Early CRE payoffs drive Bank OZK into new specialties

Commercial real estate lending is Bank OZK’s bread and butter, so a red flag went up when the Little Rock, Ark., bank reported that its national CRE portfolio shrank 1.5% in the first quarter since year-end.

The culprit? Early loan payoffs, totaling $1.5 billion.

Prepayments aren’t especially unusual in the CRE market, even in a pandemic, but the problem facing the $27.3 billion-asset Bank OZK and other commercial real estate lenders is the pandemic-driven economic slump is limiting opportunities to reinvest those funds. Mixed-use development projects in urban markets like New York, San Francisco and Chicago are fewer and farther between.

“With the pandemic and the fact New York got a little overbuilt … there haven’t been as many new products to finance,” Chairman and CEO George Gleason told analysts last week.

Bank OZK’s forecast calls for record levels of repayments in the second quarter — nearly $1.7 billion. It’s expecting payoffs to moderate in the second half of the year, but they will “remain a meaningful headwind to loan growth,” Brian Martin, an analyst at Janney Montgomery Scott, wrote in a research note.

The solution, at least in part, Bank OZK executives say, lies in expanding other commercial business lines. To that end, Bank OZK recently announced that it had hired a seasoned banker to launch a new asset-based lending unit that will focus on serving midsize businesses in the Southeast and in Texas. Bank OZK said it also expects bigger production from an existing subscription-finance team.

The added growth can’t come soon enough.

The $27.3 billion-asset Bank OZK reported record first-quarter net income of $148.4 million. However, behind that gaudy top line, Bank OZK, like much of the rest of the banking industry, is straining to originate loans.

Balances in the national CRE portfolio — which was 63% of Bank OZK’s overall loan book — fell to $11.4 billion. Bank OZK’s second-biggest loan category, recreational vehicle and marine loans, shrank by 5% to about $2.1 billion.

Bank OZK’s new commercial lending initiatives “are expected to contribute meaningfully to future growth,” Martin said, adding that he expects the new new asset-based lending team to begin making an impact in the third quarter “with growth accelerating to a more meaningful level in 2022.”

CRE repayments have proved a thorn in Bank OZK’s side in the past. They totaled $5.7 billion in 2019. Yet in prior years repayment woes were never compounded by a scarcity in origination opportunities, Gleason said.

Now, the combination of elevated prepayments and a lack of sizable deals means Bank OZK’s loan officers are booking smaller CRE loans than they have in past years. That in turn has made maintaining loan balances in some markets challenging.

In New York, for instance, Bank OZK’s CRE commitments totaled $4.9 billion at March 31, down 30% from two years earlier. Similarly, Chicago’s loan balance dropped to $1.1 billion on March 31, down 3% from year-end 2020; Los Angeles’s fell by 11.5% in the same span.

Bank OZK manages national CRE lending out of its Real Estate Specialties Group, whose lenders “closed about twice as many loans in the first quarter of this year as they did in the first quarter of 2020,” Gleason said on Friday’s call.

“They were just 60% smaller, more or less,” Gleason added.

Bank OZK tapped Michael Sheff, who led asset-based lending for BBVA USA for a decade, to lead its new business line. Sheff “has considerable expertise in managing and directing national lending teams,” spokeswoman Susan Blair said Tuesday.

It’s clear the bank is counting on Sheff’s group to generate measurable results in relatively short order. “We’ll hopefully have some wins here in 2021, but I would expect it will be 2022 before we see material moves there,” RESG President Brannon Hamblen said during Friday’s call.

Asset-based lending typically involves revolving lines of credit collateralized by business assets such as accounts receivable, inventory and equipment. Subhrojyoti Mandal, director of commercial lending at Acuity Knowledge Partners in London, said demand for asset-backed loans should increase as the economy recovers.

“From a lender’s perspective, to make the asset-backed business profitable and drive return on investment, some of the key factors to focus on are faster response time for new deal requests and robust risk management practices to underwrite good-quality loans,” Mandal added in an email Tuesday.

The sector offers significant opportunities, but it’s not without challenges, according to Pat True, a senior risk analyst at Jack Henry & Associates.

“Because of the effects of 2020 and early 2021, we’re also seeing weaker balance sheets and income statements,” True said. “A line of credit that in 2019 might have gone unsecured or loosely monitored is going to be more structured with more guardrails in place in 2021 and 2022.”

Bank OZK’s long experience with national CRE and other specialty lending lines have already given it a strong credit culture on which to build an asset-based lending platform, Hamblen said. He added that he and Sheff see eye to eye on credit.

“We’re very excited about … finding an individual to lead that group that really has the same sort of credit DNA and thought processes around how to originate, close and manage those credits that really mirror the way we think in RESG,” Hamblen said.

The RESG team reported zero charge-offs in 2019 and 2020, as well as for the first quarter of 2021. Throughout its 18-year history, RESG’s weighted average of net charge-offs is 0.11%, according to Bank OZK.

By contrast, Bank OZK’s subscription-finance team has made only a limited contribution to its loan book, but the team has been responsible for servicing a portfolio of shared national credits. Bank OZK has been systematically reducing exposure to shared national credits, allowing those loans to decline from a peak of $484 million in 2018 to $98 million at March 31.

Subscription finance involves lending to investment or venture capital groups. Now, Bank OZK is transferring supervision of that team to the Real Estate Specialties Group, in a move intended to juice originations going forward.

The subscription-finance team “had a positive year last year, but we think we’ll beat [those results] in 2021 and go from there,” Hamblen said. “They’re ahead of the game and moving.”

The emphasis on asset-based and subscription lines represents a departure for a bank that has done limited amounts of commercial and industrial lending — its C&I portfolio totaled just under $791 million at Sept. 30. Still, Bank OZK has no plans to move away from CRE lending.

Hamblen said the RESG team is adding lenders and support staff, while Gleason said the bank will remain active in CRE even in New York and other slow-growth urban markets.

“When construction and development opportunities resume in New York in meaningful ways, we’re going to be there, looking for the same quality projects to originate going forward that we’ve originated in the past,” Gleason said.

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