There is no shortage of critics who will bitterly complain about how the Bush and Obama administrations have handled the near-meltdown of the U.S. banking system. One company that is not likely to complain at all is Arkansas's Bank of the Ozarks (OZRK) as this company has feasted on FDIC-assisted acquisitions and continues to thrive by zigging where others zag. The question, though, is whether the potential returns are still worth the risk.
A Strong Close To The Year
Relative to larger banks like M&T Bank (MTB) or Wells Fargo (WFC), Bank of the Ozarks' earnings are relatively clean and simple. Although net earnings did slide about 7% from the third quarter, the bank nevertheless beat the average analyst guess by about two cents.
Net interest income rose about 3% as the company counter-balanced a slightly low number for average earning assets with a fairly whopping net interest margin of 6.05% - up 15 basis points from the third quarter. Non-interest income was a little sluggish, though, as lower mortgage lending income offset solid service fee revenue.
Loan growth was a little sluggish (about 1% sequential growth), but Bank of the Ozarks posted very significant improvements in the non-performing assets ratio (28 basis points) and non-performing loans ratio (52 basis points). Expense control was pretty solid, as the company makes progress with integrating its acquisitions.
A Tradition Of Being Different
At age 25, most people today are still trying to figure out what they want to do with themselves and/or how they're going to repay their student loans. Bank of the Ozarks CEO George Gleason took control of this bank at that age. Ever since, this is a bank that has been run in a way that definitely defies convention.
Bank of the Ozarks has built itself in part on a willingness to lend heavily to the commercial real estate market. While much larger regional banks like BB&T (BBT) have been criticized (and discounted) for this, OZRK has it made it work well. The bank employs a rather conservative "small bank" underwriting philosophy has managed to wring out the higher returns that come with CRE lending without incurring a lot of losses.
At the same time, Bank of the Ozarks has been more than willing to invest its capital in municipal securities. Creating something of its own cottage industry, the bank takes advantage of what it sees as mispricings and has reaped pretty good returns on those assets recently.
Last and not least, Bank of the Ozarks has made ample use of FDIC assistance in doing deals. OZRK has closed 7 FDIC-assisted deals since 2009 and added 42 branches that way. Moreover, about 30% of the bank's loan book is covered. More could yet be on the way - management has identified a core 12-state footprint for expansion and there are ample failures/potential failures in Georgia, Florida, and Missouri that the company could potentially acquire.
These deals look like a win-win for OZRK. The vast majority of these banks are too small to attract the attention of BB&T, PNC (PNC), Cullen/Frost (CFR), SunTrust (STI), or other would-be rivals, but they are large enough to be material for Bank of the Ozarks. So while investors wonder (and worry) what will become of BankUnited (BKU), First Horizon (FHN), and Synovus (SNV) or whether there will be a bidding war for Texas Capital (TCBI), Bank of the Ozarks quietly goes about building a great little franchise in attractive markets.
Ample Opportunities Matched With Risks
Bank of the Ozarks has long enjoyed margins and returns well ahead of its rivals. Granted, some of this is due to advantages of scale (OZRK has more high-margin opportunities than a larger bank like BB&T or PNC), but some of it is due to fundamental differences in the operating model. The question is whether those risks come home to roost.
So far the much-anticipated meltdown in commercial real estate just hasn't materialized, but OZRK's large exposure to this category (especially in retail) could lead to huge losses if it did. Likewise, the heralded muni meltdown hasn't happened either, but here too OZRK would be at risk if one come about suddenly.
The Bottom Line
Bank of the Ozarks is a remarkable community/regional banking story, but it takes equally remarkable assumptions to make this stock look cheap today. I would argue that OZRK's heavy reliance on commercial lending merits a higher discount rate than the average bank and it takes a sustained return on equity in the high 20%'s to make these shares look cheap. Given how few banks in the U.S. have maintained that sort of performance, that just seems too aggressive.
Bank of the Ozarks would be a fine stock to consider on a pullback, but the valuation just looks too rich today.
Disclosure: I am long (BBT).