Commerce Bancshares, Inc. — Q2 2017 Form 10-Q
Business context and reporting period. Commerce Bancshares is a bank holding company whose operations are conducted primarily through Commerce Bank, with Consumer, Commercial and Wealth segments. This unaudited quarterly report covers the three and six months ended June 30, 2017; balance-sheet comparisons are to December 31, 2016. Results are not necessarily indicative of full-year performance.
Financial performance
| Metric | Q2 2017 | Comparison | First half 2017 | Comparison |
|---|---|---|---|---|
| Net interest income | $182.8 million | Up 6.4% year over year | $361.1 million | Up 7.6% |
| Net interest margin, tax-equivalent | 3.19% | 3.11% in Q2 2016 | 3.16% | 3.03% in H1 2016 |
| Non-interest income | $123.1 million | Up 5.6% | $240.2 million | Up 1.9% |
| Provision for loan losses | $10.8 million | Up 16.7% | $21.9 million | Up 17.3% |
| Non-interest expense | $184.6 million | Up 4.2% | $371.4 million | Up 4.8% |
| Net income attributable to Commerce Bancshares | $79.0 million | Up 13.0% | $150.5 million | Up 11.2% |
| Diluted earnings per common share | $0.75 | $0.66 in Q2 2016 | $1.43 | $1.28 in H1 2016 |
Q2 return on average assets was 1.26%, return on average common equity was 12.48%, and the efficiency ratio was 60.24% (lower than 61.27% a year earlier). For the first half, the respective returns were 1.21% and 12.12%, and the efficiency ratio was 61.67%.
Financial position, cash flow and capital
- Total assets were $25.1 billion, down from $25.6 billion at year-end. Loans rose 1.6% to $13.6 billion; deposits declined 1.3% to $20.8 billion.
- Allowance for loan losses was $157.8 million, or 1.16% of loans. Non-performing assets were $13.9 million, 0.10% of loans; non-accrual loans were $13.4 million.
- For the first half, operating cash flow was $212.0 million and investing activities provided $145.0 million; financing activities used $608.4 million. Cash and cash equivalents ended the period at $531.1 million, down $251.3 million from year-end.
- Borrowings totaled $1.36 billion, down from $1.83 billion at year-end. Available-for-sale securities were $9.44 billion; reported liquid assets totaled $10.16 billion. Core deposits were $18.7 billion, or 90.0% of deposits.
- At June 30, the Tier 1 common, Tier 1 risk-based, total risk-based and Tier 1 leverage capital ratios were 12.28%, 13.05%, 14.00% and 9.87%, respectively. The company reported that regulatory capital exceeded well-capitalized requirements.
Material changes and drivers
- Higher loan balances and yields were the main drivers of net interest income growth. Average loans increased $669 million year over year in Q2, and the average loan yield rose 20 basis points. Funding costs also increased as rates paid on deposits and borrowings rose.
- Trust fees, deposit fees and loan fees grew; bank-card fees were broadly flat in Q2 and down 1.5% for the first half, primarily reflecting lower merchant fees. Capital-markets fees declined.
- Credit costs increased: first-half net charge-offs were $20.0 million versus $16.4 million a year earlier. Q2 annualized net charge-offs were 0.32% of average loans, compared with 0.24% in Q2 2016; consumer credit-card charge-offs were 4.25%.
- Expenses rose, particularly salaries and benefits. Securities donations to a related foundation added $2.3 million of Q2 expense and $4.5 million for the first half; excluding those donations, expense growth was 3.0% for Q2 and 3.5% for the first half.
- Reported securities gains included $2.2 million of gains in each quarter from donated appreciated securities, partly offset by private-equity fair-value losses. The donation transaction also produced tax benefits; reported tax benefits from the adoption of share-based-payment accounting were $1.6 million in Q2 and $4.5 million in Q1.
- Segment first-half pretax income declined 6.7% in Consumer and 2.4% in Commercial, while Wealth increased 13.3%. Consolidated pretax income rose 6.4%.
Outlook, risks and contingencies
- The filing provides no specific earnings or revenue guidance. Management said normal short-term liquidity needs were not expected to vary significantly and believed the company could meet them. About $1.6 billion of investment securities were expected to mature or pay down over the next 12 months.
- Interest-rate simulations showed that a gradual 100–300 basis-point increase could raise modeled net interest income by $9.1–$15.1 million under one deposit-attrition assumption, but reduce it by $5.1–$5.6 million under a more severe deposit-outflow scenario. These are model results, not forecasts.
- Loan commitments totaled $10.4 billion, including about $5.0 billion in unused approved credit-card lines. Standby letters of credit totaled $338.8 million. Commitments may expire unused or be only partly drawn.
- The company had $59.2 million in troubled debt restructurings and $107.8 million in potential problem loans. Management highlighted rising consumer credit-card losses; the allowance was unchanged at 1.16% of loans from year-end. The filing also noted expected allowance growth when the CECL standard is adopted in 2020.
- A Missouri class action alleging unlawful overdraft fees remained stayed pending the outcome of a similar case; the company said it would defend the matter and that ultimate exposure could not be determined. A Department of Labor investigation concluded in a non-material settlement in July 2017.
- Other stated risks include economic and interest-rate changes, deposit attrition, loan demand, regulation, competition, accounting and tax changes, and valuation uncertainty in securities. The company reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether loan growth and higher yields can continue to offset rising deposit and borrowing costs.
- Whether consumer credit-card charge-offs and overall loan-loss provisions stabilize, and whether the allowance remains adequate.
- How deposit balances and funding costs respond to higher rates, particularly under the more severe outflow scenario.
- How much reported earnings growth depends on securities donations, related gains and tax-accounting benefits rather than recurring operations.
- Developments in the overdraft-fee litigation, CECL implementation and the company’s substantial off-balance-sheet commitments.