Commerce Bancshares, Inc. — Q3 2020 Form 10-Q
Business context and reporting period. Commerce Bancshares is a bank holding company whose principal operations are conducted through Commerce Bank. This unaudited filing covers the quarter and nine months ended September 30, 2020, during the COVID-19 pandemic. Unless noted otherwise, dollar figures below are in U.S. dollars.
Financial performance and condition
| Metric | Q3 2020 | Nine months 2020 |
|---|---|---|
| Net interest income | $216.0 million; up 6.1% year over year | $620.1 million; up 0.2% |
| Provision for credit losses | $3.1 million | $141.6 million, versus $35.2 million |
| Non-interest income | $129.6 million; down 2.4% | $370.8 million; down 2.8% |
| Investment securities gains (losses), net | $16.2 million gain | $1.3 million loss |
| Net income attributable to Commerce Bancshares | $132.4 million; up 21.2% | $224.2 million; down 28.7% |
| Net income available to common shareholders | $125.0 million; diluted EPS $1.11 | $212.2 million; diluted EPS $1.89 |
| Net interest yield / margin measure reported | Net yield on earning assets: 2.97%, versus 3.43% | Net interest margin, tax-equivalent: 3.07%, versus 3.52% |
| Efficiency ratio | 55.00%, versus 56.66% | 57.37%, versus 57.08% |
Balance sheet and liquidity. At September 30, total assets were $31.45 billion, loans were $16.42 billion, and deposits were $25.70 billion. Loans grew 11.2% and deposits increased $5.18 billion from December 31, 2019. Non-interest-bearing deposits reached $10.73 billion. Borrowings, principally repurchase agreements, totaled about $1.65 billion, down from $1.85 billion at year-end. Reported liquid assets totaled $13.56 billion, including $11.54 billion of available-for-sale securities and $1.17 billion of interest-earning deposits at the Federal Reserve.
For the first nine months, operating activities provided $472.4 million; investing activities used $4.44 billion, including $2.7 billion net investment in securities and $1.71 billion net loan growth; financing activities provided $4.62 billion, largely from deposit growth. Cash, cash equivalents and restricted cash rose $649.7 million to $1.56 billion.
Shareholders’ equity was $3.31 billion. Regulatory capital ratios at September 30 included a 13.45% Tier 1 common risk-based ratio, 14.62% total risk-based capital ratio, and 9.39% Tier 1 leverage ratio. The company reported that it exceeded well-capitalized requirements. It redeemed its $150 million Series B preferred stock in September.
Material changes versus comparable periods
- Q3 earnings improved year over year, helped by lower deposit and borrowing costs, a lower credit-loss provision, and $16.2 million of securities gains. Loan interest income fell $17.5 million as rates declined, partly offset by loan growth.
- Nine-month net income attributable to the company fell 28.7%, primarily reflecting the $106.4 million increase in credit-loss provision. Lower loan and securities yields were partly offset by reduced funding costs.
- Q3 bank card fees declined 14.9%, mainly from reduced corporate-card transaction volume. Mortgage-related loan fees and sales rose 105.4% in the quarter.
- Loans expanded substantially, including $1.5 billion of SBA Paycheck Protection Program loans. Available-for-sale securities also increased, with purchases of $5.2 billion during the nine months.
- Non-performing assets rose to $40.3 million from $10.6 million at year-end; potential problem loans increased to $304.2 million from $164.8 million.
Outlook, risks and unusual items
- COVID-19 and credit estimates: Management’s CECL forecast assumed a gradual recovery, with no additional systemic lockdowns and recovery extending into late 2021 and 2022. The company emphasized significant uncertainty; renewed outbreaks, restrictions, or a deeper recession could increase losses. The allowance for loan losses was $236.4 million, or 1.44% of loans, at September 30; the liability for unfunded commitments was $35.2 million.
- Credit relief and exposure: Active payment deferrals totaled $84.5 million at quarter-end. Pandemic-sensitive industries represented $2.71 billion, or 18.2% of the loan portfolio, excluding PPP loans. Energy lending was $169.9 million, with 17.8% rated substandard and 8.4% on non-accrual status.
- PPP: The company funded $1.5 billion of SBA-guaranteed loans for 7,618 customers and expected most balances to be forgiven in 2021. Forgiveness processing began in Q3.
- Unusual securities and hedge activity: Q3 securities gains included $13.7 million from mortgage-backed security sales and $2.4 million of private-equity fair-value gains. For the nine months, private-equity valuation losses contributed to a net securities loss. The company monetized two interest-rate floors in Q3 and another in October; related gains are expected to be recognized in income over the original hedge periods.
- Commitments and contingencies: Loan commitments totaled $12.8 billion, including $4.9 billion of unused approved credit-card lines; standby letters of credit were $318.0 million. The company signed a $106.6 million office-development agreement. It reported routine legal proceedings and records accruals where losses are probable and estimable.
- Forward view: The filing provides no earnings or revenue guidance. Management stated it believed it could meet liquidity needs. Interest-rate sensitivity simulations showed higher net interest income under modeled rising-rate scenarios, subject to uncertain deposit behavior.
Important facts for investors to verify
- Whether pandemic-related deterioration appears in delinquencies, non-accrual loans, charge-offs, and potential problem loans as deferral programs and government support unwind.
- How sensitive the $236.4 million CECL allowance and $35.2 million unfunded-commitment liability are to revised economic forecasts and the commercial real estate, energy, and other exposed portfolios.
- Whether PPP forgiveness proceeds as expected and how loan growth and repayment affect future net interest income and liquidity.
- Whether lower card-fee revenue and loan yields are offset by deposit-cost reductions, fee growth, and securities income.
- The sustainability of earnings excluding securities gains and the effects of private-equity fair-value changes, floor monetization, and the preferred-stock redemption.
- Liquidity and capital trends, including deposit composition, repurchase-agreement funding, securities collateralization, and capital ratios.