Doug Gerlach, editor Investor Advisory Service, is a noted expert in small cap stocks. Here, he looks at two regional banking stocks — one overcoming the challenges of taxi medallion loans and the other focused on the commercial real estate sector.
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Bank of the Ozarks (OZRK) had another exemplary quarter and the market yawned again. Second quarter EPS rose 22%. Revenue increased 65% with significant help from two acquisitions completed last summer.
Loan losses and loss provisions remain exceptionally low as one would expect given its conservative lending standards. Despite the great results, Ozarks continues to expect new loan originations to be at the low end of its annual range; the first half was consistent with these expectations.
The risk to owning stock in Bank of the Ozarks is that it is mostly a lender to the commercial real estate industry, especially construction loans.
If its loan-to-value is as low as stated, less than 50%, and it primarily occupies the sole senior secured lending slot in most projects, loan losses in a downturn should not be problematic. The risk is that it won’t be able to profitably re-deploy its capital when real estate inevitably slows and construction dwindles.
The market apparently doesn’t believe Ozarks when it says that it only accepts 6%-8% of the loan applications it receives, implying it could remain fully lentup if it just increased the percentages in a down market. OZRK is a buy up to $56.
Signature Bank (SBNY) has put investors through a “death by a thousand cuts” over the past five quarters with rising loan losses on its taxi medallion loan portfolio that made up only 3% of its assets.
It keeps trying to get past the matter, and perhaps this quarter’s bold move has done it. Signature wrote down the value of its New York City taxi loans to $358,000 per loan, approximating a pessimistic estimate of the value of NYC taxi medallions.
It placed all taxi loans on nonaccrual status, meaning that loan payments will first be applied to principal and then to interest income after principal has been recouped.
It expects some additional losses on these loans, but these will fall dramatically in 2018. Despite the heavy cost of rectifying the problem, the market’s muted reaction to a weak earnings announcement suggests investors believe the worst may indeed be behind them.
In the second quarter, Signature took a $154 million write-down to its taxi portfolio, reversed an unspecified amount of interest income previously booked on these loans, and reduced the value of repossessed medallions on its books by $12.6 million.
These actions drove earnings down 86% despite an 8% increase in revenue. Excluding taxi-related losses from both periods, EPS would have been $2.21, identical to the first quarter which wasn’t heavily impacted by the taxi situation.
Deposits and loans continue to grow, but so do expenses as the company committed to beefing up its risk and compliance units in preparation for the heavier regulatory burdens that will come when its assets reach $50 billion. SBNY is a buy up to $169.
