The Canary In Coalmine: Bank OZK Plummets After Shock Commercial Real Estate Write Downs

In what may be the deadest canary in the commercial real estate coal mine yet, Bank OZK shares have plunged 26% today after the bank reported abysmal third-quarter earnings that trailed expectations, with net income tumbling but what caught traders' attention was two commercial real estate charge-offs of $45.5 million on the bank's Real Estate Specialties Group (RESG) credits for unrelated projects in South and North Carolina.

The Little Rock-based regional bank, with just over $22 billion in assets, also reported that net income declined 23% to $74.2 million in its third quarter from the same period in 2017 due to these write-offs. Bank OZK’s earnings have been closely monitored by analysts since it is such an active real estate lender. The bank reported that the two write-offs during the third quarter were in its Real Estate Specialties Group (“RESG”) portfolio and were related to properties in South Carolina and North Carolina from loans originated in 2007 and 2008, the Real Deal reported.

The bank said in its management comments that its South Carolina charge-off was secured by a regional mall, which has suffered from both “declining property performance and increasing interest rates.” The project was further impacted by uncertainty related to anchor tenants Sears and JC Penney. The North Carolina charge-off was secured by a multi-phase land, residential lot and residential home project, with the bank noting that the homes have not sold well in part due to “cheaper pricing on existing homes.”

What shocked analysts, however, is that these properties had allowance allocations totaling only $19.1 million as of June 30. But after new appraisals, which were much lower than it initially presumed, the bank said it would have to write down each credit to about 80% of its recent appraised value. The combined charge-offs on the two loans in the third quarter came to $45.5 million. Since the bank already had the $19.1 million allowance, it had to make an additional provision expense of $26.4 million. Had it not, its earnings would have slightly surpassed its third quarter 2017 earnings of $96 million.

The bank then tried to placate shareholders noting that "other than these two substandard and one watch credit, the credit quality of the RESG portfolio is excellent" however judging by the share price, it failed at this task.

Meanwhile, the bad news continued with the bank also reporting that its net interest margin was down 37 basis points from the third quarter of 2017 to 4.47%. The bank said this was due to a lower than expected yield on non-purchased loans.

The regional bank has been a very active real estate lender, providing the biggest condo construction loan in the Miami area, $558 million for The Estates at Acqualina in Sunny Isles Beach. It also provided more than $1.2 billion in construction loans in the Miami metropolitan area from 2013 through 2017, according to its 2017 annual report.

Bank OZK was formerly known as Bank of the Ozarks until July, before rebranding itself in a campaign that cost it over $10 million, in an effort to free itself from "the limitations of a name tied to a specific geographic region," according to a statement from the bank at that time.

Commenting on the results, Wall Street was relentless, with Raymond James analyst Michael Rose wiring "No Mas!" in a note downgrading OZK to market perform, adding that credit issues from OZK’s "seemingly-infallible RESG portfolio were a non-starter," and had been key tenet of formerly-positive thesis; "with defenses penetrated, no matter how small a breach, confidence in OZK mystic has evaporated."

Rose also said that his downgrade may be at/near bottom, given "expected fallout" in OZK shares; also flags slower loan growth, NIM outlook

Meanwhile, Morgan Stanley’s Ken Zerbe said that the two RESG loans had been on OZK books for 10, 11 years, and don’t represent more recent quality of loans; he sees one other loan, currently on watch list and also originated in 2008, as potentially posing credit problem. He also flagged the NIM drop of 19bps q/q to 4.47%, missing Morgan Stanley est. 4.65%; end-of-period loan balances gain of $257m q/q vs est. $525m; mgmt noting that 4Q non-purchased loan balances could be "near-zero or even negative," which would put further pressure on future net interest income. Finally, he expects to "materially reduce" EPS estimates putting his rating and price target under review.

Finally, KBW’s Catherine Mealor wrote that when there are two "losses as large as this, no matter how different they are from the rest of the portfolio, the market is going to shoot first, ask questions later", adding that OZK shares will stay at a significant discount vs peers "for the foreseeable future."

One look at the stock price of OZK today confirms the bearish thesis.