By Evan Momios Commerce Bank's (CBH) growth has been extraordinary. Over the last five years, the regional bank based in southern New Jersey has expanded its assets, deposits, and revenues at average rates in excess of 30% a year -- and done so in an industry where single-digit growth is the norm. S&P believes that Commerce can keep growth at about 20% and double its assets in about four years. Further, we view the stock's valuation as compelling given the track record and projected growth. We recently upgraded the stock to 5 STARS (buy), which is S&P's highest investment recommendation.
In recent months, shares of small and midsize banks have been trading in line with those of larger financial institutions and the broader market, mainly in response to headlines prompted by the current spate of corporate scandals. But Commerce has bucked that trend. Its shares are up over 15% so far in 2002, significantly outperforming the broader market but still about 10% below their 52-week high set in early May. We believe this retrenchment creates an opportunity to invest at a reasonable price in a high quality and rapidly growing retail bank.
BRANCHING OUT ALL OVER. Commerce's business model emphasizes convenience and knowledgeable service as the primary ways to attract and retain the low-cost deposits that fuel revenues and earnings. In 2001, 67% of its total revenue came from spread management (the amount a bank earns from loans and securities minus the amount it pays for deposits and other borrowings) and 14% from service charges on deposit accounts. Commerce enjoys one of the lowest cost-of-funds rates -- what it pays out on deposits -- in the industry (1.66% in the second quarter of 2002). And during the last five years, it has been reporting same-branch deposit-growth rates significantly above industry averages (30% in the second quarter of 2002).
The bank's growth strategy relies primarily on new-branch expansion. It currently operates 196 branches in New Jersey, Delaware, Pennsylvania, and New York. In the last three years, Commerce opened 92 branches -- and in the most recent quarter alone it opened a further nine, including two in the deposit-rich borough of Manhattan as well as its first four offices in Long Island. During 2002, it plans to open 31 offices in metropolitan New York and 10 offices in metropolitan Philadelphia. In the long term, Commerce wants to have about 160 offices in the New York area, 100 of them in Manhattan.
Gotham presents a tremendous opportunity to Commerce. According to the Federal Deposit Insurance Corporation (FDIC), the extended New York metropolitan area, which includes sections of New York, New Jersey, Connecticut, and Pennsylvania, is by far the largest deposit market in the nation, with some $564.5 billion stashed away as of June 30, 2001 (the latest available figure). Manhattan alone accounted for $218.5 billion, while the Big Apple's four other boroughs accounted for a combined $318.6 billion.
GOLDEN APPLE. On June 30, 2002, Commerce had $12.4 billion in total deposits, $312 million of which it has raised in Manhattan since opening its first two (of a total of six) branches in September, 2001. We estimate that it would take less than four years for Commerce to double its total deposits by achieving a 4.0% to 5.0% deposit market share in metropolitan New York even if other markets remained stagnant.
Commerce is not alone in its quest to crack this lucrative market. Venerable competitors, including Fifth Third and Washington Mutual, have been expanding in this highly competitive area, trying to gain market share from Citibank and Chase Manhattan. (Those two institutions together account for about half of the market.) Moreover, there is always the possibility that a stock market recovery could drain funds from banks while an increase in short-term interest rates could increase deposit costs.
Nevertheless, we believe that Commerce is well-positioned to gain market share and the initial results of its Manhattan operations raise our confidence. Although both the stock market and short-term interest rates are likely to be higher a year from now, we do not think those factors would have a significant impact on Commerce's growth prospects. We believe depositors go to Commerce for service and convenience -- not for its interest rates. This is why its growth has been consistent in a variety of interest-rate and market environments since its inception in 1973.
MULTIPLE ADVANTAGES. Over the next five years, management is targeting 20% annual deposit growth, 25% revenue growth, and earnings-per-share (EPS) growth of between 15% and 20%. In the last five years, Commerce has achieved growth rates of 31%, 33%, and 22% respectively. We believe that these goals are reasonable, and feasible, given the bank's history, and the potential for building its New York business in light of its initial success in Manhattan. We recently raised our 2002 EPS estimate to $2.00, from $1.96 and established a 2003 EPS estimate of $2.42.
The stock recently traded at 22 times our 2002 EPS estimate, in line with its 5-year price-earnings (p-e) average, but below its 2-year average of 24. Regional banks traditionally trade at p-e multiples in the low to mid teens with projected EPS growth rates of 8-10%. Comparable regional banks were recently trading on average at 1.4 times their projected 5-year growth rates, vs. Commerce's 1.1 multiple. We believe that the company's expansion in New York could lead to positive EPS surprises and an enhancement of its multiple. Analyst Momios follows banking stocks for Standard & Poor's