Greetings, and welcome to the BOK Financial Corporation third quarter 2019 earnings conference call. At this time, all participants are on a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your your telephone keypad. It is now my pleasure to introduce your host, Steven Nell, Chief Financial Officer. Thank you. You may begin.
Good morning, and thanks for joining us. Today, our CEO, Steve Bradshaw, will provide opening comments, and Stacy Kymes, Executive Vice President of Corporate Banking, will cover our loan portfolio and credit metrics. I'll then provide some details regarding our income statement items for the third quarter and provide high-level guidance for the fourth quarter. Additionally, I'll provide a range of expectations regarding the implementation of CECL. At the end of the call, we'll have Scott Grauer, Executive Vice President of Wealth Management, as well as Marc Maun, Executive Vice President and Chief Credit Officer, available for questions. PDFs of the slide presentation and third quarter press release are available at our website at www.bokf.com. We refer you to the disclaimers on slide two as it pertains to any forward-looking statements we make during this call. I'll now turn the call over to Steve Bradshaw.
Good morning. Thanks for joining us to discuss the third quarter 2019 financial results. We are pleased to report a second consecutive record quarter for BOK Financial, both from a net income and an earnings per share perspective. Despite some challenging industry headwinds, these results are a testament not only to the organization's unique mix of business revenue, but to the outstanding efforts of the entire BOK Financial team. Shown on slide four, third quarter net income was $142.2 million, or $2 per diluted share. That's up 3% from the previous quarter and up 21% from the same quarter a year ago. The quarter-over-quarter growth was driven by a number of key factors. Fee and commission revenue continued its upward trajectory this quarter, expanding nearly 6%.
Our brokerage and trading and mortgage banking revenues continue to outperform on strong mortgage-backed securities trading and mortgage loan production volumes, both impacted by lower mortgage interest rates and increased market volatility. This growth fully offset the pressure realized on net interest income and net interest margin that Steven will cover in detail momentarily. Expense management was consistent this quarter with a minimal increase in total operating expenses, mostly attributable to higher compensation related to our fee-based businesses. Our loan loss provision this quarter was slightly higher at $12 million. This level was influenced by continued loan growth. Turning to slide five, average loans were $22.4 billion, an increase of nearly 2% for the quarter. Paydowns in the public finance and manufacturing segments late in the quarter, along with loan sales, left period-end loans relatively flat. We remain confident in mid-single-digit loan growth for the remainder of the year.
Average deposits were up over 2%, and period-end deposits were up over 3% this quarter, with a significant increase in interest-bearing deposits. Growing deposits to fund loan growth has been a significant area of emphasis for BOKF, which you can now see in our results. We saw an opportunity to further invest in our company at a favorable price this quarter as we bought back 337,000 BOKF shares at $77.03 per share in the open market. I'll provide additional perspective on the results at the conclusion of the prepared remarks, but now Stacy Kymes will review the loan portfolio and credit in more detail. I'll turn the call over to Stacy.
Thanks, Steve. As you can see on slide seven, total loans were $22.3 billion, up $30 million for the quarter on a period-end basis. Total C&I was up a half of a % for the quarter. Our expertise in energy and healthcare continues to be the driving factor and was responsible for the bulk of the C&I growth. Energy was up $193 million, or nearly 5%, for the quarter. The lower than normal churn trend in the energy portfolio we've discussed continues as companies continue to be slower to divest or sell in the current market environment. Our credit history in the energy segment, proven through the last energy cycle, affirms our ability to properly underwrite and manage this lending class. Our healthcare channel grew $107 million this quarter, or 3.6%.
While paydowns impacted period-end growth rates last quarter, steady growth in commitment levels and our focus in the senior housing space preserves healthcare as a major C&I growth engine. This continued strength in energy and healthcare was offset by an intentional refinement of relationships in the public finance segment, as well as some large client paydowns in the manufacturing and other segments. Public finance, as we mentioned at the time of the CoBiz acquisition, is not a significant area of focus for us at this point due to the low lending margins in this segment today. Continued discipline and concentration limits in the commercial real estate, coupled with late quarter paydowns, left the segment down 1.8% for the quarter. Commitment volume is still very strong in this space, and we will continue to high grade through stringent customer selection as we reload the portfolio.
On slide eight, you can see that credit quality remains strong as it has all year. Nonaccruals were down $11 million during the quarter, primarily due to a $15 million decrease in other commercial and industrial loans and a $10 million decrease in healthcare sector loans. Energy loan nonaccruals did increase by $17 million this quarter, this was due to a few lingering credits from the energy downturn in 2015. We do not see any new stress in our energy portfolio today. Net charge-offs moved up slightly to 19 basis points, remaining well below the historical trend. Potential problem loans, which are defined as performing loans that, based on known information, cause management concern as to the borrower's ability to continue to perform, total $143 million at September 30th, down from $161 million at June 30th.
This was due largely to a decline in energy, wholesale retail sector, and other commercial and industrial loans, partially offset by an increase in services and healthcare sector loans. Based on an evaluation of all credit factors, including overall loan growth, changes in non-accruing and potential problem loans, and net charge-offs, the company determined that a $12 million provision for credit losses was appropriate for the third quarter of 2019. We remain appropriately reserved with a combined allowance of 0.92% of period-end loans and leases. I'll turn the call over to Steven Nell to cover the income statement in more detail. Steven?
Thanks, Stacy. As noted on slide 10, net interest income for the quarter was $279 million, down $6.3 million from the second quarter. Comparatively, the second quarter included $2.7 million more of interest recovery and $2.4 million of higher accretion. Normalizing for these items, net interest revenue was relatively flat. Net interest margin was 3.01%, down from 3.30% the previous quarter. I provided on the slide a roll forward to highlight significant items impacting NIM calculation. First, the higher interest recoveries and accretion levels in the second quarter impacted NIM by three and four basis points, respectively. Second, the $1.3 billion expansion of our fixed income mortgage-backed securities portfolio had a dilutive effect on NIM of nine basis points, but added $650,000 to net interest income. Additionally, a higher level of securities held to hedge our mortgage servicing rights diluted NIM an additional four basis points.
The remaining nine basis points difference is attributable to the overall lower interest rate environment. Loan yields, largely priced off of LIBOR, declined 21 basis points, and a carryover of higher pricing and deposit gathering activities increased interest-bearing deposit costs by four basis points. While we are working to defend net interest income, significant interest rate cuts will continue to provide pressure. On slide 11, fees and commissions were up $186 million, an increase of nearly 6% for the quarter. The trends we mentioned last quarter continue to accelerate as declining rates fueled activity in wealth management and mortgage. Brokerage and trading revenue increased over 8% for the quarter, continuing its strength triggered by lower interest rates on strong mortgage-backed security trading results, coupled with higher loan syndication activity. Lower mortgage interest rates led to a 7% increase in mortgage revenues and drove a two-year high in mortgage refinance volumes.
Gain-on-sale margins increased five basis points this quarter. Fiduciary and asset management revenue was down quarterly due to a seasonal increase in tax fees collected in the second quarter. The year-over-year figure is impacted by the large one-time fee earned in the third quarter of 2018. Other revenue was up due to an increase in repossessed asset revenues from a certain set of oil and gas properties and a business insurance credit. The increased repossessed asset revenue is largely offset by higher operating expenses related to these properties. Turning to slide 12, we continue to carefully manage expenses to drive operating leverage. In fact, we were able to maintain a sub 60% efficiency ratio this quarter. Total operating expenses were $279 million, up $2.2 million for the second quarter. Personnel expense increased $2.2 million over the previous quarter.
Incentive compensation increased to $5.5 million, led by an increase in cash-based incentive compensation, primarily related to increased sales activity in the Wealth Management and commercial banking. This increase in incentive compensation was partially offset by a decrease in regular compensation by $1.2 million and employee benefits by $2 million. Employee benefits expense was down largely due to a seasonal decrease in payroll taxes. Non-personnel expense was overall flat from the second quarter, with certain offsetting components. Mortgage banking costs increased $3.4 million, primarily due to an increase in amortization of mortgage servicing rights as lower interest rates drive an increase in prepayment speeds. In addition, data processing and communications expense increased $2.2 million, and net losses and expenses on repossessed assets increased $1.1 million. Insurance expense decreased $2.2 million and business promotion expense decreased $1.3 million.
One additional thing I'll mention is that this quarter included a $5.2 million tax benefit, largely due to the finalization of the 2018 tax return for BOK Financial and CoBiz, along with completion of a tax credit project. Slide 13 has our current outlook for the remainder of 2019. As I've done in previous years, I'll hold off on discussing next year in any detail until our budgeting process is further along. I will say, however, that our initial planning is centered around a flat rate environment for 2020. Focusing on the fourth quarter, we think mid-single-digit loan growth for C&I categories is expected for the remainder of the year. Provision level in the fourth quarter will be influenced more by loan growth as opposed to any expected credit deterioration.
The last rate cut we saw in September has clearly placed negative pressure on net interest income and net interest margin. We also expect another rate cut before year-end. Additional pressure on NII and NIM will depend on the timing of that cut. We've increased our fixed income securities portfolio in the last couple of quarters to a level that we're comfortable with. I would expect it to remain relatively flat. Revenue from fee-generating businesses, particularly brokerage and trading and mortgage, should continue to benefit from lower interest rates. However, seasonality could influence mortgage activity. Our ability to hold our efficiency ratio at or below 60% is largely dependent on total revenue and revenue mix. We'll allocate sufficient capital to support organic loan growth and expect to continue to a modest level of opportunistic share repurchases. Capital ratios are expected to improve slightly over time.
Lastly, on slide 14, a word on CECL. We are nearing completion of our CECL implementation project. Our models have been developed, and validation is being finalized. We have established an internal economic forecast committee and completed several test runs of the CECL process. These test runs consider data from our loan systems, forecasts developed by the economic committee, evaluation of the modeling results, and qualitative adjustments for credit exposure not appropriately measured by the models. Based on the results of these test runs, our allowance committee expects the pre-tax transition adjustment from CECL implementation will be between $50 million and $75 million.
As provided in our previous disclosures, the transition adjustment considers the requirement to provide duplicate allowance on nearly $2 billion of acquired loans that were previously marked to fair value, including a credit discount, and to provide an accrual for credit exposure on approximately $3.5 billion of loans serviced for Ginnie Mae that are backed by the U.S. Department of Veterans Affairs. Of course, the final transition adjustment will depend on the composition of our loan portfolios and the current and forecasted economic conditions as of January 1, 2020, the effective date for the CECL adoption. I'll now turn the call back over to Steve Bradshaw for closing commentary.
Thanks, Steven. As I mentioned at the top of the call, BOK Financial's second consecutive record quarter is a product of our structured, disciplined revenue approach. Our fee business has more than compensated for decreasing net interest income this quarter, which is how we have built the bank to perform consistently through economic and interest rate cycles. This is a quarter that really underscores the full earnings potential of our company. Looking ahead, I really believe that we're well-positioned for continued earnings performance, even if industry headwinds intensify. With 40% of our revenues derived from fee business, we have the ability to help mitigate the decline in spread revenue if rates continue to fall. While period loan growth was flat this quarter, average loan growth tells the real story.
While late quarter pay-downs might give the impression that loan growth is slowing, our energy and healthcare channels continue to outpace expectations and leave us optimistic for continued loan growth. With that, we're pleased to take your questions. Operator?
Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, that is star one to register questions at this time. Our first question is coming from Ken Zerbe of Morgan Stanley. Please go ahead.
Great. Thanks. Good morning.
Good morning.
Good morning.
Thought I'd start off on, in terms of the expense guidance, the 60% efficiency ratio, do you guys feel that you're having to delay any projects or investments in the business, or are we kind of at a good, steady state? I'm just trying to figure out how much pressure is on the expense side, given the weaker revenue outlook broadly.
Okay. Ken, this is Steven. Yeah, I think we are at a good, steady state. I don't really see a big bubble of expenses coming at us in 2020. I think it's more business as usual. I think that's why I made the comment about our efficiency ratio being really determined more around the revenue side and revenue mix, as I think the expenses are pretty steady state.
Yeah, this is Steve Bradshaw. Let me tag onto that. I think that a big part of our expense allocation, obviously, is to technology investment. We're maintaining that level even in the face of some revenue headwinds. We think of that really kind of as a percentage of revenue. We're also seeing some pretty significant technology investments we made in infrastructure back in the kind of that 2014 and 2015 timeframe that are now rolling off. It's giving us more capacity to focus our resources on technology that's more customer facing and product enhancement. We feel good about that, despite the headwinds out there.
Okay, great. Then, Steven, if we do get an October rate cut, what do you envision happens to NIM in fourth quarter?
Continues to go down.
Can you quantify that specifically?
Well, it's hard for me to quantify because there's lots of moving parts that impact our NIM calculation, as with anyone. Clearly, the LIBOR-based loans are going to continue to move down at a faster pace than our deposit pricing. The wholesale funding that's really funding the securities portfolio, that will roll down pretty much lockstep with any kind of Fed move, and so will the loans. You'll get benefit from the fact that we have a larger fixed income securities portfolio that will hold its spread and actually gain some spread. As I said last quarter, the wild card here is really the deposit gathering activity. I would say that we are seeing some rollover in our administered pricing in consumer. We're seeing some movement downward in our exception pricing in commercial.
So long as we continue to fund our loan growth with more market-based wealth-type deposits, then you're going to see that overall interest-bearing deposit cost stay relatively stable, if not perhaps a little higher.
Got it. Okay. Maybe just staying with NIM, just for my last question. I want to say, what's the right level of interest recoveries and also accretion? Obviously, it hurt you this quarter. I get accretion comes down.
Yeah.
Is this the right level of interest recoveries and what do you expect for PAA? Thanks.
Interest recoveries were only $700,000 in the third quarter. It was $3.4 million in the second quarter, somewhere in between. We usually have some level of interest recovery in the million or so level, and it's hard to say. Accretion, the level you saw in the second quarter, I think, was a bit elevated. This quarter is a little bit more normal. As time goes by, we still have about $90 million left over in the overall discount amount that will be recovered over time, the next two, three years, and there'll be a tail on that. That $10.9 million that you saw this quarter will begin to taper down as we enter 2020.
Okay, great. Thank you very much.
Thank you. Our next question is coming from Brett Rabatin of Piper Jaffray. Please go ahead.
Hey, good morning, everyone.
Morning.
Morning.
Wanted to ask about the loan growth and the guidance has mid-single-digit loan growth from C&I categories expected for the remainder of the year. Can you talk about that versus commercial real estate? If you expect additional payoffs there to kind of mute loan growth, or can you give us maybe a little more color on how you see the various categories impacting the total balance?
Yeah, it's hard to predict individual categories. Obviously, even in real estate, we had some late paydowns at the end of the third quarter, which impacted total growth. Generally speaking, we feel very comfortable what we've talked about for almost a year now, that the total portfolio would grow on a year-to-year basis in the mid-single-digit range. I still feel very comfortable with that. We've got capacity in real estate for outstanding growth. We think that we'll continue to have opportunities there. I don't see anything in the market from a real estate perspective that's driving kind of a market impetus to pay down loans that we've seen in years past. Just normal kind of timing of when loans pay off versus when they advance inside that real estate portfolio.
I think as you look forward, I think we've talked, I think, last quarter, just organically, you may have some headwind in the C&I space and in the business banking space around the kind of uncertainty in the broader markets as you go through an election cycle. As you work through that, I think sometimes that creates trepidation on the part of a borrower to kind of see what's going to happen, and uncertainty's never in our favor from that perspective. I think overall, we've got a big portfolio. We've got a lot of levers. Healthcare and energy have been good drivers for us. We've got other places in the portfolio that create opportunities to grow. CRE will continue to grow at a modest pace overall. We still feel good about that mid-single digit kind of annualized loan growth that we've been talking about.
Okay. You mentioned energy. Wanted to talk about that for a second. You mentioned no new issues, but you had a few lingering ones. I'm curious, you guys have not really changed how you did underwriting versus the industry that's kind of moved to more cash flow versus reserve-based. I'm curious, you're growing the portfolio. Have you adjusted anything in terms of how you do energy? Have you changed your debt service tests given the environment?
I've heard that people are moving to more of a cash flow-based underwriting style, and I don't understand that. Every loan we've ever underwritten at this bank in energy has had a cash flow underwriting component to that. We have never looked at this asset class as strictly an asset-based loan for which we're making a loan against the collateral. I can't speak to how others may be underwriting this asset class, but I can tell you in my history here at the bank, we have never underwritten this without looking at cash flow as a repayment source, base cash flow repayment of all debt, base cash flow repayment of bank debt as part of our underwriting. Maybe that's why we've outperformed the market in this segment. I think that's why this has been core to us.
We haven't made changes to the underwriting because our underwriting has been consistent and has performed through cycles, and we have not had to make changes as a result of that.
Okay. If I can sneak one last one in, just back on the margin question. I know there's a lot of moving parts. Would you expect NII to be down from here? Just thinking about the various pieces of the income.
Brad, if we get one more rate decline in the fourth quarter, which we're expecting, I would say yes, that we would expect NII to be down slightly. Largely because of the impact on our LIBOR-based loans. We'll grow loans, certainly, that helps. I can see a scenario, certainly, where NII goes down in the fourth quarter if we get another rate decline. We're planning, I think I mentioned, we're planning in 2020 a flat rate environment. If that holds in 2020 we continue to grow loans, certainly we're going to grow NII. I feel pressure there in the fourth quarter with another rate decline.
Okay. Appreciate all the color.
Thank you. Our next question is coming from Peter Winter of Wedbush Securities. Please go ahead.
Good morning.
Hello, Peter.
Hey, Peter.
Going back to energy. I guess this is the second quarter where there's been a decent size increase in non-performing loans. I'm just wondering if you can talk about the reserves you have against these loans and what you're thinking in terms of maybe potential future charges.
Yeah, I think, in the midst of the downturn in 2015 and 2016, we talked about because the broader market did around energy reserves specifically. We've never liked that discussion because the totality of the reserve is available for all losses, whether they're energy or not. We're not back into trying to disclose a specific reserve to energy because we've got a big reserve and it's available for all of our loans. I think what I would say is energy loans, by virtue of how wells are drilled and those types of things, are larger. When you have one deteriorate, you're going to have more lumpiness as it comes through criticized, classified, and ultimately non-performing because of the size of the loans. That's on the good and the bad side. As they get better, then they'll be lumpy from that perspective, too.
As they deteriorate, there'll be lumpiness there as well. From a loss perspective, we talk about in our presentation and on the slide around credit quality that we've been at about 19 basis points of average charge-offs over the last five quarters. That's certainly better than a through cycle view of 30, 35, 40 basis points from that perspective. I would tell you as we look forward, I think that 20 basis point average charge-offs is a good place to peg us. I think that based on the facts that we know today and the circumstances that we know today, I think that run rate is one that feels that we can continue to stay on that trajectory, even though it's better than our long-term historical average from a credit loss perspective.
Great. If I can ask a big picture type question. Obviously, you have a very long and strong history in energy. I'm just wondering, when we look out, you're seeing private equity really pull back and away from the space. What gives you the confidence to continue to grow in this area?
I think the biggest issue, if you think about our underwriting here, is those private equity investments are really for future activity, not for what has already occurred. Our lending base is on proved developed production. We're very comfortable with the cash flow that we believe will come from those wells over time to repay our debt. That has been proven out over time. I think the issue with private equity and frankly, the capital markets being closed, the broader, more complex issues around the broader energy capital stack issues really is about future investment. How much growth can there be? You see rig counts coming down almost every month now. When you see those statistics coming down, that's going to have an impact on new well production and the growth in the commodity supply.
We're not counting on future private equity investments or an open capital markets to repay our debt. Back to the earlier view, we're counting on the cash flow that we underwrite in the existing wells to repay our debt. If there is no future investment, I think it changes maybe a lot of these loans. Let's play that to its illogical conclusion. If there's no future investment, then there's no future drilling, and a lot of these energy loans become term loans, and they get repaid as the asset depletes over time. We're not counting on the capital markets or private equity to bail us out. We're not counting on them to make an investment that's going to improve our deal.
We underwrite and we approve a loan based on the existing cash flow and asset base of that borrower and counting on that to pay us back. Even times where we look at maybe private equity commitments they've made, we don't give lending credit for open and unfunded private equity commitments. We look at that, we understand that, but we're not dependent upon that to repay our energy loans.
Great. Thanks for all the color. Appreciate it.
Thank you. Our next question is coming from Jennifer Demba of SunTrust Robinson Humphrey. Please go ahead.
Thank you. Good morning.
Good morning.
Question on the mortgage business. Wonder how strong your pipelines are right now and how much of the strength we saw in 3Q will bleed over to what is usually the softer 4Q?
I think we have good pipelines there, but I'll just tell you that the fourth quarter is generally softer. That seasonality in that business, when you get into the holidays and that time of year, you generally see a slowdown in mortgage origination. Even though the environment is still very conducive for good mortgage activity, I do think you'll see some slowdown, largely just from the normal seasonality in that business.
This is Steve. I think the only mitigant is if you see a further decline in mortgage rates, then you could see a thesis that would suggest that there'll be higher refi levels coming out. I think refis in the third quarter were kind of approaching 40% for us, and we could see that go higher in a further decline rate market. I agree with Steven. You would typically see purchase lending go down in the fourth quarter. You see that virtually every year. The refi business is a little bit of a wild card relative to rates.
Okay. Question on credit. Stacy, that was some great color before on your thoughts on near-term charge-offs. Can you give us some color on what the total leverage lending book looks like for BOK? If you guys have any restaurants in your C&I portfolio right now.
I'll let Marc Maun, our Chief Credit Officer, is here. I'll let him handle that.
Yeah. From the standpoint of leverage lending, that is not something that we focus on in terms of defining it as enterprise value-type lending. We have a very limited amount of what I would call pure based on support of the value of the company to get us repaid from a collateral basis. That's not a line of business we focus on, and we've maintained that process or that strategy going forward. On the restaurant side, we have had a limited amount of business. We have $177 million in outstanding credits. It's basically very select brands that we are invested in on a franchise basis. We don't do anything that isn't based on a franchise concept. We tend to have the larger companies, the ones that are the number one or number two or number three franchise companies for that particular brand.
Frankly, right now, the credit quality of that is all positive.
Jennifer, that's never been an area of business development focus. Just from a credit philosophy, we've always liked kind of belt and suspenders, both collateral and cash flow. We have never set out with a strategy to grow that or develop business in that space.
Okay. Just one more question on credit. What kind of concentration are you comfortable with in terms of healthcare loans to the total portfolio as you progress over time?
We continue to evaluate that every six months. We look at what's going on in the industry. We look at what's going on with the regulatory environment and assess what works best for us. We have modified our strategy over time and focused more on the senior housing because the demographics really favor us in that area, as opposed to some of the out-of-network type businesses in the healthcare. We're much more comfortable where there's a Medicare, Medicaid reimbursement model. We're going to keep it in line with what we have. We have concentrations focused on energy, we have focus on CRE, and we have focus on healthcare which account for a little over 50% of our total loans. We'll keep those ratios in line over time.
Jennifer, those three areas that Marc highlighted are the ones that the credit committee and the board monitor from a concentration limit perspective. What I would tell you, we've been growing healthcare in the 6% to 10% range, and I think we have plenty of capacity to continue to grow healthcare at that rate as we look forward.
Thanks so much.
Thank you.
Thank you. Our next question is coming from Matt Olney of Stephens. Please go ahead.
Hey. Thanks. Good morning. Wanted to ask about fee income and specifically the brokerage and trading line. Can you just remind us of the mix of that line? How much of the brokerage line is from securities trading that can be influenced by rate volatility? Beyond that, what are some of the other drivers that could influence that line from quarter to quarter?
Sure. This is Scott. Matt, when you look at our product mix, we are on the fixed income side, which obviously all of the fixed income lines are going to be interest rate sensitive and be impacted by volatility and rates. When you look at our taxable component of our fixed income mix, it accounts for about 40% of our total revenue. On the fixed income side, our single largest category is our mortgage-backed securities group. We have a stable, about 10%-15% mix of municipals. The rest are a combination of corporates, treasuries, certificates, et cetera. A fairly high percentage of our total revenue is going to be interest rate sensitive. We have little on our trading component that's equity related, and other products and derivatives. We do have an active hedging activity as well in our financial risk management.
Okay. That's great. Thank you, Scott.
Matt, this is Steven. When the 10-Q comes out, we have a table that breaks down specifically all of the brokerage and trade, all the fee businesses, in fact, but it breaks down the brokerage and trading line item in about five different categories, along with what Scott said. You can look at that when that comes out in a week or so.
Okay, perfect. On the margin, and specifically on the interest-bearing deposit costs, those were up a little bit the third quarter. Can you talk about your expectations for the fourth quarter interest-bearing deposit cost and how much confidence you have that 4Q costs will be below the third quarter levels?
Yeah, I talked a little bit about that with Kenneth Zerbe's question earlier. Again, I feel like we're seeing some deposit cost decline in some of our exception priced commercial deposits and also in some of our administered rates over on the consumer side, although we didn't raise those that much when rates were going up. The wild card here is how much of the loan growth that we expect to continue that we're going to fund with new deposits. A lot of those new deposits are coming out of our wealth space. To gain some of those new deposit balances from our wealth customers, we're having to pay more towards the market index type rate. Some of those rates are 175 and above.
When you think about that level of deposit growth relative to the composite, the 1.17% interest-bearing deposit cost, then you see that it could actually average it up a little bit, depending on the size of the wealth deposit that we bring in. That's the wild card.
Yeah. Okay. Then the balance sheet migrations, we saw some really strong deposit growth this quarter. As you noted, that you have saw some flat end of period loan growth because the pay downs. Does that imply that the pay downs you received on the loan side, were those surprising to you? Was it just earlier? Any kind of commentary you can talk around the pay downs in 3Q?
It really wasn't that surprising. There was a few categories that we have migrated away from. We saw a little bit of that go away. We actually had a small loan sale before the end of the quarter, less than $100 million. It was there. That impacted period imbalances. I think the growth that Stacy talked about in terms of mid-single digit, I think we still feel confident with that, despite the fact that we saw some quarter-end pay down.
Okay. Thank you.
Thank you. Our next question is coming from Jared Shaw of Wells Fargo. Please go ahead.
Hi, good morning.
Good morning.
I just wanted to, I guess, stay on the deposit question or conversation a little bit more. I understand that we maybe look at overall costs of deposits or of interest-bearing deposits going higher because of that mix shift. As we look at the categories within deposits or the cost of those categories, should we expect to see fourth quarter maybe a decline in those incremental categories? You look at transaction costs, went up. You look at time deposit costs, they went up. You look at savings, they went up this quarter. Should we start to see some incremental decline there, but the overall cost being more impacted by the mix?
I think you should see some deposit cost decline in some of those categories. I think what I'm trying to emphasize here is the new deposits that we pull in are more market rate type deposits. Yeah, the core deposits in consumer, the core deposits in our commercial categories, even the core deposits in our wealth space, we think some of that will come down. It's the new deposits we're bringing on at much higher rates that fit into that composite rate, and that's what really trying to figure out, is that going to increase in the fourth quarter, or does it stay stable, or does it slightly decline? My feeling is, if we fund the loan growth we expect in the fourth quarter with more of these market type rates in wealth, that you could see deposit costs actually flat or slightly go up.
Looking at that.
Keep in mind.
looking at that $117 cost being flat or slightly up. Okay.
That's right. That could happen.
You will also get some seasonality with deposits in the fourth quarter as well.
Right. Okay. On the DDA side, I guess as we look over the last four quarters, the average DDA balances have trickled down. Where do you, I guess, see that bottoming out and when could we potentially see sort of growth in average DDA?
We saw some growth point to point in DDA. The average was down a little over $100 million, the point to point growth was there. I feel like as rates continue to go down a little bit, our expectation for that you see some stabilization of DDA balances.
Okay. I guess finally for me, just on the provision side, the $12 million provision this quarter, you said it was tied to the loan growth. If we see similar average loan growth for fourth quarter, then should we expect that the DDA I'm sorry, the provisions stay in that $12 million range?
I think the first thing I'll point out that we did in the third quarter is we wanted to cover the charge-offs. Charge-offs were a little bit higher, although gross charge-offs in the third quarter were actually a little bit lower than gross charge-offs in the second quarter, but we had less recoveries. The overall net charge-offs for the third quarter were $10.6 million, I believe. We wanted to cover that with our provision. Then we covered a little bit extra for the loan growth that we're talking about. Depending on what happens with net charge-offs in the fourth quarter, and depending on what happens to growth, I feel like there'll be more influence on the provision related to growth as opposed to any expected deterioration in credit quality.
Okay, great. Thanks for that color.
Thank you. Our next question is coming from Gary Tenner of D.A. Davidson & Co. Please go ahead.
Thanks. Good morning.
Hello, Gary.
I had a question in terms of the balance sheet. Steven, if we assume that the scenario that you laid out of one more cut in the fourth quarter and flat rates next year plays out, how do you think about adding additional leverage to the balance sheet in the fourth quarter to kind of support the fourth quarter potential margin pressure and support NII? Then next year, in a flat rate environment, how does that change?
Yeah, I really think we don't have any additional plans to add fixed income securities above what we already added. I know the average was up $1.3 million. We've actually added the last couple of quarters, $1.9 billion. When you look at the period-end balance sheet in the press release, you see an available for sale balance of about $11 billion. I don't really see much change to that, to answer your question. We're not going to add to that position. I don't think we would take away either. Certainly wouldn't during the fourth quarter.
Okay, thanks. Just to clarify on your CECL slide. Is that adjustment on CECL, that 50-75 is the delta to the ALLL that you'd expect on day one?
There'll be a component of that we actually will pick up in another liability reserve. That $50 million-$75 million represents about 25%-35% increase in the overall CECL implementation, of which I believe the originated loans and kind of unfunded legacy loans of BOKF is about 10%-20% of that. About 10% relates to our acquired loans and another 5% to cover the VA and other items. That's the way we kind of view it. They will show up in a couple of different categories on the balance sheet.
Okay, got it. Thank you.
Thank you. Our next question is coming from Jon Arfstrom of RBC Capital Markets. Please go ahead.
Thanks. Good morning.
Hey, Jon.
Morning.
A couple lending questions, I want to ask about mortgage as well. Stacy, the public finance paydowns, they're expected, but you still have close to $750 million in balances there. Just curious what the longer-term plan is and trajectory is.
The margins in that business kind of ebb and flow over time, and we kind of evaluate it with our other lending segments. As the margins become favorable and we can get a favorable return on equity, then we get more aggressive in that space. When the return on equity for that segment moves below our hurdle rate, then it's harder for us to originate and be competitive there. In today's environment, the return on equity in that segment is lower, and so it's not a current business development focus in a large way.
Okay. You're not saying the $750 million is really running down, it's just more of a conscious decision on your part.
That's really around new origination around the returns on equity in that business. We're not making a commentary on the asset class at all. From a credit perspective, it performs extremely well. It's really just the margins in the business ebb and flow and impact the return on equity, and that's kind of how we decide to move in and move out of the space as our internal capital allocation.
Okay. On CRE, you used the term high-grading the portfolio. Can you maybe give us an example of that, help us understand it? Are you expecting just churn in the portfolio as you high-grade it or actual growth?
I expect modest growth in CRE as we look forward. I think that we feel very good about what we've done there. That doesn't mean that if there's a recession, then there are going to be some things that come out of that that we look at and say, "Yeah, I wish that I'd done that differently." CRE is the most pro-cyclical segment, which is why we keep such a disciplined concentration around that. There are things that can come out in a recession that maybe isn't what you anticipated. In the last 45 days, we've had a very thorough review inside that portfolio between the business line and our credit partners to look at loans that are performing as agreed, that are doing very well.
That maybe there's something that's changed about our view of that segment or that geography or something like that's different than the way we looked at it when we originated it, in some cases two or three years ago. There's a modest amount of that we'll look at and say, when there's an exit opportunity, we'll do something different there.
A lot of what came out of that was we still feel extremely good about the underwriting that happened there, and how it's performing and how we look at it. I still see as we look forward, I don't see us treading water in real estate. I don't see double-digit loan growth, but I see low mid-single digit kind of growth as we look forward there.
Mm-hmm. Okay, good. Then back on mortgage, help us understand what's different in mortgage to where you were a year ago. The mortgage loans funded for sale is obviously up a lot, and I know some of that is refinance. Mortgage production volume is also up a lot, and it seems to me you're saying that you might expect a bit of a drop-off in Q4, but in terms of just your ability to generate production, what's different than maybe where you were a year ago?
Yeah. Jon, this is Steve. We've actually made some pretty fundamental changes in that business, really over the last 18 months. We exited the correspondent business. That's probably been actually closer to two years ago. We also made the decision to largely exit our consumer direct channel, which was really in the lead purchase business, and focus the core of that group on retention of our existing mortgage servicing portfolio, working leads coming out of our branches, that kind of thing. Our timing's been really fortuitous of that because as we've seen the refi business kind of come roaring back with these rate declines, we've had the ability to process that business in a really effective way. Our margins are up in that business. Our focus is really squarely on the relationship side, in footprint, and opportunities there.
We have reduced a pretty significant amount of operating expense out of that unit that was supporting those two areas that we've, in essence, exited. The profitability driver for that business has probably never been better for us than where we sit today. We're being cautious about our expense management there. We're using pricing really to manage our capacity, as opposed to adding a significant amount of incremental expense. We want to see a little bit more durability of the origination business, purchase market business, as opposed to kind of this refi mini boom that we're kind of in today. That's really what's fundamentally changed about the way that we're managing that business, and we think it's absolutely essential to the core way we think about relationships across the footprint. That's been beneficial for us. Our timing has been really good.
We can't take credit for that necessarily. Managing down into that core ahead of a refi boom and an increase in the purchase market has been really advantageous for us. We're pleased where we are with mortgage today.
Okay. Steven, for you, just on the follow-up there, it looks like you're entering the quarter with some pretty large commitment volumes, and I guess you're expressing some cautiousness, but at this point, you're not necessarily seeing any taper off in volumes. Is that fair?
On the mortgage commitments?
Yep.
Yeah. No, I think we've got a good pipeline there. To Steve's point, I just wanted to point out that there is some seasonality to this business that you generally see in the fourth quarter, despite rates, unfavorable rate environment. Just talking through that a little bit.
Yep. Okay. All right. Just one more, Steven, for you. In terms of, let's say we get a rate cut next week, how long do you think it takes for a cut to be fully reflected in your balance sheet in the NIM? I know you have a lot of wholesale funding and variable rate loans, is it a quarter? Is it two quarters? What do you think?
It's really a quarter. When you think about 75% of your loans are variable and most of them are tied to LIBOR, that's pretty immediate or within 30 days or so. Your wholesale funding, most of that's overnight. It moves pretty quickly. Of course, the lag is on the deposit side. It takes 60 to 90 days for that to kind of flow through.
Yep. Okay. All right. Thanks, guys.
Thank you.
Thank you.
Thank you. At this time, I would like to turn the floor back over to management for any additional or closing comments.
Okay. Thanks again, everyone, for joining us. If you have any further questions, please call me at 918-595-3030, or you can email at ir@bokf.com. Have a great day.
Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines at this time, and have a wonderful day.