BOKF - BOK Financial Leveraging Higher Rates To Great Effect

Summary

• BOK reported strong fourth quarter numbers, with well above average spread income growth only partly offset by higher opex spending.
• Commercial loan growth should be a driver in 2023 and while NIM has likely peaked, I expect BOKF to post above-average pre-provision growth in both 2023 and 2024.
• BOKF has achieved an attractive deposit beta, helped by a strong mix of no-cost deposits, but higher funding costs and credit losses are still meaningful threats in 2023.
• BOKF shares have outperformed with the bank's better operating performance; they're not cheap now, but relative to an above-average growth profile, they could still offer upside.

When I last wrote about BOK Financial ( BOKF ), I said that I wanted to see better asset sensitivity and operating leverage from this Oklahoma-based bank. Management delivered that and then some in 2022, with both a stronger loan beta and lower deposit beta than I’d expected, as well as better operating leverage. That, in turn, has helped BOK outperform over the past year, beating the average regional bank by about 600bp.

There are a lot of things to like about BOK at this point. Higher funding costs are a threat, but a low loan/deposit ratio helps. Higher credit costs are a risk, and I’d like to see a little more reserving, but credit seems stable for now. Net interest margin and operating leverage have probably peaked for the time being, but that’s true for most banks and I think BOK is likely to outperform on pre-provision profit growth over the next two years (and over the longer term). My biggest concern is valuation, but if sentiment on banks improves this year, I could see another $15/share or so in upside from rerating.

Strong Results Driven By Spread Income

I’m pretty much a quibbler by trade, but there wasn’t much for me to take issue within BOK’s fourth quarter results, as the financials were ahead of expectations and most of what I’d consider to be peer banks.

Revenue rose 29% year over year and about 7% sequentially, beating expectations by about 8% or close to $0.50/share. Net interest income drove this, growing 27% yoy and 11% qoq, beating expectations by around $0.42/share and roughly doubling the sequential NII growth of peer/comp banks. Net interest income was driven in large part by spread, with net interest margin up 102bp yoy and 30bp qoq to 3.54%, while earning assets rose 2% qoq.

Fee income rose less than 1% sequentially, but that was still better than expected. Mortgage banking was unsurprisingly weak (down another 11% qoq) and fiduciary and asset management was also down 1% qoq, but brokerage and trading was up 3% and card revenue improved almost 5%. Given the drivers of BOK’s fee income, I would expect stronger growth here in FY’23 than I’d expect from the average comparable bank.

Operating expenses rose 6% yoy and 8% qoq, and while operating expenses were quite a bit higher than expected (taking almost $0.28/share out of the earnings beat), the bank was only slightly higher than expected (about 20bp) on efficiency ratio (lower is better), though BOK still has a relatively high efficiency ratio next to many peers in the low-to-mid-50%s. Part of the growth in expenses this quarter was driven by higher incentive comp tied to the revenue outperformance.

Pre-provision operating income rose more than 82% yoy and 6% qoq, beating expectations by about 9% or $0.22/share and slightly outperforming its peers (closer to 5% qoq growth on average). Provisioning was a little lower than expected, but taxes were a little higher, driving a bottom-line EPS beat of about $0.25/share.

BOK Should Continue To See Profitable Spread Growth

Looking at 2023, I think BOK is in good shape to continue producing profitable growth, even with the challenges of a weaker macroeconomic backdrop and higher funding costs.

Management guided for “mid-to-high single-digit” loan growth, and unless management chooses to back off a bit (to preserve underwriting discipline), that could prove conservative. BOK isn’t a player in card lending, which I believe will be strong in FY’23, but it does have meaningful C&I lending exposure (which I think is likely the next-best category), and management has been doing a good job of expanding its lending relationships.

BOK outgrew the group with over 4% growth in C&I lending this quarter, and that was with pretty modest growth from two of its largest specialty verticals – energy (up less than 2%) and healthcare (up less than 1%). Given I have a bullish outlook on oil/gas in 2023, I think there could be more opportunities here, but I also realize that this is a sensitive point with many investors given outsized losses on energy lending in the past (even though BOK’s credit quality history here is better).

BOK has enjoyed significant benefits from asset sensitivity in the past year, with its loan yield jumping almost 130bp to 5.99%. From the start of the cycle, BOK’s loan beta is 67% - higher than other commercial lenders like Comerica ( CMA ) – but I expect the benefits to taper off from here.

On the other side of the equation, funding costs, BOK continues to perform well. Cumulative deposit beta is 18% - very competitive with its peer group, as is its total deposit costs (0.73% versus 0.07% last year and 0.37% in the prior quarter). Above-average non-interest-bearing deposit attrition (down more than 10%) concerns me some, but the loan/deposit ratio is still below 65% and non-interest-bearing deposits are still about 39% of total deposits. Moreover, the bank has ample securities on hand to fund loan growth if need be.

I also want to note that management is starting to shift its rate strategy now that we’re close to the assumed end of the rate hike cycle. Leveraging FHLB funding and acquiring more securities, BOK is moving toward a more asset-neutral position (as opposed to asset-sensitive), which makes sense given the expected shift toward a looser policy later in 2023 or in 2024. While there is a risk of missing out if the Fed is even more aggressive than expected, I think it makes sense to make this shift today.

The Outlook

I do believe that BOK has seen its peak net interest margin for the cycle, and I expect operating leverage opportunities to be fairly modest over the next year or two. Even so, the residual impact of BOK’s loan growth and spread improvement should drive strong pre-provision profit growth in 2023 (over 20%), and I think BOK has a good chance to generate double-digit growth from 2022-2024 ahead of its peers.

My biggest concern at this point is credit quality. Non-performing loans declined sequentially, but the non-performing loan ratio, non-performing asset ratio, and charge-off ratios are higher than for peers. That’s not necessarily a bad sign (some banks simply run with higher ratios), but the level of reserves (about 221% of non-performing loans) is a little lower than I’d like to see. I don’t think we’re going to see a severe recession (if we see a recession at all), and I think credit quality will be fine, but BOK has the surplus capital where it can afford to be a little more conservative here.

I’m clearly expecting very healthy growth in 2023 and 2024, and at the EPS level, my ’23 estimate is just a bit higher than the average, while my ’24 estimate is about $0.57/share higher today ($9.97 versus $9.40). There is risk here, as many banks are likely to see weaker results in 2024 relative to 2023, but for now, I think BOK will do better than many other banks. Longer term, I expect core growth around 7%, which is admittedly not a conservative assumption, particularly with so many banks targeting Texas for commercial loan growth.

Between discounted core earnings, ROTCE-driven P/TBV, and P/E, BOKF shares look only slightly undervalued at a time when many other banks are 10% to 20% undervalued. I’m using an 11x multiple on my ’23 estimate, which is above what most similarly-sized banks are getting now (9.5x to 10.5x is the normal range) and rewards the bank for its better growth profile. In normal times, a bank like BOF would typically trade at around 12.5x forward EPS, and that would offer a little more than $14/share upside from my current multiple.

The Bottom Line

I definitely underestimated BOK’s rate leverage in 2022 and its ability to generate attractive loan growth while managing deposit costs and operating expenses. I do think the shares reflect the improved execution, and I’m tempted to call this a “buy” on the basis of what I think is an above-average likelihood of noticeably better PPOP growth over the next two years. As is, this is a name I’d monitor in the hopes of getting a more interesting entry point for the shares.

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