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COMMERCE BANCSHARES INC /MO/ - Quarter Report: 2018 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, 2018

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 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 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, 2018, the registrant had outstanding 106,227,582 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, 2018
 
December 31, 2017
 
(Unaudited)
 
 
 
(In thousands)
ASSETS
 
 
 
Loans
$
13,955,559

 
$
13,983,674

  Allowance for loan losses
(159,732
)
 
(159,532
)
Net loans
13,795,827

 
13,824,142

Loans held for sale (including $10,256,000 and $15,327,000 of residential mortgage loans carried at fair value at September 30, 2018 and December 31, 2017, respectively)
16,890

 
21,398

Investment securities:
 
 
 

Available for sale debt ($553,227,000 and $662,515,000 pledged at September 30, 2018 and
 
 
 
    December 31, 2017, respectively, to secure swap and repurchase agreements)
8,674,986

 
8,725,442

Trading debt
19,676

 
18,269

Equity
4,467

 
50,591

Other
127,120

 
99,005

Total investment securities
8,826,249

 
8,893,307

Federal funds sold and short-term securities purchased under agreements to resell
14,375

 
42,775

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

 
700,000

Interest earning deposits with banks
334,752

 
30,631

Cash and due from banks
443,004

 
438,439

Land, buildings and equipment, net
331,869

 
335,110

Goodwill
138,921

 
138,921

Other intangible assets, net
8,470

 
7,618

Other assets
452,035

 
401,074

Total assets
$
25,062,392

 
$
24,833,415

LIABILITIES AND EQUITY
 
 
 
Deposits:
 
 
 

   Non-interest bearing
$
6,728,605

 
$
7,158,962

   Savings, interest checking and money market
11,733,057

 
11,499,620

   Time open and C.D.'s of less than $100,000
585,765

 
634,646

   Time open and C.D.'s of $100,000 and over
1,086,193

 
1,132,218

Total deposits
20,133,620

 
20,425,446

Federal funds purchased and securities sold under agreements to repurchase
1,862,117

 
1,507,138

Other borrowings
1,534

 
1,758

Other liabilities
257,311

 
180,889

Total liabilities
22,254,582

 
22,115,231

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 107,081,397 shares
535,407

 
535,407

   Capital surplus
1,804,031

 
1,815,360

   Retained earnings
493,641

 
221,374

   Treasury stock of 516,507 shares at September 30, 2018
 
 
 
     and 276,968 shares at December 31, 2017, at cost
(33,174
)
 
(14,473
)
   Accumulated other comprehensive income (loss)
(141,596
)
 
14,108

Total Commerce Bancshares, Inc. stockholders' equity
2,803,093

 
2,716,560

Non-controlling interest
4,717

 
1,624

Total equity
2,807,810

 
2,718,184

Total liabilities and equity
$
25,062,392

 
$
24,833,415

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)
2018
2017
 
2018
2017
 
(Unaudited)
INTEREST INCOME
 
 
 
 
 
Interest and fees on loans
$
159,182

$
138,827

 
$
460,332

$
401,423

Interest and fees on loans held for sale
315

287

 
991

746

Interest on investment securities
59,792

50,585

 
178,598

160,825

Interest on federal funds sold and short-term securities purchased under
 
 
 
 
 
   agreements to resell
69

78

 
426

138

Interest on long-term securities purchased under agreements to resell
3,915

3,805

 
11,814

11,282

Interest on deposits with banks
1,478

662

 
4,208

1,421

Total interest income
224,751

194,244

 
656,369

575,835

INTEREST EXPENSE
 
 
 
 
 
Interest on deposits:
 
 
 
 
 
   Savings, interest checking and money market
7,230

4,441

 
19,338

12,673

   Time open and C.D.'s of less than $100,000
834

676

 
2,190

1,994

   Time open and C.D.'s of $100,000 and over
3,899

2,784

 
10,221

8,369

Interest on federal funds purchased and securities sold under
 
 
 
 
 
   agreements to repurchase
5,022

2,846

 
12,979

6,423

Interest on other borrowings
12

906

 
36

2,705

Total interest expense
16,997

11,653

 
44,764

32,164

Net interest income
207,754

182,591

 
611,605

543,671

Provision for loan losses
9,999

10,704

 
30,438

32,590

Net interest income after provision for loan losses
197,755

171,887

 
581,167

511,081

NON-INTEREST INCOME
 
 
 
 
 
Bank card transaction fees
42,427

39,166

 
127,095

112,212

Trust fees
37,400

34,620

 
110,498

99,754

Deposit account charges and other fees
23,755

22,659

 
70,630

67,462

Capital market fees
1,595

1,755

 
5,878

6,253

Consumer brokerage services
3,884

3,679

 
11,623

11,054

Loan fees and sales
3,579

3,590

 
9,670

10,849

Other
11,074

11,418

 
32,860

34,296

Total non-interest income
123,714

116,887

 
368,254

341,880

INVESTMENT SECURITIES GAINS (LOSSES), NET
4,306

(3,037
)
 
6,641

(2,158
)
NON-INTEREST EXPENSE
 
 
 
 
 
Salaries and employee benefits
116,194

111,382

 
347,677

332,580

Net occupancy
11,631

11,459

 
34,333

34,332

Equipment
4,592

4,491

 
13,617

13,876

Supplies and communication
5,103

5,517

 
15,542

16,672

Data processing and software
22,056

19,968

 
63,762

59,908

Marketing
4,999

4,676

 
14,946

12,388

Deposit insurance
3,167

3,479

 
9,750

10,542

Community service
580

3,006

 
1,965

8,866

Other
16,737

15,239

 
47,604

46,320

Total non-interest expense
185,059

179,217

 
549,196

535,484

Income before income taxes
140,716

106,520

 
406,866

315,319

Less income taxes
26,647

32,294

 
79,412

90,402

Net income
114,069

74,226

 
327,454

224,917

Less non-controlling interest expense (income)
1,493

(338
)
 
3,564

(111
)
Net income attributable to Commerce Bancshares, Inc.
112,576

74,564

 
323,890

225,028

Less preferred stock dividends
2,250

2,250

 
6,750

6,750

Net income available to common shareholders
$
110,326

$
72,314

 
$
317,140

$
218,278

Net income per common share — basic
$
1.03

$
.68

 
$
2.97

$
2.04

Net income per common share — diluted
$
1.03

$
.67

 
$
2.96

$
2.03

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)
 
2018
2017
 
2018
2017
 
 
(Unaudited)
Net income
 
$
114,069

$
74,226

 
$
327,454

$
224,917

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
 
53

286

 
(25
)
457

Net unrealized gains (losses) on other securities
 
(32,232
)
24,356

 
(125,442
)
54,599

Pension loss amortization
 
393

349

 
1,180

1,030

Unrealized losses on cash flow hedge derivatives
 
(1,029
)
—

 
(1,029
)
—

Other comprehensive income (loss)
 
(32,815
)
24,991

 
(125,316
)
56,086

Comprehensive income
 
81,254

99,217

 
202,138

281,003

Less non-controlling interest expense (income)
 
1,493

(338
)
 
3,564

(111
)
Comprehensive income attributable to Commerce Bancshares, Inc.
$
79,761

$
99,555

 
$
198,574

$
281,114

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, 2017
$
144,784

$
535,407

$
1,815,360

$
221,374

$
(14,473
)
$
14,108

$
1,624

$
2,718,184

Adoption of ASU 2018-02
 
 


(2,932
)
 
2,932

 
—

Adoption of ASU 2016-01
 




33,320



(33,320
)


—

Net income
 




323,890





3,564

327,454

Other comprehensive loss
 








(125,316
)


(125,316
)
Distributions to non-controlling interest
 










(471
)
(471
)
Purchases of treasury stock
 






(39,575
)




(39,575
)
Issuance of stock under purchase and equity compensation plans
 


(20,884
)


20,874





(10
)
Stock-based compensation
 


9,555









9,555

Cash dividends on common stock ($.705 per share)
 




(75,261
)






(75,261
)
Cash dividends on preferred stock ($1.125 per depositary share)
 




(6,750
)






(6,750
)
Balance September 30, 2018
$
144,784

$
535,407

$
1,804,031

$
493,641

$
(33,174
)
$
(141,596
)
$
4,717

$
2,807,810

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 ($.643 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

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)
2018
 
2017
 
(Unaudited)
OPERATING ACTIVITIES:
 
 
 
Net income
$
327,454

 
$
224,917

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
  Provision for loan losses
30,438

 
32,590

  Provision for depreciation and amortization
28,824

 
29,521

  Amortization of investment security premiums, net
18,758

 
28,173

  Investment securities (gains) losses, net (A)
(6,641
)
 
2,158

  Net gains on sales of loans held for sale
(4,770
)
 
(6,200
)
  Originations of loans held for sale
(149,397
)
 
(162,552
)
  Proceeds from sales of loans held for sale
156,637

 
164,588

  Net (increase) decrease in trading debt securities
(4,886
)
 
7,234

  Stock-based compensation
9,555

 
9,149

  Increase in interest receivable
(5,021
)
 
(3,757
)
  Increase (decrease) in interest payable
689

 
(223
)
  Increase in income taxes payable
30,107

 
201

  Other changes, net
14,964

 
8,511

Net cash provided by operating activities
446,711

 
334,310

INVESTING ACTIVITIES:
 
 
 
Proceeds from sales of investment securities (A)
193,047

 
369,036

Proceeds from maturities/pay downs of investment securities (A)
1,222,998

 
1,384,993

Purchases of investment securities (A)
(1,520,235
)
 
(1,072,782
)
Net increase in loans
(3,588
)
 
(364,765
)
Long-term securities purchased under agreements to resell
(100,000
)
 
(75,000
)
Repayments of long-term securities purchased under agreements to resell
100,000

 
100,000

Purchases of land, buildings and equipment
(21,358
)
 
(22,853
)
Sales of land, buildings and equipment
2,342

 
2,570

Net cash provided by (used in) investing activities
(126,794
)
 
321,199

FINANCING ACTIVITIES:
 
 
 
Net decrease in non-interest bearing, savings, interest checking and money market deposits
(177,368
)
 
(12,490
)
Net decrease in time open and C.D.'s
(94,906
)
 
(424,462
)
Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase
354,979

 
(314,921
)
Repayment of long-term borrowings
(224
)
 
(218
)
Net increase in short-term borrowings
—

 
722

Purchases of treasury stock
(39,575
)
 
(11,320
)
Issuance of stock under equity compensation plans
(10
)
 
(7
)
Cash dividends paid on common stock
(75,261
)
 
(68,722
)
Cash dividends paid on preferred stock
(6,750
)
 
(6,750
)
Net cash used in financing activities
(39,115
)
 
(838,168
)
Increase (decrease) in cash, cash equivalents and restricted cash
280,802

 
(182,659
)
Cash, cash equivalents and restricted cash at beginning of year
524,352

 
782,435

Cash, cash equivalents and restricted cash at September 30
$
805,154

 
$
599,776

(A) Available for sale debt securities, equity securities and other securities
 
 
 
Income tax payments, net
$
46,122

 
$
87,449

Interest paid on deposits and borrowings
$
44,074

 
$
32,387

Loans transferred to foreclosed real estate
$
1,312

 
$
1,166

See accompanying notes to consolidated financial statements.

Restricted cash is comprised of cash collateral posted by the Company to secure interest rate swap agreements. This balance is included in other assets in the consolidated balance sheets and totaled $13.0 million and $12.8 million at September 30, 2018 and 2017, respectively.


7
Table of Contents

Commerce Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018 (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 2017 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, 2018 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.

These financial statements reflect the adoption of several FASB Accounting Standards Updates (ASUs) on January 1, 2018. In some cases, the adoption of these ASUs resulted in changes to former accounting policies as described in Note 1 to the financial statements in the 2017 Annual Report on Form 10-K. The ASUs which affected the Company's 2018 financial statements include:
•
ASU 2014-09, Revenue from Contracts with Customers, which is discussed further in Note 13.
•
ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which is discussed further in Note 3 - Investment Securities, Note 8 - Accumulated Other Comprehensive Income, and Note 15 - Fair Value of Financial Instruments.
•
ASU 2016-18, Restricted Cash, which requires that the beginning and end of period amounts shown on the statement of cash flows include not only cash and cash equivalents, but also restricted cash and restricted cash equivalents, as considered such by the reporting entity.
•
ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which is discussed further in Note 6 - Pension.
•
ASU 2018-02, Reclassification for Certain Tax Effects from Accumulated Other Comprehensive Income, which is discussed further in Note 8 - Accumulated Other Comprehensive Income.







8
Table of Contents

2. Loans and Allowance for Loan Losses
Major classifications within the Company’s held for investment loan portfolio at September 30, 2018 and December 31, 2017 are as follows:

(In thousands)
 
September 30, 2018
 
December 31, 2017
Commercial:
 
 
 
 
Business
 
$
4,966,722

 
$
4,958,554

Real estate – construction and land
 
999,691

 
968,820

Real estate – business
 
2,726,042

 
2,697,452

Personal Banking:
 
 
 
 
Real estate – personal
 
2,120,672

 
2,062,787

Consumer
 
1,967,465

 
2,104,487

Revolving home equity
 
375,322

 
400,587

Consumer credit card
 
788,111

 
783,864

Overdrafts
 
11,534

 
7,123

Total loans
 
$
13,955,559

 
$
13,983,674


At September 30, 2018, loans of $3.7 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.

Allowance for loan losses    
A summary of the activity in the allowance for loan losses during the three and nine months ended September 30, 2018 and 2017, 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
$
93,851

$
65,681

$
159,532

 
$
93,704

$
65,828

$
159,532

Provision
411

9,588

9,999

 
2

30,436

30,438

Deductions:
 
 
 
 
 
 
 
   Loans charged off
485

12,515

13,000

 
1,213

39,203

40,416

   Less recoveries on loans
314

2,887

3,201

 
1,598

8,580

10,178

Net loan charge-offs (recoveries)
171

9,628

9,799

 
(385
)
30,623

30,238

Balance September 30, 2018
$
94,091

$
65,641

$
159,732

 
$
94,091

$
65,641

$
159,732

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



9
Table of Contents

The following table shows the balance in the allowance for loan losses and the related loan balance at September 30, 2018 and December 31, 2017, disaggregated on the basis of impairment methodology. Impaired loans evaluated under Accounting Standards Codification (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, 2018
 
 
 
 
 
Commercial
$
2,746

$
91,119

 
$
91,345

$
8,601,336

Personal Banking
898

17,641

 
64,743

5,245,463

Total
$
3,644

$
108,760

 
$
156,088

$
13,846,799

December 31, 2017
 
 
 
 
 
Commercial
$
3,067

$
92,613

 
$
90,637

$
8,532,213

Personal Banking
1,176

22,182

 
64,652

5,336,666

Total
$
4,243

$
114,795

 
$
155,289

$
13,868,879


Impaired loans
The table below shows the Company’s investment in impaired loans at September 30, 2018 and December 31, 2017. 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 15.
(In thousands)
 
Sept. 30, 2018
 
Dec. 31, 2017
Non-accrual loans
 
$
8,369

 
$
11,983

Restructured loans (accruing)
 
100,391

 
102,812

Total impaired loans
 
$
108,760

 
$
114,795



10
Table of Contents

The following table provides additional information about impaired loans held by the Company at September 30, 2018 and December 31, 2017, 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, 2018
 
 
 
With no related allowance recorded:
 
 
 
Business
$
4,871

$
8,936

$
—

 
$
4,871

$
8,936

$
—

With an allowance recorded:
 
 
 
Business
$
75,324

$
75,612

$
2,262

Real estate – construction and land
412

416

11

Real estate – business
10,512

11,112

473

Real estate – personal
5,177

7,347

274

Consumer
5,309

5,309

48

Revolving home equity
68

68

—

Consumer credit card
7,087

7,087

576

 
$
103,889

$
106,951

$
3,644

Total
$
108,760

$
115,887

$
3,644

December 31, 2017
 
 
 
With no related allowance recorded:
 
 
 
Business
$
5,356

$
9,000

$
—

Real estate – business
1,299

1,303

—

Consumer
779

817

—

 
$
7,434

$
11,120

$
—

With an allowance recorded:
 
 
 
Business
$
72,589

$
73,168

$
2,455

Real estate – construction and land
837

841

27

Real estate – business
12,532

13,071

585

Real estate – personal
9,126

11,914

532

Consumer
5,388

5,426

67

Revolving home equity
204

204

11

Consumer credit card
6,685

6,685

566

 
$
107,361

$
111,309

$
4,243

Total
$
114,795

$
122,429

$
4,243




11
Table of Contents

Total average impaired loans for the three and nine month periods ended September 30, 2018 and 2017, respectively, are shown in the table below.

(In thousands)
Commercial
Personal Banking
Total
Average Impaired Loans:
 
 
 
For the three months ended September 30, 2018
 
 
 
Non-accrual loans
$
7,477

$
1,862

$
9,339

Restructured loans (accruing)
83,493

16,409

99,902

Total
$
90,970

$
18,271

$
109,241

For the nine months ended September 30, 2018
 
 
 
Non-accrual loans
$
7,888

$
2,261

$
10,149

Restructured loans (accruing)
81,543

17,426

98,969

Total
$
89,431

$
19,687

$
109,118

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


The table below shows interest income recognized during the three and nine month periods ended September 30, 2018 and 2017, 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 15.
 
For the Three Months Ended September 30
 
For the Nine Months Ended September 30
(In thousands)
2018
2017
 
2018
2017
Interest income recognized on impaired loans:
 
 
 
 
 
Business
$
939

$
473

 
$
2,817

$
1,418

Real estate – construction and land
6

10

 
19

30

Real estate – business
110

118

 
329

354

Real estate – personal
47

104

 
142

311

Consumer
79

79

 
238

236

Revolving home equity
2

7

 
6

20

Consumer credit card
129

162

 
386

486

Total
$
1,312

$
953

 
$
3,937

$
2,855



12
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, 2018 and December 31, 2017.




(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, 2018
 
 
 
 
 
Commercial:
 
 
 
 
 
Business
$
4,957,570

$
3,673

$
348

$
5,131

$
4,966,722

Real estate – construction and land
995,134

4,553

—

4

999,691

Real estate – business
2,708,294

16,281

—

1,467

2,726,042

Personal Banking:
 
 
 
 
 
Real estate – personal
2,110,198

7,571

1,136

1,767

2,120,672

Consumer
1,936,208

28,249

3,008

—

1,967,465

Revolving home equity
372,931

1,517

874

—

375,322

Consumer credit card
769,158

10,328

8,625

—

788,111

Overdrafts
11,199

335

—

—

11,534

Total
$
13,860,692

$
72,507

$
13,991

$
8,369

$
13,955,559

December 31, 2017
 
 
 
 
 
Commercial:
 
 
 
 
 
Business
$
4,949,148

$
3,085

$
374

$
5,947

$
4,958,554

Real estate – construction and land
967,321

1,473

21

5

968,820

Real estate – business
2,694,234

482

—

2,736

2,697,452

Personal Banking:
 
 
 
 
 
Real estate – personal
2,050,787

6,218

3,321

2,461

2,062,787

Consumer
2,067,025

32,674

3,954

834

2,104,487

Revolving home equity
397,349

1,962

1,276

—

400,587

Consumer credit card
764,568

10,115

9,181

—

783,864

Overdrafts
6,840

283

—

—

7,123

Total
$
13,897,272

$
56,292

$
18,127

$
11,983

$
13,983,674


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.

13
Table of Contents

Commercial Loans


(In thousands)


Business
Real
 Estate-Construction
Real
Estate-
Business


Total
September 30, 2018
 
 
 
 
Pass
$
4,772,286

$
987,352

$
2,649,964

$
8,409,602

Special mention
40,307

11,474

29,016

80,797

Substandard
148,998

861

45,595

195,454

Non-accrual
5,131

4

1,467

6,602

Total
$
4,966,722

$
999,691

$
2,726,042

$
8,692,455

December 31, 2017
 
 
 
 
Pass
$
4,740,013

$
955,499

$
2,593,005

$
8,288,517

Special mention
59,177

10,614

50,577

120,368

Substandard
153,417

2,702

51,134

207,253

Non-accrual
5,947

5

2,736

8,688

Total
$
4,958,554

$
968,820

$
2,697,452

$
8,624,826


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 real estate loans for which FICO scores are not obtained because they generally pertain to commercial customer activities and are often underwritten with other collateral considerations. These loans totaled $205.4 million at September 30, 2018 and $219.2 million at December 31, 2017. The table also excludes consumer loans related to the Company's patient healthcare loan program, which totaled $170.3 million at September 30, 2018 and $145.0 million at December 31, 2017. As the healthcare loans are guaranteed by the hospital, FICO scores are not considered relevant for this program. The personal real estate loans and consumer loans excluded below totaled less than 8% of the Personal Banking portfolio. For the remainder of loans in the Personal Banking portfolio, the table below shows the percentage of balances outstanding at September 30, 2018 and December 31, 2017 by FICO score.
   Personal Banking Loans
 
% of Loan Category
 
Real Estate - Personal
Consumer
Revolving Home Equity
Consumer Credit Card
September 30, 2018
 
 
 
 
FICO score:
 
 
 
 
Under 600
1.0
%
3.2
%
1.0
%
4.4
%
600 - 659
2.0

4.9

1.8

14.2

660 - 719
9.2

18.3

9.5

35.3

720 - 779
25.4

25.8

23.4

26.6

780 and over
62.4

47.8

64.3

19.5

Total
100.0
%
100.0
%
100.0
%
100.0
%
December 31, 2017
 
 
 
 
FICO score:
 
 
 
 
Under 600
1.3
%
3.3
%
1.1
%
4.7
%
600 - 659
2.1

5.5

1.7

14.4

660 - 719
10.5

17.3

9.5

34.4

720 - 779
25.6

26.8

21.4

26.0

780 and over
60.5

47.1

66.3

20.5

Total
100.0
%
100.0
%
100.0
%
100.0
%



14
Table of Contents

Troubled debt restructurings
As mentioned previously, the Company's impaired loans include loans which have been classified as troubled debt restructurings, as shown in the table below. 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. Commercial performing restructured loans are primarily comprised of certain business, construction and business real estate loans classified as substandard, but renewed at rates judged to be non market. These 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 and other small consumer loans under various debt management and assistance programs. Modifications to these loans generally involve removing the available line of credit, placing loans on amortizing status, and lowering the contractual interest rate. The Company also classified as consumer bankruptcy certain personal real estate, revolving home equity, and consumer loans as troubled debt restructurings because they were not reaffirmed by the borrower in bankruptcy proceedings. Interest on these loans is being recognized on an accrual basis, as the borrowers are continuing to make payments. Other consumer loans classified as troubled debt restructurings consist of various other workout arrangements with consumer customers.
(In thousands)
September 30, 2018
December 31, 2017
Accruing restructured loans:
 
 
 
Commercial
$
85,232

$
88,588

 
Assistance programs
7,386

6,941

 
Consumer bankruptcy
4,327

3,916

 
Other consumer
3,446

3,367

Non-accrual loans
5,831

7,796

Total troubled debt restructurings
$
106,222

$
110,608


The table below shows the balance of troubled debt restructurings by loan classification at September 30, 2018, 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, 2018
Balance 90 days past due at any time during previous 12 months
Commercial:
 
 
Business
$
79,963

$
28

Real estate - construction and land
408

—

Real estate - business
9,045

—

Personal Banking:
 
 
Real estate - personal
4,342

292

Consumer
5,309

89

Revolving home equity
68

—

Consumer credit card
7,087

591

Total troubled debt restructurings
$
106,222

$
1,000


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 loans under various debt management and assistance programs were estimated to decrease interest income by approximately $792 thousand on an annual, pre-tax basis, compared to amounts contractually owed. Other modifications to consumer loans mainly involve extensions and other small modifications that did not include the forgiveness of principal or interest.

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

15
Table of Contents

restructurings. Those performing loans classified as troubled debt restructurings are accruing loans which management expects to collect under contractual terms. Performing commercial loans having no other concessions granted other than being renewed at non-market interest rates are judged to 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 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 $7.7 million at September 30, 2018 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, 2018, the fair value of these loans was $10.3 million, and the unpaid principal balance was $10.0 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, 2018 totaled $6.6 million.

At September 30, 2018, 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 $1.2 million and $681 thousand at September 30, 2018 and December 31, 2017, respectively. Personal property acquired in repossession, generally autos and marine and recreational vehicles, totaled $2.3 million and $2.7 million at September 30, 2018 and December 31, 2017, 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 as shown in this report reflect revised categories as required by the Company’s adoption of ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities”, on January 1, 2018. That new guidance refined the definition of equity securities and required their segregation from available for sale debt securities. For comparability purposes, prior period disclosures in this report have been revised to show the new categorization.
 
(In thousands)
September 30, 2018
December 31, 2017
Available for sale debt securities
$
8,674,986

$
8,725,442

Trading debt securities
19,676

18,269

Equity securities:
 
 
   Readily determinable fair value
2,765

48,838

   No readily determinable fair value
1,702

1,753

Other:


 
   Federal Reserve Bank stock
33,498

33,253

   Federal Home Loan Bank stock
10,000

10,000

   Private equity investments
83,622

55,752

Total investment securities
$
8,826,249

$
8,893,307



16
Table of Contents

While changes in the fair value of available for sale debt securities continue to be recorded in the equity category of accumulated other comprehensive income, the new guidance requires changes in the fair value of equity securities to be recorded in current earnings. As required by the new guidance, the unrealized gain in fair value on equity securities (recorded in accumulated other comprehensive income at December 31, 2017) was reclassified to retained earnings on January 1, 2018. The amount of the reclassification was $33.3 million, net of tax.
Equity securities include common and preferred stock with readily determinable fair values that totaled $2.5 million at cost and $2.8 million at fair value at September 30, 2018. The decline in these balances from prior periods was due to a third party merger transaction in June 2018, in which the majority of these securities were redeemed for cash of $39.9 million. During the first nine months of 2018, unrealized net losses of $151 thousand were recognized in current earnings on equity securities still held at September 30, 2018.
Equity securities also include securities with a carrying value of $1.7 million that do not have readily determinable fair values. The Company has elected, under the ASU, to measure these at cost minus impairment, if any, plus or minus changes resulting from observable price changes for the identical or similar investment of the same issuer. The Company did not record any impairment or other adjustments to the carrying amount of these investments during the period.
Other investment securities whose accounting is not addressed in the ASU include Federal Reserve Bank (FRB) stock, Federal Home Loan Bank (FHLB) stock, and investments in portfolio concerns held by the Company's private equity subsidiaries. FRB stock and FHLB stock are held for debt and regulatory purposes. Investment in FRB 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. The private equity investments, in the absence of readily ascertainable market values, are carried at estimated fair value.
The majority of the Company’s investment portfolio is comprised of available for sale debt securities, which are carried at fair value with changes in fair value reported in accumulated other comprehensive income (AOCI). A summary of the available for sale debt securities by maturity groupings as of September 30, 2018 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.

17
Table of Contents

(In thousands)
Amortized Cost
Fair Value
U.S. government and federal agency obligations:
 
 
Within 1 year
$
23,624

$
23,532

After 1 but within 5 years
646,024

632,363

After 5 but within 10 years
183,500

177,790

After 10 years
69,283

67,430

Total U.S. government and federal agency obligations
922,431

901,115

Government-sponsored enterprise obligations:
 
 
Within 1 year
28,635

28,607

After 1 but within 5 years
121,588

119,494

After 5 but within 10 years
34,985

33,587

After 10 years
42,872

39,428

Total government-sponsored enterprise obligations
228,080

221,116

State and municipal obligations:
 
 
Within 1 year
124,946

125,248

After 1 but within 5 years
642,000

640,269

After 5 but within 10 years
551,184

545,707

After 10 years
79,516

77,674

Total state and municipal obligations
1,397,646

1,388,898

Mortgage and asset-backed securities:
 
 
  Agency mortgage-backed securities
3,351,134

3,266,524

  Non-agency mortgage-backed securities
1,103,357

1,091,382

  Asset-backed securities
1,489,750

1,475,425

Total mortgage and asset-backed securities
5,944,241

5,833,331

Other debt securities:
 
 
Within 1 year
9,002

8,984

After 1 but within 5 years
257,635

251,880

After 5 but within 10 years
73,254

69,662

Total other debt securities
339,891

330,526

Total available for sale debt securities
$
8,832,289

$
8,674,986


Investments in U.S. government and federal agency obligations include U.S. Treasury inflation-protected securities, which totaled $436.2 million, at fair value, at September 30, 2018. 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 $14.7 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.


18
Table of Contents

For debt securities classified as available for sale, the following table shows the unrealized gains and losses (pre-tax) in AOCI, by security type.
 
 
(In thousands)
Amortized Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
September 30, 2018
 
 
 
 
U.S. government and federal agency obligations
$
922,431

$
41

$
(21,357
)
$
901,115

Government-sponsored enterprise obligations
228,080

—

(6,964
)
221,116

State and municipal obligations
1,397,646

3,541

(12,289
)
1,388,898

Mortgage and asset-backed securities:
 
 
 
 
  Agency mortgage-backed securities
3,351,134

3,875

(88,485
)
3,266,524

  Non-agency mortgage-backed securities
1,103,357

6,236

(18,211
)
1,091,382

  Asset-backed securities
1,489,750

2,174

(16,499
)
1,475,425

Total mortgage and asset-backed securities
5,944,241

12,285

(123,195
)
5,833,331

Other debt securities
339,891

—

(9,365
)
330,526

Total
$
8,832,289

$
15,867

$
(173,170
)
$
8,674,986

December 31, 2017
 
 
 
 
U.S. government and federal agency obligations
$
917,494

$
4,096

$
(4,443
)
$
917,147

Government-sponsored enterprise obligations
408,266

26

(1,929
)
406,363

State and municipal obligations
1,592,707

21,413

(2,754
)
1,611,366

Mortgage and asset-backed securities:
 
 
 
 
  Agency mortgage-backed securities
3,046,701

17,956

(23,744
)
3,040,913

  Non-agency mortgage-backed securities
903,920

6,710

(4,837
)
905,793

  Asset-backed securities
1,495,380

2,657

(5,237
)
1,492,800

Total mortgage and asset-backed securities
5,446,001

27,323

(33,818
)
5,439,506

Other debt securities
350,988

1,250

(1,178
)
351,060

Total
$
8,715,456

$
54,108

$
(44,122
)
$
8,725,442


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 who 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, 2018, the fair value of securities on this watch list was $53.5 million compared to $68.0 million at December 31, 2017.

As of September 30, 2018, 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 $20.4 million. The cumulative credit-related portion of the impairment on these securities, which was recorded in earnings, totaled $14.1 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, 2018 included the following:

Significant Inputs
Range
Prepayment CPR
0%
-
25%
Projected cumulative default
12%
-
51%
Credit support
0%
-
20%
Loss severity
14%
-
63%


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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)
2018
2017
Cumulative OTTI credit losses at January 1
$
14,199

$
14,080

Credit losses on debt securities for which impairment was not previously recognized
58

98

Credit losses on debt securities for which impairment was previously recognized
10

274

Increase in expected cash flows that are recognized over remaining life of security
(138
)
(207
)
Cumulative OTTI credit losses at September 30
$
14,129

$
14,245


Debt securities with unrealized losses recorded in AOCI 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, 2018
 
 
 
 
 
 
 
 
U.S. government and federal agency obligations
$
572,747

$
12,285

 
$
270,313

$
9,072

 
$
843,060

$
21,357

Government-sponsored enterprise obligations
139,520

3,909

 
81,596

3,055

 
221,116

6,964

State and municipal obligations
715,673

7,472

 
130,190

4,817

 
845,863

12,289

Mortgage and asset-backed securities:
 
 
 
 
 
 
 
 
   Agency mortgage-backed securities
1,958,646

42,485

 
1,039,348

46,000

 
2,997,994

88,485

   Non-agency mortgage-backed securities
680,691

9,372

 
374,601

8,839

 
1,055,292

18,211

   Asset-backed securities
735,808

9,758

 
422,531

6,741

 
1,158,339

16,499

Total mortgage and asset-backed securities
3,375,145

61,615

 
1,836,480

61,580

 
5,211,625

123,195

Other debt securities
258,019

5,813

 
72,507

3,552

 
330,526

9,365

Total
$
5,061,104

$
91,094

 
$
2,391,086

$
82,076

 
$
7,452,190

$
173,170

December 31, 2017
 
 
 
 
 
 
 
 
U.S. government and federal agency obligations
$
618,617

$
4,443

 
$
—

$
—

 
$
618,617

$
4,443

Government-sponsored enterprise obligations
286,393

1,712

 
49,766

217

 
336,159

1,929

State and municipal obligations
282,843

1,752

 
49,339

1,002

 
332,182

2,754

Mortgage and asset-backed securities:
 
 
 
 
 
 
 
 
   Agency mortgage-backed securities
1,320,689

9,433

 
619,300

14,311

 
1,939,989

23,744

   Non-agency mortgage-backed securities
577,017

2,966

 
153,813

1,871

 
730,830

4,837

   Asset-backed securities
786,048

3,168

 
264,295

2,069

 
1,050,343

5,237

Total mortgage and asset-backed securities
2,683,754

15,567

 
1,037,408

18,251

 
3,721,162

33,818

Other debt securities
144,090

727

 
20,202

451

 
164,292

1,178

Total
$
4,015,697

$
24,201

 
$
1,156,715

$
19,921

 
$
5,172,412

$
44,122


The available for sale debt portfolio included $7.5 billion of securities that were in a loss position at September 30, 2018, compared to $5.2 billion at December 31, 2017.  The total amount of unrealized loss on these securities was $173.2 million at September 30, 2018, an increase of $129.0 million compared to the loss at December 31, 2017.  This increase in losses was mainly due to a rising interest rate environment. 

    

20
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)
2018
2017
Proceeds from sales of securities:
 
 
Available for sale debt securities
$
153,066

$
367,453

Equity securities
39,981

—

Other
—

1,583

Total proceeds
$
193,047

$
369,036

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

$
(254
)
Gains realized on sales
430

592

Losses realized on sales
—

(568
)
Other-than-temporary impairment recognized on debt securities
(68
)
(372
)
Equity securities:
 
 
Gains realized on donations of securities
—

6,707

Gains realized on sales
102

—

 Losses realized on sales
(8,917
)
—

 Fair value adjustments, net
2,723

—

Other:
 
 
 Gains realized on sales
—

645

 Losses realized on sales
—

(880
)
Fair value adjustments, net
12,371

(8,028
)
Total investment securities gains, net
$
6,641

$
(2,158
)

Securities gains for the nine months ended September 30, 2018 included gains in fair value of $12.4 million on private equity investments and $2.7 million on equity securities. These were offset by an $8.9 million adjustment to recognize dividend income on an equity security liquidated during the second quarter of 2018.

At September 30, 2018, securities totaling $3.9 billion in fair value were pledged to secure public fund deposits, securities sold under agreements to repurchase, trust funds, and borrowings at the FRB and FHLB. Securities pledged under agreements pursuant to which the collateral may be sold or re-pledged by the secured parties approximated $553.2 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.

21
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, 2018
 
December 31, 2017
 
 
(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

$
(28,808
)
$
—

$
2,462

 
$
31,270

$
(28,305
)
$
—

$
2,965

Mortgage servicing rights
9,701

(3,693
)
—

6,008

 
7,906

(3,244
)
(9
)
4,653

Total
$
40,971

$
(32,501
)
$
—

$
8,470

 
$
39,176

$
(31,549
)
$
(9
)
$
7,618


Aggregate amortization expense on intangible assets was $318 thousand and $338 thousand for the three month periods ended September 30, 2018 and 2017, respectively, and $952 thousand and $1.0 million for the nine month periods ended September 30, 2018 and 2017, 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, 2018. 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)
 
2018
$
1,260

2019
1,166

2020
1,003

2021
877

2022
776


Changes in the carrying amount of goodwill and net other intangible assets for the nine month period ended September 30, 2018 are as follows:
(In thousands)
Goodwill
Core Deposit Premium
Mortgage Servicing Rights
Balance January 1, 2018
$
138,921

$
2,965

$
4,653

Originations
—

—

1,795

Amortization
—

(503
)
(449
)
Impairment reversal
—

—

9

Balance September 30, 2018
$
138,921

$
2,462

$
6,008


Goodwill allocated to the Company’s operating segments at September 30, 2018 and December 31, 2017 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.

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, 2018, that net liability was $2.0 million, which will be accreted into income over the remaining life of the respective

22
Table of Contents

commitments. The contractual amount of these letters of credit, which represents the maximum potential future payments guaranteed by the Company, was $347.8 million at September 30, 2018.

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, 2018, 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 2 to 11 years. At September 30, 2018, the fair value of the Company's guarantee liabilities for RPAs was $58 thousand, and the notional amount of the underlying swaps was $104.9 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)
2018
2017
 
2018
2017
Service cost - benefits earned during the period
$
127

$
193

 
$
432

$
450

Interest cost on projected benefit obligation
916

923

 
2,817

2,869

Expected return on plan assets
(1,067
)
(1,463
)
 
(3,942
)
(4,339
)
Amortization of prior service cost
(68
)
(67
)
 
(203
)
(203
)
Amortization of unrecognized net loss
592

630

 
1,776

1,864

Net periodic pension cost
$
500

$
216

 
$
880

$
641


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 2018, the Company made no funding contributions to its defined benefit pension plan and made minimal funding contributions to a supplemental executive retirement plan (the CERP), which carries no segregated assets.

The Company adopted ASU 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost”, on January 1, 2018. This guidance requires that the service cost component of net periodic pension cost be reported in the same income statement line item as other compensation costs, while other components of net periodic pension cost be reported separately from the service cost component. Historically, the Company has reported all components of pension cost in salaries and employee benefits. Beginning in 2018, only the service cost component has been included in this category, and the other components have been recorded in other non-interest expense. Prior period financial statements have not been revised because the amount of the reclassification was not significant.


23
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)
2018
2017
 
2018
2017
Basic income per common share:
 
 
 
 
 
Net income attributable to Commerce Bancshares, Inc.
$
112,576

$
74,564

 
$
323,890

$
225,028

Less preferred stock dividends
2,250

2,250

 
6,750

6,750

Net income available to common shareholders
110,326

72,314

 
317,140

218,278

Less income allocated to nonvested restricted stock
1,161

862

 
3,421

2,750

  Net income allocated to common stock
$
109,165

$
71,452

 
$
313,719

$
215,528

Weighted average common shares outstanding
105,608

105,628

 
105,643

105,534

   Basic income per common share
$
1.03

$
.68

 
$
2.97

$
2.04

Diluted income per common share:
 
 
 
 
 
Net income available to common shareholders
$
110,326

$
72,314

 
$
317,140

$
218,278

Less income allocated to nonvested restricted stock
1,159

860

 
3,413

2,743

  Net income allocated to common stock
$
109,167

$
71,454

 
$
313,727

$
215,535

Weighted average common shares outstanding
105,609

105,628

 
105,643

105,534

  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
353

353

 
343

377

  Weighted average diluted common shares outstanding
105,962

105,981

 
105,986

105,911

    Diluted income per common share
$
1.03

$
.67

 
$
2.96

$
2.03


Unexercised stock appreciation rights of 212 thousand and 146 thousand were excluded in the computation of diluted income per common share for the nine month periods ended September 30, 2018 and 2017, 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 2017.
  

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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 debt 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. Another 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. The remaining component is gains and losses in fair value on a certain interest rate floor that has been designated as a cash flow hedging instrument.
 
Unrealized Gains (Losses) on Securities (1)
Pension Loss
Unrealized Gains (Losses) on Cash Flow Hedge Derivatives (2)
Total Accumulated Other Comprehensive Income (Loss)
(In thousands)
OTTI
Other
Balance January 1, 2018
$
3,411

$
30,326

$
(19,629
)
$
—

$
14,108

ASU 2018-02 Reclassification of tax rate change
715

6,359

(4,142
)
—

2,932

ASU 2016-01 Reclassification of unrealized gain on equity securities
—

(33,320
)
—

—

(33,320
)
Other comprehensive loss before reclassifications to current earnings
(102
)
(166,824
)
—

(1,625
)
(168,551
)
Amounts reclassified to current earnings from accumulated other comprehensive income
68

(431
)
1,573

253

1,463

 Current period other comprehensive income (loss), before tax
(34
)
(167,255
)
1,573

(1,372
)
(167,088
)
Income tax (expense) benefit
9

41,813

(393
)
343

41,772

 Current period other comprehensive income (loss), net of tax
(25
)
(125,442
)
1,180

(1,029
)
(125,316
)
Transfer of unrealized gain on securities for which impairment was not previously recognized
12

(12
)
—

—

—

Balance September 30, 2018
$
4,113

$
(122,089
)
$
(22,591
)
$
(1,029
)
$
(141,596
)
Balance January 1, 2017
$
2,975

$
27,328

$
(19,328
)
$
—

$
10,975

Other comprehensive income before reclassifications to current earnings
365

94,794

—

—

95,159

Amounts reclassified to current earnings 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

(1) The pre-tax amounts reclassified from accumulated other comprehensive income to current earnings 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 to current earnings are included in "interest and fees on loans" in the consolidated statements of income.

The requirement to revalue deferred tax assets and liabilities in the period of enactment stranded the effects of the tax rate change, mandated by the Tax Cuts and Jobs Act, in accumulated other comprehensive income. In response, the FASB issued ASU 2018-02, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income”, which the Company adopted on January 1, 2018. This ASU allowed the reclassification of the stranded tax effects from accumulated other comprehensive income (as shown in the table above) to retained earnings.
As mentioned in Note 3, additional new accounting guidance, which was effective January 1, 2018, required the reclassification of unrealized gains on equity securities from accumulated other comprehensive income to retained earnings (also shown above).
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 170 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

25
Table of Contents

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.

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, 2018
 
 
 
 
 
 
Net interest income
$
74,933

$
87,947

$
11,704

$
174,584

$
33,170

$
207,754

Provision for loan losses
(9,734
)
(166
)
80

(9,820
)
(179
)
(9,999
)
Non-interest income
31,397

49,673

43,797

124,867

(1,153
)
123,714

Investment securities gains, net
—

—

—

—

4,306

4,306

Non-interest expense
(71,171
)
(73,696
)
(30,439
)
(175,306
)
(9,753
)
(185,059
)
Income before income taxes
$
25,425

$
63,758

$
25,142

$
114,325

$
26,391

$
140,716

Nine Months Ended September 30, 2018
 
 
 
 
 
 
Net interest income
$
219,841

$
255,763

$
35,006

$
510,610

$
100,995

$
611,605

Provision for loan losses
(30,658
)
322

32

(30,304
)
(134
)
(30,438
)
Non-interest income
93,729

150,535

128,794

373,058

(4,804
)
368,254

Investment securities gains, net
—

—

—

—

6,641

6,641

Non-interest expense
(213,437
)
(221,854
)
(92,552
)
(527,843
)
(21,353
)
(549,196
)
Income before income taxes
$
69,475

$
184,766

$
71,280

$
325,521

$
81,345

$
406,866

Three Months Ended September 30, 2017
 
 
 
 
 
 
Net interest income
$
70,793

$
82,081

$
11,737

$
164,611

$
17,980

$
182,591

Provision for loan losses
(11,067
)
335

(10
)
(10,742
)
38

(10,704
)
Non-interest income
31,633

46,141

40,403

118,177

(1,290
)
116,887

Investment securities losses, net
—

—

—

—

(3,037
)
(3,037
)
Non-interest expense
(69,149
)
(69,828
)
(30,565
)
(169,542
)
(9,675
)
(179,217
)
Income before income taxes
$
22,210

$
58,729

$
21,565

$
102,504

$
4,016

$
106,520

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

$
244,088

$
35,515

$
487,024

$
56,647

$
543,671

Provision for loan losses
(31,531
)
959

(9
)
(30,581
)
(2,009
)
(32,590
)
Non-interest income
88,413

137,139

116,961

342,513

(633
)
341,880

Investment securities losses, net
—

—

—

—

(2,158
)
(2,158
)
Non-interest expense
(204,940
)
(212,327
)
(90,378
)
(507,645
)
(27,839
)
(535,484
)
Income before income taxes
$
59,363

$
169,859

$
62,089

$
291,311

$
24,008

$
315,319


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.


26
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. At September 30, 2018, with the exception of the interest rate floor (discussed below), 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, 2018
December 31, 2017
Interest rate swaps
$
1,922,172

$
1,741,412

Interest rate floor
500,000

—

Interest rate caps
30,416

31,776

Credit risk participation agreements
158,764

133,488

Foreign exchange contracts
6,087

11,826

 Mortgage loan commitments
24,997

17,110

Mortgage loan forward sale contracts
2,720

2,566

Forward TBA contracts
27,000

25,000

Total notional amount
$
2,672,156

$
1,963,178


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 clearinghouse, which 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.

During the third quarter of 2018, the Company entered into an interest rate floor with a notional value of $500.0 million to hedge the risk of declining interest rates on certain floating rate commercial loans. The premium paid for this floor totaled $9.5 million and is forward starting beginning on January 1, 2020. The interest rate floor matures on January 1, 2026. The interest rate floor qualified and was designated as a cash flow hedge and was assessed for effectiveness using regression analysis. The change in the fair value of the interest rate floor is recorded in AOCI, net of the amortization of the premium paid for the interest rate floor, which is recorded against interest and fees on loans in the consolidated statements of income. As of September 30, 2018, net deferred losses on the interest rate floor totaled $1.4 million (pre-tax) and was recorded in AOCI in the consolidated balance sheet. As of September 30, 2018, over the next twelve months, it is expected that $1.3 million (pre-tax), representing the floor premium amortization, will be reclassified from AOCI into earnings.

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.


27
Table of Contents

The fair values of the Company's derivative instruments, whose notional amounts are listed above, are shown in the table below. Information about the valuation methods used to determine fair value is provided in Note 15 on Fair Value Measurements in the 2017 Annual Report on Form 10-K.

The Company's policy is to present its derivative assets and derivative liabilities on a gross basis in its consolidated balance sheets, and these are reported in other assets and other liabilities. However, in January 2017, a clearinghouse rule change required that variation margin on centrally cleared derivatives, formerly treated as collateral, be treated as settlements of derivative exposure. As a result, the fair values of the respective derivative contracts must be reduced by variation margin payments and reported as a single, net amount. Accordingly, at September 30, 2018 in the table below, the positive fair values of cleared swaps were reduced by $19.1 million and the negative fair values of cleared swaps were reduced by $687 thousand. At December 31, 2017, the positive fair values of cleared swaps were reduced by $4.5 million and the negative fair values of cleared swaps were reduced by $4.3 million.
 
Asset Derivatives
 
Liability Derivatives
 
Sept. 30, 2018
Dec. 31, 2017
 
Sept. 30, 2018
Dec. 31, 2017
(In thousands)    
  Fair Value
 
  Fair Value
Derivatives designated as hedging instruments:
 
 
 
 
 
   Interest rate floor
$
7,829

$
—

 
$
—

$
—

Total derivatives designated as hedging instruments
$
7,829

$
—

 
$
—

$
—

Derivative instruments:
 
 
 
 
 
   Interest rate swaps
$
4,476

$
7,674

 
$
(22,916
)
$
(7,857
)
   Interest rate caps
18

16

 
(18
)
(16
)
   Credit risk participation agreements
24

46

 
(58
)
(123
)
   Foreign exchange contracts
57

21

 
(14
)
(40
)
   Mortgage loan commitments
679

580

 
—

—

   Mortgage loan forward sale contracts
9

8

 
(2
)
(7
)
   Forward TBA contracts
111

4

 
(4
)
(31
)
Total derivatives not designated as hedging instruments
$
5,374

$
8,349

 
$
(23,012
)
$
(8,074
)
 Total
$
13,203

$
8,349

 
$
(23,012
)
$
(8,074
)

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Table of Contents


The pre-tax effects of derivative instruments on the consolidated statements of income are shown in the tables below.




Amount of Gain or (Loss) Recognized in OCI
Location of Gain (Loss) Reclassified from AOCI into Income
Amount of Gain (Loss) Reclassified from AOCI into Income


For the Three Months Ended September 30
For the Nine Months Ended September 30
 
For the Three Months Ended September 30
For the Nine Months Ended September 30
(In thousands)
2018
2018
 
2018
2018
Derivatives in cash flow hedging relationships:
 
 
 
 
 
Interest rate floor* (a)
$
(1,625
)
$
(1,625
)
Interest and fees on loans
$
(253
)
$
(253
)
Total
$
(1,625
)
$
(1,625
)
 
$
(253
)
$
(253
)
* No hedging relationship existed during 2017.
(a) Amounts shown herein were excluded from the assessment of effectiveness, as they represent the time value component of derivative gains (losses).




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)
 
2018
2017
 
2018
2017
Derivative instruments:
 
 
 
 
 
 
  Interest rate swaps
Other non-interest income
$
692

$
702

 
$
2,924

$
1,301

  Credit risk participation agreements
Other non-interest income
(7
)
7

 
173

18

  Foreign exchange contracts
Other non-interest income
(120
)
51

 
62

(24
)
  Mortgage loan commitments
Loan fees and sales
(50
)
(114
)
 
99

408

  Mortgage loan forward sale contracts
Loan fees and sales
—

8

 
6

70

  Forward TBA contracts
Loan fees and sales
113

(322
)
 
646

(580
)
Total
 
$
628

$
332

 
$
3,910

$
1,193


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.


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Table of Contents

Collateral exchanged between the Company and dealer bank counterparties is generally subject to thresholds and transfer minimums, and usually consists of marketable securities. By contract, these 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 or 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, 2018
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
Derivatives subject to master netting agreements
$
12,485

$
—

$
12,485

$
(580
)
$
(10,168
)
$
1,737

Derivatives not subject to master netting agreements
718

—

718

 
 
 
Total derivatives
13,203

—

13,203

 
 
 
Liabilities:
 
 
 
 
 
 
Derivatives subject to master netting agreements
$
22,943

$
—

$
22,943

$
(580
)
$
(220
)
$
22,143

Derivatives not subject to master netting agreements
69

—

69

 
 
 
Total derivatives
23,012

—

23,012

 
 
 
December 31, 2017
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
Derivatives subject to master netting agreements
$
7,726

$
—

$
7,726

$
(233
)
$
(824
)
$
6,669

Derivatives not subject to master netting agreements
623

—

623

 
 
 
Total derivatives
8,349

—

8,349

 
 
 
Liabilities:
 
 
 
 
 
 
Derivatives subject to master netting agreements
$
7,935

$
—

$
7,935

$
(233
)
$
(1,570
)
$
6,132

Derivatives not subject to master netting agreements
139

—

139

 
 
 
Total derivatives
8,074

—

8,074

 
 
 

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.


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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 $550.0 million at September 30, 2018 and $650.0 million at December 31, 2017. At September 30, 2018, the Company had posted collateral of $553.2 million in marketable securities, consisting of agency mortgage-backed bonds and treasuries, and had accepted $557.4 million in investment grade asset-backed, commercial mortgage-backed, and corporate bonds.
 
 
 
 
Gross Amounts Not Offset in the Balance Sheet
 
(In thousands)
Gross Amount Recognized
Gross Amounts Offset in the Balance Sheet
Net Amounts Presented in the Balance Sheet
Financial Instruments Available for Offset
Securities Collateral Received/Pledged
Net Amount
September 30, 2018
 
 
 
 
 
 
Total resale agreements, subject to master netting arrangements
$
1,250,000

$
(550,000
)
$
700,000

$
—

$
(696,541
)
$
3,459

Total repurchase agreements, subject to master netting arrangements
2,053,177

(550,000
)
1,503,177

—

(1,503,177
)
—

December 31, 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
1,954,768

(650,000
)
1,304,768

—

(1,304,768
)
—


The table below shows the remaining contractual maturities of repurchase agreements outstanding at September 30, 2018 and December 31, 2017, 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, 2018
 
 
 
 
Repurchase agreements, secured by:
 
 
 
 
  U.S. government and federal agency obligations
$
324,533

$
101,720

$
250,000

$
676,253

  Government-sponsored enterprise obligations
31,753

—

—

31,753

  Agency mortgage-backed securities
541,023

22,950

207,250

771,223

  Non-agency mortgage-backed securities
173,495

—

—

173,495

  Asset-backed securities
217,719

85,000

—

302,719

  Other debt securities
97,734

—

—

97,734

   Total repurchase agreements, gross amount recognized
$
1,386,257

$
209,670

$
457,250

$
2,053,177

December 31, 2017
 
 
 
 
Repurchase agreements, secured by:
 
 
 
 
  U.S. government and federal agency obligations
$
271,820

$
1,731

$
450,000

$
723,551

  Government-sponsored enterprise obligations
149,111

—

—

149,111

  Agency mortgage-backed securities
737,975

9,750

200,000

947,725

  Asset-backed securities
89,601

30,000

—

119,601

  Other debt securities
14,780

—

—

14,780

   Total repurchase agreements, gross amount recognized
$
1,263,287

$
41,481

$
650,000

$
1,954,768



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Table of Contents

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 $3.2 million and $3.0 million in the three months ended September 30, 2018 and 2017, respectively, and $9.6 million and $9.1 million in the nine months ended September 30, 2018 and 2017, respectively.

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, 2018, and changes during the nine month period then ended, is presented below.
 
 
 

Shares
 Weighted Average Grant Date Fair Value
Nonvested at January 1, 2018
1,254,518

$38.67
Granted
246,778

60.08
Vested
(348,940
)
32.32
Forfeited
(23,772
)
46.35
Nonvested at September 30, 2018
1,128,584

$45.15

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

$12.44

Assumptions:
 
Dividend yield
1.6
%
Volatility
20.6
%
Risk-free interest rate
2.7
%
Expected term
6.6 years


A summary of SAR activity during the first nine months of 2018 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, 2018
1,179,286

$37.13
 
 
Granted
168,716

58.42
 
 
Forfeited
(13,884
)
48.09

 
 
Expired
(516
)
44.16

 
 
Exercised
(308,680
)
31.35
 
 
Outstanding at September 30, 2018
1,024,922

$42.23
7.0 years
$
24,387


13. Revenue from Contracts with Customers
The Company adopted ASU 2014-09, "Revenue from Contracts with Customers", and its related amendments on January 1, 2018. The core principle of the new guidance is that an entity should recognize revenue to reflect 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. For the nine months ended September 30, 2018, approximately 62% of the Company’s total revenue was comprised of net interest income, which is not within the scope of this guidance. Of the remaining revenue, those items that were subject to this guidance mainly included fees for bank card, trust, deposit account services and consumer brokerage services.

The Company has concluded that the new guidance did not require any significant change to its revenue recognition processes. However, application of the new guidance resulted in a reclassification of certain bank card related network and rewards costs, previously classified as non-interest expense, to a reduction to non-interest income in the Company’s consolidated statements of

32
Table of Contents

income. The reclassification had no effect on prior period net income or net income per share. The Company adopted ASU 2014-09 on a full retrospective basis, in which each prior reporting period has been presented in accordance with the new guidance.

The table below shows the effect of this reclassification on bank card fee income and non-interest expense for the three and nine months ended September 30, 2017.
 
 
Three Months Ended September 30, 2017
 
Nine Months Ended September 30, 2017
(In thousands)
 
As Previously Reported
Adoption of ASU 2014-09
As Adjusted
 
As Previously Reported
Adoption of ASU 2014-09
As Adjusted
Non-interest income:
 
 
 
 
 
 
 
 
Bank card transaction fees
 
$
44,521

$
(5,355
)
$
39,166

 
$
132,724

$
(20,512
)
$
112,212

 Total non-interest income
 
122,242

(5,355
)
116,887

 
362,392

(20,512
)
341,880

Non-interest expense:
 
 
 
 
 
 
 
 
Data processing and software
 
$
22,700

$
(2,732
)
$
19,968

 
$
69,153

$
(9,245
)
$
59,908

Other
 
17,862

(2,623
)
15,239

 
57,587

(11,267
)
46,320

 Total non-interest expense
 
184,572

(5,355
)
179,217

 
555,996

(20,512
)
535,484


The following table disaggregates non-interest income subject to ASU 2014-09 by major product line.
 
Three Months Ended September 30
 
Nine Months Ended September 30
(In thousands)
2018
2017
 
2018
2017
Bank card transaction fees
$
42,427

$
39,166

 
$
127,095

$
112,212

Trust fees
37,400

34,620

 
110,498

99,754

Deposit account charges and other fees
23,755

22,659

 
70,630

67,462

Consumer brokerage services
3,884

3,679

 
11,623

11,054

Other non-interest income
6,977

7,456

 
21,140

23,622

Total non-interest income from contracts with customers
114,443

107,580

 
340,986

314,104

Other non-interest income (a)
9,271

9,307

 
27,268

27,776

Total non-interest income
$
123,714

$
116,887

 
$
368,254

$
341,880

(a) This revenue is not within the scope of ASU 2014-09, and includes fees relating to capital market activities, loan fees and sales, derivative instruments, standby letters of credit and various other transactions.

The following table presents the opening and closing receivable balances for the nine month periods ended September 30, 2018 and 2017 for the Company’s significant revenue categories subject to ASU 2014-09.
(In thousands)
September 30, 2018
December 31, 2017
 
September 30, 2017
December 31, 2016
Bank card transaction fees
$
10,591

$
13,315

 
$
10,296

$
14,686

Trust fees
2,533

2,802

 
2,680

2,681

Deposit account charges and other fees
5,176

5,597

 
4,972

5,735

Consumer brokerage services
521

380

 
390

309


For these revenue categories, none of the transaction price has been allocated to performance obligations that are unsatisfied as of the end of a reporting period.

A description of these revenue categories follows.


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Table of Contents

Bank Card Transaction Fees
The following table presents the components of bank card fee income.
 
Three Months Ended September 30
 
Nine Months Ended September 30
(In thousands)
2018
2017
 
2018
2017
Debit card:
 
 
 
 
 
Fee income
$
10,396

$
9,986

 
$
30,740

$
29,952

Expense for network charges
(479
)
(752
)
 
(1,225
)
(4,323
)
Net debit card fees
9,917

9,234

 
29,515

25,629

 
 
 
 
 
 
Credit card:
 
 
 
 
 
Fee income
6,826

6,371

 
19,671

18,594

Expense for network charges and rewards
(4,246
)
(2,811
)
 
(10,494
)
(8,480
)
Net credit card fees
2,580

3,560

 
9,177

10,114

 
 
 
 
 
 
Corporate card:
 
 
 
 
 
Fee income
50,187

45,413

 
147,204

131,093

Expense for network charges and rewards
(25,437
)
(23,843
)
 
(73,666
)
(69,663
)
Net corporate card fees
24,750

21,570

 
73,538

61,430

 
 
 
 
 
 
Merchant:
 
 
 
 
 
Fee income
7,553

7,558

 
22,460

23,847

Fees to cardholder banks
(1,819
)
(1,985
)
 
(5,422
)
(6,154
)
Expense for network charges
(554
)
(771
)
 
(2,173
)
(2,654
)
Net merchant fees
5,180

4,802

 
14,865

15,039

Total bank card transaction fees
$
42,427

$
39,166

 
$
127,095

$
112,212


The majority of debit and credit card fees are reported in the Consumer segment, while corporate card and merchant fees are reported in the Commercial segment.

Debit and Credit Card Fees
The Company issues debit and credit cards to its retail and commercial banking customers who use the cards to purchase goods and services from merchants through an electronic payment system. As a card issuer, the Company earns fees, including interchange income, for processing the cardholder’s purchase transaction with a merchant through a settlement network. Purchases are charged directly to a customer’s checking account (in the case of a debit card), or are posted to a customer’s credit card account. The fees earned are established by the settlement network and are dependent on the type of transaction processed but are typically based on a per unit charge. Interchange income, the largest component of debit and credit card fees, is settled daily through the networks. The services provided to the cardholders include issuing and maintaining cards, settling purchases with merchants, and maintaining memberships in various card networks to facilitate processing. These services are considered one performance obligation, as one of the services would not be performed without the others. The performance obligation is satisfied as services are rendered for each purchase transaction, and income is immediately recognized.

In order to participate in the settlement network process, the Company must pay various transaction-related costs, established by the networks, including membership fees and a per unit charge for each transaction. These expenses are recorded net of the card fees earned.

Consumer credit card products offer cardholders rewards that can be later redeemed for cash or goods or services to encourage card usage. Reward programs must meet network requirements based on the type of card issued. The expense associated with the rewards granted are recorded net of the credit card fees earned.

Commercial card products offer cash rewards to corporate cardholders to encourage card usage in facilitating corporate payments. The Company pays cash rewards based on contractually agreed upon amounts, normally as a percent of each sales transaction. The expense associated with the cash rewards program is recorded net of the corporate card fees earned.


34
Table of Contents

Merchant Fees
The Company offers merchant processing services to its business customers to enable them to accept credit and debit card payments. Merchant processing activities include gathering merchant sales information, authorizing sales transactions and collecting the funds from card issuers using the networks. The merchant is charged a merchant discount fee for the services based on agreed upon pricing between the merchant and the Company. Merchant fees are recorded net of outgoing interchange costs paid to the card issuing banks and net of other network costs as show in the table above.

Merchant services provided are considered one performance obligation, as one of the services would not be performed without the others. The performance obligation is satisfied as services are rendered for each settlement transaction and income is immediately recognized. Income earned from merchant fees settles with the customer according to terms negotiated in individual customer contracts.  The majority of customers settle with the Company at least monthly. 

Trust Fees
The following table shows the components of revenue within trust fees.
 
Three Months Ended September 30
 
Nine Months Ended September 30
(In thousands)
2018
2017
 
2018
2017
Private client
$
28,210

$
25,689

 
$
83,065

$
74,152

Institutional
7,388

7,027

 
22,070

20,272

Other
1,802

1,904

 
5,363

5,330

Total trust fees
$
37,400

$
34,620

 
$
110,498

$
99,754

This revenue is reported in the Wealth segment.

The Company provides trust and asset management services to both private client and institutional trust customers including asset custody, investment advice, and reporting and administrative services. Other specialized services such as tax preparation, financial planning, representation and other related services are provided as needed. Trust fees are generally earned monthly and billed based on a rate multiplied by the fair value of the customer trust assets. The majority of customer trust accounts are billed monthly. However, some accounts are billed quarterly, and a small number of accounts are billed semi-annually or annually, in accordance with agreements in place with the customer. The Company accrues trust fees monthly based on an estimate of fees due and either directly charges the customer’s account the following month or invoices the customer for fees due.

The Company maintains written product pricing information which is used to bill each trust customer based on the services provided. Providing trust services is considered to be a single performance obligation that is satisfied on a monthly basis, involving the monthly custody of customer assets, statement rendering, periodic investment advice where applicable, and other specialized services as needed. As such, performance obligations are considered to be satisfied at the conclusion of each month while trust fee income is also recorded monthly.

Deposit Account Charges and Other Fees
The following table shows the components of revenue within deposit account charges and other fees.
 
Three Months Ended September 30
 
Nine Months Ended September 30
(In thousands)
2018
2017
 
2018
2017
Corporate cash management fees
$
9,482

$
8,862

 
$
28,974

$
27,250

Overdraft and return item fees
8,081

7,887

 
23,249

22,515

Other service charges on deposit accounts
6,192

5,910

 
18,407

17,697

Total deposit account charges and other fees
$
23,755

$
22,659

 
$
70,630

$
67,462

Approximately half of this revenue is reported in the Consumer segment, while the remainder is reported in the Commercial segment.        

The Company provides corporate cash management services to its business and non-profit customers to meet their various transaction processing needs. Such services include deposit and check processing, lockbox, remote deposit, reconciliation, on-line banking and other similar transaction processing services. The Company maintains unit prices for each type of service, and the customer is billed based on transaction volumes processed monthly. The customer is usually billed either monthly or quarterly,

35
Table of Contents

however, some customers may be billed semi-annually or annually. The customer may pay for the cash management services provided either by paying in cash or using the value of deposit balances (formula provided to the customer) held at the Company. The Company’s performance obligation for corporate cash management services is the processing of items over a monthly term, and the obligations are satisfied at the conclusion of each month.

Overdraft fees are charged to customers when daily checks and other withdrawals to customers’ accounts exceed balances on hand. Fees are based on a unit price multiplied by the number of items processed whose total amounts exceed the available account balance. The daily overdraft charge is calculated and the fee is posted to the customer’s account each day. The Company’s performance obligations for overdraft transactions is based on the daily transaction processed and the obligation is satisfied as each day’s transaction processing is concluded.

Other deposit fees include numerous smaller fees such as monthly statement fees, foreign ATM processing fees, identification restoration fees, and stop payment fees. Such fees are mostly billed to customers directly on their monthly deposit account statements, or in the case of ATM fees, the fee is charged to the customer on the day that transactions are processed. Performance obligations for all of these various services are satisfied at the time that the service is rendered.

Consumer Brokerage Services
The following shows the components of revenue within consumer brokerage services.
 
Three Months Ended September 30
 
Nine Months Ended September 30
(In thousands)
2018
2017
 
2018
2017
Commission income
$
2,147

$
2,064

 
$
6,508

$
6,487

Managed account services
1,737

1,615

 
5,115

4,567

Total consumer brokerage services
$
3,884

$
3,679

 
$
11,623

$
11,054

Nearly all of this revenue is reported in the Company's Wealth segment.    

Consumer brokerage services revenue is comprised of commissions received upon the execution of purchases and sales of mutual fund shares and equity securities, in addition to sales of annuities and certain limited insurance products in an agency capacity. Also, fees are earned on professionally managed advisory programs through arrangements with sub-advisors. Payment from the customer is due upon settlement date for purchases and sales of securities, at the purchase date for annuities and insurance products, and upon inception of the service period for advisory programs.        

Most of the contracts (except advisory contracts) encompass two types of performance obligations. The first is an obligation to provide account maintenance, record keeping and custodial services throughout the contract term. The second is the obligation to provide trade execution services for the customers' purchases and sales of products mentioned above. The first obligation is satisfied over time as the service period elapses, while the second type of obligation is satisfied upon the execution of each purchase/sale transaction. Contracts for advisory services contain a single performance obligation comprised of providing the management services and related reporting/administrative services over the contract term.

The transaction price of the contracts (except advisory contracts) is a commission charged at the time of trade execution. The commission varies across different security types, insurance products and mutual funds. It is generally determined by standardized price lists published by the Company and its mutual fund and insurance vendors. Because the transaction price relates specifically to the trade execution, it has been allocated to that performance obligation and is recorded at the time of execution. The fee for advisory services is charged to the customer in advance of the quarterly service period, based on the account balance at the beginning of the period. Revenue is recognized ratably over the service period.

Other Non-Interest Income from Contracts with Customers
Other non-interest income consists mainly of various customer deposit related fees such as ATM fees and gains on sales of tax credits, foreclosed assets, and bank premises and equipment. Performance obligations for these services consist mainly of the execution of transactions for sales of various properties or providing specific deposit related transactions. Fees from these revenue sources are recognized when the performance obligation is completed, at which time cash is received by the Company.





36
Table of Contents

14. 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 debt securities, equity securities, trading debt securities, certain investments 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 2017 Annual Report on Form 10-K. There have been no significant changes in these methodologies since then.


37
Table of Contents

Instruments Measured at Fair Value on a Recurring Basis

The table below presents the September 30, 2018 and December 31, 2017 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 2018 or the year ended December 31, 2017.
 
 
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, 2018
 
 
 
 
Assets:
 
 
 
 
  Residential mortgage loans held for sale
$
10,256

$
—

$
10,256

$
—

  Available for sale debt securities:
 
 
 
 
     U.S. government and federal agency obligations
901,115

901,115

—

—

     Government-sponsored enterprise obligations
221,116

—

221,116

—

     State and municipal obligations
1,388,898

—

1,374,169

14,729

     Agency mortgage-backed securities
3,266,524

—

3,266,524

—

     Non-agency mortgage-backed securities
1,091,382

—

1,091,382

—

     Asset-backed securities
1,475,425

—

1,475,425

—

     Other debt securities
330,526

—

330,526

—

  Trading debt securities
19,676

—

19,676

—

  Equity securities
2,765

2,765

—

—

  Private equity investments
83,622

—

—

83,622

  Derivatives *
13,203

—

12,500

703

  Assets held in trust for deferred compensation plan
14,384

14,384

—

—

  Total assets
8,818,892

918,264

7,801,574

99,054

Liabilities:
 
 
 
 
  Derivatives *
23,012

—

22,954

58

Liabilities held in trust for deferred compensation plan
14,384

14,384

—

—

  Total liabilities
$
37,396

$
14,384

$
22,954

$
58

December 31, 2017
 
 
 
 
Assets:
 
 
 
 
  Residential mortgage loans held for sale
$
15,327

$
—

$
15,327

$
—

  Available for sale debt securities:
 
 
 
 
     U.S. government and federal agency obligations
917,147

917,147

—

—

     Government-sponsored enterprise obligations
406,363

—

406,363

—

     State and municipal obligations
1,611,366

—

1,594,350

17,016

     Agency mortgage-backed securities
3,040,913

—

3,040,913

—

     Non-agency mortgage-backed securities
905,793

—

905,793

—

     Asset-backed securities
1,492,800

—

1,492,800

—

     Other debt securities
351,060

—

351,060

—

  Trading debt securities
18,269

—

18,269

—

  Equity securities
48,838

19,864

28,974

—

  Private equity investments
55,752

—

—

55,752

  Derivatives *
8,349

—

7,723

626

  Assets held in trust for deferred compensation plan
12,843

12,843

—

—

  Total assets
8,884,820

949,854

7,861,572

73,394

Liabilities:
 
 
 
 
  Derivatives *
8,074

—

7,951

123

Liabilities held in trust for deferred compensation plan
12,843

12,843

—

—

  Total liabilities
$
20,917

$
12,843

$
7,951

$
123

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






38
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, 2018
 
 
 
 
Balance June 30, 2018
$
15,073

$
68,940

$
684

$
84,697

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

4,275

(58
)
4,217

   Included in other comprehensive income *
167

—

—

167

Investment securities sold
(518
)
—

—

(518
)
Discount accretion
7

—

—

7

Purchases of private equity investments
—

10,407

—

10,407

Purchase of risk participation agreement
—

—

50

50

Sale of risk participation agreement
—

—

(31
)
(31
)
Balance September 30, 2018
$
14,729

$
83,622

$
645

$
98,996

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, 2018
$
—

$
4,275

$
672

$
4,947

For the nine months ended September 30, 2018
 
 
 
 
Balance January 1, 2018
$
17,016

$
55,752

$
503

$
73,271

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

12,371

271

12,642

   Included in other comprehensive income *
(79
)
—

—

(79
)
Investment securities sold
(2,233
)
—

—

(2,233
)
Discount accretion
25

—

—

25

Purchases of private equity investments
—

15,650

—

15,650

Sale/pay down of private equity investments
—

(186
)
—

(186
)
Capitalized interest/dividends
—

35

—

35

Purchase of risk participation agreement
—

—

50

50

Sale of risk participation agreement
—

—

(179
)
(179
)
Balance September 30, 2018
$
14,729

$
83,622

$
645

$
98,996

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, 2018
$
—

$
12,371

$
852

$
13,223

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

39
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, 2018
 
 
 
 
Total gains or losses included in earnings
$
(51
)
$
(7
)
$
4,275

$
4,217

Change in unrealized gains or losses relating to assets still held at September 30, 2018
$
679

$
(7
)
$
4,275

$
4,947

For the nine months ended September 30, 2018
 
 
 
 
Total gains or losses included in earnings
$
98

$
173

$
12,371

$
12,642

Change in unrealized gains or losses relating to assets still held at September 30, 2018
$
679

$
173

$
12,371

$
13,223

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
)

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 $14.7 million at September 30, 2018, while private equity investments, included in other securities, totaled $83.6 million.
Information about these inputs is presented in the table and discussions below.
Quantitative Information about Level 3 Fair Value Measurements
 
 
 
Weighted
 
Valuation Technique
Unobservable Input
Range
 
Average
Auction rate securities
Discounted cash flow
Estimated market recovery period


5 years
 
 
 
 
Estimated market rate
3.6%
-
5.9%
 
 
Private equity investments
Market comparable companies
EBITDA multiple
4.0
-
6.0
 
 
Mortgage loan commitments
Discounted cash flow
Probability of funding
52.8%
-
99.5%
 
81.2%
 
 
Embedded servicing value
.7%
-
2.3%
 
1.3%


40
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 2018 and 2017, and still held as of September 30, 2018 and 2017, 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, 2018 and 2017.
 
 
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, 2018
 
 
 
 
 
  Collateral dependent impaired loans
$
230

$
—

$
—

$
230

$
(197
)
  Mortgage servicing rights
6,008

—

—

6,008

9

  Long-lived assets
2,319

—

—

2,319

(858
)
 
 
 
 
 
 
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
)

15. 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.

As mentioned in Note 3, the Company prospectively adopted ASU 2016-01 on January 1, 2018. In accordance with its requirements, the fair value of loans as of September 30, 2018 was measured using an exit price notion. The fair value of loans as of December 31, 2017 was measured using an entry price notion.


41
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 at September 30, 2018 and December 31, 2017:

 
Carrying Amount
 
Estimated Fair Value at September 30, 2018

(In thousands)
 
Level 1
Level 2
Level 3
Total
Financial Assets
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
Business
$
4,966,722

 
$
—

$
—

$
4,865,676

$
4,865,676

Real estate - construction and land
999,691

 
—

—

995,910

995,910

Real estate - business
2,726,042

 
—

—

2,685,924

2,685,924

Real estate - personal
2,120,672

 
—

—

2,046,763

2,046,763

Consumer
1,967,465

 
—

—

1,937,606

1,937,606

Revolving home equity
375,322

 
—

—

368,218

368,218

Consumer credit card
788,111

 
—

—

731,363

731,363

Overdrafts
11,534

 
—

—

8,512

8,512

Total loans
13,955,559

 
—

—

13,639,972

13,639,972

Loans held for sale
16,890

 
—

16,890

—

16,890

Investment securities
8,826,249

 
903,880

7,778,818

143,551

8,826,249

Federal funds sold
14,375

 
14,375

—

—

14,375

Securities purchased under agreements to resell
700,000

 
—

—

677,352

677,352

Interest earning deposits with banks
334,752

 
334,752

—

—

334,752

Cash and due from banks
443,004

 
443,004

—

—

443,004

Derivative instruments
13,203

 
—

12,500

703

13,203

Assets held in trust for deferred compensation plan
14,384

 
14,384

—

—

14,384

       Total
$
24,318,416

 
$
1,710,395

$
7,808,208

$
14,461,578

$
23,980,181

Financial Liabilities
 
 
 
 
 
 
Non-interest bearing deposits
$
6,728,605

 
$
6,728,605

$
—

$
—

$
6,728,605

Savings, interest checking and money market deposits
11,733,057

 
11,733,057

—

—

11,733,057

Time open and certificates of deposit
1,671,958

 
—

—

1,670,416

1,670,416

Federal funds purchased
358,940

 
358,940

—

—

358,940

Securities sold under agreements to repurchase
1,503,177

 
—

—

1,504,560

1,504,560

Other borrowings
1,534

 
—

—

1,534

1,534

Derivative instruments
23,012

 
—

22,954

58

23,012

Liabilities held in trust for deferred compensation plan
14,384

 
14,384

—

—

14,384

       Total
$
22,034,667

 
$
18,834,986

$
22,954

$
3,176,568

$
22,034,508



42
Table of Contents

 
Carrying Amount
 
Estimated Fair Value at December 31, 2017

(In thousands)
 
Level 1
Level 2
Level 3
Total
Financial Assets
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
Business
$
4,958,554

 
$
—

$
—

$
4,971,401

$
4,971,401

Real estate - construction and land
968,820

 
—

—

979,389

979,389

Real estate - business
2,697,452

 
—

—

2,702,598

2,702,598

Real estate - personal
2,062,787

 
—

—

2,060,443

2,060,443

Consumer
2,104,487

 
—

—

2,074,129

2,074,129

Revolving home equity
400,587

 
—

—

400,333

400,333

Consumer credit card
783,864

 
—

—

798,093

798,093

Overdrafts
7,123

 
—

—

7,123

7,123

Total loans
13,983,674

 
—

—

13,993,509

13,993,509

Loans held for sale
21,398

 
—

21,398

—

21,398

Investment securities
8,893,307

 
937,011

7,838,522

117,774

8,893,307

Federal funds sold
42,775

 
42,775

—

—

42,775

Securities purchased under agreements to resell
700,000

 
—

—

695,194

695,194

Interest earning deposits with banks
30,631

 
30,631

—

—

30,631

Cash and due from banks
438,439

 
438,439

—

—

438,439

Derivative instruments
8,349

 
—

7,723

626

8,349

Assets held in trust for deferred compensation plan
12,843

 
12,843

—

—

12,843

       Total
$
24,131,416

 
$
1,461,699

$
7,867,643

$
14,807,103

$
24,136,445

Financial Liabilities
 
 
 
 
 
 
Non-interest bearing deposits
$
7,158,962

 
$
7,158,962

$
—

$
—

$
7,158,962

Savings, interest checking and money market deposits
11,499,620

 
11,499,620

—

—

11,499,620

Time open and certificates of deposit
1,766,864

 
—

—

1,768,780

1,768,780

Federal funds purchased
202,370

 
202,370

—

—

202,370

Securities sold under agreements to repurchase
1,304,768

 
—

—

1,305,375

1,305,375

Other borrowings
1,758

 
—

—

1,758

1,758

Derivative instruments
8,074

 
—

7,951

123

8,074

Liabilities held in trust for deferred compensation plan
12,843

 
12,843

—

—

12,843

       Total
$
21,955,259

 
$
18,873,795

$
7,951

$
3,076,036

$
21,957,782


16. Legal and Regulatory Proceedings
The Company has various legal proceedings pending at September 30, 2018, 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.



43
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 2017 Annual Report on Form 10-K. Results of operations for the three and nine month periods ended September 30, 2018 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, cybersecurity threats, 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 2017 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 2017 Annual Report on Form 10-K. There have been no changes in the Company's application of critical accounting policies since December 31, 2017.


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Table of Contents

Selected Financial Data

 
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
 
2018
2017
 
2018
2017
Per Share Data
 
    
    
 
 
 
   Net income per common share — basic
 
$
1.03

$
.68
*
 
$
2.97

$
2.04
*
   Net income per common share — diluted
 
1.03

.67
*
 
2.96

2.03
*
   Cash dividends on common stock
 
.235

.214
*
 
.705

.643
*
   Book value per common share
 
 
 
 
25.03

23.99
*
   Market price
 
 
 
 
66.02

55.02
*
Selected Ratios
 
 
 
 
 
 
(Based on average balance sheets)
 
 
 
 
 
 
   Loans to deposits (1)
 
69.28
%
66.96
%
 
69.07
%
65.53
%
   Non-interest bearing deposits to total deposits
 
33.24

35.07

 
33.49

34.52

   Equity to loans (1)
 
20.18

19.61

 
19.76

19.21

   Equity to deposits
 
13.98

13.13

 
13.65

12.59

   Equity to total assets
 
11.37

10.74

 
11.17

10.40

   Return on total assets
 
1.81

1.19

 
1.76

1.20

   Return on common equity
 
16.43

11.35

 
16.27

11.85

(Based on end-of-period data)
 
 
 
 
 
 
   Non-interest income to revenue (2)
 
37.32

39.03

 
37.58

38.61

   Efficiency ratio (3)
 
55.73

59.73

 
55.95

60.35

   Tier I common risk-based capital ratio
 
 
 
 
14.07

12.52

   Tier I risk-based capital ratio
 
 
 
 
14.83

13.28

   Total risk-based capital ratio
 
 
 
 
15.68

14.32

   Tangible common equity to tangible assets ratio (4)
 
 
 
 
10.10

9.72

   Tier I leverage ratio 
 
 
 
 
11.38

10.16


* Restated for the 5% stock dividend distributed in December 2017.
(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)
2018
2017
Total equity
$
2,807,810

$
2,704,477

Less non-controlling interest
4,717

3,933

Less preferred stock
144,784

144,784

Less goodwill
138,921

138,921

Less core deposit premium
2,462

3,143

Total tangible common equity (a)
$
2,516,926

$
2,413,696

Total assets
$
25,062,392

$
24,979,141

Less goodwill
138,921

138,921

Less core deposit premium
2,462

3,143

Total tangible assets (b)
$
24,921,009

$
24,837,077

Tangible common equity to tangible assets ratio (a)/(b)
10.10
%
9.72
%

45
Table of Contents

Results of Operations

Summary
  
Three Months Ended September 30
 
Nine Months Ended September 30
(Dollars in thousands)
2018
2017
 
% change
 
2018
2017
% change
Net interest income
$
207,754

$
182,591

 
13.8
 %
 
$
611,605

$
543,671

12.5
 %
Provision for loan losses
(9,999
)
(10,704
)
 
(6.6
)
 
(30,438
)
(32,590
)
(6.6
)
Non-interest income
123,714

116,887

 
5.8

 
368,254

341,880

7.7

Investment securities gains (losses), net
4,306

(3,037
)
 
N.M.

 
6,641

(2,158
)
N.M.

Non-interest expense
(185,059
)
(179,217
)
 
3.3

 
(549,196
)
(535,484
)
2.6

Income taxes
(26,647
)
(32,294
)
 
(17.5
)
 
(79,412
)
(90,402
)
(12.2
)
Non-controlling interest (expense) income
(1,493
)
338

 
N.M.

 
(3,564
)
111

N.M.

Net income attributable to Commerce Bancshares, Inc.
112,576

74,564

 
51.0

 
323,890

225,028

43.9

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

 
(6,750
)
(6,750
)
—

Net income available to common shareholders
$
110,326

$
72,314

 
52.6
 %
 
$
317,140

$
218,278

45.3
 %
N.M. - Not meaningful.

For the quarter ended September 30, 2018, net income attributable to Commerce Bancshares, Inc. (net income) amounted to $112.6 million, an increase of $38.0 million, or 51.0%, compared to the third quarter of the previous year. For the current quarter, the annualized return on average assets was 1.81%, the annualized return on average common equity was 16.43%, and the efficiency ratio was 55.73%. Diluted earnings per common share was $1.03, an increase of 53.7% compared to $.67 per share in the third quarter of 2017 and an increase of 2.0% compared to $1.01 per share in the previous quarter.

Compared to the third quarter of last year, net interest income increased $25.2 million, or 13.8%, mainly due to growth of $20.4 million in interest income on loans, coupled with an increase of $9.2 million in interest income on investment securities and partly offset by an increase of $5.3 million in interest expense on deposits and borrowings. The provision for loan losses totaled $10.0 million for the current quarter, representing a decrease of $705 thousand from the third quarter of 2017. Non-interest income increased $6.8 million, or 5.8%, compared to the third quarter of 2017, mainly due to combined growth of $7.1 million in trust, deposit and net bank card fee income. Non-interest expense increased $5.8 million, or 3.3%, over the third quarter of 2017 primarily due to increases in salaries and employee benefits and data processing expense. Although income before taxes was higher in the third quarter of 2018 compared to the prior year, income tax expense declined due to new tax legislation lowering the corporate tax rate in 2018.

Net investment securities gains totaled $4.3 million in the current quarter compared to losses of $3.0 million in the same quarter last year. Current quarter gains were primarily comprised of $4.3 million in unrealized gains relating to the value of the Company's private equity investments. In the same quarter last year, net securities losses resulted from the unrealized losses in fair value of the Company's private equity investments of $5.2 million and were partially offset by a $2.4 million gain on a donation of appreciated equity securities to a charitable contribution.

Net income for the first nine months of 2018 was $323.9 million, an increase of $98.9 million, or 43.9%, over the same period last year. Diluted earnings per common share were $2.96, an increase of 45.8% compared to $2.03 per share in the same period last year. For the first nine months of 2018, the annualized return on average assets was 1.76%, the annualized return on average common equity was 16.27%, and the efficiency ratio was 55.95%. Net interest income increased $67.9 million, or 12.5%, over the same period last year. This growth was largely due to increases of $59.2 million in loan interest income and $17.8 million in investment securities interest income, partly offset by a $12.6 million increase in interest expense on deposits and borrowings. The provision for loan losses was $30.4 million for the first nine months of 2018, down $2.2 million from the same period last year. Non-interest income increased $26.4 million, or 7.7%, over the first nine months of last year due to growth in bank card, trust, and deposit fees. Non-interest expense increased $13.7 million, or 2.6%, due to higher salaries and benefits expense of $15.1 million, partly offset by a $6.9 million decrease in community service expense.


46
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, 2018 vs. 2017
 
Nine Months Ended September 30, 2018 vs. 2017
 
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
$
1,218

$
6,786

$
8,004

 
$
2,489

$
18,232

$
20,721

  Real estate - construction and land
1,135

2,255

3,390

 
3,501

6,031

9,532

  Real estate - business
218

3,403

3,621

 
1,268

9,528

10,796

  Real estate - personal
878

601

1,479

 
2,034

1,528

3,562

  Consumer
(869
)
2,193

1,324

 
368

6,324

6,692

  Revolving home equity
(217
)
648

431

 
(532
)
1,870

1,338

  Consumer credit card
1,056

(67
)
989

 
2,003

978

2,981

  Overdrafts
—

—

—

 
—

—

—

     Total interest on loans
3,419

15,819

19,238

 
11,131

44,491

55,622

Loans held for sale
(13
)
41

28

 
141

104

245

Investment securities:
 
 
 
 
 
 
 
  U.S. government and federal agency securities
20

1,931

1,951

 
106

3,516

3,622

  Government-sponsored enterprise obligations
(790
)
320

(470
)
 
(1,337
)
823

(514
)
  State and municipal obligations
(2,909
)
(2,035
)
(4,944
)
 
(8,737
)
(6,158
)
(14,895
)
  Mortgage-backed securities
4,256

3,167

7,423

 
7,332

8,071

15,403

  Asset-backed securities
(2,745
)
2,157

(588
)
 
(10,349
)
6,021

(4,328
)
  Other securities
(77
)
2,737

2,660

 
708

8,227

8,935

     Total interest on investment securities
(2,245
)
8,277

6,032

 
(12,277
)
20,500

8,223

Federal funds sold and short-term securities purchased under
 
 
 
 
 
 
 
   agreements to resell
(35
)
26

(9
)
 
138

150

288

Long-term securities purchased under agreements to resell
134

(24
)
110

 
182

350

532

Interest earning deposits with banks
273

543

816

 
937

1,850

2,787

Total interest income
1,533

24,682

26,215

 
252

67,445

67,697

Interest expense:
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
  Savings
15

(18
)
(3
)
 
42

(47
)
(5
)
  Interest checking and money market
149

2,643

2,792

 
166

6,504

6,670

  Time open & C.D.'s of less than $100,000
(66
)
224

158

 
(212
)
408

196

  Time open & C.D.'s of $100,000 and over
(506
)
1,621

1,115

 
(2,192
)
4,044

1,852

     Total interest on deposits
(408
)
4,470

4,062

 
(2,196
)
10,909

8,713

Federal funds purchased and securities sold under
 
 
 
 
 
 
 
   agreements to repurchase
(59
)
2,235

2,176

 
(58
)
6,614

6,556

Other borrowings
(893
)
(1
)
(894
)
 
(2,669
)
—

(2,669
)
Total interest expense
(1,360
)
6,704

5,344

 
(4,923
)
17,523

12,600

Net interest income, tax equivalent basis
$
2,893

$
17,978

$
20,871

 
$
5,175

$
49,922

$
55,097


Net interest income in the third quarter of 2018 was $207.8 million, an increase of $25.2 million over the third quarter of 2017. On a tax equivalent (T/E) basis, net interest income totaled $211.4 million in the third quarter of 2018, up $20.9 million over the same period last year and down $4.4 million from the previous quarter. In the third quarter of 2018, a $2.0 million non-recurring equity investment dividend was recorded, while the second quarter of 2018 included dividend income of $8.9 million related to a liquidated equity security which was carried at fair value. The increase in net interest income compared to the third quarter of

47
Table of Contents

2017 was mainly due to higher interest income on loans (T/E) of $19.3 million. The increase in interest on loans was a result of higher yields on nearly all loan products, especially commercial loans, many of which have variable rates. Total interest income on investment securities (T/E) increased $6.0 million over the third quarter of 2017, which included dividend income of $2.0 million mentioned above. Also, inflation income on the Company's treasury inflation-protected securities (TIPS) increased $2.0 million over the same period last year. This increase was partly offset by a $401.8 million decrease in average investment securities balances, resulting in a decline in interest income of $2.2 million. Excluding the dividend mentioned above, the Company's net yield on earning assets (T/E) was 3.49% in the current quarter compared to 3.17% in the third quarter of 2017.
 
Total interest income (T/E) increased $26.2 million over the third quarter of 2017. Interest income on loans (T/E) was $161.0 million during the third quarter of 2018, and increased $19.3 million, or 13.6%, over the same quarter last year. The increase was due to growth of $294.5 million, or 2.2%, in average loan balances, and an increase of 46 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 $8.0 million due to a 55 basis point increase in the average rate earned, coupled with higher average balances of $148.8 million. Construction loan interest grew $3.4 million, as average balances increased $104.4 million, or 11.8%, and the average rate earned increased 90 basis points. Business real estate loan interest increased $3.6 million due to an increase of 50 basis points in the average rate earned and an increase in average balances of $22.5 million. Personal real estate loan interest increased $1.5 million due to an increase of $93.7 million, or 4.6%, in average balances, and an increase of 11 basis points in the average rate earned. Interest on consumer loans increased $1.3 million over the same period last year as the average rate increased 44 basis points, while the average balance declined $85.8 million. This decrease was mainly due to declines in auto, marine and RV and fixed rate home equity loan balances of $84.0 million, $23.6 million and $22.8 million, respectively, partly offset by growth of $52.8 million in patient health care loans. In addition, interest on consumer credit card loans grew $989 thousand over the same period last year, as average balances increased $34.8 million.

Interest income on investment securities (T/E) was $61.9 million during the third quarter of 2018, which was an increase of $6.0 million over the same quarter last year. The increase was partly due to the receipt of $2.0 million in dividend income on the equity security mentioned above. In addition, interest income earned on mortgage-backed securities grew $7.4 million and resulted from an increase of $715.4 million in average balances and a 29 basis point increase in the average rate earned. Adjustments to premium amortization expense, due to slowing prepayment speeds on various mortgage-backed and asset-backed securities, increased interest income $729 thousand in the current quarter, compared to $635 thousand in the same quarter last year. Interest income related to TIPS increased $2.0 million in the third quarter of 2018 compared to the same period in 2017 and totaled $2.5 million in the current quarter and $447 thousand in the third quarter of 2017. The largest decline in interest income occurred in state and municipal obligations, which declined $4.9 million and was impacted by a decline in average balances of $323.6 million and a lower tax equivalent adjustment. Interest income on asset-backed securities declined $588 thousand due to lower average balances of $598.4 million, partly offset by an increase in the average rate earned of 60 basis points. The average balance of the total investment portfolio (excluding unrealized fair value adjustments on available for sale debt securities) was $8.9 billion in the third quarter of 2018, compared to $9.3 billion in the third quarter of 2017.

Interest income on balances at the Federal Reserve in the third quarter of 2018 increased $816 thousand due to a 72 basis point increase in the average rate earned and an $87.4 million increase in the average balance invested.

The average tax equivalent yield on total interest earning assets was 3.80% in the third quarter of 2018, up from 3.36% in the third quarter of 2017.

Total interest expense increased $5.3 million compared to the third quarter of 2017 due to a $4.1 million increase in interest expense on interest bearing deposits and a $1.3 million increase in interest expense on borrowings. The increase in deposit expense resulted mainly from an 11 basis point increase in the overall average rate paid on deposits. Interest expense on interest checking and money market accounts increased $2.8 million due to higher rates paid. Interest expense on certificates of deposit rose $1.3 million, as the effect of higher rates paid was partly offset by lower average balances. Interest expense on borrowings increased due to higher rates paid on customer repurchase agreements, partly offset by lower average FHLB borrowings. The overall average rate incurred on all interest bearing liabilities was .45% and .31% in the third quarters of 2018 and 2017, respectively.

Net interest income (T/E) for the first nine months of 2018 was $623.8 million compared to $568.7 million for the same period in 2017. For the first nine months of 2018, the net interest margin was 3.51% compared to 3.16% for the first nine months of 2017.

Total interest income (T/E) for the first nine months of 2018 increased $55.1 million over the same period last year mainly due to higher interest income on loans. Loan interest income (T/E) rose $55.9 million due to a $354.3 million, or 2.6%, increase in total average loan balances and a 43 basis point increase in the average rate earned. Most of the increase in loan interest occurred

48
Table of Contents

in business, business real estate, construction and consumer loan categories. Interest income on investment securities (T/E) grew $8.2 million mainly due to a 35 basis point increase in the average rate earned, partly offset by an $808.2 million decrease in average balances. Increased earnings were recorded for equity securities due to the receipt of $8.9 million in dividend income during the second quarter of 2018 (mentioned previously), while interest earned on mortgage-backed securities grew $15.4 million on higher average rates earned and higher average balances. Interest earned on U.S government and federal agency securities rose due to higher TIPS interest of $3.9 million. These increases were partly offset by lower interest earned on state and municipal obligations of $14.9 million, which saw declines in average balances and rates earned. Also, interest income on asset-backed securities declined $4.3 million due to lower average balances, partly offset by higher rates earned.

Interest income on balances at the Federal Reserve in the nine months ended September 30, 2018 increased $2.8 million over the first nine months of 2017 due to a 80 basis point increase in the average rate earned and an $122.8 million increase in the average balance invested. The average tax equivalent yield on total interest earning assets was 3.77% for the first nine months of 2018, up from 3.34% in the first nine months of the prior year.

Total interest expense for the first nine months of 2018 increased $12.6 million compared to last year. Interest expense on interest bearing deposits increased $8.7 million, mainly due to a nine basis point increase in the overall rate paid. Interest expense on interest checking and money market account balances increased $6.7 million due to an eight basis point increase in the rates paid. Interest expense on certificates of deposit rose $2.0 million as the effect of higher rates paid were largely offset by a decline in average balances. Interest expense on borrowings increased $3.9 million, mainly due to higher rates paid on customer repurchase agreements, which were partly offset by lower FHLB borrowings. The overall cost of total interest bearing liabilities increased to .40% compared to .29 % 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)
2018
2017
 
% change
 
2018
2017
% change
Bank card transaction fees
$
42,427

$
39,166

 
8.3
 %
 
$
127,095

$
112,212

13.3
 %
Trust fees
37,400

34,620

 
8.0

 
110,498

99,754

10.8

Deposit account charges and other fees
23,755

22,659

 
4.8

 
70,630

67,462

4.7

Capital market fees
1,595

1,755

 
(9.1
)
 
5,878

6,253

(6.0
)
Consumer brokerage services
3,884

3,679

 
5.6

 
11,623

11,054

5.1

Loan fees and sales
3,579

3,590

 
(.3
)
 
9,670

10,849

(10.9
)
Other
11,074

11,418

 
(3.0
)
 
32,860

34,296

(4.2
)
Total non-interest income
$
123,714

$
116,887

 
5.8
 %
 
$
368,254

$
341,880

7.7
 %
Non-interest income as a % of total revenue*
37.3
%
39.0
%
 
 
 
37.6
%
38.6
%
 
* Total revenue includes net interest income and non-interest income.

For the third quarter of 2018, total non-interest income amounted to $123.7 million compared with $116.9 million in the same quarter last year, which was an increase of $6.8 million, or 5.8%. The increase was mainly due to growth in bank card, trust, deposit and cash sweep commissions.

Bank card transaction fees for the current quarter increased $3.3 million, or 8.3%, over the same quarter last year and were comprised of net fees on corporate card ($24.8 million), debit card ($9.9 million), merchant ($5.2 million) and credit card ($2.6 million) transactions. Corporate card net fees grew $3.2 million, or 14.7%, over the same period last year due to growth in interchange income from customer spend, partially offset by higher rewards costs. Debit card net fees grew $683 thousand, or 7.4%, driven by both higher fees and lower network processing costs. Overall net merchant income increased $377 thousand, or 7.9%, compared to the same period last year due to lower processing costs, while net credit card fees declined $980 thousand due to higher rewards expense.

Trust fees for the quarter increased $2.8 million, or 8.0%, over the same quarter last year, resulting mainly from growth in private client trust fees, which were up $2.5 million, or 9.8%, and institutional trust fees, which were up $360 thousand, or 5.1%. Deposit account fees increased $1.1 million, or 4.8%, over the same quarter last year, as corporate cash management fees increased $620 thousand, or 7.0%, overdraft and return item fees increased $194 thousand, or 2.5%, and deposit account service charges increased $282 thousand, or 4.8%. Consumer brokerage fees grew $205 thousand, or 5.6%, on higher fixed annuity and advisory fees, while capital market fees declined $160 thousand on lower sales of fixed income investments to clients. Other non-interest

49
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income decreased $344 thousand compared to the same quarter of last year mainly due to lower gains on sales of leased assets to customers upon lease termination, partly offset by higher cash sweep commissions.

Non-interest income for the first nine months of 2018 was $368.3 million compared to $341.9 million in the first nine months of 2017, resulting in an increase of $26.4 million, or 7.7%. Bank card fees increased $14.9 million, or 13.3%, as a result of growth in corporate card net fees of $12.1 million, or 19.7%, and debit card net fees of $3.9 million, or 15.2%, partly offset by declines of $174 thousand, or 1.2%, in merchant net fees and $937 thousand, or 9.3%, in credit card net fees. Trust fee income increased $10.7 million, or 10.8%, as a result of growth in private client and institutional trust fees, which grew $8.9 million and $1.8 million, respectively. Deposit account fees increased $3.2 million, or 4.7%, mainly due to growth of $1.7 million in corporate cash management fees, $733 thousand in overdraft and return item fees and $711 thousand in deposit account service charges. Loan fees and sales decreased $1.2 million, or 10.9%, due to lower mortgage banking revenue. Consumer brokerage fees rose $569 thousand due to higher fixed annuity and advisory fee income, while capital market fees decreased $375 thousand, or 6.0%. Other non-interest income decreased $1.4 million, or 4.2%, mainly due to lower gains on sales of branch properties, lower gains on sales of leased assets, and software write downs. These declines were partly offset by higher fees from interest rate swap sales and cash sweep commissions.

Investment Securities Gains (Losses), Net
 
Three Months Ended September 30
 
Nine Months Ended September 30
(In thousands)
2018
2017
 
2018
2017
Net gains (losses) on sales and fair value adjustments of private equity investments
$
4,275

$
(5,423
)
 
$
12,371

$
(8,263
)
Adjustment for dividend income on a liquidated equity investment
—

—

 
(8,917
)
—

Donations of equity securities
—

2,392

 
—

6,707

Fair value adjustments on equity securities
24

—

 
2,723

—

Other
7

(6
)
 
464

(602
)
Total investment securities gains (losses), net
$
4,306

$
(3,037
)
 
$
6,641

$
(2,158
)

Net gains and losses on investment securities which were recognized in earnings during the three and nine months ended September 30, 2018 and 2017 are shown in the table above. Net securities gains of $4.3 million were reported in the third quarter of 2018, compared to net losses of $3.0 million in the same period last year.  The net gains in the third quarter of 2018 were mainly comprised of unrealized gains in fair value on the Company’s holdings of private equity investments. The net losses for the same quarter last year resulted from unrealized losses in fair value on the Company’s holdings of private equity investments, partly offset by a gain recorded on the donation of appreciated equity securities to a charitable foundation. 

Included in gains and losses are credit-related impairment losses on certain non-agency guaranteed mortgage-backed securities which have been identified as other-than-temporarily impaired. Impairment losses on these securities totaled $68 thousand in the first nine months of 2018, compared to $372 thousand in the same period last year.  Private equity investment activity generated net gains of $12.4 million in the first nine months of 2018 compared to net losses of $8.3 million in the same period in 2017. These included fair value adjustments, in addition to gains and losses realized upon disposition. The portion of private equity activity attributable to minority interests is reported as non-controlling interest in the consolidated statements of income, and resulted in expense of $2.5 million during the first nine months of 2018 and income of $1.1 million during the first nine months of 2017.


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Non-Interest Expense
  
Three Months Ended September 30
 
Nine Months Ended September 30
(Dollars in thousands)
2018
2017
 
% change
 
2018
2017
% change
Salaries and employee benefits
$
116,194

$
111,382

 
4.3
 %
 
$
347,677

$
332,580

4.5
 %
Net occupancy
11,631

11,459

 
1.5

 
34,333

34,332

—

Equipment
4,592

4,491

 
2.2

 
13,617

13,876

(1.9
)
Supplies and communication
5,103

5,517

 
(7.5
)
 
15,542

16,672

(6.8
)
Data processing and software
22,056

19,968

 
10.5

 
63,762

59,908

6.4

Marketing
4,999

4,676

 
6.9

 
14,946

12,388

20.6

Deposit insurance
3,167

3,479

 
(9.0
)
 
9,750

10,542

(7.5
)
Community service
580

3,006

 
(80.7
)
 
1,965

8,866

(77.8
)
Other
16,737

15,239

 
9.8

 
47,604

46,320

2.8

Total non-interest expense
$
185,059

$
179,217

 
3.3
 %
 
$
549,196

$
535,484

2.6
 %

Non-interest expense for the third quarter of 2018 amounted to $185.1 million, an increase of $5.8 million, or 3.3%, compared with $179.2 million in the third quarter of last year. The increase in expense over the same period last year was mainly due to higher costs for salaries, employee benefits, and data processing, partly offset by lower supplies and communication, community service, and foreclosed property expense. Salaries expense increased $4.2 million, or 4.3%, mainly due to higher full-time salary costs. Employee benefits expense totaled $16.3 million, reflecting growth of $652 thousand, or 4.2%, mainly as a result higher medical costs. Full-time equivalent employees totaled 4,797 at September 30, 2018 compared to 4,811 at September 30, 2017. Occupancy costs increased $172 thousand, or 1.5%, partly due to higher repair and maintenance costs, while equipment expense increased $101 thousand, or 2.2%. Supplies and communication expense declined $414 thousand, or 7.5%, mainly due to lower data network expense. Data processing expense increased $2.1 million, or 10.5%, mainly due to higher processing and software costs, while marketing expense increased $323 thousand partly due to new bank card initiatives which are being funded by reduced bank card network costs. Deposit insurance expense decreased $312 thousand, or 9.0%, from the third quarter of last year due to decreases in average assets and the assessment rate. Community service expense declined $2.4 million due to the donation of $2.5 million in appreciated securities to a charitable foundation in the previous year, which did not recur this year. Other non-interest expense increased $1.5 million mainly due to higher costs for professional fees, travel and entertainment, partly offset by lower processing and fraud losses and foreclosed property expense.

For the first nine months of 2018, non-interest expense amounted to $549.2 million, an increase of $13.7 million, or 2.6%, compared with $535.5 million in the same period last year. Salaries and benefits increased $15.1 million, or 4.5%, mainly due to higher full-time salaries, incentives and medical expense. Equipment expense declined $259 thousand, or 1.9%, mainly due to lower depreciation expense, while supplies and communication expense was down $1.1 million, or 6.8%, due to lower data network expense. Data processing and software expense increased $3.9 million, or 6.4%, mostly due to higher processing costs. Marketing expense increased $2.6 million, or 20.6%, mainly due to new bank card initiatives in 2018 and lower spending in the first quarter of 2017. Community service expense decreased due to the donation of $7.0 million in appreciated securities in the previous year, while deposit insurance expense decreased $792 thousand, or 7.5%. Other non-interest expense increased $1.3 million mainly due to higher directors fees, professional fees, travel and entertainment and employee education expense, partly offset by lower processing and bank card fraud losses.


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Provision and Allowance for Loan Losses
 
Three Months Ended
 
Nine Months Ended September 30
(In thousands)
Sept. 30, 2018
June 30,
2018
Sept. 30, 2017
 
2018
2017
Provision for loan losses
$
9,999

$
10,043

$
10,704

 
$
30,438

$
32,590

Net loan charge-offs (recoveries):
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
  Business
332

36

195

 
354

610

  Real estate-construction and land
(119
)
(297
)
(362
)
 
(452
)
(1,104
)
  Real estate-business
(42
)
(40
)
(106
)
 
(287
)
(155
)
Commercial net loan charge-offs (recoveries)
171

(301
)
(273
)
 
(385
)
(649
)
Personal Banking:
 
 
 
 
 
 
  Real estate-personal
(153
)
(95
)
(137
)
 
(191
)
(249
)
  Consumer
2,091

1,862

3,057

 
6,481

7,795

  Revolving home equity
(1
)
—

(19
)
 
55

92

  Consumer credit card
7,340

8,251

7,631

 
23,157

22,529

  Overdrafts
351

326

445

 
1,121

1,172

Personal banking net loan charge-offs
9,628

10,344

10,977

 
30,623

31,339

Total net loan charge-offs
$
9,799

$
10,043

$
10,704

 
$
30,238

$
30,690


 
Three Months Ended
 
Nine Months Ended September 30
 
Sept. 30, 2018
June 30, 2018
Sept. 30, 2017
 
2018
2017
Annualized net loan charge-offs (recoveries)*:
 
 
 
 
 
 
Commercial:
 
 
 
 
 
 
  Business
.03
 %
—
 %
.02
 %
 
.01
 %
.02
 %
  Real estate-construction and land
(.05
)
(.12
)
(.16
)
 
(.06
)
(.17
)
  Real estate-business
(.01
)
(.01
)
(.02
)
 
(.01
)
(.01
)
Commercial net loan charge-offs (recoveries)
.01

(.01
)
(.01
)
 
(.01
)
(.01
)
Personal Banking:
 
 
 
 
 
 
  Real estate-personal
(.03
)
(.02
)
(.03
)
 
(.01
)
(.02
)
  Consumer
.42

.37

.59

 
.43

.52

  Revolving home equity
—

—

(.02
)
 
.02

.03

  Consumer credit card
3.76

4.39

4.09

 
4.06

4.07

  Overdrafts
29.60

29.08

40.37

 
32.51

35.98

Personal banking net loan charge-offs
.73

.79

.83

 
.78

.81

Total annualized net loan charge-offs
.28
 %
.29
 %
.31
 %
 
.29
 %
.30
 %
* as a percentage of average loans (excluding loans held for sale)

The Company has an established process to determine the amount of the allowance for loan losses, which assesses the risks and losses inherent in its portfolio. This process provides an allowance consisting of a specific allowance component based on certain individually evaluated loans and a general component based on estimates of allowances for pools of loans. The Company's policies and processes for determining the allowance for loan losses are discussed in Note 1 to the consolidated financial statements and in the Allowance for Loan Losses discussion in Item 7 of the 2017 Annual Report on Form 10-K.

Net loan charge-offs in the third quarter of 2018 amounted to $9.8 million, compared with $10.0 million in the prior quarter and $10.7 million in the third quarter of last year. During the third quarter of 2018, the Company recorded net recoveries on personal real estate loans of $153 thousand, compared to net recoveries of $95 thousand in the prior quarter. Additionally, net loan charge-offs on consumer credit card loans decreased $911 thousand in the third quarter of 2018 compared to the prior quarter. These decreases in net loan charge-offs were partially offset by an increase in business loan net charge-offs of $332 thousand, compared to net charge-offs of $36 thousand in prior quarter. Additionally, net charge-offs on consumer loans increased $229 thousand in the third quarter of 2018 compared to the prior quarter, and the Company recorded lower net recoveries of $178 thousand on construction loans.

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Table of Contents


For the three months ended September 30, 2018, annualized net charge-offs on average consumer credit card loans totaled 3.76%, compared to 4.39% in the previous quarter and 4.09% in the same period last year. Consumer loan annualized net charge-offs in the current quarter amounted to .42%, compared to .37% in the prior quarter and .59% 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 2018, total annualized net loan charge-offs were .28%, compared to .29% in the previous quarter and .31% in the same period last year.

The provision for loan losses totaled $10.0 million in both the current and prior quarters and exceeded net loan charge-offs by $200 thousand in the third quarter of 2018. During the third quarter of 2017, the provision for loan losses totaled $10.7 million and equaled net loan charge-offs for the same period.

For the nine months ended September 30, 2018, net loan charge-offs amounted to $30.2 million, compared to $30.7 million in the same period last year. During the first nine months of 2018, the Company recorded net recoveries of $385 thousand on commercial loans, compared to net recoveries of $649 thousand in the first nine months of 2017. Additionally, consumer loan net charge-offs decreased $1.3 million in the first nine months of 2018 compared to the first nine months of the prior year, but the decrease was partly offset by $628 thousand of higher net charge-offs on consumer credit card loans. The provision expense for the first nine months of 2018 was $30.4 million and exceeded net loan charge-offs by $200 thousand. In the same period last year, the provision for loan losses totaled $32.6 million and exceeded net loan charge-offs by $1.9 million.

At September 30, 2018, the allowance for loan losses amounted to $159.7 million, compared to $159.5 million at December 31, 2017, and was 1.14% of total loans at both period ends. The Company considers the allowance for loan losses adequate to cover losses inherent in the loan portfolio at September 30, 2018.

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, 2018
December 31, 2017
Non-accrual loans
$
8,369

$
11,983

Foreclosed real estate
1,181

681

Total non-performing assets
$
9,550

$
12,664

Non-performing assets as a percentage of total loans
.07
%
.09
%
Non-performing assets as a percentage of total assets
.04
%
.05
%
Total loans past due 90 days and still accruing interest
$
13,991

$
18,127


Non-accrual loans, which are also classified as impaired, totaled $8.4 million at September 30, 2018, and decreased $3.6 million from balances at December 31, 2017. The decrease occurred in business real estate, consumer, business, and personal real estate loans, which decreased $1.3 million, $834 thousand, $816 thousand, and $694 thousand, respectively. At September 30, 2018, non-accrual loans were comprised mainly of business (61.3%), personal real estate (21.1%), and business real estate (17.5%) loans. Foreclosed real estate totaled $1.2 million at September 30, 2018, an increase of $500 thousand when compared to December 31, 2017. Total loans past due 90 days or more and still accruing interest were $14.0 million as of September 30, 2018, a decrease of $4.1 million when compared to December 31, 2017. 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 $197.7 million at September 30, 2018 compared with $213.4 million at December 31, 2017, resulting in a decrease of $15.7 million, or 7.4%.


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(In thousands)
September 30, 2018
December 31, 2017
Potential problem loans:
 
 
  Business
$
148,998

$
153,417

  Real estate – construction and land
861

2,702

  Real estate – business
45,596

51,134

  Real estate – personal
2,226

6,121

Total potential problem loans
$
197,681

$
213,374


At September 30, 2018, the Company had $106.2 million of loans whose terms have been modified or restructured under a troubled debt restructuring. These loans have been extended to borrowers who are experiencing financial difficulty and who have been granted a concession, as defined by accounting guidance, and are further discussed in the "Troubled debt restructurings" section in Note 2 to the consolidated financial statements. This balance includes certain commercial loans totaling $85.2 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 7.2% of total loans outstanding at September 30, 2018. The largest component of construction and land loans was commercial construction, which increased $23.6 million during the nine months ended September 30, 2018. At September 30, 2018, multi-family residential construction loans totaled approximately $196.5 million, or 26.5% of the commercial construction loan portfolio, compared to $252.8 million, or 35.2%, at December 31, 2017.
(Dollars in thousands)
September 30, 2018


% of Total
% of
Total
Loans
December 31, 2017
    

% of Total
% of
Total
Loans
Residential land and land development
$
74,639

7.5
%
.5
%
$
81,859

8.5
%
.6
%
Residential construction
133,382

13.3

1.0

121,138

12.5

.9

Commercial land and land development
50,714

5.1

.4

48,474

5.0

.3

Commercial construction
740,956

74.1

5.3

717,349

74.0

5.1

Total real estate - construction and land loans
$
999,691

100.0
%
7.2
%
$
968,820

100.0
%
6.9
%

Real Estate – Business Loans
Total business real estate loans were $2.7 billion at September 30, 2018 and comprised 19.5% 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, 2018, 37.0% of business real estate loans were for owner-occupied real estate properties, which present lower risk profiles.
(Dollars in thousands)
September 30, 2018


% of Total
% of
Total
Loans
December 31, 2017


% of Total
% of
Total
Loans
Owner-occupied
$
1,007,434

37.0
%
7.2
%
$
1,010,786

37.5
%
7.2
%
Multi-family
385,820

14.2

2.8

298,605

11.1

2.1

Office
338,651

12.4

2.4

373,301

13.8

2.7

Retail
295,877

10.9

2.0

338,937

12.6

2.4

Hotels
202,569

7.4

1.5

181,704

6.7

1.3

Farm
163,318

6.0

1.2

161,972

6.0

1.2

Industrial
70,968

2.5

.5

73,078

2.7

.5

Other
261,405

9.6

1.9

259,069

9.6

1.9

Total real estate - business loans
$
2,726,042

100.0
%
19.5
%
$
2,697,452

100.0
%
19.3
%


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Table of Contents

Real Estate – Personal Loans
The Company's $2.1 billion personal real estate loan portfolio is composed mainly of residential first mortgage real estate loans. As shown on page 52, recent loss rates have remained low. At September 30, 2018, loans past due over 30 days decreased $832 thousand, and non-accrual loans decreased $694 thousand compared to December 31, 2017. Also, as shown in Note 2, only 3.0% of this portfolio has FICO scores of less than 660. Approximately $30.5 million, or 1.4%, 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, 2018, loans with no mortgage insurance and an original LTV higher than 80% totaled $181.9 million compared to $183.6 million at December 31, 2017.

Revolving Home Equity Loans
The Company had $375.3 million in revolving home equity loans at September 30, 2018 that were generally collateralized by residential real estate. Most of these loans (92.4%) 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, 2018, the outstanding principal of loans with an original LTV higher than 80% was $46.9 million, or 12.5% of the portfolio, compared to $51.3 million as of December 31, 2017. Total revolving home equity loan balances over 30 days past due or on non-accrual status were $2.4 million at September 30, 2018 compared to $3.2 million at December 31, 2017.  The weighted average FICO score for the total current portfolio balance is 792. 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 2018 through 2020, approximately 9% of the Company's current outstanding balances are expected to mature. Of these balances, approximately 90% 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, motorcycles, marine and RVs. Outstanding balances for auto loans were $920.0 million and $1.0 billion at September 30, 2018 and December 31, 2017, respectively. The balances over 30 days past due amounted to $15.0 million at September 30, 2018 compared to $18.4 million at the end of 2017, and comprised 1.6% and 1.8% of the outstanding balances of these loans at September 30, 2018 and December 31, 2017, respectively. For the nine months ended September 30, 2018, $275.1 million of new auto loans were originated, compared to $383.7 million during the first nine months of 2017.  At September 30, 2018, the automobile loan portfolio had a weighted average FICO score of 756.

Outstanding balances for motorcycle loans were $99.6 million at September 30, 2018, compared to $129.5 million at December 31, 2017. The balances over 30 days past due amounted to $1.8 million and $2.5 million at September 30, 2018 and December 31, 2017, respectively, and comprised 1.8% of the outstanding balance of these loans at September 30, 2018, compared to 1.9% at December 31, 2017. During the first nine months of 2018, new motorcycle loan originations totaled $13.1 million compared to $55.3 million during the full year of 2017.

The Company's balance of marine and RV loans totaled $55.8 million at September 30, 2018, compared to $71.8 million at December 31, 2017, and the balances over 30 days past due amounted to $2.0 million and $2.6 million at September 30, 2018 and December 31, 2017, respectively. The net charge-offs on marine and RV loans decreased from $1.0 million in the first nine months of 2017 to $293 thousand in the first nine months of the current year.

Additionally, the Company offers low promotional rates on selected consumer credit card products. Out of a portfolio at September 30, 2018 of $788.1 million in consumer credit card loans outstanding, approximately $185.0 million, or 23%, carried a low promotional rate. Within the next six months, $63.8 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.


55
Table of Contents

Energy Lending
The Company's energy lending portfolio is comprised of lending to the petroleum and natural gas sectors and totaled $147.0 million at September 30, 2018, as shown in the table below.
(In thousands)
September 30, 2018
December 31, 2017
 
Unfunded commitments at September 30, 2018
Extraction
$
112,686

$
86,040

 
$
54,329

Mid-stream shipping and storage
4,961

9,310

 
55,663

Downstream distribution and refining

15,574

25,329

 
24,165

Support activities
13,731

13,811

 
11,995

Total energy lending portfolio
$
146,952

$
134,490

 
$
146,152


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 $100 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 $813.1 million at September 30, 2018. Additional unfunded commitments at September 30, 2018 totaled $1.2 billion.

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Table of Contents

Income Taxes
Income tax expense was $26.6 million in the third quarter of 2018, compared to $29.5 million in the second quarter of 2018 and $32.3 million in the third quarter of 2017. The Company's effective tax rate, including the effect of non-controlling interest, was 19.1% in the third quarter of 2018, compared to 21.1% in the second quarter of 2018 and 30.2% in the third quarter of 2017. For the nine months ended September 30, 2018, income tax expense was $79.4 million, compared to $90.4 million for the same period during the previous year, resulting in effective tax rates of 19.7% and 28.7%, respectively. Beginning in 2018, new tax reform legislation lowered the federal tax rate from 35% to 21%, which resulted in the lower effective tax rates in 2018. The lower tax rate in the current quarter was the result of a new state law enacted in the third quarter of 2018 coupled with adjustments relating to the tax reform legislation. These adjustments resulted in tax benefits of $2.4 million recorded in the third quarter of 2018.

Financial Condition

Balance Sheet
Total assets of the Company were $25.1 billion at September 30, 2018 and $24.8 billion at December 31, 2017. Earning assets (excluding the allowance for loan losses and fair value adjustments on debt securities) amounted to $24.0 billion at September 30, 2018 and $23.7 billion at December 31, 2017, and consisted of 58% in loans and 37% in investment securities.

At September 30, 2018, total loans decreased $32.6 million, or .2%, compared with balances at December 31, 2017. This decrease was mainly due to a decline in consumer loans, which decreased $137.0 million. Consumer loans, which includes automobile, marine and RV, fixed rate home equity, and other consumer loans, decreased largely because of declines in automobile lending activity. Continued lower demand for auto loans, coupled with the sale of $25.9 million of loans to another financial institution in the second quarter of 2018, decreased auto loan balances $89.9 million at September 30, 2018 compared to balances at December 31, 2017. Marine and RV loans continued to run off during the period, declining $16.1 million, and lower demand for fixed rate home equity loans decreased balances $22.6 million. However, patient health care loans increased $25.4 million. Business loans increased $8.2 million during the first nine months of the year, primarily due to higher commercial and industrial lending activity, partly offset by lower tax-free lending. Business real estate loans grew by $28.6 million over year end balances due to growth in multi-family residential projects, while commercial construction projects contributed to the increase in construction loans of $30.9 million during the same period. Personal real estate loan balances increased $57.9 million during the first nine months of 2018; however, the Company sold $143.8 million of longer-term fixed rate loans during the first nine months of 2018 compared to $151.8 million in the same period of 2017. Consumer credit card loans increased $4.2 million, while revolving home equity loans declined $25.3 million.

Available for sale investment securities, excluding fair value adjustments, increased $116.8 million at September 30, 2018 compared to December 31, 2017. Purchases of securities during this period totaled $1.5 billion, offset by sales, maturities, and pay downs of $1.4 billion. The largest increases in outstanding balances occurred in agency mortgage-backed and non-agency mortgage-backed securities, which increased $304.4 million and $199.4 million, respectively. These increases were partially offset by decreases in state and municipal obligations and government-sponsored enterprise obligations, which decreased $195.1 million and $180.2 million, respectively. At September 30, 2018, the duration of the investment portfolio was 3.3 years, and maturities and pay downs of approximately $1.1 billion are expected to occur during the next 12 months.

Equity securities decreased $46.1 million at September 30, 2018 compared to December 31, 2017. The decline in equity securities during the first nine months of 2018 was due to a third party merger transaction in June 2018, in which the majority of these securities were redeemed for cash of $39.9 million.
Total deposits at September 30, 2018 amounted to $20.1 billion and decreased $291.8 million compared to December 31, 2017. The decrease in deposits resulted mainly from declines in demand deposits (aggregate decrease of $430.4 million) and certificates of deposit, (decrease of $94.9 million), but were partly offset by growth in savings, interest checking, and money market accounts (aggregate increase of $233.4 million). The Company’s borrowings totaled $1.9 billion at September 30, 2018, an increase of $354.8 million over balances at December 31, 2017, mainly due to growth in customer repurchase agreements and 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 debt 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, 2018
 
June 30, 2018
 
December 31, 2017
Liquid assets:
 
 
 
 
 
 
  Available for sale debt securities
 
$
8,674,986

 
$
8,412,376

 
$
8,725,442

  Federal funds sold
 
14,375

 
31,500

 
42,775

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

 
700,000

 
700,000

  Balances at the Federal Reserve Bank
 
334,752

 
114,947

 
30,631

  Total
 
$
9,724,113

 
$
9,258,823

 
$
9,498,848


Federal funds sold, which are funds lent to the Company's correspondent bank customers with overnight maturities, totaled $14.4 million as of September 30, 2018. Long-term resale agreements, maturing through 2022, totaled $700.0 million at September 30, 2018. 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 $722.0 million in fair value at September 30, 2018. Interest earning balances at the Federal Reserve Bank, which have overnight maturities and are used for general liquidity purposes, totaled $334.8 million at September 30, 2018. The fair value of the available for sale debt portfolio was $8.7 billion at September 30, 2018 and included an unrealized net loss in fair value of $157.3 million. The total net unrealized loss included net losses of $110.9 million on mortgage-backed and asset-backed securities, $21.3 million on U.S. government and federal agency obligations, $7.0 million on government-sponsored enterprise obligations and $9.4 million on other debt securities.

Approximately $1.1 billion of the available for sale debt 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, 2018
June 30, 2018
December 31, 2017
Investment securities pledged for the purpose of securing:
    
 
 
  Federal Reserve Bank borrowings
$
71,248

$
75,583

$
84,946

  FHLB borrowings and letters of credit
10,476

11,360

13,332

  Securities sold under agreements to repurchase *
2,107,468

1,623,193

2,001,401

  Other deposits and swaps
1,995,714

2,043,502

1,679,024

  Total pledged securities
4,184,906

3,753,638

3,778,703

  Unpledged and available for pledging
3,113,633

3,246,559

3,346,826

  Ineligible for pledging
1,376,447

1,412,179

1,599,913

  Total available for sale debt securities, at fair value
$
8,674,986

$
8,412,376

$
8,725,442

* 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, 2018, such deposits totaled $18.5 billion and represented 91.7% 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 $1.1 billion at September 30, 2018. These accounts are normally considered more volatile and higher costing and comprised 5.4% of total deposits at September 30, 2018.
(In thousands)
September 30, 2018
June 30, 2018
December 31, 2017
Core deposit base:
 
 
 
 Non-interest bearing
$
6,728,605

$
6,876,756

$
7,158,962

 Interest checking
1,747,327

1,592,848

1,533,904

 Savings and money market
9,985,730

10,168,984

9,965,716

 Total
$
18,461,662

$
18,638,588

$
18,658,582



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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, 2018
June 30, 2018
December 31, 2017
Borrowings:
 
 
 
 Federal funds purchased
$
358,940

$
131,685

$
202,370

 Securities sold under agreements to repurchase
1,503,177

1,035,074

1,304,768

 Other debt
1,534

9,291

1,758

 Total
$
1,863,651

$
1,176,050

$
1,508,896


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 $1.5 billion, which generally mature overnight.

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, 2018.
 
September 30, 2018
(In thousands)

FHLB
Federal Reserve

Total
Collateral value pledged
$
2,446,563

$
1,336,653

$
3,783,216

Letters of credit issued
(152,093
)
—

(152,093
)
Available for future advances
$
2,294,470

$
1,336,653

$
3,631,123


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 its 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 increase in cash and cash equivalents of $280.8 million during the first nine months of 2018, 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 $446.7 million and has historically been a stable source of funds. Investing activities, which occur mainly in the loan and investment securities portfolios, used cash of $126.8 million. Activity in the investment securities portfolio used cash of $104.2 million for purchases (net of sales, maturities and pay downs). Financing activities used cash of $39.1 million, largely resulting from dividend

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payments of $82.0 million on common and preferred stock and a net decrease in deposit balances of $272.3 million, partially offset by an increase of $355.0 million in federal funds purchased and securities sold under agreements to repurchase. Additionally, treasury stock purchases used cash of $39.6 million in the first nine months of 2018. 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, 2018 and December 31, 2017, as shown in the following table.

(Dollars in thousands)
September 30, 2018
December 31, 2017
Minimum Ratios under Capital Adequacy Guidelines *
Minimum Ratios
for
Well-Capitalized
Banks **
Risk-adjusted assets
$
18,939,262

$
19,149,949

 
 
Tier I common risk-based capital
2,664,685

2,422,480

 
 
Tier I risk-based capital
2,809,469

2,567,264

 
 
Total risk-based capital
2,970,276

2,747,863

 
 
Tier I common risk-based capital ratio
14.07
%
12.65
%
7.00
%
6.50
%
Tier I risk-based capital ratio
14.83
%
13.41
%
8.50
%
8.00
%
Total risk-based capital ratio
15.68
%
14.35
%
10.50
%
10.00
%
Tier I leverage ratio
11.38
%
10.39
%
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 615,403 shares at an average price of $64.31 during the nine months ended September 30, 2018, which were related to both open market purchases and stock-based compensation transactions. At September 30, 2018, 2,828,120 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 $.235 per share cash dividend on its common stock each quarter thus far in 2018, which was a 9.8% increase compared to its 2017 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, 2018 totaled $10.5 billion (including approximately $5.2 billion in unused approved credit card lines). In addition, the Company enters into standby and commercial letters of credit. These contracts totaled $347.8 million and $14.7 million, respectively, at September 30, 2018. 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 $2.0 million at September 30, 2018.

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 2018, purchases and sales of tax credits amounted to $75.7 million and $53.3 million, respectively. Fees from sales of tax credits were $3.0 million for nine months ended September 30, 2018, compared to $2.6 million in the same period last year. At September 30, 2018, the Company expected to fund outstanding purchase commitments of $73.5 million during the remainder of 2018.


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Segment Results

The table below is a summary of segment pre-tax income results for the first nine months of 2018 and 2017.

(Dollars in thousands)
Consumer
Commercial
Wealth
Segment
Totals    
Other/ Elimination
Consolidated Totals
Nine Months Ended September 30, 2018
    
    
    
    
    
    
Net interest income
$
219,841

$
255,763

$
35,006

$
510,610

$
100,995

$
611,605

Provision for loan losses
(30,658
)
322

32

(30,304
)
(134
)
(30,438
)
Non-interest income
93,729

150,535

128,794

373,058

(4,804
)
368,254

Investment securities gains, net
—

—

—

—

6,641

6,641

Non-interest expense
(213,437
)
(221,854
)
(92,552
)
(527,843
)
(21,353
)
(549,196
)
Income before income taxes
$
69,475

$
184,766

$
71,280

$
325,521

$
81,345

$
406,866

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

$
244,088

$
35,515

$
487,024

$
56,647

$
543,671

Provision for loan losses
(31,531
)
959

(9
)
(30,581
)
(2,009
)
(32,590
)
Non-interest income
88,413

137,139

116,961

342,513

(633
)
341,880

Investment securities losses, net
—

—

—

—

(2,158
)
(2,158
)
Non-interest expense
(204,940
)
(212,327
)
(90,378
)
(507,645
)
(27,839
)
(535,484
)
Income before income taxes
$
59,363

$
169,859

$
62,089

$
291,311

$
24,008

$
315,319

Increase in income before income taxes:
 
 
 
 
 
 
   Amount
$
10,112

$
14,907

$
9,191

$
34,210

$
57,337

$
91,547

   Percent
17.0
%
8.8
%
14.8
%
11.7
%
N.M.

29.0
%

Consumer
For the nine months ended September 30, 2018, income before income taxes for the Consumer segment increased $10.1 million, or 17.0%, compared to the first nine months of 2017. This increase in income before taxes was mainly due to growth in net interest income of $12.4 million, or 6.0%, and non-interest income of $5.3 million, or 6.0%. Also, the provision for loan losses decreased $873 thousand, or 2.8%, from the first nine months of 2017. These increases to income were partly offset by higher non-interest expense of $8.5 million, or 4.1%. Net interest income increased due to a $10.2 million increase in net allocated funding credits assigned to the Consumer segment's loan and deposit portfolios and growth of $2.9 million in loan interest income. Non-interest income increased mainly due to growth in net debit card fees (mainly lower network expense), deposit fees (mainly deposit account service fees and overdraft and return item fees) and mortgage banking revenue. Non-interest expense increased over the same period in the previous year due to higher allocated servicing and support costs, mainly marketing, online banking and information technology. The provision for loan losses totaled $30.7 million, an $873 thousand decrease from the first nine months of 2017, which was mainly due to lower personal loan and marine and RV loan net charge-offs, partly offset by higher consumer credit card loan net charge-offs.

Commercial
For the nine months ended September 30, 2018, income before income taxes for the Commercial segment increased $14.9 million, or 8.8%, compared to the same period in the previous year. This increase was mainly due to higher net interest income and non-interest income, partly offset by higher non-interest expense. Net interest income increased $11.7 million, or 4.8%, due to a $50.8 million increase in loan interest income, partly offset by a decline of $24.4 million in net allocated funding credits and higher interest expense of $14.8 million on deposits and customer repurchase agreements. Non-interest income increased $13.4 million, or 9.8%, over the previous year due to higher net corporate card fees (driven by higher fees and lower network expense), swap fees, and deposit account fees (mainly corporate cash management fees). These increases were partly offset by lower gains on sales of leased assets to customers upon lease termination. Non-interest expense increased $9.5 million, or 4.5%, mainly due to increases in allocated service and support costs (mainly information technology and commercial sales and product support fees). In addition, salaries expense and data processing expense increased over the prior year. The provision for loan losses increased $637 thousand over the same period last year, due to lower net recoveries on construction loans. This increase was partly offset by lower net charge-offs on commercial card loans and higher net recoveries on business real estate loans.


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Wealth
Wealth segment pre-tax profitability for the nine months ended September 30, 2018 increased $9.2 million, or 14.8%, over the same period in the previous year. Net interest income decreased $509 thousand, or 1.4%, mainly due to a decline in net allocated funding credits, partly offset by an increase in loan interest income. Non-interest income increased $11.8 million, or 10.1%, over the prior year largely due to higher private client and institutional trust fees, brokerage fees and cash sweep commissions. These increases were partly offset by write downs on software costs. Non-interest expense increased $2.2 million, or 2.4%, mainly due to higher salary and benefit costs, data processing expense and allocated support and corporate management fee costs, partly offset by lower trust losses and professional fees expense. The provision for loan losses decreased $41 thousand, mainly due to personal real estate loan net recoveries.

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 $57.3 million. This increase was mainly due to higher unallocated net interest income of $44.3 million and lower non-interest expense of $6.5 million, partly offset by lower non-interest income of $4.2 million. Unallocated securities gains were $6.6 million in the first nine months of 2018 compared to losses of $2.2 million in 2017. Also, the unallocated loan loss provision decreased $1.9 million, as the provision was $1.9 million in excess of charge-offs in the first nine months of 2017, while the provision was $200 thousand in excess of charge-offs during the first nine months of 2018.

Impact of Recently Issued Accounting Standards

Derivatives 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 adopted the ASU on January 1, 2018, but as the Company did not utilize hedge accounting on that date, the Company's consolidated financial statements were not affected by the adoption. The hedging improvements in the new guidance were applied to a cash flow hedge that was executed in the third quarter of 2018.

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 was adopted on January 1, 2018 under the full retrospective method with a restatement of prior periods. The impact of the adoption and required disclosures are discussed in Note 13 to the consolidated financial statements.

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 were effective for interim and annual periods beginning January 1, 2018 and did not have a significant effect 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 were effective for reporting periods beginning January 1, 2018 and did not 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 were adopted on January 1, 2018 and are further discussed in Notes 3 and 15 to the consolidated financial statements.

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 were effective January 1, 2018 and did not have a significant effect on the Company's consolidated financial statements.

The FASB issued ASU 2016-18, "Restricted Cash", in November 2016. 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 amounts reported as restricted and the nature of the restrictions on cash and cash equivalents. The amendments, which were applied on a retrospective basis, were effective January 1, 2018 and did not 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 were effective January 1, 2018 and as noted in Note 6 to the consolidated financial statements, did not 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 FASB continues to issue additional ASUs clarifying the lease guidance for certain implementation issues, providing an optional transition method allowing the standard to be initially applied at the adoption date, and providing lessors a practical expedient related to separating components of a lease. Under the ASU and the related amendments, the guidance is effective for interim and annual periods beginning January 1, 2019. The Company is the lessee in approximately 200 lease agreements. At December 31, 2017, future minimum lease payments for operating leases totaled $34 million.  The Company is in the final stages of installing and testing new lease accounting software to comply with the new accounting requirements. All existing lease agreements for which the new accounting standard is to be applied have been reviewed and processes and controls are being developed. Based on preliminary calculations, total right-of-use assets and lease liabilities are expected to range in the amount of $20 million to $30 million and should not materially impact the Company's consolidated financial statements or various balance sheet related ratios.
 
Premium Amortization The FASB issued ASU 2017-08, "Premium Amortization on Purchased Callable Debt Securities", in March 2017. Under current guidance, many entities amortize the premium on purchased callable debt securities over the contractual life of the instrument. As a result, upon the exercise of a call on a callable debt security held at a premium, the unamortized premium is recorded as a loss in earnings. The amendments in this ASU shorten the amortization period for certain callable debt securities held at a premium to the earliest call date, and more closely align the amortization period to expectations incorporated in market pricing of the instrument. The amendments are effective January 1, 2019 and are not expected to have a significant effect on the Company's consolidated financial statements.

Financial Instruments ASU 2016-13, "Measurement of Credit Losses on Financial Instruments", was issued in June 2016. Its implementation will result in a new loan loss accounting framework, also known as the current expected credit loss (CECL) model. CECL requires credit losses expected throughout the life of the asset portfolio on loans and held-to-maturity securities to be recorded at the time of origination. Under the current incurred loss model, losses are recorded when it is probable that a loss event has occurred. The new standard will require significant operational changes, especially in data collection and analysis. The ASU is effective for interim and annual periods beginning January 1, 2020, and is expected to increase the allowance upon adoption.

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The Company continues through its internal working group and its outside vendor and advisor to assess and address the various requirements of CECL and how the software purchased to assist with CECL calculations would operate. Based on preliminary model selections for the various loan segments, we continue to identify and address various data needs required in the software while working with the software vendor to set appropriate parameters. Our project plan targets year-end 2018 for initial proforma CECL calculations. 

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.

Comprehensive Income The FASB issued ASU 2018-02, "Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income", in February 2018. The guidance allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The amendments are effective for all entities effective January 1, 2019, but early adoption is permitted in certain circumstances. The Company adopted the ASU effective January 1, 2018 and recorded a reclassification which increased accumulated other comprehensive income and reduced retained earnings by $2.9 million. As these are both categories within equity, total equity was unchanged. The adoption did not have a significant effect on the Company's consolidated financial statements.

Financial Instruments The FASB issued ASU 2018-13, "Changes to the Disclosure Requirements of Fair Value Measurement", in August 2018. The amendments in the ASU eliminate or modify certain disclosure requirements for fair value measurements in Topic 820, Fair Value Measurement. In addition, the amendments in the ASU also require the addition of new disclosure requirements on fair value measurement, including the disclosure of changes in unrealized gains and losses for the period included in AOCI for recurring Level 3 fair value measurements and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The guidance is effective January 1, 2020, but early adoption is permitted. The Company is still assessing the impact on the Company's consolidated financial statements.

Intangible Assets The FASB issued ASU 2018-15, "Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract", in August 2018. Under current guidance, the accounting for implementation costs of a hosting arrangement that is a service contract is not specifically addressed. Under the new amendments, the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract are aligned with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software or hosting arrangements that include internal-use software license. The guidance is effective January 1, 2020, but early adoption is permitted. The Company is still assessing the impact on the Company's consolidated financial statements.




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AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
Three Months Ended September 30, 2018 and 2017
 
Third Quarter 2018
 
Third Quarter 2017
(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)
$
4,926,063

$
47,138

3.80
%
 
$
4,777,222

$
39,134

3.25
%
Real estate — construction and land
992,045

13,039

5.21

 
887,596

9,649

4.31

Real estate — business
2,732,968

29,946

4.35

 
2,710,453

26,325

3.85

Real estate — personal
2,110,945

20,391

3.83

 
2,017,264

18,912

3.72

Consumer
1,984,643

22,310

4.46

 
2,070,398

20,986

4.02

Revolving home equity
373,819

4,448

4.72

 
395,212

4,017

4.03

Consumer credit card
774,512

23,411

11.99

 
739,692

22,422

12.03

Overdrafts
4,704

—

—

 
4,373

—

—

Total loans
13,899,699

160,683

4.59

 
13,602,210

141,445

4.13

Loans held for sale
18,201

315

6.87

 
21,227

287

5.36

Investment securities:
  
 
 
 
 
 
 
U.S. government and federal agency obligations
923,557

5,183

2.23

 
917,808

3,232

1.40

Government-sponsored enterprise obligations
261,938

1,385

2.10

 
456,668

1,855

1.61

State and municipal obligations(A)
1,375,768

10,335

2.98

 
1,699,365

15,279

3.57

Mortgage-backed securities
4,434,119

29,578

2.65

 
3,718,697

22,155

2.36

Asset-backed securities
1,427,041

8,700

2.42

 
2,025,415

9,288

1.82

Other debt securities
339,952

2,223

2.59

 
322,231

2,041

2.51

Trading debt securities(A)
24,490

193

3.13

 
21,149

134

2.51

Equity securities(A)
4,466

368

32.69

 
51,204

520

4.02

Other securities(A)
120,206

3,940

13.00

 
100,776

1,369

5.39

Total investment securities
8,911,537

61,905

2.76

 
9,313,313

55,873

2.37

Federal funds sold and short-term securities
 
 
 
 
 
 
 
purchased under agreements to resell
13,042

69

2.10

 
23,807

78

1.30

Long-term securities purchased
 
 
 
 
 
 
 
under agreements to resell
685,869

3,915

2.26

 
662,490

3,805

2.28

Interest earning deposits with banks
298,632

1,478

1.96

 
211,219

662

1.24

Total interest earning assets
23,826,980

228,365

3.80

 
23,834,266

202,150

3.36

Allowance for loan losses
(158,840
)
 
 
 
(156,909
)
 
 
Unrealized gain (loss) on debt securities
(119,319
)
 
 
 
73,291

 
 
Cash and due from banks
356,958

 
 
 
348,554

 
 
Land, buildings and equipment, net
343,755

 
 
 
345,139

 
 
Other assets
446,537

 
 
 
428,537

 
 
Total assets
$
24,696,071

 
 
 
$
24,872,878

 
 
LIABILITIES AND EQUITY:
 
 
 
 
 
 
 
Interest bearing deposits:
 
 
 
 
 
 
 
Savings
$
877,347

249

.11

 
$
829,197

252

.12

Interest checking and money market
10,839,310

6,981

.26

 
10,387,212

4,189

.16

Time open & C.D.'s of less than $100,000
593,936

834

.56

 
667,710

676

.40

Time open & C.D.'s of $100,000 and over
1,100,299

3,899

1.41

 
1,326,290

2,784

.83

Total interest bearing deposits
13,410,892

11,963

.35

 
13,210,409

7,901

.24

Borrowings:
 
 
 
 
 
 
 
Federal funds purchased and securities sold
 
 
 
 
 
 
 
under agreements to repurchase
1,499,837

5,022

1.33

 
1,500,987

2,846

.75

Other borrowings
1,833

12

2.60

 
101,904

906

3.53

Total borrowings
1,501,670

5,034

1.33

 
1,602,891

3,752

.93

Total interest bearing liabilities
14,912,562

16,997

.45
%
 
14,813,300

11,653

.31
%
Non-interest bearing deposits
6,677,665

 
 
 
7,135,703

 
 
Other liabilities
296,884

 
 
 
251,714

 
 
Equity
2,808,960

 
 
 
2,672,161

 
 
Total liabilities and equity
$
24,696,071

 
 
 
$
24,872,878

 
 
Net interest margin (T/E)
 
$
211,368

 
 
 
$
190,497

 
Net yield on interest earning assets
 
 
3.52
%
 
 
 
3.17
%
(A) Stated on a tax equivalent basis using a federal income tax rate of 21% in 2018 and 35% in prior periods.


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AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
Nine Months Ended September 30, 2018 and 2017
 
Nine Months 2018
 
Nine Months 2017
(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)
$
4,940,920

$
135,047

3.65
%
 
$
4,836,637

$
114,326

3.16
%
Real estate — construction and land
972,090

36,307

4.99

 
859,582

26,775

4.16

Real estate — business
2,731,156

86,036

4.21

 
2,685,947

75,240

3.75

Real estate — personal
2,084,179

59,649

3.83

 
2,011,257

56,087

3.73

Consumer
2,027,145

66,223

4.37

 
2,014,701

59,531

3.95

Revolving home equity
381,568

12,819

4.49

 
400,087

11,481

3.84

Consumer credit card
762,196

68,611

12.04

 
739,619

65,630

11.86

Overdrafts
4,610

—

—

 
4,355

—

—

Total loans
13,903,864

464,692

4.47

 
13,552,185

409,070

4.04

Loans held for sale
19,836

991

6.68

 
17,214

746

5.79

Investment securities:
 
 
 
 
 
 
 

U.S. government and federal agency obligations
921,157

17,299

2.51

 
914,050

13,677

2.00

Government-sponsored enterprise obligations
340,065

4,882

1.92

 
452,529

5,396

1.59

State and municipal obligations(A)
1,427,422

32,375

3.03

 
1,751,074

47,270

3.61

Mortgage-backed securities
4,144,253

81,358

2.62

 
3,728,886

65,955

2.36

Asset-backed securities
1,434,454

24,477

2.28

 
2,238,910

28,805

1.72

Other debt securities
340,666

6,684

2.62

 
323,351

6,140

2.54

Trading debt securities(A)
24,195

546

3.02

 
22,444

448

2.67

Equity securities(A)
33,882

11,370

44.87

 
53,478

1,598

4.00

Other securities(A)
109,991

7,423

9.02

 
99,602

8,902

11.95

Total investment securities
8,776,085

186,414

2.84

 
9,584,324

178,191

2.49

Federal funds sold and short-term securities
 
 
 
 
 
 
 
purchased under agreements to resell
31,276

426

1.82

 
15,654

138

1.18

Long-term securities purchased
 
 
 
 
 
 
 
under agreements to resell
695,238

11,814

2.27

 
684,153

11,282

2.20

Interest earning deposits with banks
308,829

4,208

1.82

 
186,054

1,421

1.02

Total interest earning assets
23,735,128

668,545

3.77

 
24,039,584

600,848

3.34

Allowance for loan losses
(158,761
)
 
 
 
(156,419
)
 
 
Unrealized gain (loss) on debt securities
(95,169
)
 
 
 
48,754

 
 
Cash and due from banks
359,160

 
 
 
357,948

 
 
Land, buildings and equipment, net
343,824

 
 
 
345,123

 
 
Other assets
434,325

 
 
 
419,586

 
 
Total assets
$
24,618,507

 
 
 
$
25,054,576

 
 
LIABILITIES AND EQUITY:
 
 
 
 
 
 
 
Interest bearing deposits:
 
 
 
 
 
 
 
Savings
$
865,905

733

.11

 
$
818,766

738

.12

Interest checking and money market
10,809,459

18,605

.23

 
10,551,953

11,935

.15

Time open & C.D.'s of less than $100,000
609,307

2,190

.48

 
686,827

1,994

.39

Time open & C.D.'s of $100,000 and over
1,123,007

10,221

1.22

 
1,501,209

8,369

.75

Total interest bearing deposits
13,407,678

31,749

.32

 
13,558,755

23,036

.23

Borrowings:
 
 
 
 
 
 
 
Federal funds purchased and securities sold
 
 
 
 
 
 
 
under agreements to repurchase
1,466,340

12,979

1.18

 
1,407,308

6,423

.61

Other borrowings
1,886

36

2.55

 
103,075

2,705

3.51

Total borrowings
1,468,226

13,015

1.19

 
1,510,383

9,128

.81

Total interest bearing liabilities
14,875,904

44,764

.40
%
 
15,069,138

32,164

.29
%
Non-interest bearing deposits
6,749,951

 
 
 
7,149,010

 
 
Other liabilities
241,815

 
 
 
229,730

 
 
Equity
2,750,837

 
 
 
2,606,698

 
 
Total liabilities and equity
$
24,618,507

 
 
 
$
25,054,576

 
 
Net interest margin (T/E)
 
$
623,781

 
 
 
$
568,684

 
Net yield on interest earning assets
 
 
3.51
%
 
 
 
3.16
%
(A) Stated on a tax equivalent basis using a federal income tax rate of 21% in 2018 and 35% in prior periods.





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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 income 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 2017 Annual Report on Form 10-K.

The tables below compute the effects of gradual shifts in 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 and one falling rates scenario 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 or decreased 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, 2018
 
June 30, 2018
 (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
$
7.0

.85
 %
 
$
(360.6
)
 
$
(.2
)
(.02
)%
 
$
(339.6
)
200 basis points rising
7.3

.88

 
(248.6
)
 
2.0

.24

 
(234.1
)
100 basis points rising
5.7

.69

 
(128.9
)
 
2.5

.31

 
(120.3
)
100 basis points falling
(13.0
)
(1.56
)
 
139.3

 
(18.7
)
(2.32
)
 
131.8


Simulation B
September 30, 2018
 
June 30, 2018
 (Dollars in millions)
$ Change in
Net Interest
Income
% Change in
Net Interest
Income
 
Assumed Deposit Attrition
 
$ Change in
Net Interest
Income
% Change in
Net Interest
Income
 
Assumed Deposit Attrition
300 basis points rising
$
(15.4
)
(1.85
)%
 
$
(947.2
)
 
$
(21.4
)
(2.65
)%
 
$
(933.9
)
200 basis points rising
(12.7
)
(1.53
)
 
(838.8
)
 
(16.8
)
(2.09
)
 
(830.0
)
100 basis points rising
(11.8
)
(1.42
)
 
(723.3
)
 
(13.9
)
(1.72
)
 
(717.9
)

The difference in these two simulations is the degree in which deposits are modeled to decline in a rising rate environment, 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.  Simulation B assumes a much larger deposit attrition factor with deposits declining $947.2 million in the 300 basis points scenario compared with a decline of $360.6 million in deposits under Simulation A.  The 100 basis points falling rate scenario in Simulation A assumes that deposits would increase $139.3 million due to greater customer deposit liquidity in a falling rate environment.

Under Simulation A, a gradual increase in interest rates of 100 basis points is expected to increase net interest income over the base calculation by $5.7 million, while a gradual increase in rates of 200 basis points would increase net interest income $7.3 million. An increase in rates of 300 basis points would result in an increase in net interest income of $7.0 million, while a gradual decrease in interest rates of 100 basis points would lower net interest income $13.0 million. The change in net interest income from the base calculation at September 30, 2018 was higher than projections made in the prior quarter for both the 100, 200 and 300 basis points rising scenarios mainly due to lower deposit balances in the current quarter, which kept funding costs lower in a

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rising rate environment than in previous projections.  Under the 100 basis point rising rate scenario, deposit attrition was higher in the current quarter than the prior quarter, which helped to lower interest expense projections, and higher rates on loans, investments, and other assets provided a greater increase in interest income than in the prior quarter’s projection. As a result, net interest income increased more in the current quarter than the previous quarter for the 100 basis point rising rate scenario.  Under the 100 basis point falling rate scenario, net income is reduced by $13.0 million mainly due to the fact that rates on loans declined faster than rates paid on deposits.  Furthermore, under this scenario, deposits are projected to grow $139.3 million, with these proceeds invested in lower-earning assets.

Simulation B utilizes similar assumptions to Simulation A but assumes greater deposit attrition under rising rate scenarios. Doing so provides greater stress on projected net interest income to enable better analysis on interest rate risk.  Under the rising rate scenarios in Simulation B, net interest income declines more than in Simulation A as more expensive short-term borrowings are assumed to replace the declining deposit balances.  The results under Simulation B were only slightly different than in the prior quarter mainly due to higher loan balances and lower deposit balances in the current quarter.  The falling rate scenario in Simulation B would approximate the results in Simulation A, as the same assumptions are utilized in both simulations.

Projecting deposit activity in a period of historically low interest rates is difficult, and the Company cannot predict how deposits will actually react to rising rates.  The simulations above provide insight into potential effects of changes in rates and deposit levels on net interest income.  The Company believes that its approach to interest rate risk has appropriately considered its susceptibility to both rising and falling rates and has adopted strategies which minimize the impact of interest rate risk.

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, 2018. 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 16, 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, 2018
25,936

 
$
67.91

25,936

3,095,139

August 1 — 31, 2018
175,440

 
$
70.18

175,440

2,919,699

September 1 — 30, 2018
91,579

 
$
70.23

91,579

2,828,120

Total
292,955

 
$
70.00

292,955

2,828,120


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, 2,828,120 shares remained available for purchase at September 30, 2018.


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 5, 2018
By 
/s/  JEFFERY D. ABERDEEN
 
Jeffery D. Aberdeen
 
Controller
 
(Chief Accounting Officer)

Date: November 5, 2018


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