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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

     
(Mark One)
   
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the quarterly period ended June 30, 2002
 
or
 
o
   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the transition period from           to

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 64106

(Address of principal executive offices and Zip Code)

(816) 234-2000

(Registrant’s telephone number, including area code)

     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

      As of August 6, 2002, the registrant had outstanding 64,839,871 shares of its $5 par value common stock, registrant’s only class of common stock.

TABLE OF CONTENTS

INDEX
COMMERCE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF INCOME
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
AVERAGE BALANCE SHEETS -- AVERAGE RATES AND YIELDS
AVERAGE BALANCE SHEETS -- AVERAGE RATES AND YIELDS
PART II: OTHER INFORMATION
SIGNATURES
EX-99.1 Certification of CEO
EX-99.2 Certification of CFO

Table of Contents

COMMERCE BANCSHARES, INC. AND SUBSIDIARIES

 
INDEX
             
Page
PART I.
   FINANCIAL INFORMATION        
Item 1
  Financial Statements        
    Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001     2  
    Consolidated Statements of Income for the Three and Six Months Ended June 30, 2002 and 2001     3  
    Consolidated Statements of Stockholders’ Equity for the Six Months Ended June 30, 2002 and 2001     4  
    Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002 and 2001     5  
    Notes to Consolidated Financial Statements     6  
Item 2
  Management’s Discussion and Analysis of Results of Operations and Financial Condition     12  
Item 3
  Quantitative and Qualitative Disclosures about Market Risk     21  
PART II.
   OTHER INFORMATION        
Item 4
  Submission of Matters to a Vote of Security Holders     25  
Item 6
  Exhibits and Reports on Form 8-K     25  
Signatures     25  

1

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COMMERCE BANCSHARES, INC. AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
                       
June 30 December 31
2002 2001
(Unaudited)
(In thousands)
ASSETS
Loans, net of unearned income
  $ 7,729,147     $ 7,638,482  
Allowance for loan losses
    (129,973 )     (129,973 )
     
     
 
     
Net loans
     7,599,174       7,508,509  
     
     
 
Investment securities:
               
 
Available for sale
    3,460,586       3,654,919  
 
Trading
    31,517       12,265  
 
Non-marketable
    51,500       52,334  
     
     
 
     
Total investment securities
     3,543,603       3,719,518  
     
     
 
Federal funds sold and securities purchased under agreements to resell
    36,141       375,060  
Cash and due from banks
    610,625       824,218  
Land, buildings and equipment, net
    330,869       313,383  
Goodwill
    43,224       43,968  
Other intangible assets, net
    4,893       6,842  
Other assets
    136,202       111,308  
     
     
 
     
Total assets
   $ 12,304,731     $ 12,902,806  
     
     
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
               
 
Non-interest bearing demand
  $ 1,337,828     $ 1,579,759  
 
Savings and interest bearing demand
    5,774,566       5,652,716  
 
Time open and C.D.’s of less than $100,000
    2,030,683       2,188,448  
 
Time open and C.D.’s of $100,000 and over
    690,975       611,043  
     
     
 
     
Total deposits
     9,834,052       10,031,966  
Federal funds purchased and securities sold under agreements to repurchase
    671,369       1,087,402  
Long-term debt and other borrowings
    340,787       392,586  
Other liabilities
    90,894       118,369  
     
     
 
     
Total liabilities
     10,937,102       11,630,323  
     
     
 
Stockholders’ equity:
               
 
Preferred stock, $1 par value.
               
   
Authorized and unissued 2,000,000 shares
    —       —  
 
Common stock, $5 par value.
               
   
Authorized 100,000,000 shares; issued 65,643,792 shares in 2002 and 65,575,525 in 2001
    328,219       327,878  
 
Capital surplus
    210,637       213,888  
 
Retained earnings
    775,942       700,230  
 
Treasury stock of 390,339 shares in 2002 and 138,565 shares in 2001, at cost
    (17,518 )     (5,187 )
 
Other
    (2,025 )     (1,749 )
 
Accumulated other comprehensive income
    72,374       37,423  
     
     
 
     
Total stockholders’ equity
     1,367,629       1,272,483  
     
     
 
     
Total liabilities and stockholders’ equity
   $ 12,304,731     $ 12,902,806  
     
     
 

See accompanying notes to consolidated financial statements.

2

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COMMERCE BANCSHARES, INC. AND SUBSIDIARIES

 
CONSOLIDATED STATEMENTS OF INCOME
                                     
For the Three Months For the Six Months
Ended June 30 Ended June 30
2002 2001 2002 2001
(Unaudited)
(In thousands, except per share data)
INTEREST INCOME
                                
Interest and fees on loans
  $ 117,796     $ 153,586     $ 236,908     $ 317,968  
Interest on investment securities
    44,666       32,714       88,755       61,466  
Interest on federal funds sold and securities purchased under agreements to resell
    411       6,426       952       14,477  
     
     
     
     
 
   
Total interest income
     162,873       192,726       326,615       393,911  
     
     
     
     
 
INTEREST EXPENSE
                                
Interest on deposits:
                               
 
Savings and interest bearing demand
    12,101       27,367       24,095       63,171  
 
Time open and C.D.’s of less than $100,000
    17,872       32,046       39,121       63,464  
 
Time open and C.D.’s of $100,000 and over
    4,743       7,428       9,761       14,345  
Interest on federal funds purchased and securities sold under agreements to repurchase
    1,560       5,439       3,758       12,228  
Interest on long-term debt and other borrowings
    2,209       2,797       4,899       6,158  
     
     
     
     
 
   
Total interest expense
     38,485       75,077       81,634       159,366  
     
     
     
     
 
   
Net interest income
     124,388       117,649       244,981       234,545  
Provision for loan losses
    6,668       7,992       14,067       17,522  
     
     
     
     
 
   
Net interest income after provision for loan losses
     117,720       109,657       230,914       217,023  
     
     
     
     
 
NON-INTEREST INCOME
                                
Trust fees
    15,774       16,790       31,213       31,992  
Deposit account charges and other fees
    22,793       21,355       43,886       40,584  
Credit card transaction fees
    14,229       13,695       27,112       26,402  
Trading account profits and commissions
    3,826       3,578       7,871       7,430  
Mortgage banking revenue
    1,066       1,432       1,637       3,127  
Net gains (losses) on securities transactions
    (328 )     510       (292 )     1,747  
Other
    12,456       13,316       27,557       26,258  
     
     
     
     
 
   
Total non-interest income
     69,816       70,676       138,984       137,540  
     
     
     
     
 
NON-INTEREST EXPENSE
                                
Salaries and employee benefits
    61,066       58,772       124,701       116,685  
Net occupancy
    8,207       7,550       16,634       15,988  
Equipment
    6,003       5,527       11,114       11,155  
Supplies and communication
    8,221       8,600       16,164       16,610  
Data processing and software
    12,476       12,318       24,352       23,670  
Marketing
    3,628       3,571       6,996       6,388  
Goodwill amortization
    —       1,126       —       2,323  
Intangible assets amortization
    668       755       1,392       1,506  
Other
    12,727       13,500       25,665       25,530  
     
     
     
     
 
   
Total non-interest expense
     112,996       111,719       227,018       219,855  
     
     
     
     
 
Income before income taxes
    74,540       68,614       142,880       134,708  
Less income taxes
    24,434       22,831       45,862       45,048  
     
     
     
     
 
   
Net income
   $ 50,106     $ 45,783     $ 97,018     $ 89,660  
     
     
     
     
 
Net income per share — basic
  $ .76     $ .69     $ 1.48     $ 1.36  
     
     
     
     
 
Net income per share — diluted
  $ .75     $ .68     $ 1.46     $ 1.34  
     
     
     
     
 

See accompanying notes to consolidated financial statements.

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COMMERCE BANCSHARES, INC. AND SUBSIDIARIES

 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
                                                                     
Accumulated
Number Other
of Shares Common Capital Retained Treasury Comprehensive
Issued Stock Surplus Earnings Stock Other Income (Loss) Total
(Unaudited)
(Dollars in thousands)
Balance January 1, 2002
     65,575,525     $ 327,878     $ 213,888     $ 700,230     $ (5,187 )   $ (1,749 )   $ 37,423     $ 1,272,483  
 
Net income
                            97,018                               97,018  
 
Change in unrealized gain (loss) on available for sale securities
                                                    34,951       34,951  
                                                             
 
   
Total comprehensive income
                                                            131,969  
                                                             
 
 
Purchase of treasury stock
                                    (23,896 )                     (23,896 )
 
Issuance of stock under purchase, option and benefit plans
    68,267       341       (3,262 )             10,943                       8,022  
 
Issuance of stock under restricted stock award plan
                    11               622       (633 )             —  
 
Restricted stock award amortization
                                            357               357  
 
Cash dividends paid ($.325 per share)
                            (21,306 )                             (21,306 )
     
     
     
     
     
     
     
     
 
Balance June 30, 2002
     65,643,792     $ 328,219     $ 210,637     $ 775,942     $ (17,518 )   $ (2,025 )   $ 72,374     $ 1,367,629  
     
     
     
     
     
     
     
     
 
Balance January 1, 2001
    62,655,891     $ 313,279     $ 147,436     $ 671,147     $ (2,895 )   $ (1,179 )   $ 15,967     $ 1,143,755  
 
Net income
                            89,660                               89,660  
 
Change in unrealized gain (loss) on available for sale securities
                                                    14,250       14,250  
                                                             
 
   
Total comprehensive income
                                                            103,910  
                                                             
 
 
Pooling acquisition
    876,750       4,384       5,414       5,198                       83       15,079  
 
Purchase of treasury stock
                                    (29,684 )                     (29,684 )
 
Issuance of stock under purchase, option and benefit plans
    2,982       15       (4,160 )             10,068                       5,923  
 
Issuance of stock under restricted stock award plan
    21,564       108       719               382       (1,209 )             —  
 
Restricted stock award amortization
                                            247               247  
 
Cash dividends paid ($.305 per share)
                            (20,245 )                             (20,245 )
     
     
     
     
     
     
     
     
 
Balance June 30, 2001
    63,557,187     $ 317,786     $ 149,409     $ 745,760     $ (22,129 )   $ (2,141 )   $ 30,300     $ 1,218,985  
     
     
     
     
     
     
     
     
 

See accompanying notes to consolidated financial statements.

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COMMERCE BANCSHARES, INC. AND SUBSIDIARIES

 
CONSOLIDATED STATEMENTS OF CASH FLOWS
                     
For the Six Months Ended
June 30
2002 2001
(Unaudited)
(In thousands)
OPERATING ACTIVITIES:
                
Net income
  $ 97,018     $ 89,660  
Adjustments to reconcile net income to net cash provided by operating activities:
               
 
Provision for loan losses
    14,067       17,522  
 
Provision for depreciation and amortization
    17,210       18,428  
 
Amortization of investment security premiums, net
    8,691       3,918  
 
Net (gains) losses on sales of investment securities (A)
    292       (1,747 )
 
Net increase in trading securities
    (6,599 )     (10,198 )
 
(Increase) decrease in interest receivable
    1,316       (152 )
 
Decrease in interest payable
    (13,180 )     (1,719 )
 
Decrease in income taxes payable
    (14,148 )     (4,192 )
 
Other changes, net
    (29,957 )     5,037  
     
     
 
   
Net cash provided by operating activities
    74,710       116,557  
     
     
 
INVESTING ACTIVITIES:
                
Cash received in acquisition
    —       15,035  
Cash paid in sale of branches
    (20,252 )     —  
Proceeds from sales of investment securities(A)
    182,456       229,084  
Proceeds from maturities of investment securities(A)
    788,196       635,173  
Purchases of investment securities(A)
    (730,735 )     (1,207,205 )
Net (increase) decrease in federal funds sold and securities purchased under agreements to resell
    338,919       (290,920 )
Net (increase) decrease in loans
    (114,797 )     291,918  
Purchases of land, buildings and equipment
    (35,756 )     (44,124 )
Sales of land, buildings and equipment
    2,548       1,996  
     
     
 
   
Net cash provided by (used in) investing activities
    410,579       (369,043 )
     
     
 
FINANCING ACTIVITIES:
                
Net increase (decrease) in non-interest bearing demand, savings, and interest bearing demand deposits
    (138,719 )     77,719  
Net increase (decrease) in time open and C.D.’s
    (53,273 )     196,875  
Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase
    (416,033 )     121,869  
Repayment of long-term debt
    (51,702 )     (50,490 )
Purchases of treasury stock
    (23,896 )     (29,684 )
Issuance of stock under purchase, option and benefit plans
    6,047       4,581  
Cash dividends paid on common stock
    (21,306 )     (20,245 )
     
     
 
   
Net cash provided by (used in) financing activities
    (698,882 )     300,625  
     
     
 
   
Increase (decrease) in cash and cash equivalents
    (213,593 )     48,139  
Cash and cash equivalents at beginning of year
    824,218       616,724  
     
     
 
Cash and cash equivalents at June 30
  $ 610,625     $ 664,863  
     
     
 
(A) Available for sale and non-marketable securities
               
Net income tax payments
  $ 58,033     $ 46,222  
     
     
 
Interest paid on deposits and borrowings
  $ 94,814     $ 161,085  
     
     
 

See accompanying notes to consolidated financial statements.

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COMMERCE BANCSHARES, INC. AND SUBSIDIARIES

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2002
(Unaudited)
 
1. Principles of Consolidation and Presentation

      The accompanying consolidated financial statements include the accounts of Commerce Bancshares, Inc. and all majority-owned subsidiaries (the Company). All significant intercompany accounts and transactions have been eliminated. Certain reclassifications were made to 2001 data to conform to current year presentation. Results of operations for the three and six month periods ended June 30, 2002, are not necessarily indicative of results to be attained for any other period.

      The significant accounting policies followed in the preparation of the quarterly financial statements are the same as those disclosed in the 2001 Annual Report on Form 10-K.

 
2. Allowance for Loan Losses

      The following is a summary of the allowance for loan losses.

                                     
For the For the
Three Months Ended Six Months Ended
June 30 June 30
2002 2001 2002 2001
(In thousands)
Balance, beginning of period
   $ 129,973     $ 131,080     $ 129,973     $ 128,445  
     
     
     
     
 
Additions:
                               
 
Allowance for loan losses of acquired bank
    —       —       —       2,519  
 
Provision for loan losses
    6,668       7,992       14,067       17,522  
     
     
     
     
 
   
Total additions
    6,668       7,992       14,067       20,041  
     
     
     
     
 
Deductions:
                               
 
Loan losses
    11,231       11,243       22,161       24,493  
 
Less recoveries on loans
    4,563       3,280       8,094       7,116  
     
     
     
     
 
   
Net loan losses
    6,668       7,963       14,067       17,377  
     
     
     
     
 
Balance, June 30
   $ 129,973     $ 131,109     $ 129,973     $ 131,109  
     
     
     
     
 

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COMMERCE BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
3. Investment Securities

      Investment securities, at fair value, consist of the following at June 30, 2002, and December 31, 2001.

                     
June 30 December 31
2002 2001
(In thousands)
Available for sale:
               
 
U.S. government and federal agency obligations
  $ 1,166,942     $ 1,147,615  
 
State and municipal obligations
    39,960       43,209  
 
CMO’s and asset-backed securities
    2,088,281       2,176,551  
 
Other debt securities
    107,918       66,054  
 
Equity securities
    57,485       221,490  
Trading
    31,517       12,265  
Non-marketable
    51,500       52,334  
     
     
 
   
Total investment securities
   $ 3,543,603     $ 3,719,518  
     
     
 

      Equity securities included investments in short term mutual funds of $13,473,000 at June 30, 2002, and $176,067,000 at December 31, 2001.

 
4. Intangible Assets and Goodwill

      The following table presents information about the Company’s intangible assets which are being amortized in accordance with Statement of Financial Accounting Standards (SFAS) No. 142, discussed in note 9 below.

                                     
June 30, 2002 December 31, 2001
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
(In thousands)
Amortized intangible assets:
                               
 
Core deposit premium
  $ 47,930     $ (43,217 )   $ 50,676     $ (44,064 )
 
Mortgage servicing rights
    1,170       (990 )     1,170       (940 )
     
     
     
     
 
   
Total
  $ 49,100     $ (44,207 )   $ 51,846     $ (45,004 )
     
     
     
     
 

      Aggregate amortization expense was $668,000 and $755,000, respectively, for the three month periods ended June 30, 2002 and 2001, and $1,392,000 and $1,506,000, respectively, for the corresponding six month periods.

           
Estimated amortization expense for the years ending:
       
 
2002
  $ 2,319  
 
2003
    1,818  
 
2004
    1,776  
 
2005
    543  
 
2006
    100  

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COMMERCE BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      As required by SFAS 142, the Company discontinued recording goodwill amortization effective January 1, 2002. The following tables compare results of operations as if no goodwill amortization had been recorded in 2001.

                                   
For the Three Months For the Six Months
Ended June 30 Ended June 30
2002 2001 2002 2001
(In thousands, except per share data)
Reported net income
  $ 50,106     $ 45,783     $ 97,018     $ 89,660  
 
Add back goodwill amortization
    —       1,126       —       2,323  
     
     
     
     
 
 
Adjusted net income
  $ 50,106     $ 46,909     $ 97,018     $ 91,983  
     
     
     
     
 
Basic earnings per share:
                                
Reported net income
  $ .76     $ .69     $ 1.48     $ 1.36  
 
Add back goodwill amortization
    —       .02       —       .03  
     
     
     
     
 
 
Adjusted net income
  $ .76     $ .71     $ 1.48     $ 1.39  
     
     
     
     
 
Diluted earnings per share:
                                
Reported net income
  $ .75     $ .68     $ 1.46     $ 1.34  
 
Add back goodwill amortization
    —       .02       —       .03  
     
     
     
     
 
 
Adjusted net income
  $ .75     $ .70     $ 1.46     $ 1.37  
     
     
     
     
 

      During the six month period ended June 30, 2002, the Company sold several bank branches. Goodwill and other intangible assets of $1,300,000 were written off in these transactions.

5.     Common Stock

      The shares used in the calculation of basic and diluted income per share are shown below.

                                 
For the For the
Three Months Ended Six Months Ended
June 30 June 30
2002 2001 2002 2001
(In thousands)
Weighted average common shares outstanding
    65,507       66,203       65,513       66,110  
Net effect of the assumed exercise of nonvested restricted stock and stock options — based on the treasury stock method using average market price for the periods
    913       709       876       814  
     
     
     
     
 
      66,420       66,912       66,389       66,924  
     
     
     
     
 

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COMMERCE BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

6.     Comprehensive Income

      The Company’s only component of other comprehensive income during the periods presented below was the unrealized holding gains and losses on available for sale investment securities.

                                 
For the For the
Three Months Ended Six Months Ended
June 30 June 30
2002 2001 2002 2001
(In thousands)
Unrealized holding gains (losses)
  $ 65,607     $ (1,310 )   $ 56,758     $ 27,797  
Reclassification adjustment for gains included in net income
    (372 )     (2,425 )     (385 )     (4,820 )
     
     
     
     
 
Net unrealized gains (losses) on securities
    65,235       (3,735 )     56,373       22,977  
Income tax expense (benefit)
    24,789       (1,409 )     21,422       8,727  
     
     
     
     
 
Other comprehensive income (loss)
   $ 40,446     $ (2,326 )   $ 34,951     $ 14,250  
     
     
     
     
 

7.     Segments

      The Company segregates financial information for use in assessing its performance and allocating resources among three operating segments. The Consumer segment includes the retail branch network, consumer finance, bankcard, student loans and discount brokerage services. The Commercial segment provides corporate lending, leasing, and international services, as well as business, government deposit and cash management services. The Money Management segment provides traditional trust and estate tax planning services, and advisory and discretionary investment management services.

      The following table presents selected financial information by segment and reconciliations of combined segment totals to consolidated totals. There were no material intersegment revenues between the three segments.

                                                 
Money Segment Other/ Consolidated
Consumer Commercial Management Totals Elimination Totals
(In thousands)
Six Months Ended June 30, 2002
                                                
                                               
Net interest income after loan loss expense
  $ 43,537     $ 109,246     $ (3,902 )   $ 148,881     $ 82,033     $ 230,914  
Cost of funds allocation
    80,257       (26,806 )     8,274       61,725       (61,725 )     —  
Non-interest income
    73,738       20,501       41,430       135,669       3,315       138,984  
     
     
     
     
     
     
 
Total net revenue
    197,532       102,941       45,802       346,275       23,623       369,898  
Non-interest expense
    133,563       47,815       29,694       211,072       15,946       227,018  
     
     
     
     
     
     
 
Income before income taxes
  $ 63,969     $ 55,126     $ 16,108     $ 135,203     $ 7,677     $ 142,880  
     
     
     
     
     
     
 
Six Months Ended June 30, 2001
                                               
                                               
Net interest income after loan loss expense
  $ 6,621     $ 155,158     $ (6,647 )   $ 155,132     $ 61,891     $ 217,023  
Cost of funds allocation
    130,729       (75,351 )     10,406       65,784       (65,784 )     —  
Non-interest income
    71,705       16,591       41,426       129,722       7,818       137,540  
     
     
     
     
     
     
 
Total net revenue
    209,055       96,398       45,185       350,638       3,925       354,563  
Non-interest expense
    133,156       46,493       28,851       208,500       11,355       219,855  
     
     
     
     
     
     
 
Income before income taxes
  $ 75,899     $ 49,905     $ 16,334     $ 142,138     $ (7,430 )   $ 134,708  
     
     
     
     
     
     
 

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COMMERCE BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

                                                 
Money Segment Other/ Consolidated
Consumer Commercial Management Totals Elimination Totals
(In thousands)
Three Months Ended June 30, 2002
                                                
                                               
Net interest income after loan loss expense
  $ 22,916     $ 55,116     $ (1,711 )   $ 76,321     $ 41,399     $ 117,720  
Cost of funds allocation
    40,189       (12,839 )     3,793       31,143       (31,143 )     —  
Non-interest income
    37,301       10,515       20,810       68,626       1,190       69,816  
     
     
     
     
     
     
 
Total net revenue
    100,406       52,792       22,892       176,090       11,446       187,536  
Non-interest expense
    67,291       23,832       14,665       105,788       7,208       112,996  
     
     
     
     
     
     
 
Income before income taxes
  $ 33,115     $ 28,960     $ 8,227     $ 70,302     $ 4,238     $ 74,540  
     
     
     
     
     
     
 
Three Months Ended June 30, 2001
                                               
                                               
Net interest income after loan loss expense
  $ 4,972     $ 75,141     $ (3,117 )   $ 76,996     $ 32,661     $ 109,657  
Cost of funds allocation
    68,808       (34,463 )     4,984       39,329       (39,329 )     —  
Non-interest income
    36,096       8,775       21,033       65,904       4,772       70,676  
     
     
     
     
     
     
 
Total net revenue
    109,876       49,453       22,900       182,229       (1,896 )     180,333  
Non-interest expense
    68,749       23,315       14,580       106,644       5,075       111,719  
     
     
     
     
     
     
 
Income before income taxes
  $ 41,127     $ 26,138     $ 8,320     $ 75,585     $ (6,971 )   $ 68,614  
     
     
     
     
     
     
 

      Beginning in 2002, the Company implemented a new 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 new 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. Previous methodology used funding pools based on average rates to assign and determine value. The new method should provide a more accurate means of valuing fund sources and uses in a varying interest rate environment. The change in profitability methods mainly affected the Consumer segment and had the effect of lowering the cost of funds allocation to the Consumer segment by $30.6 million and $62.2 million, respectively, in the three and six month periods ended June 30, 2002. Segment results for the prior periods in the table above were not restated for the change in the profitability measurement method.

8.     Derivative Instruments

      The Company uses derivative instruments, on a limited basis, primarily to hedge the variability in interest payments or protect the value of certain assets and liabilities recorded in its balance sheet from changes in interest rates. The Company has three interest rate swaps which were designated as fair value hedges of certain fixed rate loans. Through its International Department, the Company enters into foreign exchange contracts consisting mainly of contracts to purchase or deliver foreign currency transactions for customers at a specific future date. Also, mortgage loan commitments and forward sales contracts are derived from the Company’s mortgage banking operation in which fixed rate personal real estate loans are originated and sold to other institutions.

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COMMERCE BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The Company’s usage of derivative instruments is detailed below.

                                                   
June 30, 2002 December 31, 2001
Positive Negative Positive Negative
Notional Fair Fair Notional Fair Fair
Amount Value Value Amount Value Value
(In thousands)
Interest rate swaps
  $ 24,500     $ —     $ (1,202 )   $ 24,912     $ —     $ (551 )
Foreign exchange contracts:
                                               
 
Forward contracts
    183,507       8,351       (7,977 )     99,232       3,373       (3,349 )
 
Options written/purchased
    1,970       33       (33 )     1,950       2       (2 )
Mortgage loan commitments
    14,448       228       (1 )     18,679       79       (162 )
Mortgage loan forward sale contracts
    14,448       18       (31 )     43,758       921       (1 )
     
     
     
     
     
     
 
 
Total
  $ 238,873     $ 8,630     $ (9,244 )   $ 188,531     $ 4,375     $ (4,065 )
     
     
     
     
     
     
 

9.     Impact of Recently Issued Accounting Standards

      Effective January 1, 2002, the Company adopted Statement of Accounting Standards No. 142, “Goodwill and Other Intangible Assets”. SFAS 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually. It also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment.

      The Statement requires the Company to perform an assessment of whether there is an indication that goodwill is impaired as of January 1, 2002. To accomplish this, the Company must identify its reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of January 1, 2002. The Statement allows until June 30, 2002, to determine the fair value of each reporting unit and compare it to the carrying amount of the reporting unit. To the extent the carrying amount of a reporting unit exceeds the fair value of the reporting unit, an indication exists that the reporting unit goodwill may be impaired and the Company must perform the second step of the transitional impairment test. In the second step, the Company must compare the implied fair value of the reporting unit goodwill with the carrying amount of the reporting unit goodwill, both of which would be measured as of January 1, 2002. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit to all of the assets (recognized and unrecognized) and liabilities of the reporting unit in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. This second step is required to be completed as soon as possible, but no later than the end of 2002. Any transitional impairment loss must be recognized as the cumulative effect of a change in accounting principle in the Company’s 2002 consolidated statement of income.

      The Company identified its reporting units as its three reportable segments of Consumer, Commercial, and Money Management. It completed the first step in the transitional goodwill impairment valuation, which was to compare the fair value of its reporting units with the carrying amount of the reporting units. Because the fair value of the reporting units exceeded the carrying value of the units, no indication of reporting unit goodwill impairment existed. As a result, performance of the second step of the transitional impairment test described above was not necessary, and no impairment loss will be recognized as a cumulative effect of a change in accounting principle in the Company’s 2002 consolidated statement of income.

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COMMERCE BANCSHARES, INC. AND SUBSIDIARIES

 
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
June 30, 2002
(Unaudited)

      The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes and with the statistical information and financial data appearing in this report as well as the Company’s 2001 Annual Report on Form 10-K. Results of operations for the three and six month periods ended June 30, 2002, are not necessarily indicative of results to be attained for any other period.

FORWARD LOOKING INFORMATION

      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, and competition with other entities that offer financial services.

CRITICAL ACCOUNTING POLICIES

      Critical accounting policies are those which are both most important to the portrayal of the Company’s financial condition and results, and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company’s critical accounting policy relates to the allowance for loan losses and involves significant management valuation judgments. The Company performs periodic and systematic detailed reviews of its lending portfolio to assess overall collectability. The level of the allowance for loan losses reflects the Company’s estimate of the collectability of the loan portfolio. Further discussion of the methodologies used in establishing this reserve is contained in the Provision and Allowance for Loan Losses section of this report. In addition, see the Summary of Significant Accounting Policies note to consolidated financial statements in the 2001 Annual Report on Form 10-K for further discussion.

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SELECTED FINANCIAL DATA

                                   
Three Months Six Months Ended
Ended June 30 June 30
2002 2001 2002 2001
Per Share Data
                                
 
Net income—basic
  $ .76     $ .69     $ 1.48     $ 1.36  
 
Net income—diluted
    .75       .68       1.46       1.34  
 
Cash dividends
    .163       .152       .325       .305  
 
Book value
                    20.98       18.46  
 
Market price
                    44.24       35.14  
Selected Ratios
                                
(Based on average balance sheets)
                               
 
Loans to deposits
    78.12 %     83.39 %     78.11 %     84.96 %
 
Non-interest bearing deposits to total deposits
    9.74       13.49       9.63       13.66  
 
Equity to loans
    17.38       15.29       17.22       15.06  
 
Equity to deposits
    13.57       12.75       13.45       12.79  
 
Equity to total assets
    11.00       10.40       10.80       10.42  
 
Return on total assets
    1.65       1.58       1.60       1.58  
 
Return on realized stockholders’ equity*
    15.62       15.60       15.42       15.54  
 
Return on total stockholders’ equity
    15.05       15.23       14.85       15.21  
(Based on end-of-period data)
                               
 
Efficiency ratio
    57.74       58.50       58.72       58.35  
 
Tier I capital ratio
                    12.98       12.82  
 
Total capital ratio
                    14.38       14.21  
 
Leverage ratio
                    10.39       9.88  

*  Excludes net unrealized holding gains on available for sale securities from average stockholders’ equity

RESULTS OF OPERATIONS

Summary

                                                   
Three Months Ended June 30 Six Months Ended June 30
2002 2001 % Change 2002 2001 % Change
(Dollars in thousands)
Net interest income
  $ 124,388     $ 117,649       5.7 %   $ 244,981     $ 234,545       4.4 %
Provision for loan losses
    (6,668 )     (7,992 )     (16.6 )     (14,067 )     (17,522 )     (19.7 )
Non-interest income
    69,816       70,676       (1.2 )     138,984       137,540       1.0  
Non-interest expense
    (112,996 )     (111,719 )     1.1       (227,018 )     (219,855 )     3.3  
Income taxes
    (24,434 )     (22,831 )     7.0       (45,862 )     (45,048 )     1.8  
     
     
     
     
     
     
 
 
Net income
   $ 50,106     $ 45,783       9.4 %   $ 97,018     $ 89,660       8.2 %
     
     
     
     
     
     
 

      Consolidated net income for the second quarter of 2002 was $50.1 million, a $4.3 million or 9.4% increase over the second quarter of 2001. Diluted earnings per share increased 10.3% to $.75 for the second quarter of 2002, compared to $.68 for the second quarter of 2001. The increase in net income was mainly the result of an increase in net interest income, coupled with a lower provision for loan losses. Stable interest rates, growth in overall earning assets, and continued repricing of certificate of deposit accounts contributed to the improvement in the net interest margin in the current quarter. Non-interest income decreased 1.2%, while non-interest expense increased 1.1% compared to the second quarter of last year. Return on average assets for the current

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quarter was 1.65% compared to 1.58% for the second quarter of 2001. Return on average realized stockholders’ equity was 15.62% compared to 15.60% in the same quarter of last year. The Company’s efficiency ratio was 57.74% for the second quarter of 2002 compared to 58.50% for the second quarter of 2001.

      Consolidated net income for the first six months of 2002 was $97.0 million, an 8.2% increase over the first six months of 2001. Diluted earnings per share was $1.46 compared to $1.34 for the first six months of last year, an increase of 9.0%. Net interest income rose $10.4 million, or 4.4%, while the provision for loan losses declined $3.5 million. Non-interest income, excluding gains and losses on securities transactions, grew 2.6%, and non-interest expense, excluding goodwill amortization, increased 4.4%. The efficiency ratio for the first six months of 2002 was 58.72% compared to 58.35% in 2001.

      The Company’s most recent bank acquisition was effective March 1, 2001, when Centennial Bank was acquired. The bank was located in the metropolitan St. Louis area, and at acquisition had assets of $254 million, loans of $189 million, and deposits of $216 million. The Company issued common stock valued at $34.4 million as consideration in the transaction. The acquisition was accounted for as a pooling of interests; however, the Company’s financial statements were not restated since restated amounts did not differ materially from the Company’s historical results.

Net Interest Income

      The following table summarizes the changes in net interest income on a fully tax 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. Management believes this allocation method, applied on a consistent basis, provides meaningful comparisons between the respective periods.

Analysis of Changes in Net Interest Income

                                                     
Three Months Ended Six Months Ended
June 30, 2002 vs. 2001 June 30, 2002 vs. 2001
Change due to Change due to
Average Average Average Average
Volume Rate Total Volume Rate Total
(In thousands)
Interest income,fully taxable equivalent basis:
                                                
Loans
  $ (3,420 )   $ (32,394 )   $ (35,814 )   $ (8,755 )   $ (72,309 )   $ (81,064 )
Investment securities:
                                               
 
U.S. government and federal agency securities
    3,846       (2,216 )     1,630       10,045       (7,468 )     2,577  
 
State and municipal obligations
    (361 )     22       (339 )     (751 )     101       (650 )
 
CMO’s and asset-backed securities
    14,955       (3,818 )     11,137       34,180       (7,994 )     26,186  
 
Other securities
    188       (774 )     (586 )     1,330       (2,330 )     (1,000 )
     
     
     
     
     
     
 
   
Total interest on investment securities
    18,628       (6,786 )     11,842       44,804       (17,691 )     27,113  
     
     
     
     
     
     
 
Federal funds sold and securities purchased under agreements to resell
    (5,442 )     (573 )     (6,015 )     (11,833 )     (1,692 )     (13,525 )
     
     
     
     
     
     
 
   
Total interest income
    9,766       (39,753 )     (29,987 )     24,216       (91,692 )     (67,476 )
     
     
     
     
     
     
 

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Three Months Ended Six Months Ended
June 30, 2002 vs. 2001 June 30, 2002 vs. 2001
Change due to Change due to
Average Average Average Average
Volume Rate Total Volume Rate Total
(In thousands)
Interest expense:
                                                
Deposits:
                                               
 
Savings
    89       (359 )     (270 )     226       (1,180 )     (954 )
 
Interest bearing demand
    1,663       (16,659 )     (14,996 )     4,661       (42,783 )     (38,122 )
 
Time open & C.D.’s of less than $100,000
    (3,188 )     (10,986 )     (14,174 )     (3,747 )     (20,596 )     (24,343 )
 
Time open & C.D.’s of $100,000 and over
    1,992       (4,677 )     (2,685 )     4,335       (8,919 )     (4,584 )
     
     
     
     
     
     
 
   
Total interest on deposits
    556       (32,681 )     (32,125 )     5,475       (73,478 )     (68,003 )
     
     
     
     
     
     
 
Federal funds purchased and securities sold under agreements to repurchase
    (732 )     (3,147 )     (3,879 )     547       (9,017 )     (8,470 )
Long-term debt and other borrowings
    2,103       (2,733 )     (630 )     4,604       (5,948 )     (1,344 )
     
     
     
     
     
     
 
   
Total interest expense
    1,927       (38,561 )     (36,634 )     10,626       (88,443 )     (77,817 )
     
     
     
     
     
     
 
Net interest income, fully taxable equivalent basis
   $ 7,839     $ (1,192 )   $ 6,647     $ 13,590     $ (3,249 )   $ 10,341  
     
     
     
     
     
     
 

      Net interest income for the second quarter of 2002 was $124.4 million, a 5.7% increase over the second quarter of 2001, and for the first six months was $245.0 million, a 4.4% increase over last year. For the quarter, the net interest rate margin was 4.47% compared with 4.44% last year, while the six month margin was 4.40% in 2002 and 4.52% in 2001.

      Total interest income in the current quarter decreased $29.9 million compared to the second quarter of 2001. During the second half of 2001, the Federal Reserve aggressively reduced interest rate levels, however, since January 1, 2002, the Federal Reserve has not changed the federal funds target rate, nor has the prime rate changed. As a result of these rate changes, during the second half of 2001 interest rates on large sections of the Company’s business, business real estate, home equity, and credit card loan portfolios repriced downward, causing a decline in interest income. Average rates on loans declined 167 basis points from the second quarter of 2001. Also, average loan balances decreased $201.3 million, or 2.6%, from the second quarter of 2001, contributing to the decrease in interest income. Partially offsetting the effects of lower loan balances and lower interest rates was an increase of $1.23 billion, or 55.9%, in investment securities balances. The average tax equivalent yield on interest earning assets was 5.85% for the second quarter of 2002 compared to 7.27% last year.

      Compared to the first six months of 2001, total interest income decreased $67.3 million. The decline reflects the same trends noted above in the quarterly comparison, with declines in average overall yields and loan balances partly offset by higher balances in investment securities. Average tax equivalent yields on interest earning assets for the six months were 5.87% in 2002 and 7.58% in 2001.

      For the three months ended June 30, 2002, total interest expense (net of capitalized interest) decreased $36.6 million compared to the same quarter last year. This was due mainly to the reduction in deposit rates (as described above) in all interest bearing deposit categories, which decreased 171 basis points overall. In addition, average rates paid on overnight borrowings and other debt declined 243 basis points. The average cost of funds was 1.59% for the second quarter of 2002, compared to 3.36% for the second quarter of 2001.

      Total interest expense decreased $77.7 million in the first six months of 2002 compared to 2001. Average rates paid on deposit balances declined 188 basis points, and rates paid on other borrowings declined 289 basis points. Higher balances in certificates of deposit of over $100,000, money market accounts, and borrowings from the Federal Home Loan Bank (FHLB) partly offset the effect of the decline in rates. The overall average cost of funds for the six month period decreased from 3.65% in 2001 to 1.68% in 2002.

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      Summaries of average assets and liabilities and the corresponding average rates earned/paid are located at the end of this discussion.

Non-Interest Income

                                                   
Three Months Ended June 30 Six Months Ended June 30
2002 2001 % Change 2002 2001 % Change
(Dollars in thousands)
Trust fees
  $ 15,774     $ 16,790       (6.1 )%   $ 31,213     $ 31,992       (2.4 )%
Deposit account charges and other fees
    22,793       21,355       6.7       43,886       40,584       8.1  
Credit card transaction fees
    14,229       13,695       3.9       27,112       26,402       2.7  
Trading account profits and commissions
    3,826       3,578       6.9       7,871       7,430       5.9  
Mortgage banking revenue
    1,066       1,432       (25.6 )     1,637       3,127       (47.6 )
Net gains (losses) on securities transactions
    (328 )     510       N.M.       (292 )     1,747       N.M.  
Other
    12,456       13,316       (6.5 )     27,557       26,258       4.9  
     
     
     
     
     
     
 
 
Total non-interest income
   $ 69,816     $ 70,676       (1.2 )%   $ 138,984     $ 137,540       1.0 %
     
     
     
     
     
     
 
As a % of operating income (net interest income plus non-interest income)
    35.9 %     37.5 %             36.2 %     37.0 %        
     
     
             
     
         

      Non-interest income for the six months ended June 30, 2002, increased $1.4 million over the same period last year. Deposit account charges and other fees increased $3.3 million, or 8.1%, over the first six months of 2001, mainly due to growth in corporate cash management fees. Credit card transaction fees rose $710 thousand, mainly due to higher cardholder and debit card fees, partly offset by lower merchant fees. Trading revenue rose by $441 thousand, or 5.9% over the prior six month period. Trust fees decreased $779 thousand, mainly due to large, one-time, probate fees in 2001 and declining asset valuations. Mortgage banking revenue declined $1.5 million, resulting from lower gains on sales of mortgage loans and fair value adjustments on mortgage commitments and related contracts. Securities transactions resulted in net losses of $292 thousand in the first six months of 2002, due mainly to a $700 thousand loss relating to a venture capital investment. During the first six months of 2001, bank portfolio gains of $4.8 million were partly offset by venture capital investment losses of $3.1 million.

      Other non-interest income grew $1.3 million, or 4.9%, over the first six months of 2001 mainly as a result of growth in brokerage related fees (fees from annuity, mutual fund and money market sweep sales), in addition to gains on bank branch and facility sales. These increases were partly offset by a loss incurred from a venture capital partnership. Total brokerage related fees grew $1.7 million, or 32%, mainly on stronger sales in all three areas. During the first six months of 2002, the Company sold its minority interest in a community bank, two bank branches in rural Kansas, and a banking facility in the St. Louis area for gains of $1.5 million, $1.7 million, and $701 thousand, respectively. In comparison, a gain of $1.5 million was recorded in the same period in 2001 on the sale of a banking facility in the St. Louis area. Also, income from a venture capital partnership investment declined $1.9 million as a result of investment losses realized by the partnership this year and non-recurring income of $1.5 million recognized last year due to partnership restructuring.

      For the second quarter of 2002, non-interest income totaled $69.8 million compared with $70.7 million in the same quarter of last year, a decrease of $860 thousand, or 1.2%. Excluding securities transactions, non-interest income was essentially flat compared with the prior year. Trust fees decreased $1.0 million and deposit account charges increased $1.4 million as a result of the same trends as noted above in the six month comparisons. Credit card transaction fees rose $534 thousand, or 3.9%, due to debit card fee growth of 18.3%, partly offset by lower merchant fees, which were constrained by a combination of lower retail sales and lower profit margins. Trading revenue exceeded results in the second quarter of last year by 6.9%. Mortgage banking

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revenue declined $366 thousand because of lower gains on loan sales to the secondary market. Net securities losses amounted to $328 thousand in the second quarter of 2002 compared to net gains of $510 thousand in the second quarter of last year. The loss in the current quarter resulted from the $700 thousand write-down of the venture capital investment mentioned above.

      Other non-interest income declined $860 thousand, or 6.5%, from the second quarter of 2001. This decrease was mainly the result of the venture capital partnership transactions, partly offset by the gains on the bank branch and facility sales, as discussed in the six month comparison above.

Non-Interest Expense

                                                   
Three Months Ended June 30 Six Months Ended June 30
2002 2001 % Change 2002 2001 % Change
(Dollars in thousands)
Salaries and employee benefits
  $ 61,066     $ 58,772       3.9 %   $ 124,701     $ 116,685       6.9 %
Net occupancy
    8,207       7,550       8.7       16,634       15,988       4.0  
Equipment
    6,003       5,527       8.6       11,114       11,155       (.4 )
Supplies and communication
    8,221       8,600       (4.4 )     16,164       16,610       (2.7 )
Data processing and software
    12,476       12,318       1.3       24,352       23,670       2.9  
Marketing
    3,628       3,571       1.6       6,996       6,388       9.5  
Goodwill amortization
    —       1,126       N.M.       —       2,323       N.M.  
Intangible assets amortization
    668       755       (11.5 )     1,392       1,506       (7.6 )
Other
    12,727       13,500       (5.7 )     25,665       25,530       .5  
     
     
     
     
     
     
 
 
Total non-interest expense
   $ 112,996     $ 111,719       1.1 %   $ 227,018     $ 219,855       3.3 %
     
     
     
     
     
     
 

      Non-interest expense rose $7.2 million, or 3.3%, over the first six months of 2001. Salaries and employee benefits increased $8.0 million, or 6.9%, due to higher medical and pension plan costs, salary merit increases, and higher incentive expense. Full-time equivalent employees totaled 5,021 and 5,113 at June 30, 2002 and 2001, respectively. Occupancy, equipment, supplies and communication, and data processing costs showed solid expense control. Data processing and software costs increased mainly due to a final contract termination payment of $1.7 million in the second quarter to an outside service provider as part of a project to internalize the mainframe computer operation. Even with this payment, outside data processing and software costs grew only $682 thousand as cost efficiencies from this project began to be realized. Goodwill amortization, which amounted to $2.3 million in the first six months of 2001, was discontinued in 2002, as required by a recent accounting pronouncement.

      For the three months ended June 30, 2002, non-interest expense increased $1.3 million, or 1.1%, compared to the second quarter of 2001. Salaries and employee benefits increased $2.3 million, or 3.9%, as a result of higher medical and pension plan costs. Occupancy expense rose $657 thousand, or 8.7%, due to increases in rent and depreciation expense on premises. Smaller increases occurred in the equipment, marketing and data processing expense categories, with a decrease in supplies and communication expense. Goodwill amortization, which was discontinued as mentioned above, decreased $1.1 million. Other non-interest expense declined $773 thousand from the second quarter of 2001, mainly due to charges of $1.5 million recorded in 2001 related to partnership restructuring expense referred to previously, but were partly offset by higher professional fees and sales tax expense in the current quarter.

      The efficiency ratio was 57.74% in the second quarter of 2002 compared to 58.17% (excluding the partnership restructuring adjustments) in the second quarter of 2001 and 59.72% in the first quarter of 2002.

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Provision and Allowance for Loan Losses

                                             
Three Months Ended Six Months Ended
June 30
June 30 June 30 March 31
2002 2001 2002 2002 2001
(Dollars in thousands)
Provision for loan losses
  $ 6,668     $ 7,992     $ 7,399     $ 14,067     $ 17,522  
     
     
     
     
     
 
Net loan charge-offs (recoveries):
                                       
 
Business
    1,118       884       1,361       2,479       3,334  
 
Credit card
    4,309       5,355       4,292       8,601       10,179  
 
Personal banking
    1,472       1,713       1,669       3,141       4,017  
 
Real estate
    (231 )     11       77       (154 )     (153 )
     
     
     
     
     
 
   
Total net loan charge-offs
  $ 6,668     $ 7,963     $ 7,399     $ 14,067     $ 17,377  
     
     
     
     
     
 
Annualized total net charge-offs as a percentage of average loans
    .35 %     .40 %     .39 %     .37 %     .44 %
     
     
     
     
     
 

      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 an allocated and an unallocated component. To determine the allocated component of the allowance, the Company combines estimates of the reserves needed for loans evaluated on an individual basis with estimates of reserves needed for pools of loans with similar risk characteristics. This process uses tools such as the “watch loan list”, loss experience, and migration models. To mitigate the imprecision in the estimation of the allocated component, specifically calculated reserve amounts are supplemented by an unallocated component. The unallocated component includes management’s determination of the amounts necessary to offset credit risk issues associated with loan concentrations, economic uncertainties, industry concerns, adverse market changes in estimated or appraised collateral values, and other subjective factors.

      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 specific loan evaluation process, including that of its regulators.

      Net loan charge-offs were $14.1 million in the first six months of 2002, a $3.3 million decrease from the same period in the prior year. The decline resulted from lower charge-offs on credit card, personal banking, and business loans, in addition to higher credit card recoveries. Total net charge-offs for the first six months of 2002 were .37% of total average loans, compared to .44% for the same period in 2001.

      Net loan charge-offs for the second quarter of 2002 amounted to $6.7 million compared to $7.4 million in the first quarter of 2002 and $8.0 million in the second quarter of last year. The ratio of net charge-offs to average loans was .35% in the current quarter compared with .39% in the first quarter of 2002 and .40% in the second quarter of 2001. The decrease in net loan charge-offs in the current quarter compared to the first quarter of this year resulted from higher recoveries on business, business real estate and credit card loans and lower charge-offs on personal banking loans. Compared to the second quarter of 2001, the reduction in net charge-offs was the result of lower losses on credit card loans of $1.0 million. Lower delinquency rates, improved underwriting controls and fewer bankruptcies on credit card and personal banking loans were responsible for lower credit losses. For the second quarter of 2002, net charge-offs on average credit card loans amounted to 3.60% compared with 3.58% in the first quarter of this year and 4.41% in the second quarter of 2001. Personal banking loan net charge-offs were .37% of average personal loans this quarter compared to .43% in the first quarter this year.

      The provision for loan losses was $14.1 million in the first six months of 2002 compared to $17.5 million in the same period in 2001. The provision for loan losses for the second quarter of 2002 totaled $6.7 million, down from $7.4 million in the first quarter of 2002 and $8.0 million in the second quarter of 2001.

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      The allowance for loan losses at June 30, 2002, was $130.0 million, or 1.68% of total loans, and represented 450% of total non-performing assets. The Company considers the allowance for loan losses adequate to cover losses inherent in the loan portfolio at June 30, 2002.

Risk Elements of Loan Portfolio

      The following table presents non-performing assets and loans which are past due 90 days and still accruing interest. Non-performing assets include non-accruing loans and foreclosed real estate. Loans are placed on non-accrual status when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment. These generally are loans that are 90 days past due as to principal and/or interest payments, unless both well-secured and in the process of collection, or are 1-4 family first mortgage loans or consumer loans that are exempt under regulatory rules from being classified as non-accrual. Those loans, anticipated to be collected, are included in the totals below for loans past due 90 days and still accruing interest.

                   
June 30 December 31
2002 2001
(Dollars in thousands)
Non-accrual loans
  $ 27,243     $ 28,819  
Foreclosed real estate
    1,660       1,949  
     
     
 
 
Total non-performing assets
  $ 28,903     $ 30,768  
     
     
 
Non-performing assets to total loans
    .37 %     .40 %
Non-performing assets to total assets
    .23 %     .24 %
Loans past due 90 days and still accruing interest
  $ 20,630     $ 19,699  
     
     
 

Income Taxes

      The Company’s income tax expense was $45.9 million in the first six months of 2002 and $45.0 million in the first six months of 2001, resulting in effective tax rates of 32.1% and 33.4%, respectively. The effective tax rate for the second quarter of 2002 was 32.8% compared with 31.4% in the first quarter of 2002 and 33.3% in the second quarter of 2001. The lower effective tax rates in 2002 compared with 2001 were impacted by both the elimination of non-deductible goodwill amortization, and the additional accrual of state and Federal rehabilitation credits to be received on the renovation of a downtown Kansas City office building.

FINANCIAL CONDITION

Balance Sheet

      Total assets of the Company were $12.3 billion at June 20, 2002 compared to $12.9 billion at December 31, 2001, a decrease of 4.6%. Earning assets at June 30, 2002 totaled $11.4 billion, composed of loans (68%), investment securities (32%) and short term investments in federal funds sold and securities purchased under agreements to resell.

      During the first six months of 2002, loans increased $90.7 million, or 1.2%, over balances at December 31, 2001. The increase was the result of higher personal banking, construction, and business loans, but partly offset by lower real estate loans. The region’s economy remains sluggish and customers with lines of credit to finance inventories and receivables have been slow to add new debt. The same remains true for other commercial lending activities. Personal real estate loans decreased $49.7 million from the year end balance, continuing the trend whereby principal amortization, coupled with lower origination of variable rate loans, resulted in lower loan balances. Long term fixed rate real estate loans originated by the Company are routinely sold to the secondary market. During the first six months of 2002, personal loans, mainly automobile lending, grew $115.4 million. The completion of major incentive programs offered by the auto companies over the last six months allowed the Company to offer more competitive products and increase loan balances.

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      Available for sale investment securities decreased $194.3 million at June 30, 2002, compared to December 31, 2001. Most of the decrease resulted from lower amounts invested in short term mutual funds by bank subsidiaries. The proceeds were used mainly to make new loans and reduce outstanding debt. The total investment securities portfolio amounted to $3.54 billion at June 30, 2002, and was comprised mainly of U.S. government and agencies (33%), mortgage-backed (38%), and other asset-backed (22%) investment securities.

      Total deposits decreased $197.9 million at June 30, 2002, compared to December 31, 2001. Non-interest bearing demand deposits declined $241.9 million, mainly in business deposits. Interest bearing deposits rose $44.0 million due to growth in money market accounts and short term certificates of deposit of $100,000 and over, partly offset by lower long term retail certificates of deposit.

      During the first half of 2002, borrowings decreased $467.8 million from 2001 year end balances. Short term borrowings of federal funds purchased and securities sold under agreements to repurchase declined $416.0 million, and a $50.0 million advance from the FHLB was repaid.

Liquidity and Capital Resources

      Liquidity represents the Company’s ability to obtain cost-effective funding to meet the needs of customers as well as the Company’s financial obligations. Liquidity can be provided through the subsidiary banks’ sale and maturity of federal funds sold and securities purchased under agreements to resell, in addition to their available for sale investment securities portfolio. These liquid assets had a fair value of $3.25 billion at June 30, 2002, which included $581.5 million pledged to secure public deposits, discount window borrowings, and other purposes as required by law. Within the next twelve months, approximately $319.7 million, or 10%, of the banks’ available for sale portfolio will mature. The available for sale bank portfolio included an unrealized net gain in fair value of $87.0 million at June 30, 2002 compared to an unrealized net gain of $29.4 million at December 31, 2001. Liquidity can also be obtained through secured advances from the FHLB, of which certain subsidiary banks are members. These borrowings are generally secured by residential mortgages and mortgage-backed securities. Advances outstanding amounted to $375.1 million at December 31, 2001 and $324.9 million at June 30, 2002. Most of the advances are payable during 2002 and 2003. An additional $120.2 million is available under the FHLB lines of credit.

      The liquid assets of the Parent consist primarily of U.S. federal agency securities, commercial paper, securities purchased under agreements to resell, and marketable corporate stock, including investments in mutual funds. The fair value of these assets was $223.7 million at June 30, 2002 compared to $175.2 million at December 31, 2001. Included in the fair values were unrealized net gains of $31.2 million at June 30, 2002, and $32.6 million at December 31, 2001. The Parent’s liabilities totaled $8.8 million at June 30, 2002, compared to $13.4 million at December 31, 2001. The Parent had no short-term borrowings from affiliate banks or long-term debt during 2002. The Parent’s commercial paper, which management believes is readily marketable, has a P1 rating from Moody’s and an A1 rating from Standard & Poor’s. The Company’s commercial paper is unissued, however, this credit availability should provide adequate funds to meet any outstanding or future commitments of the Parent.

      In February 2002, the Board of Directors re-approved a plan to authorize the Company to purchase up to 3 million shares of common stock. During the first six months of 2002, the Company purchased approximately 540 thousand shares at an average cost of $44.29. The Company has routinely used these reacquired shares to fund annual stock dividends and various stock option programs.

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      The Company had an equity to asset ratio of 10.80% based on 2002 average balances. As shown in the following table, the Company’s capital exceeded the minimum risk-based capital and leverage requirements of the regulatory agencies.

                         
Minimum
Ratios for
Well-Capitalized
June 30, 2002 December 31, 2001 Banks
(Dollars in thousands)
Risk-Adjusted Assets
  $ 9,614,687     $ 9,634,566          
Tier I Capital
    1,247,791       1,182,661          
Total Capital
    1,382,114       1,313,857          
Tier I Capital Ratio
    12.98 %     12.28 %     6.00 %
Total Capital Ratio
    14.38 %     13.64 %     10.00 %
Leverage Ratio
    10.39 %     9.81 %     5.00 %

      The following is a discussion of cash flows; these amounts are based on cash flows that exclude changes resulting from bank acquisitions and branch dispositions. The Company’s cash and cash equivalents (defined as “Cash and due from banks” on the accompanying balance sheets) were $610.6 million at June 30, 2002, a decrease of $213.6 million from December 31, 2001. Contributing to the net cash outflow were a net decrease of $416.0 million in borrowings of federal funds purchased and repurchase agreements, and a decrease of $192.0 million in deposits. Loan balances, net of repayments, increased $114.8 million. In addition, FHLB debt of $50.0 million was repaid. These cash outflows were partly offset by a decrease of $338.9 million in short-term investments in federal funds sold and securities purchased under agreements to resell, $239.9 million in maturities and sales of investment securities (net of purchases), and $74.7 million generated from operating activities.

      The Company has various commitments and contingent liabilities which, in accordance with generally accepted accounting principles, are properly not reflected on the balance sheet. These include loan commitments (excluding derivative instruments and lines of credit related to credit cards) totaling approximately $3.05 billion, standby letters of credit totaling $314.5 million, and commercial letters of credit totaling $31.9 million at June 30, 2002.

Quantitative and Qualitative Disclosures about Market Risk

      Interest rate risk management focuses on maintaining consistent growth in net interest income within Board-approved policy limits. The Company mainly uses earnings simulation models to analyze net interest sensitivity to movement in interest rates. The table below shows the effect that gradual rising and/or falling interest rates over a twelve month period would have on the Company’s net interest income, given a static balance sheet.

                                 
June 30, 2002 December 31, 2001
$ Change in % Change in $ Change in % Change in
Net Interest Net Interest Net Interest Net Interest
Scenario Income Income Income Income
(Dollars in millions)
200 basis points rising
  $ (.5 )     (.11 )%   $ (7.6 )     (1.5 )%
100 basis points rising
    .6       .13       (3.6 )     (.7 )
100 basis points falling
    (3.6 )     (.72 )     2.3       .5  

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      As reported in the previous quarter, during the second half of 2001, increased liquidity resulting from a decline in loans and an increase in both deposits and short term borrowings was invested in fixed rate investment securities. While lower funding costs coupled with higher investment securities yields resulted in growth in net interest income, the Company became less asset-sensitive mainly because of the growth in fixed rate investment securities. Since December 2001, the Company’s risk position has become more neutral. The investment securities portfolio has experienced normal maturities of fixed rate bonds and variable rate loans have shown some growth, especially in the second quarter. Also, as interest rates rise in the future, rates on student loans, which vary with certain indices, will now reprice upward. Finally, over the last six months, deposit growth occurred in several non-maturity categories. These deposits normally do not reprice immediately or in the same manner as other interest rates change. All these factors resulted in reduced interest rate risk and a slight increase in the overall asset sensitivity of the Company’s balance sheet.

      For further discussion of the Company’s market risk, see the Management’s Discussion and Analysis of Financial Condition and Results of Operations — Interest Rate Sensitivity included in the Company’s 2001 Annual Report on Form 10-K.

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AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS

Six Months Ended June 30, 2002 and 2001

                                                       
Six Months 2002 Six Months 2001
Interest Avg.Rates Interest Avg.Rates
Average Income/ Earned/ Average Income/ Earned/
Balance Expense Paid Balance Expense Paid
(Unaudited)
(Dollars in thousands)
ASSETS:
Loans:
                                               
 
Business (A)
  $ 2,407,878     $ 57,924       4.85 %   $ 2,661,946     $ 97,206       7.36 %
 
Real estate — construction
    459,033       11,787       5.18       404,817       15,948       7.94  
 
Real estate — business
    1,463,383       44,263       6.10       1,353,458       53,122       7.91  
 
Real estate — personal
    1,261,859       42,703       6.82       1,372,314       51,414       7.56  
 
Personal banking
    1,576,045       55,091       7.05       1,604,556       67,073       8.43  
 
Credit card
    483,313       25,750       10.74       495,091       33,819       13.77  
     
     
     
     
     
     
 
   
Total loans
    7,651,511       237,518       6.26       7,892,182       318,582       8.14  
     
     
     
     
     
     
 
Investment securities:
                                               
 
U.S. government & federal agency
    1,130,230       26,820       4.79       799,250       24,243       6.12  
 
State & municipal obligations (A)
    39,543       1,570       8.01       59,717       2,220       7.50  
 
CMO’s and asset-backed securities
    2,105,706       57,350       5.49       1,004,651       31,164       6.26  
 
Trading securities
    10,597       271       5.17       17,477       514       5.93  
 
Other marketable securities (A)
    161,953       2,368       2.95       106,898       2,966       5.60  
 
Non-marketable securities
    52,709       1,040       3.98       53,062       1,199       4.56  
     
     
     
     
     
     
 
   
Total investment securities
    3,500,738       89,419       5.15       2,041,055       62,306       6.16  
     
     
     
     
     
     
 
Federal funds sold and securities purchased under agreements to resell
    107,153       952       1.79       585,168       14,477       4.99  
     
     
     
     
     
     
 
   
Total interest earning assets
    11,259,402       327,889       5.87       10,518,405       395,365       7.58  
             
     
             
     
 
Less allowance for loan losses
    (129,706 )                     (129,789 )                
Unrealized gain on investment securities
    79,049                       40,279                  
Cash and due from banks
    510,001                       534,368                  
Land, buildings and equipment, net
    324,172                       270,009                  
Other assets
    153,028                       175,519                  
     
                     
                 
   
Total assets
  $ 12,195,946                     $ 11,408,791                  
     
                     
                 
LIABILITIES AND EQUITY:
Interest bearing deposits:
                                               
 
Savings
  $ 351,112       1,121       .64     $ 316,526       2,075       1.32  
 
Interest bearing demand
    5,731,654       22,974       .81       4,977,535       61,096       2.48  
 
Time open & C.D.’s of less than $100,000
    2,109,880       39,121       3.74       2,227,889       63,464       5.74  
 
Time open & C.D.’s of $100,000 and over
    659,843       9,761       2.98       499,098       14,345       5.80  
     
     
     
     
     
     
 
   
Total interest bearing deposits
    8,852,489       72,977       1.66       8,021,048       140,980       3.54  
     
     
     
     
     
     
 
Borrowings:
                                               
 
Federal funds purchased and securities sold under agreements to repurchase
    601,829       3,758       1.26       577,501       12,228       4.27  
 
Long-term debt and other borrowings (B)
    376,477       5,211       2.79       220,861       6,555       5.99  
     
     
     
     
     
     
 
   
Total borrowings
    978,306       8,969       1.85       798,362       18,783       4.74  
     
     
     
     
     
     
 
     
Total interest bearing liabilities
    9,830,795       81,946       1.68 %     8,819,410       159,763       3.65 %
             
     
             
     
 
Non-interest bearing demand deposits
    943,540                       1,268,545                  
Other liabilities
    104,121                       132,423                  
Stockholders’ equity
    1,317,490                       1,188,413                  
     
                     
                 
   
Total liabilities and equity
  $ 12,195,946                     $ 11,408,791                  
     
                     
                 
Net interest margin (T/E)
          $ 245,943                     $ 235,602          
             
                     
         
Net yield on interest earning assets
                    4.40 %                     4.52 %
                     
                     
 

(A)  Stated on a tax equivalent basis using a federal income tax rate of 35%.

(B)  Interest expense capitalized on construction projects is not deducted from the interest expense shown above.

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AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS

Three Months Ended June 30, 2002 and 2001

                                                       
Second Quarter 2002 Second Quarter 2001
Interest Avg.Rates Interest Avg.Rates
Average Income/ Earned/ Average Income/ Earned/
Balance Expense Paid Balance Expense Paid
(Unaudited)
(Dollars in thousands)
ASSETS:
Loans:
                                               
 
Business (A)
  $ 2,433,479     $ 28,963       4.77 %   $ 2,649,699     $ 45,505       6.89 %
 
Real estate — construction
    477,822       6,069       5.09       417,986       7,775       7.46  
 
Real estate — business
    1,452,686       21,993       6.07       1,372,090       26,355       7.70  
 
Real estate — personal
    1,247,701       20,916       6.72       1,356,383       25,243       7.46  
 
Personal banking
    1,594,365       27,622       6.95       1,603,979       33,056       8.27  
 
Credit card
    479,981       12,524       10.47       487,238       15,967       13.14  
     
     
     
     
     
     
 
   
Total loans
    7,686,034       118,087       6.16       7,887,375       153,901       7.83  
     
     
     
     
     
     
 
Investment securities:
                                               
 
U.S. government & federal agency
    1,130,327       14,583       5.17       868,233       12,953       5.98  
 
State & municipal obligations (A)
    38,839       774       7.99       57,456       1,113       7.77  
 
CMO’s and asset-backed securities
    2,070,332       28,030       5.43       1,098,161       16,893       6.17  
 
Trading securities
    13,298       175       5.28       15,699       166       4.24  
 
Other marketable securities (A)
    123,165       979       3.19       106,966       1,452       5.44  
 
Non-marketable securities
    52,538       452       3.45       52,703       574       4.37  
     
     
     
     
     
     
 
   
Total investment securities
    3,428,499       44,993       5.26       2,199,218       33,151       6.05  
     
     
     
     
     
     
 
Federal funds sold and securities purchased under agreements to resell
    89,793       411       1.84       586,178       6,426       4.40  
     
     
     
     
     
     
 
   
Total interest earning assets
    11,204,326       163,491       5.85       10,672,771       193,478       7.27  
             
     
             
     
 
Less allowance for loan losses
    (129,416 )                     (130,526 )                
Unrealized gain on investment securities
    81,167                       46,003                  
Cash and due from banks
    510,470                       554,204                  
Land, buildings and equipment, net
    329,429                       277,374                  
Other assets
    148,148                       179,429                  
     
                     
                 
   
Total assets
  $ 12,144,124                     $ 11,599,255                  
     
                     
                 
LIABILITIES AND EQUITY:
Interest bearing deposits:
                                               
 
Savings
  $ 362,536       581       .64     $ 328,252       851       1.04  
 
Interest bearing demand
    5,757,529       11,520       .80       5,039,600       26,516       2.11  
 
Time open & C.D.’s of less than $100,000
    2,074,133       17,872       3.46       2,284,637       32,046       5.63  
 
Time open & C.D.’s of $100,000 and over
    686,203       4,743       2.77       529,716       7,428       5.62  
     
     
     
     
     
     
 
   
Total interest bearing deposits
    8,880,401       34,716       1.57       8,182,205       66,841       3.28  
     
     
     
     
     
     
 
Borrowings:
                                               
 
Federal funds purchased and securities sold under agreements to repurchase
    512,741       1,560       1.22       589,307       5,439       3.70  
 
Long-term debt and other borrowings (B)
    361,193       2,371       2.63       210,801       3,001       5.71  
     
     
     
     
     
     
 
   
Total borrowings
    873,934       3,931       1.80       800,108       8,440       4.23  
     
     
     
     
     
     
 
     
Total interest bearing liabilities
    9,754,335       38,647       1.59 %     8,982,313       75,281       3.36 %
             
     
             
     
 
Non-interest bearing demand deposits
    958,148                       1,275,874                  
Other liabilities
    96,181                       135,204                  
Stockholders’ equity
    1,335,458                       1,205,864                  
     
                     
                 
   
Total liabilities and equity
  $ 12,144,122                     $ 11,599,255                  
     
                     
                 
Net interest margin (T/ E)
          $ 124,844                     $ 118,197          
             
                     
         
Net yield on interest earning assets
                    4.47 %                     4.44 %
                     
                     
 

(A)  Stated on a tax equivalent basis using a federal income tax rate of 35%.

(B)  Interest expense capitalized on construction projects is not deducted from the interest expense shown above.

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PART II: OTHER INFORMATION
 
Item 4. Submission of Matters to a Vote of Security Holders.

      The annual meeting of shareholders of Commerce Bancshares, Inc. was held on April 17, 2002. Proxies for the meeting were solicited pursuant to Regulation 14 of the Securities Exchange Act of 1934, and there was no solicitation in opposition to management’s nominees, as listed in the proxy statement. The five nominees for the five directorships (constituting one-third of the Board of Directors) being elected at this meeting received the following votes:

                 
Name of Director Votes For Votes Withheld
John R. Capps
    50,952,134       52,019  
W. Thomas Grant, II
    47,732,334       3,271,819  
James B. Hebenstreit
    50,712,102       292,051  
Robert C. Matthews, Jr. 
     50,967,739       36,414  
William A. Sullins, Jr. 
     50,977,032       27,121  
 
Item 6. Exhibits and Reports on Form 8-K

      (a) Exhibits.

         
  (99.1)     Certification of CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  (99.2)     Certification of CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

      (b) No reports on Form 8-K were filed during the quarter ended June 30, 2002.

SIGNATURES

      Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

  COMMERCE BANCSHARES, INC.

  By  /s/ J. DANIEL STINNETT
 
  J. Daniel Stinnett
  Vice President & Secretary

Date: August 12, 2002

  By  /s/ JEFFERY D. ABERDEEN
 
  Jeffery D. Aberdeen
  Controller (Chief Accounting Officer)

Date: August 12, 2002

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