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On Thursday, Commerce Bancshares Inc. (CBSH) reported its fourth quarter 2010 earnings per share of 70 cents, ahead of the Zacks Consensus Estimate of 66 cents.

The earnings also compare favorably with the prior quarter’s earnings of 64 cents and the year-ago quarter’s earnings of 57 cents. For fiscal year 2010, the company reported earnings of $2.52 per share, in line with the Zacks Consensus Estimate and up 27.9% from $1.97 in the year-ago period.

The results benefited from increase in net interest income and non-interest income. The company’s credit quality also showed improvement. However, increase in non-interest expense was the downside. Also, the overall loan demand remained weak, which may affect the future interest income of the company.

Quarter in Detail

Commerce Bancshares’ net income for the quarter was $61.9 million, up 10.7% from $55.9 million in the prior quarter and up 24.8% from $49.6 million in the year-ago quarter. Improvement in net income was attributable to growth in core fee income, bankcard and trust fees, coupled with a lower loan loss provision and stable core expenses.

For the fiscal year 2010, Commerce Bancshares reported net income of $221.7 million compared with $169.1 million in the prior year.

Commerce Bancshares’ quarterly total revenues were $271.1 million, up from $259.4 million in the prior quarter and $267.0 million in the prior-year quarter. The company’s revenues also beat the Zacks Consensus Estimate of $268.0 million. For fiscal year 2010, the company’s total revenues stood at $1,051.1 million, up 1.9% from $1,031.8 million in 2009 but missed the Zacks Consensus Estimate of $1,059.0 million.

Quarterly taxable-equivalent net interest income (NII) rose 0.7% sequentially but fell 2.1% year over year to $166.0 million. The sequential increase was mainly attributable to lower rates paid on both deposits and borrowings, lower average balances on Federal Home Loan Bank (FHLB) advances and growth in interest income on investment securities portfolio. Taxable-equivalent NII for the fiscal year was $666.1 million, up 1.8% year over year.

Non-interest income in the quarter was $110.5 million, up 10.4% from the prior quarter and 7.7% from the prior-year quarter. The hike was mainly attributed to growth in bank card transaction fees, trust fees, bond trading income and loan fees and sales, which was partly offset by lower deposit account charges and other fees and consumer brokerage services. For the fiscal year, non-interest income came in at $405.1 million, up 2.2% from $396.3 million in the prior year.

Non-interest expense in the quarter increased 5.4% from the prior quarter and 6.7% year over year to $164.0 million. Excluding FHLB pre-payment penalty of $11.8 million and a $2.7 million reduction in a Visa indemnification obligation, non-interest expense would have been $155.0 million. For full year 2010, non-interest expense was $631.1 million compared with $621.7 million in 2009.

Efficiency ratio in the reported quarter deteriorated to 60.33% from 59.58% in the prior quarter and 57.27% in the year-ago quarter. For the fiscal year, efficiency ratio improved slightly from 59.88% in the prior year to 59.71% in 2010.

Commerce Bancshares ended the year with 4,979 employees, compared with 5,125 employees at the end of 2009.

Credit Quality

Following the trend of improving credit quality in the previous quarter, credit quality improved further in the reported quarter. Total non-performing assets declined to $97.3 million or 1.03% of loans outstanding from $102.1 million or 1.05% of loans outstanding at the end of the prior quarter and $116.7 million or 1.15% of loans outstanding at the end of the prior-year quarter.

Provision for loan losses dropped to $21.6 million from $21.8 million in the prior quarter and $41.0 million in the year-ago quarter. Net charge-offs declined 0.9% from the prior quarter and 41.5% from the prior-year quarter to $21.6 million. The allowance for loan losses rose to 2.10% of total loans, up 6 basis points (bps) from the prior quarter and 18 bps year over year.

Balance Sheet

Average loans (excluding loans held for sale) fell 3.7% from the prior quarter and 8.0% year over year to $9.35 billion, reflecting lower loan balances in all categories except business and consumer credit card loans.

Available for-sale investment securities (excluding fair value adjustments) were up 2.5% from the prior quarter and 15.8% year over year to $7.25 billion. The increase was primarily attributable to the purchases of municipal, agency mortgage-backed and other asset-backed securities during the quarter.

Average deposits spiked 0.3% sequentially and 3.7% year over year to $13.56 billion, primarily attributable to a growth in non-interest bearing demand, money market and interest checking accounts, partly offset by a decline in certificate of deposit (CD) accounts.

Capital Ratios

Commerce Bancshares’ capital ratios showed improvement in the year. As of December 31, 2010, the company’s return on assets (ROA) improved to 1.22% from 0.96%, as of December 31, 2009. As of December 31, 2010, the company’s return on equity (ROE) also increased to 11.15% from 9.76%, as of December 31, 2009.

Book value as of December 31, 2010 was $23.36 per share, up from $21.64, as of December 31, 2009.

Stock update

During the quarter, Commerce Bancshares’ purchased 1,076,732 shares of treasury stock at an average cost of $37.09 through its previously approved treasury stock buyback plan.

Our Take

Although Commerce Bancshares saw a modest improvement in credit quality, average loans decreased on a lower line of credit usage as well as a lower demand and pay-downs by business loan customers. Given the current economic conditions, we remain cautious on the company’s credit quality and loan volumes, where improvement is necessary to gain a strong foothold in the industry.

Commerce Bancshares currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Also, considering the fundamentals, we are maintaining our long-term Neutral recommendation on the shares.

Disclosure: No position

Source: Commerce Bancshares Beats 4Q Estimates on Higher Revenues