Bank Of The Ozarks Continues To Build Value

By Stephen D. Simpson, CFA | April 12, 2013 AAA

I've long praised Little Rock-based Bank of the Ozarks (Nasdaq:OZRK) as one of the best-run banks that most investors probably don't know about. This bank has long used a mix of opportunistic M&A and focused lending expertise to grow what has become an increasing valuable Southern/Southeastern banking franchise. While today's price is not exactly a bargain, there are worse fates in investing than to hold somewhat expensive positions in very promising companies.

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First Quarter Results Basically Okay
The worst thing I think I can say about OZRK's first quarter results is that the while the bank supports a top-notch valuation, the results were basically just in line with expectations. That said, at a time when many banks are struggling to grow their business at all, this bank's results are quite impressive.

Operating revenue rose 5% this quarter, but did fall about 3% sequentially on some one-item non-interest income items in the fourth quarter. Net interest income rose 1% as reported and was closer to flat on a fully-taxed basis. Net interest margin came in at a very strong 5.8% and declined less than 20 basis points from the year-ago. While there haven't been all that many first quarter bank earnings reports yet, I suspect this number will be well ahead of what regional rivals like Regions (NYSE:RF) and BancorpSouth (NYSE:BXS) will report this quarter. Average earning asset growth was less than expected though (by about 2%), and OZRK did come in a little shy on net interest income.

Non-interest income rose 18% from last year, but fell 13% sequentially as one-time items didn't reoccur. All told, the bank outperformed here. Expense control was also good, as expenses rose 2% from the year-ago period and fell 2% sequentially. This led to an efficiency ratio just below 47%, and pre-provision net revenue growth of about 8%.

SEE: The Industry Handbook: The Banking Industry

Growing The Balancing Sheet, But Maybe Not As Fast As Expected
As I just mentioned, OZRK's average earning asset balance for the quarter was a little shy of most analyst expectations. That said, the loan balance did increase 14% from the year-ago period on just a 2% increase in deposits. It's hard to complain about double-digit year-on-year loan growth (and/or 2% sequential growth), so I'm not sure I want to argue that rivals like Prosperity Bancshares (NYSE:PB) may be gaining some loan share in markets like Texas. Still, if the economy continues to slow, it may be harder for the bank to continue growing its business lending at the same pace.

Credit quality also continues to improve. Excluding covered loans, the bank's non-performing asset ratio improved a quarter-point to 0.5%, while the net charge-off ratio improved by a similar amount to 0.19%. Again, while it's early in the reporting cycle, I suspect these numbers will compare quite favorably to even some of the best-run banks like U.S. Bancorp (NYSE:USB).

A Story With Legs And Leverage
What continues to impress me about Bank of the Ozarks is that the company sticks to its knitting and pursues a focused and disciplined growth strategy. The bank has certainly been more than willing to use M&A to expand into markets like North Carolina and Georgia, but this bank rarely pays full value for its deals – the recent deal for North Carolina's First National Bank of Shelby (OTC:FNSE), for instance, came at a one-third discount to tangible book.

It's also worth noting that this model can continue to improve from here. The CEO believes that an efficiency ratio in the 30%'s is attainable and that the bank can continue to grow without a substantial investment in branches. Along those lines, I believe that some sell-side analysts may be off the mark when they assume that OZRK will be a consolidator – I'm not sure the bank needs to scoop up a lot of branches to make this model work. For instance, Texas is only about 13-15% of the deposit base, but more than 40% of the loan book. What's more, the bank's ability to handle complex and specialized deals (particularly in commercial real estate) argues against the need for a lot of community branches.

See: Buy Side Vs. Sell Side Analysts

The Bottom Line
Bank of the Ozarks is not cheap, but then why should it be? This bank has an uncommonly strong return on tangible assets (above the likes of U.S. Bancorp, Wells Fargo (NYSE:WFC), and Prosperity) and is continuing to grow while many banks are struggling to do so. Growth, quality, and the capacity for even more growth is a heady mix for many investors.

Much as I would like to hitch my wagon to this story, it's tough to get there on valuation right now. Even if OZRK's uncommon quality argues for a 3x multiple to tangible book, that only gets you to about $42 per share. Likewise, even assuming high teens return on equity on an ongoing basis, an excess returns model won't get you past $40. I'd be in no hurry to sell these shares if I already owned them, but as a non-owner I'm going to wait in the hope that a market/sector pullback will create an eventual opportunity.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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