BOK Financial - Q2 2023
July 26, 2023
Transcript
Operator (participant)
Greetings, and welcome to the BOK Financial Corporation Q2 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. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. 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 (CFO)
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 Q2 press release are available on our website at bokf.com. We refer you to the disclaimers on slide two regarding any forward-looking statements we make during this call. I'll now turn the call over to Stacy Kymes.
Stacy Kymes (CEO)
Good morning. Thanks for joining us to discuss BOK Financial's Q2 financial results. Starting on slide four, Q2 net income was $151 million, or $2.27 per diluted share. I'm proud of the exceptional Q2 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. Non-interest 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 five, period-end core loan balances increased $488 million or 2.1% linked quarter, with growth 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 non-interest 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 billion, 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. 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. Marc Maun will review the loan portfolio and our credit metrics in more detail. I'll turn the call over to Marc.
Marc Maun (EVP, Regional Banking)
Thanks, Stacy. Turning to slide seven, 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 is offset with a $40 million or 3.8% 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, 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 triple P 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 eight, you can see that credit quality continues to be exceptionally good across the loan portfolio, well below historical norms and pre-pandemic levels. Non-performing 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 non-accruals, 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 Q2 loan growth, supported a $17 million credit loss provision for the quarter.
We remain in a solid credit position today. With a 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-perm 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 1.3x, based on the most recent semiannual review at the end of 2022. Net charge-offs were $6.7 million, or 12 basis points for the Q2, and have averaged 10 basis points over the last 12 months, far below our historic loss range of 30-40 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.
Scott Grauer (EVP, Wealth Management)
Thanks, Marc. Turning to slide 10, total fees and commissions were $200 million for the Q2, 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 Q1.
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 Q2, 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 (CFO)
Thank you, Scott. Turning to slide 12, Q2 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. Average interest-bearing deposit costs increased 73 basis points, the cumulative net interest-bearing deposit beta increased to 54%, DDA continued to shift into interest-bearing, although at a reduced pace. DDA was 32% of total deposits at June 30th. 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 Q2 of 2023, the net interest margin, excluding the impact of trading assets, was 3.36% versus 3.72% in the Q1. Growth in earning assets during the quarter was driven by loans and trading assets, as the securities portfolio remained 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 Q2, 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 is 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 Q2, 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 1st, 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 two and a half 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%. 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 seventies.
Currently, we are assuming one additional 25 basis point increase here in July before the Federal Reserve pauses. We believe that the margin will migrate lower throughout 2023 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 and 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. 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 (CEO)
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 where investing in strong banks versus trading the sector matters. Banks with thoughtful growth, a diverse business mix, meaningful core deposits, and proven 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?
Operator (participant)
Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment, please, while we poll for questions. Our first question comes from Jared Shaw with Wells Fargo Securities. Please proceed with your question.
Jared Shaw (Managing Director)
Hey, good morning.
Stacy Kymes (CEO)
Morning, Jared.
Jared Shaw (Managing Director)
Maybe starting with credit, you know, with the expectation that provision could go higher based on growth and the economic outlook. You know, 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? I guess, you know, should we assume that office continues to decline, and that provides some opportunity to fund new CRE loans that are not in office?
Marc Maun (EVP, Regional Banking)
Yeah, 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 it to continue to decline. You know, 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. We would expect that we can maintain this level of performance on the CRE portfolio going forward, as where focus has been on multifamily and industrial, which have held up very well.
Stacy Kymes (CEO)
Yeah, if you're looking at the forward guidance and trying 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. 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. It's really just a function of how we see the economy playing out in future periods.
Jared Shaw (Managing Director)
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, you know, squaring that with the broader view of, you know, 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 (CFO)
Yeah, I think that, you know, deposit growth should remain on an upward trend here with, you know, some noise within there. I think, you know, on the mix side, you know, DDA is probably the more interesting question, and we really saw the DDA mix shift slow down appreciably in May and June. In fact, you know, June average and June-ending DDA balances were about the same. That trend actually turned reasonably favorable in the back half of the quarter.
Jared Shaw (Managing Director)
Do you think that we've sort of found the bottom here on DDA then?
Marty Grunst (CFO)
Yeah, you know, I don't know if I'd call it precisely the bottom. It's certainly, you know, those trends are very favorable. You could have just a little bit more given, you know, another Fed hike here. You could have a little bit more, but, you know, those trends looked very good in the last two months.
Jared Shaw (Managing Director)
Okay. I guess finally for me, when we look at the buyback and, you know, 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?
Marty Grunst (CFO)
Yeah, those are the two factors. I mean, we're just trying to maximize shareholder value with how we do that, and price is a factor. To the extent that our outlook is for strong organic growth opportunities to be present over the couple quarters, we want to make sure that we've got, you know, sufficient wherewithal to support that. That's obviously first in the pecking order. You know, that's kind of how we do the calculus.
Stacy Kymes (CEO)
You know, Jared before the kind of Q1 events in the industry, the most common question was: What are you going to do with all your excess capital? You know, we're obviously, think that long term, we probably do have a little bit of excess capital to deploy. Share buybacks are part of that, but we're being a little bit careful, maybe in this environment, at least for the near term.
Jared Shaw (Managing Director)
Okay, thanks. I guess maybe just circling back on the deposits. You know, in terms of your expectation for beta, how should we be thinking about cumulative beta, going through with, you know, with the potential or the expectation for one more hike?
Marty Grunst (CFO)
Yeah, we do think that cumulative beta does keep moving up here. You know, we were at 54 this quarter, and our assumption that's within our guide is that that crosses 60 and gets up into the 63, 64 territory by the end of the year.
Stacy Kymes (CEO)
Yeah, I would agree with Marty, but I think the cumulative beta over the life of the cycle is going to be kind of where we said it was going to be all along, somewhere in that 40%-50% range.
Jared Shaw (Managing Director)
Thanks very much.
Operator (participant)
Our next question comes from Jon Arfstrom with RBC Capital Markets. Please proceed with your question.
Jon Arfstrom (Managing Director)
Thanks. Good morning.
Stacy Kymes (CEO)
Good morning, Jon.
Jon Arfstrom (Managing Director)
Maybe a question for you, Marty. When I do the math on the margin, it seems like there's a little bit of pressure coming, but maybe not that material. Can you confirm that? Just how much pressure do you think is ahead in the net interest margin, and what do you think the cadence might look like for the next couple of quarters, assuming the Fed's done today?
Marty Grunst (CFO)
Yeah, that's right, that is our base assumption. You know, maybe the best way to walk through that is to talk through net interest revenue, kind of what the pluses and minuses are from here, because so, like, June, net interest revenue for the month of June was $106 million. If you kind of start from that run rate, you know, loan growth is going to be a plus, obviously.
Jon Arfstrom (Managing Director)
Mm-hmm.
Marty Grunst (CFO)
Bond portfolio repricing is going to be a plus. In Q2, we saw $420 million of principal cash flows run off at about a 2.78% runoff yield, and we're reinvesting that around 4.85% for the Q2. You'll see that trend, you know, continue through future quarters. Even within the fixed rate part of the loan portfolio, though small, you've got the same dynamic going on there that provides lift and will continue to provide lift. The deposit betas, you know, we're at 54% cumulative right now. You know, that will continue to bleed up here as you get another rate hike, and then, you know, you just get a little bit of residual carry forward. You know, the July rate hike probably doesn't really independently move the needle that much.
As we were talking about before, the DDA mix shift, that's really slowed down a fair amount. So that impact gets a lot smaller. If you look at those pieces, the DDA and the deposit reprice are declining effects that are, you know, getting close to ending, you know, running their course here. The loan growth is a growing effect over time, and the bond portfolio reprice, that's a declining effect over time, but it lasts a while. You know, that kind of gives you a little bit of a color around how that plays out over the next couple of quarters.
Stacy Kymes (CEO)
Jon, we're focusing on net interest revenue versus net interest margin because the trading, size of the trading portfolio will greatly influence that margin. It's easier for us to think about it in terms of net interest revenue, because, you know, if the, if the activity is strong and the trading portfolio expands, obviously the net interest margin impact, that is very dilutive. It could be influenced by that, but that's going to benefit us on the fee side, should that trading portfolio continue to perform as it has been.
Jon Arfstrom (Managing Director)
Yeah. Okay, that makes sense. I do want to ask Scott a question on that, but just one comment you made was you grew $2 billion in deposits later in the quarter. You know, what was the driver of that? Was it, you know, higher rate deposits, or was it, more client driven or? Help us understand what that was.
Marty Grunst (CFO)
Yeah. That's mostly commercial and well driven, you know, to a lesser extent, consumer. Largely our, you know, what we talked about last quarter, just making sure that we've got price competitive offerings throughout the footprint that compete with the alternatives that our customer base have in those segments. You know, we're just making sure that our price points are at market at all price points. You know, that's what drove it.
Jon Arfstrom (Managing Director)
Okay. Got it.
Marty Grunst (CFO)
Yeah. Some success on the fee side and the consumer book as well on top of that.
Jon Arfstrom (Managing Director)
Okay. Okay. Scott, last one for you. You talked about volumes and volatility, helping-... your brokerage and trading, you talked about extending the reach of the sales force. Can you talk about that a little bit more, and about the better environment? You know, what makes for more favorable environments, so we can kind of understand, you know, how the balance sheet might flex when there's a better environment or a worse environment?
Scott Grauer (EVP, Wealth Management)
Right. Absolutely. In the, in the Q1, you know, when we saw a lot of kind of external shocks to the fixed income market, we had a very, the Fed was in the midst of very active rate hikes. We saw, you know, bid-ask spreads really widen out in the Q1, and we saw, you know, dwindling to very, very historically low mortgage origination. As we've moved into the Q2, as we mentioned, we've seen a pickup as the reality of, you know, 5%, 6% plus mortgage rate settles into the market. For home buyers, albeit still a shortage of inventory, we're seeing rate kind of expectations settle in, which has increased mortgage origination.
We've seen the moves, whether, you know, the announcement today is one more or two more rate hikes, we're clearly further into the Fed rate hike cycle, which creates a better appetite of our institutional buyers of mortgage-backed securities and all fixed income products to position their portfolios. We've seen kind of the culmination of better outlook and certainty in the fixed income markets, coupled with a little bit better flow on the mortgage-backed security side. Those factors have given us a better confidence in kind of resuming our previous levels of securities, inventory levels.
Stacy Kymes (CEO)
If you think about it from a investment portfolio manager's position, if you know you're toward the end of the hiking cycle, you know, whether it's today or today plus one more, you begin to get more confident in repositioning your portfolio because you know, you don't think, "Well, you know, this is going to keep happening, and so I, you know, I'm just gonna keep trading into that." That could optimistically help us out in the second half of the year if the market participants believe the Fed is done or near done.
Jon Arfstrom (Managing Director)
Yeah. Okay. Clearly, Q1 was abnormal, but is this, maybe an impossible question: Does this feel more normal?
Scott Grauer (EVP, Wealth Management)
It does. I think that, you know, the, as Marty indicated, our levels of trading securities, our balances there appear to be more business as usual. We look for these levels to be sustainable, given the current rate environment and the appetite for repositioning on the curve.
Jon Arfstrom (Managing Director)
Okay. All right, guys. Thank you.
Marty Grunst (CFO)
Sometimes we tell you-
Jon Arfstrom (Managing Director)
Okay.
Marty Grunst (CFO)
Jon, sometimes we tell you, don't use the end of quarter trading level as you know, the way to think about the future. You know, this quarter, it's probably better than the average.
Jon Arfstrom (Managing Director)
Yeah. Okay. Very helpful, guys. Thank you.
Operator (participant)
Our next question comes from Brady Gailey with KBW. Please proceed with your question.
Brady Gailey (Managing Director of Equity Research)
Hey, thank you. Good morning, guys.
Stacy Kymes (CEO)
Good morning.
Scott Grauer (EVP, Wealth Management)
Good morning, Brady.
Brady Gailey (Managing Director of Equity Research)
I understand the dynamics of having a net interest margin that moves a little lower in the back half of this year. I'm wondering, as we look to next year, the Fed will be done, deposit costs will probably have peaked. Could you see an expanding net interest margin into next year just because, you know, asset reprice is higher and the NIM could be actually headed higher next year?
Marty Grunst (CFO)
That's possible, I would again focus on net interest revenue as the way to think about next year. If you play out the comments that I made earlier, you know, you can see that be on a growth trend. You know, the percentage, sure, it's possible to see that higher, especially if you get, you know, less of an inverted curve, you know, that's gonna help as well.
Stacy Kymes (CEO)
You've got a couple of factors there. I think, you know, Marty's reinvestment rate, we're getting, what? Roughly $400 million a quarter in cash flow from the securities portfolio. That's reinvesting at 250-300 basis points higher than what we're receiving today. That's gonna help you a little bit. The trepidation in answering the question is really just understanding how deposit behavior is gonna be as we grind higher for longer. If we're through the worst of that from a industry perspective, then I think you're right. There's upward opportunity on the margin. If deposit pricing continues to grind higher in a more meaningful way, then that could be the offset to some of the favorable benefits that we see.
Brady Gailey (Managing Director of Equity Research)
All right. Then, you know, intra-quarter, you guys had a couple of announcements expanding into San Antonio, also expanding into Memphis. Maybe just the rationale behind those new markets, and is this something we should expect to see going forward, you know, putting new markets on the map organically?
Stacy Kymes (CEO)
Yeah, I think they're probably a little bit two different stories. San Antonio is a market that we've eyed for a long time. We have a strong presence in Dallas-Fort Worth and Houston. Central Texas has been a gap for us, and we've just been looking for kind of the right way to enter that market. We're excited about the team we've acquired there, and we'll have, you know, corporate, commercial, treasury, wealth, both in San Antonio and Austin. We'll have a complement of between 15 and 20 folks there in Central Texas, that will be an opportunity for us to meaningfully expand our presence there. That's going to be full-service banking and the beginning of another key market for us in Texas.
I think Memphis really was an opportunistic chance for us to grow our fixed income sales and trading platform, that wasn't necessarily on the radar screen as we began the year. As things unfolded and opportunities presented themselves, we really saw it as additive to the current operations we have in Little Rock, Milwaukee, and Stamford, Connecticut. It fits very cleanly. They have very little sales overlap with our existing portfolio, and we're excited for the team that is going to come on board there to help us in that area.
Brady Gailey (Managing Director of Equity Research)
All right. Just lastly, for me, you know, the price of oil is still very strong, but the price of nat gas is depressed, and we have seen a little bit of noise in that space. Maybe just talk about how you think, I know nat gas, I think it's only about a third of your energy, but, you know, do you expect to see some issues in nat gas over time?
Stacy Kymes (CEO)
Not at this point. We have, like, right now, 93% of our gas-heavy borrowers are hedged, have over 50% of their PDP in 2023, and 76% of their PDP hedged at prices in 2024, exceeding $3.50. They're well positioned to receive price well above what we're seeing in the spot market. Plus, today's market, you can hedge out all the way into 2025 at almost $4 an MCF. We continue to push hedging as a way to protect their portfolio, as well as to improve our credit risk, and our customers have been responding. We actually are in a really strong position that we expect our natural gas producers to perform well.
Brady Gailey (Managing Director of Equity Research)
Okay, great. Thanks for the color, guys.
Operator (participant)
As a reminder, if you would like to ask a question, please press star one on your telephone keypad. Our next question comes from Brandon King with Truist Securities. Please proceed with your question.
Brandon King (Managing Director and Senior Equity Research Analyst)
Hey, good morning. Thanks for taking my questions.
Marc Maun (EVP, Regional Banking)
Morning, Brandon.
Good morning.
Brandon King (Managing Director and Senior Equity Research Analyst)
I wanted to touch on the outlook as far as loan growth. In the prior quarter, you detailed that economic conditions were very strong, and in this quarter, now it's kind of been downgraded to favorable. Just want to know if you could provide more context and details around that, and what you're seeing in your markets and with your customers?
Stacy Kymes (CEO)
Yeah, I guess, you know, maybe we didn't communicate well, but we certainly don't see unfavorable economic conditions for loan growth. I mean, our footprint markets in the South, Southwest, and Midwest are performing exceptionally well. I mean, there's no signs of kind of economic slowdown or early signs of any economic issues. In fact, the long term and short term, that footprint of Texas and Colorado and Arizona, clearly are high-growth markets. Infill from in-migration from other markets, I think is going to really benefit them long term. We're very bullish. In fact, you know, we've signaled in our guidance upper single-digit loan growth for the year, and we're very confident that we'll be able to achieve that objective.
I think our year-over-year growth is about 9%, and, you know, we're in a range to continue that pace. We still see good pipelines, we still see good opportunities. Frankly, the opportunity we have in front of us is a little bit unique, in that, in that others are trying to manage capital ratios or other things like that, so they're maybe less aggressive in the marketplace. From a sales perspective, we're endeavoring to be very active in front of customers and prospects to try to add to our customer and, you know, loan deposit and asset under management book.
We want to grow all those areas, at a time where we've got lots of capital and great liquidity, and we're in business, and we're not having to kind of meter that growth. We'll take all that we can get in this environment.
Marc Maun (EVP, Regional Banking)
The only thing I will add is, the key here is that this has been a very broad-based growth. I mean, we have had all our lines of business experiencing growth, not just concentrated in one particular sector or another. Our CRE, we are kind of at our upper end of our range of our concentration, but the construction loans have continued to fund up. We're seeing it in C&I, we're seeing healthcare, energy, and CRE all experience growth. We expect that reflects a lot of the things that Stacy was talking about.
Marty Grunst (CFO)
Yeah, Brandon, if you look through to the state level GDP and state level employment for our footprint, you know, that still remains very strong. There's no downturn there at all.
Brandon King (Managing Director and Senior Equity Research Analyst)
Okay. Within that, in the tailwind from the competitive environment, with these opportunities that you're getting, are you able to get kind of higher loan spreads or better economics on some of these deals you're getting today?
Stacy Kymes (CEO)
There's no doubt, I alluded to that in my prepared comments, that we are seeing, you know, particularly on the higher end of the corporate space, deals are pricing upward, whether it's from fewer participants in the market or those beginning to price for higher capital requirements on the higher end of the banking segment. We are seeing that, you know, a 25 to 50 basis point increase in loan spreads. I think that will take some time to work through the portfolio effect. Clearly that's an opportunity as we move forward.
Brandon King (Managing Director and Senior Equity Research Analyst)
Okay. Just lastly from me, is there any way you can provide kind of a spot cost of deposits at the end of the quarter?
Marty Grunst (CFO)
Yeah, there's not really a way to do that in particular. you know, new production, you know, if you look at our CD rates that we're offering, you know, we've got, you know, rates in the upper 4s and 5s as new production for, you know, that varies by market, but that's probably what we've got for you.
Brandon King (Managing Director and Senior Equity Research Analyst)
Okay. Thanks, take more questions.
Marty Grunst (CFO)
Thanks.
Operator (participant)
Our next question comes from Matt Olney with Stephens. Please proceed with your question.
Matt Olney (Managing Director)
Thanks. Good morning. Just a few follow-ups here from some previous questions. On the customer hedging activity, obviously, a good quarter in 2Q. It sounds like this is mostly from energy customers. We'd love to appreciate if you think there's some good follow-through there, potential for the back half of the year.
Stacy Kymes (CEO)
Yeah, I think the hedging activity there, I mean, it was a record really in the Q2, but it's been strong for us, both on the energy side and the interest rate derivative side. Both experienced really strong Q2s. I think the shape of the yield curve is going to help on the interest rate derivative side. I mean, it's odd that you can go out and hedge out three years at a cheaper rate than, you know, the spot rate, but that is the case today, and so that's helping a little bit on the interest rate derivative side.
As we talked about with natural gas future prices, frankly, oil prices, the market's in a good place to hedge, to swap future prices and do it in a way that's conducive to our customers. You know, whether it's the same level as the Q2, it's hard to, you know, forecast that in a highly volatile segment. I think that there is good momentum to be able to still have that be a very strong segment for us.
Matt Olney (Managing Director)
Appreciate that, Stacy. In the press release, there was a mention of the $8.1 million gain from merchant services. Just remind me what line item this flows through?
Marty Grunst (CFO)
Yeah, that flows through the other gains and losses, kind of right below the fee income.
Matt Olney (Managing Director)
Okay, I see it. Perfect. On the trading securities, Marty, I heard your comment that the end of period balance could be a better starting point for 3Q than the average. I guess from a balance sheet standpoint, on the other side of the balance sheet, remind me of how that's typically funded.
Marty Grunst (CFO)
Yeah, we can use either FHLB or repo, either one, you know, whatever's cheaper. So it's just the short term wholesale.
Matt Olney (Managing Director)
Okay. I guess along with that, FHLB and the repo line, other borrowing lines, if you're going to see some pretty strong loan growth, it sounds like this quarter, should we see the FHLB and borrowing line come down? Is it a replacement, or do you think there'll still be an increase there given the trade securities build that you expect?
Marty Grunst (CFO)
Yeah, we'll have good loan growth, we'll have deposit growth that will fund, you know, a decent portion of that. Kind of whatever the net is from pluses or minuses in the trading portfolio, that is will really drive the changes in FHLB or repo.
Stacy Kymes (CEO)
Matt, this really goes back to kind of re-educating the investor community and kind of how we fund the bank. You know, loans fund, are funded by deposits. You saw a good loan growth this quarter. You saw a good deposit growth this quarter. That loan deposit ratio stayed relatively consistent, and we see that as we move forward. You know, on the, on the security side, whether it's the available-for-sale investment security, or the trading portfolio, those are largely going to be funded wholesale, whether that's repo or institutional or otherwise. That's entirely consistent with how we funded the bank, you know, forever pre-COVID. You're seeing higher levels of FHLB borrowings and things like that because that's, you know, we got down to none during COVID.
As things kind of revert to the mean, how we fund the bank is going to look like it did pre-COVID, and that includes, you know, how we think about loans and deposits and how we think about institutional funding or wholesale funding for our securities portfolio and trading activities.
Matt Olney (Managing Director)
Yep. Okay, that's helpful, Stacy. Just lastly, I guess, I think you mentioned earlier in the call that the AFS security deals could continue to climb as you reinvest some of those cash flows. Any more color on just kind of the roll-off, roll-on yields within the AFS book?
Marty Grunst (CFO)
We think about both AFS and held-to-maturity, you know, rolled together because both have the same driver. The roll-off yield is always going to be roughly what the portfolio yield is. I think that was 2.74%, if I'm right, for this quarter. Then, you know, current coupon, you know, 15-year MBS or maybe a little bit less than that, is kind of a good proxy for how to think about our repurchase yield, you know, on average over time. That gives you know, well over, you know, pretty good, pretty good spread, 200 basis point plus spread pickup.
Matt Olney (Managing Director)
Yep. Okay. Okay. Thanks, guys. Appreciate your help.
Operator (participant)
There are no further questions at this time. I would now like to turn the floor back over to Marty Grunst for closing comments.
Marty Grunst (CFO)
Thanks again, everyone, for joining us, and if you have further questions, please email us at ir.bokf.com. Have a great day, everyone.
Operator (participant)
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.