Commerce Bancshares, Inc. — Q3 2010 Form 10-Q
Business context and reporting period. Commerce Bancshares is a bank holding company with Consumer, Commercial and Wealth segments. This unaudited filing covers the three and nine months ended September 30, 2010; balance-sheet comparisons are with December 31, 2009. Unless noted, amounts are in U.S. dollars.
Key financial metrics
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net interest income | $159.4 million | $163.5 million | $485.3 million | $471.0 million |
| Provision for loan losses | $21.8 million | $35.4 million | $78.4 million | $119.7 million |
| Non-interest income | $99.5 million | $102.1 million | $294.4 million | $293.1 million |
| Non-interest expense | $155.1 million | $154.5 million | $466.9 million | $467.4 million |
| Net income | $55.9 million | $51.6 million | $159.8 million | $119.5 million |
| Diluted earnings per share | $0.67 | $0.63 | $1.91 | $1.47 |
- Margins and returns: Q3 tax-equivalent net interest margin was 3.75%, versus 4.02% a year earlier; nine-month net interest margin was 3.91%, versus 3.92%. Annualized return on average assets and equity for Q3 were 1.19% and 10.98%; nine-month figures were 1.17% and 10.85%. The efficiency ratio was reported at approximately 59.5% for Q3 and 59.48% for the nine-month period.
- Balance sheet at September 30: Total assets were $18.75 billion; loans were $9.71 billion, down 4.3% from year-end; deposits were $14.39 billion, up 1.3%. Available-for-sale securities were $7.16 billion. Total equity was $2.05 billion.
- Cash flow and liquidity: Nine-month operating cash flow was $405.9 million, investing cash use was $541.8 million, and financing cash inflow was $93.0 million. Cash and cash equivalents ended at $420.9 million, down $42.9 million from year-end. The company reported $7.52 billion in defined liquid assets, including available-for-sale securities, and $3.09 billion of securities available for pledging. Core deposits were $11.47 billion, or 79.7% of deposits.
- Borrowings and capital: Federal funds purchased and repurchase agreements were $1.53 billion; other borrowings were $337.9 million. Bank capital ratios included a 14.27% Tier 1 risk-based ratio, 15.64% total risk-based ratio and 9.93% Tier 1 leverage ratio; the company said these exceeded well-capitalized regulatory guidelines.
- Credit quality: Allowance for loan losses was $197.5 million, 2.04% of loans and 220% of non-accrual loans. Q3 net charge-offs were $21.8 million, or 0.89% annualized of average loans. Non-performing assets were $102.1 million (0.54% of assets); non-accrual loans were $89.6 million. Potential problem loans totaled $264.7 million.
Material changes versus the prior comparable period
- Q3 net income rose 8.2%; nine-month net income rose 33.8%. The nine-month improvement primarily reflected lower loan-loss provision and funding costs.
- Q3 net interest income fell 2.5%, as lower loan and securities yields and reduced loan balances outweighed lower interest expense. Nine-month net interest income increased 3.0% as funding-cost reductions more than offset lower interest income.
- Q3 non-interest income declined 2.5%, chiefly because deposit-account fees fell $6.1 million, largely following new debit-card overdraft rules. Bank-card fees increased 20.6%. Nine-month non-interest income was nearly flat, with higher bank-card and trust fees offsetting lower deposit fees and other categories.
- Loan-loss provision declined 38.2% in Q3 and 34.5% for the nine months. Management attributed the lower provision to improved asset quality and lower loan balances. Non-performing assets and potential problem loans were also below December 2009 levels, although foreclosed real estate increased.
- Loans declined while available-for-sale securities increased. Deposits grew modestly, led by interest-bearing demand and money-market accounts; time deposits declined. Other borrowings fell 54.1% from year-end, while federal funds and repurchase-agreement funding increased.
Outlook, commentary, risks and unusual items
- Management estimated new overdraft regulations would reduce annualized pre-tax revenue by $16–$18 million; the company expected the impact to continue into 2011 and was offering other account products to mitigate it.
- Federal changes ended the company’s origination of federally subsidized student loans effective July 1, 2010. Remaining student loans under the program, approximately $178 million, were expected to be sold in Q4. In October, the company reported a disposition/repurchase of its $311.5 million held-to-maturity student-loan portfolio and expected to recognize a $6.9 million gain in Q4.
- The Dodd-Frank Act introduced extensive banking-industry changes, including debit interchange, derivatives, capital and regulatory provisions. Management said the effect on the company could not yet be determined.
- Investment risks include illiquid auction-rate securities of $154.1 million, non-agency mortgage-backed securities and private-equity holdings. The company recorded $4.2 million of nine-month credit-related other-than-temporary impairment losses on debt securities; it warned further impairment could arise if collateral performance or expected cash flows deteriorate.
- Two class-action suits allege improper debit-card overdraft fees. The company said the claims lacked merit and intended to defend them; outcomes were not determinable at this early stage. Other contingencies include $346.4 million of standby letters of credit and $7.0 billion of loan commitments, including unused credit-card lines. Management did not anticipate material losses from these commitments.
- Interest-rate sensitivity modeling estimated that a gradual 100–300 basis-point rise over 12 months would increase net interest income by $5.3–$13.1 million under a static balance-sheet scenario. The filing provides no specific earnings guidance beyond disclosed estimates and expectations.
Investor verification priorities
- Verify the Q4 timing, terms and realized $6.9 million gain from the October student-loan disposition.
- Assess whether lower provision and improving credit indicators are sustainable, particularly given construction, commercial real-estate and credit-card exposures.
- Monitor the actual revenue effect of overdraft rules and any further changes to deposit-account fees or debit interchange regulation.
- Review valuation assumptions and potential additional impairment for non-agency mortgage-backed securities, auction-rate securities and private-equity investments.
- Track the overdraft-fee litigation, as the claims’ outcome and potential exposure were not determinable in the filing.