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COMMERCE BANCSHARES INC /MO/ - Quarter Report: 2017 September (Form 10-Q)

Table of Contents

 

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

For the quarterly period ended September 30, 2017

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

For the transition period from           to          
Commission File No. 0-2989
 
COMMERCE BANCSHARES, INC.
 
(Exact name of registrant as specified in its charter)
Missouri
 
43-0889454
(State of Incorporation)
 
(IRS Employer Identification No.)
 
 
 
1000 Walnut,
Kansas City, MO
 
64106
(Address of principal executive offices)
 
(Zip Code)
 
 
 
(816) 234-2000
 
 
(Registrant’s telephone number, including area code)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ     No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes þ     No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o
Smaller reporting company £
Emerging growth company £
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o     No þ
As of November 1, 2017, the registrant had outstanding 101,632,724 shares of its $5 par value common stock, registrant’s only class of common stock.



Commerce Bancshares, Inc. and Subsidiaries

Form 10-Q
 

 
 
 
Page
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2

Table of Contents

PART I: FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
 
 
September 30, 2017
 
December 31, 2016
 
(Unaudited)
 
 
 
(In thousands)
ASSETS
 
 
 
Loans
$
13,745,492

 
$
13,412,736

  Allowance for loan losses
(157,832
)
 
(155,932
)
Net loans
13,587,660

 
13,256,804

Loans held for sale (including $11,320,000 and $9,263,000 of residential mortgage loans carried at fair value at September 30, 2017 and December 31, 2016, respectively)
17,337

 
14,456

Investment securities:
 
 
 

Available for sale ($667,199,000 and $568,553,000 pledged at September 30, 2017 and
 
 
 
    December 31, 2016, respectively, to secure swap and repurchase agreements)
9,109,287

 
9,649,203

 Trading
24,605

 
22,225

 Non-marketable
99,268

 
99,558

Total investment securities
9,233,160

 
9,770,986

Federal funds sold and short-term securities purchased under agreements to resell
32,630

 
15,470

Long-term securities purchased under agreements to resell
700,000

 
725,000

Interest earning deposits with banks
105,422

 
272,275

Cash and due from banks
461,724

 
494,690

Land, buildings and equipment, net
335,348

 
337,705

Goodwill
138,921

 
138,921

Other intangible assets, net
7,388

 
6,709

Other assets
359,551

 
608,408

Total assets
$
24,979,141

 
$
25,641,424

LIABILITIES AND EQUITY
 
 
 
Deposits:
 
 
 

   Non-interest bearing
$
7,536,127

 
$
7,429,398

   Savings, interest checking and money market
11,091,200

 
11,430,789

   Time open and C.D.'s of less than $100,000
657,891

 
713,075

   Time open and C.D.'s of $100,000 and over
1,158,555

 
1,527,833

Total deposits
20,443,773

 
21,101,095

Federal funds purchased and securities sold under agreements to repurchase
1,408,984

 
1,723,905

Other borrowings
102,553

 
102,049

Other liabilities
319,354

 
213,243

Total liabilities
22,274,664

 
23,140,292

Commerce Bancshares, Inc. stockholders’ equity:
 
 
 

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

 
144,784

   Common stock, $5 par value
 
 
 

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

 
510,015

   Capital surplus
1,548,318

 
1,552,454

   Retained earnings
440,261

 
292,849

   Treasury stock of 197,566 shares at September 30, 2017
 
 
 
     and 364,711 shares at December 31, 2016, at cost
(9,895
)
 
(15,294
)
   Accumulated other comprehensive income
67,061

 
10,975

Total Commerce Bancshares, Inc. stockholders' equity
2,700,544

 
2,495,783

Non-controlling interest
3,933

 
5,349

Total equity
2,704,477

 
2,501,132

Total liabilities and equity
$
24,979,141

 
$
25,641,424

See accompanying notes to consolidated financial statements.

3

Table of Contents

Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
 
For the Three Months Ended September 30
 
For the Nine Months Ended September 30
(In thousands, except per share data)
2017
2016
 
2017
2016
 
(Unaudited)
INTEREST INCOME
 
 
 
 
 
Interest and fees on loans
$
138,827

$
123,750

 
$
401,423

$
364,234

Interest and fees on loans held for sale
287

334

 
746

1,161

Interest on investment securities
50,585

51,661

 
160,825

155,250

Interest on federal funds sold and short-term securities purchased under
 
 
 
 
 
   agreements to resell
78

20

 
138

63

Interest on long-term securities purchased under agreements to resell
3,805

3,328

 
11,282

10,157

Interest on deposits with banks
662

268

 
1,421

689

Total interest income
194,244

179,361

 
575,835

531,554

INTEREST EXPENSE
 
 
 
 
 
Interest on deposits:
 
 
 
 
 
   Savings, interest checking and money market
4,441

3,619

 
12,673

10,651

   Time open and C.D.'s of less than $100,000
676

683

 
1,994

2,134

   Time open and C.D.'s of $100,000 and over
2,784

2,186

 
8,369

6,519

Interest on federal funds purchased and securities sold under
 
 
 
 
 
   agreements to repurchase
2,846

724

 
6,423

2,337

Interest on other borrowings
906

906

 
2,705

3,066

Total interest expense
11,653

8,118

 
32,164

24,707

Net interest income
182,591

171,243

 
543,671

506,847

Provision for loan losses
10,704

7,263

 
32,590

25,918

Net interest income after provision for loan losses
171,887

163,980

 
511,081

480,929

NON-INTEREST INCOME
 
 
 
 
 
Bank card transaction fees
44,521

47,006

 
132,724

136,541

Trust fees
34,620

30,951

 
99,754

90,435

Deposit account charges and other fees
22,659

22,241

 
67,462

64,260

Capital market fees
1,755

2,751

 
6,253

7,976

Consumer brokerage services
3,679

3,375

 
11,054

10,375

Loan fees and sales
3,590

3,123

 
10,849

8,829

Other
11,418

9,872

 
34,296

36,497

Total non-interest income
122,242

119,319

 
362,392

354,913

INVESTMENT SECURITIES LOSSES, NET
(3,037
)
(1,965
)
 
(2,158
)
(3,704
)
NON-INTEREST EXPENSE
 
 
 
 
 
Salaries and employee benefits
111,382

107,004

 
332,580

318,671

Net occupancy
11,459

12,366

 
34,332

34,761

Equipment
4,491

4,842

 
13,876

14,257

Supplies and communication
5,517

5,968

 
16,672

18,490

Data processing and software
22,700

23,663

 
69,153

69,332

Marketing
4,676

4,399

 
12,388

12,601

Deposit insurance
3,479

3,576

 
10,542

9,884

Other
20,868

19,424

 
66,453

57,808

Total non-interest expense
184,572

181,242

 
555,996

535,804

Income before income taxes
106,520

100,092

 
315,319

296,334

Less income taxes
32,294

30,942

 
90,402

91,854

Net income
74,226

69,150

 
224,917

204,480

Less non-controlling interest expense (income)
(338
)
605

 
(111
)
668

Net income attributable to Commerce Bancshares, Inc.
74,564

68,545

 
225,028

203,812

Less preferred stock dividends
2,250

2,250

 
6,750

6,750

Net income available to common shareholders
$
72,314

$
66,295

 
$
218,278

$
197,062

Net income per common share — basic
$
.71

$
.65

 
$
2.14

$
1.94

Net income per common share — diluted
$
.71

$
.65

 
$
2.14

$
1.93

See accompanying notes to consolidated financial statements.

4

Table of Contents

Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
 
For the Three Months Ended September 30
 
For the Nine Months Ended September 30
(In thousands)
 
2017
2016
 
2017
2016
 
 
(Unaudited)
Net income
 
$
74,226

$
69,150

 
$
224,917

$
204,480

Other comprehensive income (loss):
 
 
 
 
 
 
Net unrealized gains (losses) on securities for which a portion of an other-than-temporary impairment has been recorded in earnings
 
286

46

 
457

(352
)
Net unrealized gains (losses) on other securities
 
24,356

(13,747
)
 
54,599

87,887

Pension loss amortization
 
349

359

 
1,030

1,077

Other comprehensive income (loss)
 
24,991

(13,342
)
 
56,086

88,612

Comprehensive income
 
99,217

55,808

 
281,003

293,092

Less non-controlling interest expense (income)
 
(338
)
605

 
(111
)
668

Comprehensive income attributable to Commerce Bancshares, Inc.
$
99,555

$
55,203

 
$
281,114

$
292,424

See accompanying notes to consolidated financial statements.














5

Table of Contents

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

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

$
510,015

$
1,552,454

$
292,849

$
(15,294
)
$
10,975

$
5,349

$
2,501,132

Adoption of ASU 2016-09
 
 
3,441

(2,144
)
 
 
 
1,297

Net income
 




225,028





(111
)
224,917

Other comprehensive income
 








56,086



56,086

Distributions to non-controlling interest
 










(1,305
)
(1,305
)
Purchases of treasury stock
 






(11,320
)




(11,320
)
Issuance of stock under purchase and equity compensation plans
 


(16,726
)


16,719





(7
)
Stock-based compensation
 


9,149









9,149

Cash dividends on common stock ($.675 per share)
 




(68,722
)






(68,722
)
Cash dividends on preferred stock ($1.125 per depositary share)
 




(6,750
)






(6,750
)
Balance September 30, 2017
$
144,784

$
510,015

$
1,548,318

$
440,261

$
(9,895
)
$
67,061

$
3,933

$
2,704,477

Balance December 31, 2015
$
144,784

$
489,862

$
1,337,677

$
383,313

$
(26,116
)
$
32,470

$
5,428

$
2,367,418

Net income
 




203,812





668

204,480

Other comprehensive income
 








88,612



88,612

Distributions to non-controlling interest
 










(704
)
(704
)
Purchases of treasury stock
 






(38,476
)




(38,476
)
Issuance of stock under purchase and equity compensation plans
 


(14,057
)


14,054





(3
)
Excess tax benefit related to equity compensation plans
 


2,629









2,629

Stock-based compensation
 


8,901









8,901

Cash dividends on common stock ($.643 per share)
 




(65,294
)






(65,294
)
Cash dividends on preferred stock ($1.125 per depositary share)
 
 
 
(6,750
)
 
 
 
(6,750
)
Balance September 30, 2016
$
144,784

$
489,862

$
1,335,150

$
515,081

$
(50,538
)
$
121,082

$
5,392

$
2,560,813

See accompanying notes to consolidated financial statements.



6

Table of Contents

Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
For the Nine Months Ended September 30
(In thousands)
2017
 
2016
 
(Unaudited)
OPERATING ACTIVITIES:
 
 
 
Net income
$
224,917

 
$
204,480

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
  Provision for loan losses
32,590

 
25,918

  Provision for depreciation and amortization
29,521

 
30,997

  Amortization of investment security premiums, net
28,173

 
23,357

  Investment securities losses, net (A)
2,158

 
3,704

  Net gains on sales of loans held for sale
(6,200
)
 
(4,924
)
  Originations of loans held for sale
(162,552
)
 
(115,768
)
  Proceeds from sales of loans held for sale
164,588

 
117,746

  Net decrease in trading securities, excluding unsettled transactions
7,234

 
77,262

  Stock-based compensation
9,149

 
8,901

  Increase in interest receivable
(3,757
)
 
(331
)
  Increase (decrease) in interest payable
(223
)
 
269

  Increase in income taxes payable
201

 
1,787

  Other changes, net
8,511

 
(24,602
)
Net cash provided by operating activities
334,310

 
348,796

INVESTING ACTIVITIES:
 
 
 
Proceeds from sales of investment securities (A)
369,036

 
7,946

Proceeds from maturities/pay downs of investment securities (A)
1,384,993

 
1,659,778

Purchases of investment securities (A)
(1,072,782
)
 
(1,080,003
)
Net increase in loans
(364,765
)
 
(817,886
)
Long-term securities purchased under agreements to resell
(75,000
)
 

Repayments of long-term securities purchased under agreements to resell
100,000

 
150,000

Purchases of land, buildings and equipment
(22,853
)
 
(18,479
)
Sales of land, buildings and equipment
2,570

 
5,831

Net cash provided by (used in) investing activities
321,199

 
(92,813
)
FINANCING ACTIVITIES:
 
 
 
Net increase (decrease) in non-interest bearing, savings, interest checking and money market deposits
(12,490
)
 
280,495

Net increase (decrease) in time open and C.D.'s
(424,462
)
 
14,510

Net decrease in federal funds purchased and securities sold under agreements to repurchase
(314,921
)
 
(473,661
)
Repayment of long-term borrowings
(218
)
 
(3,872
)
Additional long-term borrowings


1,469

Net increase in short-term borrowings
722

 

Purchases of treasury stock
(11,320
)
 
(38,476
)
Issuance of stock under equity compensation plans
(7
)
 
(3
)
Cash dividends paid on common stock
(68,722
)
 
(65,294
)
Cash dividends paid on preferred stock
(6,750
)
 
(6,750
)
Net cash used in financing activities
(838,168
)
 
(291,582
)
Decrease in cash and cash equivalents
(182,659
)
 
(35,599
)
Cash and cash equivalents at beginning of year
782,435

 
502,719

Cash and cash equivalents at September 30
$
599,776

 
$
467,120

(A) Available for sale and non-marketable securities
 
 
 
Income tax payments, net
$
87,449

 
$
88,531

Interest paid on deposits and borrowings
$
32,387

 
$
24,438

Loans transferred to foreclosed real estate
$
1,166

 
$
1,031

Loans transferred from held for investment to held for sale, net
$

 
$
42,688

See accompanying notes to consolidated financial statements.

7

Table of Contents

Commerce Bancshares, Inc. and Subsidiaries

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

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

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


2. Loans and Allowance for Loan Losses

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

(In thousands)
 
September 30, 2017
 
December 31, 2016
Commercial:
 
 
 
 
Business
 
$
4,834,037

 
$
4,776,365

Real estate – construction and land
 
921,609

 
791,236

Real estate – business
 
2,700,174

 
2,643,374

Personal Banking:
 
 
 
 
Real estate – personal
 
2,029,302

 
2,010,397

Consumer
 
2,113,438

 
1,990,801

Revolving home equity
 
391,308

 
413,634

Consumer credit card
 
752,379

 
776,465

Overdrafts
 
3,245

 
10,464

Total loans
 
$
13,745,492

 
$
13,412,736


At September 30, 2017, loans of $3.8 billion were pledged at the Federal Home Loan Bank as collateral for borrowings and letters of credit obtained to secure public deposits. Additional loans of $1.7 billion were pledged at the Federal Reserve Bank as collateral for discount window borrowings.


8

Table of Contents

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

Total
 
Commercial
Personal Banking

Total
Balance at beginning of period
$
92,739

$
65,093

$
157,832

 
$
91,361

$
64,571

$
155,932

Provision
24

10,680

10,704

 
1,026

31,564

32,590

Deductions:
 
 
 
 
 
 
 
   Loans charged off
378

13,592

13,970

 
1,455

39,337

40,792

   Less recoveries on loans
651

2,615

3,266

 
2,104

7,998

10,102

Net loan charge-offs (recoveries)
(273
)
10,977

10,704

 
(649
)
31,339

30,690

Balance September 30, 2017
$
93,036

$
64,796

$
157,832

 
$
93,036

$
64,796

$
157,832

Balance at beginning of period
$
89,198

$
64,634

$
153,832

 
$
82,086

$
69,446

$
151,532

Provision
(1,411
)
8,674

7,263

 
4,309

21,609

25,918

Deductions:
 
 
 
 
 
 
 
   Loans charged off
291

11,872

12,163

 
2,465

35,633

38,098

   Less recoveries on loans
2,759

2,841

5,600

 
6,325

8,855

15,180

Net loan charge-offs (recoveries)
(2,468
)
9,031

6,563

 
(3,860
)
26,778

22,918

Balance September 30, 2016
$
90,255

$
64,277

$
154,532

 
$
90,255

$
64,277

$
154,532


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

(In thousands)
Allowance for Loan Losses
Loans Outstanding
 
Allowance for Loan Losses
Loans Outstanding
September 30, 2017
 
 
 
 
 
Commercial
$
1,789

$
55,969

 
$
91,247

$
8,399,851

Personal Banking
1,322

23,571

 
63,474

5,266,101

Total
$
3,111

$
79,540

 
$
154,721

$
13,665,952

December 31, 2016
 
 
 
 
 
Commercial
$
1,817

$
44,795

 
$
89,544

$
8,166,180

Personal Banking
1,292

19,737

 
63,279

5,182,024

Total
$
3,109

$
64,532

 
$
152,823

$
13,348,204


Impaired loans
The table below shows the Company’s investment in impaired loans at September 30, 2017 and December 31, 2016. These loans consist of all loans on non-accrual status and other restructured loans whose terms have been modified and classified as troubled debt restructurings. These restructured loans are performing in accordance with their modified terms, and because the Company believes it probable that all amounts due under the modified terms of the agreements will be collected, interest on these loans is being recognized on an accrual basis. They are discussed further in the "Troubled debt restructurings" section on page 14.
(In thousands)
 
Sept. 30, 2017
 
Dec. 31, 2016
Non-accrual loans
 
$
13,640

 
$
14,283

Restructured loans (accruing)
 
65,900

 
50,249

Total impaired loans
 
$
79,540

 
$
64,532



9

Table of Contents

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


(In thousands)
Recorded Investment
Unpaid Principal
Balance
 Related
Allowance
September 30, 2017
 
 
 
With no related allowance recorded:
 
 
 
Business
$
6,196

$
9,725

$

Real estate – business
587

587


Consumer
1,023

1,047


 
$
7,806

$
11,359

$

With an allowance recorded:
 
 
 
Business
$
35,708

$
36,219

$
1,141

Real estate – construction and land
1,367

1,595

37

Real estate – business
12,111

13,319

611

Real estate – personal
9,723

12,537

607

Consumer
5,232

5,271

52

Revolving home equity
578

578

5

Consumer credit card
7,015

7,015

658

 
$
71,734

$
76,534

$
3,111

Total
$
79,540

$
87,893

$
3,111

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

$
10,470

$

Real estate – construction and land
557

752


 
$
7,932

$
11,222

$

With an allowance recorded:
 
 
 
Business
$
29,924

$
31,795

$
1,318

Real estate – construction and land
69

72

3

Real estate – business
6,870

8,072

496

Real estate – personal
6,394

9,199

642

Consumer
5,281

5,281

57

Revolving home equity
584

584

1

Consumer credit card
7,478

7,478

592

 
$
56,600

$
62,481

$
3,109

Total
$
64,532

$
73,703

$
3,109




10

Table of Contents

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

(In thousands)
Commercial
Personal Banking
Total
Average Impaired Loans:
 
 
 
For the three months ended September 30, 2017
 
 
 
Non-accrual loans
$
8,938

$
4,238

$
13,176

Restructured loans (accruing)
42,930

18,691

61,621

Total
$
51,868

$
22,929

$
74,797

For the nine months ended September 30, 2017
 
 
 
Non-accrual loans
$
9,800

$
4,098

$
13,898

Restructured loans (accruing)
36,567

16,901

53,468

Total
$
46,367

$
20,999

$
67,366

For the three months ended September 30, 2016
 
 
 
Non-accrual loans
$
15,106

$
3,928

$
19,034

Restructured loans (accruing)
31,372

17,082

48,454

Total
$
46,478

$
21,010

$
67,488

For the nine months ended September 30, 2016
 
 
 
Non-accrual loans
$
19,387

$
4,336

$
23,723

Restructured loans (accruing)
29,117

17,359

46,476

Total
$
48,504

$
21,695

$
70,199


The table below shows interest income recognized during the three and nine month periods ended September 30, 2017 and 2016, respectively, for impaired loans held at the end of each period. This interest all relates to accruing restructured loans, as discussed in the "Troubled debt restructurings" section on page 14.
 
For the Three Months Ended September 30
 
For the Nine Months Ended September 30
(In thousands)
2017
2016
 
2017
2016
Interest income recognized on impaired loans:
 
 
 
 
 
Business
$
473

$
277

 
$
1,418

$
830

Real estate – construction and land
10

2

 
30

7

Real estate – business
118

42

 
354

126

Real estate – personal
104

39

 
311

118

Consumer
79

89

 
236

267

Revolving home equity
7

7

 
20

22

Consumer credit card
162

174

 
486

522

Total
$
953

$
630

 
$
2,855

$
1,892



11

Table of Contents

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




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

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



Total
September 30, 2017
 
 
 
 
 
Commercial:
 
 
 
 
 
Business
$
4,823,779

$
2,630

$
807

$
6,821

$
4,834,037

Real estate – construction and land
917,128

3,913

35

533

921,609

Real estate – business
2,688,625

8,580

623

2,346

2,700,174

Personal Banking:
 
 
 
 
 
Real estate – personal
2,013,632

11,141

1,666

2,863

2,029,302

Consumer
2,082,203

27,450

2,708

1,077

2,113,438

Revolving home equity
388,346

1,530

1,432


391,308

Consumer credit card
734,215

8,971

9,193


752,379

Overdrafts
2,933

312



3,245

Total
$
13,650,861

$
64,527

$
16,464

$
13,640

$
13,745,492

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

$
3,735

$
674

$
8,682

$
4,776,365

Real estate – construction and land
789,633

1,039


564

791,236

Real estate – business
2,639,586

2,154


1,634

2,643,374

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

9,162

2,108

3,403

2,010,397

Consumer
1,957,358

29,783

3,660


1,990,801

Revolving home equity
411,483

1,032

1,119


413,634

Consumer credit card
757,443

10,187

8,835


776,465

Overdrafts
10,014

450



10,464

Total
$
13,324,515

$
57,542

$
16,396

$
14,283

$
13,412,736


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

12

Table of Contents

Commercial Loans


(In thousands)


Business
Real
 Estate-Construction
Real
Estate-
Business


Total
September 30, 2017
 
 
 
 
Pass
$
4,593,958

$
915,279

$
2,586,349

$
8,095,586

Special mention
123,549

2,527

57,319

183,395

Substandard
109,709

3,270

54,160

167,139

Non-accrual
6,821

533

2,346

9,700

Total
$
4,834,037

$
921,609

$
2,700,174

$
8,455,820

December 31, 2016
 
 
 
 
Pass
$
4,607,553

$
788,778

$
2,543,348

$
7,939,679

Special mention
116,642

722

45,479

162,843

Substandard
43,488

1,172

52,913

97,573

Non-accrual
8,682

564

1,634

10,880

Total
$
4,776,365

$
791,236

$
2,643,374

$
8,210,975


The credit quality of Personal Banking loans is monitored primarily on the basis of aging/delinquency, and this information is provided in the table in the above "Delinquent and non-accrual loans" section. In addition, FICO scores are obtained and updated on a quarterly basis for most of the loans in the Personal Banking portfolio. This is a published credit score designed to measure the risk of default by taking into account various factors from a borrower's financial history. The Bank normally obtains a FICO score at the loan's origination and renewal dates, and updates are obtained on a quarterly basis. Excluded from the table below are certain Personal Banking loans for which FICO scores are not obtained because they generally pertain to commercial customer activities and are often underwritten with other collateral considerations. At September 30, 2017, these were comprised of $220.7 million in personal real estate loans, or 4.2% of the Personal Banking portfolio, compared to $237.2 million at December 31, 2016. For the remainder of loans in the Personal Banking portfolio, the table below shows the percentage of balances outstanding at September 30, 2017 and December 31, 2016 by FICO score.
   Personal Banking Loans
 
% of Loan Category
 
Real Estate - Personal
Consumer
Revolving Home Equity
Consumer Credit Card
September 30, 2017
 
 
 
 
FICO score:
 
 
 
 
Under 600
1.4
%
3.3
%
.9
%
5.0
%
600 - 659
2.2

5.7

2.1

15.1

660 - 719
10.1

17.1

9.0

34.9

720 - 779
24.8

26.1

21.2

25.9

780 and over
61.5

47.8

66.8

19.1

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

6.4

1.8

15.5

660 - 719
10.4

19.7

9.7

34.9

720 - 779
25.4

26.3

21.1

25.1

780 and over
60.3

44.2

66.4

19.6

Total
100.0
%
100.0
%
100.0
%
100.0
%





13

Table of Contents

Troubled debt restructurings
As mentioned previously, the Company's impaired loans include loans which have been classified as troubled debt restructurings. Total restructured loans amounted to $73.1 million at September 30, 2017. Restructured loans are those extended to borrowers who are experiencing financial difficulty and who have been granted a concession. Restructured loans are placed on non-accrual status if the Company does not believe it probable that amounts due under the contractual terms will be collected, and those non-accrual loans totaled $7.2 million at September 30, 2017. Other performing restructured loans totaled $65.9 million at September 30, 2017. These include certain business, construction and business real estate loans classified as substandard. Upon maturity, the loans renewed at interest rates judged not to be market rates for new debt with similar risk and as a result the loans were classified as troubled debt restructurings. These commercial loans totaled $51.0 million at September 30, 2017. These restructured loans are performing in accordance with their modified terms, and because the Company believes it probable that all amounts due under the modified terms of the agreements will be collected, interest on these loans is being recognized on an accrual basis. Troubled debt restructurings also include certain credit card loans under various debt management and assistance programs, which totaled $7.0 million at September 30, 2017. Modifications to credit card loans generally involve removing the available line of credit, placing loans on amortizing status, and lowering the contractual interest rate. The Company has classified additional loans as troubled debt restructurings because they were not reaffirmed by the borrower in bankruptcy proceedings. At September 30, 2017, these loans totaled $7.7 million in personal real estate, revolving home equity, and consumer loans. Interest on these loans is being recognized on an accrual basis, as the borrowers are continuing to make payments under the terms of the loan agreements.

The following table shows the outstanding balances of loans classified as troubled debt restructurings at September 30, 2017, in addition to the outstanding balances of these restructured loans which the Company considers to have been in default at any time during the past twelve months. For purposes of this disclosure, the Company considers "default" to mean 90 days or more past due as to interest or principal.
(In thousands)
September 30, 2017
Balance 90 days past due at any time during previous 12 months
Commercial:
 
 
Business
$
40,608

$

Real estate - construction and land
1,304


Real estate - business
10,353

623

Personal Banking:
 
 
Real estate - personal
7,996

397

Consumer
5,235

32

Revolving home equity
578

42

Consumer credit card
7,015

800

Total restructured loans
$
73,089

$
1,894


For those loans on non-accrual status also classified as restructured, the modification did not create any further financial effect on the Company as those loans were already recorded at net realizable value. For those performing commercial loans classified as restructured, there were no concessions involving forgiveness of principal or interest and, therefore, there was no financial impact to the Company as a result of modification to these loans. No financial impact resulted from those performing loans where the debt was not reaffirmed in bankruptcy, as no changes to loan terms occurred in that process. The effects of modifications to consumer credit card loans were estimated to decrease interest income by approximately $979 thousand on an annual, pre-tax basis, compared to amounts contractually owed.

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

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

14

Table of Contents

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

The Company had commitments of $10.6 million at September 30, 2017 to lend additional funds to borrowers with restructured loans.

Loans held for sale
The Company designates certain long-term fixed rate personal real estate loans as held for sale, and the Company has elected the fair value option for these loans. The election of the fair value option aligns the accounting for these loans with the related economic hedges discussed in Note 10. The loans are primarily sold to FNMA, FHLMC, and GNMA. At September 30, 2017, the fair value of these loans was $11.3 million, and the unpaid principal balance was $10.9 million.

The Company also designates student loan originations as held for sale. The borrowers are credit-worthy students who are attending colleges and universities. The loans are intended to be sold in the secondary market, and the Company maintains contracts with Sallie Mae to sell the loans within 210 days after the last disbursement to the student. These loans are carried at lower of cost or fair value, which at September 30, 2017 totaled $6.0 million.

At September 30, 2017, none of the loans held for sale were on non-accrual status or 90 days past due and still accruing.
 
Foreclosed real estate/repossessed assets
The Company’s holdings of foreclosed real estate totaled $1.1 million and $366 thousand at September 30, 2017 and December 31, 2016, respectively. Personal property acquired in repossession, generally autos and marine and recreational vehicles, totaled $2.7 million and $2.2 million at September 30, 2017 and December 31, 2016, respectively. Upon acquisition, these assets are recorded at fair value less estimated selling costs at the date of foreclosure, establishing a new cost basis. They are subsequently carried at the lower of this cost basis or fair value less estimated selling costs.

3. Investment Securities

Investment securities, at fair value, consisted of the following at September 30, 2017 and December 31, 2016.
 
(In thousands)
Sept. 30, 2017
December 31, 2016
Available for sale
$
9,109,287

$
9,649,203

Trading
24,605

22,225

Non-marketable
99,268

99,558

Total investment securities
$
9,233,160

$
9,770,986


Most of the Company’s investment securities are classified as available for sale, and this portfolio is discussed in more detail below. The available for sale and the trading portfolios are carried at fair value. Securities which are classified as non-marketable include Federal Home Loan Bank (FHLB) stock and Federal Reserve Bank stock held for debt and regulatory purposes, which totaled $47.3 million at September 30, 2017 and $46.9 million at December 31, 2016. Investment in Federal Reserve Bank stock is based on the capital structure of the investing bank, and investment in FHLB stock is tied to the level of borrowings from the FHLB. These holdings are carried at cost. Non-marketable securities also include private equity investments, which amounted to $51.7 million at September 30, 2017 and $52.3 million at December 31, 2016. In the absence of readily ascertainable market values, these securities are carried at estimated fair value.


15

Table of Contents

A summary of the available for sale investment securities by maturity groupings as of September 30, 2017 is shown below. The investment portfolio includes agency mortgage-backed securities, which are guaranteed by agencies such as the FHLMC, FNMA, GNMA and FDIC, in addition to non-agency mortgage-backed securities, which have no guarantee but are collateralized by commercial and residential mortgages. Also included are certain other asset-backed securities, which are primarily collateralized by credit cards, automobiles, student loans, and commercial loans. These securities differ from traditional debt securities primarily in that they may have uncertain maturity dates and are priced based on estimated prepayment rates on the underlying collateral.
(In thousands)
Amortized Cost
Fair Value
U.S. government and federal agency obligations:
 
 
Within 1 year
$
57,511

$
58,238

After 1 but within 5 years
570,284

573,789

After 5 but within 10 years
218,912

219,468

After 10 years
69,517

67,109

Total U.S. government and federal agency obligations
916,224

918,604

Government-sponsored enterprise obligations:
 
 
Within 1 year
187,032

187,027

After 1 but within 5 years
247,444

247,141

After 10 years
35,927

35,246

Total government-sponsored enterprise obligations
470,403

469,414

State and municipal obligations:
 
 
Within 1 year
177,616

178,836

After 1 but within 5 years
659,012

671,931

After 5 but within 10 years
800,504

819,943

After 10 years
50,004

49,693

Total state and municipal obligations
1,687,136

1,720,403

Mortgage and asset-backed securities:
 
 
  Agency mortgage-backed securities
2,741,329

2,756,973

  Non-agency mortgage-backed securities
1,062,079

1,066,764

  Asset-backed securities
1,735,004

1,736,966

Total mortgage and asset-backed securities
5,538,412

5,560,703

Other debt securities:
 
 
Within 1 year
13,388

13,393

After 1 but within 5 years
207,556

210,022

After 5 but within 10 years
133,140

133,226

Total other debt securities
354,084

356,641

Equity securities
5,353

83,522

Total available for sale investment securities
$
8,971,612

$
9,109,287


Investments in U.S. government and federal agency obligations include U.S. Treasury inflation-protected securities, which totaled $438.7 million, at fair value, at September 30, 2017. Interest paid on these securities increases with inflation and decreases with deflation, as measured by the Consumer Price Index. Included in state and municipal obligations are $16.9 million, at fair value, of auction rate securities, which were purchased from bank customers in 2008. Interest on these bonds is currently being paid at the maximum failed auction rates. Included in equity securities is common and preferred stock held by the holding company, Commerce Bancshares, Inc. (the Parent), with a fair value of $83.4 million at September 30, 2017.


16

Table of Contents

For securities classified as available for sale, the following table shows the unrealized gains and losses (pre-tax) in accumulated other comprehensive income, by security type.
 
 
(In thousands)
Amortized Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
September 30, 2017
 
 
 
 
U.S. government and federal agency obligations
$
916,224

$
6,359

$
(3,979
)
$
918,604

Government-sponsored enterprise obligations
470,403

844

(1,833
)
469,414

State and municipal obligations
1,687,136

34,952

(1,685
)
1,720,403

Mortgage and asset-backed securities:
 
 
 
 
  Agency mortgage-backed securities
2,741,329

28,827

(13,183
)
2,756,973

  Non-agency mortgage-backed securities
1,062,079

8,536

(3,851
)
1,066,764

  Asset-backed securities
1,735,004

5,047

(3,085
)
1,736,966

Total mortgage and asset-backed securities
5,538,412

42,410

(20,119
)
5,560,703

Other debt securities
354,084

3,293

(736
)
356,641

Equity securities
5,353

78,169


83,522

Total
$
8,971,612

$
166,027

$
(28,352
)
$
9,109,287

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

$
7,312

$
(6,312
)
$
920,904

Government-sponsored enterprise obligations
450,448

1,126

(1,576
)
449,998

State and municipal obligations
1,778,684

12,223

(12,693
)
1,778,214

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

31,610

(20,643
)
2,685,931

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

7,686

(6,493
)
1,055,639

  Asset-backed securities
2,389,176

3,338

(11,213
)
2,381,301

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

42,634

(38,349
)
6,122,871

Other debt securities
327,030

935

(2,012
)
325,953

Equity securities
5,678

45,585


51,263

Total
$
9,600,330

$
109,815

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


The Company’s impairment policy requires a review of all securities for which fair value is less than amortized cost. Special emphasis and analysis is placed on securities whose credit rating has fallen below A3 (Moody's) or A- (Standard & Poor's), whose fair values have fallen more than 20% below purchase price for an extended period of time, or have been identified based on management’s judgment. These securities are placed on a watch list, and for all such securities, cash flow analyses are prepared. For more complex analyses, detailed cash flow models are prepared which use inputs specific to each security. Inputs to these models include factors such as cash flow received, contractual payments required, and various other information related to the underlying collateral (including current delinquencies), collateral loss severity rates (including loan to values), expected delinquency rates, credit support from other tranches, and prepayment speeds. Stress tests are performed at varying levels of delinquency rates, prepayment speeds and loss severities in order to gauge probable ranges of credit loss. At September 30, 2017, the fair value of securities on this watch list was $63.6 million compared to $79.6 million at December 31, 2016.

As of September 30, 2017, the Company had recorded other-than-temporary impairment (OTTI) on certain non-agency mortgage-backed securities, part of the watch list mentioned above, which had an aggregate fair value of $28.1 million. The cumulative credit-related portion of the impairment on these securities, which was recorded in earnings, totaled $14.2 million. The Company does not intend to sell these securities and believes it is not likely that it will be required to sell the securities before the recovery of their amortized cost.

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

Significant Inputs
Range
Prepayment CPR
3%
-
25%
Projected cumulative default
13%
-
50%
Credit support
0%
-
47%
Loss severity
16%
-
63%

17

Table of Contents

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

$
14,129

Credit losses on debt securities for which impairment was not previously recognized
98


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

270

Increase in expected cash flows that are recognized over remaining life of security
(207
)
(171
)
Cumulative OTTI credit losses at September 30
$
14,245

$
14,228


Securities with unrealized losses recorded in accumulated other comprehensive income are shown in the table below, along with the length of the impairment period.
 
Less than 12 months
 
12 months or longer
 
Total
 
(In thousands)
   Fair Value
Unrealized
Losses
 
Fair Value
Unrealized
Losses
 
Fair Value
Unrealized
Losses
September 30, 2017
 
 
 
 
 
 
 
 
U.S. government and federal agency obligations
$
123,071

$
3,979

 
$

$

 
$
123,071

$
3,979

Government-sponsored enterprise obligations
190,141

1,650

 
49,793

183

 
239,934

1,833

State and municipal obligations
95,890

692

 
38,026

993

 
133,916

1,685

Mortgage and asset-backed securities:
 
 
 
 
 
 
 
 
   Agency mortgage-backed securities
887,047

9,741

 
223,550

3,442

 
1,110,597

13,183

   Non-agency mortgage-backed securities
381,896

1,674

 
156,455

2,177

 
538,351

3,851

   Asset-backed securities
488,409

522

 
279,402

2,563

 
767,811

3,085

Total mortgage and asset-backed securities
1,757,352

11,937

 
659,407

8,182

 
2,416,759

20,119

Other debt securities
70,143

622

 
9,363

114

 
79,506

736

Total
$
2,236,597

$
18,880

 
$
756,589

$
9,472

 
$
2,993,186

$
28,352

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

$
2,823

 
$
32,208

$
3,489

 
$
381,746

$
6,312

Government-sponsored enterprise obligations
190,441

1,576

 


 
190,441

1,576

State and municipal obligations
700,779

12,164

 
15,195

529

 
715,974

12,693

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

20,638

 
2,150

5

 
1,149,566

20,643

   Non-agency mortgage-backed securities
688,131

6,373

 
34,946

120

 
723,077

6,493

   Asset-backed securities
780,209

5,277

 
358,778

5,936

 
1,138,987

11,213

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

32,288

 
395,874

6,061

 
3,011,630

38,349

Other debt securities
179,639

1,986

 
975

26

 
180,614

2,012

Total
$
4,036,153

$
50,837

 
$
444,252

$
10,105

 
$
4,480,405

$
60,942


The Company’s holdings of state and municipal obligations included gross unrealized losses of $1.7 million at September 30, 2017, of which $221 thousand related to auction rate securities. This portfolio totaled $1.7 billion at fair value, or 18.9% of total available for sale securities. The average credit quality of the portfolio is Aa2 as rated by Moody’s. The portfolio is diversified in order to reduce risk, and the Company has processes and procedures in place to monitor its holdings, identify signs of financial distress and, if necessary, exit its positions in a timely manner.

    

18

Table of Contents

The following tables present proceeds from sales of securities and the components of investment securities gains and losses which have been recognized in earnings.
 
For the Nine Months Ended September 30
(In thousands)
2017
2016
Proceeds from sales of securities:
 
 
Available for sale
$
367,453

$

Non-marketable
1,583

7,946

Total proceeds
$
369,036

$
7,946

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

Gains realized on sales
592


Losses realized on sales
(568
)

Gains realized on donations of securities
6,707


Other-than-temporary impairment recognized on debt securities
(372
)
(270
)
 Non-marketable:
 
 
 Gains realized on sales
645

3,717

 Losses realized on sales
(880
)
(502
)
Fair value adjustments, net
(8,028
)
(6,649
)
Total gains (losses), net
$
(2,158
)
$
(3,704
)

At September 30, 2017, securities totaling $3.7 billion in fair value were pledged to secure public fund deposits, securities sold under agreements to repurchase, trust funds, and borrowings at the Federal Reserve Bank and FHLB. Securities pledged under agreements pursuant to which the collateral may be sold or re-pledged by the secured parties approximated $667.2 million, while the remaining securities were pledged under agreements pursuant to which the secured parties may not sell or re-pledge the collateral. Except for obligations of various government-sponsored enterprises such as FNMA, FHLB and FHLMC, no investment in a single issuer exceeded 10% of stockholders’ equity.

19

Table of Contents

4. Goodwill and Other Intangible Assets

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

$
(28,127
)
$

$
3,143

 
$
31,270

$
(27,429
)
$

$
3,841

Mortgage servicing rights
7,361

(3,100
)
(16
)
4,245

 
5,672

(2,782
)
(22
)
2,868

Total
$
38,631

$
(31,227
)
$
(16
)
$
7,388

 
$
36,942

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


Aggregate amortization expense on intangible assets was $338 thousand and $374 thousand for the three month periods ended September 30, 2017 and 2016, respectively, and $1.0 million and $1.2 million for the nine month periods ended September 30, 2017 and 2016, respectively. The following table shows the estimated annual amortization expense for the next five fiscal years. This expense is based on existing asset balances and the interest rate environment as of September 30, 2017. The Company’s actual amortization expense in any given period may be different from the estimated amounts depending upon the acquisition of intangible assets, changes in mortgage interest rates, prepayment rates and other market conditions.
 (In thousands)
 
2017
$
1,331

2018
1,181

2019
996

2020
834

2021
711



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

$
3,841

$
2,868

Originations


1,689

Amortization

(698
)
(318
)
Impairment reversal


6

Balance September 30, 2017
$
138,921

$
3,143

$
4,245



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

Commercial segment
67,454

Wealth segment
746

Total goodwill
$
138,921


5. Guarantees

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


20

Table of Contents

Upon issuance of standby letters of credit, the Company recognizes a liability for the fair value of the obligation undertaken, which is estimated to be equivalent to the amount of fees received from the customer over the life of the agreement. At September 30, 2017, that net liability was $2.1 million, which will be accreted into income over the remaining life of the respective commitments. The contractual amount of these letters of credit, which represents the maximum potential future payments guaranteed by the Company, was $338.4 million at September 30, 2017.

The Company periodically enters into credit risk participation agreements (RPAs) as a guarantor to other financial institutions, in order to mitigate those institutions’ credit risk associated with interest rate swaps with third parties. The RPA stipulates that, in the event of default by the third party on the interest rate swap, the Company will reimburse a portion of the loss borne by the financial institution. These interest rate swaps are normally collateralized (generally with real property, inventories and equipment) by the third party, which limits the credit risk associated with the Company’s RPAs. The third parties usually have other borrowing relationships with the Company. The Company monitors overall borrower collateral and at September 30, 2017, believes sufficient collateral is available to cover potential swap losses. The RPAs are carried at fair value throughout their term with all changes in fair value, including those due to a change in the third party’s creditworthiness, recorded in current earnings. The terms of the RPAs, which correspond to the terms of the underlying swaps, range from 3 to 11 years. At September 30, 2017, the fair value of the Company's guarantee liabilities for RPAs was $129 thousand, and the notional amount of the underlying swaps was $74.9 million. The maximum potential future payment guaranteed by the Company cannot be readily estimated but is dependent upon the fair value of the interest rate swaps at the time of default.

6. Pension

The amount of net pension cost is shown in the table below:
 
For the Three Months Ended September 30
 
For the Nine Months Ended September 30
(In thousands)
2017
2016
 
2017
2016
Service cost - benefits earned during the period
$
193

$
135

 
$
450

$
406

Interest cost on projected benefit obligation
923

986

 
2,869

2,958

Expected return on plan assets
(1,463
)
(1,437
)
 
(4,339
)
(4,313
)
Amortization of prior service cost
(67
)
(68
)
 
(203
)
(203
)
Amortization of unrecognized net loss
630

647

 
1,864

1,940

Net periodic pension cost
$
216

$
263

 
$
641

$
788


Substantially all benefits accrued under the Company’s defined benefit pension plan were frozen effective January 1, 2005, and the remaining benefits were frozen effective January 1, 2011. During the first nine months of 2017, the Company made a discretionary contribution of $5.5 million to its defined benefit pension plan in order to reduce pension guarantee costs. The Company also made minimal funding contributions to a supplemental executive retirement plan (the CERP), which carries no segregated assets. The Company has no plans to make any further contributions, other than those related to the CERP, during the remainder of 2017.





21

Table of Contents

7. Common Stock *

Presented below is a summary of the components used to calculate basic and diluted income per share. The Company applies the two-class method of computing income per share, as nonvested share-based awards that contain nonforfeitable rights to dividends are considered securities which participate in undistributed earnings with common stock. The two-class method requires the calculation of separate income per share amounts for the nonvested share-based awards and for common stock. Income per share attributable to common stock is shown in the table below. Nonvested share-based awards are further discussed in Note 12.
 
For the Three Months Ended September 30
 
For the Nine Months Ended September 30
(In thousands, except per share data)
2017
2016
 
2017
2016
Basic income per common share:
 
 
 
 
 
Net income attributable to Commerce Bancshares, Inc.
$
74,564

$
68,545

 
$
225,028

$
203,812

Less preferred stock dividends
2,250

2,250

 
6,750

6,750

Net income available to common shareholders
$
72,314

$
66,295

 
218,278

197,062

Less income allocated to nonvested restricted stock
862

913

 
2,750

2,747

  Net income allocated to common stock
$
71,452

$
65,382

 
$
215,528

$
194,315

Weighted average common shares outstanding
100,598

100,198

 
100,509

100,231

   Basic income per common share
$
.71

$
.65

 
$
2.14

$
1.94

Diluted income per common share:
 
 
 
 
 
Net income available to common shareholders
$
72,314

$
66,295

 
$
218,278

$
197,062

Less income allocated to nonvested restricted stock
860

912

 
2,743

2,743

  Net income allocated to common stock
$
71,454

$
65,383

 
$
215,535

$
194,319

Weighted average common shares outstanding
100,598

100,198

 
100,509

100,231

  Net effect of the assumed exercise of stock-based awards - based on
 
 
 
 
 
    the treasury stock method using the average market price for the respective periods
336

255

 
358

248

  Weighted average diluted common shares outstanding
100,934

100,453

 
100,867

100,479

    Diluted income per common share
$
.71

$
.65

 
$
2.14

$
1.93


Unexercised stock appreciation rights of 139 thousand and 89 thousand were excluded in the computation of diluted income per common share for the nine month periods ended September 30, 2017 and 2016, respectively, because their inclusion would have been anti-dilutive.
* All prior year share and per share amounts in this note have been restated for the 5% common stock dividend distributed in December 2016.
  

22

Table of Contents

8. Accumulated Other Comprehensive Income

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

$
27,328

$
(19,328
)
$
10,975

Other comprehensive income before reclassifications
365

94,794


95,159

Amounts reclassified from accumulated other comprehensive income
372

(6,731
)
1,661

(4,698
)
Current period other comprehensive income, before tax
737

88,063

1,661

90,461

Income tax expense
(280
)
(33,464
)
(631
)
(34,375
)
Current period other comprehensive income, net of tax
457

54,599

1,030

56,086

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

(24
)


Balance September 30, 2017
$
3,456

$
81,903

$
(18,298
)
$
67,061

Balance January 1, 2016
$
3,316

$
49,750

$
(20,596
)
$
32,470

Other comprehensive income (loss) before reclassifications
(837
)
141,752


140,915

Amounts reclassified from accumulated other comprehensive income
270


1,737

2,007

Current period other comprehensive income (loss), before tax
(567
)
141,752

1,737

142,922

Income tax (expense) benefit
215

(53,865
)
(660
)
(54,310
)
Current period other comprehensive income (loss), net of tax
(352
)
87,887

1,077

88,612

Balance September 30, 2016
$
2,964

$
137,637

$
(19,519
)
$
121,082

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

9. Segments

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



23

Table of Contents

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

(In thousands)
Consumer
Commercial
Wealth
Segment Totals
Other/Elimination
Consolidated Totals
Three Months Ended September 30, 2017
 
 
 
 
 
 
Net interest income
$
70,793

$
82,012

$
11,744

$
164,549

$
18,042

$
182,591

Provision for loan losses
(11,067
)
335

(10
)
(10,742
)
38

(10,704
)
Non-interest income
35,194

47,902

40,404

123,500

(1,258
)
122,242

Investment securities losses, net




(3,037
)
(3,037
)
Non-interest expense
(72,607
)
(71,468
)
(30,528
)
(174,603
)
(9,969
)
(184,572
)
Income before income taxes
$
22,313

$
58,781

$
21,610

$
102,704

$
3,816

$
106,520

Nine Months Ended September 30, 2017
 
 
 
 
 
 
Net interest income
$
207,421

$
243,517

$
35,515

$
486,453

$
57,218

$
543,671

Provision for loan losses
(31,531
)
959

(9
)
(30,581
)
(2,009
)
(32,590
)
Non-interest income
101,211

144,781

116,961

362,953

(561
)
362,392

Investment securities losses, net




(2,158
)
(2,158
)
Non-interest expense
(217,733
)
(219,307
)
(90,323
)
(527,363
)
(28,633
)
(555,996
)
Income before income taxes
$
59,368

$
169,950

$
62,144

$
291,462

$
23,857

$
315,319

Three Months Ended September 30, 2016
 
 
 
 
 
 
Net interest income
$
67,375

$
78,514

$
10,782

$
156,671

$
14,572

$
171,243

Provision for loan losses
(9,033
)
2,432

(5
)
(6,606
)
(657
)
(7,263
)
Non-interest income
34,230

49,832

36,676

120,738

(1,419
)
119,319

Investment securities losses, net




(1,965
)
(1,965
)
Non-interest expense
(70,134
)
(71,200
)
(28,172
)
(169,506
)
(11,736
)
(181,242
)
Income before income taxes
$
22,438

$
59,578

$
19,281

$
101,297

$
(1,205
)
$
100,092

Nine Months Ended September 30, 2016
 
 
 
 
 
 
Net interest income
$
201,166

$
231,780

$
32,604

$
465,550

$
41,297

$
506,847

Provision for loan losses
(26,533
)
3,919

(120
)
(22,734
)
(3,184
)
(25,918
)
Non-interest income
97,165

149,240

107,696

354,101

812

354,913

Investment securities losses, net




(3,704
)
(3,704
)
Non-interest expense
(209,660
)
(211,450
)
(85,116
)
(506,226
)
(29,578
)
(535,804
)
Income before income taxes
$
62,138

$
173,489

$
55,064

$
290,691

$
5,643

$
296,334


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

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

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


24

Table of Contents

10. Derivative Instruments

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

(In thousands)
September 30, 2017
December 31, 2016
Interest rate swaps
$
1,723,448

$
1,685,099

Interest rate caps
31,923

59,379

Credit risk participation agreements
112,348

121,514

Foreign exchange contracts
8,783

4,046

 Mortgage loan commitments
23,616

12,429

Mortgage loan forward sale contracts
1,607

6,626

Forward TBA contracts
32,000

15,000

Total notional amount
$
1,933,725

$
1,904,093


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

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

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

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


25

Table of Contents

The fair values of the Company's derivative instruments, whose notional amounts are listed above, are shown in the table below. Derivative instruments with a positive fair value (asset derivatives) are reported in other assets in the consolidated balance sheets, while derivative instruments with a negative fair value (liability derivatives) are reported in other liabilities in the consolidated balance sheets. Information about the valuation methods used to determine fair value is provided in Note 13 on Fair Value Measurements.
 
Asset Derivatives
 
Liability Derivatives
 
Sept. 30, 2017
Dec. 31, 2016
 
Sept. 30, 2017
Dec. 31, 2016
(In thousands)    
  Fair Value
 
  Fair Value
Derivative instruments:
 
 
 
 
 
   Interest rate swaps
$
10,630

$
12,987

 
$
(5,775
)
$
(12,987
)
   Interest rate caps
29

78

 
(29
)
(78
)
   Credit risk participation agreements
56

65

 
(129
)
(156
)
   Foreign exchange contracts
68

66

 
(30
)
(4
)
   Mortgage loan commitments
757

355

 

(6
)
   Mortgage loan forward sale contracts
8


 

(63
)
   Forward TBA contracts
102

15

 
(16
)
(45
)
 Total
$
11,650

$
13,566

 
$
(5,979
)
$
(13,339
)

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

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



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


 
For the Three Months Ended September 30
 
For the Nine Months Ended September 30
(In thousands)
 
2017
2016
 
2017
2016
Derivative instruments:
 
 
 
 
 
 
  Interest rate swaps
Other non-interest income
$
702

$
203

 
$
1,301

$
3,198

  Credit risk participation agreements
Other non-interest income
7

50

 
18

(8
)
  Foreign exchange contracts
Other non-interest income
51

(20
)
 
(24
)
(12
)
  Mortgage loan commitments
Loan fees and sales
(114
)
86

 
408

613

  Mortgage loan forward sale contracts
Loan fees and sales
8

1

 
70

1

  Forward TBA contracts
Loan fees and sales
(322
)
(172
)
 
(580
)
(898
)
Total
 
$
332

$
148

 
$
1,193

$
2,894


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


26

Table of Contents

The Company is party to master netting arrangements with most of its swap derivative counterparties; however, the Company does not offset derivative assets and liabilities under these arrangements on its consolidated balance sheet. Collateral, usually in the form of marketable securities, is exchanged between the Company and dealer bank counterparties and is generally subject to thresholds and transfer minimums. By contract, it may be sold or re-pledged by the secured party until recalled at a subsequent valuation date by the pledging party. For those swap transactions requiring central clearing, the Company posts cash and securities to its clearing agent. Collateral positions are valued daily, and adjustments to amounts received and pledged by the Company are made as appropriate to maintain proper collateralization for these transactions. Swap derivative transactions with customers are generally secured by rights to non-financial collateral, such as real and personal property, which is not shown in the table below.
 
 
 
 
Gross Amounts Not Offset in the Balance Sheet
 
(In thousands)
Gross Amount Recognized
Gross Amounts Offset in the Balance Sheet
Net Amounts Presented in the Balance Sheet
Financial Instruments Available for Offset
Collateral Received/Pledged
Net Amount
September 30, 2017
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
Derivatives subject to master netting agreements
$
10,809

$

$
10,809

$
(364
)
$

$
10,445

Derivatives not subject to master netting agreements
841


841

 
 
 
Total derivatives
11,650


11,650

 
 
 
Liabilities:
 
 
 
 
 
 
Derivatives subject to master netting agreements
$
5,829

$

$
5,829

$
(364
)
$
(1,692
)
$
3,773

Derivatives not subject to master netting agreements
150


150

 
 
 
Total derivatives
5,979


5,979

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

$

$
13,111

$
(3,391
)
$

$
9,720

Derivatives not subject to master netting agreements
455


455

 
 
 
Total derivatives
13,566


13,566

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

$

$
13,124

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

Derivatives not subject to master netting agreements
215


215

 
 
 
Total derivatives
13,339


13,339

 
 
 

11. Resale and Repurchase Agreements

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

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


27

Table of Contents

The Company is party to several agreements commonly known as collateral swaps. These agreements involve the exchange of collateral under simultaneous repurchase and resale agreements with the same financial institution counterparty. These repurchase and resale agreements have the same principal amounts, inception dates, and maturity dates and have been offset against each other in the consolidated balance sheets, as permitted under the netting provisions of ASC 210-20-45. The collateral swaps totaled $650.0 million at September 30, 2017 and $550.0 million at December 31, 2016. At September 30, 2017, the Company had posted collateral of $665.5 million in marketable securities, consisting of agency mortgage-backed bonds and treasuries, and had accepted $663.1 million in investment grade asset-backed, commercial mortgage-backed, and corporate bonds.
 
 
 
 
Gross Amounts Not Offset in the Balance Sheet
 
(In thousands)
Gross Amount Recognized
Gross Amounts Offset in the Balance Sheet
Net Amounts Presented in the Balance Sheet
Financial Instruments Available for Offset
Securities Collateral Received/Pledged
Net Amount
September 30, 2017
 
 
 
 
 
 
Total resale agreements, subject to master netting arrangements
$
1,350,000

$
(650,000
)
$
700,000

$

$
(700,000
)
$

Total repurchase agreements, subject to master netting arrangements
1,708,074

(650,000
)
1,058,074


(1,058,074
)

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

$
(550,000
)
$
725,000

$

$
(725,000
)
$

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

(550,000
)
1,671,065


(1,671,065
)


The table below shows the remaining contractual maturities of repurchase agreements outstanding at September 30, 2017 and December 31, 2016, in addition to the various types of marketable securities that have been pledged as collateral for these borrowings.
 
Remaining Contractual Maturity of the Agreements
 
(In thousands)
Overnight and continuous
Up to 90 days
Greater than 90 days
Total
September 30, 2017
 
 
 
 
Repurchase agreements, secured by:
 
 
 
 
  U.S. government and federal agency obligations
$
326,080

$

$
450,000

$
776,080

  Government-sponsored enterprise obligations
186,896



186,896

  Agency mortgage-backed securities
317,780

19,730

200,000

537,510

  Asset-backed securities
117,588

90,000


207,588

   Total repurchase agreements, gross amount recognized
$
948,344

$
109,730

$
650,000

$
1,708,074

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

$

$
300,000

$
594,600

  Government-sponsored enterprise obligations
147,694


3,237

150,931

  Agency mortgage-backed securities
693,851

24,380

252,473

970,704

  Asset-backed securities
474,830

30,000


504,830

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

$
54,380

$
555,710

$
2,221,065


12. Stock-Based Compensation

The Company issues stock-based compensation in the form of nonvested restricted stock and stock appreciation rights (SARs). Most of the awards are issued during the first quarter of each year. The stock-based compensation expense that has been charged against income was $3.0 million and $2.6 million in the three months ended September 30, 2017 and 2016, respectively, and $9.1 million and $8.9 million in the nine months ended September 30, 2017 and 2016, respectively.

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

28

Table of Contents

compensation cost at that time. The effect of this change, which was recognized as a cumulative-effect adjustment on January 1, 2017, increased equity and increased deferred tax assets by approximately $1.3 million. ASU 2016-09 also changed the classification of excess tax benefits and deficiencies arising from stock-based payment transactions, resulting in reductions in income tax expense of $4.5 million in the first quarter of 2017, $1.6 million in the second quarter of 2017 and $619 thousand in the third quarter of 2017.

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

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

$34.67
Granted
242,244

57.31
Vested
(403,586
)
30.87
Forfeited
(20,250
)
40.72
Nonvested at September 30, 2017
1,210,859

$40.36

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

$12.54

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


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

$34.53
 
 
Granted
165,592

57.53
 
 
Forfeited
(9,448
)
44.25

 
 
Expired
(837
)
36.48

 
 
Exercised
(317,621
)
30.86
 
 
Outstanding at September 30, 2017
1,162,640

$38.73
6.3 years
$
21,821




29

Table of Contents

13. Fair Value Measurements

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

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


30

Table of Contents

Instruments Measured at Fair Value on a Recurring Basis

The table below presents the September 30, 2017 and December 31, 2016 carrying values of assets and liabilities measured at fair value on a recurring basis. There were no transfers among levels during the first nine months of 2017 or the year ended December 31, 2016.
 
 
Fair Value Measurements Using
(In thousands)
Total Fair Value
Quoted Prices in Active Markets for Identical Assets
(Level 1)
Significant Other Observable Inputs
(Level 2)
Significant Unobservable Inputs
(Level 3)
September 30, 2017
 
 
 
 
Assets:
 
 
 
 
  Residential mortgage loans held for sale
$
11,320

$

$
11,320

$

  Available for sale securities:
 
 
 
 
     U.S. government and federal agency obligations
918,604

918,604



     Government-sponsored enterprise obligations
469,414


469,414


     State and municipal obligations
1,720,403


1,703,550

16,853

     Agency mortgage-backed securities
2,756,973


2,756,973


     Non-agency mortgage-backed securities
1,066,764


1,066,764


     Asset-backed securities
1,736,966


1,736,966


     Other debt securities
356,641


356,641


     Equity securities
83,522

32,915

50,607


  Trading securities
24,605


24,605


  Private equity investments
50,254



50,254

  Derivatives *
11,650


10,837

813

  Assets held in trust for deferred compensation plan
12,311

12,311



  Total assets
9,219,427

963,830

8,187,677

67,920

Liabilities:
 
 
 
 
  Derivatives *
5,979


5,850

129

Liabilities held in trust for deferred compensation plan
12,311

12,311



  Total liabilities
$
18,290

$
12,311

$
5,850

$
129

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

$

$
9,263

$

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

920,904



     Government-sponsored enterprise obligations
449,998


449,998


     State and municipal obligations
1,778,214


1,761,532

16,682

     Agency mortgage-backed securities
2,685,931


2,685,931


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


1,055,639


     Asset-backed securities
2,381,301


2,381,301


     Other debt securities
325,953


325,953


     Equity securities
51,263

24,967

26,296


  Trading securities
22,225


22,225


  Private equity investments
50,820



50,820

  Derivatives *
13,566


13,146

420

  Assets held in trust for deferred compensation plan
10,261

10,261



  Total assets
9,755,338

956,132

8,731,284

67,922

Liabilities:
 
 
 
 
  Derivatives *
13,339


13,177

162

Liabilities held in trust for deferred compensation plan
10,261

10,261



  Total liabilities
$
23,600

$
10,261

$
13,177

$
162

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






31

Table of Contents

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


(In thousands)
State and Municipal Obligations
Private Equity
Investments
Derivatives
Total
For the three months ended September 30, 2017
 
 
 
 
Balance June 30, 2017
$
16,825

$
53,557

$
791

$
71,173

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

(5,198
)
(107
)
(5,305
)
   Included in other comprehensive income *
19



19

Discount accretion
9



9

Purchases of private equity investments

2,185


2,185

Sale/pay down of private equity investments

(290
)

(290
)
Balance September 30, 2017
$
16,853

$
50,254

$
684

$
67,791

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

$
(5,198
)
$
764

$
(4,434
)
For the nine months ended September 30, 2017
 
 
 
 
Balance January 1, 2017
$
16,682

$
50,820

$
258

$
67,760

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

(8,028
)
426

(7,602
)
   Included in other comprehensive income *
729



729

Investment securities called
(600
)


(600
)
Discount accretion
42



42

Purchases of private equity investments

9,269


9,269

Sale/pay down of private equity investments

(1,840
)

(1,840
)
Capitalized interest/dividends

33


33

Balance September 30, 2017
$
16,853

$
50,254

$
684

$
67,791

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

$
(7,853
)
$
775

$
(7,078
)
For the three months ended September 30, 2016
 
 
 
 
Balance June 30, 2016
$
17,679

$
62,813

$
502

$
80,994

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

(2,921
)
136

(2,785
)
   Included in other comprehensive income *
317



317

Investment securities called
(1,100
)


(1,100
)
Discount accretion
12



12

Purchases of private equity investments

2,894


2,894

Sale/pay down of private equity investments

(3,315
)

(3,315
)
Capitalized interest/dividends

15


15

Sale of risk participation agreement


(33
)
(33
)
Balance September 30, 2016
$
16,908

$
59,486

$
605

$
76,999

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

$
(2,921
)
$
926

$
(1,995
)
For the nine months ended September 30, 2016
 
 
 
 
Balance January 1, 2016
$
17,195

$
63,032

$
69

$
80,296

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

(6,645
)
605

(6,040
)
   Included in other comprehensive income *
819



819

Investment securities called
(1,200
)


(1,200
)
Discount accretion
94



94

Purchases of private equity investments

8,735


8,735

Sale/pay down of private equity investments

(5,713
)

(5,713
)
Capitalized interest/dividends

77


77

Sale of risk participation agreement


(69
)
(69
)
Balance September 30, 2016
$
16,908

$
59,486

$
605

$
76,999

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

$
(6,545
)
$
868

$
(5,677
)
* Included in "net unrealized gains (losses) on other securities" in the consolidated statements of comprehensive income.

32

Table of Contents

Gains and losses included in earnings for the Level 3 assets and liabilities in the previous table are reported in the following line items in the consolidated statements of income:
(In thousands)
Loan Fees and Sales
Other Non-Interest Income
Investment Securities Gains (Losses), Net
Total
For the three months ended September 30, 2017
 
 
 
 
Total gains or losses included in earnings
$
(115
)
$
8

$
(5,198
)
$
(5,305
)
Change in unrealized gains or losses relating to assets still held at September 30, 2017
$
756

$
8

$
(5,198
)
$
(4,434
)
For the nine months ended September 30, 2017
 
 
 
 
Total gains or losses included in earnings
$
407

$
19

$
(8,028
)
$
(7,602
)
Change in unrealized gains or losses relating to assets still held at September 30, 2017
$
756

$
19

$
(7,853
)
$
(7,078
)
For the three months ended September 30, 2016
 
 
 
 
Total gains or losses included in earnings
$
86

$
50

$
(2,921
)
$
(2,785
)
Change in unrealized gains or losses relating to assets still held at September 30, 2016
$
876

$
50

$
(2,921
)
$
(1,995
)
For the nine months ended September 30, 2016
 
 
 
 
Total gains or losses included in earnings
$
613

$
(8
)
$
(6,645
)
$
(6,040
)
Change in unrealized gains or losses relating to assets still held at September 30, 2016
$
876

$
(8
)
$
(6,545
)
$
(5,677
)

Level 3 Inputs

The Company's significant Level 3 measurements which employ unobservable inputs that are readily quantifiable pertain to auction rate securities (ARS) held by the Bank, investments in portfolio concerns held by the Company's private equity subsidiaries, and held for sale residential mortgage loan commitments. ARS are included in state and municipal securities and totaled $16.9 million at September 30, 2017, while private equity investments, included in non-marketable securities, totaled $50.3 million.
Information about these inputs is presented in the table and discussions below.
Quantitative Information about Level 3 Fair Value Measurements
 
 
 
Weighted
 
Valuation Technique
Unobservable Input
Range
 
Average
Auction rate securities
Discounted cash flow
Estimated market recovery period


5 years
 
 
 
 
Estimated market rate
2.8%
-
3.1%
 
 
Private equity investments
Market comparable companies
EBITDA multiple
4.0
-
5.8
 
 
Mortgage loan commitments
Discounted cash flow
Probability of funding
50.9%
-
100.0%
 
79.1%
 
 
Embedded servicing value
(.3)%
-
2.2%
 
1.1%



33

Table of Contents

Instruments Measured at Fair Value on a Nonrecurring Basis

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

Fair Value
Quoted Prices in Active Markets for Identical Assets
(Level 1)
Significant Other Observable Inputs
(Level 2)
Significant Unobservable Inputs
(Level 3)
Total Gains (Losses) Recognized During the Nine Months Ended September 30
September 30, 2017
 
 
 
 
 
  Collateral dependent impaired loans
$
1,468

$

$

$
1,468

$
(336
)
  Mortgage servicing rights
4,245



4,245

6

  Foreclosed assets
50



50

(83
)
  Long-lived assets
3,033



3,033

(1,167
)
 
 
 
 
 
 
September 30, 2016
 
 
 
 
 
  Collateral dependent impaired loans
$
1,756

$

$

$
1,756

$
(1,626
)
  Mortgage servicing rights
2,533



2,533

(7
)
  Foreclosed assets
47



47

(66
)
  Long-lived assets
2,232



2,232

(1,001
)


14. Fair Value of Financial Instruments

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

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


34

Table of Contents

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

(In thousands)
Carrying
Amount
Estimated
Fair Value
 
Carrying
Amount
Estimated
Fair Value
Financial Assets
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
Business
Level 3
$
4,834,037

$
4,848,169

 
$
4,776,365

$
4,787,469

Real estate - construction and land
Level 3
921,609

933,862

 
791,236

800,426

Real estate - business
Level 3
2,700,174

2,712,002

 
2,643,374

2,658,093

Real estate - personal
Level 3
2,029,302

2,034,374

 
2,010,397

2,005,227

Consumer
Level 3
2,113,438

2,088,302

 
1,990,801

1,974,784

Revolving home equity
Level 3
391,308

391,419

 
413,634

414,499

Consumer credit card
Level 3
752,379

767,344

 
776,465

794,856

Overdrafts
Level 3
3,245

3,245

 
10,464

10,464

Loans held for sale
Level 2
17,337

17,337

 
14,456

14,456

Investment securities:
 
 
 
 
 
 
Available for sale
Level 1
951,519

951,519

 
945,871

945,871

Available for sale
Level 2
8,140,915

8,140,915

 
8,686,650

8,686,650

Available for sale
Level 3
16,853

16,853

 
16,682

16,682

Trading
Level 2
24,605

24,605

 
22,225

22,225

Non-marketable
Level 3
99,268

99,268

 
99,558

99,558

Federal funds sold
Level 1
32,630

32,630

 
15,470

15,470

Securities purchased under agreements to resell
Level 3
700,000

702,989

 
725,000

728,179

Interest earning deposits with banks
Level 1
105,422

105,422

 
272,275

272,275

Cash and due from banks
Level 1
461,724

461,724

 
494,690

494,690

Derivative instruments
Level 2
10,837

10,837

 
13,146

13,146

Derivative instruments
Level 3
813

813

 
420

420

Assets held in trust for deferred compensation plan
Level 1
12,311

12,311

 
10,261

10,261

Financial Liabilities
 
 
 
 
 
 
Non-interest bearing deposits
Level 1
$
7,536,127

$
7,536,127

 
$
7,429,398

$
7,429,398

Savings, interest checking and money market deposits
Level 1
11,091,200

11,091,200

 
11,430,789
11,430,789
Time open and certificates of deposit
Level 3
1,816,446

1,820,178

 
2,240,908

2,235,218

Federal funds purchased
Level 1
350,910

350,910

 
52,840

52,840

Securities sold under agreements to repurchase
Level 3
1,058,074

1,058,459

 
1,671,065

1,671,227

Other borrowings
Level 3
102,553

103,012

 
102,049

104,298

Derivative instruments
Level 2
5,850

5,850

 
13,177

13,177

Derivative instruments
Level 3
129

129

 
162

162

Liabilities held in trust for deferred compensation plan
Level 1
12,311

12,311

 
10,261

10,261


15. Legal and Regulatory Proceedings
On August 15, 2014, a customer filed a class action complaint against Commerce Bank in the Circuit Court, Jackson County, Missouri.  The case is Cassandra Warren, et al v. Commerce Bank (Case No. 1416-CV19197). In the case, the customer alleged violation of the Missouri usury statue in connection with Commerce Bank charging overdraft fees in connection with point-of-sale/debit and automated-teller machine cards.  On August 31, 2017, the Court ruled in favor of Commerce Bank on its motion for summary judgment. The time period for any appeal on the summary judgment ruling has run with no appeal filed; accordingly, the case has been concluded with no liability to Commerce Bank.

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


35

Table of Contents

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

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

Forward-Looking Information

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

Critical Accounting Policies

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


36

Table of Contents

Selected Financial Data

 
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
 
2017
2016
 
2017
2016
Per Share Data
 
    
    
 
 
 
   Net income per common share — basic
 
$
.71

$
.65
*
 
$
2.14

$
1.94
*
   Net income per common share — diluted
 
.71

.65
*
 
2.14

1.93
*
   Cash dividends on common stock
 
.225

.214
*
 
.675

.643
*
   Book value per common share
 
 
 
 
25.19

23.82
*
   Market price
 
 
 
 
57.77

46.91
*
Selected Ratios
 
 
 
 
 
 
(Based on average balance sheets)
 
 
 
 
 
 
   Loans to deposits (1)
 
66.96
%
64.33
%
 
65.53
%
63.53
%
   Non-interest bearing deposits to total deposits
 
35.07

35.02

 
34.52

34.43

   Equity to loans (1)
 
19.61

19.56

 
19.21

19.29

   Equity to deposits
 
13.13

12.58

 
12.59

12.26

   Equity to total assets
 
10.74

10.46

 
10.40

10.15

   Return on total assets
 
1.19

1.12

 
1.20

1.11

   Return on common equity
 
11.35

10.97

 
11.85

11.28

(Based on end-of-period data)
 
 
 
 
 
 
   Non-interest income to revenue (2)
 
40.10

41.06

 
40.00

41.18

   Efficiency ratio (3)
 
60.44

62.25

 
61.25

62.04

   Tier I common risk-based capital ratio
 
 
 
 
12.52

11.66

   Tier I risk-based capital ratio
 
 
 
 
13.28

12.44

   Total risk-based capital ratio
 
 
 
 
14.32

13.39

   Tangible common equity to tangible assets ratio (4)
 
 
 
 
9.72

9.22

   Tier I leverage ratio 
 
 
 
 
10.16

9.58


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

The following table is a reconciliation of the GAAP financial measures of total equity and total assets to the non-GAAP measures of total tangible common equity and total tangible assets.
 
September 30
(Dollars in thousands)
2017
2016
Total equity
$
2,704,477

$
2,560,813

Less non-controlling interest
3,933

5,392

Less preferred stock
144,784

144,784

Less goodwill
138,921

138,921

Less core deposit premium
3,143

4,088

Total tangible common equity (a)
$
2,413,696

$
2,267,628

Total assets
$
24,979,141

$
24,734,468

Less goodwill
138,921

138,921

Less core deposit premium
3,143

4,088

Total tangible assets (b)
$
24,837,077

$
24,591,459

Tangible common equity to tangible assets ratio (a)/(b)
9.72
%
9.22
%

37

Table of Contents

Results of Operations

Summary
  
Three Months Ended September 30
 
Nine Months Ended September 30
(Dollars in thousands)
2017
2016
% change
 
2017
2016
% change
Net interest income
$
182,591

$
171,243

6.6
%
 
$
543,671

$
506,847

7.3
 %
Provision for loan losses
(10,704
)
(7,263
)
47.4

 
(32,590
)
(25,918
)
25.7

Non-interest income
122,242

119,319

2.4

 
362,392

354,913

2.1

Investment securities losses, net
(3,037
)
(1,965
)
54.6

 
(2,158
)
(3,704
)
(41.7
)
Non-interest expense
(184,572
)
(181,242
)
1.8

 
(555,996
)
(535,804
)
3.8

Income taxes
(32,294
)
(30,942
)
4.4

 
(90,402
)
(91,854
)
(1.6
)
Non-controlling interest (expense) income
338

(605
)
N.M.

 
111

(668
)
N.M.

Net income attributable to Commerce Bancshares, Inc.
74,564

68,545

8.8

 
225,028

203,812

10.4

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

 
(6,750
)
(6,750
)

Net income available to common shareholders
$
72,314

$
66,295

9.1
%
 
$
218,278

$
197,062

10.8
 %

For the quarter ended September 30, 2017, net income attributable to Commerce Bancshares, Inc. (net income) amounted to $74.6 million, an increase of $6.0 million, or 8.8%, compared to the third quarter of the previous year. For the current quarter, the annualized return on average assets was 1.19%, the annualized return on average common equity was 11.35% and the efficiency ratio was 60.44%. Diluted earnings per common share was $.71, an increase of 9.2% compared to $.65 per share in the third quarter of 2016 and a decrease of 5.3% compared to $.75 per share in the previous quarter.

Compared to the third quarter of last year, net interest income increased $11.3 million, or 6.6%, mainly due to growth of $15.1 million in interest income on loans, partly offset by an increase of $3.5 million in deposits and borrowings interest expense. The provision for loan losses totaled $10.7 million for the current quarter, representing an increase of $3.4 million over the third quarter of 2016. Non-interest income increased $2.9 million, or 2.4%, compared to the third quarter of 2016, mainly due to combined growth of $4.6 million in trust, deposit and loan fee income, in addition to higher gains of $621 thousand on sales of equipment leased to customers.

Net investment securities losses totaled $3.0 million in the current quarter compared to $2.0 million in the same quarter last year. The current quarter losses included net losses in fair value on private equity investments of $5.2 million, partly offset by gains of $2.4 million resulting from the donation of appreciated securities to a charitable foundation.

Non-interest expense increased $3.3 million, or 1.8%, over the third quarter of 2016 primarily due to increases in salaries and benefits expense and the contribution of $2.5 million in appreciated securities as mentioned above, partly offset by expense reductions resulting from a new bank card agreement which went into effect in the current quarter. The securities contribution expense and the related securities gain resulted in a pre-tax loss of $110 thousand and tax benefits of $963 thousand. The Company made similar contributions to the foundation in the first and second quarters of 2017 and will consider this strategy again in the fourth quarter of this year.

Net income for the first nine months of 2017 was $225.0 million, an increase of $21.2 million, or 10.4%, over the same period last year. Diluted earnings per common share was $2.14, an increase of 10.9% compared to $1.93 per share in the same period last year. For the first nine months of 2017, the annualized return on average assets was 1.20%, the annualized return on average common equity was 11.85%, and the efficiency ratio was 61.25%. Net interest income increased $36.8 million, or 7.3%, over the same period last year. This growth was largely due to increases of $37.2 million in loan interest income and $5.6 million in investment securities interest income, offset by a $7.5 million increase in deposits and borrowings interest expense. The provision for loan losses was $32.6 million for the first nine months of 2017, up $6.7 million over the same period last year. During the first nine months of 2017, securities losses of $2.2 million were recorded compared to $3.7 million for the same period last year. Net losses in fair value on private equity investments totaled $8.0 million in the first nine months of 2017, partly offset by gains of $6.7 million resulting from securities donations during that period. Non-interest income increased $7.5 million, or 2.1%, over the first nine months of last year due to growth in trust, deposit and loan fees. Non-interest expense increased $20.2 million, or 3.8%, due to higher salaries and benefits expense of $13.9 million, in addition to securities contributions of $7.0 million, as mentioned above.

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Table of Contents

Net Interest Income

The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates. Changes not solely due to volume or rate changes are allocated to rate.

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

Total
 
Average
Volume
Average
Rate

Total
Interest income, fully taxable equivalent basis:
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
  Business
$
606

$
4,604

$
5,210

 
$
4,539

$
9,908

$
14,447

  Real estate - construction and land
580

1,885

2,465

 
2,471

4,370

6,841

  Real estate - business
2,545

1,585

4,130

 
7,834

1,336

9,170

  Real estate - personal
689

(26
)
663

 
2,569

(459
)
2,110

  Consumer
1,207

657

1,864

 
2,247

1,353

3,600

  Revolving home equity
(150
)
477

327

 
(483
)
826

343

  Consumer credit card
(312
)
930

618

 
(626
)
1,913

1,287

  Overdrafts



 



     Total interest on loans
5,165

10,112

15,277

 
18,551

19,247

37,798

Loans held for sale
(60
)
13

(47
)
 
(450
)
35

(415
)
Investment securities:
 
 
 
 
 
 
 
  U.S. government and federal agency securities
1,172

(2,376
)
(1,204
)
 
3,214

(713
)
2,501

  Government-sponsored enterprise obligations
(141
)
(714
)
(855
)
 
(3,367
)
(2,683
)
(6,050
)
  State and municipal obligations
(440
)
(102
)
(542
)
 
207

(204
)
3

  Mortgage-backed securities
2,114

(58
)
2,056

 
5,968

(840
)
5,128

  Asset-backed securities
(1,176
)
1,766

590

 
(1,933
)
4,651

2,718

  Other securities
(320
)
(967
)
(1,287
)
 
(1,199
)
3,593

2,394

     Total interest on investment securities
1,209

(2,451
)
(1,242
)
 
2,890

3,804

6,694

Federal funds sold and short-term securities purchased under
 
 
 
 
 
 
 
   agreements to resell
17

41

58

 
7

68

75

Long-term securities purchased under agreements to resell
(453
)
930

477

 
(1,618
)
2,743

1,125

Interest earning deposits with banks
4

390

394

 
7

725

732

Total interest income
5,882

9,035

14,917

 
19,387

26,622

46,009

Interest expense:
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
  Savings
15

(2
)
13

 
39

8

47

  Interest checking and money market
53

756

809

 
312

1,663

1,975

  Time open & C.D.'s of less than $100,000
(67
)
60

(7
)
 
(199
)
59

(140
)
  Time open & C.D.'s of $100,000 and over
(202
)
800

598

 
(118
)
1,968

1,850

     Total interest on deposits
(201
)
1,614

1,413

 
34

3,698

3,732

Federal funds purchased and securities sold under
 
 
 
 
 
 
 
   agreements to repurchase
203

1,919

2,122

 
268

3,818

4,086

Other borrowings
(10
)
10


 
(1,464
)
1,103

(361
)
Total interest expense
(8
)
3,543

3,535

 
(1,162
)
8,619

7,457

Net interest income, tax equivalent basis
$
5,890

$
5,492

$
11,382

 
$
20,549

$
18,003

$
38,552


Net interest income in the third quarter of 2017 was $182.6 million, an increase of $11.3 million over the third quarter of 2016. On a tax equivalent (T/E) basis, net interest income totaled $190.5 million in the third quarter of 2017, up $11.4 million over the same period last year and down $368 thousand from the previous quarter.  The increase in net interest income compared to the third quarter of 2016 was mainly due to higher interest income on loans (T/E) of $15.3 million. The increase in interest on loans was a result of higher loan yields on nearly all loan products, especially commercial loans, many of which have variable rates.

39

Table of Contents

Interest income on investment securities (T/E) decreased $1.2 million from the third quarter of 2016, mainly due to lower interest income earned on the Company's holdings of U.S. Treasury inflation-protected securities (TIPS), which is tied to the Consumer Price Index. The Company's net yield on earning assets (T/E) was 3.18% in the current quarter compared to 3.08% in the third quarter of 2016.
 
Total interest income (T/E) increased $14.9 million over the third quarter of 2016. Interest income on loans (T/E) was $141.4 million during the third quarter of 2017, and increased $15.3 million, or 12.1%, over the same quarter last year. The increase was due to growth of $595.3 million, or 4.6%, in average loan balances, and an increase of 27 basis points in average rates earned. Most of the increase in interest income occurred in the business, construction, and business real estate loan categories. The largest increase to interest income occurred in business loan interest, which grew $5.2 million due to higher average balances of $82.9 million, or 1.8%, coupled with a 38 basis point increase in the average rate earned. Construction loan interest grew $2.5 million, as average balances increased $66.2 million, or 8.1%, and the average rate earned increased 83 basis points. Business real estate loan interest increased $4.1 million due to an increase in average balances of $278.1 million, or 11.4%, with an increase of 22 basis points in the average rate earned. Interest on consumer loans increased $1.9 million over the same period last year as the average rate increased 11 basis points, coupled with a $122.4 million increase in average balances.

Interest income on investment securities (T/E) was $55.9 million during the third quarter of 2017, which was a decrease of $1.2 million from the same quarter last year. The decrease resulted mainly from lower TIPS interest of $1.8 million and lower interest earned on non-marketable securities and government-sponsored enterprise obligations, partly offset by increased earnings on mortgage-backed securities. A decrease of $1.3 million in interest income on non-marketable investments resulted largely from the receipt of $938 thousand on a private equity debt investment, which had previously been on non-accrual status, recorded in the third quarter of 2016. Interest income on government-sponsored enterprise obligations declined $855 thousand mainly due to a decline of 63 basis points in the average rate earned, coupled with a decline of $24.9 million in average balances. Higher interest on mortgage-backed securities of $2.1 million resulted from an increase of $352.4 million in average balances. Adjustments to premium amortization expense, due to slowing prepayment speeds on various mortgage-backed and asset-backed securities, increased interest income $635 thousand in the current quarter, compared to adjustments of $746 thousand in the same quarter last year. The average balance of the total investment portfolio (excluding unrealized fair value adjustments) was $9.3 billion in the third quarter of 2017, compared to $9.1 billion in the third quarter of 2016.

Interest income on long-term securities purchased under agreements to resell increased $477 thousand over the third quarter of 2016, due to an increase in the average rate earned of 55 basis points, partly offset by lower balances invested of $103.8 million.

The average tax equivalent yield on total interest earning assets was 3.37% in the third quarter of 2017, up from 3.22% in the third quarter of 2016.

Total interest expense increased $3.5 million compared to the third quarter of 2016, due to a $1.4 million increase in interest expense on interest bearing deposits and a $2.1 million increase in interest expense on borrowings. The increase in deposit expense resulted mainly from an increase of four basis points in the overall average rate paid on deposits. Interest expense on C.D.'s of $100,000 and over rose $598 thousand due to a 22 basis point increase in average rates paid, but was partly offset by lower average balances of $108.7 million. In addition, interest expense on interest checking and money market accounts increased $809 thousand, resulting mainly from an increase of three basis points in the average rate paid. Interest expense on borrowings increased due to higher rates paid on customer repurchase agreements and overnight federal funds purchased. The overall average rate incurred on all interest bearing liabilities was .31% and .22% in the third quarters of 2017 and 2016, respectively.

Net interest income (T/E) for the first nine months of 2017 was $568.7 million compared to $530.1 million for the same period in 2016. For the first nine months of 2017, the net interest margin was 3.17% compared to 3.05% for the first nine months of 2016.

Total interest income (T/E) for the first nine months of 2017 increased $46.0 million over the same period last year, due to higher interest income on loans and investment securities. Loan interest income (T/E) rose $37.8 million due to a $733.9 million, or 5.7%, increase in total average loan balances and a 17 basis point increase in the average rate earned. Most of the increase in loan interest occurred in the business, business real estate and construction loan categories. The growth in interest income of $6.7 million on investment securities (T/E) was mainly due to an increase in the average rate earned of six basis points, coupled with an increase in average balances of $154.9 million. Increased earnings were recorded for U.S. government securities, partly due to higher TIPS interest of $704 thousand. Interest earned on non-marketable investments rose $2.5 million mainly due to one-time interest receipts of $2.7 million on a private equity investment in the first quarter of 2017, partly offset by the $938 thousand receipt in 2016 mentioned previously. Other increases in interest income occurred in mortgage-backed and asset-backed securities, which grew $5.1 million and $2.7 million, respectively. These increases were partly offset by lower interest earned on government-

40

Table of Contents

sponsored enterprise obligations of $6.1 million, which saw declines in average balances and rates earned. Interest income on long-term resell agreements grew $1.1 million due to higher average rates earned.

Total interest expense for the first nine months of 2017 increased $7.5 million compared to last year. Interest expense on interest bearing deposits increased $3.7 million, mainly due to a four basis point increase in the overall average rate paid. The overall rate increase included an increase of 18 basis points in rates paid on C.D.'s of $100,000 and over, in addition to a slight increase in rates paid on interest checking and money market account balances. Interest expense on borrowings increased $3.7 million, mainly due to higher rates paid on federal funds purchased and repurchase agreements. Interest expense on FHLB borrowings declined $412 thousand, mainly due to lower average balances, partly offset by higher rates paid. The overall cost of total interest bearing liabilities increased to .29% compared to .22% in the same period last year.

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

Non-Interest Income
  
Three Months Ended September 30
 
Nine Months Ended September 30
(Dollars in thousands)
2017
2016
% change
 
2017
2016
% change
Bank card transaction fees
$
44,521

$
47,006

(5.3
)%
 
$
132,724

$
136,541

(2.8
)%
Trust fees
34,620

30,951

11.9

 
99,754

90,435

10.3

Deposit account charges and other fees
22,659

22,241

1.9

 
67,462

64,260

5.0

Capital market fees
1,755

2,751

(36.2
)
 
6,253

7,976

(21.6
)
Consumer brokerage services
3,679

3,375

9.0

 
11,054

10,375

6.5

Loan fees and sales
3,590

3,123

15.0

 
10,849

8,829

22.9

Other
11,418

9,872

15.7

 
34,296

36,497

(6.0
)
Total non-interest income
$
122,242

$
119,319

2.4
 %
 
$
362,392

$
354,913

2.1
 %
Non-interest income as a % of total revenue*
40.1
%
41.1
%
 
 
40.0
%
41.2
%
 
* Total revenue includes net interest income and non-interest income.

For the third quarter of 2017, total non-interest income amounted to $122.2 million compared with $119.3 million in the same quarter last year, which was an increase of $2.9 million, or 2.4%. The increase was mainly due to growth in trust, deposit, swap and loan fee income, partly offset by lower bank card and capital market fees.

Bank card transaction fees for the current quarter decreased $2.5 million from the same quarter last year, mainly due to a decline in merchant fees of $1.2 million, coupled with a decline in corporate card fees of $1.5 million. The decline in merchant fees from the previous year resulted from the loss of several large customers over the last 12 months, while lower corporate card fees resulted from reduced margins earned on corporate card sales transactions compared to the same period last year. The table below is a summary of bank card transaction fees for the three and nine month periods ended September 30, 2017 and 2016.
 
Three Months Ended September 30
 
Nine Months Ended September 30
(Dollars in thousands)
2017
2016
% change
 
2017
2016
% change
Debit card fees
$
9,985

$
9,913

.7
 %
 
$
29,952

$29,330
2.1
 %
Credit card fees
6,371

6,245

2.0

 
18,594

18,192

2.2

Merchant fees
5,600

6,828

(18.0
)
 
17,739

20,857

(14.9
)
Corporate card fees
22,565

24,020

(6.1
)
 
66,439

68,162

(2.5
)
Total bank card transaction fees
$
44,521

$
47,006

(5.3
)%
 
$
132,724

$
136,541

(2.8
)%

Trust fees for the quarter increased $3.7 million, or 11.9%, over the same quarter last year, resulting mainly from continued growth in private client trust fees, which were up $2.7 million, or 11.7%. Deposit account fees increased $418 thousand, or 1.9%, over the same quarter last year, as deposit account service charges increased $606 thousand, or 11.4%, while corporate cash management fees decreased $365 thousand, or 4.0%. Consumer brokerage fees grew $304 thousand, or 9.0%, while capital market fees declined $996 thousand on lower trading securities income. Loan fees and sales increased $467 thousand, or 15.0%, this quarter mainly due to higher mortgage banking revenue related to the Company's fixed rate residential mortgage sale program. Other non-interest income increased $1.5 million compared to the same quarter last year, partly due to higher gains of $621 thousand on sales of leased assets to customers upon lease termination. In addition, fees from interest rate swap sales grew $457 thousand this quarter compared with the same quarter last year, while foreign exchange transaction fees were higher by $401 thousand.
Non-interest income for the first nine months of 2017 was $362.4 million compared to $354.9 million in the first nine months

41

Table of Contents

of 2016, resulting in an increase of $7.5 million, or 2.1%. Bank card fees decreased $3.8 million, or 2.8%, as a result of declines in merchant fees of $3.1 million, or 14.9%, and corporate card fees of $1.7 million, or 2.5%, partly offset by increases of $622 thousand in debit card fees and $402 thousand in credit card fees. Trust fee income increased $9.3 million, or 10.3%, as a result of growth in private client and institutional trust fees. Deposit account fees increased $3.2 million, or 5.0%, mainly due to growth of $2.2 million in deposit account service charges and $942 thousand in overdraft and return item fees. Loan fees and sales increased $2.0 million, or 22.9%, due to higher mortgage banking revenue. Consumer brokerage fees rose $679 thousand due to higher mutual fund and advisory fee income, while capital market fees decreased $1.7 million, or 21.6%, due to continued lower sales volume. Other non-interest income decreased $2.2 million, or 6.0%, mainly due to lower gains on sales of branch properties, lower fees from sales of interest rate swaps, and a trust-related income settlement recorded in the prior year which did not reoccur in the current period. These declines were partly offset by higher gains on leased asset sales in the current period.

Investment Securities Gains (Losses), Net
 
Three Months Ended September 30
 
Nine Months Ended September 30
(In thousands)
2017
2016
 
2017
2016
Private equity investments
$
(5,423
)
$
(1,965
)
 
$
(8,263
)
$
(3,457
)
Donations of securities
2,391


 
6,707


Other
(5
)

 
(602
)
(247
)
Total investment securities gains (losses), net
$
(3,037
)
$
(1,965
)
 
$
(2,158
)
$
(3,704
)

Net securities losses amounted to $3.0 million in the third quarter of 2017 and $2.0 million in the same period last year.  For the nine months ended September 30, net securities losses totaled $2.2 million in 2017 and $3.7 million in 2016.  The net losses for both the current quarter and the first nine months of 2017 were mainly comprised of realized and unrealized losses on the Company’s private equity securities, offset by realized gains recorded on the donation of appreciated securities to a charitable foundation.  For the first nine months of 2017, credit-related impairment losses totaled $372 thousand, compared to $270 thousand in the same period last year.  In 2016, a gain of $1.8 million was recorded which resulted from the withdrawal of a private equity fund as required under Volker Rule requirements.  The portion of private equity activity attributable to minority interests is reported as non-controlling in the consolidated statements of income and resulted in income of $1.1 million during the first nine months of 2017 and $144 thousand during the first nine months of 2016.

Non-Interest Expense
  
Three Months Ended September 30
 
Nine Months Ended September 30
(Dollars in thousands)
2017
2016
% change
 
2017
2016
% change
Salaries and employee benefits
$
111,382

$
107,004

4.1
 %
 
$
332,580

$
318,671

4.4
 %
Net occupancy
11,459

12,366

(7.3
)
 
34,332

34,761

(1.2
)
Equipment
4,491

4,842

(7.2
)
 
13,876

14,257

(2.7
)
Supplies and communication
5,517

5,968

(7.6
)
 
16,672

18,490

(9.8
)
Data processing and software
22,700

23,663

(4.1
)
 
69,153

69,332

(.3
)
Marketing
4,676

4,399

6.3

 
12,388

12,601

(1.7
)
Deposit insurance
3,479

3,576

(2.7
)
 
10,542

9,884

6.7

Other
20,868

19,424

7.4

 
66,453

57,808

15.0

Total non-interest expense
$
184,572

$
181,242

1.8
 %
 
$
555,996

$
535,804

3.8
 %

Non-interest expense for the third quarter of 2017 amounted to $184.6 million, an increase of $3.3 million, or 1.8%, compared with $181.2 million in the third quarter of last year. Salaries expense increased $5.3 million, or 5.9%, mainly due to higher full-time salaries and incentive compensation costs. Employee benefits expense totaled $15.6 million, reflecting a decline of $957 thousand, or 5.8%, mostly on lower medical costs. Growth in salaries expense resulted partly from higher staffing costs, mainly in the areas of commercial and consumer banking, wealth and information technology business units. Full-time equivalent employees totaled 4,811 at September 30, 2017 compared to 4,778 at September 30, 2016. Occupancy costs decreased $907 thousand, or 7.3%, mostly due to lower rent expense on leased properties during the third quarter of 2017 and demolition costs for a branch facility during the third quarter of 2016, which did not recur this quarter. Supplies and communication expense declined $451 thousand, or 7.6%, mainly due to lower issuance costs for credit and debit cards. Data processing expense decreased $963 thousand, or 4.1%, mainly due to incentives received related to the renegotiation of a bank card processing agreement, as mentioned above, partly offset by higher online subscription service expense. Equipment costs declined $351 thousand mainly due to lower depreciation expense. Other non-interest expense increased $1.4 million, or 7.4%, compared to the same period in the previous year. This increase was mainly due to the donation of $2.5 million in appreciated securities to a charitable foundation,

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Table of Contents

as previously mentioned. In addition, lower deferred loan origination costs and higher impairment costs on surplus branch sites were recorded. These increases were partly offset by lower bank card operating costs resulting from the new agreement, which declined approximately $1.2 million in the current quarter.

For the first nine months of 2017, non-interest expense amounted to $556.0 million, an increase of $20.2 million, or 3.8%, compared with $535.8 million in the same period last year. Salaries and benefits expense increased $13.9 million, or 4.4%, mainly due to higher full-time salaries and incentives expense. Supplies and communication expense decreased $1.8 million, or 9.8%. This decrease was mainly the result of higher chip card reissue costs last year that have now declined. FDIC insurance costs grew $658 thousand, or 6.7%, due to higher insurance rates that were effective July 1, 2016. Other non-interest expense increased $8.6 million, or 15.0%, mainly due to donations of $7.0 million in appreciated securities in the current period. Higher costs were also recorded in professional fees, bank card rewards expense, and impairment losses on surplus branch sites, in addition to lower deferred loan origination costs. Partly offsetting these increases were lower bank card operating costs due to the new agreement mentioned above. Excluding the donation expense, total non-interest expense grew 2.5% over the prior year.

Provision and Allowance for Loan Losses
 
Three Months Ended
 
Nine Months Ended September 30
(In thousands)
Sept. 30, 2017
June 30,
2017
Sept. 30, 2016
 
2017
2016
Provision for loan losses
$
10,704

$
10,758

$
7,263

 
$
32,590

$
25,918

Net loan charge-offs (recoveries):
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
  Business
195

318

(50
)
 
610

348

  Real estate-construction and land
(362
)
(207
)
(2,312
)
 
(1,104
)
(2,830
)
  Real estate-business
(106
)
(10
)
(106
)
 
(155
)
(1,378
)
Commercial net loan charge-offs (recoveries)
(273
)
101

(2,468
)
 
(649
)
(3,860
)
Personal Banking:
 
 
 
 
 
 
  Real estate-personal
(137
)
(131
)
(78
)
 
(249
)
32

  Consumer
3,057

2,642

2,240

 
7,795

6,620

  Revolving home equity
(19
)
104

79

 
92

242

  Consumer credit card
7,631

7,750

6,356

 
22,529

18,924

  Overdrafts
445

292

434

 
1,172

960

Personal banking net loan charge-offs
10,977

10,657

9,031

 
31,339

26,778

Total net loan charge-offs
$
10,704

$
10,758

$
6,563

 
$
30,690

$
22,918


 
Three Months Ended
 
Nine Months Ended September 30
 
Sept. 30, 2017
June 30, 2017
Sept. 30, 2016
 
2017
2016
Annualized net loan charge-offs (recoveries)*:
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
  Business
.02
 %
.03
 %
 %
 
.02
 %
.01
 %
  Real estate-construction and land
(.16
)
(.10
)
(1.12
)
 
(.17
)
(.49
)
  Real estate-business
(.02
)

(.02
)
 
(.01
)
(.08
)
Commercial net loan charge-offs (recoveries)
(.01
)

(.12
)
 
(.01
)
(.07
)
Personal Banking:
 
 
 
 
 
 
  Real estate-personal
(.03
)
(.03
)
(.02
)
 
(.02
)

  Consumer
.59

.53

.46

 
.52

.46

  Revolving home equity
(.02
)
.10

.08

 
.03

.08

  Consumer credit card
4.09

4.25

3.37

 
4.07

3.38

  Overdrafts
40.37

26.00

37.11

 
35.98

28.84

Personal banking net loan charge-offs
.83

.83

.71

 
.81

.71

Total annualized net loan charge-offs
.31
 %
.32
 %
.20
 %
 
.30
 %
.24
 %
* as a percentage of average loans (excluding loans held for sale)


43

Table of Contents

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

Net loan charge-offs in the third quarter of 2017 amounted to $10.7 million, compared with $10.8 million in the prior quarter and $6.6 million in the third quarter of last year. During the third quarter of 2017, the Company recorded net recoveries on commercial loans of $273 thousand, compared to net charge-offs of $101 thousand in the prior quarter and net recoveries of $2.5 million in the third quarter of last year. Net charge-offs on consumer loans increased $415 thousand compared to the prior quarter, while net charge-offs on revolving home equity and consumer credit cards loans declined by $123 thousand and $119 thousand, respectively. Additionally, net loan charge-offs on overdrafts increased $153 thousand during the third quarter of 2017, compared to the prior quarter. Compared to the third quarter of 2016, net charge-offs on consumer and consumer credit card loans increased $817 thousand and $1.3 million, respectively.

For the three months ended September 30, 2017, annualized net charge-offs on average consumer credit card loans totaled 4.09%, compared with 4.25% in the previous quarter and 3.37% in the same period last year. Consumer loan annualized net charge-offs in the current quarter amounted to .59%, compared to .53% in the prior quarter and .46% in the same period last year.  Annualized net charge-offs on personal real estate loans also remained low this quarter.  In the third quarter of 2017, total annualized net loan charge-offs were .31%, compared to .32% in the previous quarter and .20% in the same period last year.

In the current quarter, the provision for loan losses totaled $10.7 million, a slight decease compared to $10.8 million in the prior quarter. In both quarters, the provision for loan losses matched net loan charge-offs.  During the third quarter of 2016, the provision for loan losses totaled $7.3 million and exceeded net loan charge-offs by $700 thousand.

For the nine months ended September 30, 2017, net loan charge-offs totaled $30.7 million, compared to $22.9 million in 2016.  The increase in net loan charge-offs resulted mainly from an increase in consumer credit card loan net charge-offs, which increased $3.6 million, and $3.2 million fewer net recoveries on commercial loans.  Additionally, net charge-offs on consumer loans increased $1.2 million. The provision for loan losses for the first nine months of 2017 was $32.6 million and increased $6.7 million compared to the previous year. The increase in provision expense was the result of higher net loan losses during the nine months ended September 30, 2017 compared to the same period in the prior year.

At September 30, 2017, the allowance for loan losses amounted to $157.8 million and was 1.15% of total loans and more than ten times total non-accrual loans. At December 31, 2016, the allowance for loan losses amounted to $155.9 million and was 1.16% of total loans.

Risk Elements of Loan Portfolio

The following table presents non-performing assets and loans which are past due 90 days and still accruing interest. Non-performing assets include non-accruing loans and foreclosed real estate. Loans are placed on non-accrual status when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment. Loans that are 90 days past due as to principal and/or interest payments are generally placed on non-accrual, unless they are both well-secured and in the process of collection, or they are personal banking loans that are exempt under regulatory rules from being classified as non-accrual.
(Dollars in thousands)
September 30, 2017
December 31, 2016
Non-accrual loans
$
13,640

$
14,283

Foreclosed real estate
1,063

366

Total non-performing assets
$
14,703

$
14,649

Non-performing assets as a percentage of total loans
.11
%
.11
%
Non-performing assets as a percentage of total assets
.06
%
.06
%
Total loans past due 90 days and still accruing interest
$
16,464

$
16,396


Non-accrual loans, which are also classified as impaired, totaled $13.6 million at September 30, 2017, and decreased $643 thousand from balances at December 31, 2016. The decrease occurred mainly in business loans, which decreased $1.9 million, partly offset by an increase of $1.1 million in consumer loans. At September 30, 2017, non-accrual loans were comprised mainly of business (50.0%), personal real estate (21.0%), and business real estate (17.2%) loans. Foreclosed real estate totaled $1.1 million at September 30, 2017, an increase of $697 thousand when compared to December 31, 2016. Total loans past due 90

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Table of Contents

days or more and still accruing interest were $16.5 million as of September 30, 2017, an increase of $68 thousand when compared to December 31, 2016. Balances by class for non-accrual loans and loans past due 90 days and still accruing interest are shown in the "Delinquent and non-accrual loans" section in Note 2 to the consolidated financial statements.

In addition to the non-performing and past due loans mentioned above, the Company also has identified loans for which management has concerns about the ability of the borrowers to meet existing repayment terms. They are classified as substandard under the Company's internal rating system. The loans are generally secured by either real estate or other borrower assets, reducing the potential for loss should they become non-performing. Although these loans are generally identified as potential problem loans, they may never become non-performing. Such loans totaled $172.4 million at September 30, 2017 compared with $99.5 million at December 31, 2016, resulting in an increase of $73.0 million, or 73.4%.


(In thousands)
September 30, 2017
December 31, 2016
Potential problem loans:
 
 
  Business
$
109,686

$
43,438

  Real estate – construction and land
3,270

1,172

  Real estate – business
53,537

52,913

  Real estate – personal
5,955

1,955

Total potential problem loans
$
172,448

$
99,478


At September 30, 2017, the Company had $73.1 million of loans whose terms have been modified or restructured under a troubled debt restructuring. These loans have been extended to borrowers who are experiencing financial difficulty and who have been granted a concession, as defined by accounting guidance, and are further discussed in the "Troubled debt restructurings" section in Note 2 to the consolidated financial statements. This balance includes certain commercial loans totaling $51.0 million which are classified as substandard and included in the table above because of this classification.

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

Real Estate – Construction and Land Loans
The Company's portfolio of construction and land loans, as shown in the table below, amounted to 6.7% of total loans outstanding at September 30, 2017. The largest component of construction and land loans was commercial construction, which grew $158.9 million during the nine months ended September 30, 2017. At September 30, 2017, multi-family residential construction loans totaled approximately $225.0 million, or 34.0%, of the commercial construction loan portfolio.
(Dollars in thousands)
September 30, 2017


% of Total
% of
Total
Loans
December 31, 2016
    

% of Total
% of
Total
Loans
Residential land and land development
$
82,686

9.0
%
.6
%
$
86,373

10.9
%
.6
%
Residential construction
124,040

13.4

.9

132,334

16.8

1.0

Commercial land and land development
52,480

5.7

.4

69,057

8.7

.5

Commercial construction
662,403

71.9

4.8

503,472

63.6

3.8

Total real estate - construction and land loans
$
921,609

100.0
%
6.7
%
$
791,236

100.0
%
5.9
%


45

Table of Contents

Real Estate – Business Loans
Total business real estate loans were $2.7 billion at September 30, 2017 and comprised 19.6% of the Company's total loan portfolio. These loans include properties such as manufacturing and warehouse buildings, small office and medical buildings, churches, hotels and motels, shopping centers, and other commercial properties. At September 30, 2017, 36.9% of business real estate loans were for owner-occupied real estate properties, which present lower risk profiles.
(Dollars in thousands)
September 30, 2017


% of Total
% of
Total
Loans
December 31, 2016


% of Total
% of
Total
Loans
Owner-occupied
$
995,922

36.9
%
7.2
%
$
1,004,238

38.0
%
7.5
%
Office
362,477

13.4

2.6

319,638

12.1

2.4

Retail
351,671

13.0

2.6

344,221

13.0

2.5

Multi-family
293,299

10.9

2.1

255,369

9.7

1.9

Hotels
170,302

6.3

1.2

174,207

6.6

1.3

Farm
162,951

6.0

1.2

173,210

6.6

1.3

Industrial
90,167

3.4

.7

122,940

4.6

.9

Other
273,385

10.1

2.0

249,551

9.4

1.9

Total real estate - business loans
$
2,700,174

100.0
%
19.6
%
$
2,643,374

100.0
%
19.7
%

Real Estate – Personal Loans
The Company's $2.0 billion personal real estate loan portfolio is composed mainly of residential first mortgage real estate loans. As shown on page 43, recent loss rates have remained low, and at September 30, 2017, loans past due over 30 days increased $1.5 million; however, non-accrual loans decreased $540 thousand compared to December 31, 2016. Also, as shown in Note 2, only 3.6% of this portfolio has FICO scores of less than 660. Approximately $29.5 million, or 1.5%, of personal real estate loans were structured with interest only payments. These loans are typically made to high net-worth borrowers and generally have low LTV ratios at origination or have additional collateral pledged to secure the loan. Therefore, they are not perceived to represent above normal credit risk. Loans originated with interest only payments were not made to "qualify" the borrower for a lower payment amount. At September 30, 2017, loans with no mortgage insurance and an original LTV higher than 80% totaled $172.3 million compared to $158.8 million at December 31, 2016.

Revolving Home Equity Loans
The Company had $391.3 million in revolving home equity loans at September 30, 2017 that were generally collateralized by residential real estate. Most of these loans (92.6%) are written with terms requiring interest only monthly payments. These loans are offered in three main product lines: LTV up to 80%, 80% to 90%, and 90% to 100%. As of September 30, 2017, the outstanding principal of loans with an original LTV higher than 80% was $52.9 million, or 13.5% of the portfolio, compared to $55.1 million as of December 31, 2016. Total revolving home equity loan balances over 30 days past due or on non-accrual status were $3.0 million at September 30, 2017 compared to $2.2 million at December 31, 2016.  The weighted average FICO score for the total current portfolio balance is 793. At maturity, the accounts are re-underwritten, and if they qualify under the Company's credit, collateral and capacity policies, the borrower is given the option to renew the line of credit or convert the outstanding balance to an amortizing loan.  If criteria are not met, amortization is required, or the borrower may pay off the loan. During the remainder of 2017 through 2019, approximately 15% of the Company's current outstanding balances are expected to mature. Of these balances, approximately 87% have a FICO score of 700 or higher. The Company does not expect a significant increase in losses as these loans mature, due to their high FICO scores, low LTVs, and low historical loss levels.

Other Consumer Loans
Within the consumer loan portfolio are several direct and indirect product lines, which include loans for the purchase of automobiles, marine and RVs. Outstanding balances for auto loans were $1.0 billion and $972.5 million at September 30, 2017 and December 31, 2016, respectively. The balances over 30 days past due amounted to $14.1 million at September 30, 2017 compared to $13.8 million at the end of 2016, and comprised 1.4% of the outstanding balances of these loans at both September 30, 2017 and December 31, 2016. For the nine months ended September 30, 2017, $383.7 million of new auto loans were originated, compared to $431.0 million during the full year of 2016.  At September 30, 2017, the automobile loan portfolio had a weighted average FICO score of 749.
The Company's balance of marine and RV loans totaled $78.5 million at September 30, 2017, compared to $102.4 million at December 31, 2016, and the balances over 30 days past due amounted to $3.2 million at September 30, 2017 compared to $4.3 million at the end of 2016. The net charge-offs on marine and RV loans increased slightly from $858 thousand in the first nine months of 2016 to $1.0 million in the first nine months of the current year.

46

Table of Contents


Additionally, the Company offers low promotional rates on selected consumer credit card products. Out of a portfolio at September 30, 2017 of $752.4 million in consumer credit card loans outstanding, approximately $157.2 million, or 20.9%, carried a low promotional rate. Within the next six months, $44.1 million of these loans are scheduled to convert to the ongoing higher contractual rate. To mitigate some of the risk involved with this credit card product, the Company performs credit checks and detailed analysis of the customer borrowing profile before approving the loan application. Management believes that the risks in the consumer loan portfolio are reasonable and the anticipated loss ratios are within acceptable parameters.

Energy Lending
The Company's energy lending portfolio was comprised of lending to the petroleum and natural gas sectors and totaled $116.1 million at September 30, 2017, as shown in the table below. As of September 30, 2017, there were $5.5 million of energy loans, or 4.7%, of the energy portfolio, with a "substandard" rating or on non-accrual status, compared to $8.0 million, or 4.6% of the energy portfolio, at December 31, 2016. At December 31, 2016, there were non-accrual loans of $847 thousand included in these amounts, while there were no non-accrual energy loans at September 30, 2017. There were no energy loans 90 days past due and still accruing interest at September 30, 2017 or December 31, 2016.
(In thousands)
September 30, 2017
December 31, 2016
 
Unfunded commitments at September 30, 2017
Extraction
$
78,869

$
103,011

 
$
47,011

Mid-stream shipping and storage
8,158

22,985

 
61,871

Downstream distribution and refining

18,106

30,231

 
31,713

Support activities
10,919

15,296

 
22,696

Total energy lending portfolio
$
116,052

$
171,523

 
$
163,291


Shared National Credits
The Company participates in credits of large, publicly traded companies which are defined by regulation as shared national credits, or SNCs. Regulations define SNCs as loans exceeding $20 million that are shared by three or more financial institutions. The Company typically participates in these loans when business operations are maintained in the local communities or regional markets and opportunities to provide other banking services are present. The balance of SNC loans totaled $917.2 million at September 30, 2017, compared to $836.1 million at December 31, 2016. Additional unfunded commitments at September 30, 2017 totaled $1.4 billion.


47

Table of Contents

Income Taxes
Income tax expense was $32.3 million in the third quarter of 2017, compared to $30.9 million in the third quarter of 2016. The Company's effective tax rate, including the effect of non-controlling interest, was 30.2% in the third quarter of 2017, compared to 31.1% in the third quarter of 2016. For the nine months ended September 30, 2017, income tax expense was $90.4 million, compared to $91.9 million for the nine months ended September 30, 2016. The Company's effective tax rate, including the effect of non-controlling interest, was 28.7% for the first nine months of 2017, compared to 31.1% for the nine months ended September 30, 2016. The lower effective tax rate for the first nine months of 2017 was primarily due to the adoption of ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting" on January 1, 2017, as well as tax benefits related to the donation of appreciated securities to a charitable foundation. The adoption of ASU 2016-09 requires all excess tax benefits and tax deficiencies arising from share-based award payments to be recognized as income tax expense or benefit in the income statement, while in previous periods these benefits and deficiencies were recognized in equity. The amount of excess tax benefits (net of tax deficiencies) recognized as a reduction to income tax expense was $4.5 million in the first quarter of 2017, $1.6 million in the second quarter of 2017, and $619 thousand in the third quarter of 2017. These tax benefits are expected to be seasonally higher in the first quarter of each year when the majority of the Company’s equity compensation vests. Additionally, the donation of appreciated securities to a charitable foundation provided tax benefits of $2.7 million for the first nine months of 2017.

Financial Condition

Balance Sheet

Total assets of the Company were $25.0 billion at September 30, 2017 and $25.6 billion at December 31, 2016. Earning assets (excluding the allowance for loan losses and fair value adjustments on investment securities) amounted to $23.7 billion at September 30, 2017 and $24.2 billion at December 31, 2016, and consisted of 58% in loans and 38% in investment securities.

At September 30, 2017, total loans increased $332.8 million, or 2.5%, compared with balances at December 31, 2016. This increase was mainly due to growth in construction loans and consumer loans, which increased $130.4 million and $122.6 million, respectively. The increase in construction loans primarily resulted from growth in commercial construction projects. Consumer loans, which includes automobile, marine and RV, fixed rate home equity, and other consumer loans, and increased largely because of growth in automobile and other consumer lending activity. Higher demand for automobile loans, coupled with growth in patient health care and private banking lending activities grew loan balances $141.3 million. However, fixed rate home equity loans decreased by $6.1 million and marine and RV loans continued to run off during the period by $23.9 million. Business loans increased $57.7 million during the first nine months of the year primarily due to higher commercial credit card lending activity, while business real estate loans grew by $56.8 million over year end balances due to growth in multi-family residential projects. Personal real estate loan balances increased $18.9 million during the first nine months of 2017; however, the Company originated and sold $151.8 million of longer-term fixed rate loans during the first nine months of 2017 compared to $107.9 million in the same period of 2016. Consumer credit card loans and revolving home equity loans declined $24.1 million and $22.3 million, respectively.

Available for sale investment securities, excluding fair value adjustments, decreased by $628.7 million at September 30, 2017 compared to December 31, 2016. Purchases of securities during this period totaled $1.1 billion, offset by sales, maturities, and pay downs of $1.7 billion. The largest decreases in outstanding balances occurred in asset-backed securities and state and municipal obligations, which decreased $654.2 million and $91.5 million, respectively. These decreases were partially offset by an increase in agency mortgage-backed securities of $66.4 million. At September 30, 2017, the duration of the investment portfolio was 3.0 years, and maturities and pay downs of approximately $1.5 billion are expected to occur during the next 12 months.

Total deposits at September 30, 2017 amounted to $20.4 billion and decreased $657.3 million compared to deposit balances at December 31, 2016. The decline in deposits was driven by decreases in certificates of deposit (C.D.'s) of $424.5 million, or 18.9%, mainly in jumbo C.D.s, as well as declines in interest checking deposits of $251.2 million, or 19.7%, and money market deposits of $140.6 million, or 1.5%. These decreases were offset by growth in savings accounts of $52.2 million, or 6.7%. Additionally, non-interest bearing deposits increased $106.7 million, or 1.4%, mainly due to an increase of $139.1 million in business accounts, partially offset by a decrease of $43.7 million in trust accounts.

Total borrowings were $1.5 billion at September 30, 2017 compared to $1.8 billion at December 31, 2016. Short-term borrowings of federal funds purchased and customer repurchase agreements totaled $1.4 billion at September 30, 2017, a decrease of $314.9 million from balances of $1.7 billion at December 31, 2016. The overall decrease in these balances was due to a decrease of $613.0 million in customer repurchase agreements, offset by an increase of $298.1 million in federal funds purchased.


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Liquidity and Capital Resources

Liquidity Management
The Company’s most liquid assets are comprised of available for sale investment securities, federal funds sold, securities purchased under agreements to resell (resale agreements), and balances at the Federal Reserve Bank, as follows:
(In thousands)
 
September 30, 2017
 
June 30, 2017
 
December 31, 2016
Liquid assets:
 
 
 
 
 
 
  Available for sale investment securities
 
$
9,109,287

 
$
9,439,701

 
$
9,649,203

  Federal funds sold
 
32,630

 
16,520

 
15,470

  Long-term securities purchased under agreements to resell
 
700,000

 
625,000

 
725,000

  Balances at the Federal Reserve Bank
 
105,422

 
80,860

 
272,275

  Total
 
$
9,947,339

 
$
10,162,081

 
$
10,661,948


Federal funds sold, which are funds lent to the Company's correspondent bank customers with overnight maturities, totaled $32.6 million as of September 30, 2017. Long-term resale agreements, maturing through 2021, totaled $700.0 million at September 30, 2017. Under these agreements, the Company lends funds to upstream financial institutions and holds marketable securities, safe-kept by a third-party custodian, as collateral. This collateral totaled $725.7 million in fair value at September 30, 2017. Interest earning balances at the Federal Reserve Bank, which have overnight maturities and are used for general liquidity purposes, totaled $105.4 million at September 30, 2017. The fair value of the available for sale investment portfolio was $9.1 billion at September 30, 2017 and included an unrealized net gain in fair value of $137.7 million. The total net unrealized gain included net gains of $20.3 million on mortgage-backed securities, $33.3 million on state and municipal obligations, and $78.1 million on common and preferred stock held by the Parent.

Approximately $1.5 billion of the available for sale investment portfolio is expected to mature or pay down during the next 12 months, and these funds offer substantial resources to meet new loan demand or help offset reductions in the Company's deposit funding base. The Company pledges portions of its investment securities portfolio to secure public fund deposits, securities sold under agreements to repurchase, trust funds, letters of credit issued by the FHLB, and borrowing capacity at the Federal Reserve Bank. Total investment securities pledged for these purposes were as follows:
(In thousands)
September 30, 2017
June 30, 2017
December 31, 2016
Investment securities pledged for the purpose of securing:
    
 
 
  Federal Reserve Bank borrowings
$
91,819

$
99,541

$
115,858

  FHLB borrowings and letters of credit
14,363

15,560

17,781

  Securities sold under agreements to repurchase *
1,752,650

1,747,101

2,447,835

  Other deposits and swaps
1,845,395

2,032,334

1,773,017

  Total pledged securities
3,704,227

3,894,536

4,354,491

  Unpledged and available for pledging
3,605,134

3,718,231

3,516,648

  Ineligible for pledging
1,799,926

1,826,934

1,778,064

  Total available for sale securities, at fair value
$
9,109,287

$
9,439,701

$
9,649,203

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

Liquidity is also available from the Company's large base of core customer deposits, defined as non-interest bearing, interest checking, savings, and money market deposit accounts. At September 30, 2017, such deposits totaled $18.6 billion and represented 91.1% of total deposits. These core deposits are normally less volatile, as they are often with customer relationships tied to other products offered by the Company, promoting long lasting relationships and stable funding sources. Time open and certificates of deposit of $100,000 and over totaled $1.2 billion at September 30, 2017. These accounts are normally considered more volatile and higher costing and comprised 5.7% of total deposits at September 30, 2017.
(In thousands)
September 30, 2017
June 30, 2017
December 31, 2016
Core deposit base:
 
 
 
 Non-interest bearing
$
7,536,127

$
7,314,506

$
7,429,398

 Interest checking
1,024,748

1,169,605

1,275,899

 Savings and money market
10,066,452

10,258,010

10,154,890

 Total
$
18,627,327

$
18,742,121

$
18,860,187



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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, securities sold under agreements to repurchase, and advances from the FHLB, as follows:
(In thousands)
September 30, 2017
June 30, 2017
December 31, 2016
Borrowings:
 
 
 
 Federal funds purchased
$
350,910

$
253,510

$
52,840

 Securities sold under agreements to repurchase
1,058,074

1,002,934

1,671,065

 FHLB advances
100,000

100,000

100,000

 Other debt
2,553

1,903

2,049

 Total
$
1,511,537

$
1,358,347

$
1,825,954


Federal funds purchased are unsecured overnight borrowings obtained mainly from upstream correspondent banks with which the Company maintains approved lines of credit. Securities sold under agreements to repurchase are secured by a portion of the Company's investment portfolio and are comprised of non-insured customer funds totaling $1.1 billion, which generally mature overnight. The Company also borrows on a secured basis through advances from the FHLB, which totaled $100.0 million at September 30, 2017. These advances have fixed interest rates and mature in the fourth quarter of 2017.

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

FHLB
Federal Reserve

Total
Collateral value pledged
$
2,694,364

$
1,314,120

$
4,008,484

Advances outstanding
(100,000
)

(100,000
)
Letters of credit issued
(428,935
)

(428,935
)
Available for future advances
$
2,165,429

$
1,314,120

$
3,479,549


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


Issuer rating
A-

Rating outlook
Stable
Stable
Preferred stock
BBB-
Baa1
Commerce Bank


Issuer rating
A
A2
Rating outlook
Stable
Stable
Baseline credit assessment

a1
Short-term rating
A-1
P-1

The cash flows from the operating, investing and financing activities of the Company resulted in a net decrease in cash and cash equivalents of $182.7 million during the first nine months of 2017, as reported in the consolidated statements of cash flows in this report. Operating activities, consisting mainly of net income adjusted for certain non-cash items, provided cash flow of

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Table of Contents

$334.3 million and has historically been a stable source of funds. Investing activities, which occur mainly in the loan and investment securities portfolios, provided cash of $321.2 million. Activity in the investment securities portfolio provided cash of $681.2 million from sales, maturities and pay downs (net of purchases), which was partly offset by a net increase in loans of $364.8 million. Financing activities used cash of $838.2 million, largely resulting from a decrease in total deposits of $437.0 million. In addition, borrowings of federal funds purchased and securities sold under agreements to repurchase decreased $314.9 million, and cash was used to fund dividends paid on common and preferred stock of $75.5 million. Future short-term liquidity needs arising from daily operations are not expected to vary significantly, and the Company believes it will be able to meet these cash flow needs.

Capital Management

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

(Dollars in thousands)
September 30, 2017
December 31, 2016
Minimum Ratios under Capital Adequacy Guidelines *
Minimum Ratios
for
Well-Capitalized
Banks **
Risk-adjusted assets
$
18,829,003

$
18,994,730

 
 
Tier I common risk-based capital
2,356,506

2,207,370

 
 
Tier I risk-based capital
2,501,290

2,352,154

 
 
Total risk-based capital
2,695,373

2,529,675

 
 
Tier I common risk-based capital ratio
12.52
%
11.62
%
7.00
%
6.50
%
Tier I risk-based capital ratio
13.28
%
12.38
%
8.50
%
8.00
%
Total risk-based capital ratio
14.32
%
13.32
%
10.50
%
10.00
%
Tier I leverage ratio
10.16
%
9.55
%
4.00
%
5.00
%
* as of the fully phased-in date of Jan. 1, 2019, including capital conservation buffer
**under Prompt Corrective Action requirements

The Company maintains a treasury stock buyback program under authorizations by its Board of Directors and normally purchases stock in the open market. The Company purchased 200,330 shares at an average price of $56.51 during the nine months ended September 30, 2017, which was related to stock-based compensation transactions. At September 30, 2017, 3,558,345 shares remained available for purchase under the current Board authorization.

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

Commitments, Off-Balance Sheet Arrangements and Contingencies

In the normal course of business, various commitments and contingent liabilities arise which are not required to be recorded on the balance sheet. The most significant of these are loan commitments, which at September 30, 2017 totaled $10.6 billion (including approximately $5.1 billion in unused approved credit card lines). In addition, the Company enters into standby and commercial letters of credit. These contracts totaled $338.4 million and $13.0 million, respectively, at September 30, 2017. As many commitments expire unused or only partially used, these totals do not necessarily reflect future cash requirements. The carrying value of the guarantee obligations associated with the standby letters of credit, which has been recorded as a liability on the consolidated balance sheet, amounted to $2.1 million at September 30, 2017.

The Company regularly purchases various state tax credits arising from third-party property redevelopment. These credits are either resold to third parties at a profit or retained for use by the Company. During the first nine months of 2017, purchases and sales of tax credits amounted to $58.6 million and $44.9 million, respectively. Fees from sales of tax credits were $2.6 million for the nine months ended September 30, 2017, compared to $2.4 million in the same period last year. At September 30, 2017, the Company expected to fund outstanding purchase commitments of $59.3 million during the remainder of 2017 and $69.7 million in 2018.


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Table of Contents

Segment Results

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

(Dollars in thousands)
Consumer
Commercial
Wealth
Segment
Totals    
Other/ Elimination
Consolidated Totals
Nine Months Ended September 30, 2017
    
    
    
    
    
    
Net interest income
$
207,421

$
243,517

$
35,515

$
486,453

$
57,218

$
543,671

Provision for loan losses
(31,531
)
959

(9
)
(30,581
)
(2,009
)
(32,590
)
Non-interest income
101,211

144,781

116,961

362,953

(561
)
362,392

Investment securities losses, net




(2,158
)
(2,158
)
Non-interest expense
(217,733
)
(219,307
)
(90,323
)
(527,363
)
(28,633
)
(555,996
)
Income before income taxes
$
59,368

$
169,950

$
62,144

$
291,462

$
23,857

$
315,319

Nine Months Ended September 30, 2016
    
    
    
    
    
    
Net interest income
$
201,166

$
231,780

$
32,604

$
465,550

$
41,297

$
506,847

Provision for loan losses
(26,533
)
3,919

(120
)
(22,734
)
(3,184
)
(25,918
)
Non-interest income
97,165

149,240

107,696

354,101

812

354,913

Investment securities losses, net




(3,704
)
(3,704
)
Non-interest expense
(209,660
)
(211,450
)
(85,116
)
(506,226
)
(29,578
)
(535,804
)
Income before income taxes
$
62,138

$
173,489

$
55,064

$
290,691

$
5,643

$
296,334

Increase (decrease) in income before income taxes:
 
 
 
 
 
 
   Amount
$
(2,770
)
$
(3,539
)
$
7,080

$
771

$
18,214

$
18,985

   Percent
(4.5
)%
(2.0
)%
12.9
%
.3
%
322.8
%
6.4
%

Consumer

For the nine months ended September 30, 2017, income before income taxes for the Consumer segment decreased $2.8 million, or 4.5%, compared to the first nine months of 2016. This decrease in income before taxes was mainly due to higher non-interest expense of $8.1 million, or 3.9%, and an increase in the provision for loan losses of $5.0 million, or 18.8%. These increases in expense were partly offset by growth in non-interest income of $4.0 million, or 4.2%, and net interest income of $6.3 million, or 3.1%. Net interest income increased due to a $7.0 million increase in net allocated funding credits assigned to the Consumer segment's loan and deposit portfolios, partly offset by a decline of $751 thousand in loan interest income. Non-interest income increased mainly due to growth in deposit fees (mainly deposit account service fees and overdraft and return item fees), bank card fees, and mortgage banking revenue. Non-interest expense increased over the same period in the previous year due to higher allocated support costs, mainly administrative, online banking and information technology. In addition, salaries expense increased over the previous year, while supplies and communication expense decreased due to higher chip card reissue costs last year that have now declined. The provision for loan losses totaled $31.5 million, a $5.0 million increase over the first nine months of 2016, which was mainly due to higher credit card loan net charge-offs.

Commercial

For the nine months ended September 30, 2017, income before income taxes for the Commercial segment decreased $3.5 million, or 2.0%, compared to the same period in the previous year. This decrease was mainly due to lower non-interest income, higher non-interest expense and an increase in the provision for loan losses. These decreases in income before taxes were partially offset by growth in net interest income. Net interest income increased $11.7 million, or 5.1%, due to an increase in loan interest income, partly offset by a decline in net allocated funding credits and higher interest expense on deposits and customer repurchase agreements. Non-interest income decreased $4.5 million, or 3.0%, from the previous year due to lower bank card fees, swap fees, and capital market fees. These decreases were partly offset by growth in deposit account fees. Non-interest expense increased $7.9 million, or 3.7%, mainly due to increases in salaries and benefits expense and allocated service and support costs, partly offset by lower bank card costs. The provision for loan losses increased $3.0 million over the same period last year, due to lower net recoveries on construction and business real estate loans.


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Wealth

Wealth segment pre-tax profitability for the nine months ended September 30, 2017 increased $7.1 million, or 12.9%, over the same period in the previous year. Net interest income increased $2.9 million, or 8.9%, mainly due to an increase in loan interest income. Non-interest income increased $9.3 million, or 8.6%, over the prior year largely due to higher private client and institutional trust fees, brokerage fees and cash sweep fees. These increases were partly offset by a trust-related settlement received in the second quarter of 2016. Non-interest expense increased $5.2 million, or 6.1%, mainly due to higher salary and benefit costs, professional fees and allocated support costs. The provision for loan losses decreased $111 thousand, mainly due to lower revolving home equity loan net charge-offs.

The Other/Elimination category in the preceding table includes the activity of various support and overhead operating units of the Company, in addition to the investment securities portfolio and other items not allocated to the segments. In accordance with the Company’s transfer pricing procedures, the difference between the total provision and total net charge-offs/recoveries is not allocated to a business segment and is included in this category. The pre-tax profitability of this category was higher than in the same period last year by $18.2 million. This increase was mainly due to higher unallocated net interest income of $15.9 million and lower non-interest expense of $945 thousand, offset by lower non-interest income of $1.4 million. Unallocated securities losses were $2.2 million in the first nine months of 2017 compared to losses of $3.7 million in 2016. Also, the unallocated loan loss provision decreased $1.2 million, as the provision was $1.9 million in excess of charge-offs in the first nine months of 2017 compared to $3.0 million in excess of charge-offs in the first nine months of 2016.

Regulatory Changes Affecting the Banking Industry

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

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

Impact of Recently Issued Accounting Standards

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

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

The FASB issued ASU 2017-12, "Targeted Improvements to Accounting for Hedging Activities", in August 2017. The ASU improves the financial reporting of hedging relationships to better portray the economic results of an entity's risk management activities in its financial statements. These improvements allow the hedging of risk components, ease restrictions on the measurement of the change in fair value of the hedged item, aligns the recognition and presentation of the effects of the hedging instrument and the hedged item, and otherwise simplify hedge accounting guidance. The amendments are effective January 1, 2019 but may be adopted early in any interim period. The Company is currently evaluating whether to adopt the ASU early. As the Company does not currently apply hedge accounting, the Company's consolidated financial statements are not expected to be affected upon adoption of the ASU. The hedging improvements in the new guidance will be considered in the development of risk management strategies in the future.


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Table of Contents

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

Stock Compensation The FASB issued ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting", in March 2016, in order to reduce complexity in this area and improve the usefulness of information provided to users. Amendments which affected public companies included the recognition of excess tax benefits and deficiencies in income tax expense or benefit in the income statement, guidance as to the classification of excess tax benefits on the statement of cash flows, an election to account for award forfeitures as they occur, and the ability to withhold taxes up to the maximum statutory rate in the applicable jurisdictions without triggering liability classification of the award. The amendments were effective January 1, 2017. As further discussed in Note 12 to the consolidated financial statements, the Company elected to account for forfeitures as they occur.

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

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

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

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

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

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Financial Instruments The FASB issued ASU 2016-01, "Recognition and Measurement of Financial Assets and Financial Liabilities", in January 2016. The amendments require all equity investments to be measured at fair value with changes in the fair value recognized through net income, other than those accounted for under the equity method of accounting or those that result in the consolidation of the investee. The amendments also require use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes. These amendments are effective for interim and annual periods beginning January 1, 2018. As required by the ASU, at January 1, 2018, the Company will record a cumulative-effect adjustment which will reclassify net unrealized gains/losses on equity securities from accumulated other comprehensive income to retained earnings. The Company has formed a working group to evaluate the changes required as a result of the adoption of this ASU and has also engaged outside consultants who are actively engaged in preliminary estimates of the fair value of the Company's loan portfolio.

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

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

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

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

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

Financial Instruments ASU 2016-13, "Measurement of Credit Losses on Financial Instruments", was issued in June 2016. Its implementation will result in a new loan loss accounting framework, also known as the current expected credit loss (CECL) model. CECL requires credit losses expected throughout the life of the asset portfolio on loans and held-to-maturity securities to be recorded at the time of origination. Under the current incurred loss model, losses are recorded when it is probable that a loss event has occurred. The new standard will require significant operational changes, especially in data collection and analysis. The

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ASU is effective for interim and annual periods beginning January 1, 2020, and is expected to increase the allowance upon adoption. The Company has formed a working group to assess the standard and has begun assessing the data needs required. In the second quarter of 2017, the Company contracted with a software supplier to assist in the data collection and calculation of the allowance for loan losses under the new model, and is currently collecting loan data to be supplied to the vendor to allow for pro-forma calculations to begin by mid-2018.

Intangible Assets The FASB issued ASU 2017-04, "Simplifying the Test for Goodwill Impairment", in January 2017. Under current guidance, a goodwill impairment loss is measured by comparing the implied fair value of a reporting unit's goodwill with the carrying amount of that goodwill by following procedures that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Under the new amendments, the goodwill impairment test compares the fair value of a reporting unit with its carrying amount and an impairment charge is measured as the amount by which the carrying amount exceeds the reporting unit's fair value. The amendments are effective for impairment tests beginning January 1, 2020 and are not expected to have a significant effect on the Company's consolidated financial statements.



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AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
Three Months Ended September 30, 2017 and 2016
 
Third Quarter 2017
 
Third Quarter 2016
(Dollars in thousands)
Average Balance
Interest Income/Expense
Avg. Rates Earned/Paid
 
Average Balance
Interest Income/Expense
Avg. Rates Earned/Paid
ASSETS:
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
Business(A)
$
4,777,222

$
39,134

3.25
%
 
$
4,694,340

$
33,924

2.87
%
Real estate — construction and land
887,596

9,649

4.31

 
821,422

7,184

3.48

Real estate — business
2,710,453

26,325

3.85

 
2,432,325

22,195

3.63

Real estate — personal
2,017,264

18,912

3.72

 
1,943,951

18,249

3.73

Consumer
2,070,398

20,986

4.02

 
1,947,956

19,122

3.91

Revolving home equity
395,212

4,017

4.03

 
411,832

3,690

3.56

Consumer credit card
739,692

22,422

12.03

 
750,412

21,804

11.56

Overdrafts
4,373



 
4,652



Total loans
13,602,210

141,445

4.13

 
13,006,890

126,168

3.86

Loans held for sale
21,227

287

5.36

 
26,597

334

5.00

Investment securities:
  
 
 
 
 
 
 
U.S. government and federal agency obligations
917,808

3,232

1.40

 
726,469

4,436

2.43

Government-sponsored enterprise obligations
456,668

1,855

1.61

 
481,573

2,710

2.24

State and municipal obligations(A)
1,699,365

15,279

3.57

 
1,747,794

15,821

3.60

Mortgage-backed securities
3,718,697

22,155

2.36

 
3,366,292

20,099

2.38

Asset-backed securities
2,025,415

9,288

1.82

 
2,340,783

8,698

1.48

Other marketable securities(A)
327,634

2,254

2.73

 
334,747

2,307

2.74

Trading securities(A)
21,149

134

2.51

 
18,433

112

2.42

Non-marketable securities(A)
102,995

1,676

6.46

 
113,954

2,932

10.24

Total investment securities
9,269,731

55,873

2.39

 
9,130,045

57,115

2.49

Federal funds sold and short-term securities
 
 
 
 
 
 
 
purchased under agreements to resell
23,807

78

1.30

 
13,054

20

.61

Long-term securities purchased
 
 
 
 
 
 
 
under agreements to resell
662,490

3,805

2.28

 
766,302

3,328

1.73

Interest earning deposits with banks
211,219

662

1.24

 
207,944

268

.51

Total interest earning assets
23,790,684

202,150

3.37

 
23,150,832

187,233

3.22

Allowance for loan losses
(156,909
)
 
 
 
(153,517
)
 
 
Unrealized gain on investment securities
116,873

 
 
 
235,169

 
 
Cash and due from banks
348,554

 
 
 
362,130

 
 
Land, buildings and equipment, net
345,139

 
 
 
347,621

 
 
Other assets
428,537

 
 
 
441,798

 
 
Total assets
$
24,872,878

 
 
 
$
24,384,033

 
 
LIABILITIES AND EQUITY:
 
 
 
 
 
 
 
Interest bearing deposits:
 
 
 
 
 
 
 
Savings
$
829,197

252

.12

 
$
778,663

239

.12

Interest checking and money market
10,387,212

4,189

.16

 
10,210,744

3,380

.13

Time open & C.D.'s of less than $100,000
667,710

676

.40

 
740,729

683

.37

Time open & C.D.'s of $100,000 and over
1,326,290

2,784

.83

 
1,435,001

2,186

.61

Total interest bearing deposits
13,210,409

7,901

.24

 
13,165,137

6,488

.20

Borrowings:
 
 
 
 
 
 
 
Federal funds purchased and securities sold
 
 
 
 
 
 
 
under agreements to repurchase
1,500,987

2,846

.75

 
1,163,728

724

.25

Other borrowings
101,904

906

3.53

 
102,769

906

3.51

Total borrowings
1,602,891

3,752

.93

 
1,266,497

1,630

.51

Total interest bearing liabilities
14,813,300

11,653

.31
%
 
14,431,634

8,118

.22
%
Non-interest bearing deposits
7,135,703

 
 
 
7,096,218

 
 
Other liabilities
251,714

 
 
 
306,306

 
 
Equity
2,672,161

 
 
 
2,549,875

 
 
Total liabilities and equity
$
24,872,878

 
 
 
$
24,384,033

 
 
Net interest margin (T/E)
 
$
190,497

 
 
 
$
179,115

 
Net yield on interest earning assets
 
 
3.18
%
 
 
 
3.08
%
(A) Stated on a tax equivalent basis using a federal income tax rate of 35%.


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AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
Nine Months Ended September 30, 2017 and 2016
 
Nine Months 2017
 
Nine Months 2016
(Dollars in thousands)
Average Balance
Interest Income/Expense
Avg. Rates Earned/Paid
 
Average Balance
Interest Income/Expense
Avg. Rates Earned/Paid
ASSETS:
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
Business(A)
$
4,836,637

$
114,326

3.16
%
 
$
4,626,041

$
99,879

2.88
%
Real estate — construction and land
859,582

26,775

4.16

 
764,644

19,934

3.48

Real estate — business
2,685,947

75,240

3.75

 
2,401,310

66,070

3.68

Real estate — personal
2,011,257

56,087

3.73

 
1,919,905

53,977

3.76

Consumer
2,014,701

59,531

3.95

 
1,936,860

55,931

3.86

Revolving home equity
400,087

11,481

3.84

 
418,214

11,138

3.56

Consumer credit card
739,619

65,630

11.86

 
746,893

64,343

11.51

Overdrafts
4,355



 
4,447



Total loans
13,552,185

409,070

4.04

 
12,818,314

371,272

3.87

Loans held for sale
17,214

746

5.79

 
30,728

1,161

5.05

Investment securities:
 
 
 
 
 
 
 

U.S. government and federal agency obligations
914,050

13,677

2.00

 
709,414

11,176

2.10

Government-sponsored enterprise obligations
452,529

5,396

1.59

 
640,888

11,446

2.39

State and municipal obligations(A)
1,751,074

47,270

3.61

 
1,743,426

47,267

3.62

Mortgage-backed securities
3,728,886

65,955

2.36

 
3,395,053

60,827

2.39

Asset-backed securities
2,238,910

28,805

1.72

 
2,418,370

26,087

1.44

Other marketable securities(A)
328,873

6,813

2.77

 
338,221

7,008

2.77

Trading securities(A)
22,444

448

2.67

 
19,052

358

2.51

Non-marketable securities(A)
101,850

9,827

12.90

 
119,256

7,328

8.21

Total investment securities
9,538,616

178,191

2.50

 
9,383,680

171,497

2.44

Federal funds sold and short-term securities
 
 
 
 
 
 
 
purchased under agreements to resell
15,654

138

1.18

 
14,112

63

.60

Long-term securities purchased
 
 
 
 
 
 
 
under agreements to resell
684,153

11,282

2.20

 
813,685

10,157

1.67

Interest earning deposits with banks
186,054

1,421

1.02

 
184,288

689

.50

Total interest earning assets
23,993,876

600,848

3.35

 
23,244,807

554,839

3.19

Allowance for loan losses
(156,419
)
 
 
 
(152,154
)
 
 
Unrealized gain on investment securities
94,462

 
 
 
192,175

 
 
Cash and due from banks
357,948

 
 
 
384,985

 
 
Land, buildings and equipment, net
345,123

 
 
 
351,886

 
 
Other assets
419,586

 
 
 
409,043

 
 
Total assets
$
25,054,576

 
 
 
$
24,430,742

 
 
LIABILITIES AND EQUITY:
 
 
 
 
 
 
 
Interest bearing deposits:
 
 
 
 
 
 
 
Savings
$
818,766

738

.12

 
$
775,731

691

.12

Interest checking and money market
10,551,953

11,935

.15

 
10,209,076

9,960

.13

Time open & C.D.'s of less than $100,000
686,827

1,994

.39

 
758,154

2,134

.38

Time open & C.D.'s of $100,000 and over
1,501,209

8,369

.75

 
1,517,894

6,519

.57

Total interest bearing deposits
13,558,755

23,036

.23

 
13,260,855

19,304

.19

Borrowings:
 
 
 
 
 
 
 
Federal funds purchased and securities sold
 
 
 
 
 
 
 
under agreements to repurchase
1,407,308

6,423

.61

 
1,259,773

2,337

.25

Other borrowings
103,075

2,705

3.51

 
194,706

3,066

2.10

Total borrowings
1,510,383

9,128

.81

 
1,454,479

5,403

.50

Total interest bearing liabilities
15,069,138

32,164

.29
%
 
14,715,334

24,707

.22
%
Non-interest bearing deposits
7,149,010

 
 
 
6,963,081

 
 
Other liabilities
229,730

 
 
 
273,760

 
 
Equity
2,606,698

 
 
 
2,478,567

 
 
Total liabilities and equity
$
25,054,576

 
 
 
$
24,430,742

 
 
Net interest margin (T/E)
 
$
568,684

 
 
 
$
530,132

 
Net yield on interest earning assets
 
 
3.17
%
 
 
 
3.05
%
(A) Stated on a tax equivalent basis using a federal income tax rate of 35%.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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

The simulations reflect two different assumptions related to deposit attrition. The Company utilizes these simulations both for monitoring interest rate risk and for liquidity planning purposes. While the future effects of rising rates on deposit balances cannot be known, the Company maintains a practice of running multiple rate scenarios to better understand interest rate risk and its effect on the Company’s performance.  The Company believes that its approach to interest rate risk has appropriately considered its susceptibility to both rising rates and falling rates and has adopted strategies which minimize impacts to overall interest rate risk.
Simulation A
September 30, 2017
 
June 30, 2017
 (Dollars in millions)
$ Change in
Net Interest
Income
% Change in
Net Interest
Income
 
Assumed Deposit Attrition
 
$ Change in
Net Interest
Income
% Change in
Net Interest
Income
 
Assumed Deposit Attrition
300 basis points rising
$
10.4

1.41
%
 
$
(356.9
)
 
$
15.1

2.09
%
 
$
(368.0
)
200 basis points rising
10.7

1.45

 
(246.5
)
 
14.3

1.99

 
(256.2
)
100 basis points rising
7.1

.96

 
(125.7
)
 
9.1

1.26

 
(131.4
)

Simulation B
September 30, 2017
 
June 30, 2017
 (Dollars in millions)
$ Change in
Net Interest
Income
% Change in
Net Interest
Income
 
Assumed Deposit Attrition
 
$ Change in
Net Interest
Income
% Change in
Net Interest
Income
 
Assumed Deposit Attrition
300 basis points rising
$
(10.8
)
(1.45
)%
 
$
(1,122.0
)
 
$
(5.6
)
(.78
)%
 
$
(1,181.4
)
200 basis points rising
(7.3
)
(.98
)
 
(1,013.2
)
 
(3.2
)
(.44
)
 
(1,072.5
)
100 basis points rising
(7.6
)
(1.03
)
 
(895.2
)
 
(5.1
)
(.71
)
 
(952.4
)

The difference in these two simulations is the degree in which deposits are modeled to decline as noted in the above table.  Both simulations assume that a decline in deposits would be offset by increased short-term borrowings, which are more rate sensitive and can result in higher interest costs in a rising rate environment.  Under Simulation A, a gradual increase in interest rates of 100 basis points is expected to increase net interest income from the base calculation by $7.1 million, while a gradual increase in rates of 200 basis points would increase net interest income by $10.7 million.  An increase in rates of 300 basis points would result in an increase in net interest income of $10.4 million. The change in net interest income from the base calculation at September 30, 2017 was lower than projections made at June 30, 2017 largely due to higher rates and balances of repurchase agreements, which increased interest expense and lowered net interest income projections for the third quarter of 2017 compared to the prior quarter. In addition, the Company's investment portfolio is projected to produce less interest income, as a combination of lower investment securities balances and fewer variable rate securities at September 30, 2017 results in the portfolio being less rate sensitive in a rising rate environment.
Under Simulation B, the same assumptions utilized in Simulation A were applied. However, in Simulation B, deposit attrition was accelerated to consider the effects that large deposit outflows might have on net interest income and liquidity planning purposes.  The effect of higher deposit attrition was that greater reliance was placed on short-term borrowings at higher rates, which are more

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

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


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PART II: OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

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


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

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

 
 
 
Period
Total Number of Shares Purchased
 Average Price Paid per Share
Total Number of Shares Purchased as part of Publicly Announced Program
 Maximum Number that May Yet Be Purchased Under the Program
July 1 — 31, 2017
10,091

 
$
57.85

10,091

3,560,236

August 1 — 31, 2017
815

 
$
57.06

815

3,559,421

September 1 — 30, 2017
1,076

 
$
57.38

1,076

3,558,345

Total
11,982

 
$
57.75

11,982

3,558,345


The Company's stock purchases shown above were made under authorizations by the Board of Directors. Under the most recent authorization in October 2015 of 5,000,000 shares, 3,558,345 shares remained available for purchase at September 30, 2017.


Item 6. EXHIBITS

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

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

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

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


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SIGNATURES

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


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

Date: November 6, 2017
By 
/s/  JEFFERY D. ABERDEEN
 
Jeffery D. Aberdeen
 
Controller
 
(Chief Accounting Officer)

Date: November 6, 2017


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