Commerce Bancshares, Inc. — Q2 2019 Form 10-Q
Business context and reporting period. Commerce Bancshares is a bank holding company whose operations are conducted primarily through Commerce Bank. This unaudited quarterly report covers the three and six months ended June 30, 2019; comparisons are to the corresponding 2018 periods unless noted.
Financial performance and position
- Q2 earnings: Net interest income was $211.6 million, up 0.3%; non-interest income was $127.3 million, up 1.9%. Net income attributable to Commerce Bancshares was $108.0 million, down 2.1%; net income available to common shareholders was $105.7 million. Diluted EPS was $0.96, unchanged.
- First-half earnings: Net interest income was $415.1 million, up 2.8%; non-interest income was $248.5 million, up 1.6%. Net income attributable to the company was $205.1 million, down 2.9%; diluted EPS was $1.81, down 1.6%.
- Margins and returns: Q2 net yield on earning assets was 3.61%, versus 3.65% a year earlier; first-half net interest margin was 3.56%, versus 3.51%. Q2 annualized return on assets was 1.73%, return on common equity 14.46%, and efficiency ratio 55.88%.
- Loans and credit: Loans totaled $14.26 billion at June 30, up about $119 million (0.8%) from year-end. The allowance for loan losses was $161.2 million, or 1.13% of loans. First-half provision was $24.3 million and net charge-offs were $23.0 million; Q2 annualized net charge-offs were 0.32% of average loans. Non-performing assets were $12.0 million, or 0.08% of loans; potential problem loans declined to $105.8 million from $145.7 million at year-end.
- Funding and liquidity: Deposits were $19.83 billion, down $494 million from year-end; core deposits represented 89.4% of deposits. Borrowings were $2.40 billion, up $434 million, mainly from federal funds purchased and repurchase agreements. Liquid assets, as defined by management, totaled $9.87 billion. Operating cash flow was $251.7 million for the first half; cash, cash equivalents and restricted cash ended at $961.5 million, a $247.8 million decrease since year-end.
- Capital: Total equity was $3.17 billion. The Tier 1 common, Tier 1 risk-based, total risk-based and Tier 1 leverage ratios were 14.28%, 15.02%, 15.86% and 11.75%, respectively; the company reported ratios above well-capitalized thresholds. Tangible common equity to tangible assets was 11.25%.
Material changes and drivers
- Higher loan interest income supported net interest income, but rising deposit and borrowing costs absorbed much of the benefit. First-half interest expense increased $23.4 million year over year.
- First-half expenses rose 4.7% to $381.2 million, led by salaries and benefits, data processing/software, and marketing. Lower FDIC insurance expense partly offset those increases.
- First-half provision for loan losses increased 18.7% to $24.3 million, while net charge-offs increased to $23.0 million from $20.4 million. Consumer credit-card charge-offs were a notable pressure; impaired loans and potential problem loans were lower than at year-end.
- Deposits fell, particularly business demand deposits, while certificates of deposit increased. The company increased borrowings and used $86.1 million for treasury-stock purchases and $62.0 million for common and preferred dividends in the first half.
- Available-for-sale securities had a $135.7 million net unrealized gain at June 30, compared with materially larger unrealized losses at year-end. The resulting improvement contributed to first-half other comprehensive income of $173.6 million.
Outlook, risks and unusual items
- The filing gives no specific earnings or revenue guidance. Management said results for the interim periods are not necessarily indicative of full-year results and described expected short-term operating liquidity needs as manageable.
- Interest-rate sensitivity simulations showed estimated 12-month net interest income increases of 0.54% and 0.76% under 100- and 200-basis-point rising-rate scenarios with the baseline deposit-attrition assumptions; under higher assumed deposit attrition, rising-rate scenarios instead reduced estimated net interest income by about 0.8%. A 100-basis-point falling-rate scenario reduced estimated net interest income by 0.89%. These are model scenarios, not forecasts.
- Management identified economic conditions, interest rates, loan demand, regulation, liquidity, competition and cybersecurity among factors that could cause actual results to differ from forward-looking statements. The company was preparing for CECL adoption on January 1, 2020; the allowance was expected to differ under the new model, but the eventual impact was still under evaluation.
- Off-balance-sheet commitments included $10.9 billion of loan commitments, including approximately $5.1 billion in unused credit-card lines; standby letters of credit were $355 million. The company also expected to fund $120.1 million of outstanding tax-credit purchase commitments during the remainder of 2019.
- Legal proceedings were described as arising in the ordinary course. Some matters were too early-stage to determine whether a loss was probable and estimable. A $2.0 million liability was recorded for standby-letter-of-credit obligations.
- Other notable items: the company recorded a $1.1 million annual pre-tax reduction in interest income from consumer debt-management modifications; private-equity fair-value losses contributed to first-half securities losses of $1.0 million. The company also continued spending on a new core deposit system and other technology initiatives.
Important facts for investors to verify
- Whether loan growth, deposit trends and the higher reliance on short-term borrowings continue, and how funding costs affect margins.
- Whether consumer credit-card charge-offs and the allowance remain consistent with portfolio risk, especially as loan balances and economic conditions change.
- The eventual CECL allowance and retained-earnings impact at adoption, once management completes testing and validation.
- Performance of the investment portfolio and private-equity valuations, including the sensitivity of reported equity to interest-rate and market changes.
- Execution costs and benefits of technology initiatives, and the extent to which legal, guarantee and other lending commitments become funded or require payment.