BOK Financial - 10-Q quarterly report FY2012 Q1

Washington, D.C. 20549

(Mark One)

 

 

For the quarterly period ended March 31, 2012

OR

 

 

For the transition period from _____________ to ______________

Commission File No. 0-19341

 

 

(918) 588-6000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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 ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x        Accelerated filer ¨                                                                                                Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

,

,Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 68,116,893 shares of common stock ($.00006 par value) as of March 31, 2012.

BOK Financial Corporation

Form 10-Q

Quarter Ended March 31, 2012

Index

 

 

Performance Summary

BOK Financial Corporation (“the Company”) reported net income of $83.6 million or $1.22 per diluted share for the first quarter of 2012, compared to $64.8 million or $0.94 per diluted share for the first quarter of 2011 and $67.0 million or $0.98 per diluted share for the fourth quarter of 2011.

Highlights of the first quarter of 2012 included:

 

Results of Operations

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 $173.6 million for the first quarter of 2012 compared to $170.6 million for the first quarter 2011 and $171.5 million for the fourth quarter of 2011. Net interest margin was 3.19% for the first quarter of 2012, 3.47% for the first quarter of 2011 and 3.20% for the fourth quarter of 2011.

The tax-equivalent yield on earning assets was 3.64% for the first quarter of 2012, down 46 basis points from the first quarter of 2011. The available for sale securities portfolio yield decreased 67 basis points to 2.50%. Cash flows from these securities were then reinvested at current lower rates. In addition, loan yields decreased 25 basis points to 4.50% due to a combination of narrowing credit spreads and changes in market interest rates. Funding costs were down 17 basis points compared to the first quarter of 2011. Interest-bearing deposits decreased 17 basis points and the cost of other borrowed funds decreased 12 basis points. The benefit to net interest margin from earning assets funded by non-interest bearing liabilities was 18 basis points in the first quarter of 2012 compared to 17 basis points in the first quarter of 2011.

Average earning assets for the first quarter of 2012 increased $1.7 billion or 8% over first quarter of 2011. Average loans, net of allowance for loan losses, increased $826 million primarily due to growth in average commercial and residential mortgage loans. The average balance of available for sale securities, which consist largely of U.S. government agency issued residential mortgage-backed securities, increased $571 million. We purchased these securities to supplement earnings, especially in a period of declining loan demand, and to manage interest rate risk.

Average deposits increased $937 million over the first quarter of 2011, including a $1.6 billion increase in average demand deposit balances, partially offset by a $371 million decrease in average time deposits and a $313 million decrease in average interest-bearing transaction accounts. Average borrowed funds increased $565 million compared over the first quarter of 2011.

Net interest margin decreased 1 basis point from the fourth quarter of 2011. Yield on average earning assets decreased 5 basis points to 3.64%. Yield on the available for sale securities portfolio increased 12 basis points due to slower prepayment speeds on residential mortgage-backed securities which reduced premium amortization. Yield on the loan portfolio decreased 15 basis points. The cost of interest-bearing liabilities decreased 3 basis points compared to the previous quarter.

Average earning assets were up $192 million over the fourth quarter of 2011. Average outstanding loans, net of allowance for loan losses, increased $298 million due largely to growth in average commercial loan balances. Average fair value option securities decreased $105 million and available for sale securities were essentially flat compared to the prior quarter. Average deposits increased by $85 million during the first quarter of 2012, including a $259 million increase in demand deposits and a $43 million increase in interest-bearing transaction accounts, partially offset by a $239 million decrease in time deposits. The average balances of borrowed funds increased $119 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. We also may use derivative instruments to manage our interest rate risk.

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

 

Table 1 – Volume / Rate Analysis

(In thousands)

Other Operating Revenue

Other operating revenue was $140.4 million for the first quarter of 2012 compared to $117.6 million for the first quarter of 2011 and $138.0 million for the fourth quarter of 2011. Fees and commissions revenue increased $21.1 million over the first quarter of 2011. Net gains on securities, derivatives and other assets increased $1.7 million. Other-than-temporary impairment charges recognized in earnings in the first quarter of 2012 were $877 thousand less than charges recognized in the first quarter of 2011.

Other operating revenue increased $2.4 million over the fourth quarter of 2011. Fees and commissions revenue increased $12.5 million. Net gains on securities, derivatives and other assets decreased $10.2 million. Other-than-temporary impairment charges recognized in earnings were $938 thousand more than charges recognized in the fourth 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 45% of total revenue for the first quarter of 2012, excluding provision for credit losses and gains and losses on other assets, 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 includes revenues from securities trading, retail brokerage, customer derivatives and investment banking. Brokerage and trading revenue increased $5.7 million or 23% over the first quarter of 2011. Securities trading revenue totaled $15.9 million for the first quarter of 2012, up $1.3 million over the first quarter of 2011. 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.

 

 

Revenue earned from retail brokerage transactions increased $446 thousand or 6% over the first quarter of 2011 to $7.6 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 $4.6 million for the first quarter of 2012, up $3.5 million over the first quarter of 2011. Customer hedging revenue in the first quarter of 2011 was reduced by a $2.6 million credit loss on certain interest rate derivative contracts. Revenue from to be announced (“TBA”) residential mortgage backed securities which are classified as interest rate derivative contracts sold to our mortgage banking customers increased $1.6 million over the first quarter of 2011, excluding last year’s credit loss. Revenue from energy derivative contracts decreased $1.2 million compared to the first quarter of 2011.

Investment banking includes fees earned upon completion of underwriting and financial advisory service which totaled $3.0 million for the first quarter of 2012, a $486 thousand increase over the first quarter of 2011 related to the timing and volume of completed transactions.

Brokerage and trading revenue increased $5.5 million over the fourth quarter of 2011. Customer derivative revenues increased $4.9 million including the effect of a $1.7 million credit loss on unsettled contracts with MF Global recognized in the fourth quarter. Revenues from TBA securities sold to our mortgage banking customers were up $2.4 million. Retail brokerage fees were up $1.3 million over the fourth quarter of 2011, partially offset by a $598 thousand decrease in investment banking revenues. Securities trading revenue was largely unchanged compared to the fourth quarter of 2011.

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. On April 19, 2012 the Federal Reserve Board issued a statement clarifying that banking entities have until July 21, 2014 (two years from the July 21, 2012 effective date of the Volcker Rule) to conform all of their activities and investments to the requirements of the Volcker Rule. During this two year conformance period, banking entities are required to engage in good faith planning efforts, to enable them to conform their activities and investments to Volcker Rule requirements. 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 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 swap dealers and major swap participants. The CFTC and SEC delayed the effective dates of a large portion of the proposed regulations under Title VII until December 31, 2012. On April 18, 2012, the CFTC and SEC both approved interim final rules on the definition of swaps dealers. The interim final rule has not yet been made publicly available by the CFTC and the SEC. Based on summaries of the interim final rule issued by the Commissions, however, we currently understand that the interim final rule provides that entities transacting less than $8 billion in swaps over a 12 month period, or a de minimis volume, will be exempt from the definition of swaps dealer, that swaps entered into for hedging purposes or in connection with originating a loan will not be considered dealing activity, and that the rule allows for “limited purpose” swap dealers, subject to registration and regulation as swap dealers only for specified categories of swaps. If these descriptions of the interim final rule are accurate, if the interim final rule does not contain other provisions that would negate or limit the foregoing elements of the rule, and if the interim final rule goes into effect as approved by the Commissions, then the Company anticipates that one or more of its subsidiaries may be required to register as a “limited purpose swap dealer” by December 31, 2012 with the CFTC, and that, though the ultimate impact of Title VII remains uncertain, its full implementation is likely not to impose significantly higher 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 for the first quarter of 2012 decreased $3.0 million or 11% compared to the first quarter of 2011. Revenues from the processing of

 

 

 

transactions on behalf of the members of our TransFund electronic funds transfer (“EFT”) network totaled $13.3 million, up $1.3 million or 11% over the first quarter of 2011, due primarily to increased transaction volumes. Merchant services fees paid by customers for account management and electronic processing of transactions totaled $7.9 million, largely unchanged compared to the prior year.

Revenue from interchange fees paid by merchant banks for transactions processed from debit cards issued by the Company totaled $4.2 million for the first quarter of 2012 compared to $8.6 million for the first quarter of 2011. This decrease was primarily due to the impact of interchange fee regulations, commonly referred to as the Durbin Amendment, which became effective on October 1, 2011, partially offset by increased transaction volumes. Our experience in the first quarter of 2012 was consistent with our previously disclosed expectation of a decline of $20 million to $25 million annually in our transaction card revenue based on the final rule.

Transaction card revenue decreased $530 thousand compared to the fourth quarter of 2011. Revenues from processing transactions on behalf of members of our TransFund EFT network decreased $468 thousand, merchant services fees decreased $121 thousand and revenue from interchange fees paid by merchant banks for transactions processed from debit cards issued by the Company increased $59 thousand.

Trust fees and commissions totaled $18.4 million, consistent with the first quarter of 2011. 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 $2.6 million for the first quarter of 2012, $1.2 million for the first quarter of 2011 and $2.4 million for the fourth quarter of 2011. The fair value of trust assets administered by the Company totaled $35.1 billion at March 31, 2012, $32.0 billion at March 31, 2011 and $34.4 billion at December 31, 2011. Trust fees and commissions increased $573 thousand over the fourth quarter of 2011 primarily due to an increase in the fair value of trust assets and the timing of fees.

Deposit service charges and fees increased $1.9 million or 8% over the first quarter of 2011. Commercial account service charge revenue totaled $8.5 million, up $1.3 million or 17% over the prior year. The average earnings credit, a non-cash method for commercial customers to avoid incurring charges for deposit services based on account balances, decreased 25 basis points compared to the prior year consistent with the movement in market interest rates. Overdraft fees totaled $13.5 million for the first quarter of 2012, up $478 thousand or 4% over the first quarter of 2011. Service charges on deposit accounts with a standard monthly fee increased $187 thousand or 13% to $1.6 million.

Deposit service charges and fees were down $542 thousand compared to the previous quarter. Overdraft fees were down $1.9 million, partially offset by a $1.3 million increase in commercial account service charges. Service charges on deposit accounts with a standard monthly fee were flat compared to the fourth quarter of 2011.

Mortgage banking revenue grew by $15.7 million over the first quarter of 2011. Revenue from originating and marketing residential mortgage loans totaled $23.1 million, up $15.6 million or 207% over the first quarter of 2011. The unpaid principal balance of residential mortgage loans held for sale increased $109 million or 90% and unfunded mortgage loan commitments increased $143 million or 90%. Mortgage loans funded for sale totaled $746 million in the first quarter of 2012 compared to $420 million in the first quarter of 2011. A 93 basis point decrease in mortgage loan interest rates and expanded government programs such as Home Affordable Refinance Program (“HARP II”) have stimulated mortgage loan production. In addition, the Company has increased the number of mortgage loan officers by approximately 18% during the first quarter of 2011, focusing on growth in Texas, Colorado and Kansas/Missouri markets. We have expanded our mortgage banking operations to include correspondent lending. All mortgages originated by correspondent lenders are evaluated for compliance with our underwriting standards. Mortgage loans funded for sale of $746 million includes $48 million originated by correspondent lenders. Mortgage servicing revenue increased $171 thousand or 2% over the first quarter of 2011 to $10.0 million. The outstanding principal balance of residential mortgage loans serviced for others totaled $11.4 billion, a $176 million decrease compared to the first quarter 2011.

Mortgage banking revenue increased $7.6 million over the fourth quarter of 2011 due primarily to a $7.7 million increase in revenue from originating and marketing residential mortgage loans. Residential mortgage loans funded for sale decreased $55 million compared to the previous quarter. The unpaid principal balance of residential mortgage loans held for sale increased $53 million or 30% over the fourth quarter of 2011 and unfunded mortgage loan commitments increased $113 million or 59%.

Table 3 – Mortgage Banking Revenue 

(In thousands)

Net gains on securities, derivatives and other assets

The Company sold $892 million of U.S government agency mortgage-backed securities held as available for sale and recognized a gain of $11.7 million in the first quarter of 2012.  We recognized $4.9 million of gains on sales of $793 million of available for sale securities in the first quarter of 2011 and $7.1 million of net gains on sales of $667 million of available for sale securities in the fourth quarter of 2011.  In each of these periods, securities were sold either because they had reached their expected maximum potential return or to mitigate exposure to prepayment risk.

We also sold $107 million of privately issued residential mortgage-backed securities at a $7.4 million loss in March 2012. The fair value of these securities increased nearly 10% between December 31, 2011 and February 29, 2012. In response to this increase in fair value, management evaluated all privately-issued residential mortgage-backed securities to determine which securities we did not intend to sell based on their expected performance. All securities which we believe to have reached their expected maximum potential were sold in March. We do not intend to sell the remaining $371 million of privately issued residential mortgage-backed securities.

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 interest 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.

Changes in the fair value of mortgage servicing rights are highly dependent on changes in rates offered to borrowers or primary mortgage rates and assumptions about servicing revenue, servicing costs and discount rates. Changes in the fair value of residential mortgage backed securities and derivative contracts are highly dependent on changes in rates required by investors or secondary mortgage rates. While primary and secondary mortgage rates generally move in the same direction, the spread between them may widen and narrow due to market conditions and government intervention. Changes in assumptions and the spread between the primary and secondary rate can cause significant quarterly earnings volatility as shown in Table 4.

Table 4 following shows the relationship between changes in the fair value of mortgage servicing rights and financial instruments designated as an economic hedge.

Table 4 – Gain (Loss) on Mortgage Servicing Rights

(In thousands)

Other operating expense for the first quarter of 2012 totaled $185.2 million, up $6.8 million or 4% over the first quarter of 2011. Changes in the fair value of mortgage servicing rights decreased operating expense $7.1 million in the first quarter of 2012 and $3.1 million in the first quarter of 2011. Excluding changes in the fair value of mortgage servicing rights, operating expenses were up $10.8 million or 6% over the first quarter of 2011. Personnel expenses increased $14.8 million or 15%. Non-personnel expenses decreased $4.0 million or 5%.

Excluding changes in the fair value of mortgage servicing rights, operating expenses were down $21.6 million compared to the previous quarter. Personnel expenses decreased $6.4 million and non-personnel expenses decreased $15.2 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 $2.3 million or 4% over the first quarter of 2011 primarily due to standard annual merit increases which were effective in the second quarter of 2011. In addition, the Company changed the timing of annual merit increases to March 1 from April 1 for a majority of its staff beginning in 2012.

Incentive compensation increased $9.9 million or 43% over the first quarter of 2011. Cash-based incentive compensation plans are either intended to provide current rewards to employees who generate long-term business opportunities for 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 $6.7 million or 34% compared to the first quarter of 2011. Cash-based incentive compensation related to brokerage and trading revenue was up $6.3 million over the first quarter of 2011. Cash-based incentive compensation for other business lines was essentially flat compared to the first quarter of 2011.

The Company also provides stock-based incentive compensation plans. Stock-based compensation plans include both equity and liability awards. Compensation expense for equity awards decreased $532 thousand compared to the first quarter of 2012. 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 compensation expense also includes incentive compensation that will ultimately be settled in cash indexed to investment performance or changes in earnings per share. Compensation expense for liability awards increased $3.7 million over the first quarter of 2011 primarily due to a $3.0 million increase related to the BOK Financial Corp. True-Up Plan. Approved by shareholders on April 26, 2011, the True-Up Plan is designed to adjust annual and long-term performance-based incentive compensation for certain senior executives either upward or downward based on the earnings per share performance and compensation of comparable senior executives at peer banks.

Employee benefit expense increased $2.6 million or 16% over the first quarter of 2011 due primarily to increased medical insurance costs and payroll taxes.

Personnel expense decreased $6.4 million compared to the fourth quarter of 2011 due primarily to reduced incentive compensation expense, partially offset by a seasonal increase in payroll taxes. Incentive compensation decreased $9.6 million. Stock-based incentive compensation decreased $8.0 million due primarily to the timing of accruals for the BOK Financial Corporation 2011 True-Up Plan and first quarter performance of BOK Financial stock and other investments. Cash based incentive compensation decreased $1.6 million. Employee benefits expense increased $3.9 million due primarily to seasonal changes in payroll taxes.

Non-personnel operating expenses

Non-personnel operating expenses, excluding changes in the fair value of mortgage servicing rights, decreased $4.0 million compared to the first quarter of 2011. Net losses and operating expenses of repossessed assets decreased $3.8 million compared to the first quarter of 2011. FDIC insurance expense decreased $2.3 million due to the impact of a change to a risk-sensitive assessment based on assets rather than deposits. Mortgage banking costs increased $1.1 million and other expenses increased $1.1 million.

Excluding changes in the fair value of mortgage servicing rights, non-personnel operating expenses decreased $15.2 million compared to the fourth quarter of 2011 across most non-personnel expense categories. Data processing and communications expense decreased $4.5 million due to the favorable resolution of a dispute with a service provider. Net losses and operating expenses of repossessed assets were down $3.9 million due primarily to decreased write-downs and net losses on sales of repossessed assets. Mortgage banking costs were down $2.6 million due primarily to lower foreclosure costs on residential mortgage loans serviced for others.

Income tax expense was $45.5 million or 35% of book taxable income for the first quarter of 2012 compared to $38.8 million or 37% of book taxable income for the first quarter of 2011 and $37.4 million or 36% of book taxable income for the fourth quarter of 2011. The decrease in the effective tax rate over the first quarter of 2011 was due to the increased utilization of income tax credits and the decrease in the accrual for state uncertain tax positions.

During the first quarter of 2012, the Internal Revenue Service completed an audit of our federal income tax return for the year ended December 31, 2008. No changes were required.

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 March 31, 2012, $12 million at December 31, 2011 and $14 million at March 31, 2011.

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 for small businesses, middle market and larger commercial customers. Commercial banking also includes the TransFund EFT network. Consumer banking includes retail lending and deposit services 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 $17.0 million over the first quarter of 2011. The increase in net income attributed to our lines of business was due primarily to our Consumer Banking segment. Increased mortgage banking revenue was partially offset by decreased transaction card revenue due to changes as a result of debit card interchange fee revenue effective in the third quarter of 2011. In addition, brokerage and trading revenue attributed mostly to the Wealth Management segment was up and net interest revenue increased for all of our lines of business. Net income attributed to funds management and other also increased $1.8 million over the first quarter of 2011 primarily due to increased gains on securities in excess of other-than-temporary charges and a decrease in operating expenses attributed to the funds management unit. Decreased provision for credit losses in excess of net charge-offs was partially offset by a decline in net interest revenue due to lower interest rates.

Table 6 – Net Income by Line of Business

 (In thousands)

Commercial Banking

Commercial Banking contributed $33.0 million to consolidated net income in the first quarter of 2012, up $4.3 million or 15% over the first quarter of 2011. Net interest revenue increased $3.4 million or 5% primarily due to a $783 million increase in average loan balances, partially offset by a decrease in the loan yield compared to the first quarter of 2011. Fees and commissions revenue increased $3.3 million or 9%. Other operating expenses were flat compared to the first quarter of 2011.

Table 7 – Commercial Banking

(Dollars in thousands)

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 approximately $1.0 million in the first quarter of 2012 compared to the first quarter of 2011. Net interest revenue increased $1.6 million. Average deposits increased $469 million and average loans increased $12 million primarily due to the transfer. Other operating revenue increased $810 thousand and operating expenses increased $1.4 million.

Other operating revenue increased $3.4 million or 10% over the first quarter of 2011 due primarily to increased deposit service charge and transaction card revenues. The increase in deposit service charge revenue related to additional service charge revenue from the transfer of the small business banking activities and increased service charges as a result of

 

 

decreased earnings credit available to our treasury services customers.

Operating expenses were flat compared to the first quarter of 2011. Personnel costs increased $1.6 million or 7% due primarily to increased incentive compensation and standard annual merit increases. Net losses and operating expenses on repossessed assets decreased $4.0 million compared to the first quarter of 2011, primarily due to decreased write-downs and losses on sales of repossessed assets. Other non-personnel expenses were primarily flat compared to the prior year. Corporate expense allocations increased due primarily to increased customer loan and deposit activity.

The average outstanding balance of loans attributed to Commercial Banking was $8.9 billion for the first quarter of 2012, up $783 million over the first quarter of 2011. See the Loans section of Management’s Discussion and Analysis 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 $360 thousand compared to the first quarter of 2011 to $6.4 million or 0.29% 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 $8.4 billion, up $909 million or 12% over the first quarter of 2011. The transfer of small business banking activities to the Commercial Banking segment contributed $469 million to this increase. Average balances attributed to our energy customers increased $499 million or 67% and average balances attributed to our commercial & industrial loan customers increased $268 million or 9%. Average balances attributed to our treasury services customers decreased $340 million or 16% due primarily to a $220 million or 24% increase in average balances held by states and local municipalities offset by a $561 million or 46% decrease in average balances held by our other treasury services customers.

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.

The Consumer Banking segment contributed $19.5 million to consolidated net income for the first quarter of 2012, up $13.0 million over the first quarter of 2011 due primarily to growth in mortgage banking revenues. Revenue from mortgage loan production grew $15.5 million over the first quarter of 2011. Changes in fair value of our mortgage servicing rights, net of economic hedge, increased net income attributed to Consumer Banking by $1.4 million in the first quarter of 2012 and decreased net income attributed to Consumer Banking by $1.7 million in the first quarter of 2011.

Table 8 – Consumer Banking

(Dollars in thousands)

 

 

 

Net interest revenue from Consumer Banking activities increased $2.0 million or 7% compared to the first quarter of 2011 primarily due to growth in average loans. Average loan balances were up $136 million or 7% of the prior year. Other consumer loans increased, partially offset by decreased balances of indirect automobile loans. The Company previously disclosed its decision to exit the indirect automobile loan business in the first quarter of 2009.

Fees and commissions revenue increased $12.5 million over the first quarter of 2011. Mortgage banking revenue was up $15.7 million or 90% over the prior year due primarily to increased residential mortgage loan originations and commitments. Transaction card revenues were down $4.0 million or 43% compared to the prior year due primarily to the impact of interchange fee regulations which became effective on October 1, 2011. Deposit service charges decreased $875 thousand primarily related to service fees on small business deposits transferred to the Commercial Banking segment.

Excluding the change in the fair value of mortgage servicing rights, operating expenses were flat compared to the first quarter of 2011.

Net loans charged off by the Consumer Banking unit decreased $1.3 million compared to the first quarter of 2011. Net consumer banking charge-offs include residential mortgage loans, indirect automobile loans, overdrawn deposit accounts and other direct consumer loans.

Average consumer deposits decreased $324 million or 5% compared to the first quarter of 2011 primarily due to the transfer of small business banking to the Commercial Banking segment, offset by some growth in Consumer Banking deposits. Average time deposits decreased $269 million or 12% and average demand deposits decreased $143 million. Average interest-bearing transaction accounts increased $54 million or 2%.

Our Consumer Banking division originates, markets and services conventional and government-sponsored residential mortgage loans for all of our geographical markets. We funded $814 million of mortgage loans in the first quarter of 2012 and $457 million in the first quarter of 2011. Approximately 34% of our mortgage loans funded were in the Oklahoma market, 15% in the New Mexico market, 13% in the Texas market and 13% in the Colorado market. In addition, 6% of our mortgage loan fundings came from correspondent lenders. Mortgage loan fundings included $746 million of mortgage loans funded for sale in the secondary market and $68 million funded for retention within the consolidated group. At March 31, 2012, we have $230 million of residential mortgage loans held for sale and outstanding commitments to originate $302 million of residential mortgage loans. A 93 basis point decrease in mortgage loan interest rates and government programs such as HARP II have stimulated mortgage loan production. We increased the number of mortgage loan officers by approximately 18% during the first quarter of 2011, focusing on growth in Texas, Colorado and Kansas/Missouri markets.

At March 31, 2012, the Consumer Banking division services $11.4 billion of mortgage loans serviced for others and $1.0 billion of loans retained within the consolidated group. Approximately 97% of the mortgage loans serviced was to borrowers in our primary geographical market areas. The performance of residential mortgage loans serviced for others continues to improve. Loan past due 90 days or more decreased to $109 million or 0.96% of loans serviced for others at March 31, 2012 from $136 million or 1.20% of loans serviced for others at December 31, 2011. Mortgage servicing revenue increased $115 thousand or 1% over the first quarter of 2011 to $10.0 million.

 

Wealth Management

Wealth Management contributed $3.9 million to consolidated net income in first quarter of 2012 compared to $4.2 million in first quarter of 2011.

Table 9 – Wealth Management

(Dollars in thousands)

Net interest revenue for the first quarter of 2012 was up $930 thousand or 9% over the first quarter of 2011. Average loan balances were down $121 million. Net loans charged off decreased $187 thousand compared to the first quarter of 2011 to $626 thousand or 0.28% of average loans on an annualized basis. Average deposit balances were up $348 million or 9% over the prior year. Loan yields were up and funding costs related to deposits decreased compared to the first quarter of 2011.

Other operating revenue was up $6.4 million or 16% over the first quarter of 2011, primarily due to a $6.3 million or 31% increase in brokerage and trading revenues. Trust fees and commission were flat compared to the prior year.

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 first quarter of 2012, the Wealth Management division participated in 90 underwritings that totaled $1.4 billion. As a participant, the Wealth Management division was responsible for facilitating the sale of approximately $549 million of these underwritings. In the first quarter of 2011, the Wealth Management division participated in 35 underwritings that totaled approximately $774 million. Our interest in these underwritings totaled approximately $212 million.

Operating expenses increased $7.6 million or 17% over the first quarter of 2011. Personnel expenses increased $7.0 million or 25%. Incentive compensation increased $5.4 million over the prior year and regular compensation costs increased $1.3 million primarily due to increased headcount and annual merit increases. Non-personnel expenses decreased $147 thousand or 2% compared to the prior year. Corporate expense allocations were up $757 thousand or 9% due primarily to expansion of the Wealth Management business line.

Growth in average assets was largely due to funds sold to the Funds Management unit. Average deposits attributed to the Wealth Management division increased $348 million or 9% over the first quarter of 2011 including a $294 million or 72% increase in average demand deposit accounts and a $102 million or 4% increase in interest-bearing transaction accounts. Average time deposit balances decreased $50 million or 7% compared to the first quarter of 2011.

Geographical Market Distribution

The Company also 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 include 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 47% of our average loans, 55% of our average deposits and 40% of our consolidated net income in the first quarter of 2012. In addition, all mortgage servicing activity, TransFund EFT network and 72% of our trust assets is attributed to the Oklahoma market.

Table 11 – Oklahoma

(Dollars in thousands)

Net income generated in the Oklahoma market in the first quarter of 2012 increased $8.4 million or 34% over the first quarter of 2011 due primarily to growth in net interest and fee revenue, a decrease in net loans charged off and improvement in the fair value of mortgage loan servicing rights.

Net interest revenue increased $3.0 million or 5%. Average loan balances increased $176 million or 3%. The favorable net interest impact of the $881 million increase in average deposit balances was partially offset by lower yield on funds sold to the Funds Management unit.

Fees and commission revenue increased $5.7 million over the first quarter of 2011. Mortgage banking revenue increased $5.6 million due to increased mortgage loan origination and commitment volumes. Increased brokerage and trading and deposit service charge revenue were largely offset by decreased transaction card revenues.

 

Excluding the change in the fair value of mortgage servicing rights, other operating expenses increased $5.3 million or 7% over the prior year. Personnel expenses were up $2.9 million or 9% over the prior year. Incentive compensation expense increased $1.7 million and regular compensation expense was up $1.1 million. Non-personnel expenses increased $2.5 million or 8%.

Net loans charged off decreased to $1.0 million or 0.08% of average loans on an annualized basis for first quarter of 2012 compared with $6.4 million or 0.50% of average loans on an annualized basis for the first quarter of 2011.

Average deposits in the Oklahoma market increased $881 million over the first quarter of 2011. Commercial Banking deposit balances increased $588 million or 14% over the prior year. Increased deposits related to energy and commercial & industrial customers were partially offset by decreased deposits related to treasury services customers. Wealth Management deposits increased $356 million or 17% over the prior year in the private banking division, trust and broker/dealer divisions. Consumer Banking deposits decreased and Commercial Banking 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 33% of our average loans, 24% of our average deposits and 15% of our consolidated net income in the first quarter of 2012.

Table 12 – Texas

(Dollars in thousands)

Net income in the Texas market increased $2.8 million or 27% over the first quarter of 2011 primarily due to increased net interest and fees and commission revenue.

Net interest revenue increased $1.7 million or 5% over the first quarter of 2011. Average outstanding loans grew by $520 million or 16% and average deposits increased $126 million or 3% over the first quarter of 2011.

Fees and commission revenue increased $3.2 million or 20% over the first quarter of 2011 due primarily to increased mortgage banking revenue. In addition, brokerage and trading revenue, deposit service charges and trust fees and commissions revenue all increased over the prior year. Transaction card revenue was down compared to the prior year due primarily to debit card interchange fee regulations which became effective in the third quarter of 2011.

Operating expenses increased $1.1 million or 3% over the prior year. Personnel costs were up $2.3 million or 14% due primarily to incentive compensation expense and increased headcount related to higher mortgage origination activity. Net losses (gains) and operating expenses of repossessed assets improved by $721 thousand compared first quarter of 2011. Non-

 

 

personnel expenses were flat compared to the prior year and corporate expense allocations were down $419 thousand or 4% compared to the first quarter of 2011.

Net loans charged off totaled $444 thousand or 0.05% of average loans for the first quarter of 2012 on an annualized basis, down from $928 thousand or 0.12% of average loans for the first quarter of 2011 on an annualized basis.

New Mexico

Net income attributable to our New Mexico market totaled $4.5 million or 5% of consolidated net income, an increase of $1.6 million or 56% over the first quarter of 2011. Net interest income increased $163 thousand or 2% over the first quarter of 2011. Average loan balances increased $5.9 million over the first quarter of 2011. Average demand deposit balances were down $29 million or 2% compared to the prior year. Time deposit balances decreased $52 million and interest-bearing transaction deposit balance decreased $26 million, partially offset by a $48 million increase in demand deposit balances. Net charge-offs totaled $885 thousand or 0.50% of average loans attributed to the New Mexico market for the first quarter of 2012, compared to $411 thousand or 0.24% of average loans for the first quarter of 2011. Fees and commissions revenue was up $2.8 million or 37% due primarily to growth in mortgage banking revenue over the first quarter of 2011. Deposit service charges, brokerage and trading and trust fees and commission were also all up over the prior year, partially offset by a decrease in transaction card revenue due to debit card interchange fee regulations. Other operating expenses were down $129 thousand or 1% compared to the first quarter of 2011. Personnel costs increased $687 thousand, partially offset by a $606 thousand decrease in net (gains) losses and expenses of repossessed assets and a $262 thousand decrease in non-personnel expenses.

Table 13 – New Mexico

(Dollars in thousands)

 

Arkansas Market

Net income attributable to our Arkansas market increased $1.3 million or 161% over the first quarter of 2011 to $2.2 million. Net interest revenue decreased $330 thousand or 14% primarily due to a $28 million decrease in average loans. Loans in the Arkansas market continued to decrease due to the run-off of indirect automobile loans. Average deposits in our Arkansas market were down $7.0 million or 3% compared to the first quarter of 2011. Time deposits decreased $31 million, offset by a $19 million increase in interest-bearing transaction deposits and a $4.0 million increase in demand deposits. Net loans charged off decreased $272 thousand to $64 thousand or 0.10% of average loans on an annualized basis. Fees and commission revenue increased $2.8 million primarily due to increased securities trading revenue at our Little Rock office and higher mortgage banking revenues. Other operating expenses were up $565 thousand or 6% over the prior year. Personnel expense increased $259 thousand or 5% primarily due to increased incentive compensation costs related to trading activity. Non-personnel expenses were up $348 thousand over the prior year.

Table 14 – Arkansas

(Dollars in thousands)

Colorado Market

Net income attributed to our Colorado market totaled $2.5 million compared to $2.4 million in the first quarter of 2011. Net loans charged off totaled $1.9 million or 0.92% of average loans on an annualized basis compared with a net recovery of $50 thousand in the first quarter of 2011. Net interest revenue increased $699 thousand or 9% over the prior year. Average loans outstanding increased $61 million or 8% over the prior year. Average deposits were up $83 million or 7% due primarily to a $91 million increase in demand deposit balances partially offset by a $15 million decrease in time deposit balances. Fees and commission revenue increased $1.8 million or 30% over the prior year due primarily to increased mortgage banking revenue partially offset by decreased brokerage and trading and transaction card revenues. Operating expenses were up $426 thousand or 4% over the prior year. Personnel costs increased $723 thousand primarily due to increased incentive compensation related to increased mortgage activity. Net losses and operating expenses of repossessed assets were down $324 thousand compared to the prior year. Decreased non-personnel expenses were largely offset by increased corporate expense allocations.

Table 15 – Colorado

Arizona Market

The Arizona market incurred a net loss of $1.8 million for the first quarter of 2012 compared to a net loss of $3.1 million in the first quarter of 2011. Net interest revenue increased $768 thousand or 22% over the prior year. Average loan balances were flat compared to the prior year. Average deposits increased $8.8 million or 4% due primarily to a $22 million or 25% increase in demand deposit balances, partially offset by a $15 million or 31% decrease in time deposits. Growth was primarily related to commercial loans and deposits. Net loans charged off totaled $3.6 million or 2.62% of average loans on an annualized basis in the first quarter of 2012 compared to $1.9 million or 1.38% of average loans on an annualized basis for the first quarter of 2011. The increase in net loans charged off was largely due to resolution of loans from the Tucson market which we exited in 2009. Fees and commission revenue were flat compared to the prior year. Operating expense was down $3.0 million compared to the first quarter of 2011 due primarily to a $2.3 million decrease in net losses and operating expenses on repossessed assets. Personnel and other non-personnel costs were both down compared to the prior year.

 

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.

Table 16 – Arizona

(Dollars in thousands)

Kansas / Missouri Market

Net income attributed to the Kansas / Missouri market increased by $1.1 million over the first quarter of 2011. Net interest revenue increased $278 thousand or 10%. Average loan balances increased $62 million or 17% over the first quarter of 2011. Average deposits balances were down $131 million or 35%. Interest-bearing transaction deposits decreased $121 million and time deposits decreased $23 million, partially offset by a $13 million increase in demand deposits. Fees and commission revenue increased $3.7 million or 74% primarily due to increased mortgage banking and brokerage and trading revenues. Operating expenses were up $1.9 million or 31% over the prior year. Personnel costs were up $1.4 million primarily due to increased incentive compensation related to mortgage and brokerage and trading activity and increased headcount. Non-personnel expenses were flat compared to the prior year and corporate expense allocations increased due to increased transaction activity.

Table 17 – Kansas / Missouri

(Dollars in thousands)