OZKAP - Bank OZK Preferred Stock: Grasp 7.8% Dividend Before It Is Too Late

2023-05-25 05:49:14 ET

Summary

• The indiscriminate sell-off of regional banks has presented a rare investing opportunity.
• OZKAP is offering a safe 7.8% dividend yield and has 69% upside potential over the next 3-5 years.
• Bank OZK is an exceptionally well managed bank. It has grown its dividend for 27 consecutive years and in every single quarter since 2010.
• Bank OZK is expected to post record earnings this year. It grew its deposits 3.7% in the first quarter and repurchased $85 million of shares.
• All these facts are testaments to the resilience of this high-quality bank to downturns, including the ongoing financial turmoil.

Regional banks have incurred a massive sell-off this year due to the panic caused by the collapse of Silicon Valley Bank, Credit Suisse (CS) and First Republic Bank (FRC). The turmoil has hurt even the stocks of regional banks that have rock-solid business fundamentals. To be sure, the preferred stock of Bank OZK ( OZKAP ) has plunged 23% off its peak in February and thus it is currently offering a 7.8% dividend yield . In this article, I will analyze why the 7.8% dividend yield of the preferred stock of Bank OZK is safe.

Risk #1: Interest rates

The first reason behind the exceptionally high yield of the preferred stock of Bank OZK is the adverse environment of high interest rates. Due to the unprecedented fiscal stimulus packages offered by the government in response to the pandemic, inflation skyrocketed to a 40-year high last year. As a result, the Fed has been raising interest rates aggressively since early last year in order to cool the economy and restore inflation to its target level of about 2%.

The surge of interest rates has rendered preferred stocks less attractive and thus it has exerted pressure on the prices of all preferred stocks. If interest rates remain around their current level for years, the preferred stock of Bank OZK will have limited upside potential.

However, interest rates are unlikely to remain around multi-year highs beyond this year. Thanks to the aggressive policy of the Fed, inflation has declined every single month since it peaked last summer. As the central bank has clearly prioritized restoring inflation to normal levels, it is likely to achieve its goal sooner or later. In fact, the market expects inflation to remain on its downtrend in the upcoming months and the Fed to begin lowering interest rates towards the end of this year. To cut a long story short, interest rates are likely to begin to normalize at some point in 2023 or 2024 thanks to the drastic response of the Fed to high inflation. When interest rates begin to normalize, they will provide a strong tailwind to the preferred stock of Bank OZK.

To provide a perspective for the upside potential of the preferred stock of Bank OZK, the stock was trading at its nominal value of $25 in early 2022, before the surge of interest rates. Therefore, whenever interest rates revert to normal levels, one can reasonably expect the stock to revert towards its nominal value. This means that the preferred stock of Bank OZK has 69% upside potential off its current level over the next 3-5 years.

Risk #2: A collapse of Bank OZK

The other risk factor is a potential collapse of Bank OZK, just like the one experienced by Silicon Valley Bank, Credit Suisse and First Republic Bank. However, Bank OZK is an exceptionally well managed bank. Its CEO, George Gleeson, has remained at the helm of the bank since 1979 (!) and has managed the bank in an exemplary way.

Bank OZK has some striking differences from the banks that have fallen apart in the ongoing financial turmoil. First of all, Bank OZK prices its bonds mark-to-market instead of holding them to maturity. In other words, the bank does not have any hidden losses in its balance sheet due to the surge of interest rates. Instead, its balance sheet reflects the current market conditions accurately.

On the contrary, the banks that collapsed had assumed that they would hold their bonds until maturity and hence they had not reported the losses caused by the surge of interest rates on their bond portfolio. Unfortunately, at some point, they had to sell some bonds to boost their liquidity and thus they incurred severe losses. Even worse, the market lost confidence in these banks and thus these banks ran out of liquidity.

This is certainly not the case for Bank OZK, which has primarily short-term bonds in its investment portfolio and continuously reports the value of these bonds based on their actual price. Moreover, as the Fed is not likely to raise interest rates meaningfully from current levels, the worse is behind Bank OZK in reference to the value of its bond portfolio.

It is also important to note that the aforementioned banks saw their deposits evaporate due to the loss of confidence in market sentiment. On the contrary, in the first quarter of this year, Bank OZK enjoyed a 3.7% increase in its total deposits, from $21.5 billion at the end of the fourth quarter to $22.3 billion. This performance is certainly reassuring, particularly given the financial turmoil that prevailed during the first quarter.

It is also remarkable that Bank OZK repurchased $85 million of shares during the first quarter. Management stated that it kept repurchasing shares even after the collapse of Silicon Valley Bank and will continue repurchasing shares throughout the remainder of this year, as long as the stock remains undervalued. This is undoubtedly a testament to the confidence of management in the resilience of the company to the ongoing downturn. If Bank OZK was struggling to remain liquid, it would certainly eliminate share repurchases in order to fund its day-to-day operations.

Another testament to the resilience of Bank OZK to downturns is its outstanding performance record. The company has grown its (common) dividend for 27 consecutive years. As this period includes the Great Recession, which was the most severe financial crisis of the last 90 years, it is evident that the bank has a rock-solid business model in place. While several banks incurred massive losses and cut their dividends in that crisis, Bank OZK remained highly profitable and kept raising its dividend. It is also impressive that Bank OZK has been raising its dividend in every single quarter since 2010.

Despite its aggressive dividend raises, Bank OZK still has a solid payout ratio of only 27% thanks to its consistent earnings growth. Therefore, the company is likely to continue raising its dividend for many more years.

Analysts seem to agree on the promising prospects of Bank OZK. The company posted record earnings per share in each of the last two years and it is expected by analysts to grow its earnings per share by an additional 26% this year, to a new all-time high. This is certainly impressive, especially given that most banks are likely to incur a decrease in their earnings this year due to an increased cost of deposits amid high interest rates. The key behind the superior performance of Bank OZK is the focus of the bank on providing loans with a floating interest rate. Thanks to multi-year high interest rates, Bank OZK is on track to post all-time high earnings this year.

Final thoughts

Thanks to all the above facts, it is evident that the preferred stock of Bank OZK has negligible risk. As long as the common stock does not eliminate its dividend, the dividend of the preferred stock is guaranteed. Given the strong business momentum of Bank OZK, its proven resilience to downturns and its exceptional dividend growth record, the odds of a suspension of the common dividend are negligible. In fact, the bank is likely to continue raising its common dividend for many more years. Therefore, the shareholders of the preferred stock are likely to continue receiving a 7.8% dividend while waiting for interest rates to revert to normal levels. When that happens, the preferred stock is likely to revert towards its nominal value of $25, thus offering 69% off its current price. Investors should also be aware that Bank OZK can call its preferred shares at $25 beginning from 2026. Overall, the preferred stock of Bank OZK offers great upside potential and an exceptionally high dividend yield while waiting for the upside to materialize.

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