0000875357bokf:InsurancebrokeragerevenueMemberus-gaap:CorporateNonSegmentMember2019-07-012019-09-30ConsumerMemberbokf:MerchantservicesrevenueMemberus-gaap:OperatingSegmentsMember2020-01-012020-06-30

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One) 

OR

 

Commission File No. 0-19341

BOK FINANCIAL CORP

 

(Registrant’s telephone number, including area code)

BOK Financial Corporation

Form 10-Q

Quarter Ended SeptemberJune 30, 20202021

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Performance Summary

BOK Financial Corporation (“the Company”) reported net income of $154.0$166.4 million or $2.19$2.40 per diluted share for the thirdsecond quarter of 2020.2021. Net income was $142.2 million or $2.00 per diluted share for the third quarter of 2019 and $64.7 million or $0.92 per diluted share for the second quarter of 2020. No2020 and $146.1 million or $2.10 per diluted share for the first quarter of 2021. Forecasts for improving macroeconomic factors, including stabilizing energy prices, and improving credit quality metrics resulted in a negative provision for expected credit losses was necessaryof $35.0 million and $25.0 million in the thirdsecond quarter of 2020. The Company recorded a pre-tax2021 and first quarter of 2021, respectively. A provision for expected credit losses of $135.3 million was recorded in the second quarter of 2020. A pre-tax provision

Pre-provision net revenue ("PPNR"), a non-GAAP measure, was $179.9 million for incurred credit losses of $12.0 million was recorded in the thirdsecond quarter of 2019.2021 compared to $215.8 million for the second quarter of 2020. The decrease in PPNR was due to lower combined net interest revenue and fees and commission revenue. This was largely driven by lower average loan balances due to customer deleveraging during the current economic uncertainty, narrowing net interest margin and compressed margins from our mortgage banking activities. PPNR improved $16.5 million over the first quarter of 2021. Growth in much of our fee-based business, led by brokerage and trading and fiduciary and asset management revenues, was partially offset by lower mortgage banking revenue.

Highlights of the thirdsecond quarter of 20202021 included:

Results of Operations

Net interest revenue is the interest earned on debt securities, loans and other interest-earning assets less interest paid for interest-bearing deposits and other borrowings. The net interest margin is calculated by dividing tax-equivalent net interest revenue by average interest-earning assets. Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. Net interest margin is typically greater than net interest spread due to interest income earned on assets funded by non-interest bearing liabilities such as demand deposits and equity.

Tax-equivalent net interest revenue totaled $274.2$282.6 million for the thirdsecond quarter of 20202021 and $282.0$280.7 million infor the thirdsecond quarter of 2019.2020. Net purchase accounting discount accretioninterest revenue increased $13.9 million from growth in average earning assets and decreased $12.0 million due to changes in interest rates. An increase in trading securities balances was $13.3 millionpartially offset by a decrease in the third quarter of 2020 and $10.9 million in the third quarter of 2019.loan balances. Table 1 shows the effect on net interest revenue from changes in average balances and interest rates for various types of earning assets and interest-bearing liabilities.

Net interest margin was 2.812.60 percent for the thirdsecond quarter of 2020,2021, compared to 3.012.83 percent for the thirdsecond quarter of 2019. Loan discount accretion added 14 basis points to net interest margin in the third quarter of 2020 and 12 basis points in the third quarter of 2019. Recent rate cuts in2020. In response to the economic environment resultinganticipated impact to the economy from the COVID-19 pandemic, have compressed the netFederal Reserve reduced the federal funds rate to near zero in March, 2020. Other short-term market interest margin. While the company has been proactive inrates followed, reducing deposit costs and implementing LIBOR floors in loan agreements to support the margin, the continued decline in average LIBOR during the third quarter reduced the yield on both floating-rate loans and securities. Principalassets by more than the amount by which funding costs could be reduced, compressing the margin. The tax-equivalent yield on earning assets was 2.75 percent, a decrease of 37 basis points compared to the second quarter of 2020. The available for sale securities portfolio yield decreased 44 basis points to 1.85 percent as principal cash flows received from maturities of the available-for-saleavailable for sale securities portfolio continue to be reinvested at lower rates. The tax-equivalent yield on earning assets was 3.04 percent, a decrease of 121 basis points compared to the third quarter of 2019. Loan yields decreased 1529 basis points to 3.60 percent. This includes a 19 basis point benefit from3.54 percent, largely due to the decrease in short-term interest rates partially offset by the addition of PPP loan fees. The available for sale securities portfolio yield decreased 49 basis pointsPPP loan fees of $11.1 million were recognized in the second quarter of 2021. As discussed in the Management's Discussion and Analysis - Loan section following, $27.8 million of deferred loans fees remain to 2.11 percent and thebe recognized in future periods, including $3.8 million related to loans originated in 2020 that mature in 2022. The yield on trading securities decreased 15751 basis points to 1.92 percent. The yield on fair value option securities decreased 87 basis points to 1.921.95 percent.

Funding costs decreased 13716 basis points compared to the thirdsecond quarter of 2019.2020. The cost of other borrowed funds decreased 2002 basis points and the cost of interest-bearing deposits decreased 9120 basis points. The benefit to net interest margin from earning assets funded by non-interest bearing liabilities was 86 basis points for the thirdsecond quarter of 2020,2021, a decrease of 362 basis points compared to the thirdsecond quarter of 2019.2020.

Average earning assets for the thirdsecond quarter of 20202021 increased $1.9$3.5 billion or 59 percent over the thirdsecond quarter of 2019.2020. This increase was largely due to growth in our trading of U.S. government issued mortgage-backed securities and the expansion of the available for sale securities portfolio, partially offset by a decrease in loans and fair value option securities. Average trading securities increased $5.6 billion. The average balance of available for sale securities, which consists largely of residential and commercial mortgage-backed securities guaranteed by U.S. government agencies, increased $1.8 billion.$763 million. We purchase securities to supplement earnings and to manage interest rate risk. The majority of this increase occurred in the fourth quarter of 2019 and the first quarter of 2020 in order to reduce our exposure to falling short-term interest rates. Average loans, net of allowance for loan losses, increased $1.5decreased $1.9 billion, largely due to the inflowpurposeful deleveraging by our customers as borrowers continue to pay down during this time of Paycheck Protection Program ("PPP") loans.economic uncertainty. Fair valevalue option securities that we hold as an economic hedge against changes in the fair value of mortgage servicing rights decreased $1.2 billion. Receivables from unsettled securities sales, primarily related to our U.S. agency residential mortgage-backed trading operations, increased $2.8 billion. Growth in average earning assets and non-interest bearing receivables was primarily funded by an increase in average deposits.$722 million.

Average deposits increased $8.9$4.8 billion compared to the thirdsecond quarter of 2019.2020. Deposit growth is largely due to the combination of focused deposit gathering initiatives, stimulus-related deposits, and customers retaining elevated balances in the current economic environment.environment, supplemented by the most recent government stimulus payments. Interest-bearing deposits increased $6.8$3.1 billion while demand deposit balances increased $2.2$1.7 billion. Other borrowed funds decreased $3.9 billion.

Our overall objective is to manage the Company’s balance sheet to be relatively neutral to changes in interest rates as is further described in the Market Risk section of this report. Approximately 77%75% of our commercial and commercial real estate loan portfolios are either variable rate or fixed rate that will reprice within one year. These loans are funded primarily by deposit accounts that are either non-interest bearing, or that reprice more slowly than the loans. The result is a balance sheet that would be asset sensitive, which means that assets generally reprice more quickly than liabilities. One of the strategies that we use to manage toward a relative rate-neutral position is to purchase fixed-ratefixed rate residential mortgage-backed securities issued primarily by U.S. government agencies and fund them with market-rate-sensitive liabilities. The liability-sensitive nature of this strategy provides an offset to the asset-sensitive characteristics of our loan portfolio. We also may use derivative instruments to manage our interest rate risk. 

The effectiveness of these strategies is reflected in the overall change in net interest revenue due to changes in interest rates as shown in Table 1 and in the interest rate sensitivity projections as shown in the Market Risk section of this report.

(In thousands)

Other operating revenue was $234.2$191.4 million for the thirdsecond quarter of 2020,2021, a $47.7decrease of $41.8 million increase over the third quarter of 2019 and a $1.5 million increase overcompared to the second quarter of 2020. LowerMortgage production revenue was negatively impacted by a decline in mortgage interest rates have positively affected both our brokerageproduction volumes and margin compression. Brokerage and trading and mortgage banking revenue leadingdecreased largely due to increasesa shift of $25.7trading revenue to interest income from trading securities.

Other operating revenue increased $14.4 million and $21.8 million, respectively, overcompared to the thirdfirst quarter of 2019.2021. Brokerage and trading revenue increased $8.6 million. An increase in agency residential mortgage trading volumes and higher margin market opportunities combined to grow trading revenue.

(In thousands)

Diversified sources of fees and commissions revenue are a significant part of our business strategy and represented 4538 percent of total revenue for the thirdsecond quarter of 2020,2021, excluding provision for credit losses and gains and losses on other assets, securities and derivatives and the change in the fair value of mortgage servicing rights. We believe that a variety of fee revenue sources provides an offset to changes in interest rates, values in the equity markets, commodity prices and consumer spending, all of which can be volatile. As an example of this strength, many of the economic factors such as rising interest rates resulting in a declinegrowth in mortgage related trading activities and mortgage production volumes, may also increase net interest revenue or fiduciary and asset management revenue.revenue may also decrease mortgage banking production volumes and related trading. We expect growth in other operating revenue to come through offering new products and services and by further development of our presence in other markets. However, current and future economic conditions, including the recent impact of the COVID-19 pandemic, regulatory constraints, increased competition and saturation in our existing markets could affect the rate of future increases.

Brokerage and trading revenue, which includes revenues from trading, customer hedging, retail brokerage and investment banking, increased $25.7decreased $32.6 million or 5953 percent compared to the thirdsecond quarter of 2019.2020.

Trading revenue includes net realized and unrealized gains and losses primarily related to sales of residential mortgage-backed securities guaranteed by U.S. government agencies and related derivative instruments that enable our mortgage-bankingmortgage banking customers to manage their marketproduction risk. Trading revenue also includes net realized and unrealized gains and losses on municipal securities, asset-backed securities and other financial instruments that we sell to institutional customers, along with changes in the fair value of financial instruments we hold as economic hedges against market risk of our trading securities. Trading revenue was $46.9$13.0 million for the thirdsecond quarter of 2021, a $30.9 million or 70 percent decrease compared to the second quarter of 2020, primarily due to a $22.8 million or 95 percent increase comparedshift from fee revenue to the third quarternet interest revenue on trading securities. See additional discussion in "Lines of 2019. Industry-wide mortgage loan production has increased in 2020 driven by lower rates as the Federal Reserve stepped in to provide market stability. We increased our bond trading pipeline to provide greater liquidity to the housing market during a timeBusiness" section of record loan production volumes.Management's Discussion and Analysis.

Customer hedging revenue is based primarily on realized and unrealized changes in the fair value of derivative contracts held for customer risk management programs. As more fully discussed under Customer Derivative Programs in Note 3 of the Consolidated Financial Statements, we offer commodity, interest rate, foreign exchange and equity derivatives to our customers. Customer hedging revenue totaled $8.6$1.8 million for the thirdsecond quarter of 2021, a $4.4 million or 71 percent decrease compared to the second quarter of 2020, a $4.0primarily attributed to energy customers. Customer hedging revenue includes credit valuation adjustments of the fair value of derivatives to reflect the risk of counterparty default.

Revenue earned from retail brokerage transactions totaled $4.5 million or 85 percentfor the second quarter of 2021, an increase of $1.1 million compared to the thirdsecond quarter of 2019 as energy customers2020 due to increased hedging activity intrading activity.

Investment banking, which includes fees earned upon completion of underwriting, financial advisory services and loan syndication fees, totaled $7.1 million for the volatile environment.second quarter of 2021, an increase of $1.8 million or 33 percent compared to the second quarter of 2020, related to the timing and volume of completed transactions.

Transaction card revenue also increased $2.4$2.0 million as energy customers increased hedging activities. Investment banking revenue also grew by $1.8over the second quarter of 2020 and $2.5 million over the previous quarter, largely due to loan syndication activity.stimulus measures and the broader reopening of the U.S. economy, as we saw both merchant and ATM transaction volume increase this quarter.

Fiduciary and asset management revenue is earned through managing or holding of assets for customers and executing transactions or providing related services. Approximately 90 percent of fiduciary and asset management revenue is primarily based on the fair value of assets. Rates applied to asset values vary based on the nature of the relationship. Fiduciary relationships and managed asset relationships generally have higher fee rates than non-fiduciary and/or managed relationships. Fiduciary and asset management revenue decreased $3.7increased $3.6 million or 89 percent compared to the thirdsecond quarter of 2019. The2020. An increase in trust and managed account fees from higher client asset balances was partially offset by a decrease is largely due to the decline in mutual fund fees combined withas the addition oflow rate environment has put pressure on our mutual fund revenue streams. We had approximately $1.7$2.9 million in fee waivers as a resultduring the second quarter of 2021 compared to approximately $1.1 million in the significant decline in interest rates.second quarter of 2020. We have voluntarily waived certain administration fees in the third quarter of 2020 on the Cavanal Hill money market funds in order to maintain positive yields on these funds in the current low short-term interest rate environment.

Fiduciary and asset management revenue decreased $1.3increased $3.5 million or 8 percent compared to the secondfirst quarter of 2020, primarily2021 due to a decrease in seasonal tax preparation fees earnedcollected in the second quarter.quarter and higher client asset balances. A distribution of assets under management or administration and related fiduciary and asset management revenue follows:

(In thousands)

A summary of changes in assets under management or administration for the three months ended SeptemberJune 30, 20202021 and 20192020 follows:

Mortgage banking revenue increased $21.8decreased $32.7 million or 72 percent compared to the third quarter of 2019. Mortgage loan production volumes increased $134 million or 15 percent as average primary mortgage interest rates have decreased. The gain on sale margin increased 216 basis points to 3.67 percent in the third quarter of 2020. A rapid decrease in interest rates has led to increased application demand and industry-wide capacity constraints.

(In thousands)

Primary rates disclosed in Table 5 above represent rates generally available to borrowers on 30 year conforming mortgage loans.

Deposit service chargesOther revenue increased $11.7 million over the second quarter of 2020 and fees decreased $4.6$6.9 million compared to the thirdfirst quarter of 2019. During2021. The increase was primarily due to higher production revenue from repossessed oil and gas properties; however, this is partially offset by increased operating expenses on these uncertain times, we proactively waived certain fees. In addition,properties. Revenue and expense from repossessed oil and gas properties will decrease as the pandemic has resultedproperties are sold.

Other net gains totaled $16.4 million in customers retaining cash and not maintaining the usual levelsecond quarter of spending, which has decreased overdraft fees2021 compared to the prior year. Deposit service charges increased $2.2$7.3 million compared toin the second quarter. As many "Stay at Home" orders have been liftedquarter of 2020. The fluctuation is related to increased gains on alternative investments and customer activity starts to return to normal, we have seen service charges increase.sales of repossessed assets. Other net gains totaled $10.1 million in the first quarter of 2021. Increases in gains on alternative investments and the sale of fixed assets were partially offset by a decrease in gains on sales of repossessed assets.

As discussed in the Market Risk section following, the fair value of our mortgage servicing rights ("MSRs") changes in response to changes in primary mortgage loan rates and other assumptions. We attempt to mitigate the earnings volatility caused by changes in the fair value of MSRs by designating certain financial instruments as an economic hedge. Changes in the fair value of these instruments are generally expected to partially offset changes in the fair value of MSRs. In the second quarter of 2020, we completed a sale of mortgage servicing rights on $1.6 billion of unpaid principal balance, primarily related to loans guaranteed by the Veteran's Administration. This sale was completed to reduce exposure to out of footprint MSRs with higher credit risk where no other relationships with the borrower exist. Interest rate movements between the date we established the transaction price and the closing date of the sale produced positive results in the second quarter.

(In thousands)

Other operating expense for the thirdsecond quarter of 20202021 totaled $301.3$291.2 million, an increasea decrease of $22.0 million compared to the third quarter of 2019 and $5.9$4.8 million compared to the second quarter of 2020.2020 and a decrease of $4.6 million compared to the first quarter of 2021.

(In thousands)

Personnel expense increased $17.3decreased $4.2 million compared to the third quarter of 2019. Incentive compensation increased $18.6 million. Cash based incentive compensation increased $12.0 million, largely due to increased U.S. agency residential mortgage-backed securities and related derivative trading activity. Stock based compensation increased $5.3 million due to changes related to vesting assumptions regarding the Company's earnings per share growth relative to a defined peer group.

Non-personnel operating expense increased $4.7 million over the third quarter of 2019. Net losses and expenses on repossessed assets increased $4.5 million due to write-downs on a set of oil and gas properties and a retail commercial real estate property. Data processing and communications expense increased $2.8 million, primarily due to investments in technology. Professional fees increased $1.8 million and insurance expense increased $1.6 million. These increases were partially offset by a decrease of $6.2 million in business promotion expense, largely related to the pandemic.

We operate three principal lines of business: Commercial Banking, Consumer Banking and Wealth Management. Commercial Banking includes lending, treasury and cash management services and customer risk management products for small businesses, middle market and larger commercial customers. Commercial Banking also includes the TransFund EFT network. Consumer Banking includes retail lending and deposit services, lending and deposit services to small business customers served through our consumer branch network and all mortgage banking activities. Wealth Management provides fiduciary services, private banking services, insurance and investment advisory services in all markets. Wealth Management also underwrites state and municipal securities and engages in brokerage and trading activities.

In addition to our lines of business, we have a Funds Management unit. The primary purpose of this unit is to manage our overall liquidity needs and interest rate risk. Each line of business borrows funds from and provides funds to the Funds Management unit as needed to support their operations. Operating results for Funds Management and other include the effect of interest rate risk positions and risk management activities, securities gains and losses including impairment charges, the provision for credit losses in excess of net loans charged off, tax planning strategies and certain executive compensation costs that are not attributed to the lines of business.

The cost of funds borrowed from the Funds Management unit by the operating lines of business is updated annually at the beginning of the year and transfer priced at rates that approximate market rates for funds with similar repricing and cash flow characteristics. Market rates are generally based on the applicable LIBOR or interest rate swap rates, adjusted for prepayment and liquidity risk. This method of transfer-pricing funds that supports assets of the operating lines of business tends to insulate them from interest rate risk.

The value of funds provided by the operating lines of business to the Funds Management unit is alsoupdated annually at the beginning of the year and is based on rates that approximate wholesale market rates for funds with similar repricing and cash flow characteristics. Market rates are generally based on LIBOR or interest rate swap rates. The funds credit formula applied to deposit products with indeterminate maturities is established based on their repricing characteristics reflected in a combination of the short-term LIBOR rate and a moving average of an intermediate-term swap rate, with an appropriate spread applied to both. Shorter duration products are weighted towards the short-term LIBOR rate and longer duration products are weighted towards the intermediate-term swap rates. The expected duration ranges from 30 days for certain rate-sensitive deposits to five years.

Economic capital is assigned to the business units by a capital allocation model that reflects management’s assessment of risk. This model assigns capital based upon credit, operating, interest rate and other market risk inherent in our business lines and recognizes the diversification benefits among the units. The level of assigned economic capital is a combination of the risk taken by each business line, based on its actual exposures and calibrated to its own loss history where possible. Average invested capital includes economic capital and amounts we have invested in the lines of business.

As shown in Table 8, net income attributable to our lines of business decreased $8.3$41.5 million compared to the thirdsecond quarter of 2019.2020. Net interest revenue decreased by $44.4$3.1 million compared to the prior year, primarily due to decreases in the short-term interest rate related to a 225 basis point reduction in the federal funds ratedriven by the Federal Reserve since the middle of 2019.lower average outstanding loan balances. Net charge-offs increased $11.3$2.4 million compared to the thirdsecond quarter of 2019.2020. Other operating revenue increaseddecreased by $41.8$39.6 million led by our brokeragedue to a combination of inventory constraints and trading andcompressed margins that negatively impacted mortgage banking businesses.revenue and a shift from trading revenue from our agency residential mortgage trading activities to net interest revenue. Operating expense increased $9.1 million compared to the third quarter of 2019, largely due to increased incentive compensation related to trading activities.

Net interest revenue increased $8.8 million compared to the first quarter of 2021, primarily due to higher earnings from deposits sold to the effects of recent rate cuts by the Federal Reserve.Funds Management unit. Other operating revenue increased $9.2 million,$17.1 million. Growth in our fee-based business, led by an increase in brokerage and trading and fiduciary and asset management revenues, were partially offset by lower mortgage banking revenue. Higher operating revenue from repossessed oil and gas assets also contributed to the increase. Other operating expense increased $7.1$2.1 million.

Net income attributedattributable to our Funds Management and otherunit was affectedimpacted by the negative provision for expectedcredit losses in the second quarter of 2021, compared to a provision for credit losses in excess of net charge-offs of $121.2 million in the second quarter of 2020. The remaining increase in funds management in the third quarter of 2020 is due to a lower deposit funding credit to the lines of business caused by reductions in short-term interest rates.

(In thousands)