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Big Loans, Big Risks, Big Problems

Summary:
Construction lending juggernaut Bank OZK made news when its shares fell 17% after Citigroup analyst Benjamin Gerlinger wrote in a report that cut his rating to “sell.” Bloomberg reported “Bank OZK faces ‘largely idiosyncratic’ exposure to life sciences relative to peer banks,” with a 5 million loan on the Research and Development District on San Diego’s waterfront, developed by IQHQ Inc..“RaDD has been in development for more than 4 years and we believe 0% of the 1.7 million square feet is leased — indicative of a difficult life science construction lending market,” Gerlinger wrote.“Supply has outpaced demand across markets, putting leverage back in tenants’ hands and allowing start-ups to push for shorter terms,” JLL researchers led by Maddie Holmes, Amber

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Construction lending juggernaut Bank OZK made news when its shares fell 17% after Citigroup analyst Benjamin Gerlinger wrote in a report that cut his rating to “sell.” Bloomberg reported “Bank OZK faces ‘largely idiosyncratic’ exposure to life sciences relative to peer banks,” with a $915 million loan on the Research and Development District on San Diego’s waterfront, developed by IQHQ Inc..

“RaDD has been in development for more than 4 years and we believe 0% of the 1.7 million square feet is leased — indicative of a difficult life science construction lending market,” Gerlinger wrote.

“Supply has outpaced demand across markets, putting leverage back in tenants’ hands and allowing start-ups to push for shorter terms,” JLL researchers led by Maddie Holmes, Amber Schiada and Mark Bruso wrote in a May 15 report. “It is likely the market could take three to four years (or more in some submarkets) to return to a market where landlords and tenants have equal leverage in negotiations.”

Life science is not the only problem Bank OZK has. Gerlinger said he has “newfound, but substantial concerns” over what he believes to be Bank OZK’s largest individual loan: a multi-use project in Atlanta known as Echo Street West.

The Echo Street project is near the Georgia Tech campus in west downtown Atlanta. According to the project’s website, Echo Street contains 300,000 sf of office space, 292 apartment units, 50,000 sf of retail space, 16,000 of event space, 20,000 of artist and maker space(!?), and outdoor entertainment space of 6.5 acres. From the directory of tenants, it looks like the project’s artist and maker space has leased up the fastest.

“We were very confident and people were forecasting doom and gloom, but we had the data, we had done the homework,” the always confident George Gleason told Bisnow speaking about south Florida projects. “Similarly, the market’s not quite as tight now — and is probably more appropriately balanced now than it was then — but still, there’s demand for the product. We feel very good about what we’re doing down there.”

Matt Wasielewski’s gushy piece about the high-octane OZK, entitled “Bank OZK Has Dominated Construction Lending. Its CEO Has No Plans To Slow Down,” offers the eye-popping numbers. Bank OZK originated more than $3B in construction loans last year, topping mega-banks, JPMorgan Chase and Wells Fargo, which each originated less than $2B, according to MSCI. “As most banks are pulling back from the real estate sector, Bank OZK is leaning in — it followed up last year’s dominance with another $688M in construction debt in the first quarter,” Wasielewski wrote.

“We’re getting a much larger share of the pie right now, but it’s just a smaller pie,” Bank OZK CEO George Gleason told Bisnow. The bank’s construction lending business totaled $12B in outstanding loans at the end of the first quarter, 44 percent of its total real estate balance sheet.

Gleason says his bank’s strategic plan includes growing its real estate business “as big as it can be while maintaining discipline.” Catherine Mealor, an analyst at Stifel told Bisnow, “Bank OZK typically takes advantage of those moments when others pull back to step in and do it on their terms,” Mealor said. “It’s been very successful for them.”

Of course Wasielewski’s article contains plenty of quotes about Bank OZK never straying from its strict underwriting “while generally only working with developers that have both a strong track record and access to their own equity for when projects go over budget.” The key word in that sentence being “generally.” 

“Bank OZK has built this machine where they can service the loans in-house. They’ve got great underwriters, they’ve got a great closing team, they work with good counsel,” said Scott Wadler, managing director responsible for debt origination in Miami at Berkadia. “They have really become specialists in what I would call the Class-A construction space.”

The Bisnow piece goes on about projects benefiting from being pre-leased and having boldface developers. But, in a piece published this January I offered, “Even Bank OZK admits that ‘loan repayments have been subdued’ in 2023, and laughingly continued with ‘as many sponsors have been carefully monitoring interest rates and refinance market conditions to determine when to move projects from construction financing to bridge or permanent loans.’”

Ten year treasury yields have increased 70 basis points since year end so refinancing has not become easier. Of course, if a project is zero percent leased, refinancing and repayment to Bank OZK is especially difficult.

George Gleason will learn the hard way what Brian Foran recently wrote:

The dirty little secret in commercial real-estate is that loans don’t really get repaid. They get refinanced.


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