We are maintaining our Neutral recommendation on Commerce Bancshares, Inc. (CBSH - Analyst Report) as we believe that the risk-reward profile of the company is currently balanced. Our decision is based on the marginal rise in non-interest income, reduction in operating expenses and steady capital ratios in the third quarter of 2012. However, we remain concerned about the concentration risk emanating from the company’s dependence on fee income and the worrying macro economic trends.
Commerce Bancshares has maintained a steady dividend policy, delivering incremental dividends for the past 44 successive years. In November 2012, the company declared a special cash dividend and a stock dividend, apart from the regular quarterly cash dividend. In February 2012, the company had increased its regular quarterly dividend by 5% to 23 cents per share and has maintained it since then. During the quarter, Commerce Bancshares also repurchased about 98,000 shares at an average price of $39.66 per share. As a result, Commerce Bancshares remains an attractive stock for the yield-seeking investors.
Further, Commerce Bancshares has sustained its capital levels considerably above its peers. Despite increasing credit costs, the company has been registering stable capital ratios. As of September 30, 2012, the company remained well capitalized with its capital ratios – tier 1 risk-based capital of 14.92%, total risk-based capital of 16.25% and leverage of 10.00% – well above the regulatory requirements. We expect this to act as a shield against any possible loss in its credit portfolio in the forthcoming quarters.
In addition, Commerce Bancshares’ balance sheet continues to remain strong with a robust capital and deposit base. The favorably diversified balance sheet and medium interest rate risk comfortably position the company for growth. Moreover, the loan losses of the company have been subsiding for the last several quarters. With the gradual recovery of the housing sector, these losses may further decline in the near future. Furthermore, lower loan-to-deposit ratio of 55.89% will facilitate the funding of loan growth at moderate costs in the future.
We believe that such efforts will help the company gain substantial market share and enhance its profitability in the long run. Yet, Commerce Bancshares’ heavy dependence on net interest income is anticipated to thwart its growth prospects. With average demand for loans registering a steady decline, there will be an adverse impact on its top line.
Commerce Bancshares’ operations are mainly concentrated in a handful of states namely Missouri, Kansas, Illinois, Oklahoma and Colorado. The lack of geographical diversity may cause diseconomies of scale stemming from the current interest rate volatility. Moreover, regional economy does influence a company’s performance. Therefore, having operations in various regions is helpful in nullifying associated risks.
In addition, the rigorous regulatory requirements will mar the revenue projections from overdraft and credit card transactions. According to the latest proposed rules by the Federal Reserve, the banks are required to maintain 7% total tier 1 ratio, way above the current requirement of 2%. This would considerably affect the lending as well as the investment capacities of banks including Commerce Bancshares. Furthermore, such limitations may raise costs and limit its ability to pursue business opportunities.
Shares of Commerce Bancshares currently retain a Zacks #3 Rank, which translates into a short-term Hold rating. However, another institution in the same sector; namely, ViewPoint Financial Group, Inc. retains a Zacks #1 Rank (translating into short-term Strong Buy rating).