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Bank OZK downgrades loan to substandard; stock slides more than 4%

Bank OZK downgraded a loan due to cash flow issues when reporting its 2019 fourth-quarter earnings. The company's stock declined more than 4% in morning trading.

The loan backs a townhome development in Truckee, Calif. The company downgraded the credit from a "watch" rating to "substandard-accrual," prompting several questions from analysts on the bank's Jan. 17 earnings call. At 12:45 p.m. ET, the bank's stock was down 4.28% from the previous day's close.

In prepared remarks, management stated that the project was downgraded due to the delay or cancellation of "several" sales that had been slated to close in late-2019, as well as a lower-than-expected volume of pending lot sales heading into 2020.

On the earnings call, Chairman and CEO George Gleason II said while the margins on the product have narrowed, the bank still projects there will be sufficient cash flow to repay the loan's principal and interest.

"What would cause there to be loss exposure and cause this credit to move from substandard-accruing to nonaccrual status would be a change in sales prices, projected sales velocity, interest rates — that some combination of those caused that forward projection in interest and value to become negative instead of positive," he said.

Gleason said the bank expects the project to be with the bank for multiple years until the development is built out to the point that the sponsor would pay down and no longer need to draw on the loan. He said the development was launched prior to the Great Recession in 2008 and suffered a severe revaluation due to the financial crisis. The project is viable and well received by customers but is significantly over-leveraged, Gleason said.

Bank executives also provided some updates on the adoption of the current expected credit loss standard. He said the bank had previously employed a dozen or fewer risk ratings for loans. Due to CECL, the bank now has 72 risk ratings. While the standard will represent an earnings headwind when the bank reports significant loan growth, management said the additional detail on risk ratings will allow the company to be more "surgical" in pricing loans.