Commerce Bancshares, Inc. — Q2 2013 Form 10-Q
Business context and reporting period. Commerce Bancshares is a bank holding company operating primarily through Commerce Bank, with Consumer, Commercial and Wealth segments. This unaudited filing covers the three and six months ended June 30, 2013; balance-sheet comparisons are with December 31, 2012. Unless noted, amounts are in U.S. dollars.
Financial performance and condition
| Metric | Q2 2013 / June 30, 2013 | Comparable period / prior balance |
|---|---|---|
| Net income attributable to Commerce Bancshares | $65.8 million; diluted EPS $0.72 | Q2 2012: $70.7 million; $0.76 diluted EPS |
| Six-month net income attributable to Commerce Bancshares | $126.8 million; diluted EPS $1.39 | Six months 2012: $136.5 million; $1.46 diluted EPS |
| Net interest income | Q2: $159.5 million; six months: $309.8 million | Q2 2012: $165.1 million; six months 2012: $324.8 million |
| Net interest margin, tax-equivalent | Q2: 3.21% | Q2 2012: 3.55%; Q1 2013: 3.07% |
| Non-interest income | Q2: $102.7 million; six months: $202.6 million | Q2 2012: $100.8 million; six months 2012: $195.4 million |
| Non-interest expense | Q2: $157.0 million; six months: $312.0 million | Q2 2012: $156.3 million; six months 2012: $306.8 million |
| Efficiency ratio | Q2: 59.73%; six months: 60.72% | Q2 2012: 58.53%; six months 2012: 58.72% |
| Total assets | $21.91 billion | December 31, 2012: $22.16 billion |
| Loans | $10.37 billion | December 31, 2012: $9.83 billion |
| Total deposits | $17.90 billion | December 31, 2012: $18.35 billion |
| Allowance for loan losses | $166.0 million; 1.60% of loans excluding loans held for sale | December 31, 2012: $172.5 million |
Q2 return on average assets was 1.20% and return on average equity was 12.07%. Six-month figures were 1.17% and 11.73%, respectively. The company recorded Q2 provision for loan losses of $7.4 million, up from $5.2 million a year earlier; the six-month provision was $10.7 million, down from $13.4 million.
For the six months, operating activities provided $167.9 million of cash, investing activities used $393.0 million and financing activities used $125.3 million. Cash and cash equivalents declined $350.3 million to $429.5 million. Financing cash flows included a $582.1 million net decline in deposits, partly offset by $537.1 million of increased short-term federal funds purchased and repurchase agreements.
At June 30, core deposits were $15.4 billion, or 86.0% of deposits. Liquid assets totaled $10.16 billion, including $8.93 billion of available-for-sale securities and $1.20 billion of long-term resell agreements. Reported regulatory capital ratios were 13.58% Tier I risk-based, 14.85% total risk-based and 9.08% Tier I leverage; all exceeded the stated well-capitalized thresholds.
Changes versus prior periods
- Q2 net income attributable to the company fell 7.0% year over year; first-half net income fell 7.1%.
- Lower loan and securities yields drove weaker net interest income. Q2 average loan balances grew 9.5%, but the average loan yield declined to 4.34% from 4.95% a year earlier. The tax-equivalent net interest margin fell to 3.21% from 3.55%.
- Non-interest income rose 1.8% in Q2 and 3.7% for the first half, led by bank card and trust fees. Capital-markets fees declined 34.0% in Q2 and 35.2% for the first half.
- Net securities results shifted from a $1.3 million gain in Q2 2012 to a $1.6 million loss in Q2 2013; first-half results shifted from a $5.4 million gain to a $3.7 million loss.
- Loans grew 5.5% from year-end, while deposits declined 2.5%. Non-interest-bearing deposits declined $488.4 million; time deposits of $100,000 and over increased $316.8 million.
- Credit indicators improved in several areas: non-accrual loans declined to $39.1 million from $51.4 million at year-end, and non-performing assets fell to $52.5 million from $64.9 million. Q2 net charge-offs increased to $9.4 million from $7.8 million in Q1; the annualized charge-off ratio was 0.37%.
Outlook, commentary, risks and unusual items
- Acquisition: On May 15, 2013, Commerce agreed to acquire Summit Bancshares. Summit was described as adding approximately $257 million in assets, including $214 million in loans, $226 million in deposits and two Oklahoma branches. The company anticipated closing in Q3 2013, subject to regulatory and shareholder approvals, and expected to issue approximately one million shares. Closing was not assured.
- Interest-rate exposure: The company’s static-balance-sheet model estimated that a gradual 100-basis-point rate increase would reduce annual net interest income by $0.13 million; a 200-basis-point increase by $4.5 million; and a 300-basis-point increase by $11.8 million. Management attributed sensitivity to deposit costs rising faster than yields on longer-term assets, deposit runoff and slower mortgage prepayments.
- Securities valuation: Rising rates contributed to unrealized losses of $100.1 million on securities in accumulated other comprehensive income, versus $20.2 million at year-end. Securities in an unrealized loss position had a fair value of $3.7 billion. The company said it did not intend, and did not expect to be required, to sell certain impaired non-agency mortgage-backed securities before recovery; their aggregate fair value was $86.2 million.
- Credit and commitments: Troubled debt restructurings totaled $89.5 million, of which $23.1 million were on non-accrual. Loan commitments totaled $8.3 billion, including approximately $3.9 billion in unused approved credit-card lines. Standby letters of credit totaled $330.0 million. Commitments may not be fully drawn, but may create funding or credit exposure.
- Legal and fee matters: The company estimated that the proposed Visa/MasterCard settlement’s interchange-fee reduction would cost approximately $5.2 million pretax and said it had accrued for the anticipated cost in 2012. A change in debit-card transaction posting was expected to reduce annual overdraft income by $3.5 million to $5.5 million. A separate securities-fraud-related claim alleged investor losses exceeding $9 million; the company said the loss was not then probable or estimable, recorded no liability and anticipated resolution without material loss.
- Regulatory developments: A July 2013 court ruling concerning debit interchange fees could affect the industry and Commerce, but the impact was not determinable. The company expected to meet the new Basel III capital requirements and was required to submit stress-test results to the Federal Reserve by March 31, 2014.
- No earnings guidance: The filing provides no specific earnings or revenue forecast. Management said near-term operating liquidity needs were not expected to vary significantly and believed the company could meet them. Results for the interim periods were not necessarily indicative of full-year results.
Most important facts for investors to verify
- Whether Summit Bancshares closed on the anticipated terms and timing, including the share issuance and integration effects.
- Whether loan growth can offset continued yield compression and the effects of deposit mix changes and higher short-term borrowing.
- Whether credit quality and charge-offs remain consistent with the allowance, particularly in consumer credit cards and commercial real estate.
- The recoverability and valuation of securities, including the effect of interest rates on available-for-sale values and accumulated other comprehensive income.
- The eventual cost and status of interchange litigation, overdraft-related changes and the Oklahoma securities-fraud claim.
- Compliance with capital, stress-testing and other regulatory requirements, and the evolution of liquidity as deposits and short-term borrowings change.