KBRA Affirms Ratings for Bank OZK

27 Oct 2023   |   New York


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 revised to Negative from Stable.

Key Credit Considerations

The revision of the Outlook to Negative from Stable was, in large part, due to the bank’s meaningful decrease in capital ratios with its CET1 ratio (10.7% at 3Q23) falling well below that of rated peer averages (11.8% at 2Q23), largely driven by outsized loan growth (22% through 9M23) and share repurchase activity ($152 million through 9M23). Historically, OZK had managed risk-based capital at levels well above the current range, more consistent with peers. This was viewed favorably by KBRA due to the concentrated nature of the loan portfolio, including large, single name exposures. Moreover, KBRA expects capital ratios to remain pressured with limited upward potential through 2024 due to the bank’s substantial unfunded commitments coupled with slower payoffs/paydowns of existing balances due to macro-economic conditions keeping loan growth elevated through the medium term.

The ratings are affirmed due to the bank's above average earnings including a reported ROAA of 2.13% for 3Q23 with NII continuing to grow in 2023 (approximately $10 million - $12 million/qtr). In addition OZK has reported strong deposit growth (approximately 19% through 9M23) though this has largely come in the form of higher cost consumer time deposits, which represented 34% of total deposits at 3Q23. As such, deposit costs have rapidly increased, with OZK’s total cost of deposits increasing nearly 250 bps YoY to 2.90% at 3Q23. Despite funding pressures, NIM compression has been more moderate comparatively, with NIM decreasing 35 bps from peak levels in 4Q22 to 5.05% in 3Q23. OZK’s concentration in variable rate loans (~80% of total loans) has enabled the bank to offset the rise in funding costs. However, should Fed rate hikes end, OZK could see increased NIM compression as funding pressures continue to mount. Increased credit costs have further impacted earnings; higher provisions for loan losses were largely driven by loan growth, though also included moderate deterioration in asset quality with OZK reporting increased NPAs and criticized/classified loans through 9M23, yet net charge-offs remained well contained at 0.15% of average loans.

Rating Sensitivities

A return to a Stable Outlook would require the bank to materially rebuild and consistently maintain capital ratios near historical norms, including a CET1 ratio more closely aligned with rated peer averages (~12%), coupled with stable asset quality metrics. Conversely if OZK were unable to demonstrate an ability, or willingness to rebuild capital ratios closer to rated peer averages over the next 12 - 18 months, a rating downgrade could occur. In addition, further deterioration of asset quality, including elevated loss rates over historical norms, with credit costs pressuring earnings, could result in a rating downgrade.

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