BOK Financial - 10-K annual report 2010

 (Mark One)

 For the fiscal year ended December 31, 2011

OR

            For the transition period from _____________ to ______________                 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)Yes  x  No  ¨

BOK FINANCIAL CORPORATION

ANNUAL REPORT ON FORM 10-K

INDEX

PART I

ITEM 1.   BUSINESS

General

Developments relating to individual aspects of the business of BOK Financial Corporation (“BOK Financial” or “the Company”) are described below.  Additional discussion of the Company’s activities during the current year appears within Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Description of Business

BOK Financial is a financial holding company incorporated in the state of Oklahoma in 1990 whose activities are limited by the Bank Holding Company Act of 1956 (“BHCA”), as amended by the Financial Services Modernization Act or Gramm-Leach-Bliley Act.  BOK Financial offers full service banking in Oklahoma, Texas, New Mexico, Northwest Arkansas, Colorado, Arizona, and Kansas/Missouri.

BOKF, NA (“the Bank”) is the wholly owned subsidiary bank of BOK Financial.  Operating divisions of the Bank include Bank of Albuquerque, Bank of Arizona, Bank of Arkansas, Bank of Oklahoma, Colorado State Bank and Trust, Bank of Arizona, and Bank of Kansas City.  Other subsidiaries of BOK Financial include BOSC, Inc., a broker/dealer that engages in retail and institutional securities sales and municipal bond underwriting.  Other non-bank subsidiary operations do not have a significant effect on the Company’s financial statements.

Our overall strategic objective is to emphasize growth in long-term value by building on our leadership position in Oklahoma through expansion into other high-growth markets in contiguous states.  We operate primarily in the metropolitan areas of Tulsa and Oklahoma City, Oklahoma; Dallas, Fort Worth and Houston, Texas; Albuquerque, New Mexico; Denver, Colorado; Phoenix, Arizona, and Kansas City, Kansas/Missouri.  Our acquisition strategy targets quality organizations that have demonstrated solid growth in their business lines.  We provide additional growth opportunities by hiring talent to enhance competitiveness, adding locations and broadening product offerings.  Our operating philosophy embraces local decision-making in each of our geographic markets while adhering to common Company standards.  We also consider acquisitions of distressed financial institutions in our existing markets when attractive opportunities become available.

Our primary focus is to provide a comprehensive range of nationally competitive financial products and services in a personalized and responsive manner.  Products and services include loans and deposits, cash management services, fiduciary services, mortgage banking and brokerage and trading services to middle-market businesses, financial institutions and consumers.  Commercial banking represents a significant part of our business.  Our credit culture emphasizes building relationships by making high quality loans and providing a full range of financial products and services to our customers.  Our energy financing expertise enables us to offer commodity derivatives for customers to use in their risk management.  We also offer derivative products for customers to use in managing their interest rate and foreign exchange risk.  Our diversified base of revenue sources is designed to generate returns in a range of economic situations.  Historically, fees and commissions provide 40 to 45% of our total revenue.  Approximately 43% of our revenue came from fees and commission in 2011.

BOK Financial’s corporate headquarters is located at Bank of Oklahoma Tower, P.O. Box 2300, Tulsa, Oklahoma 74192.

The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports are available on the Company’s website at www.bokf.com as soon as reasonably practicable after the Company electronically files such material with or furnishes it to the Securities and Exchange Commission.

Operating Segments

BOK Financial operates 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 electronic funds network.  Consumer banking includes retail lending and deposit services and all mortgage banking activities.  Wealth management provides fiduciary services, brokerage and trading, private bank services and investment advisory services in all markets.  Discussion of these principal lines of business appears within the Lines of Business section of “Management's Discussion and Analysis of Financial Condition and Results of Operations” and within Note 17 of the Company’s Notes to Consolidated Financial Statements, both of which appear elsewhere herein.

Competition

BOK Financial and its operating segments face competition from other banks, thrifts, credit unions and other non-bank financial institutions, such as investment banking firms, investment advisory firms, brokerage firms, investment companies, government agencies, mortgage brokers and insurance companies.  The Company competes largely on the basis of customer services, interest rates on loans and deposits, lending limits and customer convenience.   Some operating segments face competition from institutions that are not as closely regulated as banks, and therefore are not limited by the same capital requirements and other restrictions.  All market share information presented below is based upon share of deposits in specified areas according to SNL DataSource as of December 31, 2011.

We are the largest financial institution in the state of Oklahoma with 13% of the state’s total deposits.  The Tulsa and Oklahoma City areas have 29% and 11% of the market share, respectively. We compete with two banks that have operations nationwide and have greater access to funds at lower costs, higher lending limits, and greater access to technology resources and also compete with regional and locally-owned banks in both the Tulsa and Oklahoma City areas, as well as in every other community in which we do business throughout the state.

Bank of Texas competes against numerous financial institutions, including some of the largest in the United States, and has a market share of approximately 2% in the Dallas, Fort Worth area and 1% in the Houston area.  Bank of Albuquerque has a number three market share position with 10% of deposits in the Albuquerque area and competes with five large national banks, some regional banks and several locally-owned smaller community banks.  Colorado State Bank and Trust has a market share of approximately 2% in the Denver area. Bank of Arkansas serves Benton and Washington counties in Arkansas with a market share of approximately 3%.  Bank of Arizona operates as a community bank with locations in Phoenix, Mesa and Scottsdale and Bank of Kansas City serves the Kansas City, Kansas/Missouri market.  The Company’s ability to expand into additional states remains subject to various federal and state laws.

Employees

As of December 31, 2011, BOK Financial and its subsidiaries employed 4,511 full-time equivalent employees.  None of the Company’s employees are represented by collective bargaining agreements.  Management considers its employee relations to be good.

Supervision and Regulation

BOK Financial and its subsidiaries are subject to extensive regulations under federal and state laws.  These regulations are designed to protect depositors, the Deposit Insurance Fund and the banking system as a whole and not necessarily to protect shareholders and creditors.  As detailed below, these regulations limit fees charged for certain services and may restrict the Company’s ability to diversify, to acquire other institutions and to pay dividends on its capital stock.  They also require the Company and its subsidiaries to maintain certain capital balances and may require the Company to provide financial support to its subsidiaries.

The following information summarizes certain existing laws and regulations that affect the Company’s operations.  It does not discuss all provisions of these laws and regulations and it does not summarize all laws and regulations that affect the Company presently or in the future.

General

As a financial holding company, BOK Financial is regulated under the BHCA and is subject to regular inspection, examination and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). Under the BHCA, BOK Financial files quarterly reports and other information with the Federal Reserve Board.

The Bank is organized as a national banking association under the National Banking Act, and is subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (the “OCC”), the Federal Deposit Insurance Corporation (the “FDIC”), the Federal Reserve Board and other federal and state regulatory agencies.  The OCC has primary supervisory responsibility for national banks and must approve certain corporate or structural changes, including changes in capitalization, payment of dividends, change of place of business, and establishment of a branch or operating subsidiary. The OCC performs its functions through national bank examiners who provide the OCC with information concerning the soundness of a national bank, the quality of management and directors, and compliance with applicable regulations. The National Banking Act authorizes the OCC to examine every national bank as often as necessary.

A financial holding company, and the companies under its control, are permitted to engage in activities considered “financial in nature” as defined by the BHCA, Gramm-Leach-Bliley Act and Federal Reserve Board interpretations, and therefore may engage in a broader range of activities than permitted for bank holding companies and their subsidiaries.  Activities that are “financial in nature” include securities underwriting and dealing, insurance underwriting, operating a mortgage company, credit card company or factoring company, performing certain data processing operations, servicing loans and other extensions of credit, providing investment and financial advice, owning and operating savings and loan associations, and leasing personal property on a full pay-out, non-operating basis.  In order for a financial holding company to commence any new activity permitted by the BHCA, each insured depository institution subsidiary of the financial holding company must have received a rating of at least satisfactory in its most recent examination under the Community Reinvestment Act.  A financial holding company is required to notify the Federal Reserve Board within thirty days of engaging in new activities determined to be “financial in nature.”  BOK Financial is engaged in some of these activities and has notified the Federal Reserve Board.

The BHCA requires the Federal Reserve Board’s prior approval for the direct or indirect acquisition of more than five percent of any class of voting stock of any non-affiliated bank.  Under the Federal Bank Merger Act, the prior approval of the OCC is required for a national

bank to merge with another bank or purchase the assets or assume the deposits of another bank.  In reviewing applications seeking approval of merger and acquisition transactions, the bank regulatory authorities consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, the applicant’s performance record under the Community Reinvestment Act and fair housing laws and the effectiveness of the subject organizations in combating money laundering activities.

A financial holding company and its subsidiaries are prohibited under the BHCA from engaging in certain tie-in arrangements in connection with the provision of any credit, property or services. Thus, a subsidiary of a financial holding company may not extend credit, lease or sell property, furnish any services or fix or vary the consideration for these activities on the condition that (1) the customer obtain or provide additional credit, property or services from or to the financial holding company or any subsidiary thereof, or (2) the customer may not obtain some other credit, property or services from a competitor, except to the extent reasonable conditions are imposed to insure the soundness of credit extended.

The Bank and other non-bank subsidiaries are also subject to other federal and state laws and regulations.  For example, BOSC, Inc., the Company’s broker/dealer subsidiary that engages in retail and institutional securities sales and municipal bond underwriting, is regulated by the Securities and Exchange Commission (“SEC”), the Financial Industry Regulatory Authority (“FINRA”), the Federal Reserve Board, and state securities regulators.  As another example, Bank of Arkansas is subject to certain consumer-protection laws incorporated in the Arkansas Constitution, which, among other restrictions, limit the maximum interest rate on general loans to five percent above the Federal Reserve Discount Rate and limit the rate on consumer loans to the lower of five percent above the discount rate or seventeen percent.

On July 21, 2010, the Dodd-Frank Act was signed into law, giving federal banking agencies authority to increase regulatory capital requirements, impose additional rules and regulations over consumer financial products and services and limit the amount of interchange fees that may be charged in an electronic debit transaction.  In addition, the Dodd-Frank Act made permanent the $250,000 limit for federal deposit insurance and provided unlimited federal deposit insurance until January 1, 2013 for non-interest bearing demand deposit accounts.  It also repeals prohibitions on payment of interest on demand deposits, which could impact how interest is paid on business transaction and other accounts.  Further, the Dodd-Frank Act prohibits banking entities from engaging in proprietary trading and restricts banking entities sponsorship of or investment in private equity funds and hedge funds.  Many of the regulations required to implement the Dodd-Frank Act have yet to be adopted and the full impact of this legislation on fee income and operating expense remains unknown.  However, the potential reduction in revenue and increase in costs could be significant.

The Durbin Amendment to the Dodd-Frank Act required that interchange fees on electronic debit transactions paid by merchants must be “reasonable and proportional to the cost incurred by the issuer” and prohibited card network rules that have limited price competition among networks.  The Federal Reserve is responsible for implementing the Durbin Amendment.  The Federal Reserve issued its final ruling which established a cap on interchange fees banks with more than $10 billion in total assets can charge merchants for certain debit card transactions.  The final ruling on interchange fees was effective October 1, 2011.  The Company expects the Durbin Amendment interchange fee cap to reduce annual non-interest revenue by $20 million to $25 million.  The Durbin Amendment also requires all banks to comply with the prohibition on network exclusivity and routing requirements.  Debit card issuers are required to make at least two unaffiliated networks available to merchants.  The final network exclusivity and routing requirements, which will become effective April 1, 2012, are not expected to have a significant impact on the Company.

We continue to monitor the on-going development of rules to implement the Volcker Rule in Title VI of the Dodd-Frank Act which prohibits banking entities from engaging in proprietary trading as defined by the Dodd-Frank Act and restrict sponsorship of, or investment in, private equity funds and hedge funds, subject to limited exceptions.  On October 11, 2011, regulators of financial institutions released a proposal for implementation of the Volcker Rule scheduled to take effect by July 21, 2012, subject in some cases to phase-in over time thereafter.  Based on the proposed rules, we expect the Company’s trading activity to be largely unaffected, as our trading activities would largely be exempted under the proposed rules.  Based on the proposed rules, the Company’s private equity investment activity may be curtailed but, if this occurs, it is not expected to result in a material impact to the Company’s financial statements.  Final regulations will likely impose additional operating and compliance costs as presently proposed.

Title VII of Dodd-Frank Act subjects nearly all derivative transactions to Commodity Futures Trading Commission (“CFTC”) or SEC regulation.  The purpose of Title VII was to reduce systemic risk, increase transparency and promote market integrity within the broader financial system.  Title VII, among other things, imposes registration, recordkeeping, reporting, capital and margin, as well as business conduct requirements on swap dealers and major swap participants.  Although many provisions of Title VII were scheduled to go into effect during 2011, the CFTC and SEC delayed the effectiveness of a large portion of the proposed regulations under Title VII until, in most instances, 60 days after final rules implementing Title VII are adopted.  Rules on basic issues such as the definitions of “swap,” “swap dealer” and “major swap participant” are not yet final.  Accordingly, the Company cannot predict when Title VII will substantially go into effect.  The Bank currently provides interest rate, foreign exchange and commodity swaps to its customers.  The Company currently anticipates that one or more of its subsidiaries may be required to register as a “swap dealer” with the CFTC.  As currently proposed, the Company does not anticipate any material changes in its customer derivative activities, though its derivatives transactions with customers involving commodities may be negatively affected.  The Company does anticipate that, when Title VII becomes effective, it will incur higher operational and compliance costs associated with its derivative trading activities.

In addition, some of the Company’s subsidiaries conduct underwriting and broker-dealer activities which are subject to regulation by the SEC, FINRA regulations, as well as other regulatory agencies.  Such regulations generally include licensing of certain personnel, customer interactions, and trading operations.  The ultimate impact of the Dodd-Frank Act on these activities remains uncertain.

Capital Adequacy and Prompt Corrective Action

The Federal Deposit Insurance Corporation Improvement Act of 1991 (the “FDICIA”), among other things, identifies five capital categories for insured depository institutions from well capitalized to critically undercapitalized and requires the respective federal regulatory agencies to implement systems for prompt corrective action for institutions failing to meet minimum capital requirements within such categories.  FDICIA imposes progressively more restrictive covenants on operations, management and capital distributions, depending upon the category in which an institution is classified.

Substantially all of the deposits held by the Bank are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and are subject to deposit insurance assessments to maintain the DIF.  In 2011, the FDIC released a final rule to implement provisions of the Dodd-Frank Act that affect deposit insurance assessments.  Among other things, the Dodd-Frank Act raised the minimum designated reserve ratio from 1.15% to 1.35% of estimated insured deposits, removed the upper limit of the designated reserve ratio, required that the designated reserve ratio reach 1.35% by September 30, 2020, and required that the FDIC offset the effect of increasing the minimum designated reserve ratio on depository institutions with total assets of less than $10 billion.  The Dodd-Frank Act also required that the FDIC redefine the assessment base to average consolidated assets minus average tangible equity.  This final rule reduced our deposit insurance assessment beginning in the second half of 2011.

On November 12, 2009 the board of directors of the FDIC voted to require insured institutions to prepay over three years of estimated insurance assessments on December 30, 2009 in order to strengthen the cash position of the DIF.  As of December 31, 2009 and each quarter thereafter, the regular quarterly assessment will be applied against the prepaid assessment until the asset is exhausted.  Any prepaid assessment not exhausted as of June 30, 2013 will be returned.  The Bank prepaid $78 million of deposit insurance assessments.  As of December 31, 2011, $43 million of prepaid deposit insurance assessments are included in Other assets on the Consolidated Balance Sheet of the Company.

Dividends

A key source of liquidity for BOK Financial is dividends from the Bank, which is limited by various banking regulations to net profits, as defined, for the year plus retained profits for the preceding two years and further restricted by minimum capital requirements.  Based on the most restrictive limitations as well as management’s internal capital policy, the Bank had excess regulatory capital and could declare up to $15 million of dividends without regulatory approval as of December 31, 2011.  This amount is not necessarily indicative of amounts that may be available to be paid in future periods.

Source of Strength Doctrine

According to Federal Reserve Board policy, bank holding companies are expected to act as a source of financial strength to each subsidiary bank and to commit resources to support each such subsidiary.  This support may be required at times when a bank holding company may not be able to provide such support.  Similarly, under the cross-guarantee provisions of the Federal Deposit Insurance Act, in the event of a loss suffered by the FDIC as a result of default of a banking subsidiary or related to FDIC assistance provided to a subsidiary in danger of default, the other Bank may be assessed for the FDIC’s loss, subject to certain exceptions.

Transactions with Affiliates

The Federal Reserve Board regulates transactions between the Company and its subsidiaries.  Generally, the Federal Reserve Act and Regulation W, as amended by the Dodd-Frank Act, limit the Company’s banking subsidiary and its subsidiaries, to lending and other “covered transactions” with affiliates.  The aggregate amount of covered transactions a banking subsidiary or its subsidiaries may enter into with an affiliate may not exceed 10 percent of the capital stock and surplus of the banking subsidiary.  The aggregate amount of covered transactions with all affiliates may not exceed 20 percent of the capital stock and surplus of the banking subsidiary.

Covered transactions with affiliates are also subject to collateralization requirements and must be conducted on arm’s length terms.  Covered transactions include (a) a loan or extension of credit by the banking subsidiary, (b) a purchase of securities issued to a banking subsidiary, (c) a purchase of assets by the banking subsidiary unless otherwise exempted by the Federal Reserve, (d) acceptance of securities issued by an affiliate to the banking subsidiary as collateral for a loan, and (e) the issuance of a guarantee, acceptance or letter of credit by the banking subsidiary on behalf of an affiliate.  Effective July 21, 2012, the Dodd-Frank Act expands the scope of the Covered Transaction Rules.  Once implemented, some of the proposed rules may further restrict transactions between BOKF’s subsidiaries.

Bank Secrecy Act and USA Patriot Act

The Bank Secrecy Act (“BSA”) imposes many requirements on financial institutions in the interest of national security. The Company must, among other things, establish internal controls that are reasonably designed to prevent the financing of terrorism and money laundering.  The BSA also imposes know-your-customer documentation and other recordkeeping requirements aimed at suspicious activity reporting.  The Company has established an anti-money laundering program in accordance with the BSA.

The USA Patriot Act of 2001 (“Patriot Act”) broadened the scope of anti-money laundering laws and regulations by creating new due diligence and compliance obligations, defining new crimes and penalties, and expanding United States’ extraterritorial jurisdiction.  Financial institutions, including the Company, are required to maintain policies, procedures and controls to detect, prevent and report terrorist financing and money laundering.  The Company must verify the identity of its customers.  Failure to implement or maintain adequate programs and controls to combat terrorist financing and money laundering may have serious legal and reputational consequences.

Governmental Policies and Economic Factors

The operations of BOK Financial and its subsidiaries are affected by legislative changes and by the policies of various regulatory authorities and, in particular, the credit policies of the Federal Reserve Board.  An important function of the Federal Reserve Board is to regulate the national supply of bank credit to moderate recessions and inflation.  Among the instruments of monetary policy used by the Federal Reserve Board to implement its objectives are: open-market operations in U.S. Government securities, changes in the discount rate and federal funds rate on bank borrowings, and changes in reserve requirements on bank deposits. The effect of future changes in such policies on the business and earnings of BOK Financial and its subsidiaries is uncertain.

In response to the significant recession in business activity which began in 2007, the U.S. government enacted various programs and continues to enact programs to stimulate the economy.  These programs include the Trouble Assets Relief Program (“TARP”), which provided capital to eligible financial institutions and other sectors of the domestic economy, and the Temporary Liquidity Guarantee Program, which expanded insurance coverage to a larger amount of deposit account balances and other qualifying debt issued by eligible

financial institutions.  The government continues to enact economic stimulus legislation and policies, including increases in government spending, reduction of certain taxes, reductions in interest rates and home affordability programs.  The Federal Reserve has indicated its intention to maintain historically low interest rates for the foreseeable future.  The short-term effectiveness and long-term impact of these programs on the economy in general and on BOK Financial Corporation in particular are uncertain.

Foreign Operations

BOK Financial does not engage in operations in foreign countries, nor does it lend to foreign governments.

ITEM 1A.   RISK FACTORS

The United States economy experienced a significant recession from 2007 to 2009.  Business activity across a wide range of industries and geographic regions decreased and unemployment increased significantly.  The financial services industry and capital markets were adversely affected by significantly declining asset values, rising delinquencies and defaults, and restricted liquidity.  Numerous financial institutions failed or required a significant amount of government assistance due to credit losses and liquidity shortages.  The rate of economic recovery remains slow, unemployment has been persistently high and the national housing market remains depressed overall.  The Federal Reserve Board continues to take steps to promote more robust economic growth including maintaining a historically low federal funds rate for an extended period of time and promoting low intermediate and long-term interest rates.  The current effect of these actions reduces earnings by narrowing net interest margins.  The long-term effect subjects banks to future interest rate risk once rates increase to more normal levels.

Although BOK Financial has developed an operating strategy which it expects to result in continuing improved financial performance, BOK Financial cannot assure that it will be successful in fulfilling this strategy or that this operating strategy will be successful. Achieving success is dependent upon a number of factors, many of which are beyond BOK Financial's direct control.  Factors that may adversely affect BOK Financial's ability to implement its operating strategy include:

A substantial majority of BOK Financial loans are generated in Oklahoma and other markets in the southwest region.  As a result, poor economic conditions in Oklahoma or other markets in the southwest region may cause BOK Financial to incur losses associated with higher default rates and decreased collateral values in BOK Financial's loan portfolio. A regional economic downturn could also adversely affect revenue from brokerage and trading activities, mortgage loan originations and other sources of fee-based revenue.

Certain industry-specific economic factors also affect BOK Financial. For example, a portion of BOK Financial's total loan portfolio is comprised of loans to borrowers in the energy industry, which is historically a cyclical industry. Low commodity prices may adversely affect that industry and, consequently, may affect BOK Financial's business negatively. The effect of volatility in commodity prices on our customer derivatives portfolio could adversely affect our liquidity and regulatory capital.  In addition, BOK Financial's loan portfolio includes commercial real estate loans. A downturn in the real estate industry in general or in certain segments of the commercial real estate industry in Oklahoma and the southwest region could also have an adverse effect on BOK Financial's operations.

Poor economic conditions globally, including those of the European Union, could impact BOK Financial’s customers and counterparties with which we do business.

BOK Financial has no direct exposure to European sovereign debt and no material exposure to European financial institutions.  We do have significant exposures to internationally active domestic financial institutions.  The financial condition of these institutions is monitored on an on-going basis.  We have not identified any significant customer exposures to European sovereign debt or European financial institutions.

BOK Financial's business is highly sensitive to:

A significant increase in market interest rates, or the perception that an increase may occur, could adversely affect both BOK Financial's ability to originate new loans and BOK Financial's ability to grow. Conversely, a decrease in interest rates could result in acceleration in the payment of loans, including loans underlying BOK Financial's holdings of residential mortgage-backed securities and termination of BOK Financial's mortgage servicing rights. In addition, changes in market interest rates, changes in the relationships between short-term and long-term market interest rates or changes in the relationships between different interest rate indices, could affect the interest rates charged on interest-earning assets differently than the interest rates paid on interest-bearing liabilities. This difference could result in an increase in interest expense relative to interest income which would reduce the Company’s net interest revenue.  An increase in market interest rates also could adversely affect the ability of BOK Financial's floating-rate borrowers to meet their higher payment obligations. If this occurred, it could cause an increase in nonperforming assets and net charge-offs, which could adversely affect BOK Financial's business.

BOK Financial has invested a substantial amount of its holdings in residential mortgage-backed securities, which are investment interests in pools of mortgages.  Residential mortgage-backed securities are highly sensitive to changes in interest rates. BOK Financial mitigates this risk somewhat by investing principally in shorter duration mortgage products, which are less sensitive to changes in interest rates.  A significant decrease in interest rates has led mortgage holders to refinance the mortgages constituting the pool backing the securities, subjecting BOK Financial to a risk of prepayment and decreased return on investment due to subsequent reinvestment at lower interest rates.  A significant decrease in interest rates has also accelerated premium amortization.  Conversely, a significant increase in interest rates could cause mortgage holders to extend the term over which they repay their loans, which delays the Company’s opportunity to reinvest funds at higher rates.

In an effort to promote a stronger pace of economic recovery and ensure inflation, over time, is at a level consistent with its mandate, the Federal Reserve Board has announced it will continue its policy of reinvesting principal payments from its security holdings in longer-term Treasury securities which may result in rising interest rates and lower fair values of our residential mortgage-backed securities.

Residential mortgage-backed securities are also subject to credit risk from delinquency or default of the underlying loans.  BOK Financial mitigates this risk somewhat by investing in securities issued by U.S. government agencies.  Principal and interest payments on the loans underlying these securities are guaranteed by these agencies.

In addition, as part of BOK Financial's mortgage banking business, BOK Financial has substantial holdings of mortgage servicing rights. The value of these rights is also very sensitive to changes in interest rates.  Falling interest rates tend to increase loan prepayments, which may lead to cancellation of the related servicing rights. BOK Financial's investments and dealings in mortgage-related products increase the risk that falling interest rates could adversely affect BOK Financial's business. BOK Financial attempts to manage this risk by maintaining an active hedging program for its mortgage servicing rights. BOK Financial's hedging program has only been partially successful in recent years.  The value of mortgage servicing rights may also decrease due to rising delinquency or default of the loans serviced.  This risk is mitigated somewhat by adherence to underwriting standards on loans originated for sale.

BOK Financial’s subsidiary bank may rely on other financial institutions and the Federal Home Loan Banks of Topeka and Dallas as a significant source of funds.  Our ability to fund loans, manage our interest rate risk and meet other obligations depends on funds borrowed from these sources.  The inability to borrow funds at market interest rates could have a material adverse effect on our operations.

Banking is a competitive business. BOK Financial competes actively for loan, deposit and other financial services business in Oklahoma, as well as in BOK Financial's other markets. BOK Financial's competitors include a large number of small and large local and national banks, savings and loan associations, credit unions, trust companies, broker-dealers and underwriters, as well as many financial and nonfinancial firms that offer services similar to BOK Financial's. Large national financial institutions have entered the Oklahoma market. These institutions have substantial capital, technology and marketing resources. Such large financial institutions may have greater access to capital at a lower cost than BOK Financial does, which may adversely affect BOK Financial's ability to compete effectively.

BOK Financial has expanded into markets outside of Oklahoma, where it competes with a large number of financial institutions that have an established customer base and greater market share than BOK Financial. BOK Financial may not be able to continue to compete successfully in these markets outside of Oklahoma. With respect to some of its services, BOK Financial competes with non-bank companies that are not subject to regulation.  The absence of regulatory requirements may give non-banks a competitive advantage.

BOK Financial and its subsidiaries are extensively regulated under both federal and state law. In particular, BOK Financial is subject to the BHCA, the National Bank Act and the Dodd-Frank Act. These regulations are primarily for the benefit and protection of BOK Financial's customers and not for the benefit of BOK Financial's investors. In the past, BOK Financial's business has been materially affected by these regulations. For example, regulations limit BOK Financial's business to banking and related businesses, and they limit the location of BOK Financial's branches and offices, as well as the amount of deposits that it can hold in a particular state. These regulations may limit BOK Financial's ability to grow and expand into new markets and businesses.

Additionally, under the Community Reinvestment Act, BOK Financial is required to provide services in traditionally underserved areas. BOK Financial's ability to make acquisitions and engage in new business may be limited by these requirements.

The FDICIA and the BHCA, and various regulations of regulatory authorities, require us to maintain specified capital ratios. Any failure to maintain required capital ratios would limit the growth potential of BOK Financial's business.

Under a long-standing policy of the Board of Governors of the Federal Reserve System, a bank holding company is expected to act as a source of financial strength for its subsidiary bank. As a result of that policy, BOK Financial may be required to commit financial and other resources to its subsidiary bank in circumstances where we might not otherwise do so.

The trend toward increasingly extensive regulation is likely to continue and become more costly in the future.  Laws, regulations or policies currently affecting BOK Financial and its subsidiaries may change at any time. Regulatory authorities may also change their interpretation of these statutes and regulations. Therefore, BOK Financial's business may be adversely affected by any future changes in laws, regulations, policies or interpretations.  For example, effective July 1, 2010, the Company implemented changes mandated by federal regulations concerning overdraft charges that significantly impacted our fee revenue in the second half of 2010.

The implementation of the Dodd-Frank Act will affect BOK Financial’s business including interchange revenue, mortgage banking, consumer products and higher capital standards.  Among the rules pending for mortgage banking are uniform lending and servicing standards, consumer protection measures and several reforms affecting loan originators.  A cap on interchange revenue implemented October 1, 2011 will significantly reduce revenue.  The Bureau of Consumer Financial Protection will have authority over banks greater than $10 billion in assets and may implement additional consumer protection standards.  BOK Financial will be affected by other aspects of the Dodd-Frank Act including new capital rules and revised deposit insurance assessments.  Provisions of the Dodd-Frank Act may also make portions of our customer hedging programs uneconomical to continue.

As a result of the financial crisis and related government intervention to stabilize the banking system, there have been a series of laws and related regulations proposed or enacted in an attempt to ensure the crisis is not repeated.  Many of the proposed new regulations are far-reaching.  The intervention by the government also impacted populist sentiment with a negative view of financial institutions.   This sentiment may increase litigation risk to the Company. While the Company did not participate in the Troubled Asset Relief Program and performed well throughout the downturn, the adverse political environment could have an adverse impact on BOK Financial’s future operations. 

BOK Financial is a financial holding company, and a substantial portion of BOK Financial's cash flow typically comes from dividends that BOK Financial's bank and nonbank subsidiaries pay to BOK Financial. Various statutory provisions restrict the amount of dividends BOK Financial's subsidiaries can pay to BOK Financial without regulatory approval. Management also developed, and the BOK Financial board of directors approved, an internal capital policy that is more restrictive than the regulatory capital standards. Subsidiary creditors are entitled to receive distributions from the assets of that subsidiary in the event of liquidation before BOK Financial, as holder of an equity

interest in the subsidiary, is entitled to receive any of the assets of the subsidiary.  However, if BOK Financial is a creditor of the subsidiary with recognized claims against it, BOK Financial will be in the same position as other creditors.

A relatively small fraction of BOK Financial's outstanding common stock is actively traded. The risks of low liquidity include increased volatility of the price of BOK Financial's common stock. Low liquidity may also limit holders of BOK Financial's common stock in their ability to sell or transfer BOK Financial's shares at the price, time and quantity desired.

Mr. George B. Kaiser owns a majority of the outstanding shares of BOK Financial's common stock. Mr. Kaiser is able to elect all of BOK Financial's directors and effectively control the vote on all matters submitted to a vote of BOK Financial's common shareholders. Mr. Kaiser's ability to prevent an unsolicited bid for BOK Financial or any other change in control could have an adverse effect on the market price for BOK Financial's common stock. A substantial majority of BOK Financial's directors are not officers or employees of BOK Financial or any of its affiliates. However, because of Mr. Kaiser's control over the election of BOK Financial's directors, he could change the composition of BOK Financial's Board of Directors so that it would not have a majority of outside directors.

Mr. Kaiser has the right to sell shares of BOK Financial's common stock in compliance with the federal securities laws at any time, or from time to time. The federal securities laws will be the only restrictions on Mr. Kaiser's ability to sell. Because of his current control of BOK Financial, Mr. Kaiser could sell large amounts of his shares of BOK Financial's common stock by causing BOK Financial to file a registration statement that would allow him to sell shares more easily. In addition, Mr. Kaiser could sell his shares of BOK Financial's common stock without registration under Rule 144 of the Securities Act. Although BOK Financial can make no predictions as to the effect, if any, that such sales would have on the market price of BOK Financial's common stock, sales of substantial amounts of BOK Financial's common stock, or the perception that such sales could occur, could adversely affect market prices. If Mr. Kaiser sells or transfers his shares of BOK Financial's common stock as a block, another person or entity could become BOK Financial's controlling shareholder.

As a financial institution, we process a significant number of customer transactions and possess a significant amount of sensitive customer information.  We engage numerous third-party vendors to support our data processing systems.  As technology advances, the ability to initiate transactions and access data has become more widely distributed among mobile phones, personal computers, automated teller machines, remote deposit capture sites and similar access points.  These technological advances increase cyber security risk.  While the Company maintains programs intended to prevent or limit the effects of cyber security risk, there is no assurance that unauthorized transactions or unauthorized access to customer information will not occur.  The financial, reputational and regulatory impact of unauthorized transactions or unauthorized access to customer information could be significant.

ITEM 1B.   UNRESOLVED STAFF COMMENTS

 

None.

BOK Financial and its subsidiaries own and lease improved real estate that is carried at $188 million, net of depreciation and amortization.  The Company’s principal offices are located in leased premises in the Bank of Oklahoma Tower in Tulsa, Oklahoma.  Banking offices are primarily located in Tulsa and Oklahoma City, Oklahoma; Dallas, Fort Worth and Houston, Texas; Albuquerque, New Mexico; Denver, Colorado; Phoenix, Arizona; and Kansas City, Kansas/Missouri.  Primary operations facilities are located in Tulsa and Oklahoma City, Oklahoma; Dallas, Texas and Albuquerque, New Mexico.  The Company’s facilities are suitable for their respective uses and present needs.

The information set forth in Notes 5 and 14 of the Company’s Notes to Consolidated Financial Statements, which appear elsewhere herein, provides further discussion related to properties.

ITEM 3.   LEGAL PROCEEDINGS

The information set forth in Note 14 of the Company’s Notes to Consolidated Financial Statements, which appear elsewhere herein, provides discussion related to legal proceedings.

ITEM 4.   MINE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

BOK Financial’s $0.00006 par value common stock is traded on the NASDAQ Stock Market under the symbol BOKF. As of January 31, 2012, common shareholders of record numbered 866 with 69,701,342 shares outstanding.

Shareholder Return Performance Graph

Set forth below is a line graph comparing the change in cumulative shareholder return of the NASDAQ Index, the NASDAQ Bank Index, and the KBW 50 Bank Index for the period commencing December 31, 2006 and ending December 31, 2011.*

 

The following table provides information with respect to purchases made by or on behalf of the Company or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of the Company’s common stock during the three months ended December 31, 2011.

ITEM 6.  SELECTED FINANCIAL DATA

The selected financial data is set forth within Table 1 of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s Assessment of Operations and Financial Condition

Overview

The following discussion is management’s analysis to assist in the understanding and evaluation of the financial condition and results of operations of BOK Financial Corporation (“BOK Financial” or “the Company”).  This discussion should be read in conjunction with the consolidated financial statements and footnotes and selected financial data presented elsewhere in this report.

From 2007 to 2009 the United States experienced a severe recession, characterized by substantial market volatility and lack of available liquidity.  Primarily characterized by slow economic growth and persistently high national unemployment rates, the effects of the recession continued to impact 2011.  In response, the U.S. government continued to provide significant liquidity and other intervening measures to support economic recovery based on evidence of subdued inflation.  Commercial lending activity increased slightly in light of the economic uncertainty and both long-term and short-term interest rates remained at historic lows throughout the year.  Low national mortgage rates during much of the year sustained a high level of mortgage lending activity and increased prepayments of our residential mortgage-backed securities.  Cash flows from these securities were reinvested at current rates.  The Federal Reserve has recently indicated its intention to keep interest rates low for the foreseeable future.  While the core inflation rate has been modest, certain commodity prices such as oil have been volatile.

BOK Financial’s net income for 2011 totaled $285.9 million or $4.17 per diluted share compared to $246.8 million or $3.61 per diluted share for 2010.  Net income was up 16% over last year primarily due to lower credit cost.  The provision for credit losses decreased $111.2 million due to sustained improvement in the loan portfolio.

Highlights of 2011 included:

Highlights of the fourth quarter of 2011 included:

The Consolidated Financial Statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”).  The Company’s accounting policies are more fully described in Note 1 of the Consolidated Financial Statements.  Management makes significant assumptions and estimates in the preparation of the Consolidated Financial Statements and accompanying notes in conformity with GAAP that may be highly subjective, complex and subject to variability.  Actual results could differ significantly from these assumptions and estimates.  The following discussion addresses the most critical areas where these assumptions and estimates could affect the financial condition, results of operations and cash flows of the Company.  These critical accounting policies and estimates have been discussed with the appropriate committees of the Board of Directors.

The allowances for loan losses and accrual for off-balance sheet credit losses are assessed by management based on an ongoing quarterly evaluation of the probable estimated losses inherent in the loan portfolio and probable estimated losses on unused commitments to provide financing.  A consistent, well-documented methodology has been developed and is applied by an independent Credit Administration department to assure consistency across the Company.  The allowance for loan losses consists of specific allowances attributed to certain impaired loans and commitments that have not yet been charged down to amounts we expect to recover, general allowances for unimpaired loans that are based on estimated loss rates by loan class and nonspecific allowances that are based on analysis of general economic conditions, growth in the loan portfolio, duration of the business cycle and other relevant factors.

Loans are considered impaired when it is probable that we will not collect all amounts due according to the contractual terms of the loan agreements.  This is substantially the same criteria utilized to determine whether a loan should be placed on nonaccrual status.  Generally, all nonaccruing commercial and commercial real estate loans, including loans modified in a troubled debt restructuring, are considered to be impaired.  Impaired loans are charged-off when the loan balance or a portion of the loan balance is no longer supported by the paying capacity of the borrower determined through a quarterly evaluation of available cash resources and collateral value.  Specific allowances for impairment of loans that have not yet been charged down to amounts we expect to recover are measured by an evaluation of estimated future cash flows discounted at the loan’s initial effective interest rate or the fair value of collateral for certain collateral dependent loans.  Collateral value of real property is generally based on third party appraisals that conform to Uniform Standards of Professional Appraisal Practice, less estimated selling costs.  Appraised values are on an “as-is” basis and are not adjusted by us.  Appraisals are updated at least annually, or more frequently, if market conditions indicate collateral values may have declined.  Collateral value of mineral rights is determined by our internal staff of engineers based on projected cash flows from proven oil and gas reserves under existing economic and operating conditions.  The value of other collateral is generally determined by our special assets staff based on projected liquidation cash flows under current market conditions.  Historical statistics may be used in limited situations to assist in estimating future cash flows or collateral values when a collateral dependent impaired loan is identified near the end of a reporting period.  We use historical statistics as a practical way to estimate impairment until an updated appraisal of collateral value is received or a full assessment of future cash flows is completed.  Estimates of future cash flows and collateral values require significant management judgments and are subject to volatility.

Effective in the fourth quarter of 2011, we enhanced the model used to estimate general allowances for unimpaired loans.  This enhancement identifies separate incurred loss rates for each loan class.  Previously, the company utilized incurred loss rates based on risk grades that did not differentiate by loan class.  Considering the results of the most recent credit cycle, we believe that using the combination of the loan class and risk grade results in greater transparency and consistency in how the Company manages the loan portfolio and its inherent credit risk.  This enhancement did not have a material impact on the results of the allowance for loan losses.  There have been no other material changes in the approach or techniques utilized in developing the combined allowances for credit losses during 2011.

For risk graded loans, estimated loss rates are developed using historical gross loss rates, as adjusted for changes in risk grading and inherent risk identified by loan class.  Loss rates for each loan class are determined by the current loss rate based on the most recent twelve months or long-term gross loss rate that most appropriately represents current economic conditions.  For each loan class, average risk grades for the most recent twelve month are compared to long-term average risk grades to determine if risk is increasing or decreasing. Appropriate loss rates are accordingly adjusted upward or downward in proportion to increasing or decreasing risk.  Risk grades are updated quarterly by management and may be based on significant subjective judgments.  Historical incurred loss rates may be further adjusted for inherent risks identified for the given loan class which have not yet been captured in the actual gross loss rates or risk grading.

Certain small balance commercial loans and substantially all residential mortgage and consumer loans are not risk graded.  Separate incurred loss rates are identified for each class of non-risk graded loans based on the most recent twelve months or long-term gross loss rate that most appropriately represents current economic conditions.  Historical incurred loss rates may be further adjusted for inherent risks identified for the given loan class which have not yet been captured in the actual gross loss rates.

Nonspecific allowances are maintained for risks beyond factors specific to a particular loan or loan class.  These factors include trends in the economy in our primary lending areas, overall growth in the loan portfolio and other relevant factors.  Nonspecific allowances may also be utilized to adjust loss rates based on historical information, including consideration of the duration of the business cycle on loss rates.

Certain assets and liabilities are recorded at fair value in the Consolidated Financial Statements.  Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liability in a principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date, using assumptions market participants would use when pricing an asset or liability.  An orderly transaction assumes exposure to the market for a customary period for marketing activities prior to the measurement date and not a forced liquidation or distressed sale.

Fair value measurement and disclosure guidance provides a three level hierarchy that prioritizes the inputs of valuation techniques used to measure fair value into three broad categories:  unadjusted quoted prices in active markets for identical assets or liabilities, other observable inputs that can be observed either directly or indirectly and unobservable inputs for assets or liabilities.  Fair value may be recorded for certain assets and liabilities every reporting period on a recurring basis or under certain circumstances on a non-recurring basis.

The following represents significant fair value measurements included in the Consolidated Financial Statements based on estimates.  See Note 18 of the Consolidated Financial Statements for additional discussion of fair value measurement and disclosure included in the Consolidated Financial Statements.

Goodwill for each reporting unit is evaluated for impairment annually as of October 1st or more frequently if conditions indicate that impairment may have occurred.  The evaluation of possible goodwill impairment involves significant judgment based upon short-term and long-term projections of future performance.

We identify the geographical market underlying each operating segment as reporting units for the purpose of performing the annual goodwill impairment test.  This is consistent with the manner in which management assesses the performance of the Company and allocates resources.  See additional discussion of the operating segments in the Assessment of Operations – Lines of Business section following.

The fair value of each of our reporting units is estimated by the discounted future earnings method.  Income growth is projected for each of our reporting units over five years and a terminal value is computed.  The projected income stream is converted to current fair value by using a discount rate that reflects a rate of return required by a willing buyer.  Assumptions used to value our reporting units are based on growth rates, volatility, discount rate and market risk premium inherent in our current stock price.  These assumptions are considered significant unobservable inputs and represent our best estimate of assumptions that market participants would use to determine fair value of the respective reporting units.  Critical assumptions in our evaluation were a 10% average expected long-term growth rate, a 0.90% volatility factor for BOK Financial common stock, a 13.03% discount rate and a 12.34% market risk premium.

The fair value, carrying value and related goodwill of reporting units for which goodwill was attributed as of our annual impairment test performed on October 1, 2011 is as follows in Table 2.

 

Based on the results of the primary discounted future earnings test performed as of October 1, 2011, no goodwill impairment was noted.

The fair value of our reporting units determined by the discounted future earnings method was further corroborated by comparison to the market capitalization of publicly traded banks of similar size and characteristics in our geographical footprint.  Considering the results of these two methods, management believes that no goodwill impairment existed as of our annual evaluation date.

As of December 31, 2011, the market value of BOK Financial common stock, a primary input in our goodwill impairment analysis, was approximately 17% above the market value used in our most recent annual evaluation.  The market value is influenced by factors affecting the overall economy and the regional banks sector of the market.  Goodwill impairment may be indicated at our next annual evaluation date if the market value of our stock declines or sooner if we incur significant unanticipated operating losses or if other factors indicate a significant decline in the value of our reporting units.  The effect of a sustained 10% negative change in the market value of our common stock on September 30, 2011 was simulated.  No additional impairment was noted by this simulation.

Numerous other factors could affect future impairment analyses including credit losses that exceed projected amounts or failure to meet growth projections.  Additionally, fee income may be adversely affected by increasing residential mortgage interest rates and changes in federal regulations.

The Company evaluates impaired debt and equity securities quarterly to determine if impairments are temporary or other-than-temporary.

For impaired debt securities, management first determines whether it intends to sell or if it is more-likely-than-not that it will be required to sell the impaired securities.  This determination considers current and forecasted liquidity requirements, regulatory and capital requirements and securities portfolio management.  All impaired debt securities we intend to sell or we expect to be required to sell are considered other-than-temporarily impaired and the full impairment loss is recognized as a charge against earnings.  All impaired debt securities we do not intend or expect to be required to sell are evaluated further.

Impairment of debt securities consistently rated investment grade by all nationally-recognized rating agencies is considered temporary unless specific contrary information is identified.  Impairment of securities rated below investment grade by at least one of the nationally-recognized rating agencies is evaluated to determine if we expect to recover the entire amortized cost basis of the security based on the present value of projected cash flows from individual loans underlying each security.  Below investment grade securities we own consist primarily of privately issued residential mortgage-backed securities.  The primary assumptions used to project cash flows are disclosed in Note 2 to the Consolidated Financial Statements.

We consider the principal and interest cash flows from the underlying loan pool as well as the remaining credit enhancement coverage as part of our assessment of cash flows available to recover the amortized cost of our securities.  The credit enhancement coverage is an estimate of currently remaining subordinated tranches available to absorb losses on pools of loans that support the security.

Credit losses, which are defined as the excess of current amortized cost over the present value of projected cash flows, on other-than-temporarily impaired debt securities are recognized as a charge against earnings.  Any remaining impairment attributed to factors other than credit losses are recognized in accumulated other comprehensive losses.

Credit losses are based on long-term projections of cash flows which are sensitive to changes in assumptions.   Changes in assumptions and differences between assumed and actual results regarding unemployment rates, delinquency rates, default rates, foreclosures costs and home price depreciation can affect estimated and actual credit losses.  Deterioration of these factors beyond those described in Note 2 to the Consolidated Financial Statements could result in the recognition of additional credit losses.

Impaired equity securities, including perpetual preferred stocks, are evaluated based on our ability and intent to hold the securities until fair value recovers over a period not to exceed three years.  The assessment of the ability and intent to hold these securities considers liquidity needs, asset / liability management objectives and securities portfolio objectives.  Factors considered when assessing recovery include forecasts of general economic conditions and specific performance of the issuer, analyst ratings, and credit spreads for preferred stocks which have debt-like characteristics.

Determination of income tax expense and related assets and liabilities is complex and requires estimates and judgments when applying tax laws, rules, regulations and interpretations.  It also requires judgments as to future earnings and the timing of future events.  Accrued income taxes represent an estimate of net amounts due to or from taxing jurisdictions based upon these estimates, interpretations and judgments.

Quarterly, management evaluates the Company’s effective tax rate based upon its current estimate of net income, tax credits and statutory tax rates expected for the full year.  Changes in income tax expense due to changes in the effective tax rate are recognized on a cumulative basis.  Annually, we file tax returns with each jurisdiction where we conduct business and settle our return liabilities.  We may also provide for estimated liabilities associated with uncertain filing positions.

Deferred tax assets and liabilities are determined based upon the differences between the values of assets and liabilities as recognized in the financial statements and their related tax basis using enacted tax rates in effect for the year in which the differences are expected to be recovered or settled.  A valuation allowance is provided when it is more likely than not that some portion of the entire deferred tax asset may not be realized based on taxes previously paid in net loss carry-back periods and other factors.

We recognize the benefit of uncertain income tax positions when based upon all relevant evidence it is more-likely-than-not that our position would prevail upon examination, including resolution of related appeals or litigation, based upon the technical merits of the position.  An allowance for the uncertain portion of the tax benefit, including estimated interest and penalties, is part of our current accrued income tax liability.  Estimated penalties and interest are recognized in income tax expense.  Income tax expense in future periods may decrease if an uncertain tax position is favorably resolved, generally upon completion of an examination by the taxing authorities, expiration of a statute of limitations, or changes in facts and circumstances.

Assessment of Operations

Tax-equivalent net interest revenue totaled $700.6 million for 2011, down $17.6 million compared to the prior year.  Net interest margin decreased 21 basis points, partially offset by the effect of a $595 million increase in average earning assets.

Table 3 shows the effects on net interest revenue of changes in average balances and interest rates for the various types of earning assets and interest-bearing liabilities.

Net interest margin, the ratio of tax-equivalent net interest revenue to average earning assets, was 3.34% for 2011 and 3.52% for 2010.  The decrease in net interest margin was due primarily to lower yield on our securities portfolio partially offset by lower funding costs.

The tax-equivalent yield on earning assets was 3.92% for 2011, down 30 basis points from 2010.  The available for sale securities portfolio yield was 2.84%, down 44 basis points from 2010.  Low intermediate and long-term interest rates continued to increase actual residential mortgage-backed securities prepayment speeds.  Cash flows from the prepayments were reinvested at current low interest rates.  Approximately $2.5 billion that had been invested to yield 3.30% was reinvested at 2.30%.  Loan yields decreased 12 basis points to 4.70% primarily due to changes in market interest rates.  The cost of interest-bearing liabilities was 0.76% for 2011, down 9 basis points from 2010 due largely to market conditions.  The cost of interest bearing deposits decreased 17 basis points to 0.68%.  The cost of other borrowed funds increased 33 basis points to 1.17%.  The benefit to net interest margin from earning assets funded by non-interest bearing liabilities was 18 basis points in 2011 compared to 15 basis points in 2010.

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.  As shown in Table 27, approximately 59% of our commercial and commercial real estate loan portfolios are either variable rate or fixed rate that will re-price within one year.  These loans are funded primarily by deposit accounts that are either non-interest bearing, or that re-price more slowly than the loans.  The result is a balance sheet that would be asset sensitive, which means that assets generally re-price more quickly than liabilities.  Among the strategies that we use to achieve a relatively rate-neutral position, we 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 3 and in the interest rate sensitivity projections as shown in the Market Risk section of this report.

The increase in average earning assets was primarily due to a $580 million increase in available for sale securities.  We historically purchase U.S. government agency issued residential mortgage-backed securities to supplement earnings during periods of declining loan demand and to manage our interest rate risk.  The larger securities portfolio was maintained throughout 2011.

Growth in average earning assets was funded primarily by a $1.8 billion increase in average deposits.  Average demand deposit account balances increased $1.1 billion and average interest-bearing transaction account balances increased $777 million. Average time deposits decreased $124 million.  Average borrowed funds also decreased $1.6 billion during 2011 due primarily to reduced borrowings from Federal Home Loan Banks.

Table 3 – Volume/Rate Analysis

(In thousands)

Fourth Quarter 2011 Net Interest Revenue

Tax-equivalent net interest revenue for the fourth quarter of 2011 totaled $173.7 million compared to $165.9 million for the fourth quarter of 2010.  Net interest margin was 3.20% for the fourth quarter of 2011 and 3.21% for the fourth quarter of 2010.

Average earning assets increased $1.1 billion or 5%.  Average net loans increased $526 million over the fourth quarter of 2010, due primarily to increased commercial and residential mortgage balances, partially offset by decreased consumer and commercial real estate balances.  Available for sale securities increased $333 million, fair value option securities increased $185 million and investment securities increased $101 million.  The growth in average earning assets was funded by a $1.4 billion increase in average demand deposits.  Other borrowings decreased $331 million compared to the fourth quarter of 2010.

The yield on the available for sale securities portfolio decreased 24 basis points to 2.39%.  Low intermediate and long term interest rates continued to increase prepayment speeds.  Cash flows from increased prepayments were reinvested at the current lower rates.  Approximately $875 million that had been yielding 3.10% was reinvested to yield 2.10%.  The loan yield decreased 11 basis points to 4.65% due primarily to changes in market interest rates.  The cost of interest-bearing liabilities was 0.66%, down 15 basis points from the fourth quarter of 2010.  The benefit to net interest margin from earning assets funded by non-interest bearing liabilities was 17 basis points in the fourth quarter of 2011 compared to 16 basis points in the fourth quarter of 2010.

2010 Net Interest Revenue

Tax-equivalent net interest revenue for 2010 was $718.2 million compared with $718.4 million for 2009.  The effect of a $525 million increase in average earning assets was largely offset by a 16 basis point decrease in net interest margin.  The increase in average earning assets was primarily due to a $1.6 billion increase in average available for sale securities partially offset by a $1.2 billion net decrease in loan balances.  Growth in the securities portfolio generally consisted of residential mortgage-backed securities issued by U.S. government agencies.  As shown in Table 3, net interest revenue increased $29 million due to changes in earning assets and interest bearing liabilities and decreased $30 million due to changes in interest yields and rates.  Net interest margin increased to 3.52% in 2010 compared with 3.68% in 2009.  The yield on available for sale securities decreased 141 basis points due to the effect of increased prepayment speeds on premium amortization and cash flow reinvestment.  The cost of interest-bearing liabilities was decreased 36 basis points due primarily to a 53 basis point decrease in deposit rates.

Other operating revenue was $572.3 million for 2011 compared to $520.9 million for 2010.  Fees and commission revenue increased $12.2 million over 2010.  Net gains on securities, derivatives and other assets increased $34.8 million over 2010.  Other-than-temporary impairment charges recognized in earnings for 2011 were $4.3 million less than charges recognized in 2010.

 

Diversified sources of fees and commissions revenue are a significant part of our business strategy and represented 43% of total revenue for 2011, excluding provision for credit losses and gains and losses on asset sales, securities and derivatives.  We believe that a variety of fee revenue sources provide an offset to changes in interest rates, values in the equity markets, commodity prices and consumer spending, all of which can be volatile.  We expect continued growth in other operating revenue through offering new products and services and by expanding into markets outside of Oklahoma.  However, current and future economic conditions, 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 securities trading, retail brokerage, customer derivative and investment banking increased $2.7 million or 3% over 2010.  Securities trading revenue totaled $59.8 million for 2011, up $3.5 million over 2010.  Securities trading revenue represents net realized and unrealized gains primarily related to sales of U.S. government securities, residential mortgage-backed securities guaranteed by U.S. government agencies and municipal securities to institutional customers, activities which we believe will be permitted under the Volcker Rule of the Dodd-Frank Act.  Increased gains from municipal securities were partially offset by decreased gains on U.S. government securities.  In 2010, credit spreads widened on credit concerns related to municipal securities resulting in a decreased volume of municipal securities sold.  Gains on residential mortgage-backed securities guaranteed by U.S. government agencies were flat compared to the prior year.

Revenue earned from retail brokerage transactions increased $4.7 million or 20% over 2010 to $28.2 million.  Retail brokerage revenue is primarily based on fees and commissions earned on sales of fixed income securities, annuities and mutual funds to retail customers.  Revenue growth was primarily due to increased market volatility which increased customer demand.

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 to the Consolidated Financial Statements, we offer commodity, interest rate, foreign exchange and equity derivatives to our customers.  Customer hedging revenue totaled $5.3 million, down $6.4 million compared to the prior year.  The decrease in customer hedging revenue included $4.4 million of credit losses.

Investment banking revenue includes fees earned upon completion of underwriting and financial advisory services which totaled $11.0 million for 2011, a $949 thousand increase over 2010 related to the timing and volume of completed transactions.

We continue to monitor the on-going development of rules to implement the Volcker Rule in Title VI of the Dodd-Frank Act which prohibits banking entities from engaging in proprietary trading as defined by the Dodd-Frank Act and which restricts sponsorship of, or investment in, private equity funds and hedge funds, subject to limited exceptions.  On October 11, 2011, regulators of financial institutions released a proposal for implementation of the Volcker Rule scheduled to take effect by July 21, 2012, subject in some cases to phase-in over time thereafter.  Based on the proposed rules, we expect the Company’s trading activity to be largely unaffected, as our trading activities are all done for the benefit of customers and securities traded are mostly exempted under the proposed rules.  The Company’s private equity investment activity may be curtailed but is not expected to result in a material impact to the Company’s financial statements.  Final regulations will likely impose additional operating and compliance costs as presently proposed.

Title VII of the Dodd-Frank Act subjects nearly all derivative transactions to CFTC or SEC regulations.  Title VII, among other things, imposes registration, recordkeeping, reporting, capital and margin, as well as business conduction requirements on major swap dealers and major swap participants.  The CFTC and SEC have recently delayed the effective dates of a large portion of the proposed regulations under Title VII until December 31, 2012.  The Company currently anticipates that one or more of its subsidiaries may be required to register as a “swap dealer” with the CFTC.  The ultimate impact of Title VII is uncertain, but may pose higher operational and compliance costs on the Company.

Transaction card revenue depends largely on the volume and amount of transactions processed, the number of TransFund automated teller machine (“ATM”) locations and the number of merchants served.  Transaction card revenue increased $4.5 million or 4% over 2010.  Revenues from processing transactions on behalf of the members of our TransFund electronic funds transfer (“EFT”) network totaled $51.1 million, up $2.4 million or 5% over 2010, due primarily to increased transaction volumes.  The number of TransFund ATM locations totaled 1,912 at December 31, 2011 compared to 1,943 at December 31, 2010.  Merchant service fees paid by customers for account management and electronic processing of transactions totaled $34.3 million, a $3.8 million or 13% increase over the prior year primarily as a result of cross-selling opportunities throughout our geographical footprint.

Revenue from interchange fees paid by merchant banks for transactions processed from debit cards issued by the Company totaled $31.4 million for 2011 compared to $33.1 million for 2010.  This decrease was primarily due to the impact of interchange fee regulations which became effective on October 1, 2011, partially offset by increased transaction volumes.  On June 29, 2011, the Federal Reserve Board issued a final rule establishing standards for debit card interchange fees and prohibiting network exclusivity arrangements and routing restrictions as required by the Dodd-Frank Act.  Under the final rule, the maximum permissible interchange fee that an issuer may receive for an electronic debit transaction is the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction.  In addition, the Federal Reserve Board approved an interim rule that allows for an upward adjustment up to 1 cent to an issuer’s debit card interchange fee for fraud prevention as outlined in the interim final rule.  Issuers meeting these standards must certify as to their eligibility to receive this adjustment.  Our experience in the fourth quarter of 2011 was consistent with our previously disclosed expectation of a decline of $20 to $25 million annually in our transaction card revenue based on the final rule.

Trust fees and commissions increased $4.3 million or 6% over 2010 primarily due to an increase in the fair value of trust assets.  We continue to voluntarily waive administration fees on our Cavanal Hill money market funds in order to maintain positive yields on these funds in the current low short-term interest rate environment.  Waived fees totaled $7.3 million for 2011 and $3.7 million for 2010.  The fair value of trust assets administered by the Company totaled $34.2 billion at December 31, 2011, up from $32.8 billion at December 31, 2010.

Deposit service charges and fees declined $7.7 million or 7% compared to 2010.  Overdraft fees declined $7.4 million or 11% to $58.4 million.  The decrease in overdraft fees was primarily due to changes in federal regulations concerning overdraft changes which were effective July 1, 2010.  Commercial account service charge revenue totaled $31.6 million, down $810 thousand compared to the prior year.   Customers continue to maintain high commercial account balances resulting in a high level of earnings credit, a non-cash method for commercial customers to avoid incurring charges for deposit services based on account balances.  Service charge revenue on deposit accounts with a standard monthly fee increased $479 thousand or 9% to $5.9 million.

Mortgage banking revenue was notably strong for both 2011 and 2010.  Low interest rates increased mortgage loan origination activity.  Mortgage banking revenue totaled $91.6 million in 2011 compared to $87.6 million in 2010.  Revenue from originating and marketing mortgage loans increased $2.5 million or 5% over the prior year to $52.0 million.  The spread between primary mortgage rates, the rates offered to borrowers, over secondary rates, the rates required by investors in residential mortgage-backed securities, nearly doubled in 2011 over 2010.  This widened spread significantly increased mortgage loan production revenue.  Mortgage loans originated for sale in the secondary market totaled $2.2 billion in 2011 and $2.5 billion in 2010.  Mortgage loan servicing revenue totaled $39.7 million or 0.35% of loans serviced for others in 2011 and $38.2 million or 0.36% of the average outstanding balance of loans serviced for others in 2010.  The average outstanding balance of loans serviced for others was $11.3 billion for 2011 and $10.7 billion for 2010.

Net gains on securities, derivatives and other assets

We recognized $34.1 million of net gains on sales of $2.7 billion of available for sale securities in 2011 and $21.9 million of net gains on sales of $2.0 billion of available for sale securities in 2010.  Securities were sold either because they had reached their expected maximum potential return or to mitigate exposure to prepayment or extension risk.

We also maintain a portfolio of residential mortgage-backed securities issued by U.S. government agencies and derivative contracts designated as an economic hedge of the changes in fair value of mortgage servicing rights that fluctuates due to changes in prepayment speeds and other assumptions as more fully described in Note 7 to the Consolidated Financial Statements.  Changes in the fair value of these securities are included in Gain (loss) on fair value option securities, net on Table 4.

Lower mortgage interest rates increased loan origination volumes, but also increased prepayments speeds which decreased the value of our mortgage servicing rights.  Table 5 shows the relationship between changes in the fair value of mortgage servicing rights and financial instruments designated as an economic hedge.

Table 5 – Gain (Loss) on Mortgage Servicing Rights, Net of Economic Hedges

(In thousands)

As more fully described in the Note 2 to the Consolidated Financial Statements, we recognized $23.5 million of other-than-temporary impairment losses in 2011 related to certain privately issued residential mortgage-backed securities and municipal securities.  We recognized $27.8 million of other-than-temporary impairment losses in earnings in 2010 related to certain privately issued residential mortgage-backed securities and other equity securities.

Net gain (loss) on other assets is composed primarily of a $5.3 million net gain on two private equity funds we sponsor primarily for our customers; $3.9 million of the gain is allocated to the limited partners of the private equity funds through Net income (loss) attributable to non-controlling interest in the Consolidated Statement of Earnings.

Fourth Quarter 2011 Other Operating Revenue

Other operating revenue for the fourth quarter of 2011 totaled $137.7 million, up $26.1 million over the prior year.  Fees and commission revenue decreased $4.2 million or 3% compared to the fourth quarter of 2010 primarily due to lower interchange fee revenue.  Net gains on securities, derivatives and other assets were up $31.2 million over the fourth quarter of 2010.  Other-than-temporary charges recognized in earnings in the fourth quarter of 2011 were $3.8 million less than charges recognized in the fourth quarter of 2010.

Brokerage and trading revenue decreased $3.0 million or 10% compared to the fourth quarter of 2010.  Securities trading revenue increased $854 thousand.  Increased gains on municipal and U.S. government securities were partially offset by decreased gains on residential mortgage-backed securities guaranteed by U.S. government agencies.  Customer hedging revenue decreased $3.0 million compared to the fourth quarter of 2010 due primarily to decreased revenue from to be announced (“TBA”) residential mortgage-backed securities which are classified as interest rate contracts sold to our mortgage banking customers and a $1.7 million credit loss on unsettled contracts.  Retail brokerage revenue was down $292 thousand and investment banking revenue was down $569 thousand.

Transaction card revenue decreased $3.5 million compared to the previous year.  Check card revenue from interchange fees paid by merchant banks for transactions processed from cards issued by the Company decreased $4.5 million compared to the fourth quarter of 2010, due primarily to the impact of debit card interchange fee regulations which were effective October 1, 2011.  Revenues from the processing of transactions on behalf of members of our TransFund EFT network increased $802 thousand over the fourth quarter of 2010 and merchant services fees paid by customers for account management and electronic processing of transactions increased $139 thousand.

Trust revenue decreased $280 thousand or 2% compared with the fourth quarter of 2010.  The fair value of trust assets was up 4% compared to the prior year.

Deposit service charges and fees for the fourth quarter of 2011 were up $1.2 million or 5% over the fourth quarter of 2010.  Overdraft fees increased $772 thousand or 5%.  Commercial account service charge revenue was flat compared to the fourth quarter of 2010.  Fees on deposit accounts with a monthly service fee increased $405 thousand or 33% over the fourth quarter of 2010.

Mortgage banking revenue for the fourth quarter of 2011 was flat compared to the fourth quarter of 2010.  Mortgage loans funded for sale totaled $753 million in the fourth quarter of 2011 compared to $821 million in the fourth quarter of 2010.

We recognized net gains of $7.1 million on sales of $667 million of available for sale securities in the fourth quarter of 2011 compared to net gains of $953 thousand on sales of $536 million of available for sale securities in the fourth quarter of 2010.

For the fourth quarter of 2011, changes in the fair value of mortgage servicing rights decreased pre-tax net income by $5.3 million, partially offset by a net gain of $343 thousand on fair value option securities and derivative contracts held as an economic hedge.  For the fourth quarter of 2010, changes in the fair value of mortgage servicing rights increased pre-tax net income by $25.1 million, partially offset by an $18.5 million net loss on fair value option securities and derivative contracts held as an economic hedge.

2010 Other Operating Revenue

Other operating revenue totaled $520.9 million for 2010, up $27.9 million over 2009.  Fees and commissions revenue increased $35.9 million partially offset by a $14.6 million decrease in net gains on securities, derivatives and other assets.  Other-than-temporary impairment charges recognized in earnings in 2010 were $6.6 million less than in 2009.  Brokerage and trading revenue increased $9.8 million over 2009.  Customer hedging revenue increased $5 million over 2009 primarily due to energy derivatives.  Investment banking revenue increased $2.3 million and retail brokerage revenue increased $3.0 million.  Securities trading revenue was flat compared to 2009.  Increased lending activity by our mortgage banking customers increased related securities transaction volume in 2010.  This activity was offset by decreased municipal trading activity as credit spreads widened on credit concerns in municipal securities. Transaction card revenue increased $6.8 million over 2009 due to increases in check card revenue and merchant services fees.  Trust fees and commissions increased $2.8 million over 2009 primarily due to growth in the fair value of trust assets, partially offset by lower balances in our proprietary mutual funds.  Deposit service charges decreased $12.2 million compared to 2009 primarily due to changes in federal regulations concerning overdraft charges which were effective July 1, 2010.  Mortgage banking revenue increased $22.6 million or 35% over 2009 primarily due to increased mortgage loan servicing revenue as the result of the Company’s acquisition of rights to service $4.2 billion of residential mortgage loans in the first quarter of 2010.

We recognized $21.9 million of net gains on available for sale securities in 2010 and $59.3 million of net gains on available for sale securities in 2009.  Securities were sold either because they had reached their expected maximum potential return or to mitigate exposure from rising interest rates.  Net gains on fair value option securities held as an economic hedge of mortgage servicing rights were $11.8 million in 2010 and were a net loss of $13.2 million in 2009.  The net gains (losses) on fair value option securities were partially offset by changes in the fair value of the mortgage servicing rights.  The gain (loss) on other assets, net decreased $5.3 million in 2010 due primarily to a $2.7 million decrease in the fair value of our private equity funds; $2.4 million of which was allocated to the limited partners through Net income (loss) attributable to non-controlling interest on the Statement of Earnings.  Other-than-temporary impairment charges recognized in earnings were $6.6 million less than in 2009.

Other Operating Expense

Other operating expense totaled $821.5 million for 2011, up $68.3 million over 2010.  Changes in fair value of mortgage servicing rights increased other operating expenses by $40.4 million in 2011 and decreased other operating expenses by $3.7 million in 2010.  Excluding changes in the fair value of mortgage servicing rights, other operating expense totaled $781.0 million for 2011, up $24.2 million or 3% over 2010.  Personnel expenses increased $28.1 million or 7% over the previous year.  Non-personnel operating expenses decreased $3.9 million or 1% compared to 2010.

 

 

Personnel Expense

Personnel expense totaled $430.0 million for 2011 and $401.9 million for 2010.  Regular compensation, which consists of salaries and wages, overtime pay and temporary personnel costs, totaled $247.9 million, up $9.3 million or 4% over 2010.  The increase in regular compensation was primarily due to an increase in the average regular compensation per full time equivalent employee.  Average staffing levels increased modestly in 2011.

Table 7 – Personnel Expense

(In thousands)

Incentive compensation increased $13.8 million or 13%.  Cash-based incentive compensation is either intended to provide current rewards to employees who generate long-term business opportunities to the Company based on growth in loans, deposits, customer relationships and other measurable metrics or intended to compensate employees with commissions on completed transactions.  Total cash-based incentive compensation for 2011 increased $6.0 million or 7% over the previous year.  Sales commissions related to brokerage and trading revenue increased $1.3 million to $39.1 million and cash-based incentive compensation for other business lines increased $4.7 million to $58.1 million.

The Company also provides stock-based incentive compensation plans.  Stock-based compensation plans include both equity and liability awards.  Compensation expense for equity awards increased $1.7 million over 2010.  Expense for equity awards is based on the grant-date fair value of the awards and is unaffected by subsequent changes in fair value.  Stock-based incentive compensation expense also included deferred compensation that will ultimately be settled in cash indexed to investment performance or changes in earnings per share.

Compensation expense related to liability awards increased $6.1 million over 2010.  Certain executive officers are permitted to defer recognition of taxable income from their stock-based compensation.  Deferred compensation may also be diversified into investments other than BOK Financial common stock.  Compensation expense reflects changes in the market value of BOK Financial common stock and other investments.  The year-end closing market price per share of BOK Financial common stock increased $1.53 during 2011 and $5.88 during 2010.

On April 26, 2011 shareholders approved the BOK Financial Corporation 2011 True-Up Plan.  The True-Up Plan was intended to address inequality in the Executive Incentive Plan which had been approved by shareholders in 2003, as a result of certain peer banks that performed poorly during the most recent economic cycle.  Performance goals for the Executive Incentive Plan are based on the Company’s earnings per share growth compared to peers and business unit performance.  As the economy improves and credit costs normalize, peer banks are expected to experience significant comparative earnings per share percentile increases.  This “bounce-back” effect would have resulted in the unanticipated result of no annual bonuses in years 2011, 2012 and 2013 and the forfeiture of long-term incentive awards for 2010 and 2011 in their entirety, despite BOK Financial’s maintaining strong annual earnings throughout the economic cycle while many peers experienced negative or declining earnings.  The True-Up Plan was designed to allow for adjustment upward or downward of certain executive officers annual and long-term compensation levels based on comparable executives at peer banks with similar earnings per share performance for the years 2006 through 2013.  Compensation is determined by ranking the BOK Financial’s earning per share performance to peer banks and then aligning compensation with the peer bank that most closely relates to the BOK Financial’s earnings per share performance.  Based on currently available information, incremental amounts due under the 2011 True-Up Plan may range from $0 to $34 million.  The final amount due under the 2011 True-Up Plan will be determined as of December 31, 2013 and distributed in 2014.  During 2011, we accrued $9.5 million of additional compensation expense.  Performance measurement through 2013 may be volatile and could result in future adjustments upward or downward to compensation expense.

Employee benefit expense increased $5.1 million or 9% over 2010.  Employee medical insurance costs of $19.8 million increased 2% over the prior year.  The Company self-insures a portion of its employee health care coverage and these costs may be volatile.  Payroll tax expense increased $1.7 million over 2010 to $23.2 million.  Employee retirement plan costs increased $1.1 million over the prior year to $15.4 million.  Pension expenses increased $830 thousand over 2010 to $4.0 million due to changes in the expected return on plan assets and discount rate.

Non-Personnel Operating Expenses

Non-personnel operating expenses, excluding changes in the fair value of mortgage servicing rights, decreased $3.9 million or 1% compared to 2010.  Net losses and operating expenses related to repossessed assets decreased $10.8 million, primarily due to a decrease in net losses from sales and write-downs of repossessed property based on our quarterly reviews of carrying values.  Operating expenses on repossessed assets were flat compared to the prior year.  FDIC insurance expense decreased $7.7 million due primarily to the change to a risk-sensitive assessment based on assets.  Mortgage banking costs were down $5.8 million compared to 2010, due primarily to a decrease in amortization expense of our mortgage servicing rights and decreased provision for foreclosure costs related to mortgage loans serviced for others, partially offset by increased provision for loans sold with recourse.  Data processing and communications expense increased $10.2 million due primarily to higher bank card transaction volume and increased software amortization expense related to recent technology investments.  Other expense increased $5.2 million over 2010 due primarily to accrual for litigation as more fully disclosed in Note 14 to the Consolidated Financial Statements.  The Company also made a $4.0 million discretionary contribution to the BOKF Charitable Foundation which partners with charitable organizations to support needs within our communities.

Fourth Quarter 2011 Operating Expenses

Other operating expense totaled $219.2 million for the fourth quarter of 2011, up $40.8 million over the fourth quarter of 2010.  Changes in the fair value of mortgage servicing rights increased operating expenses by $5.3 million in the fourth quarter of 2011 compared with a reduction in operating expenses of $25.1 million in the fourth quarter of 2010.  Excluding changes in the fair value of mortgage servicing rights, other operating expenses increased $10.5 million or 5%.  Personnel expense increased $14.4 million due largely to the $9.5 million accrual related to the True-Up Plan.  Regular compensation increased $2.1 million and cash-based incentive compensation increased $1.4 million.  Non-personnel expenses decreased $3.9 million compared to the previous year across most non-personnel expense categories.

2010 Operating Expenses

Other operating expense for 2010 totaled $753.2 million, up $56.4 million or 8% increase over 2009.  Changes in the fair value of mortgage servicing rights decreased other operating expenses by $3.7 million in 2010 and decreased other operating expenses by $12.1 million in 2009.  In addition, other operating expenses for 2009 included $11.8 million for the FDIC special assessment.  Excluding those items, other operating expense totaled $756.8 million for 2010, up $59.7 million or 9% over 2009.  Personnel expense increased $21.3 million or 6%.  Non-personnel expenses increased $38.4 million or 12% over 2009 due largely to a $23.1 million increase in losses and operating expenses of repossessed assets.

Regular compensation expense totaled $238.7 million, up $6.8 million, or 3% over 2009 due primarily to an increase in average regular compensation per full time equivalent employee.  Incentive compensation increased $12.8 million or 14% to $104.0 million.  Cash-based incentive compensation for 2010 increased $10.6 million or 13% including a $4.3 million or 13% increase in sales commissions related to brokerage and trading revenue and a $6.3 million increase in cash-based incentive compensation for other lines of business.  Stock-based compensation expense increased $2.2 million.  Liability awards decreased $297 thousand due primarily to changes in the market value of

BOK Financial common stock and other investments.  The year-end closing market price per share of BOK Financial common stock increased $5.88 during 2010.  Compensation expense for equity awards increased $2.5 million over 2009.  Employee benefit expenses increased $1.7 million or 3% over 2009 due primarily to increased employee retirement plan and pension expense.

Net losses and operating expenses of repossessed assets increased $23.1 million over 2009.  Net losses from sales and write-downs of repossessed assets based on our quarterly review of carrying values increased $17.7 million.  Operating expenses on repossessed assets, composed largely of property taxes, increased $5.4 million.  Data processing and communications expense increased $6.5 million due primarily to higher transaction volume and increased software amortization expense.  Other expense increased $11.7 million including a $6.1 million of depreciation expense on equipment we lease to earn tax credits.  The benefit of this leasing activity is largely recognized through reduced federal and state income tax expense.  All other operating expenses decreased $2.8 million or 1% compared to 2009.

Income tax expense was $158.5 million or 35% of book taxable income for 2011, $123.4 million or 33% of book taxable income for 2010 and $106.7 million or 34% of book taxable income for 2009.  Tax expense currently payable totaled $154 million in 2011, $150 million in 2010 and $129 million in 2009.

The statute of limitations expired on an uncertain income tax position and the Company adjusted its current income tax liability to amounts on filed tax returns for 2010 in 2011 and 2009 in 2010.  Excluding these adjustments, income tax expense would have been $160 million or 36% for book taxable income for 2011 and $126 million or 34% of book taxable income for 2010.

The Internal Revenue Service is currently auditing the federal income tax return of BOK Financial for the year ended December 31, 2008.  Management does not anticipate a material impact to the financial statements as a result of the audit.

Net deferred tax assets totaled $38 million at December 31, 2011 and $58 million at December 31, 2010.  The decrease was due primarily to the tax effect of increased bonus depreciation and unrealized gains on available for sale securities.  We have evaluated the recoverability of our net deferred tax asset based on taxes previously paid in net loss carry-back periods and other factors and determined that no valuation allowance was required.

The allowance for uncertain tax positions totaled $12 million at December 31, 2011 and December 31, 2010.  BOK Financial operates in numerous jurisdictions, which requires judgment regarding the allocation of income, expense and earnings under various laws and regulations of each of these taxing jurisdictions.  Each jurisdiction may audit our tax returns and may take different positions with respect to these allocations.

Income tax expense for the fourth quarter of 2011 totaled $37.4 million or 36% of book taxable income compared to $31.1 million or 34% of book taxable income for the fourth quarter of 2010.

Table 8 – Selected Quarterly Financial Data

(In thousands, except per share data)

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 to small businesses, middle market and larger commercial customers.  Commercial banking also includes the TransFund EFT network.  Consumer banking includes retail lending and deposit services and all mortgage banking activities.   Wealth management provides fiduciary services, brokerage and trading, private bank services and investment advisory services in all markets.  Wealth management also originates loans for high net worth clients.

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.  Funds management and other also included the FDIC special assessment charge in 2009.  Regular FDIC insurance assessments are charged to the business units.

We allocate resources and evaluate the performance of our lines of business after allocation of funds, certain indirect expenses, taxes based on statutory rates, actual net credit losses and capital costs. The cost of funds borrowed from the funds management unit by the operating lines of business is transfer priced at rates that approximate market for funds with similar duration.  Market is generally based on the applicable LIBOR or interest rate swap rates, adjusted for prepayment risk.  This method of transfer-pricing funds that support 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 based on swap rates, LIBOR rates and Federal Home Loan Bank advance rates.  Deposit accounts with indeterminate maturities, such as demand deposit accounts and interest-bearing transaction accounts, are transfer-priced at a rolling average based on expected duration of the accounts.  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 our assessment of risk.  This model assigns capital based upon credit, operating, interest rate and 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 9, net income attributed to our lines of business increased $32.1 million or 22% over the prior year.  The increase in net income attributed to our lines of business was due primarily to a $68.7 million decrease in net loans charged off and a $25.4 million increase in other operating revenue, partially offset by a $48.4 million increase in operating expenses attributed to the lines of business.  Net income attributed to Funds management and other increased $7.1 million compared to the prior year.  Less operating expenses were allocated to our lines of business due to a decrease in transaction volumes.   A decrease in gains on securities sold, net of other-than-temporary impairment charges, was partially offset by a decrease in the provision for credit losses.

 

Table 9 – Net Income by Line of Business