Bank Of The Ozarks Hitting Accelerator In A Low-Growth Environment

By Stephen D. Simpson, CFA | July 17, 2012 AAA

I am big fan of Bank of the Ozarks (Nasdaq:OZRK), so it bothers me that I can't find much value in these shares. Moreover, while I believe this company's aggressive growth strategy could underpin its evolution into a significant regional bank, I do worry that the bank is doing too much too soon. While it certainly makes sense to grow aggressively while many larger competitors have a hand tied behind their back, aggressive growth stories in banking have a disturbing habit of going sour at some point.

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Challenges Seem to Be Intensifying
While there are certainly regional differences in business conditions in the U.S., the fact remains that Bank of the Ozarks operates in the same low-rate/narrow spread environment as First Horizon (NYSE:FHN), Cullen/Frost (NYSE:CFR), and Regions Financial (NYSE:RF). To wit, it's a lot harder to make a buck in regular old banking.

Bank of the Ozarks saw net interest income fall almost 4% sequentially, as the company saw a roughly 1% sequential decline in earning assets and a 14 basis points decline in net interest margin. While OZRK's 5.84% net interest margin is a whopper when compared to the likes of Bank Of America (NYSE:BAC) or other large banks, investors should remember that that is a byproduct of the company's focus on commercial real estate lending and large covered loan position.

SEE: 7 Steps To A Hot Commercial Real Estate Deal

Non-interest income made up for some of the shortfall in interest income, though, as this rose nearly 14% sequentially. The bank also saw very good expense control and a pretty remarkable non-performing loan and net charge-off performance, whether you include or exclude the covered loans.

A Few Areas of Concern
While Bank of the Ozarks once again beat consensus earnings expectations, I am a little concerned about some parts of the bank's balance sheet. Loan growth (excluding covered loans) was feeble, and it looked as though it grew just 1% on an average balance basis. At the same time, the company's deposits are shrinking (down about 4% sequentially).

To be sure, there's a question of balance here. There is quite a bit more competition out there for creditworthy borrowers and the bank is likely facing pressure to accept lower rates and/or underwriting standards. At the same time, letting unattractively priced acquired deposits walk away is not the worst thing in the world if management can't find attractive uses for the capital. After all, capital really isn't the problem here.

SEE: What Credit Score Should You Have?

Speaking of capital, that brings me to my other concern about this business. Bank of the Ozarks has been very active in participating in FDIC-assisted acquisitions, and it looks like management would like to do more if the prices are right. I definitely understand that these deals can represent rare cost-effective means of expansion, but I also do believe that there are significant risks in a bank expanding faster than its systems can handle. Now, there's nothing in the company's expense ratio or bad debt lines to suggest that's a problem, but it is one of the issues that management has to consider.

The Bottom Line
As I said, I'm a big fan of this bank and the growth that the company has delivered over the past decade is nothing short of remarkable. What's more, this is a bank with a clearly defined purpose and philosophy, and has usually been willing to sacrifice growth instead of standards when the two oppose each other. It also doesn't hurt in the least that Bank of the Ozarks has targeted a part of the country that has been experiencing above-average population growth.

SEE: The Banking Industry In 2012

All of that said, it still comes down to a "right stock, right price" calculation, and this is where things don't look as good for Bank of the Ozarks. Even with the assumption of high-teens return on equity on a sustained basis, the stock is more than 10% above fair value. As a result, I will continue to admire these shares from the sidelines.

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

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