Bank OZK: Strong Q1 Results Point To Further Upside

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Bank OZK shares have recovered from last year's banking crisis, up 29%, but are still 10% below their recent high.The company's most recent quarterly results show record earnings and strong deposit ...

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Bank OZK Shares of Bank OZK (NASDAQ:OZK) have recovered solidly from last year’s banking crisis, up 29%. Still, they are more than 10% below their most recent high. Since recommending shares as a strong buy in February, OZK has returned 9% vs the 1% gain in the S&P 500. I had argued that fears over commercial real estate losses on OZK’s balance sheet in the wake of New York Community Bancorp's (NYCB) turmoil were overdone. Based on its most recent quarterly results, I continue to feel this way.   Seeking Alpha In the company’s first quarter, Bank OZK earned $1.51, which beat estimates by $0.05. This was a record quarter for the company, with earnings up 7% from last year. Many regional banks are still struggling with higher funding costs given the deposit scare last year when Silicon Valley Bank failed, making OZK’s performance a particular standout. It continues to accumulate assets, and its credit quality has remained strong. Management’s “goal” is to grow earnings from 2023 levels, and I continue to view this as a credible expectation for 2024. I have argued that stable deposits are a prerequisite when investing in the regional banks, as deposits are the lifeblood of their funding structure. While many regional banks have seen deposits come under pressure, OZK has performed remarkably in this regard. OZK has $29.4 billion in deposits, up 32% from Q1 2023. There is no sign this momentum is slowing down, as deposits rose by $2 billion sequentially. 81% of its deposits are insured or collateralized, which tends to make them stickier. The average account is $44k, well below the $250k FDIC limit. We have seen noninterest bearing deposits (NIB) leave the system most dramatically, as accountholders can earn 5%+ in money markets. Now, these are transactional accounts typically, i.e. to make payroll, so there is a natural floor to them. OZK has historically had a smaller share of NIBs, making its deposit base less vulnerable to outflow. It has $4 billion of non-interest being deposits, down just $50 million sequentially, suggesting we are near that floor. This sum is down just 10% from last year, though given the growth in deposits, the NIB share has fallen from 20% to 14%. Now, just given the rate environment, deposits obviously cost more than a year ago, which has pressured the bank’s net interest margin (NIM). Still, its NIM is wider than the industry, and the 11bp sequential decline in NIM was the slowest pace in a year. Even absent Fed rate cuts, management expects deposit costs to flatten out over the next 2-3 quarters, which should cause NIM to bottom. Even with a narrower NIM, thanks to ongoing balance sheet growth, OZK earned $377 million of net interest income from $345 million a year ago. This was also up $6 million from Q4. With balance sheet growth continuing and NIM nearing a bottom, I expect net interest income to continue to rise this year.   Bank OZK Given its strong deposit growth, OZK is also growing the asset side of its balance sheet. It has $28 billion in loans, up 27% from last year. Net loans were up $1.6 billion sequentially. Credit quality remains quite strong. Only 0.33% of assets are nonperforming, down from 0.34% last year, and there were just 0.11% of net charge-offs in Q1 from 0.14% last year. Given asset growth, OZK set aside $43 million for credit losses from $36 million a year ago, and it now has $537 million in reserves. Its reserves are nearly 5x its $117 million in nonperforming assets, well above my 2.5x benchmark for “healthy” reserves. While credit quality is strong, OZK’s large commercial real estate exposure has been a source of focus. After all, its real estate specialties group drove $1.2 billion of the $1.6 billion loan growth from Q4. Real estate accounts for 65% of the loan book, from 70% in 2016. The plan is to keep growing it while reducing its share beyond 2024. The $1.58 billion of Q1 originations was actually the second slowest of the past 2.5 years, though it remains high on an absolute basis. There are several reasons I am comfortable with this exposure, even as I am wary of commercial real estate in general. First, OZK has a sunbelt and multifamily focus to its real estate lending, areas that are likely to face smaller challenges than office.   Bank OZK Additionally, the company has conservative underwriting standards. This group’s loan book has just a 53% loan to value, assuming every loan commitment is fully drawn. As you can see below, only 4 loans have over 80% LTVs. This means valuations could fall significantly before OZK faces losses. Combined with the fact that OZK already has conservative reserve levels, even a moderate downturn in real estate from here should have minimal net income impacts.   Bank OZK I also view OZK’s loan structuring quite favorably. The average loan yield of 8.7% was up 6bp from Q4 and 64bp from Q1 2023. While most of its loan book is floating, 22% of loans have a floating rate floor within 100bps of current levels; 39% within 150bps. This will protect net interest income if the Fed starts cutting rates, as loan yields will hit floors while OZK reduces deposit rates. If the Fed ends up raising rates, these loans will also see their yields go up. Unlike banks with large losses in their securities portfolio, OZK has little issue here. It has just $3.1 billion in securities and a modest $107 million loss in accumulated other comprehensive income. There is a 2.93% yield on its investment portfolio. With a 3.8 year duration over the next year, there are $1.1 billion of principal payments. This means OZK can roll over much of the portfolio at higher yields. Considering its double-digit growth, OZK is also managing expenses well, with noninterest expense rising by 5.6% to $133 million. OZK is also well capitalized, with a 10.6% tier 1 common equity (CET1) ratio. With that capital position, I view its 3.5% dividend yield as very secure. I do not expect meaningful share repurchases, as it will use its excess capital to support ongoing loan and deposit growth. In February, I had forecast $6-6.10 in 2024 EPS, assuming flat net interest income and modest reserve building. Given ongoing growth and the fact no more than 2 rate cuts appear likely, I expect net interest income to rise from Q1 levels, while I continue to expect no more than modest reserve builds. As such, I look for OZK to earn $6.10-$6.30 this year, for a 7.4x P/E, which I view as very attractive. I believe investors are assigning too much risk to its CRE portfolio, which given prudent underwriting should suffer manageable losses.  As investors grow more comfortable with its real estate exposure, I expect shares to migrate towards 10x earnings, the low end of where peers like Huntington (HBAN), Fifth Third (FITB), and U.S. Bancorp (USB) trade, given some discount is likely to persist due to real estate fears. That still provides more than 30% upside to $60-65, and I continue to view OZK as one of the best opportunities in the sector.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2429108912"}