Commerce's Margin Squeezed; Warns on Durbin (Update 1)

Updated with comments from an interview with Commerce CFO Charles Kim.
  • Third-quarter profit of 76 cents a share misses analysts' consensus estimate of 77 cents.
  • Net interest margin declines.
  • Fee revenue increases but is expected to decline sharply in Q4 from Durbin Amendment.

KANSAS CITY, Mo. ( TheStreet) -- Commerce Bancshares ( CBSH) on Thursday reported third-quarter net income of $65.4 million, or 76 cents a share, missing the consensus estimate of 77 cents, among analysts polled by FactSet.

The results compared to a profit of $69 million, or 79 cents a share, the previous quarter and $55.9 million, or 64 cents a share a year earlier.

Commerce's shares were down 7% in morning trading, to $35.94.
Commerce Bancshares CEO David W. Kemper

The slight decline in earnings from the second quarter mainly reflected a decline in net interest income to $158.6 million in the second quarter, from $164.7 million in the second quarter and $159.4 million in the third quarter of 2010, reflecting "lower inflation income received on the Company's inflation protected securities (TIPS)," and a decline in interest income on loans, "mainly due to lower average balances and rates earned on most lending products."

While saying he was "pleased to report a 16.9% increase in net income in the third quarter of 2011 compared with the same period last year," CEO David Kemper said that "loan demand remained weak and, coupled with record low interest rates, interest margins were pressured."

Commerce's third-quarter net interest margin -- the difference between a bank's average yield on loans and investments and its average cost for loans and deposits -- declined sharply to 3.51%, compared to 3.85% the previous quarter and 3.75% a year earlier.

The third-quarter return on average assets was 1.32%, while the return on average equity was 12.2%, both strong numbers in the current environment for bank earnings.

Noninterest income increased slightly to $101.6 million during the third quarter, with increases in bank card fees, including expansion in merchant sales fees. As a result of the Federal Reserve's new rules that went into effect on October 1, limiting the interchange fees charged to merchants to process debit card purchases as required by the Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act, Commerce Bancshares said that it expected "that debit card revenues to decline approximately $7.0 million in the 4th quarter of 2011."

Commerce Bancshares CFO Charles Kim said that the company had no immediate plans to add new monthly fees for checking accounts, in an attempt to recapture lost revenue from Durbin, the wake of Bank of America's ( BAC) new $5 monthly fee for checking account customers who use debit cards to make purchases.

The CFO added that "Any time your fees are regulated by the government, you are going to have to find a way to make up the lost revenue," and that Commerce was "trying to be cautious and careful in the ways we price our products and are watching to see where the market lands."

"We are constantly evaluating our options and also trying to lower costs. "

Kim also said that the company's expanding corporate credit card business had expanded by nearly 22% year-over-year, and was unaffected by the Durbin rules.

Credit expenses continued to decline, with a third-quarter provision for loan losses of $11.4 million, compared to $12.2 million in the second quarter and $21.8 million in the third quarter of 2010. Commerce's ratio of nonperforming assets to total assets was a very strong 0.53%.

Commerce stands out among regional bank stocks with, shares down just 1% year-to-date through Wednesday's closing price of $38.56. In comparison, the KBW Bank Index ( I:BKX) was down 25% year-to-date through Wednesday's market close. Among the 24 index components, year-to-date returns ranged from a negative 51% for Bank of America ( BAC) to a positive return of 2% for Capital One ( COF), which was the only index component beating Commerce's stock performance.

While the bank hasn't yet seen lending volumes pickup in its Midwest market, Kim said the company's focuses on containing expenses was helping its bottom line. "Our efficiency improvemetn cushions the pain of some of the regulatory costs and we hope we can continue along those lines in 2012," he said.

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-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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