Commerce Bancshares, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. The interim financial statements are unaudited. Commerce Bancshares is a regional bank holding company whose principal operations are conducted through Commerce Bank, across Consumer, Commercial and Wealth segments.
Financial performance
- Q2 earnings: Net income attributable to Commerce Bancshares was $110.3 million, up 39.7% year over year. Net income available to common shareholders was $108.1 million; diluted EPS was $1.01, versus $0.71.
- First-half earnings: Net income attributable to Commerce Bancshares was $211.3 million, up 40.4%. Diluted EPS was $1.93, versus $1.36.
- Revenue and net interest: Q2 net interest income increased 15.4% to $211.0 million; non-interest income rose 8.2% to $124.9 million. For the first half, net interest income grew 11.8% to $403.9 million and non-interest income grew 8.7% to $244.5 million. First-half tax-equivalent net interest margin was 3.51%, compared with 3.16%; Q2 tax-equivalent net yield on interest-earning assets was 3.65%, compared with 3.18%.
- Fees: Q2 bank card fees increased 15.9% and trust fees 11.8%; first-half increases were 15.9% and 12.2%, respectively. Lower mortgage-related loan fees partly offset fee growth.
- Expenses and efficiency: Non-interest expense rose 2.8% in Q2 and 2.2% in the first half, primarily reflecting salaries and benefits, technology and marketing. The efficiency ratio improved to 54.06% for Q2 and 56.06% for the first half, from 59.21% and 60.67%, respectively.
- Profitability: Q2 return on average assets was 1.80% and return on average common equity was 16.78%; first-half figures were 1.73% and 16.19%, respectively.
- Taxes and unusual securities items: The effective tax rate was 21.1% in Q2 and 20.0% for the first half, down from 29.6% and 27.9%, primarily because federal tax reform reduced the federal rate from 35% to 21%. Q2 reported a $3.1 million net securities loss versus a $1.7 million gain a year earlier. A $8.9 million adjustment relating to dividend income on an equity security liquidated in Q2 was offset by a comparable increase in investment securities interest income. First-half net securities gains were $2.3 million.
Financial position, cash flow and credit
- Balance sheet at June 30: Assets were $24.5 billion, down from $24.8 billion at year-end 2017. Loans were $14.0 billion, nearly unchanged; deposits were $20.3 billion, down $103.9 million. Deposits included $18.6 billion in core accounts, or 91.7% of total deposits.
- Liquidity and borrowings: Reported liquid assets totaled $9.3 billion, including $8.4 billion of available-for-sale debt securities, $700 million of long-term resale agreements and $114.9 million of Federal Reserve balances. Borrowings totaled $1.18 billion, down from $1.51 billion at year-end, mainly due to lower repurchase-agreement balances. The company reported $3.56 billion of available future advances against pledged collateral at the FHLB and Federal Reserve.
- Cash flow, first half: Operating activities provided $288.1 million and investing activities provided $252.9 million; financing activities used $517.7 million. Cash, cash equivalents and restricted cash increased $23.2 million to $547.6 million. Financing outflows included reduced federal funds purchased and repurchase agreements and $54.7 million of common and preferred dividends.
- Credit quality: The allowance for loan losses was $159.5 million, or 1.14% of loans, unchanged from year-end. First-half provision was $20.4 million and net charge-offs were also $20.4 million. Q2 annualized net charge-offs were 0.29% of average loans, versus 0.32% a year earlier. Non-performing assets were $10.5 million, or 0.04% of assets; non-accrual loans were $9.5 million. Potential problem loans totaled $202.4 million, down 5.1% from year-end.
- Capital: At June 30, Tier 1 common, Tier 1 risk-based, total risk-based and Tier 1 leverage ratios were 13.71%, 14.48%, 15.33% and 11.18%, respectively. The company stated that it exceeded well-capitalized requirements. Book value per common share was $24.64.
Changes, outlook and risks
- Loan growth was concentrated in commercial, business real estate and personal real estate; consumer loans declined, particularly auto, marine/RV and revolving home equity balances. Management attributed auto loan weakness to lower demand and a Q2 loan sale.
- Available-for-sale securities declined from year-end. Unrealized losses on securities in a loss position increased to $137.6 million from $44.1 million, mainly due to rising interest rates. Accumulated other comprehensive loss was $108.8 million at June 30. Management said it did not intend to sell identified impaired non-agency mortgage-backed securities and did not expect to be required to sell them before recovery of amortized cost.
- Consumer credit card charge-offs remain a watch item: Q2 annualized net charge-offs were 4.39%, up from 4.05% in Q1 and 4.25% a year earlier. About $57.4 million of promotional-rate card balances were scheduled to convert to higher contractual rates within six months.
- Interest-rate simulations showed varied sensitivity to rate changes and deposit attrition. Under the more conservative deposit-attrition simulation, a 100-basis-point rate increase reduced modeled net interest income by 1.72%; a 100-basis-point decline reduced it by $18.7 million under the shared falling-rate scenario. These are modeled scenarios, not guidance.
- No earnings or revenue guidance was provided. Management said it expected to meet short-term operating cash needs and considered the loan-loss allowance adequate. It cautioned that results for the interim periods are not necessarily indicative of full-year results.
- Key risks disclosed include economic and loan-demand changes, interest-rate and deposit behavior, regulation and liquidity requirements, competition, cybersecurity, and accounting or tax changes. The company had normal-course legal proceedings; the filing does not provide a clear aggregate potential loss value. Off-balance-sheet commitments included $10.8 billion of loan commitments, $377.5 million of standby letters of credit and $4.3 million of commercial letters of credit. Management expected to fund $87.7 million of outstanding tax-credit purchase commitments during the rest of 2018.
- Accounting changes effective in 2018 included revised equity-security fair value treatment and revenue presentation. The company said these did not materially change overall revenue-recognition processes. CECL, effective for the company in 2020, was expected to increase the allowance at adoption; implementation work was underway.
Important facts for investors to verify
- Whether stronger net interest income and fee growth persist as deposit costs rise and deposit composition changes.
- Credit-card loss trends, promotional-rate conversions, and the trajectory of consumer lending and auto originations.
- The effect of interest rates on the securities portfolio, accumulated other comprehensive loss, deposit retention and modeled net interest income sensitivity.
- Whether earnings growth is sustainable after considering the lower tax rate and the unusual equity-security dividend reclassification/offsetting interest-income adjustment.
- Future funding needs from loan commitments, tax-credit purchase commitments and other contingent obligations, along with the outcome of pending legal matters.