Commerce Bancshares, Inc. — Q2 2015 Form 10-Q
Business context and reporting period. Commerce Bancshares is a bank holding company whose principal operations are conducted through Commerce Bank. This unaudited filing covers the quarter and six months ended June 30, 2015; comparisons are with the corresponding 2014 periods unless otherwise noted.
Financial performance and position
| Metric | Q2 2015 / June 30, 2015 | Comparison |
|---|---|---|
| Net interest income | $163.7 million | Up 2.0% year over year; first-half net interest income was $309.8 million, down 1.2% |
| Net income attributable to Commerce Bancshares, Inc. | $74.4 million | Up 11.8% year over year; first-half $135.4 million, up 3.5% |
| Net income available to common shareholders / diluted EPS | $72.1 million / $0.75 | Common net income up 8.4%; diluted EPS was $0.66 in Q2 2014 |
| Non-interest income | $114.1 million | Up 4.9%; first-half $220.5 million, up 4.3% |
| Non-interest expense | $165.3 million | Up 1.7%; first-half $329.0 million, up 1.4% |
| Efficiency ratio | 59.36% | 60.16% in Q2 2014; first-half 61.87% versus 61.61% |
| Net interest margin, fully taxable equivalent | First half: 2.90% | 3.08% in first-half 2014 |
| Loans / deposits | $11.93 billion / $19.29 billion | Loans up 4.1% and deposits down 1.0% from December 31, 2014 |
| Allowance / non-performing assets | $151.5 million / $30.8 million | Allowance was 1.27% of loans; non-performing assets were 0.26% of loans, versus 0.40% at year-end |
| Cash flows, first half | Operating +$193.6 million; investing −$193.8 million; financing −$399.1 million | Cash and cash equivalents fell $399.4 million to $701.3 million |
Q2 return on average assets was 1.26% and return on average common equity was 12.91%. First-half net loan charge-offs were $16.2 million, down from $17.2 million in 2014; Q2 charge-offs rose to $8.8 million from $7.4 million in Q1. The allowance declined from $156.5 million at year-end.
At June 30, total assets were $23.71 billion, total liabilities $21.39 billion, and total equity $2.32 billion. Total borrowings were $1.77 billion, principally $1.67 billion under repurchase agreements and $103.8 million in FHLB advances. Core deposits were $17.26 billion, or 89.5% of deposits. Liquid assets, as defined by the company, totaled $10.56 billion. Regulatory capital ratios under Basel III were 11.76% Tier I common, 12.62% Tier I risk-based, 13.62% total risk-based, and 9.08% Tier I leverage; management reported ratios above applicable well-capitalized thresholds.
Material changes and notable items
- Loan growth was led by business loans, up $298.0 million from year-end, and consumer loans, up $143.3 million. Consumer demand included auto and other consumer lending; marine and RV loans continued to run off.
- First-half net interest income was pressured by lower investment-securities income, particularly volatile Treasury inflation-protected securities (TIPS) income. Q2 TIPS income was $5.1 million, following a $7.0 million loss in Q1; the filing reports $6.4 million of Q2 2014 income.
- Trust fees increased 10.0% in Q2 and 10.6% for the first half. Capital markets fees fell 15.7% in Q2 and 19.3% for the first half. The company began selling certain longer-term fixed-rate residential mortgages in 2015, contributing to higher loan fees and sales.
- First-half investment securities gains were $8.2 million, including $5.8 million of private-equity gains. Q2 securities gains were $2.1 million, compared with a $2.6 million loss in Q2 2014. Q2 comprehensive income fell to $32.4 million from $109.7 million, principally reflecting a $42.9 million other comprehensive loss, including securities valuation changes.
- Non-performing assets improved from year-end, mainly after the payoff of a large business real estate loan. However, potential problem loans increased slightly to $82.5 million from $81.2 million.
- The company completed settlement of a $200 million accelerated share repurchase in June and began a second $100 million program in May, expected to settle in November 2015. It repurchased 3.32 million shares during Q2; common dividends were $0.225 per share in each 2015 quarter.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management states that it expects to meet routine short-term liquidity needs and notes that approximately $1.6 billion of available-for-sale securities are expected to mature or pay down over the next 12 months. Management’s interest-rate simulations show projected 12-month net interest income rising $4.9 million under a gradual 100-basis-point increase, rising $1.6 million under 200 basis points, and declining $4.2 million under 300 basis points, using assumptions that include deposit runoff. Alternative deposit-runoff assumptions produce materially different results.
- Key risks identified include economic conditions in the company’s markets, interest-rate movements, loan demand and credit quality, regulation, competition, liquidity needs, and estimates used in accounting and taxes. TIPS income, securities valuations, and prepayment assumptions add variability.
- Off-balance-sheet commitments included $9.2 billion of loan commitments, including about $4.3 billion of unused approved credit-card lines; standby letters of credit totaled $330.4 million. The company also had $27.9 million of outstanding state tax-credit purchase commitments expected to be funded in the remainder of 2015.
- A Missouri customer filed a purported class action alleging unlawful overdraft fees on certain debit-card and ATM transactions. The company considers the claim without merit and intends to defend it; ultimate exposure cannot be determined. Other ordinary-course litigation is also pending.
- At June 30, the available-for-sale portfolio included $92.9 million of illiquid auction-rate securities and $50.7 million fair value of non-agency mortgage-backed securities with previously recorded other-than-temporary impairment. Management 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.
- Effective January 1, 2015, the company adopted accounting for qualified affordable-housing investments that records related amortization in income tax expense rather than non-interest expense; prior-period amounts were revised. The filing says the impact was not significant.
Important facts for investors to verify
- Whether loan growth, consumer-credit performance, and the increase in Q2 net charge-offs remain consistent with management’s credit assumptions.
- How TIPS income, securities portfolio repositioning, and deposit pricing affect net interest margin and interest-rate sensitivity.
- Whether fee growth—especially trust, card, and mortgage banking fees—can offset compensation, technology, and fraud-loss expense trends.
- Developments in the overdraft-fee class action and any change in potential legal or other contingent exposures.
- Execution and final share delivery under the $100 million accelerated repurchase, and the effect of repurchases and dividends on capital and liquidity.
- Capital-ratio comparisons across periods should account for the change from Basel I to Basel III rules effective January 1, 2015.