Commerce Bancshares Beats on Margin Expansion (Update 2)

Updated with comments from KBW analyst Christopher McGratty and Jefferies analyst Emlen Harmon, and market close information.

NEW YORK ( TheStreet) -- Commerce Bancshares ( CBSH) on Thursday reported that its second-quarter net interest margin expanded to 3.55% from 3.45% the previous quarter, running counter to the trend for most banks in the prolonged low-rate environment.

The Kansas City, Mo., lender reported second-quarter earnings of $74.3 million, or 84 cents share, beating by a wide margin the consensus estimate of a 72-cent profit, among analysts polled by Thomson Reuters. In comparison, the company earned $65.8 million, or 74 cents a share, during the first quarter and $69.0 million, or 75 cents a share, during the second quarter of 2011.

The company's shares rose 2% to close at $39.28, while most other bank stocks showed declines. The KBW Bank Index ( I:BKX) declined over 1% to close at 44.46, with all 24 index components showing declines, except for Commerce Bancshares.

Commerce had $20.7 billion in total assets as of June 30. Nonperforming assets, including non-accrual loans and repossessed real estate, declined to a strong 0.88% of total assets as of June 30, improving from 0.95% the previous quarter, and 1.12% a year earlier.

Second-quarter net interest income increased to $165.1 million from $159.7 million in the first quarter, and $164.7 million in the second quarter of 2011. The improved second-quarter interest income included "interest income of $1.3 million on two non-performing commercial loans," and "interest income of $1.1 million on the early pay-off of a commercial real estate loan," according to the company. Together, these two items contributed four cents to the second-quarter bottom line.

Another major factor in Commerce's increase in net interest income -- and the widened net interest margin -- was "an increase in inflation income of $4.4 million on the Company's inflation protected securities (TIPs), which increased the yield on the overall securities portfolio by 20 basis points to 2.75%," while increasing interest income on the company's $9 billion securities portfolio by $4 million over the previous quarter.

While Commerce's average loans during the second quarter increased slightly from the second quarter and declined slightly from a year earlier, period-end total loans grew 1% sequentially and 2% year-over-year, as new lending activity accelerated toward the end of the second quarter, with "growth of $165.1 million in business, personal real estate loans and consumer loans," according to CEO David Kemper.

While the company's total non-interest income declined slightly year-over-year to $100.8 million during the second quarter, Commerce managed to offset most of the 44.5% decline in debit card interchange fees -- from the Durbin Amendment to the Dodd-Frank bank reform legislation, which cut the fees charged by large banks to merchants to process debit card purchases starting in the fourth quarter of 2011 -- with "an increase in corporate card and trust fees."

Second-quarter bank card transaction fee income totaled $38.4 million, increasing from $34.7 million in the first quarter, while declining from $41.3 million in the second quarter of 2011. Trust fee income grew to $23.8 million in the second quarter, from $22.8 million the previous quarter, and $22.5 million, a year earlier.

The company's second-quarter return on average assets (ROA) was 1.45%, improving from 1.29% in the first quarter, but down slightly from 1.47% in the second quarter of 2011. The second-quarter return on average equity (ROE) was 13.43%, increasing from 12.04% the previous quarter and 13.12% a year earlier. These are all strong figures for a large bank in the current environment, as credit quality improves, but net interest margins narrow for most banks.

Commerce's efficiency ratio -- essentially the number of pennies of overhead for each dollar of revenue -- was 56.39%, improving from 58.91% in the first quarter and 57.40% during the second quarter of 2011.

Commerce Bancshares has seen its stock return 4% year-to-date, following a 2% decline during 2011

CBSH Chart CBSH data by YCharts

The shares trade for 13 times the consensus 2013 earnings estimate of $2.99 a share. The consensus 2012 EPS estimate is $2.95.

Based on a quarterly payout of 23 cents the shares have a dividend yield of 2.34%.

The company "repurchased approximately 1,033,000 shares of Company stock at an average price per share of $38.76," during the second quarter, according to Kemper.

KBW analyst Christopher McGratty said Thursday morning that his firm was "encouraged by CBSH's 2Q results as the margin expanded nicely (+10bps), credit costs continued to fall, and fee income trends were solid," adding that "most importantly, in our view, end-of-period loan growth of nearly 6% sequentially and year-over-year was the best since the cycle started, an encouraging sign going forward."

McGratty rates Commerce Bancshares "Market Perform," with a $38 price target.

Jefferies analyst Emlen Harmon has a "Hold" rating on Commerce Bancshares, with a $41 price target, and said Thursday afternoon that "Street should trend positively as better than expected fee income works its way into numbers and '12/'13 estimates reflect the potential for credit recoveries, though interest income should give back much of its improvement from TIPS and nonaccrual recoveries."

Interested in more on Commerce Bancshares? See TheStreet Ratings' report card for this stock.

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

>Contact by Email.

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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