BOK Financial Corporation — Q1 2017 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2017. BOK Financial is a regional financial services company operating Commercial Banking, Consumer Banking and Wealth Management businesses. Comparisons below are primarily with Q1 2016; quarter-over-quarter comparisons are identified where relevant. Mobank, acquired in December 2016, contributed to year-over-year and sequential balance growth.
Financial performance and condition
- Earnings: Net income attributable to BOK Financial shareholders was $88.4 million, or $1.35 per diluted share, versus $42.6 million and $0.64 in Q1 2016. Consolidated net income was $88.7 million; pretax income was $126.8 million.
- Revenue and margin: Net interest revenue was $201.2 million, up $18.6 million year over year. Net interest margin was 2.81%, versus 2.65% a year earlier and 2.69% in Q4 2016. Other operating revenue was $170.3 million, including $164.4 million of fees and commissions. Fiduciary and asset management revenue rose 21% year over year, while mortgage banking revenue fell 22%.
- Expenses and credit costs: Operating expense was $244.7 million, up $2.1 million year over year and down $20.8 million sequentially. No provision for credit losses was recorded in Q1 2017, compared with $35.0 million in Q1 2016. Gross charge-offs were $2.2 million and recoveries $2.9 million, resulting in net recoveries of $0.7 million.
- Taxes: Income tax expense was $38.1 million, a 30.1% effective rate. A $3.9 million benefit from adopting new share-based compensation accounting reduced the rate; excluding that benefit, management reported a 33.2% rate.
- Loans and credit quality: Period-end loans were $17.0 billion, essentially unchanged from year-end; average loans increased $412 million sequentially, partly reflecting Mobank. The combined loan and off-balance-sheet credit allowance was $258 million, or 1.52% of loans. Nonperforming assets excluding U.S.-government-guaranteed assets were $240 million, or 1.43% of loans and repossessed assets, down from $263 million and 1.56% at year-end, primarily due to lower nonaccruing energy loans.
- Deposits, liquidity and debt: Period-end deposits were $22.6 billion, down $173 million from year-end; average deposits were $22.4 billion, up $666 million sequentially. Cash and cash equivalents were $2.77 billion at quarter-end. The bank reported approximately $6.2 billion of estimated unused collateralized credit availability. Total deposits were $22.6 billion; other borrowings were $5.24 billion and subordinated debentures $145 million. Average funding cost was 0.52%, up from 0.44% in Q4 2016.
- Cash flow: Operating activities used $168.7 million, investing activities provided $686.1 million, and financing activities used $287.7 million. Cash and cash equivalents increased $229.7 million during the quarter. Operating cash flow was affected by changes in trading and fair-value-option securities and other working-capital items.
- Capital and shareholder returns: At March 31, the consolidated common equity Tier 1 ratio was 11.60%, total capital ratio 13.26%, and leverage ratio 8.89%. Shareholders’ equity was $3.34 billion. The company paid a $0.44-per-share quarterly dividend and announced the same amount for the next quarter.
Material changes versus comparable periods
- Shareholder net income more than doubled year over year. Higher net interest revenue, improved credit costs and a more favorable mortgage-servicing-rights contribution were key factors.
- Net interest revenue increased with growth in average earning assets and improving yields. Average earning assets rose $1.0 billion year over year, including Mobank-related balances; loan yield increased to 3.88% from 3.57%.
- Mortgage-servicing-rights changes, net of economic hedges, contributed a $0.2 million pretax benefit in Q1 2017, compared with an $11.4 million pretax reduction in Q1 2016. Mortgage production volumes declined about 50% year over year, partly following the company’s exit from correspondent lending.
- Credit conditions improved from the energy-related stress of Q1 2016: provision expense fell from $35.0 million to zero, and net charge-offs shifted from $22.5 million to net recoveries of $0.7 million.
- Fiduciary and asset management growth and brokerage and trading revenue gains were partly offset by lower mortgage banking revenue. Fourth-quarter 2016 expenses included Mobank acquisition costs, severance and a foundation contribution, contributing to the sequential expense decline.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no general earnings or revenue guidance. Based on its December 2016 energy-portfolio stress test and then-current conditions, management expected the 2017 provision for credit losses could range from $15 million to $20 million, despite recording no provision in Q1.
- Credit and concentration risks: Energy loans totaled $2.5 billion, or 15% of loans, with $2.8 billion of unfunded energy commitments. Management cited energy-price stability as a factor in improving credit trends, but the portfolio remains exposed to commodity prices and regional economic conditions. Potential problem loans were $413 million, including $294 million in energy loans.
- Market and interest-rate risks: Management described the balance sheet as asset-sensitive overall, while employing securities and derivatives to manage rate exposure. Its model estimated that a 200-basis-point rate increase would reduce next-12-month net interest revenue by 0.53%; a 50-basis-point decrease would reduce it by 2.20%. Mortgage servicing rights, securities values, prepayments and hedge effectiveness can create earnings volatility.
- Contingencies: The filing describes litigation relating to municipal-bond trustee activities, including two bondholder actions. Management stated no loss was probable for those actions at the filing date, but noted a potentially material loss could arise if a court-ordered repayment plan fails. A separate Texas deposit-customer suit seeks $7 million; the company said a loss may be probable but could not quantify any liability. A previously approved $7.8 million deposit-account class settlement had been funded and was being implemented.
- Other notable items: Mobank was integrated into the Bank of Kansas City division in February 2017. The company recorded a $2.0 million net gain on sales of available-for-sale securities and $3.6 million of other net gains. Disclosure controls were reported effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether energy-sector credit quality and commodity-price assumptions support management’s projected $15–$20 million 2017 credit-loss provision range.
- Whether the improvement in net interest margin persists as deposit pricing and borrowing costs respond to further rate changes.
- How the sharp reduction in mortgage production and correspondent-channel exit affect recurring mortgage banking revenue and servicing economics.
- Whether Mobank integration delivers expected benefits and how much balance growth reflects acquisition effects rather than organic expansion.
- Developments in the municipal-bond litigation and Texas deposit-customer claim, including any change to management’s loss assessments or accruals.
- How derivative collateral, brokered deposits, FHLB borrowing levels and available liquidity respond to market stress or a credit-rating downgrade.