Commerce Bancshares, Inc. — Q2 2020 Form 10-Q
Business context and reporting period. Commerce Bancshares is a bank holding company whose operations are primarily conducted through Commerce Bank. This unaudited report covers the quarter and six months ended June 30, 2020. Results were significantly affected by the COVID-19 pandemic and the adoption of CECL on January 1, 2020.
Key financial results
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net interest income | $203.1 million | $211.6 million | $404.1 million | $415.1 million |
| Provision for credit losses | $80.5 million | $11.8 million | $138.5 million | $24.3 million |
| Non-interest income | $117.5 million | $127.3 million | $241.2 million | $248.5 million |
| Investment securities losses, net | $4.1 million | $0.1 million | $17.4 million | $1.0 million |
| Net income attributable to Commerce Bancshares | $39.9 million | $108.0 million | $91.7 million | $205.1 million |
| Net income available to common shareholders | $37.6 million | $105.7 million | $87.2 million | $200.6 million |
| Diluted EPS | $0.34 | $0.91 | $0.78 | $1.72 |
- Q2 net interest margin was 2.94%, versus 3.61% a year earlier; first-half margin was 3.12%, versus 3.56%. The Q2 efficiency ratio was 58.10%, compared with 55.88%.
- At June 30, assets were $30.5 billion, loans $16.4 billion, deposits $24.5 billion, and total equity $3.36 billion. Loans increased 11% and deposits increased $4.0 billion from year-end 2019.
- Allowance for credit losses on loans was $240.7 million, or 1.47% of loans; the liability for unfunded commitments was $35.3 million. Second-quarter net charge-offs were $8.4 million, an annualized 0.21% of average loans.
- Nonperforming assets were $23.1 million, or 0.08% of assets; nonaccrual loans were $22.6 million. Potential problem loans rose to $267.3 million from $164.8 million at year-end.
- First-half cash flows: operating activities provided $229.7 million, investing activities used $2.94 billion, and financing activities provided $3.62 billion. Cash, cash equivalents and restricted cash increased $910.3 million to $1.82 billion.
- Regulatory capital ratios at June 30: Tier 1 common 13.30%, Tier 1 risk-based 14.00%, total risk-based 15.22%, and Tier 1 leverage 9.88%. The company reported ratios above applicable well-capitalized thresholds.
Material changes versus comparable periods
- Q2 net income attributable to the company fell 63.1% year over year; first-half net income fell 55.3%. The principal pressure was sharply higher credit-loss provisioning, reflecting worsening pandemic-related economic forecasts.
- Q2 net interest income declined 4.1%, mainly as lower loan and securities yields outweighed reduced funding costs. First-half net interest income declined 2.6%.
- Q2 non-interest income fell 7.7%, with bank-card transaction fees down 20.9%; first-half non-interest income fell 2.9%. Capital markets and trust fees partly offset declines in other fee categories.
- Net securities losses increased, driven primarily by fair-value losses on private equity investments: $7.5 million in Q2 and $20.5 million in the first half. These losses were partly offset by gains on sales of available-for-sale securities.
- Non-interest expense was down 1.2% in Q2 and essentially unchanged for the first half. Higher salaries and benefits were offset by lower marketing and other expenses.
- Deposits and loans expanded substantially. The company originated $1.5 billion of Paycheck Protection Program loans for 7,443 customers; it said the SBA guarantees these loans and expects most balances to be forgiven.
Outlook, commentary, risks and unusual items
- Management’s CECL estimate assumed a gradual recovery from the pandemic-driven recession, with recovery extending into late 2021 and 2022. The filing emphasizes substantial uncertainty; renewed outbreaks, prolonged restrictions, unemployment, or weaker borrower and collateral conditions could deepen losses and require further reserve changes. No earnings guidance is provided.
- COVID-19 payment deferrals covered $834.0 million of loans at June 30, including $711.7 million commercial and $122.3 million personal banking. Management cautioned that delinquency and charge-off metrics may lag underlying deterioration while assistance programs are in effect.
- Energy lending was $175.1 million; 18.6% was rated substandard and 8.4% nonaccrual. The company recorded $3.0 million of energy-loan net charge-offs in the first half.
- CECL adoption increased retained earnings by $3.8 million at January 1, 2020, after a $21.0 million reduction in the loan allowance and a $16.1 million increase in the unfunded-commitment liability. The company elected the regulatory-capital transition deferral through 2021.
- In July 2020, the company monetized two interest-rate floors and expects to recognize gains of $43.5 million and $51.5 million over their original terms. It also announced redemption of all Series B preferred depositary shares on September 1, 2020, at $25 per depositary share.
- Liquidity included $12.57 billion in defined liquid assets and $22.49 billion of core deposits. Available future advances against pledged collateral at the FHLB and Federal Reserve were reported at $3.86 billion. Borrowings totaled approximately $1.74 billion at June 30; no FHLB advances were outstanding.
- Off-balance-sheet commitments included $12.6 billion of loan commitments, $428.0 million of standby letters of credit, and $8.1 million of commercial letters of credit. The filing also describes ordinary-course legal proceedings; some matters were too early to estimate a probable loss.
Important facts for investors to verify
- Whether later economic conditions and pandemic developments require material revisions to CECL assumptions, reserves, or asset-quality expectations.
- Performance and forgiveness of the $1.5 billion PPP portfolio, and the status and outcomes of the $834.0 million of payment deferrals.
- Trends in problem loans, nonaccruals, commercial and energy exposures, and consumer credit-card losses as relief programs expire.
- Whether funding costs, deposit balances, loan yields, and securities income sustain net interest margin amid low rates.
- Effects of the preferred-stock redemption and interest-rate-floor monetization on capital, earnings, and future periods.
- Actual utilization of loan commitments and contingent guarantees, and any material developments in legal proceedings.