Commerce Bancorp Inc., long known largely as a consumer bank, said deposits and loans both grew faster on the commercial side in the third quarter.
Founded in 1973, the Cherry Hill, N.J., company was first "a consumer bank, then a small-business bank, then a government bank, then a middle-market bank," president and chief executive Vernon W. Hill 2d said its inaugural earnings conference call.
"As we have been growing in size, we have been adding people, and capabilities, and functions to do all those kinds of things," Mr. Hill said.
While beefing up its staff and opening branches, the $21.4 billion-asset company is also trying to respond to growing investor demand for more disclosure - hence its first-ever earnings conference call.
True to the image of an unusual bank, the call turned from a discussion about raw numbers into a review of one of the most controversial elements of the business model: capital expenditure.
One investor on the call suggested that the $203 million Commerce spent this year on capital investments would suggest that it has shelled out around $5 million on each new branch in its ongoing branching project; it had disclosed that it was spending an average of $3.5 million per branch.
Mr. Hill countered, as he has before, that not all capital expenditure is for new branches. In the third quarter Commerce spent $51.5 million on the 14 branches it opened and $6.5 million on building new back-office facilities.
"This is a company that is growing 40-some percent a year. You need massive back-office investment," the CEO said.
Other investors chimed in support of Mr. Hill, and one even said that he would like to see Commerce allocate more capital for investments.
Commerce has doubled its assets in two years almost solely through branch-building, and after the third quarter deposits were up 41% from a year earlier, to $19.6 billion.
That was "pretty impressive," said Adam Barkstrom, an analyst with Legg Mason Wood Walker Inc. of Baltimore, who rates Commerce's shares "sell."
Profits were up 31%, to $49.3 million. Earnings per share of 67 cents beat the analyst consensus by 3 cents, according to Thomson First Call.
Strong deposit growth has been Commerce's hallmark, but in the third quarter the increase came with a twist. Commercial and government rose by a little more than 50%, and now make up just over half of Commerce's core deposits.
Mr. Hill said the third-quarter trend should persist. "We have tremendous middle-market capabilities that we never had before," and "the commercial side of the deposit is going to continue to be the highest growth segment," he said.
This is reflected in the loan book. It increased 23% from a year earlier, to $6.8 billion. Commercial loans grew 28% and consumer loans 26%.
However, the company had to digest a large hit to its profit margin on loans, which fell 44 basis points from a year ago and a hefty 20 basis points from the second quarter.
"The net interest margin compression was the worst we can expect - as a matter of fact the worst we have seen in seven years," Mr. Hill said. But he said the rise in the 10-year Treasury note yield since Oct. 1 should improve margins.
Lehman Brothers analyst Jack Micenko wrote in an e-mail to investors that he expects "the margin to expand back into the 4.40%-4.50% range over the next several quarters." He rates Commerce's shares a neutral "equal weight."
Rising interest rates did hit Commerce's sizable portfolio of mortgage-backed securities in the three months. The average duration of the securities was four years, against 3.1 in the second quarter, limiting the cash flow from the portfolio and depressing its value. A 50-basis-point rise of long-term interest rates reduced the value of its $7 billion held for sale MBS portfolio by $150 million.
Commerce bought about $4 billion worth of securities in the third quarter, with an average duration of 3.5 years at the time of the purchase, said chief financial officer Douglas Pauls. It sold $600 million worth of securities to invest in those with shorter duration.
"We have already taken some steps early in the fourth quarter to reduce the duration in our available-for-sale portfolio," Mr. Pauls said.
Mark Fitzgibbon, co-director of research at Sandler O'Neill & Partners LP, said that "given the dramatic slowdown in refinance activity, we consider the magnitude of the increase in duration as manageable."
Commerce booked mortgage-backed securities bought in the third quarter into its held-to-maturity portfolio, which does not reprice quarterly, and it plans to shift one-third of its MBS portfolio into this category. "We need some balance for the two," Mr. Hill said, and added that it may have been a mistake to book most mortgage-backed securities as available for sale.
"One of the great strengths of this company is the tremendous free cash flow from deposit growth and repayments," he said, "and in the first nine months our cash flow in from these sources was $9.6 billion."
But expenses rose 27%, to $197 million, year over year, and Mr. Hill said that the goal is to keep cost increases slightly below top-line growth. Shares of Commerce, which have risen sharply in recent months, jumped Tuesday morning and got stronger as the conference call went along. The stock closed up 1.1%.
