BOK Financial Corporation (BOKF) Q4 2017 Earnings Report, Transcript and Summary

Greetings and welcome to the BOK Financial Corporation Fourth Quarter 2017 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. It is now my pleasure to introduce your host, Joe Crivelli, Senior Vice President, Investor Relations. Thank you sir, you may begin.

Good morning, and thanks for joining us. Today we’ll hear remarks about the quarter from Steve Bradshaw, our CEO; Scott Grauer, EVP Wealth Management, Steven Nell, CFO; and Stacy Kymes, EVP, Corporate Banking. PDFs of the slide presentation and fourth quarter press release are available on 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 fourth quarter and full year 2017 financial results. The fourth quarter wrapped up a very strong year for BOK Financial. For the full year, net income was $334.6 million or $5.11 per diluted share, just under our highest EPS performance that we achieved back in 2012. All through the year we saw strong growth in net interest margin and net interest income, combined with outstanding results from our Wealth Management division, which continues to benefit from the strong economy in market, success attracting assets from external money managers and demographic trends which point to continued long-term growth. In addition, we successfully managed expenses substantially below our revenue growth rate. For the year, total revenue is defined by pre-provision, net interest revenue, plus fees and commissions was up 6.4% but total expenses was up less than 1% driving meaningful and significant earnings leverage. The credit environment was benign in 2017 as well and our energy portfolio continued to improve. Thus in the fourth quarter, we released $7 million of loan loss reserves which positively impacted our earnings. And finally, the change in hedging strategy for our MSR assets led to much more manageable impact on 2017 results. While the change in corporate tax rates will have significant long-term benefits for BOK as shareholders, there was a modest $11.7 million or $0.18 per share write-down of our deferred tax asset in the fourth quarter. In addition, we made our customary $2 million annual contribution to the BOKF Foundation to fund our community engagement efforts. As noted on Slide 5, Period-End loans of $17.2 billion were down slightly from the end of the third quarter. This was below our expectations as loan growth for the year was just 1%. We attribute the less robust loan growth in 2017 to three factors. First, the prospects of healthcare reform muted growth in our healthcare portfolio in the first half of the year. Second, we experienced a wave of commercial real estate paydowns in the second half of the year due to a flattening yield curve which was coupled with lower production volume as we were mindful of not exceeding our internal concentration limits earlier in the year. And third, uncertainty around tax reform, which negatively impacted our general C&I and business making segments. We feel that all three of these headwinds are now behind us. The healthcare group booked record new commitments in the fourth quarter exceeding the previous record set in the first quarter of 2016, almost two years ago. In commercial real estate, we have the capacity to book new deals and in fact booked $931 million of new commitments in the second half of 2017. And with tax reform now law, we expect our C&I clients to accelerate growth plans. Accordingly, we are guiding to a more normalized mid-single-digit loan growth rate in 2018 as Steven will discuss in a moment. During 2017, wealth management continues its impressive growth track record and generated record financial results. This was a big driver of our performance during the year. So I’d ask Scott Grauer, our Executive Vice President of Wealth Management Group to make a few remarks. Scott?

Thanks, Steve. On Slide 7, you’ll see highlights of the Wealth Management division’s preliminary 2017 financial results. As our investors know, wealth management is a business that we’ve been committed to for nearly a century with a broad cross-section of products and services including institutional and personal wealth management, trust services for individuals, corporations, and institutions, private banking services, retail and institutional brokerage, investment banking and financial risk management among others. Revenue was up 11.4% to $384.8 million in 2017. This is inclusive of the fee income lines that investors see on our corporate income statement. Brokerage and trading and fiduciary and asset management, but it also includes net interest income from loans and deposits in our private banking group. The growth was driven by loan growth and net interest margin expansion combined with higher trust fees, as these are typically driven by assets under management, as well as the new trading desk we established last year in Stanford Connecticut that expanded our offerings to the mortgage industry and mortgage-backed security investors. This initiative alone contributed an estimated $14.2 million to 2017 revenue, a $9 million increase from 2016. Net direct contribution, which is operating income before corporate allocations was up an even more robust 46.1% during the year. This was the result of careful expense management as total operating expenses for the division before corporate allocations were actually down 1.7% for the year despite the revenue growth. This translated into significant meaningful earnings leverage for the division. Loans and deposits were up 16% and 13% respectively in 2017, which are among the highest growth rates achieved in the company this year. Finally, with the search in new money and increases in the equity and fixed income markets during the fourth quarter, we ended the year with fiduciary assets of $48.8 billion, up 15.1% for the year and total assets under management or in custody up 8.5% and surpassing $80 billion for the first time in our company’s history. Perhaps most importantly, the stage is set for continued growth in the Wealth Management division. Longer term, the retirement of the baby boomers and the transfer of nearly $6 trillion of wealth to their heirs is one of the most powerful demographic trends facing the wealth management industry. We are well positioned to benefit with the diverse set of products and services to meet the needs of the next generation. In the near-term, the increase in assets under management and fiduciary assets in 2017 should translate to higher trust fees in 2018. This is one of the reasons we are more confident that we can deliver growth in fees and commissions in 2018 as Steven will discuss in a moment. I’ll now turn the call over to Steven now. Steven?

Thanks, Scott. As noted on Slide 9, net interest income for the quarter was $216.9 million and tax-equivalent net interest margin was 2.97%. These are down slightly from the third quarter, but keep in mind that non-accrual interest recoveries added $4.7 million to net interest income and 6 basis points to net interest margin in the third quarter. Excluding this impact, we saw healthy continued growth in both metrics as we continue to see only limited pressure on deposit cost in the fourth quarter. We reversed $7 million of loan loss reserve in the fourth quarter as we are seeing no signs of weakness from a credit standpoint and meaningful declines of both non-accrual loan and potential problem loan balances. Also, although net charge-offs were elevated in the fourth quarter, and net charge-offs for the full year were very modest 9 basis points compared to 22 basis points in 2016. As I’ll discuss in the guidance section, our bias at the moment is towards additional reversals in 2018. On Slide 10, fees and commissions were $168.2 million, down 3.1% on a sequential basis, but up 3.8% compared to last year’s fourth quarter. For the full year, fees and commissions were down 0.5%. Note that this quarter we reclassified approximately $5 million of quarterly revenues from transaction processing to deposit service charges and fees. This is revenue associated with our own BOKF, N.A. issued debit cards which we felt was better reflected on the service charge line item. The result is that the transaction card line item is now purely reflective of revenue associated with our trans funds transaction processing business. Obviously, the big driver in 2017was the decrease in mortgage banking revenue, which was in turn driven by higher rate environments which limited refinance productions volume. The lower volume industry-wide also translated to lower gain on sale margins in the mortgage business. We are pleased that despite the 22% annual decrease in mortgage revenue, our other businesses and particularly our fiduciary and asset management which grew 20.2% for the full year, we are able to compensate for this enabled us to keep fees and commissions relatively flat for the full year. The 14% sequential decrease that you’ll note in other revenue at the bottom of this chart is due to the sale of merchant banking portfolio companies earlier in the year for which we consolidated revenue. There is a corresponding decrease in other expense on the income statement. Turning to the Slide 11, operating expenses were $264 million in the quarter, down from $265.9 million in last quarter. For the full year, expenses were up and modest 0.8%, in line with our original goal to keep expenses flat on a GAAP basis compared to 2016. The fourth quarter was largely a quiet quarter from an expense standpoint. We contributed our customary $2 million to the BOKF foundation, in addition, a large customer-facing IT project was put into production mode which caused professional fees and services to increase $3.5 million on a sequential basis. Slide 12 has our current guidance for 2018. We expect mid-single-digit loan growth. As Steve noted, the three main headwinds that hampered loan growth in 2017 are behind us and our entire team feels more optimistic on this front than they did 90 days ago. We expect available-for-sale securities to be flat to slightly down. We expect continued modest growth in net interest margin with rate hikes in March and September embedded within our forecast and assuming continued active management and control of deposit pricing. We expect mid-single-digit net interest revenue growth reflecting the additional rate hikes that we did not have in our forecast 90 days ago. We expect revenues from fee-generating businesses to be up low-single-digits for the year. And we expect low-single-digit expense growth. As noted, given the current credit environment and the quality of our loan portfolio, we are biased towards additional releases of loan loss reserve at least through the first half of 2018. And we are forecasting a blended state and federal effective tax rate in the 22% to 23% range for 2018. Stacy Kymes will now review the home portfolio in more detail. Stacy?

Thanks, Steven. As you can see on Slide 14, total loans were down slightly compared to the third quarter. However, for the full year, we posted modest 1% loan growth despite the headwinds that Steve and Steven noted. Energy was up 17.3% for the full year, which is a testament to the commitment to the industry that we maintained during the recent downturns, which clearly differentiated us against other energy banks. During that time, we were able to book over $1 billion of new commitments to healthy borrowers which in 2017 translated into well-structured and well-priced loan growth in the energy industry. In addition, we are seeing more opportunities to aging credit facilities which translates to higher fee income and better returns on the total relationship. Likewise, healthcare was up 3.4% for the fourth quarter or 13.6% annualized. It’s good to see healthcare move back to its historical growth trajectory after the industry paused to wait for any potential impact of healthcare reform earlier in the year. Personal loans were up 2% for the quarter or 8% annualized and 15% for the full year, which is indicative of the strength of our wealth management business and in particular, private banking, which Scott discussed. As expected, we continued to see CRE pay downs in the fourth quarter driven by the flatter yield curve that we noted in our third quarter call. However, our commercial real estate team is back in full production mode and has capacity under our internal concentration limits to book new transactions. This is translating to new loan activity as Steve mentioned and although it will take some time for those deals to start to fund, we feel much better about commercial real estate growth in 2018. On Slide 15, credit quality remains strong. Non-accruals were down 17% during the quarter. Net charge-offs were 27 basis points. Although investors should not read too much into the increase, during the fourth quarter, we recognized charge-offs on substantially all loans for which we have allocated a specific reserve. For the full year, net charge-offs were a very modest 9 basis points, down from 22 basis points in 2016. Our loan loss reserve remains appropriate at 1.37%. Our energy portfolio is in excellent shape and the portfolio has now improved for seven consecutive quarters since the first quarter of 2016, the trough of the energy downturn. In the lower right corner of Slide 16, we have provided a five-year look at net charge-offs for the exploration and production business, which makes up 85% of our energy portfolio, as well as the overall energy banking business, so that you have a clear picture of losses before, during and after the cycle. As you can see, even in the worst downturn since the 1980s, losses were manageable, which demonstrates the message we’ve been consistently delivering to investors. We understand the cyclicality of the energy business and we underwrite and structure the portfolio with time tested discipline to minimize losses in downturns. returns: I’ll now turn the call back over to Steve Bradshaw for closing commentary.

Thanks, Stacy. 2017 was an exceptionally good year for the company. We posted very strong growth in net interest income, and net interest margin. Our fee businesses combined to overcome a downward shift in mortgage production and expense management was strong all year long for our goal of delivering flat expenses on a GAAP basis from 2016 levels in order to drive earnings leverage. Accordingly, our net income of $335 million or $5.11 per share represents the second best year in our company’s history. As evidenced by the 2018 guidance that Steven just articulated, we are more optimistic about continued earnings growth in 2018 than we were at the end of the third quarter. First, as I noted earlier, we are seeing much stronger loan pipelines as a result of the passage of tax reform, the new production activity in our CRE group and the renewed momentum in the healthcare business. Second, we now expect two rate hikes in 2018 instead of one, and on the heels of the December 2017 hike, this should drive continued margin expansion and growth in net interest income. We work steadily to prioritize to reduce expense growth throughout the fourth quarter and now expect very modest expense growth in 2018. Finally, if the stable credit environment sustains, there is potential for additional release of loan loss reserves. 2017 results reflects our company’s core strategy of strong credit discipline and an array of diverse revenue sources to overcome cyclical downturns and slower loan demand. We have a differentiated business model unlike any other mid-sized regional bank. None of this happens of course without a highly ethical and talented group of professionals that form our BOK Financial team. Their ability to attract and return quality customers in every business segment is the reason we were able to post new record earnings, while being recognized as being one of America’s most respected banks. We’ll take your questions now. Operator?

[Operator Instructions] Thank you. Our first question comes from the line of Brady Gailey with KBW. Please proceed with your question.

Hey, good morning guys.

Good morning.

Good morning.

I know it’s baked into your guidance for fee income growth of low-single-digits, but specifically in mortgage, how are you thinking about that for 2018? Do you think that there could be a little more downside to mortgage with lower volumes? Or do you think that 2018 should be more flat with the runrate in 2017?

Yes, this is Steve Bradshaw. I think it’s really more about less refinance activity given our rate forecast. Even less than what we had in 2017 which obviously was down from previous years and pressure on the margin, especially within our consumer direct segment of mortgage. So, we expect to see some continued pressure there. Our origination - kind or retail origination actually, we believe that will be up a little bit for the year. But that’s how we see mortgage today.

Okay. And then, if you look at energy, if I look back kind of a two or three years ago, I think you guys had energy at about 20% of loans that fell to under 15%. Now we are kind of on the swing back up which finished the year in a little over 17%. Do you think just given where oil is at? I know you guys are committed to the safety. Do you think that your exposure to energy should grow a little bit from here just as that backdrop has improved?

I would certainly expect it to move back up to its more historical level as a percent of the portfolio. We’ve been between 20% and 25% there on average over time and I would expect us to move back to that level. We do see that as a great opportunity for growth in 2018 outsize growth relative to the rest of the portfolio. So, clearly as a percentage, we would expect that to go up.

All right. And then lastly, just on the provision, I heard, you talked about additional loan loss reserve reversals in 2018. Do you think that translates into just a few quarters of a zero provision or do you think we can actually continue to see a negative provision for 2018?

We are really biased towards the negative provision for the first couple of quarters in 2018 honestly. When you take a look at our expectations for our non-accrual loans, our expectations for potential problem loans, we continue to see that moving down and improving. So, given our already very, very strong reserve, we feel like at least at this point, we are biased towards releases early in the year.

Okay, great. Thanks for the color guys.

Our next question comes from the line of Peter Winter with Wedbush. Please proceed with your question.

Good morning.

Good morning.

Hi, Peter.

I heard all the commentary in terms of the more positive outlook on loan growth. I am just wondering though, is there a little bit of concern about, when you look at borrowers having record levels of liquidity and their cash flows have now increased with tax reform that you could continue to see ongoing paydowns in the loan portfolio?

Well I think, clearly, liquidity of the borrowers represent a risk and I think that that is in conversations and if you look at the depth of our portfolio and where really the headwinds came from in 2017, commercial real estate being down roughly 10% year-over-year was the biggest headwind by far and so if we can stabilize that and even begin to move that up particularly in the latter half of the year with outstandings, that’s going to make a huge difference in terms of total portfolio loan growth. And so, I think that the liquidity challenge that you mentioned is one that’s been talked about in the industry really since the financial downturn where borrowers were flushed with liquidity. So, watching deposits decline before you would begin to see loan growth that hasn’t necessarily manifested itself in that manner. And so, if you look at us specifically, I think that just stabilizing commercial real estate now that we are well inside our internal concentration limits and have capacity to grow through 2018, I think that in and of itself really allows us to achieve our mid-single-digit kind of target that we have established for 2018, Peter.

And Stacy, can you just remind us what the internal concentration limits are?

So, in essence, it’s a 175% of Tier-1 capital and reserves measured on a committed basis, not on an outstanding basis.

More commercial real estate.

More commercial real estate.

And where are you guys today?

We are well below that and all of our forecast would indicate that we have effectively the capacity to grow certainly through 2018 and likely through a big chunk of 2019 based on our projections for the loan portfolio, capital growth, et cetera as we move forward. So, we don’t see that as a constraint in the next 12 to 18 months. You still have to deal with the impacts of the paydowns that we suffered in the third and to a lesser extent in the fourth quarter in commercial real estate as the yield curve flattened, particularly our industrial portfolio which has a high credit tenant occupancy was really hit hard those moved to the permanent financing market and it will take us a bit to move through that from an outstanding perspective, but we can move pretty quickly to replace it from a committed perspective.

And then, if I could just ask one follow-up to Steve on M&A. Just curious what you are seeing on M&A? We heard from one bank that said M&A activity is kind of halted for the time being as the sellers look at and try to extrapolate what the tax reform really means, and so it’s halted a little bit. I am just curious what you are seeing?

Yes, Peter, I think that’s bigger. I think of you are a potential seller, it’s a little early for you to be able to understand how that’s going to impact valuation if you are an interested acquirer and I would put us in that category, I think you’ve got two things going forward. You’ve got, obviously, some - what you believe will be expanded capital accumulation over the course of the next 12 months and ongoing. And then second, for us, while it has not happened, there is certainly legislative momentum, regulatory momentum if you will to move the SIFI threshold higher. And that would be very meaningful for a bank like BOK Financial if we were to look at larger size deals. Today, if you bump up against that $50 billion, there is a substantial increase in operating expenses that in many ways mutes or negates the value of a larger deal. So we would expect – we are expecting that threshold to move and so that’s got us thinking in terms of capital deployment perhaps a bit more aggressively than what we’ve been thinking in the past from an M&A perspective. Having said that, organic growth is still the best return for us and that’s where most of our focus is.

It’s great. Thanks very much.

Thanks, Peter.

Our next question comes from the line of Jared Shaw with Wells Fargo. Please proceed with your questions.

Hi, thank you. I guess, just following up on that last question. Does that mean that, we shouldn’t expect to see you do smaller deals that this one really more worth the time and the capital just to focus on larger deals?

I think that’s a fair way to put it. I mean there are so many fixed costs associated with an acquisition that. Again, we are still – now market that we are in today that we think we would benefit by adding scale. But I think for an organization of our size and the embedded cost in doing a deal, you need to do larger deals than perhaps what we’ve done in the past to really make that work for shareholders.

Okay, all right. Good. Just, on the CRE side, I guess, last quarter, with the paydowns and it seems like maybe you are a little more optimistic, I thought it sounded like you are a little more optimistic on being able to see a better net growth this quarter or the – with the level of paydowns it’s higher than you had expected and it was not spread out through the quarter or is more front-end loaded and that’s giving you the confidence for net growth?

Certainly, as it relates to the fourth quarter, there were more paydowns earlier in the quarter than later. But I think, we’ve seen that kind of group of loans that certainly were eligible to be refinanced out into the permanent non-recourse financing market. I won’t tell you that’s completely run its course, but I would say it has materially run its course, which allows for – been that organic growth and the coming behind that without that headwind. But we have a great origination team that had a great year last year in terms of origination. It was really the paydowns that were abnormally large that created the headwind. And so, that’s really what creates the optimism is that, we have a great team of folks who have a great group of clients who we can continue to help grow their business and their ventures and have a less impact from the paydown aspect of it.

It seems like the – that pricing still is very tied with very tight spreads. Is that holding you back at all in this year assumption for growth assume that we see an improving pricing market on the CRE side or is that not necessarily a requirement?

Well, I guess, it depends on what portion of the real estate sector you play in. I think in the sector we play in, we’ve seen stable spreads there. Others have – particularly our size and larger have been somewhat constrained in their growth in this space. And so that has enabled spreads to stay much more stable than they typically would this long into a recovery cycle where you typically have kind of rates to tighter spreads. I think spreads here has stayed very stable from our perspective in the category of commercial real estate lending that is our sweet spot.

Okay. And then, just finally for me, on the allowance level, I hear you about the strength of the quality of the portfolio. But just looking back, sort of over the last few years, the allowance to loans has been high. It’s been coming down. At what point would we – where do we have to get to in terms of allowance to loans before we stop serve looking at potential zero provision or negative provision?

Well, I mean, we don’t really stayed at the floor. We won’t go past and it all just depends on the full analysis of what our model tells us and our judgment around and expectations around non-performings and potential problem loans and that’s the way we guide, that’s the way we calculate it and we don’t have a certain spot that we say we just won’t pass through this level.

And so given the growth dynamics and the credit dynamics, I mean, would it be fair to say it could be significantly lower than where we are?

I wouldn’t say significantly lower than where we are. I mean, since I’ve been here 20 years, I’ve – it’s ranged from 185 down to 110. So, I mean, who knows where we fall in that. But, I wouldn’t see that goes down to tremendous amount.

Okay. And what’s the remaining reserve on energy at the end of the year?

Given where we are in the cycle that’s not a number that we are disclosing, I mean, the reserve that we have in our allowance is available for all of the loans that we have. And so, given where we are in the cycle, we are not back to kind of disclosing by segment, because I never thought that was a particularly insightful way to look at that and particularly now that we are past the downturn, I don’t want to get into that.

Okay. Thanks for taking my questions.

Our next question comes from the line of Ken Zerbe with Morgan Stanley. Please proceed with your question.

Great, thanks. Just going back to the – as you mentioned the sweet spot of where you playing CRE, can you just comment a little more broadly on the attractiveness of the different CRE segments, where you see the most value? Are there categories in CRE that you don’t want to play in whether it’s because of terms, conditions or spreads? Thanks.

I think the one aspect of CRE that that we have really stayed away from in the last ten years is the homebuilder segment where margins are so low and there is such little ability to navigate a downturn. We were much more active and that historically have had very little marketing or business development push in that space subsequent to the financial downturn. Clearly, retail is an area we would do retail commercial real estate today, but obviously a lot more work and analysis goes into that given what we see there. We are not of the opinion that the retail segment is headed for a cliff, but clearly there is an impact to retail particularly goods based retail and so we do a lot of work there as we’d evaluate that segment. The other side of that coin if you will, because of the Amazon effect that’s been coined – that turn has been coined, as you do see a lot more industrial and warehouse type of opportunities that develop among retailers in order to house, and deliver and ship those types of products to the consumer. And so, while retail maybe a slowing segment, we think that industrial warehouse is an increasing segment. So, we look at all aspects of that. Clearly, there are areas that we focus on more than others. But I would tell you, generally speaking, across those segments the spreads have been stable and the areas that we have wanted to focus on and we have had opportunities to do that.

Got it, okay. And then, just last question. In terms of wealth management, can you just remind us how much of your assets under management are actually tied to the equity markets? Because, I am just looking back at Slide 7, I see your total revenues are up about 11%, clearly the market is up a lot more than that last year and I am just wondering how much is not tied or tied in that type of things?

Sure. So, the asset allocation mix of our AUMA is 11% cash, 48% fixed income, 34% equity and about 7% alternatives.

Got it, okay. Perfect, thank you.

Our next question comes from the line of Brett Rabatin with Piper Jaffray. Please proceed with your question.

Hey guys. Good morning.

Good morning.

I wanted just to go back to talking about the loan portfolio and the growth in 2018. I was curious, we are seeing some folks provide some healthcare and I am just curious I know credit quality in that portfolio hasn’t been impacted, but I am just curious to hear if any changes in that industry impact the outlook for that portfolio’s growth this year and how you view that sort of with maybe some reduced competition?

Well, I mean, healthcare is a kind of a broad term for us. It really means a couple of segments. One is, hospitals and in that segment it’s generally high in credit in large metro urban areas. That’s an area that there is opportunity, but it’s not – spreads aren’t large. There is other ancillary business that drives that from a business development perspective including cash management and investment management services there. The focus of our healthcare segment in large part is senior housing, skilled nursing, assisted living, memory care, et cetera. And we do think there continues to be opportunity there. Obviously, part of what creates the opportunity is an evolving landscape from a legal and regulatory perspective, as well as the demographics of a retiring and aging baby boomer population. And so, we still see opportunity there. It’s something we’ve been doing for in excess of 15 years. We are very committed to that. We like the space. We have – it’s a dedicated line of business for us. So it’s not something that somebody is doing part-time. But they are living and breathing that every day. We have a full-time analyst on our staff who does nothing other than look for changes in federal and state reimbursement activity and budget issues that could impact our customers and our underwriting in those states. But we are still very optimistic. You saw our healthcare has a strongest fourth quarter since they’ve been a line of business we think obviously, if you look at that over a trend line, they’ve grown very, very well and we are still very optimistic about healthcare. For us, that’s largely senior housing and where the spreads are appropriate for the risk that we take there.

Okay. That’s great color. And then, wanted to hear maybe some thoughts on managing the securities portfolio, I think everybody is looking for a few rate hikes this year. What’s the plan? What the duration on the securities book and what do you guys apply and how much cash flow are you expecting this year from that?

Well, the duration, the securities portfolio is about 3.2 years. As rates rise, it really extends very, very little. So it’s, we’ve got the cash flows scheduled out really regardless of what rates do, we are going to have pretty significant cash flows that we can reinvest. And you know as rate rise will plough some of that back in at the appropriate time. I think we see relatively flat securities balances out in the future. I mean, part of that is just to maintain neutrality as it relates to interest rate risk. We have proven to be somewhat asset-sensitive as rates have gone up certainly in 2017. We kind of expect that to continue in 2018. So I would say on the short-term, we are asset-sensitive and we’ll manage the portfolio to kind of accommodate that longer-term and higher rate environment, perhaps we are more neutral. But I expect us to get some benefit from the couple of rate hikes that we’ve modeled in our asset liability modeling. And we see some improvement in net interest margin although modest in 2018 and of course the securities portfolio is just part of all of that active management.

Okay, great. Appreciate the color.

[Operator Instructions] Our next question comes from the line of Michael Rose with Raymond James. Please proceed with your question.

Hey, good morning guys.

Good morning.

Good morning. Just going back to the M&A discussion, you guys have historically done some smaller wealth or asset management deals. How should we think about those going forward? I mean, is that still something, obviously given all the talk around wealth and Scott’s comments today. Is that it’s still navigated – maybe a little bit more attractive to you near-term relative to bank M&A?

I don’t think it’s more attractive relative to bank M&A, but we would continue to look at opportunities to grow. Well, that’s part of the story about the strong performance in the last couple of years and the improving efficiency how that businesses that we did acquire multiple businesses kind of in that 2012 to 2015 range and we are reaping the benefit of that today. Five actually I think was the number that we acquired. So, I wouldn’t say that we are not still interested in that because we are. But I think, bank M&A will have the opportunity to probably drive more earnings accretion for us going forward.

Okay, that’s helpful. And then, maybe as a follow-up, before this year, you guys have had some pretty good growth in some of your smaller markets like Colorado, Arizona, et cetera? But that growth is kind of seem to stall out a little bit. What’s some of the outlook for those markets if we want to think about it on a state-by-state basis? Thanks.

Well, I think as you look out our footprint, I think you mentioned Colorado, certainly we’ve reinvested in Kansas City through the Mobank acquisition. Arizona continues to be a very focused growth market for us. We have good small market share in those markets. We continue believe those should drive growth for us as we move forward in 2018, 2019 and beyond. You can get caught up in one quarter or two quarters, but the activity is going on that underlies that is very strong and we would expect those markets to continue to be a growth driver for us as we move forward, just relatively – because we have a relatively small market share in those markets.

Okay, thanks for taking my questions.

Sure.

Our next question comes from the line of Jennifer Demba with SunTrust. Please proceed with your question.

Thank you. As you look forward, can you just kind of break down where you see yourselves deploying the additional earnings from tax reform? Whether it be in investments, growth, M&A or capital return?

Yes, Jennifer, this is Steven. I think that extra retained earnings that we’ll have, we’ll just throw in the mix of capital allocation like we’ve always thought about it. As Steve mentioned earlier, our number one capital deployment opportunity is organic growth. We think we get the best return from that. Certainly some of that could be used for opportunistic M&A. We pay a very good dividend and we’ll continue to pay in the kind of range that you’ve seen in the past in terms of a percent of earnings and then we will be opportunistic on stock buybacks where we can. But I would say rather than stating we are going to take X percent of that tax benefit and plough it back into certain areas. We are not going to say that. We are going to say, look, it goes into the capital pool and we are going to allocate it primarily towards organic growth going forward. I think it gives us opportunity and room to grow real estate a little bit more and opens up some of those areas for us and that’s what we’ll likely do with it.

And when do you see for the paydowns? Do you think that will be as high in 2018 as they were in 2017 through the industry?

For commercial real estate? I do not, I think that you had a flattening of the yield curve that happened in the third and fourth quarter that really push folks where the difference between fixed and floating, whether that’s great relative to kind of a permanent long-term rate without recourse and we had more in that queue that we are eligible if you will to move that direction. We’ve moved through a lot of that. There will still be paydowns or paydowns every year, commercial real estate probably has an average life of 2.5 years or so. So you are always going to have that. It was just more than the typical amount and I think it was because you had so much that was taking advantage of a steeper yield curve and when the yield curve began to flatten, use that as an opportunity to push out into the permanent financing market. There will still be some of that and we always have that in commercial real estate, but I think to a lesser extent in 2018 than we had in 2017.

Thank you.

Our next question comes from the line of Gary Tenner with D.A. Davidson. Please proceed with your question.

Thanks guys. My questions were just answered. Thanks.

Thank you.

Thank you.

Our next question comes from the line of Jon Arfstrom with RBC. Please proceed with your question.

Thanks. Good morning guys.

Good morning.

Good morning, Jon.

Two questions here. Stacy, you made a comment earlier about, I think you said more opportunity to lead energy deals and the potential fees that come along with that. Can you expand on that a bit?

Sure. I think, as you know, because of the nature and size of energy lending, it tends to be a larger lending group typically meets the definition of a shared national credit. That definition changed effectively in January, but still relatively true. We have more than double the number of energy deals that we lead over the last few years. It’s been a significant opportunity for us to demonstrate leadership in this space, particularly in deal sizes, $500 million or less in total. We compete effectively with anybody in the country of – a bank of any size. And our borrower base has appreciated our commitment to this space. Obviously, we have a deep history in energy and so, how we handle the downturn is, kind of a dividend that we are receiving today because we are exceeding, we are receiving numerous opportunities to lead deals and that’s an opportunity we are absolutely taking advantage of.

Okay, okay. Good. Steven, maybe a question for you. You guys alluded to making some changes in the fourth quarter to reduce the expense forecast. Can you – to the extent you can touch a little bit on what happened there?

Well, yes, you are right. In the third quarter, we guided mid-single-digit out in the future. But, as I mentioned then, we had a lot of work to do in our budgeting process and as Steve and I and all of the executive leadership team spend a tremendous amount of hours working through our budgets for 2018, looking at areas that we felt like we could tighten the belt, particularly in the non-personnel side. And then looking and scrubbing the kind of projects, IT projects and other kind of projects that we have had scheduled and really pull that back just a bit without any reduction to our client service or things we want to accomplish from building our back office infrastructure. So I think it was just really being trying to be wise about how we spend our dollars in 2018 and I think, we’ve built a plan that expects low-single-digit expense growth for next year.

Okay. And then just a follow-up there. The base – the expense baseline you’d like us to use is the reported number $1 billion $26 million?

Yes, let me just mention, if you look at the $264 million number for the fourth quarter, it’s probably a little high relative to what you’ll see in the first quarter, because we are going to reclass about $10 million of DP expenses up to against one of our revenue line items under the new revenue recognition guidance. And then, in the press release, you’ll notice several one-time items that we had in the fourth quarter, one being a contribution to our foundation and a few other items. So, that’s the way I would kind of look at the first quarter and build up the remainder of the year.

Okay. All right. Okay, thank you.

Thank you.

Mr. Crivelli, we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Well, thanks you all for joining us this morning. If you have any follow-up questions, please give me a call. I’ll be around for the rest of the day. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.