UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

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Washington, D.C. 20549

FORM 10-K

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

SECURITIES EXCHANGE ACT OF 1934

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For the Fiscal Year Ended December 31, 2004 — Commission File No. 0-2989

COMMERCE BANCSHARES, INC.

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(Exact name of registrant as specified in its charter)

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

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NONE

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

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Title of class

$5 Par Value Common Stock

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 8, 2005, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $2,659,000,000.

As of February 8, 2005, there were 67,487,701 shares of Registrant’s $5 Par Value Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

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Portions of the Registrant’s definitive proxy statement for its 2005 annual meeting of shareholders, which will be filed within 120 days of December 31, 2004, are incorporated by reference into Part III of this Report.

Commerce Bancshares, Inc.

Form 10-K

PART I

Item 1. BUSINESS

General

      Commerce Bancshares, Inc. (the “Company”), a bank holding company as defined in the Bank Holding Company Act of 1956, as amended, was incorporated under the laws of Missouri on August 4, 1966. The Company presently owns all of the outstanding capital stock of three national banking associations, which are headquartered in Missouri (the “Missouri bank”), Kansas (the “Kansas bank”), and Nebraska (the “Nebraska bank”). The Nebraska bank is limited in its activities to the issuance of credit cards. The remaining two 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 a second tier holding company that is the direct owner of both the Missouri and Kansas banks. A list of the Company’s subsidiaries is included as Exhibit 21.

      The Company is the largest bank holding company headquartered in Missouri. At December 31, 2004, the Company had consolidated assets of $14.3 billion, loans of $8.3 billion, deposits of $10.4 billion, and stockholders’ equity of $1.4 billion.

      The Missouri bank is the Company’s largest, with total assets of $12.8 billion and comprising approximately 92% of the Company’s total banking assets. The bank’s facilities are located throughout Missouri, in eastern Kansas, and in the Peoria and Bloomington areas in Illinois. The Missouri bank now includes the Company’s former Illinois bank, which was merged into the Missouri bank during 2004 in order to improve customer service and minimize operating overhead. The Kansas bank has total assets of $1.1 billion. It has significant operations and banking facilities in the areas of Wichita, Hays, Hutchinson, and Garden City, Kansas.

      The markets these banks 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, health care, numerous service industries, food production and agricultural production and related industries. In addition, several of the Illinois markets are located in areas with some of the most productive farmland in the world. The banks 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’s most recent acquisition was in January 2003 when it purchased The Vaughn Group, Inc., a direct equipment lessor based in Cincinnati, Ohio with a portfolio of direct financing, sales type and operating leases. The last bank acquisition was in March 2001, when the Company acquired Breckenridge Bancshares Company and its subsidiary, Centennial Bank. For additional information on acquisition and branch disposition activity, refer to pages 13 and 55.

Operating Segments

      The Company is managed in three operating segments. The Consumer segment includes the retail branch network, consumer installment lending, personal mortgage banking, bank card activities, student lending, and discount brokerage services. It provides services through a network of 187 full-service branches, a large ATM network, and the use of alternative delivery channels such as extensive online banking and telephone banking services. In 2004, this retail segment contributed 49% of total segment pre-

tax income. The Commercial segment provides a full array of corporate lending, leasing, and international services, as well as business and government deposit and cash management services. In 2004, 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, 2004, the Money Management segment managed investments with a market value of $10.2 billion and administered an additional $8.0 billion in non-managed assets. Additional information relating to operating segments can be found on pages 37 and 71.

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 non-banking company. Under the BHC Act, the Company may not engage in any business other than managing and controlling banks or furnishing certain specified services to subsidiaries and may not acquire voting control of non-banking companies unless the Federal Reserve Board determines such businesses and services to be closely related to banking. When reviewing bank acquisition applications for approval, the Federal Reserve Board considers, among other things, 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”.

      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 three 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.

      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 low rate environment in recent years. 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.

      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. In addition, any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.

      The principal source of the Company’s cash revenues is dividends from the subsidiary banks. 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 also be affected by factors such as the maintenance of adequate capital.

      The Company is required to comply with the capital adequacy standards established by the Federal Reserve. These capital adequacy guidelines generally require bank holding companies to maintain total capital equal to 8% of total risk-adjusted assets and off-balance sheet items (the “Total Risk-Based Capital Ratio”), with at least one-half of that amount consisting of Tier I or core capital and the remaining amount consisting of Tier II or supplementary capital. Tier I capital for bank holding companies generally consists of the sum of common shareholders’ equity, qualifying non-cumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill and other non-qualifying intangible assets. Tier II capital generally consists of hybrid capital instruments, term subordinated debt and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics.

      In addition, the Federal Reserve also requires bank holding companies to comply with minimum leverage ratio requirements. The leverage ratio is the ratio of a banking organization’s Tier I capital to its total consolidated quarterly average assets (as defined for regulatory purposes), net of the allowance for loan losses, goodwill and certain other intangible assets. The minimum leverage ratio for bank holding companies is 4%. At December 31, 2004, all of the subsidiary banks were “well-capitalized” under regulatory capital adequacy standards, as further discussed on page 74.

      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 2001, President Bush signed into law comprehensive anti-terrorism legislation known as the USA Patriot Act. Title III of the USA Patriot Act substantially broadened the scope of U.S. anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The U.S. Treasury Department issued a number of regulations implementing the USA Patriot Act that apply certain of its requirements to financial institutions such as the Company’s broker-dealer subsidiary. The regulations impose new obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing.

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 4,381 persons on a full-time basis and 718 persons on a part-time basis at December 31, 2004. The Company provides a variety of benefit programs including retirement and 401K 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.

Available Information

      The Company’s principal offices are located at 1000 Walnut, Kansas City, Missouri (telephone number 816-234-2000). The Company makes available free of charge, through its web site at www.commercebank.com, reports filed with the Securities and Exchange Commission as soon as reasonably practicable after the electronic filing. These filings include the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports.

Statistical Disclosure

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

Item 2. PROPERTIES

      The bank subsidiaries maintain their main offices in various multi-story office buildings. The Missouri bank owns its main offices and leases unoccupied premises to the public. These buildings, located in the downtown areas of Kansas City and St. Louis, include:

      During 2004, the Company sold an office building in Peoria, Illinois, which contained bank offices but was largely leased to outside tenants. The bank now leases its offices from the new owner. The Kansas charter sold its main Wichita office during 2004, and is currently leasing those premises during the construction phase of a new facility, expected to be completed in April 2005. 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 an additional 180 branch locations in Missouri, Illinois and Kansas which are owned or leased, and 143 off-site ATM locations.

      On December 22, 2004, the Missouri bank signed an agreement to purchase a multi-story office building and garage in downtown Kansas City. The agreement calls for the purchase of the building, which has 215,000 square feet of rentable area, and the attached garage for a price of $18 million. The property is being acquired from Tower Properties Company of which Commerce senior executives, David W. Kemper, CEO, and Jonathan M. Kemper, Vice-Chairman, also serve as directors. The purchase price is based on an independent outside appraisal and received the approval of the Company’s Board of Directors and independent Audit Committee. The Company expects to move its backroom check operations from its building at 720 Main Street to the new facility and sell the 720 Main building.

      The information required by this item is set forth in Item 8 under Note 18, Commitments, Contingencies and Guarantees on page 79.

      No matters were submitted during the fourth quarter of 2004 to a vote of security holders through the solicitation of proxies or otherwise.

Executive Officers of the Registrant

      The following are the executive officers of the Company, each of whom is designated annually, and there are no arrangements or understandings between any of the persons so named and any other person pursuant to which such person was designated an executive officer.

PART II

Commerce Bancshares, Inc.

Common Stock Data

      The following table sets forth the high and low prices of actual transactions for the Company’s common stock (CBSH) and cash dividends paid for the periods indicated (restated for the 5% stock dividend distributed in December 2004).

      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 4,776 shareholders of record as of December 31, 2004.

      The following table sets forth information about the Company’s purchases of its $5 par value common stock, its only class of stock registered pursuant to Section 12 of the Exchange Act.

      On January 30, 2004, the Company announced that its Board of Directors had approved the additional purchase of up to 1,825,129 shares of Company common stock. This, coupled with the shares available under the prior authorization, provided the Company with authority to purchase 3,000,000 shares.

      At its October 22, 2004 meeting, the Board of Directors approved the additional purchase of 4,296,580 shares, which brought the total current authorization up to 5,000,000 shares.

      The required information is set forth below in Item 7.

Overview

      Commerce Bancshares, Inc. (the Company) operates as a super-community bank offering an array of sophisticated financial products delivered with high-quality, personal customer service. It is the largest bank holding company headquartered in Missouri, with its principal offices in Kansas City and St. Louis, Missouri. Customers are served from over 300 locations in Missouri, Kansas, and Illinois, using delivery platforms which include an expansive ATM network, full-featured online banking, and a central contact center.

      The core of the Company’s competitive advantage is its concentration on relationship banking with high service levels and competitive products. In order to enhance shareholder value, the Company focuses on extending its core revenue, expanding its market share, utilizing improved technology, and enhancing customer satisfaction.

      Various indicators are used by management in evaluating the Company’s financial condition and operating performance. Among these indicators are the following:

      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

      The Company’s fully diluted earnings per share amounted to $3.10 in 2004 compared to $2.81 in 2003, an increase of 10.3%. Net income for 2004 was $220.3 million, which increased 6.7% over 2003, making 2004 the 20th consecutive year of record earnings. Return on assets amounted to 1.56% compared with

1.52% last year and the return on equity totaled 15.19% compared to 14.27% last year. The efficiency ratio was 59.16% in 2004 compared with 58.83% in 2003.

      The increase in net income in 2004 was principally due to growth in non-interest income of $25.3 million, or 8.4%, coupled with lower credit costs and effective expense management. Non-interest expense increased 2.3% over last year and income tax expense increased 7.2%. Net interest income declined slightly, reflecting the effects of slower growth in business and business real estate loans. Also, interest expense on deposit transaction accounts and short-term borrowings rose, mainly due to increases by the Federal Reserve in short-term interest rates during the second half of 2004. The provision for loan losses decreased $10.3 million to $30.4 million, largely due to decreases in business real estate, overdraft and consumer net loan charge-offs. The increase in non-interest income was largely due to increases in bank card fees of 16.6% and deposit account fees of 7.9%, partly offset by declines in bond and mortgage banking revenues. Non-interest expense increased a modest 2.3%, mainly due to increases in data processing costs (up 13.4%) and marketing costs (up 15.9%). Smaller increases were experienced in salaries and benefits and supplies and communications costs, with both increasing less than 1%. Also, equipment costs declined by 5.0%. Income tax expense increased in 2004 due to an increase in taxable income, but reflected an effective tax rate of 29.2% which was comparable with the prior year. Income tax expense in 2004 included tax benefits of $18.9 million, representing the effects of certain corporate restructuring initiatives, and compares to approximately $15.2 million of similar benefits recorded in 2003.

      Net income in 2003 was $206.5 million, which was a $10.2 million, or 5.2%, increase over 2002. Diluted earning per share increased 8.9% to $2.81 compared to $2.58 in 2002. Net income rose in 2003 principally due to growth in non-interest income of $21.1 million, or 7.5%, combined with effective expense management and lower income tax expense. Non-interest expense increased by 3.0% over 2002 and income tax expense declined 7.8%. The provision for loan losses increased $6.6 million to $40.7 million, largely due to increases in consumer credit losses. The increase in non-interest income was largely due to increases in deposit account fees of 8.6% and bank card fees of 13.4%, partly offset by small declines in bond, brokerage, and mortgage banking revenues. Non-interest expense increased 3.0%, mainly due to increases in salaries and benefits costs (up 3.4%), but pressured by higher costs for occupancy (up 11.8%) and equipment (up 5.4%). These increases were partly offset by a 9.8% decline in data processing and software expense. Income tax expense declined in 2003 primarily due to the recognition of additional tax benefits from various corporate reorganization initiatives.

      Effective January 2003, the Company acquired The Vaughn Group, Inc. (Vaughn), a direct equipment lessor based in Cincinnati, Ohio. At acquisition, Vaughn had a lease portfolio that was principally comprised of $32.8 million of direct financing leases. These leases are secured mainly by computer hardware and office equipment. In addition, at the date of acquisition Vaughn serviced approximately $350 million of lease agreements for other institutions involving capital equipment, ranging from production machinery to transportation equipment. The Company issued a combination of cash and stock to complete this purchase. Goodwill of $5.3 million was recognized in the transaction and recorded in the 2003 consolidated balance sheet.

      The Company continually evaluates its network of bank branches throughout Missouri, Kansas and Illinois. As a result of this evaluation process, the Company sold one branch in 2004, realizing a pre-tax gain of $1.1 million. The branch sold during 2004 had loans of $12.9 million and deposits of $16.5 million. The Company also sold three bank facilities during 2004, compared to two in 2003. The gains and losses realized on the sales of these premises were not significant. During 2002, the Company sold two bank branches and a branch facility, realizing pre-tax gains of $2.4 million on these sales. The branches sold in 2002 had loans of $15.0 million, deposits of $38.4 million, and premises of $2.9 million.

      Effective January 1, 2003, the Company voluntarily adopted the provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation”, pursuant to which the cost of stock options are expensed. The Company restated all prior periods to reflect the compensation expense that would have been recognized had the recognition provisions of Statement No. 123 been applied to all

options granted to employees after January 1, 1995. The effect of the restatement on 2002 was to lower earnings per share by $.04.

      The Company distributed a 5% stock dividend for the eleventh consecutive year on December 13, 2004. All per share and average share data in this report has been restated to reflect the 2004 stock dividend.

Critical Accounting Policies

      The Company’s consolidated financial statements are prepared based on the application of certain accounting policies, the most significant of which are described in Note 1 to the consolidated financial statements. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or be subject to variations which may significantly affect the Company’s reported results and financial position for the period or in future periods. The use of estimates, assumptions, and judgments are necessary when financial assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. Assets and liabilities carried at fair value inherently result in more financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on either quoted market prices or are provided by other independent third-party sources, when available. When such information is not available, management estimates valuation adjustments primarily by using internal cash flow and other financial modeling techniques. Changes in underlying factors, assumptions, or estimates in any of these areas could have a material impact on the Company’s future financial condition and results of operations.

      The Company has identified several policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for loan losses, pension accounting, and accounting for income taxes.

      The Company performs periodic and systematic detailed reviews of its loan portfolio to assess overall collectability. The level of the allowance for loan losses reflects the Company’s estimate of the losses inherent in the loan portfolio at any point in time. While these estimates are based on substantive methods for determining allowance requirements, nevertheless, actual outcomes may differ significantly from estimated results, especially in the areas of determining allowances for business, lease, construction and business real estate loans. These loan types are normally larger and more complex, and their collection rates are harder to predict. Consumer loans, including personal mortgage, credit card and personal loans, are individually smaller and perform in a more homogenous manner, making loss estimates more predictable. Extensive explanation of the methodologies used in establishing the allowance is provided in the Allowance for Loan Losses section of this discussion.

      Management is required to make various assumptions in valuing its pension assets and liabilities. These assumptions include the expected rate of return on plan assets, the discount rate, and the rate of increase in future compensation levels. Changes to these assumptions could impact earnings in future periods. The Company takes into account the plan asset mix, funding obligations, and expert opinions in determining the various rates used to estimate pension expense. The Company also considers the Moody’s AA corporate bond yields and other market interest rates in setting the appropriate discount rate. In addition, the Company reviews expected inflationary and merit increases to compensation in determining the rate of increase in future compensation levels. While differences in these rate assumptions could alter pension expense, given not only past history and controls in place including use of expert opinions, it is not expected that such estimates could alter expense by more than $1 to $3 million.

      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. Discussion of income taxes, including estimates of future income tax expense, is presented on page 20 of this discussion and in Note 9 on Income Taxes in the consolidated financial statements.

Net Interest Income

      Net interest income, the largest source of revenue, results from the Company’s lending, investing, borrowing, and deposit gathering activities. It is affected by both changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest bearing liabilities. The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates. Changes not solely due to volume or rate changes are allocated to rate.

      Net interest income was $497.3 million in 2004, $502.4 million in 2003 and $500.0 million in 2002. Compared to the prior year, net interest income decreased $5.1 million, or 1.0%, in 2004 compared to an increase of $2.4 million, or .5%, in 2003. During 2004, net interest income decreased from amounts recorded last year mainly because of continued downward re-pricing of loans and deposits during 2003 and the first half of 2004 and lower rates on securities purchased during the year. In addition, lower loan demand pressured interest income. However, during the second half of the year, the Federal Reserve initiated five 25 basis point rate increases, which had the effect of raising rates earned on many types of loans in the Company’s portfolio tied to variable rates. The increase in loan yields, however, was partially offset by an increase in the borrowing costs of federal funds purchased due to increases in short-term

interest rates. Yields on earning assets declined 29 basis points from the previous year, while rates paid on deposits decreased 12 basis points and rates paid on other borrowings increased 17 basis points. As a result, the Company’s net interest margin narrowed to 3.81% from 4.04% in the previous year. The Company purchased new investment securities, largely during the first part of 2004, as a hedge against lower rates and to generate added interest income. As rates began to rise at mid year, the Company reduced the level of the investment portfolio. As a result, average investment securities were $208.5 million lower during the second half of the year as compared to the first half of the year. However, the average balance of investment securities grew $451.4 million over the full year. Purchases of securities were funded by growth in deposits and other borrowed funds. During 2004, average loans grew by $120.7 million, which increased net interest income.

      During 2003, net interest income increased only slightly over amounts recorded in 2002 mainly because of the continued re-pricing downward of interest earning assets, which moved down faster than rates paid on interest bearing liabilities. Yields on earning assets declined 77 basis points from 2002, while rates paid on deposits and other borrowings declined 48 basis points. During 2003, the Federal Reserve lowered the federal funds target rate once in June by 25 basis points which lowered rates earned on many loans in the Company’s loan portfolio, which were tied to variable rates. Much of the Company’s non-maturity deposit portfolio (i.e., interest checking and money market accounts) was already at low rates and could not be lowered commensurate with the reduction of loan rates. Also putting pressure on net interest income was an acceleration of early payments received on parts of the Company’s mortgage related investment portfolio, which caused increased bond premium amortization. To partly mitigate this result, the Company purchased new investment securities to generate added interest income and grew the year to date average balance by $845.6 million. These purchases were funded by some growth in deposits and other borrowed funds. Also, average loans grew by $247.7 million during 2003 and certificate of deposit balances declined, both of which increased net interest income.

      The net yield on interest earning assets was 3.81% in 2004, 4.04% in 2003 and 4.39% in 2002. Average interest earning assets rose 4.7% in 2004 over 2003, compared to a 9.4% increase in 2003 over 2002. Average interest bearing liabilities increased 3.8% in 2004 compared to a 9.3% increase in 2003.

      Total interest income was $610.1 million in 2004, $617.4 million in 2003 and $652.6 million in 2002. Tax equivalent interest income did not materially differ. Interest income declined $7.3 million, or 1.2%, in 2004 compared to the previous year. As mentioned previously, this decline was primarily due to decreases in rates on loans and investment securities. Average loan balances, which earn higher rates, increased $120.7 million during 2004 and generated $9.9 million of interest income; however, this increase was offset by the effect of lower rates which reduced interest income by over $18 million. Since large sections of the loan portfolio are tied to indices which fluctuate with the prime rate, the rate reductions in 2003 by the Federal Reserve mentioned above caused much of the loan portfolio to re-price downward at the beginning of 2004. During the second half of the year, the Federal Reserve raised rates five times by 25 basis points which provided for additional interest income on variably priced loans. Average yields on loans increased 23 basis points in the fourth quarter of 2004 compared to the same quarter of 2003. Yields on investment securities in the fourth quarter of 2004 were 26 basis points lower than the same quarter in the previous year, as maturing securities were reinvested in lower earning securities. However, due to additional purchases, mainly during the first half of 2004, average balances of investment securities grew $451.4 million, contributing $20.2 million in additional interest income. At December 31, 2004, average balances of investment securities comprised 37% of average earning assets compared to 35% in 2003. Average loans comprised 62% of average earning assets, down from 64% in 2003.

      Total interest income declined $35.1 million, or 5.4% in 2003 compared to 2002. The decline was primarily due to decreases in yields on all loan categories and the Company’s investment securities portfolio as a result of the reduction in market rates occurring in 2003. Average loan balances increased $247.7 million during 2003 and generated $22.0 million of interest income, however this increase was offset by the effect of lower rates which reduced interest income by $60.7 million. Yields on investment securities were also lower, as maturing securities and an acceleration of early premiums were amortized at

a faster pace. Additional purchases of securities increased the average by $845.6 million and contributed $41.8 million in additional interest income.

      Total interest expense was $112.8 million in 2004, $115.0 million in 2003 and $152.6 million in 2002. Interest expense declined $2.3 million, or 2.0%, in 2004 compared to 2003. The average rate paid on interest bearing liabilities was 1.00% in 2004 compared to 1.06% in 2003. The changing interest rate environment described above resulted in an interest rate decline in 2004 of 12 basis points on deposits offset by an increase of 24 basis points on overnight borrowings. The largest decline in deposit rates was on the Company’s retail (under $100,000) certificate of deposit accounts, where rates declined 32 basis points. In addition, rates on the Company’s jumbo (over $100,000) certificates of deposit decreased 15 basis points. The continued re-pricing of short-term borrowings, primarily federal funds purchased, resulted in an increase of $4.1 million in interest expense. Growth of $277.2 million in the average balance of short-term borrowings caused interest expense to increase $3.2 million.

      The average rate paid on interest bearing liabilities was 1.06% in 2003 compared to 1.54% in 2002. The lower interest rate environment described above resulted in an interest rate decline of 50 basis points on deposits and 29 basis points on overnight borrowings. The largest decline was the result of a decrease of 80 basis points in average rates paid on retail certificates of deposit. A decline of $207.9 million in average retail certificates of deposit decreased interest expense by $6.5 million. In addition, new certificates of deposit issued in 2003 were at lower rates which further lowered interest expense compared to 2002. This continued re-pricing of deposits was offset by an increase in interest expense of $4.8 million on other borrowings which resulted mainly from growth of $776.2 million in average federal funds purchased and repurchase agreements.

Provision for Loan Losses

      The provision for loan losses was $30.4 million in 2004, compared with $40.7 million in 2003 and $34.1 million in 2002. The provision for loan losses is recorded to bring the allowance for loan losses to a level deemed adequate by management based on the factors mentioned in the following “Allowance for Loan Losses” section of this discussion.

Non-Interest Income

     Non-interest income was $326.9 million in 2004, which was a $25.3 million, or 8.4%, increase over 2003. Trust fees increased $3.3 million, or 5.5%, because of rising values in trust account assets and growing new business. Most of the growth in trust fees occurred in the institutional and private client trust product lines. In 2004, deposit account fees increased 7.9%, or $7.7 million, due to a $9.8 million increase in

overdraft and return items fees, partly offset by a $1.5 million decline in fees earned on commercial cash management accounts. Bank card fees increased $11.2 million, or 16.6%, mainly due to growth in fees on credit cardholder transactions, which rose 17.1% over the previous year. Also, merchant fees and debit card fees (components of bank card fees) increased 18.7% and 14.8%, respectively. The strong growth in credit card fees in 2004 was partly attributable to growing credit card transaction fees from commercial businesses and non profit enterprises who are utilizing these electronic transactions in greater proportions. Fees from these transactions grew 32% in 2004 over 2003, and represented 38% of total credit card fee income in 2004. Trading account fees, consisting of fees from sales of fixed income securities, declined 16.6% in 2004 due to lower demand by business and correspondent bank customers. Consumer brokerage service fees increased 3.7% mainly due to higher revenues from equity security sales. Mortgage banking revenues declined $2.2 million as a result of lower personal mortgage loan originations in 2004 versus 2003. Net gains on securities transactions amounted to $11.1 million in 2004, an increase of $6.5 million over the previous year. The 2004 activity included gains of $11.2 million resulting mainly from sales of inflation indexed bonds from the banks’ securities portfolios, and losses of $317 thousand recognized on private equity investments. Other non-interest income included gains on sales of student loans of $8.5 million, compared to a $7.0 million gain in 2003, and a $1.1 million gain on a bank branch sale in the second quarter of 2004. In addition, farm management fees declined $1.2 million due to the sale of the farm management business in the third quarter of 2003.

      In 2003, non-interest income increased $21.1 million, or 7.5%, to $301.7 million. Deposit account fees rose 8.6%, or $7.7 million, as a result of growth in fee income on overdraft and return items, coupled with higher commercial cash management fees. The increase in overdraft fees was due to both pricing increases in the Company’s Missouri markets coupled with improved collection efficiencies. Compared to the previous year, bank card fee income rose $7.9 million, or 13.4%, mainly due to 10.8% growth in cardholder transaction fees and 10.3% growth in merchant interchange revenue. Debit card fees grew 18.3% due to higher online fees, partly offset by lower transaction pricing which went into effect in August 2003 as a result of the WalMart lawsuit settlement with VISA U.S.A., Inc. Trust fee revenue increased slightly in 2003 over 2002 as the value of trust accounts upon which fees are based, which had been depressed for the past year, began to improve. Net gains on securities transactions amounted to $4.6 million in 2003, increasing $1.7 million over the previous year, and included gains of $6.9 million resulting from sales from the securities portfolio, and losses of $2.3 million recognized on private equity investments. Other non-interest income included operating lease revenues of $4.2 million related to a leasing subsidiary which was acquired at the beginning of 2003. Also, sales of student loans resulted in additional gains of $2.4 million during 2003. Trading account fee income declined 7.6% due to lower sales to business and correspondent bank customers. Consumer brokerage service fees declined 6.7% due mainly to lower mutual fund sales by the discount brokerage subsidiary. Mortgage banking revenue fell 6.3%, as loan origination volumes declined, especially in the second half of 2003.

Non-Interest Expense

      Non-interest expense was $482.8 million in 2004, an increase of $10.6 million, or 2.3%, over 2003. Compared with the prior year, salary and employee benefits expense grew slightly as a result of higher staff salaries expense and workman’s compensation insurance expense, offset by declines in incentive payments and pension plan expense. Net occupancy expense rose 2.1% over the prior year, mainly due to higher net rent expense resulting from the sale of a bank facility earlier in the year, which resulted in lower outside tenant rent income and higher rent expense as the banking operations were moved to other leased facilities. Equipment expense declined $1.2 million, or 5.0%, due to lower depreciation expense on computer hardware. Data processing costs increased $5.4 million, or 13.4%, due to higher bank card processing costs (up $2.3 million and related to the higher bank card revenues) and higher technology software expense. Marketing expense increased $2.3 million, or 15.9%, compared to the previous year as a result of incentives paid on new product offerings and expanded marketing efforts. Other non-interest expense increased $2.2 million over the prior period mainly due to lower capitalized loan costs and increases in loan collection expense and operating losses. These increases were partly offset by lower professional fees and operating lease depreciation. Also, minority interest expense, which results from venture capital activity reported by a 53%-owned affiliate, decreased compared to the previous year when venture capital gains were recorded by this affiliate.

      Non-interest expense rose 3.0% in 2003 to a total of $472.1 million, compared to $458.2 million in 2002. Salary expense increased $7.2 million, or 3.3%, in 2003 compared to 2002, and resulted from normal merit increases, partly offset by lower costs for overtime and contract labor. Benefit costs increased 4.0% due to higher pension plan expense, offset by declines in medical plan and 401K contribution expense. Full-time equivalent employees declined from 5,012 during 2002 to 4,976 during 2003. Occupancy expense rose $4.1 million, or 11.8%, mainly due to higher depreciation and operating costs resulting from a renovated office building, which was re-opened in late 2002, and termination fees paid on vacated rental space. Equipment expense increased $1.2 million, or 5.4%, due to higher maintenance contract expense and higher depreciation expense resulting from purchases of computer mainframe and disaster recovery equipment during 2002. Data processing and software expense fell $4.4 million, or 9.8%, from 2002, largely because of cost savings realized from consolidating the Company’s mainframe computer operations in-house during the second quarter of 2002. These operations had previously been out-sourced to an external vendor. Other non-interest expense included operating lease depreciation and associated costs totaling $3.3 million related to a leasing subsidiary acquired in 2003, which were not present in 2002. In addition, minority interest expense increased $1.7 million due to venture capital gains in 2003, compared to the previous year when venture capital losses were recorded.

Income Taxes

      Income tax expense was $90.8 million in 2004, compared to $84.7 million in 2003, and $91.9 million in 2002. Income tax expense in 2004 increased 7.2% over 2003, compared to a 6.8% increase in pre-tax income. The effective tax rate on income from operations was 29.2%, 29.1% and 31.9% in 2004, 2003 and 2002, respectively. The Company’s 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 the recognition of additional tax benefits from various corporate reorganization initiatives.

      In 2004, total net tax benefits associated with various corporate reorganization initiatives amounted to $18.9 million. The Company also has additional tax benefits related to other reorganization initiatives that will not be recognized in income until certain conditions are satisfied. It is projected that such conditions may be resolved as early as the third quarter of 2005 relating to approximately $13.7 million of the remaining benefits. However, because of the timing of such recognition, it is expected that the effective tax rate will be higher in the first two quarters of 2005. It is not expected that material tax benefits of this nature will continue beyond 2005.

      The decline in the effective tax rate between 2003 and 2002 resulted mainly from the recognition of $11.2 million of additional net tax benefits in 2003 associated with various corporate reorganization initiatives, offset by a $5.3 million reduction in net federal and state rehabilitation credits (recognized in 2002) related to the renovation of an office building. All of the above factors, tending to lower the effective tax rate, were partly offset by state and local income taxes.

Financial Condition

Loan Portfolio Analysis

      A schedule of average balances invested in each category of loans appears on page 42. 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.

      The contractual maturities of loan categories at December 31, 2004, and a breakdown of those loans between fixed rate and floating rate loans are as follows:

     Total loans increased $162.7 million, or 2.0%, during 2004 compared to an increase of $266.7 million, or 3.4%, during 2003. Growth in loans during 2004 came principally from business, home equity, consumer and credit card loans, partly offset by a decline in business real estate loans. Business loans grew $128.3 million, or 6.2%, mainly as a result of improving economic conditions, with added borrowings from existing customers and new customer activity. Lease activity, included in the business category, remained flat compared with the previous year. Consumer loans grew $43.1 million, or 3.7%, during the year mainly as a result of increases in marine and recreational vehicle lending. Home equity loans grew to $411.5 million, an increase of $59.5 million, or 16.9% over 2003. Personal real estate loans grew slightly by $2.0 million, as rates began to rise and customer origination activity slowed. Credit card loans increased $49.8 million, or 8.9%, and saw solid growth, especially at year end, when holiday activity is normally at its peak. Business real estate loans declined $131.8 million, or 7.0%, as a result of loan pay-downs, customer re-financing activities, and fewer loan originations, due in part to rising interest rates.

      The growth in total loans in 2003 compared to 2002 was primarily the result of increases in business and personal real estate, consumer and student 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 53% in loans to businesses and 47% in loans to consumers. A balanced approach to loan portfolio management and an historical aversion toward credit concentrations, from an industry, geographic and product perspective, have contributed to low levels of problem loans and loan losses.

      Total business loans amounted to $2.2 billion at December 31, 2004 and include loans used mainly to fund customer accounts receivable, inventories, and capital expenditures. This portfolio also includes sales type and direct financing leases totaling $182.8 million, which are used by commercial customers to finance capital purchases ranging from computer equipment to office and transportation equipment. These leases comprise 2.2% of the Company’s total loan portfolio. Business loans are made primarily to customers in the regional trade area of the Company, generally the central Midwest, encompassing the states of Missouri, Kansas, Illinois, and nearby Midwestern markets, including Iowa, Oklahoma and Indiana. The portfolio is diversified from an industry standpoint and includes businesses engaged in manufacturing, wholesaling, retailing, agribusiness, insurance, financial services, public utilities, and other service businesses. Emphasis is upon middle-market and community businesses with known local management and financial stability. The Company participates in credits of large, publicly traded companies when business operations are maintained in the local communities or regional markets and opportunities to provide other banking services are present. Consistent with management’s strategy and emphasis upon relationship banking, most borrowing customers also maintain deposit accounts and utilize other banking services. There were net loan charge-offs in this category of $5.5 million in 2004 (which included a $6.0 million charge-off on a single loan in the first quarter of 2004) compared to $4.9 million in 2003. Non-accrual business loans decreased to $9.5 million (.4% of business loans) at December 31, 2004, and included $7.0 million in leases. Total business non-accrual loans were $19.2 million (.9% of business loans) at December 31, 2003. Opportunities for growth in business loans will be based upon strong solicitation efforts in a highly competitive market environment for quality loans. Asset quality is, in part, a function of management’s consistent application of underwriting standards and credit terms through stages in economic cycles. Therefore, portfolio growth in 2005 will be dependent upon 1) the strength of the economy, 2) the actions of the Federal Reserve with regard to targets for economic growth, interest rates, and inflationary tendencies, and 3) the competitive environment.

      The portfolio of loans in this category amounted to $427.1 million at December 31, 2004 and comprised 5.1% of the Company’s total loan portfolio. This group of loans includes residential construction loans totaling $125.9 million at December 31, 2004, or 29% of the category, and commercial construction and land development loans totaling $301.2 million, or 71%. These loans are predominantly made to businesses 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, apartment complexes, shopping centers, hotels and motels, and other commercial properties. Exposure to larger speculative office properties remains low. Residential construction and land development loans are primarily for projects located in the Kansas City and St. Louis metropolitan areas. Credit losses in this portfolio are normally low, and the Company experienced net charge-offs of $4 thousand in 2004 compared to $122 thousand net recoveries in 2003. Non-accrual loans in this category decreased to $685 thousand at year end 2004 compared to $795 thousand at year end 2003.

      Total business real estate loans were $1.7 billion at December 31, 2004 and comprised 21.0% of the Company’s total loan portfolio. This category includes mortgage loans for small and medium-sized office

and medical buildings, manufacturing and warehouse facilities, shopping centers, hotels and motels, and other commercial properties. Emphasis is placed on owner-occupied and income producing commercial real estate properties which present lower risk levels. The borrowers and/or the properties are generally located in the local and regional markets of the affiliate banks. At December 31, 2004, non-accrual balances amounted to $6.6 million, or .4% of the loans in this category, compared to $9.4 million at year end 2003. The Company experienced $231 thousand net recoveries in 2004 compared to net charge-offs of $516 thousand in 2003.

      At December 31, 2004, there were $1.3 billion in outstanding personal real estate loans, which comprised 16.1% of the Company’s total loan portfolio. 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, and also retains certain fixed rate loans (typically 15 year fixed rate loans) as directed by its Asset/ Liability Management Committee. At December 31, 2004, 62% of the portfolio was comprised of adjustable rate loans while 38% was comprised of fixed rate loans. During 2004, mortgage loan originations slowed as a result of the rising rate environment, totaling $366 million compared with $701 million in 2003. The Company typically does not experience significant loan losses in this category. There were net charge-offs of $217 thousand in 2004 compared to $464 thousand in 2003. The non-accrual balances of loans in this category decreased to $458 thousand at December 31, 2004, compared to $2.4 million at year end 2003. The five year history of net charge-offs in the personal real estate loan category reflects nominal losses, and the credit quality of these loans is considered to be strong.

      Total personal banking loans, which include consumer, home equity and student loans, totaled $2.0 billion at December 31, 2004. These categories comprised 23.6% of the total loan portfolio at December 31, 2004. Consumer loans are associated with auto, marine, recreational vehicle and home improvement, and totaled $1.2 billion at year end 2004. Approximately 68% are originated indirectly from auto and other dealers, while the remaining 32% are direct loans made to consumers. Home equity lines, of which 99% are adjustable rate loans, are secured mainly by second mortgages (and less frequently, first mortgages) on residential property of the borrower. The underwriting terms for the home equity line product permit borrowing availability, in the aggregate, generally up to 80% or 90% of the appraised value of the collateral property, although a small percentage may permit borrowing up to 100% of appraised value. Given reasonably stable real estate values over time, the collateral margin improves with the regular amortization of mortgages against the properties. Home equity loans totaled $411.5 million at year end 2004 and an additional $476.5 million was outstanding in unused lines of credit, which can be drawn at the discretion of the borrower. The Company originates loans to students attending colleges and universities, which totaled $358.0 million at year end 2004. These loans are normally sold to the secondary market when the students graduate and the loans enter into repayment status. Approximately 97% of these loans are based on a variable rate. Net charge-offs for total personal banking loans were $7.5 million in 2004 compared to $8.5 million in 2003. Net charge-offs decreased to .39% of average personal banking loans in 2004 compared to .47% in 2003, and remain below national loss averages. The majority of personal banking loan losses were related to automobile lending, especially from indirect paper purchased from auto dealers.

      Total credit card loans amounted to $611.3 million at December 31, 2004 and comprised 7.4% of the Company’s total loan portfolio. The credit card portfolio is concentrated within regional markets served by the Company. The Company offers a variety of credit card products, including affinity cards, corporate purchase cards, and standard and premium credit cards. It emphasizes its credit card relationship product, Special Connections, in which the customer maintains a deposit relationship with a subsidiary bank. The Special Connections product allows the customer ATM access using the same card. 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 60% of the households in Missouri that own a Commerce credit card product also maintain a deposit relationship with a subsidiary bank. Approximately 82% of the outstanding credit card loans have a floating interest rate. Net charge-offs amounted to $19.6 million in 2004, which was a $49 thousand decrease from 2003. The ratio of net loan charge-offs to total average loans of 3.5% in 2004 and 3.7% in 2003 remain significantly 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 mainly because of their size and complexity. 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 models that track historical loan losses by loan type. 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 Company also performs analyses of the overall environment in which the Company operates, and maintains the allowance at a level 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. Although management has allocated a portion of the allowance to specific loan categories, the adequacy of the allowance must be considered in its entirety.

      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 holding company and its non-bank subsidiaries are examined by the Federal Reserve Bank.

      The allowance for loan losses was $132.4 million and $135.2 million at December 31, 2004 and 2003, respectively, and was 1.59% and 1.66% of loans outstanding. The decline in the allowance resulted mainly from loan loss provisions recorded in 2003 for loans charged off in 2004. The allowance for loan losses

covered non-performing loans by 751% at year end 2004 and 416% at year end 2003. Net charge-offs totaled $33.2 million in 2004, and decreased $3.4 million compared to $36.6 million in 2003. The ratio of net charge-offs to average loans outstanding in 2004 was .41% compared to .46% in 2003 and .43% in 2002. Approximately 59% of total net charge-offs were related to credit card loans. The provision for loan losses was $30.4 million, compared to a provision of $40.7 million in 2003 and $34.1 million in 2002.

      Net credit card charge-offs decreased to 3.5% of average credit card loans in 2004 compared to 3.7% in 2003. As mentioned earlier, the Company’s net charge-off experience for its credit card portfolio has been significantly better than industry averages, mainly due to its emphasis on Special Connections card products which provide other product relationships with the Company. The delinquency rate on credit card loans at year end 2004 was 2.45% and has remained at low levels during the year.

      The Company considers the allowance for loan losses of $132.4 million adequate to cover losses inherent in the loan portfolio at December 31, 2004.

      The schedules which follow summarize the relationship between loan balances and activity in the allowance for loan losses:

      The following schedule provides a breakdown of the allowance for loan losses by loan category and the percentage of each loan category to total loans outstanding at year end:

Risk Elements Of Loan Portfolio

      Management reviews the loan portfolio continuously for evidence of problem loans. During the ordinary course of business, management becomes aware of borrowers that may not be able to meet the contractual requirements of loan agreements. Such loans are placed under close supervision with consideration given to placing the loan on non-accrual status, the need for an additional allowance for loan loss, and (if appropriate) partial or full loan charge-off. Loans are placed on non-accrual status when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment. Loans that are 90 days past due as to principal and/or interest payments are generally placed on non-accrual, unless they are both well-secured and in the process of collection, or they are 1-4 family first mortgage loans or consumer loans that are exempt under regulatory rules from being classified as non-accrual. After a loan is placed on non-accrual status, any interest previously accrued but not yet collected is reversed against current income. Interest is included in income after the loan is placed on non-accrual status only as interest is received and so long as management is satisfied there is no impairment of collateral values. The loan is returned to accrual status only when the borrower has brought all past due principal and interest payments current and, in the opinion of management, the borrower has demonstrated the ability to make future payments of principal and interest as scheduled.

      The following schedule shows non-performing assets and loans past due 90 days and still accruing interest.

      The effect on interest income in 2004 of loans on non-accrual status at year end is presented below:

      Total non-accrual loans at year end 2004 decreased $14.9 million from 2003 levels. This decline resulted mainly from a reduction of $9.6 million in business non-accrual loans, the largest portion of which came from a negotiated settlement and a payment of $6.0 million on the remaining balance of the Company’s largest non-accrual loan. Most of the remaining non-accrual business loans were leases, which totaled $7.0 million at December 31, 2004. Non-accrual balances of business real estate and personal real estate loans declined $2.8 million and $2.0 million, respectively. Real estate that was acquired in foreclosure, which is comprised mainly of small residential properties, decreased slightly from year end 2003. Total non-performing assets remain low compared to the Company’s peers, with the non-performing loans to total loans ratio at ..21%. Loans past due 90 days and still accruing interest decreased $7.8 million at year end 2004 compared to 2003. This decline was mainly due to lower delinquencies in business real estate, personal real estate and student loans.

      In addition to the non-accrual loans mentioned above, the Company also has identified loans for which management has concerns about the ability of the borrowers to meet existing repayment terms. These loans totaled $63.9 million at December 31, 2004 compared with $61.2 million at December 31, 2003. They are primarily classified as substandard for regulatory purposes. The loans are generally secured by either real estate or other borrower assets, reducing the potential for loss should they become non-performing. Although these loans are generally identified as potential problem loans, they may never become non-performing.

      At December 31, 2004, the banking subsidiaries held fixed rate residential real estate loans of approximately $11.0 million at lower of cost or market, which are to be sold to secondary markets within approximately three months.

      There were no loan concentrations of multiple borrowers in similar activities at December 31, 2004, which exceeded 10% of total loans. The Company’s aggregate legal lending limit to any single or related borrowing entities is in excess of $125 million. The largest exposures generally do not exceed $70 million.

Investment Securities Analysis

      During 2004, total investment securities decreased $148.1 million to $4.8 billion (excluding unrealized gains/losses) compared to $4.9 billion at the previous year end. The decrease was due to fewer purchases during the year, as more proceeds from maturities were used to pay down short-term borrowings instead of being reinvested. The decline in investment securities occurred mainly in U.S. government and federal agency securities, which decreased $68.7 million, and in mortgage and asset-backed securities, which decreased $103.7 million. The average tax equivalent yield on total investment securities was 3.78% in 2004 and 4.17% in 2003.

      At December 31, 2004, the fair value of available for sale securities was $4.8 billion, and included a net unrealized gain in fair value of $63.8 million, compared to a net gain of $117.5 million at December 31, 2003. The amount of the related after tax unrealized gain reported in stockholders’ equity was $39.6 million at year end 2004. Approximately 52% of the unrealized gain in fair value related to marketable equity securities held by Commerce Bancshares, Inc., the parent holding company (the “Parent”). The rest of the unrealized gain (45%) related to U.S. government and federal agencies held by bank subsidiaries. The market value of the available for sale portfolio will vary according to changes in market interest rates and the mix and duration of investments in the portfolio. The unrealized gain in fair value at year end 2004 decreased $53.7 million from year end 2003. Available for sale securities which are due during the next 12 months total approximately $786 million, and management expects these proceeds to meet most of the Company’s liquidity needs.

      Non-marketable securities, which totaled $73.0 million at December 31, 2004, included $50.8 million in Federal Reserve Bank stock and Federal Home Loan Bank stock held by bank subsidiaries as a result of debt and regulatory requirements. These are restricted securities which, lacking a market, are carried at cost. Other non-marketable securities are generally held by the Parent and non-bank subsidiaries and include non-marketable venture capital investments, which are carried at estimated fair value.

      Investment securities at year end for the past two years are shown below:

      A summary of maturities by category of investment securities and the weighted average yield for each range of maturities as of December 31, 2004, is presented in Note 4 on Investment Securities in the consolidated financial statements. U.S. government and federal agency obligations comprise 36% of the investment portfolio at December 31, 2004, with a weighted average yield of 3.23% and an estimated average maturity of 3.6 years; mortgage and asset-backed securities comprise 55% with a weighted average yield of 3.82% and an estimated average maturity of 2.5 years.

      Other debt securities, as shown in the table above, include corporate bonds, notes, commercial paper and debentures related to venture capital funding. Equity securities are comprised of short-term investments in money market mutual funds (which totaled $187.7 million at year end 2004), Federal Reserve Bank stock, Federal Home Loan Bank stock, publicly traded stock and venture capital equity investments. Investments in mutual funds and traded equities are primarily held by the Parent. During 2004, the average yield on other debt securities was 5.23%, and the average tax equivalent yield on equity securities was 2.62%.

      The Company engages in private equity and venture capital activities through direct venture investments and two venture capital subsidiaries, which are licensed by the Small Business Administration. The first subsidiary, CFB Venture Fund I, Inc. (CFBI), held $14.5 million in venture capital investments at December 31, 2004. The second subsidiary, CFB Venture Fund II, L.P. (CFBII), is a limited partnership venture fund with 47% outside ownership and no outside debt. CFBII had total venture capital investments of $5.9 million at year end 2004. All funding commitments to this partnership have been satisfied. In addition to investments held by its venture capital subsidiaries, the Company has direct investments in several external private equity concerns, which totaled $5.3 million at year end 2004. Most of the venture capital and private equity investments are not readily marketable. While the nature of these investments carries a higher degree of risk than the normal lending portfolio, management believes the potential for long-term gains in these investments outweighs the potential risks.

      In 2005, the Company created a third venture capital subsidiary, CFB Venture Fund III, L.P. Investments held by CFBI, totaling $11.1 million, were transferred to this new subsidiary. The Company plans to fund an additional $8.7 million to the new subsidiary in the future.

Deposits and Borrowings

      Deposits are the primary funding source for the Company’s banks, and are acquired from a broad base of local markets, including both individual and corporate customers. Total deposits were $10.4 billion at December 31, 2004, compared to $10.2 billion last year, reflecting an increase of $228.1 million, or 2.2%. On a yearly average basis, deposits increased $312.5 million, or 3.1%, during 2004 compared to 2003. This increase was fueled by growth in demand, interest checking and jumbo certificate of deposit accounts, with declines in retail certificates of deposit.

      The following table shows year end deposits by type as a percentage of total deposits.

      Core deposits (defined as all non-interest and interest bearing deposits, excluding short-term C.D.’s of $100,000 and over) supported 75% of average earning assets in 2004 and 76% in 2003. Average balances by major deposit category for the last six years appear at the end of this discussion. A maturity schedule of time deposits outstanding at December 31, 2004 is included in Note 7 on Deposits in the consolidated financial statements.

      Short-term borrowings consist of federal funds purchased and securities sold under agreements to repurchase. Balances outstanding at year end 2004 were $1.9 billion, a $192.2 million decrease from $2.1 billion outstanding at year end 2003. Balances in these accounts, which generally have overnight maturities, can fluctuate significantly on a day-to-day basis. The average balance of federal funds purchased and repurchase agreements increased $277.2 million in 2004 over 2003, and increased $778.6 million in 2003 over 2002. The average rate paid on these borrowings was 1.23% during 2004 and .99% during 2003.

      Subsidiary banks also borrow from the Federal Home Loan Bank (FHLB). At year end 2004 these advances totaled $366.9 million, of which $115.2 million is due in 2005. The debt maturing in 2005 may be refinanced or may be repaid with funds generated by the loan and securities portfolios. Of the FHLB advances outstanding at year end, $300.0 million had a floating rate and $66.9 million had a fixed rate. The average rate paid on FHLB advances was 1.94% during 2004 and 1.85% during 2003. The weighted average year end rate on outstanding FHLB advances at December 31, 2004 was 2.75%. Long-term debt also includes $11.2 million borrowed from insurance companies by a venture capital subsidiary in order to fund certain investing activity as a Missouri Certified Capital Company. An additional $7.4 million in debt is related to nonrecourse lease financing.

Liquidity and Capital Resources

Liquidity Management

      Liquidity is managed within the Company in order to satisfy cash flow requirements of deposit and borrowing customers while at the same time meeting its own cash flow needs. The Company maintains its liquidity position by providing a variety of sources including:

      The Company’s most liquid assets include available for sale marketable investment securities, federal funds sold, and securities purchased under agreements to resell (resale agreements). At December 31, 2004 and 2003, such assets were as follows:

      Federal funds sold and resale agreements normally have overnight maturities and are used for general daily liquidity purposes. The Company’s available for sale investment portfolio has maturities of approximately $786 million which come due during 2005 and offers substantial resources to meet either new loan demand or reductions in the Company’s deposit funding base. Furthermore, in the normal course of business the Company will pledge portions of its investment securities portfolio to secure public fund deposits, securities sold under agreements to repurchase, trust funds, and borrowing capacity at the Federal Reserve. Total pledged investment securities for these purposes comprised 48% of the total investment portfolio, leaving approximately $2.5 billion of unpledged securities.

      Additionally, the Company maintains a large base of core customer deposits, defined as demand, interest checking, savings, and money market deposit accounts. At December 31, 2004, such deposits totaled $8.0 billion and represented 77% of the Company’s total deposits. At December 31, 2003 these deposits totaled $7.8 billion. These core deposits are normally less volatile, often with customer relationships tied to other products offered by the Company promoting long lasting relationships and stable funding sources. Time open and certificates of deposit of $100,000 or greater totaled $762.4 million and $679.2 million at December 31, 2004 and 2003, respectively. These deposits are normally considered more volatile and higher costing, but comprise just 7.3% and 6.7% of total deposits at December 31, 2004 and 2003, respectively.

      At December 31, 2004 and 2003, the Company’s outside borrowings were comprised of federal funds purchased, securities sold under agreements to repurchase, and longer-term debt as follows: