BOK Financial Corporation (NASDAQ:BOKF) Q2 2023 Earnings Call Transcript

BOK Financial Corporation (NASDAQ:BOKF) Q2 2023 Earnings Call Transcript July 26, 2023

BOK Financial Corporation misses on earnings expectations. Reported EPS is $1.96 EPS, expectations were $2.26.

Operator: Greetings, and welcome to the BOK Financial Corporation’s Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder this conference is being recorded. I would now like to turn the presentation over to Marty Grunst, Chief Financial Officer for BOK Financial Corporation. Thank you sir. You may begin.

Marty Grunst: Good morning and thank you for joining us. Today our CEO, Stacy Kymes will provide opening comments; Marc Maun, Executive Vice President for Regional Banking will cover our loan portfolio and related credit metrics; and Scott Grauer, Executive Vice President of Wealth Management will cover our fee-based results. I will then discuss financial performance for the quarter and our forward guidance. PDFs of the slide presentation and second quarter press release are available on our website at bokf.com. We refer you to the disclaimers on Slide 2 regarding any forward-looking statements we make during this call. I’ll now turn the call over to Stacy Kymes.

Stacy Kymes: Good morning. Thanks for joining us to discuss BOK Financial’s second quarter financial results. Starting on Slide 4 second quarter net income was $151 million or $2.27 per diluted share. I am proud of the exceptional second quarter financial results delivered across the board by our team. Wealth segment revenues set another record this quarter and core loans reached an all-time high led by the commercial and multifamily segments. Our growth efforts are supported by the vitality of our geographic footprint, as well as our diverse business model. Noninterest revenues were almost 40% of total revenues for the quarter. Using our capital and liquidity strength, we are taking advantage of market and economic uncertainty to prudently grow.

Our full-service banking market expansion into San Antonio and the addition of a fixed income sales and trading office in Memphis are just two more examples of how we are investing to build long-term shareholder value. That disciplined long-view approach has consistently been a distinct advantage for BOK Financial. Turning to slide 5. Period-end core loan balances increased $488 million or 2.1% linked quarter with gross spread across C&I and commercial real estate. The deposit trajectory flattened and turned positive during the quarter. Our loan-to-deposit ratio remained below 70% at the end of the quarter. Across the industry, deposit costs have accelerated for all banks including us as reported in our results. As Marty will detail later, our reported net interest margin is diluted by the increased trading activity this quarter and our margin excluding the trading activities remained healthy at 3.36%.

We’re seeing early signs of loan spreads increasing as banks seek to contract and also work through the impact of higher deposit costs and anticipated higher capital requirements for some. This impact will take many quarters to become meaningfully apparent. Our efficiency ratio came in just below 59% even with the shift in mix of noninterest revenue. Credit quality remains very strong as we continue to grow our allowance and have a combined reserve of 1.39%, which is notably above the median of our peer group. Assets under management or administration grew $1.3 billion or 1.3% linked quarter and were up $7.6 million or 8% compared to last year. The market impact on cash, equities and fixed income combined with the growth in new relationships is providing a tailwind we did not have for this area in 2022.

Finally, we repurchased 266,000 shares this quarter as we balance opportunities for growth with attractive repurchase valuations. I’ll provide additional perspective on the results before starting the Q&A session. But now Marc Maun will review the loan portfolio and our credit metrics in more detail. I’ll turn the call over to Marc.

Marc Maun: Thanks Stacy. Turning to Slide 7. Period-end loans were $23.2 billion or up 2.1% linked quarter. Total C&I loans increased $317 million or 2.2% linked quarter with year-over-year growth of $913 million or 6.7%. Commercial real estate loans increased $155 million, or 3.2% linked quarter and have increased $865 million or 21% year-over-year. This effectively returns those balances to their 2020 level after experiencing significant paydown activity in 2021. Compared to December 31, 2020, CRE balances have grown at a modest 2% annualized growth rate. Growth this quarter was primarily driven by multifamily residential properties with an increase of $139 million or 10.2% linked quarter. Industrial facility loans grew $40 million or 3.1% linked quarter which was offset with a $40 million or 3.1% linked quarter decline in loans secured by office facilities.

The year-over-year CRE growth of $865 million was primarily driven from loans secured by multifamily residential properties and industrial facilities. We have an internal limit of 185% of Tier 1 capital and reserves to total CRE commitments and we’re presently at the upper limit of that range. We do expect continued growth in outstanding CRE balances as construction loans fund up. As of June 30, CRE balances represented 21% of total outstanding loan balances a ratio well below our peers. Healthcare balances increased $92 million or 2.4% linked quarter and have grown $294 million or 8% year-over-year primarily driven by our senior housing sector. Healthcare sector loans represented 17% of total loans at quarter end. Energy balances increased $111 million or 3.3% linked quarter and have increased $116 million or 3.4% year-over-year with period-end balances representing 15% of total period-end loans.

Combined services and general business loans our core C&I loans, increased $114 million or 1.7% linked quarter with year-over-year growth of $503 million or 7.7%. These combined categories represent 30% of our total loan portfolio. Year-over-year, loans have grown $1.9 billion or 9%. Excluding PPP loans, Q2 2023 extends the linked quarter loan growth to seven consecutive quarters. Our pipeline suggests we have the current momentum to drive continued growth in the loan portfolio throughout 2023, near our current pace. Turning to slide 8, you can see that credit quality continues to be exceptionally good across the loan portfolio well below historical norms and pre-pandemic levels. Nonperforming assets excluding those guaranteed by U.S. government agencies increased $6 million this quarter.

Non-accruing loans increased $12 million driven by an increase in energy-related nonaccruals, while repossessed assets fell $8 million. The level of uncertainty in the economic outlook of our reasonable and supportable forecast remained high. And the assumptions for commercial real estate vacancy rates increased during the forecast period. Those economic factors, combined with second quarter loan growth supported a $17 million credit loss provision for the quarter. We remain in a solid credit position today. With the ratio of capital allocated to commercial real estate that’s substantially less than our peers and a history of outperformance during the past credit cycles, we believe we are well positioned should an economic slowdown materialize in the quarters ahead.

The markets are more focused on the office segment of real estate, given the recent trends in workforce preferences, though it remains an open question as to whether this will be sustained as employers continue to require more time in the physical office. Our maturities are generally ratable over the next three to four years, and we have a mini firm option if the markets are not conducive to long-term permanent financing. The average loan-to-value ratio in the office space is below 65% and average cash flow coverage exceeds 1.3 times based on the most recent semi-annual review at the end of 2022. Net charge-offs were $6.7 million or 12 basis points for the second quarter and have averaged 10 basis points over the last 12 months far below our historic loss range of 30 to 40 basis points.

Looking forward, we expect net charge-offs to continue to be low. The combined allowance for credit losses was $323 million or 1.39% of outstanding loans at quarter end. The total combined allowance is available for losses and any apples-to-apples industry comparison should include the combined reserves. We expect to maintain this ratio or to migrate slightly upward as we expect loan growth to continue and economic uncertainty to persist. I’ll turn the call over to Scott.

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Scott Grauer: Thanks, Marc. Turning to slide 10. Total fees and commissions were $200 million for the second quarter, up $14.5 million or 7.8% linked quarter. Our Wealth segment set a new quarterly high for fees and commissions at $123 million this quarter with the last four consecutive quarters representing four of the five highest quarters on record. Trading fees and customer hedging revenues were the primary drivers of the linked quarter increase, up $9.3 million and $5.3 million respectively. Fiduciary and asset management fees increased $2.3 million, largely due to seasonal tax service fees. The trading fee increase was primarily driven by a $7.9 million improvement in our MBS trading activities. Trading activity and margins improved coming off exceptionally low volume and high volatility in the first quarter.

The desk has been able to increase volume by expanding coverage to downstream accounts as mortgage originations slowly increase and market volatility returns to more normal levels. The $5.3 million customer hedging revenue increase was driven by a record quarter for energy customer hedging fees with linked quarter fees up $4.7 million. Fees from other institutional trading activities increased $1.4 million linked quarter. Fiduciary and asset management fees were $53 million for the second quarter, a 4.6% linked quarter increase. Our assets under management or administration were $103.6 billion, an increase of $1.3 billion or 1.3% linked quarter. Growth was spread across most categories and primarily driven by improved asset values. Our asset mix for assets under management or administration moved slightly this quarter, with 43% fixed income, 33% equities, 15% cash and 9% alternatives.

We believe our diversified mix of fee income is a strategic differentiator for us when compared to our peers, especially during times of economic uncertainty. We consistently rank in the top decile for fee income as a percentage of total net interest revenue and non-interest fee income. Our revenue mix has averaged just over 36% during the last 12 months. That consistently supports a revenue stream that is sustainable through a wide array of economic cycles. I’ll now turn the call over to Marty.

Marty Grunst: Thank you, Scott. Turning to Slide 12. Second quarter net interest revenue was $322 million, a $30 million decrease linked quarter. Net interest margin was 3%, a 45 basis point decrease versus Q1. It is important to note that 9 basis points of the 45 basis point margin decline was due to growth in trading assets. Our trading business grew revenue and grew profitability as you can see in the fee income trends but was dilutive to net interest margin as trading assets grew at narrower spreads relative to the rest of the balance sheet. When trading assets are higher or the yield curve is flatter or inverted both of which we experienced this quarter, the dilutive impact to net interest margin is more significant. Net of the 9 basis point impact from trading, the remaining 36 basis point decline was driven by the competitive deposit environment.

As average interest-bearing deposit costs increased 73 basis points, the cumulative net interest-bearing deposit beta increased to 54% and DDA continued to shift into interest-bearing although at a reduced pace. DDA was 32% of total deposits at June 30. This slide shows net interest margin and net interest revenue with and without the impact of the trading business to better highlight trends and comparability. For the second quarter of 2023, the net interest margin excluding the impact of trading assets was 3.36% versus 3.72% in the first quarter. Growth in earning assets during the quarter was driven by loans and trading assets as the securities portfolio remains stable to maintain our balanced interest rate risk position. Turning to Slide 13.

Liquidity and capital continue to be very strong on an absolute basis and versus peers. Total deposits grew $714 million on a period-end basis and the loan-to-deposit ratio was 70% unchanged from the prior quarter. Early in the second quarter, we saw a continued downward trend driven by April tax payments and some price-sensitive movements, though at a slower pace in the prior two quarters. Balance trends rebounded in early May, and we grew $2 billion in deposits in the back half of the quarter. This was consistent with our expectations and we are happy with the result in such a competitive environment. Our tangible common equity ratio was 7.79%, down 67 basis points linked quarter due to balance sheet growth and increases in interest rates but up 16 basis points from year-end.

Adjusted TCE including the impact of unrealized losses on held to maturity securities is 7.49%. CET1 is 12.1% and if adjusted for AOCI would be 9.9%. As regulatory capital changes are being proposed for the industry, we believe that across the array of plausible outcomes for banks in our size range, we have ample capital to support additional organic growth, while at the same time allowing for continued share buyback. During the second quarter, we repurchased 266,000 shares at an average price of $84.08 per share. Turning to slide 14. Linked quarter total expenses increased by $12.9 million or 4.2%. Personnel expense grew $8.5 million with $4.1 million due to the full quarter effect of annual merit increases implemented on March 1, while cash-based incentive compensation grew $6.6 million due to new business production.

These were partially offset by a $2.5 million seasonal decrease in payroll taxes. Other operating expense grew $4.4 million primarily due to a $2.5 million increase in mortgage banking costs driven by a seasonal increase in prepayments and a $1.1 million increase due to the donation of an appreciated asset to the BOKF Foundation. Year-over-year total operating expense increased 16.5%. However this includes the impact of market value-driven swings in deferred compensation and changes in the vesting assumptions for stock-related compensation. Excluding those two factors total operating expense increased 11% compared to Q2 2022 with a 13% increase in total personnel expense due to regular compensation and increased cash-based compensation related to new business production.

Other operating expense increased 8% primarily due to continued investments in technology, facilities and increased FDIC expense. Turning to slide 15. I’ll cover our expectations for 2023. We expect upper single-digit annualized loan growth. Economic conditions in our geographic footprint remain favorable and continue to be supported by business in migration from other markets. Changes in the competitive environment for loans should be a tailwind. We expect to continue holding our available-for-sale securities portfolio flat in 2023 to maintain a neutral interest rate risk position. We expect total deposits to be stable or grow modestly and the loan-to-deposit ratio to remain in the low 70s. Currently, we are assuming one additional 25 basis point increase here in July before the Federal Reserve positives.

We believe that the margin will migrate lower throughout 2023 and as interest-bearing deposit betas increase and demand deposit balance attrition runs its course. Net interest income is expected to be near $1.3 billion for 2023. In aggregate we expect total fees and commissions revenue to approach $800 million for 2023. We expect expenses to be near or slightly above Q2 2023 levels and the efficiency ratio to migrate slightly above 60% throughout the remainder of 2023 as our revenue mix shifts in our strategic market expansions ramp up. This does not include the impact of the FDIC special assessment, which could be finalized in the second half of 2023. Our combined allowance level is above the median of our peers and we expect to maintain a strong credit reserve.

Given our expectations for loan growth and the strength of our credit quality, we expect quarterly provision expense similar to that in recent quarters. Changes in the economic outlook will impact our provision expense. We expect to continue opportunistic share repurchases in the second half of the year. I’ll now turn the call back over to Stacy Kymes for closing commentary.

Stacy Kymes: Thanks, Marty. As we have again demonstrated this quarter strong risk management and strong financial results are not mutually exclusive. We expect to do both well. Our talented teams collaborate well to ensure we grow our company the right way, a way that is sustainable through all economic cycles. While the market is more focused on capital and liquidity, I see this as a unique opportunity to use our strength in these areas to both organically grow and invest in new markets, while others may be more internally focused. I continue to assert that we are in a stage we’re investing in strong banks versus trading the sector matters. Banks with thoughtful growth, a diverse business mix, meaningful core deposits and proving credit discipline should outperform.

That certainly continues to play out for us in 2023. We are focused on using the fantastic geographic footprint to grow both in the current environment and in the years to come. With that we are pleased to take your questions. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from Jared Shaw with Wells Fargo Securities. Please proceed with your question.

Jared Shaw: Hey good morning. Maybe starting with credit, with the expectation that provisions could go higher based on growth and the economic outlook. You call out the expectation for vacancy changes. Maybe can you spend a little time on where you think I guess specifically office vacancy is and could go and how your markets are holding up with that return to work and your outlook on office. And I guess should we assume that office continues to decline and that provides some opportunity to fund new CRE loans that are right now on office.

Marc Maun: Yes Jared, this is Marc. The office portfolio that we have we’ve been reducing our office exposure over the last several years. So this is not new. And we would expect to continue to decline. If we look at our footprint, our overall markets, we think are in great shape. I mean, you’re looking at markets that have performed very well in multiple economic downturns. When we’re looking at the economic outlook, we’re looking at its effect on the overall economy as opposed specifically to our portfolio. And we would expect that we can maintain this level of performance on the CRE portfolio going forward is where focus has been on multifamily and industrial which has held up very well.

Stacy Kymes: Yes. If you’re looking at the forward guidance and try to intimate maybe that there could be higher provision expenses, that’s not how we see it. I think that — we think that we reflected the future potential outlook in CRE and how we formulated our allowance methodology. So the forward-looking aspect of potential higher levels of office vacancies is really how we supported the allowance this quarter. We’re not trying to foreshadow that provision levels could be higher in future periods. In fact, our guidance was kind of near current levels, depending on the economic outlook. Certainly, should the economic outlook improve then provision levels could even come down from here. So it’s really just a function of how we see the economy playing out in future periods.

Jared Shaw: Okay. That’s great color. Thanks. I guess shifting to deposits and funding. You highlighted that there was strong trends in deposits in the second half of the quarter. How sustainable — squaring that with the broader view of lower growth on deposits for the year, should we assume that that growth helps you remix deposits, or how should we think about deposit mix going through the rest of the year with that growth outlook?

Marty Grunst: Yes. I think that deposit growth should remain on an upward trend here with some noise within there. I think on the mix side, DDA is probably the more interesting question and we really saw the DDA mix shift slowed down appreciably in May and June. And in fact, June average and June ending DDA balances were about the same. So, that trend actually turned reasonably favorable in the back half of the quarter.

Jared Shaw: And do you think that that could — that we’ve sort of found the bottom here on DDA then?

Stacy Kymes: Yes. I don’t know, if I’d call it precisely at the bottom. It’s certainly — those trends are very favorable. You could have just a little bit more, given another Fed hike here, you can have a little bit more. But those trends look very good in the last two months.

Jared Shaw: Okay. And then I guess finally for me, when we look at the buyback and your comments about opportunistic buyback. Is that really more opportunistic based on price, or is that opportunistic based on alternative uses of capital at any given sort of point in the quarter?