Commerce Bancshares, Inc. — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 30, 2010. Unaudited consolidated results; comparisons are with the corresponding 2009 periods unless otherwise noted. Amounts are in millions except per-share data and ratios.
Financial performance and material changes
- Q2 net income was $59.7, up 61.6%; diluted EPS was $0.71 versus $0.46. For the first half, net income was $103.9, up 53.2%, and diluted EPS was $1.24 versus $0.84.
- Q2 net interest income increased 3.6% to $163.1; the tax-equivalent net interest margin rose to 3.97% from 3.91%. Lower deposit and borrowing costs more than offset weaker loan income and lower securities yields. First-half net interest income was $325.8, up 6.0%; tax-equivalent net yield on interest-earning assets was 4.00% versus 3.87%.
- Non-interest income rose 3.1% to $101.6 in Q2 and 2.0% to $194.9 for the first half, chiefly reflecting bank-card fee growth. Q2 bank-card fees rose 25.1%; deposit fees fell 5.4%, including lower overdraft fees.
- Credit costs eased: Q2 provision was $22.2, down from $41.2, and first-half provision was $56.5 versus $84.3. Q2 net charge-offs were $22.2, or 0.91% annualized of average loans, versus 1.33% a year earlier. The allowance was $197.5, 2.03% of loans excluding loans held for sale and 219% of non-accrual loans.
- Expenses and profitability: Q2 non-interest expense declined 2.5% to $156.0; first-half expense declined 0.4% to $311.8. Q2 return on average assets was 1.33%, return on average equity 12.21%, and efficiency ratio 58.48% (62.15% a year earlier). Deposit-insurance expense declined substantially because the prior-year quarter included an FDIC special assessment; a $1.7 Visa-litigation charge reversal also reduced current-quarter expense.
- Balance sheet at June 30: Total assets were $18.38 billion, up from $18.12 billion at year-end 2009. Loans excluding held-for-sale loans fell 4.0% to $9.74 billion, while deposits rose 1.9% to $14.49 billion. Available-for-sale securities were $6.65 billion. Shareholders’ equity was $1.99 billion.
Cash flow, liquidity and capital
- First-half operating cash flow was $94.7; investing activities provided $325.5; financing activities used $232.4. Cash and cash equivalents increased $187.8 to $651.6.
- Total borrowings were $1.37 billion at June 30, down from $1.84 billion at year-end, principally following repayments of FHLB advances. Core deposits were $11.30 billion, or 78.0% of deposits. The company reported $1.11 billion of available FHLB advance capacity and $1.83 billion of Federal Reserve capacity, subject to pledged collateral and facility terms.
- The bank subsidiary’s Tier 1 risk-based, total risk-based and Tier 1 leverage ratios were 14.11%, 15.49% and 10.01%, respectively; management said these exceeded well-capitalized regulatory guidelines. The quarterly dividend was $0.235 per share.
Outlook, risks and unusual items
- Overdraft rules: New rules effective July 1, 2010 generally require customer opt-in for overdraft fees on ATM and one-time debit-card transactions. Management estimated a pre-tax reduction in deposit-fee income of up to $13 million in the second half of 2010 and $16–$21 million for full-year 2010.
- Student lending: Federal legislation ended the company’s origination of federally subsidized student loans beginning July 1, 2010. The company reported selling $218 million of student loans in July, with a $3.3 million gain, and expected to sell most remaining held-for-sale loans later in the year.
- Credit and securities exposure: Non-accrual loans declined to $90.3 million, and non-performing assets were $103.2 million, or 1.06% of loans. Potential problem loans were $279.9 million. The securities portfolio included $152.1 million of illiquid auction-rate securities valued using significant unobservable inputs, and non-agency mortgage-backed securities subject to further impairment risk. Credit-related OTTI recognized on certain non-agency securities totaled $4.6 million cumulatively; the related noncredit loss in other comprehensive income was $21.7 million pre-tax.
- Contingencies: Two class-action suits allege improper debit-card overdraft fees; the company said it considers the claims without merit and intends to defend them. Outcome was not determinable at the filing date. Standby letters of credit totaled $386.8 million; loan commitments were $6.9 billion, including about $3.3 billion in unused approved credit-card lines. These amounts are commitments, not expected cash outlays.
- The company committed to borrow $400 million under structured repurchase agreements in August 2010, largely replacing maturities. It also disclosed that the impact of the July 2010 Dodd-Frank Act could not yet be determined. No specific earnings or full-year financial guidance was provided; management cautioned that interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether lower loan balances and reduced credit costs continue, and whether the allowance remains appropriate as problem-loan and foreclosure trends evolve.
- Realized performance and valuation assumptions for non-agency mortgage-backed and auction-rate securities, including any further impairment.
- Actual revenue impact from overdraft opt-in rules, and the transition of the student-loan business after federal origination changes.
- Cash and funding needs, collateral availability, and the terms and repricing effects of the planned $400 million structured borrowing.
- Developments in the overdraft-fee lawsuits and implementation of Dodd-Frank provisions affecting the company.