BOK Financial Corporation — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010; filed August 2, 2010. BOK Financial is a regional banking and financial services company operating commercial banking, consumer banking, and wealth management businesses.
Financial performance
| Metric | Q2 2010 | Comparison |
|---|---|---|
| Net income attributable to BOK Financial | $63.5 million; $0.93 diluted EPS | Up from $52.1 million and $0.77 in Q2 2009; up from $60.1 million and $0.88 in Q1 2010 |
| Net interest revenue | $182.1 million | Up 4% year over year; slightly below Q1 2010’s $182.6 million |
| Net interest margin | 3.63% | 3.55% in Q2 2009; 3.68% in Q1 2010 |
| Other operating revenue | $157.4 million | Up 23% year over year, helped by securities and derivative gains |
| Provision for credit losses | $36.0 million | Compared with $47.1 million in Q2 2009 and $42.1 million in Q1 2010 |
| Operating expense | $205.9 million | Up 17% year over year; excluding mortgage servicing-rights fair-value changes, $186.5 million |
| Six-month net income attributable to BOK Financial | $123.7 million; $1.81 diluted EPS | Compared with $107.1 million and $1.58 in the first half of 2009 |
Q2 pretax income was $97.6 million and income tax expense was $32.0 million, a 33% effective rate. The reported income statement shows consolidated net income of $65.6 million before $2.0 million attributable to non-controlling interests.
Financial condition, cash flow and capital
- At June 30, total assets were $23.7 billion, loans before allowance were $10.9 billion, and deposits were $16.1 billion. Loans declined $89 million and deposits increased $560 million during the quarter.
- Available-for-sale securities were $9.2 billion at fair value; the broader securities balance was $10.1 billion. Agency mortgage-backed securities comprised most of the available-for-sale portfolio.
- Combined loan-loss and off-balance-sheet credit reserves were $315 million, or 2.89% of loans. Net charge-offs were $35.6 million, equal to an annualized 1.30% of average loans.
- Nonperforming assets were $460.9 million, or 4.19% of loans and repossessed assets, down from $483.3 million at March 31. Newly identified nonaccruing loans totaled $58 million in Q2.
- Shareholders’ equity was $2.43 billion; the tangible common equity ratio was 8.88%, and the consolidated Tier 1 risk-based capital ratio was 11.90%. The company and its bank subsidiaries exceeded regulatory “well capitalized” thresholds.
- Period-end funding included $2.26 billion of funds purchased and repurchase agreements, $1.71 billion of other borrowings, and $399 million of subordinated debentures. The company reported approximately $3.7 billion of unused collateralized credit capacity for subsidiary banks.
- For the first six months, operating cash flow was $15.6 million, investing cash flow was $88.4 million, and financing cash flow was negative $172.8 million. Cash and cash equivalents declined $68.7 million to $852.5 million.
- The company paid a $0.25-per-share quarterly dividend and declared another $0.25 dividend payable in August 2010. It did not participate in the TARP Capital Purchase Program.
Material changes and unusual items
- Year-over-year earnings growth reflected higher net interest revenue, lower credit-loss provision, and gains on securities and derivatives. Q2 included $23.1 million of net securities gains and $7.3 million of net derivative gains.
- Q2 expenses included a $19.5 million reduction in the fair value of mortgage servicing rights, partly offset by $22.4 million of gains on related economic-hedge instruments. The net pretax benefit from the MSR fair-value change and those hedges was about $3.0 million.
- In Q1, the company acquired servicing rights on approximately $4.2 billion of residential mortgages for about $32 million; their acquisition-date fair value was about $43.7 million, producing an $11.8 million day-one gain. The acquired rights added servicing revenue in Q2.
- Q2 repossessed-asset losses and expenses were $13.1 million, up $12.1 million year over year, including increased write-downs and losses on property. Q2 2009 expenses included an $11.8 million FDIC special assessment, which did not recur.
- The company recognized $2.6 million of Q2 impairment losses in earnings on certain privately issued residential mortgage-backed securities. At June 30, these securities had $849 million amortized cost and $736 million fair value; about $594 million were rated below investment grade by at least one rating agency.
- Commercial real estate loans fell $103 million in Q2. Nonaccruing CRE loans remained concentrated in Arizona and Colorado, where reported nonaccrual proportions were 34% and 25% of local CRE loans, respectively.
Outlook, risks and contingencies
- Management cited soft loan demand, reduced customer borrowing needs, and normal repayments; it expected construction and land-development lending to continue declining as projects are completed. No specific earnings or full-year financial guidance was provided.
- Management expected banking regulation changes effective July 1, 2010 to reduce overdraft-fee revenue by $10 million to $15 million in the second half of 2010 and was exploring ways to mitigate the impact. The effect of the Dodd-Frank Act on fees and expenses was not quantifiable at filing.
- Low intermediate and long-term rates may accelerate mortgage-security prepayments and put further downward pressure on portfolio yields and net interest margin. The company reported an asset-sensitive position in its interest-rate modeling; actual results may differ from simulations.
- Customer derivative programs create counterparty, liquidity, and capital risks. A downgrade from A1 to below investment grade could increase required cash-margin posting by about $45 million. The largest net amount due from a single counterparty was $54 million, substantially supported by letters of credit.
- Potential problem loans totaled $194 million. Management identified commercial real estate weakness, repossessed-property values, private-label mortgage securities, and borrower repayment capacity as material credit considerations.
- The company disclosed a $2.2 million Visa litigation-related contingent liability, offset by a $2.2 million receivable for its share of Visa’s escrow. Management did not anticipate a material loss from the SemGroup-related lawsuit and believed other legal matters would not be material in aggregate.
- Management stated that disclosure controls were effective and that no material change in internal control over financial reporting occurred during the quarter.
Key facts investors should verify
- Whether credit deterioration, charge-offs, repossessed-asset write-downs, and the $315 million combined reserve remain consistent with underlying loan trends, especially in Arizona and Colorado CRE.
- The assumptions, fair values, and potential further credit losses in the privately issued mortgage-backed securities portfolio, including the below-investment-grade holdings.
- How much reported earnings depend on securities and derivative gains, mortgage servicing-rights valuation and hedges, and the prior-quarter day-one servicing-rights gain.
- The effect of overdraft regulation and Dodd-Frank-related changes on fee revenue, expenses, capital requirements, and interchange income.
- Liquidity and collateral needs under adverse derivative-market or credit-rating scenarios, and the company’s continuing ability to maintain capital and dividend levels.