BOK Financial - 10-Q quarterly report FY

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

 

 

For the quarterly period ended June 30, 2011

OR

 

 

For the transition period from _____________ to ______________                 

Commission File No. 0-19341

BOK FINANCIAL CORPORATION

 

(918) 588-6000

(Registrant’s telephone number, including area code)

BOK Financial Corporation

Form 10-Q

Quarter Ended June 30, 2011

Index

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

 

BOK Financial Corporation (“the Company”) reported net income of $69.0 million or $1.00 per diluted share for the second quarter of 2011, compared to $63.5 million or $0.93 per diluted share for the second quarter of 2010 and $64.8 million or $0.94 per diluted share for the first quarter of 2011.  Net income for the six months ended June 30, 2011 totaled $133.8 million or $1.95 per diluted share compared with net income of $123.7 million or $1.81 per diluted share for the six months ended June 30, 2010.

Highlights of the second quarter of 2011 included:

The Company and its subsidiary bank exceeded the regulatory definition of well capitalized.  The Company’s Tier 1 capital ratios as defined by banking regulations were 13.30% at June 30, 2011 and 12.97% at March 31, 2011.

Net Interest Revenue and Net Interest Margin

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

Net interest revenue totaled $174.0 million for the second quarter of 2011, compared to $182.1 million for the second quarter of 2010 and $170.6 million for the first quarter of 2011.  The decrease in net interest revenue from the second quarter of 2010 was due primarily to lower yield on our available for sale securities portfolio, partially offset by lower funding costs and an increase in interest earning assets.  The increase in net interest revenue over the first quarter of 2011 results from an increase in interest earning assets.

Net interest margin was 3.40% for the second quarter of 2011, 3.65% for the second quarter of 2010 and 3.47% for the first quarter of 2011.

The tax-equivalent yield on earning assets was 4.01% for the second quarter of 2011, down 24 basis points from the second quarter of 2010.  The available for sale securities portfolio yield decreased 51 basis points to 3.04%.  Cash flows from our available for sale securities portfolio were reinvested at lower current rates.  Loan yields decreased 14 basis points to 4.69%.  Funding costs were down 4 basis points from the second quarter of 2010.  The cost of interest-bearing deposits decreased 16 basis points and the cost of other borrowed funds increased 42 basis points.  The increased cost of other borrowed funds was due to a $115 million increase in our obligation to fund scheduled payments to investors for loans sold into Government National Mortgage Association (“GNMA”) mortgage pools as discussed more fully in the Loans section of Management’s Analysis & Discussion of Financial Condition following.  The weighted average interest rate on this obligation was 5.93%.  We expect to reduce our ongoing interest costs by repurchasing a significant portion of these loans.

Net interest margin decreased 7 basis points from the first quarter of 2011.  Yield on average earning assets decreased 9 basis points to 4.01%.  Yield on the available for sale securities portfolio decreased 13 basis points.  Yield on the loan portfolio decreased 6 basis points.  The cost of interest-bearing liabilities increased 1 basis point from the previous quarter.

Average earning assets for the second quarter of 2011 increased $564 thousand or 3% over second quarter of 2010.  The average balance of available for sale securities, which consist largely of U.S. government agency issued residential mortgage-backed securities, increased $769 million.  We purchased these securities to supplement earnings, especially in a period of declining loan demand, and to manage interest rate risk.  Average loans, net of allowance for loan losses, decreased $269 million.   All major loan categories decreased largely due to reduced customer demand and normal repayment trends.

Average deposits increased $1.7 billion over the second quarter of 2010, including an $897 million increase in average interest-bearing transaction accounts and an $893 million increase in average demand deposit balances.   Average time deposits decreased $69 million compared to the second quarter of 2010.  Average borrowed funds decreased $1.8 billion compared to the second quarter of 2010.

Average earning assets for the second quarter of 2011 increased $354 million over the first quarter of 2011.  Average available for sale securities increased $167 million and mortgage trading securities increased $121 million.  Average outstanding loans, net of allowance for loan losses, increased $31 million.  Average commercial and residential mortgage loan balances increased in second quarter of 2011, offset by a decrease in commercial real estate and consumer loans.  Average deposits decreased by $138 million during the second quarter of 2011, including a $448 million decrease in interest-bearing transaction accounts, partially offset by a $288 million increase in demand deposits and a $15 million increase in time deposits.  Average balances of borrowed funds increased $332 million.

Our overall objective is to manage the Company’s balance sheet to be relatively neutral to changes in interest rates as is further described in the Market Risk section of this report.  Approximately two-thirds 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 manage toward 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.  To the extent that intermediate and longer term interest rates remain at extremely low levels, mortgage-related security prepayments may accelerate putting additional downward pressure on the securities portfolio yield and on net interest margin as discussed above.  We also may use derivative instruments to manage our interest rate risk.  Derivative contracts are carried on the balance sheet at fair value.  Changes in fair value of these contracts are included in derivatives gains or losses in the Consolidated Statements of Earnings.

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

Table 1 – Volume / Rate Analysis

(In thousands)

Other operating revenue was $143.0 million for the second quarter of 2011 compared to $157.4 million for the second quarter of 2010 and $117.6 million for the first quarter of 2011.  Fees and commissions revenue was flat with the second quarter of 2010.  Net gains on securities, derivatives and other assets decreased $12.0 million.  Other-than-temporary impairment charges recognized in earnings in the second quarter of 2011 were $2.2 million greater than charges recognized in the second quarter of 2010.

Other operating revenue increased $25.4 million over the first quarter of 2011.  Fees and commissions revenue increased $4.6 million.  Net gains on securities, derivatives and other assets increased $21.1 million.  Other-than-temporary impairment charges recognized in earnings were $225 thousand less than charges recognized in the first quarter of 2011.

 
 

Table 2 – Other Operating Revenue 

(In thousands)

Certain percentage increases (decreases) in non-fees and commissions revenue are not meaningful for comparison purposes based on the nature of the item.

Fees and commissions revenue

Diversified sources of fees and commissions revenue are a significant part of our business strategy and represented 42% of total revenue for the second quarter of 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, decreased $1.0 million or 4­­% compared to the second quarter of 2010.  Securities trading revenue totaled $13.3 million for the second quarter of 2011 compared to $14.3 million for the second quarter of 2010, down $1.0 million or 7%.   Securities trading revenue represents net realized and unrealized gains

primarily related to U.S. government securities, residential mortgage-backed securities guaranteed by U.S. government agencies and municipal securities sold to institutional customers.  The revenue decrease was largely due to lower residential mortgage-backed securities transaction volume.

Revenue earned from retail brokerage transactions increased $1.8 million or 33% over the second quarter of 2010 to $7.4 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 of the Consolidated Financial Statements, we offer commodity, interest rate, foreign exchange and equity derivatives to our customers.  Customer hedging revenue totaled $1.1 million for the second quarter of 2011, down $933 thousand or 46% compared to the second quarter of 2010.  Energy derivative volume declined due primarily to relatively stable commodity pricing, partially offset by an increase in interest rate derivative transactions.

Investment banking includes fees earned upon completion of underwriting and financial advisory service which totaled $1.9 million for the second quarter of 2011, an $886 thousand decrease compared to the second quarter of 2010 related to the timing and volume of completed transactions.

Brokerage and trading revenue decreased $1.7 million from the first quarter of 2011 due primarily to a decrease in securities trading revenue.  The volume of residential mortgage-backed securities sold to institutional customers decreased, partially offset by increases in municipal securities sales.  Decreases in energy derivative revenues were fully offset by increases in interest rate derivatives revenue.  Investment banking fees decreased compared to the previous quarter, partially offset by an increase in retail brokerage.

We continue to monitor the on-going development of rules to implement the Volcker Rule of the Dodd-Frank Act which prohibits banking entities from engaging in proprietary trading as defined by the Dodd-Frank Act and restricts sponsorship of or investment in private equity funds and hedge funds, subject to limited exceptions.  Regulations implementing the Volcker Rule are scheduled to take effect by the earlier of 12 months after such rules are final or July 21, 2012.  The ultimate impact of the implementation of the Volcker Rule remains uncertain and final regulations possibly could impose additional operational or compliance costs or prohibit certain trading activities on behalf of our customers.

Title VII of the Dodd-Frank Act subjects nearly all derivative transaction to Commodity Futures Trading Commission (“CFTC”) or Securities and Exchange Commission (“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 effectiveness of a large portion of the proposed regulations that would implement Title VII until the earlier of 60 days following the adoption of final rules or December 31, 2011.  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 $2.8 million or 10% over the second quarter of 2010.  Revenues from the processing of transactions on behalf of the members of our TransFund ATM network totaled $12.5 million, an increase of $359 thousand or 3% over the second quarter of 2010, due primarily to increased ATM transaction volumes.  Merchant services fees paid by customers for account management and electronic processing of transactions totaled $9.2 million, a $1.4 million or 18% increase over the prior year primarily as a result of cross-selling opportunities throughout our geographical footprint.  Check card revenue from interchange fees paid by merchant banks for transactions processed from cards issued by the Company increased $976 thousand or 12% to $9.3 million due primarily to an increase in the number of transactions processed.

Transaction card revenue increased $2.6 million over the first quarter of 2011.  Merchant services fees increased by $1.3 million on increased market penetration and growth in number of transactions processed.   Check card and ATM network revenue also increased over the prior quarter.

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 will be the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction.  The rule is effective on October 1, 2011.  In addition, the Board approved an interim rule that allows for an upward adjustment of no more than 1 cent to an issuer’s debit card interchange fee if the issuer develops and implements policies and procedures reasonably designed to achieve the fraud-prevention standards outlined in the interim final rule.  Issuers meeting these standards must certify as to their eligibility to receive this adjustment.  We would expect a decline of $20 million to $24 million in our transaction card revenue annually based on the final rule.

Trust fees and commissions increased $1.4 million or 8% over the second quarter of 2010 primarily due to an increase in the fair value of trust assets, partially offset by lower balances in our proprietary mutual funds.  In addition, we continue to voluntarily waive administration fees on the Cavanal Hill money market funds in order to maintain positive yields on these funds in the current low short-term interest rate environment.  Waived fees totaled $1.6 million for the second quarter of 2011, $1.2 million for the first quarter of 2011 and $816 thousand for the second quarter of 2010.  The fair value of trust assets administered by the Company totaled $33.1 billion at June 30, 2011 compared to $32.0 billion at March 31, 2011 and $29.8 billion at June 30, 2010.  Trust fees and commissions also increased $728 thousand over the first quarter of 2011.

Deposit service charges and fees decreased $4.9 million or 17% compared to the second quarter of 2010.  Overdraft fees decreased $4.5 million or 24% to $14.7 million.  The decrease in overdraft fees was primarily due to changes in federal regulations concerning certain overdraft charges which were effective July 1, 2010.  Commercial account service charge revenue totaled $7.3 million, down 1% from the prior year.  Customers continue to maintain high commercial account balances to maximize the earnings credit, a non-cash method for commercial customers to avoid incurring charges for deposit services based on account balances.  Service charges on retail deposit accounts decreased modestly to $1.4 million for the second quarter of 2011.

Deposit service charges and fees increased $1.4 million over the prior quarter primarily due a seasonal increase in overdraft charges of $1.6 million over the first quarter of 2011.  Overdraft volumes historically are lower in the first quarter of the year.

Net gains on securities, derivatives and other assets

We recognized $5.5 million of net gains on sales of $654 million of available for sale securities in the second quarter of 2011.  Securities were sold either because they had reached their expected maximum potential return or to mitigate exposure from rising interest rates.  We recognized $8.5 million of gains on sales of $595 million of available for sale securities in the second quarter of 2010 and $4.9 million of net gains on sales of $793 million of available for sale securities in the first quarter of 2011.

We also maintain a portfolio of residential mortgage backed securities issued by U.S. government agencies and interest rate derivative contracts designated as an economic hedge of the changes in the fair value of our mortgage servicing rights.  The fair value of our mortgage servicing rights fluctuate due to changes in prepayment speeds and other assumptions as more fully described in Note 5 to the Consolidated Financial Statements.  As benchmark mortgage rates increase, prepayment speeds slow and the value of our mortgage servicing rights increase.  As benchmark mortgage rates fall, prepayment speeds increase and the value of our mortgage servicing rights decrease.

Table 4 – Gain (Loss) on Mortgage Servicing Rights

(In thousands)

As more fully discussed in Note 2 to the Consolidated Financial Statements, we recognized other-than-temporary impairment losses on certain private-label residential mortgage-backed securities of $4.3 million in earnings during the second quarter of 2011.  These losses primarily related to additional declines in projected cash flows of private-label mortgage backed securities as a result of increased home price depreciation.  We also recognized a $521 thousand other-than-temporary impairment on certain below investment grade municipal securities based on our assessment of the issuer’s on-going financial difficulties.  We recognized other-than-temporary impairment losses in earnings of $2.6 million in the second quarter of 2010 and $4.6 million in the first quarter of 2011.

Other Operating Expense

Other operating expense for the second quarter of 2011 totaled $203.2 million, down $2.7 million or 1% compared to the second quarter of 2010.  Changes in the fair value of mortgage servicing rights increased operating expense $13.5 million in the second quarter of 2011 and $19.5 million in the second quarter of 2010.  Excluding changes in the fair value of mortgage servicing rights, operating expenses were up $3.3 million or 2% over the second quarter of 2010.  Personnel expenses increased $8.5 million or 9%.  Non-personnel expenses decreased $5.3 million or 6%.

Excluding changes in the fair value of mortgage servicing rights, operating expenses were up $8.1 million over the previous quarter.  Personnel expenses increased $5.6 million and non-personnel expenses increased $2.5 million.

Table 5 – Other Operating Expense

(In thousands)

Certain percentage increases (decreases) are not meaningful for comparison purposes.

Personnel expense

Regular compensation, which consists of salaries and wages, overtime pay and temporary personnel costs increased $2.4 million or 4% over the second quarter of 2010 primarily due to standard annual merit increases which were effective in the second quarter of 2011.  The Company generally awards annual merit increases effective April 1st for a majority of its staff.

Incentive compensation increased $4.1 million over the second quarter of 2010.  Cash-based incentive compensation plans are 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 increased $1.4 million over the second quarter of 2010.  Cash-based incentive compensation related to brokerage and

trading revenue was flat with the prior year.  The increase in cash-based incentive compensation was primarily for other business lines.

The Company also provides stock-based incentive compensation plans.  Stock-based compensation plans include both equity and liability awards.  Compensation expense related to liability awards increased $2.4 million over the second quarter of 2010 due to changes in the market value of BOK Financial common stock and other investments.  The market value of BOK Financial common stock increased $3.09 per share in the second quarter of 2011 and decreased $4.97 per share in the second quarter of 2010.  Compensation expense for equity awards increased $288 thousand compared with the second quarter of 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.

Employee benefit expense increased $2.0 million or 13% over the second quarter of 2010 primarily due to increased expenses related to employee medical insurance costs, employee retirement plans and payroll taxes.  Medical insurance costs were $1.0 million or 23% higher than the second quarter of 2010.  The Company self-insures a portion of its employee health care coverage and these costs may be volatile.

Personnel expense increased $5.6 million over the first quarter of 2011 primarily due to higher incentive compensation expense and employee benefits expense.  Incentive compensation increased $3.7 million over the first quarter of 2011, including a $4.0 million increase in cash-based incentive compensation, partially offset by a $309 thousand decrease in stock-based compensation.  Employee benefit expenses increased $1.4 million over the first quarter of 2011.  Increased expenses related to employee medical insurance costs and retirement plans in the second quarter of 2011 were partially offset by the impact of a seasonal increase in payroll taxes in the first quarter of 2011.  Regular compensation expense increased $576 thousand over the first quarter of 2011.

Non-personnel operating expenses

Non-personnel operating expenses, excluding changes in the fair value of mortgage servicing rights, decreased $5.3 million or 6% compared to the second quarter of 2010.  Net losses and operating expenses on repossessed assets decreased $7.2 million primarily due to a decrease in net writedowns of repossessed assets.  Mortgage banking costs decreased $1.4 million.  Expense related to actual prepayments of mortgage loans serviced for others decreased $2.4 million.  Provisions for foreclosure costs and losses on loan sold with recourse increased $959 thousand.  Data processing and communication expenses increased $2.5 million due primarily to increased transaction card activity.

Non-personnel operating expenses, excluding changes in the fair value of mortgage servicing rights, increased $2.5 million over the first quarter of 2011.  Mortgage banking costs increased $2.5 million over the first quarter of 2011.  Mortgage banking expenses increased $2.5 million primarily due to a $2.7 million increase in the provisions for losses on loans sold with recourse and foreclosure costs on loans serviced for others.  Data processing and communications expense increased $2.0 million primarily due to increased transaction card activity.  FDIC insurance expense decreased $1.5 million based on the estimated impact of a change from an assessment based on deposit balances to an assessment based on consolidated assets minus average tangible equity.

 
 

Income Taxes

Income tax expense was $39.4 million or 36% of book taxable income for the second quarter of 2011 compared to $32.0 million or 33% of book taxable income for the second quarter of 2010 and $38.8 million or 37% of book taxable income for the first quarter of 2011.  The increase in the effective tax rate over the second quarter of 2010 was due to higher state income taxes and reduced utilization of income tax credits.

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.    The reserve for uncertain tax positions was $13 million at June 30, 2011, $12 million at December 31, 2010 and $13 million at June 30, 2010.

Lines of Business

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 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.

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 rates 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 also based on rates which approximate wholesale market rates for funds with similar duration and re-pricing characteristics.  Market rates are generally based on LIBOR or interest rate swap rates.  The funds credit formula applied to deposit products with indeterminate maturities is established based on their re-pricing characteristics reflected in a combination of the short-term LIBOR rate and a moving average of an intermediate term swap rate, with an appropriate spread applied to both.  Shorter duration products are weighted towards the short term LIBOR rate and longer duration products are weighted towards the intermediate swap rates.  The expected duration ranges from 30 days for certain rate-sensitive deposits to five years.

Economic capital is assigned to the business units by a capital allocation model that reflects management’s assessment of risk.  This model assigns capital based upon credit, operating, interest rate and 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 6, net income attributable to our lines of business increased $16 million over the second quarter of 2010.   The increase in net income attributed to our lines of business was due primarily to a decrease in net loans charged off compared to the second quarter of 2010.  Net income attributed to funds management and other decreased compared to the second quarter of 2010 primarily due to a decrease in net interest revenue earned by and operating expenses attributed to the funds management unit, partially offset by a decrease in the loan loss provision in excess of charge-offs to the business lines.

Table 6 – Net Income by Line of Business

(In thousands)

Commercial Banking

Commercial banking contributed $32 million to consolidated net income in the second quarter of 2011, up $19 million over the second quarter of 2010.  Net loans charged-off decreased $18 million.  In addition, losses on repossessed assets decreased and net interest revenue increased.

The Company has focused on development of banking services for small business.  As part of this initiative, small business banking activities were transferred to the Commercial Banking segment from the Consumer Banking segment in the second quarter of 2011.  This transfer increased Commercial Banking net income by $2.5 million.    Net interest revenue increased $4.0 million.  Average deposits increased $672 million and average loans increased $21 million primarily due to the transfer of these balances from the Consumer Banking segment.  Other operating revenue increased $2.0 million mostly offset by increased operating expenses.

Table 7 – Commercial Banking

(Dollars in thousands)

Net interest revenue increased $6.4 million or 9% over the second quarter of 2010 primarily due to a $1.9 billion increase in average deposits attributed to commercial banking, including small business banking deposits transferred from the Consumer Banking segment.  Additionally, loan yields improved over the second quarter of 2010.

Other operating revenue increased $2.6 million or 8% over the second quarter of 2010 primarily related to additional service charge revenue from the transfer of the small business banking activities.  Transaction card revenue also increased due to increased customer activity.  Energy derivative trading revenue and loan syndication fees decreased on lower transaction volume.

Operating expenses increased $4.0 million or 8% over the second quarter of 2010 primarily due to increased data processing costs related to higher transaction card volumes, increased personnel costs as a result of annual merit increases and higher corporate expense allocations related to the transfer of small business banking operations.

The average outstanding balance of loans attributed to commercial banking was $8.2 billion for the second quarter of 2011, largely unchanged from the second quarter of 2010.  See the Loans section of Management’s Analysis and Discussion of Financial Condition following for additional discussion of changes in commercial and commercial real

estate loans which are primarily attributed to the commercial banking segment.  Net commercial banking loans charged off decreased $17.8 million compared to the second quarter of 2010 to $4.7 million or 0.23% of average loans attributed to this line of business on an annualized basis.  The decrease in net loans charged off was primarily due to a decrease in losses on commercial real estate loans.

 
 

Average deposits attributed to commercial banking were $7.8 billion for the second quarter of 2011, up $1.9 billion or 32% over the second quarter of 2010, including $672 million related to the transfer of small business banking activities.  Average balances attributed to our commercial & industrial loan customers increased $657 million or 32%, average treasury services deposit balances increased $364 million or 23% and average balances attributed to our energy customers increased $154 million or 23%.  We believe that commercial customers continue to retain large cash reserves primarily due to continued economic uncertainty.

Consumer Banking

Consumer banking services are provided through five primary distribution channels:  traditional branches, supermarket branches, the 24-hour ExpressBank call center, internet banking and mobile banking.

Consumer banking contributed $6.8 million to consolidated net income for the second quarter of 2011, a decrease of $2.1 million compared to the second quarter of 2010.  The change in fair value of our mortgage servicing rights, net of economic hedge decreased net income attributed to consumer banking by $2.3 million in the second quarter of 2011 and increased net income attributed to consumer banking by $3.0 million in the second quarter of 2010.  Changes in the fair value of mortgage servicing rights and securities held as an economic hedge are due to movements in interest rates, actual and anticipated loan prepayment speeds and related factors.  Decreased net charge-offs and lower operating expenses were partially offset by a decrease in other operating revenue and net interest revenue, primarily due to the transfer of small business banking activities to the Commercial Banking segment.

Table 8 – Consumer Banking

(Dollars in thousands)

Net interest revenue from consumer banking activities decreased $4.0 million or 12% compared to the second quarter of 2010 primarily due to the transfer of certain small business demand deposit balances to the Commercial Banking segment.  Average loans balances also decreased $96 million primarily due to the continued paydown of indirect automobile loans.  The Company previously disclosed its decision to exit the indirect automobile loan business in the first quarter of 2009.

Other operating revenue was down $4.1 million compared to the second quarter of 2010.  Deposit service charges decreased $6.8 million primarily due to lower overdraft fees as a result of changes in banking regulations that became effective in the third quarter of 2010.  Transaction card revenues increased $1.0 million on higher transaction volume.  Mortgage banking revenue increased $1.0 million on increased gains on mortgage loans sold in the secondary market.

Operating expenses decreased $3.5 million or 6% compared to the second quarter of 2010.  Mortgage banking expenses decreased due to lower provision for foreclosure costs on loans serviced for others.  Decreased corporate expense allocations related to the transfer of small business banking operations to the commercial banking segment were partially offset by increased personnel costs related to increased mortgage activity.

Net loans charged off by the consumer banking unit decreased $6.9 million compared to the second quarter of 2010.  Net consumer banking charge-offs include residential mortgage loans, indirect automobile loans, overdrawn deposit accounts and other direct consumer loans.

Average consumer deposits decreased $454 million or 7% compared to the second quarter of 2010 primarily due to the transfer of small business banking to the Commercial Banking segment.  Average demand deposits decreased $276 million or 32%, average time deposits decreased $149 million or 6% and average interest-bearing transaction accounts decreased $52 million or 4%.

Our Consumer Banking division originates, markets and services conventional and government-sponsored mortgage loans for all of our geographical markets.  We funded $533 million of mortgage loans in the second quarter of 2011 and $541 million in the second quarter of 2010.  Approximately 45% of our mortgage loans funded were in the Oklahoma market, 14% in the Colorado market, and 12% in the Texas market.  In addition to the $11.3 billion of mortgage loans serviced for others, the Consumer Banking division also services $833 million of loans for affiliated entities.  Approximately 93% of the mortgage loans serviced were to borrowers in our primary geographical market areas.  Mortgage servicing revenue increased $382 thousand or 4% over the second quarter of 2010 to $10.0 million.

Wealth Management

Wealth Management contributed consolidated net income of $3.4 million in second quarter of 2011 compared to $3.6 million in second quarter of 2010.

Table 9 – Wealth Management

(Dollars in thousands)

Net interest revenue for the second quarter of 2011 was flat with the second quarter of 2010.   Average loan balances were down $139 million.  Average deposit balances were up $297 million.  Loan yield decreased largely offset by decreased funding costs related to deposits.

Other operating revenue was up $679 thousand or 2% over the second quarter of 2010, primarily due to a $1.4 million or 8% increase in trust fees primarily due to increases in the fair value of trust assets.  This increase was partially offset by a decrease in brokerage and trading revenues.

Other operating revenue includes fees earned from state and municipal bond underwriting and financial advisory services, primarily in the Oklahoma and Texas markets.  In the second quarter of 2011, the Wealth Management division participated in 60 underwritings that totaled $2.4 billion.  As a participant, the Wealth Management division was responsible for facilitating the sale of approximately $1.8 billion of these underwritings.  In the second quarter of 2010, the Wealth Management division participated in 27 underwritings that totaled approximately $1.4 billion. Our interest in these underwritings totaled approximately $363 million.

Geographical Market Distribution

The Company secondarily evaluates performance by primary geographical market.  Loans are generally attributed to geographical markets based on the location of the customer and may not reflect the location of the underlying collateral.  Brokered deposits and other wholesale funds are not attributed to a geographical market.  Funds management and other also includes insignificant results of operations in locations outside our primary geographic regions.

Table 10 – Net Income by Geographic Region

(In thousands)

Oklahoma Market

Our Oklahoma offices are located primarily in the Tulsa and Oklahoma City metropolitan areas.  Oklahoma is a significant market to the Company, representing 48% of our average loans, 55% of our average deposits and 41% of our consolidated net income in the second quarter of 2011.  In addition, all of our mortgage servicing activity, TransFund network and 73% of our trust assets are attributed to the Oklahoma market.

Table 11 – Oklahoma

(Dollars in thousands)

Net income generated in the Oklahoma market in the second quarter of 2011 increased $3.8 million or 15% over the second quarter of 2010.   Net loans charged off decreased $18 million compared to the second quarter of 2010 partially offset by a $4.3 million decrease in other operating revenue.  Change in the fair value of the mortgage servicing rights, net of economic hedge, decreased pre-tax net income by $2.3 million for the second quarter of 2011 and increased pre-tax net income by $3.0 million in the second quarter of 2010.

Net interest revenue was flat with the second quarter of 2010.  Average loan balances decreased $323 million.  The favorable net interest impact of the $989 million increase in average deposit balances was partially offset by lower yield on funds sold to the funds management unit.

Other operating revenue decreased $4.3 million or 5% compared to the second quarter of 2010 in almost all revenue categories.  Deposit service charges decreased $3.7 million primarily due to a decline in overdraft fees as a result of changes in banking regulations that became effective in the third quarter of 2010.  Mortgage banking revenue decreased $2.6 million compared to the second quarter of 2010 primarily due to decreased volume of mortgage originations.  Brokerage and trading revenue decreased $934 thousand.  These decreases were partially offset by a $1.9 million increase in transaction card revenue on increased transaction volume.

Other operating expenses increased $1.3 million or 1% over the prior year.  Personnel expenses increased $2.6 million primarily due to annual merit increases partially offset by a $1.3 million decrease in non-personnel expenses primarily due to decreased corporate expense allocations.  Lower provision for foreclosure costs of loans serviced for others was offset by increased data processing and communications expenses related to increased transaction card activity.

Net loans charged off decreased to $1.9 million or 0.15% of average loans on an annualized basis for second quarter of 2011 compared with $20.1 million or 1.47% of average loans on an annualized basis for the second quarter of 2010.

Average deposits in the Oklahoma market for the second quarter of 2011 increased $989 million over the second quarter of 2010, primarily due to an increase in average commercial deposit balances.  Deposits related to commercial and industrial customers, treasury services and energy customers all increased over the prior year.  Wealth management deposits increased over the prior year primarily due to increases in the private banking and broker/dealer units, partially offset by a decrease in trust deposits.  Consumer banking deposits decreased and commercial deposits increased compared to the prior year primarily due to the transfer of small business banking activities from the Consumer Banking segment to the Commercial banking segment.

Texas Market

Our Texas offices are located primarily in the Dallas, Fort Worth and Houston metropolitan areas.  Texas is our second largest market with 32% of our average loans, 24% of our average deposits and 15% of our consolidated net income in the second quarter of 2011.

Table 12 – Texas

(Dollars in thousands)

Net income in the Texas market increased $3.2 million or 47% over the second quarter of 2010 primarily due to a decrease in net loans charged off.

Net interest revenue increased $790 thousand or 2% over the second quarter of 2010.  Average assets increased due primarily to a $424 million or 11% increase in deposits which were sold to the funds management unit.  Average outstanding loans grew by $39 million or 1% over the second quarter of 2010.

Other operating revenue increased $830 thousand or 6% over the second quarter of 2010.  Trust fees and commissions, mortgage banking revenue, transaction card revenue and trading and brokerage fees all increased over the prior year.  Deposit service charges decreased $843 million due primarily to lower overdraft fees as a result of changes in banking regulation that became effective in the third quarter of 2010.

Operating expenses increased $704 thousand or 2% over the second quarter of 2010.  Personnel costs increased primarily due to annual merit increases.  Non-personnel expenses increased, partially offset by decreased corporate expense allocations.

Net loans charged off totaled $850 thousand or 0.10% of average loans for the second quarter of 2011 on an annualized basis, down from $4.9 million or 0.58% of average loans for the second quarter of 2010 on an annualized basis.

Other Markets

Net income attributable to our New Mexico market decreased $103 thousand compared to the second quarter of 2010 to $2.7 million or 4% of consolidated net income.  Net interest income increased $341 thousand or 4% over the second quarter of 2010.  Increased net interest earned due to a $35 million increase in average deposits was partially offset by lower yields earned on funds sold to the funds management unit.  Operating revenues increased $730 thousand or 12% over the second quarter of 2010 primarily due to increased mortgage revenue and transaction card revenues, partially offset by lower overdraft fees.  Net charge-offs totaled $706 thousand or 0.40% of average loans on an annualized basis in the second quarter of 2011 compared to $366 thousand or 0.20% of average loans on an annualized basis in the second quarter of 2010.

We experienced a net loss of $34 thousand in the second quarter of 2011 in the Arkansas market compared to net income of $128 thousand for the second quarter of 2010.  Net interest revenue decreased $460 thousand primarily due to a $65 million decrease in average loans.  Loans in the Arkansas market continue to decrease due to the run-off of indirect automobile loans.  Average deposits in our Arkansas market were up $17 million or 10% over the second quarter of 2010 due primarily to increased commercial banking deposits, partially offset by decreases in consumer and wealth management deposits.  Other operating revenue decreased $565 thousand primarily due to decreased securities trading revenue at our Little Rock office.  Mortgage banking revenue also increased over the second quarter of 2010.  Other operating expenses decreased $789 thousand.  Incentive compensation costs primarily related to trading activity decreased by $1.0 million partially offset by decreased corporate cost allocations.  Net loans charged off totaled $2.2 million or 3.27% of average loans on an annualized basis compared to $2.2 million or 2.63% on an annualized basis in the second quarter of 2010.

Net income attributed to our Colorado market increased to $1.4 million compared to a net loss of $171 thousand in the second quarter of 2010.  Net loans charged off decreased $1.7 million compared to the second quarter of 2010 to $1.7 million or 0.89% on an annualized basis. Net loans charged off in the second quarter of 2010 totaled $3.4 million or 1.76% of loans on an annualized basis.  Other operating revenue increased $208 thousand over the second quarter of 2010, primarily due to increased mortgage banking revenue offset by a decrease in brokerage and trading revenue and decreased overdraft charges.  Operating expenses were flat with the prior year.  Average deposits attributable to the Colorado market increased $158 million or 14% over the second quarter of 2010 primarily related to an increase in commercial and wealth management deposits, partially offset by a decrease in consumer deposits.

The net loss attributed to the Arizona market continued to improve, totaling $898 thousand for the second quarter of 2011 compared to $8.9 million in the second quarter of 2010.  Net interest revenue increased $1.5 million or 55% over the prior year.  Average loans balances grew $71 million or 14% over the prior year and average deposits increased $58 million or 28%.  Growth was primarily related to commercial loans and deposits.  Net loans charged off in the second quarter of 2011 continued to improve as well, totaling $1.5 million or 1.04% of average loans on an annualized basis compared to $4.9 million or 3.88% of average loans on an annualized basis.  Net losses on repossessed assets were $449 thousand compared to net losses on repossessed assets of $8.0 million in the second quarter of 2010.

 
 

We continue to focus on growth in commercial and small business lending in the Arizona market and have significantly scaled back commercial real estate lending activities which were not contemplated in our initial expansion into this market.  Loan and repossessed asset losses are largely due to commercial real estate lending.  Growth was primarily related to commercial loans and deposits.  Assets attributable to the Arizona market included

$16 million of goodwill that may be impaired in future periods if our commercial and small business lending growth plans are unsuccessful.

Net income attributed to the Kansas / Missouri market decreased by $187 thousand compared to the second quarter of 2010.  Net interest revenue increased $489 thousand or 22%.  Average loan balances increased $72 million or 25% over the second quarter of 2010 and average deposits balances were up $55 million or 25% over the prior year.  Operating revenue was flat with the prior year and operating expense increased $805 thousand on increased corporate expense allocations, personnel expenses, and data processing expenses.

Table 13 – New Mexico

(Dollars in thousands)