Commerce Bancshares, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Unaudited consolidated results; amounts below are in U.S. dollars. The company is a bank holding company operating primarily through Commerce Bank, with Consumer, Commercial and Wealth segments.
Financial results and condition
- Q2 earnings: Net income attributable to Commerce Bancshares was $69.9 million, down 6.0% from $74.4 million a year earlier. Net income available to common shareholders was $67.6 million; diluted EPS was $0.70 versus $0.72.
- First-half earnings: Net income attributable to the company was $135.3 million, approximately flat year over year. Common diluted EPS rose to $1.35 from $1.30.
- Revenue and margin: Q2 net interest income was $171.8 million, up 5.0%; non-interest income was $116.6 million, up 2.0%. Tax-equivalent net interest margin was 3.11% versus 3.04% in Q2 2015. First-half tax-equivalent net interest margin was 3.03% versus 2.90%.
- Costs and profitability: Q2 non-interest expense increased 7.0% to $177.1 million. The efficiency ratio was 61.27% versus 59.39%. Q2 return on average assets was 1.15% and return on average common equity was 11.69%, both below year-earlier levels.
- Credit costs: Q2 provision for loan losses was $9.2 million, up from $6.8 million; first-half provision was $18.7 million versus $11.2 million. First-half net charge-offs were $16.4 million, little changed from $16.2 million. The allowance was $153.8 million, or 1.18% of loans, versus $151.5 million and 1.22% at year-end.
- Balance sheet and lending: Assets totaled $24.7 billion, compared with $24.6 billion at December 31, 2015. Loans, including held-for-sale loans, rose 5.5% to $13.1 billion; deposits increased to $20.2 billion. Loan growth was concentrated in business and construction lending.
- Liquidity, cash flow and funding: First-half operating cash flow was $290.9 million, investing cash flow was $18.1 million and financing cash flow was negative $186.4 million. Cash and cash equivalents ended the period at $625.2 million. Liquid assets, as defined by management, totaled $10.2 billion. Core deposits were $17.9 billion, or 88.8% of deposits. Borrowings totaled $1.7 billion, down from $2.1 billion at year-end, principally reflecting lower federal funds purchased and repurchase balances.
- Capital: The Tier 1 common, Tier 1 risk-based, total risk-based and Tier 1 leverage ratios were 11.50%, 12.29%, 13.23% and 9.36%, respectively. The company reported ratios above applicable well-capitalized thresholds. Tangible common equity to tangible assets was 9.09%, up from 8.58% a year earlier.
Material changes versus comparable periods
- Q2 net interest income benefited from loan growth; average loan balances were up 10.1% year over year. Higher deposit and borrowing costs partly offset the increase.
- Higher salaries and benefits, data processing and software, and card-related costs contributed to expense growth. The prior-year quarter included a $2.8 million recovery on a letter-of-credit exposure that did not recur.
- Investment securities moved from net gains of $2.1 million in Q2 2015 to net losses of $0.7 million in Q2 2016; first-half results shifted from $8.2 million in gains to $1.7 million in losses, mainly reflecting private-equity valuation activity.
- Non-performing assets decreased to $26.1 million from $29.4 million at year-end; non-accrual loans fell to $24.5 million. Conversely, the provision increased as the company added to its allowance.
- Available-for-sale securities declined to $9.2 billion from $9.8 billion at year-end. First-half purchases were lower than maturities and paydowns; accumulated other comprehensive income rose substantially, largely from unrealized securities gains.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management states interim results are not necessarily indicative of full-year results.
- Interest-rate simulations estimate higher net interest income under rising-rate scenarios with the company’s standard deposit-attrition assumptions. Under a more severe deposit-outflow scenario, projected benefits were much smaller or negative; actual deposit behavior is uncertain.
- Key risks identified include economic conditions, interest rates, loan demand and credit quality, deposit liquidity, regulation, competition, and accounting and tax changes. Energy loans were $148.0 million, with $24.4 million rated substandard or on non-accrual. Shared national credit exposure was $809.6 million, with $1.3 billion of related unfunded commitments.
- Loan commitments totaled $10.1 billion, including approximately $4.9 billion of unused credit-card lines. Standby letters of credit totaled $359.0 million. These commitments may not be fully drawn, but could create funding or credit exposure.
- A Missouri class action concerning overdraft fees remains stayed pending the outcome of a similar case. The company disputes the claim; potential exposure cannot be determined with certainty. Other ordinary-course legal matters are also pending.
- Unusual items included a $3.3 million gain on sale of a former branch property in Q1, an approximately $0.9 million trust-related settlement accrual in Q2, and a $1.8 million gain from withdrawal from a private-equity fund to comply with the Volcker Rule. The filing also notes that the new CECL standard is expected to increase the allowance upon adoption, effective in 2020.
Important facts for investors to verify
- Whether loan growth, particularly in business, construction, energy and shared national credit exposures, is matched by sustainable credit quality and adequate reserves.
- Whether deposit mix and funding costs remain stable, especially given growth in large time deposits and the sensitivity shown in the high-deposit-attrition interest-rate scenario.
- Whether expense growth and securities/private-equity valuation swings continue to pressure earnings and the efficiency ratio.
- Developments in the overdraft-fee litigation, contingent commitments, and implementation costs or allowance effects associated with CECL and other new accounting standards.
- Capital, liquidity and shareholder returns: the company repurchased $37.5 million of stock in the first half, paid $48.0 million in common and preferred dividends, and had 3.8 million shares remaining under its buyback authorization.