shipbuilding financing, factoring, etc etc.  You need expertise in a market.  These guys can answer your question far better.  And btw, some of them think Ozarks is too aggressive!

 

https://www.wallstreetoasis.com/forums/bank-of-the-ozarks-real-estate-specialties-group

 

Thanks for posting that link Shooter. As a shareholder Bank of the Ozarks, some of the quotes on that link you posted don't worry you at all, or at least raise the possibility that they are a risky lender?

 

Here is a sample of quotes just from the first few posts on that link:

 

"Ricky Rosay RERank: King Kong|  banana points 1,570

Second @IRRelevant. Have worked on a deal with them recently for spec office development...one of the only banks willing to lend with partial recourse on a project with minimal pre-leasing. All other banks required 50%+ preleasing, lower proceeds, crazy recourse provisions."

 

"brosephstalin RERank: King Kong|  banana points 1,902

If Ozarks doesn't do your construction deal you're in trouble. ...Clearly their deal flow is getting so heavy they need more analysts - not surprised. The big question is how long they'll stay afloat. We're taking bets in the office on how soon they're going under."

 

"GothamGuy RERank: Senior Monkey|  banana points 71

Just to add: Speak to anyone in the market about construction financing -- especially mezz -- and BOTO will come up again and again...and again. Clearly, they are taking on deals that other lenders are passing on."

 

They absolutely do.  Again, I'm trying to get to the bottom of this!  credit goes to someone else actually who shared that link earlier. 

[Shooter MacGavin]

Shooter..

 

As an investor we can justify any thing we want.  But I'd posit that there is more than meets the  eye here.  You can do a LOT of DD if you want, you can pull ALL of their borrowers, you can see who they deal with, you can talk to regulators.

 

I brought up Penn Square, and this is very similar. In both cases you're lending on some future expected output, from an oil well, or from the completion of a future construction project.  There is no cash flow until the project is complete.

 

Charge-offs and recoveries happen after the bank has failed.  A bank is required to mark loans as standard, sub-standard, impaired etc.  Their regulator requires them to put away loan loss reserves in anticipation of future problems.  Note, none of these loans are "bad", sometimes they are required to reserve when it's "good".  With the new accounting rules you need to over-reserve for defaults early.  It's up to a regulator to determine the reserves, so if everything is good it might be low, but if things start to look bad they will require additional reserves above and beyond.

 

The bank now is completely different from the bank in the past, the one that made it through the Great Recession by outrunning their losses by buying failed banks.  They are lending to speculative projects.  Want proof? Look at some of their projects, look at who they're lending to.  The bank has roughly doubled in the last three years.

 

The math is back of the envelope, because when you're a house of cards there are a lot of ways for it to fall.  The liquidity crisis is the most likely.  Deposits walk out the door, and there is nothing to call in.  Developers don't run flush with cash, and finishing a half finished shopping mall requires extra capital.

 

You can detail out some scenarios where reserves have to be boosted and suddenly profits become a loss very quickly.  They are dramatically under-reserved given their risk profile.

 

Then you have the CEO who claims they've invented a better mouse trap, and that it can't fail, and that they aren't worried about risk.  A bank is a levered bond fund, and management succeeds by managing risk.  In good times (like the last decade) everyone is a genius, becuase we're in a risking market.  The fact that they haven't blown up doesn't mean anything.

 

As I mentioned above, talk to some regulators.  Look deeply into why they switched from the Fed to the state level.  I've give you a hint, the Fed's don't like what they're doing, and if you're the biggest bank in the state there is a lot of regulatory capture and no teeth.

 

Also worth noting that the marquee names are some of the worst development type projects.  Typically a large investor will attach their name, bring in outside capital and keep almost no skin in the game.  They are the first to walk away.  You want banks with local developers where everything is on the line for them.

 

Let's look at worse case scenario here.  The economy hits a recession and there's a downturn in residential and commercial activity.  This is inevitable, maybe not this year, but in 1/3/5/10 years, at some point we will have a recession again.  They are extremely heavy in construction and unfinished projects.  The developers don't have money, and there's no buying demand so they stop building.  Ozarks stops receiving cash on those loans.  Now they foreclose and own a bunch of half finished projects.  They have two choices, the first is to sell the project as-is.  It's some dirt pushed around and a bunch of concrete casing for a building.  What does that go for during a recession?  Who is the buyer?  Loan to cost doesn't matter here anymore.

 

Or second, they realize the only way to recover money is to finish, so they extend the loan to a developer, giving them more cash to finish up.  Now any safe margin on the project (and I'd argue there aren't safe margins right now) is gone.  Now they've made a bet that things recover and it all goes back to a boom quickly.

 

In both cases their issue is time.  They have to finish or liquidate faster than their rate of deterioration.  If they can do this and somehow unload billions in dead construction projects at par then they can make it.

 

The thing banks don't have in a crisis is time.  Deposits walk quickly, and that funding gap HAS to be filled.  Filing lawsuits to foreclose take time.  When you are known as the lender who will lend on anything I'd posit that there is a lot of air in the portfolio.  You don't find that out until a crisis either.

 

This to me is like a person who walks a tight rope across Niagara Falls.  They've never fallen and so they believe they'll never fall in the future.  The problem is as they've become successful they've developed a bit of a drinking problem.  At some point drinking and walking a tight rope don't go well together.  We just don't know the when.

 

Check out some books on the S&L crisis.  Or check out Dead Bank Walking, it hits on some of this, and peels back what happens in the board room too.

 

I get the long thesis.  They have magic, they have a new mouse trap, earnings are growing, they're compounding, Gleason is a genius.  And that thesis is sound as long as we don't have a recession again.

 

For anyone short the longer this goes on the better.  For two reasons, they aren't learning any lessons, they're adding to their risk profile as they go, and they don't have an adult keeping them in check.  And second the longer this happens the less anyone thinks their could be a failure, so puts and borrow are cheap.

 

After re-reading this, I guess I'm going to summarize your view and say you think the sin that they are committing is that they are severely under-capitalized for a downward scenario.  That's a fair point to consider.  I will do more work.  I will disagree with that the point about LTC not making a difference though.  In NYC at least, there is no such thing as an unusable dirt lot...every square inch can be liquidated and there is a buyer at some price.  Particularly in Manhattan.  While the scenario you describe is true on a per-lot basis, it's less true across a portfolio in my view.  The charge-off rates that I sent in a previous link don't really adjust for LTC. 

 

Again I make the analogy about subprime auto lending. Can you conceive of a worse borrower? and yet there is a way to make money doing it if you structure it correctly. Look at CACC, one of the best performing stocks in the US market.  I'm NOT saying I'm convinced OZK is structured well.  All i'm saying is that IT IS POSSIBLE to do intelligent construction financing.

[NBL0303]

 

Again I make the analogy about subprime auto lending. Can you conceive of a worse borrower? and yet there is a way to make money doing it if you structure it correctly. Look at CACC, one of the best performing stocks in the US market.  I'm NOT saying I'm convinced OZK is structured well.  All i'm saying is that IT IS POSSIBLE to do intelligent construction financing.

 

Shooter - it is awesome that you are digging so deep and thinking about all the facts on every side of the equation.

 

I agree with you completely that it is possible to do intelligent construction financing.

 

I would say that the specific risks that some of us are worried about with Bank of the Ozarks is that this bank specifically may be engaged in risky construction lending - but not that it is impossible to lend well in this area.

 

And I'm not saying I know that Ozarks is a ticking time bomb - but the concern about them is not that they are simply engaged in construction financing. The concerns are much more specific to Ozarks then that. The concern is that the bank that has thrived all these years is no longer the same bank. The lending operation that held up very well in 2008/2009 is not at all the same as the current lending operation. Since that time, they completely changed qualitatively and qualitatively. Almost all of the loans on their books now are in the specific markets they entered since then, namely New York City and Miami. So one of the risks is just the concentration on a specific type of loan and in just a handful of specific markets. (The other side of this is that maybe that specializing in this way gives them an expertise edge/etc. But the possibility or enhanced risk is clearly present when a bank concentrates this heavily into construction loans largely in just a couple of markets.) In 2008/2009 I do not believe that Ozarks had a single construction loan in those markets; but in just the last few years - construction loans in these two markets have become a large portion of their book. The concern is enhanced because these are not underbanked markets, Ozarks had no or little experience with those markets until recently, they came out of no where and didn't really tip-toe into but jumped right into the deep end. Additionally, they are making loans that no other lenders in those markets will do; and with permissive terms in many cases that no other lenders would accept for any construction loan. Thus, they went into a traditionally risky market, that is extremely competitive and made loans that many other lenders specifically looked at and passed on. Historically in banking, this has all the hallmarks of bank that could be prone to major issues. That is one version of the bear case.

 

The other side of that is that, Ozarks has done well for a long-time and they believe they are just simply better at lending - such that these loans that other lenders (all other lenders in some of these markets) perceive as too risky, are not as risky as others perceive. If this bull case is accurate, then they truly have simply found or invented a better lending mousetrap. Which is not impossible, but in a competitive industry with 6,000 banks and large markets with dozens of large lenders, it is very, very difficult to have invented a lending mousetrap that is that much better than everyone else. Throw in the comments from many, many other bankers who will tell you that they believe Ozarks lending in the last few years is reckless and throw in the regulatory issue (the Feds pushing back on Ozarks so much that it led to Ozarks opting out of federal regulation to being regulated by its home state officials). This why many of us are skeptical - but that doesn't mean we are right and it is impossible that they indeed did invent a better lending mousetrap.

[John Hjorth]

 

Again I make the analogy about subprime auto lending. Can you conceive of a worse borrower? and yet there is a way to make money doing it if you structure it correctly. Look at CACC, one of the best performing stocks in the US market.  I'm NOT saying I'm convinced OZK is structured well.  All i'm saying is that IT IS POSSIBLE to do intelligent construction financing.

 

Shooter - it is awesome that you are digging so deep and thinking about all the facts on every side of the equation.

 

I agree with you completely that it is possible to do intelligent construction financing.

 

I would say that the specific risks that some of us are worried about with Bank of the Ozarks is that this bank specifically may be engaged in risky construction lending - but not that it is impossible to lend well in this area. ...

 

With all due respect, I think these kind of arguments are void - absolutely void, perhaps taking investment horizon into consideration as being a material matter make giving it some degree.

 

No fellow board member - as far as I can read - has so far in this topic ruled out OZRK going broke or to fail on its obligations. Actually, Nate is betting on it, ref. his posts in this topic.

 

Actually, what we from a risk perspective is dealing with here [with no visible complaints in the topic so far], is a derivative of a binominal outcome distribution with regard to your investment return, where you - year by year - has to substitute fail [= 0] with some number less than 1 of your capital at the beginning of each period - for each period, and success with some number higher than 1 of your capital at the beginning of each period - for each period.

 

All that, with the assumption, that when you [eventually] multiply "something" with zero, you get: zero.

 

 

 

[cmlber]

Again I make the analogy about subprime auto lending. Can you conceive of a worse borrower? and yet there is a way to make money doing it if you structure it correctly. Look at CACC, one of the best performing stocks in the US market.  I'm NOT saying I'm convinced OZK is structured well.  All i'm saying is that IT IS POSSIBLE to do intelligent construction financing.

 

Very dangerous to compare half constructed high-rises to cars.  There is ALWAYS a liquid market for used cars.  Prices go up and down, but the collateral is easy to repossess and easy to sell. 

 

Also, I think part of the issue here is you don't necessarily need defaults when the liabilities are short-term and the assets long-term.  Wholesale funding can disappear quickly just on the increased probability of default, and then what? 

 

Disclosure: not long or short and have not done any work on this other than following this great thread.

[s8019]

Shooter, thanks for referring to CACC. I just had a very cursory look at financials.

 

In the period of 1998-2008 this company increased lending by about 5% per year. I would say that this is pretty conservative lending growth more or less consistent with the stable underwriting standards. However in the next 10 years the company increased lending by 16% p.a. In my view there is no way they can achive this lending growth without compromising on quality. Looking at their financials I see the opposite, reserves for loan losses were 23% of total loans in 2003 for example and now it is only 8%. Really? How is that possible?

 

By the way 8% loan loss reserve on a portfolio of customers whom they charge 20%+ interest? What happened to the US if almost creditworthy people (judged by reserves) have to borrow at 20% against collateral? It seems that autolending is much better business than Facebook or Google (judged by ROE). Who khew?

 

Icing on the cake - the market values this commoditiy financial business (as far as I can see from their website they don't provide any unique services - just money) at 5 times book value.

 

Well, what can I say. I think this is insane. However it is just me of course, may be I'm very oldschool and don't get it.

 

 

[AdjustedEarnings]

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!

[Guest Schwab711]

I don't think OZK is going bankrupt any time soon but I also don't think this is a binomial distribution (bankrupt or bank continues as it has). All of the inputs governing OZK's decisions over the last 10 years have changed. The yield curve is flat but short-term rates aren't 0%. With brokered deposits at 2.5% (their marginal cost of funds) + cost of originating a loan for OZK, I don't think they can profitably originate a mortgage. That's scary for a community bank. It looks like OZK's loan portfolio is showing this to be true. 73% of 2Q 2018 loan growth was from RV/boat loans. In prior years it came from C&I. They are all-in on a strong consumer-driven economy. Maybe they are right but I think the market sees high capital ratios and doesn't appreciate just how much leverage OZK has absorbed. A relatively narrow band of economic variables must occur for OZK to grow earnings from here (or they have to buy another bank with stock). There are also some plausible scenarios where OZK takes huge losses.