Commerce Bancshares Inc. (CBSH) reported its first quarter 2011 earnings per share of 69 cents, beating the Zacks Consensus Estimate of 66 cents. Though the result compared unfavorably with the prior quarter’s earnings of 70 cents, it faired well compared with the year-ago quarter’s earnings of 50 cents.

The results benefited from increase in net interest income and lower non-interest expense. The company’s credit quality also showed improvement. However, fall in non-interest income was  the downside.

Commerce Bancshares’ net income for the quarter was $60.5 million, down 2.4% from $61.9 million in the prior quarter, but up 36.9% from $44.2 million in the year-ago quarter. The year-over-year improvement in net income was attributable to constant focus on expense management and a lower loan loss provision.

Quarter in Detail

Commerce Bancshares’ quarterly total revenues were $256.9 million, down from $271.1 million in the prior quarter but up from $255.9 million in the prior-year quarter. The company’s revenues also missed the Zacks Consensus Estimate of $260.0 million.

Quarterly taxable-equivalent net interest income inched up 0.3% sequentially but inched down 0.6% year over year to $166.5 million. Mainly, lower rates paid on deposits, lower average balances on Federal Home Loan Bank (FHLB) advances, and growth in interest income on investment securities portfolio accounted for the sequential increase.

Commerce Bancshares’ net interest margin in the first quarter stood at 3.85%, marking a sequential rise of 3 basis points (bps) but a year-over-year drop of 18 bps .

Non-interest income in the reported quarter declined 13.2% from the prior quarter but rose 2.9% from the prior-year quarter and stood at $95.9 million. The sequential drop was primarily driven by lower bank card transaction fees, trust fees, deposit account charges and other fees, bond trading income and loan fees, as well as sales. However, these were partially mitigated by a surge in consumer brokerage services and trust fees.

Non-interest expense in the quarter fell 6.1% from the prior quarter and 1.1% year over year to $154.0 million. Efficiency ratio in the reported quarter improved to 59.64% from 60.33% in the prior quarter and 60.48% in the year-ago quarter.

Credit Quality

Following the trend of improving credit quality in the previous quarter, credit quality improved further in the quarter under review. Provision for loan losses dropped from $21.6 million in the prior quarter and $34.3 million in the year-ago quarter to $15.8 million. Net charge-offs declined 13.2% from the prior quarter and 39.9% from the prior-year quarter to $18.8 million.

Total non-performing assets increased to $102.9 million or 1.10% of loans outstanding from $97.3 million or 1.03% of loans outstanding at the prior quarter end but fell from $110.1 million or 1.12% of loans outstanding at the prior-year quarter end. The allowance for loan losses stood at 2.08% of total loans, declining 2 bps sequentially and 7 bps year over year.

Balance Sheet

Average loans (excluding loans held for sale) spiked 1.0% quarter over quarter but fell 5.4% year over year to $9.43 billion. The decline from the prior-year quarter reflected lower loan balances in all categories except business loans.

Available for-sale investment securities (excluding fair value adjustments) were up 0.8% from the prior quarter and 16.3% from the year-ago quarter to $7.31 billion. The increase was primarily owing to the purchases of mortgage-backed and other asset-backed securities during the quarter.

Average deposits spiked 4.1% sequentially to $14.12 billion, reflecting a growth in non-interest bearing demand, money market, and certificate of deposit (CD) accounts.

Capital Ratios

The quarter witnessed improvement in Commerce Bancshares’ capital ratios. As of March 31, 2011, the company’s return on assets (ROA) improved to 1.32% from 1.00% as of March 31, 2010. As of March 31, 2011, the company’s return on equity (ROE) also increased to 11.95% from 9.32% as of March 31, 2010.

Similarly, book value as of March 31, 2011 was $23.77 per share, up from $22.03 per share as of March 31, 2010.

Stock Buyback

During the quarter, Commerce Bancshares purchased 101,625 shares of treasury stock at an average cost of $42.43 through its previously approved treasury stock buyback plan.

Our Take

Although Commerce Bancshares saw an improvement in credit quality, average loans declined on a lower line of credit usage. Given the current economic conditions, we remain cautious on the company’s non-performing asset positions and loan volumes, which need to improve further in order to gain a foothold in the industry.

One of the close competitors of Commerce Bancshares, TCF Financial Corporation (TCB), is expected to announce its first quarter results on April 21.

Commerce Bancshares currently retains a Zacks # 3 Rank, which translates into a short-term ‘Hold’ rating. Also, considering the fundamentals, we are maintaining our long-term ‘Neutral’ recommendation on the shares.

 
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