A Banker’s Tale

Tough times require tough people to get through them, so who better to manage a commercial bank through one of the most difficult interest rate environments the industry has seen in years than … an English major?

Yes, it’s true that the chief executive officer at St. Louisbased Commerce Bancshares Inc. has a master’s degree in English literature from Oxford University (not to mention an undergraduate degree in history from Harvard University). But the education of David W. Kemper has extended well beyond Chaucer’s The Canterbury Tales. Kemper comes from a prominent banking familyu00e2u20ac”he is the fourth Kemper male to run Commerce, which his great grandfather started in the early 1900s in Kansas City. Kemper also has an MBA from the Stanford Graduate School of Business and apparently has learned a thing or two about running a bank, judging by Commerce’s highly commendable performance in recent years.

Commerce posted a strong second-place finish on Bank Director‘s 2006 Bank Performance Scorecard, after ranking sixth in 2005. Rather than being the best bank at any one thingu00e2u20ac”its highest finish in the individual performance categories was for return on assets (ROA),where it had the 18th best score at 1.61%u00e2u20ac”Commerce is very good at most things. The bank is highly profitable, with a strong balance sheet and excellent loan quality.And those characteristics are even more impressive today,when a flat yield cure is squeezing the banking industry’s net interest margin like a vice.

With $14.2 billion is assets, Commerce operates a 340- branch network in Missouri and Kansas and also has a small credit card bank in Nebraska. The company recently pushed into the Illinois suburbs north of St. Louis with the $80.9 million purchase of West Point Bancorp. In addition to its traditional commercial banking franchise, Commerce also has a growing payments business that is targeting companies in an expanded marketing campaign throughout the upper Midwest, Southwest, and Southeast. Still, as business models go, Commerce’s is pretty conventional and straightforward. “We’re a pretty plain vanilla bank,” says the 55-year old Kemper, who has run the company since 1991.

And yet Commerce’s success serves as an important reminder that in a mature industry like banking, execution often trumps innovation, and Kemper has done a good job of running his company in an extremely challenging environment. “The bank is well managed, which I think is the key to all of it,” says David C. Stumpf, an equity analyst with A.G. Edwards & Sons in St. Louis.”Kemper is a real student of the industry.He has taken the time to think about where the industry is going. He studies other banks to see what they do well and what they do poorly.”

Operating in the nation’s heartland, Commerce has the good fortune of being located in stable markets that may not grow as fast as other parts of the United States, but aren’t as volatile either. “The economics here are pretty reflective of the national economy,” Kemper says. “I think it’s an advantage to operate in the Midwest because it tends to be a more stable economy. It has not been a boom-orbust economy.”

However, this is not to say that the greater St. Louis marketplace isn’t extremely competitiveu00e2u20ac”in part because it is so highly consolidated. Large regional players like Bank of America Corp., U.S. Bancorp, National City Corp., Fifth Third Bancorp., and Marshall & Ilsley Corp. have bullied their way into the market after acquiring local banks. And not unexpectedly, given that one usually follows the other, an “explosion” in new community banks (to use Kemper’s characterization) has added even more capacity into the St. Louis market in recent years. “Right now, the Midwest is about as competitive as any place in the country,” he says. There is considerable competition for retail deposits, which has driven up rates and helped compress operating margins. Commerce is also seeing plenty of competition for commercial loans, where “pricing has deteriorated and terms have been loosened,” according to Kemper. “We are taking less spread to hold on to our best business, and we’re fighting on [loan] terms as well,” he says.

If Commerce is well managed, it is also conservatively managedu00e2u20ac”and from Kemper’s perspective the two are pretty much synonymous. The bank has historically had a robust credit culture, evidenced by its comparatively strong showing in the asset quality category, where it had the 28th-best ratio of nonperforming assets to loans and other real estate owned out of the 150 U.S. banks surveyed, and the 24th-best reserve coverage. “We are a very creditdriven organization, and a risk-avoidance organization,” he says.

Commerce also emphasizes its burgeoning payments systems business, including credit and debit cards for consumers, and corporate purchase cards and automated clearinghouse services for businesses. “It recognized early on that credit products in a bank are more of a commodity than anything else the bank offers,” says Stumpf. For his part, Kemper believes that in today’s highly competitive market, it’s important to have a “broad portfolio of businesses.” The advantage of a strong payments capability to Commerce is that it doesn’t have to lead with credit when competing for business customers, which helps preserve its asset quality.And the fee-based revenue associated with the payments business helps boost the bank’s ROA. “We think our strongest franchise is our payments systems business,” says Kemper.

The bank’s innate conservatism shows up in other ways, as well. Commerce was a little slower to jump on the branch expansion bandwagon than many other banking companies across the country, which has helped keep its expenses under control.According to data from the Federal Deposit Insurance Corp., the number of bank branches in the St. Louis market grew 39% between 1995 and 2005, while Commerce’s branch network grew only 29%, to a total of 45. The same trend can be seen in the Kansas City market and throughout Missouri and Kansas generally, with Commerce trailing the rest of the industry.”We’re very careful with those kinds of costs and not overdoing it,” Kemper says.

Commerce also takes a cautious approach to acquisitions, generally preferring organic growth to takeovers. It’s not that Kemper is reluctant to do deal dealsu00e2u20ac”Commerce has bought 26 banks since 1991, but the most it paid was $89.3 million in 1994 when it bought People Mid-Illinois Corp. All of the deals have been in Missouri, Kansas, and Illinois, and Commerce has focused on fill-ins and market extensions that are easy to integrate rather than a large transformational deal. The West Point deal is a perfect example, since it expands the bank’s distribution network into the southern Illinois suburbs north of St. Louis.”We’ll keep looking for those kinds of deals,” Kemper says.

Stumpf believes one of Commerce’s great strengths is that Kemper manages the bank for the long haul, an approach influenced by the fact that the Kemper family still holds approximately 8% of the bank’s stock, and Kemper himself owns over one million shares of stock, which in early October was worth approximately $53.5 million. (David Kemper’s younger brother, Vice Chairman Jonathan M. Kemper, had holdings worth over $46 million.) “They have a long-term focus,” says Stumpf. “They don’t worry too much about making this quarter’s earnings estimate or next quarter’s earnings estimate.”

A good example of Kemper’s careful management occurred after the September 11, 2001 terrorist attacks. In an effort to prevent the U.S. economy from going deeply into shock, the Federal Reserve Board cut interest rates drasticallyu00e2u20ac”good for borrowers, but not so good for lenders. Rather than take on the credit risk of commercial loans written at substandard prices, Commerce opted to build up its securities portfolio.As the yield curve has flattened over the last year or so, the bank has been steadily liquidating the portfolio and plowing that money back intocommercial loans offering a higher return. That has helped preserve the bank’s net interest margin while giving it some nice top-line growth.

“It looks smart now, although they probably gave up a little [loan] growth that other banks saw earlier, but that’s the way they operate,” Stumpf says.

Mid-sized banks like Commerce are often seen as being awkwardly positioned in their marketplacesu00e2u20ac”too big to offer truly personalized service and too small to overwhelm the customer with technology and a vast array of products. And yet, “Commerce is really the only surviving hometown bank left [in St. Louis], and they’ve been in a position to benefit from that,” says Stumpf.

For his part, Kemper believes Commerce has been able to combine the personalized service and quick decision making of a small bank with the broad product set and economies of scale of a superregionalu00e2u20ac”which will help sustain it in the competitive St. Louis marketplace. “Our unit costs aren’t that different than theirs, and we can deliver better service,” he says.

Asked if he has any regrets that he’s not teaching English literature at a university somewhere, Kemper laughs.”I think I’m pretty honest about where my best talents lie,” he says. Kemper no doubt knows his Chauceru00e2u20ac” but he demonstrably knows banking, too.