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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 
Washington, D.C. 20549
 
FORM 10-K
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the Fiscal Year Ended December 31, 2009 — Commission File No. 0-2989
 
COMMERCE BANCSHARES, INC.
 
(Exact name of registrant as specified in its charter)
 
     
Missouri
  43-0889454
(State of Incorporation)   (IRS Employer Identification No.)
     
1000 Walnut,
Kansas City, MO
(Address of principal executive offices)
  64106
(Zip Code)
(816) 234-2000
(Registrant’s telephone number, including area code)
   
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of class   Name of exchange on which registered
 
$5 Par Value Common Stock
  NASDAQ Global Select Market
 
Securities registered pursuant to Section 12(g) of the Act:
 
NONE
 
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
Yes þ  No o
 
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
 
Yes o  No þ
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes þ  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
             
Large accelerated filer þ
  Accelerated filer o   Non-accelerated filer o   Smaller reporting company o
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o  No þ
 
As of June 30, 2009, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $2,065,000,000. As of February 10, 2010, there were 83,195,752 shares of Registrant’s $5 Par Value Common Stock outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
 
Portions of the Registrant’s definitive proxy statement for its 2010 annual meeting of shareholders, which will be filed within 120 days of December 31, 2009, are incorporated by reference into Part III of this Report.
 


 

 
Commerce Bancshares, Inc.
 
Form 10-K
 
                     
INDEX           Page
 
    Item 1.     Business     3  
                 
      Item 1a.     Risk Factors     9  
                 
      Item 1b.     Unresolved Staff Comments     12  
                 
      Item 2.     Properties     13  
                 
      Item 3.     Legal Proceedings     13  
                 
      Item 4.     Submission of Matters to a Vote of Security Holders    
13
 
 
 
 
                 
    Item 5.     Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     15  
                 
      Item 6.     Selected Financial Data     17  
                 
      Item 7.     Management’s Discussion and Analysis of Financial Condition and Results of Operations     17  
                 
      Item 7a.     Quantitative and Qualitative Disclosures about Market Risk     64  
                 
      Item 8.     Financial Statements and Supplementary Data     64  
                 
      Item 9.     Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     117  
                 
      Item 9a.     Controls and Procedures     117  
                 
      Item 9b.     Other Information    
119
 
 
 
 
                 
    Item 10.     Directors, Executive Officers and Corporate Governance     119  
                 
      Item 11.     Executive Compensation     119  
                 
      Item 12.     Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     119  
                 
      Item 13.     Certain Relationships and Related Transactions, and Director Independence     119  
                 
      Item 14.     Principal Accountant Fees and Services    
119
 
 
 
 
                 
PART IV     Item 15.     Exhibits and Financial Statement Schedules     120  
       
    121  
       
    E-1  
 EX-21
 EX-23
 EX-24
 EX-31.1
 EX-31.2
 EX-32


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PART I
 
Item 1.  BUSINESS
 
General
 
Commerce Bancshares, Inc. (the “Company”), a bank holding company as defined in the Bank Holding Company Act of 1956, as amended, was incorporated under the laws of Missouri on August 4, 1966. The Company owns all of the outstanding capital stock of one national banking association, Commerce Bank, N.A. (the “Bank”), which is headquartered in Missouri. The Bank engages in general banking business, providing a broad range of retail, corporate, investment, trust, and asset management products and services to individuals and businesses. The Company also owns, directly or through the Bank, various non-banking subsidiaries. Their activities include underwriting credit life and credit accident and health insurance, selling property and casualty insurance (relating to consumer loans made by the Bank), private equity investment, securities brokerage, mortgage banking, and leasing activities. The Company owns a second tier holding company that is the direct owner of the Bank. A list of the Company’s subsidiaries is included as Exhibit 21.
 
The Company is one of the nation’s top 50 bank holding companies, based on asset size. At December 31, 2009, the Company had consolidated assets of $18.1 billion, loans of $10.5 billion, deposits of $14.2 billion, and equity of $1.9 billion. All of the Company’s operations conducted by subsidiaries are consolidated for purposes of preparing the Company’s consolidated financial statements. The Company does not utilize unconsolidated subsidiaries or special purpose entities to provide off-balance sheet borrowings or securitizations.
 
The Company’s goal is to be the preferred provider of targeted financial services in its communities, based on strong customer relationships. It believes in building long-term relationships based on top quality service, high ethical standards and safe, sound assets. The Company operates under a super-community banking format with a local orientation, augmented by experienced, centralized support in select critical areas. The Company’s local market orientation is reflected in its financial centers and regional advisory boards, which are comprised of local business persons, professionals and other community representatives, that assist the Company in responding to local banking needs. In addition to this local market, community-based focus, the Company offers sophisticated financial products available at much larger financial institutions.
 
The Bank’s facilities are located throughout Missouri, Kansas, and central Illinois, and in Tulsa, Oklahoma and Denver, Colorado. Its two largest markets include St. Louis and Kansas City, which serve as the central hubs for the entire company.
 
The markets the Bank serves, being located in the lower Midwest, provide natural sites for production and distribution facilities and also serve as transportation hubs. The economy has been well-diversified in these markets with many major industries represented, including telecommunications, automobile, aircraft and general manufacturing, health care, numerous service industries, food production, and agricultural production and related industries. In addition, several of the Illinois markets are located in areas with some of the most productive farmland in the world. The real estate lending operations of the Bank are centered in its lower Midwestern markets. Historically, these markets have generally tended to be less volatile than in other parts of the country. While the decline in the national real estate market resulted in significantly higher real estate loan losses during 2008 and 2009 for the banking industry, management believes the diversity and nature of the Bank’s markets has resulted in lower real estate loan losses in these markets and is a key factor in the Bank’s relatively lower loan loss levels.
 
The Company regularly evaluates the potential acquisition of, and holds discussions with, various financial institutions eligible for bank holding company ownership or control. In addition, the Company regularly considers the potential disposition of certain of its assets and branches. The Company seeks merger or acquisition partners that are culturally similar and have experienced management and possess either significant market presence or have potential for improved profitability through financial management, economies of scale and expanded services. The Company’s most recent acquisitions were in 2007, when it


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acquired the outstanding stock of South Tulsa Financial Corporation, located in Tulsa, Oklahoma, and Commerce Bank, located in Denver, Colorado. For additional information on acquisition and branch disposition activity, refer to page 74.
 
Operating Segments
 
The Company is managed in three operating segments. The Consumer segment includes the retail branch network, consumer installment lending, personal mortgage banking, consumer debit and credit bank card activities, and student lending. It provides services through a network of 214 full-service branches, a widespread ATM network of 412 machines, and the use of alternative delivery channels such as extensive online banking and telephone banking services. In 2009, this retail segment contributed 41% of total segment pre-tax income. The Commercial segment provides a full array of corporate lending, merchant and commercial bank card products, leasing, and international services, as well as business and government deposit and cash management services. In 2009, it contributed 42% of total segment pre-tax income. The Wealth segment provides traditional trust and estate tax planning services, brokerage services, and advisory and discretionary investment portfolio management services to both personal and institutional corporate customers. This segment also manages the Company’s family of proprietary mutual funds, which are available for sale to both trust and general retail customers. Fixed income investments are sold to individuals and institutional investors through the Capital Markets Group, which is also included in this segment. At December 31, 2009, the Wealth segment managed investments with a market value of $12.8 billion and administered an additional $9.3 billion in non-managed assets. Additional information relating to operating segments can be found on pages 52 and 96.
 
Supervision and Regulation
 
General
 
The Company, as a bank holding company, is primarily regulated by the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956 (BHC Act). Under the BHC Act, the Federal Reserve Board’s prior approval is required in any case in which the Company proposes to acquire all or substantially all of the assets of any bank, acquire direct or indirect ownership or control of more than 5% of the voting shares of any bank, or merge or consolidate with any other bank holding company. The BHC Act also prohibits, with certain exceptions, the Company from acquiring direct or indirect ownership or control of more than 5% of any class of voting shares of any non-banking company. Under the BHC Act, the Company may not engage in any business other than managing and controlling banks or furnishing certain specified services to subsidiaries and may not acquire voting control of non-banking companies unless the Federal Reserve Board determines such businesses and services to be closely related to banking. When reviewing bank acquisition applications for approval, the Federal Reserve Board considers, among other things, the Bank’s record in meeting the credit needs of the communities it serves in accordance with the Community Reinvestment Act of 1977, as amended (CRA). The Bank has a current CRA rating of “outstanding”.
 
The Company is required to file with the Federal Reserve Board various reports and such additional information as the Federal Reserve Board may require. The Federal Reserve Board also makes regular examinations of the Company and its subsidiaries. The Company’s banking subsidiary is organized as a national banking association and is subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (OCC). The Bank is also subject to regulation by the Federal Deposit Insurance Corporation (FDIC). In addition, there are numerous other federal and state laws and regulations which control the activities of the Company and the Bank, including requirements and limitations relating to capital and reserve requirements, permissible investments and lines of business, transactions with affiliates, loan limits, mergers and acquisitions, issuance of securities, dividend payments, and extensions of credit. If the Company fails to comply with these or other applicable laws and regulations, it may be subject to civil monetary penalties, imposition of cease and desist orders or other written directives, removal of management and, in certain circumstances, criminal penalties. This regulatory framework is intended primarily for the protection of depositors and the preservation of the federal deposit insurance funds, and not for the protection


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of security holders. Statutory and regulatory controls increase a bank holding company’s cost of doing business and limit the options of its management to employ assets and maximize income.
 
In addition to its regulatory powers, the Federal Reserve Bank affects the conditions under which the Company operates by its influence over the national supply of bank credit. The Federal Reserve Board employs open market operations in U.S. government securities, changes in the discount rate on bank borrowings, changes in the federal funds rate on overnight inter-bank borrowings, and changes in reserve requirements on bank deposits in implementing its monetary policy objectives. These instruments are used in varying combinations to influence the overall level of the interest rates charged on loans and paid for deposits, the price of the dollar in foreign exchange markets and the level of inflation. The monetary policies of the Federal Reserve have a significant effect on the operating results of financial institutions, most notably on the interest rate environment. In view of changing conditions in the national economy and in the money markets, as well as the effect of credit policies of monetary and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels or loan demand, or their effect on the financial statements of the Company.
 
Subsidiary Bank
 
Under Federal Reserve policy, the Company is expected to act as a source of financial strength to its bank subsidiary and to commit resources to support it in circumstances when it might not otherwise do so. In addition, any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.
 
Substantially all of the deposits of the Bank are insured up to the applicable limits by the Bank Insurance Fund of the FDIC. The Emergency Economic Stabilization Act of 2008 (discussed further under “Legislation”) temporarily increased the general depositor limit from $100,000 to $250,000, through December 31, 2013. During 2009, the Bank also participated in the FDIC’s Transaction Account Guarantee Program. Under that program, all non-interest bearing transaction accounts were fully guaranteed by the FDIC for the entire amount of the account. Coverage under this program was in addition to and separate from the coverage available under the FDIC’s general deposit insurance rules. Effective January 1, 2010, the Bank no longer participates in the program, and depositor accounts are insured up to $250,000 under the FDIC’s general deposit insurance rules. The Bank pays deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC for Bank Insurance Fund member institutions. The FDIC has established a risk-based assessment system under which institutions are classified and pay premiums according to their perceived risk to the federal deposit insurance funds. The Bank’s premiums had been relatively low prior to the 2008 economic crisis. These rose significantly in 2009 due to higher fees charged by the FDIC in order to replenish its insurance fund, which has been depleted by the recent high levels of bank failures across the country. The Bank’s FDIC expense, including its portion of an industry-wide special assessment, totaled $27.4 million in 2009, compared to $2.1 million in 2008. In late 2009, the FDIC Board ruled that insured institutions must prepay their quarterly risk-based assessments for the fourth quarter of 2009 and subsequent years 2010 through 2012, in order to cover the costs of future expected bank failures. The Bank’s pre-payment on December 30, 2009 totaled $68.7 million.
 
Payment of Dividends
 
The principal source of the Company’s cash revenues is dividends paid by the Bank. The Federal Reserve Board may prohibit the payment of dividends by bank holding companies if their actions constitute unsafe or unsound practices. The OCC limits the payment of dividends by the Bank in any calendar year to the net profit of the current year combined with the retained net profits of the preceding two years. Permission must be obtained from the OCC for dividends exceeding these amounts. The payment of dividends by the Bank may also be affected by factors such as the maintenance of adequate capital.


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Capital Adequacy
 
The Company is required to comply with the capital adequacy standards established by the Federal Reserve. These capital adequacy guidelines generally require bank holding companies to maintain minimum total capital equal to 8% of total risk-adjusted assets and off-balance sheet items (the “Total Risk-Based Capital Ratio”), with at least one-half of that amount consisting of Tier I, or core capital, and the remaining amount consisting of Tier II, or supplementary capital. Tier I capital for bank holding companies generally consists of the sum of common shareholders’ equity, qualifying non-cumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill and other non-qualifying intangible assets. Tier II capital generally consists of hybrid capital instruments, term subordinated debt and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics.
 
In addition, the Federal Reserve also requires bank holding companies to comply with minimum leverage ratio requirements. The leverage ratio is the ratio of a banking organization’s Tier I capital to its total consolidated quarterly average assets (as defined for regulatory purposes), net of the allowance for loan losses, goodwill and certain other intangible assets. The minimum leverage ratio for bank holding companies is 4%. At December 31, 2009, the Bank was “well-capitalized” under regulatory capital adequacy standards, as further discussed on page 100.
 
Legislation
 
These laws and regulations are under constant review by various agencies and legislatures, and are subject to sweeping change. The Gramm-Leach-Bliley Financial Modernization Act of 1999 (GLB Act) contained major changes in laws that previously kept the banking industry largely separate from the securities and insurance industries. The GLB Act authorized the creation of a new kind of financial institution, known as a “financial holding company”, and a new kind of bank subsidiary, called a “financial subsidiary”, which may engage in a broader range of investment banking, insurance agency, brokerage, and underwriting activities. The GLB Act also included privacy provisions that limit banks’ abilities to disclose non-public information about customers to non-affiliated entities. Banking organizations are not required to become financial holding companies, but instead may continue to operate as bank holding companies, providing the same services they were authorized to provide prior to the enactment of the GLB Act. The Company currently operates as a bank holding company.
 
The Company must also comply with the requirements of the Bank Secrecy Act (BSA). The BSA is designed to help fight drug trafficking, money laundering, and other crimes. Compliance is monitored by the OCC. The BSA was enacted to prevent banks and other financial service providers from being used as intermediaries for, or to hide the transfer or deposit of money derived from, criminal activity. Since its passage, the BSA has been amended several times. These amendments include the Money Laundering Control Act of 1986 which made money laundering a criminal act, as well as the Money Laundering Suppression Act of 1994 which required regulators to develop enhanced examination procedures and increased examiner training to improve the identification of money laundering schemes in financial institutions.
 
In 2001, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA PATRIOT Act) was signed into law. The USA PATRIOT Act substantially broadened the scope of U.S. anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The U.S. Treasury Department issued a number of regulations implementing the USA PATRIOT Act that apply certain of its requirements to financial institutions such as the Company’s broker-dealer subsidiary. The regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing.


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In October 2008, the Emergency Economic Stabilization Act of 2008 was enacted in response to a global financial crisis spurred by frozen credit markets, institution failures and loss of investor confidence. Under the Act, the Troubled Asset Relief Program (TARP) was created, which authorized the U.S. Treasury department to spend up to $700 billion to purchase distressed assets and make capital injections into banks. The stated goal of TARP was to improve the liquidity of targeted illiquid, difficult-to-value assets by purchasing them from banks and other financial institutions, thus encouraging banks to resume lending again at levels seen before the crisis, loosening credit and improving the market order and investor confidence. The Company did not apply for TARP funds.
 
The FDIC’s Debt Guarantee Program allowed eligible financial institutions to issue senior unsecured debt whose principal and interest payments would be guaranteed by the FDIC. The Company did not issue debt under this program, which guaranteed debt issued on or before October 31, 2009 and maturing on or before December 31, 2012. The program has been extended through April 30, 2010 on a limited, emergency basis, which the Company does not expect to utilize.
 
The Credit Card Accountability, Responsibility, and Disclosure Act of 2009 (the Credit CARD Act) was signed into law in May 2009. It is comprehensive credit card legislation that aims to establish fair and transparent practices relating to open end consumer credit plans. The first phase of the legislation began in August 2009, under which the payment period (with no late fees) was extended from 14 days to 21 days, the advance warning period for significant changes to credit card accounts was extended from 15 days to 45 days, and opt-out provisions were made available to customers. A second phase began in February 2010, which includes provisions governing when rate increases can be applied on late accounts, requirements for clearer disclosures of terms before opening an account, prohibitions on charging over-limit fees and double-cycle billing, and various other restrictions. Additional rules will become effective in July 2010, which deal with interest rate reinstatements on former overdue accounts, and gift card expiration dates and inactivity fees.
 
In November 2009, the Federal Reserve announced that starting July 1, 2010, banks may not charge fees for paying overdrafts on ATM and debit card transactions unless the customer gives consent. Additional federal legislation has been introduced which would limit the number and amount of overdraft fees which banks can charge, prohibit ordering the posting of transactions to cause consumers to incur higher fees, prohibit non-sufficient funds fees on ATM or debit card transactions, and require banks to provide a consumer notice and opportunity to cancel transactions that would trigger an overdraft. The new regulations, including the Credit CARD Act, could result in lower fees earned on overdraft and credit card transactions.
 
In 2009 legislation was proposed by the President which could affect the way student loans are originated in the U.S. The proposed legislation would expand Pell Grants and Perkins Loan programs and require all colleges and universities to convert to direct lending programs with the U.S. government as of July 1, 2010. Currently, colleges and universities have the choice of participating in either direct lending with the U.S. government or a program whereby loans are originated by banks, but guaranteed by the U.S. government. Should this legislation ultimately be passed, the Company may not be able to continue its guaranteed student loan origination business.
 
Congress is considering sweeping legislation that would overhaul regulation of the financial services industry. The proposals include the creation of an independent Consumer Financial Protection Agency. The new agency would take consumer regulatory responsibility of financial products from other agencies and centralize it in one office. It would have the authority and accountability to supervise, examine, and enforce consumer financial protection laws, and any institution that provides consumer financial products would fall under its jurisdiction. The establishment of the proposed agency effectively separates two types of regulation: consumer protection and safety and soundness that are presently mutually reinforced within the existing agencies. This possible separation is of special concern to the financial industry, as it could result in weakening both of these aims. Other proposed legislation includes the creation of an agency to protect against systemic risk, the creation of a single Federal bank regulator, further regulation of the over-the-counter derivatives market, stricter capital and liquidity standards for large institutions, provisions for non-binding “say-on-pay” shareholder voting on executive compensation, and creation of a Securities and Exchange Commission (SEC) office with regulatory authority over credit rating agencies. Recent proposals from the administration include assessing fees totaling $170 billion against larger banks (those with assets in


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excess of $50 billion) to recoup TARP losses, in addition to prohibitions on proprietary trading activities and ownership of hedge and private equity funds.
 
Competition
 
The Company’s locations in regional markets throughout Missouri, Kansas, central Illinois, Tulsa, Oklahoma, and Denver, Colorado, face intense competition from hundreds of financial service providers. The Company competes with national and state banks for deposits, loans and trust accounts, and with savings and loan associations and credit unions for deposits and consumer lending products. In addition, the Company competes with other financial intermediaries such as securities brokers and dealers, personal loan companies, insurance companies, finance companies, and certain governmental agencies. The passage of the GLB Act, which removed barriers between banking and the securities and insurance industries, has resulted in greater competition among these industries. The Company generally competes on the basis of customer services and responsiveness to customer needs, interest rates on loans and deposits, lending limits and customer convenience, such as location of offices.
 
Employees
 
The Company and its subsidiaries employed 4,565 persons on a full-time basis and 674 persons on a part-time basis at December 31, 2009. The Company provides a variety of benefit programs including a 401K plan as well as group life, health, accident, and other insurance. The Company also maintains training and educational programs designed to prepare employees for positions of increasing responsibility.
 
Available Information
 
The Company’s principal offices are located at 1000 Walnut, Kansas City, Missouri (telephone number 816-234-2000). The Company makes available free of charge, through its web site at www.commercebank.com, reports filed with the Securities and Exchange Commission as soon as reasonably practicable after the electronic filing. These filings include the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports.
 
Statistical Disclosure
 
The information required by Securities Act Guide 3 — “Statistical Disclosure by Bank Holding Companies” is located on the pages noted below.
 
                 
         
Page
 
 
  I.    
Distribution of Assets, Liabilities and Stockholders’ Equity; Interest Rates and Interest Differential
    23, 60-63  
  II.    
Investment Portfolio
    41-43, 77-82  
  III.    
Loan Portfolio
       
       
Types of Loans
    28  
       
Maturities and Sensitivities of Loans to Changes in Interest Rates
    29  
       
Risk Elements
    35-41  
  IV.    
Summary of Loan Loss Experience
    33-35  
  V.    
Deposits
    43-44, 84  
  VI.    
Return on Equity and Assets
    18  
  VII.    
Short-Term Borrowings
    85-86  


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Item 1a.  RISK FACTORS
 
Making or continuing an investment in securities issued by Commerce Bancshares, Inc., including its common stock, involves certain risks that you should carefully consider. The risks and uncertainties described below are not the only risks that may have a material adverse effect on the Company. Additional risks and uncertainties also could adversely affect its business and financial results. If any of the following risks actually occur, its business, financial condition or results of operations could be negatively affected, the market price for your securities could decline, and you could lose all or a part of your investment. Further, to the extent that any of the information contained in this Annual Report on Form 10-K constitutes forward-looking statements, the risk factors set forth below also are cautionary statements identifying important factors that could cause the Company’s actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of Commerce Bancshares, Inc.
 
Difficult market conditions have adversely affected the Company’s industry and may continue to do so.
 
Given the concentration of the Company’s banking business in the United States, it is particularly exposed to downturns in the U.S. economy. The economic trends which began in 2008, such as declines in the housing market, falling home prices, increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities as well as major commercial and investment banks. These write-downs, initially of mortgage-backed securities and other complex financial instruments, but spreading to various classes of real estate, commercial and consumer loans in turn, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets has adversely affected the Company’s business, financial condition and results of operations through higher levels of loan losses and lower loan demand. While there have been some recent indications of stabilization, management does not expect significant economic improvement in the near future. In particular, the Company may face the following risks in connection with these market conditions:
 
  •  The Company may face increased regulation of the industry. Compliance with such regulation may divert resources from other areas of the business and limit the ability to pursue other opportunities. Recently adopted regulation over credit card and overdraft account practices could result in lower revenues from these products.
 
  •  Market developments may affect consumer confidence levels and may cause declines in consumer credit usage and adverse changes in payment patterns, causing increases in delinquencies and default rates. These could impact the Company’s loan losses and provision for loan losses, as a significant part of the Company’s business includes consumer and credit card lending.
 
  •  Reduced levels of economic activity may cause declines in financial service transactions and the fees earned by the Company on such transactions.
 
  •  The Company’s ability to assess the creditworthiness of its customers may be impaired if the models and approaches it uses to select, manage, and underwrite its customers become less predictive of future behaviors.
 
  •  The process used to estimate losses inherent in the Company’s credit exposure requires difficult, subjective, and complex judgments, including forecasts of economic conditions and how these economic predictions might impair the ability of its borrowers to repay their loans, which may no longer be capable of accurate estimation which may, in turn, impact the reliability of the process.


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  •  Competition in the industry could intensify as a result of the increasing consolidation of financial services companies in connection with current market conditions.
 
  •  With higher bank failures occurring in 2009 and more expected in the future, the Company may be required to pay significantly higher FDIC premiums for extended periods of time because of the low funding levels within the FDIC insurance fund.
 
Significant changes in banking laws and regulations could materially affect the Company’s business.
 
Increased regulation of the banking industry is being demanded by the current political administration. Certain regulation has already been imposed during the past year, and much additional regulation has been proposed. Such regulation, along with possible changes in tax laws and accounting rules, may have a significant impact on the ways that financial institutions conduct business, implement strategic initiatives, engage in tax planning and make financial disclosures. Compliance with such regulation may increase costs and limit the ability to pursue business opportunities.
 
The performance of the Company is dependent on the economic conditions of the markets in which the Company operates.
 
The Company’s success is heavily influenced by the general economic conditions of the specific markets in which it operates. Unlike larger national or other regional banks that are more geographically diversified, the Company provides financial services primarily throughout the states of Missouri, Kansas, and central Illinois, and has recently begun to expand into Oklahoma, Colorado and other surrounding states. Since the Company does not have a significant presence in other parts of the country, a prolonged economic downtown in these markets could have a material adverse effect on the Company’s financial condition and results of operations.
 
Significant changes in federal monetary policy could materially affect the Company’s business.
 
The Federal Reserve System regulates the supply of money and credit in the United States. Its polices determine in large part the cost of funds for lending and investing by influencing the interest rate earned on loans and paid on borrowings and interest bearing deposits. Credit conditions are influenced by its open market operations in U.S. government securities, changes in the member bank discount rate, and bank reserve requirements. Changes in Federal Reserve Board policies are beyond the Company’s control and difficult to predict.
 
The soundness of other financial institutions could adversely affect the Company.
 
The Company’s ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institution counterparties. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. The Company has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual funds, and other institutional clients. Transactions with these institutions include overnight and term borrowings, interest rate swap agreements, securities purchased and sold, short-term investments, and other such transactions. As a result of this exposure, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by the Company or by other institutions. Many of these transactions expose the Company to credit risk in the event of default of its counterparty or client, while other transactions expose the Company to liquidity risks should funding sources quickly disappear. In addition, the Company’s credit risk may be exacerbated when the collateral held cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to the Company. There is no assurance that any such losses would not materially and adversely affect results of operations.


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The Company’s asset valuation may include methodologies, estimations and assumptions which are subject to differing interpretations and could result in changes to asset valuations that may materially adversely affect its results of operations or financial condition.
 
The Company uses estimates, assumptions, and judgments when financial assets and liabilities are measured and reported at fair value. Assets and liabilities carried at fair value inherently result in a higher degree of financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices and/or other observable inputs provided by independent third-party sources, when available. When such third-party information is not available, fair value is estimated primarily by using cash flow and other financial modeling techniques utilizing assumptions such as credit quality, liquidity, interest rates and other relevant inputs. Changes in underlying factors, assumptions, or estimates in any of these areas could materially impact the Company’s future financial condition and results of operations.
 
During periods of market disruption, including periods of significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, it may be difficult to value certain assets if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the current financial environment. In such cases, certain asset valuations may require more subjectivity and management judgment. As such, valuations may include inputs and assumptions that are less observable or require greater estimation. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of assets as reported within our consolidated financial statements and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on results of operations or financial condition.
 
The Company’s investment portfolio values may be adversely impacted by changing interest rates and deterioration in the credit quality of underlying collateral within mortgage and other asset-backed investment securities.
 
The Company generally invests in securities issued by government-backed agencies or privately issued securities that are highly rated by credit rating agencies at the time of purchase, but are subject to changes in market value due to changing interest rates and implied credit spreads. Certain mortgage and asset-backed securities represent beneficial interests which are collateralized by residential mortgages, credit cards, automobiles, mobile homes or other assets. While these investment securities are highly rated at the time of initial investment, the value of these securities may decline significantly due to actual or expected deterioration in the underlying collateral, especially residential mortgage collateral. Market conditions have resulted in a deterioration in fair values for non-guaranteed mortgage-backed and other asset-backed securities. Under accounting rules, when the impairment is due to declining expected cash flows, some portion of the impairment, depending on the Company’s intent to sell and the likelihood of being required to sell before recovery, must be recognized in current earnings. This could result in significant non-cash losses.
 
The Company is subject to interest rate risk.
 
The Company’s net interest income is the largest source of overall revenue to the Company, representing 62% of total revenue. Interest rates are beyond the Company’s control, and they fluctuate in response to general economic conditions and the policies of various governmental and regulatory agencies, in particular, the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, will influence the origination of loans, the purchase of investments, the generation of deposits, and the rates received on loans and investment securities and paid on deposits. Management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on the Company’s results of operations. However, any substantial, prolonged change in market interest rates could have a material adverse effect on the Company’s financial condition and results of operations.


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Future loan losses could increase.
 
The Company maintains an allowance for loan losses that represents management’s best estimate of probable losses that have been incurred at the balance sheet date within the existing portfolio of loans. The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The Company has seen significant increases in losses in its loan portfolio, particularly in residential construction, consumer, and credit card loans, due to the deterioration in the housing industry and general economic conditions. Until the housing sector and overall economy begin to recover, it is likely that these losses will continue. While the Company’s credit loss ratios remain below industry averages, continued economic deterioration and further loan losses may negatively affect its results of operations and could further increase levels of its allowance. In addition, the Company’s allowance level is subject to review by regulatory agencies, that could require adjustments to the allowance. See the section captioned “Allowance for Loan Losses” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this report for further discussion related to the Company’s process for determining the appropriate level of the allowance for possible loan loss.
 
The Company operates in a highly competitive industry and market area.
 
The Company operates in the financial services industry, a rapidly changing environment having numerous competitors including other banks and insurance companies, securities dealers, brokers, trust and investment companies and mortgage bankers. The pace of consolidation among financial service providers is accelerating and there are many new changes in technology, product offerings and regulation. New entrants offering competitive products continually penetrate our markets. The Company must continue to make investments in its products and delivery systems to stay competitive with the industry as a whole or its financial performance may suffer.
 
The Company’s reputation and future growth prospects could be impaired if events occur which breach its customers’ privacy.
 
The Company relies heavily on communications and information systems to conduct its business, and as part of its business the Company maintains significant amounts of data about its customers and the products they use. While the Company has policies and procedures designed to prevent or limit the effect of failure, interruption or security breach of its information systems, there can be no assurances that any such failures, interruptions or security breaches will not occur, or if they do occur, that they will be adequately addressed. Should any of these systems become compromised, the reputation of the Company could be damaged, relationships with existing customers impaired and result in lost business and incur significant expenses trying to remedy the compromise.
 
The Company may not attract and retain skilled employees.
 
The Company’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities engaged in by the Company can be intense, and the Company spends considerable time and resources attracting and hiring qualified people for its various business lines and support units. The unexpected loss of the services of one or more of the Company’s key personnel could have a material adverse impact on the Company’s business because of their skills, knowledge of the Company’s market, years of industry experience, and the difficulty of promptly finding qualified replacement personnel.
 
Item 1b.  UNRESOLVED STAFF COMMENTS
 
None


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Item 2.  PROPERTIES
 
The main offices of the Bank are located in the larger metropolitan areas of its markets in various multi-story office buildings. The Bank owns its main offices and leases unoccupied premises to the public. The larger offices include:
 
                         
 
    Net rentable
    % occupied
    % occupied
 
Building   square footage     in total     by bank  
 
 
922 Walnut
    256,000       95 %     93 %
Kansas City, MO
                       
1000 Walnut
    403,000       84       36  
Kansas City, MO
                       
811 Main
    237,000       100       100  
Kansas City, MO
                       
8000 Forsyth
    178,000       95       92  
Clayton, MO
                       
1551 N. Waterfront     120,000       100       32  
Pkwy, Wichita, KS
                       
                         
 
 
 
The Bank leases offices in Omaha, Nebraska which house its credit card operations. Additionally, certain other installment loan, trust and safe deposit functions operate out of leased offices in downtown Kansas City. The Company has an additional 208 branch locations in Missouri, Illinois, Kansas, Oklahoma and Colorado which are owned or leased, and 160 off-site ATM locations.
 
Item 3.  LEGAL PROCEEDINGS
 
The information required by this item is set forth in Item 8 under Note 19, Commitments, Contingencies and Guarantees on page 112.
 
Item 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
No matters were submitted during the fourth quarter of 2009 to a vote of security holders through the solicitation of proxies or otherwise.
 
Executive Officers of the Registrant
 
The following are the executive officers of the Company, each of whom is designated annually, and there are no arrangements or understandings between any of the persons so named and any other person pursuant to which such person was designated an executive officer.
 
     
Name and Age   Positions with Registrant
 
Jeffery D. Aberdeen, 56
  Controller of the Company since December 1995. Prior thereto he was Assistant Controller of the Company. He is Controller of the Company’s subsidiary bank, Commerce Bank, N.A.
     
Kevin G. Barth, 49
  Executive Vice President of the Company since April 2005 and Executive Vice President of Commerce Bank, N.A. since October 1998. Senior Vice President of the Company and Officer of Commerce Bank, N.A. prior thereto.
     
Sara E. Foster, 49
  Senior Vice President of the Company since February 1998 and Vice President of the Company prior thereto.


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Name and Age   Positions with Registrant
 
     
David W. Kemper, 59
  Chairman of the Board of Directors of the Company since November 1991, Chief Executive Officer of the Company since June 1986, and President of the Company since April 1982. He is Chairman of the Board, President and Chief Executive Officer of Commerce Bank, N.A. He is the son of James M. Kemper, Jr. (a former Director and former Chairman of the Board of the Company) and the brother of Jonathan M. Kemper, Vice Chairman of the Company.
     
Jonathan M. Kemper, 56
  Vice Chairman of the Company since November 1991 and Vice Chairman of Commerce Bank, N.A. since December 1997. Prior thereto, he was Chairman of the Board, Chief Executive Officer, and President of Commerce Bank, N.A. He is the son of James M. Kemper, Jr. (a former Director and former Chairman of the Board of the Company) and the brother of David W. Kemper, Chairman, President, and Chief Executive Officer of the Company.
     
Charles G. Kim, 49
  Chief Financial Officer of the Company since July 2009. Executive Vice President of the Company since April 1995 and Executive Vice President of Commerce Bank, N.A. since January 2004. Prior thereto, he was Senior Vice President of Commerce Bank, N.A. (Clayton, MO), a former subsidiary of the Company.
     
Seth M. Leadbeater, 59
  Vice Chairman of the Company since January 2004. Prior thereto he was Executive Vice President of the Company. He has been Vice Chairman of Commerce Bank, N.A. since September 2004. Prior thereto he was Executive Vice President of Commerce Bank, N.A. and President of Commerce Bank, N.A. (Clayton, MO).
     
Robert C. Matthews, Jr., 62
  Executive Vice President and Chief Credit Officer of the Company since December 1989. Executive Vice President of Commerce Bank, N.A. since December 1997.
     
Michael J. Petrie, 53
  Senior Vice President of the Company since April 1995. Prior thereto, he was Vice President of the Company.
     
Robert J. Rauscher, 52
  Senior Vice President of the Company since October 1997. Senior Vice President of Commerce Bank, N.A. prior thereto.
     
V. Raymond Stranghoener, 58
  Executive Vice President of the Company since July 2005 and Senior Vice President of the Company prior thereto. Prior to his employment with the Company in October 1999, he was employed at BankAmerica Corp. as National Executive of the Bank of America Private Bank Wealth Strategies Group.

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PART II
 
Item 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Commerce Bancshares, Inc.
Common Stock Data
 
The following table sets forth the high and low prices of actual transactions for the Company’s common stock and cash dividends paid for the periods indicated (restated for the 5% stock dividend distributed in December 2009).
 
                             
                    Cash
 
    Quarter   High     Low     Dividends  
   
 
2009
  First   $ 42.30     $ 26.48     $ .229  
    Second     37.38       28.31       .229  
    Third     38.08       29.47       .229  
    Fourth     40.38       34.19       .229  
 
 
2008
  First   $ 41.36     $ 34.47     $ .227  
    Second     41.41       35.76       .227  
    Third     48.06       33.11       .227  
    Fourth     50.34       33.75       .227  
 
 
2007
  First   $ 43.86     $ 40.25     $ .216  
    Second     42.26       38.58       .216  
    Third     41.81       37.39       .216  
    Fourth     42.01       38.06       .216  
 
 
 
Commerce Bancshares, Inc. common shares are listed on the Nasdaq Global Select Market (NASDAQ) under the symbol CBSH. The Company had 4,444 shareholders of record as of December 31, 2009.


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Performance Graph
 
The following graph presents a comparison of Company (CBSH) performance to the indices named below. It assumes $100 invested on December 31, 2004 with dividends invested on a Total Return basis.
 
(PERFORMANCE GRAPH)
 
The following table sets forth information about the Company’s purchases of its $5 par value common stock, its only class of stock registered pursuant to Section 12 of the Exchange Act, during the fourth quarter of 2009.
 
                                 
 
    Total
          Total Number of
       
    Number
    Average
    Shares Purchased
    Maximum Number that
 
    of Shares
    Price Paid
    as Part of Publicly
    May Yet Be Purchased
 
Period   Purchased     per Share     Announced Program     Under the Program  
 
 
October 1 – 31, 2009
    1,459     $ 39.72       1,459       2,861,999  
November 1 – 30, 2009
    216     $ 38.64       216       2,861,783  
December 1 – 31, 2009
        $             2,861,783  
 
 
Total
    1,675     $ 39.58       1,675       2,861,783  
 
 
 
The Company’s stock purchases shown above were made under a 3,000,000 share authorization by the Board of Directors on February 1, 2008. Under this authorization, 2,861,783 shares remained available for purchase at December 31, 2009.


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Item 6.  SELECTED FINANCIAL DATA
 
The required information is set forth below in Item 7.
 
Item 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Overview
 
Commerce Bancshares, Inc. (the Company) operates as a super-community bank offering an array of sophisticated financial products delivered with high-quality, personal customer service. It is the largest bank holding company headquartered in Missouri, with its principal offices in Kansas City and St. Louis, Missouri. Customers are served from approximately 370 locations in Missouri, Kansas, Illinois, Oklahoma and Colorado using delivery platforms which include an extensive network of branches and ATM machines, full-featured online banking, and a central contact center.
 
The core of the Company’s competitive advantage is its focus on the local markets it services and its concentration on relationship banking, with high service levels and competitive products. In order to enhance shareholder value, the Company grows its core revenue by expanding new and existing customer relationships, utilizing improved technology, and enhancing customer satisfaction.
 
Various indicators are used by management in evaluating the Company’s financial condition and operating performance. Among these indicators are the following:
 
  •  Net income and growth in earnings per share – Net income was $169.1 million, a decline of 10.4% compared to the previous year. The return on average assets was .96%. Diluted earnings per share declined 12.3% in 2009 compared to 2008.
 
  •  Growth in total revenue – Total revenue is comprised of net interest income and non-interest income. Total revenue in 2009 grew 6.6% over 2008, which resulted from growth of $42.8 million, or 7.2%, in net interest income coupled with growth of $20.9 million, or 5.6%, in non-interest income. Total revenue has risen 4.9%, compounded annually, over the last five years.
 
  •  Expense control – Non-interest expense grew by 1.1% this year. Salaries and employee benefits, the largest expense component, grew by 3.6%, due to merit increases and higher pension and medical costs.
 
  •  Asset quality – Net loan charge-offs in 2009 increased $69.0 million over those recorded in 2008, and averaged 1.31% of loans compared to .64% in the previous year. Total non-performing assets amounted to $116.7 million, an increase of $37.6 million over balances at the previous year end, and represented 1.15% of loans outstanding.
 
  •  Shareholder return – Total shareholder return, including the change in stock price and dividend reinvestment, was 1.9% over the past 5 years and 8.5% over the past 10 years.


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The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes. The historical trends reflected in the financial information presented below are not necessarily reflective of anticipated future results.
 
Key Ratios
 
                                         
 
(Based on average balances)   2009     2008     2007     2006     2005  
 
 
Return on total assets
    .96 %     1.15 %     1.33 %     1.54 %     1.60 %
Return on total equity
    9.76       11.81       13.97       15.92       16.16  
Equity to total assets
    9.83       9.71       9.55       9.70       9.89  
Loans to deposits(1)
    79.79       92.11       88.49       84.73       81.34  
Non-interest bearing deposits to total deposits
    6.66       5.47       5.45       5.78       6.23  
Net yield on interest earning assets (tax equivalent basis)
    3.93       3.96       3.85       3.95       3.89  
(Based on end of period data)
                                       
Non-interest income to revenue(2)
    38.43       38.80       40.85       40.72       40.03  
Efficiency ratio(3)
    59.89       63.08       62.65       60.20       59.20  
Tier I risk-based capital ratio
    13.04       10.92       10.31       11.25       12.21  
Total risk-based capital ratio
    14.39       12.31       11.49       12.56       13.63  
Tier I leverage ratio
    9.58       9.06       8.76       9.05       9.43  
Tangible equity to assets ratio(4)
    9.71       8.25       8.61       8.77       9.32  
Cash dividend payout ratio
    44.15       38.54       33.76       30.19       28.92  
 
 
(1) Includes loans held for sale.
 
(2) Revenue includes net interest income and non-interest income.
 
(3) The efficiency ratio is calculated as non-interest expense (excluding intangibles amortization) as a percent of revenue.
 
(4) The tangible equity ratio is calculated as stockholders’ equity reduced by goodwill and other intangible assets (excluding mortgage servicing rights) divided by total assets reduced by goodwill and other intangible assets (excluding mortgage servicing rights).
 
Selected Financial Data
 
                                         
 
(In thousands, except per share data)   2009     2008     2007     2006     2005  
 
 
Net interest income
  $ 635,502     $ 592,739     $ 538,072     $ 513,199     $ 501,702  
Provision for loan losses
    160,697       108,900       42,732       25,649       28,785  
Non-interest income
    396,585       375,712       371,581       352,586       334,837  
Investment securities gains (losses), net
    (7,195 )     30,294       8,234       9,035       6,362  
Non-interest expense
    622,063       615,380       574,159       522,391       495,649  
Net income
    169,075       188,655       206,660       219,842       223,247  
Net income per common share-basic*
    2.07       2.37       2.58       2.70       2.64  
Net income per common share-diluted*
    2.07       2.36       2.56       2.67       2.60  
Cash dividends
    74,720       72,055       68,915       65,758       63,421  
Cash dividends per share*
    .914       .907       .864       .806       .752  
Market price per share*
    38.72       41.86       40.69       41.82       42.88  
Book value per share*
    22.72       19.85       19.33       17.86       16.31  
Common shares outstanding*
    83,008       79,580       79,155       80,979       82,179  
Total assets
    18,120,189       17,532,447       16,204,831       15,230,349       13,885,545  
Loans, including held for sale
    10,490,327       11,644,544       10,841,264       9,960,118       8,899,183  
Investment securities
    6,473,388       3,780,116       3,297,015       3,496,323       3,770,181  
Deposits
    14,210,451       12,894,733       12,551,552       11,744,854       10,851,813  
Long-term debt
    1,236,062       1,447,781       1,083,636       553,934       269,390  
Equity
    1,885,905       1,579,467       1,530,156       1,446,536       1,340,475  
Non-performing assets
    116,670       79,077       33,417       18,223       11,713  
 
 
* Restated for the 5% stock dividend distributed in December 2009.


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Results of Operations
 
                                                         
 
                      $ Change     % Change  
(Dollars in thousands)   2009     2008     2007     ’09-’08     ’08-’07     ’09-’08     ’08-’07  
 
 
Net interest income
  $ 635,502     $ 592,739     $ 538,072     $ 42,763     $ 54,667       7.2 %     10.2 %
Provision for loan losses
    (160,697 )     (108,900 )     (42,732 )     51,797       66,168       47.6       154.8  
Non-interest income
    396,585       375,712       371,581       20,873       4,131       5.6       1.1  
Investment securities gains (losses), net
    (7,195 )     30,294       8,234       (37,489 )     22,060       (123.8 )     267.9  
Non-interest expense
    (622,063 )     (615,380 )     (574,159 )     6,683       41,221       1.1       7.2  
Income taxes
    (73,757 )     (85,077 )     (93,737 )     (11,320 )     (8,660 )     (13.3 )     (9.2 )
Non-controlling interest (expense) income
    700       (733 )     (599 )     1,433       (134 )     195.5       (22.4 )
 
 
Net income
  $ 169,075     $ 188,655     $ 206,660     $ (19,580 )   $ (18,005 )     (10.4 )%     (8.7 )%
 
 
 
Net income for 2009 was $169.1 million, a decline of $19.6 million, or 10.4%, compared to $188.7 million in 2008. The decline in net income resulted from a $51.8 million increase in the provision for loan losses and a $37.5 million decrease in investment securities gains, but was partly offset by increases of $42.8 million in net interest income and $20.9 million in non-interest income. Diluted income per share was $2.07 in 2009 compared to $2.36 in 2008. Several significant items of non-interest income and non-interest expense affected results for 2009 and 2008. During 2009, FDIC insurance expense rose to $27.4 million compared to $2.1 million in 2008. Results for 2008 included a $22.2 million gain on the redemption of Visa, Inc. (Visa) stock, a loss of $33.3 million relating to purchases of auction rate securities, and a $6.9 million gain on a bank branch sale. Reductions in a Visa indemnification obligation, discussed further in the Non-Interest Expense section of this discussion, were recorded in both years. Excluding these items, diluted income per share would have been $2.27 in 2009 and $2.33 in 2008, or a decline of $.06. The return on average assets was .96% in 2009 compared to 1.15% in 2008, and the return on average equity was 9.76% compared to 11.81%. At December 31, 2009, the ratio of tangible equity to assets improved to 9.71% compared to 8.25% at year end 2008.
 
During 2009, net interest income increased $42.8 million, or 7.2%, compared to 2008. This growth was mainly the result of lower rates paid on deposits and borrowings coupled with a higher average balance in investment securities, but partly offset by lower yields on loans and investment securities and declining loan balances. The provision for loan losses totaled $160.7 million in 2009, an increase of $51.8 million over the prior year and indicative of the general decline in the U.S. economy. The Company incurred higher net loan charge-offs in all loan categories, with the largest increases in construction, consumer, consumer credit card, and business loans.
 
Non-interest income in 2009 increased $20.9 million, or 5.6%, over amounts reported in the previous year, mainly due to growth in bank card and student lending fees, which rose $8.3 million and $20.8 million, respectively. Student lending (included in loan fees and sales) included higher gains on loan sales and the reversal of certain impairment charges which had been recorded in 2008. Non-interest expense increased $6.7 million, or 1.1%, over 2008. This growth in 2009 included increases of $25.3 million in FDIC insurance expense and $12.2 million in salaries and employee benefits expense, in addition to a $7.1 million decline in reductions to the Visa indemnification obligation. These increases in expense were largely offset by the 2008 loss of $33.3 million on the purchase of auction rate securities (ARS), discussed further in the Non-Interest Expense section. Income tax expense declined 13.3% in 2009 and resulted in an effective tax rate of 30.4%, which was slightly lower than the effective tax rate of 31.1% in the previous year. The decrease in income tax expense in 2009 compared to 2008 was mainly due to changes in the mix of taxable and non-taxable income on lower pre-tax income.
 
During 2008, net income was $188.7 million, a decrease of $18.0 million, or 8.7%, compared to $206.7 million in 2007. The decline in net income was mainly the result of an increase in the provision for loan losses of $66.2 million coupled with a 7.2% increase in non-interest expense, but partly offset by increases in net interest income, investment securities gains and non-interest income. Net interest income increased $54.7 million, or 10.2%, in 2008 compared to 2007, mainly as a result of growth in loans and


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investment securities, coupled with a large reduction in rates paid on interest bearing liabilities. These effects were partly offset by lower loan yields and higher borrowings. In 2008, net investment securities gains totaled $30.3 million compared to $8.2 million in 2007. Gains in 2008 included a $22.2 million gain on the redemption of Visa stock and a gain of $7.9 million on the sale of certain ARS, further described in the Investment Securities Gains (Losses) section of this discussion.
 
Non-interest income in 2008 rose $4.1 million, or 1.1%, over amounts reported in the previous year and included a $9.4 million impairment charge on certain loans held for sale. Non-interest expense increased $41.2 million, or 7.2%, over 2007, mainly due to the $33.3 million ARS loss mentioned previously and a $9.6 million reduction in the Visa indemnification obligation. The provision for loan losses totaled $108.9 million in 2008, an increase of $66.2 million over 2007, and reflected higher net loan charge-offs, mainly in consumer and consumer credit card loans. Income tax expense declined 9.2% in 2008 and resulted in an effective tax rate of 31.1%, which was slightly lower than the effective tax rate of 31.2% in the previous year. The decrease in income tax expense in 2008 compared to 2007 was mainly due to lower pre-tax earnings.
 
The Company continually evaluates the profitability of its network of bank branches throughout its markets. As a result of this evaluation process, the Company may periodically sell the assets and liabilities of certain branches, or may sell the premises of specific banking facilities. In February 2009, the Company sold its branch in Lakin, Kansas. In this transaction, the Company sold the bank facility and certain deposits totaling approximately $4.7 million and recorded a gain of $644 thousand. During the second quarter of 2008, the Company sold its banking branch, including the facility, in Independence, Kansas. In this transaction, approximately $23.3 million in loans, $85.0 million in deposits, and various other assets and liabilities were sold. A gain of $6.9 million was recorded.
 
The Company distributed a 5% stock dividend for the sixteenth consecutive year on December 15, 2009. All per share and average share data in this report has been restated to reflect the 2009 stock dividend.
 
Critical Accounting Policies
 
The Company’s consolidated financial statements are prepared based on the application of certain accounting policies, the most significant of which are described in Note 1 to the consolidated financial statements. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or be subject to variations which may significantly affect the Company’s reported results and financial position for the current period or future periods. The use of estimates, assumptions, and judgments are necessary when financial assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. Current economic conditions may require the use of additional estimates, and some estimates may be subject to a greater degree of uncertainty due to the current instability of the economy. The Company has identified several policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for loan losses, the valuation of certain investment securities, and accounting for income taxes.
 
Allowance for Loan Losses
 
The Company performs periodic and systematic detailed reviews of its loan portfolio to assess overall collectability. The level of the allowance for loan losses reflects the Company’s estimate of the losses inherent in the loan portfolio at any point in time. While these estimates are based on substantive methods for determining allowance requirements, actual outcomes may differ significantly from estimated results, especially when determining allowances for business, lease, construction and business real estate loans. These loans are normally larger and more complex, and their collection rates are harder to predict. Personal loans, including personal mortgage, credit card and consumer loans, are individually smaller and perform in a more homogenous manner, making loss estimates more predictable. Further discussion of the methodologies used in establishing the allowance is provided in the Allowance for Loan Losses section of this discussion.


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Valuation of Investment Securities
 
The Company carries its investment securities at fair value, and employs valuation techniques which utilize observable inputs when those inputs are available. These observable inputs reflect assumptions market participants would use in pricing the security, developed based on market data obtained from sources independent of the Company. When such information is not available, the Company employs valuation techniques which utilize unobservable inputs, or those which reflect the Company’s own assumptions about market participants, based on the best information available in the circumstances. These valuation methods typically involve cash flow and other financial modeling techniques. Changes in underlying factors, assumptions, estimates, or other inputs to the valuation techniques could have a material impact on the Company’s future financial condition and results of operations. Assets and liabilities carried at fair value inherently result in more financial statement volatility. Under the fair value measurement hierarchy, fair value measurements are classified as Level 1 (quoted prices), Level 2 (based on observable inputs) or Level 3 (based on unobservable, internally-derived inputs), as discussed in more detail in Note 16 on Fair Value Measurements. Most of the available for sale investment portfolio is priced utilizing industry-standard models that consider various assumptions which are observable in the marketplace, or can be derived from observable data. Such securities totaled approximately $5.7 billion, or 89.9% of the available for sale portfolio at December 31, 2009, and were classified as Level 2 measurements. The Company also holds $167.8 million in auction rate securities. These were classified as Level 3 measurements, as no market currently exists for these securities, and fair values were derived from internally generated cash flow valuation models which used unobservable inputs which were significant to the overall measurement.
 
Changes in the fair value of available for sale securities, excluding credit losses relating to other-than-temporary impairment, are reported in other comprehensive income. The Company periodically evaluates the available for sale portfolio for other-than-temporary impairment. Evaluation for other-than-temporary impairment is based on the Company’s intent to sell the security and whether it is likely that it will be required to sell the security before the anticipated recovery of its amortized cost basis. If either of these conditions is met, the entire loss (the amount by which the amortized cost exceeds the fair value) must be recognized in current earnings. If neither condition is met, but the Company does not expect to recover the amortized cost basis, the Company must determine whether a credit loss has occurred. This credit loss is the amount by which the amortized cost basis exceeds the present value of cash flows expected to be collected from the security. The credit loss, if any, must be recognized in current earnings, while the remainder of the loss, related to all other factors, is recognized in other comprehensive income.
 
The estimation of whether a credit loss exists and the period over which the security is expected to recover requires significant judgment. The Company must consider available information about the collectability of the security, including information about past events, current conditions, and reasonable forecasts, which includes payment structure, prepayment speeds, expected defaults, and collateral values. Changes in these factors could result in additional impairment, recorded in current earnings, in future periods.
 
At December 31, 2009, non-agency guaranteed mortgage-backed securities with a par value of $171.6 million were identified as other-than-temporarily impaired. The credit-related impairment loss on these securities amounted to $2.5 million, which was recorded in the consolidated income statement in investment securities gains (losses), net. The noncredit-related loss on these securities, which was recorded in other comprehensive income, was $30.3 million on a pre-tax basis.
 
The Company, through its direct holdings and its Small Business Investment subsidiaries, has numerous private equity investments, categorized as non-marketable securities in the accompanying consolidated balance sheets. These investments are reported at fair value, and totaled $49.5 million at December 31, 2009. Changes in fair value are reflected in current earnings, and reported in investment securities gains (losses), net in the consolidated income statements. Because there is no observable market data for these securities, their fair values are internally developed using available information and management’s judgment, and are classified as Level 3 measurements. Although management believes its estimates of fair value reasonably reflect the fair value of these securities, key assumptions regarding the projected financial performance of


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these companies, the evaluation of the investee company’s management team, and other economic and market factors may affect the amounts that will ultimately be realized from these investments.
 
Accounting for Income Taxes
 
Accrued income taxes represent the net amount of current income taxes which are expected to be paid attributable to operations as of the balance sheet date. Deferred income taxes represent the expected future tax consequences of events that have been recognized in the financial statements or income tax returns. Current and deferred income taxes are reported as either a component of other assets or other liabilities in the consolidated balance sheets, depending on whether the balances are assets or liabilities. Judgment is required in applying generally accepted accounting principles in accounting for income taxes. The Company regularly monitors taxing authorities for changes in laws and regulations and their interpretations by the judicial systems. The aforementioned changes, and changes that may result from the resolution of income tax examinations by federal and state taxing authorities, may impact the estimate of accrued income taxes and could materially impact the Company’s financial position and results of operations.


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Net Interest Income
 
Net interest income, the largest source of revenue, results from the Company’s lending, investing, borrowing, and deposit gathering activities. It is affected by both changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest bearing liabilities. The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates. Changes not solely due to volume or rate changes are allocated to rate.
 
                                                 
    2009     2008  
   
    Change due to           Change due to        
    Average
    Average
          Average
    Average
       
(In thousands)   Volume     Rate     Total     Volume     Rate     Total  
 
 
Interest income, fully taxable equivalent basis
                                               
Loans
  $ (31,745 )   $ (66,327 )   $ (98,072 )   $ 57,851     $ (137,334 )   $ (79,483 )
Loans held for sale
    2,161       (8,910 )     (6,749 )     1,741       (8,713 )     (6,972 )
Investment securities:
                                               
U.S. government and federal agency obligations
    5,037       (1,503 )     3,534       (9,129 )     63       (9,066 )
State and municipal obligations
    9,669       (3,557 )     6,112       5,698       (1,344 )     4,354  
Mortgage and asset-backed securities
    63,862       (22,144 )     41,718       17,036       6,090       23,126  
Other securities
    4,524       (1,155 )     3,369       1,129       (2,010 )     (881 )
Federal funds sold and securities purchased under agreements to resell
    (7,361 )     (704 )     (8,065 )     (4,848 )     (12,746 )     (17,594 )
Interest earning deposits with banks
    1,183       (574 )     609       198             198  
 
 
Total interest income
    47,330       (104,874 )     (57,544 )     69,676       (155,994 )     (86,318 )
 
 
Interest expense
                                               
Interest bearing deposits:
                                               
Savings
    113       (657 )     (544 )     42       (923 )     (881 )
Interest checking and money market
    6,211       (35,369 )     (29,158 )     7,117       (61,197 )     (54,080 )
Time open and C.D.’s of less than $100,000
    (3,466 )     (21,874 )     (25,340 )     (9,775 )     (23,860 )     (33,635 )
Time open and C.D.’s of $100,000 and over
    8,424       (28,718 )     (20,294 )     7,566       (25,640 )     (18,074 )
Federal funds purchased and securities sold under agreements to repurchase
    (8,439 )     (12,947 )     (21,386 )     (16,534 )     (41,845 )     (58,379 )
Other borrowings
    (4,611 )     (1,767 )     (6,378 )     38,018       (13,888 )     24,130  
 
 
Total interest expense
    (1,768 )     (101,332 )     (103,100 )     26,434       (167,353 )     (140,919 )
 
 
Net interest income, fully taxable equivalent basis
  $ 49,098     $ (3,542 )   $ 45,556     $ 43,242     $ 11,359     $ 54,601  
 
 
 
Net interest income totaled $635.5 million in 2009, representing an increase of $42.8 million, or 7.2%, compared to $592.7 million in 2008. On a tax equivalent basis, net interest income totaled $654.2 million and increased $45.6 million, or 7.5%, over the previous year. This increase was mainly the result of lower rates paid on deposits and borrowings coupled with higher average investment securities balances during the year, but partly offset by lower average loan balances and yields. The net yield on earning assets (tax equivalent) was 3.93% in 2009 compared with 3.96% in the previous year.
 
During 2009, interest income on loans (tax equivalent) declined $98.1 million from 2008 due to lower rates earned on most lending products coupled with lower loan balances, especially in business, business real estate and consumer loans. The average rate earned on the loan portfolio decreased 75 basis points to 5.27%


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compared to 6.02% in the previous year. Average loan balances decreased $306.0 million, or 2.8%, reflecting lower line of credit usage, lower demand and pay-downs. Additionally, the Company has ceased most marine and recreational vehicle lending in the consumer loan portfolio. The student loan portfolio, which was acquired late in the fourth quarter of 2008, contributed $9.2 million to interest income with average loan balances of $344.2 million during 2009. Tax equivalent interest earned on investment securities increased by $54.7 million, or 29.8%, due to higher average balances of securities, partially offset by a decrease in rates earned on these investments. Average balances of mortgage and asset-backed securities increased 51.4% to $3.7 billion, and state and municipal obligations increased 25.6%. Additionally, average balances of U.S. government and federal agency securities increased 67.8% during the year to $307.1 million, primarily a result of purchases of U.S. Treasury inflation-protected securities during the last six months of 2009. Interest earned on federal funds sold and resale agreement assets declined $8.1 million, mainly due to a $381.5 million decrease in average balances coupled with much lower overnight rates. Average rates (tax equivalent) earned on interest earning assets in 2009 decreased to 4.85% compared to 5.63% in the previous year, or a decline of 78 basis points.
 
Interest expense on deposits decreased $75.3 million in 2009 compared to 2008. The decline resulted from much lower rates paid on all deposit products, but was partly offset by the effects of higher average balances of money market accounts and certificates of deposit of $100,000 and over. Average rates paid on deposit balances declined 76 basis points from 1.68% in 2008 to .92% in 2009. Interest expense on borrowings declined $27.8 million, or 44.1%, as a result of lower rates paid and lower average balances of federal funds purchased and repurchase agreement borrowings. The average rate paid on interest bearing liabilities decreased to 1.04% compared to 1.83% in 2008.
 
During 2008, interest income on loans (tax equivalent) declined $79.5 million from 2007 due to lower rates earned on virtually all lending products but offset by higher loan balances, especially in business, consumer and consumer credit card loans. The lower rates earned on the loan portfolio were related to the actions taken by the Federal Reserve Bank during 2008 to reduce interest rate levels, which caused the Company’s portfolio to re-price quickly. Tax equivalent interest earned on investment securities increased by $17.5 million, or 10.5%, due to higher average balances of mortgage-backed and municipal securities, coupled with higher rates earned on these investments. Interest earned on federal funds sold and resale agreement assets declined $17.6 million, mainly due to lower average balances coupled with lower overnight rates. Average rates (tax equivalent) earned on interest earning assets in 2008 decreased to 5.63% compared to 6.61% in the previous year, or a decline of 98 basis points.
 
Interest expense on deposits in 2008 decreased $106.7 million compared to 2007, mainly the result of much lower rates paid on all deposit products but partly offset by the effects of higher average balances of money market accounts and certificates of deposit of $100,000 and over. Average rates paid on deposit balances declined 100 basis points from 2.68% in 2007 to 1.68% in 2008. Interest expense on borrowings declined $34.2 million, or 35.2%, mainly as a result of lower rates paid and lower average balances of federal funds purchased and repurchase agreement borrowings. Also, while advances from the Federal Home Loan Bank (FHLB) and the Federal Reserve’s Term Auction Facility increased on average by $788.3 million, rates on these borrowings dropped significantly in 2008. The average rate paid on interest bearing liabilities decreased to 1.83% compared to 3.01% in 2007.
 
Provision for Loan Losses
 
The provision for loan losses totaled $160.7 million in 2009, up from $108.9 million in the previous year, or an increase of $51.8 million. In 2007 the provision totaled $42.7 million. The growth in the provision in 2009 was the result of deteriorating economic conditions affecting the Company’s loan portfolio, higher watch list loan totals, and increasing loan loss experience. As a result, the Company increased its allowance for loan losses by $21.9 million in 2009. The provision for loan losses is recorded to bring the allowance for loan losses to a level deemed adequate by management based on the factors mentioned in the following “Allowance for Loan Losses” section of this discussion.


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Non-Interest Income
 
                                         
 
                      % Change  
(Dollars in thousands)   2009     2008     2007     ’09-’08     ’08-’07  
 
 
Deposit account charges and other fees
  $ 106,362     $ 110,361     $ 117,350       (3.6 )%     (6.0 )%
Bank card transaction fees
    122,124       113,862       103,613       7.3       9.9  
Trust fees
    76,831       80,294       78,840       (4.3 )     1.8  
Bond trading income
    22,432       15,665       9,338       43.2       67.8  
Consumer brokerage services
    10,831       12,156       11,754       (10.9 )     3.4  
Loan fees and sales
    21,273       (2,413 )     8,835       N.M.       N.M.  
Other
    36,732       45,787       41,851       (19.8 )     9.4  
 
 
Total non-interest income
  $ 396,585     $ 375,712     $ 371,581       5.6 %     1.1 %
 
 
Non-interest income as a % of total revenue*
    38.4 %     38.8 %     40.8 %                
Total revenue per full-time equivalent employee
  $ 201.4     $ 185.6     $ 179.0                  
 
 
 
* Total revenue is calculated as net interest income plus non-interest income.
 
Non-interest income totaled $396.6 million, an increase of $20.9 million, or 5.6%, compared to $375.7 million in 2008. Deposit account fees declined $4.0 million, or 3.6%, as a result of lower overdraft fee revenue, which fell $6.8 million, or 9.5%. Overdraft fees comprised 60.9% of total deposit account fee income in 2009. Partly offsetting this decline was an increase in cash management fees, which grew $3.2 million, or 10.6%, over the prior year. Bank card fee income rose $8.3 million, or 7.3% overall, due to continued growth in transaction fees earned on corporate card, debit card and merchant transactions, which increased 24.1%, 4.6% and 3.4%, respectively, but was negatively impacted by lower retail sales affecting credit card fees. Trust fees decreased $3.5 million, or 4.3%, mainly in institutional and corporate fees and reflected the impact that lower markets have had on trust asset values during 2009 and the effects of low interest rates on money market assets held in trust accounts. The market value of total customer trust assets (on which fees are charged) totaled $22.1 billion at year end 2009, and grew 14.0% over year end 2008. Bond trading income rose $6.8 million due to higher sales of fixed income securities to correspondent banks and corporate customers, while consumer brokerage services revenue declined $1.3 million due to lower fees earned on sales of annuity and mutual fund products. Loan fees and sales increased by $23.7 million, as gains on student loan sales increased $20.8 million. The 2009 gains included the reversal of impairment reserves of $8.6 million on certain held for sale student loans, through sales of the related loans and recoveries in the fair value of most of the remaining outstanding loans. The impairment had originally been established in 2008 due to liquidity concerns, which at year end 2009 were largely alleviated. In addition, mortgage banking revenue and loan commitment fees both increased over 2008. The decrease in other non-interest income of $9.1 million from 2008 was mainly due to a gain of $6.9 million recorded in the second quarter of 2008 on the sale of a banking branch in Independence, Kansas, mentioned previously. Other declines were reported in cash sweep commissions, equipment rental income and fees on interest rate swap sales. Partly offsetting these declines was an impairment charge of $1.1 million recorded in 2008 on an office building held for sale, which formerly housed the Company’s check processing operations.
 
During 2008, non-interest income increased $4.1 million, or 1.1%, over 2007 to $375.7 million. Results for 2008 included an impairment charge of $9.4 million, recorded in loan fees and sales, on certain student loans held for sale. The Company has agreements to sell its portfolio of originated student loans to various student loan servicing agencies. Due to uncertainties surrounding some of these agencies’ abilities to fulfill these contracts in the future, the Company recorded the impairment in order to adjust a portion of the portfolio, totaling $206.1 million, to fair value. Most of the charge was reversed in 2009, as mentioned above. During 2008, bank card fee income grew by $10.2 million, or 9.9%, over 2007 due to solid growth in debit card and corporate credit card fee income, which grew by 9.4% and 28.6%, respectively. However, deposit account fees declined by $7.0 million, or 6.0%, mainly due to a decrease of $10.4 million in deposit account overdraft fees. This decline was partly offset by growth in corporate cash management fee income, which increased $4.5 million, or 17.2%. Trust fee income grew by $1.5 million, or 1.8%, and was especially affected in the fourth quarter by lower market values of the trust assets on which fees are based. Market values of total trust


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assets at year end 2008 were 14.6% lower than at year end 2007. Consumer brokerage services revenue grew by $402 thousand, or 3.4%, on higher annuity commissions. Bond trading income increased $6.3 million, or 67.8%, due to increased sales volumes from its correspondent bank and commercial customers. Other non-interest income rose $3.9 million over the prior year, largely due to the $6.9 million gain on the Independence branch sale. Additional increases occurred in cash sweep commission income and fees on interest rate swap sales. These increases were partly offset by the impairment charge on the office building mentioned above, in addition to declines in official check sales and equipment rental income.
 
Investment Securities Gains (Losses), Net
 
Net gains and losses on investment securities during 2009, 2008 and 2007 are shown in the table below. Included in these amounts are gains and losses arising from sales of bonds from the Company’s available for sale portfolio, including credit-related losses on debt securities identified as other-than-temporarily impaired. Also included are gains and losses on sales of publicly traded common stock held by the holding company, Commerce Bancshares, Inc. (the Parent). Gains and losses relating to non-marketable private equity investments, which are primarily held by the Parent’s majority-owned venture capital subsidiaries, are also shown below. These include fair value adjustments, in addition to gains and losses realized upon disposition. The portion of the activity attributable to minority interests is reported as non-controlling interest in the consolidated income statement and resulted in income of $1.1 million in 2009 and expense of $299 thousand and $389 thousand in 2008 and 2007, respectively.
 
Net securities losses of $7.2 million were recorded in 2009. Most of the loss resulted from a $5.0 million net decline in fair value of various private equity securities. In addition, credit-related other-than-temporary impairment (OTTI) losses of $2.5 million were recorded on certain non-agency mortgage-backed securities with a par value of $171.6 million. The non credit-related loss on these securities, which was recorded in other comprehensive income, was $30.3 million.
 
Net securities gains of $30.3 million were recorded in 2008, compared to net gains of $8.2 million in 2007. Most of the net gain in 2008 occurred because of Visa’s redemption of certain Class B stock held by its former member banks. The redemption occurred in conjunction with an initial public offering by Visa in which 500 thousand shares of Class B stock held by the Company were redeemed, resulting in a $22.2 million gain. Also, in December 2008, $341.4 million in auction rate securities were sold in exchange for federally guaranteed student loans, resulting in a gain of $7.9 million.
 
                         
 
(Dollars in thousands)   2009     2008     2007  
 
 
Available for sale:
                       
Preferred equity securities
  $     $ (3,504 )   $ (663 )
Common stock
          (294 )     2,521  
Auction rate securities
          7,861        
Other bonds:
                       
Realized gains
    322       1,140       1,069  
OTTI losses
    (2,473 )            
Non-marketable:
                       
Private equity investments
    (5,044 )     2,895       5,307  
Visa Class B stock
          22,196        
 
 
Total investment securities gains (losses), net
  $ (7,195 )   $ 30,294     $ 8,234  
 
 


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Non-Interest Expense
 
                                         
 
                      % Change  
(Dollars in thousands)   2009     2008     2007     ’09-’08     ’08-’07  
 
 
Salaries
  $ 290,289     $ 286,161     $ 265,378       1.4 %     7.8 %
Employee benefits
    55,490       47,451       43,390       16.9       9.4  
Net occupancy
    45,925       46,317       45,789       (.8 )     1.2  
Equipment
    25,472       24,569       24,121       3.7       1.9  
Supplies and communication
    32,156       35,335       34,162       (9.0 )     3.4  
Data processing and software
    61,789       56,387       50,342       9.6       12.0  
Marketing
    18,231       19,994       18,199       (8.8 )     9.9  
Deposit insurance
    27,373       2,051       1,412       N.M.       45.3  
Loss on purchase of auction rate securities
          33,266             N.M.       N.M.  
Indemnification obligation
    (2,496 )     (9,619 )     20,951       N.M.       N.M.  
Other
    67,834       73,468       70,415       (7.7 )     4.3  
 
 
Total non-interest expense
  $ 622,063     $ 615,380     $ 574,159       1.1 %     7.2 %
 
 
Efficiency ratio
    59.9 %     63.1 %     62.7 %                
Salaries and benefits as a % of total non-interest expense
    55.6 %     54.2 %     53.8 %                
Number of full-time equivalent employees
    5,125       5,217       5,083                  
 
 
 
Non-interest expense was $622.1 million in 2009, an increase of $6.7 million, or 1.1%, over the previous year. A major expense to the Company in 2009 was FDIC deposit insurance, which rose dramatically over amounts recorded in previous years. The Company expects these costs to remain high as the banking industry replenishes the FDIC insurance fund, which has been depleted by the recent high levels of bank failures across the country. The Company incurred total annual expense of $27.4 million during 2009 as a result of normal deposit premiums and special assessments, compared to $2.1 million in 2008. Also, the FDIC required insured institutions to prepay their quarterly risk-based assessments for the fourth quarter of 2009 and subsequent years 2010 through 2012. Accordingly, a cash payment of $68.7 million was paid by the Company on December 30, 2009. The payment has been recorded as an asset and will be reduced each quarter as the Company’s regular quarterly assessments come due and are expensed.
 
During 2009, salaries and benefits expense increased by $12.2 million, or 3.6%, over 2008 due to merit increases and higher pension and medical costs. Occupancy expense decreased slightly, while equipment expense increased $903 thousand, or 3.7%, mainly due to higher data processing equipment depreciation expense. Supplies and communication expense decreased $3.2 million, or 9.0%, as a result of lower supplies and courier expense. Data processing and software costs grew by $5.4 million, or 9.6%. Core data processing expense increased $3.5 million due to several new software and servicing systems, in addition to higher bank card processing costs, which increased in relation to higher bank card revenues. Marketing expense decreased $1.8 million, or 8.8%. Other expense decreased $5.6 million, or 7.7%, partly due to declines in travel and entertainment expense and impairment charges on foreclosed property. Other decreases occurred in leased asset depreciation, professional fees and recruiting expense, which were partly offset by a decline in loan origination cost deferrals.
 
In 2008, non-interest expense was $615.4 million, an increase of 7.2% over the previous year. Salaries and benefits expense grew by $24.8 million, or 8.0%, due to merit increases, higher incentive payments, and increased medical insurance costs. In addition, increased salary costs resulted from higher staffing in areas such as commercial bank card, private banking, and commercial banking, which were part of certain growth initiatives established by the Company in 2007. Occupancy, supplies and communication, and equipment costs grew by 1.2%, 3.4%, and 1.9%, respectively, and were well controlled. Occupancy costs increased mainly as a result of higher building services and repairs expense. Equipment expense grew mainly due to higher repairs and maintenance expense, partly offset by a decline in equipment depreciation expense. Supplies and


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communication costs were higher due to increased costs for supplies and courier expense. Data processing and software expense increased $6.0 million, or 12.0%, mainly due to higher bank card processing costs. Exclusive of bank card costs, core data processing expense increased $2.1 million, or 6.7%, over the prior year due to investments in new software and servicing systems. Marketing expense also rose by $1.8 million, or 9.9%, over the prior year mainly related to deposit account product marketing and other campaigns supporting Company initiatives. Other non-interest expense increased $3.1 million, or 4.3%, in 2008 partly due to a $2.5 million impairment charge on foreclosed land which was sold later that year. Other increases occurred in travel and entertainment, FHLB letter of credit fees, and credit card rewards expense. Partly offsetting these increases were declines in professional fees and leased asset depreciation.
 
Non-interest expense in 2008 also included a $33.3 million non-cash loss related to the purchase of auction rate securities from customers. The securities were purchased at par value from the customers, and this loss represents the amount by which par value exceeded estimated fair value on the purchase date. Most of these securities were subsequently sold in the fourth quarter of 2008, and the gain relating to that transaction was recorded in investments securities gains (losses), as noted above.
 
Also included in non-interest expense were adjustments to the Company’s estimate of its share of certain litigation costs arising from its member bank relationship with Visa. An obligation was initially recorded in 2007 which represented the Company’s portion of litigation costs relating to various suits against Visa. The obligation has been periodically adjusted to reflect escrow funding by Visa, suit settlements, and changes in estimates of remaining litigation costs. As a result of these adjustments, reductions to the obligation were recorded in 2009 and 2008 of $2.5 million and $9.6 million, respectively.
 
Income Taxes
 
Income tax expense was $73.8 million in 2009, compared to $85.1 million in 2008 and $93.7 million in 2007. Income tax expense in 2009 decreased 13.3% from 2008, compared to an 11.8% decrease in pre-tax income. The effective tax rate was 30.4%, 31.1% and 31.2% in 2009, 2008 and 2007, respectively. The Company’s effective tax rates in those years were lower than the federal statutory rate of 35% mainly due to tax-exempt interest on state and local municipal obligations.
 
Financial Condition
 
Loan Portfolio Analysis
 
Classifications of consolidated loans by major category at December 31 for each of the past five years are shown in the table below. This portfolio consists of loans which the Company intends to hold to their maturity, and includes a portfolio of student loans which was acquired in 2008. The Company’s portfolio of originated student loans was classified as held for sale in 2006, and is included in the table below only for 2005. Loans held for sale are discussed in the following section. A schedule of average balances invested in each loan category below appears on page 60.
 
                                         
 
    Balance at December 31  
(In thousands)   2009     2008     2007     2006     2005  
 
 
Business
  $ 2,877,936     $ 3,404,371     $ 3,257,047     $ 2,860,692     $ 2,527,654  
Real estate – construction and land
    665,110       837,369       668,701       658,148       424,561  
Real estate – business
    2,104,030       2,137,822       2,239,846       2,148,195       1,919,045  
Real estate – personal
    1,537,687       1,638,553       1,540,289       1,478,669       1,352,339  
Consumer
    1,333,763       1,615,455       1,648,072       1,435,038       1,287,348  
Home equity
    489,517       504,069       460,200       441,851       448,507  
Student
    331,698       358,049                   330,238  
Consumer credit card
    799,503       779,709       780,227       648,326       592,465  
Overdrafts
    6,080       7,849       10,986       10,601       10,854  
 
 
Total loans
  $ 10,145,324     $ 11,283,246     $ 10,605,368     $ 9,681,520     $ 8,893,011  
 
 


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In December 2008, the Company elected to reclassify certain segments of its real estate, business, and consumer portfolios. The reclassifications were made to better align the loan reporting with its related collateral and purpose. Amounts reclassified to real estate construction and land pertained mainly to commercial or residential land and lots which were held by borrowers for future development. Amounts reclassified to personal real estate related mainly to one to four family rental property secured by residential mortgages. The table below shows the effect of the reclassifications on the various lending categories as of the transfer date. Because the information was not readily available and it was impracticable to do so, periods prior to 2008 were not restated.
 
         
 
    Effect of
 
(In thousands)   reclassification  
 
 
Business
  $ (55,991 )
Real estate – construction and land
    158,268  
Real estate – business
    (214,071 )
Real estate – personal
    142,093  
Consumer
    (30,299 )
 
 
Net reclassification
  $  
 
 
 
The contractual maturities of loan categories at December 31, 2009, and a breakdown of those loans between fixed rate and floating rate loans are as follows:
 
                                         
 
    Principal Payments Due              
    In
    After One
    After
             
    One Year
    Year Through
    Five
             
(In thousands)   or Less     Five Years     Years     Total        
 
 
Business
  $ 1,566,491     $ 1,141,653     $ 169,792     $ 2,877,936          
Real estate – construction and land
    477,162       185,124       2,824       665,110          
Real estate – business
    653,649       1,232,146       218,235       2,104,030          
Real estate – personal
    188,587       384,937       964,163       1,537,687          
 
 
Total business and real estate loans
  $ 2,885,889     $ 2,943,860     $ 1,355,014       7,184,763          
 
 
Consumer(1)
                            1,333,763          
Home equity(2)
                            489,517          
Student(3)
                            331,698          
Consumer credit card(4)
                            799,503          
Overdrafts
                            6,080          
 
 
Total loans
                          $ 10,145,324          
 
 
Loans with fixed rates
  $ 614,446     $ 1,622,946     $ 465,016     $ 2,702,408          
Loans with floating rates
    2,271,443       1,320,914       889,998       4,482,355          
 
 
Total business and real estate loans
  $ 2,885,889     $ 2,943,860     $ 1,355,014     $ 7,184,763          
 
 
 
(1) Consumer loans with floating rates totaled $113.6 million.
 
(2) Home equity loans with floating rates totaled $483.9 million.
 
(3) All student loans have floating rates.
 
(4) Consumer credit card loans with floating rates totaled $732.3 million.
 
Total loans at December 31, 2009 were $10.1 billion, a decrease of $1.1 billion, or 10.1%, from balances at December 31, 2008. The decline in loans during 2009 came principally from business, construction, personal real estate and consumer loans. Business loans declined $526.4 million, or 15.5%, reflecting lower line of credit usage, lower demand and pay-downs by business loan customers. Lease balances, which are included in the business category, decreased $26.8 million, or 8.7%, compared with the previous year end balance, as demand for equipment financing weakened. Business real estate loans were lower by $33.8 million, or 1.6%, and construction loans decreased $172.3 million, or 20.6%. The decline in construction loans reflected continued uncertain economic conditions in the real estate markets and lower overall demand. Personal real estate loans and consumer loans declined $100.9 million and $281.7 million, respectively, as loan pay-downs exceeded new loan originations. Consumer loans also declined, as in mid 2008 the Company ceased most marine and recreational vehicle lending from that portfolio. Home equity loans decreased $14.6 million due to


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fewer new account activations, and student loans declined $26.4 million due to principal pay-downs. Consumer credit card loans increased by $19.8 million, or 2.5%.
 
Period end loans increased $677.9 million, or 6.4%, in 2008 compared to 2007, resulting from increases in business, business real estate and student loans. In December 2008, the Company acquired $358.5 million of federally guaranteed student loans from a student loan agency in exchange for certain auction rate securities.
 
The Company currently generates approximately 31% of its loan portfolio in the St. Louis market, 29% in the Kansas City market, and 40% in various other regional markets. The portfolio is diversified from a business and retail standpoint, with 56% in loans to businesses and 44% in loans to consumers. A balanced approach to loan portfolio management and an historical aversion toward credit concentrations, from an industry, geographic and product perspective, have contributed to low levels of problem loans and loan losses.
 
Business
 
Total business loans amounted to $2.9 billion at December 31, 2009 and include loans used mainly to fund customer accounts receivable, inventories, and capital expenditures. This portfolio also includes direct financing and sales type leases totaling $281.4 million, which are used by commercial customers to finance capital purchases ranging from computer equipment to office and transportation equipment. These leases comprise 2.8% of the Company’s total loan portfolio. Business loans are made primarily to customers in the regional trade area of the Company, generally the central Midwest, encompassing the states of Missouri, Kansas, Illinois, and nearby Midwestern markets, including Iowa, Oklahoma, Colorado and Ohio. The portfolio is diversified from an industry standpoint and includes businesses engaged in manufacturing, wholesaling, retailing, agribusiness, insurance, financial services, public utilities, and other service businesses. Emphasis is upon middle-market and community businesses with known local management and financial stability. The Company participates in credits of large, publicly traded companies when business operations are maintained in the local communities or regional markets and opportunities to provide other banking services are present. Consistent with management’s strategy and emphasis upon relationship banking, most borrowing customers also maintain deposit accounts and utilize other banking services. Net loan charge-offs in this category totaled $12.8 million in 2009 and $4.4 million in 2008. Non-accrual business loans were $12.9 million (.4% of business loans) at December 31, 2009 compared to $4.0 million at December 31, 2008. Included in these totals were non-accrual lease-related loans of $3.3 million and $1.0 million at December 31, 2009 and 2008, respectively. Growth opportunities in business loans will largely depend on economic and market conditions affecting businesses and their ability to grow and invest in new capital, and the Company’s own solicitation efforts in attracting new, high quality loans. Asset quality is, in part, a function of management’s consistent application of underwriting standards and credit terms through stages in economic cycles. Therefore, portfolio growth in 2010 will be dependent upon 1) the strength of the economy, 2) the actions of the Federal Reserve with regard to targets for economic growth, interest rates, and inflationary tendencies, 3) customer demand, and 4) the competitive environment.
 
Real Estate-Construction and Land
 
The portfolio of loans in this category amounted to $665.1 million at December 31, 2009 and comprised 6.6% of the Company’s total loan portfolio. These loans are predominantly made to businesses in the local markets of the Company’s banking subsidiary. Commercial construction loans are made during the construction phase for small and medium-sized office and medical buildings, manufacturing and warehouse facilities, apartment complexes, shopping centers, hotels and motels, and other commercial properties. Exposure to larger speculative commercial properties remains low. Commercial land and land development loans relate to land owned or developed for use in conjunction with business properties. The largest percentage of residential construction and land development loans are for projects located in the Kansas City and St. Louis metropolitan areas. Credit risk in this sector has risen over the last two years, especially in residential construction and land development lending, as a result of the slowdown in the housing industry and worsening economic conditions. Net loan charge-offs increased to $34.1 million in 2009, compared to net charge-offs of $6.2 million in 2008. The increase in net charge-offs in 2009 was mainly comprised of


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$28.1 million in charge-offs on nine specific loans. Construction and land development loans on non-accrual status rose to $62.5 million at year end 2009, compared to $48.9 million at year end 2008. The non-accrual balance included a $14.8 million residential construction loan within the Bank’s market, which was placed on non-accrual status in December 2008. The remainder of the non-accrual balance at year end 2009 was mainly composed of loans to 15 borrowers, with balances ranging from $500 thousand to $8.7 million. The Company’s watch list, which includes special mention and substandard categories, included $149.3 million of residential land and construction loans which are being closely monitored.
 
Real Estate-Business
 
Total business real estate loans were $2.1 billion at December 31, 2009 and comprised 20.7% of the Company’s total loan portfolio. This category includes mortgage loans for small and medium-sized office and medical buildings, manufacturing and warehouse facilities, shopping centers, hotels and motels, and other commercial properties. Emphasis is placed on owner-occupied and income producing commercial real estate properties, which present lower risk levels. The borrowers and/or the properties are generally located in local and regional markets. Additional information about loans by category is presented on page 38. At December 31, 2009, non-accrual balances amounted to $21.8 million, or 1.0%, of the loans in this category, up from $13.1 million at year end 2008. The Company experienced net charge-offs of $5.2 million in 2009, compared to net charge-offs of $2.2 million in 2008.
 
Real Estate-Personal
 
At December 31, 2009, there were $1.5 billion in outstanding personal real estate loans, which comprised 15.2% of the Company’s total loan portfolio. The mortgage loans in this category are mainly for owner-occupied residential properties. The Company originates both adjustable rate and fixed rate mortgage loans. The Company retains adjustable rate mortgage loans, and may from time to time retain certain fixed rate loans (typically 15-year fixed rate loans) as directed by its Asset/Liability Management Committee. Other fixed rate loans in the portfolio have resulted from previous bank acquisitions. The Company does not purchase loans from outside parties or brokers, and has never maintained or promoted subprime or reduced document products. At December 31, 2009, 54% of the portfolio was comprised of adjustable rate loans while 46% was comprised of fixed rate loans. Levels of mortgage loan origination activity increased slightly in 2009 compared to 2008, with originations of $199 million in 2009 compared with $181 million in 2008. Growth in mortgage loan originations continued to be constrained in 2009 as a result of the weakened economy, slower housing starts, and lower resales within the Company’s markets. The Company has experienced lower loan losses in this category than many others in the industry, and believes this is partly because it does not offer subprime lending products or purchase loans from brokers. Net loan charge-offs for 2009 amounted to $2.8 million, compared to $1.7 million in the previous year. The non-accrual balances of loans in this category increased to $9.4 million at December 31, 2009, compared to $6.8 million at year end 2008.
 
Personal Banking
 
Total personal banking loans, which include consumer, student and revolving home equity loans, totaled $2.2 billion at December 31, 2009 and comprised 21.2% of the Company’s total loan portfolio. Consumer loans consist of auto, marine, tractor/trailer, recreational vehicle (RV) and fixed rate home equity loans, and totaled $1.3 billion at year end 2009. Approximately 68% of consumer loans outstanding were originated indirectly from auto and other dealers, while the remaining 32% were direct loans made to consumers. Approximately 28% of the consumer portfolio consists of automobile loans, 50% in marine and RV loans and 10% in fixed rate home equity lending. As mentioned above, total consumer loans declined $281.7 million in 2009 as a result of a decrease of $156.0 million in marine and RV loans, due to the Company’s decision in 2008 to cease most marine and RV lending. In addition, auto lending declined $97.0 million, or 20.8%. Net charge-offs on consumer loans were $32.2 million in 2009 compared to $21.4 million in 2008. Net charge-offs increased to 2.2% of average consumer loans in 2009 compared to 1.3% in 2008. The increase in net charge-offs in 2009 compared to 2008 was mainly due to higher marine and RV charge-offs. Net charge-offs on marine and RV loans were $8.3 million higher in 2009 compared to 2008, and were 3.0% of average marine and RV loans in 2009 compared to 1.7% in 2008.


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Revolving home equity loans, of which 99% are adjustable rate loans, totaled $489.5 million at year end 2009. An additional $658.8 million was available in unused lines of credit, which can be drawn at the discretion of the borrower. Home equity loans are secured mainly by second mortgages (and less frequently, first mortgages) on residential property of the borrower. The underwriting terms for the home equity line product permit borrowing availability, in the aggregate, generally up to 80% or 90% of the appraised value of the collateral property at the time of origination. While in prior years a small percentage of borrowers were permitted borrowing up to 100% of appraised value, this practice was discontinued in 2009.
 
As mentioned above, in December 2008 the Company acquired federally guaranteed student loans from a student loan agency. The loans were acquired in exchange for certain auction rate securities issued by that agency and purchased earlier in the year by the Bank from its customers. The loans, which had an average estimated life of approximately seven years at purchase date, were recorded at fair value, which resulted in a discount from their face value of approximately 2.5%. At December 31, 2009, these student loan balances totaled $331.7 million.
 
Consumer Credit Card
 
Total consumer credit card loans amounted to $799.5 million at December 31, 2009 and comprised 7.9% of the Company’s total loan portfolio. The credit card portfolio is concentrated within regional markets served by the Company. The Company offers a variety of credit card products, including affinity cards, rewards cards, and standard and premium credit cards, and emphasizes its credit card relationship product, Special Connections. Approximately 65% of the households in Missouri that own a Commerce credit card product also maintain a deposit relationship with the subsidiary bank. Approximately 92% of the outstanding credit card loans have a floating interest rate. Net charge-offs amounted to $49.3 million in 2009, which was a $17.8 million increase over 2008. The annual ratio of net credit card loan charge-offs to total average credit card loans totaled 6.8% in 2009 compared to 4.1% in 2008. These ratios, however, remain below national loss averages.
 
Loans Held for Sale
 
Total loans held for sale at December 31, 2009 were $345.0 million, a decrease of $16.3 million, or 4.5%, from $361.3 million at year end 2008. Loans classified as held for sale consist of student loans and residential mortgage loans.
 
Most of the portfolio is comprised of originated loans to students attending colleges and universities. These loans are normally sold to the secondary market when the student graduates and the loan enters into repayment status. Nearly all of these loans are based on variable rates. The Company maintains agreements to sell these student loans to various student loan servicing agencies, including the Missouri Higher Education Loan Authority and the Student Loan Marketing Association. In mid 2008, the Company also entered into an agreement with the Department of Education (DOE) which covers all new loans originated beginning July 1, 2008. Under this agreement, loans originated for the school year 2008-2009 were sold in 2009. Total student loans sold to the DOE and other agencies were approximately $439 million in 2009 and $164 million in 2008.
 
Due to uncertainties during 2008 surrounding some of the student loan agencies’ future ability to fulfill these contracts, the Company adjusted loans totaling $206.1 million to fair value and recorded impairment charges of $9.4 million at year end 2008. Of these losses, $8.6 million were reversed during 2009, as various sales of the related loans were made in accordance with contractual terms and performance concerns diminished. Due to higher sales of student loans in 2009, student loan balances declined by $24.0 million, or 6.7%, to $334.5 million at year end 2009, compared to $358.6 million at year end 2008.
 
The remainder of the held for sale portfolio consists of fixed rate mortgage loans, which are sold in the secondary market, generally within three months of origination. These loans totaled $10.5 million and $2.7 million at December 31, 2009 and 2008, respectively.


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Allowance for Loan Losses
 
The Company has an established process to determine the amount of the allowance for loan losses, which assesses the risks and losses inherent in its portfolio. This process provides an allowance consisting of a specific allowance component based on certain individually evaluated loans and a general component based on estimates of reserves needed for pools of loans with similar risk characteristics.
 
Loans subject to individual evaluation are defined by the Company as impaired, and generally consist of business, construction, commercial real estate and personal real estate loans on non-accrual status. In addition, loans that have been modified and meet the criteria for troubled debt restructuring are also included in impaired loans. Impaired loans are evaluated individually for the impairment of repayment potential and collateral adequacy, and in conjunction with current economic conditions and loss experience, allowances are estimated. Loans not individually evaluated are aggregated and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type, delinquencies, current economic factors, loan risk ratings and industry concentrations.
 
The Company’s estimate of the allowance for loan losses and the corresponding provision for loan losses rests upon various judgments and assumptions made by management. Factors that influence these judgments include past loan loss experience, current loan portfolio composition and characteristics, trends in portfolio risk ratings, levels of non-performing assets, prevailing regional and national economic conditions, and the Company’s ongoing examination process including that of its regulators. The Company has internal credit administration and loan review staffs that continuously review loan quality and report the results of their reviews and examinations to the Company’s senior management and Board of Directors. Such reviews also assist management in establishing the level of the allowance. The Company’s subsidiary bank continues to be subject to examination by the Office of the Comptroller of the Currency (OCC) and examinations are conducted throughout the year, targeting various segments of the loan portfolio for review. In addition to the examination of the subsidiary bank by the OCC, the parent holding company and its non-bank subsidiaries are examined by the Federal Reserve Bank.
 
At December 31, 2009, the allowance for loan losses was $194.5 million compared to a balance at year end 2008 of $172.6 million. The $21.9 million, or 12.7%, increase in the allowance for loan losses during 2009 was primarily a result of increasing levels of watch list loans and deteriorating general economic conditions. Total loans delinquent 90 days or more increased $2.7 million, or 6.7% at December 31, 2009 compared to year end 2008. Delinquencies of 90 days or more on consumer credit card loans increased $3.1 million, or 22.2%, compared to 2008. Loans on non-accrual status increased $33.7 million to $106.6 million in 2009 from $72.9 million in 2008. This growth included increases of $13.6 million in non-accrual construction and land loans, $8.6 million in non-accrual business real estate loans, and $8.9 million in business loans. Other loans identified as potential future problem loans increased $8.9 million. This group of loans saw a $58.0 million increase in business real estate loans during the year, offset by declines in business and construction and loans. These trends were reflective of the economic downturn experienced in 2009. The Company’s analysis of the allowance considered these trends, which resulted in an increase in the allowance balance during 2009 and 2008. The percentage of allowance to loans increased to 1.92% at December 31, 2009 compared to 1.53% at year end 2008 as a result of the increase in the allowance balance, coupled with a decrease in period end loan balances of 10.1%.
 
Net loan charge-offs totaled $138.8 million in 2009, and increased $69.0 million, compared to net charge-offs of $69.9 million in 2008. Net charge-offs related to business loans were $12.8 million in 2009 compared to $4.4 million in 2008. Construction and land loans incurred net charge-offs of $34.1 million in 2009 compared to $6.2 million in 2008. Net charge-offs related to consumer loans increased by $10.8 million to $32.2 million at December 31, 2009, representing 23.2% of total net charge-offs during 2009. This increase was due primarily to a $8.3 million increase in net charge-offs related to marine and recreational vehicle loans. Additionally, net charge-offs related to consumer credit cards increased $17.8 million to $49.3 million in 2009 compared to $31.5 million in 2008. Approximately 35.5% of total net loan charge-offs during 2009 were related to consumer credit card loans compared to 45.1% during 2008. Net consumer credit card charge-offs increased to 6.8% of average consumer credit card loans in 2009 compared to 4.1% in 2008.


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The ratio of net charge-offs to total average loans outstanding in 2009 was 1.31% compared to .64% in 2008 and .42% in 2007. The provision for loan losses in 2009 was $160.7 million, compared to a provision of $108.9 million in 2008 and $42.7 million in 2007.
 
The Company considers the allowance for loan losses of $194.5 million adequate to cover losses inherent in the loan portfolio at December 31, 2009.
 
The schedules which follow summarize the relationship between loan balances and activity in the allowance for loan losses:
 
                                         
 
    Years Ended December 31  
(Dollars in thousands)   2009     2008     2007     2006     2005  
 
 
Net loans outstanding at end of year(A)
  $ 10,145,324     $ 11,283,246     $ 10,605,368     $ 9,681,520     $ 8,893,011  
 
 
Average loans outstanding(A)
  $ 10,629,867     $ 10,935,858     $ 10,189,316     $ 9,105,432     $ 8,549,573  
 
 
Allowance for loan losses:
                                       
Balance at beginning of year
  $ 172,619     $ 133,586     $ 131,730     $ 128,447     $ 132,394  
 
 
Additions to allowance through charges to expense
    160,697       108,900       42,732       25,649       28,785  
Allowances of acquired companies
                1,857       3,688        
 
 
Loans charged off:
                                       
Business
    15,762       7,820       5,822       1,343       1,083  
Real estate – construction and land
    34,812       6,215       2,049       62        
Real estate – business
    5,957       2,293       2,396       854       827  
Real estate – personal
    3,150       1,765       181       119       87  
Consumer
    35,973       26,229       14,842       11,364       13,441  
Home equity
    1,197       447       451       158       34  
Student
    6                          
Consumer credit card
    54,060       35,825       28,218       22,104       28,263  
Overdrafts
    3,493       4,499       4,909       4,940       3,485  
 
 
Total loans charged off
    154,410       85,093       58,868       40,944       47,220  
 
 
Recovery of loans previously charged off:
                                       
Business
    2,925       3,406       1,429       2,166       4,099  
Real estate – construction and land
    720             37              
Real estate – business
    709       117       1,321       890       330  
Real estate – personal
    363       51       42       27       57  
Consumer
    3,772       4,782       5,304       5,263       4,675  
Home equity
    7       18       5       23        
Consumer credit card
    4,785       4,309       4,520       4,250       3,851  
Overdrafts
    2,293       2,543       3,477       2,271       1,476  
 
 
Total recoveries
    15,574       15,226       16,135       14,890       14,488  
 
 
Net loans charged off
    138,836       69,867       42,733       26,054       32,732  
 
 
Balance at end of year
  $ 194,480     $ 172,619     $ 133,586     $ 131,730     $ 128,447  
 
 
Ratio of allowance to loans at end of year
    1.92 %     1.53 %     1.26 %     1.36 %     1.44 %
Ratio of provision to average loans outstanding
    1.51 %     1.00 %     .42 %     .28 %     .34 %
 
 
(A) Net of unearned income, before deducting allowance for loan losses, excluding loans held for sale.
 


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    Years Ended December 31  
(Dollars in thousands)   2009     2008     2007     2006     2005  
 
 
Ratio of net charge-offs to average loans outstanding, by loan category:
                                       
Business
    .41 %     .13 %     .14 %     NA       NA  
Real estate – construction and land
    4.61       .89       .30       .01        
Real estate – business
    .24       .10       .05       NA       .03  
Real estate – personal
    .18       .11       .01       .01        
Consumer
    2.20       1.28       .61       .45       .71  
Home equity
    .24       .09       .10       .03       .01  
Consumer credit card
    6.77       4.06       3.56       3.00       4.40  
Overdrafts
    12.27       16.40       10.36       18.18       14.36  
 
 
Ratio of total net charge-offs to total average loans outstanding
    1.31 %     .64 %     .42 %     .29 %     .38 %
 
 
NA: Net recoveries were experienced in these years.
 
The following schedule provides a breakdown of the allowance for loan losses by loan category and the percentage of each loan category to total loans outstanding at year end:
 
                                                                                 
 
(Dollars in thousands)   2009     2008     2007     2006     2005  
 
    Loan Loss
    % of Loans
    Loan Loss
    % of Loans
    Loan Loss
    % of Loans
    Loan Loss
    % of Loans
    Loan Loss
    % of Loans
 
    Allowance
    to Total
    Allowance
    to Total
    Allowance
    to Total
    Allowance
    to Total
    Allowance
    to Total
 
    Allocation     Loans     Allocation     Loans     Allocation     Loans     Allocation     Loans     Allocation     Loans  
   
 
Business
  $ 42,949       28.4 %   $ 37,912       30.2 %   $ 29,392       30.7 %   $ 28,529       29.5 %   $ 26,211       28.4 %
RE – construction and land
    30,776       6.6       23,526       7.4       8,507       6.3       4,605       6.8       3,375       4.8  
RE – business
    30,640       20.7       25,326       19.0       14,842       21.1       19,343       22.2       19,432       21.6  
RE – personal
    5,231       15.2       4,680       14.5       2,389       14.5       2,243       15.3       4,815       15.3  
Consumer
    29,994       13.1       28,638       14.3       24,611       15.6       18,655       14.8       18,951       14.5  
Home equity
    1,590       4.8       1,332       4.4       5,839       4.3       5,035       4.6       5,916       5.0  
Student
    229       3.3             3.2                               497       3.7  
Consumer credit card
    51,801       7.9       49,492       6.9       44,307       7.4       39,965       6.7       35,513       6.6  
Overdrafts
    1,270             1,713       .1       2,351       .1       3,592       .1       2,739       .1  
Unallocated
                            1,348             9,763             10,998        
 
 
Total
  $ 194,480       100.0 %   $ 172,619       100.0 %   $ 133,586       100.0 %   $ 131,730       100.0 %   $ 128,447       100.0 %
 
 
 
Risk Elements of Loan Portfolio
 
Management reviews the loan portfolio continuously for evidence of problem loans. During the ordinary course of business, management becomes aware of borrowers that may not be able to meet the contractual requirements of loan agreements. Such loans are placed under close supervision with consideration given to placing the loan on non-accrual status, the need for an additional allowance for loan loss, and (if appropriate) partial or full loan charge-off. Loans are placed on non-accrual status when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment. Loans that are 90 days past due as to principal and/or interest payments are generally placed on non-accrual, unless they are both well-secured and in the process of collection, or they are consumer loans that are exempt under regulatory rules from being classified as non-accrual. Consumer installment loans and related accrued interest are normally charged down to the fair value of related collateral (or are charged off in full if no collateral) once the loans are more than 120 days delinquent. Credit card loans and the related accrued interest are charged off when the receivable is more than 180 days past due. After a loan is placed on non-accrual status, any interest previously accrued but not yet collected is reversed against current income. Interest is included in income only as received and only after all previous loan charge-offs have been recovered, so long as management is satisfied there is no impairment of collateral values. The loan is returned to accrual status only when the borrower has brought all past due principal and interest payments current and, in the opinion of

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management, the borrower has demonstrated the ability to make future payments of principal and interest as scheduled.
 
The following schedule shows non-performing assets and loans past due 90 days and still accruing interest.
 
                                         
 
    December 31  
(Dollars in thousands)   2009     2008     2007     2006     2005  
 
 
Non-performing assets:
                                       
Non-accrual loans:
                                       
Business
  $ 12,874     $ 4,007     $ 4,700     $ 5,808     $ 5,916  
Real estate – construction and land
    62,509       48,871       7,769       120        
Real estate – business
    21,756       13,137       5,628       9,845       3,149  
Real estate – personal
    9,384       6,794       1,095       384       261  
Consumer
    90       87       547       551       519  
 
 
Total non-accrual loans
    106,613       72,896       19,739       16,708       9,845  
 
 
Real estate acquired in foreclosure
    10,057       6,181       13,678       1,515       1,868  
 
 
Total non-performing assets
  $ 116,670     $ 79,077     $ 33,417     $ 18,223     $ 11,713  
 
 
Non-performing assets as a percentage of total loans
    1.15 %     .70 %     .32 %     .19 %     .13 %
 
 
Non-performing assets as a percentage of total assets
    .64 %     .45 %     .21 %     .12 %     .08 %
 
 
Past due 90 days and still accruing interest:
                                       
Business
  $ 3,672     $ 1,459     $ 1,427     $ 2,814     $ 1,026  
Real estate – construction and land
    1,184       466       768       593        
Real estate – business
    402       1,472       281       1,336       1,075  
Real estate – personal
    3,102       4,717       5,131       3,994       2,998  
Consumer
    2,045       3,478       1,914       1,255       1,069  
Home equity
    878       440       700       659       429  
Student
    14,346       14,018       1       1       74  
Consumer credit card
    17,003       13,914       10,664       9,724       7,417  
 
 
Total past due 90 days and still accruing interest
  $ 42,632     $ 39,964     $ 20,886     $ 20,376     $ 14,088  
 
 
 
The table below shows the effect on interest income in 2009 of loans on non-accrual status at year end.
 
         
   
(In thousands)      
   
 
Gross amount of interest that would have been recorded at original rate
  $ 8,332  
Interest that was reflected in income
    2,136  
 
 
Interest income not recognized
  $ 6,196  
 
 
 
Total non-accrual loans at year end 2009 were $106.6 million, an increase of $33.7 million over the balance at year end 2008. Most of the increase occurred in non-accrual construction and land loans, which included a $19.9 million residential construction loan placed on non-accrual status in December. In addition, business and business real estate non-accrual loans increased $8.9 million and $8.6 million, respectively. Foreclosed real estate increased to a total of $10.1 million at year end 2009. Total non-performing assets remain low compared to the overall banking industry in 2009, with the non-performing loans to total loans ratio at 1.05% at December 31, 2009. Loans past due 90 days and still accruing interest increased $2.7 million at year end 2009 compared to 2008, mainly due to higher credit card and business loan delinquencies, partly offset by lower real estate and consumer loan delinquencies. Loans past due 90 days includes $13.8 million in federally guaranteed student loans that the Company intends to hold to maturity.
 
Commercial loans (business, business real estate, and construction) and personal real estate loans whose terms have been modified in a troubled debt restructuring are generally placed on non-accrual status until a six-month payment history is sustained. Non-accrual loan balances at December 31, 2009 included $735 thousand of such loans.


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The Company seeks to assist customers that are experiencing financial difficulty through renegotiating credit card loans under various debt management and assistance programs. At December 31, 2009, the Company had renegotiated consumer credit card loans of $16.0 million, of which $8.4 million were current or less than 30 days past due under the modified terms. These renegotiated loans are excluded from non-performing loans, in accordance with the Company’s classification policy on the overall consumer credit card portfolio.
 
In addition to non-accrual loans, renegotiated loans, and loans past due 90 days and still accruing interest, the Company also has identified loans for which management has concerns about the ability of the borrowers to meet existing repayment terms, which are shown in the table below. These loans are primarily classified as substandard for regulatory purposes under the Company’s internal rating system. The loans are generally secured by either real estate or other borrower assets, reducing the potential for loss should they become non-performing. Although these loans are generally identified as potential problem loans, they may never become non-performing.
 
                 
 
    December 31
    December 31
 
(In thousands)   2009     2008  
 
 
Potential problem loans:
               
Business
  $ 93,256     $ 126,409  
Real estate – construction and land
    115,251       135,324  
Real estate – business
    98,951       40,919  
Real estate – personal
    12,013       8,336  
Consumer
    409       41  
 
 
Total potential problem loans
  $ 319,880     $ 311,029  
 
 
 
Loans with Special Risk Characteristics
 
Within the loan portfolio, certain types of loans are considered at higher risk of loss due to their terms, location, or special conditions. Certain personal real estate products have contractual features that could increase credit exposure in a market of declining real estate prices, when interest rates are steadily increasing, or when a geographic area experiences an economic downturn. Loans might be considered at higher risk when 1) loan terms require a minimum monthly payment that covers only interest, or 2) loan-to-collateral value (LTV) ratios are above 80%, with no private mortgage insurance. Information presented below is based on LTV ratios which were generally calculated with valuations at loan origination date.
 
Real Estate – Construction and Land Loans
 
The Company’s portfolio of construction loans, as shown in the table below, amounted to 6.6% of total loans outstanding at December 31, 2009.
 
                                                 
   
                % of
                % of
 
    December 31
    % of
    Total
    December 31
    % of
    Total
 
(In thousands)   2009     Total     Loans     2008     Total     Loans  
   
 
Residential land and land development
  $ 181,257       27.2 %     1.8 %   $ 246,335       29.4 %     2.2 %
Residential construction
    110,165       16.6       1.1       141,405       16.9       1.3  
Commercial land and land development
    144,880       21.8       1.4       139,726       16.7       1.2  
Commercial construction
    228,808       34.4       2.3       309,903       37.0       2.7  
 
 
Total real estate – construction and land loans
  $ 665,110       100.0 %     6.6 %   $ 837,369       100.0 %     7.4 %
 
 


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Real Estate – Business Loans
 
Total business real estate loans were $2.1 billion at December 31, 2009 and comprised 20.7% of the Company’s total loan portfolio. These loans include properties such as manufacturing and warehouse buildings, small office and medical buildings, churches, hotels and motels, shopping centers, and other commercial properties. Approximately 52% of these loans were for owner-occupied real estate properties, which present lower risk profiles.
 
                         
   
    December 31
    % of
    % of
 
(In thousands)   2009     Total     Total Loans  
   
 
Owner-occupied
  $ 1,101,870       52.4 %     10.9 %
Industrial
    142,745       6.8       1.4  
Office
    214,408       10.2       2.1  
Retail
    210,619       10.0       2.1  
Multi-family
    112,664       5.3       1.1  
Farm
    131,245       6.2       1.3  
Hotels
    115,056       5.5       1.1  
Other
    75,423       3.6       .7  
 
 
Total real estate – business loans
  $ 2,104,030       100.0 %     20.7 %
 
 
 
Real Estate – Personal Loans
 
The Company’s $1.5 billion personal real estate portfolio is composed of loans collateralized with residential real estate. Included in this portfolio are personal real estate loans made to commercial customers, which totaled $270.5 million at December 31, 2009. This group of loans has an original weighted average term of approximately 5 years, with 58% of the balance in fixed rate loans and 42% in floating rate loans. The remainder of the personal real estate portfolio, totaling $1.3 billion at December 31, 2009, is comprised of loans made to the retail customer base. It includes adjustable rate mortgage loans and certain fixed rate loans, retained by the Company as directed by its Asset/Liability Management Committee.
 
Within the larger mortgage loan group, only 2% were made with interest only payments (see table below). These loans are typically made to high net-worth borrowers and generally have low LTV ratios or have additional collateral pledged to secure the loan and, therefore, they are not perceived to represent above normal credit risk. At December 31, 2009, these loans had a weighted average LTV and FICO score of 55.4% and 757 respectively, and there were no delinquencies noted in this group. The majority of these loans (95.7%) consist of loans written within the Company’s five state branch network territories of Missouri, Kansas, Illinois, Oklahoma, and Colorado. Loans originated with interest only payments were not made to “qualify” the borrower for a lower payment amount.
 
The following table presents information about the retail based personal real estate loan portfolio for 2009 and 2008.
 
                                 
 
    2009     2008  
    Principal
          Principal
       
    Outstanding at
    % of Loan
    Outstanding at
    % of Loan
 
(Dollars in thousands)   December 31     Portfolio     December 31     Portfolio  
 
 
Loans with interest only payments
  $ 25,201       2.0 %   $ 35,649       2.6 %
 
 
Loans with no insurance and LTV:
                               
Between 80% and 90%
    99,395       7.8       74,094       5.4  
Between 90% and 95%
    31,331       2.5       25,495       1.9  
Over 95%
    52,033       4.1       35,653       2.6  
 
 
Over 80% LTV with no insurance
    182,759       14.4       135,242       9.9  
 
 
Total loan portfolio from which above loans were identified
    1,267,156               1,360,204          
 
 


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Revolving Home Equity Loans
 
The Company also has revolving home equity loans that are generally collateralized by residential real estate. Most of these loans (95.9%) are written with terms requiring interest only monthly payments. These loans are offered in three main product lines: LTV up to 80%, 80% to 90%, and 90% to 100%. The following tables break out the year end outstanding balances by product for 2009 and 2008.
 
                                                                 
 
    Principal
                      Unused Portion
                   
    Outstanding at
          New Lines
          of Available Lines
          Balances
       
    December 31
          Originated During
          at December 31
          Over 30
       
(Dollars in thousands)   2009     *     2009     *     2009     *     Days Past Due     *  
 
 
Loans with interest only payments
  $ 469,460       95.9 %   $ 30,832       6.3 %   $ 647,669       132.3 %   $ 2,102       .4 %
 
 
Loans with LTV:
                                                               
Between 80% and 90%
    63,369       12.9       3,181       .7       44,261       9.0       547       .1  
Over 90%
    23,369       4.8       104             16,751       3.5       504       .1  
 
 
Over 80% LTV
    86,738       17.7       3,285       .7       61,012       12.5       1,051       .2  
 
 
Total loan portfolio from which above loans were identified
    489,517               32,485               658,845                          
 
 
* Percentage of total principal outstanding of $489.5 million at December 31, 2009.
 
                                                                 
 
    Principal
                      Unused Portion
                   
    Outstanding at
          New Lines
          of Available Lines
          Balances
       
    December 31
          Originated During
          at December 31
          Over 30
       
(Dollars in thousands)   2008     *     2008     *     2008     *     Days Past Due     *  
 
 
Loans with interest only payments
  $ 476,354       94.5 %   $ 172,868       34.3 %   $ 675,819       134.1 %   $ 1,217       .2 %
 
 
Loans with LTV:
                                                               
Between 80% and 90%
    66,009       13.1       19,578       3.9       49,781       9.9       428       .1  
Over 90%
    28,292       5.6       3,815       .7       20,025       3.9       206        
 
 
Over 80% LTV
    94,301       18.7       23,393       4.6       69,806       13.8       634       .1  
 
 
Total loan portfolio from which above loans were identified
    504,069               174,903               690,751                          
 
 
* Percentage of total principal outstanding of $504.1 million at December 31, 2008.


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Fixed Rate Home Equity Loans
 
In addition to the residential real estate mortgage loans and the revolving floating rate line product discussed above, the Company offers a third choice to those consumers looking for a fixed rate loan and a fixed maturity date. This fixed rate home equity loan, typically for home repair or remodeling, is an alternative for individuals who want to finance a specific project or purchase, and decide to lock in a specific monthly payment over a defined period. This portfolio of loans totaled $132.6 million and $151.4 million at December 31, 2009 and 2008, respectively. At times, these loans are written with interest only monthly payments and a balloon payoff at maturity; however, less than 4% of the outstanding balance has interest only payments. During 2009, the Company continued limiting the offering of products with LTV ratios over 90%, which resulted in a $3.5 million decrease in new loans with LTV ratios over 90% in 2009 compared to 2008. The delinquency history on this product has been low, as balances over 30 days past due totaled only $1.7 million and $1.4 million, respectively, or 1.3% and .9%, respectively, of the portfolio, at year end 2009 and 2008.
 
                                                                 
 
    2009     2008  
    Principal
                      Principal
                   
    Outstanding at
          New Loans
          Outstanding at
          New Loans
       
(Dollars in thousands)   December 31     *     Originated     *     December 31     *     Originated     *  
 
 
Loans with interest only payments
  $ 4,731       3.6 %   $ 2,355       1.8 %   $ 5,725       3.8 %   $ 5,136       3.4 %
 
 
Loans with LTV:
                                                               
Between 80% and 90%
    19,526       14.7       7,682       5.8       18,996       12.5       10,960       7.2  
Over 90%
    25,398       19.1       924       .7       34,772       23.0       4,431       3.0  
 
 
Over 80% LTV
    44,924       33.8       8,606       6.5       53,768       35.5       15,391       10.2  
 
 
Total loan portfolio from which above loans were identified
    132,747                               151,361                          
 
 
* Percentage of total principal outstanding of $132.7 million and $151.4 million at December 31, 2009 and 2008, respectively.
 
Management does not believe these loans collateralized by real estate (personal real estate, revolving home equity, and fixed rate home equity) represent any unusual concentrations of risk, as evidenced by net charge-offs in 2009 of $2.8 million, $1.2 million and $1.1 million, respectively. The amount of any increased potential loss on high LTV agreements relates mainly to amounts advanced that are in excess of the 80% collateral calculation, not the entire approved line. The Company currently offers no subprime loan products, which is defined as those offerings made to customers with a FICO score below 650, and has purchased no brokered loans.
 
Other Consumer Loans
 
Within the consumer loan portfolio of several product lines, the Company experienced rapid growth in marine and RV loans outstanding from 2005 through 2007. The majority of these loans were outside the Company’s basic five state branch network. The loss ratios experienced in this portion of the portfolio recently were higher than for other consumer loan products, as reflected in the delinquency figures in the table below. Due to the continued weakening credit and economic conditions, this loan product offering was curtailed in mid 2008, as less than $10 million in new loans were written over the last three months of 2008, and only $3.8 million new marine and RV loans written the entire year of 2009. The table below provides the total outstanding principal and other data for this group of direct and indirect lending products at December 31, 2009 and 2008.
 


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    2009     2008  
    Principal
          Balances
    Principal
          Balances
 
    Outstanding at
    New Loans
    Over 30
    Outstanding at
    New Loans
    Over 30
 
(Dollars in thousands)   December 31     Originated     Days Past Due     December 31     Originated     Days Past Due  
 
 
Passenger vehicles
  $ 371,009     $ 130,839     $ 5,281     $ 469,100     $ 256,274     $ 8,876  
Marine
    182,866       1,537       5,617       230,715       43,458       8,174  
RV
    466,757       2,214       10,793       566,429       150,792       10,265  
Other
    42,726       25,345       740       59,322       41,860       1,326  
 
 
Total
  $ 1,063,358     $ 159,935     $ 22,431     $ 1,325,566     $ 492,384     $ 28,641  
 
 
 
Additionally, the Company offers low introductory rates on selected consumer credit card products. Out of a portfolio at December 31, 2009 of $799.5 million in consumer credit card loans outstanding, approximately $152.0 million, or 19.0%, carried a low introductory rate. These loans are scheduled to convert to the ongoing higher contractual rate on a weighted average of approximately 7 months. To mitigate some of the risk involved with this credit card product, the Company performs credit checks and detailed analysis of the customer borrowing profile before approving the loan application.
 
Investment Securities Analysis
 
Investment securities are comprised of securities which are available for sale, non-marketable, and held for trading. During 2009, total investment securities increased $2.5 billion, or 65.9%, to $6.4 billion (excluding unrealized gains/losses) compared to $3.8 billion at the previous year end. During 2009, securities of $4.1 billion were purchased, which included $1.1 billion in agency mortgage-backed securities, $1.6 billion in other asset-backed securities, $538.5 million in U.S. Treasury inflation-protected securities (TIPS), and $339.7 million in state and municipal obligations. Total maturities and paydowns were $1.3 billion during 2009. Sales proceeds were $207.9 million, of which $121.8 million related to TIPS sales. During 2010, maturities of approximately $1.5 billion are expected to occur. The average tax equivalent yield earned on total investment securities was 4.54% in 2009 and 5.09% in 2008.
 
At December 31, 2009, the fair value of available for sale securities was $6.3 billion, including a net unrealized gain in fair value of $103.6 million, compared to a net loss of $58.7 million at December 31, 2008. The overall unrealized gain in fair value at December 31, 2009 included gains of $56.8 million in agency mortgage-backed securities, $22.1 million in state and municipal obligations, and $28.6 million in marketable equity securities held by the Parent, partly offset by an unrealized loss of $45.7 million in non-agency mortgage-backed securities.

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Available for sale investment securities at year end for the past two years are shown below:
 
                 
   
    December 31  
(In thousands)   2009     2008  
   
 
Amortized Cost
               
U.S. government and federal agency obligations
  $ 436,607     $ 10,478  
Government-sponsored enterprise obligations
    162,191       135,825  
State and municipal obligations
    917,267       715,421  
Agency mortgage-backed securities
    2,205,177       1,685,821  
Non-agency mortgage-backed securities
    654,711       742,090  
Other asset-backed securities
    1,685,691       275,641  
Other debt securities
    164,402       116,527  
Equity securities
    11,285       7,680  
 
 
Total available for sale investment securities
  $ 6,237,331     $ 3,689,483  
 
 
Fair Value
               
U.S. government and federal agency obligations
  $ 447,038     $ 11,594  
Government-sponsored enterprise obligations
    165,814       141,957  
State and municipal obligations
    939,338       719,752  
Agency mortgage-backed securities
    2,262,003       1,711,404  
Non-agency mortgage-backed securities
    609,016       620,479  
Other asset-backed securities
    1,701,569       253,756  
Other debt securities
    176,331       121,861  
Equity securities
    39,866       49,950  
 
 
Total available for sale investment securities
  $ 6,340,975     $ 3,630,753  
 
 
 
The largest component of the available for sale portfolio consists of agency mortgage-backed securities, which are collateralized bonds issued by government-sponsored agencies, including FNMA, GNMA, FHLMC, FHLB, and Federal Farm Credit Banks. Non-agency mortgage-backed securities totaled $654.7 million, on an amortized cost basis, at December 31, 2009, and included Alt-A type mortgage-backed securities of $221.5 million and prime/jumbo loan type securities of $433.1 million. Nearly all of these securities had credit ratings of AAA (or the equivalent) from at least two rating agencies at their purchase date. The portfolio does not have exposure to subprime originated mortgage-backed or collateralized debt obligation instruments.
 
At December 31, 2009, U.S. government obligations included $435.0 million in TIPS, and state and municipal obligations included $167.8 million in auction rate securities. Other debt securities include corporate bonds, notes and commercial paper. Available for sale equity securities are mainly comprised of publicly traded stock held by the Parent.
 
A summary of maturities by category of investment securities and the weighted average yield for each range of maturities as of December 31, 2009, is presented in Note 4 on Investment Securities in the consolidated financial statements. The table below provides additional information for each category of debt securities.
 
                         
 
    December 31, 2009  
   
 
    Percent
    Weighted
    Estimated
 
    of Total
    Average
    Average
 
    Debt Securities     Yield     Maturity*  
   
 
Available for sale debt securities:
                       
U.S. government and federal agency obligations
    7.1 %     1.07 %     4.4 years
Government-sponsored enterprise obligations
    2.6       2.62       1.6  
State and municipal obligations
    14.9       3.23       9.4  
Agency mortgage-backed securities
    35.9       4.17       2.7  
Non-agency mortgage-backed securities
    9.7       6.21       3.0  
Other asset-backed securities
    27.0       2.51       1.2  
Other debt securities
    2.8       4.69       2.9  
 
 
  Based on call provisions and estimated prepayment speeds.  


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Non-marketable securities, which totaled $122.1 million at December 31, 2009, included $30.3 million in Federal Reserve Bank stock and $42.3 million in Federal Home Loan Bank (Des Moines) stock held by the bank subsidiary in accordance with debt and regulatory requirements. These are restricted securities which, lacking a market, are carried at cost. Other non-marketable securities also include private equity securities which are carried at estimated fair value.
 
The Company engages in private equity activities through direct private equity investments and through three private equity/venture capital subsidiaries. The subsidiaries hold investments in various portfolio concerns, which are carried at fair value and totaled $44.8 million at December 31, 2009. The Company expects to fund an additional $31.9 million to these subsidiaries for investment purposes over the next several years. In addition to investments held by its private equity/venture capital subsidiaries, the Parent directly holds investments in several private equity concerns, which totaled $3.9 million at year end 2009. Most of the private equity investments are not readily marketable. While the nature of these investments carries a higher degree of risk than the normal lending portfolio, this risk is mitigated by the overall size of the investments and oversight provided by management, which believes the potential for long-term gains in these investments outweighs the potential risks.
 
Non-marketable securities at year end for the past two years are shown below:
 
                 
   
    December 31  
(In thousands)   2009     2008  
   
 
Debt securities
  $ 19,908     $ 22,297  
Equity securities
    102,170       117,603  
 
 
Total non-marketable investment securities
  $ 122,078     $ 139,900  
 
 
 
Deposits and Borrowings
 
Deposits are the primary funding source for the Bank, and are acquired from a broad base of local markets, including both individual and corporate customers. Total deposits were $14.2 billion at December 31, 2009, compared to $12.9 billion last year, reflecting an increase of $1.3 billion, or 10.2%. Average deposits grew by $1.6 billion, or 12.8%, in 2009 compared to 2008 with most of this growth centered in non-interest bearing demand deposits, which grew $250.0 million, or 37.3%, in 2009 compared to 2008. Certificates of deposit with balances under $100,000 fell on average by $93.2 million, or 4.3%, while certificates of deposit over $100,000 grew $229.0 million, or 14.1%.
 
The following table shows year end deposits by type as a percentage of total deposits.
 
                 
   
    December 31  
    2009     2008  
   
 
Non-interest bearing demand
    12.6 %     10.7 %
Savings, interest checking and money market
    64.8       59.0  
Time open and C.D.’s of less than $100,000
    12.7       16.0  
Time open and C.D.’s of $100,000 and over
    9.9       14.3  
 
 
Total deposits
    100.0 %     100.0 %
 
 
 
Core deposits, which include demand, interest checking, savings, and money market deposits, supported 59% of average earning assets in 2009 and 55% in 2008. Average balances by major deposit category for the last six years appear at the end of this discussion. A maturity schedule of time deposits outstanding at December 31, 2009 is included in Note 7 on Deposits in the consolidated financial statements.
 
The Company’s primary sources of overnight borrowings are federal funds purchased and securities sold under agreements to repurchase (repurchase agreements). Balances in these accounts can fluctuate significantly on a day-to-day basis, and generally have one day maturities. The Company has also entered into structured repurchase agreements totaling $500.0 million which mature in mid 2010. Total balances outstanding at year end 2009 were $1.1 billion, a $76.7 million increase from $1.0 billion outstanding at


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year end 2008. On an average basis, these borrowings declined $405.0 million, or 29.5% during 2009, with declines of $251.1 million in federal funds purchased and $153.8 million in repurchase agreements. The average rate paid on total federal funds purchased and repurchase agreements was .38% during 2009 and 1.83% during 2008.
 
Additional short-term borrowings may be periodically acquired under the Federal Reserve’s temporary Term Auction Facility (TAF) program, which was instituted in December 2007. The TAF is a credit facility under which banking institutions may bid for term borrowings in bi-weekly auctions. The TAF credit is collateralized similarly to discount window borrowings, generally with investment securities and loans. The amount borrowed under this program totaled $700.0 million at December 31, 2008. Borrowing activity under the program declined during 2009, and there were no outstanding borrowings at December 31, 2009.
 
Most of the Company’s long-term debt is comprised of fixed rate advances from the Federal Home Loan Bank (FHLB). These borrowings declined from $1.0 billion at December 31, 2008 to $724.4 million outstanding at December 31, 2009. Approximately 59% of the outstanding balance is due within the next year. The average rate paid on FHLB advances was 3.68% during 2009 and 3.81% during 2008.
 
Liquidity and Capital Resources
 
Liquidity Management
 
Liquidity is managed within the Company in order to satisfy cash flow requirements of deposit and borrowing customers while at the same time meeting its own cash flow needs. The Company maintains its liquidity position through a variety of sources including:
 
  •  A portfolio of liquid assets including marketable investment securities and overnight investments,
 
  •  A large customer deposit base and limited exposure to large, volatile certificates of deposit,
 
  •  Lower long-term borrowings that might place demands on Company cash flow,
 
  •  Relatively low loan to deposit ratio promoting strong liquidity,
 
  •  Excellent debt ratings from both Standard & Poor’s and Moody’s national rating services, and
 
  •  Available borrowing capacity from outside sources.
 
During 2008, liquidity risk became a concern affecting the general banking industry, as some of the major banking institutions across the country experienced an unprecedented erosion in capital. This erosion was fueled by declines in asset values, losses in market and investor confidence, and higher defaults, resulting in higher costing and less available credit. The Company, as discussed below, took numerous steps to address liquidity risk and over the past few years has developed a variety of liquidity sources which it believes will provide the necessary funds to grow its business into the future. During 2009, overall liquidity improved significantly throughout the banking industry and in the Company by a combination of growth in deposits and a decline in loans outstanding. The Company’s average loans to deposits ratio, one measure of liquidity, decreased from 92.1% in 2008 to 79.8% in 2009.
 
The Company did not apply for funds through the Federal Treasury’s Capital Purchase Program. This program is part of the federal government’s Troubled Asset Relief Program approved by Congress in October 2008 to build capital in U.S. financial institutions and increase the flow of financing to business and consumers. Under this program, the Company, if approved, would have been eligible to issue senior preferred stock to the Treasury, ranging from approximately $140 million to $400 million, in addition to warrants to purchase common stock. The program was carefully studied and the Company made a business decision not to apply. Management believes that the Company’s earnings, capital and liquidity are strong and sufficient to grow its business.


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The Company’s most liquid assets include available for sale marketable investment securities, federal funds sold, balances at the Federal Reserve Bank (FRB), and securities purchased under agreements to resell (resale agreements). At December 31, 2009 and 2008, such assets were as follows:
 
                 
   
(In thousands)   2009     2008  
   
 
Available for sale investment securities
  $ 6,340,975     $ 3,630,753  
Federal funds sold
    22,590       59,475  
Resale agreements
          110,000  
Balances at the Federal Reserve Bank
    24,118       638,158  
 
 
Total
  $ 6,387,683     $ 4,438,386  
 
 
 
Federal funds sold and resale agreements normally have overnight maturities and are used to satisfy the daily cash needs of the Company. Effective October 1, 2008, required and excess cash balances maintained at the FRB began earning interest. These balances are also used for general daily liquidity purposes. The interest rate on these balances during 2009 was 25 basis points. The Company’s available for sale investment portfolio has maturities of approximately $1.5 billion which are scheduled to occur during 2010 and offers substantial resources to meet either new loan demand or reductions in the Company’s deposit funding base. The Company pledges portions of its investment securities portfolio to secure public fund deposits, repurchase agreements, trust funds, letters of credit issued by the FHLB, and borrowing capacity at the FRB. At December 31, 2009, total investment securities pledged for these purposes were as follows:
 
         
   
(In thousands)   2009  
   
 
Investment securities pledged for the purpose of securing:
       
Federal Reserve Bank borrowings
  $ 1,180,924  
FHLB borrowings and letters of credit
    395,925  
Repurchase agreements
    1,541,936  
Other deposits
    1,013,422  
 
 
Total pledged, at fair value
  $ 4,132,207  
 
 
Total unpledged and available for pledging, at fair value
  $ 1,765,214  
 
 
 
Liquidity is also available from the Company’s large base of core customer deposits, defined as demand, interest checking, savings, and money market deposit accounts. At December 31, 2009, such deposits totaled $11.0 billion and represented 77.4% of the Company’s total deposits. These core deposits are normally less volatile, often with customer relationships tied to other products offered by the Company promoting long lasting relationships and stable funding sources. During 2009, total core deposits increased $2.0 billion, mainly in non-interest bearing demand and money market accounts. This increase was comprised of growth in consumer deposits of $1.6 million and corporate and non-personal deposits of $390.4 million. Some of the growth in corporate deposits was the result of both extremely low interest rates and FDIC insurance programs, which effectively guaranteed all such deposits. While the Company considers core consumer deposits less volatile, corporate deposits could decline if interest rates increase significantly or if corporate customers move funds from the Company. In order to address funding needs, should these corporate deposits decline, the Company maintains adequate levels of earning assets maturing in 2010. Time open and certificates of deposit of $100,000 or greater totaled $1.4 billion at December 31, 2009. These deposits are normally considered more volatile and higher costing, and comprised 9.9% of total deposits at December 31, 2009.
 
                 
   
(In thousands)   2009     2008  
   
 
Core deposit base:
               
Non-interest bearing demand
  $ 1,793,816     $ 1,375,000  
Interest checking
    735,870       700,714  
Savings and money market
    8,467,046       6,909,592  
 
 
Total
  $ 10,996,732     $ 8,985,306  
 
 


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Other important components of liquidity are the level of borrowings from third party sources and the availability of future credit. The Company’s outside borrowings are mainly comprised of federal funds purchased, repurchase agreements, and advances from the FRB and the FHLB, as follows:
 
                 
   
(In thousands)   2009     2008  
   
 
Borrowings:
               
Federal funds purchased
  $ 62,130     $ 24,900  
Repurchase agreements
    1,041,061       1,001,637  
FHLB advances
    724,386       1,025,721  
Subordinated debentures
    4,000       14,310  
Term auction facility
          700,000  
Other long-term debt
    7,676       7,750  
 
 
Total
  $ 1,839,253     $ 2,774,318  
 
 
 
Federal funds purchased and repurchase agreements are generally borrowed overnight and amounted to $1.1 billion at December 31, 2009. Federal funds purchased are unsecured overnight borrowings obtained mainly from upstream correspondent banks with which the Company maintains approved lines of credit. Repurchase agreements are secured by a portion of the Company’s investment portfolio and are comprised of both non-insured customer funds, totaling $541.1 million at December 31, 2009, and structured repurchase agreements of $500.0 million purchased from an upstream financial institution. Customer repurchase agreements are offered to customers wishing to earn interest in highly liquid balances and are used by the Company as a funding source considered to be stable, but short-term in nature. Beginning in mid 2008, the Company began to periodically borrow additional short-term funds from the FRB through its Term Auction Facility (TAF). The TAF offered attractive funding with low rates and made possible the reduction in federal funds purchased during 2008. The Company curtailed these borrowings during 2009 as rising deposit balances provided other sources of liquidity, and at December 31, 2009 the Company had no TAF borrowings outstanding. The Company also borrows on a secured basis through advances from the FHLB, which totaled $724.4 million at December 31, 2009. Most of these advances have fixed interest rates and mature in 2010 through 2011. The Company’s other borrowings are comprised of debentures funded by trust preferred securities and debt related to the Company’s private equity business. The overall long-term debt position of the Company is small relative to the Company’s overall liability position.
 
The Company pledges certain assets, including loans and investment securities, to both the Federal Reserve Bank and the FHLB as security to establish lines of credit and borrow from these entities. Based on the amount and type of collateral pledged, the FHLB establishes a collateral value from which the Company may draw advances against the collateral. Also, this collateral is used to enable the FHLB to issue letters of credit in favor of public fund depositors of the Company. The Federal Reserve Bank also establishes a collateral value of assets pledged and permits borrowings from either the discount window or the Term Auction Facility. The following table reflects the collateral value of assets pledged, borrowings, and letters of credit outstanding, in addition to the estimated future funding capacity available to the Company at December 31, 2009:
 
                 
   
    December 31, 2009  
   
 
(In thousands)   FHLB     Federal Reserve  
   
 
Total collateral value pledged
  $ 2,150,085     $ 1,980,798  
Advances outstanding
    (724,386 )      
Letters of credit issued
    (533,309 )      
 
 
Available for future advances
  $ 892,390     $ 1,980,798  
 
 


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The Company had an average loans to deposits ratio of 79.8% at December 31, 2009, which is considered in the banking industry to be a conservative measure of good liquidity. Also, the Company receives outside ratings from both Standard & Poor’s and Moody’s on both the consolidated company and its subsidiary bank, Commerce Bank, N.A. These ratings are as follows:
 
         
 
    Standard & Poor’s   Moody’s
 
 
Commerce Bancshares, Inc.
       
Counterparty rating
  A-1    
Commercial paper rating
  A-1   P-1
Commerce Bank, N. A.
       
Issuer rating
  A+   Aa2
Bank deposits
  A+   Aa2
Bank financial strength rating
      B+
 
 
 
The Company considers these ratings to be indications of a sound capital base and good liquidity, and believes that these ratings would help ensure the ready marketability of its commercial paper, should the need arise. No commercial paper has been outstanding over the past ten years. The Company has little subordinated debt or hybrid instruments which would affect future borrowings capacity. Because of its lack of significant long-term debt, the Company believes that, through its Capital Markets Group or in other public debt markets, it could generate additional liquidity from sources such as jumbo certificates of deposit, privately-placed corporate notes or other forms of debt. Future financing could also include the issuance of common or preferred stock.
 
The cash flows from the operating, investing and financing activities of the Company resulted in a net decrease in cash and cash equivalents of $835.5 million in 2009, as reported in the consolidated statements of cash flows on page 67 of this report. Operating activities, consisting mainly of net income adjusted for certain non-cash items, provided cash flow of $295.3 million and has historically been a stable source of funds. Investing activities used total cash of $1.6 billion in 2009, and consist mainly of purchases and maturities of available for sale investment securities and changes in the level of the Company’s loan portfolio. The investment securities portfolio grew during 2009, using cash of $2.5 billion, while the loan portfolio decreased, providing cash of $999.1 million. Investing activities are somewhat unique to financial institutions in that, while large sums of cash flow are normally used to fund growth in investment securities, loans, or other bank assets, they are normally dependent on the financing activities described below.
 
Financing activities provided total cash of $441.5 million, resulting from a $1.3 billion increase in deposits, partly offset by net debt repayments of $1.1 billion. The stock sale program (described below) provided cash of $98.2 million, while cash dividend payments totaled $74.7 million. Future short-term liquidity needs for daily operations are not expected to vary significantly and the Company maintains adequate liquidity to meet these cash flows. The Company’s sound equity base, along with its low debt level, common and preferred stock availability, and excellent debt ratings, provide several alternatives for future financing. Future acquisitions may utilize partial funding through one or more of these options.
 
Cash flows resulting from the Company’s transactions in its common stock were as follows:
 
                         
   
(In millions)   2009     2008     2007  
   
 
Stock sale program
  $ 98.2     $     $  
Exercise of stock-based awards and sales to affiliate non-employee directors
    5.5       16.0       13.7  
Purchases of treasury stock
    (.5 )     (9.5 )     (128.6 )
Cash dividends paid
    (74.7 )     (72.1 )     (68.9 )
 
 
Cash provided (used)
  $ 28.5     $ (65.6 )   $ (183.8 )
 
 


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The Parent faces unique liquidity constraints due to legal limitations on its ability to borrow funds from its bank subsidiary. The Parent obtains funding to meet its obligations from two main sources: dividends received from bank and non-bank subsidiaries (within regulatory limitations) and from management fees charged to subsidiaries as reimbursement for services provided by the Parent, as presented below:
 
                         
   
(In millions)   2009     2008     2007  
   
 
Dividends received from subsidiaries
  $ 45.1     $ 76.2     $ 179.5  
Management fees
    46.6       44.0       39.1  
 
 
Total
  $ 91.7     $ 120.2     $ 218.6  
 
 
 
These sources of funds are used mainly to pay cash dividends on outstanding common stock, pay general operating expenses, and purchase treasury stock when appropriate. At December 31, 2009, the Parent’s available for sale investment securities totaled $115.2 million at fair value, consisting mainly of publicly traded common stock and non-agency backed collateralized mortgage obligations. To support its various funding commitments, the Parent maintains a $20.0 million line of credit with its subsidiary bank. The Parent had no borrowings outstanding under the line at December 31, 2009.
 
Company senior management is responsible for measuring and monitoring the liquidity profile of the organization with oversight by the Company’s Asset/Liability Committee. This is done through a series of controls, including a written Contingency Funding Policy and risk monitoring procedures, including daily, weekly and monthly reporting. In addition, the Company prepares forecasts which project changes in the balance sheet affecting liquidity, and which allow the Company to better plan for forecasted changes.
 
Capital Management
 
The Company maintains strong regulatory capital ratios, including those of its banking subsidiary, in excess of the “well-capitalized” guidelines under federal banking regulations. The Company’s capital ratios at the end of the last three years are as follows:
 
                                 
   
                      Well-Capitalized
 
                      Regulatory
 
    2009     2008     2007     Guidelines  
   
 
Risk-based capital ratios:
                               
Tier I capital
    13.04 %     10.92 %     10.31 %     6.00 %
Total capital
    14.39       12.31       11.49       10.00  
Leverage ratio
    9.58       9.06       8.76       5.00  
Tangible equity to assets
    9.71       8.25       8.61          
Dividend payout ratio
    44.15       38.54       33.76          
 
 
 
The components of the Company’s regulatory risked-based capital and risk-weighted assets at the end of the last three years are as follows:
 
                         
   
(In thousands)   2009     2008     2007  
   
 
Regulatory risk-based capital:
                       
Tier I capital
  $ 1,708,901     $ 1,510,959     $ 1,375,035  
Tier II capital
    177,077       191,957       157,154  
Total capital
    1,885,978       1,702,916       1,532,189  
Total risk-weighted assets
    13,105,948       13,834,161       13,330,968  
 
 
 
In February 2008, the Board of Directors authorized the Company to purchase additional shares of common stock under its repurchase program, which brought the total purchase authorization to 3,000,000 shares. During 2009, approximately 16,000 shares were acquired under the current Board authorization at an average price of $33.50 per share.


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The Company’s common stock dividend policy reflects its earnings outlook, desired payout ratios, the need to maintain adequate capital levels and alternative investment options. Per share cash dividends paid by the Company increased .8% in 2009 compared with 2008. The Company paid its sixteenth consecutive annual stock dividend in December 2009.
 
Common Equity Offering
 
On February 27, 2009, the Company entered into an equity distribution agreement with a broker dealer, acting as the Company’s sales agent, relating to the offering of the Company’s common stock having aggregate gross sales proceeds of up to $200 million. This offering was described in a prospectus supplement, including the associated base prospectus, which the Company filed with the SEC on February 27, 2009.
 
Sales of these shares were made by means of brokers’ transactions on or through the Nasdaq Global Select Market, trading facilities of national securities associations or alternative trading systems, block transactions and such other transactions as agreed upon by the Company and the sales agent, at market prices prevailing at the time of the sale or at prices related to the prevailing market prices. The Company and the sales agent determined jointly, as often as daily, how many shares to sell under this offering. On July 31, 2009, the Company terminated the offering.
 
Total shares sold under the offering amounted to 2,894,773. Total gross proceeds for the entire offering were $100.0 million, with an average sale price of $34.55 per share, and total commissions paid to the sales agent for the sale of these shares were $1.5 million. After payment of commissions and SEC, legal and accounting fees relating to the offering, net proceeds for the entire offering totaled $98.2 million, with average net sale proceeds of $33.91 per share.
 
Commitments, Contractual Obligations, and Off-Balance Sheet Arrangements
 
Various commitments and contingent liabilities arise in the normal course of business, which are not required to be recorded on the balance sheet. The most significant of these are loan commitments, totaling $7.0 billion (including approximately $3.3 billion in unused approved credit card lines), and the contractual amount of standby letters of credit, totaling $404.1 million at December 31, 2009. Since many commitments expire unused or only partially used, these totals do not necessarily reflect future cash requirements. Management does not anticipate any material losses arising from commitments and contingent liabilities and believes there are no material commitments to extend credit that represent risks of an unusual nature.
 
A table summarizing contractual cash obligations of the Company at December 31, 2009 and the expected timing of these payments follows:
 
                                         
    Payments Due by Period  
   
          After One Year
    After Three
    After
       
    In One Year
    Through Three
    Years Through
    Five
       
(In thousands)   or Less     Years     Five Years     Years     Total  
   
 
Long-term debt obligations, including structured repurchase agreements*
  $ 927,597     $ 125,386     $ 52,703     $ 130,376     $ 1,236,062  
Operating lease obligations
    5,805       8,226       6,211       21,227       41,469  
Purchase obligations
    36,640       58,189       17,210       4,149       116,188  
Time open and C.D.’s*
    2,604,292       534,819       74,122       486       3,213,719  
 
 
Total
  $ 3,574,334     $ 726,620     $ 150,246     $ 156,238     $ 4,607,438  
 
 
Includes principal payments only.
 
As of December 31, 2009, the Company has unrecognized tax benefits that, if recognized, would impact the effective tax rate in future periods. Due to the uncertainty of the amounts to be ultimately paid as well as the timing of such payments, all uncertain tax liabilities that have not been paid have been excluded from the table above. Further detail on the impact of income taxes is located in Note 9 of the consolidated financial statements.


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The Company funds a defined benefit pension plan for a majority of its employees. Under the funding policy for the plan, contributions are made as necessary to provide for current service and for any unfunded accrued actuarial liabilities over a reasonable period. During recent years, the Company has not been required to make cash contributions to the plan and does not expect to do so in 2010.
 
The Company has investments in several low-income housing partnerships within the area it serves. At December 31, 2009, these investments totaled $4.7 million and were recorded as other assets in the Company’s consolidated balance sheet. These partnerships supply funds for the construction and operation of apartment complexes that provide affordable housing to that segment of the population with lower family income. If these developments successfully attract a specified percentage of residents falling in that lower income range, state and/or federal income tax credits are made available to the partners. The tax credits are normally recognized over ten years, and they play an important part in the anticipated yield from these investments. In order to continue receiving the tax credits each year over the life of the partnership, the low-income residency targets must be maintained. Under the terms of the partnership agreements, the Company has a commitment to fund a specified amount that will be due in installments over the life of the agreements, which ranges from 10 to 15 years. These unfunded commitments are recorded as liabilities on the Company’s consolidated balance sheet, and aggregated $3.7 million at December 31, 2009.
 
The Company regularly purchases various state tax credits arising from third-party property redevelopment. While most of the tax credits are resold to third parties, some are periodically retained for use by the Company. During 2009, purchases and sales of tax credits amounted to $51.4 million and $42.5 million, respectively. At December 31, 2009, the Company had outstanding purchase commitments totaling $114.7 million.
 
The Parent has investments in several private equity concerns which are classified as non-marketable securities in the Company’s consolidated balance sheet. Under the terms of the agreements with three of these concerns, the Parent has unfunded commitments outstanding of $1.4 million at December 31, 2009. The Parent also expects to fund $31.9 million to venture capital subsidiaries over the next several years.
 
Interest Rate Sensitivity
 
The Company’s Asset/Liability Management Committee (ALCO) measures and manages the Company’s interest rate risk on a monthly basis to identify trends and establish strategies to maintain stability in earnings throughout various rate environments. Analytical modeling techniques provide management insight into the Company’s exposure to changing rates. These techniques include net interest income simulations and market value analyses. Management has set guidelines specifying acceptable limits within which net interest income and market value may change under various rate change scenarios. These measurement tools indicate that the Company is currently within acceptable risk guidelines as set by management.
 
The Company’s main interest rate measurement tool, income simulations, projects net interest income under various rate change scenarios in order to quantify the magnitude and timing of potential rate-related changes. Income simulations are able to capture option risks within the balance sheet where expected cash flows may be altered under various rate environments. Modeled rate movements include “shocks, ramps and twists”. Shocks are intended to capture interest rate risk under extreme conditions by immediately shifting rates up and down, while ramps measure the impact of gradual changes and twists measure yield curve risk. The size of the balance sheet is assumed to remain constant so that results are not influenced by growth predictions. The table below shows the expected effect that gradual basis point shifts in the LIBOR/swap curve over a twelve month period would have on the Company’s net interest income, given a static balance sheet.
 
                                                 
   
    December 31, 2009     September 30, 2009     December 31, 2008  
    Increase
    % of Net Interest
    Increase
    % of Net Interest
    Increase
    % of Net Interest
 
(Dollars in millions)   (Decrease)     Income     (Decrease)     Income     (Decrease)     Income  
   
 
300 basis points rising
  $ 21.6       3.22 %   $ 26.3       3.97 %   $ 37.3       6.38 %
200 basis points rising
    17.3       2.57       21.4       3.23       30.6       5.23  
100 basis points rising
    10.6       1.58       12.1       1.83       18.1       3.10  
 
 


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The Company also employs a sophisticated simulation technique known as a stochastic income simulation. This technique allows management to see a range of results from hundreds of income simulations. The stochastic simulation creates a vector of potential rate paths around the market’s best guess (forward rates) concerning the future path of interest rates and allows rates to randomly follow paths throughout the vector. This allows for the modeling of non-biased rate forecasts around the market consensus. Results give management insight into a likely range of rate-related risk as well as worst and best-case rate scenarios.
 
The Company also uses market value analyses to help identify longer-term risks that may reside on the balance sheet. This is considered a secondary risk measurement tool by management. The Company measures the market value of equity as the net present value of all asset and liability cash flows discounted along the current LIBOR/swap curve plus appropriate market risk spreads. It is the change in the market value of equity under different rate environments, or effective duration that gives insight into the magnitude of risk to future earnings due to rate changes. Market value analyses also help management understand the price sensitivity of non-marketable bank products under different rate environments.
 
The Company’s modeling of interest rate risk as of December 31, 2009 shows that under various rising rate scenarios, net interest income would show growth. The Company has not modeled falling rate scenarios due the extremely low interest rate environment. At December 31, 2009, the Company calculated that a gradual increase in rates of 100 basis points would increase net interest income by $10.6 million, or 1.6%, compared with an increase of $18.1 million projected at December 31, 2008. A 200 basis point gradual rise in rates calculated at December 31, 2009 would increase net interest income by $17.3 million, or 2.6%, down from an increase of $30.6 million last year. Also, a gradual increase of 300 basis points would increase net interest income by $21.6 million, or 3.2%, compared to a growth of $37.3 million at December 31, 2008.
 
Using rising rate models, the potential increase in net interest income is lower at December 31, 2009 when compared to the prior year due to several factors. These factors include a decline of $255.8 million in average loan balances in 2009 compared to the previous year, which are mainly variable rate assets, and average growth of $1.7 billion in available for sale securities, most of which have fixed rates. In addition to the change in earning assets, average interest bearing deposits grew during 2009 by $1.3 billion, mainly in money market deposit accounts, which have lower rates and can re-price upwards more slowly.
 
Thus, under rising rate scenarios, the Company benefits from the repricing of its loan portfolio, the majority of which is variable rate. However, higher levels of fixed rate securities will partly offset the effect of the loan portfolio on interest income. Additionally, deposit balances have a smaller impact on net interest income when rates are rising, due to lower overall rates and fewer accounts that carry variable rates moving in sequence with market rates.
 
Through review and oversight by the ALCO, the Company attempts to engage in strategies that neutralize interest rate risk as much as possible. The Company’s balance sheet remains well-diversified with moderate interest rate risk and is well-positioned for future growth. The use of derivative products is limited and the deposit base is strong and stable. The loan to deposit ratio is still at relatively low levels, which should present the Company with opportunities to fund future loan growth at reasonable costs. The Company believes that its approach to interest rate risk has appropriately considered its susceptibility to both rising and falling rates and has adopted strategies which minimize impacts of interest rate risk.
 
Derivative Financial Instruments
 
The Company maintains an overall interest rate risk management strategy that permits the use of derivative instruments to modify exposure to interest rate risk. The Company’s interest rate risk management strategy includes the ability to modify the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not adversely affect the net interest margin and cash flows. Interest rate swaps are used on a limited basis as part of this strategy. As of December 31, 2009, the Company had entered into three interest rate swaps with a notional amount of $16.9 million which are designated as fair value hedges of certain fixed rate loans. The Company also sells swap contracts to customers who wish to modify their interest rate sensitivity. The Company offsets the interest rate risk of these swaps by purchasing


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matching contracts with offsetting pay/receive rates from other financial institutions. The notional amount of these types of swaps at December 31, 2009 was $486.6 million.
 
The Company enters into foreign exchange derivative instruments as an accommodation to customers and offsets the related foreign exchange risk by entering into offsetting third-party forward contracts with approved, reputable counterparties. In addition, the Company takes proprietary positions in such contracts based on market expectations. Hedge accounting has not been applied to these foreign exchange activities. This trading activity is managed within a policy of specific controls and limits. Most of the foreign exchange contracts outstanding at December 31, 2009 mature within 90 days, and the longest period to maturity is 12 months.
 
Additionally, interest rate lock commitments issued on residential mortgage loans held for resale are considered derivative instruments. The interest rate exposure on these commitments is economically hedged primarily with forward sale contracts in the secondary market.
 
In all of these contracts, the Company is exposed to credit risk in the event of nonperformance by counterparties, who may be bank customers or other financial institutions. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures. Because the Company generally enters into transactions only with high quality counterparties, there have been no losses associated with counterparty nonperformance on derivative financial instruments.
 
The following table summarizes the notional amounts and estimated fair values of the Company’s derivative instruments at December 31, 2009 and 2008. Notional amount, along with the other terms of the derivative, is used to determine the amounts to be exchanged between the counterparties. Because the notional amount does not represent amounts exchanged by the parties, it is not a measure of loss exposure related to the use of derivatives nor of exposure to liquidity risk. Positive fair values are recorded in other assets and negative fair values are recorded in other liabilities in the consolidated balance sheets.
 
                                                 
   
    2009     2008  
          Positive
    Negative
          Positive
    Negative
 
    Notional
    Fair
    Fair
    Notional
    Fair
    Fair
 
(In thousands)   Amount     Value     Value     Amount     Value     Value  
   
 
Interest rate swaps
  $ 503,530     $ 16,962     $ (17,816 )   $ 492,111     $ 25,274     $ (26,568 )
Interest rate caps
    16,236       239       (239 )                  
Credit risk participation agreements
    53,246       140       (239 )     47,750       117       (178 )
Foreign exchange contracts:
                                               
Forward contracts
    17,475       415       (295 )     6,226       207       (217 )
Option contracts
                      3,300       18       (18 )
Mortgage loan commitments
    9,767       44       (16 )     23,784       198       (6 )
Mortgage loan forward sale contracts
    19,986       184       (5 )     26,996       21       (88 )
 
 
Total at December 31
  $ 620,240     $ 17,984     $ (18,610 )   $ 600,167     $ 25,835     $ (27,075 )
 
 
 
Operating Segments
 
The Company segregates financial information for use in assessing its performance and allocating resources among three operating segments. The results are determined based on the Company’s management accounting process, which assigns balance sheet and income statement items to each responsible segment. These segments are defined by customer base and product type. The management process measures the performance of the operating segments based on the management structure of the Company and is not necessarily comparable with similar information for any other financial institution. Each segment is managed by executives who, in conjunction with the Chief Executive Officer, make strategic business decisions regarding that segment. The three reportable operating segments are Consumer, Commercial and Wealth (formerly titled Money Management). Additional information is presented in Note 13 on Segments in the consolidated financial statements.


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The Company uses a funds transfer pricing method to value funds used (e.g., loans, fixed assets, cash, etc.) and funds provided (deposits, borrowings, and equity) by the business segments and their components. This process assigns a specific value to each new source or use of funds with a maturity, based on current LIBOR interest rates, thus determining an interest spread at the time of the transaction. Non-maturity assets and liabilities are assigned to LIBOR based funding pools. This method helps to provide an accurate means of valuing fund sources and uses in a varying interest rate environment. The Company also assigns loan charge-offs and recoveries (labeled in the table below as “provision for loan losses”) directly to each operating segment instead of allocating an estimated loan loss provision. The operating segments also include a number of allocations of income and expense from various support and overhead centers within the Company.
 
The table below is a summary of segment pre-tax income results for the past three years.
 
                                                 
   
                      Segment
    Other/
    Consolidated
 
(Dollars in thousands)   Consumer     Commercial     Wealth     Totals     Elimination     Totals  
   
 
Year ended December 31, 2009:
                                               
Net interest income
  $ 348,362     $ 258,886     $ 42,074     $ 649,322     $ (13,820 )   $ 635,502  
Provision for loan losses
    (84,019 )     (54,230 )     (520 )     (138,769 )     (21,928 )     (160,697 )
Non-interest income
    162,374       115,697       114,838       392,909       3,676       396,585  
Investment securities losses, net
                            (7,195 )     (7,195 )
Non-interest expense
    (301,622 )     (192,722 )     (106,604 )     (600,948 )     (21,115 )     (622,063 )
 
 
Income (loss) before income taxes
  $ 125,095     $ 127,631     $ 49,788     $ 302,514     $ (60,382 )   $ 242,132  
 
 
Year ended December 31, 2008:
                                               
Net interest income
  $ 323,568     $ 203,950     $ 37,188     $ 564,706     $ 28,033     $ 592,739  
Provision for loan losses
    (56,639 )     (13,526 )     (265 )     (70,430 )     (38,470 )     (108,900 )
Non-interest income
    146,051       107,586       114,482       368,119       7,593       375,712  
Investment securities gains, net
                            30,294       30,294  
Non-interest expense
    (285,466 )     (180,930 )     (131,982 )     (598,378 )     (17,002 )     (615,380 )
 
 
Income (loss) before income taxes
  $ 127,514     $ 117,080     $ 19,423     $ 264,017     $ 10,448     $ 274,465  
 
 
2009 vs. 2008
                                               
Increase (decrease) in income before income taxes:
                                               
 
 
Amount
  $ (2,419 )   $ 10,551     $ 30,365     $ 38,497     $ (70,830 )   $ (32,333 )
 
 
Percent
    (1.9 )%     9.0 %     156.3 %     14.6 %     N.M.       (11.8 )%
 
 
Year ended December 31, 2007:
                                               
Net interest income
  $ 318,970     $ 184,263     $ 34,484     $ 537,717     $ 355     $ 538,072  
Provision for loan losses
    (34,737 )     (8,376 )     (154 )     (43,267 )     535       (42,732 )
Non-interest income
    167,352       124,377       106,026       397,755       (26,174 )     371,581  
Investment securities gains, net
                            8,234       8,234  
Non-interest expense
    (275,161 )     (180,389 )     (90,280 )     (545,830 )     (28,329 )     (574,159 )
 
 
Income (loss) before income taxes
  $ 176,424     $ 119,875     $ 50,076     $ 346,375     $ (45,379 )   $ 300,996  
 
 
2008 vs. 2007
                                               
Increase (decrease) in income before income taxes:
                                               
 
 
Amount
  $ (48,910 )   $ (2,795 )   $ (30,653 )   $ (82,358 )   $ 55,827     $ (26,531 )
 
 
Percent
    (27.7 )%     (2.3 )%     (61.2 )%     (23.8 )%     N.M.       (8.8 )%
 
 
 
Consumer
 
The Consumer segment includes consumer deposits, consumer finance, consumer debit and credit card bank cards, and student lending. Pre-tax income for 2009 was $125.1 million, a decrease of $2.4 million, or 1.9%, from 2008. The decline in profitability was mainly due to an increase of $27.4 million in net loan charge-offs and an increase of $16.2 million in non-interest expense, which were partly offset by higher net interest income of $24.8 million and $16.3 million in non-interest income. The increase in net interest income resulted


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mainly from a $53.0 million decrease in deposit interest expense, mainly in premium money market accounts and short-term certificates of deposit. This effect was partly offset by a decline of $7.8 million in net allocated funding credits assigned to the Consumer segment’s loan and deposit portfolios and a $20.4 million decrease in loan interest income. The increase in net loan charge-offs occurred mainly in consumer credit card and marine and RV loans. An increase of $16.3 million, or 11.2%, in non-interest income resulted mainly from higher gains on sales of student loans, including the reversal of an impairment reserve discussed above in the Non-Interest Income section of this discussion. This increase in income was partly offset by a decline in overdraft charges. Non-interest expense grew $16.2 million, or 5.7%, over the prior year due to higher FDIC insurance expense and data processing costs, partly offset by lower bank card servicing expense. Total average loans increased slightly in 2009 over the prior year due to the student loan portfolio acquired late in 2008, partly offset by declines in other types of consumer loans. Average deposits increased 2.8% over the prior period, resulting mainly from growth in interest checking and premium money market deposit accounts, partly offset by a decline in certificates of deposit.
 
Pre-tax profitability for 2008 was $127.5 million, a decrease of $48.9 million, or 27.7%, from 2007. The decrease was due to increases of $10.3 million in non-interest expense and $21.9 million in net loan charge-offs. In addition, non-interest income declined $21.3 million, while net interest income increased $4.6 million. The increase in net interest income resulted mainly from an $83.9 million decline in deposit interest expense, partly offset by a $64.5 million decrease in net allocated funding credits assigned to the Consumer segment and a $14.8 million decrease in loan interest income. The decrease in non-interest income resulted largely from lower overdraft and return item fees, an impairment charge taken on certain held for sale student loans, and lower gains on student loan sales. These declines were partly offset by an increase in bank card fee income (primarily debit card fees). Non-interest expense increased $10.3 million over the previous year mainly due to higher bank card processing costs, telephone support fees and teller services processing costs. Net loan charge-offs increased $21.9 million, or 63.1%, in the Consumer segment, with most of the increase due to higher consumer credit card and marine and RV loan charge-offs. Total average assets directly related to the segment rose 6.5% over 2007, mainly due to growth in consumer loans and consumer credit card loans. Average deposits decreased slightly from the prior year, mainly due to lower balances in long-term certificates of deposit, partly offset by growth in premium money market deposit accounts.
 
Commercial
 
The Commercial segment provides corporate lending (including the Small Business Banking product line within the branch network), leasing, international services, and business, government deposit, and related commercial cash management services, as well as merchant and commercial bank card products. In 2009, pre-tax profitability for the Commercial segment increased $10.6 million, or 9.0%, compared to the prior year. The growth was mainly due to a $54.9 million, or 26.9%, increase in net interest income and an $8.1 million increase in non-interest income. Partly offsetting the increases in income were higher net loan charge-offs of $40.7 million and non-interest expense of $11.8 million. The increase in net interest income was mainly due to lower net allocated funding costs of $129.6 million and a decrease of $6.7 million in deposit interest expense, which were partly offset by a decline in loan interest income of $81.3 million. The growth in net loan charge-offs included a $27.9 million increase in construction and land loan net charge-offs and smaller increases in other commercial loan categories. Non-interest income increased $8.1 million, or 7.5%, over the prior year and included higher commercial cash management fees and bank card fees (mainly corporate card), partly offset by lower cash sweep commissions. Non-interest expense increased $11.8 million, or 6.5%, over the previous year, mainly due to higher FDIC insurance expense and an increase in salaries and benefits expense. Total average assets directly related to the segment declined 4.7% from 2008. Average segment loans decreased 4.9% compared to 2008 as a result of declines in business and business real estate loans, while average deposits increased 38.0% due to growth in non-interest bearing demand and money market deposit accounts.
 
Pre-tax income for 2008 decreased $2.8 million, or 2.3%, compared to the prior year. Most of the decrease was due to a decline of $16.8 million in non-interest income and an increase of $5.2 million in net loan charge-offs. Net interest income increased $19.7 million, or 10.7%, which resulted from lower net allocated funding costs of $81.1 million and lower deposit interest expense of $7.0 million, partly offset by a $68.3 million


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decline in loan interest income. Non-interest income decreased by 13.5% from the previous year largely due to lower bank card fees, partly offset by higher commercial cash management fees. Non-interest expense increased slightly over the prior year and included higher salaries expense and impairment charges on foreclosed land, partly offset by lower commercial card servicing costs. Net loan charge-offs were $13.5 million in 2008 compared to $8.4 million in 2007. The increase was mainly due to higher construction and land loan net charge-offs. Total average assets directly related to the segment rose 7.0% over 2007, largely due to growth in business and business real estate loans. Average deposits increased 7.2% due to growth in non-interest bearing demand, money market and interest checking deposit accounts.
 
Wealth
 
The Wealth segment provides traditional trust and estate planning, advisory and discretionary investment management services, brokerage services, and includes Private Banking accounts. At December 31, 2009 the Trust group managed investments with a market value of $12.8 billion and administered an additional $9.3 billion in non-managed assets. It also provides investment management services to The Commerce Funds, a series of mutual funds with $1.4 billion in total assets at December 31, 2009. The Capital Markets Group sells primarily fixed-income securities to individuals, corporations, correspondent banks, public institutions, and municipalities, and also provides investment safekeeping and bond accounting services. Pre-tax profitability for the Wealth segment was $49.8 million in 2009 compared to $19.4 million in 2008, an increase of $30.4 million. The profitability increase was the result of a $25.4 million decline in non-interest expense, which was due to a $33.3 million loss on the purchase of auction rate securities in 2008, which is discussed above in the Non-Interest Expense section of this discussion. Partly offsetting this decline in expense were increases in FDIC insurance costs, allocated processing costs, and salaries and benefits expense. Net interest income increased $4.9 million, or 13.1%, largely due to a $13.9 million decline in interest expense on short-term jumbo certificates of deposit, and a $7.6 million decline in overnight borrowings expense. These effects were partly offset by a $13.2 million decrease in assigned net funding credits. Non-interest income increased slightly over the prior year due to higher bond trading income in the Capital Markets Group, partly offset by lower trust fee income and cash sweep commissions. Average assets decreased $7.7 million during 2009 mainly due to a decline in the trading securities portfolio. Average deposits increased $400.3 million, or 25.3%, during 2009, due to growth in premium money market accounts and certificates of deposit over $100,000.
 
In 2008, pre-tax income for the Wealth segment was $19.4 million compared to $50.1 million in 2007, a $30.7 million decline mainly due to the auction rate securities loss mentioned above. Excluding this loss, segment profitability in 2008 would have been $52.7 million, a 5.2% increase over 2007. Net interest income increased $2.7 million, or 7.8%, over the prior year, due to lower interest expense on short-term borrowings and deposits, partly offset by lower interest income on overnight investments. Non-interest income increased $8.5 million, or 8.0%, mainly due to higher private client and corporate trust fees and bond trading income. Non-interest expense, excluding the auction rate securities loss, rose $8.4 million over 2007, mainly in salary expense. Average assets decreased $305.2 million during 2008 because of lower overnight investments of liquid funds. Average deposits increased $306.5 million during 2008, due to growth in short-term certificates of deposit over $100,000.
 
The segment activity, as shown above, includes both direct and allocated items. Amounts in the “Other/Elimination” column include activity not related to the segments, such as certain administrative functions, the investment securities portfolio, and the effect of certain expense allocations to the segments. Also included in this category is the excess of the Company’s provision for loan losses over net loan charge-offs, which are generally assigned directly to the segments. In 2009, the pre-tax loss in this category was $60.4 million, compared to profitability of $10.4 million in 2008. The decline in profitability was partly due to items relating to the Bank’s relationship with Visa which were not assigned to a segment. As mentioned earlier, Visa-related stock redemption gains of $22.2 million and indemnification obligation reversals of $9.6 million were recorded in 2008, compared to obligation reversals of $2.5 million in 2009. In addition, unallocated net interest income in this category, relating to earnings on the Company’s investment portfolio and interest expense on overnight borrowings not allocated to the segments, decreased $41.9 million


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in 2009. These declines in profitability were partly offset by a $16.5 million decrease in the unallocated loan loss provision.
 
Impact of Recently Issued Accounting Standards
 
Fair Value Measurements The Company adopted new accounting guidance for determining fair value, issued by the Financial Accounting Standards Board (FASB), on January 1, 2008. Under this guidance, fair value is defined as a market-based measurement and should be determined based on assumptions that a market participant would use when pricing an asset or liability. Additionally, it establishes a fair value hierarchy that provides the highest priority to measurements using quoted prices in active markets and the lowest priority to measurements based on unobservable data. No new fair value measurements are required. The guidance for initial recognition of fair value for certain derivative contracts held by the Company was modified. Former accounting guidance precluded immediate recognition in earnings of an unrealized gain or loss, measured as the difference between the transaction price and fair value of these instruments at initial recognition. This guidance was nullified and in accordance with the new recognition requirements, the Company increased equity by $903 thousand on January 1, 2008.
 
In April 2009, the FASB issued additional guidance on reliance on transaction prices or quoted prices when estimating fair value when market volume and activity have significantly decreased. The guidance reaffirms the definition of fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. It provides a two-step process to determine whether there has been a significant decrease in the volume and level of activity for an asset or liability when compared with normal market activity for the asset or liability, and whether a transaction is not orderly. If it is determined that there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability, transactions or quoted prices may not be determinative of fair value. Accordingly, further analysis of the transactions or quoted prices is needed, and a significant adjustment to the transactions or quoted prices may be necessary to estimate fair value. The Company adopted the guidance in March 2009, and its application did not result in a change in valuation techniques and related inputs.
 
Business Combinations In December 2007, the FASB issued guidance which, while retaining the fundamental requirements of the acquisition method of accounting for business combinations, broadened the scope and improved the application of this method. Under the new guidance, the acquirer in a business combination must recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date. The recognition at the acquisition date of an allowance for loan losses on acquired loans was eliminated, as credit-related factors are now incorporated directly into the fair value of the loans. Costs incurred to effect the acquisition are to be recognized separately from the acquisition. Assets and liabilities arising from contractual contingencies must be measured at fair value as of the acquisition date. Contingent consideration must also be measured at fair value as of the acquisition date. The guidance also changes the accounting for negative goodwill arising from a bargain purchase, requiring recognition in earnings instead of allocation to assets acquired. For business combinations achieved in stages (step acquisitions), the assets and liabilities must be recognized at the full amounts of their fair values, while under former guidance the entity was acquired in a series of purchases, with costs and fair values being identified and measured at each step. The new accounting requirements apply to business combinations occurring after January 1, 2009.
 
Non-controlling Interests Also in December 2007, the FASB issued guidance which clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. A single method of accounting exists for changes in a parent’s ownership interest if the parent retains its controlling interest, deeming these to be equity transactions. Such changes include the parent’s purchases and sales of ownership interests in its subsidiary and the subsidiary’s acquisition and issuance of its ownership interests. The parent must recognize a gain or loss in net income when a subsidiary is deconsolidated. The guidance changed the way the consolidated income statement is presented, requiring consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest, and requires disclosure of these


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amounts on the face of the consolidated statement of income. The guidance was effective on January 1, 2009, and its adoption did not have a significant effect on the Company’s consolidated financial statements.
 
Income per Share In June 2008, the FASB issued guidance which defined unvested stock awards which contain nonforfeitable rights to dividends as securities which participate in undistributed earnings. Such participating securities must be included in the computation of income per share under the two-class method. The two-class method is an earnings allocation formula that determines income per share for common stock and for participating securities according to dividends declared and participation rights in undistributed earnings. The Company was required to apply the two-class method to its computation of income per share effective January 1, 2009, and its application did not have a significant effect on the computation of income per share attributable to common shareholders.
 
Benefit Plans In December 2008, the FASB expanded its disclosure requirements about pension and other postretirement benefit plan assets. These disclosures, for each major asset category, include fair value measurements, valuation techniques, risk concentrations, and rate of return assumptions. Information about asset investment policies and strategies, such as investment goals and risk management practices, must also be provided. The new disclosures are required on an annual basis, effective with the December 31, 2009 financial statements.
 
Other-Than-Temporary Impairments In April 2009, the FASB issued new accounting guidance for the measurement and recognition of other-than-temporary impairment for debt securities. The guidance addresses how to evaluate whether an impairment of a debt security is other than temporary, determination of the amount of impairment to be recognized in earnings and other comprehensive income, and subsequent accounting for these securities. It requires a new presentation on the statement of earnings which shows the total impairment, offset for that amount considered noncredit-related and recognized in other comprehensive income. Various additional disclosures are required for investments in an unrealized loss position, in addition to information about the methodologies and inputs used in calculating the portion of impairment recognized in earnings. The Company adopted the new guidance in March 2009, and has presented the required disclosures in Note 4 on Investment Securities in the accompanying consolidated financial statements.
 
Subsequent Events The FASB issued guidance in May 2009 for accounting and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The guidance sets the period after the balance sheet date during which management should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, and the circumstances under which they should be recognized. The guidance was effective with the June 30, 2009 financial statements, and its application did not have a significant effect on the Company’s financial statements.
 
Accounting for Transfers of Financial Assets The FASB issued additional guidance in June 2009 with the objective of providing greater transparency about transfers of financial assets and a transferor’s continuing involvement. The new guidance limits the circumstances in which a financial asset should be derecognized when the transferor has not transferred the entire original financial asset, or when the transferor has continuing involvement with the transferred asset. It establishes conditions for reporting a transfer of a portion of a financial asset as a sale. Also, it eliminates the exception for qualifying special purpose entities from consolidation guidance, and the exception that permitted sale accounting for certain mortgage securitizations when a transferor has not surrendered control over the transferred assets. The new accounting requirements must be applied to transactions occurring on or after January 1, 2010. The Company does not expect their adoption to have a significant effect on its financial statements.
 
Variable Interest Entities In June 2009, the FASB issued new accounting guidance related to variable interest entities. This guidance replaces a quantitative-based risks and rewards calculation for determining which entity, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which entity has the power to direct the activities of a variable interest entity that most significantly impact its economic performance and the obligation to absorb its losses or the right to receive its benefits. This guidance requires reconsideration of whether an entity is a variable interest entity when any changes in facts or circumstances occur such that the holders of the equity investment at risk, as a group, lose


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the power to direct the activities of the entity that most significantly impact the entity’s economic performance. It also requires ongoing assessments of whether a variable interest holder is the primary beneficiary of a variable interest entity. The guidance was effective on January 1, 2010, and its adoption did not have a significant effect on the Company’s financial statements.
 
Effects of Inflation
 
The impact of inflation on financial institutions differs significantly from that exerted on industrial entities. Financial institutions are not heavily involved in large capital expenditures used in the production, acquisition or sale of products. Virtually all assets and liabilities of financial institutions are monetary in nature and represent obligations to pay or receive fixed and determinable amounts not affected by future changes in prices. Changes in interest rates have a significant effect on the earnings of financial institutions. Higher interest rates generally follow the rising demand of borrowers and the corresponding increased funding requirements of financial institutions. Although interest rates are viewed as the price of borrowing funds, the behavior of interest rates differs significantly from the behavior of the prices of goods and services. Prices of goods and services may be directly related to that of other goods and services while the price of borrowing relates more closely to the inflation rate in the prices of those goods and services. As a result, when the rate of inflation slows, interest rates tend to decline while absolute prices for goods and services remain at higher levels. Interest rates are also subject to restrictions imposed through monetary policy, usury laws and other artificial constraints.
 
During the second half of 2008, the national economy experienced a significant deterioration which has continued throughout 2009. As a result, interest rates fell significantly and have remained at low levels, while prices of consumer goods and services have been relatively constant. New legislation was enacted to mitigate the effects of the recession and revive the economy, and additional legislation is probable. It is difficult to predict the inflationary impact of the recession and the accompanying legislative measures taken to combat it.
 
Corporate Governance
 
The Company has adopted a number of corporate governance measures. These include corporate governance guidelines, a code of ethics that applies to its senior financial officers and the charters for its audit committee, its committee on compensation and human resources, and its committee on governance/directors. This information is available on the Company’s web site www.commercebank.com under Investor Relations.
 
Forward-Looking Statements
 
This report may contain “forward-looking statements” that are subject to risks and uncertainties and include information about possible or assumed future results of operations. Many possible events or factors could affect the future financial results and performance of the Company. This could cause results or performance to differ materially from those expressed in the forward-looking statements. Words such as “expects”, “anticipates”, “believes”, “estimates”, variations of such words and other similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in, or implied by, such forward-looking statements. Readers should not rely solely on the forward-looking statements and should consider all uncertainties and risks discussed throughout this report. Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. Such possible events or factors include: changes in economic conditions in the Company’s market area; changes in policies by regulatory agencies, governmental legislation and regulation; fluctuations in interest rates; changes in liquidity requirements; demand for loans in the Company’s market area; changes in accounting and tax principles; estimates made on income taxes; and competition with other entities that offer financial services.


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SUMMARY OF QUARTERLY STATEMENTS OF INCOME
 
                                 
Year Ended December 31, 2009
  For the Quarter Ended  
(In thousands, except per share data)   12/31/09     9/30/09     6/30/09     3/31/09  
   
Interest income
  $ 194,999     $ 201,647     $ 198,992     $ 193,874  
Interest expense
    (30,496 )     (38,108 )     (41,547 )     (43,859 )
 
 
Net interest income
    164,503       163,539       157,445       150,015  
Non-interest income
    103,457       102,135       98,562       92,431  
Investment securities losses, net
    (1,325 )     (945 )     (2,753 )     (2,172 )
Salaries and employee benefits
    (85,480 )     (87,267 )     (86,279 )     (86,753 )
Other expense
    (69,197 )     (67,222 )     (73,732 )     (66,133 )
Provision for loan losses
    (41,002 )     (35,361 )     (41,166 )     (43,168 )
 
 
Income before income taxes
    70,956       74,879       52,077       44,220  
Income taxes
    (21,493 )     (23,415 )     (15,257 )     (13,592 )
Non-controlling interest
    159       185       148       208  
 
 
Net income
  $ 49,622     $ 51,649     $ 36,968     $ 30,836  
 
 
Net income per common share – basic*
  $ .60     $ .63     $ .46     $ .38  
Net income per common share – diluted*
  $ .60     $ .63     $ .46     $ .38  
 
 
Weighted average shares – basic*
    82,684       82,169       80,251       79,487  
Weighted average shares – diluted*
    83,040       82,491       80,524       79,807  
 
 
 
                                 
Year Ended December 31, 2008
  For the Quarter Ended  
(In thousands, except per share data)   12/31/08     9/30/08     6/30/08     3/31/08  
   
Interest income
  $ 209,628     $ 209,464     $ 208,204     $ 222,553  
Interest expense
    (53,339 )     (57,900 )     (63,425 )     (82,446 )
 
 
Net interest income
    156,289       151,564       144,779       140,107  
Non-interest income
    85,226       95,593       102,733       92,160  
Investment securities gains, net
    4,814       1,149       1,008       23,323  
Salaries and employee benefits
    (83,589 )     (83,766 )     (83,247 )     (83,010 )
Other expense
    (60,099 )     (100,680 )     (63,818 )     (57,171 )
Provision for loan losses
    (41,333 )     (29,567 )     (18,000 )     (20,000 )
 
 
Income before income taxes
    61,308       34,293       83,455       95,409  
Income taxes
    (17,757 )     (9,534 )     (27,118 )     (30,668 )
Non-controlling interest
    285       (86 )     (358 )     (574 )
 
 
Net income
  $ 43,836     $ 24,673     $ 55,979     $ 64,167  
 
 
Net income per common share – basic*
  $ .55     $ .31     $ .70     $ .81  
Net income per common share – diluted*
  $ .55     $ .31     $ .70     $ .80  
 
 
Weighted average shares – basic*
    79,400       79,228       79,119       79,027  
Weighted average shares – diluted*
    79,986       79,868       79,754       79,702  
 
 
 
                                 
Year Ended December 31, 2007
  For the Quarter Ended  
(In thousands, except per share data)   12/31/07     9/30/07     6/30/07     3/31/07  
   
Interest income
  $ 236,752     $ 238,274     $ 232,808     $ 228,267  
Interest expense
    (99,285 )     (103,012 )     (98,944 )     (96,788 )
 
 
Net interest income
    137,467       135,262       133,864       131,479  
Non-interest income
    98,101       95,137       94,059       84,284  
Investment securities gains (losses), net
    3,270       1,562       (493 )     3,895  
Salaries and employee benefits
    (78,433 )     (77,312 )     (76,123 )     (76,900 )
Other expense
    (84,204 )     (61,608 )     (60,251 )     (59,328 )
Provision for loan losses
    (14,062 )     (11,455 )     (9,054 )     (8,161 )
 
 
Income before income taxes
    62,139       81,586       82,002       75,269  
Income taxes
    (18,187 )     (25,515 )     (26,453 )     (23,582 )
Non-controlling interest
    (260 )     (173 )     25       (191 )
 
 
Net income
  $ 43,692     $ 55,898     $ 55,574     $ 51,496  
 
 
Net income per common share – basic*
  $ .55     $ .70     $ .69     $ .64  
Net income per common share – diluted*
  $