BOK Financial Corp
NASDAQ:BOKF
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BOK Financial Corp
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[Call starts Abruptly]… 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 2 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 unique mix of business revenue, but to the outstanding efforts of the entire BOK Financial team.
Shown on Slide 4, 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 5, average loans were $22.4 billion, an increase of nearly 2% for the quarter. Pay downs in the public finance and manufacturing segments late in the quarter along with loan sales left period end loans relatively flat, but 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. And 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 7, total loans were $22.3 billion, up $30 million for the quarter on a period-end basis. Total C&I was up 0.5% 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 pay downs impacted period-end growth rate last quarter, steady growth in commitment levels and our focus in the senior housing space preserved 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 pay downs 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 pay downs left this segment down at 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 8, you can see that credit quality remained strong as it has all year. Non-accruals 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 non-accruals did increase by $17 million this quarter, but this was due to a few lingering credits from the energy downturn in 2015. We do not see any new stress on 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 caused management concern as to the borrower's ability to continue to perform, totaled $143 million at September 30th, down from $161 million at June 30th. This was due largely to a decline in energy, wholesale or 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-occurring 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 the 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 calculations. First, the higher interest recoveries and accretion levels in the second quarter impacted NIM by 3 basis points and 4 basis points respectively. Second, the $1.3 billion expansion of our fixed income mortgage-backed securities portfolio had a dilutive effect on NIM of 9 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 4 basis points. The remaining 9 basis points difference is attributable to the overall lower interest rate environment. Loan yields partially -- largely priced off of LIBOR, declined 21 basis points in a carryover of higher pricing in deposit gathering activities increased interest bearing deposit cost by 4 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 a 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 2-year high and mortgage refinance volumes. Gain on sale margins increased 5 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 in 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 $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 decrease in regular compensation by $1.2 million and employee benefits by $2 million. Employee benefits expense was down largely due to the seasonal decrease in payroll taxes.
Non-personnel expense was overall flat from the second quarter with certain offsetting components. Mortgage banking cost 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, 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 the 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 was further along. I will say, however, that our initial planning is centered around a flat rate environment for 2020. But, 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, so 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. So I would expect it to remain relatively flat.
Revenue from fee-generating businesses, particularly brokerage and trading and mortgage, to 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 total revenue and revenue mix. We will allocate sufficient capital to support organic loan growth and expect to continue a modest level of opportunistic share repurchases. Capital ratios are expected to improve slightly over time.
And 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 seasonal process. These test runs consider data from our loan systems, forecast developed by the economic committee, the valuation 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 expect 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 loan serviced for Ginnie Mae that are backed by the 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 1st, 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 Financials' second consecutive record quarter is a product of our structured discipline revenue approach our fee business is more than compensated for decrease in 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 our performance even if industry headwinds intensify. With 40% of our revenue is derived from fee business, we have the ability to help mitigate the decline in spread revenue if rates continue to fall. So while period end loan growth was flat this quarter, average loan growth tell 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.
So with that, we're pleased to take your questions, operator?
Thank you. [Operator Instructions]. Our first question is coming from Ken Zerbe of Morgan Stanley. Please go ahead.
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 at a good steady state? I'm just trying to figure out if how much pressures on the expense side, given the weaker revenue outlook?
Ken, this is, Steven. Yes, I think we are at 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. And so 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.
Yes, this is Steve Bradshaw let me tag on to that. I think that a big part of our expense allocation obviously is to technology investment and we are maintaining that level, even in the face of some revenue headwinds. So we think of that really kind of as a percentage of revenue. And we're also seeing some pretty significant technology investments we made in infrastructure back in '14 and '15 timeframe that are now rolling off. So it's giving us more capacity to focus our resources on technology that's more customer-facing and product enhancements. So we feel good about that despite the headwinds out there.
And then Steven, if we do get an October rate cut, what do you envision happens to NIM in the fourth quarter.
Continues to go down ….
Can you quantify that specifically?
Well just -- it's hard for me to quantify because there's lots of moving parts that impact our NIM calculation as with anyone. But clearly the LIBOR-based loans are going to continue to move down at a faster pace. Then 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 with the loans. You get benefit from the fact that we have larger fixed income securities portfolio that will hold it's spread, it actually gained some spread. As I said last quarter, the wildcard here is really the deposit gathering activity and I would say that we are seeing some rollover in our administered pricing and consumer. We are seeing some movement downward in our exception pricing and commercial. But as 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 costs stay relatively stable, if not perhaps a little higher.
And then maybe just staying with NIM, just for my last question. What's the right level of interest recoveries and also accretion? Because obviously I heard you this quarter. I get accretion comes down, but is this the right level of interest recoveries and what do you expect for PAA? Thanks.
Interest recoveries were only $700 million -- $700,000, excuse me, in the third quarter, it was $3.4 million in the second quarter. It's somewhere in between, we usually have some level of interest recovery in $1 million or so level and it's hard to say. And then accretion that the level you saw in the second quarter, I think it was a bit elevated. This quarter is a little bit more normal and as time goes by, we still have about $90 million left over in the overall discount amount that will be recovered over time in the next two to three years and there'll be a tail on that. So that pinpoint $9 million that you saw this quarter will begin to taper down as we enter 2020.
Thank you. Our next question is coming from Brett Rabatin of Piper Jaffray. Please go ahead.
I wanted to ask about the loan growth and the guidance is mid-single digit loan growth from C&I category is expected for the remainder of the year. Can you talk about that versus commercial real estate and 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?
Yes, I mean it's hard to predict individual categories. Obviously, even in real estate, we had some late pay downs at the end of the third quarter, which impacted total growth. I mean, generally speaking, we feel very comfortable what we've talked about for almost a year now, but the total portfolio would grow on a year-to-year basis in the mid-single digit range and I still feel very comfortable with that. We've got capacity in real estate, we -- for outstanding growth-- we think that we'll continue to have opportunities there. I don't see anything -- 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 payoff versus when they advance inside that real estate portfolio. I think as you look in -- 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 the borrower to kind of see what's going to happen and uncertainties are never in our favor from that perspective. But 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. So we still feel good about that mid-single digit kind of annualized loan growth that we've been talking about.
Okay. And then 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 your 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 and how you change your debt service given the environment?
I've heard that, 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 and energy has had a cash flow underwriting component to that. And so we have never looked at this asset class as strictly an asset-based loan for which we're making a loan against the collateral. And 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 it 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, and maybe that's why we've outperformed the market in this segment. But I think that, 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. And 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, then I would say yes. That we would expect NII to be down slightly, largely because of the impact on our LIBOR-based loans. We will grow loans, certainly and that helps, but I can see a scenario certainly where NII goes down in the fourth quarter if we get another rate decline. Now, if we're planning. I think I mentioned we're planning in 2020 a flat rate environment, if that holds in 2020 and we continue to grow loans, certainly we're going to grow NII, but I feel pressure there in the fourth quarter with another rate.
Thank you. Our next question is coming from Peter Winter of Wedbush Securities. Please go ahead.
Just going back to energy, I guess this is a second quarter where there has 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?
Yes, I think in the midst of the downturn in '15 to '16, we talked about -- because the kind of the broader market did around energy reserve specifically, we've never liked that discussion because the totality of the reserve is available for all losses whether the energy or not. So we're not kind of back into trying to disclose a specific reserved 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 type of things are larger. And so 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 there will be lumpy from that perspective too is they deteriorate, there will be lumpiness there as well.
From a loss perspective, when 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. And that's certainly better than kind of a through cycle, view of kind of 30, 35, 40 basis points from that perspective. And I would tell you, as we look forward, I think that kind of 20 basis point average charge-offs is a good place to pack it. I think that based on the facts that we know today and the circumstances that we know today, I think that's -- that run rate is one that deals -- 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 could ask, kind of a big picture type question, obviously you have a very long and strong history in energy. I'm just wondering kind of when we look out, you're seeing private equity really pull back in a way from the space, what kind of 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. And our lending base is on proved developed production, and we're very comfortable with the cash flow that we believe will come from those wells over time to repay our debt and that has been proven out over time. I think the issue with private equity and frankly the capital markets being closed, kind of the broader, more complex issues around the broader energy kind of 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, but we're not counting on future private equity investments or an open capital markets to repay our debt.
Back to kind of the early review, we are counting on the cash flow that we underwrite in the existing wells to repay our debt. And so if there is no future investment, I think it changes -- maybe a lot of these loans, let's play that too it's kind of a logical conclusion, if there is no future investment, then there is no future drilling and a lot of these energy loans become term loans and they get repaid as the asset depletes over time. But 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 accounting on that to pay us back. Even times when we look at maybe private equity commitments they've made, we don't give lending credit for kind of open an unfunded private equity commitments. We look at that. We understand that, but we're not dependent upon that to repay our energy loans.
Thank you. Our next question is coming from Jennifer Demba of SunTrust Robinson Humphrey. Please go ahead.
Question on the mortgage business. Just 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 softer 4Q?
Yes, I think we have good pipelines there, but I'll just tell you that the fourth quarter is generally softer. I mean it's -- that seasonality in that business, when you get into the holidays and that time, you generally see a slowdown in mortgage originations. So 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.
Yes, this is Steve. I think the, the only mitigate is if you see further decline in mortgage rates then you could see a thesis that would suggest that there will be higher refi levels coming out. I think refi in the third quarter, were kind of approaching 40% for us and we could see that go higher in a further decline rate market. So that would be, I agree with Steven, you would typically see purchase -- purchase lending go down in the fourth quarter. You see that virtually every year, but the refi business is a little bit of a wildcard relative to rates.
Okay. Question on credit, Stacy, that was some great color before on your thoughts on kind of near-term charge-offs. Can you give us some color on what the total leverage lending book looks like for BOK? And if you guys have any rest tranche in your C&I portfolio, right now?
I'll let Marc Maun, our Chief Credit Officer is here, I'll let him handle that.
Yes, 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. So that's not a line of business we focus on. And we've maintained that process -- 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 select -- 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. So there -- and we tend to have the larger companies. The ones that are number one, number 2 or number 3 franchise companies for that particular brand. And 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'd always like kind of belt and suspenders both collateral and cash flow. And so 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?
Well, 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 focus 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. So we're much more comfortable -- where there is a Medicare/Medicaid reimbursement model. We're going to keep it in line with what we have. We have concentrations focused on energy. We are focused on CRE, and we have focused on care, which accounted for a little over 50% of our total loans. And we will keep that -- kind of those ratios in line over time.
So, Jennifer, those three areas that Marc highlighted are the ones that the credit committee of 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.
Thank you. Our next question is coming from Matt Olney of Stephens. Please go ahead.
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? And then beyond that, what are some of the other drivers that could influence that line from quarter-to-quarter?
Sure. So, this is Scott. Matt, you know 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 being impacted by volatility in rates. So 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 and then we have a stable about 10% to 15% mix of municipals, the rest of the combination of corporate treasuries certificates etc. So 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. But we have been active -- hedging activity as well in our financial risk management.
Matt, this is Steve. When the 10-Q comes out, we have a table that breaks down specifically. All of the brokerage and -- all fee businesses, in fact, but it breaks down the brokerage and trading line item in about five different categories along with what Scott said. So you can look at that when it comes out in a week or so.
Okay, perfect. And then on the margin, and specifically on the interest-bearing deposit cost, those were up a little bit in 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 cost will be below the third quarter level?
Yes. I talked a little bit about that with Ken Zerbe's question earlier, but 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 have much when rates are going up. It's the -- the wildcard here is how much of the loan growth that we expect to continue that we're going to fund with new deposits. And a lot of those new deposits are coming out of our wealth space. And to gain some of those new deposit balances from our wealth customers we're having to pay more towards the market index type rate. I mean some of those rates are [175] and above. And so when you think about that level of deposit growth relative to the composite, the 1.17% interest bearing deposit costs and you see the -- that it could actually average it up a little bit depending on the size of the wealth deposits that we bring in. So it's -- that's the wildcard.
And then the balance sheet migrations, we saw some really strong deposit growth this quarter and as you noted that you saw some flat end of period loan growth because the pay downs. Does that imply that the pay downs you received from -- on the loan side, were those surprising to you? Was it just earlier, any kind of commentary you can talk around that -- the pay downs in 3Q?
Yes, it really wasn't that surprising. I mean there was a few categories that we have kind of 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, but it was there, that impacted period imbalances, but none of that activity really -- 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.
Thank you. Our next question is coming from Jared Shaw of Wells Fargo. Please go ahead.
I just wanted to I guess stay on the deposit question, our conversation a little bit more. So I understand that -- maybe look at overall cost of deposits or interest bearing deposits going higher because of that mix shift, but as we look at the categories within deposits -- the cost of those categories, should we expect to see fourth quarter, maybe a decline in those incremental category? If you look at transaction costs, it went up. If you look at time deposit costs, they went up. You might 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 or more market rate type deposits. And so, yeah, the core deposits in consumer, the core deposits in our commercial categories, even the core deposits in our wealth space, we think we will continue -- 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. Does it stays stable or is it slightly declined? My feeling is if we find the loan growth we expect in the fourth quarter before these market type rates in wealth that you could see deposit costs actually flat or slightly go up.
So, looking at that ones that attained costs being flat or slightly up? Okay.
That could happen.
You also get some seasonality with deposits in the fourth quarter as well.
Great. Okay. And then on the DDA side, I guess, as we look over the last four quarters, the average DDA balances have trickle 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, but the point-to-point growth was there and so I, feel like as rates continue to go down a little bit, our expectation for that, that you see some stabilization of DDA balances.
Okay. And then, I guess finally from me just on the provision side. The $12 million provision this quarter, you said it's tied to the loan growth. So if we see similar average loan growth for fourth quarter, then should we expect that the DDA -- I'm sorry the provision stay in that $12 million range?
Well, I think the first thing I'll point out that we did in the third quarter, we wanted to cover the charge-offs. So 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. But the overall net charge-offs for the third quarter was $10.6 million, I believe, and we wanted to cover that with our provision. And then we covered a little bit extra for the loan growth that we're talking about. So 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.
Thank you. Our next question is coming from Gary Tenner of DA Davidson. Please go ahead.
I had a question on -- in terms of the balance sheet, Steven, if we assume that the scenario that you laid out of one more time in the fourth quarter 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 or -- and then next year in a flat rate environment, kind of that …
Yes, 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. So when you look at the period end balance sheet in the press release, you see available for sale balance was $11 billion. I don't really see much change to that to answer your question. We're not going to add to that position, but I think we would take away either, certainly wouldn't during the fourth quarter.
Okay, thanks. And then just to clarify on your CECL slide, is that adjustment on CECL? Is that $50 million to $75 million, is the delta to the ALLL that that you'd expect on day one?
There will be a component of that, that we actually will pick up in another liability reserve, but that $50 million to $75 million, represents about 25% to 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% to 20% of that, and then about 10% relates to our acquired loans and another 5% to cover the VA and other items. So that's the way we kind of view it, but there will be -- they will show up in a couple of different categories on the balance sheet.
Thank you. Our next question is coming from Jon Arfstrom of RBC Capital Markets. Please go ahead.
A couple of lending questions, I want to ask about mortgage as well, but Stacy, the public finance pay downs they are expected, but you still have of course the $750 million in balances there. Just curious what the longer term plan in trajectory is?
Yes, the margins in that business kind of ebb and flow over time and we kind of evaluate it with our other lending segments and as the margins become favorable and we can get a favorable return on equity then we get more aggressive in that space, but 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. So you're not saying the $750 million is really running down, it's just more about conscious decision on your part?
That's really around new origination, around the returns on equity in that business, not -- we're not making a commentary on the asset class at all. From a credit perspective it performed 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 is 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? And is it -- are you expecting just churn in the portfolio, is your high graded or actual growth?
I expect modest growth in CRE as we look forward. I think that, that we feel very good about what we've done there. That doesn't mean that if there is a recession and they're asking some things that come out of that that we look at and say yeah, we should have done that differently, CRE the most pro cyclical segment, which is why we keep such a disciplined concentration around that and there are things that can come out of the recession that maybe isn't what you anticipated, but 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. But that maybe there is something that's changed about our view of that segment or that geography or something like that, that is different than what the way we looked at it, when we originated it, in some cases two or three years ago. And there is a modest amount of that, that will look at and say, when there is an exit opportunity, we'll do something different there. But 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. So I still see as we look forward, I don't see kind of that -- I don't see it's treading water in real estate. I don't see double-digit loan growth, but I see kind of low, mid-single digit kind of growth, as we look forward there.
Okay, good. And then on mortgage -- 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 refinanced. 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?
Yes, Jon, this is Steve. I -- 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 being actually closer to two years ago and then 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 has 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.
So our margins are up in that business. Our focus is really squarely on the relationship side in footprint and opportunities there and we have reduced a pretty significant amount of operating expense out of that unit that was supporting those two areas that we've exited. So the profitability driver for that business is probably never been better for us than where we fit 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. But 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, the way we think about relationships across the footprint, and that's been beneficial for us. Our timing has been really good. We can't take credit for that necessarily, but managing down that core and ahead of the refi boom and an increase in the purchase market has been really advantageous for us. So we're pleased where we are with mortgage today.
Okay. And Steven for you just on the follow-up, 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 commitment?
Yes.
Yes, 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, a favorable rate environment just talking through that a little bit.
And then 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, but is it a quarter, is it two quarters? What do you think?
It's really a quarter -- I mean when you think about 75% of your loans are variable and most of them are tied to LIBOR, that's pretty immediate -- within 30 days or so. And then your wholesale funding moves, I mean, most of that's overnight, it moves pretty quickly. And then, of course the lag is on the deposit side. It takes -- it takes 60 days to 90 days for that just kind of flow through.
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.
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