Bank Of The Ozarks: The Growth Story Is Still Intact

| About: Bank of (OZRK)

Summary

3Q marked another quarter of pacey growth in Bank of the Ozarks, as the bank showed solid operational performance.

We see downside risks to loan growth, upside risks to margins, and efficiency ratio going a little bit higher in years to come.

Ozarks is still a unique growth story in the banking space, and the stock trading below $40 presents an attractive entry point.

Bank of the Ozarks (NASDAQ:OZRK) reported once again reported a solid quarter, posting a EPS beat and reiterating the solid guidance that was provided with last quarter's earnings. A net income of $76 million was posted for the quarter (up 64.8% y/y), or $0.66 per share, coming 6 cents above the market consensus. Ozarks's earnings in 9M16 reached $182 million, corresponding to 39% y/y growth. Following its solid results, we continue to keep Ozarks among our top pick in the banking space.

Click to enlarge

Ozarks's average non-purchased loan book growth (+69% y/y) accelerated in 3Q16, which was way above the industry average. Meanwhile, YTD growth reached 72%, and demonstrated that Ozarks has the best-in-class capabilities when it comes to growing its business. However, strong prepayment trends are likely to drive downward risks to loan growth in the upcoming period. At this point, management also slightly revised down its guidance.

On the other hand, Ozarks registered 16 bps y/y yield expansion for its non-purchased loan portfolio. While this was partly due to prepayment penalties that took yields up, the upward trend in Libor rates has clearly supported the margins. Given the fact that more than four fifths of the total portfolio is variable rate loans of which yields are moving in line with Libor, we recognize that risks are mostly upside to margins.

Still, we should note the bank has suffered a y/y NIM decline of 17 bps in 3Q16, which was driven by higher cost of funding. That said, when compared to the rest of the industry, Ozarks has a superior NIM, which already had been expected to contract in a normalization process; somehow, we now believe that could be milder than expected.

Bank of the Ozarks Financial Data

9M16

9M15

Change

Income statement data:

Net interest income

406,705

275,633

47.6%

Provision for loan and lease losses

13,937

14,205

-1.9%

Non-interest income

71,829

74,475

-3.6%

Non-interest expense

177,395

139,336

27.3%

Net income

182,193

130,798

39.3%

Common stock data:

Net income per share - diluted

$1.84

$1.51

$0.33

Net income per share - basic

$1.84

$1.52

$0.32

Cash dividends per share

$0.47

$0.41

$0.06

Book value per share

$22.75

$14.89

$7.86

Tangible book value per share

$16.79

$13.13

$3.66

Balance sheet data at period end:

Assets

18,451,783

9,329,216

97.8%

Non-purchased loans and leases

8,759,766

5,447,278

60.8%

Purchased loans

5,399,831

1,963,078

175.1%

Investment securities

1,341,894

796,373

68.5%

Deposits

15,123,804

7,606,790

98.8%

Common stockholders' equity

2,756,346

1,314,517

109.7%

Selected ratios (pp):

ROAA

1.88

2.11

-23 bps

ROAE

13.27

14.95

-168 bps

ROATCE

15.88

17.05

-117 bps

Equity to Total Assets

14.15

14.14

+1 bps

Loans-to-deposit ratio

93.62

97.42

-380 bps

NIM

4.88

5.28

-40 bps

Efficiency ratio

36.57

38.96

-239 bps

NCO Rate

0.06

0.17

-11 bps

NPA Rate

0.28

0.41

-13 bps

ALLL Rate

0.78

1.08

-30 bps

Source: SEC

Click to enlarge

Recently, concerns have been raised about the bank's concentration risk in commercial real estate lending. While accepting that being heavily positioned in one specific industry may pose significant risks for any bank, this, we believe, is currently not the case for Ozarks, and is very unlikely to be in the future. First, the bank implies tight underwriting standards that has paved the way for having the best asset quality metrics in the U.S. banking universe.

Ozarks's so called Real Estate Specialties Group, or in short the RESG portfolio, that currently represents almost 70% (91%) of total loans (total commitments), has had only two loans resulting in losses in 13 years, causing total credit losses of $10.4 million, or 8 bps of the average balance reported through this time. Also, the bank has managed to keep its NCO rate below the industry average since it went on public 19 years ago.

Admittedly, CRE loans are known for its alpha plus credit metrics during the non-recession periods, and might quickly get sour when the economy moves into a pretty state of affairs, but the loan-to-appraised value of Ozarks's portfolio, which is now at 42%, mitigates the risks in our view.

In the upcoming period, it is very likely that we will see faster expansion in the areas other than RESG, as the management plans to lower the share of RESG to 57% in its total loan portfolio. This also will help the bank reduce the risks stemming from the heavy concentration. While we see this as a positive for the margin outlook, Ozarks will increasingly feel the pressure on the funding side as it is not comfortable with its relatively high loans to deposits ratio.

We expect this to be a drag on margins. We appreciate the bank's efforts for setting up its branch network with the intention of growing its share in the deposit market, which would ease the pressure of higher cost of funding to some extent. Bank of the Ozarks's total assets will exceed $20 billion next year.

For 3Q, the bank recorded an efficiency ratio of 38% (36.6% for 9M16) which proved Ozarks's rigorous expense management. Any way you cut it, this bank is run lean and mean. However, it is hard to make sure that the bank would keep it sustainable over the next years as the bank is set to become a systemically important financial institution.

Lower merger expenses will have some positive effect in the short term, but for now, we do not see any long-term drivers on the expenses side. Still, the bank will be able to operate at superior ratios with its optimized branch footprints and strong revenue streams.

Ozarks's high quality is reflected in its premium valuation, with the stock trading at a premium to peers, but given the future growth outlook, we still see more upside. Our 12-month horizon price target of $55, or a target P/TBV of 2.75x, which is derived from a sustainable ROATCE of 16% in 2017-18, a cost of equity of 9%, a generic long-term growth rate of 4% on a 2017E TBVPS of $20, implies 38% upside potential from the current stock price. We believe that the stock has reached an attractive entry point and maintain our buy rating.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.