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On June 29, 2007 the Office of the Comptroller of the Currency issued a cease-and-desist order against the lead unit of Commerce Bancorp (NYSE:CBH) which effectively forced founder, Chairman and CEO Vernon W. Hill II to resign. The rare move by the OCC to intervene in the corporate governance of a bank apparently was related to an investigation into real-estate deals between CBH, Hill, and entities controlled by his wife and family, according to the OCC order.

Hill was a towering figure in the banking community, a self-made entrepreneur and maverick who taunted his peers at industry conferences for not following CBH's lead in terms of aggressive growth and Wal-Mart (NYSE:WMT) style operating rules. Superior customer service, not interest rates, said Hill, would generate deposit growth and profitability.

Sell-side pundits like CNBC's Jim Cramer relentlessly touted the stock, comparing Hill to a Jove; a colossus visionary leading the banking industry to a promised land of profitability and double digit growth. Even now, Cramer likes CBH trading on a 24 P/E and 2.5x book, albeit as an M&A play.

On Friday, we called Jim Cramer during the taping of the "Mad Money" program. Despite repeated assurances to "just hold on," after an hour passed his handlers still had not given us an opportunity to ask Cramer what he thinks of CBH, particularly given that Vernon Hill is headed for early retirement and the bank is facing ongoing federal inquiries.

Memo to Jim Cramer: Want to debate I.R.A. on live TV regarding your bull calls on CBH? We're ready when you are. And we'll bring a fresh roasted crow for your dining pleasure.

We never bought the Cramarian view of CBH. In fact, before IRA got out of the business of issuing buy/sell ratings on bank stocks more than a year ago, we maintained a "Sell" rating on CBH due to the bank's mediocre financial performance and aggressive growth strategy. In one past report, we referred to CBH as "the 7-Eleven of the banking world."

With a "bank only" ROA of 0.7% and and ROE of 11.6% for 2006, CBH's earnings steadily tracked a full standard deviation below peer since 2000, this according to The IRA Bank Monitor using "as filed" call report data from the FDIC. The peer performance report prepared by the Federal Financial Institutions Examinations Council for the period ending March 2007 shows that, in terms of ROA, CBH hasn't broken out of the bottom quartile of the 67-member peer group of large bank holding companies since 2004.

One media maven not fooled by Hill's aggressive style is John Crudele at the New York Post. For years, Crudele questioned the way Hill ran CBH and directed business to his wife and family. In earlier columns, Crudele also noted CBH's astonishing growth rate and asked, in so many words, if such organic growth could even be possible in a heavily regulated industry like commercial banking. Good question.

Crudele wrote on March 6th of this year: "The guessing is that the bank is in trouble for booking as revenues real estate transactions that were really inside deals with a partnership owned by Hill. There might also be some question about the size of the bank's deposits." The clear implication of Crudele's report and the OCC consent decree, is that Hill may have used "transactions with affiliates," as it is know in Section 23 of the Federal Reserve Act, to inflate the bank's earnings and assets.

Whenever you see an aggressive "Type A" personality at the head of a company, a person who claims to have found a better way to do things, a way that is different from the rest of the subjects in an industry, that is a red flag, in our view. Look into the heart of most of the major financial scandals of the past decade and you'll find such a forceful, "Type A" personality at the center of the action.

Combine an evangelical, "revolutionary" personality with indicators such as evidence of self-dealing by the CEO and his family, and a board that is packed with long-serving associates of that CEO, then an auditor, lawyer or bank examiner needs to start asking some tough questions about internal systems and controls. As we've said before, five years is the outer limit for the tenure of outside directors of public companies -- not decades, as in the case of CBH.

We have to believe that CBH's auditor, Ernst & Young, is asking those tough questions -- maybe for the very first time. E&Y spokesman Charlie Perkins had no comment when contacted by The IRA on Thursday last seeking comment for this report.

Any risk manager, audit assurance officer or investment analyst watching CBH's current financials would know, at a minimum, that the bank is an outlier among its peer group in terms of basic measures of sources and uses of funds. More, the degree of deviation from the peer mean evidenced in CBH's financials is, to us at least, as extraordinary as Hill's braying regarding the manifold virtues of the CBH business model.

The first thing to notice about CBH is that its ratio of core deposits to assets is very high - in 2006, over 90% vs. the peer average of 69%, using data from the FDIC and calculations by the IRA Bank Monitor. Indeed, this key business model indicator has been above 90% or over two standard deviations above the peer average since the middle of 2003 -- and this with remarkably few acquisitions.

One of the hallmarks of the Hill years at CBH has been "internal growth," which is of course desirable. But when a bank's internal growth rate far outstrips the other players in a given industry, does that raise a flag? According to data from the Federal Reserve Board and calculations from the FFIEC, since 2004 CBH's annual asset growth rate ranged between 2x and 3x the peer average of 10.5%, a truly remarkable -- even incredible statistic.

The outlier status CBH earns from its high deposit to asset ratio is all the more remarkable when you look at how these deposits are employed. With only 34% of assets or $15.6 billion deployed in loans and leases at the end of 2006, CBH is more than a standard deviation below peer (67%) in terms of the loan to deposit ratio.

Why does CBH have so little of its assets deployed in loans? Because as of March 2007, 50% of the bank's assets were invested in mortgage backed securities or MBS, according to the Form Y-9 filed with the Fed. This concentration of MBS is five times the peer average of 9.6%. And nearly 85% of the CBH portfolio of MBS has a maturity of five years or more, above the peer mean of 61% and adding considerable duration risk to the bank's balance sheet.

CBH is known for having one of the highest deposit growth rates in the industry, 325% for core deposits over five years. That's over 60% annual growth with virtually no M&A. Over the same period, non-interest bearing deposits grew over 800% and accounted for nearly 20% of total deposits at the end of March 2007. Ominously, in Q1 2007, CBH's non-core fuding dropped almost 10% vs. a 13% increase for the peer group.

Combine above-peer deposit growth and overhead expenses, below peer lending activity, and an asset concentration in long-dated MBS, and the result seems to be poor financial performance overall and below-peer capital ratios. At the end of March 2007, CBH had Tier One capital to total assets of just 6.1% vs 7.7% for the peer group.

The CBH capital picture is even less flattering measured on a total capital basis, with CBH, which has no Tier Two capital, still at 6.1% of total assets vs 9.25% for the 67 instititions in the peer group defined by the Fed. That puts CBH in the bottom decile of the peer group in terms of total capital vs. total assets, a troubling indicator given the bank's poor asset performance and risk profile that emphasizes the trading book.

According to the Economic Capital simulation in The IRA Bank Monitor, CBH should have $7.50 in Economic Capital for every dollar of Tier One Risk Based Capital ("RBC") currently held by the bank. Indeed, so large is the concentration of MBS on the CBH balance sheet that, based upon the Economic Capital model in The IRA Bank Monitor, CBH has the highest ratio of Economic Capital to Tier One RBC of any US bank holding company with assets above $10 billion except State Street (NYSE:STT).

The table below shows Economic Capital, Risk Adjusted Return on Capital ("RAROC"), Tier 1 RBC and is sorted based upon the ratio of EC to Tier 1 RBC for the top 25 US bank holding companies as of year-end 2006, using calculations by The IRA Bank Monitor. Notice that the ratio of EC to Tier One RBC generated by our Economic Capital simulation for CBH is significantly higher than that for JPMorgan Chase (NYSE:JPM), Citigroup (NYSE:C) and HSBC (NYSE:HBC) -- the relative outliers in the large commercial bank peer group.

The IRA Bank Monitor -- 2006


The OCC may be entirely justified in forcing Vernon Hill out as CEO, pursuing its continuing investigation of transactions with Hill's family, and requiring changes in CBH's corporate governance. To us, however, the bank's financial performance as currently stated continues to be a source of concern and wonderment. Should the OCC inquiry result in a restatement of past period financials by CBH, then we'll need to look at the results anew.

Here's our question for CBH, E&Y, the OCC and Jim Cramer too: Given the fact of the removal of Hill and the aggressive, "you don't get it" attitude he brought to running CBH, do the bank's historical financial statements warrant a second look? Were the growth rates posted by CBH over the past five years a little to good to be true?

Disclosure: Author has no position in CBH

Source: What Does Jim Cramer See in Commerce Bancorp?