Commerce Bancshares, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Unaudited consolidated results; most banking operations are conducted through Commerce Bank.
Financial performance and condition
| Metric | Q3 2012 | Prior comparable period |
|---|---|---|
| Net income attributable to Commerce Bancshares | $66.0 million | $65.4 million; up 1.0% |
| Diluted EPS | $0.75 | $0.72; up 4.2% |
| Net interest income | $153.8 million | $158.6 million; down 3.0% |
| Net interest margin | 3.30% | 3.51%; 3.55% in Q2 2012 |
| Provision for loan losses | $5.6 million | $11.4 million |
| Non-interest income | $100.9 million | $101.6 million |
| Non-interest expense | $153.4 million | $153.7 million |
| Efficiency ratio | 59.99% | 58.71% |
First nine months: Net income attributable to the company was $202.5 million, up 4.0%; diluted EPS was $2.29 versus $2.13. Net interest income fell 1.2% to $478.7 million, non-interest income fell 0.9% to $296.3 million, and non-interest expense declined 0.2% to $460.2 million. The lower loan-loss provision—$19.0 million versus $39.4 million—was an important contributor to earnings growth.
Balance sheet at September 30: Total assets were $20.88 billion, loans $9.64 billion, deposits $16.85 billion, and total equity $2.31 billion. Loans grew 4.8% from year-end 2011; deposits were up less than 1%. Non-interest-bearing deposits increased 8.1%, while time deposits declined 19.3%. Borrowings totaled approximately $1.36 billion, little changed from year-end.
Cash flow and liquidity: For the first nine months, operating activities provided $295.4 million; investing activities used $186.8 million; financing activities used $56.8 million. Cash and cash equivalents increased $51.8 million to $569.4 million. The company reported $10.01 billion in liquid assets, including $9.02 billion of available-for-sale securities, and $3.29 billion of estimated additional FHLB and Federal Reserve borrowing capacity. Core deposits were $14.84 billion, or 88.1% of deposits.
Credit and capital: Net charge-offs were $28.5 million for nine months, down from $48.9 million. Non-accrual loans declined to $55.2 million from $75.5 million at year-end; non-performing assets were $73.4 million, or 0.35% of assets. The allowance was $175.0 million, 1.82% of loans and 317% of non-accrual loans. At September 30, the Tier 1 risk-based, total risk-based, and Tier 1 leverage ratios were 14.92%, 16.25%, and 10.00%, respectively, above stated well-capitalized thresholds.
Material changes and management commentary
- Lower loan and securities yields pressured net interest income and margin; the company cited falling rates, lower TIPS inflation-related income, and lower reinvestment yields. Lower deposit costs partially offset the pressure.
- Debit interchange regulation reduced bank-card income: nine-month debit interchange fees fell $19.7 million. Trust fees, merchant and corporate card fees, and capital-markets fees provided partial offsets.
- Q3 loan balances increased, particularly business, personal real estate, and consumer loans; construction and land loans declined amid weak demand. Management reported improved non-performing and potential problem loan balances.
- Management said capital and liquidity were strong. It provided no specific earnings or revenue guidance; results for interim periods are not necessarily indicative of full-year results.
Outlook, risks, contingencies, and unusual items
- Card litigation and fees: The company accrued $5.2 million for the anticipated cost of the proposed Visa/Mastercard interchange settlement. It estimated a further 10-basis-point reduction in interchange income for eight months, likely beginning in 2013. The settlement remained subject to court and merchant processes. Separately, a court-pending overdraft litigation settlement requires chronological debit-card posting no later than April 2013; management estimated annual overdraft-income reduction of $6 million to $8 million.
- Credit and commitments: Loan commitments totaled $8.1 billion, including about $3.9 billion in unused approved credit-card lines. Standby letters of credit totaled $371.9 million; their recorded liability was $4.5 million. Restructured loans were $87.3 million, including $27.5 million on non-accrual. Management identified ordinary-course lawsuits; some early-stage matters could not yet be estimated.
- Securities valuation: The available-for-sale portfolio included $127.7 million of illiquid auction-rate securities valued using significant unobservable inputs. Certain non-agency mortgage-backed securities had $108.1 million fair value and $11.3 million cumulative credit-related impairment recorded in earnings. Portfolio values and impairment estimates depend on assumptions about collateral performance, rates, and liquidity.
- Regulatory and market risks: Management cited ongoing Dodd-Frank implementation, new derivatives requirements, proposed Basel III capital rules, and stress-testing requirements. Interest-rate simulations estimated net interest income increases of 1.4% under a gradual 100-basis-point rise and 1.8% under a 200-basis-point rise; these are modeled scenarios, not forecasts. The filing identifies economic conditions, interest rates, regulation, loan demand, competition, and settlement outcomes as risks.
- Subsequent capital distributions: On November 2, the board approved a 5% stock dividend and a $1.50-per-share special cash dividend, in addition to a regular $0.23 dividend. Management said capital would remain strong after the special dividend and expected to support growth, buybacks, and regular dividends.
Important facts for investors to verify
- Whether net interest margin stabilizes as asset yields, deposit pricing, and reinvestment rates change.
- Whether lower provisions and improving non-performing loans persist, especially given consumer-card charge-offs and restructured credits.
- The final terms, timing, and earnings impact of the interchange and overdraft settlements and related fee changes.
- Valuation and impairment assumptions for auction-rate and non-agency mortgage-backed securities.
- The effect of the special cash dividend, stock dividend, and repurchases on capital and per-share comparisons.
- Actual drawdowns and losses, if any, under the substantial loan commitments, letters of credit, and other contingencies.