Commerce Bancshares - 10-Q quarterly report FY

 

SECURITIES AND EXCHANGE COMMISSION

 

 

 

 

(Mark One)

 

 

For the quarterly period ended September 30, 2000

 

 

 

For the transition period from to

 

 

 

 

 

 

          Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes  X No 

 

          As of November 3, 2000, the registrant had outstanding 59,777,243 shares of its $5 par value common stock, registrant’s only class of common stock.

 

 

Part I: FINANCIAL INFORMATION

 

          In the opinion of management, the consolidated financial statements of Commerce Bancshares, Inc. and Subsidiaries as of September 30, 2000 and December 31, 1999 and the related notes include all material adjustments which were regularly recurring in nature and necessary for fair presentation of the financial condition and the results of operations for the periods shown .

 

          The consolidated financial statements of Commerce Bancshares, Inc. and Subsidiaries and management’s discussion and analysis of financial condition and results of operations are presented in the schedules as follows:

 

 

 

 

          (a) Exhibits

 

 

          (b) No reports on Form 8-K were filed during the quarter ended September 30, 2000.

 

 

          Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

Date: November 10, 2000

 

 

Date: November 10, 2000

 

Schedule 1

 

 

 

 

See accompanying notes to financial statements.

Schedule 2

 

 

 

 

See accompanying notes to financial statements.

 

Schedule 3

 

 

 

 

See accompanying notes to financial statements.

 

Schedule 4

 

 

 

 

 

          Net cash payments of income taxes for the nine month period were $68,265,000 in 2000 and $81,754,000 in 1999. Interest paid on deposits and borrowings for the nine month period was $240,525,000 in 2000 and $218,995,000 in 1999.

 

See accompanying notes to financial statements.

 

Schedule 5

 

 

 

 

 

          The accompanying consolidated financial statements include the accounts of Commerce Bancshares, Inc. and all majority-owned subsidiaries (the Company). All significant intercompany accounts and transactions have been eliminated. Certain reclassifications were made to 1999 data to conform to current year presentation. Results of operations for the nine month period ended September 30, 2000 are not necessarily indicative of results to be attained for any other period.

 

          The significant accounting policies followed in the preparation of the quarterly financial statements are the same as those disclosed in the 1999 Annual Report to stockholders to which reference is made.

 

 

          The Company has signed a definitive agreement to acquire Breckenridge Bancshares Company, a Missouri holding company with assets of $260 million. Subject to regulatory and stockholder approvals, completion of the acquisition should occur in the first quarter of 2001. This acquisition will be accounted for as a pooling of interests transaction and is not expected to have a material impact on the financial statements of the Company.

 

 

          The following is a summary of the allowance for loan losses.

 

 

          At September 30, 2000, non-performing assets were $46,708,000, which was .59% of total loans and .43% of total assets. This balance consisted of $14,640,000 in loans not accruing interest, $30,883,000 in loans past due 90 days and still accruing interest, and $1,185,000 in foreclosed real estate.

 

4. Investment Securities

 

          Available for sale investment securities, at fair value, consist of the following at September 30, 2000 and December 31, 1999.

 

 

 

          The shares used in the calculation of basic and diluted income per share are shown below.

 

 

 

          Comprehensive income is defined as the change in equity from transactions and other events and circumstances from non-owner sources, and excludes investments by and distributions to owners. Comprehensive income includes net income and other items of comprehensive income meeting the above criteria. The Company’s only component of other comprehensive income is the unrealized holding gains and losses on available for sale securities.

 

 

7. Segments

 

          Management has established three operating segments within the Company. The Consumer segment includes the retail branch network, consumer finance, bankcard, student loans and discount brokerage services. The Commercial segment provides corporate lending, leasing, and international services, as well as business, government deposit and cash management services. The Money Management segment provides traditional trust and estate tax planning services, and advisory and discretionary investment management services.

 

          The following table presents selected financial information by segment and reconciliations of combined segment totals to consolidated totals. There were no material intersegment revenues between the three segments.

 

 

          Average total deposits in the Consumer segment decreased 3.8% compared to the first nine months of 1999. Average loans in the Commercial segment increased 17.5%, and average total deposits decreased 2.5% from 1999 levels.

 

          The segment activity, as shown above, includes both direct and allocated items. Amounts in the “ Other/Elimination” column include activity not related to the segments, such as that relating to administrative functions, and the effect of certain expense allocations to the segments.

 

Schedule 6

 

 

 

 

          The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes and with the statistical information and financial data appearing in this report as well as the Company’s 1999 Annual Report on Form 10-K. Results of operations for the nine month period ended September 30, 2000 are not necessarily indicative of results to be attained for any other period.

 

 

 

          Consolidated net income for the third quarter of 2000 was $45.5 million; a $4.1 million or 9.9% increase over the third quarter of 1999. Diluted earnings per share increased 13.8% to $.74 for the third quarter of 2000 compared to $.65 for the third quarter of 1999. The third quarter of 2000 was the Company’s eighteenth consecutive quarter of double-digit growth in earnings per share. Return on average assets for the quarter was 1.65% compared to 1.49% last year. Return on average realized stockholders’ equity for the third quarter was 16.35% compared to 15.53% in the previous year. The Company’s efficiency ratio, a measure of expense efficiency in generating income, was 58.56% for the third quarter of 2000.

 

          Consolidated net income for the first nine months of 2000 was $132.4 million, an 8.6% increase over the first nine months of 1999. Diluted earnings per share was $2.14 compared to $1.89 last year. Compared to last year, net interest income increased 4.2% due to average loan growth of 9.1%, coupled with stable funding costs. The increase in non-interest income was the result of growth in credit card, trust, and deposit account fees. Non- interest expense increased mainly due to higher salary costs, bank occupancy expense, and data processing and other technology costs. The Company’s efficiency ratio for the first nine months of 2000 was 57.71%.

 

          The Company has signed a definitive agreement to merge with Breckenridge Bancshares Company, a one-bank holding company in the St. Louis area. The bank has three locations and approximately $260 million in assets. Subject to regulatory and stockholder approvals, completion of the acquisition is expected in the first quarter of 2001. The acquisition will be accounted for as a pooling of interests transaction and is not expected to have a material impact on the financial statements of the Company.

 

 

          The following table summarizes the changes in net interest income on a fully tax equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates. Changes not solely due to volume or rate changes are allocated to rate. Management believes this allocation method, applied on a consistent basis, provides meaningful comparisons between the respective periods.

 

 

 

          Net interest income for the third quarter of 2000 was $120.7 million, a 1.4% increase over the third quarter of 1999, and for the first nine months was $360.9 million, a 4.2% increase over last year. The third quarter 2000 increase in net interest income over third quarter 1999, when compared to the increase realized in the first six months of 2000, reflects a mixture of tightening interest rate spread, shrinking average deposit balances, and a slower rate of growth in average loan balances. For the quarter, the net interest rate margin was 4.75% compared with 4.67% last year, while the nine month margin was 4.73% in 2000 and 4.59% in 1999.

 

          Total interest income increased $17.4 million, or 9.2%, over the third quarter of 1999 and increased $48.0 million, or 8.6%, over the first nine months of 1999. The increases were mainly due to higher loan demand and higher rates earned on loans. Average loans outstanding increased $501.6 million on a quarterly comparison and $647.5 million year to date. Average rates earned on loans increased 71 basis points and 50 basis points over the prior third quarter and year to date periods, respectively. The increases in these periods were partly offset by decreases in average investment securities. Average investments in U.S. government and federal agency securities declined by over 25% compared to previous periods. Lower investments in CMO’s and asset-backed securities also contributed to the decrease. The average tax equivalent yield on interest earning assets was 8.12% for the third quarter of 2000 compared to 7.42% last year. The nine month yield increased from 7.38% in 1999 to 7.93% in 2000.

 

          Total interest expense (net of capitalized interest) increased $15.7 million, or 22.2%, compared to the third quarter of 1999 and increased $33.3 million, or 15.7%, over the first nine months of 1999. The increases were mainly due to higher rates paid on the Company’s Premium Money Market deposit accounts. Higher rates paid on certificates of deposit also contributed to the increases. The deposit rate increases were partly offset by lower deposit balances. Additionally, interest expense increased over 1999 third quarter and year to date periods due to higher borrowings of and rates paid on federal funds purchased and securities sold under agreements to repurchase. The overall average cost of funds increased from 3.28% in the third quarter of 1999 to 4.05% in the third quarter of 2000. The nine month cost increased from 3.32% in 1999 to 3.84% in 2000. Average core deposits (deposits excluding short-term certificates of deposit over $100,000) for the first nine months of 2000 decreased 3.6% compared to the same period last year. Core deposits supported 87% of average earning assets in 2000.

 

          Summaries of average assets and liabilities and the corresponding average rates earned/paid appear on pages 18 and 19.

 

 

          Non-performing assets include impaired loans (non-accrual loans and loans 90 days delinquent and still accruing interest) and foreclosed real estate. Loans are placed on non-accrual status when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment (generally, loans that are 90 days past due as to principal and/or interest payments). These loans were made primarily to borrowers in Missouri, Kansas and Illinois. The following table presents non-performing assets.

 

 

          The level of non-performing assets increased $11.1 million, or 31.0%, over year end 1999 totals. Most of the increase occurred in loans which were past due 90 days or more, and still accruing interest. This category included business loans of $12.8 million, credit card loans of $6.4 million, personal real estate loans of $5.8 million, and personal loans of $4.8 million. Non-accrual loans at September 30, 2000 consisted mainly of business loans ($6.2 million), business real estate loans ($6.5 million), and construction and land development loans ($1.6 million).

 

           Credit card loans outstanding were $500.3 million at September 30, 2000 compared to $521.8 million at year end 1999. These loans traditionally have a higher than average ratio of net charge-offs to loans outstanding when compared to other portfolio segments. This ratio, which was below industry national averages, was 3.21% for the first nine months of 2000 compared to 3.27% for the first nine months of 1999. The risk presented by the above loans and foreclosed real estate is not considered by management to be materially adverse in relation to normal credit risks generally taken by lenders.

 

 

 

          Management records the provision for loan losses, on an individual bank basis, in amounts that result in an allowance for loan losses sufficient to cover current net charge-offs and risks believed to be inherent in the loan portfolio of each bank. Management’s evaluation includes such factors as past loan loss experience, current loan portfolio mix, evaluation of actual and potential losses in the loan portfolio, prevailing regional and national economic conditions that might have an impact on the portfolio, regular reviews and examinations of the loan portfolio conducted by internal loan reviewers supervised by Commerce Bancshares, Inc. (the Parent), and reviews and examinations by bank regulatory authorities. The allowance for loan losses as a percentage of loans outstanding was 1.63% at September 30, 2000, compared to 1.62% at year-end 1999 and 1.63% at September 30, 1999. The allowance at September 30, 2000 was 275% of non-performing assets. Management believes that the allowance for loan losses, which is a general reserve, is adequate to cover actual and probable losses in the loan portfolio under current conditions. Other than as previously noted, management is not aware of any significant risks in the current loan portfolio due to concentrations of loans within any particular industry, nor of any separate types of loans within a particular category of non-performing loans that are unusually significant as to probable loan losses when compared to the entire loan portfolio.

 

 

 

          Non-interest income rose $9.3 million over the first nine months of last year. Most of the increase occurred in credit card transaction fees, which increased $5.5 million, or 17.9%, due to higher transaction volumes and growth in fees from the Company’s debit card product. Trust fees and deposit account fees both increased 3% over the first nine months of 1999. Trading account profits and commissions decreased $1.4 million due to lower sales to financial institutions, where there is less liquidity to purchase investment securities. The other income category increased $2.7 million, or 6.3% over last year. This increase included gains of $4.0 million on the sales of three bank branches in the second and third quarters of 2000. The increase was partly offset by a decline in gains on loan sales of $2.1 million. A venture capital partnership investment contributed net gains of $3.0 million in 2000; however, these were $814 thousand lower than the net partnership gains recognized during the first nine months of 1999.

 

          Non-interest income increased $7.4 million in the third quarter of 2000 compared to the third quarter of 1999. Credit card transaction fees rose $1.9 million and trust fees increased $721 thousand. Trading account profits continued to show a negative trend, with a $720 thousand decline from the third quarter of 1999. Other income increased $4.9 million over the third quarter of 1999, due to gains on two bank branch sales and the venture capital partnership gain mentioned above. Partly offsetting these gains was a $1.1 million decrease in gains on loan sales.

 

 

 

          Non-interest expense rose $8.6 million, or 2.8%, over the first nine months of 1999 and increased $5.4 million, or 5.2%, over the third quarter of 1999. Salaries and employee benefits increased $4.4 million over the first nine months of 1999 and increased $1.9 million over the third quarter of 1999. Higher incentive compensation payments and merit increases contributed to the salary increase. Occupancy costs increased 9.3% and 7.7% over the 1999 year and quarter to date periods, partly due to lower outside tenant revenues associated with a building renovation occurring in Kansas City. Equipment expense increases over the prior periods occurred in rental costs and depreciation on data processing equipment. Charges related to data processing increased $1.1 million and $452 thousand over the 1999 year and quarter to date periods, partly because of higher charges by information service providers. Other expense increased over the 1999 year and quarter to date periods mainly due to the contribution of $3.6 million in appreciated securities to a charitable organization, which was partly offset by a decrease in processing losses. The efficiency ratio was 58.56% in the third quarter of 2000 compared to 58.35% in the third quarter of 1999 and 56.14% in the second quarter of 2000.

 

 

          The Company’s effective tax rate declined from 34.1% in the second quarter of 2000 to 31.7% in the third quarter of 2000. This decrease was mainly the result of the charitable contribution mentioned above, which had the effect of decreasing income taxes by approximately $2.0 million.

 

 

          The Company segregates financial information for use in assessing its performance and allocating resources among three operating segments. The results are determined based on the Company’s management accounting process, which assigns balance sheet and income statement items to each responsible segment. These segments are defined by customer base and product type. The management process measures the performance of the operating segments based on the management structure of the Company and is not necessarily comparable with similar information for any other financial institution. Each segment is managed by executives who, in conjunction with the Chief Executive Officer, make strategic business decisions regarding that segment. The three reportable operating segments are Consumer, Commercial and Money Management.

 

          In the recent rising interest rate environment, sources of funds (deposits) become more valuable and uses of funds (loans and investments) become more expensive, thereby affecting the profitability of the related activities. The Company’s internal funds transfer pricing methodology uses a moving average market rate, and it has increased at a faster pace than the actual increase in our average deposit rates, loan yields, and faster especially than our average investment yields. The transfer pricing rate increase in 2000 had the effect of improving the profitability of funds providers (Consumer segment), reducing profitability of funds users (Commercial segment), and reducing the investment portfolio profitability (outside of the segments). The increased volume in Commercial lending more than offset the negative effect of an increased cost of funds rate.

 

 

          The Consumer segment includes the retail branch network, consumer finance, bankcard, student loans and discount brokerage. For the nine months ended September 30, 2000, pre-tax earnings amounted to $104.4 million, up $34.6 million, or 49.5%, over the previous year. Most of this increase was due to a $26.1 million increase in funding credits allocated to the segment. Non-interest income increased $7.5 million, mainly in credit card fees and deposit account charges. Non-interest expense decreased $7.1 million mainly due to lower salaries and employee benefit expense.

 

 

          The Commercial segment provides corporate lending, leasing, international services, and corporate cash management services. Pre-tax earnings for the first nine months of 2000 were $85.8 million, an increase of 13.9% over the prior year. Direct net interest income increased $58.7 million, with average loans increasing 17.5% and average interest bearing deposits remaining static. Assigned costs of funding increased $45.5 million, partly due to the increased transfer pricing rate described above. Non-interest income was relatively unchanged. Non-interest expense increased $3.2 million mainly as a result of higher costs for salaries, marketing, and assigned management costs.

 

 

          The Money Management segment consists of the Investment Management Group (IMG) and the Capital Markets Group (CMG). IMG provides trust and estate planning services, and advisory and discretionary investment management services. CMG sells primarily fixed income securities to individuals, corporations, correspondent banks, public institutions, and municipalities, and also provides investment safekeeping and bond accounting services to these entities. Pre-tax earnings were $16.4 million for the first nine months in 2000, a decrease of 17.1% compared to the same period in the prior year. A $3.2 million increase in direct net interest income was offset by a comparable decrease in allocated funding credits. Non-interest income was stable. Non-interest expense increased $3.0 million over 1999, mainly due to higher costs for salaries and data processing expense.

 

 

          The liquid assets of the Parent consist primarily of commercial paper, overnight repurchase agreements and equity securities, most of which are readily marketable. The fair value of these investments was $127.0 million at September 30, 2000 compared to $113.3 million at December 31, 1999. Included in the fair values were unrealized net gains of $29.1 million at September 30, 2000 and $25.1 million at December 31, 1999. The Parent’s liabilities totaled $120.0 million at September 30, 2000, compared to $14.2 million at December 31, 1999. Liabilities at September 30, 2000 included $101.8 million advanced mainly from subsidiary bank holding companies in order to combine resources for short-term investment in liquid assets. The funds advanced from the subsidiary bank holding companies consist mainly of subsidiary bank dividends. The Parent had no short-term borrowings from affiliate banks or long-term debt during 2000. The Parent’s commercial paper, which management believes is readily marketable, has a P1 rating from Moody’s and an A1 rating from Standard & Poor’s. The Company is also rated A by Thomson BankWatch with a corresponding short-term rating of TBW-1. This credit availability should provide adequate funds to meet any outstanding or future commitments of the Parent.

 

          The liquid assets held by bank subsidiaries include federal funds sold and securities purchased under agreements to resell and available for sale investment securities. These liquid assets had a fair value of $2.01 billion at September 30, 2000 and $2.56 billion at December 31, 1999. The available for sale bank portfolio included an unrealized net loss in fair value of $24.6 million at September 30, 2000 compared to an unrealized net loss of $29.7 million at December 31, 1999. U.S. government and federal agency securities comprised 44% and CMO’s and asset-backed securities comprised 52% of the banking subsidiaries’ available for sale portfolio at September 30, 2000. The estimated average maturity of the available for sale investment portfolio was 2.9 years at September 30, 2000 and December 31, 1999.

 

          In February 2000, the Board of Directors announced the approval of additional purchases of the Company’s common stock, bringing the total purchase authorization to 3,000,000 shares. At September 30, 2000, the Company had acquired 1,941,750 shares under this authorization. The Company has routinely used these reacquired shares to fund annual stock dividends and employee benefit programs. At an October 2000 meeting, the Board authorized the seventh annual consecutive 5% stock dividend, which will be distributed in December 2000.

 

          The Company had an equity to asset ratio of 9.87% based on 2000 average balances. As shown in the following table, the Company’s capital exceeded the minimum risk-based capital and leverage requirements of the regulatory agencies.

 

 

          The Company’s cash and cash equivalents (defined as “Cash and due from banks”) were $532.3 million at September 30, 2000, a decrease of $152.9 million from December 31, 1999. Contributing to the net cash outflow were a $357.3 million increase in loans (net of repayments), a net decrease in deposits of $228.5 million, and a net decrease in borrowings of $125.3 million. Partially offsetting these net outflows were $475.4 million in maturities and sales of investment securities, net of purchases, and $190.9 million generated from operating activities. Total assets decreased $437.4 million from December 31, 1999.

 

          The Company has various commitments and contingent liabilities which are properly not reflected on the balance sheet. Loan commitments (excluding lines of credit related to credit card loan agreements) totaled approximately $2.97 billion, standby letters of credit totaled $276.6 million, and commercial letters of credit totaled $31.2 million at September 30, 2000. The Company has little risk exposure in off-balance-sheet derivative contracts. The notional value of these contracts (interest rate and foreign exchange rate contracts) was $157.7 million at September 30, 2000. The current credit exposure (or replacement cost) across all off-balance-sheet derivative contracts covered by the risk-based capital standards was $4.0 million at September 30, 2000. Management does not anticipate any material losses to arise from these contingent items and believes there are no material commitments to extend credit that represent risks of an unusual nature.

 

Quantitative and Qualitative Disclosures about Market Risk

 

          The Company’s assets and liabilities are principally financial in nature and the resulting net interest income thereon is subject to changes in market interest rates and the mix of various assets and liabilities. Interest rates in the financial markets affect the Company’s decisions on pricing its assets and liabilities which impacts net interest income, a significant cash flow source for the Company. As a result, a substantial portion of the Company’s risk management activities relates to managing interest rate risk.

 

          The Company’s Asset/Liability Management Committee monitors on a monthly basis the interest rate sensitivity of the Company’s balance sheet using earnings simulation models and interest sensitivity GAP analysis. Using these tools, management attempts to optimize the asset/liability mix to minimize the impacts of significant rate movements within a broad range of interest rate scenarios.

 

          One set of simulation models is prepared to determine the impact on net interest income for the coming twelve months under several interest rate scenarios. One such scenario uses rates and volumes at September 30, 2000 for the twelve month projection. When this position is subjected to a graduated shift in interest rates, the annual impact to the Company’s net interest income is as follows:

 

 

          Currently, the Company does not have significant risks related to foreign exchange, commodities or equity risk exposures.

 

 

          Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities”, and its amendments will be adopted by the Company on January 1, 2001. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and hedging activities. All derivatives must be recognized on the balance sheet at fair value, with the adjustment to fair value recorded in current earnings. For derivatives qualifying as hedges, changes in the fair value of the derivatives will be either offset against the changes in fair value of the hedged items through current earnings, or recognized in other comprehensive income until the hedged items are recognized in current earnings based on the nature of the hedge. The ineffective portion of the derivative’s change in fair value will be immediately recognized in current earnings.

 

          The Company uses some derivative products as part of its overall risk management process. Through an implementation process, the Company has identified several areas in which derivative products exist and will be affected by this new accounting standard. Forward contracts are used to manage risk positions associated with certain residential mortgage banking and foreign exchange activities. The Company also has a minimal number of interest rate swaps in place to manage interest rate risk on fixed rate loans. Management expects the transition entry that will be recorded upon adoption of the statement, and future application of SFAS 133, to have an immaterial impact on the financial statements of the Company.

 

 

          This report contains “forward-looking statements” within the meaning of the federal securities laws. Such statements are subject to certain risks and uncertainties, including changes in economic conditions in the Company’s market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the Company’s market area, and competition, that could cause actual results to differ materially from historical earnings and those presently anticipated or projected.

 

AVERAGE BALANCE SHEETS—AVERAGE RATES AND YIELDS

 

 

 

 

 

AVERAGE BALANCE SHEETS—AVERAGE RATES AND YIELDS