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I believe that at least part of the reason that investors are willing to bid up Commerce Bancshares (NASDAQ:CBSH) to above-average multiples is that this bank is built to weather the ups and downs of normal banking cycles without much drama. And so it would seem to be the case in the fourth quarter as well, as the bank continues to see solid, but not spectacular, results.
Commerce shares are up a bit from my last update, outperforming peers in a market where there is still a lot of angst as to what banking earnings will look like in 2023 due to rising deposit costs and more limited operating leverage prospects. As much as it surprises me to say this, I don't find the valuation all that bad, at least relative to what passes for normal with Commerce, and while I can't really recommend it wholeheartedly as a bank stock likely to generate substantial outperformance, I think it is a name for investors who want less drama and volatility.
Mixed Results, But Okay At The Core Level
How Commerce did in the fourth quarter depends in part on how you define core results - I exclude items like investment gains/losses from core results, but not all analysts do, and that actually decides whether Commerce beat or missed pre-provision profit expectations. I call it a miss, but not a particularly substantial one.
Revenue rose about 10% year over year and close to 2% quarter over quarter in the fourth quarter, missing slightly (about $0.01/share) relative to sell-side expectations. Net interest income was as expected, growing more than 22% yoy and 3% qoq on a fully-taxed equivalent basis, as earning assets shrank modestly (down 2.5% qoq), but net interest margin improved 17bp qoq to 3.18%.
Fee-based income fell more than 7% yoy and 1% qoq, missing by about $0.015/share when excluding securities gains. Neither cards (flat qoq) or trust fees (down 1.5% qoq) were much help this quarter.
Operating expenses rose more than 6% yoy and almost 2% qoq, coming in a bit higher than expected in both absolute terms and in efficiency ratio. Still, a 55% efficiency ratio isn't bad on a peer basis. Pre-provision earnings rose about 15% yoy and 1.5% qoq, missing by around $0.02 relative to sell-side estimates (trying to adjust for the aforementioned treatment of security gains).
Strong Core Deposits Give The Company Affordable Dry Powder
Commerce's loan performance was fairly average in the fourth quarter; 2.5% sequential loan growth was less than the growth for the banking system as a whole in the quarter (3%-plus), but it was better than the 2% growth seen at the largest banks. As Commerce is sort of "in-between" (it's the 42nd-largest bank by assets), I'd call that a wash.
Business lending grew close to 3% in the quarter, again a little worse than the banking system, but a little better than the largest banks. CRE lending was meaningfully better (up 2.7% versus systemwide growth closer to 2%), and construction (up 13%) was strong. Mortgage lending was up 2% and consistent with the market. Loan yields improved 66bp qoq, with C&I yields up 74bp to 4.68% - lagging the 115bp qoq improvement at Truist, but then Commerce is a more credit-cautious lender.
Deposits fell 5% sequentially (end of period), with non-interest-bearing deposits down 4% (both end of period and average). Erosion in non-interest-bearing deposits is a fact of life now for banks, and Commerce is around average attrition. Still, the bank has close to 40% of its deposits in NIBs and that's better than average, and Commerce continues to support a better-than-average funding structure, with total deposit costs of just 0.24% (up 12bp qoq).
Commerce's deposit betas remain quite low, with a cycle-to-date interest-bearing deposit beta of just around 8% and a total cumulative deposit beta of around 5% - well below a peer average in the low-20%s. With a loan/deposit ratio still around 60% and meaningful securities still on the balance sheet, I don't think Commerce needs to scramble to acquire higher-cost funding (an issue with banks like First Republic (FRC)) to maintain its likely loan growth.
How well demand holds up is another question. Commerce has started targeting higher-growth markets like Dallas, Houston, and Nashville, but overall the company's footprint is slower-growing than names more focused on Texas and/or the Southeast U.S. I expect business loan demand to weaken from here, as companies work down their inventories and hold off on major expansions, and considering that Commerce isn't exactly an aggressive lender.
I do expect ongoing investment/reinvestment into payment systems, though, including specialty verticals like healthcare, and I believe a more robust service platform could help drive some loan share growth.
The Outlook
Commerce has its operating plan and management sticks to it; this isn't the bank to pick if you want dynamic strategic reinvention, and that's fine given the results produced by this operating model over the years.
I'm looking for around 4% medium-term core earnings growth (I haven't changed my numbers much relative to my last update, but the starting point for the growth calculation has shifted) and longer-term core earnings growth of around 5%. I'm also looking for near-term returns on tangible common equity in the high-teens to low-20%s, as well as EPS of $4.11 for FY'23.
Between all of this, I can say that a share price in the mid-$60's to $70 is actually not unreasonable. Granted, this still assumes that the P/E part of the valuation continues to get a meaningful premium relative to other banks, but given the company's track record (lower credit losses, higher margins/returns) that's not unreasonable.
The Bottom Line
I'm honestly surprised that Commerce's valuation is where it is. I can't say it's an absolute bargain, but I can say that the valuation is considerably more reasonable than it typically is, and that's about as good as readers can usually expect. I do think a hawkish Fed will keep a lid on sentiment for bank stocks for at least the first half of the year, so I could see owning Commerce as insurance from further erosion in outlooks and sentiment. For the long term, I think there are better-priced ideas out there, but I can't really quibble too much with owning these shares now.
