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EX-32 - EXHIBIT 32 - COMMERCE BANCSHARES INC /MO/cbsh6302017ex32.htm
EX-31.2 - EXHIBIT 31.2 - COMMERCE BANCSHARES INC /MO/cbsh6302017ex312.htm
EX-31.1 - EXHIBIT 31.1 - COMMERCE BANCSHARES INC /MO/cbsh6302017ex311.htm

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
 
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934
_________________________________________________________

For the quarterly period ended June 30, 2017

OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934
____________________________________________________________

For the transition period from           to          
Commission File No. 0-2989
 
COMMERCE BANCSHARES, INC.
 
(Exact name of registrant as specified in its charter)
Missouri
 
43-0889454
(State of Incorporation)
 
(IRS Employer Identification No.)
 
 
 
1000 Walnut,
Kansas City, MO
 
64106
(Address of principal executive offices)
 
(Zip Code)
 
 
 
(816) 234-2000
 
 
(Registrant’s telephone number, including area code)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ     No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes þ     No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o
Smaller reporting company £
Emerging growth company £
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o     No þ
As of August 1, 2017, the registrant had outstanding 101,625,940 shares of its $5 par value common stock, registrant’s only class of common stock.



Commerce Bancshares, Inc. and Subsidiaries

Form 10-Q
 

 
 
 
Page
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


PART I: FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
 
 
June 30, 2017
 
December 31, 2016
 
(Unaudited)
 
 
 
(In thousands)
ASSETS
 
 
 
Loans
$
13,626,592

 
$
13,412,736

  Allowance for loan losses
(157,832
)
 
(155,932
)
Net loans
13,468,760

 
13,256,804

Loans held for sale (including $14,118,000 and $9,263,000 of residential mortgage loans carried at fair value at June 30, 2017 and December 31, 2016, respectively)
22,002

 
14,456

Investment securities:
 
 
 

Available for sale ($719,820,000 and $568,553,000 pledged at June 30, 2017 and
 
 
 
    December 31, 2016, respectively, to secure swap and repurchase agreements)
9,439,701

 
9,649,203

 Trading
22,291

 
22,225

 Non-marketable
102,388

 
99,558

Total investment securities
9,564,380

 
9,770,986

Federal funds sold and short-term securities purchased under agreements to resell
16,520

 
15,470

Long-term securities purchased under agreements to resell
625,000

 
725,000

Interest earning deposits with banks
80,860

 
272,275

Cash and due from banks
433,747

 
494,690

Land, buildings and equipment, net
334,586

 
337,705

Goodwill
138,921

 
138,921

Other intangible assets, net
7,002

 
6,709

Other assets
387,065

 
608,408

Total assets
$
25,078,843

 
$
25,641,424

LIABILITIES AND EQUITY
 
 
 
Deposits:
 
 
 

   Non-interest bearing
$
7,314,506

 
$
7,429,398

   Savings, interest checking and money market
11,427,615

 
11,430,789

   Time open and C.D.'s of less than $100,000
679,668

 
713,075

   Time open and C.D.'s of $100,000 and over
1,403,873

 
1,527,833

Total deposits
20,825,662

 
21,101,095

Federal funds purchased and securities sold under agreements to repurchase
1,256,444

 
1,723,905

Other borrowings
101,903

 
102,049

Other liabilities
266,627

 
213,243

Total liabilities
22,450,636

 
23,140,292

Commerce Bancshares, Inc. stockholders’ equity:
 
 
 

   Preferred stock, $1 par value
 
 
 
      Authorized 2,000,000 shares; issued 6,000 shares
144,784

 
144,784

   Common stock, $5 par value
 
 
 

 Authorized 120,000,000 shares;
 
 
 
   issued 102,003,046 shares
510,015

 
510,015

   Capital surplus
1,546,534

 
1,552,454

   Retained earnings
390,853

 
292,849

   Treasury stock of 207,294 shares at June 30, 2017
 
 
 
     and 364,711 shares at December 31, 2016, at cost
(10,373
)
 
(15,294
)
   Accumulated other comprehensive income
42,070

 
10,975

Total Commerce Bancshares, Inc. stockholders' equity
2,623,883

 
2,495,783

Non-controlling interest
4,324

 
5,349

Total equity
2,628,207

 
2,501,132

Total liabilities and equity
$
25,078,843

 
$
25,641,424

See accompanying notes to consolidated financial statements.

3


Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
 
For the Three Months Ended June 30
 
For the Six Months Ended June 30
(In thousands, except per share data)
2017
2016
 
2017
2016
 
(Unaudited)
INTEREST INCOME
 
 
 
 
 
Interest and fees on loans
$
134,273

$
121,151

 
$
262,596

$
240,484

Interest and fees on loans held for sale
263

692

 
459

827

Interest on investment securities
54,975

54,698

 
110,240

103,589

Interest on federal funds sold and short-term securities purchased under
 
 
 
 
 
   agreements to resell
37

19

 
60

43

Interest on long-term securities purchased under agreements to resell
3,684

3,354

 
7,477

6,829

Interest on deposits with banks
362

151

 
759

421

Total interest income
193,594

180,065

 
381,591

352,193

INTEREST EXPENSE
 
 
 
 
 
Interest on deposits:
 
 
 
 
 
   Savings, interest checking and money market
4,342

3,548

 
8,232

7,032

   Time open and C.D.'s of less than $100,000
674

709

 
1,318

1,451

   Time open and C.D.'s of $100,000 and over
2,822

2,347

 
5,585

4,333

Interest on federal funds purchased and securities sold under
 
 
 
 
 
   agreements to repurchase
2,038

725

 
3,577

1,613

Interest on other borrowings
911

907

 
1,799

2,160

Total interest expense
10,787

8,236

 
20,511

16,589

Net interest income
182,807

171,829

 
361,080

335,604

Provision for loan losses
10,758

9,216

 
21,886

18,655

Net interest income after provision for loan losses
172,049

162,613

 
339,194

316,949

NON-INTEREST INCOME
 
 
 
 
 
Bank card transaction fees
44,999

45,065

 
88,203

89,535

Trust fees
33,120

30,241

 
65,134

59,484

Deposit account charges and other fees
22,861

21,328

 
44,803

42,019

Capital market fees
2,156

2,500

 
4,498

5,225

Consumer brokerage services
3,726

3,491

 
7,375

7,000

Loan fees and sales
4,091

3,196

 
7,259

5,706

Other
12,131

10,749

 
22,878

26,625

Total non-interest income
123,084

116,570

 
240,150

235,594

INVESTMENT SECURITIES GAINS (LOSSES), NET
1,651

(744
)
 
879

(1,739
)
NON-INTEREST EXPENSE
 
 
 
 
 
Salaries and employee benefits
108,829

104,808

 
221,198

211,667

Net occupancy
11,430

11,092

 
22,873

22,395

Equipment
4,776

4,781

 
9,385

9,415

Supplies and communication
5,446

5,693

 
11,155

12,522

Data processing and software
23,356

22,770

 
46,453

45,669

Marketing
4,488

4,389

 
7,712

8,202

Deposit insurance
3,592

3,143

 
7,063

6,308

Other
22,677

20,413

 
45,585

38,384

Total non-interest expense
184,594

177,089

 
371,424

354,562

Income before income taxes
112,190

101,350

 
208,799

196,242

Less income taxes
33,201

31,542

 
58,108

60,912

Net income
78,989

69,808

 
150,691

135,330

Less non-controlling interest expense (income)
29

(85
)
 
227

63

Net income attributable to Commerce Bancshares, Inc.
78,960

69,893

 
150,464

135,267

Less preferred stock dividends
2,250

2,250

 
4,500

4,500

Net income available to common shareholders
$
76,710

$
67,643

 
$
145,964

$
130,767

Net income per common share — basic
$
.75

$
.67

 
$
1.43

$
1.29

Net income per common share — diluted
$
.75

$
.66

 
$
1.43

$
1.28

See accompanying notes to consolidated financial statements.

4


Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
 
For the Three Months Ended June 30
 
For the Six Months Ended June 30
(In thousands)
 
2017
2016
 
2017
2016
 
 
(Unaudited)
Net income
 
$
78,989

$
69,808

 
$
150,691

$
135,330

Other comprehensive income (loss):
 
 
 
 
 
 
Net unrealized gains (losses) on securities for which a portion of an other-than-temporary impairment has been recorded in earnings
 
76


 
171

(398
)
Net unrealized gains on other securities
 
11,241

31,139

 
30,243

101,634

Pension loss amortization
 
341

356

 
681

718

Other comprehensive income
 
11,658

31,495

 
31,095

101,954

Comprehensive income
 
90,647

101,303

 
181,786

237,284

Less non-controlling interest expense (income)
 
29

(85
)
 
227

63

Comprehensive income attributable to Commerce Bancshares, Inc.
$
90,618

$
101,388

 
$
181,559

$
237,221

See accompanying notes to consolidated financial statements.














5


Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
 
 
Commerce Bancshares, Inc. Shareholders
 
 
 
 

(In thousands, except per share data)
Preferred Stock
Common Stock
Capital Surplus
Retained Earnings
Treasury Stock
Accumulated Other Comprehensive Income (Loss)
Non-Controlling Interest
Total
 
(Unaudited)
Balance December 31, 2016
$
144,784

$
510,015

$
1,552,454

$
292,849

$
(15,294
)
$
10,975

$
5,349

$
2,501,132

Adoption of ASU 2016-09
 
 
3,441

(2,144
)
 
 
 
1,297

Net income
 




150,464





227

150,691

Other comprehensive income
 








31,095



31,095

Distributions to non-controlling interest
 










(1,252
)
(1,252
)
Purchases of treasury stock
 






(10,628
)




(10,628
)
Issuance of stock under purchase and equity compensation plans
 


(15,556
)


15,549





(7
)
Stock-based compensation
 


6,195









6,195

Cash dividends on common stock ($.450 per share)
 




(45,816
)






(45,816
)
Cash dividends on preferred stock ($.750 per depositary share)
 




(4,500
)






(4,500
)
Balance June 30, 2017
$
144,784

$
510,015

$
1,546,534

$
390,853

$
(10,373
)
$
42,070

$
4,324

$
2,628,207

Balance December 31, 2015
$
144,784

$
489,862

$
1,337,677

$
383,313

$
(26,116
)
$
32,470

$
5,428

$
2,367,418

Net income
 




135,267





63

135,330

Other comprehensive income
 








101,954



101,954

Distributions to non-controlling interest
 










(586
)
(586
)
Purchases of treasury stock
 






(37,462
)




(37,462
)
Issuance of stock under purchase and equity compensation plans
 


(11,873
)


11,871





(2
)
Excess tax benefit related to equity compensation plans
 


1,904









1,904

Stock-based compensation
 


6,287









6,287

Cash dividends on common stock ($.429 per share)
 




(43,522
)






(43,522
)
Cash dividends on preferred stock ($.750 per depositary share)
 
 
 
(4,500
)
 
 
 
(4,500
)
Balance June 30, 2016
$
144,784

$
489,862

$
1,333,995

$
470,558

$
(51,707
)
$
134,424

$
4,905

$
2,526,821

See accompanying notes to consolidated financial statements.



6


Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
For the Six Months Ended June 30
(In thousands)
2017
 
2016
 
(Unaudited)
OPERATING ACTIVITIES:
 
 
 
Net income
$
150,691

 
$
135,330

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
  Provision for loan losses
21,886

 
18,655

  Provision for depreciation and amortization
19,890

 
20,689

  Amortization of investment security premiums, net
17,827

 
16,014

  Investment securities (gains) losses, net (A)
(879
)
 
1,739

  Net gains on sales of loans held for sale
(3,547
)
 
(2,880
)
  Originations of loans held for sale
(96,943
)
 
(70,880
)
  Proceeds from sales of loans held for sale
92,423

 
68,486

  Net decrease in trading securities, excluding unsettled transactions
6,097

 
81,184

  Stock-based compensation
6,195

 
6,287

  (Increase) decrease in interest receivable
(428
)
 
60

  Increase (decrease) in interest payable
(692
)
 
57

  Increase in income taxes payable
1,483

 
73

  Other changes, net
(1,985
)
 
(9,785
)
Net cash provided by operating activities
212,018

 
265,029

INVESTING ACTIVITIES:
 
 
 
Proceeds from sales of investment securities (A)
6,552

 
2,071

Proceeds from maturities/pay downs of investment securities (A)
910,411

 
1,109,707

Purchases of investment securities (A)
(625,931
)
 
(414,154
)
Net increase in loans
(234,405
)
 
(693,522
)
Repayments of long-term securities purchased under agreements to resell
100,000

 
50,000

Purchases of land, buildings and equipment
(14,117
)
 
(13,649
)
Sales of land, buildings and equipment
2,527

 
5,399

Net cash provided by investing activities
145,037

 
45,852

FINANCING ACTIVITIES:
 
 
 
Net increase (decrease) in non-interest bearing, savings, interest checking and money market deposits
77,562

 
(38,985
)
Net increase (decrease) in time open and C.D.'s
(157,367
)
 
267,339

Net decrease in federal funds purchased and short-term securities sold under agreements to repurchase
(467,461
)
 
(331,280
)
Repayment of long-term borrowings
(146
)
 
(840
)
Additional long-term borrowings


900

Purchases of treasury stock
(10,628
)
 
(37,462
)
Issuance of stock under equity compensation plans
(7
)
 
(2
)
Cash dividends paid on common stock
(45,816
)
 
(43,522
)
Cash dividends paid on preferred stock
(4,500
)
 
(4,500
)
Net cash used in financing activities
(608,363
)
 
(188,352
)
Increase (decrease) in cash and cash equivalents
(251,308
)
 
122,529

Cash and cash equivalents at beginning of year
782,435

 
502,719

Cash and cash equivalents at June 30
$
531,127

 
$
625,248

(A) Available for sale and non-marketable securities
 
 
 
Income tax payments, net
$
54,621

 
$
59,886

Interest paid on deposits and borrowings
$
21,203

 
$
16,532

Loans transferred to foreclosed real estate
$
461

 
$
861

Loans transferred from held for investment to held for sale
$

 
$
50,360

See accompanying notes to consolidated financial statements.

7


Commerce Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2017 (Unaudited)
 
1. Principles of Consolidation and Presentation

The accompanying consolidated financial statements include the accounts of Commerce Bancshares, Inc. and all majority-owned subsidiaries (the Company). Most of the Company's operations are conducted by its subsidiary bank, Commerce Bank (the Bank). The consolidated financial statements in this report have not been audited by an independent registered public accounting firm, but in the opinion of management, all adjustments necessary to present fairly the financial position and the results of operations for the interim periods have been made. All such adjustments are of a normal recurring nature. All significant intercompany accounts and transactions have been eliminated. Certain reclassifications were made to 2016 data to conform to current year presentation. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Management has evaluated subsequent events for potential recognition or disclosure. The results of operations for the three and six month periods ended June 30, 2017 are not necessarily indicative of results to be attained for the full year or any other interim period.

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission. Accordingly, the financial statements do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the Company's most recent Annual Report on Form 10-K, containing the latest audited consolidated financial statements and notes thereto.


2. Loans and Allowance for Loan Losses

Major classifications within the Company’s held for investment loan portfolio at June 30, 2017 and December 31, 2016 are as follows:

(In thousands)
 
June 30, 2017
 
December 31, 2016
Commercial:
 
 
 
 
Business
 
$
4,852,408

 
$
4,776,365

Real estate – construction and land
 
848,152

 
791,236

Real estate – business
 
2,727,349

 
2,643,374

Personal Banking:
 
 
 
 
Real estate – personal
 
2,009,203

 
2,010,397

Consumer
 
2,038,514

 
1,990,801

Revolving home equity
 
403,387

 
413,634

Consumer credit card
 
740,865

 
776,465

Overdrafts
 
6,714

 
10,464

Total loans
 
$
13,626,592

 
$
13,412,736


At June 30, 2017, loans of $3.9 billion were pledged at the Federal Home Loan Bank as collateral for borrowings and letters of credit obtained to secure public deposits. Additional loans of $1.6 billion were pledged at the Federal Reserve Bank as collateral for discount window borrowings.


8


Allowance for loan losses    
A summary of the activity in the allowance for loan losses during the three and six months ended June 30, 2017 and 2016, respectively, follows:
 
 
For the Three Months Ended June 30
 
For the Six Months Ended June 30
(In thousands)
 
Commercial
Personal Banking

Total
 
Commercial
Personal Banking

Total
Balance at beginning of period
$
92,951

$
64,881

$
157,832

 
$
91,361

$
64,571

$
155,932

Provision
(111
)
10,869

10,758

 
1,002

20,884

21,886

Deductions:
 
 
 
 
 
 
 
   Loans charged off
531

13,415

13,946

 
1,077

25,745

26,822

   Less recoveries on loans
430

2,758

3,188

 
1,453

5,383

6,836

Net loan charge-offs (recoveries)
101

10,657

10,758

 
(376
)
20,362

19,986

Balance June 30, 2017
$
92,739

$
65,093

$
157,832

 
$
92,739

$
65,093

$
157,832

Balance at beginning of period
$
86,027

$
66,105

$
152,132

 
$
82,086

$
69,446

$
151,532

Provision
1,569

7,647

9,216

 
5,720

12,935

18,655

Deductions:
 
 
 
 
 
 
 
   Loans charged off
661

11,984

12,645

 
2,174

23,761

25,935

   Less recoveries on loans
2,263

2,866

5,129

 
3,566

6,014

9,580

Net loan charge-offs (recoveries)
(1,602
)
9,118

7,516

 
(1,392
)
17,747

16,355

Balance June 30, 2016
$
89,198

$
64,634

$
153,832

 
$
89,198

$
64,634

$
153,832


The following table shows the balance in the allowance for loan losses and the related loan balance at June 30, 2017 and December 31, 2016, disaggregated on the basis of impairment methodology. Impaired loans evaluated under ASC 310-10-35 include loans on non-accrual status, which are individually evaluated for impairment, and other impaired loans discussed below, which are deemed to have similar risk characteristics and are collectively evaluated. All other loans are collectively evaluated for impairment under ASC 450-20.
 
Impaired Loans
 
All Other Loans

(In thousands)
Allowance for Loan Losses
Loans Outstanding
 
Allowance for Loan Losses
Loans Outstanding
June 30, 2017
 
 
 
 
 
Commercial
$
1,454

$
44,937

 
$
91,285

$
8,382,972

Personal Banking
1,433

20,221

 
63,660

5,178,462

Total
$
2,887

$
65,158

 
$
154,945

$
13,561,434

December 31, 2016
 
 
 
 
 
Commercial
$
1,817

$
44,795

 
$
89,544

$
8,166,180

Personal Banking
1,292

19,737

 
63,279

5,182,024

Total
$
3,109

$
64,532

 
$
152,823

$
13,348,204


Impaired loans
The table below shows the Company’s investment in impaired loans at June 30, 2017 and December 31, 2016. These loans consist of all loans on non-accrual status and other restructured loans whose terms have been modified and classified as troubled debt restructurings. These restructured loans are performing in accordance with their modified terms, and because the Company believes it probable that all amounts due under the modified terms of the agreements will be collected, interest on these loans is being recognized on an accrual basis. They are discussed further in the "Troubled debt restructurings" section on page 14.
(In thousands)
 
June 30, 2017
 
Dec. 31, 2016
Non-accrual loans
 
$
13,362

 
$
14,283

Restructured loans (accruing)
 
51,796

 
50,249

Total impaired loans
 
$
65,158

 
$
64,532



9


The following table provides additional information about impaired loans held by the Company at June 30, 2017 and December 31, 2016, segregated between loans for which an allowance for credit losses has been provided and loans for which no allowance has been provided.


(In thousands)
Recorded Investment
Unpaid Principal
Balance
 Related
Allowance
June 30, 2017
 
 
 
With no related allowance recorded:
 
 
 
Business
$
5,566

$
9,000

$

Real estate – construction and land
537

752


 
$
6,103

$
9,752

$

With an allowance recorded:
 
 
 
Business
$
29,226

$
29,821

$
914

Real estate – construction and land
65

68

3

Real estate – business
9,543

10,961

537

Real estate – personal
6,286

9,258

570

Consumer
6,242

6,280

259

Revolving home equity
582

582

10

Consumer credit card
7,111

7,111

594

 
$
59,055

$
64,081

$
2,887

Total
$
65,158

$
73,833

$
2,887

December 31, 2016
 
 
 
With no related allowance recorded:
 
 
 
Business
$
7,375

$
10,470

$

Real estate – construction and land
557

752


 
$
7,932

$
11,222

$

With an allowance recorded:
 
 
 
Business
$
29,924

$
31,795

$
1,318

Real estate – construction and land
69

72

3

Real estate – business
6,870

8,072

496

Real estate – personal
6,394

9,199

642

Consumer
5,281

5,281

57

Revolving home equity
584

584

1

Consumer credit card
7,478

7,478

592

 
$
56,600

$
62,481

$
3,109

Total
$
64,532

$
73,703

$
3,109




10


Total average impaired loans for the three and six month periods ended June 30, 2017 and 2016, respectively, are shown in the table below.

(In thousands)
Commercial
Personal Banking
Total
Average Impaired Loans:
 
 
 
For the three months ended June 30, 2017
 
 
 
Non-accrual loans
$
9,867

$
4,539

$
14,406

Restructured loans (accruing)
34,765

15,780

50,545

Total
$
44,632

$
20,319

$
64,951

For the six months ended June 30, 2017
 
 
 
Non-accrual loans
$
10,238

$
4,027

$
14,265

Restructured loans (accruing)
33,333

15,991

49,324

Total
$
43,571

$
20,018

$
63,589

For the three months ended June 30, 2016
 
 
 
Non-accrual loans
$
22,098

$
4,461

$
26,559

Restructured loans (accruing)
28,775

17,297

46,072

Total
$
50,873

$
21,758

$
72,631

For the six months ended June 30, 2016
 
 
 
Non-accrual loans
$
21,551

$
4,542

$
26,093

Restructured loans (accruing)
27,977

17,499

45,476

Total
$
49,528

$
22,041

$
71,569


The table below shows interest income recognized during the three and six month periods ended June 30, 2017 and 2016, respectively, for impaired loans held at the end of each period. This interest all relates to accruing restructured loans, as discussed in the "Troubled debt restructurings" section on page 14.
 
For the Three Months Ended June 30
 
For the Six Months Ended June 30
(In thousands)
2017
2016
 
2017
2016
Interest income recognized on impaired loans:
 
 
 
 
 
Business
$
319

$
236

 
$
637

$
472

Real estate – construction and land
1

3

 
2

5

Real estate – business
88

56

 
175

112

Real estate – personal
36

42

 
71

84

Consumer
80

89

 
159

177

Revolving home equity
6

4

 
12

7

Consumer credit card
145

159

 
289

318

Total
$
675

$
589

 
$
1,345

$
1,175



11


Delinquent and non-accrual loans
The following table provides aging information on the Company’s past due and accruing loans, in addition to the balances of loans on non-accrual status, at June 30, 2017 and December 31, 2016.




(In thousands)
Current or Less Than 30 Days Past Due

30 – 89
Days Past Due
90 Days Past Due and Still Accruing
Non-accrual



Total
June 30, 2017
 
 
 
 
 
Commercial:
 
 
 
 
 
Business
$
4,842,945

$
2,761

$
372

$
6,330

$
4,852,408

Real estate – construction and land
843,289

4,319


544

848,152

Real estate – business
2,721,612

3,904


1,833

2,727,349

Personal Banking:
 
 
 
 
 
Real estate – personal
1,997,661

6,060

1,978

3,504

2,009,203

Consumer
2,012,634

22,526

2,203

1,151

2,038,514

Revolving home equity
400,306

2,154

927


403,387

Consumer credit card
722,604

9,111

9,150


740,865

Overdrafts
6,414

300



6,714

Total
$
13,547,465

$
51,135

$
14,630

$
13,362

$
13,626,592

December 31, 2016
 
 
 
 
 
Commercial:
 
 
 
 
 
Business
$
4,763,274

$
3,735

$
674

$
8,682

$
4,776,365

Real estate – construction and land
789,633

1,039


564

791,236

Real estate – business
2,639,586

2,154


1,634

2,643,374

Personal Banking:
 
 
 
 
 
Real estate – personal
1,995,724

9,162

2,108

3,403

2,010,397

Consumer
1,957,358

29,783

3,660


1,990,801

Revolving home equity
411,483

1,032

1,119


413,634

Consumer credit card
757,443

10,187

8,835


776,465

Overdrafts
10,014

450



10,464

Total
$
13,324,515

$
57,542

$
16,396

$
14,283

$
13,412,736


Credit quality
The following table provides information about the credit quality of the Commercial loan portfolio, using the Company’s internal rating system as an indicator. The internal rating system is a series of grades reflecting management’s risk assessment, based on its analysis of the borrower’s financial condition. The “pass” category consists of a range of loan grades that reflect increasing, though still acceptable, risk. Movement of risk through the various grade levels in the “pass” category is monitored for early identification of credit deterioration. The “special mention” rating is applied to loans where the borrower exhibits negative financial trends due to borrower specific or systemic conditions that, if left uncorrected, threaten its capacity to meet its debt obligations. The borrower is believed to have sufficient financial flexibility to react to and resolve its negative financial situation. It is a transitional grade that is closely monitored for improvement or deterioration. The “substandard” rating is applied to loans where the borrower exhibits well-defined weaknesses that jeopardize its continued performance and are of a severity that the distinct possibility of default exists. Loans are placed on “non-accrual” when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment.

12


Commercial Loans


(In thousands)


Business
Real
 Estate-Construction
Real
Estate-
Business


Total
June 30, 2017
 
 
 
 
Pass
$
4,617,838

$
843,151

$
2,629,544

$
8,090,533

Special mention
180,380

1,754

44,279

226,413

Substandard
47,860

2,703

51,693

102,256

Non-accrual
6,330

544

1,833

8,707

Total
$
4,852,408

$
848,152

$
2,727,349

$
8,427,909

December 31, 2016
 
 
 
 
Pass
$
4,607,553

$
788,778

$
2,543,348

$
7,939,679

Special mention
116,642

722

45,479

162,843

Substandard
43,488

1,172

52,913

97,573

Non-accrual
8,682

564

1,634

10,880

Total
$
4,776,365

$
791,236

$
2,643,374

$
8,210,975


The credit quality of Personal Banking loans is monitored primarily on the basis of aging/delinquency, and this information is provided in the table in the above "Delinquent and non-accrual loans" section. In addition, FICO scores are obtained and updated on a quarterly basis for most of the loans in the Personal Banking portfolio. This is a published credit score designed to measure the risk of default by taking into account various factors from a borrower's financial history. The Bank normally obtains a FICO score at the loan's origination and renewal dates, and updates are obtained on a quarterly basis. Excluded from the table below are certain Personal Banking loans for which FICO scores are not obtained because they generally pertain to commercial customer activities and are often underwritten with other collateral considerations. At June 30, 2017, these were comprised of $227.4 million in personal real estate loans, or 4.4% of the Personal Banking portfolio, compared to $237.2 million at December 31, 2016. For the remainder of loans in the Personal Banking portfolio, the table below shows the percentage of balances outstanding at June 30, 2017 and December 31, 2016 by FICO score.
   Personal Banking Loans
 
% of Loan Category
 
Real Estate - Personal
Consumer
Revolving Home Equity
Consumer Credit Card
June 30, 2017
 
 
 
 
FICO score:
 
 
 
 
Under 600
1.2
%
3.2
%
1.0
%
4.9
%
600 - 659
2.7

5.7

1.8

14.8

660 - 719
10.6

18.5

9.5

34.8

720 - 779
26.1

26.9

21.8

25.8

780 and over
59.4

45.7

65.9

19.7

Total
100.0
%
100.0
%
100.0
%
100.0
%
December 31, 2016
 
 
 
 
FICO score:
 
 
 
 
Under 600
1.3
%
3.4
%
1.0
%
4.9
%
600 - 659
2.6

6.4

1.8

15.5

660 - 719
10.4

19.7

9.7

34.9

720 - 779
25.4

26.3

21.1

25.1

780 and over
60.3

44.2

66.4

19.6

Total
100.0
%
100.0
%
100.0
%
100.0
%





13


Troubled debt restructurings
As mentioned previously, the Company's impaired loans include loans which have been classified as troubled debt restructurings. Total restructured loans amounted to $59.2 million at June 30, 2017. Restructured loans are those extended to borrowers who are experiencing financial difficulty and who have been granted a concession. Restructured loans are placed on non-accrual status if the Company does not believe it probable that amounts due under the contractual terms will be collected, and those non-accrual loans totaled $7.4 million at June 30, 2017. Other performing restructured loans totaled $51.8 million at June 30, 2017. These include certain business, construction and business real estate loans classified as substandard. Upon maturity, the loans renewed at interest rates judged not to be market rates for new debt with similar risk and as a result the loans were classified as troubled debt restructurings. These commercial loans totaled $36.8 million at June 30, 2017. These restructured loans are performing in accordance with their modified terms, and because the Company believes it probable that all amounts due under the modified terms of the agreements will be collected, interest on these loans is being recognized on an accrual basis. Troubled debt restructurings also include certain credit card loans under various debt management and assistance programs, which totaled $7.1 million at June 30, 2017. Modifications to credit card loans generally involve removing the available line of credit, placing loans on amortizing status, and lowering the contractual interest rate. The Company has classified additional loans as troubled debt restructurings because they were not reaffirmed by the borrower in bankruptcy proceedings. At June 30, 2017, these loans totaled $7.6 million in personal real estate, revolving home equity, and consumer loans. Interest on these loans is being recognized on an accrual basis, as the borrowers are continuing to make payments under the terms of the loan agreements.

The following table shows the outstanding balances of loans classified as troubled debt restructurings at June 30, 2017, in addition to the outstanding balances of these restructured loans which the Company considers to have been in default at any time during the past twelve months. For purposes of this disclosure, the Company considers "default" to mean 90 days or more past due as to interest or principal.
(In thousands)
June 30, 2017
Balance 90 days past due at any time during previous 12 months
Commercial:
 
 
Business
$
34,088

$

Real estate - construction and land
537


Real estate - business
7,710


Personal Banking:
 
 
Real estate - personal
3,995

353

Consumer
5,149

50

Revolving home equity
582

47

Consumer credit card
7,111

649

Total restructured loans
$
59,172

$
1,099


For those loans on non-accrual status also classified as restructured, the modification did not create any further financial effect on the Company as those loans were already recorded at net realizable value. For those performing commercial loans classified as restructured, there were no concessions involving forgiveness of principal or interest and, therefore, there was no financial impact to the Company as a result of modification to these loans. No financial impact resulted from those performing loans where the debt was not reaffirmed in bankruptcy, as no changes to loan terms occurred in that process. The effects of modifications to consumer credit card loans were estimated to decrease interest income by approximately $862 thousand on an annual, pre-tax basis, compared to amounts contractually owed.

The allowance for loan losses related to troubled debt restructurings on non-accrual status is determined by individual evaluation, including collateral adequacy, using the same process as loans on non-accrual status which are not classified as troubled debt restructurings. Those performing loans classified as troubled debt restructurings are accruing loans which management expects to collect under contractual terms. Performing commercial loans have had no other concessions granted other than being renewed at an interest rate judged not to be market. As such, they have similar risk characteristics as non-troubled debt commercial loans and are collectively evaluated based on internal risk rating, loan type, delinquency, historical experience and current economic factors. Performing personal banking loans classified as troubled debt restructurings resulted from the borrower not reaffirming the debt during bankruptcy and have had no other concession granted, other than the Bank's future limitations on collecting payment deficiencies or in pursuing foreclosure actions. As such, they have similar risk characteristics as non-troubled debt personal banking loans and are evaluated collectively based on loan type, delinquency, historical experience and current economic factors.

If a troubled debt restructuring defaults and is already on non-accrual status, the allowance for loan losses continues to be based on individual evaluation, using discounted expected cash flows or the fair value of collateral. If an accruing troubled debt

14


restructuring defaults, the loan's risk rating is downgraded to non-accrual status and the loan's related allowance for loan losses is determined based on individual evaluation, or if necessary, the loan is charged off and collection efforts begun.

The Company had commitments of $3.6 million at June 30, 2017 to lend additional funds to borrowers with restructured loans.

Loans held for sale
The Company designates certain long-term fixed rate personal real estate loans as held for sale, and the Company has elected the fair value option for these loans. The election of the fair value option aligns the accounting for these loans with the related economic hedges discussed in Note 10. The loans are primarily sold to FNMA, FHLMC, and GNMA. At June 30, 2017, the fair value of these loans was $14.1 million, and the unpaid principal balance was $13.6 million.

The Company also designates student loan originations as held for sale. The borrowers are credit-worthy students who are attending colleges and universities. The loans are intended to be sold in the secondary market, and the Company maintains contracts with Sallie Mae to sell the loans within 210 days after the last disbursement to the student. These loans are carried at lower of cost or fair value, which at June 30, 2017 totaled $7.9 million.

At June 30, 2017, none of the loans held for sale were on non-accrual status or 90 days past due and still accruing.
 
Foreclosed real estate/repossessed assets
The Company’s holdings of foreclosed real estate totaled $515 thousand and $366 thousand at June 30, 2017 and December 31, 2016, respectively. Personal property acquired in repossession, generally autos and marine and recreational vehicles, totaled $2.4 million and $2.2 million at June 30, 2017 and December 31, 2016, respectively. Upon acquisition, these assets are recorded at fair value less estimated selling costs at the date of foreclosure, establishing a new cost basis. They are subsequently carried at the lower of this cost basis or fair value less estimated selling costs.

3. Investment Securities

Investment securities, at fair value, consisted of the following at June 30, 2017 and December 31, 2016.
 
(In thousands)
June 30, 2017
December 31, 2016
Available for sale
$
9,439,701

$
9,649,203

Trading
22,291

22,225

Non-marketable
102,388

99,558

Total investment securities
$
9,564,380

$
9,770,986


Most of the Company’s investment securities are classified as available for sale, and this portfolio is discussed in more detail below. The available for sale and the trading portfolios are carried at fair value. Securities which are classified as non-marketable include Federal Home Loan Bank (FHLB) stock and Federal Reserve Bank stock held for debt and regulatory purposes, which totaled $47.1 million at June 30, 2017 and $46.9 million at December 31, 2016. Investment in Federal Reserve Bank stock is based on the capital structure of the investing bank, and investment in FHLB stock is tied to the level of borrowings from the FHLB. These holdings are carried at cost. Non-marketable securities also include private equity investments, which amounted to $55.0 million at June 30, 2017 and $52.3 million at December 31, 2016. In the absence of readily ascertainable market values, these securities are carried at estimated fair value.


15


A summary of the available for sale investment securities by maturity groupings as of June 30, 2017 is shown below. The investment portfolio includes agency mortgage-backed securities, which are guaranteed by agencies such as the FHLMC, FNMA, GNMA and FDIC, in addition to non-agency mortgage-backed securities, which have no guarantee but are collateralized by residential mortgages. Also included are certain other asset-backed securities, which are primarily collateralized by credit cards, automobiles, student loans, and commercial loans. These securities differ from traditional debt securities primarily in that they may have uncertain maturity dates and are priced based on estimated prepayment rates on the underlying collateral.
(In thousands)
Amortized Cost
Fair Value
U.S. government and federal agency obligations:
 
 
Within 1 year
$
58,665

$
58,829

After 1 but within 5 years
499,601

502,990

After 5 but within 10 years
318,318

318,212

After 10 years
35,444

32,524

Total U.S. government and federal agency obligations
912,028

912,555

Government-sponsored enterprise obligations:
 
 
Within 1 year
98,069

98,206

After 1 but within 5 years
336,302

335,723

After 10 years
12,493

12,356

Total government-sponsored enterprise obligations
446,864

446,285

State and municipal obligations:
 
 
Within 1 year
171,936

172,890

After 1 but within 5 years
643,200

654,145

After 5 but within 10 years
879,036

900,292

After 10 years
50,896

50,470

Total state and municipal obligations
1,745,068

1,777,797

Mortgage and asset-backed securities:
 
 
  Agency mortgage-backed securities
2,604,217

2,620,198

  Non-agency mortgage-backed securities
1,063,236

1,066,889

  Asset-backed securities
2,249,399

2,250,426

Total mortgage and asset-backed securities
5,916,852

5,937,513

Other debt securities:
 
 
Within 1 year
13,387

13,389

After 1 but within 5 years
176,199

177,812

After 5 but within 10 years
125,910

126,503

Total other debt securities
315,496

317,704

Equity securities
5,463

47,847

Total available for sale investment securities
$
9,341,771

$
9,439,701


Investments in U.S. government and federal agency obligations include U.S. Treasury inflation-protected securities, which totaled $432.0 million, at fair value, at June 30, 2017. Interest paid on these securities increases with inflation and decreases with deflation, as measured by the Consumer Price Index. Included in state and municipal obligations are $16.8 million, at fair value, of auction rate securities, which were purchased from bank customers in 2008. Interest on these bonds is currently being paid at the maximum failed auction rates. Included in equity securities is common and preferred stock held by the holding company, Commerce Bancshares, Inc. (the Parent), with a fair value of $47.7 million at June 30, 2017.


16


For securities classified as available for sale, the following table shows the unrealized gains and losses (pre-tax) in accumulated other comprehensive income, by security type.
 
 
(In thousands)
Amortized Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
June 30, 2017
 
 
 
 
U.S. government and federal agency obligations
$
912,028

$
5,575

$
(5,048
)
$
912,555

Government-sponsored enterprise obligations
446,864

892

(1,471
)
446,285

State and municipal obligations
1,745,068

34,717

(1,988
)
1,777,797

Mortgage and asset-backed securities:
 
 
 
 
  Agency mortgage-backed securities
2,604,217

29,780

(13,799
)
2,620,198

  Non-agency mortgage-backed securities
1,063,236

8,063

(4,410
)
1,066,889

  Asset-backed securities
2,249,399

5,725

(4,698
)
2,250,426

Total mortgage and asset-backed securities
5,916,852

43,568

(22,907
)
5,937,513

Other debt securities
315,496

2,745

(537
)
317,704

Equity securities
5,463

42,384


47,847

Total
$
9,341,771

$
129,881

$
(31,951
)
$
9,439,701

December 31, 2016
 
 
 
 
U.S. government and federal agency obligations
$
919,904

$
7,312

$
(6,312
)
$
920,904

Government-sponsored enterprise obligations
450,448

1,126

(1,576
)
449,998

State and municipal obligations
1,778,684

12,223

(12,693
)
1,778,214

Mortgage and asset-backed securities:
 
 
 
 
  Agency mortgage-backed securities
2,674,964

31,610

(20,643
)
2,685,931

  Non-agency mortgage-backed securities
1,054,446

7,686

(6,493
)
1,055,639

  Asset-backed securities
2,389,176

3,338

(11,213
)
2,381,301

Total mortgage and asset-backed securities
6,118,586

42,634

(38,349
)
6,122,871

Other debt securities
327,030

935

(2,012
)
325,953

Equity securities
5,678

45,585


51,263

Total
$
9,600,330

$
109,815

$
(60,942
)
$
9,649,203


The Company’s impairment policy requires a review of all securities for which fair value is less than amortized cost. Special emphasis and analysis is placed on securities whose credit rating has fallen below A3 (Moody's) or A- (Standard & Poor's), whose fair values have fallen more than 20% below purchase price for an extended period of time, or have been identified based on management’s judgment. These securities are placed on a watch list, and for all such securities, cash flow analyses are prepared. For more complex analyses, detailed cash flow models are prepared which use inputs specific to each security. Inputs to these models include factors such as cash flow received, contractual payments required, and various other information related to the underlying collateral (including current delinquencies), collateral loss severity rates (including loan to values), expected delinquency rates, credit support from other tranches, and prepayment speeds. Stress tests are performed at varying levels of delinquency rates, prepayment speeds and loss severities in order to gauge probable ranges of credit loss. At June 30, 2017, the fair value of securities on this watch list was $68.9 million compared to $79.6 million at December 31, 2016.

As of June 30, 2017, the Company had recorded other-than-temporary impairment (OTTI) on certain non-agency mortgage-backed securities, part of the watch list mentioned above, which had an aggregate fair value of $30.3 million. The cumulative credit-related portion of the impairment on these securities, which was recorded in earnings, totaled $14.3 million. The Company does not intend to sell these securities and believes it is not likely that it will be required to sell the securities before the recovery of their amortized cost.

The credit-related portion of the loss on these securities was based on the cash flows projected to be received over the estimated life of the securities, discounted to present value, and compared to the current amortized cost bases of the securities. Significant inputs to the cash flow models used to calculate the credit losses on these securities at June 30, 2017 included the following:

Significant Inputs
Range
Prepayment CPR
4%
-
25%
Projected cumulative default
14%
-
51%
Credit support
0%
-
38%
Loss severity
16%
-
63%

17


The following table presents a rollforward of the cumulative OTTI credit losses recognized in earnings on all available for sale debt securities.
 
For the Six Months Ended June 30
(In thousands)
2017
2016
Cumulative OTTI credit losses at January 1
$
14,080

$
14,129

Credit losses on debt securities for which impairment was not previously recognized
46


Credit losses on debt securities for which impairment was previously recognized
274

270

Increase in expected cash flows that are recognized over remaining life of security
(146
)
(37
)
Cumulative OTTI credit losses at June 30
$
14,254

$
14,362


Securities with unrealized losses recorded in accumulated other comprehensive income are shown in the table below, along with the length of the impairment period.
 
Less than 12 months
 
12 months or longer
 
Total
 
(In thousands)
   Fair Value
Unrealized
Losses
 
Fair Value
Unrealized
Losses
 
Fair Value
Unrealized
Losses
June 30, 2017
 
 
 
 
 
 
 
 
U.S. government and federal agency obligations
$
145,884

$
5,048

 
$

$

 
$
145,884

$
5,048

Government-sponsored enterprise obligations
181,682

1,471

 


 
181,682

1,471

State and municipal obligations
168,613

1,365

 
13,761

623

 
182,374

1,988

Mortgage and asset-backed securities:
 
 
 
 
 
 
 
 
   Agency mortgage-backed securities
959,777

13,795

 
1,720

4

 
961,497

13,799

   Non-agency mortgage-backed securities
503,709

4,165

 
47,189

245

 
550,898

4,410

   Asset-backed securities
795,526

2,606

 
234,619

2,092

 
1,030,145

4,698

Total mortgage and asset-backed securities
2,259,012

20,566

 
283,528

2,341

 
2,542,540

22,907

Other debt securities
65,547

500

 
1,463

37

 
67,010

537

Total
$
2,820,738

$
28,950

 
$
298,752

$
3,001

 
$
3,119,490

$
31,951

December 31, 2016
 
 
 
 
 
 
 
 
U.S. government and federal agency obligations
$
349,538

$
2,823

 
$
32,208

$
3,489

 
$
381,746

$
6,312

Government-sponsored enterprise obligations
190,441

1,576

 


 
190,441

1,576

State and municipal obligations
700,779

12,164

 
15,195

529

 
715,974

12,693

Mortgage and asset-backed securities:
 
 
 
 
 
 
 
 
   Agency mortgage-backed securities
1,147,416

20,638

 
2,150

5

 
1,149,566

20,643

   Non-agency mortgage-backed securities
688,131

6,373

 
34,946

120

 
723,077

6,493

   Asset-backed securities
780,209

5,277

 
358,778

5,936

 
1,138,987

11,213

Total mortgage and asset-backed securities
2,615,756

32,288

 
395,874

6,061

 
3,011,630

38,349

Other debt securities
179,639

1,986

 
975

26

 
180,614

2,012

Total
$
4,036,153

$
50,837

 
$
444,252

$
10,105

 
$
4,480,405

$
60,942


The Company’s holdings of state and municipal obligations included gross unrealized losses of $2.0 million at June 30, 2017, of which $230 thousand related to auction rate securities. This portfolio totaled $1.8 billion at fair value, or 18.8% of total available for sale securities. The average credit quality of the portfolio, excluding auction rate securities, is Aa2 as rated by Moody’s. The portfolio is diversified in order to reduce risk, and the Company has processes and procedures in place to monitor its holdings, identify signs of financial distress and, if necessary, exit its positions in a timely manner.

    

18


The following tables present proceeds from sales of securities and the components of investment securities gains and losses which have been recognized in earnings.
 
For the Six Months Ended June 30
(In thousands)
2017
2016
Proceeds from sales of securities:
 
 
Available for sale
$
4,972

$

Non-marketable
1,580

2,071

Total proceeds
$
6,552

$
2,071

 
 
 
Investment securities gains (losses), net:
 
 
Available for sale:
 
 
Losses realized on called bonds
$
(254
)
$

Losses realized on sales
(22
)

Gains realized on donations
4,315


Other-than-temporary impairment recognized on debt securities
(320
)
(270
)
 Non-marketable:
 
 
 Gains realized on sales
642

2,260

 Losses realized on sales
(652
)

Fair value adjustments, net
(2,830
)
(3,729
)
Total gains (losses), net
$
879

$
(1,739
)

At June 30, 2017, securities totaling $3.9 billion in fair value were pledged to secure public fund deposits, securities sold under agreements to repurchase, trust funds, and borrowings at the Federal Reserve Bank and FHLB. Securities pledged under agreements pursuant to which the collateral may be sold or re-pledged by the secured parties approximated $719.8 million, while the remaining securities were pledged under agreements pursuant to which the secured parties may not sell or re-pledge the collateral. Except for obligations of various government-sponsored enterprises such as FNMA, FHLB and FHLMC, no investment in a single issuer exceeded 10% of stockholders’ equity.

19


4. Goodwill and Other Intangible Assets

The following table presents information about the Company's intangible assets which have estimable useful lives.
 
June 30, 2017
 
December 31, 2016
 
 
(In thousands)
Gross Carrying Amount
Accumulated Amortization
Valuation Allowance
Net Amount
 
Gross Carrying Amount
Accumulated Amortization
Valuation Allowance
Net Amount
Amortizable intangible assets:
 
 
 
 
 
 
 
 
 
Core deposit premium
$
31,270

$
(27,914
)
$

$
3,356

 
$
31,270

$
(27,429
)
$

$
3,841

Mortgage servicing rights
6,637

(2,975
)
(16
)
3,646

 
5,672

(2,782
)
(22
)
2,868

Total
$
37,907

$
(30,889
)
$
(16
)
$
7,002

 
$
36,942

$
(30,211
)
$
(22
)
$
6,709


Aggregate amortization expense on intangible assets was $330 thousand and $399 thousand for the three month periods ended June 30, 2017 and 2016, respectively, and $678 thousand and $794 thousand for the six month periods ended June 30, 2017 and 2016, respectively. The following table shows the estimated annual amortization expense for the next five fiscal years. This expense is based on existing asset balances and the interest rate environment as of June 30, 2017. The Company’s actual amortization expense in any given period may be different from the estimated amounts depending upon the acquisition of intangible assets, changes in mortgage interest rates, prepayment rates and other market conditions.
 (In thousands)
 
2017
$
1,141

2018
1,091

2019
917

2020
765

2021
651



Changes in the carrying amount of goodwill and net other intangible assets for the six month period ended June 30, 2017 is as follows:
(In thousands)
Goodwill
Core Deposit Premium
Mortgage Servicing Rights
Balance January 1, 2017
$
138,921

$
3,841

$
2,868

Originations


965

Amortization

(485
)
(193
)
Impairment reversal


6

Balance June 30, 2017
$
138,921

$
3,356

$
3,646



Goodwill allocated to the Company’s operating segments at June 30, 2017 and December 31, 2016 is shown below.
(In thousands)
 
Consumer segment
$
70,721

Commercial segment
67,454

Wealth segment
746

Total goodwill
$
138,921


5. Guarantees

The Company, as a provider of financial services, routinely issues financial guarantees in the form of financial and performance standby letters of credit. Standby letters of credit are contingent commitments issued by the Company generally to guarantee the payment or performance obligation of a customer to a third party. While these represent a potential outlay by the Company, a significant amount of the commitments may expire without being drawn upon. The Company has recourse against the customer for any amount it is required to pay to a third party under a standby letter of credit. The letters of credit are subject to the same credit policies, underwriting standards and approval process as loans made by the Company. Most of the standby letters of credit are secured, and in the event of nonperformance by customers, the Company has rights to the underlying collateral, which could include commercial real estate, physical plant and property, inventory, receivables, cash and marketable securities.


20


Upon issuance of standby letters of credit, the Company recognizes a liability for the fair value of the obligation undertaken, which is estimated to be equivalent to the amount of fees received from the customer over the life of the agreement. At June 30, 2017, that net liability was $2.1 million, which will be accreted into income over the remaining life of the respective commitments. The contractual amount of these letters of credit, which represents the maximum potential future payments guaranteed by the Company, was $338.8 million at June 30, 2017.

The Company periodically enters into credit risk participation agreements (RPAs) as a guarantor to other financial institutions, in order to mitigate those institutions’ credit risk associated with interest rate swaps with third parties. The RPA stipulates that, in the event of default by the third party on the interest rate swap, the Company will reimburse a portion of the loss borne by the financial institution. These interest rate swaps are normally collateralized (generally with real property, inventories and equipment) by the third party, which limits the credit risk associated with the Company’s RPAs. The third parties usually have other borrowing relationships with the Company. The Company monitors overall borrower collateral and at June 30, 2017, believes sufficient collateral is available to cover potential swap losses. The RPAs are carried at fair value throughout their term with all changes in fair value, including those due to a change in the third party’s creditworthiness, recorded in current earnings. The terms of the RPAs, which correspond to the terms of the underlying swaps, range from 3 to 11 years. At June 30, 2017, the fair value of the Company's guarantee liabilities for RPAs was $139 thousand, and the notional amount of the underlying swaps was $75.3 million. The maximum potential future payment guaranteed by the Company cannot be readily estimated but is dependent upon the fair value of the interest rate swaps at the time of default.

6. Pension

The amount of net pension cost is shown in the table below:
 
For the Three Months Ended June 30
 
For the Six Months Ended June 30
(In thousands)
2017
2016
 
2017
2016
Service cost - benefits earned during the period
$
128

$
138

 
$
257

$
271

Interest cost on projected benefit obligation
973

1,005

 
1,946

1,972

Expected return on plan assets
(1,438
)
(1,439
)
 
(2,876
)
(2,876
)
Amortization of prior service cost
(68
)
(67
)
 
(136
)
(135
)
Amortization of unrecognized net loss
617

642

 
1,234

1,293

Net periodic pension cost
$
212

$
279

 
$
425

$
525


Substantially all benefits accrued under the Company’s defined benefit pension plan were frozen effective January 1, 2005, and the remaining benefits were frozen effective January 1, 2011. During the first six months of 2017, the Company made no funding contributions to its defined benefit pension plan and made minimal funding contributions to a supplemental executive retirement plan (the CERP), which carries no segregated assets. The Company has no plans to make any further contributions, other than those related to the CERP, during the remainder of 2017.





21


7. Common Stock *

Presented below is a summary of the components used to calculate basic and diluted income per share. The Company applies the two-class method of computing income per share, as nonvested share-based awards that contain nonforfeitable rights to dividends are considered securities which participate in undistributed earnings with common stock. The two-class method requires the calculation of separate income per share amounts for the nonvested share-based awards and for common stock. Income per share attributable to common stock is shown in the table below. Nonvested share-based awards are further discussed in Note 12.
 
For the Three Months Ended June 30
 
For the Six Months Ended June 30
(In thousands, except per share data)
2017
2016
 
2017
2016
Basic income per common share:
 
 
 
 
 
Net income attributable to Commerce Bancshares, Inc.
$
78,960

$
69,893

 
$
150,464

$
135,267

Less preferred stock dividends
2,250

2,250

 
4,500

4,500

Net income available to common shareholders
$
76,710

$
67,643

 
145,964

130,767

Less income allocated to nonvested restricted stock
943

940

 
1,888

1,834

  Net income allocated to common stock
$
75,767

$
66,703

 
$
144,076

$
128,933

Weighted average common shares outstanding
100,555

100,151

 
100,463

100,247

   Basic income per common share
$
.75

$
.67

 
$
1.43

$
1.29

Diluted income per common share:
 
 
 
 
 
Net income available to common shareholders
$
76,710

$
67,643

 
$
145,964

$
130,767

Less income allocated to nonvested restricted stock
941

938

 
1,883

1,831

  Net income allocated to common stock
$
75,769

$
66,705

 
$
144,081

$
128,936

Weighted average common shares outstanding
100,555

100,151

 
100,463

100,247

  Net effect of the assumed exercise of stock-based awards - based on
 
 
 
 
 
    the treasury stock method using the average market price for the respective periods
344

261

 
370

245

  Weighted average diluted common shares outstanding
100,899

100,412

 
100,833

100,492

    Diluted income per common share
$
.75

$
.66

 
$
1.43

$
1.28


Unexercised stock appreciation rights of 126 thousand and 208 thousand were excluded in the computation of diluted income per common share for the six month periods ended June 30, 2017 and 2016, respectively, because their inclusion would have been anti-dilutive.
* All prior year share and per share amounts in this note have been restated for the 5% common stock dividend distributed in December 2016.
  

22


8. Accumulated Other Comprehensive Income

The table below shows the activity and accumulated balances for components of other comprehensive income. The largest component is the unrealized holding gains and losses on available for sale securities. Unrealized gains and losses on debt securities for which an other-than-temporary impairment (OTTI) has been recorded in current earnings are shown separately below. The other component is the amortization from other comprehensive income of losses associated with pension benefits, which occurs as the losses are included in current net periodic pension cost.
 
Unrealized Gains (Losses) on Securities (1)
Pension Loss (2)
Total Accumulated Other Comprehensive Income
(In thousands)
OTTI
Other
Balance January 1, 2017
$
2,975

$
27,328

$
(19,328
)
$
10,975

Other comprehensive income (loss) before reclassifications
(44
)
53,072


53,028

Amounts reclassified from accumulated other comprehensive income
320

(4,293
)
1,098

(2,875
)
Current period other comprehensive income, before tax
276

48,779

1,098

50,153

Income tax expense
(105
)
(18,536
)
(417
)
(19,058
)
Current period other comprehensive income, net of tax
171

30,243

681

31,095

Transfer of unrealized gain on securities for which impairment was not previously recognized
24

(24
)


Balance June 30, 2017
$
3,170

$
57,547

$
(18,647
)
$
42,070

Balance January 1, 2016
$
3,316

$
49,750

$
(20,596
)
$
32,470

Other comprehensive income (loss) before reclassifications
(911
)
163,925


163,014

Amounts reclassified from accumulated other comprehensive income
270


1,158

1,428

Current period other comprehensive income (loss), before tax
(641
)
163,925

1,158

164,442

Income tax (expense) benefit
243

(62,291
)
(440
)
(62,488
)
Current period other comprehensive income (loss), net of tax
(398
)
101,634

718

101,954

Balance June 30, 2016
$
2,918

$
151,384

$
(19,878
)
$
134,424

(1) The pre-tax amounts reclassified from accumulated other comprehensive income are included in "investment securities gains (losses), net" in the consolidated statements of income.
(2) The pre-tax amounts reclassified from accumulated other comprehensive income are included in the computation of net periodic pension cost as "amortization of prior service cost" and "amortization of unrecognized net loss" (see Note 6), for inclusion in the consolidated statements of income.

9. Segments

The Company segregates financial information for use in assessing its performance and allocating resources among three operating segments: Consumer, Commercial and Wealth. The Consumer segment consists of various consumer loan and deposit products offered through its retail branch network of approximately 180 locations.  This segment also includes indirect and other consumer loan financing businesses, along with debit and credit card loan and fee businesses.  Residential mortgage origination, sales and servicing functions are included in this consumer segment, but residential mortgage loans retained by the Company are not considered part of this segment.  The Commercial segment provides corporate lending, leasing, and international services, along with business and governmental deposit products and commercial cash management services.  This segment includes both merchant and commercial bank card products. It also includes the Capital Markets Group which sells fixed income securities and provides safekeeping and accounting services to its business and correspondent bank customers.  The Wealth segment provides traditional trust and estate planning, advisory and discretionary investment management, and brokerage services.  This segment also provides various loan and deposit related services to its private banking customers.



23


The following table presents selected financial information by segment and reconciliations of combined segment totals to consolidated totals. There were no material intersegment revenues among the three segments. Management periodically makes changes to methods of assigning costs and income to its business segments to better reflect operating results. If appropriate, these change are reflected in prior year information presented below.

(In thousands)
Consumer
Commercial
Wealth
Segment Totals
Other/Elimination
Consolidated Totals
Three Months Ended June 30, 2017
 
 
 
 
 
 
Net interest income
$
69,274

$
81,718

$
11,933

$
162,925

$
19,882

$
182,807

Provision for loan losses
(10,802
)
111

24

(10,667
)
(91
)
(10,758
)
Non-interest income
34,459

49,746

38,851

123,056

28

123,084

Investment securities gains, net




1,651

1,651

Non-interest expense
(73,603
)
(74,054
)
(29,446
)
(177,103
)
(7,491
)
(184,594
)
Income before income taxes
$
19,328

$
57,521

$
21,362

$
98,211

$
13,979

$
112,190

Six Months Ended June 30, 2017
 
 
 
 
 
 
Net interest income
$
136,628

$
161,505

$
23,771

$
321,904

$
39,176

$
361,080

Provision for loan losses
(20,464
)
624

1

(19,839
)
(2,047
)
(21,886
)
Non-interest income
66,017

96,879

76,557

239,453

697

240,150

Investment securities gains, net




879

879

Non-interest expense
(145,126
)
(147,839
)
(59,795
)
(352,760
)
(18,664
)
(371,424
)
Income before income taxes
$
37,055

$
111,169

$
40,534

$
188,758

$
20,041

$
208,799

Three Months Ended June 30, 2016
 
 
 
 
 
 
Net interest income
$
67,227

$
77,249

$
10,947

$
155,423

$
16,406

$
171,829

Provision for loan losses
(8,775
)
1,468

(9
)
(7,316
)
(1,900
)
(9,216
)
Non-interest income
33,038

48,289

36,618

117,945

(1,375
)
116,570

Investment securities losses, net




(744
)
(744
)
Non-interest expense
(70,522
)
(70,637
)
(28,356
)
(169,515
)
(7,574
)
(177,089
)
Income before income taxes
$
20,968

$
56,369

$
19,200

$
96,537

$
4,813

$
101,350

Six Months Ended June 30, 2016
 
 
 
 
 
 
Net interest income
$
133,791

$
153,266

$
21,822

$
308,879

$
26,725

$
335,604

Provision for loan losses
(17,500
)
1,487

(115
)
(16,128
)
(2,527
)
(18,655
)
Non-interest income
62,935

99,408

71,020

233,363

2,231

235,594

Investment securities losses, net




(1,739
)
(1,739
)
Non-interest expense
(139,526
)
(140,250
)
(56,944
)
(336,720
)
(17,842
)
(354,562
)
Income before income taxes
$
39,700

$
113,911

$
35,783

$
189,394

$
6,848

$
196,242


The information presented above was derived from the internal profitability reporting system used by management to monitor and manage the financial performance of the Company. This information is based on internal management accounting procedures and methods, which have been developed to reflect the underlying economics of the businesses. The methodologies are applied in connection with funds transfer pricing and assignment of overhead costs among segments. Funds transfer pricing was used in the determination of net interest income by assigning a standard cost (credit) for funds used (provided) by assets and liabilities based on their maturity, prepayment and/or repricing characteristics.

The segment activity, as shown above, includes both direct and allocated items. Amounts in the “Other/Elimination” column include activity not related to the segments, such as that relating to administrative functions, the investment securities portfolio, and the effect of certain expense allocations to the segments. The provision for loan losses in this category contains the difference between net loan charge-offs assigned directly to the segments and the recorded provision for loan loss expense. Included in this category’s net interest income are earnings of the investment portfolio, which are not allocated to a segment.

The performance measurement of the operating segments is based on the management structure of the Company and is not necessarily comparable with similar information for any other financial institution. The information is also not necessarily indicative of the segments' financial condition and results of operations if they were independent entities.


24


10. Derivative Instruments

The notional amounts of the Company’s derivative instruments are shown in the table below. These contractual amounts, along with other terms of the derivative, are used to determine amounts to be exchanged between counterparties and are not a measure of loss exposure. The Company’s derivative instruments are accounted for as free-standing derivatives, and changes in their fair value are recorded in current earnings.

(In thousands)
June 30, 2017
December 31, 2016
Interest rate swaps
$
1,693,637

$
1,685,099

Interest rate caps
32,890

59,379

Credit risk participation agreements
118,081

121,514

Foreign exchange contracts
5,556

4,046

 Mortgage loan commitments
29,429

12,429

Mortgage loan forward sale contracts
1,026

6,626

Forward TBA contracts
43,000

15,000

Total notional amount
$
1,923,619

$
1,904,093


The largest group of notional amounts relate to interest rate swap contracts sold to commercial customers who wish to modify their interest rate sensitivity. These swaps are offset by matching contracts purchased by the Company from other financial dealer institutions. Contracts with dealers that require central clearing are novated to a regulated clearing organization who becomes the Company's legal counterparty. Because of the matching terms of the offsetting contracts, in addition to collateral provisions which mitigate the impact of non-performance risk, changes in fair value subsequent to initial recognition have a minimal effect on earnings.

Many of the Company’s interest rate swap contracts with large financial institutions contain contingent features relating to debt ratings or capitalization levels. Under these provisions, if the Company’s debt rating falls below investment grade or if the Company ceases to be “well-capitalized” under risk-based capital guidelines, certain counterparties can require immediate and ongoing collateralization on interest rate swaps in net liability positions or instant settlement of the contracts. The Company maintains debt ratings and capital well above these minimum requirements.

The Company also contracts with other financial institutions, as a guarantor or beneficiary, to share credit risk associated with certain interest rate swaps through risk participation agreements. The Company’s risks and responsibilities as guarantor are further discussed in Note 5 on Guarantees. In addition, the Company enters into foreign exchange contracts, which are mainly comprised of contracts to purchase or deliver foreign currencies for customers at specific future dates.

Under its program to sell residential mortgage loans in the secondary market, the Company designates certain newly-originated residential mortgage loans as held for sale. Derivative instruments arising from this activity include mortgage loan commitments and forward loan sale commitments. Changes in the fair values of the loan commitments and funded loans prior to sale that are due to changes in interest rates are economically hedged with forward contracts to sell residential mortgage-backed securities in the to-be-announced (TBA) market. These forward TBA contracts are also considered to be derivatives and are settled in cash at the security settlement date.


25


The fair values of the Company's derivative instruments, whose notional amounts are listed above, are shown in the table below. Derivative instruments with a positive fair value (asset derivatives) are reported in other assets in the consolidated balance sheets, while derivative instruments with a negative fair value (liability derivatives) are reported in other liabilities in the consolidated balance sheets. Information about the valuation methods used to determine fair value is provided in Note 13 on Fair Value Measurements.
 
Asset Derivatives
 
Liability Derivatives
 
June 30, 2017
Dec. 31, 2016
 
June 30, 2017
Dec. 31, 2016
(In thousands)    
  Fair Value
 
  Fair Value
Derivative instruments:
 
 
 
 
 
   Interest rate swaps
$
10,887

$
12,987

 
$
(5,987
)
$
(12,987
)
   Interest rate caps
34

78

 
(34
)
(78
)
   Credit risk participation agreements
58

65

 
(139
)
(156
)
   Foreign exchange contracts
39

66

 
(53
)
(4
)
   Mortgage loan commitments
872

355

 

(6
)
   Mortgage loan forward sale contracts


 

(63
)
   Forward TBA contracts
137

15

 
(34
)
(45
)
 Total
$
12,027

$
13,566

 
$
(6,247
)
$
(13,339
)

Due to rule changes by the Company's clearing counterparty effective January 2017, collateral previously recorded in "other assets" has been reclassified and offset against the fair values of cleared swaps, such that at June 30, 2017, the positive fair values of cleared swaps were reduced by $2.4 million and the negative fair values of cleared swaps were reduced by $7.3 million, as reflected in the table above.

The effects of derivative instruments on the consolidated statements of income are shown in the table below.



Location of Gain or (Loss) Recognized in Income on Derivatives
Amount of Gain or (Loss) Recognized in Income on Derivatives


 
For the Three Months Ended June 30
 
For the Six Months Ended June 30
(In thousands)
 
2017
2016
 
2017
2016
Derivative instruments:
 
 
 
 
 
 
  Interest rate swaps
Other non-interest income
$
456

$
769

 
$
599

$
2,995

  Credit risk participation agreements
Other non-interest income
1

(23
)
 
11

(58
)
  Foreign exchange contracts
Other non-interest income
(55
)
57

 
(75
)
8

  Mortgage loan commitments
Loan fees and sales
(32
)
19

 
522

527

  Mortgage loan forward sale contracts
Loan fees and sales
(4
)
1

 
62


  Forward TBA contracts
Loan fees and sales
(160
)
(397
)
 
(258
)
(726
)
Total
 
$
206

$
426

 
$
861

$
2,746


The following table shows the extent to which assets and liabilities relating to derivative instruments have been offset in the consolidated balance sheets. It also provides information about these instruments which are subject to an enforceable master netting arrangement, irrespective of whether they are offset, and the extent to which the instruments could potentially be offset. Also shown is collateral received or pledged in the form of other financial instruments, which is generally cash or marketable securities. The collateral amounts in this table are limited to the outstanding balances of the related asset or liability (after netting is applied); thus amounts of excess collateral are not shown. Most of the derivatives in the following table were transacted under master netting arrangements that contain a conditional right of offset, such as close-out netting, upon default.


26


The Company is party to master netting arrangements with most of its swap derivative counterparties; however, the Company does not offset derivative assets and liabilities under these arrangements on its consolidated balance sheet. Collateral, usually in the form of marketable securities, is exchanged between the Company and dealer bank counterparties and is generally subject to thresholds and transfer minimums. By contract, it may be sold or re-pledged by the secured party until recalled at a subsequent valuation date by the pledging party. For those swap transactions requiring central clearing, the Company posts cash and securities to its clearing agent. Collateral positions are valued daily, and adjustments to amounts received and pledged by the Company are made as appropriate to maintain proper collateralization for these transactions. Swap derivative transactions with customers are generally secured by rights to non-financial collateral, such as real and personal property, which is not shown in the table below.
 
 
 
 
Gross Amounts Not Offset in the Balance Sheet
 
(In thousands)
Gross Amount Recognized
Gross Amounts Offset in the Balance Sheet
Net Amounts Presented in the Balance Sheet
Financial Instruments Available for Offset
Collateral Received/Pledged
Net Amount
June 30, 2017
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
Derivatives subject to master netting agreements
$
11,088

$

$
11,088

$
(514
)
$

$
10,574

Derivatives not subject to master netting agreements
939


939

 
 
 
Total derivatives
12,027


12,027

 
 
 
Liabilities:
 
 
 
 
 
 
Derivatives subject to master netting agreements
$
6,066

$

$
6,066

$
(514
)
$
(1,710
)
$
3,842

Derivatives not subject to master netting agreements
181


181

 
 
 
Total derivatives
6,247


6,247

 
 
 
December 31, 2016
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
Derivatives subject to master netting agreements
$
13,111

$

$
13,111

$
(3,391
)
$

$
9,720

Derivatives not subject to master netting agreements
455


455

 
 
 
Total derivatives
13,566


13,566

 
 
 
Liabilities:
 
 
 
 
 
 
Derivatives subject to master netting agreements
$
13,124

$

$
13,124

$
(3,391
)
$
(5,292
)
$
4,441

Derivatives not subject to master netting agreements
215


215

 
 
 
Total derivatives
13,339


13,339

 
 
 

11. Resale and Repurchase Agreements

The following table shows the extent to which assets and liabilities relating to securities purchased under agreements to resell (resale agreements) and securities sold under agreements to repurchase (repurchase agreements) have been offset in the consolidated balance sheets, in addition to the extent to which they could potentially be offset. Also shown is collateral received or pledged, which consists of marketable securities. The collateral amounts in the table are limited to the outstanding balances of the related asset or liability (after netting is applied); thus amounts of excess collateral are not shown. The agreements in the following table were transacted under master netting arrangements that contain a conditional right of offset, such as close-out netting, upon default.

Resale and repurchase agreements are agreements to purchase/sell securities subject to an obligation to resell/repurchase the same or similar securities. They are accounted for as collateralized financing transactions, not as sales and purchases of the securities portfolio. The securities collateral accepted or pledged in resale and repurchase agreements with other financial institutions also may be sold or re-pledged by the secured party, but is usually delivered to and held by third party trustees. The Company generally retains custody of securities pledged for repurchase agreements with customers.


27


The Company is party to several agreements commonly known as collateral swaps. These agreements involve the exchange of collateral under simultaneous repurchase and resale agreements with the same financial institution counterparty. These repurchase and resale agreements have the same principal amounts, inception dates, and maturity dates and have been offset against each other in the consolidated balance sheets, as permitted under the netting provisions of ASC 210-20-45. The collateral swaps totaled $700.0 million at June 30, 2017 and $550.0 million at December 31, 2016. At June 30, 2017, the Company had posted collateral of $718.1 million in marketable securities, consisting of agency mortgage-backed bonds and treasuries, and had accepted $724.4 million in investment grade asset-backed, commercial mortgage-backed, and corporate bonds.
 
 
 
 
Gross Amounts Not Offset in the Balance Sheet
 
(In thousands)
Gross Amount Recognized
Gross Amounts Offset in the Balance Sheet
Net Amounts Presented in the Balance Sheet
Financial Instruments Available for Offset
Securities Collateral Received/Pledged
Net Amount
June 30, 2017
 
 
 
 
 
 
Total resale agreements, subject to master netting arrangements
$
1,325,000

$
(700,000
)
$
625,000

$

$
(625,000
)
$

Total repurchase agreements, subject to master netting arrangements
1,702,934

(700,000
)
1,002,934


(1,002,934
)

December 31, 2016
 
 
 
 
 
 
Total resale agreements, subject to master netting arrangements
$
1,275,000

$
(550,000
)
$
725,000

$

$
(725,000
)
$

Total repurchase agreements, subject to master netting arrangements
2,221,065

(550,000
)
1,671,065


(1,671,065
)


The table below shows the remaining contractual maturities of repurchase agreements outstanding at June 30, 2017 and December 31, 2016, in addition to the various types of marketable securities that have been pledged as collateral for these borrowings.
 
Remaining Contractual Maturity of the Agreements
 
(In thousands)
Overnight and continuous
Up to 90 days
Greater than 90 days
Total
June 30, 2017
 
 
 
 
Repurchase agreements, secured by:
 
 
 
 
  U.S. government and federal agency obligations
$
330,173

$
1,728

$
450,000

$
781,901

  Government-sponsored enterprise obligations
180,496



180,496

  Agency mortgage-backed securities
379,441

70,325

200,000

649,766

  Asset-backed securities
10,771

80,000


90,771

   Total repurchase agreements, gross amount recognized
$
900,881

$
152,053

$
650,000

$
1,702,934

December 31, 2016
 
 
 
 
Repurchase agreements, secured by:
 
 
 
 
  U.S. government and federal agency obligations
$
294,600

$

$
300,000

$
594,600

  Government-sponsored enterprise obligations
147,694


3,237

150,931

  Agency mortgage-backed securities
693,851

24,380

252,473

970,704

  Asset-backed securities
474,830

30,000


504,830

   Total repurchase agreements, gross amount recognized
$
1,610,975

$
54,380

$
555,710

$
2,221,065


12. Stock-Based Compensation

The Company issues stock-based compensation in the form of nonvested restricted stock and stock appreciation rights (SARs). Most of the awards are issued during the first quarter of each year. The stock-based compensation expense that has been charged against income was $3.1 million and $2.9 million in the three months ended June 30, 2017 and 2016, respectively, and $6.2 million and $6.3 million in the six months ended June 30, 2017 and 2016, respectively.

The Company adopted ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting," on January 1, 2017. The Company elected to change its method of accounting for forfeitures, as allowed by this guidance. In 2016 and prior years, accruals of compensation cost were reduced by an estimate of awards not expected to vest and further adjusted when actual forfeitures occurred. In 2017 and subsequent years, forfeitures will be accounted for when they occur and recognized in

28


compensation cost at that time. The effect of this change, which was recognized as a cumulative-effect adjustment on January 1, 2017, increased equity and increased deferred tax assets by approximately $1.3 million. ASU 2016-09 also changed the classification of excess tax benefits and deficiencies arising from stock-based payment transactions, resulting in reductions in income tax expense of $4.5 million in the first quarter of 2017 and $1.6 million in the second quarter of 2017.

Nonvested stock awards generally vest in 4 to 7 years and contain restrictions as to transferability, sale, pledging, or assigning, among others, prior to the end of the vesting period. Dividend and voting rights are conferred upon grant. A summary of the status of the Company’s nonvested share awards as of June 30, 2017, and changes during the six month period then ended, is presented below.
 
 
 

Shares
 Weighted Average Grant Date Fair Value
Nonvested at January 1, 2017
1,392,451

$34.67
Granted
233,520

57.32
Vested
(394,130
)
30.79
Forfeited
(9,388
)
38.78
Nonvested at June 30, 2017
1,222,453

$40.22

SARs are granted with exercise prices equal to the market price of the Company’s stock at the date of grant. SARs vest ratably over 4 years of continuous service and have 10-year contractual terms. All SARs must be settled in stock under provisions of the plan. In determining compensation cost, the Black-Scholes option-pricing model is used to estimate the fair value of SARs on date of grant. The current year per share average fair value and the model assumptions are shown in the table below.
        
Weighted per share average fair value at grant date

$12.54

Assumptions:
 
Dividend yield
1.6
%
Volatility
21.1
%
Risk-free interest rate
2.4
%
Expected term
7.0 years


A summary of SAR activity during the first six months of 2017 is presented below.
 
 
 
 
(Dollars in thousands, except per share data)
Rights
Weighted Average Exercise Price
Weighted Average Remaining Contractual Term
Aggregate Intrinsic Value
Outstanding at January 1, 2017
1,324,954

$34.53
 
 
Granted
165,592

57.53
 
 
Forfeited
(4,182
)
42.82

 
 
Expired
(797
)
36.22

 
 
Exercised
(263,503
)
30.58
 
 
Outstanding at June 30, 2017
1,222,064

$38.47
6.5 years
$
22,583




29


13. Fair Value Measurements

The Company uses fair value measurements to record fair value adjustments to certain financial and nonfinancial assets and liabilities and to determine fair value disclosures. Various financial instruments such as available for sale and trading securities, certain non-marketable securities relating to private equity activities, and derivatives are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets and liabilities on a nonrecurring basis, such as mortgage servicing rights and certain other investment securities. These nonrecurring fair value adjustments typically involve lower of cost or fair value accounting or write-downs of individual assets.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Depending on the nature of the asset or liability, the Company uses various valuation techniques and assumptions when estimating fair value. For accounting disclosure purposes, a three-level valuation hierarchy of fair value measurements has been established. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:
Level 1 – inputs to the valuation methodology are quoted prices for identical assets or liabilities in active markets.
Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and inputs that are observable for the assets or liabilities, either directly or indirectly (such as interest rates, yield curves, and prepayment speeds).
Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value. These may be internally developed, using the Company’s best information and assumptions that a market participant would consider.
The valuation methodologies for assets and liabilities measured at fair value on a recurring and non-recurring basis are described in the Fair Value Measurements note in the Company's 2016 Annual Report on Form 10-K. There have been no significant changes in these methodologies since then, except for a change in the valuation of cleared interest rate swaps as discussed in Note 10.


30


Instruments Measured at Fair Value on a Recurring Basis

The table below presents the June 30, 2017 and December 31, 2016 carrying values of assets and liabilities measured at fair value on a recurring basis. There were no transfers among levels during the first six months of 2017 or the year ended December 31, 2016.
 
 
Fair Value Measurements Using
(In thousands)
Total Fair Value
Quoted Prices in Active Markets for Identical Assets
(Level 1)
Significant Other Observable Inputs
(Level 2)
Significant Unobservable Inputs
(Level 3)
June 30, 2017
 
 
 
 
Assets:
 
 
 
 
  Residential mortgage loans held for sale
$
14,118

$

$
14,118

$

  Available for sale securities:
 
 
 
 
     U.S. government and federal agency obligations
912,555

912,555



     Government-sponsored enterprise obligations
446,285


446,285


     State and municipal obligations
1,777,797


1,760,972

16,825

     Agency mortgage-backed securities
2,620,198


2,620,198


     Non-agency mortgage-backed securities
1,066,889


1,066,889


     Asset-backed securities
2,250,426


2,250,426


     Other debt securities
317,704


317,704


     Equity securities
47,847

21,156

26,691


  Trading securities
22,291


22,291


  Private equity investments
53,557



53,557

  Derivatives *
12,027


11,097

930

  Assets held in trust for deferred compensation plan
11,893

11,893



  Total assets
9,553,587

945,604

8,536,671

71,312

Liabilities:
 
 
 
 
  Derivatives *
6,247


6,108

139

Liabilities held in trust for deferred compensation plan
11,893

11,893



  Total liabilities
$
18,140

$
11,893

$
6,108

$
139

December 31, 2016
 
 
 
 
Assets:
 
 
 
 
  Residential mortgage loans held for sale
$
9,263

$

$
9,263

$

  Available for sale securities:
 
 
 
 
     U.S. government and federal agency obligations
920,904

920,904



     Government-sponsored enterprise obligations
449,998


449,998


     State and municipal obligations
1,778,214


1,761,532

16,682

     Agency mortgage-backed securities
2,685,931


2,685,931


     Non-agency mortgage-backed securities
1,055,639


1,055,639


     Asset-backed securities
2,381,301


2,381,301


     Other debt securities
325,953


325,953


     Equity securities
51,263

24,967

26,296


  Trading securities
22,225


22,225


  Private equity investments
50,820



50,820

  Derivatives *
13,566


13,146

420

  Assets held in trust for deferred compensation plan
10,261

10,261



  Total assets
9,755,338

956,132

8,731,284

67,922

Liabilities:
 
 
 
 
  Derivatives *
13,339


13,177

162

Liabilities held in trust for deferred compensation plan
10,261

10,261



  Total liabilities
$
23,600

$
10,261

$
13,177

$
162

* The fair value of each class of derivative is shown in Note 10.






31


The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows:
 
Fair Value Measurements Using
Significant Unobservable Inputs
(Level 3)


(In thousands)
State and Municipal Obligations
Private Equity
Investments
Derivatives
Total
For the three months ended June 30, 2017
 
 
 
 
Balance March 31, 2017
$
17,083

$
52,800

$
822

$
70,705

Total gains or losses (realized/unrealized):
 
 
 
 
   Included in earnings

48

(31
)
17

   Included in other comprehensive income *
319



319

Investment securities called
(600
)


(600
)
Discount accretion
23



23

Purchases of private equity investments

2,259


2,259

Sale/pay down of private equity investments

(1,550
)

(1,550
)
Balance June 30, 2017
$
16,825

$
53,557

$
791

$
71,173

Total gains or losses for the three months included in earnings attributable to the change in unrealized gains or losses relating to assets still held at June 30, 2017
$

$
48

$
872

$
920

For the six months ended June 30, 2017
 
 
 
 
Balance January 1, 2017
$
16,682

$
50,820

$
258

$
67,760

Total gains or losses (realized/unrealized):
 
 
 
 
   Included in earnings

(2,830
)
533

(2,297
)
   Included in other comprehensive income *
710



710

Investment securities called
(600
)


(600
)
Discount accretion
33



33

Purchases of private equity investments

7,084


7,084

Sale/pay down of private equity investments

(1,550
)

(1,550
)
Capitalized interest/dividends

33


33

Balance June 30, 2017
$
16,825

$
53,557

$
791

$
71,173

Total gains or losses for the six months included in earnings attributable to the change in unrealized gains or losses relating to assets still held at June 30, 2017
$

$
(2,655
)
$
882

$
(1,773
)
For the three months ended June 30, 2016
 
 
 
 
Balance March 31, 2016
$
17,209

$
67,432

$
506

$
85,147

Total gains or losses (realized/unrealized):
 
 
 
 
   Included in earnings

(2,810
)
(4
)
(2,814
)
   Included in other comprehensive income *
401



401

Discount accretion
69



69

Purchases of private equity investments

575


575

Sale/pay down of private equity investments

(2,398
)

(2,398
)
Capitalized interest/dividends

14


14

Balance June 30, 2016
$
17,679

$
62,813

$
502

$
80,994

Total gains or losses for the three months included in earnings attributable to the change in unrealized gains or losses relating to assets still held at June 30, 2016
$

$
(2,810
)
$
767

$
(2,043
)
For the six months ended June 30, 2016
 
 
 
 
Balance January 1, 2016
$
17,195

$
63,032

$
69

$
80,296

Total gains or losses (realized/unrealized):
 
 
 
 
   Included in earnings

(3,724
)
469

(3,255
)
   Included in other comprehensive income *
502



502

Investment securities called
(100
)


(100
)
Discount accretion
82



82

Purchases of private equity investments

5,841


5,841

Sale/pay down of private equity investments

(2,398
)

(2,398
)
Capitalized interest/dividends

62


62

Sale of risk participation agreement


(36
)
(36
)
Balance June 30, 2016
$
17,679

$
62,813

$
502

$
80,994

Total gains or losses for the six months included in earnings attributable to the change in unrealized gains or losses relating to assets still held at June 30, 2016
$

$
(3,724
)
$
732

$
(2,992
)
* Included in "net unrealized gains (losses) on other securities" in the consolidated statements of comprehensive income.

32



Gains and losses included in earnings for the Level 3 assets and liabilities in the previous table are reported in the following line items in the consolidated statements of income:
(In thousands)
Loan Fees and Sales
Other Non-Interest Income
Investment Securities Gains (Losses), Net
Total
For the three months ended June 30, 2017
 
 
 
 
Total gains or losses included in earnings
$
(32
)
$
1

$
48

$
17

Change in unrealized gains or losses relating to assets still held at June 30, 2017
$
871

$
1

$
48

$
920

For the six months ended June 30, 2017
 
 
 
 
Total gains or losses included in earnings
$
522

$
11

$
(2,830
)
$
(2,297
)
Change in unrealized gains or losses relating to assets still held at June 30, 2017
$
871

$
11

$
(2,655
)
$
(1,773
)
For the three months ended June 30, 2016
 
 
 
 
Total gains or losses included in earnings
$
19

$
(23
)
$
(2,810
)
$
(2,814
)
Change in unrealized gains or losses relating to assets still held at June 30, 2016
$
790

$
(23
)
$
(2,810
)
$
(2,043
)
For the six months ended June 30, 2016
 
 
 
 
Total gains or losses included in earnings
$
527

$
(58
)
$
(3,724
)
$
(3,255
)
Change in unrealized gains or losses relating to assets still held at June 30, 2016
$
790

$
(58
)
$
(3,724
)
$
(2,992
)

Level 3 Inputs

The Company's significant Level 3 measurements which employ unobservable inputs that are readily quantifiable pertain to auction rate securities (ARS) held by the Bank, investments in portfolio concerns held by the Company's private equity subsidiaries, and held for sale residential mortgage loan commitments. ARS are included in state and municipal securities and totaled $16.8 million at June 30, 2017, while private equity investments, included in non-marketable securities, totaled $53.6 million.
Information about these inputs is presented in the table and discussions below.
Quantitative Information about Level 3 Fair Value Measurements
 
 
 
Weighted
 
Valuation Technique
Unobservable Input
Range
 
Average
Auction rate securities
Discounted cash flow
Estimated market recovery period


5 years
 
 
 
 
Estimated market rate
2.8%
-
3.1%
 
 
Private equity investments
Market comparable companies
EBITDA multiple
4.0
-
5.8
 
 
Mortgage loan commitments
Discounted cash flow
Probability of funding
53.0%
-
99.3%
 
80.2%
 
 
Embedded servicing value
(.2)%
-
2.2%
 
1.0%



33


Instruments Measured at Fair Value on a Nonrecurring Basis

For assets measured at fair value on a nonrecurring basis during the first six months of 2017 and 2016, and still held as of June 30, 2017 and 2016, the following table provides the adjustments to fair value recognized during the respective periods, the level of valuation inputs used to determine each adjustment, and the carrying value of the related individual assets or portfolios at June 30, 2017 and 2016.
 
 
Fair Value Measurements Using
 
(In thousands)

Fair Value
Quoted Prices in Active Markets for Identical Assets
(Level 1)
Significant Other Observable Inputs
(Level 2)
Significant Unobservable Inputs
(Level 3)
Total Gains (Losses) Recognized During the Six Months Ended June 30
June 30, 2017
 
 
 
 
 
  Collateral dependent impaired loans
$
2,044

$

$

$
2,044

$
(550
)
  Mortgage servicing rights
3,646



3,646

6

  Foreclosed assets
75



75

(58
)
  Long-lived assets
1,834



1,834

(343
)
 
 
 
 
 
 
June 30, 2016
 
 
 
 
 
  Collateral dependent impaired loans
$
5,001

$

$

$
5,001

$
(1,491
)
  Mortgage servicing rights
2,191



2,191

(2
)
  Foreclosed assets
28



28

(10
)
  Long-lived assets
1,871



1,871

(956
)


14. Fair Value of Financial Instruments

The carrying amounts and estimated fair values of financial instruments held by the Company are set forth below. Fair value estimates are made at a specific point in time based on relevant market information. They do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for many of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, risk characteristics and economic conditions. These estimates are subjective, involve uncertainties, and cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

The methods and inputs used in the estimation of fair value for the financial instruments in the table below are discussed in the Fair Value Measurements and the Fair Value of Financial Instruments notes in the Company's 2016 Annual Report on Form 10-K. There have been no significant changes in these methods and inputs since December 31, 2016, except as mentioned in Note 10 on Derivatives.


34


The estimated fair values of the Company’s financial instruments and the classification of their fair value measurement within the valuation hierarchy are as follows:
 
Fair Value Hierarchy Level
June 30, 2017
 
December 31, 2016

(In thousands)
Carrying
Amount
Estimated
Fair Value
 
Carrying
Amount
Estimated
Fair Value
Financial Assets
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
Business
Level 3
$
4,852,408

$
4,866,125

 
$
4,776,365

$
4,787,469

Real estate - construction and land
Level 3
848,152

859,171

 
791,236

800,426

Real estate - business
Level 3
2,727,349

2,740,841

 
2,643,374

2,658,093

Real estate - personal
Level 3
2,009,203

2,022,671

 
2,010,397

2,005,227

Consumer
Level 3
2,038,514

2,021,537

 
1,990,801

1,974,784

Revolving home equity
Level 3
403,387

404,177

 
413,634

414,499

Consumer credit card
Level 3
740,865

754,763

 
776,465

794,856

Overdrafts
Level 3
6,714

6,714

 
10,464

10,464

Loans held for sale
Level 2
22,002

22,002

 
14,456

14,456

Investment securities:
 
 
 
 
 
 
Available for sale
Level 1
933,711

933,711

 
945,871

945,871

Available for sale
Level 2
8,489,165

8,489,165

 
8,686,650

8,686,650

Available for sale
Level 3
16,825

16,825

 
16,682

16,682

Trading
Level 2
22,291

22,291

 
22,225

22,225

Non-marketable
Level 3
102,388

102,388

 
99,558

99,558

Federal funds sold
Level 1
16,520

16,520

 
15,470

15,470

Securities purchased under agreements to resell
Level 3
625,000

628,148

 
725,000

728,179

Interest earning deposits with banks
Level 1
80,860

80,860

 
272,275

272,275

Cash and due from banks
Level 1
433,747

433,747

 
494,690

494,690

Derivative instruments
Level 2
11,097

11,097

 
13,146

13,146

Derivative instruments
Level 3
930

930

 
420

420

Assets held in trust for deferred compensation plan
Level 1
11,893

11,893

 
10,261

10,261

Financial Liabilities
 
 
 
 
 
 
Non-interest bearing deposits
Level 1
$
7,314,506

$
7,314,506

 
$
7,429,398

$
7,429,398

Savings, interest checking and money market deposits
Level 1
11,427,615

11,427,615

 
11,430,789
11,430,789
Time open and certificates of deposit
Level 3
2,083,541

2,075,563

 
2,240,908

2,235,218

Federal funds purchased
Level 1
253,510

253,510

 
52,840

52,840

Securities sold under agreements to repurchase
Level 3
1,002,934

1,003,183

 
1,671,065

1,671,227

Other borrowings
Level 3
101,903

102,907

 
102,049

104,298

Derivative instruments
Level 2
6,108

6,108

 
13,177

13,177

Derivative instruments
Level 3
139

139

 
162

162

Liabilities held in trust for deferred compensation plan
Level 1
11,893

11,893

 
10,261

10,261


15. Legal and Regulatory Proceedings
On August 15, 2014, a customer filed a class action complaint against the Bank in the Circuit Court, Jackson County, Missouri.  The case is Cassandra Warren, et al v. Commerce Bank (Case No. 1416-CV19197).  In the case, the customer alleges violation of the Missouri usury statute in connection with the Bank charging overdraft fees in connection with point-of-sale/debit and automated-teller machine cards. The class was certified and consists of Missouri customers of the Bank who may have been similarly affected. The case has been stayed pending the final outcome of a similar case in which a ruling has been made in favor of the bank defendant. The Company believes that the stay will remain in effect until any appeals in the similar case have run their course.  The Company believes the Warren complaint lacks merit and will defend itself vigorously. The amount of any ultimate exposure cannot be determined with certainty at this time.

The Company has been in ongoing discussions with the U.S. Department of Labor concerning an investigation involving ERISA regulations related to a managed trust account. The investigation concluded in a non-material settlement between the Company and the U.S. Department of Labor during July 2017.


35


The Company has various other legal proceedings pending at June 30, 2017, arising in the normal course of business. While some matters pending against the Company specify damages claimed by plaintiffs, others do not seek a specified amount of damages or are at very early stages of the legal process. The Company records a loss accrual for all legal and regulatory matters for which it deems a loss is probable and can be reasonably estimated. Some matters, which are in the early stages, have not yet progressed to the point where a loss amount can be determined to be probable and estimable.

Item 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes and with the statistical information and financial data appearing in this report as well as the Company's 2016 Annual Report on Form 10-K. Results of operations for the three and six month periods ended June 30, 2017 are not necessarily indicative of results to be attained for any other period.

Forward-Looking Information

This report may contain "forward-looking statements" that are subject to risks and uncertainties and include information about possible or assumed future results of operations. Many possible events or factors could affect the future financial results and performance of the Company. This could cause results or performance to differ materially from those expressed in the forward-looking statements. Words such as "expects", "anticipates", "believes", "estimates", variations of such words and other similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in, or implied by, such forward-looking statements. Readers should not rely solely on the forward-looking statements and should consider all uncertainties and risks discussed throughout this report. Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. Such possible events or factors include: changes in economic conditions in the Company's market area, changes in policies by regulatory agencies, governmental legislation and regulation, fluctuations in interest rates, changes in liquidity requirements, demand for loans in the Company's market area, changes in accounting and tax principles, estimates made on income taxes, competition with other entities that offer financial services, and such other factors as discussed in Part I Item 1A - "Risk Factors" and Part II Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's 2016 Annual Report on Form 10-K.

Critical Accounting Policies

The Company has identified several policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for loan losses, the valuation of certain investment securities, and accounting for income taxes. A discussion of these policies can be found in the sections captioned "Critical Accounting Policies" and "Allowance for Loan Losses" in Management's Discussion and Analysis of Financial Condition and Results of Operations included in the Company's 2016 Annual Report on Form 10-K. There have been no changes in the Company's application of critical accounting policies since December 31, 2016.


36


Selected Financial Data

 
 
Three Months Ended June 30
 
Six Months Ended June 30
 
 
2017
2016
 
2017
2016
Per Share Data
 
    
    
 
 
 
   Net income per common share — basic
 
$
.75

$
.67
*
 
$
1.43

$
1.29
*
   Net income per common share — diluted
 
.75

.66
*
 
1.43

1.28
*
   Cash dividends on common stock
 
.225

.214
*
 
.450

.429
*
   Book value per common share
 
 
 
 
24.44

23.49
*
   Market price
 
 
 
 
56.83

45.62
*
Selected Ratios
 
 
 
 
 
 
(Based on average balance sheets)
 
 
 
 
 
 
   Loans to deposits (1)
 
65.25
%
63.45
%
 
64.82
%
63.13
%
   Non-interest bearing deposits to total deposits
 
34.03

33.83

 
34.25

34.13

   Equity to loans (1)
 
19.26

19.15

 
19.00

19.15

   Equity to deposits
 
12.57

12.15

 
12.32

12.09

   Equity to total assets
 
10.42

10.13

 
10.23

9.99

   Return on total assets
 
1.26

1.15

 
1.21

1.11

   Return on common equity
 
12.48

11.69

 
12.12

11.44

(Based on end-of-period data)
 
 
 
 
 
 
   Non-interest income to revenue (2)
 
40.24

40.42

 
39.94

41.25

   Efficiency ratio (3)
 
60.24

61.27

 
61.67

61.93

   Tier I common risk-based capital ratio
 
 
 
 
12.28

11.50

   Tier I risk-based capital ratio
 
 
 
 
13.05

12.29

   Total risk-based capital ratio
 
 
 
 
14.00

13.23

   Tangible common equity to tangible assets ratio (4)
 
 
 
 
9.37

9.09

   Tier I leverage ratio 
 
 
 
 
9.87

9.36


* Restated for the 5% stock dividend distributed in December 2016.
(1) Includes loans held for sale.
(2) Revenue includes net interest income and non-interest income.
(3) The efficiency ratio is calculated as non-interest expense (excluding intangibles amortization) as a percent of revenue.
(4) The tangible common equity to tangible assets ratio is a measurement which management believes is a useful indicator of capital adequacy and utilization. It provides a meaningful basis for period to period and company to company comparisons, and also assists regulators, investors and analysts in analyzing the financial position of the Company. Tangible common equity and tangible assets are non-GAAP measures and should not be viewed as substitutes for, or superior to, data prepared in accordance with GAAP.

The following table is a reconciliation of the GAAP financial measures of total equity and total assets to the non-GAAP measures of total tangible common equity and total tangible assets.
 
June 30
(Dollars in thousands)
2017
2016
Total equity
$
2,628,207

$
2,526,821

Less non-controlling interest
4,324

4,905

Less preferred stock
144,784

144,784

Less goodwill
138,921

138,921

Less core deposit premium
3,356

4,370

Total tangible common equity (a)
$
2,336,822

$
2,233,841

Total assets
$
25,078,843

$
24,709,693

Less goodwill
138,921

138,921

Less core deposit premium
3,356

4,370

Total tangible assets (b)
$
24,936,566

$
24,566,402

Tangible common equity to tangible assets ratio (a)/(b)
9.37
%
9.09
%

37


Results of Operations

Summary
  
Three Months Ended June 30
 
Six Months Ended June 30
(Dollars in thousands)
2017
2016
% change
 
2017
2016
% change
Net interest income
$
182,807

$
171,829

6.4
%
 
$
361,080

$
335,604

7.6
 %
Provision for loan losses
(10,758
)
(9,216
)
16.7

 
(21,886
)
(18,655
)
17.3

Non-interest income
123,084

116,570

5.6

 
240,150

235,594

1.9

Investment securities gains (losses), net
1,651

(744
)
N.M.

 
879

(1,739
)
N.M.

Non-interest expense
(184,594
)
(177,089
)
4.2

 
(371,424
)
(354,562
)
4.8

Income taxes
(33,201
)
(31,542
)
5.3

 
(58,108
)
(60,912
)
(4.6
)
Non-controlling interest (expense) income
(29
)
85

N.M.

 
(227
)
(63
)
N.M.

Net income attributable to Commerce Bancshares, Inc.
78,960

69,893

13.0

 
150,464

135,267

11.2

Preferred stock dividends
(2,250
)
(2,250
)

 
(4,500
)
(4,500
)

Net income available to common shareholders
$
76,710

$
67,643

13.4
%
 
$
145,964

$
130,767

11.6
 %

For the quarter ended June 30, 2017, net income attributable to Commerce Bancshares, Inc. (net income) amounted to $79.0 million, an increase of $9.1 million, or 13.0%, compared to the second quarter of the previous year. For the current quarter, the annualized return on average assets was 1.26%, the annualized return on average common equity was 12.48% and the efficiency ratio was 60.24%. Diluted earnings per common share was $.75, an increase of 13.6% compared to $.66 per share in the second quarter of 2016 and an increase of 10.3% compared to $.68 per share in the previous quarter.

Compared to the second quarter of last year, net interest income increased $11.0 million, or 6.4%, mainly due to growth of $13.1 million in interest income on loans, partly offset by an increase of $2.6 million in deposits and borrowings interest expense. The provision for loan losses totaled $10.8 million for the current quarter, representing an increase of $1.5 million over the second quarter of 2016. Non-interest income increased $6.5 million, or 5.6%, compared to the second quarter of 2016, mainly due to combined growth of $5.3 million in trust, deposit and loan fee income, in addition to current quarter gains of $1.7 million on sales of branch properties and equipment leased by customers. Non-interest expense increased $7.5 million, or 4.2%, over the second quarter of 2016 primarily due to increases in salaries and benefits and the contribution of $2.3 million in appreciated securities to a related foundation. A $2.2 million securities gain was recorded on the transaction, resulting in a pre-tax loss of $97 thousand and tax benefits of $873 thousand. The Company made a similar contribution to the foundation in the first quarter of 2017 and intends to make similar contributions in subsequent quarters this year.

Net investment securities gains totaled $1.7 million in the current quarter and $879 thousand in the first six months of 2017. Gains resulting from the securities donations were $2.2 million in both the first and second quarters of 2017, partly offset by losses in fair value on private equity securities of $2.8 million in the six month period.

Net income for the first six months of 2017 was $150.5 million, an increase of $15.2 million, or 11.2%, over the same period last year. Diluted earnings per common share was $1.43, an increase of 11.7% compared to $1.28 per share in the same period last year. For the first six months of 2017, the annualized return on average assets was 1.21%, the annualized return on average common equity was 12.12%, and the efficiency ratio was 61.67%. Net interest income increased $25.5 million, or 7.6%, over the same period last year. This growth was largely due to increases of $22.1 million in loan interest income and $6.7 million in investment securities interest income, offset by a $3.9 million increase in deposits and borrowings interest expense. The provision for loan losses was $21.9 million for the first six months of 2017, up $3.2 million over the same period last year. Non-interest income increased $4.6 million, or 1.9%, over the first six months of last year due to growth in trust, deposit and loan fees. Non-interest expense increased $16.9 million, or 4.8%, due to higher salaries and benefits expense of $9.5 million, in addition to securities contributions of $4.5 million, as mentioned above.

38


Net Interest Income

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.

Analysis of Changes in Net Interest Income
 
Three Months Ended June 30, 2017 vs. 2016
 
Six Months Ended June 30, 2017 vs. 2016
 
Change due to
 
 
Change due to
 
 
(In thousands)
Average
Volume
Average
Rate

Total
 
Average
Volume
Average
Rate

Total
Interest income, fully taxable equivalent basis:
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
  Business
$
978

$
3,766

$
4,744

 
$
3,934

$
5,303

$
9,237

  Real estate - construction and land
631

1,836

2,467

 
1,888

2,488

4,376

  Real estate - business
2,870

415

3,285

 
5,282

(242
)
5,040

  Real estate - personal
919

(144
)
775

 
1,878

(431
)
1,447

  Consumer
662

735

1,397

 
1,047

689

1,736

  Revolving home equity
(121
)
256

135

 
(332
)
348

16

  Consumer credit card
(192
)
713

521

 
(315
)
984

669

  Overdrafts



 



     Total interest on loans
5,747

7,577

13,324

 
13,382

9,139

22,521

Loans held for sale
(442
)
13

(429
)
 
(388
)
20

(368
)
Investment securities:
 
 
 
 
 
 
 
  U.S. government and federal agency securities
1,843

(2,159
)
(316
)
 
2,023

1,682

3,705

  Government-sponsored enterprise obligations
(1,632
)
(1,601
)
(3,233
)
 
(3,279
)
(1,916
)
(5,195
)
  State and municipal obligations
70

50

120

 
651

(106
)
545

  Mortgage-backed securities
1,846

(36
)
1,810

 
3,862

(790
)
3,072

  Asset-backed securities
(153
)
1,596

1,443

 
(776
)
2,904

2,128

  Other securities
(360
)
906

546

 
(835
)
4,516

3,681

     Total interest on investment securities
1,614

(1,244
)
370

 
1,646

6,290

7,936

Federal funds sold and short-term securities purchased under
 
 
 
 
 
 
 
   agreements to resell
2

16

18

 
(9
)
26

17

Long-term securities purchased under agreements to resell
(648
)
978

330

 
(1,159
)
1,807

648

Interest earning deposits with banks
17

194

211

 
2

336

338

Total interest income
6,290

7,534

13,824

 
13,474

17,618

31,092

Interest expense:
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
  Savings
12

4

16

 
23

11

34

  Interest checking and money market
109

669

778

 
258

908

1,166

  Time open & C.D.'s of less than $100,000
(66
)
31

(35
)
 
(132
)
(1
)
(133
)
  Time open & C.D.'s of $100,000 and over
(184
)
659

475

 
76

1,176

1,252

     Total interest on deposits
(129
)
1,363

1,234

 
225

2,094

2,319

Federal funds purchased and securities sold under
 
 
 
 
 
 
 
   agreements to repurchase
89

1,224

1,313

 
67

1,897

1,964

Other borrowings
(17
)
21

4

 
(1,254
)
893

(361
)
Total interest expense
(57
)
2,608

2,551

 
(962
)
4,884

3,922

Net interest income, tax equivalent basis
$
6,347

$
4,926

$
11,273

 
$
14,436

$
12,734

$
27,170


Net interest income in the second quarter of 2017 was $182.8 million, an increase of $11.0 million over the second quarter of 2016. On a tax equivalent (T/E) basis, net interest income totaled $190.9 million in the second quarter of 2017, up $11.3 million over the same period last year and up $3.5 million over the previous quarter.  The increase in net interest income compared to the second quarter of 2016 was mainly due to higher interest income on loans (T/E) of $13.3 million. The increase in interest on loans was a result of higher loan yields on nearly all loan products, especially commercial loans, many of which have variable rates.

39


Interest income on investment securities (T/E) increased $370 thousand over the second quarter of 2016, mainly due to higher interest income earned on mortgage-backed and asset-backed securities. Securities interest also includes inflation-related interest on the Company's holdings of U.S. Treasury inflation-protected securities (TIPS), which is tied to the Consumer Price Index. Interest income related to TIPS increased $2.5 million in the first six months of 2017 compared to the same period in 2016, and totaled $2.9 million in the current quarter and $3.7 million in the second quarter of 2016.  The Company's net yield on earning assets (T/E) was 3.19% in the current quarter compared to 3.11% in the second quarter of 2016.
 
Total interest income (T/E) increased $13.8 million over the second quarter of 2016. Interest income on loans (T/E) was $136.8 million during the second quarter of 2017, and increased $13.3 million, or 10.8%, over the same quarter last year. The increase was due to growth of $669.4 million, or 5.2%, in average loan balances, and an increase of 20 basis points in average rates earned. Most of the increase in interest income occurred in the business, construction, and business real estate loan categories. The largest increase to interest income occurred in business loan interest, which grew $4.7 million due to higher average balances of $136.0 million, or 2.9%, coupled with a 31 basis point increase in the average rate earned. Construction loan interest grew $2.5 million, as average balances increased $73.2 million, or 9.3%, and the average rate earned increased 84 basis points. Business real estate loan interest increased $3.3 million due to an increase in average balances of $312.0 million, or 13.1%, with an increase of five basis points in the average rate earned. Interest on consumer loans increased $1.4 million over the same period last year as the average rate increased 14 basis points, coupled with a $69.8 million increase in average balances.

Interest income on investment securities (T/E) was $60.5 million during the second quarter of 2017, which was an increase of $370 thousand over the same quarter last year. The increase resulted mainly from increased earnings on mortgage-backed and asset-backed securities, partly offset by lower TIPS interest of $869 thousand and lower interest earned on government-sponsored enterprise obligations. Higher interest on mortgage-backed securities of $1.8 million resulted from an increase of $313.7 million in average balances. Interest income on asset-backed securities grew $1.4 million mainly due to a 27 basis point increase in the average rate earned. Partly offsetting these increases was a $3.2 million decline in interest income on government-sponsored enterprise obligations, which was partly the result of early maturity calls on certain securities in the second quarter of 2016. The average balance of government-sponsored enterprise obligations decreased $216.0 million and the average rate earned decreased 144 basis points. During the current quarter and the same quarter last year, adjustments to premium amortization expense, due to changes in prepayment speeds on various mortgage and asset-backed securities, were not significant. The average balance of the total investment portfolio (excluding unrealized fair value adjustments) was $9.6 billion in the second quarter of 2017, compared to $9.4 billion in the second quarter of 2016.

Interest income on long-term securities purchased under agreements to resell increased $330 thousand over the second quarter of 2016, due to an increase in the average rate earned of 58 basis points, partly offset by lower balances invested of $159.3 million.

The average tax equivalent yield on total interest earning assets was 3.37% in the second quarter of 2017, up from 3.25% in the second quarter of 2016.

Total interest expense increased $2.6 million compared to the second quarter of 2016, due to a $1.2 million increase in interest expense on interest bearing deposits and a $1.3 million increase in interest expense on borrowings. The increase in deposit expense resulted mainly from an increase of three basis points in the overall average rate paid on deposits. Interest expense on C.D.'s of $100,000 and over rose $475 thousand due to a 17 basis point increase in average rates paid, but was partly offset by lower average balances of $125.9 million. In addition, interest expense on interest checking and money market accounts increased $778 thousand, as average balances increased $379.1 million and average rates paid rose slightly. Interest expense on borrowings increased due to higher rates paid on customer repurchase agreements and overnight federal funds purchased. The overall average rate incurred on all interest bearing liabilities was .29% and .22% in the second quarters of 2017 and 2016, respectively.

Net interest income (T/E) for the first six months of 2017 was $378.2 million compared to $351.0 million for the same period in 2016. For the first six months of 2017, the net interest margin was 3.16% compared to 3.03% for the first six months of 2016.

Total interest income (T/E) for the first six months of 2017 increased $31.1 million over the same period last year, due to higher interest income on loans and investment securities. Loan interest income (T/E) rose $22.5 million due to an $803.8 million, or 6.3%, increase in total average loan balances and a 12 basis point increase in the average rate earned. Most of the increase in loan interest occurred in the business, business real estate and construction loan categories. The growth in interest income of $7.9 million on investment securities (T/E) was mainly due to a $163.4 million increase in average balances coupled with a 13 basis point increase in the average rate earned. Increased earnings were recorded for U.S. government and federal agency securities due to higher TIPS interest of $2.5 million, while interest earned on non-marketable investments rose $3.8 million partly due to one-time interest receipts of $2.7 million on a private equity investment in the first quarter of 2017. Other increases in interest income occurred in mortgage-backed and asset-backed securities, which grew $3.1 million and $2.1 million, respectively. These increases were partly offset by lower interest earned on government-sponsored enterprise obligations of $5.2 million, which saw

40


declines in average balances and rates earned. Interest income on long-term resell agreements grew $648 thousand due to higher average rates earned, partly offset by lower average balances.

Total interest expense for the first six months of 2017 increased $3.9 million compared to last year. Interest expense on interest bearing deposits increased $2.3 million, mainly due to a three basis point increase in the overall average rate paid. The overall rate increase included an increase of 15 basis points in rates paid on C.D.'s of $100,000 and over, in addition to a slight increase in rates paid on interest checking and money market account balances. Interest expense on borrowings also increased $1.6 million, mainly due to higher rates paid on federal funds purchased and repurchase agreements. Interest expense on FHLB borrowings declined $404 thousand, mainly due to lower average balances, partly offset by higher rates paid. The overall cost of total interest bearing liabilities increased to .27% compared to .22% in the same period last year.

Summaries of average assets and liabilities and the corresponding average rates earned/paid appear on the last page of this discussion.

Non-Interest Income
  
Three Months Ended June 30
 
Six Months Ended June 30
(Dollars in thousands)
2017
2016
% change
 
2017
2016
% change
Bank card transaction fees
$
44,999

$
45,065

(.1
)%
 
$
88,203

$
89,535

(1.5
)%
Trust fees
33,120

30,241

9.5

 
65,134

59,484

9.5

Deposit account charges and other fees
22,861

21,328

7.2

 
44,803

42,019

6.6

Capital market fees
2,156

2,500

(13.8
)
 
4,498

5,225

(13.9
)
Consumer brokerage services
3,726

3,491

6.7

 
7,375

7,000

5.4

Loan fees and sales
4,091

3,196

28.0

 
7,259

5,706

27.2

Other
12,131

10,749

12.9

 
22,878

26,625

(14.1
)
Total non-interest income
$
123,084

$
116,570

5.6
 %
 
$
240,150

$
235,594

1.9
 %
Non-interest income as a % of total revenue*
40.2
%
40.4
%
 
 
39.9
%
41.2
%
 
* Total revenue includes net interest income and non-interest income.

For the second quarter of 2017, total non-interest income amounted to $123.1 million compared with $116.6 million in the same quarter last year, which was an increase of $6.5 million, or 5.6%. The increase was mainly due to growth in trust, deposit and loan fee income, coupled with gains on sales of several branch properties and equipment leased to customers.

Bank card transaction fees for the current quarter decreased slightly from the same quarter last year, mainly due to a decline in merchant fees of $614 thousand, offset by growth of 2.9% in both debit and credit card fees. Commercial card fees increased slightly over the same quarter last year. The table below is a summary of bank card transaction fees for the three and six month periods ended June 30, 2017 and 2016.
 
Three Months Ended June 30
 
Six Months Ended June 30
(Dollars in thousands)
2017
2016
% change
 
2017
2016
% change
Debit card fees
$
10,326

$
10,032

2.9
 %
 
$
19,967

$19,417
2.8
 %
Credit card fees
6,482

6,302

2.9

 
12,223

11,947

2.3

Merchant fees
6,297

6,911

(8.9
)
 
12,139

14,029

(13.5
)
Corporate card fees
21,894

21,820

.3

 
43,874

44,142

(.6
)
Total bank card transaction fees
$
44,999

$
45,065

(.1
)%
 
$
88,203

$
89,535

(1.5
)%

Trust fees for the quarter increased $2.9 million, or 9.5%, over the same quarter last year, resulting mainly from continued growth in private client trust fees, which were up $2.0 million, or 9.0%. Deposit account fees increased $1.5 million, or 7.2%, over the same quarter last year, as deposit account service charges increased $895 thousand, or 17.8%, while overdraft and return item fees and corporate cash management fees increased 4.8% and 3.3%, respectively. Consumer brokerage fees grew $235 thousand, while capital market fees declined $344 thousand on lower sales demand. Loan fees and sales increased $895 thousand, or 28.0%, this quarter mainly due to higher mortgage banking revenue related to the Company's fixed rate residential mortgage sale program. Other non-interest income increased $1.4 million compared to the same quarter last year. This increase was mainly the result of current quarter gains of $860 thousand on sales of several branch properties, in addition to gains of $824 thousand recorded on sales of several leased assets to customers upon lease termination. Fees from the sales of tax credits grew $521 thousand this quarter compared with the same quarter last year, while letter of credit fees were higher by $294 thousand. These increases were partly offset by a decline of $289 thousand in fees on interest rate swap sales, and income of $897 thousand recorded in the second quarter of last year for a trust-related settlement, which did not reoccur in the current period.

41


Non-interest income for the first six months of 2017 was $240.2 million compared to $235.6 million in the first six months of 2016, resulting in an increase of $4.6 million, or 1.9%. Bank card fees decreased $1.3 million, or 1.5%, as a result of a decline in merchant fees of $1.9 million, or 13.5%, partly offset by increases of $550 thousand in debit card fees and $276 thousand in credit card fees. Trust fee income increased $5.7 million, or 9.5%, as a result of growth in private client and institutional trust fees. Deposit account fees increased $2.8 million, or 6.6%, mainly due to growth of $1.6 million in deposit account service charges and $766 thousand in overdraft and return item fees. Loan fees and sales increased $1.6 million, or 27.2%, due to higher mortgage banking revenue. Consumer brokerage fees rose $375 thousand due to higher mutual fund and advisory fee income, while capital market fees decreased $727 thousand, or 13.9%, due to continued lower sales volume. Other non-interest income decreased $3.7 million, or 14.1%, mainly due to lower gains on sales of branch properties, lower fees from sales of interest rate swaps, and the prior year trust settlement mentioned above.

Investment Securities Gains (Losses), Net
 
Three Months Ended June 30
 
Six Months Ended June 30
(In thousands)
2017
2016
 
2017
2016
Available for sale
$
1,671

$
(147
)
 
$
3,719

$
(270
)
Non-marketable
(20
)
(597
)
 
(2,840
)
(1,469
)
Total investment securities gains (losses), net
$
1,651

$
(744
)
 
$
879

$
(1,739
)

Net gains and losses on investment securities which were recognized in earnings during the three and six months ended June 30, 2017 and 2016 are shown in the table above. Net securities gains amounted to $1.7 million in the second quarter of 2017 and $879 thousand in the first six months of 2017. Included in these gains and losses are credit-related impairment losses on certain non-agency guaranteed mortgage-backed securities which have been identified as other-than-temporarily impaired. These identified securities had a total fair value of $30.3 million at June 30, 2017. During the first six months of 2017, credit-related impairment losses of $320 thousand were recorded, compared to $270 thousand in the same period last year. The current period also included gains on donations of appreciated common stock to a related charitable foundation, which were $2.2 million in both the first and the second quarters of 2017.

Gains and losses on non-marketable investment securities include those relating to private equity investments, which are primarily held by the Parent's majority-owned private equity subsidiaries. These gains and losses include fair value adjustments and gains and losses realized upon disposition. During the first six months of 2017, net losses in fair value of $2.8 million were recorded, compared to similar losses of $3.7 million in the same period in 2016. A gain of $1.8 million was also recorded in 2016 resulting from the Parent's withdrawal from a private equity fund, as required under the Volcker Rule investment prohibitions. The portion of the private equity activity attributable to minority interests is reported as non-controlling interest in the consolidated statements of income and resulted in income of $654 thousand during the first six months of 2017 and $379 thousand during the first six months of 2016.

Non-Interest Expense
  
Three Months Ended June 30
 
Six Months Ended June 30
(Dollars in thousands)
2017
2016
% change
 
2017
2016
% change
Salaries and employee benefits
$
108,829

$
104,808

3.8
 %
 
$
221,198

$
211,667

4.5
 %
Net occupancy
11,430

11,092

3.0

 
22,873

22,395

2.1

Equipment
4,776

4,781

(.1
)
 
9,385

9,415

(.3
)
Supplies and communication
5,446

5,693

(4.3
)
 
11,155

12,522

(10.9
)
Data processing and software
23,356

22,770

2.6

 
46,453

45,669

1.7

Marketing
4,488

4,389

2.3

 
7,712

8,202

(6.0
)
Deposit insurance
3,592

3,143

14.3

 
7,063

6,308

12.0

Other
22,677

20,413

11.1

 
45,585

38,384

18.8

Total non-interest expense
$
184,594

$
177,089

4.2
 %
 
$
371,424

$
354,562

4.8
 %

Non-interest expense for the second quarter of 2017 amounted to $184.6 million, an increase of $7.5 million, or 4.2%, compared with $177.1 million in the second quarter of last year. Salaries expense increased $4.0 million, or 4.5%, mainly due to higher full-time salaries and incentive compensation costs. Employee benefits expense totaled $15.8 million, slightly higher than in the same period last year as increases in payroll taxes and 401(k) expense were offset by lower medical costs. Growth in salaries expense resulted partly from higher staffing costs, mainly in the areas of commercial and consumer banking, commercial payments, residential lending and information technology business units. Full-time equivalent employees totaled 4,805 at June 30, 2017

42


compared to 4,779 at June 30, 2016. Occupancy costs increased $338 thousand, or 3.0%, mostly due to higher branch maintenance costs, while supplies and communication, marketing and equipment costs were well controlled. Data processing expense increased $586 thousand, or 2.6%, mainly due to higher online subscription service expense. FDIC insurance costs increased $449 thousand, or 14.3%, due to higher insurance rates that were effective July 1, 2016. Other non-interest expense increased $2.3 million, or 11.1%, compared to the same period in the previous year. This increase was mainly due to the donation of $2.3 million in appreciated securities to a related charitable foundation, as previously mentioned. In addition, lower deferred loan origination costs and higher professional fees expense were recorded. Excluding the donation expense, total non-interest expense grew 3.0% over the same period in 2016.

For the first six months of 2017, non-interest expense amounted to $371.4 million, an increase of $16.9 million, or 4.8%, compared with $354.6 million in the same period last year. Salaries and benefits increased $9.5 million, or 4.5%, mainly due to higher full-time salaries and incentives expense. Supplies and communication expense decreased $1.4 million, or 10.9%. This decrease was mainly the result of higher chip card reissue costs last year that have now declined. Marketing costs were down$490 thousand, or 6.0%, due to lower spending in the first quarter of 2017, but are expected to increase in subsequent quarters this year. FDIC insurance costs grew $755 thousand while data processing costs grew $784 thousand, both due to the trends mentioned above. Other non-interest expense increased $7.2 million, or 18.8%, mainly due to donations of $4.5 million in appreciated securities in the current period. Higher costs were also recorded in professional fees, bank card rewards and royalty fees expense, in addition to lower deferred loan origination costs. Excluding the donation expense, total non-interest expense grew 3.5% over the prior year.

Provision and Allowance for Loan Losses
 
Three Months Ended
 
Six Months Ended June 30
(In thousands)
June 30,
2017
Mar. 31, 2017
June 30,
2016
 
2017
2016
Provision for loan losses
$
10,758

$
11,128

$
9,216

 
$
21,886

$
18,655

Net loan charge-offs (recoveries):
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
  Business
318

97

(65
)
 
415

398

  Real estate-construction and land
(207
)
(535
)
(507
)
 
(742
)
(518
)
  Real estate-business
(10
)
(39
)
(1,030
)
 
(49
)
(1,272
)
Commercial net loan charge-offs (recoveries)
101

(477
)
(1,602
)
 
(376
)
(1,392
)
Personal Banking:
 
 
 
 
 
 
  Real estate-personal
(131
)
19

305

 
(112
)
110

  Consumer
2,642

2,096

1,781

 
4,738

4,380

  Revolving home equity
104

7

75

 
111

163

  Consumer credit card
7,750

7,148

6,650

 
14,898

12,568

  Overdrafts
292

435

307

 
727

526

Personal banking net loan charge-offs
10,657

9,705

9,118

 
20,362

17,747

Total net loan charge-offs
$
10,758

$
9,228

$
7,516

 
$
19,986

$
16,355



43


 
Three Months Ended
 
Six Months Ended June 30
 
June 30, 2017
Mar. 31, 2017
June 30, 2016
 
2017
2016
Annualized net loan charge-offs (recoveries)*:
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
  Business
.03
 %
.01
 %
(.01
)%
 
.02
 %
.02
 %
  Real estate-construction and land
(.10
)
(.26
)
(.26
)
 
(.18
)
(.14
)
  Real estate-business

(.01
)
(.17
)
 

(.11
)
Commercial net loan charge-offs (recoveries)

(.02
)
(.08
)
 
(.01
)
(.04
)
Personal Banking:
 
 
 
 
 
 
  Real estate-personal
(.03
)

.06

 
(.01
)
.01

  Consumer
.53

.43

.37

 
.48

.46

  Revolving home equity
.10

.01

.07

 
.06

.08

  Consumer credit card
4.25

3.88

3.62

 
4.06

3.39

  Overdrafts
26.00

42.15

31.53

 
33.73

24.35

Personal banking net loan charge-offs
.83

.77

.74

 
.80

.71

Total annualized net loan charge-offs
.32
 %
.28
 %
.24
 %
 
.30
 %
.26
 %
* as a percentage of average loans (excluding loans held for sale)

The Company has an established process to determine the amount of the allowance for loan losses, which assesses the risks and losses inherent in its portfolio. This process provides an allowance consisting of a specific allowance component based on certain individually evaluated loans and a general component based on estimates of allowances for pools of loans. The Company's policies and processes for determining the allowance for loan losses are discussed in Note 1 to the consolidated financial statements and in the Allowance for Loan Losses discussion in Item 7 of the 2016 Annual Report on Form 10-K.

Net loan charge-offs in the second quarter of 2017 amounted to $10.8 million, compared with $9.2 million in the prior quarter and $7.5 million in the second quarter of last year. The increase in current quarter net charge-offs over the previous quarter was mainly due to increases in consumer credit card, consumer, and business net loan charge-offs of $602 thousand, $546 thousand, and $221 thousand, respectively. The increase in net loan charge-offs was also driven by lower net recoveries on construction loans, which totaled $207 thousand in the second quarter of 2017, compared to net recoveries of $535 thousand in the prior quarter. These increases in net loan charge-offs were partially offset by decreases of $150 thousand and $143 thousand in net charge-offs on personal real estate loans and overdrafts, respectively.

For the three months ended June 30, 2017, annualized net loan charge-offs on average consumer credit card loans totaled 4.25%, compared with 3.88% in the previous quarter and 3.62% in the same period last year. Consumer loan annualized net charge-offs in the current quarter amounted to .53%, compared to .43% in the prior quarter and .37% in the same period last year.  Annualized net charge-offs on personal real estate loans also remained low this quarter.  In the second quarter of 2017, total annualized net loan charge-offs were .32%, compared to .28% in the previous quarter and .24% in the same period last year.

In the current quarter, the provision for loan losses totaled $10.8 million and matched net loan charge-offs.  In the prior quarter, the provision for loan losses totaled $11.1 million and exceeded net loan charge-offs by $1.9 million, and in the same period last year, the provision for loan losses totaled $9.2 million and exceeded net loan charge-offs by $1.7 million.  The provision for loan losses in the current quarter decreased by $370 thousand compared to the previous quarter. 

For the six months ended June 30, 2017, net loan charge-offs totaled $20.0 million, compared to $16.4 million in 2016.  The increase in net loan charge-offs resulted mainly from an increase in consumer credit card net loan charge-offs, which increased $2.3 million, and fewer recoveries on business real estate loans, which declined $1.2 million.  The provision for loan losses for the first six months of 2017 was $21.9 million and increased $3.2 million compared to the previous year. The increase in provision expense was the result of higher net loan losses during the six months ended June 30, 2017 compared to the same period in the prior year.

At June 30, 2017, the allowance for loan losses amounted to $157.8 million and was 1.16% of total loans and more than ten times total non-accrual loans. At December 31, 2016, the allowance for loan losses amounted to $155.9 million and was 1.16% of total loans and over ten times total non-accrual loans.


44


Risk Elements of Loan Portfolio

The following table presents non-performing assets and loans which are past due 90 days and still accruing interest. Non-performing assets include non-accruing loans and foreclosed real estate. Loans are placed on non-accrual status when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment. 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 personal banking loans that are exempt under regulatory rules from being classified as non-accrual.
(Dollars in thousands)
June 30, 2017
December 31, 2016
Non-accrual loans
$
13,362

$
14,283

Foreclosed real estate
515

366

Total non-performing assets
$
13,877

$
14,649

Non-performing assets as a percentage of total loans
.10
%
.11
%
Non-performing assets as a percentage of total assets
.06
%
.06
%
Total loans past due 90 days and still accruing interest
$
14,630

$
16,396


Non-accrual loans, which are also classified as impaired, totaled $13.4 million at June 30, 2017, and decreased $921 thousand from balances at December 31, 2016. The decrease occurred mainly in business loans, which decreased $2.4 million, partly offset by an increase of $1.2 million in consumer loans. At June 30, 2017, non-accrual loans were comprised mainly of business (47.4%), personal real estate (26.2%), and business real estate (13.7%) loans. Foreclosed real estate totaled $515 thousand at June 30, 2017, an increase of $149 thousand when compared to December 31, 2016. Total loans past due 90 days or more and still accruing interest were $14.6 million as of June 30, 2017, a decrease of $1.8 million when compared to December 31, 2016. Balances by class for non-accrual loans and loans past due 90 days and still accruing interest are shown in the "Delinquent and non-accrual loans" section in Note 2 to the consolidated financial statements.

In addition to the non-performing and past due 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. They are classified as substandard under the Company's internal rating system. The loans are generally secured by either real estate or other borrower assets, reducing the potential for loss should they become non-performing. Although these loans are generally identified as potential problem loans, they may never become non-performing. Such loans totaled $107.8 million at June 30, 2017 compared with $99.5 million at December 31, 2016, resulting in an increase of $8.3 million, or 8.3%.


(In thousands)
June 30, 2017
December 31, 2016
Potential problem loans:
 
 
  Business
$
47,860

$
43,438

  Real estate – construction and land
2,703

1,172

  Real estate – business
51,693

52,913

  Real estate – personal
5,507

1,955

Total potential problem loans
$
107,763

$
99,478


At June 30, 2017, the Company had $59.2 million of loans whose terms have been modified or restructured under a troubled debt restructuring. These loans have been extended to borrowers who are experiencing financial difficulty and who have been granted a concession, as defined by accounting guidance, and are further discussed in the "Troubled debt restructurings" section in Note 2 to the consolidated financial statements. This balance includes certain commercial loans totaling $36.8 million which are classified as substandard and included in the table above because of this classification.

Loans with Special Risk Characteristics
Management relies primarily on an internal risk rating system, in addition to delinquency status, to assess risk in the loan portfolio, and these statistics are presented in Note 2 to the consolidated financial statements. However, certain types of loans are considered at high risk of loss due to their terms, location, or special conditions. Additional information about the major types of loans in these categories and their risk features are provided below. Information based on loan-to-value (LTV) ratios was generally calculated with valuations at loan origination date. The Company normally obtains an updated appraisal or valuation at the time a loan is renewed or modified, or if the loan becomes significantly delinquent or is in the process of being foreclosed upon.

45


Real Estate – Construction and Land Loans
The Company's portfolio of construction and land loans, as shown in the table below, amounted to 6.2% of total loans outstanding at June 30, 2017. The largest component of construction and land loans was commercial construction, which grew $77.7 million during the six months ended June 30, 2017. At June 30, 2017, multi-family residential construction loans totaled approximately $218.6 million, or 37.6%, of the commercial construction loan portfolio.
(Dollars in thousands)
June 30, 2017


% of Total
% of
Total
Loans
December 31, 2016
    

% of Total
% of
Total
Loans
Residential land and land development
$
79,120

9.3
%
.6
%
$
86,373

10.9
%
.6
%
Residential construction
130,231

15.4

.9

132,334

16.8

1.0

Commercial land and land development
57,637

6.8

.4

69,057

8.7

.5

Commercial construction
581,164

68.5

4.3

503,472

63.6

3.8

Total real estate - construction and land loans
$
848,152

100.0
%
6.2
%
$
791,236

100.0
%
5.9
%

Real Estate – Business Loans
Total business real estate loans were $2.7 billion at June 30, 2017 and comprised 20.0% of the Company's total loan portfolio. These loans include properties such as manufacturing and warehouse buildings, small office and medical buildings, churches, hotels and motels, shopping centers, and other commercial properties. At June 30, 2017, 36.8% of business real estate loans were for owner-occupied real estate properties, which present lower risk profiles.
(Dollars in thousands)
June 30, 2017


% of Total
% of
Total
Loans
December 31, 2016


% of Total
% of
Total
Loans
Owner-occupied
$
1,002,503

36.8
%
7.4
%
$
1,004,238

38.0
%
7.5
%
Office
349,017

12.8

2.6

319,638

12.1

2.4

Retail
353,936

13.0

2.6

344,221

13.0

2.5

Multi-family
305,019

11.2

2.2

255,369

9.7

1.9

Hotels
155,979

5.7

1.1

174,207

6.6

1.3

Farm
162,952

6.0

1.2

173,210

6.6

1.3

Industrial
123,537

4.4

.9

122,940

4.6

.9

Other
274,406

10.1

2.0

249,551

9.4

1.9

Total real estate - business loans
$
2,727,349

100.0
%
20.0
%
$
2,643,374

100.0
%
19.7
%

Real Estate – Personal Loans
The Company's $2.0 billion personal real estate loan portfolio is composed mainly of residential first mortgage real estate loans. As shown on page 44, recent loss rates have remained low, and at June 30, 2017, loans past due over 30 days decreased $3.2 million; however, non-accrual loans increased $101 thousand compared to December 31, 2016. Also, as shown in Note 2, only 3.9% of this portfolio has FICO scores of less than 660. Approximately $21.9 million, or 1.1%, of personal real estate loans were structured with interest only payments. These loans are typically made to high net-worth borrowers and generally have low LTV ratios at origination or have additional collateral pledged to secure the loan. Therefore, they are not perceived to represent above normal credit risk. Loans originated with interest only payments were not made to "qualify" the borrower for a lower payment amount. At June 30, 2017, loans with no mortgage insurance and an original LTV higher than 80% totaled $165.6 million compared to $158.8 million at December 31, 2016.

Revolving Home Equity Loans
The Company had $403.4 million in revolving home equity loans at June 30, 2017 that were generally collateralized by residential real estate. Most of these loans (92.9%) are written with terms requiring interest only monthly payments. These loans are offered in three main product lines: LTV up to 80%, 80% to 90%, and 90% to 100%. As of June 30, 2017, the outstanding principal of loans with an original LTV higher than 80% was $54.0 million, or 13.4% of the portfolio, compared to $55.1 million as of December 31, 2016. Total revolving home equity loan balances over 30 days past due or on non-accrual status were $3.1 million at June 30, 2017 compared to $2.2 million at December 31, 2016.  The weighted average FICO score for the total current portfolio balance is 793. At maturity, the accounts are re-underwritten, and if they qualify under the Company's credit, collateral and capacity policies, the borrower is given the option to renew the line of credit or convert the outstanding balance to an amortizing loan.  If criteria are not met, amortization is required, or the borrower may pay off the loan. During the remainder of 2017 through 2019, approximately 18% of the Company's current outstanding balances are expected to mature. Of these balances, approximately

46


81% have a FICO score of 700 or higher. The Company does not expect a significant increase in losses as these loans mature, due to their high FICO scores, low LTVs, and low historical loss levels.

Other Consumer Loans
Within the consumer loan portfolio are several direct and indirect product lines, which include loans for the purchase of automobiles, marine and RVs. Outstanding balances for auto loans were $993.3 million and $972.5 million at June 30, 2017 and December 31, 2016, respectively. The balances over 30 days past due amounted to $12.7 million at June 30, 2017 compared to $13.8 million at the end of 2016, and comprised 1.3% and 1.4% of the outstanding balances of these loans at June 30, 2017 and December 31, 2016, respectively. For the six months ended June 30, 2017, $239.7 million of new auto loans were originated, compared to $431.0 million during the full year of 2016.  At June 30, 2017, the automobile loan portfolio had a weighted average FICO score of 747.
The Company's balance of marine and RV loans totaled $85.2 million at June 30, 2017, compared to $102.4 million at December 31, 2016, and the balances over 30 days past due amounted to $2.8 million at June 30, 2017 compared to $4.3 million at the end of 2016. The net charge-offs on marine and RV loans increased slightly from $691 thousand in the first six months of 2016 to $741 thousand in the first six months of the current year.

Additionally, the Company offers low promotional rates on selected consumer credit card products. Out of a portfolio at June 30, 2017 of $740.9 million in consumer credit card loans outstanding, approximately $155.1 million, or 20.9%, carried a low promotional rate. Within the next six months, $43.7 million of these loans are scheduled to convert to the ongoing higher contractual rate. To mitigate some of the risk involved with this credit card product, the Company performs credit checks and detailed analysis of the customer borrowing profile before approving the loan application. Management believes that the risks in the consumer loan portfolio are reasonable and the anticipated loss ratios are within acceptable parameters.

Energy Lending
The Company's energy lending portfolio was comprised of lending to the petroleum and natural gas sectors and totaled $140.8 million at June 30, 2017, as shown in the table below. As of June 30, 2017, there were $6.9 million of energy loans, or 4.9%, of the energy portfolio, with a "substandard" rating or on non-accrual status, compared to $8.0 million, or 4.6% of the energy portfolio, at December 31, 2016. Included in these amounts were non-accrual loans of zero at June 30, 2017, compared to $847 thousand at December 31, 2016. There were no energy loans 90 days past due and still accruing interest at June 30, 2017 or December 31, 2016.
(In thousands)
June 30, 2017
December 31, 2016
 
Unfunded commitments at June 30, 2017
Extraction
$
87,935

$
103,011

 
$
38,761

Mid-stream shipping and storage
7,904

22,985

 
61,800

Downstream distribution and refining

30,900

30,231

 
18,033

Support activities
14,028

15,296

 
21,832

Total energy lending portfolio
$
140,767

$
171,523

 
$
140,426


Shared National Credits
The Company participates in credits of large, publicly traded companies which are defined by regulation as shared national credits, or SNCs. Regulations define SNCs as loans exceeding $20 million that are shared by three or more financial institutions. The Company typically participates in these loans when business operations are maintained in the local communities or regional markets and opportunities to provide other banking services are present. The balance of SNC loans totaled $892.4 million at June 30, 2017, compared to $836.1 million at December 31, 2016. Additional unfunded commitments at June 30, 2017 totaled $1.3 billion.


47


Income Taxes
Income tax expense was $33.2 million in the second quarter of 2017, compared to $24.9 million in the first quarter of 2017 and $31.5 million in the second quarter of 2016. The Company's effective tax rate, including the effect of non-controlling interest, was 29.6% in the second quarter of 2017, compared to 25.8% in the first quarter of 2017 and 31.1% in the second quarter of 2016. The lower effective tax rate for the first quarter of 2017 was primarily due to the adoption of ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting" on January 1, 2017. The ASU requires all excess tax benefits and tax deficiencies arising from share-based award payments to be recognized as income tax expense or benefit in the income statement, while in previous periods these benefits and deficiencies were recognized in equity. The amount of excess tax benefits (net of tax deficiencies) recognized as a reduction to income tax expense was $4.5 million in the first quarter of 2017 and $1.6 million in the second quarter of 2017. These tax benefits are expected to be seasonally higher in the first quarter of each year when the majority of the Company’s equity compensation vests.
The decrease in the Company's effective tax rate for the three months ended June 30, 2017 compared to the same period in the prior year was due to tax benefits related to the donation of appreciated securities to a charitable foundation lowering the effective tax rate in the current quarter, as mentioned previously.

Financial Condition

Balance Sheet

Total assets of the Company were $25.1 billion at June 30, 2017 and $25.6 billion at December 31, 2016. Earning assets (excluding the allowance for loan losses and fair value adjustments on investment securities) amounted to $23.8 billion at June 30, 2017 and $24.2 billion at December 31, 2016, and consisted of 57% in loans and 40% in investment securities.

At June 30, 2017, total loans increased $213.9 million, or 1.6%, compared with balances at December 31, 2016. On an overall basis, the largest contributions to loan growth occurred in business loans and business real estate loans, which increased $76.0 million and $84.0 million, respectively, over year end balances. The increase in business loans primarily resulted from growth in commercial and industrial loans, commercial credit card loans, and tax-free loans. Business real estate loans increased largely because of growth in multi-family residential loans. Consumer loans, which includes automobile, marine and RV, fixed rate home equity, and other consumer loans, increased $47.7 million during the first six months of the year. Higher demand for automobile and other consumer loans grew loan balances $71.0 million. However, fixed rate home equity loans decreased by $6.1 million and marine and RV loans continued to run off during the period by $17.2 million. Construction loans increased $56.9 million during the first six months of the year primarily due to commercial construction projects. Personal real estate loan balances were largely unchanged from year end balances; however, the Company originated and sold $87.7 million of longer-term fixed rate loans during the first six months of 2017 compared to $64.5 million in the same period of 2016. Declines in consumer credit card (down $35.6 million) and revolving home equity loans (down $10.2 million) partially offset growth throughout the year.

Available for sale investment securities, excluding fair value adjustments, decreased by $258.6 million at June 30, 2017 compared to December 31, 2016. Purchases of securities during this period totaled $672.4 million, offset by sales, maturities, and pay downs of $912.0 million. The largest decreases in outstanding balances occurred in asset-backed securities, agency mortgage-backed securities, and state and municipal obligations, which decreased $139.8 million, $70.7 million, and $33.6 million, respectively. At June 30, 2017, the duration of the investment portfolio was 2.8 years, and maturities and pay downs of approximately $1.6 billion are expected to occur during the next 12 months.

Total deposits at June 30, 2017 amounted to $20.8 billion and decreased $275.4 million compared to deposit balances at December 31, 2016. The decline in deposits was driven by decreases in certificates of deposit of $157.4 million, or 7.0%, mainly in jumbo accounts, and interest checking deposits of $106.3 million, or 8.3%. These decreases were offset by growth in money market deposits of $42.6 million, or .5%, and savings accounts of $60.6 million, or 7.8%. Non-interest bearing deposits also declined $114.9 million, or 1.5%, mainly due to a reduction of $164.4 million in business accounts, partially offset by an increase of $66.3 million in personal accounts.

Total borrowings were $1.4 billion at June 30, 2017 compared to $1.8 billion at December 31, 2016. Short-term borrowings of federal funds purchased and customer repurchase agreements totaled $1.3 billion at June 30, 2017, a decrease of $467.5 million from balances of $1.7 billion at December 31, 2016. The overall decrease in these balances was due to a decrease of $668.1 million in customer repurchase agreements, offset by an increase of $200.7 million in federal funds purchased.


48


Liquidity and Capital Resources

Liquidity Management
The Company’s most liquid assets are comprised of available for sale investment securities, federal funds sold, securities purchased under agreements to resell (resale agreements), and balances at the Federal Reserve Bank, as follows:
(In thousands)
 
June 30, 2017
 
March 31, 2017
 
December 31, 2016
Liquid assets:
 
 
 
 
 
 
  Available for sale investment securities
 
$
9,439,701

 
$
9,671,975

 
$
9,649,203

  Federal funds sold
 
16,520

 
2,205

 
15,470

  Long-term securities purchased under agreements to resell
 
625,000

 
725,000

 
725,000

  Balances at the Federal Reserve Bank
 
80,860

 
120,234

 
272,275

  Total
 
$
10,162,081

 
$
10,519,414

 
$
10,661,948


Federal funds sold, which are funds lent to the Company's correspondent bank customers with overnight maturities, totaled $16.5 million as of June 30, 2017. Long-term resale agreements, maturing through 2018, totaled $625.0 million at June 30, 2017. Under these agreements, the Company lends funds to upstream financial institutions and holds marketable securities, safe-kept by a third-party custodian, as collateral. This collateral totaled $653.4 million in fair value at June 30, 2017. Interest earning balances at the Federal Reserve Bank, which have overnight maturities and are used for general liquidity purposes, totaled $80.9 million at June 30, 2017. The fair value of the available for sale investment portfolio was $9.4 billion at June 30, 2017 and included an unrealized net gain in fair value of $97.9 million. The total net unrealized gain included net gains of $19.6 million on mortgage-backed securities, $32.7 million on state and municipal obligations, and $42.3 million on common and preferred stock held by the Parent.

Approximately $1.6 billion of the available for sale investment portfolio is expected to mature or pay down during the next 12 months, and these funds offer substantial resources to meet new loan demand or help offset reductions in the Company's deposit funding base. The Company pledges portions of its investment securities portfolio to secure public fund deposits, securities sold under agreements to repurchase, trust funds, letters of credit issued by the FHLB, and borrowing capacity at the Federal Reserve Bank. Total investment securities pledged for these purposes were as follows:
(In thousands)
June 30, 2017
March 31, 2017
December 31, 2016
Investment securities pledged for the purpose of securing:
    
 
 
  Federal Reserve Bank borrowings
$
99,541

$
108,240

$
115,858

  FHLB borrowings and letters of credit
15,560

16,743

17,781

  Securities sold under agreements to repurchase *
1,747,101

1,726,909

2,447,835

  Other deposits and swaps
2,032,334

1,956,791

1,773,017

  Total pledged securities
3,894,536

3,808,683

4,354,491

  Unpledged and available for pledging
3,718,231

4,071,649

3,516,648

  Ineligible for pledging
1,826,934

1,791,643

1,778,064

  Total available for sale securities, at fair value
$
9,439,701

$
9,671,975

$
9,649,203

* Includes securities pledged for collateral swaps, as discussed in Note 11 to the consolidated financial statements.

Liquidity is also available from the Company's large base of core customer deposits, defined as non-interest bearing, interest checking, savings, and money market deposit accounts. At June 30, 2017, such deposits totaled $18.7 billion and represented 90.0% of total deposits. These core deposits are normally less volatile, as they are 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 and over totaled $1.4 billion at June 30, 2017. These accounts are normally considered more volatile and higher costing and comprised 6.7% of total deposits at June 30, 2017.
(In thousands)
June 30, 2017
March 31, 2017
December 31, 2016
Core deposit base:
 
 
 
 Non-interest bearing
$
7,314,506

$
7,237,815

$
7,429,398

 Interest checking
1,169,605

1,146,600

1,275,899

 Savings and money market
10,258,010

10,292,478

10,154,890

 Total
$
18,742,121

$
18,676,893

$
18,860,187



49


Other important components of liquidity are the level of borrowings from third party sources and the availability of future credit. The Company's outside borrowings are mainly comprised of federal funds purchased, securities sold under agreements to repurchase, and advances from the FHLB, as follows:
(In thousands)
June 30, 2017
March 31, 2017
December 31, 2016
Borrowings:
 
 
 
 Federal funds purchased
$
253,510

$
340,195

$
52,840

 Securities sold under agreements to repurchase
1,002,934

980,954

1,671,065

 FHLB advances
100,000

100,000

100,000

 Other debt
1,903

1,975

2,049

 Total
$
1,358,347

$
1,423,124

$
1,825,954


Federal funds purchased are unsecured overnight borrowings obtained mainly from upstream correspondent banks with which the Company maintains approved lines of credit. Securities sold under agreements to repurchase are secured by a portion of the Company's investment portfolio and are comprised of non-insured customer funds totaling $1.0 billion, which generally mature overnight. The Company also borrows on a secured basis through advances from the FHLB, which totaled $100.0 million at June 30, 2017. These advances have fixed interest rates and mature in the fourth quarter of 2017.

The Company pledges certain assets, including loans and investment securities, to both the Federal Reserve Bank and the FHLB as security to establish lines of credit and borrow from these entities. Based on the amount and type of collateral pledged, the FHLB establishes a collateral value from which the Company may draw advances against the collateral. Also, this collateral is used to enable the FHLB to issue letters of credit in favor of public fund depositors of the Company. The Federal Reserve Bank also establishes a collateral value of assets pledged to support borrowings from the discount window. The following table reflects the collateral value of assets pledged, borrowings, and letters of credit outstanding, in addition to the estimated future funding capacity available to the Company at June 30, 2017.
 
June 30, 2017
(In thousands)

FHLB
Federal Reserve

Total
Collateral value pledged
$
2,734,323

$
1,272,837

$
4,007,160

Advances outstanding
(100,000
)

(100,000
)
Letters of credit issued
(555,957
)

(555,957
)
Available for future advances
$
2,078,366

$
1,272,837

$
3,351,203


In addition to those mentioned above, several other sources of liquidity are available. No commercial paper has been issued or outstanding during the past ten years. The Company has no subordinated debt or hybrid instruments which could affect future borrowing capacity. Because of its lack of significant long-term debt, the Company believes that it could generate additional liquidity through its Capital Markets Group from sources such as jumbo certificates of deposit or privately placed corporate debt. The Company receives strong outside rankings from both Standard & Poor's and Moody's on both the consolidated company level and it's subsidiary bank, Commerce Bank, which would support future financing efforts, should the need arise. These ratings are as follows:
 
Standard & Poor’s
Moody’s
Commerce Bancshares, Inc.


Issuer rating
A-

Rating outlook
Stable
Stable
Preferred stock
BBB-
Baa1
Commerce Bank


Issuer rating
A
A2
Rating outlook
Stable
Stable
Baseline credit assessment

a1
Short-term rating
A-1
P-1

The cash flows from the operating, investing and financing activities of the Company resulted in a net decrease in cash and cash equivalents of $251.3 million during the first six months of 2017, as reported in the consolidated statements of cash flows in this report. Operating activities, consisting mainly of net income adjusted for certain non-cash items, provided cash flow of

50


$212.0 million and has historically been a stable source of funds. Investing activities, which occur mainly in the loan and investment securities portfolios, provided cash of $145.0 million. Activity in the investment securities portfolio provided cash of $291.0 million from sales, maturities and pay downs (net of purchases), and repayments of long-term securities purchased under agreements to resell provided cash of $100.0 million. These cash inflows were partly offset by a net increase in loans of $234.4 million. Financing activities used cash of $608.4 million, largely resulting from a net decrease in borrowings of federal funds purchased and securities sold under agreements to repurchase of $467.5 million. In addition, deposits decreased $79.8 million, and cash was used to fund dividends paid on common and preferred stock of $50.3 million. Future short-term liquidity needs arising from daily operations are not expected to vary significantly, and the Company believes it will be able to meet these cash flow needs.

Capital Management

The Company met all capital adequacy requirements and had regulatory capital ratios in excess of the levels established for well-capitalized institutions at June 30, 2017 and December 31, 2016, as shown in the following table.

(Dollars in thousands)
June 30, 2017
December 31, 2016
Minimum Ratios under Capital Adequacy Guidelines *
Minimum Ratios
for
Well-Capitalized
Banks **
Risk-adjusted assets
$
18,766,184

$
18,994,730

 
 
Tier I common risk-based capital
2,304,532

2,207,370

 
 
Tier I risk-based capital
2,449,316

2,352,154

 
 
Total risk-based capital
2,627,297

2,529,675

 
 
Tier I common risk-based capital ratio
12.28
%
11.62
%
7.00
%
6.50
%
Tier I risk-based capital ratio
13.05
%
12.38
%
8.50
%
8.00
%
Total risk-based capital ratio
14.00
%
13.32
%
10.50
%
10.00
%
Tier I leverage ratio
9.87
%
9.55
%
4.00
%
5.00
%
* as of the fully phased-in date of Jan. 1, 2019, including capital conservation buffer
**under Prompt Corrective Action requirements

The Company maintains a treasury stock buyback program under authorizations by its Board of Directors and normally purchases stock in the open market. The Company purchased 188,348 shares at an average price of $56.43 during the six months ended June 30, 2017, which was related to stock-based compensation transactions. At June 30, 2017, 3,570,327 shares remained available for purchase under the current Board authorization.

The Company's common stock dividend policy reflects its earnings outlook, desired payout ratios, the need to maintain adequate capital and liquidity levels, and alternative investment options. The Company paid a $.225 per share cash dividend on its common stock in both the first and second quarters of 2017, which was a 5% increase compared to its 2016 quarterly dividend.

Commitments, Off-Balance Sheet Arrangements and Contingencies

In the normal course of business, various commitments and contingent liabilities arise which are not required to be recorded on the balance sheet. The most significant of these are loan commitments, which at June 30, 2017 totaled $10.4 billion (including approximately $5.0 billion in unused approved credit card lines). In addition, the Company enters into standby and commercial letters of credit. These contracts totaled $338.8 million and $13.3 million, respectively, at June 30, 2017. As many commitments expire unused or only partially used, these totals do not necessarily reflect future cash requirements. The carrying value of the guarantee obligations associated with the standby letters of credit, which has been recorded as a liability on the consolidated balance sheet, amounted to $2.1 million at June 30, 2017.

The Company regularly purchases various state tax credits arising from third-party property redevelopment. These credits are either resold to third parties at a profit or retained for use by the Company. During the first six months of 2017, purchases and sales of tax credits amounted to $42.0 million and $31.7 million, respectively. Fees from sales of tax credits were $1.9 million for the six months ended June 30, 2017, compared to $1.7 million in the same period last year. At June 30, 2017, the Company expected to fund outstanding purchase commitments of $79.2 million during the remainder of 2017.


51


Segment Results

The table below is a summary of segment pre-tax income results for the first six months of 2017 and 2016.

(Dollars in thousands)
Consumer
Commercial
Wealth
Segment
Totals    
Other/ Elimination
Consolidated Totals
Six Months Ended June 30, 2017
    
    
    
    
    
    
Net interest income
$
136,628

$
161,505

$
23,771

$
321,904

$
39,176

$
361,080

Provision for loan losses
(20,464
)
624

1

(19,839
)
(2,047
)
(21,886
)
Non-interest income
66,017

96,879

76,557

239,453

697

240,150

Investment securities gains, net




879

879

Non-interest expense
(145,126
)
(147,839
)
(59,795
)
(352,760
)
(18,664
)
(371,424
)
Income before income taxes
$
37,055

$
111,169

$
40,534

$
188,758

$
20,041

$
208,799

Six Months Ended June 30, 2016
    
    
    
    
    
    
Net interest income
$
133,791

$
153,266

$
21,822

$
308,879

$
26,725

$
335,604

Provision for loan losses
(17,500
)
1,487

(115
)
(16,128
)
(2,527
)
(18,655
)
Non-interest income
62,935

99,408

71,020

233,363

2,231

235,594

Investment securities losses, net




(1,739
)
(1,739
)
Non-interest expense
(139,526
)
(140,250
)
(56,944
)
(336,720
)
(17,842
)
(354,562
)
Income before income taxes
$
39,700

$
113,911

$
35,783

$
189,394

$
6,848

$
196,242

Increase (decrease) in income before income taxes:
 
 
 
 
 
 
   Amount
$
(2,645
)
$
(2,742
)
$
4,751

$
(636
)
$
13,193

$
12,557

   Percent
(6.7
)%
(2.4
)%
13.3
%
(.3
)%
192.7
%
6.4
%

Consumer

For the six months ended June 30, 2017, income before income taxes for the Consumer segment decreased $2.6 million, or 6.7%, compared to the first six months of 2016. This decrease in income before taxes was mainly due to higher non-interest expense of $5.6 million, or 4.0%, and an increase in the provision for loan losses of $3.0 million, or 16.9%. These increases in expense were partly offset by growth in non-interest income of $3.1 million, or 4.9%, and net interest income of $2.8 million, or 2.1%. Net interest income increased due to a $4.3 million increase in net allocated funding credits assigned to the Consumer segment's loan and deposit portfolios, partly offset by a decline of $1.5 million in loan interest income. Non-interest income increased mainly due to growth in deposit fees (mainly deposit account service fees and overdraft and return item fees), bank card fees, and mortgage banking revenue. Non-interest expense increased over the same period in the previous year due to higher allocated support costs, mainly administrative, online banking and information technology. In addition, salaries, bank card rewards, and royalty fees expense increased over the previous year, while supplies and communication expense decreased due to higher chip card reissue costs last year that have now declined. The provision for loan losses totaled $20.5 million, a $3.0 million increase over the first six months of 2016, which was mainly due to higher credit card loan net charge-offs.

Commercial

For the six months ended June 30, 2017, income before income taxes for the Commercial segment decreased $2.7 million, or 2.4%, compared to the same period in the previous year. This decrease was mainly due to lower non-interest income, higher non-interest expense and an increase in the provision for loan losses and was partially offset by growth in net interest income. Net interest income increased $8.2 million, or 5.4%, due to an increase in loan interest income, partly offset by a decline in net allocated funding credits and higher deposit interest expense. Non-interest income decreased $2.5 million, or 2.5%, from the previous year due to lower swap fees, bank card fees, and capital market fees. These decreases were partly offset by growth in deposit account fees. Non-interest expense increased $7.6 million, or 5.4%, mainly due to increases in salaries and benefits expense and allocated service and support costs. The provision for loan losses increased $863 thousand over the same period last year, due to lower net recoveries on business real estate loans.


52


Wealth

Wealth segment pre-tax profitability for the six months ended June 30, 2017 increased $4.8 million, or 13.3%, over the same period in the previous year. Net interest income increased $1.9 million, or 8.9%, mainly due to an increase in loan interest income. Non-interest income increased $5.5 million, or 7.8%, over the prior year largely due to higher private client and institutional trust fees, brokerage fees and cash sweep fees. These increases were partly offset by a trust related settlement received in the second quarter of 2016. Non-interest expense increased $2.9 million, or 5.0%, mainly due to higher salary and benefit costs, professional fees and allocated support costs. The provision for loan losses decreased $116 thousand, mainly due to lower revolving home equity loan net charge-offs.

The Other/Elimination category in the preceding table includes the activity of various support and overhead operating units of the Company, in addition to the investment securities portfolio and other items not allocated to the segments. In accordance with the Company’s transfer pricing procedures, the difference between the total provision and total net charge-offs/recoveries is not allocated to a business segment and is included in this category. The pre-tax profitability of this category was higher than in the same period last year by $13.2 million. This increase was mainly due to higher unallocated net interest income of $12.5 million, offset by lower non-interest income of $1.5 million and higher non-interest expense of $822 thousand. Unallocated securities gains were $879 thousand in the first six months of 2017 compared to losses of $1.7 million in 2016. Also, the unallocated loan loss provision decreased $480 thousand, as the provision was $1.9 million in excess of charge-offs in the first six months of 2017 compared to $2.3 million in excess of charge-offs in the first six months of 2016.

Regulatory Changes Affecting the Banking Industry

In accordance with the Dodd-Frank Act, the Company began submitting its stress test results to the Federal Reserve in March 2014 and publicly disclosed the results of its stress testing for the first time in June 2015. In 2017, the Company submitted its stress test report to the Federal Reserve in July and expects to publicly disclose the results in October.

The Volcker Rule of the Dodd-Frank Act, effective on April 1, 2014, places trading restrictions on financial institutions and separates investment banking, private equity and proprietary trading (hedge fund) sections of financial institutions from their consumer lending arms. Key provisions restrict banks from simultaneously entering into advisory and creditor roles with their clients, such as with private equity firms. The Volcker Rule also restricts financial institutions from investing in and sponsoring certain types of investments, which must be divested by July 21, 2017. In 2016, the Company withdrew from a private equity fund investment to comply with the Volcker Rule requirement and holds no other significant investments requiring disposal.

Impact of Recently Issued Accounting Standards

Derivatives In March 2016, the FASB issued ASU 2016-05, "Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships", which clarifies that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. The amendments were effective January 1, 2017 and did not have a significant effect on the Company's consolidated financial statements.

The FASB issued ASU 2016-06, "Contingent Put and Call Options in Debt Instruments", in March 2016. The ASU clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. Under the new guidance, the embedded options should be assessed solely in accordance with a four-step decision sequence, with no additional assessment of whether the triggering event is indexed to interest rates or credit risk. The amendments were effective January 1, 2017 and did not have a significant effect on the Company's consolidated financial statements.

Investments The FASB issued ASU 2016-07, "Equity Method and Joint Ventures", in March 2016, which eliminates the requirement that an entity retroactively adopt the equity method of accounting if an investment qualifies for use of the equity method as a result of an increase in ownership or influence. Instead, the cost of acquiring the additional interest should be added to the current basis of the previously held interest, and equity method accounting applied prospectively. The amendments were effective January 1, 2017 and did not have a significant effect on the Company's consolidated financial statements.

Stock Compensation The FASB issued ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting", in March 2016, in order to reduce complexity in this area and improve the usefulness of information provided to users. Amendments which will affect public companies include the recognition of excess tax benefits and deficiencies in income tax expense or benefit in the income statement, guidance as to the classification of excess tax benefits on the statement of cash flows, an election to

53


account for award forfeitures as they occur, and the ability to withhold taxes up to the maximum statutory rate in the applicable jurisdictions without triggering liability classification of the award. The amendments were effective January 1, 2017. As further discussed in Note 12 to the consolidated financial statements, the Company elected to account for forfeitures as they occur.

Consolidation The FASB issued ASU 2016-17, "Interests Held through Related Parties That Are under Common Control", in October 2016. The ASU amends current guidance on how a reporting entity that is the single decision maker of a variable interest entity (VIE) should treat indirect interests in the entity held through related parties that are under common control with the reporting entity when determining whether it is the primary beneficiary of that VIE. Current GAAP requires a single decision maker to attribute indirect interests held by certain of its related parties entirely to itself, while the amendments require inclusion of those interests on a proportionate basis consistent with indirect interests held through other related parties. The amendments were effective January 1, 2017 and did not have a significant effect on the Company's consolidated financial statements.

Revenue from Contracts with Customers The FASB issued ASU 2014-09, "Revenue from Contracts with Customers", in May 2014, which has been followed by additional clarifying guidance on specified implementation issues. The ASU supersedes revenue recognition requirements in Topic 605, Revenue Recognition, including most industry specific revenue recognition guidance in the FASB Accounting Standards Codification. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance identifies specific steps that entities should apply in order to achieve this principle. Under the ASU and related amendments, the guidance is effective for interim and annual periods beginning January 1, 2018 and must be applied retrospectively, whether through a full restatement of prior periods or a cumulative adjustment upon adoption of the ASU.

Approximately 60% of the Company’s revenue is comprised of net interest income on financial assets and financial liabilities, and is explicitly out of scope of the guidance. The Company has identified the primary contracts in scope as those relating to brokerage commissions, trust fees, deposit account fees, real estate sales, and credit card revenues.  Over the last twelve months, significant discussions have been held with representatives of the business lines associated with the revenues described above and documentation has been accumulated and reviewed.  The Company is currently in the process of contract sampling, which should be completed early in the fourth quarter.  The Company’s analysis to date suggests that adoption of this ASU should not alter the way in which revenue for these significant areas is determined currently, but could possibly net certain revenues against expense or certain expenses against revenue.  Final conclusions are anticipated to be reached later this year.  The Company plans to adopt this ASU on January 1, 2018 with a cumulative effect adjustment to opening retained earnings, if such adjustment is deemed to be significant.

Liabilities The FASB issued ASU 2016-04, "Recognition of Breakage for Certain Prepaid Stored-Value Products", in March 2016, in order to address current and potential future diversity in practice related to the derecognition of a prepaid stored-value product liability. Such products include prepaid gift cards issued on a specific payment network and redeemable at network-accepting merchant locations, prepaid telecommunication cards, and traveler's checks. The amendments require that the portion of the dollar value of prepaid stored-value products that is ultimately unredeemed (that is, the breakage) be accounted for consistent with the breakage guidance for stored-value product transactions provided in ASC Topic 606 - Revenue from Contracts with Customers. These amendments are effective for interim and annual periods beginning January 1, 2018. The Company is in the process of evaluating the impact of the ASU's adoption on the Company's consolidated financial statements.

Income Taxes The FASB issued ASU 2016-16, "Intra-Entity Transfers of Assets Other Than Inventory", in October 2016. Current GAAP prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. The amendments require the recognition of income tax consequences of an intra-entity transfer of an asset (other than inventory) when the transfer occurs. This change removes the current exception to the principal of comprehensive recognition of current and deferred income taxes in GAAP (except for inventory). These amendments are effective for reporting periods beginning January 1, 2018 and are not expected to have a significant effect on the Company's consolidated financial statements.

Financial Instruments The FASB issued ASU 2016-01, "Recognition and Measurement of Financial Assets and Financial Liabilities", in January 2016. The amendments require all equity investments to be measured at fair value with changes in the fair value recognized through net income, other than those accounted for under the equity method of accounting or those that result in the consolidation of the investee. Additionally, these amendments require presentation in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk for those liabilities measured at fair value. The amendments also require use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes. These amendments are effective for interim and annual periods beginning January 1, 2018. The Company has formed a working group to evaluate the changes required as a result of the adoption of this ASU and

54


has also engaged outside consultants to assist with data collection and calculation of fair value information, particularly for fair value disclosures of the Company's loan portfolio.

Statement of Cash Flows The FASB issued ASU 2016-15, "Classification of Certain Cash Receipts and Cash Payments", in August 2016. The ASU addresses the presentation and classification in the Statement of Cash Flows of several specific cash flow issues. These include cash payments for debt prepayment or extinguishment costs, settlement of zero-coupon debt instruments, distributions received from equity method investees, and separately identifiable cash flows and application of the predominance principle. The amendments are effective January 1, 2018 and are not expected to have a significant effect on the Company's consolidated financial statements.

The FASB issued ASU 2016-18, "Restricted Cash", in November 2016. The ASU addresses the current diversity in the classification and presentation of changes in restricted cash on the statement of cash flows. The ASU requires that amounts described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning and end of period amounts shown on the statement of cash flows. Disclosures are to be provided on the nature of restrictions on cash and cash equivalents. When presented in more than one line item within the statement of financial position, the entity shall disclose the amounts, disaggregated by line item, of cash, cash equivalents, restricted cash, and restricted cash equivalents reported within the statement of financial position. The amendments are effective January 1, 2018 and are not expected to have a significant effect on the Company's consolidated financial statements.

Retirement Benefits The FASB issued ASU 2017-07, "Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost", in March 2017. Under current guidance, the different components comprising net benefit cost are aggregated for reporting in the financial statements. Because these components are heterogeneous, the current presentation reduces the transparency and usefulness of the financial statements. The ASU requires that an employer report the service cost component of net benefit cost in the same line item as other compensation costs arising from services rendered during the period. The other components of net benefit cost are required to be presented separately from the servicing cost component. Only service cost is eligible for capitalization when applicable. The amendments are effective January 1, 2018 and are not expected to have a significant effect on the Company's consolidated financial statements.

Leases In February 2016, the FASB issued ASU 2016-02, "Leases", in order to increase transparency and comparability by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The ASU primarily affects lessee accounting, which requires the lessee to recognize a right-of-use asset and a liability to make lease payments for those leases classified as operating leases under previous GAAP. For leases with a term of 12 months or less, an election by class of underlying asset not to recognize lease assets and lease liabilities is permitted. The ASU also provides additional guidance as to the definition of a lease, identification of lease components, and sale and leaseback transactions. The amendments in the ASU are effective for interim and annual periods beginning January 1, 2019. The Company is the lessee in approximately 200 lease agreements that are subject to this ASU. The Company has formed a working group to assess the changes required and is actively working with its current software vendor to acquire a new module designed to comply with the new accounting requirements.

Premium Amortization The FASB issued ASU 2017-08, "Premium Amortization on Purchased Callable Debt Securities", in March 2017. Under current guidance, many entities amortize the premium on purchased callable debt securities over the contractual life of the instrument. As a result, upon the exercise of a call on a callable debt security held at a premium, the unamortized premium is recorded as a loss in earnings. The amendments in this ASU shorten the amortization period for certain callable debt securities held at a premium to the earliest call date, and more closely align the amortization period to expectations incorporated in market pricing of the instrument. The amendments are effective January 1, 2019 and are not expected to have a significant effect on the Company's consolidated financial statements.

Financial Instruments ASU 2016-13, "Measurement of Credit Losses on Financial Instruments", was issued in June 2016. Its implementation will result in a new loan loss accounting framework, also known as the current expected credit loss (CECL) model. CECL requires credit losses expected throughout the life of the asset portfolio on loans and held-to-maturity securities to be recorded at the time of origination. Under the current incurred loss model, losses are recorded when it is probable that a loss event has occurred. The new standard will require significant operational changes, especially in data collection and analysis. The ASU is effective for interim and annual periods beginning January 1, 2020, and is expected to increase the allowance upon adoption. The Company has formed a working group to assess the standard and has begun assessing the data needs required. In the second quarter of 2017, the Company contracted with a software supplier to assist in the data collection and calculation of the allowance for loan losses under the new model, to allow for pro-forma calculations to begin by mid-2018.

Intangible Assets The FASB issued ASU 2017-04, "Simplifying the Test for Goodwill Impairment", in January 2017. Under current guidance, a goodwill impairment loss is measured by comparing the implied fair value of a reporting unit's goodwill with

55


the carrying amount of that goodwill by following procedures that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Under the new amendments, the goodwill impairment test compares the fair value of a reporting unit with its carrying amount and an impairment charge is measured as the amount by which the carrying amount exceeds the reporting unit's fair value. The amendments are effective for impairment tests beginning January 1, 2020 and are not expected to have a significant effect on the Company's consolidated financial statements.



56


AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
Three Months Ended June 30, 2017 and 2016
 
Second Quarter 2017
 
Second Quarter 2016
(Dollars in thousands)
Average Balance
Interest Income/Expense
Avg. Rates Earned/Paid
 
Average Balance
Interest Income/Expense
Avg. Rates Earned/Paid
ASSETS:
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
Business(A)
$
4,827,439

$
38,606

3.21
%
 
$
4,691,476

$
33,862

2.90
%
Real estate — construction and land
862,479

9,256

4.30

 
789,329

6,789

3.46

Real estate — business
2,701,144

25,219

3.74

 
2,389,170

21,934

3.69

Real estate — personal
2,003,997

18,602

3.72

 
1,905,968

17,827

3.76

Consumer
1,997,761

19,614

3.94

 
1,927,925

18,217

3.80

Revolving home equity
399,730

3,822

3.84

 
413,198

3,687

3.59

Consumer credit card
731,471

21,705

11.90

 
738,130

21,184

11.54

Overdrafts
4,505



 
3,916



Total loans
13,528,526

136,824

4.06

 
12,859,112

123,500

3.86

Loans held for sale
18,341

263

5.75

 
56,272

692

4.95

Investment securities:
  
 
 
 
 
 
 
U.S. government and federal agency obligations
910,821

5,731

2.52

 
698,374

6,047

3.48

Government-sponsored enterprise obligations
450,362

1,782

1.59

 
666,354

5,015

3.03

State and municipal obligations(A)
1,771,674

15,924

3.61

 
1,763,849

15,804

3.60

Mortgage-backed securities
3,708,124

21,702

2.35

 
3,394,466

19,892

2.36

Asset-backed securities
2,335,344

10,037

1.72

 
2,377,708

8,594

1.45

Other marketable securities(A)
326,398

2,249

2.76

 
337,572

2,325

2.77

Trading securities(A)
21,062

142

2.70

 
20,540

116

2.27

Non-marketable securities(A)
101,790

2,915

11.49

 
116,103

2,319

8.03

Total investment securities
9,625,575

60,482

2.52

 
9,374,966

60,112

2.58

Federal funds sold and short-term securities
 
 
 
 
 
 
 
purchased under agreements to resell
13,115

37

1.13

 
11,916

19

.64

Long-term securities purchased
 
 
 
 
 
 
 
under agreements to resell
665,655

3,684

2.22

 
824,999

3,354

1.64

Interest earning deposits with banks
139,061

362

1.04

 
125,024

151

.49

Total interest earning assets
23,990,273

201,652

3.37

 
23,252,289

187,828

3.25

Allowance for loan losses
(157,003
)
 
 
 
(151,622
)
 
 
Unrealized gain on investment securities
102,935

 
 
 
191,565

 
 
Cash and due from banks
349,132

 
 
 
372,275

 
 
Land, buildings and equipment, net
344,310

 
 
 
351,095

 
 
Other assets
413,086

 
 
 
389,844

 
 
Total assets
$
25,042,733

 
 
 
$
24,405,446

 
 
LIABILITIES AND EQUITY:
 
 
 
 
 
 
 
Interest bearing deposits:
 
 
 
 
 
 
 
Savings
$
831,038

240

.12

 
$
787,478

224

.11

Interest checking and money market
10,667,042

4,102

.15

 
10,287,923

3,324

.13

Time open & C.D.'s of less than $100,000
688,047

674

.39

 
758,703

709

.38

Time open & C.D.'s of $100,000 and over
1,510,001

2,822

.75

 
1,635,892

2,347

.58

Total interest bearing deposits
13,696,128

7,838

.23

 
13,469,996

6,604

.20

Borrowings:
 
 
 
 
 
 
 
Federal funds purchased and securities sold
 
 
 
 
 
 
 
under agreements to repurchase
1,363,031

2,038

.60

 
1,211,892

725

.24

Other borrowings
105,311

911

3.47

 
104,649

907

3.49

Total borrowings
1,468,342

2,949

.81

 
1,316,541

1,632

.50

Total interest bearing liabilities
15,164,470

10,787

.29
%
 
14,786,537

8,236

.22
%
Non-interest bearing deposits
7,065,849

 
 
 
6,885,889

 
 
Other liabilities
203,139

 
 
 
260,179

 
 
Equity
2,609,275

 
 
 
2,472,841

 
 
Total liabilities and equity
$
25,042,733

 
 
 
$
24,405,446

 
 
Net interest margin (T/E)
 
$
190,865

 
 
 
$
179,592

 
Net yield on interest earning assets
 
 
3.19
%
 
 
 
3.11
%
(A) Stated on a tax equivalent basis using a federal income tax rate of 35%.


57


AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
Six Months Ended June 30, 2017 and 2017
 
Six Months 2017
 
Six Months 2016
(Dollars in thousands)
Average Balance
Interest Income/Expense
Avg. Rates Earned/Paid
 
Average Balance
Interest Income/Expense
Avg. Rates Earned/Paid
ASSETS:
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
Business(A)
$
4,866,837

$
75,192

3.12
%
 
$
4,591,516

$
65,955

2.89
%
Real estate — construction and land
845,343

17,126

4.09

 
735,943

12,750

3.48

Real estate — business
2,673,491

48,915

3.69

 
2,385,632

43,875

3.70

Real estate — personal
2,008,203

37,175

3.73

 
1,907,750

35,728

3.77

Consumer
1,986,391

38,545

3.91

 
1,931,251

36,809

3.83

Revolving home equity
402,565

7,464

3.74

 
421,440

7,448

3.55

Consumer credit card
739,582

43,208

11.78

 
745,114

42,539

11.48

Overdrafts
4,346



 
4,344



Total loans
13,526,758

267,625

3.99

 
12,722,990

245,104

3.87

Loans held for sale
15,174

459

6.10

 
32,816

827

5.07

Investment securities:
 
 
 
 
 
 
 

U.S. government and federal agency obligations
912,140

10,445

2.31

 
700,793

6,740

1.93

Government-sponsored enterprise obligations
450,425

3,541

1.59

 
721,421

8,736

2.44

State and municipal obligations(A)
1,777,357

31,991

3.63

 
1,741,218

31,446

3.63

Mortgage-backed securities
3,734,065

43,800

2.37

 
3,409,591

40,728

2.40

Asset-backed securities
2,347,427

19,517

1.68

 
2,457,590

17,389

1.42

Other marketable securities(A)
329,503

4,559

2.79

 
339,977

4,701

2.78

Trading securities(A)
23,102

314

2.74

 
19,365

246

2.55

Non-marketable securities(A)
101,268

8,151

16.23

 
121,936

4,396

7.25

Total investment securities
9,675,287

122,318

2.55

 
9,511,891

114,382

2.42

Federal funds sold and short-term securities
 
 
 
 
 
 
 
purchased under agreements to resell
11,510

60

1.05

 
14,647

43

.59

Long-term securities purchased
 
 
 
 
 
 
 
under agreements to resell
695,164

7,477

2.17

 
837,637

6,829

1.64

Interest earning deposits with banks
173,263

759

.88

 
172,330

421

.49

Total interest earning assets
24,097,156

398,698

3.34

 
23,292,311

367,606

3.17

Allowance for loan losses
(156,170
)
 
 
 
(151,465
)
 
 
Unrealized gain on investment securities
83,071

 
 
 
170,442

 
 
Cash and due from banks
362,723

 
 
 
396,538

 
 
Land, buildings and equipment, net
345,115

 
 
 
354,042

 
 
Other assets
415,036

 
 
 
392,485

 
 
Total assets
$
25,146,931

 
 
 
$
24,454,353

 
 
LIABILITIES AND EQUITY:
 
 
 
 
 
 
 
Interest bearing deposits:
 
 
 
 
 
 
 
Savings
$
813,464

486

.12

 
$
774,249

452

.12

Interest checking and money market
10,635,689

7,746

.15

 
10,208,233

6,580

.13

Time open & C.D.'s of less than $100,000
696,544

1,318

.38

 
766,962

1,451

.38

Time open & C.D.'s of $100,000 and over
1,590,118

5,585

.71

 
1,559,796

4,333

.56

Total interest bearing deposits
13,735,815

15,135

.22

 
13,309,240

12,816

.19

Borrowings:
 
 
 
 
 
 
 
Federal funds purchased and securities sold
 
 
 
 
 
 
 
under agreements to repurchase
1,359,692

3,577

.53

 
1,308,323

1,613

.25

Other borrowings
103,670

1,799

3.50

 
241,180

2,160

1.80

Total borrowings
1,463,362

5,376

.74

 
1,549,503

3,773

.49

Total interest bearing liabilities
15,199,177

20,511

.27
%
 
14,858,743

16,589

.22
%
Non-interest bearing deposits
7,155,774

 
 
 
6,895,781

 
 
Other liabilities
218,556

 
 
 
257,308

 
 
Equity
2,573,424

 
 
 
2,442,521

 
 
Total liabilities and equity
$
25,146,931

 
 
 
$
24,454,353

 
 
Net interest margin (T/E)
 
$
378,187

 
 
 
$
351,017

 
Net yield on interest earning assets
 
 
3.16
%
 
 
 
3.03
%
(A) Stated on a tax equivalent basis using a federal income tax rate of 35%.

58


Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest rate risk management focuses on maintaining consistent growth in net interest income within Board-approved policy limits. The Company primarily uses earnings simulation models to analyze net interest sensitivity to movement in interest rates. The Company performs monthly simulations which model interest rate movements and risk in accordance with changes to its balance sheet composition. For further discussion of the Company’s market risk, see the Interest Rate Sensitivity section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s 2016 Annual Report on Form 10-K.

The tables below compute the effects of gradual rising interest rates over a twelve month period on the Company’s net interest income, assuming a static balance sheet with the exception of deposit attrition. The difference between the two simulations is the amount of deposit attrition incorporated, which is shown in the tables below. In both simulations, three rising rate scenarios were selected as shown in the tables, and net interest income was calculated and compared to a base scenario in which assets, liabilities and rates remained constant over a twelve month period.  For each of the simulations, interest rates applicable to each interest earning asset or interest bearing liability were ratably increased during the year (by either 100, 200 or 300 basis points).  The balances contained in the balance sheet were assumed not to change over the twelve month period, except that as presented in the tables below, it was assumed certain non-maturity type deposit attrition would occur, as a result of higher interest rates, and would be replaced with short-term federal funds borrowings. 

The simulations reflect two different assumptions related to deposit attrition. The Company utilizes these simulations both for monitoring interest rate risk and for liquidity planning purposes. While the future effects of rising rates on deposit balances cannot be known, the Company maintains a practice of running multiple rate scenarios to better understand interest rate risk and its effect on the Company’s performance.  The Company believes that its approach to interest rate risk has appropriately considered its susceptibility to both rising rates and falling rates and has adopted strategies which minimize impacts to overall interest rate risk.
Simulation A
June 30, 2017
 
March 31, 2017
 (Dollars in millions)
$ Change in
Net Interest
Income
% Change in
Net Interest
Income
 
Assumed Deposit Attrition
 
$ Change in
Net Interest
Income
% Change in
Net Interest
Income
 
Assumed Deposit Attrition
300 basis points rising
$
15.1

2.09
%
 
$
(368.0
)
 
$
18.1

2.54
%
 
$
(379.4
)
200 basis points rising
14.3

1.99

 
(256.2
)
 
16.6

2.33

 
(266.7
)
100 basis points rising
9.1

1.26

 
(131.4
)
 
10.8

1.52

 
(140.0
)

Simulation B
June 30, 2017
 
March 31, 2017
 (Dollars in millions)
$ Change in
Net Interest
Income
% Change in
Net Interest
Income
 
Assumed Deposit Attrition
 
$ Change in
Net Interest
Income
% Change in
Net Interest
Income
 
Assumed Deposit Attrition
300 basis points rising
$
(5.6
)
(.78
)%
 
$
(1,181.4
)
 
$
(3.3
)
(.45
)%
 
$
(1,269.4
)
200 basis points rising
(3.2
)
(.44
)
 
(1,072.5
)
 
(1.3
)
(.19
)
 
(1,161.5
)
100 basis points rising
(5.1
)
(.71
)
 
(952.4
)
 
(3.6
)
(.51
)
 
(1,042.3
)

The difference in these two simulations is the degree in which deposits are modeled to decline as noted in the above table.  Both simulations assume that a decline in deposits would be offset by increased short-term borrowings, which are more rate sensitive and can result in higher interest costs in a rising rate environment.  Under Simulation A, a gradual increase in interest rates of 100 basis points is expected to increase net interest income from the base calculation by $9.1 million, while a gradual increase in rates of 200 basis points would increase net interest income by $14.3 million.  An increase in rates of 300 basis points would result in an increase in net interest income of $15.1 million. The change in net interest income from the base calculation at June 30, 2017 was lower than projections made at March 31, 2017 largely due to a Federal Reserve rate increase during the second quarter of 2017 and higher rates paid on certificates of deposit, partly offset lower balances. Higher rates and balances of repurchase agreements, as well as higher balances of interest checking and money market deposits, also increased interest expense this quarter, lowering net interest income projections for the second quarter of 2017 compared to the prior quarter.
Under Simulation B, the same assumptions utilized in Simulation A were applied. However, in Simulation B, deposit attrition was accelerated to consider the effects that large deposit outflows might have on net interest income and liquidity planning purposes.  The effect of higher deposit attrition was that greater reliance was placed on short-term borrowings at higher rates, which are more

59


rate sensitive.  As shown in the table, under these assumptions, net interest income in Simulation B was significantly lower than in Simulation A, reflecting higher costs for short-term borrowings.
Projecting deposit activity in a historically low interest rate environment is difficult, and the Company cannot predict how deposits will react to rising rates.  The comparison provided above provides insight into potential effects of changes in rates and deposit levels on net interest income.
Item 4. CONTROLS AND PROCEDURES

An evaluation was performed under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of June 30, 2017. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective. There were no changes in the Company's internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.


60


PART II: OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

The information required by this item is set forth in Part I, Item 1 under Note 15, Legal and Regulatory Proceedings.


Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table sets forth information about the Company's purchases of its $5 par value common stock, its only class of common stock registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended.

 
 
 
Period
Total Number of Shares Purchased
 Average Price Paid per Share
Total Number of Shares Purchased as part of Publicly Announced Program
 Maximum Number that May Yet Be Purchased Under the Program
April 1 — 30, 2017
53,468

 
$
54.05

53,468

3,578,470

May 1 — 31, 2017
5,501

 
$
55.19

5,501

3,572,969

June 1 — 30, 2017
2,642

 
$
56.91

2,642

3,570,327

Total
61,611

 
$
54.27

61,611

3,570,327


The Company's stock purchases shown above were made under authorizations by the Board of Directors. Under the most recent authorization in October 2015 of 5,000,000 shares, 3,570,327 shares remained available for purchase at June 30, 2017.


Item 6. EXHIBITS

See Index to Exhibits.




61


SIGNATURES

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


COMMERCE BANCSHARES, INC.
 
 
By 
/s/  THOMAS J. NOACK
 
Thomas J. Noack
 
Vice President & Secretary

Date: August 7, 2017
By 
/s/  JEFFERY D. ABERDEEN
 
Jeffery D. Aberdeen
 
Controller
 
(Chief Accounting Officer)

Date: August 7, 2017


62


INDEX TO EXHIBITS


31.1 — Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2 — Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32 — Certifications of CEO and CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101 — Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Notes to Consolidated Financial Statements, tagged as blocks of text and in detail
 
 









63