Commerce Bancshares, Inc. — Q3 2013 Form 10-Q
Business context and reporting period. Unaudited consolidated results for the three and nine months ended September 30, 2013, compared with the corresponding 2012 periods. Commerce Bancshares is a bank holding company whose principal operations are conducted through Commerce Bank.
Financial performance and condition
| Metric | Q3 2013 | First nine months 2013 |
|---|---|---|
| Net interest income | $154.7 million; up 0.6% year over year | $464.5 million; down 3.0% |
| Non-interest income | $106.3 million; up 5.3% | $308.9 million; up 4.2% |
| Investment securities gains (losses), net | $0.7 million, versus $3.2 million gains | ($3.1) million, versus $8.6 million gains |
| Net income attributable to Commerce Bancshares | $68.2 million; up 3.4% | $195.0 million; down 3.7% |
| Diluted earnings per share | $0.75, versus $0.72 | $2.14, versus $2.18 |
| Net interest margin, tax-equivalent basis | 3.11%, versus 3.30% | 3.13%, versus 3.43% |
| Efficiency ratio | 59.72%, versus 59.99% | 60.38%, versus 59.14% |
Q3 return on average assets was 1.26% and return on average equity was 12.69%. Lower deposit costs and growth in bank-card and trust fees supported quarterly results; lower securities gains and higher operating expenses were offsets. Nine-month earnings fell as lower loan and securities yields and weaker private-equity investment results outweighed fee growth and lower credit costs.
Balance sheet and liquidity at September 30, 2013: Total assets were $22.45 billion, loans $10.82 billion, deposits $18.22 billion, and total equity $2.18 billion. Loans grew 10.0% from year-end 2012, while deposits declined $130.9 million. Cash and cash equivalents were $949.0 million. Liquid assets, as defined by the company, totaled $10.08 billion; core deposits were $15.87 billion, or 87.1% of deposits.
Federal funds purchased and repurchase-agreement balances were $1.76 billion, and other borrowings were $105.9 million. Regulatory capital ratios were 13.65% Tier 1 risk-based, 14.89% total risk-based, and 9.43% Tier 1 leverage; the company reported these exceeded well-capitalized thresholds. The tangible common equity-to-assets ratio was 9.10%, down from 10.47% a year earlier.
Cash flow, first nine months: Operating activities provided $288.8 million; investing activities used $185.4 million; financing activities provided $65.9 million. Cash and cash equivalents increased $169.2 million to $949.0 million. Financing cash flow included a $726.8 million increase in short-term borrowings, partly offset by deposit outflows, $69.2 million of treasury-stock purchases, and $61.5 million of dividends.
Material changes versus comparable periods
- Q3 net income rose year over year, but nine-month net income and diluted EPS declined. Nine-month net interest income fell 3.0%, with the tax-equivalent net interest margin down 30 basis points.
- Fee income growth was led by bank cards and trust services. Capital-market fees fell 35.6% for the nine months, while non-interest expense rose 1.8%.
- Credit indicators improved: nine-month net charge-offs were $23.8 million versus $28.5 million; non-performing assets were $44.8 million, or 0.41% of loans, versus $64.9 million, or 0.66%, at year-end 2012. The allowance was $163.5 million, 1.51% of loans.
- Available-for-sale securities fell to $8.58 billion from $9.52 billion at year-end 2012. Net unrealized losses increased substantially during 2013, mainly as interest rates rose; accumulated other comprehensive income declined to $26.0 million from $136.3 million.
- On September 1, the company acquired Summit Bancshares for company shares valued at $43.2 million, adding $261.6 million in assets, including $207.4 million in loans, $232.3 million in deposits, and two Oklahoma branches. Summit results are included from the acquisition date.
Outlook, risks, contingencies and unusual items
The filing provides no quantified earnings or revenue guidance. Management cautions that interim results are not necessarily indicative of full-year results. The company identified economic conditions, interest rates, loan demand, regulation, liquidity requirements, competition, and litigation-settlement outcomes as factors that could cause actual results to differ from forward-looking statements.
- Interest-rate sensitivity analysis estimated that a gradual 100-basis-point rise would increase annual net interest income by $1.8 million, while a 200-basis-point rise would reduce it by $0.8 million and a 300-basis-point rise by $6.7 million. Management attributed adverse larger-rate scenarios to deposit repricing and funding costs, among other factors.
- The company held $125.0 million of auction-rate securities valued using significant unobservable inputs and $64.5 million of private-equity investments measured at fair value. Credit-related impairment on certain non-agency mortgage-backed securities was $1.3 million for the nine months; cumulative credit-related impairment was $12.8 million. Management stated it did not intend, and did not expect to be required, to sell those securities before cost recovery.
- Commitments included $8.4 billion of loan commitments, $347.3 million of standby letters of credit, and $186.5 million of outstanding state tax-credit purchase commitments. The company noted that commitments may expire unused or only partly used.
- Legal matters included a $1.0 million loss contingency for a claim alleging successor liability related to Bank South, and a $4.5 million remaining liability for Visa interchange-related reductions. The company estimated that changed debit-card transaction posting could reduce annual overdraft income by $3.5 million to $5.5 million.
- Management expected compliance with Basel III capital rules based on current capital ratios. The company was required to submit stress-test results to the Federal Reserve by March 31, 2014. Potential effects of a court ruling on debit interchange fees were uncertain and not quantifiable at filing.
Key facts for investors to verify
- Whether loan growth and Summit integration sustain earnings while deposit balances decline and short-term borrowings increase.
- Whether net interest margin stabilizes amid falling loan yields and potential deposit repricing.
- Whether credit quality and the allowance remain adequate as lending expands, including exposure to consumer credit cards and commercial real estate.
- How interest-rate changes affect the available-for-sale portfolio, accumulated other comprehensive income, and reported capital.
- Developments in the cited litigation, interchange regulation, and the company’s significant off-balance-sheet commitments.