BOKF - BOK Financial Playing Offense When Others Choose Defense

2023-10-27 00:39:56 ET

Summary

• BOK Financial reported an ugly quarter with much weaker net interest margin and operating leverage than expected.
• BOK Financial wants to take advantage of its rivals' retreat from lending markets to gain market share, but this means adding more high-cost deposits and perhaps more credit risk.
• For at least a couple of years, BOKF won't be in a position to offer what the Street currently wants most - well-contained deposit costs, operating leverage, and conservative underwriting.
• It remains to be seen whether the bank can win, and keep, quality commercial relationships; the shares do appear undervalued today, but that's true for many regional banks.

It would seem that BOK Financial (BOKF) is really taking Warren Buffett's quote about being greedy when others are fearful to heart. While the Street has generally been more supportive of banks willing to shelter in place as deposit pricing and rising credit costs sweep through the sector, this bank is taking the retreat of rivals from lending markets as a rare opportunity to gain share. Time will tell if the company can hold on to this newly-won business and generate strong long-term margins from it, but in the short term it is definitely going to carry a high cost for the bank and its shareholders.

BOK shares are down close to 40% since my last update , but prior to this third quarter earnings release, the stock had been largely outperforming regional banks - not by a lot, but still outperforming. I've had issues with BOK's valuation in the past, and that's still at least partly true now. While BOK shares do look undervalued on mid-single-digit long-term core earnings growth and nearer-term metrics, the shares still aren't all that cheap relative to other regional banks.

An Ugly Quarter

Maybe third quarter results will eventually be looked back upon as just part of the bank's management being willing to pay a cost and take risks that others weren't in the pursuit of long-term market share growth and value creation. In the here and now, though, it was one of the ugliest quarters I've seen from a large(-ish) bank relative to sell-side expectations.

Revenue declined 2% year over year and about 5% quarter over quarter, which honestly wouldn't be that bad, but it was still bad enough to drive a $0.17/share shortfall versus Street expectations. Net interest income fell about 5% yoy and 7% qoq, missing by more than $0.12, as the bank came in with a far lower net interest margin than expected (down 55bp yoy and 31bp qoq to 2.69%), though earning assets did grow a faster-than-expected 3%.

Fee-based income is a significant part of the revenue mix at BOK (around 40%), but only a marginally positive contributor this quarter. This line-item rose about 3% yoy and fell 1% qoq, missing by more than $0.04/share. Fiduciary/asset management was down modestly, mortgage banking was down double-digits, and brokerage and trading was down about 4%, while card revenue ticked up modestly.

Operating expenses rose 10% yoy and 2% qoq, driving another $0.03-plus miss relative to the Street, and an efficiency ratio of almost 65% is nothing particularly special. Pre-provision operating profit fell 18% yoy and 14% qoq, missing by almost $0.21/share (almost 9%). Much lower than expected provisioning and a modestly lower tax rate shrunk some of the underperformance, but core earnings performance was quite weak.

Hitting The Gas When Others Are Pulling Over

Right now the Street wants low deposit beta, positive operating leverage, and reduced credit risk … and BOK management is prepared to give them exactly none of that.

At a time when many banks have reduced their lending activity, whether that's to improve/preserve liquidity, manage/reduce credit risk, or manage profitability, BOK is charging ahead, seeing this retreat from its rivals as an opportunity to take share in markets with attractive long-term characteristics (Texas, in particular).

To that end, loans rose 9% yoy and 2% qoq, well above the sector-wide average and not too far off the growth reported by Pinnacle ( PNFP ) on a sequential basis. Growth was pretty well-balanced, with above-market growth in C&I lending (up 8% yoy and more than 1% qoq), adjusted CRE lending (up about 5% yoy and more than 1% qoq), and mortgage lending (up more than 6% yoy and more than 3% qoq). Multifamily was also a strong growth driver, up 54% yoy and more than 15% qoq, and only consumer declined on a sequential basis (so did construction, but it's not a meaningful category).

Yields remain strong, with loan yields up 231bp yoy and 22bp qoq to 7.25%, and BOK sports an impressive 71% cumulative loan yield beta.

Growing the loan book comes at a cost, though, and deposit pricing pressures are weighing more heavily on the bank. Deposits rose 1% qoq on an end-of-period basis, but non-interest-bearing deposits declined more than 7% qoq, on the high end of what banks have been reporting this quarter. While NIB deposits are still about 30% of the deposit mix (solid, on a relative basis), the need to replace those NIBs is driving much higher deposit costs, with total costs up 51bp qoq to 2.20% and interest-bearing costs up 61bp to 3.17%. This isn't the worst I've seen, Bank OZK ( OZK ) is in a similar place, and Zions ( ZION ) did worse this quarter on a sequential basis, but this isn't a competition you want to be in the running to win.

With BOK now likely to generate mid-single-digit or greater loan growth over the next couple of years, NIM pressure is going to remain a bigger issue. BOK's interest-bearing deposit beta has shot up to 59% and is now on the higher end of the comp group. With the Fed likely to raise at least one more time, and with deposit costs historically continuing to rise another quarter or two after the Fed finishes tightening, I do see an ongoing risk of greater spread pressure.

As all this goes on, operating leverage will be harder to come by. BOK has never been a leader in operating efficiency, and it's going to be tough to meaningfully cut costs will actively look to take new business and expand lending. With that, mid-to-high 60%'s ERs seem more likely over the next couple of years.

The Outlook

I suppose it's refreshing for the Street to be fretting over something other than BOK's energy exposure for once, and I likewise personally don't have too many worries about the office portfolio - it's not that large at around 4% of loans, and I'm not as concerned about office markets like Dallas, Denver, and Houston as I am NYC.

The Street certainly didn't like BOK's sizable miss and the company's decision to strategically target share growth. I understand this to a point - the Street is definitely risk-averse when it comes to banks right now, and you can make a good argument that "risk-averse" is generally the right way to be as a bank in most times. On the other hand, the companies that really outperform over time often include those who are willing to make bold strategic moves that run against the grain, and BOK is certainly giving that a shot.

I actually like this willingness to pay today for market share tomorrow, provided that the bank doesn't let its underwriting standards slip and provided that it can turn these new customers into loyal long-term customers. What I don't want is to see them becoming the marginal lender of choice for borrowers that don't have better options.

I'm now looking for mid-single-digit long-term core earnings growth from BOK (around 5%), but it's well worth remembering that with these very highly leveraged businesses, relatively small changes in modeling assumptions a couple of years down the road can drive big swings in earnings and growth rates. Discounted back, those core earning streams support a fair value of around $80.

Shorter-term approaches are less generous. If I use a 10x forward P/E (a 20% haircut to the long-term average for peer banks) on my '24 EPS estimate, I get a $70 fair value. Likewise, using my estimates for FY'24/'25 ROTCE (in the 11%'s), I get a P/TBV multiple of 1.35x or about $76.

The Bottom Line

Although BOK has often traded at a premium to apparent fair value, even now that undervaluation isn't as impressive relative to how other regional banks, banks with arguably less execution risk, are now valued. If you believe in the long-term story, this is probably a good opportunity to pick up shares. If you don't, I don't know what price would be suitable, and there are certainly potential downside drivers (like the unrealized securities losses, spread pressure, credit, et al). I think there are better ideas right now, including Pinnacle and perhaps Bank OZK , but this is a name that I'm finding more interesting than I generally have in recent years.

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