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With shares of banks getting pummeled into the ground over the last few months and valuations reaching highly attractive levels, many investors are tempted to follow investing gurus like Warren Buffett and buy into the sector as a value play. However, there are a lot of risks in buying a bank whose price is propped up on valuations alone. Attractive P/E and P/B ratios have a nasty habit of vanishing when financial instruments held by a bank collapse in value. With the seemingly imminent Greek default approaching, as well as possible defaults from Italy, Spain, and a number of other nations, there is a serious risk to a financial institution dealing in sovereign debt and complicated instruments like credit default swaps [Bank of America (NYSE:BAC), JP Morgan (NYSE:JPM), UBS (UBS), Deutsche Bank (NYSE:DB), et al.] An attractive Price to Book today might not look so good tomorrow when the book portion of the equation decreases drastically overnight. The fear that bank balance sheets may not hold up in the near future has driven the financial sector down hard, but as in any fear driven broad sector selloff, there are companies that have been unfairly sold off which represent a buying opportunity to the investor willing to put in the effort to do the research and uncover the truth. I believe that one such company is Bank of the Ozarks (NASDAQ:OZRK).

Bank of the Ozarks provides retail banking services from 73 offices across the Southeastern United States. Bank of the Ozarks’ business model is relatively easy to understand. Like other financial institutions, the bank relies upon the difference between interest income, earned from loans, leases, covered loans, and other investments, and interest expenses, paid on interest bearing liabilities such as deposits and borrowings, to make money. The company also generates some income from miscellaneous sources such as service charges. Currently, the bank trades at a trailing P/E of 7.49 and P/B of 2.24. The bank has somewhat higher valuation metrics than some of its industry peers, and has significantly outperformed both the S&P 500 and the financial sector over the last year, but when analyzing a company’s worth, it is important to look beyond the ratios and see what is driving the numbers.


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Bank of the Ozarks’ performance reflects the benefits of its recent expansion. Finding itself in better shape than many other banks during the 2008-2009crisis thanks to a conservative lending strategy, OZRK moved to scoop up the assets of several distressed regional banks at a bargain price. Bank of the Ozarks partnered with the FDIC to acquire the assets under what are referred to as an “FDIC Loss Share Agreements.” Under these agreements, the FDIC agrees to shoulder a percentage of charge offs of the assets of the failed banks. Bank of the Ozarks made loss share agreements on 4 bank acquisitions in 2010. The agreements are complicated, with several tiers of loss absorption depending on the dollar amount of the loss, but generally the terms are that the FDIC will shoulder 80% of the loss below a certain value, then up to 95% of a more catastrophic loss (for specific terms, see page 24 of the company’s 2010 annual report). The assets acquired under the loss share agreements are doubly advantageous for Bank of the Ozarks because they are higher yielding than its previous portfolio, which increases returns, and because the government has agreed to shoulder the majority of the charge offs if the assets go bad, reducing risk.

Even with the new acquisitions, the bank boasts some of the highest quality assets in the banking sector. The bank’s 2010 charge off ratio of 0.81% is 178 basis points lower than the average FDIC insured institution’s ratio of 2.59%, and the bank has a long history of conservative lending, leading to lower ratios than its competitors. Further helping OZRK’s earnings are the low prevailing interest rates on deposits, which show little sign of increasing anytime soon with the uncertainty in the economy. In short, the company is earning more interest and paying out less, which is reflected in the TTM EPS growth of nearly 125%. The bank’s Net Interest Margin is at an all time high, so it is unlikely that this is a sustainable rate of growth, but even when NIM decreases, the company has an edge on its competitors and appears poised to continue at or above its 5 year average growth rate of 14.8%.

Management is a key factor to the success of any business, and Bank of the Ozarks boasts top quality management with a vested interest in the company. Bank of the Ozarks’ CEO has 32 years of tenure, and has overseen a 115 fold increase in the bank’s size since he purchased the company in 1979 for less than $30 million. Management has shown the ability to take calculated risks to safely grow the business. The bank submitted bids to take over almost 50 failed banks in 2010, but only took over 4 portfolios, reflecting a strong desire to avoid overpaying for assets and a cautionary approach to avoid poisoning its balance sheet.

A final reason to invest in OZRK is the dividend. Research has shown that stocks that pay consistently growing dividends tend to outperform the aggregate over the long term. At current prices, OZRK's dividend yield stands at about 1.7%, with a payout ratio just over 15%. Combine the low payout ratio with the low market cap and the 5 year dividend growth rate of over 13%, which went uninterrupted by the financial crisis, and there is some serious dividend growth stock potential in Bank of the Ozarks.

Before you follow the herd and put your money on BAC or another big beaten down name just because it's cheap, take a moment to consider a less well known bank like OZRK. You may find a better long term risk/reward proposition for your hard earned money. As always, I encourage you to do your own research before investing and, by all means, please share what you find.

Disclosure: I am long OZRK. I am by no means any sort of financial expert and this article is solely for the purpose of sharing investing ideas with others. Please do your own diligence before acting on any advice from this article.

Source: Bank of the Ozarks: The Real Bank of Opportunity