BOK FINANCIAL CORP (BOKF) FY 2021 MD&A

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

1    Metric meaningful due to the U.S. government agency guarantee and short-term nature of the Paycheck Protection Program ("PPP") loans.

2    Includes allowance for loan losses and accrual for off-balance sheet credit risk.

Management’s Assessment of Operations and Financial Condition

Overview

The following discussion is management’s analysis to assist in the understanding and evaluation of the financial condition and results of operations of BOK Financial Corporation ("BOK Financial" or "the Company"). This discussion should be read in conjunction with the Consolidated Financial Statements and footnotes and selected financial data presented elsewhere in this report.

Economic conditions across the U.S. have continued to improve throughout 2021 following the initial year of the COVID-19 pandemic. As of December, 2021, the unemployment rate was down to 3.9%, a sharp decline from the levels experienced in 2020. In 2021, real GDP increased 5.7% compared to 3.4% in 2020. Inflation continues to be well above the FOMC's target of 2%. The Federal Reserve has kept the Federal Funds rate at or near zero throughout 2021, but has recently announced that increases may soon be appropriate. In addition, the FOMC has decided to reduce the monthly pace of net asset purchases and bring them to an end in March, 2022. See "Summary of Credit Loss Experience" section of Management's Discussion and Analysis for additional discussion around our economic forecast.

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Performance Summary

Net income for the year ended December 31, 2021 totaled $618.1 million or $8.95 per diluted share compared with net income of $435.0 million or $6.19 per diluted share for the year ended December 31, 2020. An improved outlook of economic conditions related to the COVID-19 pandemic and massive government stimulus drove a $100.0 million reversal in 2021 of the $222.6 million provision for credit losses recorded in 2020.

Pre-provision net revenue ("PPNR"), a non-GAAP measure, was $697.9 million for 2021 compared to $786.4 million in the prior year. The decrease in PPNR was due to lower combined net interest revenue and fees and commission revenue. This was largely driven by lower average loan balances due to customer deleveraging during current economic uncertainty, narrowing net interest margin and compressed margins and production volumes from our mortgage-banking activities. The decline was partially offset by gains recognized on the sales of an alternative investment and repossessed assets.

Highlights of 2021 included:

•Net interest revenue totaled $1.1 billion for 2021, consistent with the prior year. Net interest margin was 2.60% for 2021 compared to 2.83% for 2020. The full impact of the reduction of the federal funds rate by the Federal Reserve in 2020 was realized in 2021. The following reduction in other short-term market interest rates reduced the yield on floating-rate assets by more than the amount by which funding costs could be reduced, compressing the margin. Average earning assets were $43.8 billion for 2021, up $3.1 billion over 2020, largely due to increased trading securities.

•Fees and commissions revenue was $668.3 million for 2021, a decrease of $142.0 million compared to 2020. Brokerage and trading revenues decreased $108.8 million due to a shift from fee revenue to net interest revenue, combined with narrowing margins. Mortgage banking revenue decreased $76.5 million due to a decrease in mortgage production volume combined with a reduction in production revenue as a percentage of production volume. Other revenue increased $18.3 million, primarily due to higher production revenue on repossessed oil and gas properties, which was largely offset by related operating expenses.

•Other gains, net increased $57.7 million to $63.7 million due to sales of an alternative investment and repossessed assets.

•Other operating expense totaled $1.2 billion, a $13.4 million increase compared to 2020. Personnel expense increased $6.9 million. Non-personnel expense increased $6.5 million, including an increase of $10.8 million of operating expenses on repossessed assets.

•The net economic benefit of the changes in the fair value of mortgage servicing rights and related economic hedges was $21.0 million during 2021 compared to an economic benefit of $24.9 million during 2020.

•The combined allowance for credit losses totaled $289 million or 1.45% of outstanding loans, excluding Paycheck Protection Program ("PPP") loans, at December 31, 2021. The combined allowance for credit losses was $426 million or 2.00% of outstanding loans, excluding PPP loans, at December 31, 2020.

•Nonperforming assets not guaranteed by U.S. government agencies decreased $173 million compared to December 31, 2020. Potential problem loans decreased $255 million and other loans especially mentioned decreased $212 million. Net charge-offs were $37.0 million or 0.17% of average loans, excluding PPP loans, in 2021. Net loans charged-off were $70.4 million or 0.32% of average loans, excluding PPP loans, in 2020.

•Period-end outstanding loan balances decreased $2.8 billion to $20.2 billion at December 31, 2021. Period-end PPP loans decreased $1.4 billion to $276.3 million. Commercial real estate loans decreased $867 million and commercial loans decreased $571 million. Average loans were $21.5 billion, a $1.9 billion decrease compared to 2020.

•Average deposits increased $5.2 billion to $37.9 billion and period-end deposits increased $5.1 billion to $41.2 billion at December 31, 2021, as customers maintained higher deposit balances during this time of economic uncertainty. Average interest bearing deposits increased $2.9 billion and average demand deposits grew by $2.3 billion.

•Common equity Tier 1 capital ratio was 12.24% at December 31, 2021. In addition, the Tier 1 capital ratio was 12.25%, total capital ratio was 13.29% and leverage ratio was 8.55% at December 31, 2021. At December 31, 2020, the Tier 1 capital ratio was 11.95%, the total capital ratio was 13.82% and the leverage ratio was 8.28%.

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•The Company repurchased 1,359,657 common shares at an average price of $86.74 per share during 2021 and 1,107,100 common shares at an average price of $68.49 during 2020.

•The Company paid cash dividends of $2.09 per common share during 2021 and $2.05 per common share in 2020.

Net income for the fourth quarter of 2021 totaled $117.3 million or $1.71 per diluted share, compared to $188.3 million or $2.74 per diluted share for the third quarter of 2021.

Highlights of the fourth quarter of 2021 included:

•Net interest revenue totaled $277.1 million for the fourth quarter of 2021, a decrease of $3.2 million compared to the third quarter of 2021. Net interest margin was 2.52% for the fourth quarter of 2021 and 2.66% for the third quarter of 2021. PPP loan fees of $7.7 million were recognized in the fourth quarter of 2021 compared to $12.7 million in the previous quarter.

•Operating revenue totaled $157.4 million for the fourth quarter of 2021, a $72.4 million decrease compared to the third quarter of 2021. Brokerage and trading revenue decreased $33.1 million as uncertainty in the markets led to reduced transaction activity and tighter margins compared to elevated volumes in the third quarter. Lower mortgage loan production volume and smaller margins also reduced mortgage banking revenue by $5.0 million. The prior quarter also included a $31.1 million pre-tax gain on the sale of an alternative investment.

•Operating expenses in the fourth quarter totaled $299.5 million, an $8.2 million increase compared to the third quarter of 2021. The fourth quarter of 2021 included a $5.0 million charitable donation to the BOKF Foundation. Increases in business promotion costs, professional fees, and other expenses were partially offset by lower personnel expense.

•Continued strength in commodity prices coupled with an outlook for moderate growth in gross domestic product and the labor markets, improving credit quality metrics and lower loan balances resulted in a $17.0 million negative provision for expected credit losses in the fourth quarter of 2021. A $23.0 million negative provision for expected credit losses was recorded in the third quarter of 2021.

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Critical Accounting Policies & Estimates

The Consolidated Financial Statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). The Company's accounting policies are more fully described in Note 1 of the Consolidated Financial Statements. Management makes significant assumptions and estimates in the preparation of the Consolidated Financial Statements and accompanying notes in conformity with GAAP that may be highly subjective, complex and subject to variability. Actual results could differ significantly from these assumptions and estimates. The following discussion addresses the most critical areas where these assumptions and estimates could affect the financial condition, results of operations and cash flows of the Company. These critical accounting policies and estimates have been discussed with the appropriate committees of the Board of Directors.

Allowance for Loan Losses and Accrual for Off-Balance Sheet Credit Risk from Loan Commitments

The allowance for loan losses and accrual for off-balance sheet credit risk from unfunded loan commitments represent the portion of amortized cost basis of loans and related unfunded commitments we do not expect to collect over the asset’s contractual life, considering past events, current conditions, as well as reasonable and supportable forecasts of future economic conditions. Appropriateness of the allowance for loan losses and accrual for off-balance sheet credit risk from unfunded loan commitments is determined by a senior management Allowance Committee which requires judgment about effects of uncertain matters, resulting in a subjective calculation which is inherently imprecise. Because of the subjective forward-looking nature of the calculation, changes in these measures may not directly correlate with actual economic events. In future periods, management judgment may consider new or changed information which may cause significant changes in these allowances in those future periods.

On January 1, 2020 BOK Financial’s accounting policies changed significantly with the adoption of Financial Accounting Standards Board ("FASB") Accounting Standards Update No. 2016-13 Financial Instruments - Credit Losses (Topic 326): Assets Measured at Amortized Cost ("ASU 2016-13" or "CECL"). Prior years were not restated. Prior to January 1, 2020, general allowances and nonspecific allowances were based on incurred credit losses. See Note 4 to the Consolidated Financial Statements for the description of the expected credit losses calculation of the allowance for loan losses and accrual for off-balance sheet credit risk from unfunded loan commitments.

For the majority of risk-graded loans, the accruing loan’s expected credit loss estimate is sensitive to management judgment, particularly probability of default and loss given default assumptions, changes in specific macroeconomic factor forecasts and the probability weight assigned to each economic scenario, and appropriate adjustments.

Significant assumptions and estimates affecting the allowance for loan losses and accrual for off-balance sheet credit risk include:

•Probability of default and loss given default measurements are based on historical data that may not be a good predictor of future performance or actual losses.

•Probability of default is based on risk grades, a subjective measurement of the risk of a loan. This subjective assessment of risk may not reflect actual risk of loss.

•The forecast for each relevant economic loss driver and the probability weighting of economic scenarios are overseen by a senior management Economic Forecast Committee which includes members independent of the allowance process.

•The Allowance Committee may increase or decrease the allowance to reflect risks not captured in the quantitative component. Examples of circumstances that may result in adjustments include, but are not limited to, new lines of business, market conditions that have not been previously encountered, observed changes in credit risk that are not yet reflected in macroeconomic factors, or economic conditions that impact loss given default assumptions.

Although the resulting expected credit loss estimate represents management’s best estimates at the time, actual credit losses will differ from management’s estimate. Portfolio composition will change over time, actual economic conditions will differ from probability-weighted assumptions, borrower-specific circumstances will change, as well as other factors. Differences between actual losses and management's estimates may materially affect the Company's results of operations.

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We describe critical elements affecting our estimate of expected credit loss in the "Summary of Credit Loss Experience" section of Management's Discussion and Analysis. While it is challenging to evaluate the allowance impact for a change in a particular input, results of such an analysis demonstrate how the quantitative element of the allowance behaves under different conditions. The sensitivity to management's economic scenario weighting may be quantified by comparing the results of weighting each economic scenario at 100%. For example, compared to a 100% Base Case scenario, a 100% Downside case would result in an additional $85 million in quantitative reserve, while a 100% Upside Case would result in $8 million less in quantitative reserve at December 31, 2021. Such sensitivity calculations do not necessarily reflect the nature and extent of future changes in the related allowance for a number of reasons including (1) management's weighting of multiple forecasted economic scenarios in estimating expected credit losses; (2) management's predictions of future economic trends and relationships among the scenarios may differ from actual events; and (3) management's application of subjective measures to modeled results when appropriate.

Fair Value Measurement

Certain assets and liabilities are recorded at fair value in the Consolidated Financial Statements. Fair value is defined by applicable accounting guidance as the price to sell an asset or transfer a liability in an orderly transaction between market participants in the principal markets for the given asset or liability at the measurement date based on market conditions at that date. An orderly transaction assumes exposure to the market for a customary period for marketing activities prior to the measurement date and not a forced liquidation or distressed sale.

A hierarchy for fair value has been established that prioritizes the inputs of valuation techniques used to measure fair value into three broad categories: unadjusted quoted prices in active markets for identical assets or liabilities (Level 1), other observable inputs that can be observed either directly or indirectly (Level 2) and unobservable inputs for assets or liabilities (Level 3). Fair value may be recorded for certain assets and liabilities every reporting period on a recurring basis or under certain circumstances on a non-recurring basis. Fair value measurements of significant assets or liabilities that are based on unobservable inputs (Level 3) are considered Critical Accounting Policies and Estimates. Additional discussion of fair value measurement and disclosure is included in Notes 7 and 19 of the Consolidated Financial Statements.

Mortgage Servicing Rights

We have a significant investment in mortgage servicing rights. Our mortgage servicing rights are primarily retained from sales in the secondary market of residential mortgage loans we have originated or purchased from correspondent lenders. Occasionally, mortgage servicing rights may be purchased from other lenders. Both originated and purchased mortgage servicing rights are initially recognized at fair value. We carry all mortgage servicing rights at fair value. Changes in fair value are recognized in earnings as they occur.

Mortgage servicing rights are not traded in active markets. The fair value of mortgage servicing rights is determined by discounting the projected cash flows. Certain significant assumptions and estimates used in valuing mortgage servicing rights are based on current market sources including projected prepayment speeds, assumed servicing costs, earnings on escrow deposits, ancillary income and discount rates. Assumptions used to value our mortgage servicing rights are considered significant unobservable inputs and represent our best estimate of assumptions that market participants would use to value this asset. A separate third party model is used to estimate prepayment speeds based on interest rates, housing turnover rates, estimated loan curtailment, anticipated defaults and other relevant factors. The prepayment model is updated periodically for changes in market conditions and adjusted to better correlate with actual performance of our servicing portfolio. The discount rate is based on benchmark rates for mortgage loans plus a market spread expected by investors in servicing rights. Significant assumptions used to determine the fair value of our mortgage servicing rights are presented in Note 7 to the Consolidated Financial Statements. At least annually, we request estimates of fair value from outside sources to corroborate the results of the valuation model.

The assumptions used in this model are primarily based on mortgage interest rates. Evaluation of the effect of a change in one assumption without considering the effect of that change on other assumptions is not meaningful. Considering all related assumptions, we expect a 50 basis point increase in primary mortgage interest rates to increase the fair value of our servicing rights by $32 million. We expect a $42 million decrease in the fair value of our mortgage servicing rights from a 50 basis point decrease in primary mortgage interest rates.

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Results of Operations

Net Interest Revenue and Net Interest Margin

2021 Net Interest Revenue

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.

Tax-equivalent net interest revenue totaled $1.1 billion for 2021, consistent with the prior year. This includes $42.7 million of PPP loan fees for 2021 and $35.5 million for 2020. At December 31, 2021, $7.5 million of PPP loan fees remain to be recognized. Also included in 2021 was $16.1 million of net purchase discount accretion compared to $26.0 million in 2020. Approximately $31 million of purchase accounting discount remains to be accreted. Net interest revenue decreased $64.0 million due to changes in interest rates and increased $72.4 million from growth in earning assets. Table 2 shows the effects on net interest revenue due to changes in average balances and interest rates for the various types of earning assets and interest-bearing liabilities. In addition, see the Annual and Quarterly Financial Summary of consolidated daily average balances, yields and rates following the Consolidated Financial Statements.

Net interest margin was 2.60% for 2021 and 2.83% for 2020. The tax-equivalent yield on earning assets was 2.74% for 2021 compared to 3.24% in 2020. The full impact of the reduction of the federal funds rate by the Federal Reserve in 2020 was realized in 2021. A reduction in other short-term market interest rates followed, which reduced the yield on floating-rate assets by more than funding costs could be reduced, compressing the margin. Loan yields decreased 22 basis points to 3.62%. The available for sale securities portfolio yield decreased 41 basis points to 1.80%. The yield on trading securities fell 77 basis points to 1.98%. The yield on interest-bearing cash and cash equivalents decreased 32 basis points to 0.13%.

Funding costs decreased 32 basis points compared to 2020. The cost of interest-bearing deposits decreased 28 basis points. The cost of other short-term borrowings decreased 31 basis points. The benefit to net interest margin from earning assets funded by non-interest bearing liabilities was 7 basis points for 2021, down from 12 basis points for 2020.

Average earning assets for 2021 increased $3.1 billion or 8% over 2020, largely due to an increase in our trading of U.S. government agency residential mortgage-backed securities, partially offset by a reduction in the loan portfolio. Average trading securities balances increased $4.7 billion due to increased customer demand. Average loans, net of allowance for loan losses, decreased $1.9 billion, largely due to purposeful deleveraging by our customers as borrowers continue to pay down during this time of economic uncertainty. The average balance of available for sale securities, which consists largely of residential and commercial mortgage-backed securities guaranteed by U.S. government agencies, increased $922 million. Fair value option securities that we hold as an economic hedge against changes in the fair value of mortgage servicing rights decreased $702 million.

Total average deposits grew by $5.2 billion over the prior year. This increase is largely due to customers retaining elevated balances in the current economic environment combined with government stimulus-related deposits. Average interest-bearing transaction account balances increased $3.0 billion. Average demand deposit balances increased $2.3 billion. Average short-term borrowings decreased $3.5 billion.

Our overall objective is to manage the Company’s balance sheet for changes in interest rates as is further described in the Market Risk section of this report. Approximately 76% of our commercial and commercial real estate loan portfolios are either variable rate loans or fixed rate loans that will re-price within one year. These loans are funded primarily by deposit accounts that are either non-interest bearing, or that re-price more slowly than the loans. The result is a balance sheet that would be asset sensitive, which means that assets generally re-price more quickly than liabilities. Among the strategies that we use to manage toward a relatively rate-neutral position, we purchase fixed rate residential mortgage-backed securities issued primarily by U.S. government agencies and fund them with market rate sensitive liabilities. The liability-sensitive nature of this strategy provides an offset to the asset-sensitive characteristics of our loan portfolio. We also may use derivative instruments to manage our interest rate risk.

The effectiveness of these strategies is reflected in the overall change in net interest revenue due to changes in interest rates as shown in Table 2 and in the interest rate sensitivity projections as shown in the Market Risk section of this report.

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Fourth Quarter 2021 Net Interest Revenue

Tax-equivalent net interest revenue totaled $279.2 million for the fourth quarter of 2021, a decrease of $3.3 million compared to the third quarter of 2021.

Net interest margin was 2.52% for the fourth quarter of 2021 compared to 2.66% for the third quarter of 2021. PPP loan fees of $7.7 million were recognized in the fourth quarter of 2021 compared to $12.7 million in the previous quarter. The tax-equivalent yield on earning assets was 2.66% for the fourth quarter of 2021, a decrease of 12 basis points compared to the third quarter of 2021. Loan yields increased 2 basis points to 3.70%. Excluding PPP loan fees, the loan portfolio yield increased 11 basis points, primarily due to the timing of loan fees. Yield on available for sale securities decreased 8 basis points to 1.72%. Yield on trading securities was down 15 basis points to 1.89%.

Funding costs increased 2 basis points compared to the third quarter of 2021. The cost of other short-term borrowings increased 37 basis points while the cost of interest-bearing deposits decreased 1 basis point. The cost of subordinated debentures decreased 61 basis points due to the redemption of $150 million in the third quarter of 2021. The benefit to net interest margin from earning assets funded by non-interest bearing liabilities was 7 basis points in the fourth quarter of 2021 and third quarter of 2021.

Average earning assets for the fourth quarter of 2021 increased $1.3 billion over the third quarter of 2021. Average loans, net of allowance for loan losses, decreased $572 million, largely due to paydowns of PPP and commercial real estate loans, partially offset by growth in commercial loans. Trading securities balances increased $1.6 billion as we increased our trading of U.S. government agency residential mortgage-backed securities. Average interest bearing cash and cash equivalents grew by $526 million. Available for sale securities decreased $198 million.

Average deposits increased $2.0 billion over the third quarter of 2021, as customers choose to retain elevated balances in the current environment. Average demand deposit balances increased $1.1 billion and average interest-bearing transaction accounts increased $891 million. Other borrowings decreased $1.7 billion while funds purchased and repurchase agreements increased $1.4 billion.

2020 Net Interest Revenue

Tax-equivalent net interest revenue for 2020 was $1.1 billion, consistent with 2019. This included $26.0 million of net purchase discount accretion for 2020 and $37.8 million for 2019. Also included for 2020 was $35.5 million of PPP loan fees, which were not present in 2019. Net interest revenue decreased $108.7 million due to rates and increased $102.8 million from growth in earning assets.

Net interest margin was 2.83% for 2020 compared to 3.11% for 2019. The tax-equivalent yield on average earning assets decreased 103 basis points compared to 2019. In response to the anticipated impact to the economy from the COVID-19 pandemic, the Federal Reserve reduced the federal funds rate to near zero in March, 2020. The resulting impact on market interest rates compressed the net interest margin. Loan yields decreased 129 basis points. The available for sale securities portfolio yield decreased 37 basis points. The yield on interest-bearing cash and cash equivalents decreased 183 basis points. The yield on trading securities fell 80 basis points. The cost of interest-bearing deposits decreased 69 basis points and the cost of other short-term borrowings decreased 161 basis points. The benefit to net interest margin from earning assets funded by non-interest bearing liabilities was 12 basis points for 2020, down from 45 basis points for 2019.

Average earning assets increased $4.3 billion or 12% over 2019, largely due to the expansion of the available for sale securities portfolio, loans originated as part of the PPP, and an increase in trading of U.S. government agency residential mortgage-backed securities. Average loans, net of allowance for loan losses, increased $1.1 billion, primarily related to $1.4 billion in average PPP loans. The average balance of available for sale securities increased $2.3 billion in order to reduce our exposure to falling short-term interest rates. The average balance of trading securities increased $1.3 billion. Total average deposits grew by $7.1 billion over 2019. This increase was largely due to the combination of focused deposit gathering initiatives, stimulus-related deposits, and customers retaining elevated balances in the current economic environment. Average interest-bearing transaction deposits increased $5.6 billion. Average short-term borrowings decreased $1.7 billion.

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Table 2 – Volume/Rate Analysis

(In thousands)

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

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Table 2 – Volume/Rate Analysis (continued)

(In thousands)

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

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Other Operating Revenue

2021 Other Operating Revenue

Other operating revenue was $755.8 million for 2021, a decrease of $86.5 million or 10% compared to 2020. Brokerage and trading revenue decreased largely due to a shift from fee revenue to net interest revenue and narrowing margins. Mortgage production revenue was negatively impacted by a decline in mortgage production volumes and margin compression. Other gains, net increased $57.7 million due to sales of an alternative investment and repossessed assets.

Table 3 – Other Operating Revenue

(Dollars in thousands)

Fees and commissions revenue

Diversified sources of fees and commissions revenue are a significant part of our business strategy and represented 37% of total revenue for 2021, excluding provision for credit losses, gains and losses on securities and derivatives, other gains and losses 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 banking production volumes and related trading. 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, including the impact of the COVID-19 pandemic, regulatory constraints, increased competition and saturation in our existing markets could affect the rate of future increases.

Brokerage and trading revenue, which includes revenues from trading, customer hedging, retail brokerage and investment banking, decreased $108.8 million or 49% compared to the prior year.

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Trading revenue includes net realized and unrealized gains and losses primarily related to sales of residential mortgage-backed securities guaranteed by U.S. government agencies and related derivative instruments that enable our mortgage-banking customers to manage their production risk. Trading revenue also includes net realized and unrealized gains and losses on municipal securities, asset-backed securities and other financial instruments that we sell to institutional customers, along with changes in the fair value of financial instruments we hold as economic hedges against market risk of our trading securities. Trading revenue was $27.6 million for 2021, a decrease of $116.7 million compared to 2020, due to a shift from fee revenue to net interest revenue on trading securities, combined with increased market volatility. See additional discussion in "Lines of Business" section of Management's Discussion and Analysis.

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. Derivative contracts executed with customers are offset with contracts between selected counterparties and exchanges to minimize market risk from changes in commodity prices, interest rates or foreign exchange rates. Customer hedging revenue totaled $20.4 million for 2021, a decrease of $2.3 million or 10% compared to 2020, primarily attributed to our energy customers.

Revenue earned from retail brokerage transactions totaled $18.8 million for 2021, an increase of $3.1 million or 20% over 2020. Retail brokerage revenue is primarily based on 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 type of product.

Insurance brokerage fees were $11.8 million for 2021, consistent with the prior year.

Investment banking, which includes fees earned upon completion of underwriting, financial advisory services and loan syndication fees, totaled $34.4 million for 2021, an increase of $8.0 million or 30% compared to 2020, related to the timing and volume of commercial loan syndication fees.

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 totaled $97.0 million for 2021, a $6.8 million or 8% increase over 2020. Revenues from the processing of transactions on behalf of the members of our TransFund electronic funds transfer ("EFT") network totaled $80.1 million, up $1.8 million or 2% over 2020. The number of TransFund ATM locations totaled 2,593 at December 31, 2021 compared to 2,599 at December 31, 2020. Corporate card revenue totaled $5.0 million, up $2.4 million or 93% over 2020 due to increased transactions from the broader reopening of the economy. Merchant services fees paid by customers for account management and electronic processing of card transactions totaled $11.9 million, an increase of $2.6 million or 28% over the prior year.

Fiduciary and asset management revenue is earned through managing or holding of assets for customers and executing transactions or providing related services. Approximately 90% of fiduciary and asset management revenue is primarily based on the fair value of assets. Rates applied to those asset values vary based on the nature of the relationship. Fiduciary and managed asset relationships generally have a higher fee rate than non-fiduciary and/or managed relationships.

Fiduciary and asset management revenue increased $10.8 million or 6% compared to 2020. An increase in trust and managed account fees from higher client asset balances was partially offset by a decrease in mutual fund fees as the low rate environment has put pressure on our mutual fund revenue streams. We also had approximately $11.7 million in fee waivers during 2021 compared to approximately $5.6 million in fee waivers during 2020. We have voluntarily waived certain administration fees on the Cavanal Hill money market funds in order to maintain positive yields on these funds in the current low short-term interest rate environment.

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

Table 4 -- Assets Under Management or Administration

(Dollars in thousands)

1    Fiduciary and asset management revenue includes asset-based and other fees associated with the assets.

2    Revenue divided by period-end balance.

A summary of changes in assets under management or administration for the year ended December 31, 2021, 2020, and 2019 follows:

Table 5 -- Changes in Assets Under Management or Administration

(In thousands)

Assets under management as of December 31, 2021 consist of 41% fixed income, 38% equities, 14% cash and 7% alternative investments. Net inflows to assets under management increased during 2021 as new financial institution client relationships were gained and existing clients added to their asset balances.

Deposit service charges and fees totaled $104.2 million for 2021, a $7.4 million or 8% increase over 2020. Service charges earned primarily on commercial deposit accounts totaled $54.4 million, a $5.9 million or 12% increase over the previous year. Decreases in the earnings credit rates caused by the low interest rate environment resulted in higher service charges. Check card revenue totaled $23.7 million, up $2.4 million or 11% over 2020 due to increased volume. Overdraft fees earned primarily on consumer deposit accounts totaled $21.6 million for 2021, unchanged from 2020.

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Mortgage banking revenue totaled $105.9 million for 2021, a $76.5 million or 42% decrease compared to 2020. Mortgage production revenue decreased $65.1 million. Production volume was down $1.4 billion and production revenue as a percentage of production volume also decreased 83 basis points to 2.33%. Mortgage servicing revenue was $45.2 million, an $11.3 million decrease compared to the prior year. The average outstanding principal balance of mortgage loans serviced for others totaled $15.4 billion at December 31, 2021, a $3.0 billion decrease compared to December 31, 2020, largely due to a decline in mortgage loan production attributable to industry-wide housing inventory constraints and overall market conditions. During the fourth quarter of 2021, we completed an acquisition of mortgage servicing rights with an unpaid principal balance of $2.0 billion.

Table 6 – Mortgage Banking Revenue

(Dollars in thousands)

Primary rates disclosed in Table 6 above represent rates generally available to borrowers on 30 year conforming mortgage loans.

Other revenue totaled $70.0 million for 2021, an increase of $18.3 million or 35% over 2020, primarily due to higher production revenue from repossessed oil and gas properties; however, this was partially offset by increased operating expenses on these properties.

Other gains, net and net gains on securities and derivatives

Other gains, net increased $57.7 million compared to 2020. The sale of an alternative investment resulted in a $31.1 million gain, net of non-controlling interest. A $14.1 million gain realized on the sale of an equity interest received as part of the workout of a defaulted energy loan was partially offset by a $5.2 million loss on the extinguishment of subordinated debentures.

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.

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Table 7 – Gain (Loss) on Mortgage Servicing Rights, Net of Economic Hedge

(In thousands)

1    Actual interest earned on fair value option securities less internal transfer-priced cost of funds.

Fourth Quarter 2021 Other Operating Revenue

Table 8 – Fourth Quarter 2021 Other Operating Revenue

(Dollars in thousands)

Other operating revenue was $157.4 million for the fourth quarter of 2021, a $72.4 million or 31% decrease compared to the third quarter of 2021.

Brokerage and trading revenue decreased $33.1 million to $14.9 million. Uncertainty around tapering by the Federal Reserve combined with year-end balance sheet management and concerns over yield curve steepening, resulted in decreased transaction activity and tighter margins for trading activities in the market. These factors combined to decrease trading revenue by $37.3 million. Customer hedging revenue increased $2.2 million, primarily attributed to energy customers. Investment banking revenue increased $2.6 million, largely due to the timing and increase of syndication activity.

Mortgage banking revenue was $21.3 million for the fourth quarter of 2021, a decrease of $5.0 million compared to the third quarter of 2021 due to lower production volume combined with narrowing margins. Mortgage loan production volumes were $501 million for the fourth quarter of 2021, compared to $615 million in the third quarter of 2021. Production revenue as a percentage of production volume, which includes unrealized gains and losses on our mortgage commitment pipeline and related hedges, decreased 50 basis points to 2.00%.

Other revenue decreased $7.3 million as a result of lower operating revenue from repossessed oil and gas assets due to the sale of a property, which was largely offset by a reduction of expenses on the same property.

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Other gains, net, decreased $25.0 million compared to the prior quarter. The third quarter of 2021 included a $31.1 million gain on the sale of an alternative investment, which was partially offset by a $5.2 million loss on the extinguishment of subordinated debentures and a $3.9 million loss on the sale of a repossessed oil and gas asset.

2020 Other Operating Revenue

Other operating revenue totaled $842.3 million for 2020, an increase of $147.1 million or 21% compared to 2019. Lower mortgage interest rates during 2020 increased both mortgage loan production and related trading activities.

Brokerage and trading revenue for 2020 increased $62.0 million compared to 2019. Trading revenue increased $55.7 million over 2019. Customer hedging revenue increased $3.8 million compared to 2019 as energy customers increased hedging activity in the volatile commodity price environment. Insurance brokerage fees decreased $1.2 million compared to 2019. Investment banking revenue increased $4.1 million related to the timing and volume of completed transactions.

Transaction card revenue grew by $3.0 million over 2019, primarily due to growth in transaction volumes. Fiduciary and asset management revenue decreased $9.6 million compared to 2019. The low rate environment put pressure on our mutual fund revenue streams, partially offset by increased trust and managed account fees from higher client asset balances. Deposits service charges and fees decreased $15.7 million due to lower overdraft fee volumes.

Mortgage banking revenue increased by $74.8 million over 2019. Lower mortgage interest rates led to an increase in mortgage loan production.

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Other Operating Expense

2021 Other Operating Expense

Other operating expense for 2021 totaled $1.2 billion, a $13.4 million or 1% increase over the prior year. Personnel expense increased $6.9 million or 1%. Non-personnel expense increased $6.5 million or 1%.

Table 9 – Other Operating Expense

(Dollars in thousands)

Personnel expense

Personnel expense increased $6.9 million in 2021. Employee benefits expense increased $11.9 million or 14%, largely due to increased employee healthcare costs. Healthcare costs in 2020 were unusually low due to limitations placed on non-essential procedures as a result of the COVID-19 pandemic. Cash-based incentive compensation plans, which 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, grew $4.1 million or 2% over 2020, primarily related to incentives on trading activity. These increases were partially offset by a decrease of $5.5 million or 1% in regular compensation expense and lower share-based compensation expense which decreased $5.0 million or 27% based on changes in assumptions of certain performance-based equity awards.

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Non-personnel expense

Non-personnel expense increased $6.5 million or 1% over the prior year.

Other expense increased $16.4 million or 43%, primarily due to increased operating expense on repossessed assets; however, this was offset by increased operating revenue on these properties. Data processing and communications expense increased $16.1 million or 12%, largely due to technology project costs. These expense increases were partially offset by a decrease of $14.0 million or 25% in mortgage banking costs, primarily due to lower accruals related to default servicing and loss mitigation costs on loans serviced for others, combined with a decrease in prepayments. Occupancy and equipment expense decreased $4.1 million or 4%, as the prior year included impairment of two leases. Expense associated with FDIC insurance decreased $4.1 million or 21% as the Company's risk profile and liquidity improved.

Fourth Quarter 2021 Operating Expenses

Table 10 – Fourth Quarter 2021 Other Operating Expense

(Dollars in thousands)

Other operating expense for the fourth quarter of 2021 totaled $299.5 million, an increase of $8.2 million or 3% over the third quarter of 2021.

Personnel expense decreased $1.4 million or 1% compared to the third quarter of 2021. Cash-based incentive compensation plans, which 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, decreased $8.8 million or 16%, primarily due to reduced trading volumes. Share-based compensation expense, which represents expense for equity awards based on the grant date fair value, increased $5.9 million or 462% due to changes in vesting assumptions related to performance-based share awards.

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Non-personnel expense increased $9.6 million or 8% compared to the third quarter of 2021. The fourth quarter of 2021 included a $5.0 million charitable donation to the BOKF Foundation as we continue to focus on the communities we serve and the extreme need created by the pandemic. Smaller increases in business promotion costs, professional fees and services expense, and other expense supplemented the overall increase in non-personnel expense.

2020 Operating Expenses

Other operating expense totaled $1.2 billion for 2020, a $31.1 million or 3% increase over 2019. CoBiz added $17.2 million in integration costs in 2019. The fluctuation discussion below excludes these costs.

Personnel expense increased $30.8 million in 2020. Cash based incentive compensation grew $41.6 million over 2019, largely related to growth in mortgage-backed securities trading activities. This increase was partially offset by lower employee benefits costs of $7.2 million, largely related to decreased employee healthcare costs.

Non-personnel expense increased $17.5 million or 4% over 2019. Data processing and communications expense increased $12.5 million due to technology project costs. Occupancy and equipment expense increased $6.4 million, largely due to increased cleaning costs related to the COVID-19 pandemic as well as increased depreciation costs. Mortgage banking costs increased $6.0 million, primarily due to an increase in prepayments and accruals related to default servicing and loss mitigation costs on loans serviced for others. Charitable contributions to the BOKF Foundation increased $6.0 million as we focus on the communities we serve and the extreme need created by the pandemic. Professional fees increased $5.0 million. Business promotion costs, consisting largely of travel and entertainment and advertising costs, were down $19.5 million, primarily due to the effects of the COVID-19 pandemic.

Income Taxes

Income tax expense was $179.8 million or 22.6% of net income before taxes for 2021, $128.8 million or 22.8% of net income before taxes for 2020 and $130.2 million or 20.6% of net income before taxes for 2019.

Net deferred tax assets totaled $34.5 million at December 31, 2021 compared to net deferred tax liabilities of $9.5 million at December 31, 2020. We have evaluated the recoverability of our deferred tax assets based on the generation of future taxable income during the periods in which those temporary differences become deductible and determined that no valuation allowance was required in 2021 or 2020.

Income tax expense was $34.8 million or 22.9% of net income before taxes for the fourth quarter of 2021 compared to $54.1 million or 22.4% of net income before taxes for the third quarter of 2021.

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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 loan origination and servicing activities. Wealth Management provides fiduciary services, private bank services, insurance 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. The Funds Management unit also initially recognizes accruals for loss contingencies when losses become probable. Actual losses are recognized by the lines of business if the accruals are settled.

We allocate resources and evaluate the performance of our lines of business using the net direct contribution, which includes the allocation of funds and capital costs. Credit costs are attributed to the lines of business based on net loans charged off or recovered. The difference between credit costs attributed to the lines of business and the consolidated provision for credit losses is attributed to Funds Management. In addition, we measure the performance of our business lines after allocations 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 wholesale borrowing rates or interest rate swap rates, adjusted for prepayment risk and liquidity risk. This method of transfer-pricing funds that support assets of the operating lines of business tends to insulate them from interest rate risk.

The value of funds provided by the operating lines of business to the Funds Management unit is also based on rates that approximate wholesale market rates for funds with similar repricing and cash flow characteristics. Market rates are generally based on a proxy of wholesale borrowing rates 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 wholesale funding 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 wholesale funding rates and longer duration products are weighted towards the intermediate swap rates. The expected duration ranges from 30 days for certain rate-sensitive deposits to five years. In order to appropriately reflect the organizational value of these deposits to the lines of business, methodology adjustments are made each January that attribute more or less deposit credit value to the business lines dependent upon historical and forward-looking interest rate expectations, with the offset to Funds Management and other. During 2019, short-term rates moved down materially, which was reflected in the funding credit to the business lines beginning in January, 2020. Those funding credits continued their downward trend in 2021 as a result of the sustained low-rate environment.

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.

As shown in Table 11 following, net income attributable to our lines of business decreased $49.9 million or 10% compared to the prior year. Net interest revenue was consistent with the prior year as increased interest revenue from trading activities was offset by a decrease resulting from reduced average loan balances in 2021. Net charge-offs decreased $37.2 million compared to the prior year. Other operating revenue decreased $95.2 million largely due to a shift from fee revenue to net interest revenue and a decrease in mortgage banking revenues. An increase in other gains (losses), net, primarily from the $31.1 million gain recognized on the sale of an alternative investment, positively impacted other operating revenue. Other operating expense decreased $3.9 million compared to prior year, largely due to decreased compensation costs. The increase in net income attributed to Funds Management and other is largely due to release of provision during 2021 for expected credit losses over net charge-offs.

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Table 11 – Net Income by Line of Business

(In thousands)

2021 Commercial Banking

Commercial Banking contributed $328.5 million to consolidated net income in 2021, an increase of $22.5 million or 7% compared to prior year. Other gains, net increased $35.1 million, primarily from the gain recognized on the sale of a merchant banking alternative investment in the third quarter of 2021.

Table 12 – Commercial Banking

(In thousands)

Net interest revenue decreased $52.8 million or 9% compared to the prior year, primarily due to reduced loan balances and lower yields on deposits sold to our Funds Management unit as the value of deposits was impacted by falling interest rates. Net loans charged-off decreased $38.3 million.

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Fees and commissions revenue increased $40.0 million or 21%. Production revenue from repossessed oil and gas properties increased $17.1 million. Syndication fees increased $7.7 million due to the timing and volume of completed transactions during the year. The remaining increase was due to growth in revenues from the processing of transactions on behalf of the members of our TransFund EFT network and deposit service charges and fees.

Operating expense increased $22.2 million or 9% over 2020. Personnel expense increased $9.1 million or 6%, primarily due to incentive compensation costs. Non-personnel expense increased $13.1 million or 13%, primarily due to increased operating expenses on repossessed oil and gas properties. Corporate expense allocations increased $25.1 million or 101% compared to the prior year, largely due to credits received in 2020 related to PPP loan originations.

The average outstanding balance of loans attributed to Commercial Banking decreased $1.9 billion or 10% compared to 2020 to $16.9 billion, primarily due to purposeful deleveraging by our customers. 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 $17.7 billion for 2021, a $3.3 billion or 23% increase over the prior year. See Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital for further discussion of change.

Fourth Quarter 2021 Commercial Banking

Table 13 - Commercial Banking - Fourth Quarter 2021

(Dollars in thousands)

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Commercial Banking contributed $83.5 million to consolidated net income in the fourth quarter of 2021, a decrease of $19.2 million compared to the third quarter of 2021. The prior quarter included a pre-tax gain of $31.1 million from the sale of an alternative investment. Net interest revenue increased $6.6 million over the third quarter of 2021, largely driven by increased deposit balances and improved spreads, partially offset by a $5.3 million increase in personnel expense.

2020 Commercial Banking

Commercial Banking contributed $306.0 million to consolidated net income in 2020, a decrease of $68.8 million or 18% compared to 2019. Net interest revenue decreased $87.8 million or 13% as yields on deposits sold to the Funds Management unit decreased as the value of deposits was impacted by falling interest rates. Net loans charged-off increased $30.5 million.

Fees and commissions revenue increased $18.5 million or 11% due to growth in customer energy hedging revenue and an increase in revenues from processing transactions on behalf of the members of our TransFund EFT network.

Operating expense increased $6.4 million or 3%, over 2019. Non-personnel expense increased $10.4 million or 12%. Increases in data processing and communications expense, occupancy and equipment expense, intangible amortization and deposit insurance costs were partially offset by a decrease in business promotion expense. Personnel expense decreased $3.9 million or 2%. A decrease in incentive compensation costs was partially offset by an increase in regular compensation. Corporate expense allocations decreased $18.2 million or 42% compared to the prior year.

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2021 Consumer Banking

Consumer Banking services are provided 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.

Net income attributed to Consumer Banking totaled $27.6 million for 2021, compared to $98.0 million in the prior year, largely due to lower mortgage loan production volumes and compression of margins.

Table 14 – Consumer Banking

(In thousands)

Net interest revenue from Consumer Banking activities decreased by $43.5 million or 30% compared to 2020, primarily due to a decrease in the yield on deposits sold to our Funds Management unit. Average consumer deposits grew $840 million with interest-bearing transaction deposit balances increasing $429 million or 13% and demand deposit balances up by $390 million or 15%.

Fees and commissions revenue decreased $72.2 million or 29% compared to the prior year due to lower mortgage loan production volume combined with narrowing margins. Mortgage production volume decreased $1.4 billion or 35% and production revenue as a percentage of production volume, which includes unrealized gains and losses on our mortgage commitment pipeline and related hedges, decreased 83 basis points to 2.33%. Operating expense decreased $20.8 million or 9% compared to 2020, due to lower mortgage banking costs and compensation expense. Corporate expense allocations increased $3.9 million or 9% compared to the prior year.

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Changes in the fair value of our mortgage servicing rights, net of economic hedges, as more fully presented in Table 7, resulted in a $19.8 million increase to pre-tax net income for 2021 compared to a $15.8 million increase to pre-tax net income in 2020.

Fourth Quarter 2021 Consumer Banking

Table 15 - Consumer Banking - Fourth Quarter 2021

(Dollars in thousands)

Consumer Banking contributed $6.8 million to net income in the fourth quarter of 2021, a decrease of $5.6 million compared to the third quarter of 2021. Net interest revenue increased $3.2 million mainly due to increased deposit balances and improved spreads. Fees and commissions revenue decreased $5.5 million primarily due to normal seasonality in mortgage loan production volume and margin compression. Other operating expense increased $2.6 million over the third quarter of 2021, due to increases in professional fees and other expenses.

2020 Consumer Banking

Net income attributed to Consumer Banking totaled $98.0 million for 2020, compared to $60.2 million in 2019. Net interest revenue decreased $48.5 million or 25%, primarily due to a decrease in the yield on deposits sold to our Funds Management unit. Fees and commissions revenue increased $57.6 million or 31% over 2019. Lower mortgage interest rates increased mortgage loan origination volumes by $1.0 billion or 34% and production revenue as a percentage of production volume increased 172 basis points due to industry-wide capacity constraints. Deposit service charges decreased $15.4 million or 24% as we proactively waived certain fees and the pandemic resulted in customers retaining cash and not maintaining the usual level of spending. Operating expense increased $4.1 million or 2% over 2019 as an increase in mortgage banking costs was largely offset by lower business promotion expenses.

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2021 Wealth Management

Wealth Management contributed $113.6 million to consolidated net income in 2021, a decrease of $2.1 million or 2% compared to record earnings in the prior year.

Table 16 – Wealth Management

(In thousands)

Combined net interest revenue and fees and commission revenue attributed to the Wealth Management segment totaled $512.8 million for 2021, largely unchanged from the previous year. Revenue, primarily from U.S. government agency residential mortgage-backed securities trading activity, decreased $10.8 million due to narrowing margins, which was completely offset by increased fiduciary and asset management revenue. Growth in trust fees and managed account fees as a result of growth in assets under management and administration was partially offset by lower mutual fund fees and increased waivers.

Average Wealth Management loans grew by $223 million or 13% to $2.0 billion. Average deposits attributed to Wealth Management increased $751 million or 9% to $9.4 billion in 2021, led by growth in interest-bearing transaction deposits.

Operating expense decreased $5.3 million or 2% compared to the prior year. Personnel expense decreased $9.7 million or 4% primarily related to incentive compensation as a result of lower trading revenue. Non-personnel expense increased $4.4 million or 5% over 2020 largely due to technology project costs. Corporate expense allocations increased $5.0 million or 14% over the prior year.

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Fourth Quarter 2021 Wealth Management

Table 17 - Wealth Management - Fourth Quarter 2021

(Dollars in thousands)

Wealth Management contributed $21.7 million to net income in the fourth quarter of 2021, a decrease of $19.7 million compared to the third quarter of 2021. Combined net interest and fee revenue totaled $114.5 million, a decrease of $38.7 million compared to prior quarter. Uncertainty around tapering by the Federal Reserve combined with year-end balance sheet management and concerns over yield curve steepening, resulted in decreased transaction activity and tighter margins. Operating expense decreased $12.5 million, primarily due to incentive compensation costs related to reduced trading activity.

2020 Wealth Management

Wealth Management contributed $115.6 million to consolidated net income in 2020, up $20.3 million or 21% over 2019. Revenue attributed to the Wealth Management segment totaled $516.5 million for 2020, a $75.1 million or 17% increase over the previous year. Demand for mortgage loans and related derivative contracts increased significantly due to a decrease in mortgage interest rates that began in early 2020 and continued throughout the year. We expanded trading activities that provide liquidity to our mortgage banking customers and enable them to manage their market risk. Growth in transaction volumes resulted in an $89.7 million increase in combined net interest revenue and trading revenue.

Growth in total revenue from expanded trading activities was partially offset by decreased net interest revenue generated by deposits sold to our Funds Management unit and loans attributed to the Wealth Management segment, and fiduciary and asset management fees. Both were negatively affected by the low short-term interest rate environment.

Operating expense increased $48.4 million or 17% over 2019. Personnel expense increased $42.1 million or 21%, primarily related to incentive compensation as a result of higher trading activity. Non-personnel expense increased $6.3 million or 8% over 2019.

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Financial Condition

Securities

We maintain a securities portfolio to enhance profitability, manage interest rate risk, provide liquidity and comply with regulatory requirements. Securities are classified as trading, held for investment, or available for sale. See Note 2 to the Consolidated Financial Statements for the composition of the securities portfolio as of December 31, 2021 and December 31, 2020.

We hold an inventory of trading securities in support of sales to a variety of customers, including banks, corporations, insurance companies, money managers and others. Trading securities totaled $9.1 billion at December 31, 2021, an increase of $4.4 billion compared to December 31, 2020. Our trading portfolio expanded during 2021 in order to provide greater liquidity in the housing market during a time of record mortgage loan production volumes and to meet demand of our growing institutional customer base. Inventory levels were elevated at December 31, 2021 as many investors moved to the sidelines on the news of the upcoming taper by the Federal Reserve, year-end balance sheet management and concerns over yield curve steepening. As discussed in the Market Risk section of this report, trading activities involve risk of loss from adverse price movement. We mitigate this risk within board-approved value-at-risk limits through the use of derivative contracts, short-sales and other techniques. These limits remain relatively unchanged from levels set before our expanded trading activities.

Investment securities consist primarily of intermediate and long-term, fixed rate Oklahoma and Texas municipal bonds and taxable Texas school construction bonds. The investment security portfolio is diversified among issuers.

Available for sale securities, which may be sold prior to maturity, are carried at fair value. Unrealized gains or losses, net of deferred taxes, are recorded as accumulated other comprehensive income in shareholders’ equity. The amortized cost of available for sale securities totaled $13.1 billion at December 31, 2021, an increase of $455 million compared to December 31, 2020. Available for sale securities consist primarily of U.S. government agency residential mortgage-backed securities and U.S. government agency commercial mortgage-backed securities. Both residential and commercial mortgage-backed securities have credit risk from delinquency or default of the underlying loans. We mitigate this risk by primarily investing in securities issued by U.S. government agencies. Principal and interest payments on the underlying loans are fully guaranteed. Commercial mortgage-backed securities have prepayment penalties similar to commercial loans. At December 31, 2021, residential mortgage-backed securities represented 61% of total available for sale securities.

A primary risk of holding residential mortgage-backed securities comes from extension during periods of rising interest rates or prepayment during periods of falling interest rates. We evaluate this risk through extensive modeling of risk both before making an investment and throughout the life of the security. Our best estimate of the effective duration of the combined residential mortgage-backed securities portfolio held in investment and available for sale securities portfolios at December 31, 2021 is 3.1 years. Management estimates the combined portfolios' duration extends to 4.2 years assuming an immediate 200 basis point upward shock. The estimated duration contracts to 2.1 years assuming a 100 basis point decline in the current low rate environment.

The aggregate gross amount of unrealized losses on available for sale securities totaled $114 million at December 31, 2021, a $105 million increase compared to December 31, 2020. On a quarterly basis, we perform an evaluation on debt securities to determine if the unrealized losses are temporary as more fully described in Note 2 of the Consolidated Financial Statements. No credit impairment of available for sale securities was identified in 2021.

Certain residential mortgage-backed securities issued by U.S. government agencies and included in Fair value option securities on the Consolidated Balance Sheets have been segregated and designated as economic hedges of changes in the fair value of our mortgage servicing rights. We have elected to carry these securities at fair value with changes in fair value recognized in current period income. These securities are held with the intent that gains or losses will offset changes in the fair value of mortgage servicing rights and related derivative contracts. Fair value option securities totaled $44 million, a decrease of $71 million. See Market Risk section for further details.

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Bank-Owned Life Insurance

We have approximately $406 million of bank-owned life insurance at December 31, 2021. This investment is expected to provide a long-term source of earnings to support existing employee benefit programs. Approximately $313 million is held in separate accounts. Our separate account holdings are invested in diversified portfolios of investment-grade fixed income securities and cash equivalents, including U.S. Treasury and Agency securities, residential mortgage-backed securities, corporate debt, asset-backed and commercial mortgage-backed securities. The portfolios are managed by unaffiliated professional managers within parameters established in the portfolio’s investment guidelines. The cash surrender value of certain life insurance policies is further supported by a stable value wrap, which protects against changes in the fair value of the investments. As of December 31, 2021, the fair value of investments held in separate accounts was approximately $323 million. As the underlying fair value of the investments held in a separate account at December 31, 2021 exceeded the net book value of the investments, no cash surrender value was supported by the stable value wrap. The stable value wrap is provided by a domestic financial institution. The remaining cash surrender value of $93 million primarily represents the cash surrender value of policies held in general accounts and other amounts due from various insurance companies.

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Loans

The aggregate loan portfolio before allowance for loan losses totaled $20.2 billion at December 31, 2021, a decrease of $2.8 billion compared to December 31, 2020, primarily due to a decrease in PPP loan balances and paydowns of energy and commercial real estate loans.

Table 18 – Loans

(In thousands)

Commercial

Commercial loans represent loans for working capital, facilities acquisition or expansion, purchases of equipment and other needs of commercial customers primarily located within our geographical footprint. Commercial loans are underwritten individually and represent ongoing relationships based on a thorough knowledge of the customer, the customer’s industry and market. While commercial loans are generally secured by the customer’s assets including real property, inventory, accounts receivable, operating equipment, interests in mineral rights and other property and may also include personal guarantees of the owners and related parties, the primary source of repayment of the loans is the on-going cash flow from operations of the customer’s business. Inherent lending risks are centrally monitored on a continuous basis from underwriting throughout the life of the loan for compliance with commercial lending policies.

Commercial loans totaled $12.5 billion or 62% of the loan portfolio at December 31, 2021, decreasing $571 million or 4% compared to December 31, 2020 primarily related to paydowns of energy loan balances. Services and general business loans also decreased, partially offset by growth in healthcare sector loans.

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Approximately 77% of loans in this segment are located within our geographic footprint, based on collateral location. Loans for which the collateral location is less relevant, such as unsecured loans and reserve-based energy loans are categorized by the borrower's primary operating location. The largest concentration of loans in this segment outside of our footprint is California, totaling 4% of the segment.

Supporting the energy industry with loans to producers and other energy-related entities has been a hallmark of the Company since its founding and represents a large portion of our commercial loan portfolio. In addition, energy production and related industries have a significant impact on the economy in our primary markets. Loans collateralized by oil and gas properties are subject to a semi-annual engineering review by our internal staff of petroleum engineers. This review is used as the basis for developing the expected cash flows supporting the loan amount. The projected cash flows are discounted according to risk characteristics of the underlying oil and gas properties. Loans are evaluated to demonstrate with reasonable certainty that crude oil, natural gas and natural gas liquids can be recovered from known oil and gas reservoirs under existing economic and operating conditions at current pricing levels and with existing conventional equipment and operating methods and costs. As part of our evaluation of credit quality, we analyze rigorous stress tests over a range of commodity prices and take proactive steps to mitigate risk when appropriate.

Outstanding energy loans totaled $3.0 billion or 15% of total loans at December 31, 2021. Approximately $2.2 billion or 73% of energy loans were to oil and gas producers, a $435 million decrease compared to December 31, 2020. The majority of this portfolio is first lien, senior secured, reserve-based lending, which we believe is the lowest risk form of energy lending. Approximately 67% of the committed production loans are secured by properties primarily producing oil and 33% of the committed production loans are secured by properties primarily producing natural gas.

Loans to midstream oil and gas companies totaled $646 million or 21% of energy loans, a decrease of $54 million compared to the prior year. Loans to borrowers that provide services to the energy industry totaled $142 million or 5% of energy loans, a $33 million increase during 2021. Loans to other energy borrowers, including those engaged in wholesale or retail energy sales totaled $30 million or 1% of energy loans, a $5.7 million decrease from the prior year.

Unfunded energy loan commitments were $3.0 billion at December 31, 2021, up $569 million over December 31, 2020. While utilization levels remain low, this provides ample capacity for growth from our current customer base.

The healthcare sector of the loan portfolio totaled $3.4 billion or 17% of total loans. Healthcare loans increased $109 million over December 31, 2020, primarily due to growth in loans to senior housing and care facilities. Healthcare sector loans consist primarily of loans for the development and operation of senior housing and care facilities, including independent living, assisted living and skilled nursing. Generally we loan to borrowers with a portfolio of multiple facilities that serves to help diversify risks specific to a single facility.

The services sector of the loan portfolio decreased $141 million to $3.4 billion or 17% of total loans. Service sector loans consist of a large number of loans to a variety of businesses, including Native American tribal and state and local governments, Native American tribal casino operations, foundations and not-for-profit organizations, educational services and specialty trade contractors. Approximately $1.7 billion of the services category is made up of loans with individual balances of less than $10 million. Service sector loans are generally secured by the assets of the borrower with repayment coming from the cash flows of ongoing operations of the customer’s business.

General business loans decreased $76 million to $2.7 billion or 13% of total loans. General business loans primarily consist of $1.4 billion of wholesale/retail loans and $1.3 billion of loans from other commercial industries.

We participate in shared national credits when appropriate to obtain or maintain business relationships with local customers. Shared national credits are defined by banking regulators as credits of more than $100 million and with three or more non-affiliated banks as participants. At December 31, 2021, the outstanding principal balance of these loans totaled $3.8 billion, including $1.7 billion in the energy sector. Approximately 84% of shared national credits are to borrowers with local market relationships. We serve as the agent lender in approximately 24% of our shared national credits, based on dollars committed. We hold shared national credits to the same standard of analysis and perform the same level of review as internally originated credits. Our lending policies generally avoid loans in which we do not have the opportunity to maintain or achieve other business relationships with the customer. In addition to management’s quarterly assessment of credit risk, banking regulators annually review a sample of shared national credits for proper risk grading.

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Commercial Real Estate

Commercial real estate represents loans for the construction of buildings or other improvements to real estate and property held by borrowers for investment purposes generally within our geographical footprint. We require collateral values in excess of the loan amounts, demonstrated cash flows in excess of expected debt service requirements, equity investment in the project and a portion of the project already sold, leased or permanent financing already secured. The expected cash flows from all significant new or renewed income producing property commitments are stress tested to reflect the risks in varying interest rates, vacancy rates and rental rates. As with commercial loans, inherent lending risks are centrally monitored on a continuous basis from underwriting throughout the life of the loan for compliance with applicable lending policies.

The commercial real estate loan balance as a percentage of our total loan portfolio has historically ranged from 20% to 25%. The outstanding balance of commercial real estate loans decreased $867 million compared to 2020. Borrowers continued to refinance to long-term, non-recourse markets in this low interest rate environment as markets became more open in 2021. Loans secured by multifamily real estate decreased $542 million or 41%. Other real estate loans decreased $121 million or 22%. Loans secured by retail facilities decreased $116 million or 15%. Loans secured by office buildings decreased $44 million or 4% and loans secured by industrial facilities decreased $44 million or 5%.

Approximately 71% of loans in this segment are in our geographic footprint based on collateral location. The largest concentration of loans in this segment outside our footprint is Utah, totaling 9% of the segment. All other states represent less than 5% individually.

Paycheck Protection Program

We participated in programs initiated by the Coronavirus Aid, Relief and Economic Security Act ("CARES Act"), including the Small Business Administration's ("SBA") Paycheck Protection Program ("PPP") that began on April 3, 2020. PPP provided fully forgivable loans when utilized for qualified expenditures, including to help small business maintain payrolls during the COVID-19 pandemic. These loans generally have a contractual term of two years, though most are expected to be forgiven prior to maturity after completion of a compliance period. Loans are guaranteed and amounts forgiven will be reimbursed to the Company by the SBA. The loans carry a rate of 1%. Interest plus loan fees, which vary depending on loan size, are accrued over the contractual life of the loan. Any unaccreted origination fees will be recognized when the loan is paid. The pace of forgiveness activity for the initial rounds of PPP loans was slower than initially anticipated. At December 31, 2021, approximately $39 million of PPP loans from the initial rounds remain outstanding, with an insignificant unaccreted origination fee balance remaining.

The Company also participated in the most recent round of PPP in 2021. Approximately $237 million of PPP loans from this round remain outstanding. The newest round of loans have a fixed interest rate of 1% and a contractual term of five years, but are expected to be forgiven prior to maturity. Unaccreted origination fees related to the 2021 vintage of PPP loans totaled $7.5 million at December 31, 2021.

Loans to Individuals

Loans to individuals include residential mortgage and personal loans. Residential mortgage loans provide funds for our customers to purchase or refinance their primary residence or to borrow against the equity in their home. These loans are secured by a first or second mortgage on the customer's primary residence. These loans are made in accordance with underwriting policies we believe to be conservative and are fully documented. Loans may be individually underwritten or credit scored based on size and other criteria. Credit scoring is assessed based on significant credit characteristics including credit history, residential and employment stability.

In general, we sell the majority of our conforming fixed rate loan originations in the secondary market and retain the majority of our non-conforming and adjustable-rate mortgage loans. Our mortgage loan portfolio does not include payment option adjustable rate mortgage loans or adjustable rate mortgage loans with initial rates that are below market. Home equity loans are primarily first-lien and fully amortizing.

Residential mortgage, which includes home equity loans, and personal loans are made in accordance with underwriting policies we believe to be conservative and are fully documented. Loans may be individually underwritten or credit scored based on size and other criteria. Credit scoring is assessed based on significant credit characteristics including credit history, residential and employment stability.

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Personal loans consist primarily of loans to Wealth Management clients secured by the cash surrender value of insurance policies and marketable securities. It also includes direct loans secured by and for the purchase of automobiles, recreational and marine equipment as well as unsecured loans. Personal loans grew by $238 million or 19%.

Approximately 91% of the loans in this segment are secured by collateral located within our geographical footprint. Loans for which the collateral location is less relevant, such as unsecured loans are categorized by the borrower’s primary operating location.

Residential mortgage loans guaranteed by U.S. government agencies have limited credit exposure because of the agency guarantee. This amount includes residential mortgage loans previously sold into GNMA mortgage pools that the Company may repurchase when certain defined delinquency criteria are met. Because of this repurchase right, the Company is deemed to have regained effective control over these loans and must include them on the Consolidated Balance Sheet. Residential mortgage loans guaranteed by U.S. government agencies decreased $55 million compared to December 31, 2020. As loans exited forbearance and delinquencies cured, many of these loan met GNMA requirements to be resold into GNMA mortgage pools.

The Company secondarily evaluates loan portfolio performance based on the primary geographical market managing the loan. Loans attributed to a geographical market may not represent the location of the borrower or the collateral. All permanent mortgage loans serviced by our mortgage banking unit and held for investment by the Company are centrally managed by the Oklahoma market.

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Table 19 – Loans Managed by Primary Geographical Market

(In thousands)

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Table 20 – Loan Maturity and Interest Rate Sensitivity at December 31, 2021

(In thousands)

Off-Balance Sheet Commitments

We enter into certain off-balance sheet arrangements in the normal course of business as shown in Table 21. Loan commitments may be unconditional obligations to provide financing or conditional obligations that depend on the borrower’s financial condition, collateral value or other factors. Standby letters of credit are unconditional commitments to guarantee the performance of our customer to a third party. Since some of these commitments are expected to expire before being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

We have off-balance sheet commitments related to certain residential mortgage loans sold into mortgage-backed securities as part of our mortgage banking activities. We retain off-balance sheet credit risk related to losses in excess of amounts guaranteed by the U.S. Department of Veteran's Affairs ("VA").

We also have off-balance sheet credit risk related to certain residential mortgage loans primarily originated under community development loan programs that were sold to a U.S. government agency with full recourse prior to 2007. We are obligated to repurchase these loans for the life of these loans in the event of foreclosure for the unpaid principal and interest at the time of foreclosure. The majority of our conforming fixed rate loan originations are sold in the secondary market and we only retain repurchase obligations under standard underwriting representations and warranties.

Table 21 – Off-Balance Sheet Credit Commitments

(In thousands)

Customer Derivative Programs

We offer programs that permit our customers to hedge various risks, including fluctuations in energy, cattle and other agricultural product prices, interest rates and foreign exchange rates. Each of these programs work essentially the same way. Derivative contracts are executed between the customers and the Company. Offsetting contracts are executed between the Company and selected counterparties or exchanges to minimize market risk to us from changes in commodity prices, interest rates or foreign exchange rates. The counterparty contracts are identical to the customer contracts, except for a fixed pricing spread or a fee paid to us as compensation for administrative costs, credit risk and profit.

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The customer derivative programs create credit risk for potential amounts due to the Company from our customers and from the counterparties. Customer credit risk is monitored through existing credit policies and procedures. The effects of changes in commodity prices, interest rates or foreign exchange rates are evaluated across a range of possible options to determine the maximum exposure we are willing to have individually to any customer. Customers may also be required to provide cash margin or other collateral in conjunction with our credit agreements to further limit our credit risk.

Counterparty credit risk is evaluated through existing policies and procedures. This evaluation considers the total relationship between BOK Financial and each of the counterparties. Individual limits are established by management, approved by Credit Administration and reviewed by the Asset/Liability Committee. Margin collateral is required if the exposure between the Company and any counterparty exceeds established limits. Based on declines in the counterparties’ credit ratings, these limits may be reduced and additional margin collateral may be required.

A deterioration of the credit standing of one or more of the customers or counterparties to these contracts may result in BOK Financial recognizing a loss as the fair value of the affected contracts may no longer move in tandem with the offsetting contracts. This occurs if the credit standing of the customer or counterparty deteriorated such that either the fair value of underlying collateral no longer supports the contract or the customer or counterparty’s ability to provide margin collateral was impaired. Credit losses on customer derivatives reduce brokerage and trading revenue in the Consolidated Statements of Earnings.

Derivative contracts are carried at fair value. At December 31, 2021, the net fair values of derivative contracts, before consideration of cash margin, reported as assets under these programs totaled $1.1 billion compared to $625 million at December 31, 2020. Derivative contracts carried as assets include energy contracts with fair values of $793 million, foreign exchange contracts with fair values of $215 million and interest rate swaps primarily sold to loan customers with fair values of $44 million. Before consideration of cash margin paid to counterparties, the aggregate net fair values of derivative contracts held under these programs reported as liabilities totaled $1.1 billion.

At December 31, 2021, total derivative assets were reduced by $242 thousand of cash collateral received from counterparties and total derivative liabilities were reduced by $837 million of cash collateral paid to counterparties related to instruments executed with the same counterparty under a master netting agreement.

A table showing the notional and fair value of derivative assets and liabilities on both a gross and net basis is presented in Note 3 to the Consolidated Financial Statements.

The fair value of derivative contracts reported as assets under these programs, net of cash margin held by the Company, by category of debtor at December 31, 2021 follows in Table 22.

Table 22 – Fair Value of Derivative Contracts

(In thousands)

The largest exposure to a single counterparty was to a customer for an energy swap which totaled $61 million at December 31, 2021.

Our customer derivative program also introduces liquidity and capital risk. We are required to provide cash margin to certain counterparties when the net negative fair value of the contracts exceeds established limits. Also, changes in commodity prices affect the amount of regulatory capital we are required to hold as support for the fair value of our derivative assets. These risks are modeled as part of the management of these programs. Based on current prices, a decrease in market prices equal to the equivalent of $33.38 per barrel of oil would decrease the fair value of derivative assets by $388 million, with dealer counterparties comprising the bulk of the assets. An increase in prices equal to the equivalent of $91.03 per barrel of oil would increase the fair value of derivative assets by $447 million. Liquidity requirements of this program are also affected by our credit rating. A decrease in credit rating to below investment grade would increase our obligation to post cash margin on existing contracts by approximately $10 million. The fair value of our to-be-announced residential mortgage-backed securities and interest rate swap derivative contracts is affected by changes in interest rates. Based on our assessment as of December 31, 2021, changes in interest rates would not materially impact regulatory capital or liquidity needed to support this portion of our customer derivative program.

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Summary of Credit Loss Experience

Table 23 – Summary of Loan Loss Experience

(In thousands)

1 Represents ratio of loan category balance to total loans.

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Table 23 – Summary of Loan Loss Experience (continued)

(In thousands)