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Section 1: 10-Q (10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One) 
ý
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
OR
¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _____________ to ______________                 

Commission File No. 0-19341

BOK FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter) 
Oklahoma
 
73-1373454
(State or other jurisdiction
of Incorporation or Organization)
 
(IRS Employer
Identification No.)
 
 
 
Bank of Oklahoma Tower
 
 
Boston Avenue at Second Street
 
 
Tulsa, Oklahoma
 
74192
(Address of Principal Executive Offices)
 
(Zip Code)
 
(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  ý  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  ý  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  ý                                               Accelerated filer           ¨                                   
Non-accelerated filer   ¨ (Do not check if a smaller reporting company)    Smaller reporting company ¨
Emerging growth company ¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 65,439,090 shares of common stock ($.00006 par value) as of June 30, 2018.





BOK Financial Corporation
Form 10-Q
Quarter Ended June 30, 2018

Index

Part I.  Financial Information
Management’s Discussion and Analysis (Item 2)        
Market Risk (Item 3)                                                                                              
Controls and Procedures (Item 4)
Consolidated Financial Statements – Unaudited (Item 1)
Quarterly Financial Summary – Unaudited (Item 2)
Quarterly Earnings Trend – Unaudited
 
 
Part II.  Other Information
Item 1.  Legal Proceedings
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.  Exhibits
Signatures




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

BOK Financial Corporation (“the Company”) reported net income of $114.4 million or $1.75 per diluted share for the second quarter of 2018, compared to $88.1 million or $1.35 per diluted share for the second quarter of 2017 and $105.6 million or $1.61 per diluted share for the first quarter of 2018

On June 18, 2018, the Company announced the signing of a definitive merger agreement with CoBiz Financial Inc. CoBiz is headquartered in Denver with a presence in Colorado and Arizona and has approximately $3.8 billion in assets. Upon completion of the merger, CoBiz shareholders will receive 0.17 shares of BOK Financial common stock and $5.70 in cash for each share of CoBiz common stock. The merger is subject to customary closing conditions including regulatory approval.

Highlights of the second quarter of 2018 included:
Net interest revenue totaled $238.6 million, up from $205.2 million in the second quarter of 2017 and $219.7 million in the first quarter of 2018. The increase in net interest revenue over the prior year was driven by both improving yields and growth in average earning assets. Net interest margin was 3.17 percent for the second quarter of 2018. Net interest margin was 2.89 percent for the second quarter of 2017 and 2.99 percent for the first quarter of 2018. Average earning assets were $30.3 billion for the second quarter of 2018 compared to $29.2 billion for the second quarter of 2017.
Fees and commissions revenue totaled $157.9 million. Adoption of the new revenue recognition accounting standard in the first quarter of 2018 resulted in interchange fees we pay to issuing banks being netted against transaction card revenue. Previously these fees were included in data processing and communications expense. Excluding this impact, fees and commissions revenue decreased $9.4 million compared to the second quarter of 2017. Brokerage and trading revenue decreased $5.3 million while mortgage banking revenue decreased $3.9 million, both affected by rising interest rates. Fees and commissions revenue decreased $1.1 million compared to the first quarter of 2018. Modest changes in revenue from other business lines was offset by decreased brokerage and trading revenue.
Other operating expense totaled $246.5 million, a $5.8 million or 2 percent increase over the second quarter of 2017 on a comparable basis. Personnel expense decreased $4.8 million, primarily due to decreased incentive compensation expense. Non-personnel expense increased $10.6 million due largely to an increase in deposit insurance expense as a result of credits in the second quarter of 2017 along with increased project and acquisition costs. Operating expense increased $2.0 million compared to the first quarter of 2018 on a comparable basis. Personnel expense decreased $1.0 million and non-personnel expense increased $3.0 million. Professional fees and services expense and mortgage banking costs were higher in the second quarter.
Income tax expense was $33.3 million or 22.4 percent of net income before taxes for the second quarter of 2018 compared to $47.7 million or 34.9 percent for the second quarter of 2017. Beginning January 1, 2018, the Tax Cuts and Jobs Act ("the Act") decreased the corporate income tax rate from 35% to 21%.
The Company recorded no provision for credit losses in the second quarter of 2018. A $5.0 million negative provision for credit losses was recorded in the first quarter of 2018. Net charge-offs totaled $10.5 million or 0.24 percent of average loans on an annualized basis in the second quarter of 2018 compared to net charge-offs of $1.3 million or 0.03 percent of average loans on an annualized basis for the first quarter of 2018. Net charge-offs were $26.9 million or 0.16 percent of average loans over the last four quarters.
The combined allowance for credit losses totaled $218 million or 1.21 percent of outstanding loans at June 30, 2018 compared to $228 million or 1.32 percent of outstanding loans at March 31, 2018.
Nonperforming assets that are not guaranteed by U.S. government agencies totaled $186 million or 1.04 percent of outstanding loans and repossessed assets at June 30, 2018 and $195 million or 1.13 percent of outstanding loans and repossessed assets at March 31, 2018. Potential problem loans decreased $82 million to $140 million at June 30, 2018.
Average loan balances grew by $490 million over the previous quarter, primarily due to growth in commercial and commercial real estate loan balances. Period-end outstanding loan balances totaled $18.0 billion at June 30, 2018, an increase of more than $665 million over March 31, 2018.

- 1 -



Average deposits were largely unchanged compared to the previous quarter. Average demand deposit balances increased $72 million, while interest-bearing transaction deposit balances decreased $155 million. Period-end deposits were $22.2 billion at June 30, 2018, a $36 million decrease compared to March 31, 2018.
The common equity Tier 1 capital ratio at June 30, 2018 was 11.92 percent. Other regulatory capital ratios were Tier 1 capital ratio, 11.92 percent, total capital ratio, 13.26 percent, and leverage ratio, 9.57 percent. At March 31, 2018, the common equity Tier 1 capital ratio was 12.06 percent, the Tier 1 capital ratio was 12.06 percent, total capital ratio was 13.49 percent, and leverage ratio was 9.40 percent.
The company paid a regular cash dividend of $29.3 million or $0.45 per common share during the second quarter of 2018. On July 24, 2018, the board of directors approved an increase in the quarterly cash dividend to $0.50 per common share payable on or about August 27, 2018 to shareholders of record as of August 13, 2018.
The company repurchased 8,257 common shares at an average price of $99.84 per share during the second quarter of 2018. The company repurchased 82,583 common shares at an average price of $91.83 per share during the first quarter of 2018.

- 2 -



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 tax-equivalent 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 $238.6 million for the second quarter of 2018, up from $205.2 million in the second quarter of 2017 and $219.7 million in the first quarter of 2018. Net interest margin was 3.17 percent for the second quarter of 2018, 2.89 percent for the second quarter of 2017 and 2.99 percent for the first quarter of 2018. Recoveries of foregone interest on nonaccruing loans added $5.3 million or 7 basis points to net interest margin in the second quarter of 2018. Recoveries of foregone interest were not significant in the first quarter of 2018 or the second quarter of 2017. The discussion following excludes the impact of recoveries of foregone interest in the second quarter of 2018 on net interest margin.

In addition to the impact of foregone interest recoveries on the second quarter of 2018, net interest margin was 4 basis points lower in the second quarter of 2018 compared to the second quarter of 2017 due to the impact of lower effective tax rates from the implementation of the Tax Cut and Jobs Act on the tax-equivalent yield of our tax-exempt loans and securities. However, net interest margin was 4 basis points higher in the second quarter of 2018 as we reduced our excess cash balances at the Federal Reserve. Beginning in 2014, the Company increased borrowings from the Federal Home Loan Banks, depositing the excess cash balances in the Federal Reserve to earn a spread. In conjunction with the Federal Reserve's monetary policy normalization, this spread narrowed in the second quarter of 2018.

Tax-equivalent net interest revenue increased $31.0 million over the second quarter of 2017. Table 1 shows the effect on net interest revenue from changes in average balances and interest rates for various types of earning assets and interest-bearing liabilities. Changes in interest rates and yields increased net interest revenue by $20.5 million. The benefit of an increase in short-term interest rates on the floating-rate earning assets was partially offset by higher borrowing costs. Tax-equivalent net interest revenue increased $10.5 million due to growth in average assets. Growth in the average balances of trading securities and loans was partially offset by decreases in interest-bearing cash and cash equivalents.

The tax-equivalent yield on earning assets was 3.84 percent, up 54 basis points over the second quarter of 2017, primarily due to increases in short-term interest rates resulting from three 25 basis point increases in the federal funds rate by the Federal Reserve. Loan yields increased 65 basis points to 4.68 percent. The yield on interest-bearing cash and cash equivalents increased 82 basis points. The available for sale securities portfolio yield was up 19 basis points to 2.30 percent. Funding costs were up 48 basis points over the second quarter of 2017. The cost of interest-bearing deposits increased 26 basis points and the cost of other borrowed funds increased 82 basis points. The benefit to net interest margin from earning assets funded by non-interest bearing liabilities was 37 basis points for the second quarter of 2018, up 15 basis points over the second quarter of 2017.

Average earning assets for the second quarter of 2018 increased $1.1 billion or 4 percent over the second quarter of 2017. The average balance of trading securities grew by $1.0 billion, primarily due to expansion of U.S. agency residential mortgage-backed securities trading activities. Average loans, net of allowance for loan losses, increased $650 million, due primarily to growth in commercial loans. Restricted equity security balances were up $53 million. Interest-bearing cash and cash equivalent balances decreased $334 million. Available for sale securities decreased $221 million. Investment securities balances decreased $100 million.

Average deposits decreased $37 million compared to the second quarter of 2017. Demand deposit balances decreased $115 million and time deposit balances decreased $66 million. Interest-bearing transaction account balances increased $102 million and savings account balances increased $42 million. Average borrowed funds increased $1.0 billion over the second quarter of 2017, primarily due to the net impact of increased borrowings from the Federal Home Loan Banks. Funds purchased and repurchase agreement balances also increased over the prior year.


- 3 -



The yield on average earning assets was 3.84 percent, a 23 basis point increase over the prior quarter. The loan portfolio yield also increased 23 basis points to 4.68 percent. The yield on the available for sale securities portfolio increased 7 basis points to 2.30 percent. The yield on interest-bearing cash and cash equivalents increased 29 basis points. Funding costs were 1.11 percent, up 18 basis points. The cost of interest-bearing deposits increased 9 basis points to 0.66 percent. The cost of other borrowed funds was up 34 basis points to 1.84 percent. The benefit to net interest margin from earning assets funded by non-interest bearing liabilities increased 6 basis points over the prior quarter.
Average earning assets increased $423 million over the first quarter of 2018. Trading securities balances increased $549 million. Average loan balances grew by $490 million. Average interest-bearing cash and cash equivalents balances decreased $386 million. Fair value option securities held as an economic hedge of our mortgage servicing rights decreased $139 million. Available for sale securities decreased $74 million.
Average deposits decreased $72 million compared to the previous quarter. Interest-bearing transaction account balances decreased by $155 million. Demand deposit balances increased $72 million. The average balance of borrowed funds increased $231 million over the first quarter of 2018, primarily due to increased borrowings from the Federal Home Loan Banks and funds purchased and repurchase agreement balances.

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 82% of our commercial and commercial real estate loan portfolios are either variable rate or fixed rate that will reprice within one year. These loans are funded primarily by deposit accounts that are either non-interest bearing, or that reprice more slowly than the loans. The result is a balance sheet that would be asset sensitive, which means that assets generally reprice more quickly than liabilities. One of the strategies that we use to manage toward a relative rate-neutral position is to 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. For the remainder of 2018, we expect low-to-mid single digit expansion in net interest margin for each 25 basis point increase in the federal funds rate.

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.

- 4 -




Table 1 -- Volume/Rate Analysis
(In thousands)
 
 
Three Months Ended
June 30, 2018 / 2017
 
Six Months Ended
June 30, 2018 / 2017
 
 
 
 
Change Due To1
 
 
 
Change Due To1
 
 
Change
 
Volume
 
Yield/Rate
 
Change
 
Volume
 
Yield/Rate
Tax-equivalent interest revenue:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing cash and cash equivalents
 
$
2,542

 
$
(1,215
)
 
$
3,757

 
$
6,280

 
$
(1,190
)
 
$
7,470

Trading securities
 
9,567

 
8,625

 
942

 
12,007

 
12,203

 
(196
)
Investment securities:
 
 
 
 
 
 
 
 
 
 
 
 
Taxable securities
 
(86
)
 
(24
)
 
(62
)
 
(143
)
 
45

 
(188
)
Tax-exempt securities
 
(661
)
 
(609
)
 
(52
)
 
(1,346
)
 
(1,160
)
 
(186
)
Total investment securities
 
(747
)
 
(633
)
 
(114
)
 
(1,489
)
 
(1,115
)
 
(374
)
Available for sale securities:
 
 
 
 
 
 
 
 
 
 
 
 
Taxable securities
 
4,402

 
247

 
4,155

 
7,290

 
(1,009
)
 
8,299

Tax-exempt securities
 
(584
)
 
(354
)
 
(230
)
 
(1,119
)
 
(681
)
 
(438
)
Total available for sale securities
 
3,818

 
(107
)
 
3,925

 
6,171

 
(1,690
)
 
7,861

Fair value option securities
 
388

 
93

 
295

 
2,827

 
1,725

 
1,102

Restricted equity securities
 
1,009

 
817

 
192

 
1,817

 
1,376

 
441

Residential mortgage loans held for sale
 
(53
)
 
(260
)
 
207

 
(45
)
 
(438
)
 
393

Loans
 
40,127

 
6,745

 
33,382

 
65,682

 
8,062

 
57,620

Total tax-equivalent interest revenue
 
56,651

 
14,065

 
42,586

 
93,250

 
18,933

 
74,317

Interest expense:
 
 
 
 
 
 
 
 
 
 
 
 
Transaction deposits
 
7,556

 
164

 
7,392

 
13,836

 
(29
)
 
13,865

Savings deposits
 

 
4

 
(4
)
 
1

 
9

 
(8
)
Time deposits
 
785

 
(193
)
 
978

 
1,369

 
(492
)
 
1,861

Funds purchased and repurchase agreements
 
618

 
81

 
537

 
1,044

 
39

 
1,005

Other borrowings
 
16,637

 
3,532

 
13,105

 
29,831

 
5,223

 
24,608

Subordinated debentures
 
45

 
(1
)
 
46

 
23

 
1

 
22

Total interest expense
 
25,641

 
3,587

 
22,054

 
46,104

 
4,751

 
41,353

Tax-equivalent net interest revenue
 
31,010

 
10,478

 
20,532

 
47,146

 
14,182

 
32,964

Change in tax-equivalent adjustment
 
(2,348
)
 
 
 
 
 
(4,766
)
 
 
 
 
Net interest revenue
 
$
33,358

 
 
 
 
 
$
51,912

 
 
 
 
1 
Changes attributable to both volume and yield/rate are allocated to both volume and yield/rate on an equal basis.

- 5 -



Other Operating Revenue

Other operating revenue was $156.4 million for the second quarter of 2018, a $15.6 million decrease compared to the second quarter of 2017 and largely unchanged compared to the first quarter of 2018. Fees and commissions revenue decreased $9.4 million compared to the second quarter of 2017 and was very consistent compared to the prior quarter. 

Table 2Other Operating Revenue 
(In thousands)
 
 
Three Months Ended
June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
 
Three Months Ended Mar 31, 2018
 
Increase (Decrease)
 
% Increase (Decrease)
 
 
2018
 
2017
 
 
 
 
 
Brokerage and trading revenue
 
$
26,488

 
$
31,764

 
$
(5,276
)
 
(17
)%
 
$
30,648

 
$
(4,160
)
 
(14
)%
Transaction card revenue1
 
20,975

 
20,009

 
966

 
5
 %
 
20,990

 
(15
)
 
 %
Fiduciary and asset management revenue
 
41,699

 
41,808

 
(109
)
 
 %
 
41,832

 
(133
)
 
 %
Deposit service charges and fees
 
27,827

 
28,422

 
(595
)
 
(2
)%
 
27,161

 
666

 
2
 %
Mortgage banking revenue
 
26,346

 
30,276

 
(3,930
)
 
(13
)%
 
26,025

 
321

 
1
 %
Other revenue
 
14,518

 
14,984

 
(466
)
 
(3
)%
 
12,330

 
2,188

 
18
 %
Total fees and commissions revenue
 
157,853

 
167,263


(9,410
)
 
(6
)%
 
158,986


(1,133
)
 
(1
)%
Other gains (losses), net
 
3,983

 
6,108

 
(2,125
)
 
N/A

 
(664
)
 
4,647

 
N/A

Loss on derivatives, net
 
(3,057
)
 
3,241

 
(6,298
)
 
N/A

 
(5,685
)
 
2,628

 
N/A

Loss on fair value option securities, net
 
(3,341
)
 
1,984

 
(5,325
)
 
N/A

 
(17,564
)
 
14,223

 
N/A

Change in fair value of mortgage servicing rights
 
1,723

 
(6,943
)
 
8,666

 
N/A

 
21,206

 
(19,483
)
 
N/A

Gain (loss) on available for sale securities, net
 
(762
)
 
380

 
(1,142
)
 
N/A

 
(290
)
 
(472
)
 
N/A

Total other operating revenue
 
$
156,399

 
$
172,033

 
$
(15,634
)
 
(9
)%
 
$
155,989

 
$
410

 
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-GAAP Reconciliation:1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Transaction card revenue on income statement
 
$
20,975

 
$
30,228

 
N/A

 
N/A

 
$
20,990

 
N/A

 
N/A

Netting adjustment
 

 
(10,219
)
 
N/A

 
N/A

 

 
N/A

 
N/A

Transaction card revenue after netting adjustment
 
$
20,975

 
$
20,009

 
966

 
5
 %
 
$
20,990

 
(15
)
 
 %
1 
Non-GAAP measure to net interchange charges from prior quarters between transaction card revenue and data processing and communications expense. This measure has no effect on net income or earnings per share.

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 40 percent of total revenue for the second quarter of 2018, excluding provision for credit losses and gains and losses on other assets, securities and derivatives and the change in the fair value of mortgage servicing rights. We believe that a variety of fee revenue sources provides an offset to changes in interest rates, values in the equity markets, commodity prices and consumer spending, all of which can be volatile. As an example of this strength, many of the economic factors such as rising interest rates resulting in growth in net interest revenue or fiduciary and asset management revenue, may also decrease mortgage production volumes. We expect growth in other operating revenue to come through offering new products and services and by further development of our presence in other markets. However, current and future economic conditions, regulatory constraints, increased competition and saturation in our existing markets could affect the rate of future increases.


- 6 -



Brokerage and Trading Revenue

Brokerage and trading revenue, which includes revenues from trading, customer hedging, retail brokerage and investment banking, decreased $5.3 million or 17 percent compared to the second quarter of 2017.

Trading revenue includes 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 and related derivative instruments. Trading revenue was $6.3 million for the second quarter of 2018, a $3.7 million or 37 percent decrease compared to the second quarter of 2017. Rising mortgage interest rates narrowed trading margins and slowed turnover of our trading inventory. However, the longer average hold time of trading securities increased net interest revenue by $3.1 million.

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 $9.8 million for the second quarter of 2018, a $1.8 million or 16 percent decrease compared to the second quarter of 2017.

Revenue earned from retail brokerage transactions decreased $1.2 million or 20 percent compared to the second quarter of 2017 to $4.8 million. Retail brokerage revenue includes fees and commissions earned on sales of fixed income securities, annuities, mutual funds and other financial instruments to retail customers. Revenue is primarily based on the volume of customer transactions and applicable commission rate for each product type. The implementation of the new Department of Labor ("DOL") fiduciary rule in the second quarter of 2017 has negatively impacted retail brokerage revenue.

Investment banking revenue, which includes fees earned upon completion of underwriting and financial advisory services and loan syndication fees, totaled $5.5 million for the second quarter of 2018, a $1.5 million or 37 percent increase over the second quarter of 2017. Changes in investment banking revenue are primarily related to the timing and volume of completed transactions.

Brokerage and trading revenue decreased $4.2 million compared to the first quarter of 2018, largely driven by a decrease in trading revenue due primarily to customer reaction to higher interest rates.

Transaction Card Revenue

Transaction card revenue depends largely on the volume and amount of transactions processed, the number of TransFund automated teller machine (“ATM”) locations and the number of merchants served. Transaction card revenue increased $966 thousand or 5 percent over the second quarter of 2017, primarily due to increases in transaction volumes. Transaction card was largely unchanged compared to the first quarter of 2018. The increase in transaction card revenue from the first quarter of 2018 due to an early customer termination fee was matched in the second quarter of 2017 with a seasonal increase in the volume of transactions processed.

Fiduciary and Asset Management Revenue

Fiduciary and asset management revenue is earned through managing or holding of assets for customers and executing transactions or providing related services. Approximately 80 percent of fiduciary and asset management revenue is primarily based on the fair value of assets. Rates applied to asset values vary based on the nature of the relationship. Fiduciary relationships and managed asset relationships generally have higher fee rates than non-fiduciary and/or managed relationships. Fiduciary and asset management revenue was largely unchanged compared to the second quarter of 2017 and the first quarter of 2018.


- 7 -



A distribution of assets under management or administration and related fiduciary and asset management revenue follows:

Table 3 -- Assets Under Management or Administration
 
Three Months Ended
 
June 30, 2018
 
June 30, 2017
 
Mar. 31, 2018
 
Balance
 
Revenue1
 
Margin2
 
Balance
 
Revenue1
 
Margin2
 
Balance
 
Revenue1
 
Margin2
Managed fiduciary assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Personal
$
7,791,094

 
$
23,307

 
1.20
%
 
$
7,581,555

 
$
21,698

 
1.14
%
 
$
7,577,717

 
22,632

 
1.19
%
Institutional
13,448,068

 
5,596

 
0.17
%
 
12,265,037

 
5,475

 
0.18
%
 
13,322,472

 
5,469

 
0.16
%
Total managed fiduciary assets
21,239,162

 
28,903

 
0.54
%
 
19,846,592

 
27,173

 
0.55
%
 
20,900,189

 
28,101

 
0.54
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-managed assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fiduciary
25,292,738

 
12,426

 
0.20
%
 
25,242,561

 
14,049

 
0.22
%
 
25,748,101

 
12,997

 
0.20
%
Non-fiduciary
16,422,810

 
370

 
0.01
%
 
16,579,586

 
586

 
0.01
%
 
16,321,458

 
734

 
0.02
%
Safekeeping and brokerage assets under administration
15,918,736

 

 
%
 
16,143,023

 

 
%
 
15,909,241

 

 
%
Total non-managed assets
57,634,284

 
12,796

 
0.09
%
 
57,965,170

 
14,635

 
0.10
%
 
57,978,800

 
13,731

 
0.09
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets under management or administration
$
78,873,446

 
$
41,699

 
0.21
%
 
$
77,811,762

 
$
41,808

 
0.21
%
 
$
78,878,989

 
$
41,832

 
0.21
%
1 
Fiduciary and asset management revenue includes asset-based and other fees associated with the assets.
2 
Annualized revenue divided by period-end balance.

A summary of changes in assets under management or administration for the three months ended June 30, 2018 and 2017 follows:

Table 4 -- Changes in Assets Under Management or Administration
 
 
Three Months Ended
June 30,
 
 
2018
 
2017
Beginning balance
 
$
78,878,989

 
$
77,418,956

Net inflows (outflows)
 
(746,477
)
 
(918,076
)
Net change in fair value
 
740,934

 
1,310,882

Ending balance
 
$
78,873,446

 
$
77,811,762


Mortgage Banking Revenue

Mortgage banking revenue decreased $3.9 million or 13 percent compared to the second quarter of 2017 due to a decrease in mortgage production revenue. Mortgage loan production volumes decreased $157 million or 18 percent. Production volumes decreased compared to the prior year as average primary mortgage interest rates were up 56 basis points over the second quarter of 2017. Mortgage servicing revenue was relatively consistent compared to the second quarter of 2017. The outstanding principal balance of mortgage loans serviced for others totaled $22.0 billion, consistent with the second quarter of 2017.



- 8 -



Table 5Mortgage Banking Revenue 
(In thousands)
 
 
Three Months Ended
June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
 
Three Months Ended Mar. 31, 2018
 
Increase (Decrease)
 
% Increase (Decrease)
 
 
2018
 
2017
 
 
 
 
Mortgage production revenue
 
$
9,915

 
$
13,840

 
$
(3,925
)
 
(28
)%
 
$
9,452

 
$
463

 
5
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans funded for sale
 
$
773,910

 
$
902,978

 


 


 
$
664,958

 
 
 
 
Add: Current period end outstanding commitments
 
251,231

 
362,088

 
 
 
 
 
298,318

 
 
 
 
Less: Prior period end outstanding commitments
 
298,318

 
381,732

 
 
 
 
 
222,919

 
 
 
 
Total mortgage production volume
 
$
726,823

 
$
883,334

 
$
(156,511
)
 
(18
)%
 
$
740,357

 
$
(13,534
)
 
(2
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage loan refinances to mortgage loans funded for sale
 
22
%
 
33
%
 
(1,100
) bps
 
 
 
42
%
 
(2,000
) bps
 
 
Gains on sale margin
 
1.36
%
 
1.57
%
 
(21
) bps
 
 
 
1.28
%
 
8
 bps
 
 
Primary mortgage interest rates:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average
 
4.54
%
 
3.98
%
 
56
 bps
 
 
 
4.28
%
 
26
 bps
 
 
Period end
 
4.55
%
 
3.88
%
 
67
 bps
 
 
 
4.44
%
 
11
 bps
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage servicing revenue
 
$
16,431

 
$
16,436

 
$
(5
)
 
 %
 
$
16,573

 
$
(142
)
 
(1
)%
Average outstanding principal balance of mortgage loans serviced for others
 
21,986,065

 
22,055,127

 
(69,062
)
 
 %
 
22,027,726

 
(41,661
)
 
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average mortgage servicing revenue rates
 
0.30
%
 
0.30
%
 

 
 
 
0.31
%
 
(1
) bp
 
 
1 
Actual interest earned on fair value option securities less internal transfer-priced cost of funds.

Primary rates disclosed in Table 5 above represent rates generally available to borrowers on 30 year conforming mortgage loans.

Net gains on other assets, securities and derivatives

Other net gains totaled $4.0 million in the second quarter of 2018 compared to net gains of $6.1 million in the second quarter of 2017. The second quarter of 2017 included the sale of a merchant banking investment. Other net losses totaled $664 thousand in the first quarter of 2018.

As discussed in the Market Risk section following, the fair value of our mortgage servicing rights ("MSRs") changes in response to changes in primary mortgage loan rates and other assumptions. We attempt to mitigate the earnings volatility caused by changes in the fair value of MSRs by designating certain financial instruments as an economic hedge. Changes in the fair value of these instruments are generally expected to partially offset changes in the fair value of MSRs.


- 9 -



Table 6 - Gain (Loss) on Mortgage Servicing Rights
(In thousands)
 
 
Three Months Ended
 
 
June 30, 2018
 
Mar. 31, 2018
 
June 30, 2017
Gain (loss) on mortgage hedge derivative contracts, net
 
$
(3,070
)
 
$
(5,698
)
 
$
3,241

Gain (loss) on fair value option securities, net
 
(3,341
)
 
(17,564
)
 
1,984

Gain (loss) on economic hedge of mortgage servicing rights, net
 
(6,411
)
 
(23,262
)
 
5,225

Gain (loss) on change in fair value of mortgage servicing rights
 
1,723

 
21,206

 
(6,943
)
Loss on changes in fair value of mortgage servicing rights, net of economic hedges included in other operating revenue
 
(4,688
)
 
(2,056
)
 
(1,718
)
Net interest revenue on fair value option securities1
 
1,203

 
1,800

 
1,965

Total economic benefit (cost) of changes in the fair value of mortgage servicing rights, net of economic hedges
 
$
(3,485
)
 
$
(256
)
 
$
247

1 Actual interest earned on fair value option securities less internal transfer-priced cost of funds.
During the second quarter of 2018, we changed certain assumptions used in our prepayment speed model to better align with current market expectations. During the second quarter of 2018 the fair value of our mortgage servicing rights was reduced by $3.7 million due primarily to an update of assumptions in our prepayment model designed to better align our model with current market behavior and observed portfolio performance.


- 10 -



Other Operating Expense

Other operating expense for the second quarter of 2018 totaled $246.5 million, an increase of $5.8 million or 2 percent compared to the second quarter of 2017. Personnel expense decreased $4.8 million or 3 percent. Non-personnel expense increased $10.6 million or 11 percent compared to the prior year.

Other operating expense increased $2.0 million over the previous quarter. Personnel expense decreased $1.0 million and non-personnel expense increased $3.0 million.

Table 7Other Operating Expense
(In thousands)
 
 
Three Months Ended
June 30,
 
Increase (Decrease)
 
%
Increase (Decrease)
 
Three Months Ended Mar. 31, 2018
 
Increase (Decrease)
 
%
Increase (Decrease)
 
 
2018
 
2017
 
 
 
 
 
Regular compensation
 
$
86,231

 
$
83,630

 
$
2,601

 
3
 %
 
$
84,991

 
$
1,240

 
1
 %
Incentive compensation:
 
 
 
 
 


 


 
 
 
 
 
 
Cash-based
 
31,933

 
29,954

 
1,979

 
7
 %
 
29,549

 
2,384

 
8
 %
Share-based
 
(1,361
)
 
7,380

 
(8,741
)
 
(118
)%
 
2,902

 
(4,263
)
 
(147
)%
Deferred compensation
 
900

 
1,000

 
(100
)
 
N/A

 
44

 
856

 
N/A

Total incentive compensation
 
31,472

 
38,334

 
(6,862
)
 
(18
)%
 
32,495

 
(1,023
)
 
(3
)%
Employee benefits
 
21,244

 
21,780

 
(536
)
 
(2
)%
 
22,461

 
(1,217
)
 
(5
)%
Total personnel expense
 
138,947

 
143,744

 
(4,797
)
 
(3
)%
 
139,947

 
(1,000
)
 
(1
)%
Business promotion
 
7,686

 
7,738

 
(52
)
 
(1
)%
 
6,010

 
1,676

 
28
 %
Professional fees and services
 
14,978

 
12,419

 
2,559

 
21
 %
 
10,200

 
4,778

 
47
 %
Net occupancy and equipment
 
22,761

 
21,125

 
1,636

 
8
 %
 
24,046

 
(1,285
)
 
(5
)%
Insurance
 
6,245

 
689

 
5,556

 
806
 %
 
6,593

 
(348
)
 
(5
)%
Data processing and communications1
 
27,739

 
26,111

 
1,628

 
6
 %
 
27,817

 
(78
)
 
 %
Printing, postage and supplies
 
4,011

 
4,140

 
(129
)
 
(3
)%
 
4,089

 
(78
)
 
(2
)%
Net losses (gains) and operating expenses of repossessed assets
 
2,722

 
2,267

 
455

 
20
 %
 
7,705

 
(4,983
)
 
(65
)%
Amortization of intangible assets
 
1,386

 
1,803

 
(417
)
 
(23
)%
 
1,300

 
86

 
7
 %
Mortgage banking costs
 
12,890

 
12,072

 
818

 
7
 %
 
10,149

 
2,741

 
27
 %
Other expense
 
7,111

 
8,558

 
(1,447
)
 
(17
)%
 
6,574

 
537

 
8
 %
Total other operating expense
 
$
246,476

 
$
240,666

 
$
5,810

 
2
 %
 
$
244,430

 
$
2,046

 
1
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average number of employees (full-time equivalent)
 
4,875

 
4,910

 
(35
)
 
(1
)%
 
4,899

 
(24
)
 
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-GAAP Reconciliation:1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Data processing and communications expense on income statement
 
27,739

 
36,330

 
N/A

 
N/A

 
27,817

 
N/A

 
N/A

Netting adjustment
 

 
(10,219
)
 
N/A

 
N/A

 

 
N/A

 
N/A

Data processing and communications expense after netting adjustment
 
27,739

 
26,111

 
N/A

 
N/A

 
27,817

 
N/A

 
N/A

1 
Non-GAAP measure to net interchange charges from prior quarters between transaction card revenue and data processing and communications expense. This measure has no effect on net income or earnings per share.

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


- 11 -



Personnel expense

Regular compensation, which consists of salaries and wages, overtime pay and temporary personnel costs, increased $2.6 million or 3 percent over the second quarter of 2017. The average number of employees was relatively unchanged compared to the prior year. Standard annual merit increases in regular compensation were effective for the majority of our staff on March 1.

Incentive compensation decreased $6.9 million or 18 percent compared to the second quarter of 2017, primarily due to decreased share-based compensation expense based on changes in assumptions of certain performance-based equity awards. Share-based compensation expense represents expense for equity awards based on grant-date fair value. Non-vested shares generally cliff vest in 3 years and are subject to a two year holding period after vesting. The number of shares that will ultimately vest is determined by BOKF's change in earnings per share relative to a defined group of peer banks. In addition, compensation costs related to certain shares are variable based on changes in the the fair value of BOK Financial common shares.

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. Cash-based incentive compensation expense increased $2.0 million or 7 percent over the second quarter of 2017.

Employee benefits expense decreased $536 thousand or 2 percent compared to the second quarter of 2017.
Personnel expense decreased $1.0 million compared to the first quarter of 2018. Incentive compensation expense decreased $1.0 million. Regular compensation expense increased $1.2 million. A $2.3 million seasonal decrease in payroll tax expense was partially offset by a $1.3 million increase in employee healthcare costs. The Company is self-insured and these costs may be volatile.

Non-personnel operating expense

Non-personnel operating expense increased $10.6 million or 11 percent compared to the second quarter of 2017.

Deposit insurance expense increased $5.6 million over the second quarter of 2017. The second quarter of 2017 included $5.1 million in credits related to the revision of certain inputs to the assessment calculation filed for years 2013 through 2016.

Professional fees and services expense increased $2.6 million or 21 percent mainly due to the inclusion of CoBiz acquisition costs and an increase in Consumer Banking related project costs in the second quarter of 2018.

Data processing and communications expense increased $1.6 million or 6 percent. Occupancy and equipment expense increased $1.6 million or 8 percent. These increases were primarily related to increased project costs and data processing transaction activity.
Non-personnel expense increased $3.0 million compared to the first quarter of 2018. Professional fees and services expense increased $4.8 million mainly due to expenses related to project costs of $1.8 million, CoBiz acquisition expenses of $1.0 million and $953 thousand in seasonal tax preparation charges from trust operations. Mortgage banking costs increased $2.7 million primarily due to a $1.9 million increase in accruals related to default servicing and loss mitigation costs on loans serviced for others.
Net losses and operating expenses of repossessed assets decreased $5.0 million, primarily due to a write-down of a set of repossessed oil and gas properties in the first quarter of 2018.


- 12 -



Income Taxes

The Company's income tax expense was $33.3 million or 22.4 percent of net income before taxes for the second quarter of 2018 compared to $47.7 million or 34.9 percent of net income before taxes for the second quarter of 2017 and $30.9 million or 22.7 percent of net income before taxes for the first quarter of 2018.

The Tax Cut and Jobs Act ("the Act") enacted on December 22, 2017 reduced the federal corporate tax rate from 35 percent to 21 percent beginning January 1, 2018. The Company continues to evaluate the impact the Act will have on its financial position and results of operations, including recognition and measurement of deferred tax assets and liabilities and the determination of effective current and deferred federal and state income tax rates. We initially recorded provisional adjustments of $11.7 million as a charge to income tax expense in the fourth quarter of 2017. We recorded an additional $1.9 million of net income tax expense for changes in provisional adjustments identified in the first quarter of 2018. No adjustments to provisional amounts were made during the second quarter of 2018.

The Company's effective tax rate is affected by recurring items such as tax-exempt income, net amortization related to its investments in low-income housing tax credit investments and share-based compensation. The effective tax rate is also affected by items that may occur in any given period but are not consistent from period to period. Accordingly, the comparability of the effective tax rate from period to period may be impacted.

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 $20 million at June 30, 2018, $20 million at March 31, 2018 and $17 million at June 30, 2017.


- 13 -



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, lending and deposit services to small business customers served through our consumer branch network and all mortgage banking activities. Wealth Management provides fiduciary services, private banking services and investment advisory services in all markets. Wealth Management also underwrites state and municipal securities and engages in brokerage and trading activities.

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 using the net direct contribution, which includes the allocation of funds, actual net credit losses and capital costs. In addition, we measure the performance of our business lines after allocation of certain indirect expenses and taxes based on statutory rates.

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 repricing and cash flow characteristics. Market rates are generally based on the applicable LIBOR or interest rate swap rates, adjusted for prepayment and liquidity risk. This method of transfer-pricing funds that supports 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 that approximate wholesale market rates for funds with similar repricing and cash flow 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 repricing 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-term 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 other 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.


- 14 -



As shown in Table 8, net income attributable to our lines of business was up $20.4 million or 22% percent over the second quarter of 2017. Net interest revenue grew by $25.6 million over the prior year, primarily due to loan growth. Other operating revenue decreased by $12.4 million primarily due to decreased mortgage banking revenue and brokerage and trading revenue. The second quarter of 2017 included a gain on a merchant banking investment. Operating expense decreased by $153 thousand. Income tax expense attributable to the lines of business was down $23 million, primarily due to lower corporate tax rates related to tax reform.

Table 8 -- Net Income by Line of Business
(In thousands)
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2018
 
2017
 
2018
 
2017
Commercial Banking
 
$
87,577

 
$
71,345

 
$
166,822

 
$
139,756

Consumer Banking
 
6,102

 
6,332

 
15,478

 
9,577

Wealth Management
 
20,119

 
15,689

 
39,728

 
29,848

Subtotal
 
113,798

 
93,366

 
222,028

 
179,181

Funds Management and other
 
574

 
(5,219
)
 
(2,094
)
 
(2,678
)
Total
 
$
114,372

 
$
88,147

 
$
219,934

 
$
176,503


- 15 -



Commercial Banking

Commercial Banking contributed $87.6 million to consolidated net income in the second quarter of 2018, an increase of $16.2 million or 23 percent over the second quarter of 2017. Growth in net interest revenue was partially offset by higher net charge-offs. In addition, the second quarter of 2017 included a $5.6 million gain on the sale of a merchant banking investment.

Table 9 -- Commercial Banking
(Dollars in thousands)
 
 
Three Months Ended
 
Increase (Decrease)
 
Six Months Ended
 
Increase (Decrease)
 
 
June 30,
 
 
June 30,
 
 
 
2018
 
2017
 
 
2018
 
2017
 
Net interest revenue from external sources
 
$
182,127

 
$
154,377

 
$
27,750

 
$
342,541

 
$
301,753

 
$
40,788

Net interest expense from internal sources
 
(37,102
)
 
(21,715
)
 
(15,387
)
 
(65,445
)
 
(39,831
)
 
(25,614
)
Total net interest revenue
 
145,025

 
132,662

 
12,363

 
277,096

 
261,922

 
15,174

Net loans charged off (recovered)
 
10,108

 
1,228

 
8,880

 
10,735

 
(236
)
 
10,971

Net interest revenue after net loans charged off (recovered)
 
134,917

 
131,434

 
3,483

 
266,361

 
262,158

 
4,203

 
 
 
 
 
 
 
 
 
 
 
 
 
Fees and commissions revenue1
 
42,874

 
40,303

 
2,571

 
82,891

 
76,303

 
6,588

Other gains (losses), net
 
173

 
5,831

 
(5,658
)
 
(169
)
 
7,473

 
(7,642
)
Other operating revenue
 
43,047

 
46,134

 
(3,087
)
 
82,722

 
83,776

 
(1,054
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Personnel expense
 
29,584

 
28,271

 
1,313

 
58,505

 
55,633

 
2,872

Non-personnel expense1
 
17,899

 
21,021

 
(3,122
)
 
35,445

 
37,361

 
(1,916
)
Other operating expense
 
47,483

 
49,292

 
(1,809
)
 
93,950

 
92,994

 
956

 
 
 
 
 
 
 
 
 
 
 
 
 
Net direct contribution
 
130,481

 
128,276

 
2,205

 
255,133

 
252,940

 
2,193

Gain on financial instruments, net
 
9

 
3

 
6

 
16

 
41

 
(25
)
Gain (loss) on repossessed assets, net
 
(67
)
 
1,403

 
(1,470
)
 
(4,232
)
 
1,398

 
(5,630
)
Corporate expense allocations
 
11,269

 
8,955

 
2,314

 
23,776

 
17,674

 
6,102

Income before taxes
 
119,154

 
120,727

 
(1,573
)
 
227,141

 
236,705

 
(9,564
)
Federal and state income tax
 
31,577

 
49,382

 
(17,805
)
 
60,319

 
96,949

 
(36,630
)
Net income
 
$
87,577

 
$
71,345

 
$
16,232

 
$
166,822

 
$
139,756

 
$
27,066

 
 
 
 
 
 
 
 
 
 
 
 
 
Average assets
 
$
18,072,155

 
$
17,791,671

 
$
280,484

 
$
17,933,756

 
$
17,716,738

 
$
217,018

Average loans
 
14,900,918

 
14,390,452

 
510,466

 
14,665,144

 
14,297,634

 
367,510

Average deposits
 
8,379,584

 
8,696,691

 
(317,107
)
 
8,521,231

 
8,688,028

 
(166,797
)
Average invested capital
 
1,345,840

 
1,290,167

 
55,673

 
1,352,648

 
1,313,997

 
38,651

1 
Fees and commission revenue for 2017 has been adjusted on a comparable basis with 2018 (Non-GAAP measure) to net $10.2 million and $19.4 million of interchange fees paid to issuing banks on card transactions processed by our TransFund merchant processing services for the three and six months ended June 30, 2017, respectively. The discussion following is based on this comparable basis.

Net interest revenue increased $12.4 million or 9 percent over the prior year. Growth in net interest revenue was primarily due to yields on commercial loans rising in excess of funding costs and a $510 million or 4 percent increase in average loan balances. Yields on deposits sold to the funds management unit also went up due to the increase in short-term interest rates. Net loans charged-off increased $8.9 million. Over half of 2018 net charge-offs was from an energy loan previously identified as impaired and appropriately reserved.

Fees and commissions revenue increased $2.6 million or 6 percent over the second quarter of 2017, primarily due to increases in transaction card volumes. In addition, loan syndication fees and commercial deposit service charges and fees were up over the prior year.

- 16 -



Operating expenses decreased $1.8 million or 4 percent percent compared to the second quarter of 2017. Personnel expense increased $1.3 million or 5 percent, primarily due to incentive compensation expense. Non-personnel expense decreased $3.1 million or 15 percent.

Corporate expense allocations were up $2.3 million or 26 percent over the prior year, primarily due to enhancements of activity based costing drivers to better reflect services being utilized by the Commercial Banking line of business.

The average outstanding balance of loans attributed to Commercial Banking were up $510 million or 4 percent over the second quarter of 2017 to $14.9 billion. 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. 
 
Average deposits attributed to Commercial Banking were $8.4 billion for the second quarter of 2018, a 4% decrease compared to the second quarter of 2017. See Management's Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital for further discussion of change.



- 17 -



Consumer Banking

Consumer Banking provides retail banking services through four primary distribution channels:  traditional branches, the 24-hour ExpressBank call center, Internet banking and mobile banking. Consumer Banking also conducts mortgage banking activities through offices located outside of our consumer banking markets and through Home Direct Mortgage, an online origination channel.

Consumer Banking contributed $6.1 million to consolidated net income for the second quarter of 2018, a decrease of $230 thousand compared to the second quarter of 2017. Growth in net interest revenue was partially offset by decreased mortgage banking revenue. Changes in the fair value of mortgage servicing rights, net of economic hedges, decreased pre-tax net income for second quarter of 2018 $4.7 million compared to a $1.7 million decrease in pre-tax net income in the second quarter of 2017.

Table 10 -- Consumer Banking
(Dollars in thousands)
 
 
Three Months Ended
 
Increase (Decrease)
 
Six Months Ended
 
Increase (Decrease)
 
 
June 30,
 
 
June 30,
 
 
 
2018
 
2017
 
 
2018
 
2017
 
Net interest revenue from external sources
 
$
21,746

 
$
20,756

 
$
990

 
$
43,499

 
$
39,348

 
$
4,151

Net interest revenue from internal sources
 
17,548

 
13,447

 
4,101

 
32,772

 
25,864

 
6,908

Total net interest revenue
 
39,294

 
34,203

 
5,091

 
76,271

 
65,212

 
11,059

Net loans charged off
 
1,139

 
926

 
213

 
2,440

 
2,199

 
241

Net interest revenue after net loans charged off
 
38,155

 
33,277

 
4,878

 
73,831

 
63,013

 
10,818

 
 
 
 
 
 
 
 
 
 
 
 
 
Fees and commissions revenue
 
46,332

 
50,745

 
(4,413
)
 
91,296

 
95,939

 
(4,643
)
Other losses, net
 
(12
)
 
(1
)
 
(11
)
 
(27
)
 
(60
)
 
33

Other operating revenue
 
46,320

 
50,744

 
(4,424
)
 
91,269

 
95,879

 
(4,610
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Personnel expense
 
24,995

 
25,133

 
(138
)
 
49,336

 
50,052

 
(716
)
Non-personnel expense
 
30,911

 
29,992

 
919

 
56,424

 
57,939

 
(1,515
)
Total other operating expense
 
55,906

 
55,125

 
781

 
105,760

 
107,991

 
(2,231
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Net direct contribution
 
28,569

 
28,896

 
(327
)
 
59,340

 
50,901

 
8,439

Gain (loss) on financial instruments, net
 
(6,411
)
 
5,224

 
(11,635
)
 
(29,672
)
 
3,557

 
(33,229
)
Change in fair value of mortgage servicing rights
 
1,723

 
(6,943
)
 
8,666

 
22,929

 
(5,087
)
 
28,016

Gain (loss) on repossessed assets, net
 
174

 
98

 
76

 
66

 
(39
)
 
105

Corporate expense allocations
 
15,867

 
16,912

 
(1,045
)
 
31,897

 
33,658

 
(1,761
)
Income before taxes
 
8,188

 
10,363

 
(2,175
)
 
20,766

 
15,674

 
5,092

Federal and state income tax
 
2,086

 
4,031

 
(1,945
)
 
5,288

 
6,097

 
(809
)
Net income
 
$
6,102

 
$
6,332

 
$
(230
)
 
$
15,478

 
$
9,577

 
$
5,901

 
 
 
 
 
 
 
 
 
 
 
 
 
Average assets
 
$
8,353,558

 
$
8,441,831

 
$
(88,273
)
 
$
8,410,513

 
$
8,360,022

 
$
50,491

Average loans
 
1,716,259

 
1,733,165

 
(16,906
)
 
1,731,115

 
1,736,870

 
(5,755
)
Average deposits
 
6,579,635

 
6,618,958

 
(39,323
)
 
6,558,980

 
6,576,664

 
(17,684
)
Average invested capital
 
293,420

 
298,165

 
(4,745
)
 
284,797

 
300,990

 
(16,193
)

Net interest revenue from Consumer Banking activities grew by $5.1 million or 15 percent over the the second quarter of 2017, primarily due to increased rates received on deposit balances sold to the Funds Management unit.


- 18 -



Fees and commissions revenue decreased $4.4 million or 9 percent compared to the second quarter of 2017. Higher interest rates in the second quarter of 2018 decreased mortgage loan production volumes and gains on sale margin were lower compared to the prior year.

Operating expenses increased $781 thousand or 1 percent over the second quarter of 2017. Personnel expenses were largely unchanged compared to the second quarter of 2017. Non-personnel expenses increased $919 thousand or 3 percent over the prior year. Professional fees increased $904 thousand. Mortgage banking costs were up $818 thousand, primarily due to a decrease in accruals related to default servicing and loss mitigation costs on loans serviced for others. These increases were partially offset by lower data processing and communications expense and miscellaneous expense.

Corporate expense allocations were $1.0 million or 6 percent lower than the prior year.

Average consumer deposits were largely unchanged compared to the second quarter of 2017. Demand deposit balances grew by $126 million or 7 percent and savings deposit balances were up $42 million or 10 percent. Higher-costing time deposit balances decreased $129 million or 13 percent and interest-bearing transaction account balances decreased $79 million or 2 percent.



- 19 -



Wealth Management

Wealth Management contributed $20.1 million to consolidated net income in the second quarter of 2018, up $4.4 million or 28 percent over the second quarter of 2017. Growth in net interest revenue was partially offset by a decrease in brokerage and trading revenue.

Table 11 -- Wealth Management
(Dollars in thousands)
 
 
Three Months Ended
 
Increase (Decrease)
 
Six Months Ended
 
Increase (Decrease)
 
 
June 30,
 
 
June 30,
 
 
 
2018
 
2017
 
 
2018
 
2017
 
Net interest revenue from external sources
 
$
18,754

 
$
10,475

 
$
8,279

 
$
34,161

 
$
21,960

 
$
12,201

Net interest revenue from internal sources
 
10,232

 
10,325

 
(93
)
 
20,164

 
19,181

 
983

Total net interest revenue
 
28,986

 
20,800

 
8,186

 
54,325

 
41,141

 
13,184

Net loans charged off (recovered)
 
(105
)
 
(92
)
 
(13
)