Uncategorized

Revisiting opportunities in community bank paper

| January 10, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Amidst an onslaught of new issuance and tight spreads, a niche market that warrants continued focus is the higher-yielding bonds from a subset of domestic banks: the large community and smaller regional banks, with roughly $15 – 50 billion in total assets. The relative value proposition is two-fold: (i) the callable structures frequently utilized by these issuers offer additional yield over bullets on a yield-to-worst and yield-to-maturity basis; and (ii) investors able to invest in the mostly non-index and non-investment grade subgroup can capture an additional liquidity premium.

In July of 2019, callables issued by large community/smaller regional banks were mostly yielding 3.5-5.5% (see Callable bank structures present alternative to corporate bullets), while investors are now more likely to be compensated in the low 3%-to-high 4% range. On a duration weighted basis, investors are still getting +150-300 bp of yield per turn of duration, a staggering amount when compared to the 45-50 bp of yield per turn being offered by the broad IG Banking segment at year-end. Opportunity for outperformance among these private placement bank securities still exists (see Mining liquidity in private bank placements), and the sector could potentially see renewed liquidity as investors reassess portfolios ahead of seasonal bank issuance in the weeks ahead. Domestic bank earnings season begins with Citigroup (C), JP Morgan (JPM), and Wells Fargo reporting on Tuesday 1/14/19.

Actionable security in the segment: Bank OZK (OZK) 7/1/2026 callable notes;

Indicative offer level (dollar price): OZK  5.50%  7/1/26-21 at $103.125

  • 3.30% yield-to-call (7/21); spread-to-Treasury of +170/2-year
  • 5.55% yield-to-maturity (7/26); spread-to-Treasury of +386/5-year

Bond description

Issuer: Bank OZK (no longer a holding company)

Structure: Callable 07/01/2021 at par; floating spread of 3-month LIBOR + 442.5 bp

Amount outstanding: $225 million, non-index eligible

Senior ratings: Kroll – A-

Subordinated HoldCo issue: Kroll – BBB+; EJR – A-

Operating comps: SFNC, HOMB, PNFP, UCBI, STL, SBNY, TOWN, BUSE, OPB

Exhibit 1: US community bank subs – callables vs regional/money center bullets

Source: Bloomberg/TRACE indications, Amherst Pierpont Securities

Credit Summary

  • OZK Bank, which previously dissolved its HoldCo/OpCo structure, is a relatively sizable southern community/regional bank, with a sprawling footprint across its home state of Arkansas, Georgia, North Carolina, Texas, and Florida. With roughly 250 branches, OZK employs a traditional “brick and mortar” approach to banking. This helps the bank maintain extraordinarily conservative lending practices, despite concentrations in what can typically be more speculative lending categories. One of the bank’s core competencies is in Commercial Real Estate (CRE), specifically in construction and land development loans. Most of the lending is done within its branch footprint, though many development properties lie outside in areas that include Alabama (two branches there), Tennessee, and some large exposures in western states (CA, AZ, and CO among others).
  • The bank currently has total assets of around $23 billion (updated regulatory numbers for year-end 2019 should be available by the end of January), with over $17 billion in loans and over $18 billion in deposits. OZK saw its most rapid period of expansion beginning in 2014, as total assets doubled in size from $4.8 billion at year-end 2013 to $9.9 billion at year-end 2015; during which period OZK merged with Summit Bancorp (AR), Intervest Bancshares (NY/FL), Bancshares Inc. (TX) and Bank of the Carolinas over this period. Shortly thereafter, OZK bought Community & Southern for $800 million, which again doubled total assets by year-end 2016. Despite this period of rapid expansion, OZK was very quickly able to employ its conservative lending techniques to these newly acquired branches, in large part by making sizable investments in risk management.
  • Like a large portion of the large community/small regional segment, OZK’s loan book is weighted substantially toward commercial lending, with CRE (25%) and construction (38%) making up just under 60% of its loan book. Consumer loans make up the next largest and fastest-growing segment at 14%, with an additional 6.0% in residential, 6.5% in multifamily, and the remainder in C&I and other niche loan categories.
  • OZK padded capital ratios to compensate for growth, and reached their highest levels at year-end 2018 since their large expansion began in 2014. Tier 1 Common (CET1) ratio is 12.7%, with a total risk-based capital ratio of 14.4%. Those levels are down from 15.7% and 16.7%, respectively,  as of  year-end 2013, but the bank is 4x larger and there is much more certainty about regulatory capital needs now versus back then. The bank maintains enough deposits to fund its entire loan book, with a loan/deposit ratio of 93%, and only utilizes wholesale funding for about 8-13% of liabilities. Use of shorter-term and professional money market funding was at 17% at year-end 2018, and brokered deposits were around 11%, both of which appear commensurate with their operating profile.
  • Credit quality has not been a concern for OZK throughout recent periods of expansion. Non-performing assets (NPA) are just 0.40% of total assets, and the bank maintains well over 100% of those totals in reserves to meet potential charge-offs. The Texas Ratio—which measures NPAs and 90-day past-due loans as a percentage of all reserves as well as equity—is remarkably low at under 3%. A bank like OZK would not be considered an immediate risk unless that measure got above 20%. The low Texas Ratio indicates the bank is very well positioned to address potential delinquent loans with minimal impact to the overall credit profile. This was demonstrated in 3Q18 when the bank took two large loan charge-offs, for a combined provision of $42 million for the quarter, which was a significant earnings event, and reflected in share price; but there was limited if any consequence to OZK credit quality. Construction and development loans do have a tendency to see heightened delinquencies during periods of market stress, or at least in the limited scope of the ’08 financial crisis. At the peak of post-crisis loan charge-offs in 2011, OZK saw NPAs top out at 7.9% and its Texas Ratio temporarily rose above 60%. Both credit metrics quickly recovered, and the bank has almost completely overhauled its lending practices and risk safeguards since then.  
  • The bank’s net interest margin (NIM) is very high for its peer group at 4.47% as of 1Q19, as the bank’s portfolio provides higher margins than community/regionals with higher concentrations in C&I and residential. OZK’s return on average equity (ROAE) last year was 11.6%, which was down modestly from prior years, but included the large one-time charge-offs in late 2018. OZK has demonstrated the capacity to operate with a run rate in the 14-15% range in more normal operating years. The bank’s efficiency ratio (operating expenses vs operating revenue) was 37% last year, which is among the best in the peer group, and even more impressive when considering the sizable integration and investments to risk management over the past several years.

admin
jkillian@apsec.com
john.killian@santander.us 1 (646) 776-7714

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2025 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

Important disclaimers for clients in the EU and UK

This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).

The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.

This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.

This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.

This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.

The Library

Search Articles