Geoff Gannon May 31, 2016

Commerce Bancshares (CBSH) is a Durable Family Run Bank

(This post is a reprint of one of the nine sections that make up the recently released Singular Diligence issue on Commerce Bancshares.)

Commerce has been controlled by the same family – the Kemper family – for over 100 years. In the 113 years since the Panic of 1903, Commerce has survived several financial crises. In 2008, it did not accept TARP money from the U.S. government. Commerce’s net charge off rate peaked at just 1.31% in 2009. Even in that crisis year, loan losses at Commerce were quite low (well less than half a percentage point) in all areas except credit cards, real estate construction, and consumer credit. These 3 areas are high risk loan categories. Right now, about 13% of Commerce’s total loans are in areas Quan and I consider high risk. Credit cards are 7% of total loans, real estate construction (and land) is 4% of total loans, and boat and recreational vehicle loans are 2% of total loans. So, 13% of Commerce’s loans are in areas that would be severely stressed by a financial crisis like the one seen in 2008. The next financial crisis probably won’t look like the last one though. They never do. So, it doesn’t make sense to focus too much on loans that go bad with the housing market and household finances. Just know that about 87% of Commerce’s total loan portfolio is in fairly safe and traditional types of lending. None of these types of loans had charge-off rates above 0.41% in 2009. Those are very low charge-off rates. So, any risk to the durability of Commerce comes from the other 13% of loans that are in credit cards, real estate construction, and marine and RV lending.

Overall, Commerce makes all types of loans. Consumer and mortgage loans are 41% of total loans. Real estate is 47% of total loans. Real estate is diversified among: business real estate (20% of total loans), personal real estate (16%), home equity (7%), and construction (4%). There are many ways to break down a bank’s loan portfolio. In Commerce’s case we can look at some big and fairly traditional forms of lending and see what they add up to. Business loans (non-real estate – so commercial loans) are 35% of all loans. Business mortgages are 20%. Personal mortgages are 16%. So, right there, you have 71% of loans from those 3 categories. These loans are very typical of what banks we’ve talked about before make. Then, we get down to some categories of loans that Commerce makes which are less important at other banks – or even non-existent. We have 8.5% car and motorcycle loans, plus 1.3% RV loans, plus 0.4% boat loans equals 10.2% vehicle loans of some kind. We have 7% credit card loans. And we have 6.6% home equity loans. Home equity loans are fairly common at other banks. Auto loans and credit card loans are often a lot smaller at the banks we’ve talked about then at Commerce though.

Commerce’s charge-off rate tends to be much lower than the industry. This isn’t just overall. It’s also within each category. Commerce did have higher charge-offs in 2009 than Frost. A lot higher, in fact. But, this was due to Commerce making types of loans that Frost does not. So, in 2009, Commerce peaked at a 1.31% charge off rate. Frost peaked at 0.58%. As you know from reading our bank issues – Frost and BOK Financial and Prosperity all had very low charge-offs right through the crisis. Commerce did not have an extraordinarily low charge-off rate. But, the crisis was a much tougher test of the types of loans Commerce makes than it was at Frost. Frost makes a lot of business loans in Texas. Businesses in Texas just weren’t very stressed by the crisis. Real estate in parts of the country was stressed. Households around the country were stressed. But, businesses in Texas were stressed much less by the 2008 financial crisis than by the early 1990s recession or the early 1980s oil bust. So, 2008 was not the toughest moment for Frost’s borrowers. It was certainly the toughest moment in 30 or more years for some of the consumer type loans that Commerce makes.

For example, Commerce made construction loans. These are very risky in a housing bubble. In 2008, 2009, 2010, and 2011 Commerce charged off 0.89%, 4.61%, 2.69% and 1.66% of its construction loans. That sounds high. But, now, let’s do a comparison of Commerce versus the industry in that loan category. In 2008, Commerce charged off 0.89% of its construction loans versus 2.63% for the industry. In 2009, it was 4.61% vs. 5.40%. In 2010, it was 2.69% versus 5.45%. And in 2011, it was 1.66% versus 3.33%. In 2012, 2013, and 2014 – Commerce then had a negative charge-off rate (it actually recovered on some written off loans) while the industry as a whole never did. For the entire period of 2008 through 2014, Commerce wrote off far less of its construction loans than the industry did.

Over the last 24 years, Commerce has only charged off an average of 0.63% a year of its consumer loans (these are passenger vehicles, boats, and recreational vehicles – probably they are mostly cars). In each year from 2008 through 2014, Commerce charged off less than the industry did within the category. It’s also worth mentioning that the composition of this category is now different. In 2009, boat and recreational vehicle loans were 50% of all consumer loans at Commerce. Today, boat and RV combined are just 12% of all consumer loans at Commerce. So, Commerce is making far more car loans in this category relative to boat and RV loans.

Charge-offs in credit card lending are always high. Over the last 24 years, Commerce has averaged a charge-off rate of 3.5% a year in this category. Commerce’s charge-offs peaked in 2009 at 6.77% of all its credit card loans. The industry peaked in 2010 at 10.08% of all of its credit card loans. Again, Commerce’s charge-off rate in this category was lower than the industry’s charge-off rate in every single year from 2008 through 2012.

I focused on these riskier categories even though they are not Commerce’s biggest categories – because they are the only categories where charge-offs have ever been high enough to cause any concern. Commerce’s biggest loan categories are actually real estate loans. Missouri and Kansas didn’t have a housing bubble. So, Commerce’s record in these areas is pristine. Net charge-offs in business loans averaged 0.07% a year. They peaked at 0.70% in 1991. Charge-offs were a lot lower in the 2008 crisis than in the early 1990s recession. The same pattern is true for residential real estate loans. The very worst charge-off rate for residential real estate was just 0.19%. The industry average was 9 times higher at 1.72% in 2009. Commerce probably had low losses because Missouri and Kansas didn’t have a real estate bubble, Commerce generally originated the loans on its books (it didn’t acquire them), it never made subprime loans, and it generally required at least a 20% down payment. To illustrate, in the year 2006 (a bubble year in the U.S.), 87% of all Commerce’s residential real estate loans had a loan-to-value ratio of 80% or less. And 98% of loans required principal payments be made – not just interest payments.

Commerce’s commercial and industrial loans actually have even lower charge-off rates than Frost’s C&I loans. So, by category, Commerce is a more conservative lender than Frost. To be fair to Frost, that bank specializes in commercial lending and avoids things like credit card and home mortgage loans entirely.

Commerce – like Frost – also has a lot of cultural continuity. If the bank didn’t make risky loans in a category in the past – it’s very unlikely to start making risky loans in that category, because the same people are making the loans. Commerce has been run by the same family for over 110 years. It is the slowest growing bank among those we’ve profiled. It is in the slowest growing region. And it isn’t a serial acquirer. BOK Financial, Frost, and Prosperity all grow faster and either make acquisitions or have to hire new employees more frequently than Commerce. In 2013, the company’s CFO said: “Somebody that’s been with us for 10 years is a short-timer. We still look at them kind of as a newbie and that’s just sort of the culture at Commerce.” Commerce made it safely through the 2008 financial crisis without accepting TARP money. There is no reason to believe another 2008 type crisis is imminent. When another crisis like 2008 does happen though, Commerce should be in the same position to survive it. Commerce’s durability should be equal to or greater than the durability at BOK Financial, Frost, and Prosperity. Cultural continuity is probably even higher at Commerce than at those banks. And the bank doesn’t grow as quickly as those banks do. So, the pace of change in risk taking is probably slower at Commerce than at those banks. It’s a durable bank.