Commerce Bancshares, Inc. — Q3 2011 Form 10-Q
Business context and reporting period. Unaudited results cover the three and nine months ended September 30, 2011, compared with the corresponding 2010 periods. Commerce Bancshares is a regional banking and financial services company with Consumer, Commercial and Wealth segments. Results for interim periods are not necessarily indicative of full-year results.
Financial results and condition
| Metric | Q3 2011 | Q3 2010 | First nine months 2011 | First nine months 2010 |
|---|---|---|---|---|
| Net interest income | $158.6 million | $159.4 million | $484.3 million | $485.3 million |
| Provision for loan losses | $11.4 million | $21.8 million | $39.4 million | $78.4 million |
| Non-interest income | $101.6 million | $100.0 million | $298.9 million | $294.7 million |
| Non-interest expense | $153.7 million | $155.6 million | $461.2 million | $467.1 million |
| Net income attributable to Commerce Bancshares | $65.4 million | $55.9 million | $194.8 million | $159.8 million |
| Diluted earnings per share | $0.76 | $0.64 | $2.24 | $1.82 |
- Q3 net income rose 16.9%; nine-month net income rose 21.9%. Lower loan-loss provisions were a major contributor. For the nine months, net income also benefited from higher fee income and lower expenses.
- Tax-equivalent net interest margin was 3.51% in Q3, down from 3.75%; the nine-month net yield on interest-earning assets was 3.73%, versus 3.91%. Lower loan balances and yields pressured interest income, partly offset by lower funding costs and growth in securities income.
- Bank-card fees and trust fees grew. Nine-month deposit account fees fell 12.8%, and loan fees and sales fell 46.7%, mainly reflecting regulatory limits on overdraft fees and the exit from most student lending.
- At September 30, total assets were $20.64 billion, up from $18.50 billion at December 31, 2010. Deposits were $16.01 billion, up 6.2%; loans were $9.07 billion, down 3.6%. Available-for-sale securities increased to $9.28 billion from $7.29 billion.
- Cash and cash equivalents were $569.7 million, compared with $460.7 million at year-end 2010. Nine-month operating cash flow was $311.1 million; investing activities used $1.07 billion and financing activities provided $868.7 million. Investing outflows primarily reflected securities purchases and resell agreements.
- Period-end borrowings included $1.06 billion of repurchase-agreement funding and $111.9 million of other borrowings. Core deposits were $13.42 billion, or 83.8% of deposits. Management reported $2.90 billion of available future FHLB and Federal Reserve advances.
- Equity totaled $2.13 billion. Regulatory capital ratios were 14.58% Tier 1 risk-based, 15.92% total risk-based and 9.74% Tier 1 leverage; each exceeded the stated well-capitalized threshold.
- Net loan charge-offs were $48.9 million for the first nine months, down from $75.3 million. The allowance for loan losses was $188.0 million, 2.07% of loans excluding loans held for sale, and 247.7% of non-accrual loans.
Material changes, outlook and risks
- Non-accrual loans declined to $75.9 million from $85.3 million at year-end, but foreclosed real estate rose to $23.8 million from $12.0 million. Potential problem loans increased to $250.6 million from $233.5 million; management cited business real estate downgrades. A $47.8 million increase in business real estate loans past due 30–89 days was largely tied to six loans renewed or paid in October.
- Management estimated that Federal Reserve debit-interchange rules effective October 1, 2011 would reduce debit-card revenue by approximately $7 million in Q4 2011. No broader earnings guidance is provided. The company expected the bank’s change to a state-chartered Federal Reserve member bank to reduce annual examination fees by about $1.5 million.
- Q3 non-interest expense included a $5.9 million accrual related to potential litigation losses; nine-month litigation accruals totaled $10.9 million. Separately, the company said reasonably possible losses could exceed amounts accrued by up to $4 million and stated it expected the claims to be resolved without material loss. A class-action overdraft-fee case remains pending.
- The securities portfolio includes $139.7 million of illiquid auction-rate securities valued using significant unobservable inputs, and non-agency mortgage-backed securities with recorded credit impairment. Management warned further deterioration in collateral performance could cause additional impairment losses. The company reported no exposure to subprime-originated mortgage-backed or collateralized debt obligation instruments.
- Interest-rate sensitivity modeling showed a gradual 200-basis-point rise could reduce 12-month net interest income by $1.5 million (0.24%), and a 300-basis-point rise by $4.0 million (0.64%), assuming a static balance sheet. Management did not model falling-rate scenarios because rates were already low.
- Loan commitments totaled $7.5 billion, including about $3.5 billion of unused approved credit-card lines; standby letters of credit were $322.7 million. These are contingent commitments and may not be fully drawn. The company also had $100.1 million of outstanding tax-credit purchase commitments.
- The company repurchased 2.18 million shares during Q3 for $101.1 million at an average $38.04 per share; 824,115 shares remained under the 3 million-share authorization. It paid $0.23 per share in each of the first three quarters.
Most important facts for investors to verify
- Whether credit quality continues to improve, particularly potential problem loans, foreclosed real estate and commercial real estate delinquencies, and whether the allowance remains adequate.
- How the debit-interchange cap affects card revenue and whether other regulatory or compliance costs offset expected examination-fee savings.
- Whether net interest margin stabilizes as loan yields, deposit costs, securities growth and interest-rate sensitivity evolve.
- Valuation and credit performance of non-agency mortgage-backed and auction-rate securities, including potential future impairment charges.
- Progress and ultimate cost of pending litigation, especially the overdraft-fee class action and the recorded contingency accruals.
- Whether deposit growth and available liquidity remain sufficient to support securities settlement, funding needs and capital returns.