BOK Financial Corporation (NASDAQ:BOKF) reported earnings of $0.92 per share in the second quarter of 2020, up 5% from the first quarter. The earnings improvement was attributable to higher mortgage banking revenue and a sharp decline in funding cost. Earnings will likely continue to improve in the year ahead due to the Paycheck Protection Program. Moreover, the provision expense will likely decline in the year ahead, but remain above normal. Overall, I’m expecting BOKF’s earnings in the second quarter to increase by 77% from the first half’s earnings. However, the bottom line in the remainder of the year will likely decline on a year-over-year basis due to elevated provision expense. For the full year, I’m expecting BOKF to report earnings of $5.0 per share, down 29% from last year. BOKF is facing a high level of credit risk in the current environment because of its substantial exposure to the oil and gas segment and COVID-19-sensitive industries. The stock’s riskiness will likely keep the market price subdued in the near term despite the attractive valuation. Hence, I’m adopting a neutral rating on BOKF.
Paycheck Protection Program to be the Chief Earnings Driver
As mentioned in the second quarter’s investor presentation, BOKF funded $2.1 billion of loans under the Paycheck Protection Program, PPP. Assuming fees of 3% and funding cost of 0.35%, PPP will add an estimated total of $56 million to BOKF’s net interest income. According to details given in the presentation, BOKF has already booked around $14 million of fees in the second quarter. I’m expecting most of the PPP loans to get forgiven before the year-end; therefore, I’m expecting BOKF to book the remaining fees in the second half of the year.
Excluding the impact of PPP, BOKF’s net interest income is likely to trend downwards in the year ahead due to a decline in net interest margin, NIM. BOKF’s NIM improved in the second quarter by 9bps as the company was able to substantially slash its deposit costs. The management mentioned in the presentation that it has realized most of the deposit rates decline to-date; hence, there is little room for funding cost to further decline. As a result, I’m expecting the NIM to face pressure in the year ahead. Moreover, the management expects the yield on the available for sale security portfolio to decrease as prepayments will force reinvestment at lower rates. Considering these factors, I’m expecting NIM to decline by 6bps in the third quarter and 2bps in the last quarter of the year. The following table shows my estimates for yield, cost, and NIM.
As I’m expecting most of the PPP loans to get forgiven before the year-end, BOKF’s total loan portfolio will likely decline in the remainder of 2020. As mentioned in the presentation, the management expects loan growth to be soft in the year ahead. The uncertainties related to the COVID-19 pandemic and the upcoming presidential elections will likely keep demand for commercial loans low. Considering these factors, I’m expecting the year-end loans to stand at $21.9 billion, down 8% from the end of June 2020, and up 1.4% from the end of 2019.
Another Sizable Reserve Build Likely
BOKF reported provision expense of $135 million in the second quarter, up from $94 million in the first quarter of 2020. The management considered forecasts for different economic variables to determine the provisioning requirement. Below are the base case assumptions, as mentioned in the second quarter’s conference call:
- The management assumed that GDP would increase by 18% in the third quarter and 5% in 12 months ending June 2021.
- Further, the management assumed a civilian unemployment rate of 8.4% in the third quarter and 8.5% in the 12 months ending June 2021.
- The management assumed a WTI crude oil price of $38.99 per barrel in the third quarter, increasing to $40.13 per barrel in the second quarter of 2021.
In my opinion, the GDP forecast incorporated in the loan loss reserves for the second quarter appears too optimistic given the current economic scenario. The Economist Intelligence Unit expects GDP to increase by just 2.17% in the third quarter. As a result, I’m expecting BOKF to substantially increase its loan loss reserves in the year ahead. I’m expecting BOKF to report a provision expense of $354 million in 2020, up from $44 million in 2019.
The company is currently facing a high level of credit risk because of its exposure to the oil and gas segment. As mentioned in the presentation, the energy segment made up 16.5% of total loans as of the end of the last quarter. Additionally, COVID-19-sensitive industries, including retail and the gaming industry, made up 6.63% of total loans. Due to the mix of the loan portfolio, BOKF is currently facing a high level of credit risk. I believe the risks will keep the stock price subdued in the next two to three months.
Expecting Earnings to Decline by 29% in the Full Year
Earnings will likely improve in the second half of the year compared to the first half because of PPP and lower provision expense. Consequently, I’m expecting the net income in the second half of the year to be 77% higher than the net income for the first half of the year. For the full year, I’m expecting BOKF to report earnings of $5.0 per share, down 29% from last year. The following table shows my income statement estimates.
BOKF Offers Opportunity for Capital Appreciation for a Holding Period of One Year
BOKF has traded at an average price-to-book ratio, P/B, of 1.01 in 2019 and the first half of 2020. Multiplying this P/B ratio with the June 2021 forecast book value per share of $77.1 gives a target price of $78.1 for the mid of next year. This target price implies a hefty price upside of 40% from BOKF’s July 31 closing price. The following table shows the sensitivity of the target price to the P/B multiple.
Apart from the price upside, BOKF is also offering a dividend yield of 3.7%, assuming the company maintains its quarterly dividend at the current level of $0.51 per share. There is little threat of a dividend cut because the earnings and dividend estimates suggest a payout ratio of 41%, which is sustainable.
Credit Risks Likely to Keep the Stock Price Subdued
As discussed above, BOKF faces a high level of credit risks due to its exposure to the oil and gas segment. Additionally, the company has some loans to COVID-19-sensitive industries, including recreation, restaurants, and hotels. Moreover, around 37% of BOKF’s loans are based in Texas, which is one of the states hit hardest by the pandemic. The risks will likely keep the stock price subdued in the next two to three months regardless of the attractive valuation. Consequently, I’m adopting a neutral rating on BOKF for the near term.
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Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.