While 2011 was a pretty good year for quality banks, and 2012 was a better year for lower-quality banks, 2013 will likely be a challenging year for many banks. Commerce Bancshares (Nasdaq:CBSH) has a relatively good mix of fee income and a solid commercial lending business, but low yields on loans and securities will likely lead to slow going over the next year or two. Though I think Commerce can continue to do better than small rivals with more balance sheet growth and competitive share gains, it's hard to get fired up about the shares right now.

SEE: Commercial Banking - Bank Crises And Panics

Decent Fourth Quarter Results, but Special Items Helped a Lot
Commerce Bancshares did all right on a reported basis, but investors should appreciate that the results wouldn't have been so good without a few "non-operating" items.

Operating revenue rose 4% both annually and sequentially, with net interest income flat from last year and up 5% sequentially. Interest income got a significant boost from inflation-indexed securities and special dividends on private equity investments, and "core" net interest income was up 1% sequentially. Likewise, while the sequential five basis point (BPS) improvement in net interest margin (to 3.35%) looked good, underlying run-rate NIM (net interest margin) was not so strong.

Commerce did grow the balance sheet this quarter, with average earning assets up 4% from Q3, and with loans and securities both up. Ending loan balances were up 7% from last year and 2% from Q3, but non-performing loans were down by almost one-third and 7%, respectively. The non-performing asset (NPA) ratio declined another 10 BPS to a very low 0.7% level (versus 3% at Wells Fargo (NYSE:WFC) and about 1% at U.S. Bancorp (NYSE:USB).

Expenses increased 3% sequentially, with the efficiency ratio coming in at 58.2% (versus 58.5% last year and 58.8% in the last quarter). Fee income growth was OK, up 2% sequentially, with good strength in the company's largest individual source (bank card fees up 5% sequentially).

Real Pressure in the Core Business
Commerce Bancshares, like most banks in and outside of the Midwest, is still seeing significant pressure on its earnings potential. As mentioned before, the bank got a meaningful boost to its interest income from its securities portfolio, as the company's yield was up just two BPS sequentially.

Like other banks, the challenge for Commerce will be growing spreads in this low-rate environment. The company saw the cost of interest-bearing funds drop two BPS to 0.28%, while the overall cost of deposits came in at 0.18%. Non-interest-bearing deposits rose 16% (against a nearly 2% increase in interest-bearing deposits), but I'm not sure how much juice can be squeezed from this orange. That, in a nutshell, is the challenge for quality banks right now - the cost of funds can't go below zero, so there aren't a lot of levers to pull to improve NIM in the near term.

SEE: Commercial Banking - Operations

Still Opportunities to Grow
I don't want to give investors the impression that Commerce has no chance of growing in a low-rate environment. Commerce is a pretty conservatively run bank, and the company has the balance sheet strength to do a deal if management can find the right bank at the right price. Likewise, the company could do more lending if it wanted to - although chasing poor credit risks just for the sake of growth is not how this bank operates.

One way or another, Commerce needs to do something. The company already has a sizable share of the markets in Missouri and Kansas, and I'm not sure grabbing share from Wells Fargo and U.S. Bancorp is a long-term winning formula. On the other hand, going after the share held by Bank of America (NYSE:BAC) and the numerous small banks in states such as Colorado and Oklahoma could be more viable.

The Bottom Line
I continue to believe that Commerce Bancshares can return to a 13% or 14% return on equity over a five-year horizon. Unfortunately, that only points to a fair value in the high $30 range. Likewise, giving the bank a valuation of 1.5 times estimated 2013 tangible book value (which may arguably be a little low for a high-quality bank) suggests a mid-$30s valuation. All of that leads me to believe that Commerce Bancshares remains a solid hold for long-term shareholders, but not necessarily a compelling buy today.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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