Bok Financial Corp Q2 FY2020 Earnings Call

Greetings. And welcome to the BOK Financial Corporation Second Quarter 2020 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Steven Nell, Chief Financial Officer for BOK Financial Corporation. Thank you. You may begin.

Good morning and thanks for joining us. Today our CEO, Steve Bradshaw, will provide opening comments, and Stacy Kymes, Executive Vice President of Corporate Banking, will cover our loan portfolio, including details around our energy, healthcare, and commercial real estate portfolios. Marc Maun, our Chief Credit Officer, will cover credit metrics; and Scott Grauer, our Executive Vice President of Wealth Management, will cover the outstanding results from his team this quarter. Lastly, I will provide second quarter details regarding net interest income, net interest margin, additional fee revenues, expenses, and our overall balance sheet position from a liquidity and capital standpoint. In addition, I will provide a few thoughts regarding expectations for future quarters. PDFs of the slide presentation and second quarter press release are available on our website at bokf.com. We refer you to the disclaimers on slide two as it pertains to any forward-looking statements we make during the call. I will now turn the call over to Steve Bradshaw.

Good morning. Thanks for joining us to discuss the second quarter 2020 financial results. We are pleased to report a record quarter for BOK Financial in terms of pre-provision net revenue, despite the many economic challenges due to COVID-19. Shown on slide four, second quarter net income was $64.7 million or $0.92 per diluted share. That’s up 4% from last quarter, despite another quarter of elevated provision for credit losses. Earnings this quarter were bolstered dramatically by $214 million in revenues from our fee businesses, as our Wealth Management and Mortgage teams have continued their momentum to post simultaneous record quarters for the company. Focusing on pre-provision net revenue, it’s clear to see the significant benefit we drive for our company with our long-term commitment to balanced revenue and breadth of business capabilities. Pre-provision net revenue was $216 million this quarter, the highest level in the history of our company. Considering the environment we find ourselves in today, this is truly a remarkable outcome that all of our high-performing and talented employees should be proud of. Fees and commissions revenue was up nearly 11% from the previous quarter and an incredible 21% quarterly year-over-year on continued strong Wealth Management and Mortgage revenues. Fee revenue now represents 43% of total revenue. That’s up from 38% in the same quarter a year ago. This once again demonstrates an important differentiating characteristic of BOK Financial. We have long had a diverse revenue mix that provides an earnings buffer in economic downturns because of the counter-cyclical nature of some of these fee revenue streams. Expense management remains prudent, with an efficiency ratio below 60% for the quarter, even with the shift in the mix of revenue towards fee income. It should also be noted that we added $3 million in unplanned contributions to our foundation, including an incremental $1 million in the second quarter to aid those in our communities with food insecurity, while providing much-needed jobs for displaced restaurant workers. Our loan loss provision was $135 million this quarter, due to a combination of changes in our reasonable and supportable forecasts of macroeconomic variables, along with some credit migration that Marc will cover in more detail momentarily. While we continue to build a reserve again this quarter, we believe the material reserve build should be largely complete, assuming our economic forecast is in line going forward. Net interest revenue was up $16.7 million to $278 million this quarter. Despite the ongoing impact of the 150 basis points of emergency rate cuts in March, our ability to decrease deposit costs and the relatively elevated nature of LIBOR early in the quarter helps preserve a large portion of our margin. Steven will cover the underlying components in more detail later in the call. Turning to slide five, average loans increased $2.2 billion to eclipse $24 billion this quarter. While this was positive for the company overall, $1.7 billion of this was due to the Small Business Administration’s PPP Program. Average deposits were up nearly 16% linked quarter and up nearly 30% from the same quarter a year ago. We attribute this strong growth to continued momentum in deposit-gathering activities, along with PPP loan deposits and government stimulus payments. Even with the significant growth in deposits, we were able to bring overall interest-bearing costs down from 98 basis points last quarter to 34 basis points this quarter as we were able to adjust rates paid on interest-bearing deposits due to our proactive management in the face of an unprecedented Fed movement in the first quarter. Assets under management or in custody were up nearly 5% this quarter on strong sales efforts and increases in the equity markets during the quarter. We believe asset growth is in part attributable to the volatility in the markets, which really underscores the value that a professional advisor brings to individual and corporate investors during times of extreme uncertainty. I will provide additional perspective on the results at the conclusion of the prepared remarks, but now Stacy Kymes will review the loan portfolio in more detail. I will turn the call over to Stacy.

Thanks, Steve. As you can see on slide seven, period end loans were $24.2 billion, up $1.7 billion for the quarter. PPP loans added $2.1 billion to the portfolio, so we did see growth in some of our specialty areas net of PPP broad paydowns across our core commercial and industrial loan book, which actually contracted the portfolio this quarter. Some of this was repayment of more defensive draws in the first quarter, and some of this was through the organic decline in economic activity. Energy loans contracted 3.3% for the quarter, as commodity prices made new deals difficult to source in the current environment. Energy borrowers are paying down debt to reduce leverage at this point in the cycle. Energy commitments were down $360 million from the first quarter of 2020 and $630 million since the end of the year. These commitment declines are a direct result of the redetermination of borrowing basis that occurred during the second quarter. Despite these factors, we remain open for business and continue to support our customers in the energy industry. Energy lending is core to our DNA, and our experience in previous commodity cycles proves that this is a profitable business when approached in a consistent and disciplined manner. This business is more than just lending activities, as evidenced by the record quarter we had with $5.4 million in energy derivatives revenue this quarter as customers continue to aggressively manage their commodity risk. This long-term view has served us well, and today we remain well-positioned in the industry with a complete service offering, world-class bankers, and an enviable customer base. We continue to see great opportunity for our energy franchise over the next several years, as other banks have retreated from this space entirely or in part. Marc will cover the credit specifics of the energy portfolio momentarily. But as we have said in the past, we believe the duration of the oil price decline is a more significant factor affecting performance than the level of prices. Our healthcare sector loan balances increased $124 million to $3.3 billion or nearly 4% for the quarter, primarily due to growth in balances from the hospital system clients who demonstrate a strong credit profile. This client segment has been impacted due to deferrals of elective procedures, as well as the need to increase inventory of supplies and protective equipment. That said, the CARES Act has multiple revenue enhancement measures for both hospitals and skilled nursing facilities as they manage through the risk of the virus. This has benefited multiple clients and is expected to help mitigate the credit risk in the healthcare portfolio. While it is still early, thus far, we have not realized any material credit migration or deterioration in this portfolio. Commercial real estate loan balances were up 2.3% from the previous quarter, largely due to the lowest level of paydowns we have seen in many years as a result of friction in the permanent financing market. While PPP loans did help stimulate overall loan growth in the second quarter, our outlook for loan growth for the rest of the year will largely be determined by the speed and shape of the broader economic recovery. I will turn the call over to Marc Maun to discuss our credit metrics.

Thanks, Stacy. Turning to slide nine, we have again compiled a list of loan segments we consider more exposed to the economic impact of the pandemic. As you can see, the exposure to the entertainment and recreation, which includes gaming in our Native American Specialty portfolio that boasts a strong credit profile, retail, hotels, churches, airline travel, and higher education that are dependent on large social gatherings to remain profitable today is less than 7% of our total portfolio. This group of loans is highly diversified with over 550 loans for an average loan size of less than $3 million. Some of these clients have participated in the Paycheck Protection Program, which has provided some measure of relief. We will obviously continue monitoring these exposures closely in the coming months. Credit quality has remained manageable, but there has been some migration of non-accrual and potential problem loans, given the current economic environment, primarily in our energy portfolio, that led to a larger provision for credit losses in the second quarter. Slide 10 details our provision actions this quarter. The total provision was $135.3 million, with $138.8 million related to lending activities. Changes in our reasonable and supportable forecasts of macroeconomic variables, primarily due to the anticipated impact of the ongoing COVID-19 pandemic, required a provision of $54.6 million. All other changes totaled $84.2 million, which included $14.4 million primarily due to increased specific impairment of energy loans and portfolio changes of $55.7 million, primarily due to changes in risk grades related to energy loans. The $84.2 million was partially offset by the impact of a decrease in loan balances and net charge-offs of $14.1 million, bringing net portfolio change adjustments to $70.1 million for the quarter. The provision related to lending activities was partially offset by a $3.6 million decrease in the accrual for expected credit losses for Mortgage Banking activities. Our base case reasonable and supportable forecast includes an 18% increase in GDP and an 8.4% civilian unemployment rate in the third quarter of 2020, as adjusted for the impact of government stimulus programs. Our forward 12-month forecast through the second quarter of 2021 assumes a 5% increase in GDP and an 8.5% civilian unemployment rate. WTI oil prices are projected to generally follow the NYMEX forward curve that existed at the end of June 2020, $38.99 per barrel for delivery in the third quarter of 2020 and increasing to $40.13 per barrel in the second quarter of 2021. Our downside reasonable and supportable forecast reflects a more severe and prolonged disruption in economic activity than the base case and includes a 6% increase in GDP and a 9.7% adjusted civilian unemployment rate in the third quarter of 2020. Our forward 12-month forecast through the second quarter of 2021 assumes a 6% increase in GDP and a 10% adjusted civilian unemployment rate. WTI oil prices are projected to range from $33.99 per barrel for delivery in the third quarter of 2020 to $34.63 per barrel for delivery in the second quarter of 2021. Turning to slide 11, non-accruing loans increased $92 million this quarter, primarily due to a $67 million increase in non-accruing energy loans and a $13 million increase in non-accruing service loans. As we have said before, we believe the risk of migration to potential problem and non-accruing status outweighs the risk of loss in the energy portfolio. Potential problem loans totaled $626 million at quarter-end, up from $293 million at March 31st. This increase largely comes from the energy portfolio, as the recent oil price decline, coupled with the capital markets environment requiring certain customers to work through their liquidity needs, weighed on some energy borrowers. Commodity prices, particularly oil prices, remain depressed throughout most of the second quarter but recovered somewhat in June. As we noted last quarter, if prices remain depressed as we went through the spring borrowing base redetermination process, we would expect continued credit quality issues in this portfolio. We realized this migration as we completed most of our redeterminations in April and May. Prices have improved since, but do remain fragile and closely tied to the continued economic recovery. Should current price levels hold into the fall, we would anticipate positive credit quality migration in this portfolio. The allowance for loan losses totaled $436 million, or 1.8% of outstanding loans at June 30, 2020. Excluding PPP loans, the allowance for loan losses was 1.97% of outstanding loans, and the combined allowance for loan losses and accrual for off-balance sheet credit risk from unfunded loan commitments was 2.12%. Fiscal stimulus has had a positive effect on credit quality through PPP loans, SBA support, and other CARES Act programs. That said, we received a number of deferral or forbearance requests early in the quarter but very few new ones after April. All requests were evaluated on a case-by-case basis, and we have granted $1.2 billion in forbearance requests from customers as of June 30th, including $704 million, or about 5% of commercial loans, primarily in the small business and healthcare portfolios, $398 million, or roughly 9% of the commercial real estate loans, and $143 million, or roughly 4% of loans to individuals. We are just starting to reach the expiration of the first 90 days; and today, over 60% of the deferred loans are going back to regular payments. While retail commercial real estate does account for over 40% of our commercial real estate deferrals, we have not experienced any material credit issues to date, primarily due to stimulus programs. Clearly, the retail portion of this portfolio is the most vulnerable to sustain stay-at-home and shelter-in-place directives. As with oil, the loss content in retail will closely correlate with the duration of the various governmental orders and adjustments in consumer behavior after these orders are lifted. In our office and multifamily segments, we believe our geographic footprint will help us long-term, because of the strong in-migration over time. Short-term quality migration in commercial real estate will be dependent on economic recovery and the impact of fiscal stimulus. I will turn the call over to Scott Grauer to cover the Wealth Management fee revenue contribution this quarter.

Thanks, Marc. On slide 13, you will see the highlights of the Wealth Management division's second quarter financial results. As our investors know, Wealth Management is a business that we have been committed to for over a century at BOK Financial, with a broad cross-section of products and services including institutional and personal wealth management, trust services for individuals and corporations, private banking services, retail and institutional brokerage, investment banking, and financial risk management, as well as a few others. Wealth Management revenue was up 14% to $134 million from the previous quarter and up 18% quarterly year-over-year. This is inclusive of the fee income lines that investors see in our corporate income statement, brokerage and trading, and fiduciary asset management, but it also includes net interest income from loans and deposits, and our private wealth group in our trading portfolio. BOKF continued its growth in hedging pipeline risk and providing liquidity to mortgage originators, strengthening its position as a market leader and a market maker in that space. Overall, mortgage issuance increases driven by lower rates as the Fed stepped in to provide market stability and GSE policy changes around forbearance created an opportunity for BOKF to provide greater liquidity to the housing market during a period of record volume, increasing the trading portfolio by 27% and driving a record quarter in our trading and derivatives business. Total brokerage and trading revenues generated in the Wealth Management division were up 61% from the same quarter a year ago, eclipsing $54 million. The majority of this was derived from mortgage-related trading activity, with second quarter total MBS, TBA trading-related revenue of $48 million. That’s a 21% increase over linked quarter and a 220% increase from the same quarter a year ago. Net direct contribution, which is operating income before corporate allocations, was up a robust 37% for the quarter. This was a result of careful expense management, as total operating expenses for the division before corporate allocations were up only 3% compared to last quarter and up 16% from the same quarter a year ago, despite the outsized revenue growth. This translated into significant and meaningful earnings leverage for the division. On the net interest revenue side, Wealth Management loans were up slightly and deposits were up 10% respectively this quarter, a testament to our ability to be additive in multiple ways to the company. In fact, Wealth Management deposits now represent 26% of the total company deposits, as our efforts there have expanded relative to the rest of the company. Perhaps most importantly, the stage is set for continued growth in the Wealth Management division. In the short term, lower interest rates and the resulting stimulation of the mortgage industry bode well for continued performance in our brokerage and trading segment. Longer term, the retirement of the baby boomers and the transfer of nearly $6 trillion of wealth to their heirs is one of the most powerful demographic trends facing the Wealth Management industry. We believe we are well-positioned to benefit with a diverse set of products and services to meet the needs of the next generation. I will now turn the call over to Steven Nell.

Thanks, Scott. As noted on slide 15, net interest income for the quarter was $278 million, up nearly $17 million from the first quarter, though $13.6 million of that was attributable to PPP loan activity. Net interest margin was 2.83%, compared to 2.80% in the previous quarter. The extreme reduction in deposit costs of 64 basis points all the way down to 34 basis points and LIBOR spread remaining elevated early in the second quarter and the strategic positioning of our balance sheet have combined to reduce the pressure on margin this quarter. Excluding the impact of PPP loans, net interest margin was 2.82%, compared to 2.80% in the previous quarter, a testament to the steps we have taken. Average earning assets increased $1.9 billion over the last quarter, and average loan balances increased $2.2 billion, largely due to the influx of PPP loans in the second quarter. Available-for-sale securities increased $816 million as we have adjusted our balance sheet for the current rate environment. Fair value operations and securities held as an economic hedge of the changes in fair value of mortgage servicing rights decreased by $1 billion. In addition, receivables from unsettled security sales primarily related to our mortgage-backed trading operations increased $1.6 billion. Growth in average earning assets and non-interest-bearing receivables was largely funded by a $2.2 billion increase in interest-bearing deposits. More than $2 billion of PPP loans outstanding at quarter end were funded through the Federal Reserve PPP liquidity facility. On slide 16, fees and commissions were $213.7 million, an increase of nearly 11% from last quarter and an increase of 21% quarterly year-over-year. This was fueled largely by strength in our brokerage and trading business as Scott just covered, but also a record quarter from our Mortgage Banking activities. Mortgage Banking saw a significant surge in production revenue this quarter, growing $17.6 million, or more than 81% relative to last quarter and almost 230% from the same quarter a year ago. While volumes were up, it was the increase in gain on sale margins of 159 basis points compared to last quarter that drove the strength. Today, the industry is against capacity constraints, which is easing pricing competition and growing margins. Refinances represented 71% of total originations as low rates drove much of the demand. While we see the second quarter as peak seasonality in the space, we fully expect to be able to capture our share of the purchase and refinance activity as long as the opportunities persist. Service charges decreased $4.1 million, largely due to the shelter-in-place impacts, coupled with proactive waivers of fees that were extended as a courtesy to our customers during the pandemic. Another success story of the quarter relates to the hedging of our mortgage servicing rights. This quarter, the net MSR activity resulted in a $9.3 million benefit due to the combination of positive net hedging results, modest assumption updates, and an economic benefit from the sale of approximately $1.6 billion in unpaid principal balance of our out-of-footprint Ginnie Mae servicing rights, an impressive outcome as the rate environment remains volatile. Many of our fee businesses are clearly driving the overall success story of the company, once again highlighting the significance of the revenue diversity that we have. Turning to slide 17, total operating expenses increased $26.8 million to $295.4 million. Personnel expense increased $20 million for the quarter, largely due to a $22.3 million increase in incentive-based compensation split between cash-based and deferred compensation. The cash-based portion of $11 million resulted from increased trading in mortgage activity, and $11.6 million of deferred compensation is largely related to the overall equity market recovery. This recognition of deferred compensation expense is offset by an $11.7 million gain on related deferred compensation assets, resulting in no earnings impact for the quarter. Other components included an increase in regular compensation of $1.5 million and a seasonal payroll tax decrease and employee benefits of $2.1 million. Non-personnel expense was up $6.7 million for the quarter. Mortgage Banking costs increased $5.1 million, with $1.7 million due to MSR amortization expense and $2.8 million due to changes in our portfolio and loan counts, delinquency levels, and additional accrual related to losses on loans in forbearance. Occupancy and equipment expense increased $4.6 million due to the impairment of two leases. We also made a charitable contribution of $3 million to the BOKF Foundation in the second quarter. These increases were partially offset by a decrease of $4.3 million in business promotion costs, largely related to reduced travel and entertainment expenses as a result of the pandemic. Our liquidity position remains very strong, given the exceptional inflow of deposit balances. Our loan-to-deposit ratio is now 71%, compared to 77% at March 31st, providing significant on-balance sheet liquidity to meet future customer needs. Additionally, we have $14.6 billion of secured borrowing capacity and over $6.5 billion of unsecured and contingent liquidity capacities to support liquidity needs of the company. Our capital levels remained strong with a common equity Tier 1 ratio of 11.4%, an improvement from 10.98% last quarter and well ahead of our internal operating range minimums and a full 440 basis points above regulatory minimums. Our internal stress tests have given us confidence to support our customer base and to maintain our current level of dividends. Although we have no set plans or commitments to buy back stock in the near term, our capital levels would allow for that opportunity. Currently, we don’t feel the need to supplement the holding company or bank-level capital with any capital raising actions. Due to the continued uncertainty around the severity and duration of the pandemic and its impact on the broader economy, it’s difficult to provide specific guidance that we have done in more normal times, but I will give you a few comments on slide 19 that might be helpful. Our loan growth is expected to be soft for the foreseeable future, most energy deals will likely not be done at current prices, many healthcare opportunities will remain on hold due to the pandemic, and little activity will be present in our CRE and C&I portfolios. We will continue to originate mortgage loans, with very limited amounts ending up in our permanent portfolio. Our available-for-sale securities portfolio, which is largely agency mortgage-backed securities, yielded 2.29% during the second quarter. Given the sustained low rate environment, prepayments could reach over $700 million per quarter. We expect to reinvest those cash flows at current rates around 90 basis points to 100 basis points. As we noted, we had success during the second quarter driving deposit costs down significantly. We feel there’s a bit more room to reduce deposit costs, but likely will not drift much below 30 basis points, which is comparable to our deposit cost low watermark during the last near-zero rate environment. The combination of pressure on asset yields and little room to lower deposit costs will put some pressure on net interest margin in the next quarter. Our diverse portfolio of fee revenue streams should continue to provide some mitigating impact to overall earnings pressure being felt in our spread businesses. We expect our brokerage and trading activity to continue at elevated levels, given our products and capabilities in the mortgage-backed trading space. Our mortgage origination and servicing business should remain solid, but will likely slow some as refinance opportunities abate and seasonality trends slow as the year progresses. Our disciplined approach to controlling personnel and non-personnel costs will continue. We have no plans to reduce staffing or cut existing capabilities or products. As you have seen with BOKF and most other banks, significant loan loss reserve building has taken place during the first quarter and second quarter. Although there remains much uncertainty in the economic environment, we believe loan loss reserve building is largely behind us. As I mentioned a moment ago, we feel good about our capital strength; we will maintain our current level of quarterly cash dividends, and we will evaluate share buyback as the year continues. I will now turn the call back over to Steve Bradshaw for closing commentary.

Thanks, Steven. Our success this quarter is a result of a long-term strategy to serve clients in a holistic way, with a benefit to shareholders of less earnings volatility and enhanced risk mitigation, as we do not feel any temptation to reach for growth by extending risk in any of our lending businesses. Those who have been with us for a while can think back to the last interest rate cycle where most financial institutions saw their earnings opportunities compressed with business revenue. At that time, as it does today, BOK Financial outperformed with a unique heavily fee-based business model that benefited our shareholders through that challenging environment. While no two downturns are the same, there are clearly several bright spots proven out of BOKF today, namely in our Wealth Management and our Mortgage businesses. That said, the most significant uptake going forward will be the return of full economic activity in a safe manner across the nation. Ultimately, we thrive when our clients and our communities do, so our expectations remain tempered as the path to a healthier macro environment comes into focus. Until that time, we will continue to do everything we can to assist our customers, regardless of the speed and shape of the economic recovery. Achieving more together is a phrase you will often hear at BOKF, and that couldn’t be more true today. When COVID-19 began to threaten our communities, we stood together, taking difficult steps to reduce the risk of infection from clients and each other. Being together apart does have its own set of challenges, but we continue to learn from our virtual experience, and we are laying the groundwork for how we will manage aspects of our business going forward. I am just as proud of the resiliency I see in the individuals across our organization as I am of the financial outcomes it is generating. Our strategy and our people at BOK Financial are clearly different than most similar-sized peers, and I think that our ability to compete effectively with the national banks and investment firms is a significant factor in the results we have produced this quarter. With that, we are pleased to take your questions.

Thank you. Our first question is coming from Ken Zerbe of Morgan Stanley. Please go ahead.

Great. Thanks. Good morning.

Good morning, Ken.

Good morning.

I have a general question about energy. When the pandemic began, I recall you mentioning some cautious thoughts regarding the potential duration and severity of the situation, which could result in notable losses. It's been three months since your last earnings report, so how has the energy industry performed compared to your initial expectations at the start of this cycle? Thank you.

Sure. Ken, this is Stacy. I think from our perspective, the recovery has been swifter than we would have anticipated when it began. I think the market, and I think, including us, didn’t forecast the level of shut-in production and things that would happen to curtail supply in this environment. We saw a very strong response from the industry when prices declined so precipitously, and so the industry has always been self-healing, and we talk about that. It usually takes six to eighteen months to kind of find a new equilibrium price. But certainly, the price recovery that we have seen in the last 30 days or so, particularly in oil, has been very encouraging, and certainly, we feel much, much better about future loss potential at these price levels than what we were at before. On the strip average, not on the spot, but only on the strip average, we are $12 or so per barrel higher today than we were when we had our earnings call last quarter, and that makes a big difference in terms of our outlook and what we see as a potential loss content there. I think Marc alluded in his comments to the fact that if prices stay here, we would expect to see positive credit outcomes from a credit migration perspective as we move into the third quarter and the fourth quarter. Recall that we don’t downgrade the whole portfolio when prices move. We do that as we touch them through the semiannual redetermination process, and those prices were not great prices when we were going through the redetermination. But much in the same way, we don’t upgrade the entire portfolio when there is a price recovery. So as we touch those credits in late third quarter and into the fourth quarter, if prices hold at these levels, we would expect to see a very positive migration in that book.

All right. Great. Perfect. I have a second question regarding your press release mentioning that $2.7 billion of your deposit growth was linked to CARES Act funding. I believe you had $2.1 billion in PPP loans. Could you clarify whether you utilized the federal government’s facility to fund these PPP loans and if that contributed to the deposit growth?

Ken, this is Steven. No. That was just an inflow both from PPP, as well as all other kinds of CARES Act initiatives that generated that deposit growth. So it was not just PPP, but it was other CARES Act stimulus that flowed into our customers’ accounts. So we went through and tried to find out how much of our $4.5 billion of deposit growth was related to either CARES or other stimulus programs and came up with roughly $2.7 billion of that growth was from those areas. The rest of it was just regular kind of growth from our core customer base.

I understand. So, if the PPP loans are repaid, or if we consider both PPP and other loans, then potentially $2.7 billion of that funding could diminish or those deposits could decrease. However, you're suggesting that the remaining approximately $2 billion in deposits consists of core deposits that may be more stable over time.

That’s correct.

All right. Perfect. Thank you very much for the questions.

Thank you. Our next question is coming from Gary Tenner of D.A. Davidson. Please go ahead.

Thanks. Good morning, everybody.

Good morning.

Marc, I appreciate your insights on the economic outlook. In the slide deck, you mentioned that the build was based on three scenarios, two of which you highlighted. Can you clarify whether the third scenario is a further adverse situation or an optimistic one? Additionally, could you share the weightings assigned to each of the three scenarios you considered?

Sure. The base case scenarios that we highlighted there that we weighted at 50%. We also run an upside case and a downside case that weighted each of those at 25%. That’s similar weighting to what we had in the first quarter. Again, the economy is moving so quickly and changing so rapidly that we felt that kind of that base even weighting across those scenarios of 50%-25%-25% help reflect kind of that potential volatility.

Okay. Thank you. And then as you are thinking about recognizing the fee side of the PPP loans and what you have got embedded in the net interest revenue this quarter from that. Was that just based on a 24-month average life or have you made any other adjustments in terms of assuming a shorter average life for revenue recognition purposes?

So, yeah, this is Steven. You are correct. There was about $13.6 million, I believe, benefit in our net interest income from PPP split. Well, not split, but roughly $10 million or a little bit more was the fee recognition side and another $3 million or so just in net interest income from PPP loans. We have it weighted as those loans begin to get forgiven out more in the fourth quarter than any other period. So you will see additional in the third quarter, but then more in the fourth quarter as we think a lot of those will begin to get into forgiveness status and then there will be a tail of it as those loans stay on the books out for 24 months. So we have got it spaced out that way.

All right. Thank you.

Thank you. Our next question is coming from Brady Gailey of KBW. Please go ahead.

Hey. Thanks. Good morning, guys.

Good morning.

Good morning.

I wanted to start with fee income. You have achieved another new record this quarter after setting one last quarter, but from your commentary, it appears that brokerage and trading may stay at this level while mortgage could decrease somewhat. It seems that fee income will likely stay close to this elevated level for the remainder of the year. Is that the correct way to assess the strength in fee income?

Scott, why don’t you take the brokerage and trading piece, then I can make some comments about mortgage.

Okay. This is Scott Grauer. We are confident about the momentum in Wealth Management for a few reasons. Beyond the strong volume and activity in mortgage-backed securities during the first and second quarters, we aim to maintain robust levels in our TBA hedging activity and overall volumes in the mortgage-backed securities product mix. We also have good momentum and positive results in our Financial Institutions Group, which provides both taxable and tax-exempt securities to downstream banks as they adjust their securities portfolios amid waning loan demand. That activity has been strong. In our corporate trust and retirement plans businesses, we have seen significant activity and healthy pipelines. Notably, in our defaulted debt sector, we currently have eight defaulted debt assignments, which presents good opportunities for us. Our investment banking activities in the second quarter were robust across municipal advisory, underwriting, and corporate deals, particularly with a surprisingly high number of capital market transactions involving energy companies. Looking at trust fees, we experienced a decline from late 2019 to the end of March, where trust fee revenue dropped about 17% from peak to trough. However, we have since recaptured that decline and are back to year-end trust fee levels as of June. We believe we have strong activity that gives us confidence in sustaining this momentum.

So Brady, regarding mortgages, we have experienced two consecutive quarters with mortgage production volumes exceeding a billion dollars. The key difference this quarter was the margin, which improved from 2.06% in the first quarter to 3.65% in the second quarter. This improvement largely contributed to the increase in mortgage revenue. I believe we will remain strong in this area for the year, but I am aware of some seasonality. The second quarter had a significant portion of 71% refinancing, and those refinancing opportunities won't last indefinitely; I expect them to decrease over time. While I anticipate mortgage performance will remain strong, I am cautious about it reaching the same peak as the second quarter due to the unusually high margins. Other fee businesses are looking promising as well. For instance, the TransFund network's activity shows some softness in consumer service charges, which has been observed industry-wide due to the pandemic, and we will see if that recovers over time. I believe our fee businesses will be a major contributor in the upcoming quarters compared to our other banking businesses.

All right. That’s helpful. And then lastly for me, if you look at potential problem loans, they are up a pretty notable amount, I think, they went from roughly $300 million to about $600 million. I think you guys call out energy as one big driver. But any other color on the increase and potential problem loans in the quarter?

Well, this is Marc. So far, it has really been driven by energy. The season for redetermining the borrowing base primarily took place in April and May, coinciding with the low point for oil prices. This led to the increase in potential problem loans, which we hope will improve as prices stabilize, as Stacy mentioned earlier, going into the fall. We haven't observed any significant changes in our other portfolios. There haven't been any notable issues compared to what one would typically expect in a normal cycle. We continue to monitor all our portfolios closely, conducting in-depth analyses of areas we consider to be higher risk, and we are focused on those. We are watching them carefully and assessing their progress, but we haven’t seen any significant changes yet.

And I would expect to see that improve much like the commodity price improvement that we have seen. That’s also that potential problem loans bucket is where we put those revolving credits in energy that have gone through bankruptcy. But the revolver is generally okay, but the sub-debt or the capital markets unsecured debt that is being cleansed and equitized. We have used that potential problem loan bucket to kind of park those as they go through that process. So as those begin to emerge, there could be some positive credit migration that would come out of there from that perspective as well.

Got it. Thanks, guys.

Thank you. Our next question is coming from Jennifer Demba of SunTrust Robinson Humphrey. Please go ahead.

Hey, this is Brandon King on for Jennifer.

Hey. Hey.

And I noticed that your impact areas table that churches and colleges are mentioned, and I wanted to know if you had any color on what was going on as far as trends in these portfolios?

To date, we haven’t encountered any significant issues with our college and university portfolios. Given that it's summer, we're waiting to see how various universities plan to reopen and bring students back. However, during our visits, we feel confident about the current status of those loans, and we are monitoring them closely. Regarding the church loans, this is a diverse portfolio consisting mostly of smaller loans. We have experienced a few issues with two or three of these loans, but overall, we haven’t noticed any deterioration yet. This portfolio is much larger in number but primarily contains smaller loans, so we believe we can effectively manage the associated risks.

Okay. Thanks. And just additionally, of the impacted areas, which of the areas are you seeing the most stress, and what areas are you seeing the least stress?

I believe the least stress is likely in the casino segment. These are primarily Native American and tribal casinos. Approximately 70% of our outstanding loans are backed by cash available at the casinos or from the tribes. Although they were closed for a couple of months, they are beginning to reopen. We are fairly confident in the tribes' liquidity. There were very few requests for PPP loans or loan deferrals related to the casinos, indicating that segment has performed positively. We also have a small hotel portfolio from our CoBiz acquisition, which we never actively pursued. This portfolio is small, but it is likely to be the most challenged compared to our other loans.

All right. Thank you very much.

Thank you. Our next question is coming from Jon Arfstrom of RBC Capital Markets. Please go ahead.

Hey. Thanks. Good morning.

Good morning.

Good morning.

A couple of cleanup follow-up questions, I guess. This on the energy NPLs, Stacy or Marc, can you just talk about the characteristics of the increase that may be obvious, but give us an idea of what’s in there?

The rise in non-performing loans primarily resulted from the borrowing base redetermination process we underwent in April and May when our price estimates were $10 to $12 lower. As we evaluated cash flows, we found that the collateral support was in some cases below the loan levels, leading to deficiencies that needed attention. While the overall quality of the collateral base remained robust enough to provide coverage, we did not foresee significant losses, although it created a stressful situation for some borrowers, contributing to the uptick in non-performing loans. Moving forward, one benefit of our energy lending portfolio is the ability to resize and reassess loans every six months according to the updated price levels. We expect that as we review these loans in the fall, they will likely show improvement due to anticipated price increases. It's crucial to emphasize that we are not depending on drilling for repayment; rather, we rely on the production of the existing collateral within the borrowing base. Additionally, we have a strong hedging position in our portfolio, with 77% of our oil commitments hedged at over 50% for $52 through the rest of 2020 and 41% hedged at over 50% for $52.20 in 2021. This hedging strategy for both our oil and gas portfolios will support them through this transition as the economy recovers and prices rise.

Okay. That’s great.

And you also see...

Yeah.

You have got an allowance there for energy that’s 4.4%, that’s well above what it was during the last cycle at peak. And our view is that we are trying to address this now through CECL proactively so you kind of get this all reserved for. We evaluate every one of those NPLs for any impairment as we look at those. So I think the perspective is, we reserve for that; we will continue to evaluate circumstances, but we think that we are well reserved and adequately reserved for that portfolio as we move forward.

Okay, that’s all helpful. I have two more questions. I tried to incorporate abate into my loan loss provision line in my model, but it didn’t work, so I need some clarification on what abate means in the context of reserve building. Are you indicating that you expect to build reserves somewhat, but you’re not anticipating significant loss content? You’ve clearly communicated your stance on loan balances, so should we expect a considerable reduction in the provision from this point onward?

I wouldn’t…

Go ahead, Marc.

I wouldn’t say that we will have a significant retreat. I suggest that with CECL designed to bring reserve build earlier in the cycle, the economic forecasts and our own portfolio assessment have led to a strong reserve build so far. If our base case forecast holds, we wouldn't need to build additional reserves. However, we won't start reducing that reserve unless we observe improving credit quality or do not see an increase in credit deterioration depending on economic developments. We are confident about the energy portfolio and recognize that stimulus packages have supported retail in some COVID-impacted industries, and we need to monitor how those evolve over the next few quarters. If conditions change into 2021, we may have the opportunity to reassess the reserve level.

Jon, we define reserve build as provision greater than charge-offs, and it’s certainly dependent on what we see from a credit migration as this virus unfolds. What we are trying to foreshadow there is, we do think the significant provision in reserve building that we experienced in the first quarter and second quarter is largely behind us. And as we move forward, we would be more responsive to actual charge-off levels than continuing to try to build the reserve if our economic forecast holds.

Okay. I may follow up on that, but it seems to me that with your potential issues coming down, you are not really indicating a lot of stress in credit from here based on my interpretation. I can follow up on that. My last question is about the buyback; what would you need to feel comfortable thinking about restarting the repurchase program? That’s all I have. Thanks.

This is Steven. I believe the pricing is appealing, and we'll need to assess the environment moving forward. We have a strong capital position, which actually improved this quarter. I'm not making any definitive statements regarding whether we will engage in buybacks, but it is a topic we consider opportunistically at the bank, and we will make a decision accordingly. It's not ruled out. Unlike many banks that have announced a halt to buybacks for the year, we are not in that situation. We will review the circumstances as the year progresses and may decide to repurchase some shares.

Yeah.

Just no firm commitment.

All right. Good. Thank you.

Thank you. Our next question is coming from Jared Shaw of Wells Fargo. Please go ahead.

Hi. Good morning. This is actually Timur Braziler for Jared.

Hi.

I’d like to just follow up on the credit question from the prior caller. It looked like the allowance build this quarter was quite sensitive to credit migration. And from all the commentary that you are saying, it seems like a combination of the improved pricing along with other things, if there’s going to be some potentially meaningful positive credit migration in as early as the third quarter. I guess, what would prevent that same level of sensitivity of allowance coming off as migration improves in the coming quarters versus allowing it to build when migration worsened in the second quarter?

I believe that’s the essence of CECL. Our models incorporate a factor for risk grade migration, which we experienced. As Marc and Stacy mentioned, during our borrowing base assessments, we evaluated the risk grade of our energy customers and observed a negative migration. This impacts our probability of loss and default calculations in our CECL model. If we see improvements in those grades in the third or fourth quarter when we reassess the borrowing base, especially given the significant price recovery since June, we would anticipate a positive shift in risk grade migration, which would positively influence our CECL calculations. If we determine that reserves need to be reduced, we will do so, but we need to wait to see how things play out in the third and fourth quarters to understand how this will unfold.

Okay. That’s helpful. And then just last one for me, there is a statement in the release talking about repurchasing loans from Ginnie Mae when certain delinquency criteria are met. Is that mandatory when certain criteria are met; you have to repurchase them back from those pools or is that at your discretion, and I guess any kind of color you could provide around that would be helpful?

Yeah. It’s not mandatory. It’s at our discretion. But you lose both sales. You basically have controls since you can purchase them back. So you bring them back on your balance sheet. But it just grossly ups the balance sheet. So you don’t actually purchase them, but you bring the loans back, and then you have an offsetting liability on the other side. So it’s not mandatory. But we have in the past purchased some of those for real and had gains some advantage of that over time, but that’s the way the accounting works there.

Got it. Thank you.

Thank you. Our next question is coming from Gary Tenner of D.A. Davidson. Please proceed with your follow-up.

Thanks. I just had one quick follow-up. In terms of the $1.6 billion of the COVID-19 impact area loans on slide nine, what amount of those have been under forbearance or modification since this pandemic started?

Yeah. This is Marc. What amount has been under deferral? We have actually had our deferral amount is about 5.6% of our total loans, but 70% of the loans that are in that slide actually received PPP as opposed to asking for deferrals. So we haven’t had any significant increase in deferrals on that particular slide relative to any other part of the portfolio, because they were primary beneficiaries from PPP and that caused a number of them not to take deferrals.

Okay. The slide says, PPP loans to those categories are $240 million versus the…

Correct.

...$1.6 billion, so that’s about 15%.

Right. 15% of those loans received PPP, but 70% of the customers got the PPP loans.

I see.

Have been put more account in the dollars.

Okay. Perfect. Thank you.

At this time, I would like to turn the floor back over to Mr. Nell for closing comments.

Okay. If that’s all the questions we have, then we really appreciate everyone joining us today. If you have any further questions, feel free to call me at 918-595-3030 or you can email us at ir@bokf.com. Everyone have a great day. Thank you.

Ladies and gentlemen, thank you for your participation. This concludes today’s event. You may disconnect your lines and log off the webcast at this time and have a wonderful day.