BOK Financial Corporation (BOKF) Q2 2023 Earnings Call Transcript

BOK Financial Corporation (NASDAQ:BOKF) Q2 2023 Earnings Conference Call July 26, 2023 10:00 AM ET

Company Participants

Marty Grunst – Chief Financial Officer

Stacy Kymes – Chief Executive Officer

Marc Maun – Executive Vice President, Regional Banks

Scott Grauer – Executive Vice President, Wealth Management

Conference Call Participants

Jared Shaw – Wells Fargo Securities

Jon Arfstrom – RBC Capital Markets

Brady Gailey – KBW

Brandon King – Truist Securities

Matt Olney – Stephens

Operator

Greetings, and welcome to the BOK Financial Corporation’s Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder this conference is being recorded.

I would now like to turn the presentation over to Marty Grunst, Chief Financial Officer for BOK Financial Corporation. Thank you sir. You may begin.

Marty Grunst

Good morning and thank you for joining us. Today our CEO, Stacy Kymes will provide opening comments; Marc Maun, Executive Vice President for Regional Banking will cover our loan portfolio and related credit metrics; and Scott Grauer, Executive Vice President of Wealth Management will cover our fee-based results. I will then discuss financial performance for the quarter and our forward guidance. PDFs of the slide presentation and second quarter press release are available on our website at bokf.com. We refer you to the disclaimers on Slide 2 regarding any forward-looking statements we make during this call.

I’ll now turn the call over to Stacy Kymes.

Stacy Kymes

Good morning. Thanks for joining us to discuss BOK Financial’s second quarter financial results. Starting on Slide 4 second quarter net income was $151 million or $2.27 per diluted share. I am proud of the exceptional second quarter financial results delivered across the board by our team. Wealth segment revenues set another record this quarter and core loans reached an all-time high led by the commercial and multifamily segments. Our growth efforts are supported by the vitality of our geographic footprint, as well as our diverse business model. Noninterest revenues were almost 40% of total revenues for the quarter.

Using our capital and liquidity strength, we are taking advantage of market and economic uncertainty to prudently grow. Our full-service banking market expansion into San Antonio and the addition of a fixed income sales and trading office in Memphis are just two more examples of how we are investing to build long-term shareholder value. That disciplined long-view approach has consistently been a distinct advantage for BOK Financial.

Turning to slide 5. Period-end core loan balances increased $488 million or 2.1% linked quarter with gross spread across C&I and commercial real estate. The deposit trajectory flattened and turned positive during the quarter. Our loan-to-deposit ratio remained below 70% at the end of the quarter. Across the industry, deposit costs have accelerated for all banks including us as reported in our results. As Marty will detail later, our reported net interest margin is diluted by the increased trading activity this quarter and our margin excluding the trading activities remained healthy at 3.36%.

We’re seeing early signs of loan spreads increasing as banks seek to contract and also work through the impact of higher deposit costs and anticipated higher capital requirements for some. This impact will take many quarters to become meaningfully apparent.

Our efficiency ratio came in just below 59% even with the shift in mix of noninterest revenue. Credit quality remains very strong as we continue to grow our allowance and have a combined reserve of 1.39%, which is notably above the median of our peer group. Assets under management or administration grew $1.3 billion or 1.3% linked quarter and were up $7.6 million or 8% compared to last year. The market impact on cash, equities and fixed income combined with the growth in new relationships is providing a tailwind we did not have for this area in 2022. Finally, we repurchased 266,000 shares this quarter as we balance opportunities for growth with attractive repurchase valuations.

I’ll provide additional perspective on the results before starting the Q&A session. But now Marc Maun will review the loan portfolio and our credit metrics in more detail. I’ll turn the call over to Marc.

Marc Maun

Thanks Stacy. Turning to Slide 7. Period-end loans were $23.2 billion or up 2.1% linked quarter. Total C&I loans increased $317 million or 2.2% linked quarter with year-over-year growth of $913 million or 6.7%. Commercial real estate loans increased $155 million, or 3.2% linked quarter and have increased $865 million or 21% year-over-year. This effectively returns those balances to their 2020 level after experiencing significant paydown activity in 2021.

Compared to December 31, 2020, CRE balances have grown at a modest 2% annualized growth rate. Growth this quarter was primarily driven by multifamily residential properties with an increase of $139 million or 10.2% linked quarter. Industrial facility loans grew $40 million or 3.1% linked quarter which was offset with a $40 million or 3.1% linked quarter decline in loans secured by office facilities.

The year-over-year CRE growth of $865 million was primarily driven from loans secured by multifamily residential properties and industrial facilities. We have an internal limit of 185% of Tier 1 capital and reserves to total CRE commitments and we’re presently at the upper limit of that range.

We do expect continued growth in outstanding CRE balances as construction loans fund up. As of June 30, CRE balances represented 21% of total outstanding loan balances a ratio well below our peers.

Healthcare balances increased $92 million or 2.4% linked quarter and have grown $294 million or 8% year-over-year primarily driven by our senior housing sector. Healthcare sector loans represented 17% of total loans at quarter end.

Energy balances increased $111 million or 3.3% linked quarter and have increased $116 million or 3.4% year-over-year with period-end balances representing 15% of total period-end loans.

Combined services and general business loans our core C&I loans, increased $114 million or 1.7% linked quarter with year-over-year growth of $503 million or 7.7%. These combined categories represent 30% of our total loan portfolio.

Year-over-year, loans have grown $1.9 billion or 9%. Excluding PPP loans, Q2 2023 extends the linked quarter loan growth to seven consecutive quarters. Our pipeline suggests we have the current momentum to drive continued growth in the loan portfolio throughout 2023, near our current pace.

Turning to slide 8, you can see that credit quality continues to be exceptionally good across the loan portfolio well below historical norms and pre-pandemic levels. Nonperforming assets excluding those guaranteed by U.S. government agencies increased $6 million this quarter. Non-accruing loans increased $12 million driven by an increase in energy-related nonaccruals, while repossessed assets fell $8 million.

The level of uncertainty in the economic outlook of our reasonable and supportable forecast remained high. And the assumptions for commercial real estate vacancy rates increased during the forecast period. Those economic factors, combined with second quarter loan growth supported a $17 million credit loss provision for the quarter. We remain in a solid credit position today.

With the ratio of capital allocated to commercial real estate that’s substantially less than our peers and a history of outperformance during the past credit cycles, we believe we are well positioned should an economic slowdown materialize in the quarters ahead.

The markets are more focused on the office segment of real estate, given the recent trends in workforce preferences, though it remains an open question as to whether this will be sustained as employers continue to require more time in the physical office. Our maturities are generally ratable over the next three to four years, and we have a mini firm option if the markets are not conducive to long-term permanent financing.

The average loan-to-value ratio in the office space is below 65% and average cash flow coverage exceeds 1.3 times based on the most recent semi-annual review at the end of 2022. Net charge-offs were $6.7 million or 12 basis points for the second quarter and have averaged 10 basis points over the last 12 months far below our historic loss range of 30 to 40 basis points. Looking forward, we expect net charge-offs to continue to be low.

The combined allowance for credit losses was $323 million or 1.39% of outstanding loans at quarter end. The total combined allowance is available for losses and any apples-to-apples industry comparison should include the combined reserves. We expect to maintain this ratio or to migrate slightly upward as we expect loan growth to continue and economic uncertainty to persist.

I’ll turn the call over to Scott.

Scott Grauer

Thanks, Marc. Turning to slide 10. Total fees and commissions were $200 million for the second quarter, up $14.5 million or 7.8% linked quarter. Our Wealth segment set a new quarterly high for fees and commissions at $123 million this quarter with the last four consecutive quarters representing four of the five highest quarters on record.

Trading fees and customer hedging revenues were the primary drivers of the linked quarter increase, up $9.3 million and $5.3 million respectively.

Fiduciary and asset management fees increased $2.3 million, largely due to seasonal tax service fees. The trading fee increase was primarily driven by a $7.9 million improvement in our MBS trading activities. Trading activity and margins improved coming off exceptionally low volume and high volatility in the first quarter. The desk has been able to increase volume by expanding coverage to downstream accounts as mortgage originations slowly increase and market volatility returns to more normal levels.

The $5.3 million customer hedging revenue increase was driven by a record quarter for energy customer hedging fees with linked quarter fees up $4.7 million. Fees from other institutional trading activities increased $1.4 million linked quarter. Fiduciary and asset management fees were $53 million for the second quarter, a 4.6% linked quarter increase. Our assets under management or administration were $103.6 billion, an increase of $1.3 billion or 1.3% linked quarter.

Growth was spread across most categories and primarily driven by improved asset values. Our asset mix for assets under management or administration moved slightly this quarter, with 43% fixed income, 33% equities, 15% cash and 9% alternatives. We believe our diversified mix of fee income is a strategic differentiator for us when compared to our peers, especially during times of economic uncertainty.

We consistently rank in the top decile for fee income as a percentage of total net interest revenue and non-interest fee income. Our revenue mix has averaged just over 36% during the last 12 months. That consistently supports a revenue stream that is sustainable through a wide array of economic cycles.

I’ll now turn the call over to Marty.

Marty Grunst

Thank you, Scott. Turning to Slide 12. Second quarter net interest revenue was $322 million, a $30 million decrease linked quarter. Net interest margin was 3%, a 45 basis point decrease versus Q1. It is important to note that 9 basis points of the 45 basis point margin decline was due to growth in trading assets.

Our trading business grew revenue and grew profitability as you can see in the fee income trends but was dilutive to net interest margin as trading assets grew at narrower spreads relative to the rest of the balance sheet. When trading assets are higher or the yield curve is flatter or inverted both of which we experienced this quarter, the dilutive impact to net interest margin is more significant.

Net of the 9 basis point impact from trading, the remaining 36 basis point decline was driven by the competitive deposit environment. As average interest-bearing deposit costs increased 73 basis points, the cumulative net interest-bearing deposit beta increased to 54% and DDA continued to shift into interest-bearing although at a reduced pace. DDA was 32% of total deposits at June 30.

This slide shows net interest margin and net interest revenue with and without the impact of the trading business to better highlight trends and comparability. For the second quarter of 2023, the net interest margin excluding the impact of trading assets was 3.36% versus 3.72% in the first quarter. Growth in earning assets during the quarter was driven by loans and trading assets as the securities portfolio remains stable to maintain our balanced interest rate risk position.

Turning to Slide 13. Liquidity and capital continue to be very strong on an absolute basis and versus peers. Total deposits grew $714 million on a period-end basis and the loan-to-deposit ratio was 70% unchanged from the prior quarter. Early in the second quarter, we saw a continued downward trend driven by April tax payments and some price-sensitive movements, though at a slower pace in the prior two quarters.

Balance trends rebounded in early May, and we grew $2 billion in deposits in the back half of the quarter. This was consistent with our expectations and we are happy with the result in such a competitive environment. Our tangible common equity ratio was 7.79%, down 67 basis points linked quarter due to balance sheet growth and increases in interest rates but up 16 basis points from year-end.

Adjusted TCE including the impact of unrealized losses on held to maturity securities is 7.49%. CET1 is 12.1% and if adjusted for AOCI would be 9.9%. As regulatory capital changes are being proposed for the industry, we believe that across the array of plausible outcomes for banks in our size range, we have ample capital to support additional organic growth, while at the same time allowing for continued share buyback. During the second quarter, we repurchased 266,000 shares at an average price of $84.08 per share.

Turning to slide 14. Linked quarter total expenses increased by $12.9 million or 4.2%. Personnel expense grew $8.5 million with $4.1 million due to the full quarter effect of annual merit increases implemented on March 1, while cash-based incentive compensation grew $6.6 million due to new business production. These were partially offset by a $2.5 million seasonal decrease in payroll taxes.

Other operating expense grew $4.4 million primarily due to a $2.5 million increase in mortgage banking costs driven by a seasonal increase in prepayments and a $1.1 million increase due to the donation of an appreciated asset to the BOKF Foundation. Year-over-year total operating expense increased 16.5%. However this includes the impact of market value-driven swings in deferred compensation and changes in the vesting assumptions for stock-related compensation.

Excluding those two factors total operating expense increased 11% compared to Q2 2022 with a 13% increase in total personnel expense due to regular compensation and increased cash-based compensation related to new business production. Other operating expense increased 8% primarily due to continued investments in technology, facilities and increased FDIC expense.

Turning to slide 15. I’ll cover our expectations for 2023. We expect upper single-digit annualized loan growth. Economic conditions in our geographic footprint remain favorable and continue to be supported by business in migration from other markets.

Changes in the competitive environment for loans should be a tailwind. We expect to continue holding our available-for-sale securities portfolio flat in 2023 to maintain a neutral interest rate risk position. We expect total deposits to be stable or grow modestly and the loan-to-deposit ratio to remain in the low 70s.

Currently, we are assuming one additional 25 basis point increase here in July before the Federal Reserve positives. We believe that the margin will migrate lower throughout 2023 and as interest-bearing deposit betas increase and demand deposit balance attrition runs its course.

Net interest income is expected to be near $1.3 billion for 2023. In aggregate we expect total fees and commissions revenue to approach $800 million for 2023. We expect expenses to be near or slightly above Q2 2023 levels and the efficiency ratio to migrate slightly above 60% throughout the remainder of 2023 as our revenue mix shifts in our strategic market expansions ramp up. This does not include the impact of the FDIC special assessment, which could be finalized in the second half of 2023.

Our combined allowance level is above the median of our peers and we expect to maintain a strong credit reserve. Given our expectations for loan growth and the strength of our credit quality, we expect quarterly provision expense similar to that in recent quarters. Changes in the economic outlook will impact our provision expense. We expect to continue opportunistic share repurchases in the second half of the year.

I’ll now turn the call back over to Stacy Kymes for closing commentary.

Stacy Kymes

Thanks, Marty. As we have again demonstrated this quarter strong risk management and strong financial results are not mutually exclusive. We expect to do both well.

Our talented teams collaborate well to ensure we grow our company the right way, a way that is sustainable through all economic cycles. While the market is more focused on capital and liquidity, I see this as a unique opportunity to use our strength in these areas to both organically grow and invest in new markets, while others may be more internally focused.

I continue to assert that we are in a stage we’re investing in strong banks versus trading the sector matters. Banks with thoughtful growth, a diverse business mix, meaningful core deposits and proving credit discipline should outperform. That certainly continues to play out for us in 2023. We are focused on using the fantastic geographic footprint to grow both in the current environment and in the years to come.

With that we are pleased to take your questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from Jared Shaw with Wells Fargo Securities. Please proceed with your question.

Jared Shaw

Hey good morning. Maybe starting with credit, with the expectation that provisions could go higher based on growth and the economic outlook. You call out the expectation for vacancy changes. Maybe can you spend a little time on where you think I guess specifically office vacancy is and could go and how your markets are holding up with that return to work and your outlook on office. And I guess should we assume that office continues to decline and that provides some opportunity to fund new CRE loans that are right now on office.

Marc Maun

Yes Jared, this is Marc. The office portfolio that we have we’ve been reducing our office exposure over the last several years. So this is not new. And we would expect to continue to decline. If we look at our footprint, our overall markets, we think are in great shape. I mean, you’re looking at markets that have performed very well in multiple economic downturns. When we’re looking at the economic outlook, we’re looking at its effect on the overall economy as opposed specifically to our portfolio. And we would expect that we can maintain this level of performance on the CRE portfolio going forward is where focus has been on multifamily and industrial which has held up very well.

Stacy Kymes

Yes. If you’re looking at the forward guidance and try to intimate maybe that there could be higher provision expenses, that’s not how we see it. I think that — we think that we reflected the future potential outlook in CRE and how we formulated our allowance methodology. So the forward-looking aspect of potential higher levels of office vacancies is really how we supported the allowance this quarter. We’re not trying to foreshadow that provision levels could be higher in future periods. In fact, our guidance was kind of near current levels, depending on the economic outlook. Certainly, should the economic outlook improve then provision levels could even come down from here. So it’s really just a function of how we see the economy playing out in future periods.

Jared Shaw

Okay. That’s great color. Thanks. I guess shifting to deposits and funding. You highlighted that there was strong trends in deposits in the second half of the quarter. How sustainable — squaring that with the broader view of lower growth on deposits for the year, should we assume that that growth helps you remix deposits, or how should we think about deposit mix going through the rest of the year with that growth outlook?

Marty Grunst

Yes. I think that deposit growth should remain on an upward trend here with some noise within there. I think on the mix side, DDA is probably the more interesting question and we really saw the DDA mix shift slowed down appreciably in May and June. And in fact, June average and June ending DDA balances were about the same. So, that trend actually turned reasonably favorable in the back half of the quarter.

Jared Shaw

And do you think that that could — that we’ve sort of found the bottom here on DDA then?

Stacy Kymes

Yes. I don’t know, if I’d call it precisely at the bottom. It’s certainly — those trends are very favorable. You could have just a little bit more, given another Fed hike here, you can have a little bit more. But those trends look very good in the last two months.

Jared Shaw

Okay. And then I guess finally for me, when we look at the buyback and your comments about opportunistic buyback. Is that really more opportunistic based on price, or is that opportunistic based on alternative uses of capital at any given sort of point in the quarter?

Marc Maun

Yes, those are the two factors. I mean, we’re just trying to maximize shareholder value with how we do that and price is a factor and to the extent that our outlook is for strong organic growth opportunities to be present over the couple of quarters. We want to make sure that we’ve got sufficient wherewithal to support that. And that’s obviously first in the pecking order, but that’s kind of how we do the calculus.

Stacy Kymes

Jared, before the kind of first quarter in the industry, the most common question was what are you going to do with all your excess capital? So we obviously, think that long-term we probably do have a little bit of excess capital to deploy share buybacks are part of that, but we’re being a little bit careful maybe in this environment at least for the near term.

Jared Shaw

Okay. And I guess, maybe just circling back on the deposits. In terms of your expectation for beta, how should we be thinking about cumulative beta going through with the potential or the expectation for one more hike?

Marty Grunst

Yes. We do think that cumulative beta does keep moving up here. We were at 54% this quarter. And our assumption that’s within our guide is that that crossed the 60% and gets up into the 63%, 64% territory by the end of the year.

Marc Maun

Yes. I would agree with Marty, but I think the cumulative beta over the life of the cycle is going to be kind of where we said it was going to be all along somewhere in that 40% to 50% range.

Jared Shaw

Thanks very much.

Operator

Our next question comes from Jon Arfstrom with RBC Capital Markets. Please proceed with your question.

Jon Arfstrom

Thanks. Good morning.

Stacy Kymes

Good morning, Jon.

Jon Arfstrom

Maybe a question for you, Marty. When I do the math on the margin, it seems like there’s a little bit of pressure coming to maybe not that material. Can you confirm that? Just how much pressure do you think is ahead in the net interest margin? And what do you think the cadence might look like for the next couple of quarters assuming the Fed is done today?

Marty Grunst

Yes, that’s right. And that is our base assumption. And maybe the best way to walk through that is to talk through net interest revenue kind of what the pluses and minuses are from here, because like June net interest revenue for the month of June was $106 million. And so if you kind of start from that run rate loan growth is going to be a plus obviously. Bond portfolio repricing is going to be a plus.

In Q2, we saw $420 million of principal cash flows run off at about a 278 runoff yield and we’re reinvesting that around 485 for the second quarter. And you’ll see that trend continue through future quarters. And even within the fixed rate part of the loan portfolio that small you’ve got the same dynamic going on there that provides lift and we’ll continue to provide lift.

The deposit betas we’re at 54 cumulative right now. That will continue to bleed up here as you get out of the rate hike and then you just get a little bit of residual carry forward. The July rate hike probably doesn’t really independently move the needle that much. And then as you were talking about before the DDA mix shift that’s really slowed down a fair amount. So that impact gets a lot smaller.

So if you look at those pieces the DDA and the deposit reprice are declining effects that are getting close to pending running their course here. And then the loan growth is a growing effect over time and the bond portfolio reprice. It’s a declining effect over time but it lasts a while. So that kind of gives you a little bit of color around how that plays out over the next couple of quarters.

Stacy Kymes

And Jon we’re focusing on net interest revenue versus net interest margin, because the trading size of the trading portfolio will greatly influence that margin. And so it’s easier for us to think about it in terms of net interest revenue, because if the activity is strong and the trade portfolio expands, obviously, the net interest margin impact that is very dilutive. And so it could be influenced by that, but that’s going to benefit us on the fee side should that trading portfolio continue to perform as it has been.

Jon Arfstrom

Yes. Okay. That makes sense. I do want to ask a question on that. But just one comment you made was you grew $2 billion in deposits later in the quarter. What was the driver of that? And was it higher rate deposits, or was it more client-driven or help us understand what that was?

Marty Grunst

Yes. So that’s mostly commercial and well-driven to a lesser extent consumer. But largely our — what we talked about last quarter just making sure that we’ve got price competitive offerings throughout the footprint that compete with the alternatives that our customer base have in those segments. And so we’re just making sure that our price points are at market, at all price points and that’s what drove it. On the fee side, and the consumer book as well on top of that.

Jon Arfstrom

Okay. Then Scott, last one for you. You talked about volumes and volatility helping your brokerage and trading. You talked about extending the reach of the sales force. Can you talk about that a little bit more, and about the better environment what makes for a more favorable environment so we can kind of understand, how the balance sheet might flex when there’s a better environment or a worse environment?

Scott Grauer

Right, absolutely. So in the first quarter, when we saw a lot of kind of external shocks to the fixed income market, we had a very — the Fed was in the midst of very active rate hikes. We saw bid-ask spreads, really widened out in the first quarter and we saw dwindling to very historically low mortgage origination. So, as we’ve moved into the second quarter, as we mentioned we’ve seen a pickup, as the reality of 5% 6% plus mortgage rate settles into the market, for homebuyers albeit, still a shortage of inventory we’re seeing great kind of expectations settle in which has increased mortgage origination.

We’ve seen the moves, whether the announcement today is one more or two more rate hikes we’re clearly, further into the Fed rate hike cycle, which creates a better appetite of our institutional buyers of mortgage-backed securities and all fixed income products to position their portfolios. So, we’ve seen kind of the culmination of better outlook and certainty in the fixed income markets, coupled with a little bit better flow on the mortgage-backed security side. So, those factors have given us better confidence in kind of resuming, our previous levels of securities inventory levels.

Stacy Kymes

And if you think about it from an investment portfolio manager position, if you know you’re toward the end of the hiking cycle, whether it’s today or today plus one more, you begin to get more confident in repositioning our portfolio because you don’t think well, I’m just — this is going to keep happening. And so, I’m just going to keep trading into that. That could optimistically help us out in the second half of the year, if market participants believe the Fed is done or near done.

Jon Arfstrom

Okay. Clearly, first quarter was abnormal. But is this maybe an impossible question. Does this feel more normal?

Scott Grauer

It does. And I think that the — as Marty indicated, our levels of trading securities, our balances there appear to be more business as usual. So we look for these levels to be sustainable, given the current rate environment, and the appetite for repositioning on the curve.

Jon Arfstrom

Okay.

Marty Grunst

Jon, sometimes we tell you don’t use the end of quarter trading level as the way to think about the future. This quarter, it’s probably better than the average.

Jon Arfstrom

Okay. Very helpful, guys. Thank you.

Operator

Our next question comes from Brady Gailey with KBW. Please proceed with your question.

Brady Gailey

Hi. Thank you. Good morning, guys.

Stacy Kymes

Good morning.

Marty Grunst

Good morning.

Brady Gailey

I understand the dynamics of having a net interest margin that moves a little lower in the back half of this year. But I’m wondering, as we look to next year, the Fed will be done deposit costs will probably have peaked could you see an expanding net interest margin into next year, just because your asset reprice is higher and the NIM could be actually headed higher next year?

Marty Grunst

Yes. So, that’s possible. And I would again, focus on net interest revenue is the way to think about next year. And if you play out the comments that I made earlier, you can see that be on a growth trend. And the percentage, sure it’s possible to see that higher especially, if you get less of an inverted curve that’s going to help as well.

Stacy Kymes

You get a couple of factors there. I think Marty’s reinvestment rate, we’re getting what roughly $400 million, a quarter in cash flow from the securities portfolio that’s reinvesting at 250 to 300 basis points higher, than what we’re receiving today. That’s going to help you a little bit.

The trepidation in answering the question is really just understanding, how deposit behavior is going to be as we grind higher for longer. If we’re through the worst of that from an industry perspective then I think you’re right, there’s upward opportunity on the margin, if deposit pricing continues to grind higher in a more meaningful way than that could be the offset to some of the favorable benefits that we see.

Brady Gailey

All right. And then intra-quarter you guys had a couple of announcements expanding into San Antonio, also expanding into Memphis maybe just the rationale behind those new markets? And is this something we should expect to see going forward putting new markets on the map organically?

Stacy Kymes

Yeah. I think they’re probably a little bit two different stories. San Antonio is a market that we buy for a long time. We have a strong presence in Dallas-Fort Worth and Houston. Central Texas has been a gap for us, and we’ve just been looking for kind of the right way to enter that market. We’re excited about the team we’ve acquired there, and we’ll have corporate commercial treasury wealth both in San Antonio and Austin, we’ll have a complement of between 15 and 20 folks. They’re in Central Texas that will be an opportunity for us to meaningfully expand our presence there. And so that’s going to be full-service banking and the beginning of another key market for us in Texas.

I mean, Memphis really was an opportunistic chance for us to grow our fixed income sales and trading platform that wasn’t necessarily on the radar screen as we began the year. But as things unfolded and opportunities presented themselves, we really saw it as additive to the current operations we have in Little Rock Milwaukee and Stamford Connecticut. It fits very cleanly. They have very little sales overlap with our existing portfolio and we’re excited for the team that is going to come on board there to help us in that area.

Brady Gailey

All right. And just lastly for me, the price of oil is still very strong. But the price of nat gas is depressed and we have seen a little bit of noise in that space. Maybe just talk about how you think — I know nat gas, I think it’s only about a-third of your energy. But do you expect to see some issues in nat gas over time?

Marc Maun

Not at this point we have like right now 93% of our gas-heavy borrowers are hedged in have over 50% of their PDP in 2023 and 76% of their PDP hedged at prices in 2024 exceeding $3.50. So they’re well positioned to receive a price well above what we’re seeing in the spot market plus today’s market you can hedge out all the way into 2025 at almost $4 an Mcf. So we continue to push hedging as a way to protect their portfolio as well as to improve our credit risk. And our customers have been responding. So we actually are in a really strong position that we expect our natural gas producers to perform well.

Brady Gailey

Okay. Great. Thanks for the color, guys.

Operator

[Operator Instructions] Our next question comes from Brandon King with Truist Securities. Please proceed with your question.

Brandon King

Hey, good morning, Thanks for taking my questions.

Stacy Kymes

Good morning.

Marty Grunst

Good morning, Brad.

Brandon King

Yes. So I wanted to touch on the outlook as far as loan growth. In the prior quarter, you detail that economic conditions were very strong and in this quarter now has kind of been downgraded to favorable. So I just want to know, if you could provide more context and details around that and what you’re seeing in your markets and with your customers?

Stacy Kymes

Yeah. I guess, maybe we didn’t communicate well but we certainly don’t see unfavorable economic conditions for loan growth. I mean, our footprint markets in the Southwest, Midwest are performing exceptionally well. I mean, there’s no signs of kind of economic slowdown or early signs of any economic issues. In fact, the long term and short term that footprint of Texas and Colorado Arizona clearly are high-growth markets infill from in-migration from other markets, I think is going to really benefit them long term.

So, we’re very bullish. And in fact, we’ve signaled in our guidance upper single-digit loan growth for the year and we are very confident that we’ll be able to achieve that objective.

I think our year-over-year growth is about 9%. And we’re in a range to continue that pace. So we’re — we still see good pipelines. We still see good opportunities. And frankly, the opportunity we have in front of us is a little bit unique in that others are trying to manage capital ratios or other things like that so they’re maybe less aggressive in the marketplace. And so from a sales perspective, we’re endeavoring to be very active in front of customers and prospects to try to add to our customer and loan deposit and asset under management book. We want to grow all those areas at a time where we’ve got lots of capital and great liquidity and we’re in business. And we’re not having to kind of meter that growth we’ll take all that we can get in this environment.

Marc Maun

Yeah. The only thing I will add is the key here is that this has been a very broad-based growth. I mean we have had all our lines of business experiencing growth, not just concentrated in one particular sector or another. Our CRE, we are kind of at our upper end of our range of our concentration, but the construction loans have continued to fund up. So we’re seeing it in C&I. We’re seeing healthcare energy and CRE all experienced growth. So we expect that reflects a lot of the things that Stacy was talking about.

Marty Grunst

And Brandon, if you look through to the state level GDP and state level employment for our footprint that still remains very strong. There’s no downturn there at all.

Brandon King

Okay. And within that and the tailwind from the competitive environment with these opportunities that you’re getting are you able to get kind of higher loan spreads or better economics on some of these deals you’re getting today?

Stacy Kymes

There’s no doubt. I alluded to that in my prepared comments that we are seeing particularly on the higher end of the corporate space, deals are pricing upward whether it’s from fewer participants in the market, are those beginning to price for higher capital requirements on the higher end of the banking segment, we are seeing that a 25 to 50 basis point increase in loan spreads, I think that that will take some time to work through the portfolio effect. But clearly, that’s an opportunity as we move forward.

Brandon King

Okay. And then just lastly for me. Is there any way you can provide kind of a spot cost of deposits at the end of the quarter?

Marty Grunst

Yeah. There’s not really a way to do that in particular. New production — if you look at our CD rates that we’re offering, we’ve got rates in the upper 4s and 5s as new production for that varies by market but that’s probably what we’ve got for you.

Brandon King

Okay. Thanks for taking my questions.

Marty Grunst

Thank you.

Operator

Our next question comes from Matt Olney with Stephens. Please proceed with your question.

Matt Olney

Thanks. Good morning. Just a few follow-ups here from some previous questions. On the customer hedging activity, obviously a good quarter in 2Q. It sounds like this is mostly from energy customers. Would love to appreciate, if you think there’s some good follow-through there potential for the back half of the year?

Stacy Kymes

Yeah. I think the hedging activity there I mean, it was a record really in the second quarter, but it’s been strong for us both on the energy side and the interest rate derivative side, both experienced really strong second quarter. I think the shape of the yield curve is going to help on the interest rate derivatives side. I mean, it’s odd that you can go out and hedge out three years at a cheaper rate than the spy rate, but that is the case today. And so that’s helping a little bit on the interest rate derivative side. And as we talked about with natural gas future prices and frankly oil prices, the market is in a good place to hedge to swap future prices and do it in a way that’s conducive to our customers. So whether it’s the same level as the second quarter, it’s hard to forecast that in a highly volatile segment. But I think that there is good momentum to be able to still have that be a very strong segment for us.

Matt Olney

Okay. Appreciate that Stacy. And then in the press release there was a mention of the $8.1 million gain from merchant services. Just remind me what line item this flows through.

Marty Grunst

Yeah that flows through the other gains and losses kind of right below the fee income.

Matt Olney

Okay. I see it. Perfect. And then, on the trading securities, Marty I heard your comment that the end-of-period balance could be a better starting point for 3Q than the average. I guess from a balance sheet standpoint on the other side of the balance sheet, remind me of how that’s typically funded?

Marty Grunst

Yes. So we can use either FHLB or repo either one whatever is cheaper. And so, it’s just the short-term wholesale.

Matt Olney

Okay. And then I guess along with that the FHLB and the repo line, other borrowing lines, if you’re going to see some pretty strong loan growth it sounds like this quarter, should we see the FHLB and borrowing line come down? Is it a replacement, or do you think there’ll still be an increase there given the trade securities build that you expect?

Marty Grunst

Yes. So we’ll have good loan growth. We’ll have deposit growth that will fund a decent portion of that and then kind of whatever the net is from pluses or minuses in the trading portfolio that really drive the changes in FHLB or repo.

Stacy Kymes

Yes. But Matt, this really goes back to kind of reeducating the investor community and kind of how we fund the bank. Loans are funded by deposits. You saw a good loan growth this quarter. You saw good deposit growth this quarter that loan-to-deposit ratio stayed relatively consistent. And we see that as we move forward.

On the security side, whether it’s the available-for-sale investment security to the trading portfolio, those are largely going to be funded wholesale, whether that’s repo or institutional or otherwise. And that’s entirely consistent with how we funded the bank forever pre-COVID.

You’re seeing higher levels of FHLB borrowings and things like that, because that’s — we got down to none during COVID. So as things kind of revert to the mean how we fund the bank is going to look like it did pre-COVID and that includes how we think about loans and deposits and how we think about institutional funding or wholesale funding for our securities portfolio and trading activities.

Matt Olney

Yes. Okay. That’s helpful, Stacy. And then just lastly I guess, I think you mentioned earlier in the call that the AFS securities yields could continue to climb as you get some — reinvest some of those cash flows. Any more color on just kind of the roll-off or on yields with an AFS book?

Marty Grunst

Yes. So we think about both AFS and held-to-maturity rolled together, because both have the same driver and the roll-off yield there’s always going to be roughly what the portfolio yield is. I think that was $274 million, if I’m right for this quarter. And then, current coupon, 15-year MBS or maybe a little bit less than that is kind of a good proxy for how to think about our repurchase yield on average over time. And so that gives you well over pretty good spread 200 basis point plus spread pickup.

Matt Olney

Yes. Okay. Okay, thanks guys. Appreciate your help.

Operator

There are no further questions at this time. I would now like to turn the floor back over to Marty Grunst for closing comments.

Marty Grunst

Thanks again everyone for joining us. And if you have further questions, please e-mail us at [email protected]. Have a great day everyone.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.