Commerce Bancshares: A Great Business But Not A Buy Yet (NASDAQ:CBSH)

Commerce Bancshares (NASDAQ:CBSH), founded in 1966 and headquartered in Kansas City, Missouri, provides retail, asset management, mortgage banking, investment, corporate, and trust products and services to individuals and businesses.

Although this is one of those businesses that enjoy slow but steady growth with conservative capital management and plenty of liquidity, the price doesn’t reflect an opportunity here. Regardless, interested investors should keep a close eye on future developments as this might change.

Business & Portfolio

As a regional bank, CBSH is at the lower end of the size spectrum with $31.7 billion in assets, a loan portfolio valued at $17.2 billion, a deposit base of $25.4 billion, and a market cap of $6.91 billion.

While the bank has significant reliance on lending for generating its revenue, it’s worth noting that its card transaction and trust fee businesses are also large contributors as the fees represented 19.55% of total interest and non-interest revenue in 2023. Both of those sources contributed almost equally last year.

Now, its lending business is very well diversified, considering that it has 141 branches spread across Missouri, Kansas, Illinois, Tulsa, Oklahoma, and Colorado. To get an idea of the geographical composition of its loan portfolio, 31% is allocated in Kansas City, 25% in St. Louis, and 44% in the rest. Despite its relatively small size, note that in Kansas City and St. Louis, the company has captured a significant market share (12% and 7% of deposits, respectively).

The portfolio is also well-diversified based on the customer type, with 65% of the borrowers being businesses and 35% consumers.

Last, its commercial real estate exposure is relatively small:

Performance

Looking at the long-term performance first, I like what I’m seeing. Though the business has expanded slowly over the last 10 years, it also has done so steadily for the most part, as depicted by the charts below:

Tangible book value indeed shrank recently, but that is to be expected when the value of investment securities and MBS, together representing about 42% of total assets, fell during the same year that interest rates started increasing so fast. Below, you can observe the YoY changes in these two items’ values:

That being said, I think CBSH has done a great job with its deposit growth over the last 10 years (below are the YoY changes during the period):

Not surprisingly, it managed to steadily increase its loan portfolio as well:

Now, the bank naturally experienced its loan portfolio’s yield increase over the last 3 years; 3.67% at year-end 2021, 4.18% in 2022, and 5.9% in 2023.

What’s interesting however is that its net interest spread expanded, indicating an asset-sensitive business; 3.67% in 2021, 4.18% in 2022, and 4.46% in 2023.

As a result, instead of experiencing a net interest margin compression like so many other banks, its NIM actually widened; it was 2.58% in 2021, 2.85% in 2022, and 3.16% in 2023. It’s not uncommon to see banks enjoying a >3% NIM two years ago and now suffering a margin that is 100 bps lower.

Moving to profitability, interest revenue increased to $1.4 billion by the year-end 2023, a remarkable 38.3% YoY increase. Moreover, net interest income reached $998.1 million, a 5.93% YoY increase. Also, non-interest income grew by 4.85% on a YoY basis to $573 million.

However, expenses applied enough pressure to move net income slightly down to $477 million, a 2.3% decrease. Consequently, diluted EPS also experienced a decrease, albeit lower at 0.8%. On the bright side, tangible book value made a partial recovery, reaching $2.8 billion; a 20% YoY growth. Last, ROA increased by 4 bps YoY to 1.49% and ROE decreased to 7.94%, down from 17.31% the year before (for context, the ROE in 2022 reflected the lower equity base and almost the same net income as in 2023).

Solvency & Liquidity

Before we talk about the price, let’s first check a few things regarding solvency and the level of liquidity.

First, as of the end of December 2023, CBSH had a Tier 1 common ratio of 15.25%, reflecting a 112 bps increase YoY. To put things into context, the minimum capital requirement is much lower at 4.5%. Second, its total capital ratio was 16.03%, a 114 bps increase since the previous year and well above the minimum requirement of 8%. Last, its Tier 1 leverage ratio increased by 91 bps YoY to 11.25%, also well exceeding the minimum of 4%.

So we’re looking at a very well-capitalized business. But what about the cost of funding? This is where CBSH truly shines with an average deposit rate of only 1.44%. While this is obviously much higher than the 0.18% and 0.07% it enjoyed in 2022 and 2021, respectively, it’s still incredibly low. That’s thanks to its reliance on interest checking and money market deposits (76.8% of total deposits). While wholesale funds are more expensive for the bank right now at 3.83%, they represent 17.4% of the interest-bearing liabilities and only manage to increase the total cost of liabilities to 1.86% which is still impressively low.

Keep in mind, however, that the bank’s reliance on interest checking and MMA deposits, can result in a less stable deposit base. That being said, with an LDR of only 66.31%, there is a large margin of safety here. While that ratio is partly because the bank opts to keep funds tied with AFS securities (30.5% of total assets), it also has a lot of cash and equivalents set aside (9.9% of total assets).

Even though its LDR is so low, it’s worth demonstrating the resilience of its loan portfolio by mentioning a few key points regarding its credit quality as of the year-end of 2023:

• 0.31% of commercial loans had a Special Mention rating
• 2.48% of commercial loans were rated Substandard
• 0.35% of personal banking loans were over 90 days delinquent
• 95.7% of real estate personal loans were given to individuals with a Prime FICO score and above (660-719)
• 93.2% of consumer loans had Prime and above FICO scores
• 94.8% of Revolving Home Equity loans were rated Prime and Above
• 83.2% of credit card debt had Prime and above FICOs
• The reserve coverage ratio was 0.2%
• Charge-offs increased by $12 million YoY to $31.1 million and the charge-off ratio increased to 0.19% from 0.12% in 2022.

Dividend & Valuation

CBSH currently pays a quarterly dividend of $0.27 per share, resulting in a forward yield of 2.06%. While the yield is low, there are a couple of things to consider here.

First, the payout ratio was 28.24% in 2023, a 214 bps YoY growth during a period of increasing pressure for the industry with the stock’s dividend actually increasing YoY; the payout ratio has also been pretty much that low for the last 5 years, with the highest one being 35.32% in 2020 during that period.

Second, the company has been raising its dividend for 55 years in a row:

This is very impressive. If it at least keeps the same pace it achieved in the last decade (the distribution more than doubled during that period), potential shareholders may benefit from a stable and attractive income stream down the road.

However, the current yield hints at something you may have figured out by now. The price you’d have to pay to own a piece of that business is very high. Evidently, the market has shown its appreciation throughout the years:

Because of the asset sensitivity we observed above, the profitability here didn’t take as big of a hit as that of other banks when interest rates started rising in 2022. And it appears that the market has responded well by not punishing BCSH as severely after the Fed Funds rate hikes began:

For this reason, the stock price has a lot of support and it’s unlikely that we will see an undervaluation anytime soon. Right now, the forward earnings multiple is not much below its 5-year mean:

The same goes for the book value premium:

Obviously, a business that can do well through various interest rate environments and that greatly relies on services for its revenue which are intangible can justify a large premium to some degree, but this is simply too high for my tastes. Even if tangible book value recovers back to 2021 levels, the premium would remain substantial.

Risks

Which brings me to what I consider the most important risk with this stock. The lack of an upside through a visible margin of safety represents an opportunity risk. This is a good business, but its growth is relatively slow and the market may continue to appreciate its growth slowly as well. The dividend yield is way too low to have any meaningful reduction of an opportunity cost.

Another risk you should know is related to changes in interest rates. If they start falling as many experts predict and liabilities reprice more slowly than interest-earning assets, the bottom line may be affected temporarily and while liability-sensitive banks enjoy higher margins, CBSH may experience a NIM compression instead. This is unlikely to go unnoticed and the stock price may fall to some degree.

Verdict

All in all, this is a great business at a not-so-great price and I am rating it a hold for now. I believe it’s unlikely that the stock price will fall a lot anytime soon, but you never know so I will keep an eye on it. Keep in mind that the fair value of nearly half the assets has had a major impact on tangible book value, hence the very high premium right now. So there is a good chance that TBV will increase to pre-2022 levels when interest rates start falling, excluding any future retained earnings. If the market doesn’t overreact to this fast enough, an opportunity may come our way. Who knows? It’s best to stay on the sidelines and see what happens.

What’s your view? Do you own shares in the business? What was your cost basis if I may ask? Also, let me know if you liked this article as this means a lot to me. Thank you for reading!