Ernest Hemingway wrote in his 1926 novel The Sun Also Rises, “How did you go bankrupt? Two ways. Gradually, then suddenly.” Artificial Intelligence (AI) tells me this snippet of dialogue between Mike and Bill is now “widely recognized as a metaphor for situations where something builds up slowly, like accumulated debt or a creeping disaster, before reaching a critical point and exploding suddenly.”
Bank failures happen the same way. Government protection and deposit insurance slows the inevitable—until it doesn’t.
Bank OZK was featured in a recent Wall Street Journal article for finally dialing back its commercial real estate lending. OZK’s defiant Chief Executive Officer, George Gleason, has called criticisms of his bank’s aggressive real estate lending an “abnormal phobia” and said the naysayers “will get over it.”
I wrote on Power & Market,
Gleason says his bank’s strategic plan includes growing its real estate business “as big as it can be while maintaining discipline.” Catherine Mealor, an analyst at Stifel told Bisnow, “Bank OZK typically takes advantage of those moments when others pull back to step in and do it on their terms,” Mealor said. “It’s been very successful for them.”
Gleason hasn’t changed his story, telling the WSJ, “We have built our portfolio with the goal that it will perform well in adverse conditions, and that discipline has been evident in our recent results.”
For all the talk of lending discipline, concerning OZK’s loans on large real estate projects, the WSJ writes, “Seventeen of the completed projects it committed to finance had vacancy rates of more than 90%, according to Wells Fargo’s Braziler. Nearly two dozen had vacancy rates of more than 50%.”
“We’re thrilled to death to have loans stay on the books longer,” OZK Chief Executive George Gleason told analysts in October (2023), noting higher yields and improving loan-to-value and loan-to-cost ratios.
But now, OZK is looking to diversify its loan portfolio, capping new loan production at $500 million. But it may be too late to put the toothpaste back in the tube. “Even if Bank OZK reaches its targets, it would still have high concentrations of commercial real estate compared with other banks,” wrote Gina Heeb. “[Gleason] has called its commercial real-estate portfolio the most conservative in the industry. The bank has sought to take the lowest-risk position on deals and to keep loan amounts low relative to property values.”
Despite being “conservative,” Heeb reports of OZK foreclosing on raw land in a large Chicago project and writing off a third of the loan balance. Bank OZK funded a loan for one eight-story life-sciences office building in the project. It has zero tenants.
To fund its real estate loan growth, Bank OZK is heavily reliant on certificate of deposits for funding, at a much higher cost than demand deposits. These CD deposits are also quick to leave with any sign of trouble.
As for OZK stock, since a Citibank downgrade, short sellers are circling, with short interest now 16.5 percent of the float.
Short sellers will wait through the gradual part, looking to profit suddenly.
