Bank OZK Puts Cap On Loan Size, Expects To 'Take A Hit' As Rates Fall

Bank OZK, the nation's most prolific construction lender, is capping the size of its loans going forward as it pushes to diversify and reduce the concentration of risk in its portfolio due to its CRE exposure.

The bank is putting a limit of $500M on newly originated loans, it disclosed in commentary of its third-quarter earnings, released Friday. During a call with analysts to discuss the results, chairman and CEO George Gleason said that a recent large loan brought unwanted attention.

“When you’ve got a big credit out there, it creates an environment where people can make that a target and spin a story that may have no foundation and basis in fact and may not be completely accurate to create a lot of drama about a single credit,” Gleason said. ‘We just decided that wasn’t worth the headache of having to deal with that sort of crap, honestly.” 

Gleason was likely referring to the bank’s RaDD loan, a $915M loan for life sciences developer IQHQ’s 1.7M SF San Diego project that remains without any signed lab tenants. The project was one of the main reasons Citibank analysts lowered Bank OZK’s rating from “buy” to “sell” in May.

In conjunction with the limit on jumbo loans, Bank OZK launched a loan syndication desk, which will allow it to bring in other lenders on deals that exceed its limit.

Bank OZK recorded another quarter of record earnings, a streak that the bank itself believes is soon to be broken due to the expected schedule of rate cuts, which will temporarily eat into the income of the prolific construction lender at the same time it seeks to further diversify its portfolio. 

While the bank notched its eighth consecutive quarter of record net income and earnings per share and ninth consecutive quarter of record net interest income, it expects its net interest margin, or NIM, to decline in Q4 and the first half of 2025 due to the Fed lowering rates and more variable rate loans reaching their floor. 

The bank expects NIM to begin to improve again during the second half of 2025. 

“We're focused on more diversification within the portfolio and less concentration risk,” Gleason said. 

Bank OZK has been navigating a year of higher rates and uncertain economic conditions, and it now has to factor in the changes that the Fed’s rate cuts will bring to its performance.  

The rate cuts, and expected additional cuts, have led sponsors to begin carefully monitoring interest rates and refinancing options. As of Sept. 30, $28.8B of the bank's Real Estate Specialty Group, or RESG, loans — 87% of its book — have been appraised after the Fed raising interest rates in March 2022. This trend has caused RESG total commitments, both funded and unfunded, to recede by $1.1B, from a peak of $34.5B in March to $33.4B in September, a trend expected to continue in coming quarters. 

Predictions that interest rate cuts would eat into the firm’s income from interest payments have come true and are expected to weigh down profits in coming quarters, just as the increase helped increase profits on the way up. Gleason expects to “take a hit from this payoff wave” before income once again trends upward. 

“Our Fed assumptions assume 25 basis point decline for the next six meetings,” Bank OZK Chief Financial Officer Tim Hicks. “So if the Fed moves slower than that, then that's a good situation for us. If the Fed moves at a quicker pace, that's more headwinds.”

The Arkansas-based bank is among the five U.S. lending institutions with the most exposure to CRE, and it has been diversifying its loan book.

More than half of Bank OZK's loan growth, or $320M, came from indirect RV and marine lending, corporate and institutional banking and community banking. RESG only recorded $220M in loan growth. RESG’s percentage of the institution's total loans hit 64% by the end of September and is forecast to drop into the upper 50s by the end of 2025. The eventual goal is a portfolio with half RESG loans. 

Bank OZK had $26M in net charge-offs in the third quarter, up from $11.2M at the end of Q2. The bank’s total allowance for credit losses increased to $594.5M, or 1.2% of total loans and unfunded credit commitments. The bank has doubled its ACL over the last nine quarters from $300M to nearly $600M, and Gleason expects, as rates decline and stress abates in the commercial real estate sector, that will free up some of the reserve allocations for some of those loans.  

When asked about the firm’s life sciences and office exposure that led to the Citibank downgrade, Gleason argued that “the quality of the asset and the quality of the sponsors are the key differentiators in these loans,” in effect that because the assets were new and valuable, sponsors would have a strong motivation to defend and keep the assets.