KBRA Affirms Ratings for Bank OZK

KBRA affirms the deposit and senior unsecured debt ratings of A-, the subordinated debt rating of BBB+, the preferred stock rating of BBB, and the short-term deposit and debt ratings of K2 for Little Rock, Arkansas based Bank OZK (NASDAQ: OZK) (“the bank”). The Outlook for all long-term ratings is Negative.

Key Credit Considerations

The Negative Outlook reflects the challenging operating environment, particularly the stress within the CRE market that has led to moderate deterioration of asset quality though NPAs and charge-offs remained well contained (the bank reported NPA and NCO ratios of 0.87% and 0.21%, respectively). Given OZK’s elevated concentration in CRE and C&D (358% and 197% at 2Q24, respectively), asset quality could remain stressed over the near term, though KBRA recognizes the long-term performance of the bank’s RESG portfolio which had a weighted average NCO ratio of 0.10% since its inception in 2003.

Outsized loan growth (27% in 2023) and share repurchase activity (~$500 million in 2022 and 2023 combined) caused capital ratios to decrease significantly in recent years, with risk-based measures falling +200 bps below rated peer averages by YE23. However, more moderate loan growth (~8% annualized in 2Q24 and 3Q24 combined) along with limited share repurchase activity and continued strong internal capital generation allowed for the meaningful rebuild of capital in 2Q24 and 3Q24, with risk-based measures increasing roughly 50 bps – 60 bps (OZK reported a CET1 ratio of 11.2% at 3Q24). We further note the bank's build up of reserves in 2023 and 2024, with total allowances for loan losses at 1.4% of total loans at 3Q24 (ACL was 1.2% of total loans + unfunded commitments), tracking above rated peer averages.

While earnings (more specifically ROA and RoRWA) headwinds have continued, namely NIM compression due to rising funding costs (OZK reported total funding costs of 3.71% for 3Q24), the bank has continued to report above-average returns with an RoRWA (1.75%) tracking ~50 bps above the rated peer average through 1H24. With that said, NIM compression is expected to continue into early 2025, in part, due to the recent 50 bp cut to the Fed Funds target rate and the asset sensitive nature of the balance sheet. Additional rate decreases of the Fed Funds rate would negatively impact loan yields (+80% of outstanding balances are in adjustable rates), though OZK has floors in place on most loans to protect against significant rate cuts. Furthermore, although the bank continues to rely on consumer time deposits for deposit growth, management believes the bank has reached an inflection point regarding deposit costs, primarily due to the expected favorable repricing of roughly $12 billion in maturing CDs in 4Q24 and 1Q25.

Rating Sensitivities

A return to Stable Outlook would need to be supported by stabilization of asset quality metrics demonstrated over multiple quarters as well as the continued rebuilding of capital ratios with risk-based measures more closely aligned with rated peer averages. Conversely, further deterioration in asset quality with increased credit costs materially impacting earnings capacity and negatively affecting the bank’s ability to further build capital or the return to more aggressive capital management could result in a rating downgrade.

To access ratings and relevant documents, click here.

Methodologies