This column was originally published on RealMoney on July 11 at 11:00 a.m. EDT. It's being republished as a bonus for TheStreet.com readers.Commerce Bancorp ( CBH) shares dropped 7% last Wednesday, representing a loss of about $400 million in market value. This was in response to a Jesse Eisinger column in The Wall Street Journal that heaped negativity on the company. The drop in Commerce's stock, which currently trades around $32 a share, is good news for bargain hunters. My calculations indicate that Commerce will be worth more than double the current quote, or $67 a share, by 2008, and worth triple the current quote, or $100 a share, in four years. Investors interested in the upside opportunity in Commerce stock have to be able to see through the negativity in Eisinger's column. At a minimum, the bulk of the argument is misleading. I'll review where his conclusions go awry.
GrowthEisinger first takes issue with Commerce's comparable-store deposit growth. According to disclosures made by Commerce, same-store deposit growth in the first quarter will be about 18%, and total first-quarter deposits will be up about 24%. The 24% total increase is derived from same-store deposit growth plus growth in deposits from new stores. The 18% same-store growth rate for the first quarter is down from an average same-store growth rate of 20.3% for 2005. Consider this comment from the Journal column: "The growth rate is falling ... the slowdown is just one sign that Commerce's vaunted business model is breaking down." To divine meaning from a slight decline off a high base is quite a stretch, particularly when it's based on just one quarter of data. To say that it is an indication that the "business model is breaking down" is nonsense.
Balance Sheet"Perhaps most worrisome are concerns about the bank's liabilities" is a criticism that sounds scary, but is inconsistent with the facts. Commerce's balance sheet is quite healthy, with no long-term debt and credit risk far lower than its peer group. Eisinger selected one issue from the balance sheet to make his "most worrisome" case, but then failed to identify a critical mitigating factor. Here's the issue: Commerce generates deposits much faster than it can make loans. Rather than get aggressive in lending and absorb extra credit risk, Commerce invests a large percentage of those deposits in AAA-rated income securities, such as mortgages. These fixed-income instruments mature in four years, on average. Because interest rates have recently moved up, the market quote for these securities has declined. As a result, Commerce has a "paper loss" on these securities. As Eisinger points out, if Commerce holds the securities for the duration (about four years), there is no actual loss, because it will receive 100% of the face value. So far, so good. This is an issue worth noting.
Earnings per ShareThe 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.
Liquidity in the Financial System
The fans long have figured the stock was worth the price because they thought Commerce had cracked the growth code. But the model wasn't so mysterious: It worked because the world was awash in cheap money. When rates were near zero, it doesn't matter what a customer gets on a certificate of deposit. Friendly service stands out. But as rates have risen, customers have started to relearn that Spinal Tap tune, "Gimme Some Money."That is a cute characterization, to be sure, but it's false. It is inaccurate to say the model "worked because the world was awash in cheap money." Either Eisinger did not check Commerce's record or has to make the embarrassing case that the world has been "awash in cheap money" for more than 20 years. The Commerce model has thrived as a deposit-gathering machine each and every year, in all varieties of interest-rate environments, for more than 20 years. It's interesting to note that Commerce's long-term business value growth does not correlate to whether money is cheap or tight. Rather, the business value of Commerce has moved upward in concert with deposit growth. P.S. from TheStreet.com Editor-in-Chief, Dave Morrow:
It's always been my opinion that it pays to have more -- not fewer -- expert market views and analyses when you're making investing or trading decisions. That's why I recommend you take advantage of our free trial offer to TheStreet.com's RealMoney premium Web site, where you'll get in-depth commentary and money-making strategies from over 50 Wall Street pros, including Jim Cramer. Take my advice -- try it now.