Dead malls, half-empty office buildings and regulators’ repeated warnings about risks in commercial real estate lending do not scare Bank of the Ozarks’ CEO George Gleason.
While many other banks have been methodically reducing their CRE exposure, the $20 billion-asset Bank of the Ozarks has been rapidly growing its CRE portfolio in recent years. The Little Rock, Ark., company, which lends nationwide, has been particularly aggressive in pursuing what regulators say is the riskiest subsector of CRE, construction loans.
Gleason is confident in his bank’s ability to expand its CRE lending because it has demonstrated its underwriting prowess to the market. Bank of the Ozarks has charged off only a small handful of CRE loans over the past decade and none since 2011.
“When we do business with really smart borrowers, they know we’ve done our homework,” said Gleason, who is also the bank’s chairman. “They appreciate that we do really deep [underwriting] analytics.”
Even so, some investors have questioned its business model, and wondered if the recent departure of the head of its real estate group was an indicator of deeper problems. Last year, Carson Block, the founder of Muddy Water Research and an investor known for shorting stocks, said he believed Bank of the Ozarks' management was downplaying the risk in its portfolio of construction loans (though analysts who cover the bank rose to its defense).
Brian Martin, an analyst at FIG Partners, said that Bank of the Ozarks is better suited than most banks to manage CRE lending through a downturn.
He pointed out that Gleason, who bought the bank in 1979 and has built it both organically and through acquisitions, has hired dozens of financial and real estate experts to perform highly detailed market analysis. That expertise has given Bank of the Ozarks the confidence to make loans that other banks might view as too risky or too much work and, importantly, allows it to charge higher rates than many of its competitors, Martin said.
“They definitely have, in my mind, better procedures than other banks,” he said. “Their closing processes are better and they’re getting paid because people know they will deliver with speed and certainty.”
Still, there are some risks Bank of the Ozarks is not willing to take. With the retail segment struggling mightily in the face of stiff competition from online commerce, Bank of the Ozarks has sharply reduced its exposure to the retail sector over the past decade.
“We’ve not done a tremendous amount of retail business lately because the world needs less retail development,” Gleason said.
Bank of the Ozarks would still lend to a retail project, or any real estate project, if it can stand up to the bank’s rigorous due diligence, he added.
Bank of the Ozarks’ real estate specialties group, based in Dallas, includes five attorneys who handle complex real estate matters, plus accountants and experts in structured finance and real estate development finance.
The bank’s analysis is often conducted parallel to the studies performed by the in-house teams of real estate lenders. Bank of the Ozarks’ analysis may be duplicative of those efforts, but they act like a second opinion, which borrowers value, said Gleason, who also personally approves every loan the group originates.
“They do their own detailed analytics and we come along and do our own analytics and that provides [borrowers] with an independent assurance that they made a good decision,” Gleason said.
This detailed analysis has allowed Bank of the Ozarks to expand its construction and development lending. The bank’s originations of construction loans rose to 29% of total originations last year, compared with 8% in 2013, according to the real estate data firm CrediFi.
Overall, loan balances within its real estate specialties group, which handles complex real estate transactions, have increased by about 500% in the past four years, to $7.5 billion.
“When you deal with really high-quality product and you deal with really high-quality [borrowers] and you're at the low leverage we are, you're not going to have a lot of problems,” Gleason said at the Barclays Global Financial Services Conference in New York earlier this month.
And the bank prices for the risks it takes. Its average yield on all loans was 5.54% in the second quarter, higher than the 4.2% average yield of loans in its peer group, according to BankRegData.com.
Morgan Stanley analyst Ken Zerbe said Bank of the Ozarks can also charge higher rates because it closes loans faster than other banks, typically between 45 and 60 days.
“Paying Bank of the Ozarks extra … knowing [the loan will close as agreed, with no changes in terms or rate, could be viewed almost like an insurance policy,” Zerbe said. “Not every bank can make that claim.”
Investors have still looked for potential warning signs in Bank of the Ozarks’ business. Some may have been spooked by the recent departure of Vice Chairman Dan Thomas, who was also head of the real estate specialties group, as Bank of the Ozarks’ stock fell about 11% on the day after his resignation was announced. The company did not give a reason for Thomas’ departure, but FIG’s Martin said it was because he was displeased with his reassignment to an administrative role, not because of any deeper problems.
Thomas’ departure notwithstanding, analysts and Gleason expect Bank of the Ozarks to keep growing at a rapid clip, fueled largely by real estate lending. Zerbe projects Bank of the Ozarks to generate nonpurchased loan growth of 31% over the next three years, about half of that coming from real estate.