Commerce Bancshares, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual report, not a standalone fourth-quarter filing; selected fourth-quarter results are included below. The company is a regional bank holding company operating primarily in the lower Midwest, with Commercial, Consumer and Wealth segments.
Financial performance and position
| Metric | 2018 | 2017 |
|---|---|---|
| Net interest income | $823.8 million | $733.7 million |
| Non-interest income | $501.3 million | $461.3 million |
| Total revenue (net interest income plus non-interest income) | $1.325 billion | $1.195 billion |
| Net income attributable to Commerce Bancshares | $433.5 million | $319.4 million |
| Diluted earnings per common share | $3.78 | $2.76 |
| Net yield on interest-earning assets, tax-equivalent | 3.53% | 3.19% |
| Loans, year-end | $14.14 billion | $13.98 billion |
| Deposits, year-end | $20.32 billion | $20.43 billion |
| Total assets, year-end | $25.46 billion | $24.83 billion |
| Total equity, year-end | $2.94 billion | $2.72 billion |
| Long-term debt, year-end | $8.7 million | $1.8 million |
Net income rose 35.7%; diluted EPS rose 37.0%. Net interest income increased 12.3%, mainly as asset yields rose faster than funding costs. Non-interest income increased 8.7%, led by bank card, trust and deposit fees. Non-interest expense declined 0.9%, largely because a $32.0 million charitable securities donation recorded in 2017 did not recur; excluding that item, expense grew 3.6%, principally due to salaries and benefits.
Return on average assets was 1.76% versus 1.28%, and return on average common equity was 16.16% versus 12.46%. The efficiency ratio improved to 55.58% from 62.18%; the prior-year donation materially affected comparability. Net loan charge-offs were $42.3 million, or 0.30% of average loans, compared with $41.6 million, or 0.31%. The allowance for loan losses was $159.9 million, 1.13% of loans versus 1.14%.
Fourth quarter: Net income attributable to the company was $109.7 million, compared with $94.4 million in fourth-quarter 2017. Fourth-quarter diluted EPS was $0.96 versus $0.82. Quarterly net interest income was $212.2 million, and the provision for loan losses was $12.3 million.
Cash flow, liquidity and capital
Operating activities provided $552.7 million of cash; investing activities used $91.0 million; and financing activities provided $223.3 million. Cash, cash equivalents and restricted cash increased $684.9 million to $1.21 billion. Financing included a $449.3 million increase in federal funds purchased and short-term repurchase-agreement funding, while deposits decreased $48.5 million on the cash-flow statement.
Core deposits were $18.67 billion, or 91.8% of deposits. Available-for-sale debt securities were $8.54 billion; reported liquid assets totaled $9.93 billion. The average loans-to-deposits ratio was 69.27%. The company reported $3.56 billion of available future borrowing capacity through the FHLB and Federal Reserve, with no FHLB advances outstanding at year-end. Short-term borrowings, principally repurchase agreements, totaled $1.96 billion.
Capital remained strong: the consolidated Tier 1 common risk-based capital ratio was 14.22%, total risk-based capital was 15.82%, and the Tier 1 leverage ratio was 11.52%. Tangible common equity to tangible assets was 10.45%, up from 9.84%. The company and its bank subsidiary exceeded applicable well-capitalized requirements.
Material changes and unusual items
- Net securities results were a $0.5 million loss in 2018, versus $25.1 million in gains in 2017. The 2018 result included $9.7 million of losses on debt-security sales as the company repositioned the portfolio, and an $8.9 million adjustment related to a liquidated equity investment; private-equity and other equity gains partly offset these items. The 2017 result included gains associated with donated appreciated securities.
- The available-for-sale debt portfolio had a $64.6 million net unrealized loss at year-end, compared with a $10.0 million unrealized gain a year earlier, mainly reflecting rising rates. This affected accumulated other comprehensive income and equity.
- The federal corporate tax rate reduction contributed to a lower effective tax rate: income tax expense was $105.9 million and the effective rate was 19.6%, versus $110.5 million and 25.7% in 2017.
- The company repurchased 1.19 million shares during 2018 for $75.2 million and paid $100.2 million of common dividends. The common dividend was increased 16% for the first quarter of 2019; the 2018 annual common cash dividend was $0.895 per share. A 5% stock dividend was distributed in December 2018, and per-share figures are restated for it.
- Leadership changed in August 2018: John W. Kemper became CEO and David W. Kemper became Executive Chairman.
Outlook, risks and contingencies
The filing provides no specific earnings, revenue or loan-growth guidance. Management described economic conditions in its markets as favorable but made no prediction about future interest rates, deposits, loan demand or their financial effects. Its strategy emphasizes core revenue growth, customer relationships, controlled market expansion, technology and customer service.
- Rates and funding: The Federal Reserve raised its benchmark rate four times in 2018. Management’s simulations show differing net-interest-income outcomes depending on rate movements and deposit attrition; under a modeled 100-basis-point rate decline, net interest income falls 2.03% in one scenario. Actual deposit behavior and results may differ. LIBOR transition also creates uncertainty for instruments linked to that benchmark.
- Credit: Non-performing assets were $13.9 million, or 0.10% of loans, and potential problem loans declined to $145.7 million from $213.4 million. Credit-card charge-offs remained a substantial share of total charge-offs. The allowance depends on estimates and could require adjustment as conditions change.
- Securities and valuation: Market-rate changes, credit deterioration and less-observable valuation inputs could affect securities values and earnings. Level 3 recurring fair-value assets totaled $100.4 million.
- Commitments and legal matters: Off-balance-sheet commitments included $11.2 billion to extend credit, including $5.3 billion of unused approved credit-card lines, and $353.9 million of standby letters of credit. Management did not anticipate material losses from these commitments. Ordinary-course legal proceedings were pending; the filing does not quantify potential losses where they were not considered probable and estimable.
- Other execution and regulatory risks: The company identified cybersecurity, reliance on external vendors, competition, regulation and its core deposit-system replacement as risks. It expected CECL adoption on January 1, 2020 to increase the allowance, but the amount was not yet determined. The company adopted the new lease standard in January 2019, recognizing a $28.1 million lease liability and $27.5 million right-of-use asset; management did not expect a material impact on consolidated statements or key balance-sheet ratios.
Most important facts for investors to verify
- Whether net interest income growth can continue as deposit costs rise and deposits shift or run off.
- Credit trends, especially card losses, business-loan exposures, non-accrual loans and the eventual effect of CECL on reserves and capital.
- Whether securities valuation losses and unrealized portfolio marks recover, stabilize or lead to further earnings or equity effects.
- Actual utilization and funding needs for large credit commitments, repurchase agreements and the $180.5 million of tax-credit purchase commitments expected to be funded in 2019.
- Progress and costs of the core deposit-system replacement, cybersecurity controls and LIBOR-transition preparations.
- The assumptions underlying the favorable economic commentary and the absence of formal financial guidance.
KPMG issued unqualified opinions on the consolidated financial statements and on the effectiveness of internal control over financial reporting as of December 31, 2018.