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CBSH Reaffirmed at Neutral

Vaishali Doshi Shah

We are maintaining our Neutral recommendation on Commerce Bancshares, Inc. (CBSH) as we believe that the risk-reward profile for the company is currently balanced. Our decision is based on the company’s better-than-expected first quarter 2012 results that include increased top line and declining operating expenses. However, we remain concerned about the concentration risk emanating from dependence on fee income and the dodging macro economic issues.

Commerce Bancshares reported first quarter 2012 earnings of 75 cents per share, substantially ahead of the Zacks Consensus Estimate. The improvement in results was driven by higher fee income, lower operating expenses, sturdy capital position and enhanced asset quality. However, declining net interest income and dwindling loan demands were the dampeners.

Commerce Bancshares remains an attractive pick for the yield-seeking investors due to its extensive capital deployment activities. The company has been maintaining a sound dividend policy for the past 44 years. In February 2012, the dividend was hiked by 5% to 23 cents and since then the company has maintained this level. Moreover, under its share repurchase program, Commerce Bancshares has purchased approximately.

Commerce Bancshares has significantly elevated its capital ratios compared with peers. The company remains comfortably placed with – tier 1 risk based capital of 14.85%, total risk based capital of 16.19% and leverage ratio of 9.70% - well above the regulatory requirements. This is expected to withstand any financial crisis.

Further, strong equity, nominal debt, common and preferred stock availability and noteworthy debt ratings ensure robust liquidity levels at Commerce Bancshares. Though the company lacks long-term debt, it is well-placed to raise additional debt via jumbo certificates of deposit, privately placed corporate notes or other types of debt through its Capital Markets Group or other public debt markets in the subsequent quarters.

We believe that such efforts will help the company to gain substantial market share and enhance its profitability in the long run. Yet, Commerce Bancshares’ heavy dependence on net interest income is anticipated to thwart its growth prospects. With average demand for loans registering a constant decline, there will be an adversely impact on its top line.

Commerce Bancshares operations are mainly concentrated in a handful of states namely Missouri, Kansas, Illinois, Oklahoma and Colorado. The lack of geographical diversity may cause diseconomies of scale stemming from the current interest rate volatility. Moreover, regional economy does influence a company’s performance. Therefore, having operations in various regions is helpful in nullifying associated risks.

The rigorous regulatory requirements will mar the revenue projections from overdraft and credit card transactions. According to the latest proposed rules by the Federal Reserve, the banks are required to maintain 7% total tier 1 ratio, way above the current requirement of 2%. This would considerably affect the lending as well as the investment capacities of banks including Commerce Bancshares. Furthermore, such limitations may raise costs and limit its ability to pursue business opportunities.

Shares of Commerce Bancshares currently retain a Zacks #3 Rank, which translates into a short-term Hold rating. One of its peers First Merchants Corp (FRME) retains a Zacks #1 Rank, which translates into short-term Strong Buy rating.

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