Commerce Bancshares, Inc. — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; unaudited consolidated results. Commerce Bancshares is a bank holding company with Consumer, Commercial, and Wealth segments. Comparisons below are with Q1 2010 unless otherwise noted.
Financial performance and condition
- Profit: Net income was $60.5 million, up 36.9%; diluted EPS was $0.69 versus $0.50. Pretax income rose to $88.5 million from $62.2 million. Return on average assets was 1.32% and return on average equity was 11.95%.
- Revenue and margins: Net interest income was $161.0 million, down 1.1%; noninterest income was $95.9 million, up 2.9%. Net interest margin was 3.85%, versus 4.03%. The efficiency ratio improved to 59.64% from 60.48%.
- Credit costs: Provision for loan losses declined to $15.8 million from $34.3 million. Net charge-offs were $18.8 million, or 0.81% annualized, versus $31.3 million and 1.27%. The allowance was $194.5 million, 2.08% of loans and 250% of non-accrual loans.
- Cash flow: Operating activities provided $102.0 million; investing activities used $417.1 million; financing activities provided $424.1 million. Cash and cash equivalents increased $109.0 million to $569.7 million.
- Balance sheet and funding: Assets were $19.02 billion, up from $18.50 billion at year-end 2010. Loans were $9.37 billion, slightly down from $9.41 billion; deposits rose to $15.54 billion from $15.09 billion. Total equity was $2.07 billion. Federal funds purchased and repurchase agreements were $923.0 million; other borrowings were $112.0 million.
- Capital and liquidity: Tier 1 risk-based capital was 14.75%, total risk-based capital 16.12%, and Tier 1 leverage 10.27%; each exceeded the stated well-capitalized minimum. Liquid assets totaled $8.41 billion. Core deposits were $12.63 billion, or 81.3% of deposits; the company reported $2.82 billion available for future advances from the FHLB and Federal Reserve against pledged collateral.
Material changes versus comparable periods
- Net income increased despite lower net interest income, supported by the lower loan-loss provision, higher fee income, and a $5.0 million year-over-year improvement in securities gains (from a $3.7 million loss to a $1.3 million gain).
- Bank-card fees rose 15.3% and trust fees rose 11.7%; deposit account charges fell 19.5%, including a $4.3 million decline in overdraft fees after new opt-in rules took effect in July 2010.
- Average loans were down $964.3 million year over year, principally reflecting student-loan portfolio sales and declines in construction and consumer lending. Average business loans increased $222.2 million.
- Non-performing assets increased to $103.0 million from $97.3 million at December 31, 2010, primarily because foreclosed real estate rose to $25.1 million from $12.0 million. Potential problem loans rose 11.1% to $259.3 million.
- Total noninterest expense declined 1.1%, including a $1.4 million reduction in the Visa indemnification obligation; however, other expense included a $910,000 resell-agreement termination fee and $877,000 related to a donation of appreciated securities.
Outlook, commentary, risks, and unusual items
- The filing provides no specific earnings or revenue guidance. Management cautions that quarterly results are not necessarily indicative of full-year results. It expected the bank to receive a state banking charter by June 30, 2011; the change was expected to reduce examination fees by approximately $1.5 million annualized.
- Management said it expected to meet short-term liquidity needs. Approximately $1.4 billion of investment securities were expected to mature over the next 12 months. The company had $7.2 billion of loan commitments, including about $3.4 billion of unused approved credit-card lines, and $323.3 million of standby letters of credit; actual funding needs may be lower because commitments can expire unused.
- Credit risks include continued weakness in construction and housing collateral, higher foreclosed real estate, and growth in potential problem loans. Non-agency mortgage-backed securities and illiquid auction-rate securities are also exposed to valuation and credit assumptions. Management warned that further deterioration could produce additional impairment losses.
- At March 31, the company held $143.2 million of auction-rate securities valued using significant unobservable inputs. It recorded $274,000 of additional credit impairment in Q1; cumulative credit-related impairment was $7.8 million. Management said it did not intend, and did not expect to be required, to sell the impaired securities before recovery.
- Proposed debit-card interchange rules could materially reduce fee revenue; the filing noted industry estimates of reductions up to 70% and reported $57 million of debit interchange fees subject to the proposal in 2010. Final rules had been delayed, and the impact remained uncertain. The full effect of Dodd-Frank was also not yet assessable.
- Two proposed class actions allege unfair debit-card overdraft fees. Management said the cases were at an early stage and the probable outcome could not be determined; it did not expect other pending ordinary-course litigation to materially affect results.
- Interest-rate simulations estimated that a gradual 100-basis-point rise would reduce annual net interest income by $2.4 million, while 200- and 300-basis-point rises would increase it by $1.1 million and $2.6 million, respectively. The company did not model a 100-basis-point decline because rates were already low.
Important facts for investors to verify
- Whether credit quality continues to improve: monitor non-performing assets, foreclosed property, potential problem loans, charge-offs, and allowance adequacy.
- Whether lower loan yields and balances continue to pressure net interest income and margin, and whether deposit growth and funding costs offset that pressure.
- Realized performance and valuation assumptions for non-agency mortgage-backed securities, auction-rate securities, and private-equity holdings, including any additional impairment.
- Final debit-interchange regulation and its effect on card revenue, alongside ongoing declines in overdraft fees.
- Progress and realized savings from the proposed state-charter transition, and developments in the overdraft-fee litigation.