Given the current critical sustainability factor, we are downgrading our recommendation on the shares of Commerce Bancshares Inc. (CBSH) to Neutral from Outperform. Although the company’s third quarter results were substantially ahead of the Zacks Consensus Estimate, continued weakness in loan demand and the credit metrics modestly offset the cost-cutting initiatives and growth in core fees and net interest income.
Additionally, more aggressive credit conditions are expected to prevail over time in the backdrop of stricter regulations in the sluggish macroeconomic environment. This could further worsen the already weak status of non-performing assets and the net-charge offs in the business. Hence, it remains to be seen if the gradual growth sustains in the upcoming quarters.
As well, constrained exposure in most parts of the country except Missouri, Kansas and central Illinois raises significant risk of diseconomies of scale, especially in the current fragile economic condition where interest rate volatility furthers the adverse impact on credit quality and operating leverage of the company. Although, the company has recently begun to spread into Oklahoma, Colorado and the other surrounding states, it still requires expanding its coverage in other parts in order to negate the competitive pressure from the larger national or other regional banks.
Moreover, Commerce Bancshares has grown through a mix of organic growth and intermittent acquisitions. The splurge in acquisitions (2 each in 2006 and 2007) highlights that organic growth is hard to come by, besides posing additional risk for the company as integration and asset quality issues may be more difficult to manage and could be costlier than originally anticipated.
However, Commerce Bancshares has maintained its capital levels significantly above peers such as Associate Banc-Corp. (ASBC), FirstMerit Corp. (FMER) and TCF Financial Corp. (TCB). Despite the recent increase in credit costs, the company has a very respectable 9.60% tangible equity as of Sep 30, 2009. Moreover, a declining efficiency ratio also reflects the positive effects of expense management. We expect this to act as a buffer against any probable losses in its credit portfolio in the upcoming quarters.
Overall, the company is poised to grow significantly with its extensive growth strategy which includes expanding core fee businesses, maintaining tight control over operating expenses, continuing strict focus on risk management, preserving its strong capital position and investing in technology in a more favorable operating environment. However, given the current sluggish growth across most of its businesses ─ which are mostly market driven of course ─ we prefer to remain slightly on the edge in the near term.
On Monday, the shares of Commerce Bancshares closed at $39.28, down by 0.2% on the New York Stock Exchange.
Read the full analyst report on “CBSH”
Read the full analyst report on “ASBC”
Read the full analyst report on “TCF”
Read the full analyst report on “FMER”
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