CBSH - Commerce Bancshares' Conservatism Hasn't Really Spared Its Shareholders Much Pain

2023-10-19 16:46:49 ET

Summary

• The bank's Q3 earnings were relatively flat at the pre-provision profit line, with no major problem areas, but also few significant positives.
• The bank's funding and lending growth remain strong, but there are valid concerns about weaker loan growth and fees driven by business activity, and operating leverage looks limited.
• Commerce Bancshares' stock has underperformed the broader regional bank sector by almost 10%, undercutting the notion that paying higher multiples is rewarded in the bad times.
• Commerce Bancshares does look undervalued on mid-single-digit core earnings growth, which is rare, but I believe there are better ideas out there.

The basic story on Commerce Bancshares ( CBSH ) for many many years now has been that this isn’t a bank to invest in with the expectation of tremendous growth, but rather predictability and stability. Yet, for all of the bank’s conservatism and focus on sustainable profitability, the shares are down about 27% since my last update, underperforming the broader regional bank sector by almost 10%.

If mid-single-digit core earnings growth over the long term remains a reasonable expectation (and I believe it does), these shares are undervalued. That said, there are so many other bank stocks trading below fair value today, I don’t see a compelling reason to own Commerce unless you believe that the shares will rerate back to their former elevated multiple levels.

Not Much To Excite In Q3 Earnings

There weren’t any clear problem areas with Commerce’s third quarter results, but there likewise wasn’t much to celebrate with a more or less “down the fairway” set of results.

Revenue rose about 2% yoy and fell more than 1% qoq, more or less matching expectations (there was a little spread between various third-party average revenue estimates). Net interest income rose 1% yoy and fell modestly, beating by about a penny as a modest miss in average earning asset growth (down about 1% qoq, missing by 1%) was more than made up for by a 6bps beat in net interest margin (down 1bp qoq to 3.11%).

Fee-based income lines remain sluggish overall, though, with 3% year-over-year growth and a 3% sequential decline that missed expectations by close to a penny. Card revenue declined 6% sequentially, which isn’t too surprising to me given that a lot of the card business is tied to business activity and companies are tightening up on discretionary expenses. Trust fees were up 4% qoq, though, and that was a solid performance.

Operating expenses were flat qoq (up 7% yoy), and that’s a relatively good performance at this point in the reporting cycle, though it was about a penny worse than expected. With an efficiency ratio a little above 58%, Commerce is more or less a median performer among similarly-sized banks. Pre-provision profits declined 5% yoy and almost 4% qoq, missing by a penny.

Reported earnings beat expectations with a boost from lower provisioning and a lower effective tax rate.

Good Funding, And Share Growth In Lending

One area where Commerce continues to legitimately excel is its funding. Although Commerce has seen erosion in non-interest-bearing deposits similar to peers (down 24% yoy and 3% qoq on an end-of-period basis), the ratio of NIB to total deposits is still quite good at over 31%.

What’s more, Commerce has been good at tapping other sources of low-cost funding (including securities). Total deposit costs rose 34bp qoq in the quarter (around average so far), but at 1.2% for total deposit costs and 1.76% for interest-bearing deposit costs, skews well below average. Not surprisingly, then, the deposit beta is also low – a cumulative deposit beta of 33% is likely to keep the company near the bottom of the list this quarter (compared to companies like Bank OZK ( OZK ), Pinnacle ( PNFP ), and BankUnited ( BKU ) in the 50%’s.

Turning to loans, Commerce saw the same roughly 20bp increase (18bp, technically) in sequential loan yields that I’m seeing a lot from banks this quarter. Loan growth was sort of a mixed bag. On one hand, 1% sequential growth (EOP basis) is nothing special and was a little weaker than expected. On the other hand, nearly 8% year-over-year growth almost doubled the growth rate for loans across the banking system in the third quarter, and Commerce outperformed in C&I, CRE, and construction lending.

I don’t believe that Commerce is being all that aggressive in going after new business. Likewise, I don’t think Commerce is a core market share disruptor (the net promoter score is too average to support that idea). What I do think is happening is that management is executing on its middle market lending expansion strategy (organically entering new markets like Dallas, Houston, and Nashville) and benefiting from other banks that are having to pull back on lending because of deposit/capital limitations.

Credit metrics look largely okay. C&I charge-offs did jump from basically nothing in Q2’23 to 0.18% and overall charge-offs rose from 0.16% to 0.23%, but I’m not really concerned about overall credit quality (non-performing loan balances remain small, for instance). I’d also note that card charge-offs actually declined a bit on a sequential basis. Neither office nor retail lending are large parts of the business (3% and 2% of the loan book, respectively), and even within those businesses there aren’t any obvious issues.

The Outlook

With a 48% loan yield beta and more tailwinds from loan repricing, coupled with low deposit/funding costs and an approaching peak in these costs, I’m not too concerned about Commerce’s spreads, even if it’s not really one of the best plays on “higher for longer” rates. Weaker loan growth is likely to be a headwind, as is weaker business activity-based fees, and I don’t see a lot of room for significant cost-driven leverage.

I don’t expect much momentum in pre-provision profits in ’24 or ’25. Even so, my revisions here have been more mild than for many banks, and I’m still looking for long-term core growth around 5%. If that’s a valid projection, the shares should trade closer to the mid-$50’s on discounted core earnings.

Multiples-based approaches are more problematic. The shares are pricey on likely near-term ROTCE and likewise not obviously undervalued on forward P/E.

The Bottom Line

Evaluating Commerce Bancshares over a nine-month period and noting underperformance doesn’t prove that this is a bad holding; the shares have outperformed on a longer-term basis and I can appreciate the virtues of a “sleep well at night” holding. I prefer other names, though, and I think Commerce remains more of an “okay” idea for investors more focused on conservative ideas than a compelling idea, even though it is indeed rare for the shares to trade at much (if any) discount to long-term fair value.

For further details see: