Commerce Bancshares, Inc. — Q2 2014 Form 10-Q
Business context and reporting period. The filing covers the unaudited quarter and six months ended June 30, 2014. Commerce Bancshares is a bank holding company whose principal operations are conducted through Commerce Bank, across Consumer, Commercial and Wealth segments. Results include Summit Bancshares, acquired in September 2013; the company cautions that interim results are not necessarily indicative of full-year performance.
Financial performance and condition
| Metric | Q2 2014 | Six months 2014 |
|---|---|---|
| Net interest income | $160.5 million, up 0.6% year over year | $313.6 million, up 1.2% |
| Non-interest income | $108.8 million, up 5.9% | $211.4 million, up 4.4% |
| Provision for loan losses | $7.6 million | $17.2 million, up 61.4% |
| Net income attributable to Commerce Bancshares | $66.5 million, up 1.1% | $130.8 million, up 3.2% |
| Diluted EPS | $0.70, versus $0.69 | $1.37, versus $1.32 |
| Net interest margin, tax-equivalent | 3.13%, versus 3.21% | 3.08%, versus 3.14% |
| Efficiency ratio | 60.30%, versus 59.73% | 61.75%, versus 60.72% |
Quarterly pre-tax income was essentially unchanged at $96.2 million. Higher card and trust fees supported revenue, while higher salaries and benefits, other operating costs and loan-loss provision weighed on earnings. Return on average assets was 1.18% for Q2 and 1.17% for the first half.
Balance sheet and funding. Total assets were $23.0 billion at June 30, 2014, broadly flat from year-end. Loans grew 4.6% to $11.46 billion, led by business and consumer lending. Deposits were $18.94 billion, down $107.5 million from year-end; non-interest-bearing deposits declined $337.5 million. Total borrowings were $1.26 billion, down from $1.45 billion at year-end. The allowance for loan losses was $161.5 million, or 1.41% of loans and 373% of non-accrual loans.
Cash flow and liquidity. First-half operating cash flow was $208.9 million; investing activities used $538.3 million and financing activities used $375.2 million. Cash and cash equivalents declined $704.6 million to $564.9 million. Management reported $10.28 billion of liquid assets, including available-for-sale securities and resell agreements, and $3.41 billion of estimated additional FHLB/Federal Reserve advance capacity. Core deposits represented 87.1% of deposits. These figures should be considered alongside pledged collateral and the company’s reliance on repurchase funding.
Capital. At June 30, the Tier 1 risk-based capital ratio was 13.39%, total risk-based capital ratio 14.58%, and Tier 1 leverage ratio 9.12%. The company said it expected to remain well-capitalized under Basel III rules taking effect in 2015. Tangible common equity to assets was 8.61%, versus 9.06% a year earlier.
Material changes and notable items
- Loan growth was accompanied by a higher first-half provision, while net charge-offs were nearly unchanged year over year at $17.2 million. Q2 annualized net charge-offs were 0.27% of average loans, down from 0.37% a year earlier.
- Non-performing assets fell to $51.7 million, or 0.45% of loans, from $55.4 million at year-end. However, potential problem loans increased 11.9% to $110.1 million. Troubled debt restructurings totaled $82.3 million.
- First-half investment securities gains were $7.5 million, versus losses of $3.7 million in the prior-year period. The 2014 result included a $19.5 million gain from a long-held private equity investment sale, partly offset by other private equity valuation losses and a $5.2 million realized loss on Treasury inflation-protected securities. Q2 recorded net securities losses of $2.6 million.
- In June, the company issued preferred stock with $150 million aggregate liquidation preference, receiving approximately $144.8 million net, and entered a $200 million accelerated share repurchase. It received 3.06 million shares initially; final settlement was expected by June 2015. The preferred shares carry a 6% non-cumulative dividend if declared; the first dividend was declared after quarter-end.
- On July 25, 2014, the company sold three Missouri branches, including approximately $13.3 million of loans and $60.3 million of deposits.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management cited continued sensitivity to economic conditions, interest rates, loan demand, regulation, competition, tax estimates and litigation outcomes. Its interest-rate simulations estimated that a gradual 100-basis-point rate increase would raise annual net interest income by 0.72%, a 200-basis-point increase by 0.18%, while a 300-basis-point increase would reduce it by 0.66%; management noted the profile had become less asset-sensitive. No falling-rate scenarios were modeled.
Key credit and market exposures include consumer credit card charge-offs, rising potential problem loans, impaired and restructured credits, and valuation uncertainty in private equity and auction-rate securities. Available-for-sale securities had a $160.7 million net unrealized gain; $132.1 million of auction-rate securities relied on Level 3 valuation inputs. Commitments included $8.3 billion of loan commitments, $340.1 million of standby letters of credit, and $186.3 million of outstanding tax-credit purchase commitments. The company reported no material pending or threatened legal proceedings; certain routine lawsuits remain, and it recorded a $3.4 million liability for standby letters of credit.
Important facts for investors to verify
- Whether loan growth and fee income can offset pressure on loan yields, net interest margin and operating expenses.
- Credit quality trends, particularly the increase in potential problem loans, TDR performance, consumer credit card losses and adequacy of the unchanged allowance.
- How much reported first-half earnings depended on private equity gains and other securities transactions, and whether those items recur.
- Liquidity and capital effects of the $200 million share repurchase, preferred dividends, deposit mix changes and pledged collateral.
- Actual performance under changing interest rates, including outcomes outside the modeled scenarios and Basel III capital requirements.