Business context and reporting period
Commerce Bancshares, Inc. is a Missouri-based bank holding company providing retail and commercial banking, wealth management and related financial services, primarily across Missouri, Kansas, central Illinois, Oklahoma and Colorado. This Form 10-K reports the fiscal year ended December 31, 2011, with comparisons to 2010. The bank became a state-chartered Federal Reserve member bank in June 2011. The independent auditor issued an unqualified opinion on the financial statements and internal controls.
Financial performance and position
| Metric | 2011 | 2010 |
|---|---|---|
| Net interest income | $646.1 million | $645.9 million |
| Net interest margin, tax-equivalent | 3.65% | 3.89% |
| Non-interest income | $392.9 million | $405.1 million |
| Investment securities gains (losses), net | $10.8 million | ($1.8 million) |
| Net income attributable to Commerce Bancshares | $256.3 million | $221.7 million |
| Diluted earnings per share | $2.82 | $2.40 |
| Provision for loan losses | $51.5 million | $100.0 million |
| Net charge-offs / average loans | 0.70% | 1.00% |
| Non-interest expense | $617.2 million | $631.1 million |
| Return on average assets / equity | 1.32% / 12.15% | 1.22% / 11.15% |
Revenue, defined by the company as net interest income plus non-interest income, fell 1.1% to approximately $1.039 billion. At year-end, assets were $20.65 billion, loans $9.21 billion, deposits $16.80 billion and equity $2.17 billion. The allowance for loan losses was $184.5 million, or 2.01% of loans. Non-performing assets were $93.8 million, equal to 1.02% of loans.
Operating cash flow was $407.4 million; investing activities used $2.18 billion and financing activities provided $1.83 billion. Cash and cash equivalents increased $56.9 million. Total year-end borrowings were $1.37 billion, including $511.8 million of long-term debt. The average loans-to-deposits ratio was 59.2%; the reported year-end ratio was approximately 55%. Regulatory capital remained strong: the consolidated Tier 1 risk-based ratio was 14.71%, total risk-based capital 16.04% and leverage ratio 9.55%.
Fourth-quarter 2011 net income was $61.5 million, or $0.69 diluted per share, compared with $61.9 million, or $0.67 per share, in fourth-quarter 2010.
Material changes versus 2010
- Net income rose 15.6%, mainly as the provision for loan losses declined $48.5 million, expenses fell $13.9 million and securities gains improved. Lower credit costs were a major earnings driver.
- Loans declined 2.5%, while deposits increased 11.4% ($1.7 billion) and investment securities increased to $9.36 billion. Management placed much of the deposit growth into securities amid weak loan demand.
- Net interest income was nearly flat, but margin narrowed 24 basis points to 3.65%, reflecting lower asset yields and a shift toward securities, partly offset by reduced deposit and borrowing costs.
- Non-interest income declined 3.0%. Lower overdraft fees, debit interchange income and student-loan sale gains outweighed growth in corporate card and trust fees. Debit-card revenues fell approximately $7.1 million in fourth-quarter versus third-quarter 2011 after the interchange fee cap took effect.
- Net charge-offs fell $32.4 million, and non-performing assets decreased $3.5 million. However, substandard potential problem loans increased to $250.7 million from $233.5 million.
Outlook, risks, contingencies and unusual items
Management did not provide numerical earnings or revenue guidance and said it did not expect significant economic growth in the near future. It cited continuing uncertainty, weak loan demand and elevated, though improving, credit losses. Key sensitivities include regional economic conditions, interest rates and margin pressure, credit quality, deposit movements, competition, and regulatory and compliance costs.
- New rules reduced overdraft and debit-card revenues; Dodd-Frank implementation and further regulation could increase costs or constrain revenues. The company said the full effect of Dodd-Frank could not yet be assessed.
- The bank recorded an $18.3 million expense for a class-action settlement concerning debit-card overdraft fees. The bank admitted no wrongdoing; settlement documentation and court approval remained outstanding. Related litigation was expected to be addressed by the settlement. Management said other pending suits were not expected to have a significant effect and that possible additional losses beyond accruals were not material.
- Non-agency mortgage-backed securities carried $10.1 million of cumulative credit impairment recognized in earnings. Auction-rate securities of $135.6 million and private-equity holdings rely partly on less observable valuation inputs.
- Liquidity was described as strong, supported by core deposits and marketable securities, but management noted corporate deposits could decline and future liquidity would depend on managing securities maturities. Approximately $1.6 billion of securities were scheduled to mature in 2012.
- The company was evaluating proposed Basel III requirements; management stated capital ratios exceeded proposed minimums. New U.S. rules were still subject to rulemaking.
- Other notable items included $10.8 million of net securities gains, mainly from private-equity sales and fair-value adjustments, and a $4.4 million reduction in the Visa indemnification liability, which was reduced to zero.
Important facts for investors to verify
- Whether credit quality continues to improve, particularly in construction, consumer and credit-card lending, and whether the $184.5 million allowance remains adequate.
- How the enlarged securities portfolio, including non-agency mortgage-backed and auction-rate securities, performs and is valued as rates and credit conditions change.
- The ongoing revenue and expense effects of debit interchange limits, overdraft rules and other Dodd-Frank requirements.
- The status and final cost of the overdraft litigation settlement, including court approval and resolution of related claims.
- Whether deposit growth persists, especially corporate deposits, and how securities maturities support liquidity and potential loan growth.
- Changes in net interest margin, capital ratios, and regulatory requirements, including implementation of Basel III and stress-testing rules.