Commerce Bancshares, Inc. — Q1 2018 Form 10-Q
Business context and reporting period. Commerce Bancshares is a bank holding company whose operations are primarily conducted through Commerce Bank, across Consumer, Commercial and Wealth segments. This unaudited filing covers the three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017. Amounts below are in U.S. dollars.
Key financial results
| Metric | Q1 2018 | Q1 2017 / comparison |
|---|---|---|
| Net interest income | $192.9 million | $178.3 million; up 8.2% |
| Net interest income after provision | $182.5 million | $167.1 million |
| Non-interest income | $119.7 million | $109.6 million; up 9.2% |
| Investment securities gains (losses), net | $5.4 million | ($0.8) million |
| Non-interest expense | $182.3 million | $179.4 million; up 1.6% |
| Net income attributable to Commerce Bancshares, Inc. | $101.0 million | $71.5 million; up 41.2% |
| Net income available to common shareholders | $98.7 million | $69.3 million; up 42.6% |
| Diluted earnings per common share | $0.92 | $0.65 |
| Net interest margin, tax-equivalent | 3.37% | 3.13% |
| Efficiency ratio | 58.21% | 62.19% |
| Return on average assets / common equity | 1.66% / 15.58% | 1.15% / 11.74% |
Balance sheet, credit and liquidity
- Total assets were $24.6 billion, down from $24.8 billion at year-end. Loans were $13.9 billion, down modestly from $14.0 billion; deposits were $20.5 billion, up from $20.4 billion.
- Average loans grew 2.9% year over year, supported by commercial and consumer lending. Average investment securities fell by $1.0 billion year over year to $8.7 billion as maturities and paydowns were generally reinvested in loans.
- The allowance for loan losses was $159.5 million, or 1.15% of loans, unchanged in dollars from year-end. Q1 provision was $10.4 million, approximately equal to net charge-offs. Annualized net charge-offs were 0.30% of average loans, versus 0.28% a year earlier.
- Non-performing assets were $11.6 million, or 0.08% of loans. Non-accrual loans were $10.3 million. Potential problem loans declined to $196.6 million from $213.4 million at year-end; troubled debt restructurings totaled $100.9 million.
- Cash from operating activities was $144.0 million; investing activities provided $283.4 million; financing activities used $366.8 million. Cash, cash equivalents and restricted cash increased $60.6 million to $584.9 million.
- Liquid assets totaled $9.3 billion. Core deposits were $18.8 billion, or 91.4% of deposits. Borrowings were $1.14 billion, down from $1.51 billion at year-end, primarily reflecting lower repurchase-agreement and federal-funds balances.
- Capital ratios remained above well-capitalized thresholds: Tier 1 common 13.26%, Tier 1 risk-based 14.02%, total risk-based 14.87%, and Tier 1 leverage 10.83%. The company repurchased 290,684 shares at an average $58.71 and paid a $0.235 common dividend per share.
Material changes versus the prior comparable period
- Earnings growth reflected higher loan interest income, fee growth and a $6.2 million year-over-year swing in securities results. Higher average loan balances and yields lifted tax-equivalent loan interest income by $17.6 million; higher deposit and borrowing costs partly offset the benefit.
- Bank-card fees rose 15.9%, trust fees 12.6%, and deposit-account fees 4.7%. Expense growth was restrained at 1.6%, although salaries and benefits and marketing costs increased.
- Income tax expense fell to $23.3 million from $24.9 million despite higher pretax income. Management attributed the lower tax burden primarily to the federal corporate tax rate reduction from 35% to 21%, as well as first-quarter share-based tax benefits.
- Unrealized losses on available-for-sale debt securities increased with the rising-rate environment. The portfolio had $114.4 million of gross unrealized losses at March 31, compared with $44.1 million at year-end; the filing attributes the increase mainly to rising rates. The accumulated other comprehensive income balance moved from a $14.1 million gain at year-end to an $89.6 million loss.
Management commentary, outlook and risks
- The filing gives no specific earnings or revenue guidance. Management states that Q1 results are not necessarily indicative of full-year results and expects routine short-term liquidity needs to be met.
- Interest-rate simulations show mixed sensitivity: with the lower deposit-attrition assumption, a gradual 100- or 200-basis-point rise was projected to increase 12-month net interest income by $3.0 million or $1.9 million, while a 300-basis-point rise was projected to reduce it by $2.3 million. Under the higher deposit-attrition scenario, projected net interest income declined under all three rising-rate cases, by $13.0 million to $23.3 million. These are simulations, not forecasts.
- Management identified loan-loss allowance estimation, valuation of certain investment securities and income taxes as critical accounting areas involving judgment. The company expects adoption of the CECL credit-loss standard in 2020 to increase the allowance; implementation work was underway.
- Commitments included $10.8 billion of loan commitments, including about $5.2 billion of unused approved credit-card lines; $389.6 million of standby letters of credit; and $102.7 million of expected remaining-2018 tax-credit purchase commitments. These amounts do not necessarily represent future cash requirements.
- The company had ordinary-course legal proceedings; some early-stage matters could not yet be assessed as probable and estimable. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
- New accounting standards adopted in 2018 included equity-security fair-value changes through earnings and reclassifications between accumulated other comprehensive income and retained earnings. Adoption of revenue guidance also changed presentation of certain card-network and rewards costs, with no effect on prior-period net income or EPS.
Important facts for investors to verify
- Whether loan growth and higher loan yields can continue to offset rising deposit and borrowing costs, and how deposit pricing and retention evolve.
- Credit performance, particularly consumer credit-card charge-offs, consumer loan losses, restructured loans and the adequacy of the $159.5 million allowance.
- Whether the securities portfolio’s unrealized losses remain rate-driven or reflect deterioration in expected cash flows; also verify the timing and realization of private-equity gains and the anticipated equity-security merger transaction.
- How much the lower federal tax rate and seasonal share-based tax benefits contribute to future effective tax rates.
- Execution of CECL preparation and the eventual allowance impact, alongside lease-standard implementation for approximately 200 lease agreements.
- Use of capital for dividends and repurchases, and the potential funding impact of loan commitments, deposit movements and off-balance-sheet contingencies.