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UNITED STATES

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

COMMERCE BANCSHARES, INC.

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

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  X  No

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 checkmark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act.) þ

As of February 7, 2003, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $2,073,000,000.

As of February 7, 2003, there were 66,855,683 shares of Registrant’s $5 Par Value Common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement with respect to the annual meeting of shareholders to be held on April 16, 2003, are incorporated in Part III.

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Commerce Bancshares, Inc.

Form 10-K

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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 presently owns all of the outstanding capital stock of four national banking associations, which are headquartered in Missouri, Illinois, Kansas, and Nebraska. The Nebraska bank is limited in its activities to the issuance of credit cards. The remaining three banking subsidiaries engage in general banking business, providing a broad range of retail, corporate, investment and private banking products and services to individuals and businesses. The Company also owns, directly or through its banking subsidiaries, various non-banking subsidiaries. Their activities include owning real estate leased to the Company’s banking subsidiaries, underwriting credit life and credit accident and health insurance, selling property and casualty insurance (relating to consumer loans made by the banking subsidiaries), venture capital investment, securities brokerage, mortgage banking, and leasing activities. The Company owns two second tier holding companies that are the direct owners of several of the above mentioned banks. The table setting forth the names and locations of the Company’s subsidiaries is included as Exhibit 21 hereto.

      The Company is the largest bank holding company headquartered in Missouri. At December 31, 2002, the Company had consolidated assets of $13.3 billion, loans of $7.9 billion, deposits of $9.9 billion, and equity of $1.4 billion. Its 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.

      The Company’s Missouri bank charter is its largest, with total assets of $11.2 billion and offices in both Missouri and Kansas. The Missouri bank charter comprises approximately 84% of the banking assets of the Company. The Company’s bank charters in Kansas and Illinois operate within each of the states and have total assets of $1.2 billion and $914 million, respectively. The Kansas banking charter has significant operations and banking facilities mainly in the areas of Wichita, Hays, and Garden City, Kansas, along with facilities in the southeast Kansas area. The Illinois banking charter operates mainly in the Peoria and Bloomington, Illinois, areas.

      The markets these three banking charters serve, being centrally located in the Midwest, provide natural sites for production and distribution facilities and also serve as transportation hubs. The economy has been well-diversified with many major industries represented, including telecommunications, automobile manufacturing, aircraft manufacturing, numerous service industries, food production and agricultural production and related industries. The markets served by the Illinois bank are located in an area with some of the best land in the world for crop production. The three banking charters operate in areas with stable real estate markets, which in the past have avoided the volatile prices that other parts of the country have experienced.

      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 acquired The Vaughn Group, Inc. (Vaughn), a Cincinnati-based leasing company, on January 2, 2003. Vaughn has a lease portfolio of approximately $39 million, consisting mainly of data processing hardware. In addition, Vaughn services approximately $425 million of lease agreements for other institutions involving capital equipment ranging from production machinery to transportation equipment. The Company’s most recent bank acquisition was in March 2001, when Breckenridge Bancshares Company and its subsidiary, Centennial Bank, were acquired. For additional information on these acquisitions and other branch disposition activity, refer to pages 8 and 46.

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Operating Segments

      The Company is managed in three operating segments. The Consumer segment includes the retail branch network, consumer installment lending, bankcard, student lending, and discount brokerage services. It provides services through a network of 191 full-service branches, an extensive ATM network, and the use of alternative delivery channels such as PC Banking and telephone banking. In 2002, this segment contributed 48% of total segment pre-tax income. The Commercial segment provides a full array of corporate lending, leasing, and international services, as well as business, government deposit and cash management services. In 2002, it contributed 41% of total segment pre-tax income. The Money Management segment provides traditional trust and estate tax planning services, and advisory and discretionary investment portfolio management services. 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, 2002, the Money Management segment managed investments with a market value of $9.3 billion and administered an additional $7.4 billion in non-managed assets. Additional information relating to operating segments can be found on pages 28 and 60.

Supervision and Regulation

      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 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 nonbanking 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 nonbanking 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, each subsidiary 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 Missouri, Kansas and Nebraska bank charters have current CRA ratings of “outstanding”, and the Illinois charter has a “satisfactory” rating.

      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 four banking subsidiaries are organized as national banking associations and are subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (OCC). All banks are also subject to regulation by the Federal Deposit Insurance Corporation. In addition, there are numerous other federal and state laws and regulations which control the activities of the Company and its banking subsidiaries, 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. 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 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.

      Under Federal Reserve policy, the Company is expected to act as a source of financial strength to each of its bank subsidiaries and to commit resources to support each bank subsidiary in circumstances when it might not otherwise do so. 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 bank subsidiaries in any calendar year to the net profit of the current year combined with the retained net profits of the preceding two years. The payment of dividends by the bank subsidiaries may

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      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.

      In addition to its regulatory powers, the Federal Reserve impacts 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 had a significant effect on the operating results of financial institutions in the past, most notably the strong decrease in interest rates which occurred in 2001 and the low rate environment in 2002. 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.

Competition

      The Company’s locations in regional markets throughout Missouri, Kansas and central Illinois 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. 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 methods of competition center around various factors, such as customer services, interest rates on loans and deposits, lending limits and customer convenience, such as location of offices. 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.

Employees

      The Company and its subsidiaries employed 4,437 persons on a full-time basis and 773 persons on a part-time basis at December 31, 2002. The Company provides a variety of benefit programs including retirement and stock ownership plans 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.

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Statistical Disclosure

      The information required by Securities Act Guide 3 – “Statistical Disclosure by Bank Holding Companies” is located on the pages noted below.

      The Missouri, Illinois, and Kansas bank subsidiaries maintain their main offices in various multi-story office buildings. These are owned by the bank or a subsidiary of the bank. The banks lease unoccupied premises to the public. The buildings, located in the downtown areas of the major market they serve, include:

     The Nebraska credit card bank leases its offices in Omaha, Nebraska. Additionally, certain other installment loan and credit card functions operate out of leased offices in downtown Kansas City. The Company also has 185 branch locations in Missouri, Illinois and Kansas which are owned or leased, and an additional 148 off-site ATM locations.

      The information required by this item is set forth in Item 8 under the caption “Commitments and Contingencies” on page 67.

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      No matters were submitted during the fourth quarter of 2002 to a vote of security holders through the solicitation of proxies or otherwise.

Commerce Bancshares, Inc.

      The following table sets forth the high and low prices of actual transactions for the Company’s common stock (CBSH) and cash dividends paid for the periods indicated (restated for the 5% stock dividend distributed in December 2002).

      Commerce Bancshares, Inc. common shares are publicly traded on The Nasdaq Stock Market (NASDAQ). NASDAQ is a highly-regulated electronic securities market comprised of competing Market Makers whose trading is supported by a communications network linking them to quotation dissemination, trade reporting, and order execution systems. The Company had 5,081 shareholders of record as of December 31, 2002.

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      The required information is set forth below in Item 7.

      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

Selected Financial Data

Results of Operations

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      Commerce Bancshares, Inc. and Subsidiaries (the “Company”) announced record earnings in 2002 of $199.5 million, an increase of $17.5 million, or 9.6%, over last year. This was the eighteenth consecutive year of record earnings for the Company. Earnings per share on a fully diluted basis amounted to $2.89 in 2002 compared with $2.60 last year, or an increase of 11.2%. Return on assets amounted to 1.61% compared with 1.55% last year and the return on equity totaled 14.71% compared to 14.88% last year. The efficiency ratio was 57.94% in 2002 compared with 58.10% in 2001.

      The increase in net income over the previous year resulted from strong growth in net interest income of $31.2 million, or 6.7%, coupled with lower credit costs and good expense management. Non-interest income increased a modest 2.0% while non-interest expense grew by 3.4%. The provision for loan losses totaled $34.1 million and was 6.4% less than amounts recorded in the prior year. Net interest income grew mainly as a result of the continued re-pricing of deposit products, especially certificates of deposit, and overall growth in earning assets. The growth in non-interest income occurred mainly as a result of deposit account fees (up 8.1%), credit card fees (up 6.0%) and higher fees earned on bond and brokerage fees, offset by lower trust fees. Non-interest expense grew a modest 3.4% mainly as a result of growth in salaries and benefits of 6.1%, occupancy of 8.1% and higher costs for equipment and marketing. Offsetting these were lower costs for data processing, supplies, and goodwill amortization.

      Net income in 2001 was $182.0 million, which was a 1.9% increase compared to 2000. Diluted earnings per share was $2.60, an increase of 3.6% over 2000. The increase in net income over 2000 resulted from 7.6% growth in non-interest income and good control over non-interest expense. Net interest income declined 2.7% because of the slowing economy and strong interest rate reductions by the Federal Reserve. During 2001, the Federal Reserve reduced the federal funds target rate eleven times in an effort to stimulate a slowing economy. These actions had the related effect of reducing the prime rate from 9.5% in early January 2001 to 4.75% by year end. The rate reductions caused a significant portion of the Company’s earning assets to reprice downward faster than its interest bearing liabilities, resulting in lower net interest income. Non-interest income rose $19.4 million over 2000, mainly in the areas of deposit account charges, trust fees, and trading account profits. Non-interest expense increased $3.8 million, or .9%, and included a 7.0% increase in salaries and employee benefits. The provision for loan losses was $1.3 million higher than in the previous year mainly as a result of higher commercial loan losses.

      Effective January 2003, the Company acquired The Vaughn Group, Inc. (Vaughn), a leasing company based in Cincinnati, Ohio. Vaughn is a direct lessor with a lease portfolio of approximately $39 million consisting mainly of data processing hardware. In addition, Vaughn services approximately $425 million of lease agreements for other institutions, which involve capital equipment, ranging from production machinery to transportation equipment. The Company issued a combination of cash and stock to complete this purchase.

      In March 2001, the Company acquired Breckenridge Bancshares Company and its subsidiary, Centennial Bank. The bank had three locations in the St. Louis area, with assets of $254 million, loans of $189 million, and deposits of $216 million. Common stock valued at $34.4 million was issued by the Company as consideration in the transaction. The acquisition was accounted for as a pooling of interests transaction; however, the Company’s financial statements were not restated because restated amounts did not differ materially from historical results.

      The Company continually evaluates its network of bank branches throughout Missouri, Kansas and Illinois. As a result, the Company sold two bank branches and a separate branch facility during 2002. Pre-tax gains of $2.4 million were realized on these sales. These locations had loans of $15.0 million, deposits of $38.4 million, and premises of $2.9 million. In 2001, the Company sold the assets and liabilities of one bank branch and the premises of two other branches. Pre-tax gains of $2.2 million were realized on the 2001 sales, which included loans of $662 thousand, deposits of $5.3 million, and premises of $714 thousand. During 2000, the Company sold four bank branches with $42.7 million in loans and $71.5 million in deposits. Pre-tax gains of $5.9 million were realized on the 2000 transactions.

      During 2002, the Company’s investment in a venture capital limited partnership, previously accounted for on the equity method, was reclassified as a consolidated subsidiary. Financial statements for

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      The Company distributed a 5% stock dividend for the ninth consecutive year on December 13, 2002. All per share and average share data in this report has been restated to reflect the 2002 stock dividend.

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 policies relate to the allowance for loan losses, the valuation of certain non-marketable investments, and accounting for income taxes, all of which involve significant judgment by management.

      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. While these estimates are based on substantive methods for determining allowance requirements, nevertheless, actual outcomes may differ significantly from estimated results. Extensive explanation of the methodologies used in establishing this reserve is provided in the Allowance for Loan Losses section of this discussion.

      The Company, through its Small Business Investment subsidiaries, has numerous private equity and venture capital investments, which totaled $25.5 million at December 31, 2002. These private equity and venture capital securities are reported at estimated fair values in the absence of readily ascertainable fair values. Management believes that the cost of an investment is initially the best indication of estimated fair value unless there has been significant subsequent positive or negative developments that justify an adjustment to the fair value estimate. The values assigned to these securities where no market quotations exist are based upon available information and management’s judgment. Although management believes its estimates of fair value reasonably and conservatively reflect the fair value of these securities, key assumptions regarding the projected financial performance of 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.

      The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences, including the effects of IRS examinations and examinations by other state agencies, could materially impact the Company’s financial position and its results of operations.

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

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      Net interest income was $500.0 million in 2002, $468.8 million in 2001 and $481.6 million in 2000. Compared to the prior year, net interest income increased $31.2 million, or 6.7%, in 2002 compared to a decrease of $12.9 million, or 2.7%, in 2001. During 2002, the Company’s net interest income grew mainly as a result of the continued re-pricing of deposit products, especially certificates of deposit, and overall growth in earning assets. During the first three quarters of 2002, the interest rate environment remained somewhat stable, allowing for modest downward re-pricing of the Company’s loan portfolio. In addition, during 2002 average investment securities increased $1.12 billion, which added approximately $66 million in additional interest income. Also during the year, interest costs on interest bearing liabilities declined by approximately $136 million as a result of the re-pricing of almost all deposit products. With interest rates stable through October 2002, most of the re-pricing came from the Company’s certificate of deposit products, although certain money market deposits also began to re-price downward in late summer. In November 2002, the Federal Reserve lowered short-term rates by 50 basis points, which reduced interest income on large portions of the Company’s loan portfolio that were variably priced. Rates on deposits were

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      During 2001, a series of rate reductions by the Federal Reserve caused a significant portion of the Company’s earning assets to reprice downward. Most of these earning assets were loans, whose interest rates are tied to variable rate indices or the federal funds rate. While these rate reductions also allowed the deposit base to re-price downward, the overall decline in deposit rates was not enough to offset the effects of the change in asset rates. The net effect of the rate declines was to lower 2001 net interest income by $22.5 million. The changes in the economy also had an impact on growth in both earning assets and liabilities. Compared to 2000, average deposit balances increased 5.9% during 2001, while average loans were essentially flat. The added liquidity from the deposit growth was invested in the longer term fixed rate investment securities portfolio. This added to the earning asset base, which improved net interest income in 2001.

      The net yield on earning assets was 4.39% in 2002, 4.35% in 2001 and 4.74% in 2000. Average interest earning assets rose 5.7% in 2002 over 2001, compared to a 6.0% increase in 2001 over 2000. Average interest bearing liabilities increased 7.4% in 2002 compared to a 9.1% increase in 2001.

      Total interest income was $652.6 million in 2002, $751.8 million in 2001 and $813.1 million in 2000. Tax equivalent interest income did not materially differ. Interest income declined $99.2 million, or 13.2%, in 2002 compared to the previous year. This decline was primarily due to decreases in rates on all loan products as a result of the large reduction in rates occurring mainly in 2001, offset by growth in earning assets. Interest rates, which declined throughout 2001, had the impact of reducing interest income on variably priced loans. Also, fixed rate loans which matured or were originated in 2001 and 2002 were impacted by lower rates. Average loan balances, which earn higher rates, decreased $48.2 million and also contributed to the lower interest income. Rates on investment securities were lower as maturing securities were reinvested in lower earning securities, however, average balances of investment securities grew $1.12 billion, contributing approximately $66 million of additional interest income. At December 31, 2002, average balances of investment securities comprised 31% of average earning assets compared to 23% in 2001. This growth helped to offset the effect of the lower rates described above. Average loans decreased slightly in 2002 compared to 2001, and comprised 68% of average earning assets, down from 72% in 2001.

      Total interest income declined $61.3 million, or 7.5% in 2001 compared to 2000. Average loan balances were flat in 2001 compared to 2000, while loan yields declined 94 basis points. Increased liquidity provided by deposit growth allowed the Company to purchase investment securities, which increased an average of $291.3 million, and overnight investments in federal funds and repurchase agreements, which increased $314.3 million. However, average rates earned on investment securities and overnight investments fell 59 and 225 basis points, respectively, during 2001. The effect of interest rate declines on earning assets, especially loan rates, more than offset the income provided by higher average investment balances.

      Total interest expense was $152.6 million in 2002, $283.0 million in 2001 and $331.5 million in 2000. Interest expense declined $130.4 million, or 46.1%, in 2002 compared to 2001. The average rate paid on interest bearing liabilities was 1.54% in 2002 compared to 3.06% in 2001. The lower interest rate environment described above resulted in an interest rate decline of 148 basis points on deposits, 191 basis points on overnight borrowings, and 212 basis points on longer-term borrowings. The decline in deposit rates affected all deposit products, with the largest effect on the Company’s Premium Money Market deposit accounts, where rates declined 194 basis points. A decline of $213.1 million in average retail certificates of deposit also contributed to lower interest expense. However, the average balance of interest checking and money market deposits rose $509.4 million, or 9.7%, during 2002.

      In 2001, interest expense decreased $48.4 million, or 14.6%, from 2000. The decrease was due to rate declines of 68 basis points on deposits, 259 basis points on overnight borrowings, and 165 basis points on longer-term borrowings. The decline in deposit interest resulted mainly from rate reductions of 176 basis points paid on the Company’s Premium Money Market deposit accounts. Average interest bearing deposits grew $756.3 million, or 9.9%, during 2001.

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Provision for Loan Losses

      The provision for loan losses was $34.1 million in 2002, compared with $36.4 million in 2001 and $35.2 million in 2000. The provision for loan losses is recorded to bring the allowance for loan losses to a level deemed appropriate by management based on the factors mentioned in the following “Allowance for Loan Losses” section of this discussion.

Non-Interest Income

     Non-interest income increased $5.6 million, or 2.0%, during 2002 to $280.6 million. Trust fees declined $2.1 million, or 3.3%, because of the continuing decline in the value of trust account assets upon which fees are based. Most of the decline in trust fees occurred in the personal trust product line, while institutional trust fees increased somewhat. Deposit account fees increased 8.1%, or $6.8 million, in 2002 due to higher fee income in commercial cash management accounts and fees earned on deposit account overdrafts. Credit card fees increased $3.3 million, or 6.0%, mainly due to continuing growth in debit card fee income, which rose 15.0% over the previous year. Also, fees on credit cardholder transactions increased 7.2%. Trading account fees, which consist of fees from sales of fixed income securities, rose 4.1%, and were strong all year as a result of sustained demand by business and correspondent bank customers. Consumer brokerage service fees increased 5.8% on sales of annuities by the discount brokerage subsidiary. Mortgage banking revenues declined $1.9 million as a result of lower sales of mortgages to upstream correspondent banks. During the year, the Company retained more 15 year fixed rate loans it originated on its balance sheet than in previous years. This reduced sales to upstream banks and reduced profit. The Company continues to originate and sell all long-term fixed rate loans in excess of 15 years to upstream banks. Net gains on securities transactions amounted to $2.8 million in 2002, a decrease of $305 thousand from the previous year. Current year activity included gains of $6.0 million resulting from sales from the banks’ securities portfolios and losses of $3.2 million recognized on venture capital investments. Other non-interest income included a $1.5 million gain on the sale of the Company’s minority interest in an Illinois community bank. Also included were gains on sales of student loans. Student loan balances of $133.3 million were sold in 2002 compared to $233.3 million in 2001, which resulted in lower gains of $1.5 million. Sales of bank branches and facilities were comparable in 2002 and 2001, with gains of $2.4 million recorded in 2002 and $2.2 million in 2001.

      In 2001, non-interest income totaled $275.0 million, which was a $19.4 million, or 7.6%, increase over 2000. Deposit account fees increased $13.5 million, or 19.0%, mainly due to growth in overdraft fees and commercial cash management revenue. Trust fees increased $4.2 million as a result of stronger personal trust business and included approximately $1.2 million in probate fees received from one trust customer. These increases offset the effect of an environment of declining trust account asset valuations upon which

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Non-Interest Expense

      Non-interest expense was $452.9 million in 2002, an increase of $14.9 million, or 3.4%, over 2001. Salary expense grew $7.1 million, or 3.5%, due to higher full-time employee costs and growth in incentive payments. Employee benefit costs increased $7.3 million, or 23.6%, due to higher health care costs, higher 401K retirement expense, and an increase in pension expense. Net occupancy expense rose $2.6 million over last year, partly due to higher depreciation and operating costs resulting from a recently renovated office building, which was re-opened in October 2002. Marketing expense increased $2.1 million, or 16.2%, compared to the previous year as a result of added advertising costs for several consumer loan products. Data processing costs declined $2.2 million, largely due to the Company’s mainframe computer operations, which were consolidated in-house in the second quarter of 2002. Previously, this operation was out-sourced to an external vendor. Goodwill amortization was subject to new accounting rules, which discontinued the amortization of goodwill in 2002. This had the effect of lowering non-interest expense by $4.7 million in 2002 compared to 2001. Other non-interest expense included a $2.1 million charitable contribution of securities in 2002. In addition, losses related to check processing increased in 2002 compared to 2001 because of certain recoveries which were recorded in 2001.

      Non-interest expense was $438.0 million in 2001, an increase of $3.8 million, or .9%, compared to 2000. Salaries expense increased $13.6 million over the previous year due to merit increases for full-time employees. Employee benefits expense increased $1.8 million mainly because of higher social security taxes and 401K retirement expense. Net occupancy and equipment costs grew 5.4% and 6.4%, respectively, over 2000 and were partly offset by declines in supplies and communication, data processing and marketing. Charitable contributions in 2001 declined as a result of a large contribution made in 2000.

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Income Taxes

      Income tax expense was $94.0 million in 2002, compared to $87.4 million in 2001, and $89.3 million in 2000. Income tax expense increased 7.6% over 2001, compared to a 9.0% increase in pre-tax income. The effective tax rate on income from operations was 32.0%, 32.4% and 33.3% in 2002, 2001 and 2000, respectively. The effective tax rates were lower than the federal statutory rate of 35% mainly due to tax exempt interest on state and municipal obligations, state and federal tax credits realized, and various other tax initiatives. In 2002, the effective rate declined slightly because of the elimination of non-deductible goodwill amortization described above and the additional accrual of state and federal rehabilitation credits to be received on the renovation of an office building. The 2000 rate was lowered by the contribution of appreciated securities to a charitable organization in exchange for state tax credits, which resulted in a $2.0 million tax reduction. All of the above factors, tending to lower the effective tax rate, were partly offset by state and local income taxes.

Financial Condition

      A schedule of average balances invested in each category of loans appears on page 32. Classifications of consolidated loans by major category at December 31 for each of the past five years are as follows:

      At December 31, 2002, the Company elected to reclassify certain segments of its business, construction, business real estate and personal portfolios. The reclassifications were made to better realign the loan reporting with its related collateral and purpose. The adjustments also reclassified certain construction loans that had moved into amortizing term loans following project completion. The table below shows the effect of the reclassifications on the various lending categories at December 31, 2002. Because the information was not readily available, prior periods were not restated.

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      The contractual maturities of loan categories at December 31, 2002, and a breakdown of those loans between fixed rate and floating rate loans are as follows:

     Total loans increased $237.5 million, or 3.1%, during 2002 compared to a decline of $268.2 million, or 3.4%, during 2001. Excluding the reclassification effects mentioned above, growth in loans during 2002 came principally from personal banking, real estate construction, business, and credit card loans. Personal banking loans grew $122.2 million during the year mainly as a result of growth in home equity loan balances and higher totals for student and installment lending products. Real estate construction loans increased $80.4 million, or 19.5%, due to increased activity in the single-family construction area. Business loans increased $58.8 million, or 2.4%, mainly in the late third and early fourth quarters due to additional seasonal borrowings and higher line of credit usage. Credit card loans increased $15.8 million, or 3.1%, mainly at year end due to higher holiday activity. These increases were partly offset by a decline in personal real estate loans which were down $61.3 million, or 4.8%. This decline was the result of higher loan pay-offs of adjustable rate and other fixed rate loans in the portfolio due to the low rate environment that occurred during the year. The decline in total loans in 2001 compared to 2000 was primarily the result of reductions in business, personal real estate and personal banking loans. The overall decline in total loans during 2001 was partially offset by growth in business and construction real estate loans.

      The Company currently generates approximately 32% of its loan portfolio in the St. Louis regional market and 28% in the Kansas City regional market. The portfolio is diversified from a business and retail standpoint, with 56% in loans to businesses and 44% in loans to individual 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.

      Total business loans amounted to $2.26 billion at December 31, 2002. This group of loans is comprised primarily of loans to customers in the regional trade area of the bank subsidiaries in the central Midwest, encompassing the states of Missouri, Kansas, Illinois and adjacent Midwestern markets. 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 bank subsidiaries participate in credits of large, publicly traded companies when business

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      The portfolio of loans in this category amounted to $404.5 million at December 31, 2002. The portfolio consists of residential construction, commercial construction and land development loans, predominantly in the local markets of the Company’s banking subsidiaries. Commercial construction loans are for small and medium-sized office and medical buildings, manufacturing and warehouse facilities, strip shopping centers, hotels and motels, and other commercial properties. Exposure to larger speculative office and rental space remains low. Residential construction and land development loans are primarily for projects located in the Kansas City and St. Louis metropolitan areas. The Company experienced $58 thousand net recoveries in 2002 compared to $49 thousand net charge-offs in 2001. Non-accrual loans in this category decreased to $301 thousand at year end 2002 compared to $501 thousand at year end 2001.

      Total business real estate loans were $1.74 billion at December 31, 2002. This category includes mortgage loans for small and medium-sized office and medical buildings, manufacturing and warehouse facilities, strip 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 the local and regional markets of the affiliate banks. At December 31, 2002, non-accrual balances amounted to $10.6 million, or .6% of the loans in this category, compared to $5.4 million at year end 2001. The Company experienced net charge-offs of $296 thousand in 2002 and $90 thousand in 2001.

      At December 31, 2002, there were $1.28 billion in outstanding personal real estate loans. The mortgage loans in this category are extended, predominately, for owner-occupied residential properties. The Company originates both adjustable rate and fixed rate mortgage loans. The Company retains adjustable rate mortgage loans, but ordinarily sells most fixed rate loans to other lenders and investors, although some 15 year fixed rate loans are retained. During 2002, in a low rate environment, the Company originated more fixed rate loans than variable rate loans. At the same time, its portfolio of higher rate loans declined as customers refinanced their debt. The combination of these two effects resulted in a net decline in these loans. The Company typically does not experience significant loan losses in this category. There were net charge-offs of $230 thousand in 2002 compared to $370 thousand in 2001. The non-accrual balances of loans in this category increased to $1.4 million at December 31, 2002, compared to $147 thousand at year end 2001. The five year history of net charge-offs in the personal real estate loan category reflects nominal losses, and credit quality is considered to be strong.

      Total personal banking loans were $1.66 billion at December 31, 2002, and consisted of installment loans (mainly auto) of $1.09 billion, home equity loans of $305.3 million and student loans of $269.6 mil-

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      Total credit card loans amounted to $526.1 million at December 31, 2002. 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, purchase cards, and normalized credit cards. It emphasizes its credit card relationship product, Special Connections, in which the customer maintains a deposit relation with a subsidiary bank. The Special Connections product allows the customer ATM access using the same card and provides certain pricing advantages. The Company has found this product to be more profitable by incurring fewer credit losses than other card products and it allows for better cross sale into other bank products. Approximately 61% of the households in Missouri that own a Commerce credit card product also maintain a deposit relationship with a subsidiary bank. Approximately 88% of the outstanding credit card loans have a floating interest rate. Net charge-offs amounted to $17.3 million in 2002, which was a $1.7 million decrease from 2001. The net charge-off ratios of 3.5% in 2002 and 3.9% in 2001 remain well below national loss averages. The Company refrains from national pre-approved mailing techniques which have caused some of the credit card problems experienced by other banking companies. Significant changes in loss trends are not currently anticipated by management.

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 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.

      Loans subject to individual evaluation generally consist of commercial and commercial real estate loans. These loans are analyzed and assigned to risk categories according to the Company’s internal risk rating system. Loans with a greater risk of loss are identified and placed on the “watch list” for regular management review. Those loans judged to reflect the highest risk profiles 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. Other loans identified on the Company’s “watch list” but not judged to be individually impaired from a repayment or collateral adequacy perspective are aggregated and reserves are recorded using migration models, that track actual portfolio movements from problem asset loan grades to loss over a 5 to 10 year period. In the case of other more homogeneous loan portfolios, including auto loans, residential mortgages, home equity loans and credit card loans, the determination of the allocated reserve is computed on a pooled basis. For these loan pools, historical loss ratios by loan type, current loss and past due experience, and management’s judgment of recent and forecasted economic effects on portfolio performance are factors utilized to determine the appropriate reserve amounts.

      To mitigate the imprecision inherent in estimates of expected credit losses, the allocated component of the allowance is supplemented by an unallocated component. This portion of the allowance 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 ap-

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      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 banks continue 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 subsidiary banks by the OCC, the Parent and its non-bank subsidiaries are examined by the Federal Reserve Bank.