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CBSH > SEC Filings for CBSH > Form 10-Q on 4-Nov-2011All Recent SEC Filings

Show all filings for COMMERCE BANCSHARES INC /MO/ | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for COMMERCE BANCSHARES INC /MO/


4-Nov-2011

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes and with the statistical information and financial data appearing in this report as well as the Company's 2010 Annual Report on Form 10-K. Results of operations for the three and nine month periods ended September 30, 2011 are not necessarily indicative of results to be attained for any other period.

Forward Looking Information

This report may contain "forward-looking statements" that are subject to risks and uncertainties and include information about possible or assumed future results of operations. Many possible events or factors could affect the future financial results and performance of the Company. This could cause results or performance to differ materially from those expressed in the forward-looking statements. Words such as "expects", "anticipates", "believes", "estimates", variations of such words and other similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in, or implied by, such forward-looking statements. Readers should not rely solely on the forward-looking statements and should consider all uncertainties and risks discussed throughout this report. Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. Such possible events or factors include: changes in economic conditions in the Company's market area, changes in policies by regulatory agencies, governmental legislation and regulation, fluctuations in interest rates, changes in liquidity requirements, demand for loans in the Company's market area, and competition with other entities that offer financial services.

Critical Accounting Policies

The Company's consolidated financial statements are prepared based on the application of certain accounting policies, some of which require numerous estimates and strategic or economic assumptions that may prove inaccurate or be subject to variations which may significantly affect the Company's reported results and financial position for the current period or future periods. The use of estimates, assumptions, and judgment is necessary when assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. Current economic conditions may require the use of additional estimates, and some estimates may be subject to a greater degree of uncertainty due to the current instability of the economy. The Company has identified several policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for loan losses, the valuation of certain investment securities, and accounting for income taxes.


Allowance for Loan Losses

The Company performs periodic and systematic detailed reviews of its loan portfolio to assess overall collectability. The level of the allowance for loan losses reflects the Company's estimate of the losses inherent in the loan portfolio at any point in time. While these estimates are based on substantive methods for determining allowance requirements, actual outcomes may differ significantly from estimated results, especially when determining allowances for business, lease, construction and business real estate loans. These loans are normally larger and more complex, and their collection rates are harder to predict. Personal loans, including personal mortgage, credit card and consumer loans, are individually smaller and perform in a more homogenous manner, making loss estimates more predictable. Further discussion of the methodology used in establishing the allowance is provided in the Provision and Allowance for Loan Losses section of this discussion.

Valuation of Investment Securities

The Company carries its investment securities at fair value and employs valuation techniques which utilize observable inputs when those inputs are available. These observable inputs reflect assumptions market participants would use in pricing the security and are developed based on market data obtained from sources independent of the Company. When such information is not available, the Company employs valuation techniques which utilize unobservable inputs, or those which reflect the Company's own assumptions about market participants, based on the best information available in the circumstances. These valuation methods typically involve cash flow and other financial modeling techniques. Changes in underlying factors, assumptions, estimates, or other inputs to the valuation techniques could have a material impact on the Company's future financial condition and results of operations. Assets and liabilities carried at fair value inherently result in more financial statement volatility. Under the fair value measurement hierarchy, fair value measurements are classified as Level 1 (quoted prices), Level 2 (based on observable inputs) or Level 3 (based on unobservable, internally-derived inputs), as discussed in more detail in Note 13 to the consolidated financial statements. Most of the available for sale investment portfolio is priced utilizing industry-standard models that consider various assumptions which are observable in the marketplace, or which can be derived from observable data. Such securities totaled approximately $8.8 billion, or 94.4% of the available for sale portfolio at September 30, 2011 and were classified as Level 2 measurements. The Company also holds $139.7 million in auction rate securities. These were classified as Level 3 measurements, as no market currently exists for these securities, and fair values were derived from internally generated cash flow valuation models which used unobservable inputs significant to the overall measurement.

Changes in the fair value of available for sale securities, excluding credit losses relating to other-than-temporary impairment, are reported in other comprehensive income. The Company periodically evaluates the available for sale portfolio for other-than-temporary impairment. Evaluation for other-than-temporary impairment is based on the Company's intent to sell the security and whether it is likely that it will be required to sell the security before the anticipated recovery of its amortized cost basis. If either of these conditions is met, the entire loss (the amount by which the amortized cost exceeds the fair value) must be recognized in current earnings. If neither condition is met, but the Company does not expect to recover the amortized cost basis, the Company must determine whether a credit loss has occurred. This credit loss is the amount by which the amortized cost basis exceeds the present value of cash flows expected to be collected from the security. The credit loss, if any, must be recognized in current earnings, while the remainder of the loss, related to all other factors, is recognized in other comprehensive income.

The estimation of whether a credit loss exists and the period over which the security is expected to recover requires significant judgment. The Company must consider available information about the collectability of the security, including information about past events, current conditions, and reasonable forecasts, which include payment structure, prepayment speeds, expected defaults, and collateral values. Changes in these factors could result in additional impairment, recorded in current earnings, in future periods.

At September 30, 2011, non-agency guaranteed mortgage-backed securities with a par value of $153.2 million were identified as other-than-temporarily impaired. The credit-related impairment loss on these securities amounted to $9.3 million, which was recorded in the consolidated income statements in investment securities gains (losses), net. The noncredit-related loss on these securities, which was recorded in other comprehensive income, was $7.6 million on a pre-tax basis.

The Company, through its direct holdings and its Small Business Investment subsidiaries, has numerous private equity investments, categorized as non-marketable securities in the accompanying consolidated balance sheets. These investments totaled $66.4 million at September 30, 2011, and most are carried at fair value. Changes in fair value are reflected in current earnings and reported in investment securities gains (losses), net, in the consolidated income statements. Because there is no observable market data for these securities, their fair values are internally developed using available information and management's judgment, and they are classified as Level 3 measurements. Although management believes its estimates of fair value reasonably reflect the fair value of these securities, key assumptions regarding the projected financial performance of these companies, the evaluation of the investee company's management team, and other economic and market factors may affect the amounts that will ultimately be realized from these investments.


Accounting for Income Taxes

Accrued income taxes represent the net amount of current income taxes which are expected to be paid attributable to operations as of the balance sheet date. Deferred income taxes represent the expected future tax consequences of events that have been recognized in the financial statements or income tax returns. Current and deferred income taxes are reported as either a component of other assets or other liabilities in the consolidated balance sheets, depending on whether the balances are assets or liabilities. Judgment is required in applying generally accepted accounting principles in accounting for income taxes. The Company regularly monitors taxing authorities for changes in laws and regulations and their interpretations by the judicial systems. The aforementioned changes, and changes that may result from the resolution of income tax examinations by federal and state taxing authorities, may impact the estimate of accrued income taxes and could materially impact the Company's financial position and results of operations.

Selected Financial Data
                                               Three Months Ended September 30,         Nine Months Ended September 30,
                                                    2011               2010                 2011               2010
Per Share Data
  Net income per common share - basic       $           .76      $           .63     $          2.25     $          1.82
  Net income per common share - diluted                 .76                  .64                2.24                1.82
  Cash dividends                                       .230                 .224                .690                .671
  Book value                                                                                   25.15               23.37
  Market price                                                                                 34.75               35.80
Selected Ratios
(Based on average balance sheets)
  Loans to deposits (1)                               58.29 %              68.88 %             60.27 %             71.88 %
  Non-interest bearing deposits to total
deposits                                              30.49                28.86               29.75               28.26
  Equity to loans (1)                                 23.35                20.18               22.54               19.17
  Equity to deposits                                  13.61                13.90               13.59               13.78
  Equity to total assets                              10.85                10.84               11.03               10.81
  Return on total assets                               1.32                 1.19                1.37                1.17
  Return on total equity                              12.15                10.98               12.41               10.85
(Based on end-of-period data)
  Non-interest income to revenue (2)                  39.05                38.55               38.16               37.78
  Efficiency ratio (3)                                58.71                59.58               58.57               59.49
  Tier I risk-based capital ratio                                                              14.58               14.27
  Total risk-based capital ratio                                                               15.92               15.64
  Tangible common equity to assets ratio
(4)                                                                                             9.72               10.26
  Tier I leverage ratio                                                                         9.74                9.93

(1) Includes loans held for sale.
(2) Revenue includes net interest income and non-interest income.
(3) The efficiency ratio is calculated as non-interest expense (excluding intangibles amortization) as a percent of revenue.
(4) The tangible common equity ratio is calculated as stockholders' equity reduced by goodwill and other intangible assets (excluding mortgage servicing rights) divided by total assets reduced by goodwill and other intangible assets (excluding mortgage servicing rights).


Results of Operations

Summary
                                  Three Months Ended September 30,             Nine Months Ended September 30,
(Dollars in thousands)            2011            2010       % Change          2011            2010       % Change
Net interest income          $    158,630    $    159,437        (.5 )%   $    484,313    $    485,255       (.2 )%
Provision for loan losses         (11,395 )       (21,844 )    (47.8 )         (39,372 )       (78,353 )   (49.8 )
Non-interest income               101,632         100,010        1.6           298,882         294,657       1.4
Investment securities gains
(losses), net                       2,587              16       N.M.             5,870          (2,989 )    N.M.
Non-interest expense             (153,746 )      (155,586 )     (1.2 )        (461,219 )      (467,103 )    (1.3 )
Income taxes                      (31,699 )       (26,012 )     21.9           (91,898 )       (71,817 )    28.0
Non-controlling interest
(expense) income                     (657 )          (136 )    383.1            (1,737 )           139      N.M.
Net income attributable to
 Commerce Bancshares, Inc.   $     65,352    $     55,885       16.9  %   $    194,839    $    159,789      21.9  %

N.M. = Not meaningful

For the quarter ended September 30, 2011, net income attributable to Commerce Bancshares, Inc. amounted to $65.4 million, an increase of $9.5 million, or 16.9%, compared to the third quarter of the previous year. For the current quarter, the annualized return on average assets was 1.32%, the annualized return on average equity was 12.15%, and the efficiency ratio was 58.71%. Diluted earnings per share was $.76, an increase of 18.8% compared to $.64 per share in the third quarter of 2010. Compared to the third quarter of last year, net interest income decreased $807 thousand, or .5%, due to lower interest earned on loans, which was partly offset by higher earnings on investment securities and securities purchased under agreements to resell and lower expense incurred on deposits and borrowings. Non-interest income increased $1.6 million, or 1.6%, and included growth in bank card and trust fee income. Compared to the same period last year, non-interest expense decreased $1.8 million, or 1.2%, which included declines of $2.0 million in deposit insurance expense and $1.1 million in supplies and communication costs, partly offset by a $3.0 million increase in other non-interest expense. The provision for loan losses totaled $11.4 million for the current quarter, representing a decrease of $10.4 million from the third quarter of 2010.

Net income attributable to Commerce Bancshares, Inc. for the first nine months of 2011 was $194.8 million, an increase of $35.1 million, or 21.9%, over the same period in the previous year. For the first nine months of 2011, the annualized return on average assets was 1.37%, the annualized return on average equity was 12.41%, and the efficiency ratio was 58.57%. Diluted earnings per share was $2.24, an increase of 23.1% over $1.82 per share in the same period last year. Compared to the first nine months of 2010, net interest income decreased slightly, with trends similar to the quarterly comparison above. Non-interest income grew $4.2 million, or 1.4%, largely due to increases of $13.0 million in bank card transaction fees and $6.4 million in trust fees, which were partially offset by a $9.1 million decline in deposit account fees and a $5.2 million decline in loan fees and sales. Non-interest expense declined $5.9 million compared to the same period last year due to decreases of $2.7 million in salaries and benefits expense, $4.0 million in supplies and communication costs and $4.0 million in deposit insurance expense, which were partially offset by an $8.5 million increase in other non-interest expense. The provision for loan losses totaled $39.4 million, down $39.0 million compared to the same period last year.

On June 29, 2011, the Company's sole bank subsidiary (the Bank), formerly a national banking association, became a state chartered Federal Reserve member bank. The Bank's main regulator changed from the Office of the Comptroller of the Currency to both the Federal Reserve Bank of Kansas City and the Missouri Division of Finance. The Bank's deposits continue to be fully insured by the FDIC in accordance with applicable laws and regulations. As a result of this change, the Company expects to reduce its annual examination fees by approximately $1.5 million.


Net Interest Income

The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates. Changes not solely due to volume or rate changes are allocated to rate.

Analysis of Changes in Net Interest Income
                                         Three Months Ended September 30, 2011       Nine Months Ended September 30, 2011
                                                        vs. 2010                                  vs. 2010
                                               Change due to                             Change due to
                                           Average      Average                      Average       Average
(In thousands)                              Volume        Rate        Total          Volume         Rate         Total
Interest income, fully taxable
equivalent basis:
Loans                                    $  (5,606 )  $  (5,776 )  $  (11,382 )   $  (15,278 )  $  (20,110 )  $  (35,388 )
Loans held for sale                         (1,181 )         83        (1,098 )       (4,903 )         247        (4,656 )
Investment securities:
 U.S. government and federal agency
securities                                    (296 )      1,930         1,634         (1,168 )       9,247         8,079
 Government-sponsored enterprise
obligations                                    146          527           673            443           321           764
 State and municipal obligations             2,318         (979 )       1,339          8,193        (2,439 )       5,754
 Mortgage and asset-backed securities        8,026       (8,759 )        (733 )       22,187       (29,312 )      (7,125 )
 Other securities                             (113 )     (1,207 )      (1,320 )         (818 )          56          (762 )
   Total interest on investment
securities                                  10,081       (8,488 )       1,593         28,837       (22,127 )       6,710
Short-term federal funds sold and
securities purchased under
  agreements to resell                           7           (6 )           1             22           (17 )           5
Long-term securities purchased under
agreements to resell                         2,813          238         3,051          8,652          (274 )       8,378
Interest earning deposits with banks            98            7           105             33             6            39
Total interest income                        6,212      (13,942 )      (7,730 )       17,363       (42,275 )     (24,912 )
Interest expense:
Deposits:
 Savings                                        21           40            61             45           130           175
 Interest checking and money market          1,023       (1,900 )        (877 )        2,963        (5,489 )      (2,526 )
 Time open & C.D.'s of less than
$100,000                                    (1,409 )     (1,622 )      (3,031 )       (3,626 )      (5,571 )      (9,197 )
 Time open & C.D.'s of $100,000 and over       (69 )     (1,262 )      (1,331 )          515        (4,224 )      (3,709 )
   Total interest on deposits                 (434 )     (4,744 )      (5,178 )         (103 )     (15,154 )     (15,257 )
Federal funds purchased and securities
sold under
  agreements to repurchase                       4         (296 )        (292 )         (113 )        (516 )        (629 )
Other borrowings                            (1,897 )         93        (1,804 )      (10,376 )         (92 )     (10,468 )
Total interest expense                      (2,327 )     (4,947 )      (7,274 )      (10,592 )     (15,762 )     (26,354 )
Net interest income, fully taxable
equivalent basis                         $   8,539    $  (8,995 )  $     (456 )   $   27,955    $  (26,513 )  $    1,442

Net interest income for the third quarter of 2011 was $158.6 million (not tax equated), an $807 thousand decrease from the third quarter of 2010. The decrease in net interest income was primarily the result of lower interest income earned on loans, due to lower average rates and lower average balances, partly offset by a decline in interest expense incurred on deposits and other borrowings coupled with higher interest income earned on investment securities and securities purchased under agreements to resell. The Company's tax equivalent net interest rate margin was 3.51% for the third quarter of 2011 compared to 3.75% in the third quarter of 2010.

Total interest income, on a tax equivalent basis (T/E), decreased $7.7 million, or 4.2%, from the third quarter of 2010. Interest income on loans (T/E, including held for sale) declined $12.5 million due to a decrease of $871.1 million, or 8.7%, in average loan balances, coupled with a 14 basis point decrease in average rates earned. The decrease in average loans compared to the third quarter of 2010 included a decrease of $573.7 million in average student loans, contributing to a decrease in interest income of $3.0 million. The majority of this portfolio was sold in the fourth quarter of 2010. Interest income from consumer loans decreased from the third quarter of 2010 due to a decline of 10.5%, or $129.5 million, in average consumer loans coupled with a 45 basis point decrease in average rates earned. Included in the decrease in average consumer loan balances was a decline in marine and


recreational vehicle (RV) loans of $124.1 million, resulting from the Company's decision to exit the marine/RV loan origination business. Average business loans decreased $102.7 million and the average rate earned decreased 26 basis points, as demand remains weak and usage on lines of credit continues at low levels. Business real estate loans increased 6.2%, or $124.5 million, over the third quarter of 2010, which was offset by a decrease in the average rate earned of 36 basis points. Demand for personal real estate and construction loans continues to be negatively affected by housing industry weakness. Average construction loan balances decreased $118.0 million, which was slightly offset by an increase in average rates earned. Average personal real estate loan balances decreased $20.9 million compared to the third quarter of 2010 and experienced a decrease of 38 basis points in average rates earned.

Interest income on investment securities (T/E) increased $1.6 million over the third quarter of 2010. This increase resulted mainly from a $1.4 million increase in inflation income earned on TIPS, coupled with increases in average balances in state and municipal obligations and mortgage and asset-backed securities of $203.1 million and $1.1 billion, respectively. These increases were partially offset by decreases in average rates earned on mortgage and asset-backed securities, which lowered interest income by $8.8 million. During the third quarter of 2011, the Company purchased approximately $1.3 billion of agency mortgage-backed securities with forward settlement dates, of which approximately $1.0 billion will settle in the fourth quarter of 2011. Since interest does not accrue on these bonds until the actual settlement date, the effect of these forward purchases was to increase quarterly average earning assets by $284.0 million and reduce income by $1.5 million compared to estimated normal settlement. Because the market awards a lower price to forward settled securities, the Company will earn approximately 14 basis points more on these securities over their estimated lives. The Company began investing in long-term securities purchased under agreements to resell in the second half of 2010 to diversify its investment portfolio. The average balance in this category increased $650.7 million to $850.0 million during the third quarter of 2011 and contributed $3.1 million in interest income. The average tax equivalent yield on total interest earning assets was 3.77% in the third quarter of 2011 compared to 4.19% in the third quarter of 2010.

Total interest expense decreased $7.3 million, or 37.3%, compared to the third quarter of 2010, due to a $5.2 million decrease in interest expense on interest bearing deposits, coupled with a $1.8 million decrease in interest expense on other borrowings. The decrease in interest expense on deposits resulted from a 22 basis point decrease in average rates paid. Average balances of interest checking and money market accounts increased $962.3 million, or 14.2%, while average certificates of deposit decreased $455.2 million, or 14.9%. Interest expense on other borrowings declined mainly due to lower average FHLB advances, which declined $237.7 million, or 69.5%, due to scheduled maturities of advances and the early pay off of $125.0 million in the fourth quarter of 2010. The overall average rate incurred on all interest bearing liabilities decreased to .40% in the third quarter of 2011 compared to .66% in the third quarter of 2010.

Net interest income for the first nine months of 2011 was $484.3 million compared to $485.3 million for the same period in 2010. For the first nine months of 2011, the net yield on total interest earning assets on a tax equivalent basis was 3.73% compared to 3.91% in the first nine months of 2010. The components of net interest income for the first nine months in 2011 compared to the same period in 2010 reflected trends similar to the quarterly discussion above.

Total interest income (T/E) for the first nine months of 2011 decreased $24.9 million from the same period last year primarily due to lower interest income earned on the loan portfolio, partially offset by increases in interest income earned on investment securities and securities purchased under agreements to . . .

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