Commerce Can Shake Off Criticisms

Eisinger then reports that "Commerce's paper losses look to be the worst among the banks [Morgan Stanley analyst Chris Chouinard] follows." That doesn't tell the whole story. Other banks struggle with deposit growth rates of nil to 5%. Commerce total deposits this year will grow by 24%, and by about 50% over the next 24 months.

A large percentage of these deposits will be invested at the new higher rates. This deposit flow mitigates interest rate risk in a material way. It's an interest rate hedge that other banks don't have and that the Journal neglected to mention.

Earnings per Share

The next statement to challenge: "The bulls ... have stuck with the company despite surprisingly lackluster earnings per share." There is only one reason earnings have been "surprisingly lackluster," and it has nothing to do with the efficacy of the operating model. Earnings are temporarily lackluster because of the yield curve. Because Commerce is a deposit-gathering machine with large investments in AAA-rated income securities, its earnings are unusually sensitive to the shape of the yield curve.

The long-term average net interest margin (NIM) for Commerce is 4.3%, with a peak of 4.76% (2001) and an all-time low of 3.4% expected for this year. It's not difficult to calculate the impact that a return to a normal interest rate curve would have on Commerce earnings. For example, if next year's NIM is slightly below the long-term average, at, say, 4.1%, Commerce's EPS would be $3.42. While I can't predict when the curve will revert to a normal slope, this illustrates the earnings power of the operating model.

By the way, underlying my $100 target for Commerce in 2010 is a gradual slowing of total deposit growth to 19% (same-store growth of 15% plus deposits from new branches), a 10% expansion in the shares outstanding and a NIM of 4.1%. That implies EPS in 2010 of $5 to $5.50. Even at a NIM of 3.75%, which would be well below the long-term average, my 2010 valuation target for Commerce stock is 2.5 times today's quote.