Commerce Bancshares, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. The interim financial statements are unaudited. Commerce Bancshares is a bank holding company whose operations are primarily conducted through Commerce Bank.
Financial performance
| Metric | Q3 2017 | Q3 2016 | First 9 months 2017 | First 9 months 2016 |
|---|---|---|---|---|
| Net interest income | $182.6 million | $171.2 million | $543.7 million | $506.8 million |
| Provision for loan losses | $10.7 million | $7.3 million | $32.6 million | $25.9 million |
| Non-interest income | $122.2 million | $119.3 million | $362.4 million | $354.9 million |
| Non-interest expense | $184.6 million | $181.2 million | $556.0 million | $535.8 million |
| Net income attributable to Commerce Bancshares | $74.6 million | $68.5 million | $225.0 million | $203.8 million |
| Diluted earnings per common share | $0.71 | $0.65 | $2.14 | $1.93 |
- Q3 net income attributable to the company rose 8.8% year over year; nine-month net income rose 10.4%. Common-shareholder net income was $72.3 million for Q3 and $218.3 million for the first nine months.
- Q3 net interest margin was 3.18%, versus 3.08% a year earlier; the nine-month margin was 3.17%, versus 3.05%. The efficiency ratio was 60.44% for Q3 and 61.25% for the first nine months, improving from 62.25% and 62.04%, respectively.
- Quarterly annualized return on average assets was 1.19% and return on average common equity was 11.35%. Nine-month figures were 1.20% and 11.85%.
- Net cash provided by operating activities was $334.3 million for the first nine months, versus $348.8 million in 2016. Investing activities provided $321.2 million, versus using $92.8 million; financing activities used $838.2 million, versus $291.6 million. Cash and cash equivalents declined $182.7 million to $599.8 million.
Financial position, credit and liquidity
- At September 30, total assets were $25.0 billion, down from $25.6 billion at December 31, 2016. Loans were $13.75 billion, up 2.5% from year-end; total deposits were $20.44 billion, down $657.3 million. Total borrowings were $1.51 billion, down from $1.83 billion.
- Available-for-sale securities totaled $9.11 billion. Reported liquid assets were $9.95 billion, down from $10.66 billion at year-end. Management cited core deposits of $18.63 billion, or 91.1% of deposits, and approximately $3.48 billion of estimated available future advances from the FHLB and Federal Reserve, subject to collateral and facility terms.
- Stockholders’ equity was $2.70 billion. Regulatory capital ratios were 12.52% Tier 1 common, 13.28% Tier 1 risk-based, 14.32% total risk-based, and 10.16% Tier 1 leverage. The company reported ratios above applicable well-capitalized thresholds.
- The allowance for loan losses was $157.8 million, or 1.15% of loans, compared with $155.9 million, or 1.16%, at year-end. Nine-month net charge-offs rose to $30.7 million from $22.9 million; the annualized Q3 net charge-off rate was 0.31%, versus 0.20% a year earlier. Consumer and credit-card charge-offs were notable contributors.
- Non-accrual loans were $13.6 million and non-performing assets were $14.7 million, both broadly stable versus year-end. However, potential problem loans increased to $172.4 million from $99.5 million. Total troubled debt restructurings were $73.1 million; $65.9 million were accruing.
Changes, outlook and material items
- Q3 net interest income growth reflected higher loan balances and yields; loan interest income increased $15.1 million year over year. Higher deposit and borrowing costs partly offset the benefit. Management also attributed revenue growth to trust, deposit and loan fees.
- Trust fees rose 11.9% in Q3, while bank-card transaction fees declined 5.3%, including lower merchant and corporate-card fees. Management cited loss of several large merchant customers over the prior 12 months. Nine-month non-interest expense increased 3.8%, driven chiefly by salaries and benefits and charitable securities contributions.
- Q3 investment securities losses were $3.0 million, including private-equity fair-value losses, partly offset by gains on donated appreciated securities. For the first nine months, private-equity losses were $8.3 million and donation-related gains were $6.7 million. Associated donation expense was $7.0 million year to date; management said it would consider the strategy again in Q4. These items affected reported results and tax expense.
- The 2017 adoption of share-based compensation guidance reduced income tax expense by approximately $6.7 million through Q3. The company also reported $2.7 million of tax benefits from securities donations for the first nine months. The lower nine-month effective tax rate was 28.7%, versus 31.1% in 2016.
- No numerical earnings or operating guidance was provided. Management stated that maturities and paydowns of approximately $1.5 billion of available-for-sale securities were expected over the next 12 months and could support lending or deposit funding needs. It did not expect significant losses from scheduled home-equity loan maturities, citing borrower credit scores, loan-to-value ratios and historical loss levels.
- Interest-rate sensitivity simulations varied materially with deposit attrition assumptions: a 100-basis-point rise was modeled to increase net interest income by $7.1 million in one scenario, but decrease it by $7.6 million in the higher-attrition scenario. Management cautioned that deposit behavior under rising rates is uncertain.
- Key risks identified include economic conditions, interest rates, deposit liquidity, loan demand, credit losses, regulation, competition, accounting and tax changes. The company had $10.6 billion of loan commitments, including approximately $5.1 billion in unused approved credit-card lines, and $338.4 million of standby letters of credit. These are contingent commitments and may not be fully drawn.
- A Missouri overdraft-fee class action was resolved in the bank’s favor; the appeal period expired without an appeal and the company reported no liability. Other proceedings remained pending in the ordinary course, with some matters too early for probable and estimable loss assessment.
Important facts for investors to verify
- Whether the increase in potential problem loans and consumer/credit-card charge-offs persists, and whether the allowance remains adequate as loan growth continues.
- Trends in deposit balances, funding costs and deposit mix, particularly under rising-rate or higher-outflow conditions.
- Whether trust-fee growth offsets continued bank-card and capital-markets fee pressure, and whether expense growth moderates.
- The sustainability of earnings excluding private-equity valuation changes, securities donations and related tax effects.
- Future capital, liquidity and credit impacts of the company’s sizable commitments, securities portfolio and forthcoming accounting standards, including CECL.