This arguably isn't the sort of market that really favors a stock like Commerce Bancshares (Nasdaq:CBSH). While the Midwest wasn't hit as hard in the housing crunch, it isn't a sexy market like the Southeast or Texas. What's more, with the generally conservative habits of Commerce Bancshares leadership, this stock is more likely to accrete value slowly (but dependably) rather than make flashy moves.
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Q2 Results Not Quite As Good As They Seem
On first blush, it looks like Commerce Bancshares had a great quarter - reported earnings of 83 cents handily surpassed the average estimate of about 72 cents. Alas, while it was a good quarter, it wasn't quite that good.
Reported net interest income was up 3% sequentially and comfortably ahead of expectations, as was the net interest margin of 3.55% (up from 3.45% in the first quarter). Unfortunately, these figures were boosted by an early loan pay-off, interest from a large non-performing commercial loan, and extra income from some TIPS holdings. Strip these out, and net interest margin was more on the order of 3.41% - still better than generally expected, but only barely so.
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On a more sustainable note, non-interest income was pretty strong (up more than 6% sequentially), and the company's expenses seem to be well in hand. The company's credit quality is also quite strong, as both the non-performing asset and net charge-off ratio looked good.
Where Will the Growth Come from?
On a less encouraging note, the company's loan book and deposit balance didn't grow much at all from the first quarter. The challenge for Commerce Bancshares, as well as competitors like U.S. Bancorp (NYSE:USB) and Bank of America (NYSE:BAC), is finding high-quality borrowers in the current environment.
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While Commerce has long been able to fund its loan book with its deposits (and many of those deposits cost it little or nothing in interest), there's just not much business to be done in its core commercial lending markets. As a result, the company's securities portfolio is larger than its loan book. Why that is problematic becomes clearer when you look at the average yields - 2.75% for securities and 4.95% for loans.
Commerce does have a sizable non-interest business (including credit cards, where credit trends have been encouraging lately), but Commerce really needs to see a growing interest spread to get growing going.
At the same time, it looks like Commerce is going to rely on good old-fashioned out-competing to win business in the interim. As the number three bank in Missouri, Commerce wants to grab share from U.S. Bancorp and Bank of America; the former seems like a formidable challenge, but I do believe B of A could be vulnerable. At the same time, smaller rivals like Bank of Montreal's (NYSE:BMO) Marshall & Ilsley could be a little vulnerable. In any case, don't expect a large or aggressive acquisition - that's just not how this bank operates.
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The Bottom Line
Improving interest rate spreads and/or stronger demand for business loans would do wonders for Commerce Bancshares' returns, but I wouldn't expect to see that anytime soon. Consequently, this bank ends up looking like a decent enough hold, but not really a compelling buy. Should the bank regain a 14% long-term return on equity (close to its long-term average), fair value would seem to be in the low $40s - again, enough to hold, but not really enough to encourage new investors to buy.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.