Bank OZK’s Preferred Shares Are Now Yielding 6.6%

Introduction

Again in Might, I assumed the popular shares of Financial institution OZK (NASDAQ:OZK) had been too low-cost to disregard as the popular dividend yield had elevated to roughly 6.4%. On the present share value of $17.55 for the popular shares, buying and selling with (NASDAQ:OZKAP) as ticker image, the yield is roughly 6.6%. On this article, I’ll primarily give attention to the sustainability of the popular dividend yield and I’d advocate you to learn a few of my older articles to get a greater understanding of the financial institution’s enterprise mannequin.

The financial institution carried out nicely within the second quarter

Though I am primarily within the financial institution’s most popular shares as I solely personal these fixed-income securities, it’s clearly vital to inspect how the enterprise is doing as finally, the financial institution wants to have the ability to afford the popular dividends. The rising rates of interest ought to assist the financial institution to develop its web curiosity margin, however we additionally should not overlook inflation and an financial slowdown might weigh on the efficiency of the mortgage e book, with extra loans coming into the ‘overdue’ stage.

Fortuitously, the financial institution reported a really strong consequence within the second quarter as its curiosity earnings elevated to $281.5M whereas the curiosity bills got here in at simply $15.7M. This resulted in a web curiosity earnings of simply over $265M, which is a rise versus the $250M within the first quarter of this 12 months and the $241M in Q2 final 12 months.

The web curiosity earnings stays essential for Financial institution OZK because the financial institution would not generate quite a lot of income from its non-interest actions. As you’ll be able to see above, Financial institution OZK solely reported $26.3M in non-interest earnings for the quarter whereas the whole non-interest bills got here in at $109M for a web non-interest expense of $83M.

This resulted in a pre-tax and pre-loan loss provision earnings of roughly $183M and because the financial institution recorded simply over $7M in provisions for credit score losses, the reported pre-tax earnings was just below $176M leading to a web earnings of $136.4M. We nonetheless must deduct the popular inventory dividends which totalled simply over $4M, leading to a web earnings of $132.4M attributable to the widespread shareholders.

This already is an effective first step for the popular shares as the popular dividends require lower than 3% of the earnings to be totally coated. Or in different phrases, the popular dividend protection degree exceeds 3,000%.

And looking out on the liabilities aspect of the steadiness sheet, it seems to be like we should not be too nervous in regards to the asset protection degree both. The financial institution has 14 million most popular shares excellent for a complete of $350M. Which means of the $4.6B in fairness, roughly $4.25B ranks junior to those most popular shares. Or if we take a look at it from the alternative perspective, the asset protection degree is in extra of 1,300%.

There’s one caveat although, the steadiness sheet of Financial institution OZK accommodates simply over $666M in goodwill and intangible property, however even should you would exclude these from the equation, the asset protection ratio stays very sturdy.

The mortgage e book stays sturdy

The mixture of a really sturdy most popular dividend protection ratio and a robust asset protection ratio is nice information for the popular shares. However the asset protection ratio additionally requires a robust mortgage e book. If instantly half of the mortgage e book defaults on loans, then even the popular shares will likely be dealing with powerful instances as Financial institution OZK must scramble to guard its fairness cushion.

Fortuitously, Financial institution OZK is operating a strong steadiness sheet. Of the $26B in property, nearly $5B is held in money and funding securities, so the liquidity degree is fairly good. I am primarily within the $18.55B mortgage e book and notably within the comparatively low quantity of mortgage loss allowances.

Trying on the breakdown of the mortgage e book, it is clear the non-farm and non-residential in addition to the development and improvement loans signify nearly two-thirds of the mortgage e book. Fortuitously, the overwhelming majority of those loans is certified as ‘go’ with just below $160M of the loans categorized as ‘particular point out’ or ‘substandard’.

Much more vital than the classification, there’s the low quantity of loans overdue. As you’ll be able to see beneath, simply over $22.5M of the $18.7B mortgage e book was categorized as overdue, and that is a fairly sturdy efficiency and a lower in comparison with nearly $31.5M as of the top of 2021.

An extra $36M of the loans is at the moment categorized as ‘non-accrual’ however that is also a lower in comparison with the $44.3M as of the top of final 12 months. And with a mean loan-to-value ratio of 64% within the Actual Property Specialties Group, Financial institution OZK ought to be capable of keep away from substantial haircuts on its mortgage e book, even on the loans that at the moment are categorized as non-performing. This implies Financial institution OZK ought to proceed its sturdy historical past of being one of many banks with the bottom charge-off ratios within the USA.

Funding thesis

The rising web curiosity margin might enhance the earnings profile of the financial institution, however maybe Financial institution OZK may also have to extend its mortgage loss provisions as I can think about the present inflationary setting places a number of the debtors in a tricky place. From an funding perspective, I proceed to carry the popular shares in Financial institution OZK, and given the sturdy most popular dividend protection ratio and asset protection ratio, I am very happy to take care of my place and I would not thoughts including to this place on additional weak point.