In this issue of The Institutional Risk Analyst, we speak to George Gleason, II, Chairman and CEO of Bank of the Ozarks (NASDAQ:OZRK). Since acquiring a controlling stake in the bank in 1979, Gleason has built the $20 billion total assets institution into a regional powerhouse with over 250 offices in 9 states and a national commercial lending business. As we noted in our discussion with John Kanas of BankUnited, short-sellers have lost a lot of money betting against Gleason and his team at OZRK.
The IRA: George, you have been running OZRK for almost four decades in some of the fastest growing areas of the US. Looking back over that period, how have things changed for the bank and the regions that you serve?
Gleason: At the risk of sounding like Charles Dickens, I would say that everything has changed, and nothing has changed at all. In my 38-year career, the pendulum has swung from Paul Volker pushing the fed funds target rate over 20% to Ben Bernanke pushing it to almost zero. The seemingly inexorable trend of suburbanization has given way to a massive trend of re-urbanization. Technology has evolved rapidly with a rate of acceleration that seemingly increases every day. The changes are almost unlimited, but at the outset of my first day on the job 38 years ago, I articulated to our staff the principles of pursuing excellence in everything we do, always striving to be the best we can be, improving every day, working hard and adhering to the highest standards of ethics, integrity and fair dealing. Those values and principles have not changed. Whatever success we have had is attributable to our dual abilities to rapidly evolve with the constantly changing macro environment, while relentlessly holding true to the core principles and values that define our bank.
The IRA: OZRK is known for being aggressive when it comes to commercial real estate lending, but also for excellence when it comes to managing credit. Of the bank’s $15 billion or so in total loans, $12 billion is in real estate. Looking back over the past three decades, OZRK has reported loan losses that are significantly below its peers. How have you been able to manage the bank so impressively including through the financial crisis?
Gleason: The word “aggressive” is often used to describe our real estate business, and I don’t think that is accurate. I view us as “very active” in the real estate space, but very conservative. Real Estate Specialties Group (RESG), our large real estate group, does business across the nation with many of the best sponsors on many of the best properties on extremely conservative terms. At June 30, 2017, assuming every loan in the group was fully advanced, our weighted average loan-to-cost would be about 49% and our weighted average loan-to-value would be about 42%. We are extremely conservative, approving a mid to low single digit percentage of the loans we see. Because of our expertise in CRE and the value we bring to our clients, we see a huge volume of business and that allows us to be very selective.
The IRA: Looking at some of the bank’s credit and performance metrics, you have above-average asset returns and margins, excellent operating efficiency, and a default rate that is a half a standard deviation below your asset peers. Your loan book also has a very short duration, less than three years and again well-below peer. Finally, your level of unused credit lines is above peer. How did you come to formulate this remarkable business model?
Gleason: We are fortunate to have been among the best performers in the industry year after year for many years. The explanation for that performance is not simple. It is not just the CEO or the head of this unit or that unit or a few great strategies. It is a result of hundreds of skilled and highly motivated people working hard, as a team, in a constant pursuit of doing a better job today than yesterday – always striving to get better. It also has a lot to do with our mission to be the best bank in the eyes of four competing constituencies with very different goals – our customers, shareholders, employees and regulators. Simultaneously making all four of those competing interests view our bank as the “best bank” is like putting a twin fitted sheet on a king bed. They have very different interests, but solving that complex equation of reconciling those competing interests is exactly the goal we vigorously pursue every day!
The IRA: Last year seemed to be a peak in terms of bank lending, both for C&I and CRE exposures. How do you see your local markets and also the national CRE market where OZRK is one of the most prominent players?
Gleason: We feel good about the current environment. After the Great Recession, there were a few years where new CRE supply did not keep pace with demand growth, and that was followed by a few years where a robust level of construction occurred due to the pent-up demand. Today in most markets, submarkets and micro-markets, supply and demand is pretty much in balance for most product types. There are of course exceptions both ways, but most markets are exhibiting reasonably healthy conditions. New construction in certain markets and product types continues to be justified by population growth, household formation, job growth, changing demographics and other such trends. You just have to do your supply/demand homework on each project and make sure that the demand is going to be there to justify the new supply. Working with intelligent and discerning sponsors helps in that regard, as it means two of us are very critically and thoughtfully looking at the supply/demand metrics.
The IRA: Given the bank’s consistent financial performance, you trade at a premium valuation of almost 2x book value and have 80% institutional ownership. Yet there is a certain constituency on Wall Street that seems bound and determined to short OZRK’s stock. Do you think that these pessimistic souls actually understand the bank’s business or are they simply looking at the real estate exposure?
Gleason: No, I don’t think they understand our business. My guess is that they screened for banks with a high growth rate and high levels of CRE. Their dual assumptions are probably that CRE is bad and all CRE is more or less the same. That is silly. First, we see great CRE opportunities and we see bad CRE opportunities every day. Our track record over several decades suggests we are good at knowing which is which. Second, at 49% LTC and 42% LTV our RESG CRE exposure has a massively different risk profile than some other banks’ CRE portfolios at 75% or 80% LTV.
The IRA: The US economy has been through five extraordinary years of Fed monetary policy where our central bank has deliberately manipulated credit spreads. How concerned are you about the impact of the Fed’s action distorting asset prices in sectors such as commercial real estate?
Gleason: It has been a fascinating time to be either a commercial banker or a central banker! You probably recall that even before the official arbiters announced that the Great Recession was in fact a recession; people were all abuzz about what shape the recovery would be. Would it be “U” shaped, or “V” shaped or whatever? When asked that question back then, I always gave this answer: “The U.S. economy has fallen from a ten story window and is battered and bruised on the sidewalk. The recovery will be the economy crawling down the sidewalk, battered and bloodied, for years to come.” As we expected, it has been a long, slow and erratic path back from the bottom. Understanding that we operate in a very complex global economic and geopolitical environment with a constantly changing array of risks, our bank has become more conservative over the last ten years than ever before. For example, the leverage in our CRE portfolio is about 25 points lower on average than it was a decade ago. That doesn’t mean we have a negative view of the future, it simply means that we want to be prepared no matter what the future holds. Maybe thinking like that, I can keep my job another 38 years!
The IRA: OZRK is in the process of shedding its parent holding company to save costs and boost returns. Can you talk about what drove this decision and how the change will impact the bank going forward?
Gleason: For many years we did nothing in our holding company that we could not do in the bank. Early this year, I asked myself the question, “Why do we have a holding company?” When I couldn’t answer that question, I started asking others. We began to realize that we were incurring a lot of accounting, administrative and regulatory costs and work for a holding company we weren’t using. I analogized it to paying taxes, insurance and maintenance on a beach house you never visit. We got rid of it. We don’t believe it limits or changes our business strategy at all for many years to come.
The IRA: Finally, talk a little about your plans for the bank going forward. You have done a series of acquisitions over the past two decades. What should your investors and customers expect to see in the future?
Gleason: Last week some of our directors and a few of our top officers joined me to ring the NASDAQ opening bell to celebrate our 20th anniversary of going public. That sort of thing is not really my cup of tea, but the people at NASDAQ were wonderful and it was a great experience. I told our directors the night before that as we were ringing the bell, I was going to be thinking 1% about the last 20 years and 99% about the next 20 years. And that’s exactly what I was thinking. Our focus is clearly on the future.
The IRA: No surprise there, but will we see more acquisitions?
Gleason: We expect great organic growth, and some very accretive acquisitions. We are confident that the world in which we operate will continue to rapidly change, and we believe that our unchanging principles and our great people will achieve some remarkable things. I firmly believe that our best years lie ahead!
The IRA: Thanks George.