Commerce Bancshares, Inc. — Q1 2017 Form 10-Q
Business context and period. Commerce Bancshares is a regional bank holding company whose operations are primarily conducted through Commerce Bank, with Consumer, Commercial and Wealth segments. This unaudited filing covers the three months ended March 31, 2017; comparisons are with Q1 2016 unless otherwise noted.
Financial performance and condition
| Metric | Q1 2017 / March 31, 2017 | Comparable period |
|---|---|---|
| Net interest income | $178.3 million; up 8.9% | $163.8 million |
| Net interest margin, tax-equivalent | 3.14% | 2.95% |
| Non-interest income | $117.1 million; down 1.6% | $119.0 million |
| Non-interest expense | $186.8 million; up 5.3% | $177.5 million |
| Provision for loan losses | $11.1 million | $9.4 million |
| Net income attributable to Commerce Bancshares | $71.5 million; diluted EPS $0.68 | $65.4 million; diluted EPS $0.62 |
| Return on average assets / common equity | 1.15% / 11.74% | 1.07% / 11.20% |
| Efficiency ratio | 63.14% | 62.62% |
| Total assets / total loans | $25.3 billion / $13.6 billion | $25.6 billion / $13.4 billion at year-end 2016 |
| Total deposits / total equity | $21.1 billion / $2.56 billion | $21.1 billion / $2.50 billion at year-end 2016 |
| Cash and cash equivalents | $538.6 million at quarter-end | $782.4 million at year-end 2016 |
Cash flow and liquidity. Operating activities provided $141.3 million, investing activities used $173.4 million, and financing activities used $211.8 million. Net cash and cash equivalents declined $243.8 million during the quarter. Core deposits were $18.7 billion, or 88.6% of deposits. Available-for-sale securities were $9.7 billion, including $4.1 billion reported as unpledged and available for pledging. Borrowings totaled $1.42 billion; the filing also reports $3.44 billion in available future funding capacity from the FHLB and Federal Reserve, subject to collateral and facility terms.
Capital and credit. The Tier 1 common, Tier 1 risk-based, total risk-based and Tier 1 leverage ratios were 11.98%, 12.75%, 13.72% and 9.56%, respectively; the company reported ratios above applicable well-capitalized thresholds. The allowance for loan losses was $157.8 million, or 1.16% of loans. Quarterly net charge-offs were $9.2 million, 0.28% annualized. Non-accrual loans were $14.8 million; non-performing assets were $15.2 million, or 0.06% of assets. Substandard potential problem loans rose to $106.4 million from $99.5 million at year-end.
Material changes and management commentary
- Net interest income growth reflected higher loan and securities income. Average loans increased $940.7 million, or 7.5%, year over year. The quarter’s securities income included a one-time $2.7 million interest receipt on a private-equity debt investment and higher inflation-related TIPS interest.
- Non-interest income declined partly because Q1 2016 included a $3.3 million gain on sale of a former branch property. Merchant fees fell 17.9%, which management attributed in part to the loss of several large merchant customers. Trust fees rose 9.5%.
- Expenses increased 5.3%; excluding a $2.3 million contribution of appreciated securities to a related foundation, management reported expense growth of 4.0%. Management said it intended to make similar foundation contributions in subsequent quarters of 2017 and expected marketing costs to increase in future quarters.
- The effective tax rate was 25.8%, versus 31.0% in Q1 2016. Adoption of share-based payment accounting guidance produced a $4.5 million reduction in income tax expense; tax benefits associated with the foundation donation also lowered the rate.
- Common dividends were $0.225 per share, up 5% from the 2016 quarterly dividend. The company repurchased 126,737 shares at an average $57.47 during the quarter.
Outlook, risks and contingencies
- No specific earnings or revenue guidance is provided. Management cautions that quarterly results are not necessarily indicative of full-year results.
- Interest-rate sensitivity simulations show higher net interest income under rising-rate scenarios with the lower deposit-attrition assumptions; under the more severe attrition scenario, modeled net interest income declined. Actual deposit behavior and rate effects remain uncertain.
- Management expects the CECL credit-loss standard, effective for the company in 2020, to increase the allowance upon adoption; implementation will require significant data and process work. The company was evaluating the impact of revenue recognition and other pending accounting standards.
- Contingencies include a stayed Missouri class action alleging unlawful overdraft fees and an ongoing Department of Labor investigation concerning ERISA rules for a managed trust account. Outcomes and potential exposure were not determinable. The company also had $10.5 billion in loan commitments, $387.8 million in standby letters of credit, and $87.3 million in expected tax-credit purchase commitments for the remainder of 2017.
- Investment risks include $29.3 million fair value of non-agency mortgage-backed securities with previously recorded OTTI and $17.1 million of auction-rate securities. The company said it did not intend to sell the impaired securities and did not expect to be required to sell them before recovery of amortized cost.
Most important facts for investors to verify
- Whether loan growth and stronger net interest income persist as deposit costs and funding needs evolve.
- Credit quality trends, particularly consumer credit-card charge-offs, potential problem loans and the allowance’s adequacy.
- How much of earnings growth reflects recurring operations versus the $4.5 million share-based tax benefit and unusual securities income and donation items.
- Liquidity and funding assumptions, including deposit attrition, repurchase funding and the availability of collateral-dependent borrowing capacity.
- Developments in the overdraft-fee litigation, the Department of Labor investigation, and the company’s expected CECL implementation impact.