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 March 31,June 30, 2021

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

Performance Summary

BOK Financial Corporation (“the Company”) reported net income of $166.4 million or $2.40 per diluted share for the second quarter of 2021. Net income was $64.7 million or $0.92 per diluted share for the second quarter of 2020 and $146.1 million or $2.10 per diluted share for the first quarter of 2021. Net income was $62.1 million or $0.88 per diluted share for the first quarter of 2020 and $154.2 million or $2.21 per diluted share for the fourth quarter of 2020. Forecasts for improving macroeconomic factors, as the pace of COVID-19 vaccinations accelerates andincluding stabilizing energy prices, stabilizeand improving credit quality metrics resulted in a negative provision for expected credit losses of $25.0$35.0 million and $6.5$25.0 million in the firstsecond quarter of 2021 and fourthfirst quarter of 2020,2021, respectively. A provision for expected credit losses of $93.8$135.3 million was recorded in the firstsecond quarter of 2020.

Pre-provision net revenue ("PPNR"), a non-GAAP measure, was $163.4$179.9 million for the firstsecond quarter of 2021 $173.2compared to $215.8 million for the first quarter of 2020, and $192.9 million for the fourthsecond quarter of 2020. The decrease in PPNR for the first quarter of 2021 compared to the previous periods was due to lower combined net interest revenue and fees and commission revenue. This was largely driven by a shift inlower average earning assets from loansloan balances due to trading securities,customer deleveraging during the current economic uncertainty, narrowing net interest margin and compressed margins onfrom our mortgage loansbanking activities. PPNR improved $16.5 million over the first quarter of 2021. Growth in much of our fee-based business, led by brokerage and mortgage-backed trading assets.and fiduciary and asset management revenues, was partially offset by lower mortgage banking revenue.

Highlights of the firstsecond quarter of 2021 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 $282.7$282.6 million for the firstsecond quarter of 2021 and $264.1$280.7 million infor the firstsecond quarter of 2020. Net interest revenue increased $13.9 million from growth in average earning assets and decreased $20.7$12.0 million due to changes in interest rates and increased $39.3 million from growth in earning assets, largely due to therates. An increase in trading securities balances was partially offset by a decrease in 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 2.622.60 percent for the firstsecond quarter of 2021, compared to 2.802.83 percent for the firstsecond quarter of 2020. In response to the anticipated impact to the economy from the COVID-19 pandemic, the Federal Reserve reduced the federal funds rate to near zero in March, 2020. Other short-term market interest rates followed, reducing the yield on floating-rate assets by more than the amount by which funding costs could be reduced, compressing the margin. The tax-equivalent yield on earning assets was 2.782.75 percent, a decrease of 9537 basis points compared to the firstsecond 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 sale securities portfolio continue to be reinvested at lower rates. Loan yields decreased 959 basis points to 3.553.54 percent, largely due to the decrease in short-term interest rates partially offset by the addition of PPP loan fees. PPP loan fees of $11.2$11.1 million were recognized in the firstsecond quarter of 20212021. As discussed in the Management's Discussion and $34.2Analysis - Loan section following, $27.8 million remainsof deferred loans fees remain to be recognized in future periods. The available for sale securities portfolio yield decreased 64 basis pointsperiods, including $3.8 million related to 1.84 percent as principal cash flows received from maturities of the available for sale securities portfolio continue to be reinvested at lower rates. Cash flows received from these securities are currently being reinvested at 95-105 basis points.loans originated in 2020 that mature in 2022. The yield on trading securities decreased 8351 basis points to 2.061.95 percent.

Funding costs decreased 9516 basis points compared to the firstsecond quarter of 2020. The cost of other borrowed funds decreased 1172 basis points and the cost of interest-bearing deposits decreased 8120 basis points. The benefit to net interest margin from earning assets funded by non-interest bearing liabilities was 86 basis points for the firstsecond quarter of 2021, a decrease of 182 basis points compared to the firstsecond quarter of 2020.

Average earning assets for the firstsecond quarter of 2021 increased $5.8$3.5 billion or 159 percent over the firstsecond quarter of 2020,2020. This increase was largely due to an increasegrowth 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 PPP loans.fair value option securities. Average trading securities increased $5.3 billion.The$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. Average loans, net of allowance for loan losses, increased $682 million,decreased $1.9 billion, largely due to the inflow of PPP loans, partially offset by purposeful deleveraging by our customers as borrowers continue to pay down during this time of economic uncertainty. Fair valevalue option securities that we hold as an economic hedge against changes in the fair value of mortgage servicing rights decreased $1.7 billion.$722 million.

Average deposits increased $8.3$4.8 billion compared to the firstsecond quarter of 2020. Deposit growth is largely due to customers retaining elevated balances in the current economic environment, supplemented by the most recent government stimulus payments. Interest-bearing deposits increased $5.2$3.1 billion while demand deposit balances increased $3.1$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 76%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 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 $163.9$191.4 million for the firstsecond quarter of 2021, a decrease of $16.4$41.8 million compared to the firstsecond quarter of 2020,2020. Mortgage production revenue was negatively impacted by a decline in mortgage production volumes and margin compression. Brokerage and trading revenue decreased largely due to a shift of trading revenue to interest income from trading securities.

Other operating revenue decreased $32.9increased $14.4 million compared to the fourthfirst quarter of 2020.2021. Brokerage and trading revenue decreased $18.7increased $8.6 million. Margin compression and reducedAn increase in agency residential mortgage-backed securitiesmortgage trading volumes have negatively affected our brokerage 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 3738 percent of total revenue for the firstsecond quarter of 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 growth in net interest revenue or fiduciary and asset management 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, decreased $30.0$32.6 million or 5953 percent compared to the firstsecond quarter of 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 banking customers to manage their production risk. Trading revenue also includes net realized and unrealized gains and losses on municipal 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 $3.7$13.0 million for the firstsecond quarter of 2021, a $30.7$30.9 million or 8970 percent decrease compared to the firstsecond quarter of 2020, primarily due to a shift from fee revenue to net interest revenue on trading securities. See additional discussion in "Lines of Business" section of 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 $2.6$1.8 million for the firstsecond quarter of 2021, a $631 thousand$4.4 million or 2071 percent decrease compared to the firstsecond quarter of 2020.2020, primarily attributed to energy customers. Customer hedging revenue includes credit valuation adjustments of the fair value of derivatives to reflect the risk of counterparty default.

Investment banking, which includes fees earned upon completion of underwriting, financial advisory services and loan syndication fees, totaled $6.8$7.1 million for the firstsecond quarter of 2021, an increase of $1.8 million or 3533 percent compared to the firstsecond quarter of 2020, related to the timing and volume of completed transactions.

Transaction card revenue increased $2.0 million over the second quarter of 2020 and $2.5 million over the previous quarter, largely due to margin compressionstimulus measures and reductionthe broader reopening of residential mortgage-backed securities trading volumes from record levels in the fourth quarter of 2020. Customer hedging revenue also decreased $2.1 millionU.S. economy, as energy customers decreased hedging activities. Investment banking revenue decreased $2.1 million mainly due to timing of loan syndication activity.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 $3.1increased $3.6 million or 79 percent compared to the firstsecond quarter of 2020. TheAn increase in trust and managed account fees from higher client asset balances was partially offset by a decrease in mutual fund fees as the low rate environment has put pressure on our mutual fund revenue streams. We also had approximately $2.8$2.9 million in fee waivers during the firstsecond quarter of 2021 that did not existcompared to approximately $1.1 million in the firstsecond quarter of 2020. We have voluntarily waived certain administration fees on the Cavanal Hill money market funds in order to maintain positive yields on these funds in the current short-term interest rate environment. These decreases were partially offset by

Fiduciary and asset management revenue increased trust$3.5 million or 8 percent compared to the first quarter of 2021 due to seasonal tax preparation fees collected in the second quarter and managed account fees from 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 March 31,June 30, 2021 and 2020 follows:

Mortgage banking revenue was consistent withDeposit service charges and fees increased $3.8 million compared to the firstsecond quarter of 2020. Mortgage loan production volumes decreased $1982020 and $1.7 million or 19 percent as average primary mortgage interest rates began to increase inover the first quarter of 2021. The gain on sale marginThis increase was 2.98 percentprimarily due to commercial accounts where lower earnings credit rates caused by the low interest rate environment have resulted in the first quarter of 2021, 92 basis points higher than first quarter of 2020.

(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 $1.9$6.9 million compared to the first quarter of 2020.The stimulus programs enacted2021. 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 properties. Revenue and expense from repossessed oil and gas properties will decrease as a result of the pandemic have led to customers retaining higher cash balances. This, combined with lower levels of spending during the pandemic, has resulted in decreased overdraft fees compared to the prior year. Deposit service charges were relatively consistent with the fourth quarter of 2020.properties are sold.

Other net lossesgains totaled $3.0$16.4 million in the second quarter of 2021 compared to $7.3 million in the second quarter of 2020. The fluctuation is related to increased gains on alternative investments and sales of repossessed assets. Other net gains totaled $10.1 million in the first quarter of 2021 compared to other net losses2021. Increases in gains on alternative investments and the sale of $10.7 millionfixed assets were partially offset by a decrease in the first quartergains on sales of 2020 and other net gains of $5.4 million in the fourth quarter of 2020. These fluctuations are primarily related to changes in the fair value of investments related to deferred compensation that are largely offset in deferred compensation expense. The first quarter of 2021 included a $3.6 million impairment of a merchant banking investment. The first quarter of 2020 included a $3.1 million impairment of an energy fund investment.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.

Historically low mortgage rates in 2020 and early 2021 resulted in a favorable risk profile for our MSRs that supported hedge performance during that time period. A sharp increaseIncreases in longer-term interest rates during the first quarter2021 has returned the risk profile of our MSRs to a more balanced profile, as can be seen in Table 25 of the Market Risk section.

(In thousands)

Other operating expense for the firstsecond quarter of 2021 totaled $282.6$291.2 million, an increasea decrease of $14.0$4.8 million overcompared to the firstsecond quarter of 2020 and a decrease of $18.0$4.6 million compared to the fourthfirst quarter of 2020.2021.

(In thousands)

Personnel expense increased $16.8decreased $4.2 million compared to the firstsecond quarter of 2020. Incentive compensation increased $15.5decreased $6.1 million. Cash based incentiveShare-based compensation expense increased $5.8 million, largely attributed to incentives on lending and trading activity. Deferred compensation expense increased $7.9 million; however, this is largely offset by an increase in the value of related investments included in Other gains (losses), net. Employee benefits increased $1.9 million primarily due to increased healthcare costs. Regular compensation was relatively consistent with the first quarter of 2020 as the impact of annual standard merit increases was dampened by a decrease in the number of employees.

Non-personnel operating expense was relatively consistent with the second quarter of 2020. Mortgage banking costs decreased $2.8$4.5 million, substantially due to a decrease in accruals related to default servicing and loss mitigation costs on loans serviced for others. Occupancy and equipment expenses decreased $4.0 million as the second quarter of 2020 included impairment of two leases where assumptions regarding subleasing changed due to deteriorating economic conditions. Also, a $3.0 million charitable contribution was made to the BOKF Foundation in the second quarter of 2020. These expense decreases were almost entirely offset by an increase of $7.7 million in other expense, largely due to increased operating expenses on repossessed oil and gas properties, and a $3.5 million increase in data processing and communications expense, primarily due to continued investment in technology upgrades.

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.

We allocate resources and evaluate the performance of our lines of business using the net direct contribution, which includes the allocation of funds, actual net credit losses and capital costs. In addition, we measure the performance of our business lines after allocation of certain indirect expenses and taxes based on statutory rates.

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 also updated 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 $25.3$41.5 million compared to the firstsecond quarter of 2020. Net interest revenue decreased by $14.9$3.1 million compared to the prior year, primarily driven by lower average outstanding loan balances and lower yields on deposits sold to the Funds Management unit.balances. Net charge-offs decreased $3.0increased $2.4 million compared to the firstsecond quarter of 2020. Other operating revenue decreased by $26.2$39.6 million primarily due to a combination of inventory constraints and compressed margins that negatively impacted mortgage banking revenue and a shift from trading revenue from our agency residential mortgage trading activities to net interest revenue. Operating expense increased $8.5$1.5 million compared to the firstsecond quarter of 2020, primarily in Commercial Banking.

Net interest revenue decreased $21.9increased $8.8 million compared to the fourthfirst quarter of 2020,2021, primarily due to lower loan balances and lowerhigher earnings from deposits sold to the Funds Management unit. Other operating revenue decreased $21.0 million primarily relatedincreased $17.1 million. Growth in our fee-based business, led by 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 a reversion of our agency mortgage trading volumes from elevated levels experienced in the fourth quarter of 2020 and narrowing margins.increase. Other operating expense decreased $10.4increased $2.1 million.

Net income attributable to our Funds Management unit was impacted by the negative provision for credit losses in the firstsecond quarter of 2021, compared to a provision for credit losses in excess of charge-offs in the firstsecond quarter of 2020.

(In thousands)

Commercial Banking contributed $69.7$72.6 million to consolidated net income in the firstsecond quarter of 2021, a decrease of $5.3$8.4 million or 710 percent compared to the firstsecond quarter of 2020.

(Dollars in thousands)