BOK Stock: Overvalued Relative To Growth & Profitability (NASDAQ:BOKF)

Banks are looking at improving earnings outlooks, with rates set to continue to rise and improving loan demand giving them better-earning options for their capital. Still, there are increasing uncertainties about the pace of rate hikes, as well as opportunities for operating cost leverage in 2022. I believe BOK Financial (NASDAQ:BOKF) has above-average loan growth prospects in 2022 and 2023, but I believe some of that leverage is tempered by less promising outlooks in the fee-based businesses and a structurally less profitable business than many peers.

At this point I’m not all that bullish on BOK Financial shares, even with the year-to-date underperformance. I like the bank’s leverage to energy lending and the attractive Texas loan market, but higher expenses are a drag and I just don’t find the valuation all that compelling now.

Opportunities To Outperform In Loan Growth

Management’s initial guidance for loan growth in FY’22 was 6% to 7%, which is around the average of comparable banks, and I think it’s a reasonable balance between multiple growth opportunities and the risk of some ongoing pressure from elevated paydowns. Still, I do see areas where the company can outperform, and energy lending is one of the best opportunities in my view.

BOK has long had above-average exposure to energy lending, and unlike many lenders who flit in and out, and get burned on credit, management has created an underwriting approach that has driven above-average results across multiple cycles.

For starters, the bank focuses on secured senior first liens with relatively low loan-to-value ratios (60% or below) that are secured by actual oil or gas in the ground (seasoned producing reserves). The bank has historically stayed away from riskier areas like mezzanine or subordinated lending, and the credit performance of the portfolio has been quite good over multiple cycles.

Given current circumstances, this is looking like an even more attractive opportunity. Between elevated losses and ESG mandates, many banks have abandoned the energy space. That is giving BOK improved spreads (75bp to 100bp) and the opportunity to be the lead bank on more syndication deals (where it collects syndication fees. Given attractive energy prices and shrinking sources of capital, I believe BOK could leverage its surplus energy lending capacity to drive more growth, and more profitable growth, in FY’22 and FY’23.

I also think BOK’s core Texas market remains fundamentally attractive across a range of lending categories. While Oklahoma is where BOK has the largest percentage of its deposits (close to half), Texas is where over 40% of the loan book is based. Given ongoing population growth, business creation, and business relocation to Texas, I see attractive overall prospects for C&I and CRE lending, even in what is a very competitive market.

Asset Sensitivity Is Not So Special

While asset sensitivity discussions are never entirely simple, BOK screens out as having mixed to below-average sensitivity. While a significant percentage of the loan book is variable rate, a lot of the portfolio will have to clear rate floors first. What’s more, BOK has a below-average amount of cash on the balance sheet (6% of average earning assets versus a peer average closer to 10% to 12%), and just an average loan/deposit ratio.

Deposit beta will be a key variable to follow. So far very few banks have meaningfully increased deposit rates (peer Texas bank Cullen/Frost (CFR) is something of an exception), and BOK screens as having an average deposit beta. Refocusing efforts on improving core deposit growth in under-leveraged markets like Texas and Arizona would be a help, though BOK’s deposit costs are already quite competitive.

A Pick-Up In Fee Income Would Be Welcome

One of the special characteristics of BOK relative to other banks of similar size is that this bank generates substantial non-interest income, close to 40% on a normalized basis. Significant fee-based businesses can meaningfully boost bank profitability, particularly as they don’t often tie up capital, but in the case of BOK they can also act as countercyclical balances.

Trading/brokerage and mortgage banking helped offset pressures on spread income in 2020, but both weakened significantly in FY’21 and seem unlikely to drive a significant rebound in FY’22. Mortgage banking is being hampered by declining refinancing activity, and higher rates are unlikely to help that situation. Trading/brokerage is harder to predict, but given the outlook for rates and the commentary from larger players in the space, I wouldn’t expect a big rebound in 2022.

Still, there are other contributors here, including solid trust and wealth management businesses, and I expect some overall improvement in fee-based income late in FY’22 and into FY’23.

The Outlook

The biggest area where I’d like to see improvement from BOK is in basic profitability – operating costs relative to revenue. One of the things I find interesting about sell-side coverage on this name is analysts talking about the gap in P/TBV ratios between BOK and some of its peers without also acknowledging the gap in profitability.

Since 2018, BOK’s efficiency ratio has been consistently about 300bp to 500bp worse than its peer group, and I don’t see that changing to a meaningful extent. With those higher expenses, the return on tangible common equity has dipped below its peer group and it seems likely to stay there for the next couple of years. While that might be okay if the bank were generating above-average revenue growth, that too is really not the case.

I’m looking for BOK to generate long-term core earnings growth of around 6% over the long term, a modest slowdown from the trailing growth rate of 8%. I’d also note that this bank has generated long-term tangible book value per share growth of 5.7% – on the better side of average, but not enough to stand out as exceptional. I do see some opportunities for better growth, with the biggest potential driver being a recovery in lucrative fee-generating businesses and improved operating efficiency.

The Bottom Line

None of the approaches I use for bank valuation – discounted long-term core earnings, ROTCE-driven P/TBV, P/E – suggest that BOK shares are undervalued today. Even if I use a 150bp premium to the peer average ’23 P/E (12.5x versus 11x), I still only get a fair value of $96.50, and my FY’23 EPS estimate of $7.71 is about 7% higher than the current sell-side average.

While there are certainly some fine attributes to BOK, I just don’t see enough here to argue for buying the shares at today’s price/valuation.