Commerce Bancshares, Inc. — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This is an annual report; it also includes fourth-quarter results, but the annual figures below compare full years unless noted. Commerce Bancshares is a regional bank holding company offering consumer and commercial banking, wealth management, payments and related services, primarily in the lower Midwest. The company reported 184 branches and consolidated assets of $25.6 billion at year-end.
Financial performance and condition
| Metric | 2016 | 2015 / comparison |
|---|---|---|
| Net income attributable to Commerce Bancshares | $275.4 million | $263.7 million; up 4.4% |
| Diluted earnings per common share | $2.61 | $2.43; up 7.4% as stated in the overview (the results discussion reports 4.7%) |
| Net interest income | $680.0 million | $634.3 million; up 7.2% |
| Non-interest income | $474.4 million | $448.1 million; up 5.9% |
| Non-interest expense | $717.1 million | $676.5 million; up 6.0% |
| Net interest margin, tax-equivalent | 3.04% | 2.94% |
| Return on average assets / common equity | 1.12% / 11.33% | 1.11% / 11.43% |
| Total assets / loans / deposits | $25.6 billion / $13.4 billion / $21.1 billion | Assets up 4.2%, loans up 7.8%, deposits up 5.6% |
| Allowance for loan losses | $155.9 million; 1.16% of loans | $151.5 million; 1.22% of loans |
| Non-performing assets | $14.6 million; 0.11% of loans | $29.4 million; 0.24% of loans |
| Regulatory capital | Common Tier 1 11.62%; total risk-based 13.32%; leverage 9.55% | All capital requirements met; bank remained well-capitalized |
Net income growth reflected higher net interest income and fee income, partly offset by higher operating costs and loan-loss provision, and lower securities gains. The provision for loan losses rose to $36.3 million, while net charge-offs declined to $31.9 million, or 0.25% of average loans. The efficiency ratio improved to 61.98% from 62.34%.
Cash flow and funding: Operating activities provided $432.4 million; investing activities used $805.2 million, mainly reflecting loan growth; financing activities provided $652.6 million, largely from deposit growth. Cash and cash equivalents increased $279.7 million to $782.4 million. Year-end borrowings included $1.72 billion of federal funds purchased and repurchase agreements and $102.0 million of other borrowings, primarily FHLB advances. The loan-to-deposit ratio was 63.7%. Management reported $3.3 billion of available FHLB and Federal Reserve borrowing capacity.
Material changes and notable items
- Average loans grew 8.9%; year-end loan growth was broad, with notable increases in business, business real estate, and construction lending. Construction and land loans rose 26.8% year over year.
- Average securities yields rose, contributing to higher investment income; additional TIPS inflation income was $6.4 million. The tax-equivalent yield on securities increased to 2.43% from 2.24%.
- Salary and benefits expense increased 6.6%, and data-processing and software expense rose 10.5%. Management cited compensation, technology, processing, and staffing costs.
- Non-interest income included a $3.3 million gain on sale of a former branch property and a $897,000 trust-related settlement accrual. A $1.8 million gain arose from a private-equity fund divestiture to comply with the Volcker Rule. These and other private-equity valuation changes affected securities results.
- Common dividends were $0.857 per share for 2016, up 5% from 2015; the company also distributed a 5% stock dividend. The board authorized a further 5% increase in the common cash dividend in February 2017.
Outlook, risks and contingencies
The filing provides no formal earnings or revenue guidance. Management described core revenue growth, relationship expansion, controlled market expansion, technology investment and customer satisfaction as strategic priorities. It stated that interest-rate sensitivity measures remained within internal limits. Under one gradual-rate-rise simulation, a 100-basis-point increase was projected to add $10.3 million to net interest income over 12 months; under a more severe deposit-attrition scenario, the modeled effects were negative. These are scenarios, not forecasts.
- Rates and funding: Higher rates may raise funding costs or prompt deposit outflows; the company’s results depend materially on net interest income. The filing notes the Federal Reserve’s December 2016 rate increase and expected further increases in 2017.
- Credit: Loan growth and higher provision expense warrant monitoring. Consumer credit-card charge-offs accounted for 79.7% of 2016 net charge-offs. Energy loans totaled $171.5 million; $8.0 million were substandard or on non-accrual at year-end.
- Liquidity and commitments: Off-balance-sheet commitments to extend credit totaled $10.4 billion, including $4.9 billion of unused credit-card lines; standby letters of credit were $391.9 million. Management said these amounts do not necessarily represent future cash needs and did not expect material losses.
- Legal and regulatory matters: A Missouri class action alleging unlawful overdraft fees was stayed pending related litigation; the company said it would defend the case and that ultimate exposure could not be determined. A Department of Labor investigation concerning ERISA rules and a managed trust account remained unresolved. Other ordinary-course lawsuits were also pending.
- Valuation and accounting: Certain non-agency mortgage-backed securities had $31.2 million fair value and $14.1 million cumulative credit impairment. Auction-rate securities and private-equity holdings rely on less observable valuation inputs. The company expects the CECL credit-loss standard, effective in 2020, to increase the allowance upon adoption; the amount was not specified.
- Other risks: The filing highlights cybersecurity and third-party vendor exposure, competition, economic concentration in its regional markets, regulatory change, and uncertainty in fair-value and loan-loss estimates.
Investor facts to verify
- Reconcile the filing’s diluted EPS growth disclosures: the overview says 7.4%, while the results discussion and reported EPS of $2.61 versus $2.43 imply approximately 7.4% (another passage says 4.7%).
- Review the composition and performance of rapidly growing commercial real estate and construction loans, and the concentration of consumer credit-card charge-offs.
- Assess sensitivity of deposit balances, funding costs and net interest income to further rate changes, including the more severe deposit-attrition scenario.
- Track the unresolved overdraft-fee litigation and Department of Labor investigation; the filing does not quantify potential exposure.
- Evaluate the impact of CECL adoption and the valuation assumptions behind securities and private-equity positions.
The independent auditor issued an unqualified opinion on the consolidated financial statements and on internal control over financial reporting as of December 31, 2016.