BOK Financial Corporation — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. BOK Financial is a regional banking and financial-services company with commercial banking, consumer banking, and wealth-management businesses.
Financial performance and condition
- Q3 earnings: Net income attributable to BOK Financial shareholders was $87.4 million, or $1.27 per diluted share, versus $85.1 million, or $1.24, in Q3 2011. Q2 2012 was $97.6 million, or $1.43 per diluted share.
- Nine-month earnings: Shareholder-attributable net income was $268.6 million, or $3.92 per diluted share, versus $218.9 million, or $3.19, in the first nine months of 2011.
- Revenue and margins: Q3 net interest revenue was $176.0 million and net interest margin was 3.12%, down from 3.34% a year earlier and 3.30% in Q2. Other operating revenue was $179.9 million, including $166.3 million of fees and commissions. Mortgage banking revenue reached $50.3 million.
- Expenses and taxes: Operating expenses were $222.3 million, including a $9.6 million expense from the decline in mortgage servicing rights fair value. Excluding that change, expenses were $212.8 million, up 9% year over year. The effective tax rate was 34%.
- Credit: No provision for credit losses was recorded in Q3. Net charge-offs were $5.7 million, or 0.19% of average loans annualized; this included a $7.1 million refund to the City of Tulsa. Excluding that item, the company reported net recoveries of $1.4 million. The combined credit-loss allowance was $236 million, or 1.99% of loans.
- Loans and asset quality: Loans totaled $11.8 billion at quarter-end, up $256 million from June 30. Nonperforming assets were $264 million, or 2.21% of loans and repossessed assets, down from $279 million, or 2.38%, at June 30. Nonaccruing loans were $132 million, or 1.11% of loans.
- Deposits, liquidity, and debt: Period-end deposits were $19.1 billion, up $781 million from June 30. Cash and cash equivalents were $615 million. The bank reported about $9.3 billion of estimated unused collateralized credit availability. Quarter-end borrowings included $1.68 billion of funds purchased, $1.11 billion of repurchase agreements, $639 million of other borrowings, and $348 million of subordinated debentures. No amount was outstanding under the parent’s $100 million revolving credit facility.
- Capital and distributions: The company reported a 9.67% tangible common equity ratio, a 13.21% Tier 1 capital ratio, and a 15.71% total risk-based capital ratio; the company and bank exceeded well-capitalized regulatory thresholds. It paid a $0.38-per-share quarterly dividend. After quarter-end, the board approved a further $0.38 quarterly dividend and a $1.00 special dividend, payable in November 2012.
- Cash flow: For the first nine months, operating cash flow was $448.6 million, investing cash flow was negative $1.93 billion, and financing cash flow was positive $1.11 billion. Cash and cash equivalents decreased $370.9 million to $615.5 million.
Material changes versus comparable periods
- Q3 net income rose modestly year over year, while nine-month net income increased substantially, supported in part by stronger mortgage banking and lower credit costs.
- Q3 fees and commissions increased 14% year over year. Mortgage banking revenue increased 70%, reflecting higher loan production and improved secondary-market pricing. Mortgage loans funded for sale totaled $1.05 billion, up 64%.
- Net interest revenue was nearly flat year over year, but margin compressed as loan and securities yields declined. Average earning assets grew 11% year over year, while reinvestment of securities cash flows at lower rates and lower loan yields offset much of the volume benefit.
- Credit indicators improved overall: nonperforming assets declined from $388 million a year earlier and nonaccruing loans from $229 million. Reported Q3 net charge-offs include the unusual City of Tulsa repayment; excluding it, credit performance was stronger than the headline ratio suggests.
- Available-for-sale securities increased to $11.5 billion, primarily through purchases of short-duration agency mortgage-backed securities. Deposits increased from $18.4 billion at June 30 to $19.1 billion.
Outlook, commentary, risks, and unusual items
- Management said net interest margin could fall below 3% if short- and intermediate-term rates remain low; further funding-cost reductions are limited. Management also noted that continued asset growth without excessive interest-rate risk may be constrained.
- Management expects further fee-revenue growth from new products and expansion outside Oklahoma, but cited economic conditions, regulation, competition, and market saturation as potential constraints. Mortgage banking benefited from low rates and strong refinancing demand, conditions that may not persist.
- Credit exposure includes energy loans of $2.4 billion, or 21% of loans, and commercial real estate loans of $2.2 billion. Energy lending is exposed to commodity-price and reserve-estimation risk; nonperforming commercial real estate remains concentrated in construction and land development and in several regional markets. Potential problem loans totaled $150 million.
- Private-label mortgage-backed securities had $337 million amortized cost and $332 million fair value; the company recorded $1.1 million of additional credit impairment in Q3. The broader securities portfolio is sensitive to interest rates, prepayments, and extension risk.
- Mortgage servicing rights are valued using assumptions that can create earnings volatility. The Q3 decline in their fair value was partly offset by economic hedges. The company also accrued $4.8 million for potential mortgage-loan repurchases under representations and warranties, noting that loss severity had increased.
- Other exposures include $6.4 billion of unfunded loan commitments, $448 million of standby letters of credit, $238 million of older mortgage loans sold with recourse, and derivative counterparty and collateral requirements. A downgrade below investment grade could increase derivative-related cash-margin needs by about $35 million.
- Unusual items include the $7.1 million payment to the City of Tulsa after the Oklahoma Supreme Court invalidated a prior settlement; the company is pursuing claims against the Tulsa Airports Improvement Trust. A $19 million overdraft-litigation settlement was paid in Q2 and had been accrued in 2011. The filing says the class settlement received court approval in August 2012.
- The company acquired a majority interest in an aircraft-parts supplier and acquired Denver-based Milestone Group in August. Combined purchase price was $41 million, including $12 million contingent consideration; management said the pro forma impact was not material.
- The filing estimates that forthcoming OCC guidance on certain retail loans in Chapter 7 bankruptcy may add $10 million to $15 million to nonaccruing loans and troubled debt restructurings; implementation was expected in Q4. Regulatory changes, including Basel III and Dodd-Frank requirements, may also affect capital, compliance costs, or distributions.
Most important facts for investors to verify
- Whether margin compression continues and whether reported margin approaches or falls below management’s stated 3% risk level.
- How sustainable mortgage banking revenue is if refinancing volumes or secondary-market pricing weaken, and how servicing-rights valuation changes affect earnings.
- Whether credit quality continues improving, especially in commercial real estate, energy, Arizona, and the $150 million potential-problem-loan pool; assess the allowance relative to future losses.
- The cash and capital effects of the special dividend, ongoing securities purchases, loan growth, and funding mix; confirm liquidity remains adequate under stress.
- Developments in the City of Tulsa litigation, mortgage repurchase requests and reserve adequacy, and the expected classification changes under OCC bankruptcy guidance.
- Actual impact of the acquisitions, regulatory implementation, and any changes to capital requirements or shareholder distributions.