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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 
Washington, D.C. 20549
 
FORM 10-K
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the Fiscal Year Ended December 31, 2008 — Commission File No. 0-2989
 
COMMERCE BANCSHARES, INC.
 
(Exact name of registrant as specified in its charter)
 
     
Missouri
  43-0889454
(State of Incorporation)   (IRS Employer Identification No.)
     
1000 Walnut,
Kansas City, MO

(Address of principal executive offices)
  64106
(Zip Code)
(816) 234-2000

(Registrant’s telephone number, including area code)
   
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of class   Name of exchange on which registered
 
$5 Par Value Common Stock
  NASDAQ Global Select Market
 
Securities registered pursuant to Section 12(g) of the Act:
 
NONE
 
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
Yes þ  No o
 
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
 
Yes o  No þ
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes þ  No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company o
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o  No þ
 
As of June 30, 2008, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $2,352,000,000.
 
As of February 11, 2009, there were 75,911,939 shares of Registrant’s $5 Par Value Common Stock outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
 
Portions of the Registrant’s definitive proxy statement for its 2009 annual meeting of shareholders, which will be filed within 120 days of December 31, 2008, are incorporated by reference into Part III of this Report.
 


 

 
Commerce Bancshares, Inc.
 
Form 10-K
 
                     
INDEX           Page
 
    Item 1.     Business     3  
                 
      Item 1a.     Risk Factors     8  
                 
      Item 1b.     Unresolved Staff Comments     11  
                 
      Item 2.     Properties     12  
                 
      Item 3.     Legal Proceedings     12  
                 
      Item 4.     Submission of Matters to a Vote of Security Holders    
12
 
 
 
 
                 
    Item 5.     Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     14  
                 
      Item 6.     Selected Financial Data     15  
                 
      Item 7.     Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations     15  
                 
      Item 7a.     Quantitative and Qualitative Disclosures about Market Risk     61  
                 
      Item 8.     Consolidated Financial Statements and Supplementary Data     61  
                 
      Item 9.     Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     113  
                 
      Item 9a.     Controls and Procedures     113  
                 
      Item 9b.     Other Information    
115
 
 
 
 
                 
    Item 10.     Directors, Executive Officers and Corporate Governance     115  
                 
      Item 11.     Executive Compensation     115  
                 
      Item 12.     Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     115  
                 
      Item 13.     Certain Relationships and Related Transactions, and Director Independence     115  
                 
      Item 14.     Principal Accounting Fees and Services    
115
 
 
 
 
                 
    Item 15.     Exhibits and Financial Statement Schedules     116  
       
    117  
           
        E-1  
 EX-21
 EX-23
 EX-24
 EX-31.1
 EX-31.2
 EX-32


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PART I
 
Item 1.  BUSINESS
 
General
 
Commerce Bancshares, Inc. (the “Company”), a bank holding company as defined in the Bank Holding Company Act of 1956, as amended, was incorporated under the laws of Missouri on August 4, 1966. The Company presently owns all of the outstanding capital stock of one national banking association, which is headquartered in Missouri (the “Bank”). During 2008, two former banking subsidiaries, located in Kansas and Nebraska, were merged into the Bank. The Bank engages in general banking business, providing a broad range of retail, corporate, investment, trust, and asset management products and services to individuals and businesses. The Company also owns, directly or through the Bank, various non-banking subsidiaries. Their activities include underwriting credit life and credit accident and health insurance, selling property and casualty insurance (relating to consumer loans made by the Bank), venture capital investment, securities brokerage, mortgage banking, and leasing activities. The Company owns a second tier holding company that is the direct owner of the Bank. A list of the Company’s subsidiaries is included as Exhibit 21.
 
The Company is one of the nation’s top 50 bank holding companies, based on asset size. At December 31, 2008, the Company had consolidated assets of $17.5 billion, loans of $11.6 billion, deposits of $12.9 billion, and stockholders’ equity of $1.6 billion. All of the Company’s operations conducted by subsidiaries are consolidated for purposes of preparing the Company’s consolidated financial statements. The Company does not utilize unconsolidated subsidiaries or special purpose entities to provide off-balance sheet borrowings or securitizations.
 
The Company’s goal is to be the preferred provider of targeted financial services in its communities, based on strong customer relationships. It believes in building long-term relationships based on top quality service, high ethical standards and safe, sound assets. The Company operates under a super-community banking format with a local orientation, augmented by experienced, centralized support in select critical areas. The Company’s local market orientation is reflected in its financial centers and regional advisory boards, which are comprised of local business persons, professionals and other community representatives, that assist the Company in responding to local banking needs. In addition to this local market, community-based focus, the Company offers sophisticated financial products available at much larger financial institutions.
 
The Bank’s facilities are located throughout Missouri, Kansas, and central Illinois, and it entered markets in Tulsa, Oklahoma and Denver, Colorado during 2007. Its two largest markets include St. Louis and Kansas City, which serve as the central hubs for the entire company.
 
The markets the Bank serves, being located in the lower Midwest, provide natural sites for production and distribution facilities and also serve as transportation hubs. The economy has been well-diversified in these markets with many major industries represented, including telecommunications, automobile, aircraft and general manufacturing, health care, numerous service industries, food production, and agricultural production and related industries. In addition, several of the Illinois markets are located in areas with some of the most productive farmland in the world. The real estate operations of the Bank are centered in its lower Midwestern markets. Historically, these markets have generally tended to be less volatile than in other parts of the country. While a declining national real estate market has resulted in significantly higher real estate loan losses in 2008 for the banking industry, the Bank has avoided much of the market deterioration seen in other areas of the country.
 
The Company regularly evaluates the potential acquisition of, and holds discussions with, various financial institutions eligible for bank holding company ownership or control. In addition, the Company regularly considers the potential disposition of certain of its assets and branches. The Company seeks merger or acquisition partners that are culturally similar and have experienced management and possess either significant market presence or have potential for improved profitability through financial management, economies of scale and expanded services. During 2007 the Company completed two acquisitions; acquiring the outstanding stock of South Tulsa Financial Corporation, located in Tulsa, Oklahoma, and Commerce


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Bank, located in Denver, Colorado. The Company also completed two acquisitions in 2006; a purchase and assumption transaction with Boone National Savings and Loan Association in Columbia, Missouri, and the acquisition of the outstanding stock of West Pointe Bancorp, Inc. in Belleville, Illinois. For additional information on acquisition and branch disposition activity, refer to pages 18 and 71.
 
Operating Segments
 
The Company is managed in three operating segments. The Consumer segment includes the retail branch network, consumer installment lending, personal mortgage banking, bank card activities, student lending, and discount brokerage services. It provides services through a network of 217 full-service branches, a widespread ATM network of 404 machines, and the use of alternative delivery channels such as extensive online banking and telephone banking services. In 2008 this retail segment contributed 52% of total segment pre-tax income. The Commercial segment provides a full array of corporate lending, leasing, and international services, as well as business and government deposit and cash management services. In 2008 it contributed 46% of total segment pre-tax income. The Money Management segment provides traditional trust and estate tax planning services, and advisory and discretionary investment portfolio management services to both personal and institutional corporate customers. This segment also manages the Company’s family of proprietary mutual funds, which are available for sale to both trust and general retail customers. Fixed income investments are sold to individuals and institutional investors through the Capital Markets group, which is also included in this segment. At December 31, 2008 the Money Management segment managed investments with a market value of $10.9 billion and administered an additional $8.5 billion in non-managed assets. Additional information relating to operating segments can be found on pages 48 and 94.
 
Supervision and Regulation
 
General
 
The Company, as a bank holding company, is primarily regulated by the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956 (BHC Act). Under the BHC Act, the Federal Reserve Board’s prior approval is required in any case in which the Company proposes to acquire all or substantially all of the assets of any bank, acquire direct or indirect ownership or control of more than 5% of the voting shares of any bank, or merge or consolidate with any other bank holding company. The BHC Act also prohibits, with certain exceptions, the Company from acquiring direct or indirect ownership or control of more than 5% of any class of voting shares of any non-banking company. Under the BHC Act, the Company may not engage in any business other than managing and controlling banks or furnishing certain specified services to subsidiaries and may not acquire voting control of non-banking companies unless the Federal Reserve Board determines such businesses and services to be closely related to banking. When reviewing bank acquisition applications for approval, the Federal Reserve Board considers, among other things, the Bank’s record in meeting the credit needs of the communities it serves in accordance with the Community Reinvestment Act of 1977, as amended (CRA). The Bank has a current CRA rating of “outstanding”.
 
The Company is required to file with the Federal Reserve Board various reports and such additional information as the Federal Reserve Board may require. The Federal Reserve Board also makes regular examinations of the Company and its subsidiaries. The Company’s banking subsidiary is organized as a national banking association and is subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (OCC). The Bank is also subject to regulation by the Federal Deposit Insurance Corporation (FDIC). In addition, there are numerous other federal and state laws and regulations which control the activities of the Company and the Bank, including requirements and limitations relating to capital and reserve requirements, permissible investments and lines of business, transactions with affiliates, loan limits, mergers and acquisitions, issuance of securities, dividend payments, and extensions of credit. If the Company fails to comply with these or other applicable laws and regulations, it may be subject to civil monetary penalties, imposition of cease and desist orders or other written directives, removal of management and, in certain circumstances, criminal penalties. This regulatory framework is intended primarily for the protection of depositors and the preservation of the federal deposit insurance funds, and not for the protection


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of security holders. Statutory and regulatory controls increase a bank holding company’s cost of doing business and limit the options of its management to employ assets and maximize income.
 
In addition to its regulatory powers, the Federal Reserve Bank impacts the conditions under which the Company operates by its influence over the national supply of bank credit. The Federal Reserve Board employs open market operations in U.S. government securities, changes in the discount rate on bank borrowings, changes in the federal funds rate on overnight inter-bank borrowings, and changes in reserve requirements on bank deposits in implementing its monetary policy objectives. These instruments are used in varying combinations to influence the overall level of the interest rates charged on loans and paid for deposits, the price of the dollar in foreign exchange markets and the level of inflation. The monetary policies of the Federal Reserve have a significant effect on the operating results of financial institutions, most notably on the interest rate environment. In view of changing conditions in the national economy and in the money markets, as well as the effect of credit policies of monetary and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels or loan demand, or their effect on the financial statements of the Company.
 
Subsidiary Bank
 
Under Federal Reserve policy, the Company is expected to act as a source of financial strength to its bank subsidiary and to commit resources to support it in circumstances when it might not otherwise do so. In addition, any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.
 
Substantially all of the deposits of the Bank are insured up to the applicable limits by the Bank Insurance Fund of the FDIC. Until recently these limits were $100,000 per insured depositor and $250,000 for retirement accounts. The Emergency Economic Stabilization Act of 2008 (discussed further under “Legislation”) temporarily increased the general depositor limit from $100,000 to $250,000, through December 31, 2009. The Bank also participates in the FDIC’s Transaction Account Guarantee Program. Under that program, through December 31, 2009, all non-interest bearing transaction accounts are fully guaranteed by the FDIC for the entire amount of the account. Coverage under this program is in addition to and separate from the coverage available under the FDIC’s general deposit insurance rules. The Bank pays deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC for Bank Insurance Fund member institutions. The FDIC has established a risk-based assessment system under which institutions are classified and pay premiums according to their perceived risk to the federal deposit insurance funds. The Bank’s premiums have been relatively low in recent years. However, the Bank expects premiums to rise to approximately $15.6 million in 2009, as the FDIC replenishes the deposit insurance fund in the wake of recent bank failures and expectations of future failures.
 
Payment of Dividends
 
The principal source of the Company’s cash revenues is dividends paid by the Bank. The Federal Reserve Board may prohibit the payment of dividends by bank holding companies if their actions constitute unsafe or unsound practices. The OCC limits the payment of dividends by the Bank in any calendar year to the net profit of the current year combined with the retained net profits of the preceding two years. Permission must be obtained from the OCC for dividends exceeding these amounts. The payment of dividends by the Bank may also be affected by factors such as the maintenance of adequate capital.
 
Capital Adequacy
 
The Company is required to comply with the capital adequacy standards established by the Federal Reserve. These capital adequacy guidelines generally require bank holding companies to maintain minimum total capital equal to 8% of total risk-adjusted assets and off-balance sheet items (the “Total Risk-Based Capital Ratio”), with at least one-half of that amount consisting of Tier I, or core capital, and the remaining


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amount consisting of Tier II, or supplementary capital. Tier I capital for bank holding companies generally consists of the sum of common shareholders’ equity, qualifying non-cumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill and other non-qualifying intangible assets. Tier II capital generally consists of hybrid capital instruments, term subordinated debt and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics.
 
In addition, the Federal Reserve also requires bank holding companies to comply with minimum leverage ratio requirements. The leverage ratio is the ratio of a banking organization’s Tier I capital to its total consolidated quarterly average assets (as defined for regulatory purposes), net of the allowance for loan losses, goodwill and certain other intangible assets. The minimum leverage ratio for bank holding companies is 4%. At December 31, 2008 the Bank was “well-capitalized” under regulatory capital adequacy standards, as further discussed on page 97.
 
Legislation
 
These laws and regulations are under constant review by various agencies and legislatures, and are subject to sweeping change. The Gramm-Leach-Bliley Financial Modernization Act of 1999 (GLB Act) contained major changes in laws that previously kept the banking industry largely separate from the securities and insurance industries. The GLB Act authorized the creation of a new kind of financial institution, known as a “financial holding company” and a new kind of bank subsidiary called a “financial subsidiary”, which may engage in a broader range of investment banking, insurance agency, brokerage, and underwriting activities. The GLB Act also included privacy provisions that limit banks’ abilities to disclose non-public information about customers to non-affiliated entities. Banking organizations are not required to become financial holding companies, but instead may continue to operate as bank holding companies, providing the same services they were authorized to provide prior to the enactment of the GLB Act.
 
The Company must also comply with the requirements of the Bank Secrecy Act (BSA). The BSA is designed to help fight drug trafficking, money laundering, and other crimes. Compliance is monitored by the OCC. The BSA was enacted to prevent banks and other financial service providers from being used as intermediaries for, or to hide the transfer or deposit of money derived from, criminal activity. Since its passage, the BSA has been amended several times. These amendments include the Money Laundering Control Act of 1986 which made money laundering a criminal act, as well as the Money Laundering Suppression Act of 1994 which required regulators to develop enhanced examination procedures and increased examiner training to improve the identification of money laundering schemes in financial institutions.
 
In 2001, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA Patriot Act) was signed into law. The USA Patriot Act substantially broadened the scope of U.S. anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The U.S. Treasury department issued a number of regulations implementing the USA Patriot Act that apply certain of its requirements to financial institutions such as the Company’s broker-dealer subsidiary. The regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing.
 
In October 2008, the Emergency Economic Stabilization Act of 2008 was enacted in response to a global financial crisis spurred by frozen credit markets, institution failures and loss of investor confidence. Under the Act, the Troubled Asset Relief Program (TARP) was created, which authorizes the U.S. Treasury department to spend up to $700 billion to purchase distressed assets and make capital injections into banks. The stated goal of TARP is to improve the liquidity of targeted illiquid, difficult-to-value assets by purchasing them from banks and other financial institutions. Another important goal of TARP is to encourage banks to resume lending again at levels seen before the crisis, loosening credit and improving the market order and investor confidence. The first $350 billion of TARP funds were primarily used to buy preferred stock and warrants of bank applicants. The Company studied the program and made a business decision not to apply


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for funds under the TARP, believing its earnings, capital and liquidity were strong and sufficient to grow its business in the current challenging banking environment.
 
As mentioned earlier, the Company has chosen to participate in the FDIC’s Temporary Liquidity Guarantee Program. Under this program, the Company may in future issue senior unsecured debt whose principal and interest payments would be guaranteed by the FDIC. All newly issued debt must be issued on or before June 30, 2009 to be covered. The expiration date of the FDIC’s guarantee is the earlier of the maturity date of the debt or June 30, 2012. The Company has not issued debt under the program. Its debt guarantee limit is 2% of consolidated total liabilities, or approximately $300 million.
 
Competition
 
The Company’s locations in regional markets throughout Missouri, Kansas, central Illinois, Tulsa, Oklahoma, and Denver, Colorado, face intense competition from hundreds of financial service providers. The Company competes with national and state banks for deposits, loans and trust accounts, and with savings and loan associations and credit unions for deposits and consumer lending products. In addition, the Company competes with other financial intermediaries such as securities brokers and dealers, personal loan companies, insurance companies, finance companies, and certain governmental agencies. The passage of the GLB Act, which removed barriers between banking and the securities and insurance industries, has resulted in greater competition among these industries. The Company generally competes on the basis of customer services and responsiveness to customer needs, interest rates on loans and deposits, lending limits and customer convenience, such as location of offices.
 
Employees
 
The Company and its subsidiaries employed 4,666 persons on a full-time basis and 674 persons on a part-time basis at December 31, 2008. The Company provides a variety of benefit programs including a 401K plan as well as group life, health, accident, and other insurance. The Company also maintains training and educational programs designed to prepare employees for positions of increasing responsibility.
 
Available Information
 
The Company’s principal offices are located at 1000 Walnut, Kansas City, Missouri (telephone number 816-234-2000). The Company makes available free of charge, through its web site at www.commercebank.com, reports filed with the Securities and Exchange Commission as soon as reasonably practicable after the electronic filing. These filings include the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports.
 
Statistical Disclosure
 
The information required by Securities Act Guide 3 — “Statistical Disclosure by Bank Holding Companies” is located on the pages noted below.
 
                 
          Page  
 
  I.    
Distribution of Assets, Liabilities and Stockholders’ Equity; Interest Rates and Interest Differential
    21, 56-59  
  II.    
Investment Portfolio
    37-39, 75-79  
  III.    
Loan Portfolio
       
       
Types of Loans
    26  
       
Maturities and Sensitivities of Loans to Changes in Interest Rates
    27  
       
Risk Elements
    33-37  
  IV.    
Summary of Loan Loss Experience
    30-33  
  V.    
Deposits
    56-57, 81-82  
  VI.    
Return on Equity and Assets
    16  
  VII.    
Short-Term Borrowings
    82-83  


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


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  •  The Company may be required to pay significantly higher Federal Deposit Insurance Corporation premiums because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits.
 
The performance of the Company is dependent on the economic conditions of the markets in which the Company operates.
 
The Company’s success is heavily influenced by the general economic conditions of the specific markets in which it operates. Unlike larger national or other regional banks that are more geographically diversified, the Company provides financial services primarily throughout the states of Missouri, Kansas, and central Illinois, and has recently begun to expand into Oklahoma, Colorado and other surrounding states. Since the Company does not have significant presence in other parts of the country, a prolonged economic downturn in these markets could have a material adverse effect on the Company’s financial condition and results of operations.
 
The soundness of other financial institutions could adversely affect the Company.
 
The Company’s ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. The Company has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual funds, and other institutional clients. Transactions with these institutions include overnight and term borrowings, interest rate swap agreements, securities purchased and sold, short-term investments, and other such transactions. As a result of this exposure, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by the Company or by other institutions. Many of these transactions expose the Company to credit risk in the event of default of its counterparty or client, while other transactions expose the Company to liquidity risks should funding sources quickly disappear. In addition, the Company’s credit risk may be exacerbated when the collateral held cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to the Company. There is no assurance that any such losses would not materially and adversely affect results of operations.
 
Liquidity is essential to the Company’s businesses and it relies on the securities market and other external sources to finance a significant portion of its operations.
 
Liquidity affects the Company’s ability to meet its financial commitments. The Company’s main source of funding comes from customer deposits, which comprise 82% of its total funding at December 31, 2008. The Company’s other funding sources include the Federal Home Loan Bank and other wholesale providers. Its liquidity could be negatively affected if these funding sources diminish or cease to be available. Factors that the Company cannot control, such as disruption of the financial markets or negative views about the general financial services industry could impair its ability to raise or maintain funding. If it is unable to raise funding, it would likely need to sell assets, such as its investment and trading portfolios, to meet maturing liabilities. The Company may be unable to sell some of its assets on a timely basis, or it may have to sell assets at a discount from market value, either of which could adversely affect results of operations. The Company’s liquidity and funding policies have been designed to ensure that it maintains sufficient liquid financial resources to continue to conduct its business for an extended period in a stressed liquidity environment. If its liquidity and funding policies are not adequate, it may be unable to access sufficient financing to service its financial obligations when they come due, which could have a material adverse franchise or business impact. See “Liquidity and Capital Resources” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this report for a discussion of how the Company monitors and manages liquidity risk.


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The Company’s asset valuation may include methodologies, estimations and assumptions which are subject to differing interpretations and could result in changes to asset valuations that may materially adversely affect its results of operations or financial condition.
 
The Company uses estimates, assumptions, and judgments when financial assets and liabilities are measured and reported at fair value. Assets and liabilities carried at fair value inherently result in a higher degree of financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices and/or other observable inputs provided by independent third-party sources, when available. When such third-party information is not available, fair value is estimated primarily by using cash flow and other financial modeling techniques utilizing assumptions such as credit quality, liquidity, interest rates and other relevant inputs. Changes in underlying factors, assumptions, or estimates in any of these areas could materially impact the Company’s future financial condition and results of operations.
 
During periods of market disruption, including periods of significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, it may be difficult to value certain assets if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the current financial environment. In such cases, certain asset valuations may require more subjectivity and management judgment. As such, valuations may include inputs and assumptions that are less observable or require greater estimation. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of assets as reported within our consolidated financial statements and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on results of operations or financial condition.
 
Valuation methodologies which are particularly susceptible to the conditions mentioned above include those used to value certain securities in the Company’s available for sale investment portfolio such as auction rate securities and non-agency mortgage and asset-backed securities, in addition to non-marketable private equity securities, loans held for sale and intangible assets.
 
The Company’s investment portfolio values may be adversely impacted by changing interest rates and deterioration in the credit quality of underlying collateral within mortgage and other asset-backed investment securities.
 
The Company generally invests in securities issued by government-backed agencies or privately issued securities that are highly rated by credit rating agencies at the time of purchase, but are subject to changes in market value due to changing interest rates and implied credit spreads. Certain mortgage and asset-backed securities represent beneficial interests which are collateralized by residential mortgages, credit cards, automobiles, mobile homes or other assets. While these investment securities are highly rated at the time of initial investment, the value of these securities may decline significantly due to actual or expected deterioration in the underlying collateral, especially residential mortgage collateral. Recent market conditions have seen deterioration in fair values for certain types of non-guaranteed mortgage-backed securities. Furthermore, under impairment accounting rules, securities that are determined to have some level of other-than-temporary impairment due to declining expected cash flows, etc., are required to be adjusted to fair value through current earnings, which could result in significant non-cash losses beyond calculated impairments.
 
The Company is subject to interest rate risk.
 
The Company’s net interest income is the largest source of overall revenue to the Company, representing 61% of total revenue. Interest rates are beyond the Company’s control, and they fluctuate in response to general economic conditions and the policies of various governmental and regulatory agencies, in particular, the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, will influence the origination of loans, the purchase of investments, the generation of deposits, and the rates received on loans and investment securities and paid on deposits. Management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on the


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


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Item 2.  PROPERTIES
 
The main offices of the Bank are located in the larger metropolitan areas of its markets in various multi-story office buildings. The Bank owns its main offices and leases unoccupied premises to the public. The larger offices include:
 
                         
 
    Net rentable
    % occupied
    % occupied
 
Building   square footage     in total     by bank  
 
 
922 Walnut
    256,000       95 %     93 %
Kansas City, MO
                       
1000 Walnut
    403,000       82       36  
Kansas City, MO
                       
811 Main
    237,000       100       100  
Kansas City, MO
                       
8000 Forsyth
    178,000       95       92  
Clayton, MO
                       
1551 N. Waterfront
                       
Pkwy
    120,000       100       32  
  Wichita, KS
                       
 
 
 
The Bank leases offices in Omaha, Nebraska which house its credit card operations. Additionally, certain other installment loan, trust and safe deposit functions operate out of leased offices in downtown Kansas City. The Company has an additional 211 branch locations in Missouri, Illinois, Kansas, Oklahoma and Colorado which are owned or leased, and 151 off-site ATM locations.
 
Item 3.  LEGAL PROCEEDINGS
 
The information required by this item is set forth in Item 8 under Note 19, Commitments, Contingencies and Guarantees on page 107.
 
Item 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
No matters were submitted during the fourth quarter of 2008 to a vote of security holders through the solicitation of proxies or otherwise.
 
Executive Officers of the Registrant
 
The following are the executive officers of the Company, each of whom is designated annually, and there are no arrangements or understandings between any of the persons so named and any other person pursuant to which such person was designated an executive officer.
 
     
Name and Age   Positions with Registrant
 
Jeffery D. Aberdeen, 55
  Controller of the Company since December 1995. Prior thereto he was Assistant Controller of the Company. He is Controller of the Company’s subsidiary bank, Commerce Bank, N.A.
     
Kevin G. Barth, 48
  Executive Vice President of the Company since April 2005 and Executive Vice President of Commerce Bank, N.A. since October 1998. Senior Vice President of the Company and Officer of Commerce Bank, N.A. prior thereto.
     
A. Bayard Clark, 63
  Chief Financial Officer and Executive Vice President of the Company since December 1995. Executive Vice President of the Company prior thereto. Treasurer of the Company from December 1995 until February 2007.


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Name and Age   Positions with Registrant
 
     
Sara E. Foster, 48
  Senior Vice President of the Company since February 1998 and Vice President of the Company prior thereto.
     
David W. Kemper, 58
  Chairman of the Board of Directors of the Company since November 1991, Chief Executive Officer of the Company since June 1986, and President of the Company since April 1982. He is Chairman of the Board, President and Chief Executive Officer of Commerce Bank, N.A. He is the son of James M. Kemper, Jr. (a former Director and former Chairman of the Board of the Company) and the brother of Jonathan M. Kemper, Vice Chairman of the Company.
     
Jonathan M. Kemper, 55
  Vice Chairman of the Company since November 1991 and Vice Chairman of Commerce Bank, N.A. since December 1997. Prior thereto, he was Chairman of the Board, Chief Executive Officer, and President of Commerce Bank, N.A. He is the son of James M. Kemper, Jr. (a former Director and former Chairman of the Board of the Company) and the brother of David W. Kemper, Chairman, President, and Chief Executive Officer of the Company.
     
Charles G. Kim, 48
  Executive Vice President of the Company since April 1995 and Executive Vice President of Commerce Bank, N.A. since January 2004. Prior thereto, he was Senior Vice President of Commerce Bank, N.A. (Clayton, MO), a former subsidiary of the Company.
     
Seth M. Leadbeater, 58
  Vice Chairman of the Company since January 2004. Prior thereto he was Executive Vice President of the Company. He has been Vice Chairman of Commerce Bank, N.A. since September 2004. Prior thereto he was Executive Vice President of Commerce Bank, N.A. and President of Commerce Bank, N.A. (Clayton, MO).
     
Robert C. Matthews, Jr., 61
  Executive Vice President of the Company since December 1989. Executive Vice President of Commerce Bank, N.A. since December 1997.
     
Michael J. Petrie, 52
  Senior Vice President of the Company since April 1995. Prior thereto, he was Vice President of the Company.
     
Robert J. Rauscher, 51
  Senior Vice President of the Company since October 1997. Senior Vice President of Commerce Bank, N.A. prior thereto.
     
V. Raymond Stranghoener, 57
  Executive Vice President of the Company since July 2005 and Senior Vice President of the Company prior thereto. Prior to his employment with the Company in October 1999, he was employed at BankAmerica Corp. as National Executive of the Bank of America Private Bank Wealth Strategies Group. He joined Boatmen’s Trust Company in 1993, which subsequently merged with BankAmerica Corp.

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PART II
 
Item 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Commerce Bancshares, Inc.
Common Stock Data
 
The following table sets forth the high and low prices of actual transactions for the Company’s common stock and cash dividends paid for the periods indicated (restated for the 5% stock dividend distributed in December 2008).
 
                             
                    Cash
 
    Quarter   High     Low     Dividends  
   
 
2008
  First   $ 43.43     $ 36.19     $ .238  
    Second     43.49       37.55       .238  
    Third     50.47       34.76       .238  
    Fourth     52.86       35.44       .238  
 
 
2007
  First   $ 46.05     $ 42.26     $ .227  
    Second     44.37       40.51       .227  
    Third     43.90       39.26       .227  
    Fourth     44.11       39.96       .227  
 
 
2006
  First   $ 45.38     $ 42.45     $ .212  
    Second     45.96       42.62       .212  
    Third     44.27       41.99       .212  
    Fourth     45.90       41.36       .212  
 
 
 
Commerce Bancshares, Inc. common shares are listed on the Nasdaq Global Select Market under the symbol CBSH. The Company had 4,512 shareholders of record as of December 31, 2008.
 
The following table sets forth information about the Company’s purchases of its $5 par value common stock, its only class of stock registered pursuant to Section 12 of the Exchange Act, during the fourth quarter of 2008. This information has not been restated for the 5% stock dividend in December 2008.
 
                                 
 
    Total
          Total Number of
       
    Number
    Average
    Shares Purchased
    Maximum Number that
 
    of Shares
    Price Paid
    as Part of Publicly
    May Yet Be Purchased
 
Period   Purchased     per Share     Announced Program     Under the Program  
 
 
October 1 – 31, 2008
    566     $ 53.97       566       2,903,380  
November 1 – 30, 2008
        $             2,903,380  
December 1 – 31, 2008
    25,828     $ 39.98       25,828       2,877,552  
 
 
Total
    26,394     $ 40.28       26,394       2,877,552  
 
 
 
The Company’s stock purchases shown above were made under a 3,000,000 share authorization by the Board of Directors on February 1, 2008. Under this authorization, 2,877,552 shares remained available for purchase at December 31, 2008.


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Performance Graph
 
The following graph presents a comparison of Company (CBSH) performance to the indices named below. It assumes $100 invested on December 31, 2003 with dividends invested on a Total Return basis.
 
(PERFORMANCE GRAPH)
 
Item 6.  SELECTED FINANCIAL DATA
 
The required information is set forth below in Item 7.
 
Item 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Overview
 
Commerce Bancshares, Inc. (the Company) operates as a super-community bank offering an array of sophisticated financial products delivered with high-quality, personal customer service. It is the largest bank holding company headquartered in Missouri, with its principal offices in Kansas City and St. Louis, Missouri. Customers are served from approximately 360 locations in Missouri, Kansas, Illinois, Oklahoma and Colorado using delivery platforms which include an extensive network of branches and ATM machines, full-featured online banking, and a central contact center.


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The core of the Company’s competitive advantage is its focus on the local markets it services and its concentration on relationship banking, with high service levels and competitive products. In order to enhance shareholder value, the Company grows its core revenue by expanding new and existing customer relationships, utilizing improved technology, and enhancing customer satisfaction.
 
Various indicators are used by management in evaluating the Company’s financial condition and operating performance. Among these indicators are the following:
 
  •  Growth in earnings per share – Diluted earnings per share declined 7.8% in 2008 compared to 2007.
 
  •  Growth in total revenue – Total revenue is comprised of net interest income and non-interest income. Total revenue in 2008 grew 6.5% over 2007, which resulted from growth of $54.7 million, or 10.2%, in net interest income coupled with growth of $4.1 million, or 1.1%, in non-interest income. Total revenue has risen 3.9%, compounded annually, over the last five years.
 
  •  Expense control – Non-interest expense grew by 7.2% this year. Salaries and employee benefits, the largest expense component, grew by 8.0%, partly due to increased staffing in areas such as commercial bank card, private banking, and commercial banking, which were part of certain growth initiatives established by the Company in 2007.
 
  •  Asset quality – Net loan charge-offs in 2008 increased $27.1 million over those recorded in 2007, and averaged .64% of loans compared to .42% in the previous year. Total non-performing assets amounted to $79.1 million, an increase of $45.7 million over balances at the previous year end, and represented .70% of loans outstanding.
 
  •  Shareholder return – Total shareholder return, including the change in stock price and dividend reinvestment, was 4.8% over the past 5 years and 7.3% over the past 10 years.
 
The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes. The historical trends reflected in the financial information presented below are not necessarily reflective of anticipated future results.
 
Key Ratios
 
                                         
 
(Based on average balance sheets):   2008     2007     2006     2005     2004  
 
 
Return on total assets
    1.15 %     1.33 %     1.54 %     1.60 %     1.56 %
Return on stockholders’ equity
    11.83       14.00       15.96       16.19       15.19  
Tier I capital ratio
    10.92       10.31       11.25       12.21       12.21  
Total capital ratio
    12.31       11.49       12.56       13.63       13.57  
Leverage ratio
    9.06       8.76       9.05       9.43       9.60  
Equity to total assets
    9.69       9.54       9.68       9.87       10.25  
Non-interest income to revenue*
    38.80       40.85       40.72       40.03       38.84  
Efficiency ratio**
    63.16       62.72       60.55       59.30       59.16  
Loans to deposits***
    92.11       88.49       84.73       81.34       78.71  
Net yield on interest earning assets (tax equivalent basis)
    3.93       3.80       3.92       3.89       3.81  
Non-interest bearing deposits to total deposits
    5.47       5.45       5.78       6.23       12.47  
Cash dividend payout ratio
    38.39       33.76       30.19       28.92       28.26  
 
 
 * Revenue includes net interest income and non-interest income.
 
** The efficiency ratio is calculated as non-interest expense (excluding intangibles amortization) as a percent of revenue.
 
*** Includes loans held for sale.


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Selected Financial Data
 
                                         
 
(In thousands, except per share data)   2008     2007     2006     2005     2004  
 
 
Net interest income
  $ 592,739     $ 538,072     $ 513,199     $ 501,702     $ 497,331  
Provision for loan losses
    108,900       42,732       25,649       28,785       30,351  
Non-interest income
    375,712       371,581       352,586       334,837       315,839  
Investment securities gains, net
    30,294       8,234       9,035       6,362       11,092  
Non-interest expense
    616,113       574,758       525,425       496,522       482,769  
Net income
    188,655       206,660       219,842       223,247       220,341  
Net income per share-basic*
    2.50       2.72       2.84       2.77       2.59  
Net income per share-diluted*
    2.48       2.69       2.80       2.73       2.55  
Cash dividends
    72,055       68,915       65,758       63,421       61,135  
Cash dividends per share*
    .952       .907       .847       .790       .721  
Market price per share*
    43.95       42.72       43.91       45.02       41.30  
Book value per share*
    20.80       20.26       18.70       17.09       17.20  
Common shares outstanding*
    75,791       75,386       77,123       78,266       82,967  
Total assets
    17,532,447       16,204,831       15,230,349       13,885,545       14,250,368  
Loans, including held for sale
    11,644,544       10,841,264       9,960,118       8,899,183       8,305,359  
Investment securities
    3,780,116       3,297,015       3,496,323       3,770,181       4,837,368  
Deposits
    12,894,733       12,551,552       11,744,854       10,851,813       10,434,309  
Long-term debt
    1,447,781       1,083,636       553,934       269,390       389,542  
Stockholders’ equity
    1,576,632       1,527,686       1,442,114       1,337,838       1,426,880  
Non-performing assets
    79,077       33,417       18,223       11,713       18,775  
 
 
* Restated for the 5% stock dividend distributed in December 2008.
 
Results of Operations
 
                                                         
 
                      $ Change     % Change  
(Dollars in thousands)   2008     2007     2006     ’08-’07     ’07-’06     ’08-’07     ’07-’06  
 
 
Net interest income
  $ 592,739     $ 538,072     $ 513,199     $ 54,667     $ 24,873       10.2 %     4.8 %
Provision for loan losses
    (108,900 )     (42,732 )     (25,649 )     66,168       17,083       154.8       66.6  
Non-interest income
    375,712       371,581       352,586       4,131       18,995       1.1       5.4  
Investment securities gains, net
    30,294       8,234       9,035       22,060       (801 )     267.9       (8.9 )
Non-interest expense
    (616,113 )     (574,758 )     (525,425 )     41,355       49,333       7.2       9.4  
Income taxes
    (85,077 )     (93,737 )     (103,904 )     (8,660 )     (10,167 )     (9.2 )     (9.8 )
 
 
Net income
  $ 188,655     $ 206,660     $ 219,842     $ (18,005 )   $ (13,182 )     (8.7 )%     (6.0 )%
 
 
 
For the year ended December 31, 2008, net income amounted to $188.7 million, a decrease of $18.0 million, or 8.7%, compared to $206.7 million in 2007. The decline in net income was mainly the result of an increase in the provision for loan losses of $66.2 million coupled with a 7.2% increase in non-interest expense, but partly offset by increases in net interest income, investment securities gains and non-interest income. Net interest income increased $54.7 million, or 10.2%, in 2008 compared to 2007, mainly as a result of growth in loans and investment securities, coupled with a large reduction in rates paid on interest bearing liabilities. These effects were partly offset by lower loan yields and higher borrowings. In 2008, net investment securities gains totaled $30.3 million compared to $8.2 million in 2007. Gains in 2008 included a $22.2 million gain on the redemption of Visa, Inc. (Visa) stock and a gain of $7.9 million on the sale of certain auction rate securities (ARS), further described in the Investment Securities Gains section of this discussion.
 
Non-interest income totaled $375.7 million in 2008, an increase of $4.1 million, or 1.1%, over amounts reported in the previous year and included a $9.4 million impairment charge on certain loans held for sale. Non-interest expense totaled $616.1 million, an increase of $41.4 million, or 7.2%, over 2007. Included in non-interest expense was a non-cash loss of $33.3 million as a result of the Company’s purchase of ARS from its customers in the third quarter of 2008. Non-interest expense also included a $9.6 million reduction in an


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indemnification obligation for the Company’s share of certain Visa litigation costs, which is discussed further in the Non-Interest Expense section of this discussion. The provision for loan losses totaled $108.9 million in 2008, an increase of $66.2 million, and reflected higher net loan charge-offs, mainly in consumer and consumer credit card loans, and the need to increase loan loss reserves to address inherent risk in the loan portfolio. Income tax expense declined 9.2% in 2008 and resulted in an effective tax rate of 31.1%, which was slightly lower than the effective tax rate of 31.2% in the previous year. The decrease in income tax expense in 2008 compared to 2007 was mainly due to lower pre-tax earnings.
 
For the year ended December 31, 2007, net income amounted to $206.7 million, a decrease of $13.2 million, or 6.0%, from 2006. Net income in 2007 included a pre-tax charge of $21.0 million recorded in the fourth quarter, related to the Company’s share of certain Visa litigation costs. Exclusive of this item, net income in 2007 amounted to $219.9 million, virtually the same as in 2006. Net interest income increased $24.9 million, or 4.8%, reflecting growth in average loan balances and higher average overall rates earned on loans and investment securities, partly offset by declining average balances in investment securities. Countering these effects was a rise in interest expense on deposit accounts and short-term borrowings, resulting from increases in interest rates on virtually all deposit accounts, coupled with growth in certificate of deposit balances and higher average short-term borrowings. Non-interest income rose $19.0 million, or 5.4%, largely due to increases of 9.1% in bank card fees, 1.6% in deposit account fees, and 9.2% in trust revenues. Exclusive of the Visa charge, non-interest expense grew $28.4 million, or 5.4%, which was mainly the result of a 7.1% increase in salaries and benefits. The provision for loan losses increased $17.1 million to $42.7 million, reflecting higher incurred losses in nearly all loan categories, with the largest increases in business, consumer, and consumer credit card loans. Income tax expense declined 9.8% in 2007 and resulted in an effective tax rate of 31.2%, compared to an effective tax rate of 32.1% in the prior year. The decrease in income tax expense in 2007 occurred mainly due to the change in the mix of taxable and non-taxable income.
 
The Company acquired two banking franchises during 2007. In April 2007, the Company acquired South Tulsa Financial Corporation. In this transaction, the Company acquired the outstanding stock of South Tulsa and issued shares of Company stock valued at $27.6 million. The Company’s acquisition of South Tulsa added two branch locations in Tulsa, Oklahoma. In July 2007, the Company acquired Commerce Bank in Denver, Colorado. In this transaction, the Company acquired all of the outstanding stock of Commerce Bank for $29.5 million in cash. The acquisition added the Company’s first location in Colorado.
 
During 2006, the Company also acquired two banks. The first acquisition was in July 2006, when the Company, through a bank subsidiary, acquired certain assets and assumed certain liabilities of Boone National Savings and Loan Association in a purchase and assumption agreement for cash of $19.1 million. Boone operated four branches in central Missouri. In September 2006, the Company acquired the outstanding stock of West Pointe Bancorp, Inc. in Belleville, Illinois, which operated five branch locations in the greater St. Louis area. The total purchase price of $80.5 million consisted of cash of $13.1 million and shares of Company stock valued at $67.5 million.
 
The transactions discussed above are collectively referred to as “bank acquisitions” throughout the remainder of this report. Additional information about acquired balances and intangible assets recognized is presented below.
 
                                 
 
    2007     2006  
(In millions)   Denver     South Tulsa     Boone     West Pointe  
 
 
Purchase price
  $ 29.5     $ 27.6     $ 19.1     $ 80.5  
Acquired balances:
                               
Total assets
    103.9       127.3       126.4       455.1  
Loans
    74.5       114.7       126.4       255.0  
Deposits
    72.2       103.9       100.9       381.8  
Intangible assets recognized:
                               
Goodwill
    15.1       11.9       15.6       38.3  
Core deposit premium
    4.9       3.4       2.6       14.9  
Mortgage servicing rights
                .3       .5  
 
 


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The Company continually evaluates the profitability of its network of bank branches throughout its markets. As a result of this evaluation process, the Company may periodically sell the assets and liabilities of certain branches, or may sell the premises of specific banking facilities. In May 2008, the Company sold its banking branch, including the facility, in Independence, Kansas. In this transaction, approximately $23.3 million in loans, $85.0 million in deposits, and various other assets and liabilities were sold. The Company paid $54.1 million in cash, representing the net liabilities sold, and recorded a pre-tax gain of $6.9 million, representing the approximate premium paid by the buyer. During 2007 and 2006, the Company sold several bank facilities each year, realizing pre-tax gains on these sales of $1.6 million and $579 thousand, respectively.
 
In February 2009, the Company sold its branch in Lakin, Kansas. In this transaction, the Company sold the bank facility and certain deposits of approximately $6.9 million, and paid cash of approximately $5.6 million.
 
The Company distributed a 5% stock dividend for the fifteenth consecutive year on December 1, 2008. All per share and average share data in this report has been restated to reflect the 2008 stock dividend.
 
Critical Accounting Policies
 
The Company’s consolidated financial statements are prepared based on the application of certain accounting policies, the most significant of which are described in Note 1 to the consolidated financial statements. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or be subject to variations which may significantly affect the Company’s reported results and financial position for the current period or future periods. The use of estimates, assumptions, and judgments are necessary when financial assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. Current economic conditions may require the use of additional estimates, and some estimates may be subject to a greater degree of uncertainty due to the current instability of the economy. The Company has identified several policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for loan losses, the valuation of certain investment securities, and accounting for income taxes.
 
Allowance for Loan Losses
 
The Company performs periodic and systematic detailed reviews of its loan portfolio to assess overall collectability. The level of the allowance for loan losses reflects the Company’s estimate of the losses inherent in the loan portfolio at any point in time. While these estimates are based on substantive methods for determining allowance requirements, actual outcomes may differ significantly from estimated results, especially when determining allowances for business, lease, construction and business real estate loans. These loans are normally larger and more complex, and their collection rates are harder to predict. Personal loans, including personal mortgage, credit card and consumer loans, are individually smaller and perform in a more homogenous manner, making loss estimates more predictable. Further discussion of the methodologies used in establishing the allowance is provided in the Provision and Allowance for Loan Losses section of this discussion.
 
Valuation of Investment Securities
 
The Company carries its investment securities at fair value, and in accordance with the requirements of Statement of Financial Accounting Standards (SFAS) No. 157, the Company employs valuation techniques which utilize observable inputs when those inputs are available. These observable inputs reflect assumptions market participants would use in pricing the security, developed based on market data obtained from sources independent of the Company. When such information is not available, the Company employs valuation techniques which utilize unobservable inputs, or those which reflect the Company’s own assumptions about market participants, based on the best information available in the circumstances. These valuation methods typically involve cash flow and other financial modeling techniques. Changes in underlying factors, assumptions, estimates, or other inputs to the valuation techniques could have a material impact on the Company’s


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future financial condition and results of operations. Assets and liabilities carried at fair value inherently result in more financial statement volatility. SFAS 157, which requires fair value measurements to be classified as Level 1 (quoted prices), Level 2 (based on observable inputs) or Level 3 (based on unobservable, internally-derived inputs) is discussed in more detail in Note 16 to the consolidated financial statements.
 
Available for sale securities are reported at fair value, with changes in fair value reported in other comprehensive income. Most of the portfolio is priced utilizing industry-standard models that consider various assumptions which are observable in the marketplace, or can be derived from observable data. Such securities totaled approximately $3.4 billion, or 94.6% of the portfolio at December 31, 2008, and were classified as Level 2 measurements. The Company also holds $168.0 million in auction rate securities. These were classified as Level 3 measurements, as no market currently exists for these securities, and fair values were derived from internally generated cash flow valuation models which used unobservable inputs which were significant to the overall measurement. The Company periodically evaluates the available for sale portfolio for other-than-temporary impairment. Impairment which is deemed other-than-temporary is reflected in current earnings and reported in investment securities gains and losses in the consolidated statements of income. Evaluation for other-than-temporary impairment includes an analysis of the facts and circumstances of each individual security such as the severity of loss, the length of time the fair value has been below cost, the creditworthiness of the issuer, and the Company’s intent and ability to hold the security to maturity. Impairment is measured using a cash flows modeling technique whose results are highly dependent on estimates of default rates, loss severities, and prepayment speeds. Future economic trends which signal changes to these estimates may have a negative effect on results of operations.
 
The Company, through its direct holdings and its Small Business Investment subsidiaries, has numerous private equity and venture capital investments, categorized as non-marketable securities in the accompanying consolidated balance sheets. These investments are reported at fair value, and totaled $55.4 million at December 31, 2008. Changes in fair value are reflected in current earnings, and reported in investment securities gains and losses in the consolidated statements of income. Because there is no observable market data for these securities, their fair values are internally developed using available information and management’s judgment. Although management believes its estimates of fair value reasonably reflect the fair value of these securities, key assumptions regarding the projected financial performance of these companies, the evaluation of the investee company’s management team, and other economic and market factors may affect the amounts that will ultimately be realized from these investments.
 
Accounting for Income Taxes
 
As more fully discussed in Notes 1 and 9 of the consolidated financial statements, the Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”. Accrued income taxes represent the net amount of current income taxes which are expected to be paid attributable to operations as of the balance sheet date. Deferred income taxes represent the expected future tax consequences of events that have been recognized in the financial statements or income tax returns. Current and deferred income taxes are reported as either a component of other assets or other liabilities in the consolidated balance sheets, depending on whether the balances are assets or liabilities. Judgment is required in applying the principles of SFAS No. 109. The Company regularly monitors taxing authorities for changes in laws and regulations and their interpretations by the judicial systems. The aforementioned changes, and changes that may result from the resolution of income tax examinations by federal and state taxing authorities, may impact the estimate of accrued income taxes and could materially impact the Company’s financial position and results of operations.


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Net Interest Income
 
Net interest income, the largest source of revenue, results from the Company’s lending, investing, borrowing, and deposit gathering activities. It is affected by both changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest bearing liabilities. The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates. Changes not solely due to volume or rate changes are allocated to rate.
 
                                                 
    2008     2007  
   
    Change due to           Change due to        
    Average
    Average
          Average
    Average
       
(In thousands)   Volume     Rate     Total     Volume     Rate     Total  
 
 
Interest income, fully taxable equivalent basis
                                               
Loans
  $ 57,585     $ (137,217 )   $ (79,632 )   $ 77,356     $ 14,896     $ 92,252  
Loans held for sale
    1,741       (8,713 )     (6,972 )     412       (260 )     152  
Investment securities:
                                               
U.S. government and federal agency obligations
    (9,129 )     63       (9,066 )     (8,190 )     1,878       (6,312 )
State and municipal obligations
    4,582       3,135       7,717       8,058       251       8,309  
Mortgage and asset-backed securities
    17,036       6,090       23,126       (3,547 )     9,520       5,973  
Other securities
    942       (2,396 )     (1,454 )     (3,126 )     (2,090 )     (5,216 )
Federal funds sold and securities purchased under agreements to resell
    (4,848 )     (12,746 )     (17,594 )     11,852       (1,608 )     10,244  
Interest earning deposits with banks
    198             198                    
 
 
Total interest income
    68,107       (151,784 )     (83,677 )     82,815       22,587       105,402  
 
 
Interest expense
                                               
Interest bearing deposits:
                                               
Savings
    42       (923 )     (881 )     (5 )     (132 )     (137 )
Interest checking and money market
    7,117       (61,197 )     (54,080 )     8,541       11,248       19,789  
Time open and C.D.’s of less than $100,000
    (9,775 )     (23,860 )     (33,635 )     11,563       13,970       25,533  
Time open and C.D.’s of $100,000 and over
    7,566       (25,640 )     (18,074 )     9,001       6,357       15,358  
Federal funds purchased and securities sold under agreements to repurchase
    (16,534 )     (41,845 )     (58,379 )     10,826       2,484       13,310  
Other borrowings
    38,018       (13,888 )     24,130       5,346       (315 )     5,031  
 
 
Total interest expense
    26,434       (167,353 )     (140,919 )     45,272       33,612       78,884  
 
 
Net interest income, fully taxable equivalent basis
  $ 41,673     $ 15,569     $ 57,242     $ 37,543     $ (11,025 )   $ 26,518  
 
 
 
Net interest income totaled $592.7 million in 2008, representing an increase of $54.7 million, or 10.2%, compared to $538.1 million in 2007. On a tax equivalent basis, net interest income totaled $604.1 million and increased $57.2 million, or 10.5%, over the previous year. This increase was mainly the result of lower rates paid on deposits and other borrowings, coupled with higher average loan and investment securities balances during the year. The net yield on earning assets (tax equivalent) was 3.93% in 2008 compared with 3.80% in the previous year.
 
Interest income on loans (tax equivalent) declined $86.6 million due to lower rates earned on virtually all lending products but offset by higher loan balances, especially in business, consumer and consumer credit card loans. The lower rates earned on the loan portfolio were related to the actions taken by the Federal Reserve Bank during 2008 to reduce interest rate levels, which caused the Company’s portfolio to re-price


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quickly. Tax equivalent interest earned on investment securities increased by $20.3 million, or 12.7%, due to higher average balances of mortgage-backed and municipal securities, coupled with higher rates earned on these investments. Included in municipal securities were the Company’s purchases of auction rate securities in the third quarter of 2008, which increased interest income. The majority of these securities were sold in the fourth quarter. Interest earned on federal funds sold and resale agreement assets declined $17.6 million, mainly due to lower average balances coupled with much lower overnight rates. Average rates (tax equivalent) earned on interest earning assets in 2008 decreased to 5.60% compared to 6.56% in the previous year, or a decline of 96 basis points.
 
Interest expense on deposits decreased $106.7 million, mainly the result of much lower rates paid on all deposit products but partly offset by the effects of higher average balances of money market accounts and certificates of deposit of $100,000 and over. Average rates paid on deposit balances declined 100 basis points from 2.68% in 2007 to 1.68% in 2008. Interest expense on borrowings declined $34.2 million, or 35.2%, mainly as a result of lower rates paid and lower average balances of federal funds purchased and repurchase agreement borrowings. Also, while advances from the Federal Home Loan Bank and the Federal Reserve’s Term Auction Facility increased on average by $788.3 million, rates on these borrowings dropped significantly in 2008. The average rate paid on interest bearing liabilities decreased to 1.83% compared to 3.01% in 2007.
 
Net interest income in 2007 increased $24.9 million, or 4.8%, to $538.1 million, compared to $513.2 million in 2006. On a tax equivalent basis, net interest income increased $26.5 million, or 5.1%, in 2007 compared to 2006. The increase in net interest income in 2007 compared to 2006 was due mainly to growth in interest on loans, investment securities and short-term investments, offset by higher interest expense on deposit accounts and borrowings. The increase in interest income on loans was the result of increases in both rates and balances of virtually all loan products. The effect on rates was mainly due to Federal Reserve rate increases in 2006 which impacted average balances and earnings for the full year in 2007. The growth in average balances partly resulted from bank acquisitions occurring in 2007 and 2006, which increased average loan balances by $337.8 million in 2007. Tax equivalent interest earned on investment securities increased by 1.8% due to higher rates earned on mortgage and asset-backed securities and U.S. government and federal agency securities, but was partly offset by lower overall average balances. Interest earned on federal funds sold and resale agreement assets rose by $10.2 million, mainly due to higher average balances in overnight resale agreements. Average rates earned on total interest earning assets in 2007 increased to 6.56% compared to 6.32% in the previous year.
 
Interest expense on deposits increased $60.5 million in 2007 over 2006 due to higher average balances of money market accounts and short-term certificates of deposit, in addition to higher rates paid on most deposit products. Interest expense on borrowings increased $18.4 million over 2006. This growth resulted from an increase of $350.6 million in average balances, mainly in securities sold under repurchase agreements and Federal Home Loan Bank advances, coupled with higher average rates paid on the repurchase agreements. The average rate paid on interest bearing liabilities increased to 3.01% compared to 2.63% in 2006. The tax adjusted net yield on earning assets totaled 3.80% in 2007 and 3.92% in 2006.
 
Provision for Loan Losses
 
The provision for loan losses totaled $108.9 million in 2008, up from $42.7 million in the previous year, or an increase of $66.2 million. In 2006 the provision totaled $25.6 million. The growth in the provision in 2008 was the result of deteriorating economic conditions affecting the Company’s loan portfolio, higher watch list loans totals, and increasing loan losses experience, especially in consumer and consumer credit card loans, during 2008. As a result, the Company increased its allowance for loan losses by $39.0 million in 2008. The provision for loan losses is recorded to bring the allowance for loan losses to a level deemed adequate by management based on the factors mentioned in the following “Allowance for Loan Losses” section of this discussion.


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Non-Interest Income
 
                                         
 
                      % Change  
(Dollars in thousands)   2008     2007     2006     ’08-’07     ’07-’06  
 
 
Deposit account charges and other fees
  $ 110,361     $ 117,350     $ 115,453       (6.0 )%     1.6 %
Bank card transaction fees
    113,862       103,613       94,928       9.9       9.1  
Trust fees
    80,294       78,840       72,180       1.8       9.2  
Trading account profits and commissions
    14,268       8,647       8,132       65.0       6.3  
Consumer brokerage services
    13,553       12,445       9,954       8.9       25.0  
Loan fees and sales
    (2,413 )     8,835       10,503       N.M.       (15.9 )
Other
    45,787       41,851       41,436       9.4       1.0  
 
 
Total non-interest income
  $ 375,712     $ 371,581     $ 352,586       1.1 %     5.4 %
 
 
Non-interest income as a % of total revenue*
    38.8 %     40.8 %     40.7 %                
Total revenue per full-time equivalent employee
  $ 185.6     $ 179.0     $ 175.5                  
 
 
* Total revenue is calculated as net interest income plus non-interest income.
 
Non-interest income totaled $375.7 million, an increase of $4.1 million or 1.1%, compared to $371.6 million in 2007. Non-interest income included an impairment charge of $9.4 million, recorded in loan fees and sales, on certain student loans held for sale. The Company has agreements to sell its portfolio of originated student loans to various student loan servicing agencies. Due to uncertainties surrounding some of these agencies’ ability to fulfill these contracts in the future, the Company adjusted a portion of the portfolio, totaling $206.1 million, to fair value, and recorded the above mentioned impairment charge. Bank card fee income grew by $10.2 million, or 9.9%, due to solid growth in debit card and corporate credit card fee income, which grew by 9.4% and 28.6%, respectively. However, deposit fees declined by $7.0 million, or 6.0%, mainly due to a decrease of $10.4 million in deposit account overdraft fees. This decline was partly offset by growth in corporate cash management fee income, which increased $4.5 million, or 17.2%. Trust fee income grew by $1.5 million, or 1.8%, and was especially affected in the fourth quarter by lower market values of the trust assets on which fees are based. Market values of total trust assets at year end 2008 were 14.6% lower than at year end 2007. Consumer brokerage services revenue grew by $1.1 million, or 8.9%, on higher bond sales and annuity commissions. Bond trading income increased $5.6 million, or 65.0%, due to increased sales volumes from its correspondent bank and commercial customers. Other non-interest income rose $3.9 million over the prior year, largely due to a $6.9 million gain on the sale of a bank branch. Additional increases occurred in cash sweep commission income and fair value gains on interest rate swaps. These were partly offset by a $1.1 million impairment charge on an office building held for sale, in addition to declines in official check sales and equipment rental income.
 
In 2007, non-interest income increased $19.0 million, or 5.4%, to $371.6 million. Compared to 2006, deposit account fees increased $1.9 million, or 1.6%, as a result of higher corporate cash management fees, which grew by $2.8 million, or 12.2%. This growth was partly offset by a slight decline in deposit account overdraft fees. Bank card fees rose $8.7 million, or 9.1% overall, primarily due to growth in debit card and corporate card fee income, which grew by 12.2% and 30.0%, respectively. Trust fees increased $6.7 million, or 9.2%, due to an 8.3% increase in private client account fees and a 14.7% increase in corporate and institutional trust account fees. Bond trading income rose $515 thousand due to an increase in underwriting fees on customer debt issues, in addition to higher corporate and correspondent bank sales. Consumer brokerage services revenue rose $2.5 million, or 25.0%, mainly due to growth in annuity commissions and mutual fund fees. Loan fees and sales decreased by $1.7 million as gains on sales of student loans declined from $6.3 million in 2006 to $4.5 million in 2007, which resulted from narrowing profit margins on loans sold to various servicing agencies. Other non-interest income rose $415 thousand over the prior year, largely due to increases of $1.1 million in cash sweep commission income and $1.0 million in gains on sales of various bank facilities. These increases were partly offset by impairment losses of $1.3 million recorded on several properties and the receipt in 2006 of $1.2 million in non-recurring income from an equity investment held by Commerce Bancshares, Inc., the parent holding company (the “Parent”).


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Investment Securities Gains, Net
 
Net gains and losses on investment securities during 2008, 2007 and 2006 are shown in the table below. Included in these amounts are gains and losses arising from sales of bonds from the Bank’s available for sale portfolio and sales of publicly traded equity securities held by the Parent. Also shown are gains and losses relating to non-marketable private equity and venture capital investments, which are primarily held by the Parent’s majority-owned venture capital subsidiaries. These include fair value adjustments, in addition to gains and losses realized upon disposition. Minority interest expense pertaining to these net gains is reported in other non-interest expense, and totaled $299 thousand, $389 thousand, and $2.2 million in 2008, 2007 and 2006, respectively.
 
Net securities gains of $30.3 million were recorded in 2008, compared to $8.2 million in 2007 and $9.0 million in 2006. Most of the net gain in 2008 occurred because of Visa’s redemption of certain Class B stock held by its former member banks. The redemption occurred in conjunction with an initial public offering by Visa in March 2008. Approximately 500 thousand shares of the Company’s Class B stock were redeemed, which resulted in a $22.2 million gain. Also, in December 2008, $341.4 million in auction rate securities were sold in exchange for federally guaranteed student loans, resulting in a gain of $7.9 million. Preferred equity securities issued by the Student Loan Marketing Association and the Federal National Mortgage Association, totaling $20.7 million, were sold early in the year for a loss of $3.5 million.
 
                         
 
(Dollars in thousands)   2008     2007     2006  
 
 
Available for sale:
                       
Preferred equity securities
  $ (3,504 )   $ (663 )   $  
Common stock
    (296 )     2,521        
Auction rate securities
    7,861              
Other bonds
    1,140       1,069       (2,083 )
Non-marketable:
                     
Private equity and venture investments
    2,897       5,307       8,278  
Visa Class B stock
    22,196              
MasterCard stock
                2,840  
 
 
Total investment securities gains, net
  $ 30,294     $ 8,234     $ 9,035  
 
 
 
Non-Interest Expense
 
                                         
 
                      % Change  
(Dollars in thousands)   2008     2007     2006     ’08-’07     ’07-’06  
 
 
Salaries
  $ 286,161     $ 265,378     $ 244,887       7.8 %     8.4 %
Employee benefits
    47,451       43,390       43,386       9.4        
Net occupancy
    46,317       45,789       43,276       1.2       5.8  
Equipment
    24,569       24,121       25,665       1.9       (6.0 )
Supplies and communication
    35,335       34,162       32,670       3.4       4.6  
Data processing and software
    56,387       50,342       51,601       12.0       (2.4 )
Marketing
    19,994       18,199       17,317       9.9       5.1  
Loss on purchase of auction rate securities
    33,266                   N.M.       N.M.  
Indemnification obligation
    (9,619 )     20,951             N.M.       N.M.  
Other
    76,252       72,426       66,623       5.3       8.7  
 
 
Total non-interest expense
  $ 616,113     $ 574,758     $ 525,425       7.2 %     9.4 %
 
 
Efficiency ratio
    63.2 %     62.7 %     60.6 %                
Salaries and benefits as a % of total non-interest expense
    54.1 %     53.7 %     54.9 %                
Number of full-time equivalent employees
    5,217       5,083       4,932                  
 
 


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Non-interest expense was $616.1 million in 2008, an increase of 7.2% over the previous year. Salaries and benefits expense grew by $24.8 million, or 8.0%, due to merit increases, higher incentive payments, and increased medical insurance costs. In addition, increased salary costs resulted from higher staffing in areas such as commercial bank card, private banking, and commercial banking, which were part of certain growth initiatives established by the Company in 2007. Occupancy, supplies and communication, and equipment costs grew by 1.2%, 3.4%, and 1.9%, respectively, and were well controlled. Occupancy costs increased mainly as a result of higher building services and repairs expense. Equipment expense grew mainly due to higher repairs and maintenance expense, partly offset by a decline in equipment depreciation expense. Supplies and communication costs were higher due to increased costs for supplies and courier expense. Data processing and software expense increased $6.0 million, or 12.0%, mainly due to higher bank card processing costs which increased in relation to higher bank card revenues. Exclusive of bank card costs, core data processing expense increased $2.1 million, or 6.7%, over the prior year due to investments in new software and servicing systems. Marketing expense also rose by $1.8 million, or 9.9%, over the prior year mainly related to deposit account product marketing and other campaigns supporting Company initiatives. Other non-interest expense increased $3.8 million, or 5.3%, in 2008 partly due to an impairment charge of $2.5 million related to foreclosed land sold in the third quarter of 2008. Other increases occurred in travel and entertainment, FHLB letter of credit fees, and credit card rewards expense. Partly offsetting these increases were declines in professional fees and leased equipment depreciation.
 
Non-interest expense in 2008 included a $33.3 million non-cash loss related to the purchase of auction rate securities from customers in the third quarter. The securities were purchased at par value from the customers, and this loss represents the amount by which par value exceeded estimated fair value on the purchase date. Most of these securities were subsequently sold in the fourth quarter, and the gain relating to that transaction was recorded in investments securities gains, as noted above.
 
Also included in non-interest expense are adjustments to the Company’s estimate of its share of certain litigation costs arising from its member bank relationship with Visa. A non-cash expense charge of $21.0 million was recorded in the fourth quarter of 2007 to establish the Company’s obligation for its portion of litigation costs relating to various suits against Visa. The obligation was reduced in the first quarter of 2008 upon the funding of an escrow account for these suits, in conjunction with Visa’s initial public offering. The obligation was subsequently adjusted during the year to reflect changes in estimates of litigation costs and additional escrow funding. As a result of these adjustments, an overall reduction in the obligation of $9.6 million was recorded during 2008.
 
In 2007, non-interest expense was $574.8 million, which included the charge of $21.0 million related to the Visa indemnification obligation. Excluding this charge, non-interest expense was $553.8 million in 2007, and grew 5.4% over 2006. Salaries and benefits expense grew by $20.5 million, or 7.1%, due to merit increases, incentive compensation, payroll taxes and the effects of the 2007 and 2006 bank acquisitions, which contributed $5.4 million of this increase. Partly offsetting these increases was a decline in employee group medical plan expense, resulting from favorable claims experience. Occupancy expense increased by $2.5 million, or 5.8%, over 2006 mainly as a result of seasonal maintenance costs, higher building depreciation and real estate taxes. Higher rent income from tenants, resulting from an increase in overall building occupancy, partly offset these expenses. Equipment expense declined by $1.5 million, or 6.0%, mainly due to declines in depreciation expense on data processing equipment and maintenance contract expense, in addition to relocation costs of a check processing function in 2006. Supplies and communication costs grew by $1.5 million, or 4.6%, mainly due to higher costs for supplies, postage and courier expense, partly offset by a decline in data network expense. Data processing and software expense declined $1.3 million, or 2.4%, mainly due to lower license costs related to online banking systems and a decline in bank card processing fees. A smaller variance occurred in marketing expense, which increased $882 thousand, or 5.1%, over the prior year. Other non-interest expense increased $5.8 million, or 8.7%, in 2007 due to increases in intangible asset amortization (resulting from recent bank acquisitions), bank card and other fraud losses, and dues and subscription expense. Partly offsetting these increases were declines in minority interest expense and foreclosed property expense.


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Income Taxes
 
Income tax expense was $85.1 million in 2008, compared to $93.7 million in 2007 and $103.9 million in 2006. Income tax expense in 2008 decreased 9.2% from 2007, compared to an 8.9% decrease in pre-tax income. The effective tax rate was 31.1%, 31.2% and 32.1% in 2008, 2007 and 2006, respectively. The Company’s effective tax rates in those years were lower than the federal statutory rate of 35% mainly due to tax-exempt interest on state and municipal obligations.
 
Financial Condition
 
Loan Portfolio Analysis
 
A schedule of average balances invested in each category of loans appears on page 56. Classifications of consolidated loans by major category at December 31 for each of the past five years are as follows. In 2008, the Company acquired a portfolio of student loans which it intends to hold until maturity, which is shown in the table below. The Company’s portfolio of originated student loans was classified as held for sale in 2006, and is included in the table below only for years 2004 and 2005. Refer to the following section, Loans Held for Sale, for information regarding originated student loans.
 
                                         
 
    Balance at December 31  
(In thousands)   2008     2007     2006     2005     2004  
 
 
Business
  $ 3,404,371     $ 3,257,047     $ 2,860,692     $ 2,527,654     $ 2,246,287  
Real estate – construction and land
    837,369       668,701       658,148       424,561       427,124  
Real estate – business
    2,137,822       2,239,846       2,148,195       1,919,045       1,743,293  
Real estate – personal
    1,638,553       1,540,289       1,478,669       1,352,339       1,329,568  
Consumer
    1,615,455       1,648,072       1,435,038       1,287,348       1,193,822  
Home equity
    504,069       460,200       441,851       448,507       411,541  
Student
    358,049                   330,238       357,991  
Consumer credit card
    779,709       780,227       648,326       592,465       561,054  
Overdrafts
    7,849       10,986       10,601       10,854       23,673  
 
 
Total loans
  $ 11,283,246     $ 10,605,368     $ 9,681,520     $ 8,893,011     $ 8,294,353  
 
 
 
In December 2008, the Company elected to reclassify certain segments of its real estate, business, and consumer portfolios. The reclassifications were made to better align the loan reporting with its related collateral and purpose. Amounts reclassified to real estate construction and land pertained mainly to commercial or residential land and lots which were held by borrowers for future development. Amounts reclassified to personal real estate related mainly to one to four family rental property secured by residential mortgages. The table below shows the effect of the reclassifications on the various lending categories as of the transfer date. Because the information was not readily available and it was impracticable to do so, prior periods were not restated.
 
         
 
    Effect of
 
(In thousands)   reclassification  
 
 
Business
  $ (55,991 )
Real estate – construction and land
    158,268  
Real estate – business
    (214,071 )
Real estate – personal
    142,093  
Consumer
    (30,299 )
 
 
Net reclassification
  $  
 
 


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The contractual maturities of loan categories at December 31, 2008, and a breakdown of those loans between fixed rate and floating rate loans are as follows:
 
                                 
 
    Principal Payments Due        
    In
    After One
    After
       
    One Year
    Year Through
    Five
       
(In thousands)   or Less     Five Years     Years     Total  
 
 
Business
  $ 1,879,301     $ 1,321,504     $ 203,566     $ 3,404,371  
Real estate – construction and land
    527,974       282,944       26,451       837,369  
Real estate – business
    575,279       1,287,961       274,582       2,137,822  
Real estate – personal
    188,639       391,782       1,058,132       1,638,553  
 
 
Total business and real estate loans
  $ 3,171,193     $ 3,284,191     $ 1,562,731       8,018,115  
 
 
Consumer(1)
                            1,615,455  
Home equity(2)
                            504,069  
Student(3)
                            358,049  
Consumer credit card(4)
                            779,709  
Overdrafts
                            7,849  
 
 
Total loans, net of unearned income
                          $ 11,283,246  
 
 
Loans with fixed rates
  $ 664,714     $ 1,714,646     $ 479,711     $ 2,859,071  
Loans with floating rates
    2,506,479       1,569,545       1,083,020       5,159,044  
 
 
Total business and real estate loans
  $ 3,171,193     $ 3,284,191     $ 1,562,731     $ 8,018,115  
 
 
(1) Consumer loans with floating rates totaled $88.5 million.
(2) Home equity loans with floating rates totaled $497.1 million.
(3) All student loans have floating rates.
(4) Consumer credit card loans with floating rates totaled $709.0 million.
 
Total loans at December 31, 2008 were $11.3 billion, an increase of $677.9 million, or 6.4%, over balances at December 31, 2007. Excluding the effects of the reclassification mentioned above, loan growth during 2008 came principally from business, business real estate, and student loans. Business loans grew $203.3 million, or 6.2%, reflecting continued customer demand and higher line of credit usage. Lease balances, which are included in the business category, increased $32.2 million, or 11.7%, compared with the previous year end balance, as equipment financing remained strong. Business real estate loans rose $112.0 million, or 5.0%, and construction loans increased $10.4 million, or 1.6%. The increase in construction loans pertained to commercial construction, as opposed to land development and residential construction, which declined approximately $40 million in 2008. Consumer loans declined $2.3 million, partly as a result of a decline in automobile lending, but offset by growth in marine and recreational vehicle loans, which grew $27.6 million. Beginning in the third quarter, the Company elected to reduce its originations of certain types of marine and recreational vehicle loans due to current market conditions. Personal real estate loans decreased by $43.8 million, or 2.8%, while consumer credit card loans decreased slightly by $518 thousand. During 2008, home equity loans increased $43.9 million, or 9.5%, due to an increase in new account activations. In December 2008, the Company acquired $358.5 million of federally guaranteed student loans from a student loan agency in exchange for certain auction rate securities acquired by the Company in the previous quarter, and issued by that agency. The loans, which have an average estimated life of approximately seven years, were recorded at fair value, which resulted in a discount from their face value of approximately 2.5%. The Company intends to hold these loans to maturity.
 
Period end loans increased $923.8 million, or 9.5%, in 2007 compared to 2006, resulting from increases in business, business real estate, personal real estate, consumer and credit card loans.
 
The Company currently generates approximately 31% of its loan portfolio in the St. Louis market, 30% in the Kansas City market, and 39% in various other regional markets. The portfolio is diversified from a business and retail standpoint, with 57% in loans to businesses and 43% in loans to consumers. A balanced


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approach to loan portfolio management and an historical aversion toward credit concentrations, from an industry, geographic and product perspective, have contributed to low levels of problem loans and loan losses.
 
Business
 
Total business loans amounted to $3.4 billion at December 31, 2008 and include loans used mainly to fund customer accounts receivable, inventories, and capital expenditures. This portfolio also includes sales type and direct financing leases totaling $308.2 million, which are used by commercial customers to finance capital purchases ranging from computer equipment to office and transportation equipment. These leases comprise 2.7% of the Company’s total loan portfolio. Business loans are made primarily to customers in the regional trade area of the Company, generally the central Midwest, encompassing the states of Missouri, Kansas, Illinois, and nearby Midwestern markets, including Iowa, Oklahoma, Colorado and Ohio. The portfolio is diversified from an industry standpoint and includes businesses engaged in manufacturing, wholesaling, retailing, agribusiness, insurance, financial services, public utilities, and other service businesses. Emphasis is upon middle-market and community businesses with known local management and financial stability. The Company participates in credits of large, publicly traded companies when business operations are maintained in the local communities or regional markets and opportunities to provide other banking services are present. Consistent with management’s strategy and emphasis upon relationship banking, most borrowing customers also maintain deposit accounts and utilize other banking services. Net loan charge-offs in this category totaled $4.4 million in both 2008 and in 2007. Non-accrual business loans were $4.0 million (.1% of business loans) at December 31, 2008 compared to $4.7 million at December 31, 2007. Included in these totals were non-accrual lease-related loans of $1.0 million and $167 thousand at December 31, 2008 and 2007, respectively. Growth opportunities in business loans will largely depend on economic and market conditions affecting businesses and their ability to grow and invest in new capital, and the Company’s own solicitation efforts in attracting new, high quality loans. Asset quality is, in part, a function of management’s consistent application of underwriting standards and credit terms through stages in economic cycles. Therefore, portfolio growth in 2009 will be dependent upon 1) the strength of the economy, 2) the actions of the Federal Reserve with regard to targets for economic growth, interest rates, and inflationary tendencies, and 3) the competitive environment.
 
Real Estate-Construction and Land
 
The portfolio of loans in this category amounted to $837.4 million at December 31, 2008 and comprised 7.4% of the Company’s total loan portfolio. The table below shows the Company’s holdings of the major types of construction loans.
 
                 
 
    Balance at
       
    December 31
       
(In thousands)   2008     % of Total  
 
 
Residential land and land development
  $ 139,726       16.7 %
Residential construction
    141,405       16.9  
Commercial land and land development
    246,335       29.4  
Commercial construction
    309,903       37.0  
 
 
Total real estate-construction and land loans
  $ 837,369       100.0 %
 
 
 
These loans are predominantly made to businesses in the local markets of the Company’s banking subsidiaries. Commercial construction loans are made during the construction phase for small and medium-sized office and medical buildings, manufacturing and warehouse facilities, apartment complexes, shopping centers, hotels and motels, and other commercial properties. Exposure to larger speculative office properties remains low. Commercial land and land development loans relate to land owned or developed for use in conjunction with business properties. The largest percentage of residential construction and land development loans are for projects located in the Kansas City and St. Louis metropolitan areas. Credit exposure in this sector has risen over the last two years, especially in residential construction and land development lending, as a result of the slowdown in the housing industry and worsening economic conditions. Net loan charge-offs increased to $6.2 million in 2008, compared to net charge-offs of $2.0 million in 2007. The increase


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in net charge-offs in 2008 was mainly related to charge-offs of $4.3 million on four specific loans. In addition, construction and land loans on non-accrual status rose to $48.9 million at year end 2008, compared to $7.8 million at year end 2007. Much of the increase was the result of placing a $19.9 million residential construction loan within our market on non-accrual status in December 2008. The remainder of the non-accrual balance is composed of approximately 14 borrowers, whose loan balances range from $700 thousand to $6.6 million. The Company’s watch list, which includes special mention and substandard categories, includes $124.7 million of residential land and construction loans which are being closely monitored.
 
Real Estate-Business
 
Total business real estate loans were $2.1 billion at December 31, 2008 and comprised 18.9% of the Company’s total loan portfolio. This category includes mortgage loans for small and medium-sized office and medical buildings, manufacturing and warehouse facilities, shopping centers, hotels and motels, and other commercial properties. Emphasis is placed on owner-occupied and income producing commercial real estate properties, which present lower risk levels. The borrowers and/or the properties are generally located in the local and regional markets of the affiliate banks. At December 31, 2008, non-accrual balances amounted to $13.1 million, or .6% of the loans in this category, up from $5.6 million at year end 2007. The Company experienced net charge-offs of $2.2 million in 2008, compared to net charge-offs of $1.1 million in 2007.
 
Real Estate-Personal
 
At December 31, 2008, there were $1.6 billion in outstanding personal real estate loans, which comprised 14.5% of the Company’s total loan portfolio. The mortgage loans in this category are mainly for owner-occupied residential properties. The Company originates both adjustable rate and fixed rate mortgage loans. The Company retains adjustable rate mortgage loans, and may from time to time retain certain fixed rate loans (typically 15-year fixed rate loans) as directed by its Asset/Liability Management Committee. Other fixed rate loans in the portfolio have resulted from previous bank acquisitions. The Company does not purchase loans from outside parties or brokers, and has never maintained or promoted subprime or reduced document products. At December 31, 2008, 59% of the portfolio was comprised of adjustable rate loans while 41% was comprised of fixed rate loans. Levels of mortgage loan origination activity declined in 2008 compared to 2007, with originations of $181 million in 2008 compared with $283 million in 2007. Growth in mortgage loan originations was constrained in 2008 as a result of the deteriorating economy, slower housing starts, and lower resales within the Company’s markets. The Company has not experienced significant loan losses in this category, and believes this is partly because it does not offer subprime lending products or purchase loans from brokers. While loan losses have remained low during the year, the Company saw an increase in losses in the fourth quarter of 2008, and recorded net loan charge-offs of $1.4 million in that quarter. Net loan charge-offs for 2008 amounted to $1.7 million, compared to $139 thousand in the previous year. The non-accrual balances of loans in this category increased to $8.4 million at December 31, 2008, compared to $1.1 million at year end 2007.
 
Personal Banking
 
Total personal banking loans, which include consumer, student and revolving home equity loans, totaled $2.5 billion at December 31, 2008 and, excluding the reclassification mentioned above, increased 19.0% during 2008. These categories comprised 22.0% of the total loan portfolio at December 31, 2008. Consumer loans consist of auto, marine, tractor/trailer, recreational vehicle (RV) and fixed rate home equity loans, and totaled $1.6 billion at year end 2008. Approximately 70% of consumer loans outstanding were originated indirectly from auto and other dealers, while the remaining 30% were direct loans made to consumers. Approximately 29% of the consumer portfolio consists of automobile loans, 51% in marine and RV loans and 9% in fixed rate home equity lending. As mentioned above, total consumer loans declined $2.3 million in 2008 as a result of a decline in auto lending, which decreased $15.6 million, or 3.2%, but was offset by a $27.6 million increase in marine and RV lending. Since July 2008 and in conjunction with the Company’s decision to reduce marine and RV originations, these loans have declined $38.7 million. Net charge-offs on consumer loans were $21.4 million in 2008 compared to $9.5 million in 2007. Net charge-offs increased to 1.3% of average consumer loans in 2008 compared to .6% in 2007. The increase in net charge-offs in 2008 compared to 2007 was mainly due to higher marine and RV charge-offs. Net charge-offs on marine and RV


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loans were $9.9 million higher in 2008 compared to 2007, and were 1.7% of average marine and RV loans in 2008 compared to .6% in 2007.
 
Revolving home equity loans, of which 99% are adjustable rate loans, totaled $504.1 million at year end 2008. An additional $690.8 million was outstanding in unused lines of credit, which can be drawn at the discretion of the borrower. Home equity loans are secured mainly by second mortgages (and less frequently, first mortgages) on residential property of the borrower. The underwriting terms for the home equity line product permit borrowing availability, in the aggregate, generally up to 80% or 90% of the appraised value of the collateral property at the time of origination, although a small percentage may permit borrowing up to 100% of appraised value.
 
As mentioned previously, in December 2008, the Company acquired federally guaranteed student loans from a student loan agency in exchange for certain auction rate securities issued by that agency. At December 31, 2008, these student loans totaled $358.0 million.
 
Consumer Credit Card
 
Total consumer credit card loans amounted to $779.7 million at December 31, 2008 and comprised 6.9% of the Company’s total loan portfolio. The credit card portfolio is concentrated within regional markets served by the Company. The Company offers a variety of credit card products, including affinity cards, rewards cards, and standard and premium credit cards, and emphasizes its credit card relationship product, Special Connections. Approximately 63% of the households in Missouri that own a Commerce credit card product also maintain a deposit relationship with the subsidiary bank. Approximately 91% of the outstanding credit card loans have a floating interest rate. Net charge-offs amounted to $31.5 million in 2008, which was a $7.8 million increase over 2007. While the annual ratio of net credit card loan charge-offs to total average credit card loans totaled 4.1% in 2008 compared to 3.6% in 2007, annualized 2008 fourth quarter net credit card charge-offs on average loans increased to 4.5%. These ratios, however, remain below national loss averages.
 
Loans Held for Sale
 
Total loans held for sale at December 31, 2008 were $361.3 million, an increase of $125.4 million, or 53.2%, from $235.9 million at year end 2007. Loans classified as held for sale consist of residential mortgage loans and student loans.
 
Mortgage loans are fixed rate loans, which are sold in the secondary market, generally within three months of origination, and totaled $2.7 million and $6.9 million at December 31, 2008 and 2007, respectively.
 
The Company originates loans to students attending colleges and universities and these loans are normally sold to the secondary market when the student graduates and the loan enters into repayment status. Nearly all of these loans are based on variable rates. The Company maintains agreements to sell these student loans to various student loan servicing agencies, including the Missouri Higher Education Loan Authority and the Student Loan Marketing Association. In mid 2008, the Company also entered into an agreement with the Department of Education (DOE) which covers all new loans originated beginning July 1, 2008. Under this agreement, loans originated for the school year 2008-2009 are expected to be sold in September 2009.
 
Due to uncertainties surrounding some of the student loan agencies’ ability to fulfill these contracts in the future, the Company adjusted loans totaling $206.1 million to fair value and recorded impairment charges of $9.4 million during the second half of 2008. Student loan balances grew by $129.5 million, or 56.6%, to $358.6 million at year end 2008, compared to $229.0 million at year end 2007. This growth was mainly due to continued loan originations under the DOE agreement, coupled with fewer sales of those loans originated prior to July 1, 2008. At December 31, 2008, student loans held for sale to the DOE totaled $158.2 million.
 
Allowance for Loan Losses
 
The Company has an established process to determine the amount of the allowance for loan losses, which assesses the risks and losses inherent in its portfolio. This process provides an allowance consisting of a


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specific allowance component based on certain individually evaluated loans and a general component based on estimates of reserves needed for pools of loans with similar risk characteristics.
 
Loans subject to individual evaluation are defined by the Company as impaired, and generally consist of business, construction, commercial real estate and personal real estate loans on non-accrual status. These loans are evaluated individually for the impairment of repayment potential and collateral adequacy, and in conjunction with current economic conditions and loss experience, allowances are estimated. Loans not individually evaluated are aggregated and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type, delinquencies, current economic factors, loan risk ratings and industry concentrations.
 
The Company’s estimate of the allowance for loan losses and the corresponding provision for loan losses rests upon various judgments and assumptions made by management. Factors that influence these judgments include past loan loss experience, current loan portfolio composition and characteristics, trends in portfolio risk ratings, levels of non-performing assets, prevailing regional and national economic conditions, and the Company’s ongoing examination process including that of its regulators. The Company has internal credit administration and loan review staffs that continuously review loan quality and report the results of their reviews and examinations to the Company’s senior management and Board of Directors. Such reviews also assist management in establishing the level of the allowance. The Company’s subsidiary bank continues to be subject to examination by the Office of the Comptroller of the Currency (OCC) and examinations are conducted throughout the year, targeting various segments of the loan portfolio for review. In addition to the examination of the subsidiary bank by the OCC, the parent holding company and its non-bank subsidiaries are examined by the Federal Reserve Bank.
 
At December 31, 2008, the allowance for loan losses was $172.6 million compared to a balance at year end 2007 of $133.6 million. The $39.0 million, or 29.2%, increase in the allowance for loan losses during 2008 was primarily a result of increasing levels of watch list loans and deteriorating general economic conditions. Loans delinquent 90 days or more increased $19.1 million in 2008 compared to 2007 primarily due to the acquisition of a $358.5 million, federally guaranteed, student loan portfolio in the fourth quarter of 2008 that had $13.9 million of loans in 90 days past due status. Delinquencies of 90 days or more on consumer credit card loans increased $3.3 million, or 30.5% compared to 2007. Loans on non-accrual status increased $53.2 million to $72.9 million in 2008 from $19.7 million in 2007. This growth included increases of $41.1 million in non-accrual construction and land loans, $7.5 million in non-accrual business real estate loans, and $5.7 million in non-accrual personal real estate loans. Other loans identified as potential future problem loans increased $211.5 million, primarily due to increases in business loans and construction and land loans. These trends were reflective of the economic downturn experienced in 2008. The Company’s analysis of the allowance considered these trends, which resulted in an increase in the allowance balance during 2008. The percentage of allowance to loans increased to 1.53% in 2008 compared to 1.26% in 2007 as a result of the increase in the allowance balance, offset slightly by an increase in loan balances of 6.4%.
 
Net charge-offs totaled $69.9 million in 2008, and increased $27.1 million, or 63.5%, compared to net charge-offs of $42.7 million in 2007. Net charge-offs related to business loans were $4.4 million annually in 2008 and 2007. Construction and land loans incurred net charge-offs of $6.2 million in 2008 compared to $2.0 million in 2007. Certain construction and land loans have experienced lower credit quality in 2008 resulting from the slowdown in the housing market, which has affected the construction business. Net charge-offs related to consumer loans increased by $11.9 million to $21.4 million at December 31, 2008, representing 30.7% of total net charge-offs during 2008. This increase was due primarily to a $9.9 million increase in net charge-offs related to marine and recreational vehicle loans. Additionally, net charge-offs related to consumer credit cards increased $7.8 million to $31.5 million in 2008 compared to $23.7 million in 2007. Approximately 45.1% of total net loan charge-offs during 2008 were related to consumer credit card loans compared to 55.5% during 2007. Net consumer credit card charge-offs increased to 4.1% of average consumer credit card loans in 2008 compared to 3.6% in 2007. At year end 2008, the ratio of consumer credit card loans 30 days or more delinquent to the total outstanding balance was 3.9%, compared to 2.8% at year end 2007.


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The ratio of net charge-offs to average loans outstanding in 2008 was .64% compared to .42% in 2007 and .29% in 2006. The provision for loan losses was $108.9 million, compared to a provision of $42.7 million in 2007 and $25.6 million in 2006.
 
The Company considers the allowance for loan losses of $172.6 million adequate to cover losses inherent in the loan portfolio at December 31, 2008.
 
The schedules which follow summarize the relationship between loan balances and activity in the allowance for loan losses:
 
                                         
 
    Years Ended December 31  
(Dollars in thousands)   2008     2007     2006     2005     2004  
 
 
Net loans outstanding at end of year(A)
  $ 11,283,246     $ 10,605,368     $ 9,681,520     $ 8,893,011     $ 8,294,353  
 
 
Average loans outstanding(A)
  $ 10,935,858     $ 10,189,316     $ 9,105,432     $ 8,549,573     $ 8,117,608  
 
 
Allowance for loan losses:
                                       
Balance at beginning of year
  $ 133,586     $ 131,730     $ 128,447     $ 132,394     $ 135,221  
 
 
Additions to allowance through charges to expense
    108,900       42,732       25,649       28,785       30,351  
Allowances of acquired companies
          1,857       3,688              
 
 
Loans charged off:
                                       
Business
    7,820       5,822       1,343       1,083       8,047  
Real estate – construction and land
    6,215       2,049       62             7  
Real estate – business
    2,293       2,396       854       827       747  
Real estate – personal
    1,765       181       119       87       355  
Consumer(B)
    26,229       14,842       11,364       13,441       12,764  
Home equity(B)
    447       451       158       34        
Consumer credit card
    35,825       28,218       22,104       28,263       23,682  
Overdrafts
    4,499       4,909       4,940       3,485       2,551  
 
 
Total loans charged off
    85,093       58,868       40,944       47,220       48,153  
 
 
Recovery of loans previously charged off:
                                       
Business
    3,406       1,429       2,166       4,099       2,405  
Real estate – construction and land
          37                   3  
Real estate – business
    117       1,321       890       330       978  
Real estate – personal
    51       42       27       57       138  
Consumer(B)
    4,782       5,304       5,263       4,675       5,288  
Home equity(B)
    18       5       23              
Consumer credit card
    4,309       4,520       4,250       3,851       4,249  
Overdrafts
    2,543       3,477       2,271       1,476       1,914  
 
 
Total recoveries
    15,226       16,135       14,890       14,488       14,975  
 
 
Net loans charged off
    69,867       42,733       26,054       32,732       33,178  
 
 
Balance at end of year
  $ 172,619     $ 133,586     $ 131,730     $ 128,447     $ 132,394  
 
 
Ratio of allowance to loans at end of year
    1.53 %     1.26 %     1.36 %     1.44 %     1.60 %
Ratio of provision to average loans outstanding
    1.00 %     .42 %     .28 %     .34 %     .37 %
 
 
(A) Net of unearned income, before deducting allowance for loan losses, excluding loans held for sale.
(B) For 2004, amounts for home equity loans are included in the consumer category.
 


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    Years Ended December 31  
(Dollars in thousands)   2008     2007     2006     2005     2004  
 
 
Ratio of net charge-offs to average loans outstanding, by loan category:
                                       
Business
    .13 %     .14 %     NA       NA       .27 %
Real estate – construction and land
    .89       .30       .01              
Real estate – business
    .10       .05       NA       .03       NA  
Real estate – personal
    .11       .01       .01             .02  
Consumer*
    1.28       .61       .45       .71       .39  
Home equity*
    .09       .10       .03       .01        
Consumer credit card
    4.06       3.56       3.00       4.40       3.77  
Overdrafts
    16.40       10.36       18.18       14.36       4.78  
 
 
Ratio of total net charge-offs to total average loans outstanding
    .64 %     .42 %     .29 %     .38 %     .41 %
 
 
For 2004, the consumer charge-off ratio is the combined ratio for consumer and home equity loans.
NA: Net recoveries were experienced in these years.
 
The following schedule provides a breakdown of the allowance for loan losses by loan category and the percentage of each loan category to total loans outstanding at year end:
 
                                                                                 
 
(Dollars in thousands)   2008     2007     2006     2005     2004  
 
    Loan Loss
    % of Loans
    Loan Loss
    % of Loans
    Loan Loss
    % of Loans
    Loan Loss
    % of Loans
    Loan Loss
    % of Loans
 
    Allowance
    to Total
    Allowance
    to Total
    Allowance
    to Total
    Allowance
    to Total
    Allowance
    to Total
 
    Allocation     Loans     Allocation     Loans     Allocation     Loans     Allocation     Loans     Allocation     Loans  
   
 
Business
  $ 37,912       30.2 %   $ 29,392       30.7 %   $ 28,529       29.5 %   $ 26,211       28.4 %   $ 39,312       27.0 %
RE – construction and land
    23,526       7.4       8,507       6.3       4,605       6.8       3,375       4.8       1,420       5.2  
RE – business
    25,326       19.0       14,842       21.1       19,343       22.2       19,432       21.6       15,910       21.0  
RE – personal
    4,680       14.5       2,389       14.5       2,243       15.3       4,815       15.3       7,620       16.1  
Consumer*
    28,638       14.3       24,611       15.6       18,655       14.8       18,951       14.5       22,652       14.4  
Home equity*
    1,332       4.4       5,839       4.3       5,035       4.6       5,916       5.0             4.9  
Student*
          3.2                               497       3.7             4.3  
Consumer credit card
    49,492       6.9       44,307       7.4       39,965       6.7       35,513       6.6       28,895       6.8  
Overdrafts
    1,713       .1       2,351       .1       3,592       .1       2,739       .1       4,895       .3  
Unallocated
                1,348             9,763             10,998             11,690        
 
 
Total
  $ 172,619       100.0 %   $ 133,586       100.0 %   $ 131,730       100.0 %   $ 128,447       100.0 %   $ 132,394       100.0 %
 
 
* In 2004, the allowance allocation to the consumer loan category included allocations for home equity and student loans.
 
Risk Elements of Loan Portfolio
 
Management reviews the loan portfolio continuously for evidence of problem loans. During the ordinary course of business, management becomes aware of borrowers that may not be able to meet the contractual requirements of loan agreements. Such loans are placed under close supervision with consideration given to placing the loan on non-accrual status, the need for an additional allowance for loan loss, and (if appropriate) partial or full loan charge-off. Loans are placed on non-accrual status when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment. Loans that are 90 days past due as to principal and/or interest payments are generally placed on non-accrual, unless they are both well-secured and in the process of collection, or they are consumer loans that are exempt under regulatory rules from being classified as non-accrual. Consumer installment loans and related accrued interest are normally charged down to the fair value of related collateral (or are charged off in full if no collateral) once the loans are more than 120 days delinquent. Credit card loans and the related accrued interest are charged off when the receivable is more than 180 days past due. After a loan is placed on non-accrual status, any interest previously accrued but not yet collected is reversed against current income. Interest is included in income only as received and only after all previous loan charge-offs have been recovered, so long as management is satisfied there is no

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impairment of collateral values. The loan is returned to accrual status only when the borrower has brought all past due principal and interest payments current and, in the opinion of management, the borrower has demonstrated the ability to make future payments of principal and interest as scheduled.
 
The following schedule shows non-performing assets and loans past due 90 days and still accruing interest.
 
                                         
 
    December 31  
(Dollars in thousands)   2008     2007     2006     2005     2004  
 
 
Non-accrual loans:
                                       
Business
  $ 4,007     $ 4,700     $ 5,808     $ 5,916     $ 9,547  
Real estate – construction and land
    48,871       7,769       120             685  
Real estate – business
    13,137       5,628       9,845       3,149       6,558  
Real estate – personal
    6,794       1,095       384       261       458  
Consumer
    87       547       551       519       370  
 
 
Total non-accrual loans
    72,896       19,739       16,708       9,845       17,618  
 
 
Real estate acquired in foreclosure
    6,181       13,678       1,515       1,868       1,157  
 
 
Total non-performing assets
  $ 79,077     $ 33,417     $ 18,223     $ 11,713     $ 18,775  
 
 
Non-performing assets as a percentage of total loans
    .70 %     .32 %     .19 %     .13 %     .23 %
 
 
Non-performing assets as a percentage of total assets
    .45 %     .21 %     .12 %     .08 %     .13 %
 
 
Past due 90 days and still accruing interest:
                                       
Business
  $ 1,459     $ 1,427     $ 2,814     $ 1,026     $ 357  
Real estate – construction and land
    466       768       593              
Real estate – business
    1,472       281       1,336       1,075       520  
Real estate – personal
    4,717       5,131       3,994       2,998       3,165  
Consumer
    3,478       1,914       1,255       1,069       916  
Home equity
    440       700       659       429       317  
Student
    14,018       1       1       74       199  
Consumer credit card
    13,914       10,664       9,724       7,417       7,311  
Overdrafts
                            282  
 
 
Total past due 90 days and still accruing interest
  $ 39,964     $ 20,886     $ 20,376     $ 14,088     $ 13,067  
 
 
 
The effect on interest income in 2008 of loans on non-accrual status at year end is presented below:
 
         
   
(In thousands)      
   
 
Gross amount of interest that would have been recorded at original rate
  $ 5,676  
Interest that was reflected in income
    2,960  
 
 
Interest income not recognized
  $ 2,716  
 
 
 
Total non-accrual loans at year end 2008 were $72.9 million, an increase of $53.2 million over the balance at year end 2007. Most of the increase occurred in non-accrual construction and land loans, which included a $19.9 million residential construction loan placed on non-accrual status in December. In addition, business real estate and personal real estate non-accrual loans increased $7.5 million and $5.7 million, respectively. Foreclosed real estate decreased to a total of $6.2 million at year end 2008. Total non-performing assets remain low compared to the Company’s peers, with the non-performing loans to total loans ratio at .65%. Loans past due 90 days and still accruing interest increased $19.1 million at year end 2008 compared to 2007, mainly due to delinquencies in the student loan portfolio acquired in December.
 
In addition to the non-accrual loans mentioned above, the Company also has identified loans for which management has concerns about the ability of the borrowers to meet existing repayment terms. These loans are primarily classified as substandard for regulatory purposes under the Company’s internal rating system. The loans are generally secured by either real estate or other borrower assets, reducing the potential for loss should they become non-performing. Although these loans are generally identified as potential problem loans, they may never become non-performing. Such loans totaled $338.7 million at December 31, 2008 compared with $127.2 million at December 31, 2007. The balance at December 31, 2008 included $135.3 million in construction real estate loans, $125.6 million in business loans and $41.8 million in business real estate loans.


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Loans with Special Risk Characteristics
 
Within the loan portfolio, certain types of loans are considered at higher risk of loss due to their terms, location, or special conditions. Certain personal real estate products have contractual features that could increase credit exposure in a market of declining real estate prices, when interest rates are steadily increasing, or when a geographic area experiences an economic downturn. Loans might be considered at higher risk when 1) loan terms require a minimum monthly payment that covers only interest, or 2) loan-to-collateral value (LTV) ratios are above 80%, with no private mortgage insurance. Information presented below is based on LTV ratios which were generally calculated with valuations at loan origination date.
 
Personal Real Estate Loans
 
Out of the Company’s $1.6 billion personal real estate loan portfolio, approximately 2.6% of the current outstandings are structured with interest only payments. Loans originated with interest only payments were not made to “qualify” the borrower for a lower payment amount. These loans are made to high net-worth borrowers and generally have low LTV ratios or have additional collateral pledged to secure the loan and, therefore, they are not perceived to represent above normal credit risk. At December 31, 2008, these loans had a weighted average LTV of 68%, and there were no delinquencies noted in this group. The majority of the personal real estate portfolio (96.0%) consists of loans written within the Company’s five state branch network territories of Missouri, Kansas, Illinois, Oklahoma, and Colorado.
 
The following table presents information about the personal real estate loan portfolio for 2008 and 2007.
 
                                 
 
    2008     2007  
    Principal
          Principal
       
    Outstanding at
    % of Loan
    Outstanding at
    % of Loan
 
(Dollars in thousands)   December 31     Portfolio     December 31     Portfolio  
 
 
Loans with interest only payments
  $ 35,649       2.6 %   $ 42,309       3.0 %
 
 
Loans with no insurance and LTV:
                               
Between 80% and 90%
    111,220       8.2       94,681       6.6  
Between 90% and 100%
    104,718       7.7       72,438       5.1  
Over 100%
    6,068       .4       3,221       .2  
 
 
Over 80% LTV with no insurance
    222,006       16.3       170,340       11.9  
 
 
Total loan portfolio from which above loans were identified
    1,360,204               1,431,172          
 
 
The weighted average credit score and LTV for this portfolio of personal real estate loans was 732 and 63%, respectively, at December 31, 2008.
 
Revolving Home Equity Loans
 
The Company also has revolving home equity loans that are generally collateralized by residential real estate. Most of these loans (94.5%) are written with terms requiring interest only monthly payments. These loans are offered in three main product lines: LTV up to 80%, 80% to 90%, and 90% to 100%. The following tables break out the year end outstanding balances by product for 2008 and 2007.
 
                                                                 
 
    Principal
                      Unused Portion
                   
    Outstanding at
          New Lines
          of Available Lines
          Balances
       
    December 31
          Originated During
          at December 31
          Over 30
       
(Dollars in thousands)   2008     *     2008     *     2008     *     Days Past Due     *  
 
 
Loans with interest only payments
  $ 476,354       94.5 %   $ 172,868       34.3 %   $ 675,819       134.1 %   $ 1,217       .2 %
 
 
Loans with LTV:
                                                               
Between 80% and 90%
    66,009       13.1       19,578       3.9       49,781       9.9       428       .1  
Over 90%
    28,292       5.6       3,815       .7       20,025       3.9       206        
 
 
Over 80% LTV
    94,301       18.7       23,393       4.6       69,806       13.8       634       .1  
 
 
Total loan portfolio from which above loans were identified
    504,069               174,903               690,800                          
 
 
* Percentage of total principal outstanding of $504.1 million at December 31, 2008.
 


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    Principal
                      Unused Portion
                   
    Outstanding at
          New Lines
          of Available Lines
          Balances
       
    December 31
          Originated During
          at December 31
          Over 30
       
(Dollars in thousands)   2007     *     2007     *     2007     *     Days Past Due     *  
 
 
Loans with interest only payments
  $ 429,875       93.4 %   $ 193,158       42.0 %   $ 668,686       145.3 %   $ 2,764       .6 %
 
 
Loans with LTV:
                                                               
Between 80% and 90%
    57,587       12.5       20,998       4.6       50,406       11.0       677       .2  
Over 90%
    30,451       6.6       17,310       3.8       22,794       5.0       172        
 
 
Over 80% LTV
    88,038       19.1       38,308       8.4       73,200       16.0       849       .2  
 
 
Total loan portfolio from which above loans were identified
    460,200               203,454               685,800                          
 
 
* Percentage of total principal outstanding of $460.2 million at December 31, 2007.
 
Fixed Rate Home Equity Loans
 
In addition to the residential real estate mortgage loans and the revolving floating rate line product discussed above, the Company offers a third choice to those consumers looking for a fixed rate loan and a fixed maturity date. This fixed rate home equity loan, typically for home repair or remodeling, is an alternative for individuals who want to finance a specific project or purchase, and decide to lock in a specific monthly payment over a defined period. This portfolio of loans totaled $151.4 million and $153.2 million at December 31, 2008 and 2007, respectively. At times, these loans are written with interest only monthly payments and a balloon payoff at maturity; however, less than 5% of the outstanding balance has interest only payments. During 2008, the Company stopped offering products with LTV ratios over 90%, which resulted in a $15.5 million decrease in new loans with LTV ratios over 90% in 2008 compared to 2007. The delinquency history on this product has been low, as balances over 30 days past due totaled only $1.4 million and $1.3 million, respectively, or .9% of the portfolio, at year end 2008 and 2007.
 
                                                                 
 
    2008     2007  
    Principal
                      Principal
                   
    Outstanding at
          New Loans
          Outstanding at
          New Loans
       
(Dollars in thousands)   December 31     *     Originated     *     December 31     *     Originated     *  
 
 
Loans with interest only payments
  $ 5,725       3.8 %   $ 5,136       3.4 %   $ 3,534       2.3 %   $ 954       .6 %
 
 
Loans with LTV:
                                                               
Between 80% and 90%
    18,996       12.5       10,960       7.2       13,049       8.5       5,093       3.3  
Over 90%
    34,772       23.0       4,431       3.0       43,140       28.2       19,952       13.0  
 
 
Over 80% LTV
    53,768       35.5       15,391       10.2       56,189       36.7       25,045       16.3  
 
 
Total loan portfolio from which above loans were identified
    151,361                               153,235                          
 
 
* Percentage of total principal outstanding of $151.4 million and $153.2 million at December 31, 2008 and 2007, respectively.
 
Management does not believe these loans collateralized by real estate (personal real estate, revolving home equity, and fixed rate home equity) represent any unusual concentrations of risk, as evidenced by net charge-offs in 2008 of $1.7 million, $429 thousand and $447 thousand, respectively. The amount of any increased potential loss on high LTV agreements relates mainly to amounts advanced that are in excess of the 80% collateral calculation, not the entire approved line. The Company currently offers no subprime loan products, which is defined as those offerings made to customers with a FICO score below 650, and has purchased no brokered loans.
 
Other Consumer Loans
 
Within the consumer loan portfolio of several product lines, the Company has experienced rapid growth in marine and RV loans outstanding over the past 3 years. The majority of these loans were outside the

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Company’s basic five state branch network. The loss ratios experienced in this portion of the portfolio recently were higher than for other consumer loan products, as reflected in the delinquency figures in the table below. Due to the continued weakening credit and economic conditions, this loan product offering was curtailed in mid 2008, as less than $10 million in new loans were written over the last three months of the year. The table below provides the total outstanding principal and other data for this group of direct and indirect lending products at December 31, 2008 and 2007.
 
                                                 
 
    2008     2007  
    Principal
          Balances
    Principal
          Balances
 
    Outstanding at
    New Loans
    Over 30
    Outstanding at
    New Loans
    Over 30
 
(Dollars in thousands)   December 31     Originated     Days Past Due     December 31     Originated     Days Past Due  
 
 
Passenger Vehicles
  $ 485,237     $ 264,096     $ 9,193     $ 500,368     $ 223,995     $ 11,966  
Marine
    230,715       43,458       8,174       238,336       100,476       5,471  
RV
    565,807       150,678       10,264       526,791       311,132       6,659  
Other
    43,833       34,093       634       58,649       65,713       1,156  
 
 
Total
  $ 1,325,592     $ 492,325     $ 28,265     $ 1,324,144     $ 701,316     $ 25,252  
 
 
 
Additionally, the Company offers low introductory “teaser” rates on selected consumer credit card products. Out of a portfolio at December 31, 2008 of $779.7 million in consumer credit card loans outstanding, approximately $151.3 million, or 19.4%, carried a low introductory rate. Within the next 6 months, 75% 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.
 
Investment Securities Analysis
 
Investment securities are comprised of securities which are available for sale, non-marketable, and held for trading. During 2008, total investment securities increased $590.3 million to $3.8 billion (excluding unrealized gains/losses) compared to $3.2 billion at the previous year end. During 2008, securities of $2.4 billion were purchased, which included $602.1 million in agency mortgage-backed securities, $366.7 million in non-agency mortgage-backed securities, $212.6 million in other asset-backed securities, and $539.9 million in auction rate securities (which are included in the state and municipal obligations category). As discussed further in Note 4 to the consolidated financial statements, these auction rate securities (ARS) were purchased from customers with cash flow needs arising from illiquidity in the ARS market. Approximately $341.4 million of these securities were subsequently exchanged for certain loans in December 2008. Total maturities and paydowns were $1.3 billion during 2008. The average tax equivalent yield earned on total investment securities was 4.99% in 2008 and 4.75% in 2007.
 
At December 31, 2008, the fair value of available for sale securities was $3.6 billion, including a net unrealized loss in fair value of $58.7 million, compared to a net gain of $48.4 million at December 31, 2007. The amount of the related after tax unrealized loss reported in stockholders’ equity was $36.4 million at year end 2008. The unrealized loss in fair value was the result of unrealized losses of $121.6 million that relate to non-agency mortgage-backed securities, partly offset by an unrealized gain of $42.3 million on marketable equity securities held by the Parent.


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Available for sale investment securities at year end for the past two years are shown below:
 
                 
   
    December 31  
(In thousands)   2008     2007  
   
 
Amortized Cost
               
U.S. government and federal agency obligations*
  $ 146,303     $ 359,118  
State and municipal obligations
    715,421       498,628  
Agency mortgage-backed securities
    1,685,821       1,523,941  
Non-agency mortgage-backed securities
    742,090       404,909  
Other asset-backed securities
    275,641       218,504  
Other debt securities
    116,527       21,397  
Equity securities
    7,680       90,083  
 
 
Total available for sale investment securities
  $ 3,689,483     $ 3,116,580  
 
 
Fair Value
               
U.S. government and federal agency obligations*
  $ 153,551     $ 360,317  
State and municipal obligations
    719,752       503,363  
Agency mortgage-backed securities
    1,711,404       1,525,122  
Non-agency mortgage-backed securities
    620,479       398,375  
Other asset-backed securities
    253,756       216,988  
Other debt securities
    121,861       21,327  
Equity securities
    49,950       139,528  
 
 
Total available for sale investment securities
  $ 3,630,753     $ 3,165,020  
 
 
  This category includes obligations of government sponsored enterprises, such as FNMA and FHLMC, which are not backed by the full faith and credit of the United States government. Such obligations are separately disclosed in Note 4 on Investment Securities in the consolidated financial statements.
 
 
The Company’s investments in agency mortgage-backed securities are collateralized by U.S. federal agencies, including FNMA, GNMA, FHLMC, FHLB, and Federal Farm Credit Banks. The amortized cost of non-agency mortgage-backed securities at December 31, 2008 totaled $742.1 million and included Alt-A type mortgage-backed securities of $261.7 million and prime/jumbo loan type securities of $480.3 million. At purchase date, these securities all had credit ratings of AAA (or the equivalent) from at least two ratings agencies. The Company’s investment securities portfolio does not have any exposure to subprime originated mortgage-backed or collateralized debt obligation instruments.
 
Other available for sale debt securities, as shown in the table above, include corporate bonds, notes and commercial paper. Available for sale equity securities are comprised of publicly traded stock and short-term investments in money market mutual funds, which totaled $47.0 million and $3.0 million, respectively, at December 31, 2008. In September 2008, the Company shifted much of its investment in mutual funds, which totaled $58.9 million at year end 2007, into other types of securities. Publicly traded stock is held by the Parent.
 
A summary of maturities by category of investment securities and the weighted average yield for each range of maturities as of December 31, 2008, is presented in Note 4 on Investment Securities in the consolidated financial statements. The table below provides summarized information for each category of debt securities.
 
                         
   
    December 31, 2008  
    Percent
    Weighted
    Estimated
 
    of Total
    Average
    Average
 
    Debt Securities     Yield     Maturity*  
   
Available for sale debt securities:
                       
U.S. government and federal agency obligations
    4.3 %     3.62 %     1.8 years
State and municipal obligations
    20.0       4.01       8.6  
Agency mortgage-backed securities
    47.9       4.94       3.2  
Non-agency mortgage-backed securities
    17.3       5.90       5.0  
Other asset-backed securities
    7.1       5.53       1.5  
Other debt securities
    3.4       6.25       4.5  
 
 
  Based on call provisions and estimated prepayment speeds  


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Non-marketable securities, which totaled $139.9 million at December 31, 2008, included $28.7 million in Federal Reserve Bank stock and $55.7 million in Federal Home Loan Bank (Des Moines) stock held by the bank subsidiary in accordance with debt and regulatory requirements. These are restricted securities which, lacking a market, are carried at cost. Other non-marketable securities also include private equity and venture capital securities which are carried at estimated fair value.
 
The Company engages in private equity and venture capital activities through direct private equity investments and through three private equity/venture capital subsidiaries. The subsidiaries hold investments in various portfolio concerns, which are carried at fair value and totaled $49.5 million at December 31, 2008. The Company expects to fund an additional $25.9 million to these subsidiaries for investment purposes over the next several years. In addition to investments held by its private equity/venture capital subsidiaries, the Parent directly holds investments in several private equity concerns, which totaled $5.2 million at year end 2008. Most of the venture capital and private equity investments are not readily marketable. While the nature of these investments carries a higher degree of risk than the normal lending portfolio, this risk is mitigated by the overall size of the investments and oversight provided by management, which believes the potential for long-term gains in these investments outweighs the potential risks.
 
Non-marketable securities at year end for the past two years are shown below:
 
                 
   
    December 31  
(In thousands)   2008     2007  
   
Debt securities
  $ 22,297     $ 17,055  
Equity securities
    117,603       88,462  
 
 
Total non-marketable investment securities
  $ 139,900     $ 105,517  
 
 
 
Deposits and Borrowings
 
Deposits are the primary funding source for the Company’s subsidiary bank, and are acquired from a broad base of local markets, including both individual and corporate customers. Total deposits were $12.9 billion at December 31, 2008, compared to $12.6 billion last year, reflecting an increase of $343.2 million, or 2.7%. Average deposits grew by $371.8 million, or 3.1%, in 2008 compared to 2007 with most of this growth centered in money market accounts, which grew $401.9 million, or 5.9% in 2008 compared to 2007. Certificates of deposit with balances under $100,000 fell on average by $210.3 million, or 8.9%, while certificates of deposit over $100,000 grew $148.6 million, or 10.0%.
 
The following table shows year end deposits by type as a percentage of total deposits.
 
                 
   
    December 31  
    2008     2007  
   
Non-interest bearing demand
    10.7 %     11.3 %
Savings, interest checking and money market
    59.0       57.0  
Time open and C.D.’s of less than $100,000
    16.0       18.9  
Time open and C.D.’s of $100,000 and over
    14.3       12.8  
 
 
Total deposits
    100.0 %     100.0 %
 
 
 
Core deposits (defined as all non-interest and interest bearing deposits, excluding short-term C.D.’s of $100,000 and over) supported 71% of average earning assets in 2008 and 75% in 2007. Average balances by major deposit category for the last six years appear at the end of this discussion. A maturity schedule of time deposits outstanding at December 31, 2008 is included in Note 7 on Deposits in the consolidated financial statements.
 
The Company’s primary sources of overnight borrowings are federal funds purchased and repurchase agreements. Balances in these accounts can fluctuate significantly on a day-to-day basis, and generally have one day maturities. Balances outstanding at year end 2008 were $1.0 billion, a $212.7 million decrease from $1.2 billion outstanding at year end 2007. On an average basis, these borrowings declined $323.0 million, or 19.0% during 2008. Most of this decline occurred in federal funds purchased which, on an average basis,


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declined $332.9 million, or 52.3% in 2008 compared to 2007, as the Company took steps to reduce its inter-bank borrowings exposure. At December 31, 2008, federal funds purchased totaled $24.9 million. The average rate paid on federal funds purchased and repurchase agreements was 1.83% during 2008 and 4.92% during 2007.
 
Additional short-term borrowings are periodically acquired under the Federal Reserve’s temporary Term Auction Facility (TAF) program, which was instituted in December 2007. The TAF is a credit facility under which banking institutions may bid for term borrowings in bi-weekly auctions. The TAF credit is collateralized similarly to discount window borrowings, generally with investment securities and loans. These borrowings totaled $700.0 million at December 31, 2008, with the latest maturity occurring in March 2009. Rates are fixed throughout the term of the advance, and the average rate paid by the Company on its TAF borrowings was 1.36% during 2008.
 
Most of the Company’s long-term debt is comprised of fixed rate advances from the Federal Home Loan Bank (FHLB). As the Company further diversified its funding sources during 2008, these borrowings rose from $561.5 million at December 31, 2007 to $1.0 billion outstanding at December 31, 2008. Approximately 70% of the outstanding balance is due within two years. The average rate paid on FHLB advances was 3.81% during 2008 and 4.68% during 2007.
 
Liquidity and Capital Resources
 
Liquidity Management
 
Liquidity is managed within the Company in order to satisfy cash flow requirements of deposit and borrowing customers while at the same time meeting its own cash flow needs. The Company maintains its liquidity position through a variety of sources including:
 
  •  A portfolio of liquid assets including marketable investment securities and overnight investments,
 
  •  A large customer deposit base and limited exposure to large, volatile certificates of deposit,
 
  •  Lower long-term borrowings that might place a demand on Company cash flow,
 
  •  Relatively low loan to deposit ratio promoting strong liquidity,
 
  •  Excellent debt ratings from both Standard & Poor’s and Moody’s national rating services, and
 
  •  Available borrowing capacity from outside sources.
 
During 2008, liquidity risk became a concern affecting the general banking industry, as some of the major banking institutions across the country experienced an unprecedented erosion in capital. This erosion was fueled by declines in asset values, losses in market and investor confidence, and higher defaults, resulting in higher costing and less available credit. The Company, as discussed below, has taken numerous steps to address liquidity risk and over the past few years has developed a variety of liquidity sources which it believes will provide the necessary funds to grow its business into the future.
 
The Company did not apply for funds through the Federal Treasury’s Capital Purchase Program. This program is part of the federal government’s Troubled Asset Relief Program approved by Congress in October 2008 to build capital in U.S. financial institutions and increase the flow of financing to business and consumers. Under this program, the Company, if approved, would have been eligible to issue senior preferred stock to the Treasury, ranging from approximately $140 million to $400 million, in addition to warrants to purchase common stock. The program was carefully studied and the Company made a business decision not to apply. Management believes that the Company’s earnings, capital and liquidity are strong and sufficient to grow its business. Conditions that might induce the Company to seek additional capital include acquisition opportunities or events discussed under Risk Factors on page 8. While the current troubled banking and economic environment is historic and has understandably created a high degree of uncertainty, the Company believes it is well positioned to face this challenge.


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The Company’s most liquid assets include available for sale marketable investment securities, federal funds sold, balances at the Federal Reserve Bank (FRB), and securities purchased under agreements to resell (resale agreements). At December 31, 2008 and 2007, such assets were as follows:
 
                 
   
(In thousands)   2008     2007  
   
Available for sale investment securities
  $ 3,630,753     $ 3,165,020  
Federal funds sold
    59,475       261,165  
Resale agreements
    110,000       394,000  
Balances at the Federal Reserve Bank
    638,158        
 
 
Total
  $ 4,438,386     $ 3,820,185  
 
 
 
Federal funds sold and resale agreements normally have overnight maturities and are used to satisfy the daily cash needs of the Company. Effective October 1, 2008, cash balances maintained at the FRB began earning interest. These balances are also used for general daily liquidity purposes. The Company’s available for sale investment portfolio has maturities of approximately $516 million which will occur during 2009 and offers substantial resources to meet either new loan demand or reductions in the Company’s deposit funding base. The Company pledges portions of its investment securities portfolio to secure public fund deposits, securities sold under agreements to repurchase (repurchase agreements), trust funds, letters of credit issued by the FHLB, and borrowing capacity at the FRB. At December 31, 2008, total investment securities pledged for these purposes were as follows:
 
         
   
(In thousands)   2008  
   
Investment securities pledged for the purpose of securing:
       
Federal Reserve Bank borrowings
  $ 268,967  
FHLB borrowings and letters of credit
    418,293  
Repurchase agreements
    1,363,294  
Other deposits
    544,580  
 
 
Total pledged, at fair value
  $ 2,595,134  
 
 
 
Liquidity is also available from the Company’s large base of core customer deposits, defined as demand, interest checking, savings, and money market deposit accounts. At December 31, 2008, such deposits totaled $9.0 billion and represented 69.7% of the Company’s total deposits. These core deposits are normally less volatile, often with customer relationships tied to other products offered by the Company promoting long lasting relationships and stable funding sources. Time open and certificates of deposit of $100,000 or greater totaled $1.8 billion at December 31, 2008. These deposits are normally considered more volatile and higher costing, and comprised 14.3% of total deposits at December 31, 2008.
 
                 
   
(In thousands)   2008     2007  
   
Core deposit base:
               
Non-interest bearing demand
  $ 1,375,000     $ 1,413,849  
Interest checking
    700,714       580,048  
Savings and money market
    6,909,592       6,575,318  
 
 
Total
  $ 8,985,306     $ 8,569,215  
 
 


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Other important components of liquidity are the level of borrowings from third party sources and the availability of future credit. The Company’s outside borrowings are mainly comprised of federal funds purchased, repurchase agreements, and advances from the FRB and the FHLB, as follows:
 
                 
   
(In thousands)   2008     2007  
   
Borrowings:
               
Federal funds purchased
  $ 24,900     $ 126,077  
Repurchase agreements
    1,001,637       1,113,142  
FHLB advances
    1,025,721       561,475  
Subordinated debentures
    14,310       14,310  
Term auction facility
    700,000        
Other long-term debt
    7,750       7,851  
 
 
Total
  $ 2,774,318     $ 1,822,855  
 
 
 
Federal funds purchased and repurchase agreements are generally borrowed overnight and amounted to $1.0 billion at December 31, 2008. Federal funds purchased are unsecured overnight borrowings obtained mainly from upstream correspondent banks with which the Company maintains approved lines of credit. Repurchase agreements are secured by a portion of the Company’s investment portfolio and are comprised of both non-insured customer funds, totaling $501.6 million at December 31, 2008, and structured repurchase agreements of $500.0 million purchased from an upstream financial institution. Customer repurchase agreements are offered to customers wishing to earn interest in highly liquid balances and are used by the Company as a funding source considered to be stable, but short-term in nature. Beginning in mid 2008, the Company began to periodically borrow additional short-term funds from the FRB through its Term Auction Facility (TAF), of which $700.0 million were outstanding at December 31, 2008. The TAF offered attractive funding with low rates and made possible the reduction in federal funds purchased. The Company also borrows on a secured basis through advances from the FHLB, which totaled $1.0 billion at December 31, 2008. Most of these advances have fixed interest rates and mature in 2009 through 2010. The Company’s other borrowings are comprised of debentures funded by trust preferred securities and debt related to the Company’s venture capital business. The overall long-term debt position of the Company is small relative to the Company’s overall liability position.
 
The Company pledges certain assets, including loans and investment securities, to both the Federal Reserve Bank and the FHLB as security to establish lines of credit and borrow from these entities. Based on the amount and type of collateral pledged, the FHLB establishes a collateral value from which the Company may draw advances against the collateral. Also, this collateral is used to enable the FHLB to issue letters of credit in favor of public fund depositors of the Company. The Federal Reserve Bank also establishes a collateral value of assets pledged and permits borrowings from either the discount window or the Term Auction Facility. The following table reflects the collateral value of assets pledged, borrowings, and letters of credit outstanding, in addition to the estimated future funding capacity available to the Company at December 31, 2008:
 
                 
   
    December 31, 2008  
(In thousands)   FHLB     Federal Reserve  
   
Collateral value pledged
  $ 2,533,656     $ 1,327,851  
Advances outstanding
    (1,025,721 )      
Letters of credit issued
    (1,068,990 )      
Term auction facility
          (700,000 )
 
 
Available for future advances
  $ 438,945     $ 627,851  
 
 


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The Company had an average loans to deposits ratio of 92% at December 31, 2008, which is considered in the banking industry to be a conservative measure of good liquidity. Also, the Company receives outside ratings from both Standard & Poor’s and Moody’s on both the consolidated company and its subsidiary bank, Commerce Bank, N.A. These ratings are as follows:
 
         
 
    Standard & Poor’s   Moody’s
 
Commerce Bancshares, Inc.
       
Counterparty rating
  A-1    
Commercial paper rating
  A-1    
Short-term
      P-1
Rating outlook
  Stable   Stable
Commerce Bank, N. A.
       
Counterparty credit
  A+    
Senior long-term rating
  A+    
Long-term bank deposits
      Aa2
Bank financial strength rating
      B+
 
 
 
The Company considers these ratings to be indications of a sound capital base and good liquidity, and believes that these ratings would help ensure the ready marketability of its commercial paper, should the need arise. No commercial paper was outstanding over the past ten years. The Company has little subordinated debt or hybrid instruments which would affect future borrowings capacity. Because of its lack of significant long-term debt, the Company believes that, through its Capital Markets Group or in other public debt markets, it could generate additional liquidity from sources such as jumbo certificates of deposit, privately-placed corporate notes or other debt. Future financing could also include the issuance of common or preferred stock.
 
The Company funds a defined benefit pension plan for a majority of its current employees. Under the funding policy for the plan, contributions are made as necessary to provide for current service and for any unfunded accrued actuarial liabilities over a reasonable period. During the period 2006 through 2008, the Company has not been required to make cash contributions to the plan and does not expect to do so in 2009.
 
The cash flows from the operating, investing and financing activities of the Company resulted in a net decrease in cash and cash equivalents of $28.9 million in 2008, as reported in the consolidated statements of cash flows on page 64 of this report. Operating activities, consisting mainly of net income adjusted for certain non-cash items, provided cash flow of $217.3 million and has historically been a stable source of funds. Investing activities used total cash of $1.5 billion in 2008, and consist mainly of purchases and maturities of available for sale investment securities and changes in the level of the Company’s loan portfolio. Both the investment securities and loan portfolios grew during 2008, using cash of $952.7 million and $412.6 million, respectively. Investing activities are somewhat unique to financial institutions in that, while large sums of cash flow are normally used to fund growth in investment securities, loans, or other bank assets, they are normally dependent on the financing activities described below.
 
Financing activities provided total cash of $1.2 billion, resulting from increases of $800.0 million in short-term borrowings and $364.1 million in long-term borrowings, in addition to a net increase in deposits of $344.7 million. Partly offsetting these cash inflows were a decline in federal funds purchased and repurchase agreements of $212.4 million and cash dividend payments of $72.1 million. Future short-term liquidity needs for daily operations are not expected to vary significantly and the Company maintains adequate liquidity to meet these cash flows. The Company’s sound equity base, along with its low debt level, common and preferred stock availability, and excellent debt ratings, provide several alternatives for future financing. Future acquisitions may utilize partial funding through one or more of these options.


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Cash used for treasury stock purchases, net of cash received in connection with stock programs, and dividend payments were as follows:
 
                         
   
(In millions)   2008     2007     2006  
   
Purchases of treasury stock
  $ 9.5     $ 128.6     $ 135.0  
Exercise of stock options and sales to affiliate non-employee directors
    (16.0 )     (13.7 )     (7.3 )
Cash dividends
    72.1       68.9       65.8  
 
 
Total
  $ 65.6     $ 183.8     $ 193.5  
 
 
 
In the first quarter of 2008, given the challenging banking environment, the Company elected to cease market purchases of treasury stock and preserve its cash and capital position. Accordingly, cash purchases of treasury stock declined $119.1 million in 2008 compared to 2007.
 
The Parent faces unique liquidity constraints due to legal limitations on its ability to borrow funds from its bank subsidiary. The Parent obtains funding to meet its obligations from two main sources: dividends received from bank and non-bank subsidiaries (within regulatory limitations) and from management fees charged to subsidiaries as reimbursement for services provided by the Parent, as presented below:
 
                         
   
(In millions)   2008     2007     2006  
   
Dividends received from subsidiaries
  $ 76.2     $ 179.5     $ 140.5  
Management fees
    44.0       39.1       37.7  
 
 
Total
  $ 120.2     $ 218.6     $ 178.2  
 
 
 
These sources of funds are used mainly to purchase treasury stock, pay cash dividends on outstanding common stock, and pay general operating expenses. At December 31, 2008, the Parent’s available for sale investment securities totaled $47.5 million at fair value, consisting mainly of publicly traded common stock. To support its various funding commitments, the Parent maintains a $20.0 million line of credit with its subsidiary bank. The Parent had no borrowings outstanding under the line at December 31, 2008.
 
Company senior management is responsible for measuring and monitoring the liquidity profile of the organization with oversight by the Company’s Asset/Liability Committee (ALCO). This is done through a series of controls, including a written Contingency Funding Policy and risk monitoring procedures, including daily, weekly and monthly reporting. In addition, the Company prepares forecasts which project changes in the balance sheet affecting liquidity, and which allow the Company to better plan for forecasted changes.
 
Capital Management
 
The Company maintains strong regulatory capital ratios, including those of its principal banking subsidiaries, in excess of the “well-capitalized” guidelines under federal banking regulations. The Company’s capital ratios at the end of the last three years are as follows:
 
                                 
   
                      Well-Capitalized
 
                      Regulatory
 
    2008     2007     2006     Guidelines  
   
Risk-based capital ratios:
                               
Tier I capital
    10.92 %     10.31 %     11.25 %     6.00 %
Total capital
    12.31       11.49       12.56       10.00  
Leverage ratio
    9.06       8.76       9.05       5.00  
Common equity/assets
    9.69       9.54       9.68          
Dividend payout ratio
    38.39       33.76       30.19          
 
 
 


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The components of the Company’s regulatory risked-based capital and risk-weighted assets at the end of the last three years are as follows:
 
                         
   
(In thousands)   2008     2007     2006  
   
Regulatory risk-based capital:
                       
Tier I capital
  $ 1,510,959     $ 1,375,035     $ 1,345,378  
Tier II capital
    191,957       157,154       157,008  
Total capital
    1,702,916       1,532,189       1,502,386  
Total risk-weighted assets
    13,834,161       13,330,968       11,959,757  
 
 
 
In February 2008, the Board of Directors authorized the Company to purchase additional shares of common stock under its repurchase program, which brought the total purchase authorization to 3,000,000 shares. During 2008, approximately 231,000 shares were acquired under the current Board authorization at an average price of $41.15 per share.
 
The Company’s common stock dividend policy reflects its earnings outlook, desired payout ratios, the need to maintain adequate capital levels and alternative investment options. Per share cash dividends paid by the Company increased 5.0% in 2008 compared with 2007. The Company paid its fifteenth consecutive annual stock dividend in December 2008.
 
Commitments, Contractual Obligations, and Off-Balance Sheet Arrangements
 
Various commitments and contingent liabilities arise in the normal course of business, which are not required to be recorded on the balance sheet. The most significant of these are loan commitments, totaling $7.9 billion (including approximately $3.6 billion in unused approved credit card lines), and the contractual amount of standby letters of credit, totaling $418.0 million at December 31, 2008. The Company has various other financial instruments with off-balance sheet risk, such as commercial letters of credit and commitments to purchase and sell when-issued securities. Since many commitments expire unused or only partially used, these totals do not necessarily reflect future cash requirements. Management does not anticipate any material losses arising from commitments and contingent liabilities and believes there are no material commitments to extend credit that represent risks of an unusual nature.
 
A table summarizing contractual cash obligations of the Company at December 31, 2008 and the expected timing of these payments follows:
 
                                         
    Payments Due by Period  
   
          After One Year
    After Three
    After
       
    In One Year
    Through Three
    Years Through
    Five
       
(In thousands)   or Less     Years     Five Years     Years     Total  
   
 
Long-term debt obligations, including structured repurchase agreements*
  $ 301,140     $ 920,171     $ 59,734     $ 166,736     $ 1,447,781  
Operating lease obligations
    5,860       8,236       5,350       23,008       42,454  
Purchase obligations
    27,933       33,180       18,853       300       80,266  
Time open and C.D.’s*
    3,432,816       425,068       51,235       308       3,909,427  
 
 
Total
  $ 3,767,749     $ 1,386,655     $ 135,172     $ 190,352     $ 5,479,928  
 
 
Includes principal payments only
 
As of December 31, 2008, the Company has unrecognized tax benefits that, if recognized, would impact the effective tax rate in future periods. Due to the uncertainty of the amounts to be ultimately paid as well as the timing of such payments, all uncertain tax liabilities that have not been paid have been excluded from the table above. Further detail on the impact of income taxes is located in Note 9 of the consolidated financial statements.
 
The Company has investments in several low-income housing partnerships within the area it serves. At December 31, 2008, these investments totaled $4.3 million and were recorded as other assets in the Company’s consolidated balance sheet. These partnerships supply funds for the construction and operation of apartment complexes that provide affordable housing to that segment of the population with lower family


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income. If these developments successfully attract a specified percentage of residents falling in that lower income range, state and/or federal income tax credits are made available to the partners. The tax credits are normally recognized over ten years, and they play an important part in the anticipated yield from these investments. In order to continue receiving the tax credits each year over the life of the partnership, the low-income residency targets must be maintained. Under the terms of the partnership agreements, the Company has a commitment to fund a specified amount that will be due in installments over the life of the agreements, which ranges from 10 to 15 years. These unfunded commitments are recorded as liabilities on the Company’s consolidated balance sheet, and aggregated $3.3 million at December 31, 2008.
 
The Company periodically purchases various state tax credits arising from third-party property redevelopment. Most of the tax credits are resold to third parties, although some may be retained for use by the Company. During 2008, purchases and sales of tax credits amounted to $41.6 million and $43.3 million, respectively, generating combined gains on sales and tax savings of $2.2 million. At December 31, 2008, the Company had outstanding purchase commitments totaling $135.2 million.
 
The Parent has investments in several private equity concerns which are classified as non-marketable securities in the Company’s consolidated balance sheet. Under the terms of the agreements with three of these concerns, the Parent has unfunded commitments outstanding of $1.6 million at December 31, 2008. The Parent also expects to fund $25.9 million to venture capital subsidiaries over the next several years.
 
Interest Rate Sensitivity
 
The Company’s Asset/Liability Management Committee (ALCO) measures and manages the Company’s interest rate risk on a monthly basis to identify trends and establish strategies to maintain stability in earnings throughout various rate environments. Analytical modeling techniques provide management insight into the Company’s exposure to changing rates. These techniques include net interest income simulations and market value analyses. Management has set guidelines specifying acceptable limits within which net interest income and market value may change under various rate change scenarios. These measurement tools indicate that the Company is currently within acceptable risk guidelines as set by management.
 
The Company’s main interest rate measurement tool, income simulations, projects net interest income under various rate change scenarios in order to quantify the magnitude and timing of potential rate-related changes. Income simulations are able to capture option risks within the balance sheet where expected cash flows may be altered under various rate environments. Modeled rate movements include “shocks, ramps and twists”. Shocks are intended to capture interest rate risk under extreme conditions by immediately shifting rates up and down, while ramps measure the impact of gradual changes and twists measure yield curve risk. The size of the balance sheet is assumed to remain constant so that results are not influenced by growth predictions. The table below shows the expected effect that gradual basis point shifts in the LIBOR/swap curve over a twelve month period would have on the Company’s net interest income, given a static balance sheet.
 
                                                 
   
    December 31, 2008     September 30, 2008     December 31, 2007  
    Increase
    % of Net Interest
    Increase
    % of Net Interest
    Increase
    % of Net Interest
 
(Dollars in millions)   (Decrease)     Income     (Decrease)     Income     (Decrease)     Income  
   
300 basis points rising
  $ 37.3       6.38 %   $ 10.6       1.77 %   $ (.7 )     (.12 )%
200 basis points rising
    30.6       5.23       8.7       1.46       2.3       .40  
100 basis points rising
    18.1       3.10       4.7       .79       2.0       .34  
100 basis points falling
    N.A.       N.A.       (3.1 )     (.51 )     (1.2 )     (.20 )
 
 
 
The Company also employs a sophisticated simulation technique known as a stochastic income simulation. This technique allows management to see a range of results from hundreds of income simulations. The stochastic simulation creates a vector of potential rate paths around the market’s best guess (forward rates) concerning the future path of interest rates and allows rates to randomly follow paths throughout the vector. This allows for the modeling of non-biased rate forecasts around the market consensus. Results give management insight into a likely range of rate-related risk as well as worst and best-case rate scenarios.


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The Company also uses market value analyses to help identify longer-term risks that may reside on the balance sheet. This is considered a secondary risk measurement tool by management. The Company measures the market value of equity as the net present value of all asset and liability cash flows discounted along the current LIBOR/swap curve plus appropriate market risk spreads. It is the change in the market value of equity under different rate environments, or effective duration, that gives insight into the magnitude of risk to future earnings due to rate changes. Market value analyses also help management understand the price sensitivity of non-marketable bank products under different rate environments.
 
The Company’s modeling of interest rate risk as of December 31, 2008 shows that under various rising rate scenarios, net interest income would show growth. The Company has not modeled a 100 basis point falling scenario due to the already extremely low interest rate environment. At December 31, 2008, the Company calculated that a gradual increase in rates of 100 basis points would increase net interest income by $18.1 million, or 3.1% of total net interest income, compared with an increase of $2.0 million calculated at December 31, 2007. A 200 basis point gradual rise in rates calculated at December 31, 2008 would increase net interest income by $30.6 million, or 5.2%, up from an increase of $2.3 million last year. Also, a gradual increase of 300 basis points would increase net interest income by $37.3 million, or 6.4%, compared to a decline of $700 thousand at December 31, 2007.
 
The projected increase in net interest income in various rising rate environments is due to several factors, including higher average loan balances in 2008 compared to the previous year (average increase of $746.5 million) which contain both variable and fixed rate loans, but with relatively short maturities and growth of $411.2 million in average non-maturity deposits, which have lower rates and can re-price upwards more slowly. Also, average certificates of deposit balances, which carry higher rates and re-price more slowly, declined $61.6 million from the prior year. Overnight borrowings with variable rates declined $323.0 million, while other borrowed funds, mostly with fixed rates, increased $800.3 million over 2007. The simulation models also calculate a slower upward re-pricing of non-maturity deposits, while the overall loan portfolio, due to its average life and composition of variable rate loans, will re-price more quickly.
 
Through review and oversight by the ALCO, the Company attempts to engage in strategies that neutralize interest rate risk as much as possible. The Company’s balance sheet remains well-diversified with moderate interest rate risk and is well-positioned for future growth. The use of derivative products is limited and the deposit base is strong and stable. The loan to deposit ratio is still at relatively low levels, which should present the Company with opportunities to fund future loan growth at reasonable costs. The Company believes that its approach to interest rate risk has appropriately considered its susceptibility to both rising and falling rates and has adopted strategies which minimize impacts of interest rate risk.
 
Derivative Financial Instruments
 
The Company maintains an overall interest rate risk management strategy that permits the use of derivative instruments to modify exposure to interest rate risk. The Company’s interest rate risk management strategy includes the ability to modify the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not adversely affect the net interest margin and cash flows. Interest rate swaps are used on a limited basis as part of this strategy. As of December 31, 2008, the Company had entered into two interest rate swaps with a notional amount of $12.2 million which are designated as fair value hedges of certain fixed rate loans. The Company also sells swap contracts to customers who wish to modify their interest rate sensitivity. The Company offsets the interest rate risk of these swaps by purchasing matching contracts with offsetting pay/receive rates from other financial institutions. The notional amount of these types of swaps at December 31, 2008 was $479.9 million.
 
The Company enters into foreign exchange derivative instruments as an accommodation to customers and offsets the related foreign exchange risk by entering into offsetting third-party forward contracts with approved, reputable counterparties. In addition, the Company takes proprietary positions in such contracts based on market expectations. This trading activity is managed within a policy of specific controls and limits.


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Most of the foreign exchange contracts outstanding at December 31, 2008 mature within 90 days, and the longest period to maturity is 11 months.
 
Additionally, interest rate lock commitments issued on residential mortgage loans held for resale are considered derivative instruments. The interest rate exposure on these commitments is economically hedged primarily with forward sale contracts in the secondary market.
 
In all of these contracts, the Company is exposed to credit risk in the event of nonperformance by counterparties, who may be bank customers or other financial institutions. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures. Because the Company generally enters into transactions only with high quality counterparties, there have been no losses associated with counterparty nonperformance on derivative financial instruments.
 
Effective January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements”. This Statement modified the accounting for initial recognition of fair value for certain interest rate swap contracts held by the Company. Former accounting guidance precluded immediate recognition in earnings of an unrealized gain or loss, measured as the difference between the transaction price and fair value of these instruments at initial recognition. This former guidance was nullified by SFAS No. 157, which allows for the immediate recognition of a gain or loss under certain circumstances. In accordance with the new recognition requirements, the Company increased equity by $903 thousand on January 1, 2008 to reflect the swaps at fair value as defined by SFAS No. 157.
 
The following table summarizes the notional amounts and estimated fair values of the Company’s derivative instruments at December 31, 2008 and 2007. Notional amount, along with the other terms of the derivative, is used to determine the amounts to be exchanged between the counterparties. Because the notional amount does not represent amounts exchanged by the parties, it is not a measure of loss exposure related to the use of derivatives nor of exposure to liquidity risk. Positive fair values are recorded in other assets and negative fair values are recorded in other liabilities in the consolidated balance sheets.
 
                                                 
   
    2008     2007  
          Positive
    Negative
          Positive
    Negative
 
    Notional
    Fair
    Fair
    Notional
    Fair
    Fair
 
(In thousands)   Amount     Value     Value     Amount     Value     Value  
   
 
Interest rate swaps
  $ 492,111     $ 25,274     $ (26,568 )   $ 308,361     $ 4,766     $ (6,333 )
Credit risk participation agreements
    47,750       117       (178 )     25,389             (174 )
Foreign exchange contracts:
                                               
Forward contracts
    6,226       207       (217 )     12,212       105       (149 )
Option contracts
    3,300       18       (18 )     3,120       9       (9 )
Mortgage loan commitments
    23,784       198       (6 )     7,123       18       (10 )
Mortgage loan forward sale contracts
    26,996       21       (88 )     15,017       25       (34 )
 
 
Total at December 31
  $ 600,167     $ 25,835     $ (27,075 )   $ 371,222     $ 4,923     $ (6,709 )
 
 
 
Operating Segments
 
The Company segregates financial information for use in assessing its performance and allocating resources among three operating segments. The results are determined based on the Company’s management accounting process, which assigns balance sheet and income statement items to each responsible segment. These segments are defined by customer base and product type. The management process measures the performance of the operating segments based on the management structure of the Company and is not necessarily comparable with similar information for any other financial institution. Each segment is managed by executives who, in conjunction with the Chief Executive Officer, make strategic business decisions regarding that segment. The three reportable operating segments are Consumer, Commercial and Money Management. Additional information is presented in Note 13 on Segments in the consolidated financial statements.


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The Company uses a funds transfer pricing method to value funds used (e.g., loans, fixed assets, cash, etc.) and funds provided (deposits, borrowings, and equity) by the business segments and their components. This process assigns a specific value to each new source or use of funds with a maturity, based on current LIBOR interest rates, thus determining an interest spread at the time of the transaction. Non-maturity assets and liabilities are assigned to LIBOR based funding pools. This method helps to provide an accurate means of valuing fund sources and uses in a varying interest rate environment. The Company also assigns loan charge-offs and recoveries directly to each operating segment instead of allocating a portion of actual loan loss provision to the segments. The operating segments also include a number of allocations of income and expense from various support and overhead centers within the Company. Management periodically makes changes to the method of assigning costs and income to its business segments to better reflect operating results. Beginning in 2008, modifications were made to the funds transfer pricing process which eliminated allocations to net interest income for capital. This change was also reflected in the prior year information presented below.
 
The table below is a summary of segment pre-tax income results for the past three years.
 
                                                 
   
                Money
    Segment
    Other/
    Consolidated
 
(Dollars in thousands)   Consumer     Commercial     Management     Totals     Elimination     Totals  
   
Year ended December 31, 2008:
                                               
Net interest income
  $ 351,387     $ 208,348     $ 8,192     $ 567,927     $ 24,812     $ 592,739  
Provision for loan losses
    (57,044 )     (13,389 )           (70,433 )     (38,467 )     (108,900 )
Non-interest income
    166,968       97,038       100,381       364,387       11,325       375,712  
Investment securities gains, net
                            30,294       30,294  
Non-interest expense
    (322,978 )     (169,834 )     (103,632 )     (596,444 )     (19,669 )     (616,113 )
 
 
Income before income taxes
  $ 138,333     $ 122,163     $ 4,941     $ 265,437     $ 8,295     $ 273,732  
 
 
Year ended December 31, 2007:
                                               
Net interest income
  $ 344,640     $ 191,248     $ 8,468     $ 544,356     $ (6,284 )   $ 538,072  
Provision for loan losses
    (34,787 )     (8,026 )           (42,813 )     81       (42,732 )
Non-interest income
    186,792       85,151       92,628       364,571       7,010       371,581  
Investment securities gains, net
                            8,234       8,234  
Non-interest expense
    (305,718 )     (158,017 )     (65,722 )     (529,457 )     (45,301 )     (574,758 )
 
 
Income (loss) before income taxes
  $ 190,927     $ 110,356     $ 35,374     $ 336,657     $ (36,260 )   $ 300,397  
 
 
2008 vs. 2007
                                               
Increase (decrease) in income before income taxes:
                                               
 
 
Amount
  $ (52,594 )   $ 11,807     $ (30,433 )   $ (71,220 )   $ 44,555     $ (26,665 )
 
 
Percent
    (27.5 )%     10.7 %     (86.0 )%     (21.2 )%     N.M.       (8.9 )%
 
 
Year ended December 31, 2006:
                                               
Net interest income
  $ 330,935     $ 184,245     $ 8,019     $ 523,199     $ (10,000 )   $ 513,199  
Provision for loan losses
    (26,338 )     295             (26,043 )     394       (25,649 )
Non-interest income
    179,401       79,427       85,235       344,063       8,523       352,586  
Investment securities gains, net
    2,839                   2,839       6,196       9,035  
Non-interest expense
    (286,011 )     (143,970 )     (60,388 )     (490,369 )     (35,056 )     (525,425 )
 
 
Income (loss) before income taxes
  $ 200,826     $ 119,997     $ 32,866     $ 353,689     $ (29,943 )   $ 323,746  
 
 
2007 vs. 2006
                                               
Increase (decrease) in income before income taxes:
                                               
 
 
Amount
  $ (9,899 )   $ (9,641 )   $ 2,508     $ (17,032 )   $ (6,317 )   $ (23,349 )
 
 
Percent
    (4.9 )%     (8.0 )%     7.6 %     (4.8 )%     (21.1 )%     (7.2 )%
 
 
 
Consumer
 
The Consumer segment includes the retail branch network, consumer finance, bank card, student loans and discount brokerage services. Pre-tax income for 2008 was $138.3 million, a decrease of $52.6 million, or


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27.5% from 2007. The decrease was due to increases of $17.3 million in non-interest expense and $22.3 million in net loan charge-offs. In addition, non-interest income declined $19.8 million, while net interest income increased $6.7 million. The increase in net interest income resulted mainly from a $92.2 million decline in deposit interest expense, partly offset by a $71.8 million decrease in net allocated funding credits assigned to the Consumer segment’s deposit and loan portfolio and a $14.1 million decrease in loan interest income. The decrease in non-interest income resulted largely from lower overdraft and return item fees, an impairment charge taken on certain held for sale student loans, and lower gains on student loan sales. The declines were partly offset by an increase in bank card fee income (primarily debit card fees). Non-interest expense increased $17.3 million, or 5.6%, over the previous year mainly due to higher bank card processing costs, salaries expense, corporate management fees and telephone support fees. Net loan charge-offs increased $22.3 million, or 64.0%, in the Consumer segment, with most of the increase due to higher consumer credit card and marine and RV loan charge-offs. Total average assets directly related to the segment rose 7.0% over 2007. During 2008, total average loans increased 6.9%, compared to a 9.7% increase in 2007. The increase in average loans during 2008 resulted mainly from growth in consumer loans and consumer credit card loans. Average deposits increased slightly over the prior year, mainly due to growth in premium money market deposit accounts, partly offset by a decline in long-term certificates of deposit.
 
Pre-tax income for 2007 was $190.9 million, a decrease of $9.9 million, or 4.9%, from 2006. This decrease was due to an increase of $19.7 million, or 6.9%, in non-interest expense, coupled with an $8.4 million increase in net loan charge-offs, mainly relating to consumer credit card and marine and RV loans. The increase in non-interest expense over the previous year was mainly due to higher salaries expense, occupancy expense, corporate management fees and various assigned processing costs. In addition, net investment securities gains declined by $2.8 million due to a gain recorded in 2006 on the sale of MasterCard Inc. shares. Partly offsetting these effects was a $13.7 million increase in net interest income. This growth resulted mainly from a $32.3 million increase in net allocated funding credits assigned to the Consumer segment’s deposit and loan portfolios, and higher loan interest income of $38.2 million, which more than offset growth of $56.6 million in deposit interest expense. Non-interest income increased $7.4 million, or 4.1%, mainly due to higher bank card transaction fees (primarily debit card) and consumer brokerage and insurance fees, partly offset by a decline in overdraft and return item fees and lower gains on sales of student loans. Total average assets directly related to the segment rose 10.5% over 2006. During 2007, total average loans increased 9.7%, mainly from growth in consumer, personal real estate and consumer credit card loans. Average deposits increased 9.8% over the prior year, mainly due to growth in short-term certificates of deposit and premium money market deposit accounts.
 
Commercial
 
The Commercial segment provides corporate lending, leasing, international services, and corporate cash management services. Pre-tax profitability for the Commercial segment increased $11.8 million, or 10.7%, compared to the prior year. Most of the increase was due to a $17.1 million, or 8.9%, increase in net interest income and an $11.9 million increase in non-interest income. The increase in net interest income resulted from lower net allocated funding costs of $80.2 million and lower deposit interest expense of $7.1 million, partly offset by a $70.1 million decline in loan interest income. Non-interest income increased by 14.0% over the previous year largely due to higher commercial cash management fees and bank card fees (mainly corporate card fees). Partly offsetting these increases in income was an increase in non-interest expense, which rose $11.8 million, or 7.5%, over the prior year. The increase included a $2.5 million impairment charge on foreclosed land (which was sold in the third quarter of 2008), in addition to higher salaries expense and commercial card servicing costs. Net loan charge-offs were $13.4 million in 2008 compared to $8.0 million in 2007. The increase was mainly due to higher construction and land loan net charge-offs. Total average assets directly related to the segment rose 8.1% over 2007. Average segment loans increased 8.2% compared to 2007 as a result of growth in business and business real estate loans. Average deposits increased 7.5% due to growth in non-interest bearing demand, money market and interest checking deposit accounts.
 
In 2007, income before income taxes for the Commercial segment decreased $9.6 million, or 8.0%, compared to the prior year. Most of the decrease was due to a $14.0 million, or 9.8%, increase in non-interest expense and an $8.3 million increase in net loan charge-offs. Partly offsetting these increases in expense were


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a $7.0 million, or 3.8%, increase in net interest income and a $5.7 million increase in non-interest income. Included in net interest income was a $57.9 million increase in loan interest income, which was partly offset by higher assigned net funding costs of $46.5 million and higher deposit interest expense of $4.4 million. Non-interest income increased by 7.2% over the previous year as a result of higher commercial cash management fees, overdraft fees, bank card fees (mainly corporate card) and cash sweep commissions. The increase in non-interest expense resulted from higher salaries expense, commercial deposit account processing costs and corporate management fees, partly offset by a decline in foreclosed property expense. Net loan charge-offs were $8.0 million in 2007 compared to net recoveries of $295 thousand in 2006. The increase over 2006 was due to charge-offs related to several specific commercial borrowers. Total average assets directly related to the segment rose 14.4% over 2006. Average segment loans increased 14.1% compared to 2006 as a result of growth in business, construction real estate and business real estate loans, while average deposits increased 1.7% due to growth in interest checking deposit accounts.
 
Money Management
 
The Money Management segment consists of the trust and capital markets activities. The Trust group provides trust and estate planning services, and advisory and discretionary investment management services. At December 31, 2008 the Trust group managed investments with a market value of $10.9 billion and administered an additional $8.5 billion in non-managed assets. It also provides investment management services to The Commerce Funds, a series of mutual funds with $1.2 billion in total assets at December 31, 2008. The Capital Markets Group sells primarily fixed-income securities to individuals, corporations, correspondent banks, public institutions, and municipalities, and also provides investment safekeeping and bond accounting services. Pre-tax income for the segment was $4.9 million in 2008 compared to $35.4 million in 2007, mainly due to a $33.3 million loss on the purchase of auction rate securities, which is discussed above in the Non-Interest Expense section of this discussion. Excluding this charge, segment profitability would have been $38.2 million, an 8.0% increase over 2007. Net interest income decreased $276 thousand, or 3.3%, from the prior year, due to a decline in interest income on overnight investments, offset by lower interest expense on short-term borrowings. Non-interest income increased $7.8 million, or 8.4%, mainly due to higher private client and corporate trust fees and bond trading income in the Capital Markets Group. Average assets decreased $345.1 million during 2008 because of lower overnight investments of liquid funds. Average deposits increased $213.3 million during 2008, due to continuing growth in short-term certificates of deposit over $100,000.
 
Pre-tax income for the Money Management segment was $35.4 million in 2007 compared to $32.9 million in 2006, an increase of $2.5 million, or 7.6%. The increase over the prior year was mainly due to higher non-interest income. Non-interest income increased $7.4 million, or 8.7%, due to higher private client, institutional and corporate trust fees, bond trading income and cash sweep commissions. Net interest income increased $449 thousand, or 5.6%, over the prior year. Growth in interest income on short-term investments was partly offset by higher net funding charges assigned to the segment’s short-term investments and borrowings, in addition to an increase in interest expense on deposits and borrowings. Non-interest expense increased $5.3 million, or 8.8%, over the prior year mainly due to higher salaries expense, assigned processing costs and corporate management fees. Average assets increased $148.0 million during 2007 because of higher overnight investments. Average deposits increased $14.8 million during 2007, mainly due to growth in short-term certificates of deposit over $100,000.
 
The segment activity, as shown above, includes both direct and allocated items. Amounts in the “Other/Elimination” column include activity not related to the segments, such as certain administrative functions, the investment securities portfolio, and the effect of certain expense allocations to the segments. Also included in this category is the excess of the Company’s provision for loan losses over net loan charge-offs, which are generally assigned directly to the segments. In 2008, the pre-tax profitability in this category was $8.3 million, compared to a loss of $36.3 million in 2007. The profitability increase was partly due to items relating to the Bank’s relationship with Visa, as discussed earlier, which were not assigned to a segment. In 2008, Visa stock redemption gains of $22.2 million and indemnification obligation reversals of $9.6 million were recorded, compared to obligation charges of $21.0 million in 2007. In addition, unallocated net interest income in this category, relating to earnings on the Company’s investment portfolio and interest expense on


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overnight borrowings not allocated to the segments, rose $31.1 million in 2008. These increases were partly offset by a $38.5 million loan loss provision in this category, as described above.
 
Impact of Recently Issued Accounting Standards
 
In June 2006, the FASB issued Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (FIN 48), which prescribes the recognition threshold and measurement attributes necessary for recognition in the financial statements of a tax position taken, or expected to be taken, in a tax return. Under FIN 48, an income tax position will be recognized if it is more likely than not that it will be sustained upon IRS examination, based upon its technical merits. Once that status is met, the amount recorded will be the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. It also provides guidance on derecognition, classification, interest and penalties, interim period accounting, disclosure, and transition requirements. As a result of the Company’s adoption of FIN 48, additional income tax benefits of $446 thousand were recognized as of January 1, 2007 as an increase to equity.
 
The Company adopted Statement of Financial Accounting Standards No. 157, “Fair Value Measurements”, on January 1, 2008. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. It emphasizes that fair value is a market-based measurement and should be determined based on assumptions that a market participant would use when pricing an asset or liability. Additionally, it establishes a fair value hierarchy that provides the highest priority to measurements using quoted prices in active markets and the lowest priority to measurements based on unobservable data. The Statement does not require any new fair value measurements. The Statement also modifies the guidance for initial recognition of fair value for certain derivative contracts held by the Company. Former accounting guidance precluded immediate recognition in earnings of an unrealized gain or loss, measured as the difference between the transaction price and fair value of these instruments at initial recognition. This guidance was nullified by the Statement. In accordance with the new recognition requirements of the Statement, the Company increased equity by $903 thousand on January 1, 2008.
 
The Company adopted Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”, at December 31, 2006. The Statement requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through other comprehensive income. The Company’s initial recognition at December 31, 2006 of the funded status of its defined benefit pension plan reduced its prepaid pension asset by $17.5 million, reduced deferred tax liabilities by $6.6 million, and reduced the equity component of accumulated other comprehensive income by $10.9 million. Beginning in 2008, the Statement also requires an employer to measure plan assets and obligations as of the date of its fiscal year end statement of financial position. In order to transition to a fiscal year end measurement date, the Company used earlier measurements to allocate net periodic benefit cost for the period between September 30, 2007 (the previous measurement date) and December 31, 2008 proportionately between retained earnings and net periodic benefit cost recognized during 2008. The Company recorded the transition adjustment, which increased retained earnings by $348 thousand, on December 31, 2008.
 
In September 2006, the Emerging Issues Task Force (EITF) reached a consensus on EITF Issue 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements”. This EITF Issue addresses accounting for separate agreements which split life insurance policy benefits between an employer and employee. The Issue requires the employer to recognize a liability for future benefits payable to the employee based on the substantive agreement with the employee, because the postretirement benefit obligation is not effectively settled through the purchase of the insurance policy. The EITF Issue was effective January 1, 2008, and the Company’s adoption on that date resulted in a reduction to equity of $716 thousand.
 
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement


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No. 115”. This Statement permits entities to choose to measure many financial instruments and certain other items at fair value, on an instrument-by-instrument basis. Once an entity has elected to record eligible items at fair value, the decision is irrevocable and the entity should report unrealized gains and losses for which the fair value option has been elected in earnings. The Statement’s objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is expected to expand the use of fair value measurement, which is consistent with the Board’s long-term measurement objectives for accounting for financial instruments. The Statement may be applied to financial instruments existing at the January 1, 2008 adoption date, financial instruments recognized after the adoption date, and upon certain other events. As of the adoption date and subsequent to that date, the Company has chosen not to elect the fair value option, but continues to consider future election and the effect on its consolidated financial statements.
 
In November 2007, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 109 (SAB 109). SAB 109 provides revised guidance on the valuation of written loan commitments accounted for at fair value through earnings. Former guidance under SAB 105 indicated that the expected net future cash flows related to the associated servicing of the loan should not be incorporated into the measurement of the fair value of a derivative loan commitment. The new guidance under SAB 109 requires these cash flows to be included in the fair value measurement, and the SAB requires this view to be applied on a prospective basis to derivative loan commitments issued or modified after January 1, 2008. The Company’s application of SAB 109 in 2008 did not have a material effect on its consolidated financial statements.
 
In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(revised), “Business Combinations”. The Statement retains the fundamental requirements in Statement 141 that the acquisition method of accounting be used for business combinations, but broadens the scope of Statement 141 and contains improvements to the application of this method. The Statement requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date. Costs incurred to effect the acquisition are to be recognized separately from the acquisition. Assets and liabilities arising from contractual contingencies must be measured at fair value as of the acquisition date. Contingent consideration must also be measured at fair value as of the acquisition date. The Statement also changes the accounting for negative goodwill arising from a bargain purchase, requiring recognition in earnings instead of allocation to assets acquired. For business combinations achieved in stages (step acquisitions), the assets and liabilities must be recognized at the full amounts of their fair values, while under former guidance the entity was acquired in a series of purchases, with costs and fair values being identified and measured at each step. The Statement applies to business combinations occurring after January 1, 2009.
 
Also in December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51”. The Statement clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. The Statement establishes a single method of accounting for changes in a parent’s ownership interest if the parent retains its controlling interest, deeming these to be equity transactions. Such changes include the parent’s purchases and sales of ownership interests in its subsidiary and the subsidiary’s acquisition and issuance of its ownership interests. The Statement also requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. It changes the way the consolidated income statement is presented, requiring consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest, and requires disclosure of these amounts on the face of the consolidated statement of income. The Statement is effective on January 1, 2009. The Company does not expect adoption of the Statement to have a significant effect on its consolidated financial statements.
 
In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133”. This Statement requires enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for, and how these activities affect its


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financial position, financial performance, and cash flows. The Statement is effective for financial statements issued in 2009. The Company does not expect adoption of the Statement to have a significant effect on its consolidated financial statements.
 
In June 2008, the FASB posted Staff Position No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities”. This pronouncement defines unvested stock awards which contain nonforfeitable rights to dividends as securities which participate in undistributed earnings. Such participating securities must be included in the computation of earnings per share under the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for common stock and participating securities according to dividends declared and participation rights in undistributed earnings. The Company is required to apply the two-class method to its computation of earnings per share effective January 1, 2009, and does not expect its application to have a significant effect on the computation of earnings per share attributable to common shareholders.
 
In January 2009, the FASB issued Staff Position No. EITF 99-20-1, “Amendments to the Impairment Guidance of EITF Issue No. 99-20”. The amendment’s purpose is to achieve a more consistent determination of whether an other-than-temporary impairment has occurred on beneficial interests. Specifically, the new pronouncement no longer requires the usage of market participant assumptions about future cash flows in determining other-than-temporary impairment under the EITF 99-20 model, and aligns that model’s impairment guidance with SFAS 115. The Company has not yet been required to assess impairment under EITF 99-20, and its assessments have been in accordance with SFAS 115 guidelines.
 
Effects of Inflation
 
The impact of inflation on financial institutions differs significantly from that exerted on industrial entities. Financial institutions are not heavily involved in large capital expenditures used in the production, acquisition or sale of products. Virtually all assets and liabilities of financial institutions are monetary in nature and represent obligations to pay or receive fixed and determinable amounts not affected by future changes in prices. Changes in interest rates have a significant effect on the earnings of financial institutions. Higher interest rates generally follow the rising demand of borrowers and the corresponding increased funding requirements of financial institutions. Although interest rates are viewed as the price of borrowing funds, the behavior of interest rates differs significantly from the behavior of the prices of goods and services. Prices of goods and services may be directly related to that of other goods and services while the price of borrowing relates more closely to the inflation rate in the prices of those goods and services. As a result, when the rate of inflation slows, interest rates tend to decline while absolute prices for goods and services remain at higher levels. Interest rates are also subject to restrictions imposed through monetary policy, usury laws and other artificial constraints.
 
During the second half of 2008, the national economy experienced a significant downturn. Because of this downturn, interest rates fell significantly while the price of consumer goods and services remained constant. New legislation was enacted to help mitigate any negative impact of the economic downturn. As a result, it is difficult to predict what inflationary impacts the economic slowdown will have on the Company and its operations.
 
Corporate Governance
 
The Company has adopted a number of corporate governance measures. These include corporate governance guidelines, a code of ethics that applies to its senior financial officers and the charters for its audit committee, its committee on compensation and human resources, and its committee on governance/directors. This information is available on the Company’s web site www.commercebank.com under Investor Relations.
 
Forward-Looking Statements
 
This report may contain “forward-looking statements” that are subject to risks and uncertainties and include information about possible or assumed future results of operations. Many possible events or factors


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could affect the future financial results and performance of the Company. This could cause results or performance to differ materially from those expressed in the forward-looking statements. Words such as “expects”, “anticipates”, “believes”, “estimates”, variations of such words and other similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in, or implied by, such forward-looking statements. Readers should not rely solely on the forward-looking statements and should consider all uncertainties and risks discussed throughout this report. Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. Such possible events or factors include: changes in economic conditions in the Company’s market area; changes in policies by regulatory agencies, governmental legislation and regulation; fluctuations in interest rates; changes in liquidity requirements; demand for loans in the Company’s market area; changes in accounting and tax principles; estimates made on income taxes; and competition with other entities that offer financial services.


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AVERAGE BALANCE SHEETS – AVERAGE RATES AND YIELDS
 
                                                                         
    Years Ended December 31  
    2008     2007     2006  
                Average
                Average
                Average
 
          Interest
    Rates
          Interest
    Rates
          Interest
    Rates
 
    Average
    Income/
    Earned/
    Average
    Income/
    Earned/
    Average
    Income/
    Earned/
 
(Dollars in thousands)   Balance     Expense     Paid     Balance     Expense     Paid     Balance     Expense     Paid  
   
 
ASSETS                                                                        
Loans:(A)
                                                                       
Business(B)
  $ 3,478,927     $ 169,767       4.88 %   $ 3,110,386     $ 208,819       6.71 %   $ 2,688,722     $ 177,313       6.59 %
Real estate – construction and land
    701,519       34,445       4.91       671,986       49,436       7.36       540,574       40,477       7.49  
Real estate – business
    2,281,664       136,955       6.00       2,204,041       154,819       7.02       2,053,455       140,659       6.85  
Real estate – personal
    1,522,172       88,322       5.80       1,521,066       90,537       5.95       1,415,321       79,816       5.64  
Consumer
    1,674,497       119,837       7.16       1,558,302       115,184       7.39       1,352,047       95,074       7.03  
Home equity
    474,635       23,960       5.05       443,748       33,526       7.56       445,376       33,849       7.60  
Student(C)
    13,708       287       2.10                                      
Consumer credit card
    776,810       83,972       10.81       665,964       84,856       12.74       595,252       77,737       13.06  
Overdrafts
    11,926                   13,823                   14,685              
 
 
Total loans
    10,935,858       657,545       6.01       10,189,316       737,177       7.23       9,105,432       644,925       7.08  
 
 
Loans held for sale
    347,441       14,968       4.31       321,916       21,940       6.82       315,950       21,788       6.90  
Investment securities:
                                                                       
U.S. government & federal agency
    183,083       7,439       4.06       410,170       16,505       4.02       640,239       22,817       3.56  
State & municipal obligations(B)
    695,542       34,572       4.97       594,154       26,855       4.52       414,282       18,546       4.48  
Mortgage and asset-backed securities
    2,469,467       125,369       5.08       2,120,521       102,243       4.82       2,201,685       96,270       4.37  
Trading securities
    28,840       1,154       4.00       22,321       1,057       4.73       17,444       762       4.37  
Other marketable securities(B)
    98,650       4,283       4.34       129,622       7,795       6.01       200,013       11,248       5.62  
Non-marketable securities
    133,996       7,378       5.51       92,251       5,417       5.87       85,211       7,475       8.77  
 
 
Total investment securities
    3,609,578       180,195       4.99       3,369,039       159,872       4.75       3,558,874       157,118       4.41  
 
 
Federal funds sold and securities purchased under agreements to resell
    425,273       8,287       1.95       527,304       25,881       4.91       299,554       15,637       5.22  
Interest earning deposits with banks
    46,670       198       .42                                      
 
 
Total interest earning assets
    15,364,820       861,193       5.60       14,407,575       944,870       6.56       13,279,810       839,468       6.32  
 
 
Less allowance for loan losses
    (145,176 )                     (132,234 )                     (129,224 )                
Unrealized gain (loss) on investment securities
    27,068                       25,333                       (9,443 )                
Cash and due from banks
    451,105                       463,970                       470,826                  
Land, buildings and equipment — net
    412,852                       400,161                       376,375                  
Other assets
    343,664                       315,522                       250,260                  
                                                                 
                                                                 
Total assets
  $ 16,454,333                     $ 15,480,327                     $ 14,238,604                  
                                                                 
                                                                 
LIABILITIES AND EQUITY
                                                                       
Interest bearing deposits:
                                                                       
Savings
  $ 400,948       1,186       .30     $ 392,942       2,067       .53     $ 393,870       2,204       .56  
Interest checking and money market
    7,400,125       59,947       .81       6,996,943       114,027       1.63       6,717,280       94,238       1.40  
Time open & C.D.’s of less than $100,000
    2,149,119       77,322       3.60       2,359,386       110,957       4.70       2,077,257       85,424       4.11  
Time open & C.D.’s of $100,000 and over
    1,629,500       55,665       3.42       1,480,856       73,739       4.98       1,288,845       58,381       4.53  
 
 
Total interest bearing deposits
    11,579,692       194,120       1.68       11,230,127       300,790       2.68       10,477,252       240,247       2.29  
 
 
Borrowings:
                                                                       
Federal funds purchased and securities sold under agreements to repurchase
    1,373,625       25,085       1.83       1,696,613       83,464       4.92       1,455,544       70,154       4.82  
Other borrowings(D)
    1,092,746       37,905       3.47       292,446       13,775       4.71       182,940       8,744       4.78  
 
 
Total borrowings