COMMERCE BANCSHARES INC quarterly report, Q2 FY2011

Commerce Bancshares, Inc. — Q2 2011 Form 10-Q

Business context and reporting period. Commerce Bancshares is a bank holding company with Consumer, Commercial and Wealth segments. This unaudited filing covers the quarter and six months ended June 30, 2011; comparisons are with the corresponding 2010 periods. Balance-sheet comparisons are with December 31, 2010. Figures below are in U.S. dollars; financial statement amounts are rounded to millions unless stated otherwise.

Key financial results

MetricQ2 2011Q2 2010Six months 2011Six months 2010
Net interest income$164.7m$163.1m$325.7m$325.8m
Provision for loan losses$12.2m$22.2m$28.0m$56.5m
Non-interest income$101.3m$101.5m$197.3m$194.6m
Investment securities gains, net$2.0m$0.7m$3.3m$(3.0)m
Non-interest expense$153.5m$155.8m$307.5m$311.5m
Net income attributable to Commerce$69.0m$59.7m$129.5m$103.9m
Diluted earnings per share$0.79$0.68$1.48$1.18
  • Q2 net income attributable to Commerce rose 15.6%; six-month income rose 24.6%. Lower loan-loss provisions were a major contributor to the improvement.
  • Q2 tax-equivalent net interest margin was 3.85%, down from 3.97% a year earlier. The six-month net yield on interest-earning assets was 4.17%, versus 4.57%.
  • Q2 return on average assets was 1.47%, return on average equity 13.12%, and efficiency ratio 57.40%. For the first six months, these were 1.40%, 12.54%, and 58.50%, respectively.
  • Bank card and trust fees grew, while deposit account charges fell. Six-month non-interest income increased 1.3%; expense declined 1.3%.

Financial position, liquidity and capital

  • At June 30, total assets were $19.57bn, up from $18.50bn at year-end. Total loans were $9.24bn, down from $9.41bn; deposits were $15.66bn, up from $15.09bn.
  • Available-for-sale securities totaled $7.72bn. Cash and cash equivalents were $887.1m, compared with $460.7m at year-end. Reported liquid assets, including available-for-sale securities and resell agreements, totaled $9.11bn.
  • Six-month cash flows: operating activities provided $194.9m; investing activities used $667.2m; financing activities provided $898.8m. Net cash increased $426.5m.
  • Total liabilities were $17.44bn. Federal funds purchased and repurchase-agreement balances were $1.28bn; other borrowings were $111.9m. Management described long-term debt as limited and reported no subordinated debt or hybrid instruments.
  • Regulatory capital remained above well-capitalized thresholds: Tier 1 risk-based capital ratio 15.10%, total risk-based ratio 16.46%, and Tier 1 leverage ratio 10.32% at June 30.

Material changes and credit quality

  • Net charge-offs declined to $15.2m in Q2 from $22.2m a year earlier; the annualized charge-off rate was 0.66%, compared with 0.91%. Six-month net charge-offs were $34.0m versus $53.5m.
  • The allowance for loan losses was $191.5m, or 2.07% of loans excluding loans held for sale, and 240.3% of non-accrual loans. Management considered the allowance adequate.
  • Non-accrual loans were $79.7m, down from $85.3m at year-end, but foreclosed real estate rose to $23.6m from $12.0m. Total non-performing assets increased to $103.3m from $97.3m.
  • Potential problem loans increased 15.4% to $269.6m from $233.5m, largely following credit-rating downgrades in business real estate and construction lending. Total troubled debt restructurings were approximately $99.9m; $30.0m were non-accrual.
  • Available-for-sale securities increased from $7.29bn to $7.72bn. The company recorded $0.9m of net impairment losses for the six months; cumulative credit-related impairment on certain non-agency mortgage-backed securities was $8.5m. Management warned that further deterioration in collateral performance could cause additional impairment.

Outlook, commentary and risks

  • No general earnings or full-year financial guidance was provided. Management cautioned that interim results are not necessarily indicative of future periods.
  • The Federal Reserve’s debit-card interchange rule was expected to reduce debit-card revenue by approximately $7m in Q4 2011. The bank also anticipated about $1.5m in annual examination-fee savings following its June 2011 conversion to a state-chartered Federal Reserve member bank.
  • Management cited weak demand for business and construction loans, continued paydowns in consumer and marine/RV lending, and lower loan yields. The company had largely exited student-loan originations following regulatory changes.
  • A May 2011 tornado in Joplin destroyed two of the company’s four branches there. Management expected insurance to cover the premises loss and did not expect a significant effect on overall operations.
  • Q2 other expense included a $5m accrual for potential litigation losses and a $1m fraud loss. The filing said reasonably possible additional legal losses could reach $5m above amounts accrued. An overdraft-fee class-action case remained pending; management said it believed it had substantial defenses.
  • Other risks include uncertain economic and regulatory conditions, interest-rate changes, credit losses, valuation uncertainty in securities and private equity, and liquidity or funding changes. The filing noted $141.9m of illiquid auction-rate securities valued using significant unobservable inputs.

Important facts for investors to verify

  • Whether credit quality continues to improve, particularly given higher foreclosed real estate and potential problem loans.
  • Whether the $191.5m loan-loss allowance remains adequate as charge-offs, delinquencies, and loan ratings evolve.
  • The realized impact of debit interchange limits on card revenue and the extent to which new fees or other income offset it.
  • Future impairment exposure in non-agency mortgage-backed, auction-rate, and private equity holdings, including key valuation assumptions.
  • The outcome and potential cost of pending litigation, including the overdraft-fee case and the $5m accrual and additional-loss estimate.
  • How deposit growth, repurchase funding, and investment maturities affect liquidity, and whether capital remains above regulatory requirements.