Commerce Bancshares, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015. Unaudited consolidated results include the Company and its subsidiaries; most operations are conducted through Commerce Bank. Comparisons are with Q1 2014 unless otherwise noted.
Financial performance
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Net interest income | $146.1 million | $153.1 million |
| Non-interest income | $106.4 million | $102.6 million |
| Investment securities gains, net | $6.0 million | $10.0 million |
| Non-interest expense | $163.7 million | $162.0 million |
| Net income attributable to Commerce Bancshares | $61.1 million | $64.3 million |
| Net income available to common shareholders; diluted EPS | $58.8 million; $0.61 | $64.3 million; $0.64 |
| Net interest margin (tax-equivalent); efficiency ratio | 2.76%; 64.63% | 3.03%; 63.13% |
| Return on average assets; return on average common equity | 1.05%; 10.69% | 1.16%; 11.56% |
Net income attributable to the Company fell 5.1%; earnings available to common shareholders fell 8.6%, partly reflecting $2.25 million of preferred dividends. Net interest income declined primarily because inflation-related interest on Treasury inflation-protected securities (TIPS) was $7.8 million lower. Tax-equivalent net interest income was $153.3 million, down $6.4 million. Net yield on earning assets was 2.76%, versus 3.03% a year earlier; excluding lower inflation income, management reported a 2.86% yield.
Non-interest income grew 3.7%, led by trust fees (+11.3%), as well as brokerage and mortgage banking revenue. Non-interest expense increased 1.1%, mainly from salaries and benefits. Securities gains were lower year over year: Q1 2015 included $3.5 million of private-equity gains and $2.5 million of gains on securities sales; Q1 2014 included a large gain on a long-held private-equity investment.
Financial position, cash flow and capital
- Balance sheet: Total assets were $24.05 billion at March 31, 2015, compared with $23.99 billion at December 31, 2014. Loans were $11.72 billion, up from $11.47 billion; available-for-sale securities were $9.92 billion, up from $9.52 billion.
- Funding and liquidity: Deposits totaled $19.58 billion, including $17.44 billion of core deposits (89.1% of deposits). Borrowings totaled $1.71 billion, principally repurchase agreements. Cash and cash equivalents were $552.3 million, down $548.4 million during the quarter. Operating cash flow was $95.5 million; investing activities used $600.5 million, including securities purchases and loan growth; financing activities used $43.5 million.
- Capital: Under Basel III, effective for the Company from January 1, 2015, the Tier 1 common risk-based ratio was 12.10%, Tier 1 risk-based ratio 12.96%, total risk-based ratio 13.98%, and Tier 1 leverage ratio 9.31%. Management said the Company exceeded well-capitalized thresholds. The Basel III risk-weighted-asset calculation and new rules make direct comparison with Q1 2014 capital ratios inappropriate.
- Dividends and repurchases: The common dividend was $0.225 per share, up 5% from the 2014 quarterly dividend. The 2014 accelerated share repurchase was expected to be finally settled by June 2015; in April, the Board increased repurchase authorization to 5 million shares.
Material changes, credit quality and notable items
- Provision for loan losses declined to $4.4 million from $9.7 million. Net charge-offs were $7.4 million, or 0.26% annualized of average loans, versus $9.7 million and 0.35%. The allowance was $153.5 million, 1.31% of loans and 429% of non-accrual loans.
- Non-accrual loans decreased to $35.8 million from $40.8 million at year-end; non-performing assets were $40.8 million, or 0.17% of assets. However, potential problem loans increased 11.2% to $90.3 million, largely from several commercial and industrial loans. Troubled debt restructurings totaled $65.9 million.
- Available-for-sale securities had a $184.4 million net unrealized gain. Securities with unrealized losses declined to $1.9 billion fair value and $19.7 million of losses from $3.3 billion and $35.4 million at year-end. The portfolio included $93.3 million of illiquid auction-rate securities; management’s valuation depends on unobservable assumptions. Certain non-agency mortgage-backed securities had $52.5 million fair value and $13.7 million cumulative credit-related impairment.
- The Company began selling certain newly originated long-term fixed-rate residential mortgages in 2015 and recorded $2.8 million of such loans held for sale at quarter-end. It also adopted a new low-income-housing-investment accounting method, reclassifying amortization to income tax expense; management said the impact was not significant.
- Q1 property write-downs included $1.6 million on two bank properties. The quarter’s securities sales were part of a plan to extend portfolio duration and improve net interest margins.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management said it expects to meet short-term operating cash needs and described substantial liquidity sources, including approximately $3.37 billion of estimated additional FHLB and Federal Reserve advance capacity, subject to collateral availability. About $2.0 billion of securities were expected to mature or pay down over the next 12 months. Management cautioned that quarterly results are not necessarily indicative of full-year results.
Interest-rate simulations showed that, with the modeled deposit runoff assumptions, a gradual 100-basis-point rise would increase annual net interest income by 1.01%, a 200-basis-point rise by 0.73%, and a 300-basis-point rise would reduce it by 0.03%. Alternative simulations assuming less deposit runoff showed gains under all three scenarios. Outcomes are sensitive to deposit behavior, funding costs, prepayments and asset mix; the Company did not model falling-rate scenarios.
Key risks discussed include changes in economic conditions, interest rates, loan demand, regulation, liquidity requirements, competition and accounting or tax rules. Off-balance-sheet commitments included $9.3 billion of loan commitments (about $4.3 billion of unused approved credit-card lines), $313.8 million of standby letters of credit and $12.2 million of commercial letters of credit. A Missouri customer class action alleges unlawful overdraft fees on debit/POS and ATM transactions; the Company disputes the claim, and potential exposure could not be determined. Other ordinary-course litigation is also pending.
Important facts for investors to verify
- Whether loan growth and fee growth can offset lower net interest income and continued margin pressure, particularly as TIPS inflation income changes.
- Whether potential problem loans, consumer credit-card charge-offs and troubled restructurings remain contained, and whether the allowance remains adequate.
- How auction-rate securities and other less-liquid or Level 3 investments perform, and whether securities gains remain a meaningful but variable contributor to earnings.
- Actual funding and deposit behavior under rising rates, including reliance on overnight repurchase funding and the availability of pledged collateral.
- Resolution and possible financial impact of the overdraft-fee class action, and final settlement of the accelerated share repurchase and its effect on capital and common shares.