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quacy, credit quality and profitability, and is more
and those loans grow by at least 50% in the prior
heavily weighted toward profitability.
36 months. By comparison, CRE loans represent-
The source of Bank OZK’s profits — and con-
ed 455% of Bank OZK’s tangible common equity
troversy — comes from its real estate specialties
at the end of the first quarter. When including un-
group, or RESG, a national leader in commercial
funded commitments in total CRE exposure, the
real estate construction and development finance.
percentage is “nearly twice that amount,” accord-
“They’re really big, chunky loans,” says Ben-
ing to a June 6 report from Moody’s Ratings.
jamin Gerlinger, vice president of equity research,
The RESG segment has grown “like a weed”
regional banks, at Citigroup. “They’re construction
as the bank has gotten bigger, says Gerlinger. The
development loans, which are much, much larg-
risk now, he and others believe, is that multiyear
er than any bank with a [similarly] sized balance
construction projects that started in a zero-rate
sheet would take.”
environment will not fare well in a 5%-plus rate
Gerlinger points out that the asset class carries
environment, and that office buildings will fail to
the notoriety of being one of the worst credit per-
attract the same rent as workforce habits change
formers in an economic downturn. Commercial
or the economy slows down. But the developers —
real estate can become a siren song for banks,
and the bank behind them — are still under pres-
which are active in the space but often succumb to
sure to finish partially constructed buildings even
the temptation to grow through unmanaged risk
as demand changes.
that becomes evident in a downturn. Construc-
Gerlinger became the face of the Bank OZK crit-
tion is seen as an especially risky area of CRE.
ics when he published an analyst report downgrad-
Risk factors in this space include highly leveraged
ing the firm on May 29 due to “substantial con-
transactions and long credit gestation periods that
cerns” about two of the bank’s projects, including
are vulnerable to changes in supply and demand
what he believes is its largest individual loan. The
market dynamics. These transactions sometimes
downgrade led to a 15% selloff in the bank’s stock
are structured in a way that shields the group be-
that same day, dropping to $39.60 — a price close
hind a construction project from default risk, and
to Gerlinger’s price target of $37.00. Bank OZK’s
a bank may finance them outside of its market
share price has recovered, to $47.08 as of July 30,
area and geographic expertise, according to the
is higher than its second quarter 2024 tangible
Federal Deposit Insurance Corp.’s 2023 Supervi-
book value of $38.85 per common share. Gerlinger
sory Insights that builds on regulators’ 2006 guid-
thinks the lower price target is “appropriate for the
ance on managing CRE risk.
amount of risk that they’re taking because it implies
that earnings are at risk, but maybe not capital.”
Growing “Like a Weed”
“From an operational perspective, I believe that
That 2006 interagency guidance was seminal for
they are solid operators, don’t get me wrong,” he
the industry because it established two key thresh-
adds. “But I also believe that they’ve taken a tre-
olds for bank CRE concentration risk: A bank has
mendous amount of risk and the market’s moved
a CRE concentration if construction, land devel-
on them, and they are forced to keep it because
opment and other land loans equal 100% of total
the construction loan can’t stop the moment the
risk-based capital. In addition, a bank can be clas-
shovel hits the ground.”
sified as CRE-heavy if the bank has multifamily,
construction and nonfarm, nonresidential property
loans that reach 300% of total risk-based capital,
Mitigating Risk
George Gleason II, the bank’s chairman and
