Investment Securities

Investment securities, at fair value, consisted of the following at June 30, 2012 and December 31, 2011.



(In thousands)	June 30, 2012		Dec. 31, 2011
Available for sale	$	9,206,451	$	9,224,702
Trading	14,313		17,853
Non-marketable	116,190		115,832
Total investment securities	$	9,336,954	$	9,358,387

Most of the Company’s investment securities are classified as available for sale, and this portfolio is discussed in more detail below. Securities which are classified as non-marketable include Federal Home Loan Bank (FHLB) stock and Federal Reserve Bank stock held for debt and regulatory purposes, which totaled $45.3 million at both June 30, 2012 and December 31, 2011. Investment in Federal Reserve Bank stock is based on the capital structure of the investing bank, and investment in FHLB stock is tied to the level of borrowings from the FHLB. Non-marketable securities also include private equity investments, which amounted to $70.9 million and $70.5 million at June 30, 2012 and December 31, 2011, respectively.

A summary of the available for sale investment securities by maturity groupings as of June 30, 2012 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. 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. The Company does not have exposure to subprime originated mortgage-backed or collateralized debt obligation instruments.



(In thousands)	Amortized Cost		Fair Value
U.S. government and federal agency obligations:
Within 1 year	$	7,962	$	8,014
After 1 but within 5 years	189,657		206,839
After 5 but within 10 years	135,908		155,270
Total U.S. government and federal agency obligations	333,527		370,123
Government-sponsored enterprise obligations:
After 1 but within 5 years	108,745		112,338
After 5 but within 10 years	28,318		28,561
After 10 years	125,441		125,803
Total government-sponsored enterprise obligations	262,504		266,702
State and municipal obligations:
Within 1 year	87,437		88,192
After 1 but within 5 years	591,654		614,243
After 5 but within 10 years	453,346		468,436
After 10 years	200,329		187,666
Total state and municipal obligations	1,332,766		1,358,537
Mortgage and asset-backed securities:
Agency mortgage-backed securities	3,660,014		3,802,110
Non-agency mortgage-backed securities	262,191		269,304
Asset-backed securities	2,981,425		2,991,092
Total mortgage and asset-backed securities	6,903,630		7,062,506
Other debt securities:
Within 1 year	36,708		37,495
After 1 but within 5 years	69,786		73,319
Total other debt securities	106,494		110,814
Equity securities	14,135		37,769
Total available for sale investment securities	$	8,953,056	$	9,206,451

Included in U.S. government securities are $362.0 million, at fair value, of U.S. Treasury inflation-protected securities (TIPS). 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 $127.5 million, at fair value, of auction rate securities, which were purchased from bank customers in 2008. Included in equity securities is common stock held by the holding company, Commerce Bancshares, Inc. (the Parent), with a fair value of $27.0 million at June 30, 2012.

For securities classified as available for sale, the following table shows the unrealized gains and losses (pre-tax) in accumulated other comprehensive income, by security type.



(In thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
June 30, 2012
U.S. government and federal agency obligations	$	333,527	$	36,596	$	—		$	370,123
Government-sponsored enterprise obligations	262,504		4,326		(128		)	266,702
State and municipal obligations	1,332,766		42,003		(16,232		)	1,358,537
Mortgage and asset-backed securities:
Agency mortgage-backed securities	3,660,014		142,232		(136		)	3,802,110
Non-agency mortgage-backed securities	262,191		9,515		(2,402		)	269,304
Asset-backed securities	2,981,425		11,637		(1,970		)	2,991,092
Total mortgage and asset-backed securities	6,903,630		163,384		(4,508		)	7,062,506
Other debt securities	106,494		4,320		—			110,814
Equity securities	14,135		23,634		—			37,769
Total	$	8,953,056	$	274,263	$	(20,868	)	$	9,206,451
December 31, 2011
U.S. government and federal agency obligations	$	328,530	$	36,135	$	—		$	364,665
Government-sponsored enterprise obligations	311,529		4,169		—			315,698
State and municipal obligations	1,220,840		35,663		(11,219		)	1,245,284
Mortgage and asset-backed securities:
Agency mortgage-backed securities	3,989,464		117,088		(493		)	4,106,059
Non-agency mortgage-backed securities	315,752		8,962		(7,812		)	316,902
Asset-backed securities	2,692,436		7,083		(6,376		)	2,693,143
Total mortgage and asset-backed securities	6,997,652		133,133		(14,681		)	7,116,104
Other debt securities	135,190		6,070		—			141,260
Equity securities	18,354		23,337		—			41,691
Total	$	9,012,095	$	238,507	$	(25,900	)	$	9,224,702

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/A-, whose fair values have fallen more than 20% below purchase price for an extended period of time, or have been identified based on management’s judgment. These securities are placed on a watch list, and for all such securities, detailed cash flow models are prepared which use inputs specific to each security. Inputs to these models include factors such as cash flow received, contractual payments required, and various other information related to the underlying collateral (including current delinquencies), collateral loss severity rates (including loan to values), expected delinquency rates, credit support from other tranches, and prepayment speeds. Stress tests are performed at varying levels of delinquency rates, prepayment speeds and loss severities in order to gauge probable ranges of credit loss. At June 30, 2012, the fair value of securities on this watch list was $211.4 million.

As of June 30, 2012, 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 $109.9 million. The credit-related portion of the impairment totaled $10.7 million and was recorded in earnings. The noncredit-related portion of the impairment totaled $684 thousand on a pre-tax basis, and has been recognized in accumulated other comprehensive income. 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 bases.

The credit 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 included the following:



Significant Inputs	Range
Prepayment CPR	0%	-	30%
Projected cumulative default	13%	-	53%
Credit support	0%	-	17%
Loss severity	33%	-	57%

The following table shows changes in the credit losses recorded in the six months ended June 30, 2012 and 2011, for which a portion of an OTTI was recognized in other comprehensive income.



	For the Six Months Ended June 30
(In thousands)	2012			2011
Balance at January 1	$	9,931		$	7,542
Credit losses on debt securities for which impairment was not previously recognized	—			53
Credit losses on debt securities for which impairment was previously recognized	670			871
Increase in expected cash flows that are recognized over remaining life of security	(70		)	(53		)
Balance at June 30	$	10,531		$	8,413

Securities with unrealized losses recorded in accumulated other comprehensive income are shown in the table below, along with the length of the impairment period.



	Less than 12 months				12 months or longer				Total
(In thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
June 30, 2012
Government-sponsored enterprise obligations	$	32,357	$	128	$	—	$	—	$	32,357	$	128
State and municipal obligations	130,356		940		87,238		15,292		217,594		16,232
Mortgage and asset-backed securities:
Agency mortgage-backed securities	7,292		8		19,737		128		27,029		136
Non-agency mortgage-backed securities	—		—		74,614		2,402		74,614		2,402
Asset-backed securities	374,732		1,488		70,362		482		445,094		1,970
Total mortgage and asset-backed securities	382,024		1,496		164,713		3,012		546,737		4,508
Total	$	544,737	$	2,564	$	251,951	$	18,304	$	796,688	$	20,868
December 31, 2011
State and municipal obligations	$	65,962	$	712	$	110,807	$	10,507	$	176,769	$	11,219
Mortgage and asset-backed securities:
Agency mortgage-backed securities	72,019		493		—		—		72,019		493
Non-agency mortgage-backed securities	23,672		784		118,972		7,028		142,644		7,812
Asset-backed securities	1,236,526		4,982		87,224		1,394		1,323,750		6,376
Total mortgage and asset-backed securities	1,332,217		6,259		206,196		8,422		1,538,413		14,681
Total	$	1,398,179	$	6,971	$	317,003	$	18,929	$	1,715,182	$	25,900

The total available for sale portfolio consisted of approximately 1,600 individual securities at June 30, 2012. The portfolio included 121 securities, having an aggregate fair value of $796.7 million, that were in a loss position at June 30, 2012. Securities identified as other-than-temporarily impaired which have been in a loss position for 12 months or longer totaled $60.5 million at fair value, or .7% of the total available for sale portfolio value. Securities with temporary impairment which have been in a loss position for 12 months or longer totaled $191.5 million, or 2.1% of the total portfolio value.

The Company’s holdings of state and municipal obligations included gross unrealized losses of $16.2 million at June 30, 2012. Of these losses, $15.8 million related to auction rate securities (ARS) and $430 thousand related to other state and municipal obligations. This portfolio, exclusive of ARS, totaled $1.2 billion at fair value, or 13.4% of total available for sale securities. The average credit quality of the portfolio, excluding ARS, is Aa2 as rated by Moody’s. The portfolio is diversified in order to reduce risk, and information about the largest holdings, by state and economic sector, is shown in the table below.



	% of Portfolio		Average Life (in years)	Average Rating (Moody’s)
At June 30, 2012
Texas	10.3	%	5.3	Aa1
Florida	8.8		4.5	Aa2
Washington	6.0		3.8	Aa2
Arizona	5.1		3.7	Aa3
Ohio	4.8		4.9	Aa2
General obligation	27.6	%	4.3	Aa2
Housing	21.7		5.5	Aa1
Transportation	13.9		3.9	Aa3
Lease	13.5		3.5	Aa3
Limited Tax	6.1		5.1	Aa1

The remaining unrealized losses on the Company’s investments, as shown in the preceding tables, are largely contained in the categories of non-agency mortgage-backed and other asset-backed securities. These securities are not guaranteed by an outside agency and are dependent on payments received from the underlying collateral. While virtually all of these securities, at purchase date, were comprised of senior tranches and were highly rated by various rating agencies, changes in interest rates, the adverse housing market, liquidity pressures, and overall economic climate has resulted in low fair values for certain of these securities. As mentioned above, the Company maintains a watch list comprised mostly of these securities, and has recorded OTTI losses on certain of these securities.

The following table presents proceeds from sales of securities and the components of investment securities gains and losses which have been recognized in earnings.



	For the Six Months Ended June 30
(In thousands)	2012			2011
Proceeds from sales of available for sale securities	$	4,951		$	11,202
Proceeds from sales of non-marketable securities	9,165			—
Total proceeds	$	14,116		$	11,202
Available for sale:
Gains realized on sales	$	342		$	177
Other-than-temporary impairment recognized on debt securities	(670		)	(924		)
Non-marketable:
Gains realized on sales	304			—
Losses realized on sales	(200		)	—
Fair value adjustments, net	5,600			4,030
Investment securities gains, net	$	5,376		$	3,283

At June 30, 2012, securities carried at $4.1 billion were pledged to secure public fund deposits, securities sold under agreements to repurchase, trust funds, and borrowings at the Federal Reserve Bank and FHLB. Securities pledged under agreements pursuant to which the collateral may be sold or re-pledged by the secured parties approximated $629.6 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 exceeds 10% of stockholders’ equity.