Bank OZK: The 6.4% Preferred Shares Are Now Too Cheap To Ignore

Summary

• Bank OZK is an Arkansas-based bank with an excellent history of below-average loan losses.
• The bank's share price has lost about 25% since January, making the stock increasingly appealing.
• However, I am focusing on the preferred shares whose share price has been sliding by the same percentage.
• This boosted the (non-cumulative) preferred dividend yield to 6.4% and I like the risk/reward ratio here.
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Introduction

Some of the larger regional banks offer good value and Bank OZK (NASDAQ:OZK) is one of the more reputable banks in that segment. The current market capitalization of Bank OZK is just around $5B as the share price has lost about 25% of its value since January. And due to the higher market interest rates, the bank’s preferred shares have lost a similar percentage and are currently trading at just around $18 (versus a $25 par value). I was waiting for Bank OZK to report its Q1 results before checking up on the preferred shares and I think they are now becoming too cheap to ignore.

Data by YCharts

Now the Q1 results have been published I’m more comfortable with Bank OZK

In order to figure out how attractive the preferred shares are, we need to have a look at the bank’s financial performance first as that will tell us how well the preferred dividends are covered by the bank’s earnings profile and how strong the asset coverage level is.

In the first quarter of 2022, Bank OZK was able to keep its interest income relatively stable as it decreased by less than 1%. Additionally, the interest expenses fell by an additional 55% to just $13M (and this may very well be the last quarter we see the interest expenses decrease). The lower interest expenses resulted in an increase of the net interest income which went up from just under $235M to just over $249M.

Bank OZK Investor Relations

The bank also reported a total net non-interest expense of approximately $76M (in line with the Q1 2021 net non-interest expense) resulting in a pre-tax and pre-provision income of $173M. A relatively strong performance compared to the $161M in Q1 2021. Bank OZK did have to record a $4.2M loan loss provision which weighed on the results a little bit. It also is the only reason why the net income decreased compared to the first quarter of 2021. In the first quarter of last year, Bank OZK was able to reverse almost $32M in previously recorded provisions and that boosted the reported pre-tax income. That was a non-recurring item and if anything, the total amount of loan loss provisions will continue to increase from the $4.2M in Q1 2022. So shareholders should not be too alarmed by what appears to be a 10%+ EPS drop. That’s entirely related to non-recurring items.

I’m not too worried about the loan book as Bank OZK has a very strong history of keeping loan losses very limited.

Bank OZK Investor Relations

What are the implications for the preferred shares?

The consistently strong performance of Bank OZK is one of the reasons why I have the bank’s preferred shares on my shortlist. These preferred shares are trading with NASDAQ:OZKAP as ticker symbol and offer a 4.625% preferred dividend yield based on the par value of $25/share. Due to the increasing interest rates on the financial markets, the share price of these preferred shares has been going down to bring the preferred dividend yield in line with the market expectations. Based on last Friday’s closing price of $18.08 and the non-cumulative annual preferred dividend of $1.15625, the current preferred dividend yield is 6.4%. These securities can be called from November 2026 on but that appears to be quite unlikely given the current circumstances.

There are 14 million preferred shares outstanding, resulting in Bank OZK having to pay a preferred dividend of $16.2M per year, or $4.05M per quarter. Considering the bank reported an after-tax net income of $132.5M, the $4.05M in quarterly preferred dividends have an exceptionally high coverage ratio as the bank needs to spend less than 4% of its income on the preferred dividends. Even if the loan loss provisions would suddenly quintuple, the preferred dividend coverage ratio would still exceed 2,500%. So I don’t anticipate any issues here.

We also need to look at the asset coverage ratio. As of the end of March, Bank OZK had a book value of $4.7B. This includes $350M in preferred shares (the book value of the preferred equity is just under $339M, but should OZK repurchase all of its preferred shares, it would cost the bank $350M and that’s the number I will use here).

This means that the total equity of $4.69B is about 13 times higher than the preferred equity. Even if you would only take the tangible assets into account and remove the $668M in goodwill from the calculation, the preferred equity would still represent less than 10% of the total equity portion on the balance sheet.

Investment thesis

Some commenters on one of my previous articles argued it would make more sense to just buy the common shares of Bank OZK. There’s something to be said for that approach, especially after the recent correction, but I’m looking at OZKAP as an addition to my income-focused portion of my portfolio. Capital gains are not as important there as I am just interested in the income stream and reliable dividend (and interest) income is more important.

In a previous article I mentioned I was waiting for a better entry point to initiate a long position in the preferred shares. I think this is that moment, and I’ll likely initiate a long position in OZKAP sooner rather than later.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in OZKAP over 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.