10-K 1 cbsh1231201810k.htm 10-K Document

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549
FORM 10-K

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

For the Fiscal Year Ended December 31, 2018 — 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
(Zip Code)
(Address of principal executive offices)
 
(Zip Code)
(816) 234-2000
 
 
(Registrant’s telephone number, including area code)
 
 
Securities registered pursuant to Section 12(b) of the Act:
 
 
 
Title of class
 
Name of exchange on which registered
$5 Par Value Common Stock
 
NASDAQ Global Select Market
Depositary Shares, each representing a 1/1000th interest in a share of 6.0% Series B Non-Cumulative Perpetual Preferred Stock
 
NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No þ
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark 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 and post such files). Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 o
Emerging growth company o
 
 
 (Do not check if a smaller reporting 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 June 30, 2018, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $6,364,000,000.
As of February 14, 2019, there were 110,901,627 shares of Registrant’s $5 Par Value Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s definitive proxy statement for its 2019 annual meeting of shareholders, which will be filed within 120 days of December 31, 2018, are incorporated by reference into Part III of this Report.
 


Commerce Bancshares, Inc.
 
 
 
 
 
 
Form 10-K
 
 
 
 
 
 
 
INDEX
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



2

PART I
Item 1.
BUSINESS
General
Commerce Bancshares, Inc., a bank holding company as defined in the Bank Holding Company Act of 1956, as amended, was incorporated under the laws of Missouri on August 4, 1966. Through a second tier wholly-owned bank holding company, it owns all the outstanding capital stock of Commerce Bank (the “Bank”), which is headquartered in Missouri. The Bank engages in general banking business, providing a broad range of retail, mortgage banking, corporate, investment, trust, and asset management products and services to individuals and businesses. Commerce Bancshares, Inc. also owns, directly or through the Bank, various non-banking subsidiaries. Their activities include private equity investment, securities brokerage, insurance agency, and leasing activities. A list of Commerce Bancshares, Inc.'s subsidiaries is included as Exhibit 21.

Commerce Bancshares, Inc. and its subsidiaries (collectively, the "Company") is one of the nation’s top 50 bank holding companies, based on asset size. At December 31, 2018, the Company had consolidated assets of $25.5 billion, loans of $14.1 billion, deposits of $20.3 billion, and equity of $2.9 billion. The Company’s operations are consolidated for purposes of preparing the Company’s consolidated financial statements. The Company's principal markets, which are served by 169 branch facilities, are located throughout Missouri, Kansas, and central Illinois, as well as Tulsa and Oklahoma City, Oklahoma and Denver, Colorado. Its two largest markets are St. Louis and Kansas City, which serve as central hubs for the Company. The Company also has offices supporting its commercial customers in Dallas, Houston, Cincinnati, Nashville, Des Moines, Indianapolis, and Grand Rapids, and operates a payments business with sales representatives covering the continental United States of America (“U.S.”).

The Company’s goal is to be the preferred provider of financial services in its communities, based on strong customer relationships built through providing top quality service with a strong risk management culture, and employing a strong balance sheet with industry-leading capital levels. The Company operates under a super-community banking format which incorporates large bank product offerings coupled with deep local market knowledge, augmented by experienced, centralized support in select, critical areas. The Company’s focus on local markets is supported by an experienced team of bankers assigned to each market coupled with industry specialists. The Company also uses regional advisory boards, comprised of local business persons, professionals and other community representatives, who assist the Company in responding to local banking needs. In addition to this local market, community-based focus, the Company offers sophisticated financial products usually only available at much larger financial institutions.

The markets the Bank serves, being mainly located in the lower Midwest, provide natural sites for production and distribution facilities and serve as transportation hubs. The economy has been well-diversified in these markets with many major industries represented, including telecommunications, automobile, technology, financial services, aircraft and general manufacturing, health care, numerous service industries, and food and agricultural production. The real estate lending operations of the Bank are predominantly centered in its lower Midwestern markets. Historically, these markets have tended to be less volatile than in other parts of the country. Management believes the diversity and nature of the Bank’s markets has a mitigating effect on real estate loan losses in these markets.

From time to time, the Company evaluates the potential acquisition of various financial institutions. In addition, the Company regularly considers the purchase and disposition of real estate assets and branch locations as situations dictate. The Company seeks merger or acquisition partners that are culturally similar, have experienced management and either possess significant market presence or have potential for improved profitability through financial management, economies of scale and expanded services. The Company has not completed any bank acquisitions since 2013.

Employees
The Company employed 4,570 persons on a full-time basis and 299 persons on a part-time basis at December 31, 2018. The Company provides a comprehensive array of flexible benefit programs to its employees with a focus on financial and physical wellness. The Company's financial benefits package includes a company-matching 401(k) savings plan, a 529 college savings plan, and educational and adoption assistance programs. The Company's physical wellness package includes health, dental, vision, life and various other insurances, as well as a wellness program that incentivizes employees to live a healthy and balanced lifestyle. The Company has developed several training and development programs designed to challenge and develop the management and leadership skills of employees, promote collaboration amongst various internal departments and geographic locations, and share best-practices to meet the needs of customers and communities. The Company has also developed numerous training courses targeted to develop interpersonal and technical skills, as well as, to provide training on new banking regulations. None of the Company's employees are represented by collective bargaining agreements.


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Competition
The Company operates in the highly competitive environment of financial services. The Company regularly faces competition from banks, savings and loan associations, credit unions, brokerage companies, mortgage companies, insurance companies, trust companies, credit card companies, private equity firms, leasing companies, securities brokers and dealers, financial technology companies, e-commerce companies, mutual fund companies, and other companies providing financial services. Some of these competitors are not subject to the same regulatory restrictions as domestic banks and bank holding companies. Some other competitors are significantly larger than the Company, and therefore have greater economies of scale, greater financial resources, higher lending limits, and may offer products and services that the Company does not provide. The Company competes by providing a broad offering of products and services to support the needs of customers, matched with a strong commitment to customer service. The Company also competes based on quality, innovation, convenience of locations, reputation, industry knowledge, and price. In its two largest markets, the Company has approximately 13% of the deposit market share in Kansas City and approximately 9% of the deposit market share in St. Louis.

Operating Segments
The Company is managed in three operating segments: Commercial, Consumer, and Wealth. The Commercial segment provides a full array of corporate lending, merchant and commercial bank card products, leasing, and international services, as well as business and government deposit, investment, and cash management services. The Consumer segment includes the retail branch network, consumer installment lending, personal mortgage banking, and consumer debit and credit bank card activities. The Wealth segment provides traditional trust and estate planning services, brokerage services, and advisory and discretionary investment portfolio management services to both personal and institutional corporate customers. In 2018, the Commercial, Consumer and Wealth segments contributed 57%, 21% and 22% of total segment pre-tax income, respectively. Additional information relating to operating segments can be found on pages 48 and 95.

Government Policies
The Company's operations are affected by federal and state legislative changes, by the United States government, and by policies of various regulatory authorities, including those of the numerous states in which they operate. These include, for example, the statutory minimum legal lending rates, domestic monetary policies of the Board of Governors of the Federal Reserve System, United States fiscal policy, international currency regulations and monetary policies, the U.S. Patriot Act, and capital adequacy and liquidity constraints imposed by federal and state bank regulatory agencies.

Supervision and Regulation
The following information summarizes existing laws and regulations that materially affect the Company's operations. It does not discuss all provisions of these laws and regulations, and it does not include all laws and regulations that affect the Company presently or may affect the Company in the future.
General
The Company, as a bank holding company, is primarily regulated by the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, as amended (BHC Act). Under the BHC Act, the Federal Reserve Board’s prior approval is required in any case in which the Company proposes to acquire all or substantially all the assets of any bank, acquire direct or indirect ownership or control of more than 5% of the voting shares of any bank, or merge or consolidate with any other bank holding company. With certain exceptions, the BHC Act also prohibits the Company from acquiring direct or indirect ownership or control of more than 5% of any class of voting shares of any non-banking company. Under the BHC Act, the Company may not engage in any business other than managing and controlling banks or furnishing certain specified services to subsidiaries, and may not acquire voting control of non-banking companies unless the Federal Reserve Board determines such businesses and services to be closely related to banking. When reviewing bank acquisition applications for approval, the Federal Reserve Board considers, among other things, the Bank’s record in meeting the credit needs of the communities it serves in accordance with the Community Reinvestment Act of 1977, as amended (CRA). Under the terms of the CRA, banks have a continuing obligation, consistent with safe and sound operation, to help meet the credit needs of their communities, including providing credit to individuals residing in low- and moderate-income areas. The Bank has a current CRA rating of “outstanding.”

The Company is required to file various reports and additional information with the Federal Reserve Board. The Federal Reserve Board regularly performs examinations of the Company. The Bank is a state-chartered Federal Reserve member bank and is subject to regulation, supervision and examination by the Federal Reserve Bank of Kansas City and the Missouri Division of Finance. The Bank is also subject to regulation by the Federal Deposit Insurance Corporation (FDIC). In addition, there are numerous other federal and state laws and regulations which control the activities of the Company, including requirements and limitations relating to capital and reserve requirements, permissible investments and lines of business, transactions with affiliates, loan limits, mergers and acquisitions, issuance of securities, dividend payments, and extensions of credit. The Bank is subject to

4

federal and state consumer protection laws, including laws designed to protect customers and promote fair lending. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, and their respective state law counterparts. If the Company fails to comply with these or other applicable laws and regulations, it may be subject to civil monetary penalties, imposition of cease and desist orders or other written directives, removal of management and, in certain circumstances, criminal penalties. This regulatory framework is intended primarily for the protection of depositors and the preservation of the federal deposit insurance funds. Statutory and regulatory controls increase a bank holding company’s cost of doing business and limit the options of its management to employ assets and maximize income.

In addition to its regulatory powers, the Federal Reserve Bank affects the conditions under which the Company operates by its influence over the national supply of bank credit. The Federal Reserve Board employs open market operations in U.S. government securities and oversees changes in the discount rate on bank borrowings, changes in the federal funds rate on overnight inter-bank borrowings, and changes in reserve requirements on bank deposits in implementing its monetary policy objectives. These methods are used in varying combinations to influence the overall level of the interest rates charged on loans and paid for deposits, the price of the dollar in foreign exchange markets, and the level of inflation. The monetary policies of the Federal Reserve have a significant effect on the operating results of financial institutions, most notably on the interest rate environment. In view of changing conditions in the national economy and in the money markets, as well as the effect of credit policies of monetary and fiscal authorities, the Company makes no prediction as to possible future changes in interest rates, deposit levels or loan demand, or their effect on the financial statements of the Company.

The financial industry operates under laws and regulations that are under regular review by various agencies and legislatures and are subject to change. The Company currently operates as a bank holding company, as defined by the Gramm-Leach-Bliley Financial Modernization Act of 1999 (GLB Act), and the Bank qualifies as a financial subsidiary under the GLB Act, which allows it to engage in investment banking, insurance agency, brokerage, and underwriting activities that were not available to banks prior to the GLB Act. The GLB Act also included privacy provisions that limit banks’ abilities to disclose non-public information about customers to non-affiliated entities.

The Company must also comply with the requirements of the Bank Secrecy Act (BSA). The BSA is designed to help fight drug trafficking, money laundering, and other crimes. Compliance is monitored by the Federal Reserve. The BSA was enacted to prevent banks and other financial service providers from being used as intermediaries for, or to hide the transfer or deposit of money derived from, criminal activity. Since its passage, the BSA has been amended several times. These amendments include the Money Laundering Control Act of 1986 which made money laundering a criminal act, as well as the Money Laundering Suppression Act of 1994 which required regulators to develop enhanced examination procedures and increased examiner training to improve the identification of money laundering schemes in financial institutions.

The USA PATRIOT Act, established in 2001, substantially broadened the scope of U.S. anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the U.S. The regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent, and report money laundering and terrorist financing. The regulations include significant penalties for non-compliance.

The Company is subject to regulation under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2011 (Dodd-Frank Act). Among its many provisions, the Dodd-Frank Act required stress-testing for certain financial services companies and established a new council of “systemic risk” regulators. The Dodd Frank Act also established the Consumer Financial Protection Bureau (CFPB) which is authorized to supervise certain financial services companies and has responsibility to implement, examine for compliance with, and enforce “Federal consumer financial law.” The Company is subject to examinations by the CFPB. The Dodd-Frank Act, through Title VI, commonly known as the Volcker Rule, placed trading restrictions on financial institutions and separated investment banking, private equity and proprietary trading (hedge fund) sections of financial institutions from their consumer lending arms. The Volcker Rule also restricts financial institutions from investing in and sponsoring certain types of investments.

In May 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act was signed into law which provides a number of limited amendments to the Dodd-Frank Act. Notable provisions of the legislation include: an increase in the asset threshold from $50 billion to $250 billion, above which the Federal Reserve is required to apply enhanced prudential standards; an exemption from the Volker Rule for insured depository institutions with less than $10 billion in consolidated assets; modifications to the Liquidity Coverage and Supplementary Leverage ratios; and the elimination of Dodd-Frank company-run stress tests for banks and bank holding companies with less than $250 billion in assets. While most of these provisions affect institutions larger than the Company, the Company is no longer required to prepare stress testing as specified by the Dodd-Frank Act.


5

Subsidiary Bank
Under Federal Reserve policy, the bank holding company, Commerce Bancshares, Inc. (the "Parent"), is expected to act as a source of financial strength to its bank subsidiary and to commit resources to support it in circumstances when it might not otherwise do so. In addition, loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.

Deposit Insurance
Substantially all of the deposits held by the Bank are insured up to applicable limits (generally $250,000 per depositor for each account ownership category) by the Deposit Insurance Fund (DIF) of the FDIC and are subject to deposit insurance assessments to maintain the DIF. In 2011, the FDIC released a final rule to implement provisions of the Dodd-Frank Act that affect deposit insurance assessments. Among other things, the Dodd-Frank Act raised the minimum designated reserve ratio from 1.15% to 1.35% of estimated insured deposits, removed the upper limit of the designated reserve ratio, required that the designated reserve ratio reach 1.35% by September 30, 2020, and required that the FDIC offset the effect of increasing the minimum designated reserve ratio on depository institutions with total assets of less than $10 billion. The Dodd-Frank Act provided the FDIC flexibility in the implementation of the increase in the designated reserve ratio, but it will ultimately result in increased deposit insurance costs to the Company. The Dodd-Frank Act also required that the FDIC redefine the assessment base to average consolidated assets minus average tangible equity. 

On June 30, 2016, the DIF rose above the 1.15%, resulting in a reduction of the initial assessment rate for all banks and implementing a 4.5 basis point surcharge on insured depository institutions with total consolidated assets of $10 billion or more. Effective October 1, 2018, this surcharge was eliminated as the DIF reached its required level of 1.35% of estimated insured deposits. This had the effect of reducing the Company’s insurance costs by $1.5 million in the fourth quarter of 2018.

Payment of Dividends
The Federal Reserve Board may prohibit the payment of cash dividends to shareholders by bank holding companies if their actions constitute unsafe or unsound practices. The principal source of the Parent's cash revenues is cash dividends paid by the Bank. The amount of dividends paid by the Bank in any calendar year is limited to the net profit of the current year combined with the retained net profits of the preceding two years, and permission must be obtained from the Federal Reserve Board for dividends exceeding these amounts. The payment of dividends by the Bank may also be affected by factors such as the maintenance of adequate capital.

Capital Adequacy
The Company is required to comply with the capital adequacy standards established by the Federal Reserve, which are based on the risk levels of assets and off-balance sheet financial instruments. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to judgments by regulators regarding qualitative components, risk weightings, and other factors.

A new comprehensive capital framework was established by the Basel Committee on Banking Supervision, which was effective for large and internationally active U.S. banks and bank holding companies on January 1, 2015. A key goal of the new framework, known as "Basel III," was to strengthen the capital resources of banking organizations during normal and challenging business environments. Basel III increased minimum requirements for both the quantity and quality of capital held by banking organizations. The rule includes a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets. The capital conservation buffer, which is being phased in during 2016-2019, is intended to absorb losses during periods of economic stress. Failure to maintain the buffer will result in constraints on dividends, equity repurchases and executive compensation. The rule also adjusted the methodology for calculating risk-weighted assets to enhance risk sensitivity. At December 31, 2018, the Company met all capital adequacy requirements under Basel III on a fully phased-in basis as if such requirements had been in effect.

The Federal Deposit Insurance Corporation Improvement Act (FDICIA) requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. Pursuant to FDICIA, the FDIC promulgated regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Under the prompt corrective action provisions of FDICIA, an insured depository institution generally will be classified as well-capitalized (under

6

the Basel III rules mentioned above) if it has a Tier 1 capital ratio of at least 8%, a common equity Tier 1 capital ratio of at least 6.5%, a total capital ratio of at least 10%, and a Tier 1 leverage ratio of at least 5%. An institution that, based upon its capital levels, is classified as “well-capitalized,” “adequately capitalized,” or “undercapitalized,” may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions and prohibitions, including restrictions on growth, restrictions on interest rates paid on deposits, restrictions or prohibitions on payment of dividends, and restrictions on the acceptance of brokered deposits. Furthermore, if a bank is classified in one of the undercapitalized categories, it is required to submit a capital restoration plan to the federal bank regulator, and the holding company must guarantee the performance of that plan. The Bank has consistently maintained regulatory capital ratios at or above the “well-capitalized” standards.

Stress Testing
As required by the Dodd-Frank Act, the Company performed stress tests as specified by the Federal Reserve requirement and published results beginning in 2014 through 2017. On May 24, 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act was enacted, which eliminated the required stress testing under the Dodd-Frank Act for banks with consolidated assets of less than $100 billion. The Company continues to perform periodic stress-testing based on its own internal criteria.

Executive and Incentive Compensation
Guidelines adopted by federal banking agencies prohibit excessive compensation as an unsafe and unsound practice, and describe compensation as "excessive" when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal shareholder. The Federal Reserve Board has issued comprehensive guidance on incentive compensation intended to ensure that the incentive compensation policies do not undermine safety and soundness by encouraging excessive risk taking. This guidance covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, based on key principles that (i) incentives do not encourage risk-taking beyond the organization's ability to identify and manage risk, (ii) compensation arrangements are compatible with effective internal controls and risk management, and (iii) compensation arrangements are supported by strong corporate governance, including active and effective board oversight. Deficiencies in compensation practices may affect supervisory ratings and enforcement actions may be taken if incentive compensation arrangements pose a risk to safety and soundness.

Transactions with Affiliates
The Federal Reserve Board regulates transactions between the Bank and its subsidiaries. Generally, the Federal Reserve Act and Regulation W, as amended by the Dodd-Frank Act, limit the Company’s banking subsidiary and its subsidiaries to lending and other “covered transactions” with affiliates. The aggregate amount of covered transactions a banking subsidiary or its subsidiaries may enter into with an affiliate may not exceed 10% of the capital stock and surplus of the banking subsidiary. The aggregate amount of covered transactions with all affiliates may not exceed 20% of the capital stock and surplus of the banking subsidiary.

Covered transactions with affiliates are also subject to collateralization requirements and must be conducted on arm’s length terms. Covered transactions include (a) a loan or extension of credit by the banking subsidiary, including derivative contracts, (b) a purchase of securities issued to a banking subsidiary, (c) a purchase of assets by the banking subsidiary unless otherwise exempted by the Federal Reserve, (d) acceptance of securities issued by an affiliate to the banking subsidiary as collateral for a loan, and (e) the issuance of a guarantee, acceptance or letter of credit by the banking subsidiary on behalf of an affiliate.

Certain transactions with the Company's directors, officers or controlling persons are also subject to conflicts of interest regulations. Among other things, these regulations require that loans to such persons and their related interests be made on terms substantially the same as for loans to unaffiliated individuals, and must not create an abnormal risk of repayment or other unfavorable features for the financial institution. See Note 2 to the consolidated financial statements for additional information on loans to related parties.

Available Information
The Company’s principal offices are located at 1000 Walnut Street, Kansas City, Missouri (telephone number 816-234-2000). The Company makes available free of charge, through its website at www.commercebank.com, reports filed with the Securities and Exchange Commission as soon as reasonably practicable after the electronic filing. These filings include the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports.


7

Statistical Disclosure
The information required by Securities Act Guide 3 — “Statistical Disclosure by Bank Holding Companies” is located on the pages noted below.
 
 
 
Page
I.
 
Distribution of Assets, Liabilities and Stockholders’ Equity; Interest Rates and Interest Differential
22, 54-57

II.
 
Investment Portfolio
39-40, 80-84

III.
 
Loan Portfolio
 
 
 
Types of Loans

 
 
Maturities and Sensitivities of Loans to Changes in Interest Rates
28-29

 
 
Risk Elements
34-38

IV.
 
Summary of Loan Loss Experience
31-34

V.
 
Deposits

VI.
 
Return on Equity and Assets
17

VII.
 
Short-Term Borrowings


Item 1a.
RISK FACTORS
Making or continuing an investment in securities issued by Commerce Bancshares, Inc., including its common and preferred stock, involves certain risks that you should carefully consider. If any of the following risks actually occur, its business, financial condition or results of operations could be negatively affected, the market price for your securities could decline, and you could lose all or a part of your investment. Further, to the extent that any of the information contained in this Annual Report on Form 10-K constitutes forward-looking statements, the risk factors set forth below also are cautionary statements identifying important factors that could cause the Company’s actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of Commerce Bancshares, Inc.

Difficult market conditions may affect the Company’s industry.
The concentration of the Company’s banking business in the United States particularly exposes it to downturns in the U.S. economy. While current economic conditions are favorable, there remain risks in that environment.
In particular, the Company may face the following risks in connection with market conditions:     
•
In the current national environment, positive trends in job growth, unemployment levels, consumer confidence, and credit conditions are expected to continue, but the current recovery is historically long, there has been recent stock market volatility, and consumer debt has been increasing. Further, the U.S. economy is affected by global economic events and conditions, including recent U.S. trade disputes with various countries. Although the Company does not hold foreign debt or have significant activities with foreign customers, the global economy, the strength of the U.S. dollar, and oil prices may ultimately affect interest rates, business import/export activity, capital expenditures by businesses, and investor confidence. Unfavorable changes in these factors may result in declines in consumer credit usage, adverse changes in payment patterns, reduced loan demand, and higher loan delinquencies and default rates. These could impact the Company’s future loan losses and provision for loan losses, as a significant part of the Company’s business includes consumer and credit card lending.
•
In addition to the results above, a slowdown in economic activity may cause declines in financial services activity, including declines in bank card, corporate cash management and other fee businesses, as well as the fees earned by the Company on such transactions.
•
The process used to estimate losses inherent in the Company’s loan portfolio requires difficult, subjective, and complex judgments, including consideration of economic conditions and how these economic predictions might impair the ability of its borrowers to repay their loans. If an instance occurs that renders these predictions no longer capable of accurate estimation, this may in turn impact the reliability of the process.
•
Competition in the industry could intensify as a result of the increasing consolidation of financial services companies in connection with current market conditions, thereby reducing market prices for various products and services which could in turn reduce the Company’s revenues.


8

The performance of the Company is dependent on the economic conditions of the markets in which the Company operates.
The Company’s success is heavily influenced by the general economic conditions of the specific markets in which it operates. Unlike larger national or other regional banks that are more geographically diversified, the Company provides financial services primarily throughout the states of Missouri, Kansas, central Illinois, Oklahoma, and Colorado. It also has a growing presence in additional states through its commercial banking offices in: Texas, Iowa, Indiana, Michigan, Ohio, and Tennessee. As the Company does not have a significant banking presence in other parts of the country, a prolonged economic downturn in these markets could have a material adverse effect on the Company’s financial condition and results of operations.

The Company operates in a highly competitive industry and market area.
The Company operates in the financial services industry and has numerous competitors including other banks and insurance companies, securities dealers, brokers, trust and investment companies, mortgage bankers, and financial technology companies. Consolidation among financial service providers and new changes in technology, product offerings and regulation continue to challenge the Company's marketplace position. As consolidation occurs, larger regional and national banks may enter the Company's markets and add to existing competition. Large, national financial institutions have substantial capital, technology and marketing resources. These new competitors may lower fees to grow market share, which could result in a loss of customers and lower fee revenue for the Company. They may have greater access to capital at a lower cost than the Company, and may have higher loan limits, both of which may adversely affect the Company’s ability to compete effectively. The Company must continue to make investments in its products and delivery systems to stay competitive with the industry, or its financial performance may suffer.

The soundness of other financial institutions could adversely affect the Company.
The Company’s ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institution counterparties. Financial services institutions are interrelated because of trading, clearing, counterparty or other relationships. The Company has exposure to many different industries and counterparties and routinely executes transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual funds, and other institutional clients. Transactions with these institutions include overnight and term borrowings, interest rate swap agreements, securities purchased and sold, short-term investments, and other such transactions. Because of this exposure, defaults by, or rumors or questions about, one or more financial services institutions or the financial services industry in general, could lead to market-wide liquidity problems and defaults by other institutions. Many of these transactions expose the Company to credit risk in the event of default of its counterparty or client, while other transactions expose the Company to liquidity risks should funding sources quickly disappear. In addition, the Company’s credit risk may be exacerbated when the collateral held cannot be realized or is liquidated at prices not sufficient to recover the full amount of the exposure due to the Company. Any such losses could materially and adversely affect results of operations.

The Company is subject to increasingly extensive government regulation and supervision.
As part of the financial services industry, the Company has been subject to increasingly extensive federal and state regulation and supervision over the past several years. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds, and the banking system, not shareholders. These regulations affect the Company’s lending practices, capital structure, investment practices, dividend policy, and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations, and policies for possible changes. Changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to additional costs, limit the types of financial services and products it may offer, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations, or policies could result in sanctions by regulatory agencies, civil money penalties, and/or reputation damage, which could have a material adverse effect on the Company’s business, financial condition, and results of operations. While the Company has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.

Significant changes in federal monetary policy could materially affect the Company’s business.
The Federal Reserve System regulates the supply of money and credit in the United States. Its policies determine in large part the cost of funds for lending and interest rates earned on loans and paid on borrowings and interest-bearing deposits. Credit conditions are influenced by its open market operations in U.S. government securities, changes in the member bank discount rate, and bank reserve requirements. Changes in Federal Reserve Board policies are beyond the Company’s control and difficult to predict, and such changes may result in lower interest margins and a lack of demand for credit products.


9

The Company is subject to both interest rate and liquidity risk.
With oversight from its Asset-Liability Management Committee, the Company devotes substantial resources to monitoring its liquidity and interest rate risk on a monthly basis. The Company's net interest income is the largest source of overall revenue to the Company, representing 62% of total revenue for the year ended December 31, 2018. The interest rate environment in which the Company operates fluctuates in response to general economic conditions and policies of various governmental and regulatory agencies, particularly the Federal Reserve Board, which regulates the supply of money and credit in the U.S. Changes in monetary policy, including changes in interest rates, will influence loan originations, deposit generation, demand for investments and revenues, and costs for earning assets and liabilities, and could significantly impact the Company’s net interest income.

The Federal Reserve Board raised the benchmark interest rate four times during 2018 for a total of 100 basis points. Future economic conditions or other factors could shift monetary policy resulting in no additional rate increases in 2019 or decreases in the benchmark rate. Furthermore, changes in interest rates could result in unanticipated changes to customer deposit balances and funding costs, and affect the Company’s source of funds for future loan growth.

The Company has a significant number of loans, derivative contracts, borrowings and other financial instruments with attributes that are either directly or indirectly dependent on LIBOR. In 2017, the U.K. Financial Conduct Authority announced that LIBOR is to be transitioned to alternative rates during the next four years. U.S. regulatory authorities have voiced similar support for phasing out LIBOR. The impact of alternatives to LIBOR on the valuations, pricing and operation of the Company's financial instruments is not yet known.

The Company’s asset valuation may include methodologies, models, estimations and assumptions which are subject to differing interpretations and could result in changes to asset valuations that may materially adversely affect its results of operations or financial condition.
The Company uses estimates, assumptions, and judgments when certain financial assets and liabilities are measured and reported at fair value. Assets and liabilities carried at fair value inherently result in greater financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices and/or other observable inputs provided by independent third-party sources, when available. When such third-party information is not available, fair value is estimated primarily by using cash flow and other financial modeling techniques utilizing assumptions such as credit quality, liquidity, interest rates and other relevant inputs. Changes in underlying factors, assumptions, or estimates in any of these areas could materially impact the Company’s future financial condition and results of operations. Furthermore, if models used to calculate fair value of financial instruments are inadequate or inaccurate due to flaws in their design or execution, upon sale, the Company may not realize the cash flows of a financial instrument as modeled and could incur material, unexpected losses.

During periods of market disruption, including periods of significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, it may be difficult to value certain assets if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes in active markets with significant observable data that become illiquid due to the current financial environment. In such cases, certain asset valuations may require more subjectivity and management judgment. As such, valuations may include inputs and assumptions that are less observable or require greater estimation. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of assets as reported within the Company’s consolidated financial statements, and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on results of operations or financial condition.

The Company’s investment portfolio values may be adversely impacted by deterioration in the credit quality of underlying collateral within the various categories of investment securities it owns.
The Company generally invests in securities issued by municipal entities, government-backed agencies or privately issued securities, with collateral that are highly rated and evaluated at the time of purchase, however, these securities are subject to changes in market value due to changing interest rates and implied credit spreads. While the Company maintains rigorous risk management practices over bonds issued by municipalities, credit deterioration in these bonds could occur and result in losses. Certain mortgage and asset-backed securities (which are collateralized by residential mortgages, credit cards, automobiles, mobile homes or other assets) may decline in value due to actual or expected deterioration in the underlying collateral. Under accounting rules, when the impairment is due to declining expected cash flows, some portion of the impairment, depending on the Company’s intent to sell and the likelihood of being required to sell before recovery, must be recognized in current earnings. This could result in significant losses.


10

Future loan losses could increase.
The Company maintains an allowance for loan losses that represents management’s best estimate of probable losses that have been incurred at the balance sheet date within the existing portfolio of loans. The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, including emergence periods, current loan portfolio quality, present economic, political, and regulatory conditions, and unidentified losses inherent in the current loan portfolio. Although the loan losses have been stable during the past several years, an unforeseen deterioration of financial market conditions could result in larger loan losses, which may negatively affect the Company's results of operations and could further increase levels of its allowance for loan losses. In addition, the Company’s allowance level is subject to review by regulatory agencies, and that review could result in adjustments to the allowance for loan losses. See the section captioned “Allowance for Loan Losses” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this report for further discussion related to the Company’s process for determining the appropriate level of the allowance for probable loan losses.

In 2016, the Financial Accounting Standards Board (FASB) issued a new accounting standard "Measurement of Credit Losses on Financial Instruments" (ASU 2016-13), which is effective January 1, 2020. This new standard significantly alters the way the reserve for credit losses is determined. The new standard utilizes a life of loan loss concept and will require significant operational changes, especially in data collection and analysis. While an implementation plan has been established and much progress has been made to date, the impact to the Company’s current reserve for credit losses from this new standard is not yet determined. Due to the significant changes required by this new standard, it is possible that higher reserves could be required resulting in reduced capital and earnings.

New lines of business or new products and services may subject the Company to additional risk.
From time to time, the Company may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and new products or services, the Company may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives and shifting market preferences may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business, or new product or service, could have a significant impact on the effectiveness of the Company’s system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business and new products or services could have a material adverse effect on the Company’s financial condition and results of operations.

A successful cyber attack or other computer system breach could significantly harm the Company, its reputation and its customers.
The Company relies heavily on communications and information systems to conduct its business, and as part of its business, the Company maintains significant amounts of data about its customers and the products they use. Information security risks continue to increase due to new technologies, the increasing use of the Internet and telecommunication technologies (including mobile devices) to conduct financial and other business transactions, and the increased sophistication and activities of organized crime, perpetrators of fraud, hackers, and others. The Company makes significant investments in various technology to identify and prevent intrusions into its information system. The Company also has policies and procedures designed to prevent or limit the effect of failure, interruption or security breach of its information systems and performs regular audits using both internal and outside resources. However, there can be no assurances that any such failures, interruptions or security breaches will not occur, or if they do occur, that they will be adequately addressed. In addition to unauthorized access, denial-of-service attacks, or other operational disruptions could overwhelm Company websites and prevent the Company from adequately serving customers. Should any of the Company's systems become compromised or customer information be obtained by unauthorized parties, the reputation of the Company could be damaged, relationships with existing customers may be impaired, and the Company could be subject to lawsuits, all of which could result in lost business and have a material adverse effect on the Company’s business, financial condition and results of operations.


11

The Company’s operations rely on certain external vendors.
The Company relies on third-party vendors to provide products and services necessary to maintain day-to-day operations. For example, the Company outsources a portion of its information systems, communication, data management, and transaction processing to third parties. Accordingly, the Company is exposed to the risk that these vendors might not perform in accordance with the contracted arrangements or service level agreements because of changes in the vendor’s organizational structure, financial condition, support for existing products and services, or strategic focus. Such failure to perform could be disruptive to the Company’s operations, which could have a materially adverse impact on its business, results of operations and financial condition. These third parties are also sources of risk associated with operational errors, system interruptions or breaches and unauthorized disclosure of confidential information. If the vendors encounter any of these issues, the Company could be exposed to disruption of service, damage to reputation and litigation. Because the Company is an issuer of both debit and credit cards, it is periodically exposed to losses related to security breaches which occur at retailers that are unaffiliated with the Company (e.g., customer card data being compromised at retail stores). These losses include, but are not limited to, costs and expenses for card reissuance as well as losses resulting from fraudulent card transactions.

The Company continually encounters technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services, including the entrance of financial technology companies offering new financial service products. The Company regularly upgrades or replaces core technological systems and is currently in the process of replacing its core deposit system, which is a significant project. The effective use of technology increases efficiency and enables financial institutions to better serve customers and reduce costs. The Company’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in the Company’s operations. Many of the Company’s competitors have substantially greater resources to invest in technological improvements. The Company may encounter significant problems or may not be able to effectively implement new technology-driven products, including the core deposit system, and services, or be successful in marketing the new products and services to its customers. These problems might include significant time delays, cost overruns, loss of key people, and technological system failures. Failure to successfully keep pace with technological change affecting the financial services industry or failure to successfully complete the replacement of the core deposit system, or another core technological system, could have a material adverse effect on the Company’s business, financial condition and results of operations.

Commerce Bancshares, Inc. relies on dividends from its subsidiary bank for most of its revenue.
Commerce Bancshares, Inc. is a separate and distinct legal entity from its banking and other subsidiaries. It receives substantially all of its revenue from dividends from its subsidiary bank. These dividends, which are limited by various federal and state regulations, are the principal source of funds to pay dividends on its preferred and common stock and to meet its other cash needs. In the event the subsidiary bank is unable to pay dividends, the Company may not be able to pay dividends or other obligations, which would have a material adverse effect on the Company's financial condition and results of operations.

The Company must attract and retain skilled employees.
The Company’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people can be intense, and the Company spends considerable time and resources attracting, hiring, and retaining qualified people for its various business lines and support units. The unexpected loss of the services of one or more of the Company’s key personnel could have a material adverse impact on the Company’s business because of their skills, knowledge of the Company’s market, and years of industry experience, as well as the difficulty of promptly finding qualified replacement personnel.

Item 1b.
UNRESOLVED STAFF COMMENTS
None


12

Item 2.
PROPERTIES
The main offices of the Bank are located in the larger metropolitan areas of its markets in various multi-story office buildings. The Bank owns its main offices and leases unoccupied premises to the public. The larger office buildings include:

Building
Net rentable square footage
% occupied in total
% occupied by Bank
922 Walnut
Kansas City, MO
256,000

95
%
93
%
1000 Walnut
Kansas City, MO
391,000

86

46

811 Main
Kansas City, MO
237,000

100

100

8000 Forsyth
Clayton, MO
178,000

100

100

1551 N. Waterfront Pkwy
Wichita, KS
124,000

96

34


The Company has an additional 164 branch locations in Missouri, Illinois, Kansas, Oklahoma and Colorado which are owned or leased, and 151 off-site ATM locations.

Item 3.
LEGAL PROCEEDINGS
The information required by this item is set forth in Item 8 under Note 20, Commitments, Contingencies and Guarantees on page 120.


Item 4.
MINE SAFETY DISCLOSURES
Not applicable    


13

Executive Officers of the Registrant
The following are the executive officers of the Company as of February 21, 2019, each of whom is designated annually. There are no arrangements or understandings between any of the persons so named and any other person pursuant to which such person was designated an executive officer.
Name and Age
Positions with Registrant
Jeffery D. Aberdeen, 64
Controller of the Company since December 1995. He is also Controller of the Company's subsidiary bank, Commerce Bank.
 
 
Kevin G. Barth, 58
Executive Vice President of the Company since April 2005, and Community President and Chief Executive Officer of Commerce Bank since October 1998. Senior Vice President of the Company and Officer of Commerce Bank prior thereto.
 
 
Jeffrey M. Burik, 60
Senior Vice President of the Company since February 2013. Executive Vice President of Commerce Bank since November 2007.
 
 
Daniel D. Callahan, 62
Executive Vice President and Chief Credit Officer of the Company since December 2010 and Senior Vice President of the Company prior thereto. Executive Vice President of Commerce Bank since May 2003.
 
 
Sara E. Foster, 58
Executive Vice President of the Company since February 2012 and Senior Vice President of the Company prior thereto. Executive Vice President of Commerce Bank since January 2016 and Senior Vice President of Commerce Bank prior thereto.
 
 
John K. Handy, 55
Executive Vice President of the Company since January 2018 and Senior Vice President of the Company prior thereto. Community President and Chief Executive Officer of Commerce Bank since January 2018 and Senior Vice President of Commerce Bank prior thereto.
 
 
Robert S. Holmes, 55
Executive Vice President of the Company since April 2015, and Community President and Chief Executive Officer of Commerce Bank since January 2016. Prior to his employment with Commerce Bank in March 2015, he was employed at a Midwest regional bank where he served as managing director and head of Regional Banking.
 
 
Patricia R. Kellerhals, 61
Senior Vice President of the Company since February 2016 and Vice President of the Company prior thereto. Executive Vice President of Commerce Bank since 2005.
 
 
David W. Kemper, 68
Executive Chairman of the Company and of the Board of Directors of the Company since August 2018. Prior thereto, he was Chief Executive Officer of the Company and Chairman of the Board of Directors of the Company. He was President of the Company from April 1982 until February 2013. He is the brother of Jonathan M. Kemper (a former Vice Chairman of the Company), and father of John W. Kemper, President and Chief Executive Officer of the Company.
 
 
John W. Kemper, 41
Chief Executive Officer of the Company and Chairman and Chief Executive Officer of Commerce Bank since August 2018. Prior thereto, he was Chief Operating Officer of the Company. President of the Company since February 2013 and President of Commerce Bank since March 2013. Member of Board of Directors since September 2015. He is the son of David W. Kemper, Executive Chairman of the Company and nephew of Jonathan M. Kemper (a former Vice Chairman of the Company).
 
 
Charles G. Kim, 58
Chief Financial Officer of the Company since July 2009. Executive Vice President of the Company since April 1995 and Executive Vice President of Commerce Bank since January 2004. Prior thereto, he was Senior Vice President of Commerce Bank.
 
 
Douglas D. Neff, 50
Senior Vice President of the Company since January 2019 and Chairman and Chief Executive Officer of Commerce Bank Southwest Region since 2013.
 
 
Paula S. Petersen, 52
Senior Vice President of the Company since July 2016 and Executive Vice President of Commerce Bank since March 2012.
 
 
David L. Roller, 48
Senior Vice President of the Company since July 2016 and Senior Vice President of Commerce Bank since September 2010.
 
 

14

PART II

Item 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Commerce Bancshares, Inc.
Common Stock Data
Commerce Bancshares, Inc. common shares are listed on the Nasdaq Global Select Market (NASDAQ) under the symbol CBSH. The Company had 3,664 common shareholders of record as of December 31, 2018. Certain of the Company's shares are held in "nominee" or "street" name and the number of beneficial owners of such shares is approximately 58,500.

Performance Graph
The following graph presents a comparison of Company (CBSH) performance to the indices named below. It assumes $100 invested on December 31, 2013 with dividends invested on a cumulative total shareholder return basis.
chart-a7ae56a5faed551fa33.jpg
 
2013
2014
2015
2016
2017
2018
Commerce (CBSH)
100.00

103.68

108.62

157.84

162.62

174.88

NASDAQ OMX Global-Bank
100.00

111.83

114.30

144.63

171.24

143.15

S&P 500
100.00

113.68

115.24

128.98

157.12

150.22



15

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 Exchange Act, during the fourth quarter of 2018.
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
October 1—31, 2018
140,934


$62.14

140,934

2,687,186

November 1—30, 2018
167,286


$65.37

167,286

2,519,900

December 1—31, 2018
270,337


$59.05

270,337

2,249,563

Total
578,557


$61.63

578,557

2,249,563


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, 2,249,563 shares remained available for purchase at December 31, 2018.

Item 6.
SELECTED FINANCIAL DATA
The required information is set forth below in Item 7.


Item 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements
This report may contain “forward-looking statements” that are subject to risks and uncertainties and include information about possible or assumed future results of operations. Many possible events or factors could affect the future financial results and performance of Commerce Bancshares, Inc. and its subsidiaries (the "Company"). This could cause results or performance to differ materially from those expressed in the forward-looking statements. Words such as “expects”, “anticipates”, “believes”, “estimates”, variations of such words and other similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in, or implied by, such forward-looking statements. Readers should not rely solely on the forward-looking statements and should consider all uncertainties and risks discussed throughout this report. Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. Such possible events or factors include the risk factors identified in Item 1a Risk Factors and the following: 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; failure of litigation settlement agreements to become final in accordance with their terms; and competition with other entities that offer financial services.
Overview
The Company operates as a super-community bank and offers a broad range of financial products to consumer and commercial customers, delivered with a focus on high-quality, personalized service. It is the largest bank holding company headquartered in Missouri, with its principal offices in Kansas City and St. Louis, Missouri. Customers are served from 320 locations in Missouri, Kansas, Illinois, Oklahoma and Colorado and commercial offices throughout the nation's midsection. A variety of delivery platforms are utilized, including an extensive network of branches and ATM machines, full-featured online banking, and a central contact center.

The core of the Company’s competitive advantage is its focus on the local markets in which it operates, its offering of competitive, sophisticated financial products, and its concentration on relationship banking and high-touch service. In order to enhance shareholder value, the Company targets core revenue growth. To achieve this growth, the Company focuses on strategies that will expand new and existing customer relationships, offer opportunities for controlled expansion in additional markets, utilize improved technology, and enhance customer satisfaction.


16

Various indicators are used by management in evaluating the Company’s financial condition and operating performance. Among these indicators are the following:
•
Net income and earnings per share — Net income attributable to Commerce Bancshares, Inc. was $433.5 million, an increase of 35.7% compared to the previous year. The return on average assets was 1.76% in 2018, and the return on average common equity was 16.16%. Diluted earnings per share increased 37.0% in 2018 compared to 2017.
•
Total revenue — Total revenue is comprised of net interest income and non-interest income. Total revenue in 2018 increased $130.2 million, or 10.9% over 2017, driven by growth in net interest income and non-interest income of $90.1 million and $40.1 million, respectively. The growth in net interest income in 2018 was mainly due to higher rates on interest earning assets, which grew 44 basis points over 2017 rates, partially offset by higher rates on interest-bearing liabilities, which grew 15 basis points in 2018 over the prior year. Growth in non-interest income resulted principally from increases in bank card fees, trust fees, and deposit fees.
•
Non-interest expense — Total non-interest expense decreased .9% this year compared to 2017, mainly due to $32.0 million of donations made to a related foundation during 2017, which did not recur in 2018. Excluding these donations, non-interest expense grew 3.6% in the current year, primarily driven by higher expense for salaries and benefits.
•
Asset quality — Net loan charge-offs totaled $42.3 million in 2018, an increase of $650 thousand over those recorded in 2017, and averaged .30% of loans compared to .31% in the previous year. Total non-performing assets, which include non-accrual loans and foreclosed real estate, amounted to $13.9 million at December 31, 2018, compared to $12.7 million at December 31, 2017, and represented .10% of loans outstanding at December 31, 2018.
•
Shareholder return — During 2018, the Company paid cash dividends of $.895 per share on its common stock, representing an increase of 9.7% over the previous year, and paid dividends of 6% on its preferred stock. In 2018, the Company issued its 25th consecutive annual 5% common stock dividend, and in January 2019, the Company's Board of Directors authorized an increase of 16% in the common cash dividend. In 2018, the Company purchased 1,193,960 shares of treasury stock.
    
The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes. The historical trends reflected in the financial information presented below are not necessarily reflective of anticipated future results.

Key Ratios
 
2018
2017
2016
2015
2014
(Based on average balances)
 
 
 
 
 
Return on total assets
1.76
%
1.28
%
1.12
%
1.11
%
1.15
%
Return on common equity
16.16

12.46

11.33

11.43

11.65

Equity to total assets
11.24

10.53

10.16

10.00

10.10

Loans to deposits (1)
69.27

66.18

63.71

61.44

59.91

Non-interest bearing deposits to total deposits
33.43

34.85

34.67

35.12

33.73

Net yield on interest earning assets (tax equivalent basis)
3.53

3.20

3.04

2.94

3.00

(Based on end of period data)
 
 
 
 
 
Non-interest income to revenue (2)
37.83

39.88

41.09

41.40

41.31

Efficiency ratio (3)
55.58

62.18

61.04

61.42

61.00

Tier I common risk-based capital ratio (4)
14.22

12.65

11.62

11.52

NA

Tier I risk-based capital ratio (4)
14.98

13.41

12.38

12.33

13.74
%
Total risk-based capital ratio (4)
15.82

14.35

13.32

13.28

14.86

Tier I leverage ratio (4)
11.52

10.39

9.55

9.23

9.36

Tangible common equity to tangible assets ratio (5)
10.45

9.84

8.66

8.48

8.55

Common cash dividend payout ratio
23.61

29.52

32.69

33.35

32.69

(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)
Risk-based capital information at December 31, 2018, 2017, 2016 and 2015 was prepared under Basel III requirements, which were effective January 1, 2015. Risk-based capital information for prior years was prepared under Basel I requirements.
(5)
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 assist 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.

17

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.
(Dollars in thousands)
2018
2017
2016
2015
2014
Total equity
$
2,937,149

$
2,718,184

$
2,501,132

$
2,367,418

$
2,334,246

Less non-controlling interest
5,851

1,624

5,349

5,428

4,053

Less preferred stock
144,784

144,784

144,784

144,784

144,784

Less goodwill
138,921

138,921

138,921

138,921

138,921

Less core deposit premium
2,316

2,965

3,841

5,031

6,572

Total tangible common equity (a)
$
2,645,277

$
2,429,890

$
2,208,237

$
2,073,254

$
2,039,916

Total assets
$
25,463,842

$
24,833,415

$
25,641,424

$
24,604,962

$
23,994,280

Less goodwill
138,921

138,921

138,921

138,921

138,921

Less core deposit premium
2,316

2,965

3,841

5,031

6,572

Total tangible assets (b)
$
25,322,605

$
24,691,529

$
25,498,662

$
24,461,010

$
23,848,787

Tangible common equity to tangible assets ratio (a)/(b)
10.45
%
9.84
%
8.66
%
8.48
%
8.55
%

Selected Financial Data
(In thousands, except per share data)
2018
2017
2016
2015
2014
Net interest income
$
823,825

$
733,679

$
680,049

$
634,320

$
620,204

Provision for loan losses
42,694

45,244

36,318

28,727

29,531

Non-interest income
501,341

461,263

446,556

422,444

410,393

Investment securities gains (losses), net
(488
)
25,051

(53
)
6,320

14,124

Non-interest expense
737,821

744,343

689,229

650,792

630,757

Net income attributable to Commerce Bancshares, Inc.
433,542

319,383

275,391

263,730

261,754

Net income available to common shareholders
424,542

310,383

266,391

254,730

257,704

Net income per common share-basic*
3.79

2.77

2.38

2.21

2.16

Net income per common share-diluted*
3.78

2.76

2.37

2.21

2.15

Cash dividends on common stock
100,238

91,619

87,070

84,961

84,241

Cash dividends per common share*
.895

.816

.777

.740

.705

Market price per common share*
56.37

53.18

52.44

36.75

35.78

Book value per common share*
25.13

22.99

21.07

19.75

18.70

Common shares outstanding*
111,331

111,946

111,861

112,551

117,087

Total assets
25,463,842

24,833,415

25,641,424

24,604,962

23,994,280

Loans, including held for sale
14,160,992

14,005,072

13,427,192

12,444,299

11,469,238

Investment securities
8,698,666

8,893,307

9,770,986

9,901,680

9,645,792

Deposits
20,323,659

20,425,446

21,101,095

19,978,853

19,475,778

Long-term debt
8,702

1,758

102,049

103,818

104,058

Equity
2,937,149

2,718,184

2,501,132

2,367,418

2,334,246

Non-performing assets
13,949

12,664

14,649

29,394

46,251

*
Restated for the 5% stock dividend distributed in December 2018.



18

Results of Operations
 
 
 
 
$ Change
 
% Change
(Dollars in thousands)
2018
2017
2016
'18-'17
'17-'16
 
'18-'17
'17-'16
Net interest income
$
823,825

$
733,679

$
680,049

$
90,146

$
53,630

 
12.3
%
7.9
%
Provision for loan losses
(42,694
)
(45,244
)
(36,318
)
(2,550
)
8,926

 
(5.6
)
24.6

Non-interest income
501,341

461,263

446,556

40,078

14,707

 
8.7

3.3

Investment securities gains (losses), net
(488
)
25,051

(53
)
(25,539
)
25,104

 
N.M.

N.M.

Non-interest expense
(737,821
)
(744,343
)
(689,229
)
(6,522
)
55,114

 
(.9
)
8.0

Income taxes
(105,949
)
(110,506
)
(124,151
)
(4,557
)
(13,645
)
 
(4.1
)
(11.0
)
Non-controlling interest expense
(4,672
)
(517
)
(1,463
)
4,155

(946
)
 
N.M.

(64.7
)
Net income attributable to Commerce Bancshares, Inc.
433,542

319,383

275,391

114,159

43,992

 
35.7

16.0

Preferred stock dividends
(9,000
)
(9,000
)
(9,000
)
—

—

 
N.M.

N.M.

Net income available to common shareholders
$
424,542

$
310,383

$
266,391

$
114,159

$
43,992

 
36.8
%
16.5
%
N.M. - Not meaningful.

Net income attributable to Commerce Bancshares, Inc. (net income) for 2018 was $433.5 million, an increase of $114.2 million, or 35.7%, compared to $319.4 million in 2017. Diluted income per common share increased 37.0% to $3.78 in 2018, compared to $2.76 in 2017. The growth in net income resulted from increases of $90.1 million in net interest income and $40.1 million in non-interest income, as well as decreases of $6.5 million in non-interest expense, $4.6 million in income tax expense and $2.6 million in the provision for loan losses. These increases in net income were partly offset by a $25.5 million decrease in investment securities gains. The return on average assets was 1.76% in 2018 compared to 1.28% in 2017, and the return on average common equity was 16.16% in 2018 compared to 12.46% in 2017. At December 31, 2018, the ratio of tangible common equity to assets increased to 10.45%, compared to 9.84% at year end 2017.

During 2018, the increase in net interest income mainly resulted from increased rates on the Company’s loan and investment portfolios, partially offset by higher rates paid on interest-bearing deposits and borrowings.  Total rates earned on average earning assets grew 44 basis points this year, while funding costs for deposits and borrowings increased by 15 basis points.  Non-interest income grew 8.7% in 2018, primarily from growth in bank card, trust and deposit fee income.  Investment securities net losses in 2018 were mainly comprised of net losses on sales of available for sale debt securities of $9.7 million and a $8.9 million adjustment to recognize dividend income on a liquidated equity security. These losses were offset by realized and unrealized net gains on the Company’s portfolio of private equity securities of $13.8 million, as well as gains of $4.3 million on sales and fair value adjustments on equity securities.  Additionally, net securities gains in 2017 included a gain of $32.0 million on the appreciation of securities donated to a related foundation, which did not recur in 2018.

Non-interest expense declined $6.5 million in 2018 compared to 2017, with the decrease resulting from a $32.0 million donation of appreciated securities to a charitable organization in 2017 that did not recur in 2018.  This decrease in non-interest expense was partly offset by increases in salaries and benefits, data processing and software, and marketing expense, which increased $19.9 million, $5.0 million, and $4.2 million, respectively.  The provision for loan losses totaled $42.7 million, a decrease of $2.6 million from the previous year.

Net income attributable to Commerce Bancshares, Inc. for 2017 was $319.4 million, an increase of $44.0 million, or 16.0%, compared to $275.4 million in 2016. Diluted income per common share increased 16.5% to $2.76 in 2017, compared to $2.37 in 2016. The increase in net income resulted from increases of $53.6 million in net interest income, $14.7 million in non-interest income, and $25.1 million in investment securities gains, as well as a decrease of $13.6 million in income tax expense. These increases in net income were partly offset by increases of $55.1 million in non-interest expense and $8.9 million in the provision for loan losses. The return on average assets was 1.28% in 2017 compared to 1.12% in 2016, and the return on average common equity was 12.46% in 2017 compared to 11.33% in 2016. At December 31, 2017, the ratio of tangible common equity to assets increased to 9.84%, compared to 8.66% at year end 2016.

During 2017, net interest income increased $53.6 million compared to 2016. This increase reflected growth of $53.9 million in interest on loans, resulting from higher average balances and loan yields. In addition, interest on investment securities grew by $7.5 million due to higher rates earned, which included $2.0 million in additional inflation income earned on the Company's portfolio of U.S. Treasury inflation-protected securities (TIPS). Interest expense on deposits and borrowings rose by $10.7 million largely due to higher average rates paid. The provision for loan losses increased $8.9 million over the previous year, totaling $45.2 million in 2017, and was $3.6 million higher than net loan charge-offs. Net charge-offs increased by $9.7 million in 2017 compared

19

to 2016, mainly due to higher net charge-offs on consumer credit card loans and lower net recoveries on construction and business real estate loans.

Non-interest income in 2017 was $461.3 million, an increase of $14.7 million, or 3.3%, compared to $446.6 million in 2016. This increase resulted mainly from growth in trust fees, deposit account fees, and loan fees and sales, which increased $13.4 million, $3.7 million, and $2.5 million, respectively. Non-interest expense in 2017 was $744.3 million, an increase of $55.1 million over $689.2 million in 2016. The increase in non-interest expense included a $21.0 million, or 4.9%, increase in salaries and benefits expense due to higher full-time salaries, incentive compensation, and payroll taxes. As mentioned above, expense in 2017 also included $32.0 million of contribution expense resulting from the donation of appreciated securities to a charitable foundation. Investment securities net gains in 2017 totaled $25.1 million, largely resulting from these donations.

The Company distributed a 5% stock dividend for the 25th consecutive year on December 17, 2018. All per share and average share data in this report has been restated for the 2018 stock dividend.

Critical Accounting Policies
The Company's consolidated financial statements are prepared based on the application of certain accounting policies, the most significant of which are described in Note 1 to the consolidated financial statements. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or be subject to variations which may significantly affect the Company's reported results and financial position for the current period or future periods. The use of estimates, assumptions, and judgments are necessary when financial assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. Current economic conditions may require the use of additional estimates, and some estimates may be subject to a greater degree of uncertainty due to the current instability of the economy. The Company has identified several policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for loan losses, fair value measurement, and accounting for income taxes.

Allowance for Loan Losses
The Company performs periodic and systematic detailed reviews of its loan portfolio to assess overall collectability. The level of the allowance for loan losses reflects the Company's estimate of the losses inherent in the loan portfolio at any point in time. While these estimates are based on substantive methods for determining allowance requirements, actual outcomes may differ significantly from estimated results, especially when determining allowances for business, construction and business real estate loans. These loans are normally larger and more complex, and their collection rates are harder to predict. Personal banking loans, including personal real estate, credit card and consumer loans, are individually smaller and perform in a more homogenous manner, making loss estimates more predictable. Further discussion of the methodology used in establishing the allowance is provided in the Allowance for Loan Losses section of Item 7 and in Note 1 to the consolidated financial statements.

Fair Value Measurement
Investment securities, including available-for-sale, trading, equity and other securities, residential mortgage loans held for sale, derivatives and deferred compensation plan assets and associated liabilities are recorded at fair value on a recurring basis. Additionally, from time to time, other assets and liabilities may be recorded at fair value on a nonrecurring basis, such as impaired loans that have been reduced based on the fair value of the underlying collateral, other real estate (primarily foreclosed property), non-marketable equity securities and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve write-downs of individual assets or application of lower of cost or fair value accounting.

Fair value is an estimate of the exchange price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (i.e., not a forced transaction, such as a liquidation or distressed sale) between market participants at the measurement date and is based on the assumptions market participants would use when pricing an asset or liability. Fair value measurement and disclosure guidance establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The fair value hierarchy, the extent to which fair value is used to measure assets and liabilities and the valuation methodologies and key inputs used are discussed in Note 16 on Fair Value Measurements.

At December 31, 2018, assets and liabilities measured using observable inputs that are classified as either Level 1 or Level 2 represented 98.9% and 99.6% of total assets and liabilities recorded at fair value, respectively. Valuations generated from model-based techniques that use at least one significant assumption not observable in the market are considered Level 3, and the Company's Level 3 assets totaled $100.4 million, or 1.2% of total assets recorded at fair value on a recurring basis.  Unobservable assumptions reflect estimates of assumptions market participants would use in pricing the asset or liability. Fair value measurements for assets

20

and liabilities where limited or no observable market data exists often involves significant judgments about assumptions, such as determining an appropriate discount rate that factors in both liquidity and risk premiums, and in many cases may not reflect amounts exchanged in a current sale of the financial instrument. In addition, changes in market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. Therefore, when market data is not available, the Corporation would use valuation techniques requiring more management judgment to estimate the appropriate fair value.

Accounting for Income Taxes
Accrued income taxes represent the net amount of current income taxes which are expected to be paid attributable to operations as of the balance sheet date. Deferred income taxes represent the expected future tax consequences of events that have been recognized in the financial statements or income tax returns. Deferred tax assets and liabilities are measured using the enacted tax rates that are expected to apply to taxable income when such assets and liabilities are anticipated to be settled or realized. Current and deferred income taxes are reported as either a component of other assets or other liabilities in the consolidated balance sheets, depending on whether the balances are assets or liabilities. Judgment is required in applying generally accepted accounting principles in accounting for income taxes. The Company regularly monitors taxing authorities for changes in laws and regulations and their interpretations by the judicial systems. The aforementioned changes, as well as any changes that may result from the resolution of income tax examinations by federal and state taxing authorities, may impact the estimate of accrued income taxes and could materially impact the Company’s financial position and results of operations.


21

Net Interest Income
Net interest income, the largest source of revenue, results from the Company’s lending, investing, borrowing, and deposit gathering activities. It is affected by both changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest bearing liabilities. The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates. Changes not solely due to volume or rate changes are allocated to rate.
 
2018
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
$
4,235

$
25,921

$
30,156

$
5,190

$
15,053

$
20,243

Real estate- construction and land
3,614

8,511

12,125

3,628

6,235

9,863

Real estate - business
1,637

13,870

15,507

9,284

3,420

12,704

Real estate - personal
2,765

2,333

5,098

3,114

(264
)
2,850

Consumer
(1,018
)
9,027

8,009

3,441

2,548

5,989

Revolving home equity
(735
)
2,732

1,997

(669
)
1,388

719

Consumer credit card
2,956

984

3,940

(654
)
2,975

2,321

Total interest on loans
13,454

63,378

76,832

23,334

31,355

54,689

Loans held for sale
154

144

298

(368
)
51

(317
)
Investment securities:
 
 
 
 
 
 
U.S. government and federal agency obligations
146

1,877

2,023

3,831

238

4,069

Government-sponsored enterprise obligations
(2,331
)
1,108

(1,223
)
(3,108
)
(2,744
)
(5,852
)
State and municipal obligations
(11,184
)
(8,022
)
(19,206
)
(1,191
)
3

(1,188
)
Mortgage-backed securities
9,931

12,132

22,063

7,771

(1,036
)
6,735

Asset-backed securities
(11,051
)
8,517

(2,534
)
(4,884
)
6,295

1,411

Other securities
734

11,382

12,116

(1,151
)
4,199

3,048

Total interest on investment securities
(13,755
)
26,994

13,239

1,268

6,955

8,223

Federal funds sold and short-term securities purchased
   under agreements to resell
105

184

289

36

116

152

Long-term securities purchased under agreements to
   resell
186

255

441

(1,765
)
3,661

1,896

Interest earning deposits with banks
1,206

2,804

4,010

97

1,153

1,250

Total interest income
1,350

93,759

95,109

22,602

43,291

65,893

Interest expense
 
 
 
 
 
 
Interest bearing deposits:
 
 
 
 
 
 
Savings
57

(65
)
(8
)
53

5

58

Interest checking and money market
328

10,174

10,502

235

2,650

2,885

Certificates of deposit of less than $100,000
(264
)
834

570

(272
)
108

(164
)
Certificates of deposit of $100,000 and over
(2,393
)
6,192

3,799

(439
)
2,753

2,314

Federal funds purchased and securities sold under agreements to repurchase
48

9,778

9,826

463

6,051

6,514

Other borrowings
(3,041
)
—

(3,041
)
(1,955
)
1,073

(882
)
Total interest expense
(5,265
)
26,913

21,648

(1,915
)
12,640

10,725

Net interest income, fully taxable equivalent basis
$
6,615

$
66,846

$
73,461

$
24,517

$
30,651

$
55,168


Net interest income totaled $823.8 million in 2018, increasing $90.1 million, or 12.3%, compared to $733.7 million in 2017. On a tax equivalent (T/E) basis, net interest income totaled $840.1 million, and increased $73.5 million over 2017. This increase included growth of $76.8 million in loan interest income (T/E), resulting from higher average balances and higher rates earned. In addition, interest earned on investment securities increased $13.2 million, mainly due to higher rates earned and the receipt of $8.9 million in dividend income during the second quarter of 2018, which was related to a liquidated equity security that was carried at fair value. Interest expense on deposits and borrowings combined was $65.4 million and increased $21.6 million, mostly due to higher rates paid. The net yield on earning assets (T/E) was 3.53% in 2018 compared with 3.19% in 2017.


22

During 2018, loan interest income (T/E) grew $76.8 million over 2017 mainly due to higher rates earned coupled with increased average balances for most loan categories. The average tax equivalent rate earned on the loan portfolio increased 46 basis points to 4.53% in 2018 compared to 4.07% in 2017. The higher rates earned on the loan portfolio were partly related to continued actions taken by the Federal Reserve to raise short-term interest rates, which enabled much of the Company's loan portfolio to re-price higher. In addition, average loan balances increased 2.3%, or $314.4 million, this year. Increased interest on business loans was the main driver of overall higher loan interest income, mostly due to higher rates, as many of these loans contain variable interest rate terms. Average business loan balances also grew $131.0 million this year. Increases in average balances and rates on construction and business real estate loans drove interest income growth a combined $27.6 million this year. Interest on personal real estate loans increased $5.1 million as average balances were higher by $74.1 million or 3.7%, and the average rate grew 11 basis points. Interest on consumer loans grew $8.0 million over the prior year as the average rate earned increased 45 basis points, but was partly offset by a decline in average balances of $25.6 million. Consumer credit card loan interest was higher by $3.9 million due to growth of $24.9 million in average balances, coupled with a 13 basis point increase in the average rate earned.

Tax equivalent interest income on total investment securities increased $13.2 million during 2018, as the average rate earned increased 33 basis points, while average balances declined $661.6 million. The average rate on the total investment portfolio was 2.84% in 2018 compared to 2.51% in 2017, while the average balance of the total investment securities portfolio (excluding unrealized fair value adjustments on available for sale debt securities) was $8.8 billion in 2018 compared to an average balance of $9.5 billion in 2017. The increase in interest income was mainly due to higher interest earned on mortgage-backed securities, coupled with increased interest and dividend income on equity and other securities. These increases were partly offset lower interest earned on state and municipal securities. Interest income on mortgage-backed securities increased $22.1 million, due to an increase in average balances of $419.0 million and an increase of 29 basis points in the average rate earned. Interest income on equity securities increased due to $8.9 million in dividend income during the second quarter of 2018 (mentioned previously), while interest on other securities increased $1.9 million due to an increase in receipts of non-recurring equity investment dividends during 2018. Interest earned on U.S. government securities grew $2.0 million, which included growth of $2.1 million in inflation income on the Company's treasury inflation-protected securities (TIPS). Partly offsetting these increases in interest income were declines of $19.2 million, $2.5 million and $1.2 million in interest earned on state and municipal, asset-backed and government-sponsored enterprise (GSE) securities, respectively. The decline in state and municipal interest resulted from a decline of $310.0 million in average balances coupled with a lower tax equivalent rate due to tax law changes in 2018. Asset-backed securities interest decreased mainly due to a decline of $627.9 million in average balances, partly offset by higher average rates. Interest earned on GSE's declined mainly due to lower average balances, partly offset by growth in the average rate. Interest earned on deposits with banks increased $4.0 million mainly due to an 88 basis point increase in average rates earned and an increase of $112.7 million in average balances.

During 2018, interest expense on deposits increased $14.9 million over 2017 and 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 $10.5 million due to higher rates paid, which rose nine basis points. The growth in interest expense on certificates of deposit was largely due to higher rates paid on certificates of deposit over $100,000, which increased 54 basis points, partly offset by lower total average certificate of deposit balances, which fell $363.3 million, or 17.5%. The overall rate paid on total deposits increased from .23% in 2017 to .34% in the current year. Interest expense on borrowings increased due to higher rates paid on customer repurchase agreements, partly offset by the elimination of all Federal Home Loan Bank (FHLB) borrowings in 2018. The overall average rate incurred on all interest bearing liabilities was .44% in 2018, compared to .29% in 2017.

During 2017, net interest income totaled $733.7 million, increasing $53.6 million, or 7.9%, compared to $680.0 million in 2016. On a tax equivalent (T/E) basis, net interest income totaled $766.6 million and increased $55.2 million over 2016. This increase included growth of $54.7 million in loan interest, resulting from higher average loan balances and higher rates earned. In addition, interest earned on investment securities increased $8.2 million, mainly due to higher rates earned. Interest expense on deposits and borrowings combined was $43.7 million and increased $10.7 million compared to 2016 largely due to higher rates paid. The net yield on earning assets (T/E) was 3.19% in 2017 compared to 3.04% in 2016.

During 2017, loan interest income (T/E) grew $54.7 million over 2016 due to average loan growth of $683.9 million, or 5.3%. The average tax equivalent rate earned on the loan portfolio was 4.07% in 2017 compared to 3.86% in 2016. Similar to 2018, the higher rates earned on the loan portfolio were partly related to increases in interest rate levels taken by the Federal Reserve during 2017. The largest increase in loan interest occurred in business loans, which was higher by $20.2 million as a result of growth in the average rate earned of 31 basis points. Also contributing to the increase were higher average business loan balances of $179.5 million, or 3.9%, as growth trends continued in commercial and industrial, tax-free, and lease loans. Construction and land loan interest grew $9.9 million due to a 71 basis point increase in average rates and a $103.1 million, or 13.2%, increase in average balances. Business real estate interest was higher by $12.7 million as a result of an increase in average balances of $253.7 million, or 10.4%, along with an increase in average rates of 13 basis points. Interest earned on consumer loans increased $6.0 million over the prior year as the average rate increased 12 basis points and average balances increased $89.2 million. Personal real estate

23

loan interest was higher by $2.9 million and resulted from growth in average balances of $83.3 million. Interest on consumer credit card loans rose $2.3 million due to a 40 basis point increase in the average rate earned.

Tax equivalent interest income on total investment securities increased $8.2 million during 2017, as the average rate earned increased nine basis points, while total average balances declined slightly. The average rate earned on the total investment portfolio was 2.51% in 2017 compared to 2.42% in 2016, while the average balance of the total investment securities portfolio (excluding unrealized fair value adjustments on available for sale debt securities) was approximately $9.5 billion during both years. The increase in interest income was mainly due to higher interest earned on U.S. government obligations, mortgage-backed securities, and other securities. Interest earned on U.S. government securities grew $4.1 million, which included growth of $2.0 million in inflation-adjusted interest on TIPS. In addition, average balances rose $179.9 million, or 24.5%. Interest income on mortgage-backed securities increased $6.7 million, due to an increase in average balances of $323.8 million, partly offset by a decline of three basis points in the average rate earned. Interest earned on asset-backed securities increased $1.4 million, mainly due to an increase of 30 basis points in the average rate earned, partly offset by a decline in average balances of $334.5 million. Interest income on other securities increased $2.9 million, largely due to one-time interest payments received on a private equity investment in 2017. Partly offsetting these increases in interest income were declines of $5.9 million and $1.2 million in interest on GSE and state and municipal securities, respectively. The decline in GSE interest resulted from a $139.4 million decline in average balances, coupled with a rate decrease of 61 basis points, while state and municipal interest was lower due to a decrease of $33.0 million in average balances. Interest earned on deposits with banks increased $1.3 million mainly due to a 55 basis point increase in average rates earned. Interest on long-term securities purchased under resell agreements increased $1.9 million in 2017 compared to 2016 due to an increase in the average rate of 53 basis points, partly offset by a $103.2 million decrease in the average balances of these instruments.

During 2017, interest expense on deposits increased $5.1 million over 2016. This growth was comprised of higher interest expense on money market and interest checking accounts of $2.9 million and higher interest expense on certificates of deposit of $2.2 million. The increase in money market and interest checking interest expense resulted mainly from higher average rates paid, which rose three basis points. The growth in certificate of deposit interest expense was largely due to higher rates paid on certificates of deposit over $100,000, which increased 19 basis points, partly offset by lower total average certificate of deposit balances, which fell $139.6 million, or 6.3%. The overall rate paid on total deposits increased from .19% in 2016 to .23% in the current year. Interest expense on borrowings increased $5.6 million, due to higher average rates paid on repurchase agreements during 2017, partly offset by lower FHLB borrowings. The overall average rate incurred on all interest bearing liabilities was .29% in 2017, compared to .22% in 2016.

Provision for Loan Losses
The provision for loan losses is recorded to bring the allowance for loan losses to a level deemed adequate by management based on the factors mentioned in the “Allowance for Loan Losses” section of this discussion. The provision for loan losses totaled $42.7 million in 2018, a decrease of $2.6 million from the 2017 provision of $45.2 million. In 2017, the provision exceeded net loan charge-offs by $3.6 million, increasing the allowance for loan losses by the same amount, whereas the 2018 provision was $400 thousand greater than net loan charge-offs for the year.
Net loan charge-offs for the year totaled $42.3 million and increased $650 thousand compared to $41.6 million in 2017. The increase in net loan charge-offs over the previous year was mainly the result of higher net charge-offs on business loans, which increased $724 thousand and was largely the result of a charge-off recorded on one larger loan. In addition, consumer credit card net charge-offs increased $325 thousand, while construction loan net recoveries declined $556 thousand. Partly offsetting these increases in net charge-offs were lower net charge-offs on consumer loans, which decreased $693 thousand from the prior year. The allowance for loan losses totaled $159.9 million at December 31, 2018, an increase of $400 thousand compared to the prior year, and represented 1.13% of outstanding loans at year end 2018, compared to 1.14% at year end 2017.


24

Non-Interest Income
 
 
 
 
% Change
(Dollars in thousands)
2018
2017
2016
'18-'17
'17-'16
Bank card transaction fees
$
171,576

$
155,100

$
154,043

10.6
 %
0.7
 %
Trust fees
147,964

135,159

121,795

9.5

11.0

Deposit account charges and other fees
94,517

90,060

86,394

4.9

4.2

Capital market fees
7,721

7,996

10,655

(3.4
)
(25.0
)
Consumer brokerage services
15,807

14,630

13,784

8.0

6.1

Loan fees and sales
12,723

13,948

11,412

(8.8
)
22.2

Other
51,033

44,370

48,473

15.0

(8.5
)
Total non-interest income
$
501,341

$
461,263

$
446,556

8.7
 %
3.3
 %
Non-interest income as a % of total revenue*
37.8
%
38.6
%
39.6
%
 
 
Total revenue per full-time equivalent employee
$
276.4

$
248.9

$
235.5

 
 
*
Total revenue is calculated as net interest income plus non-interest income.

Non-interest income totaled $501.3 million, an increase of $40.1 million, or 8.7%, compared to $461.3 million in 2017. Bank card fees increased $16.5 million, or 10.6%, over the prior year, as a result of growth in net debit card fees of $4.1 million and net corporate card fees of $14.8 million. These increases were partly offset by declines in net credit card fees of $1.6 million and net merchant fees of $836 thousand. The table below is a summary of bank card transaction fees for the last three years.
 
 
 
 
% Change
(Dollars in thousands)
2018
2017
2016
'18-'17
'17-'16
Net debit card fees
$
39,738

$
35,636

$
33,441

11.5
 %
6.6
 %
Net credit card fees
12,965

14,576

14,834

(11.1
)
(1.7
)
Net merchant fees
19,233

20,069

23,043

(4.2
)
(12.9
)
Net corporate card fees
99,640

84,819

82,725

17.5

2.5

Total bank card transaction fees
$
171,576

$
155,100

$
154,043

10.6
 %
0.7
 %
     
Trust fee income increased $12.8 million, or 9.5%, as a result of continued growth in both personal (up 11.1%) and institutional (up 6.4%) trust fees. The market value of total customer trust assets totaled $50.0 billion at year end 2018, which was an increase of 2.7% over year end 2017 balances. Deposit account fees increased $4.5 million, or 4.9%, mainly due to growth of $2.4 million in corporate cash management fees, $1.1 million in deposit account service charges and $892 thousand in overdraft and return item fees. In 2018, corporate cash management fees comprised 40.7% of total deposit fees, while overdraft fees comprised 33.3% of total deposit fees. Capital market fees declined $275 thousand, or 3.4%, due to continued lower sales volumes, while consumer brokerage services revenue increased $1.2 million, or 8.0%, mainly due to growth in advisory and fixed annuity fees. Loan fees and sales decreased $1.2 million, or 8.8%, from the prior year mainly due to declines mortgage banking revenue as a result of lower originations of fixed-rate loans in 2018. Total mortgage banking revenue totaled $8.2 million in 2018 compared to $9.2 million in 2017. Other non-interest income increased $6.7 million, or 15.0%, over the prior year, mainly due to gains of $6.6 million recorded on the sale of branch properties in 2018. In addition, cash sweep commissions, interest rate swap fees, and fees from sales of tax credits increased $1.6 million, $2.1 million, and $1.6 million, respectively, over 2017. These increases were partly offset by lower gains of $1.1 million on sales of leased assets to customers upon lease termination.

During 2017, non-interest income increased $14.7 million, or 3.3%, to $461.3 million compared to $446.6 million in 2016. Bank card fees increased $1.1 million, or .7%, over 2016. This growth included increases of $2.2 million, or 6.6%, in net debit card fees and $2.1 million, or 2.5%, in net corporate card fees, partly offset by a decline of $3.0 million, or 12.9%, in net merchant fees. Trust fee income increased $13.4 million, or 11.0%, as a result of growth in both personal (up 10.3%) and institutional (up 11.9%) trust fees. The market value of total customer trust assets totaled $48.7 billion at year end 2017, which was an increase of 13.1% over year end 2016 balances. Deposit account fees increased $3.7 million, or 4.2%, mainly due to growth in service charges on deposits of $2.5 million, or 12.1%. In addition, overdraft fees increased $1.2 million, or 4.2%, while corporate cash management fees were flat. Capital market fees declined $2.7 million, or 25.0%, due to lower sales volumes, while consumer brokerage services revenue increased $846 thousand, or 6.1%, due to growth in advisory fees. Loan fees and sales increased $2.5 million in 2017 compared to 2016, mainly due to higher mortgage banking revenue. Other non-interest income decreased $4.1 million, or 8.5%, from 2016. This decrease was due in part to a decline in interest rate swap fees of $3.9 million due to lower origination volume. In addition, a large gain on a branch sale and a trust settlement were recorded in 2016, which did not recur in 2017. These declines were partly offset by higher gains of $1.2 million on sales of leased assets to customers upon lease termination.

25

Investment Securities Gains (Losses), Net
(In thousands)
2018
 
2017
 
2016
Net gains (losses) on sales of available for sale debt securities
$
(9,653
)
 
$
(9,695
)
 
$
109

Net gains on sales of equity securities
1,759

 
10,643

 
1,904

Fair value adjustments on equity securities
2,542

 
—

 
—

Adjustment for dividend income on a liquidated equity investment
(8,917
)
 
—

 
—

Donations of equity securities
—

 
31,074

 
—

Net gains (losses) on sales and fair value adjustments of private equity investments
13,849

 
(6,332
)
 
(1,796
)
Other
(68
)
 
(639
)
 
(270
)
Total investment securities gains (losses), net
$
(488
)
 
$
25,051

 
$
(53
)
Net gains and losses on investment securities during 2018, 2017 and 2016 are shown in the table above. Included in these amounts are gains and losses arising from sales of securities from the Company’s available for sale debt portfolio, including credit-related losses on debt securities identified as other-than-temporarily impaired. Also shown are gains and losses relating to private equity investments, which are primarily held by the Parent’s majority-owned private equity subsidiaries. These include fair value adjustments, in addition to gains and losses realized upon disposition. The portions of private equity investment gains and losses that are attributable to minority interests are reported as non-controlling interest in the consolidated statements of income, and resulted in expense of $2.8 million in 2018, compared to income of $575 thousand in 2017 and expense of $573 thousand in 2016.
Net securities losses of $488 thousand were recorded in 2018, which included $9.7 million in net losses realized on bond sales resulting from the Company's sale of approximately $680 million (book value) of bonds, mainly mortgage and asset-backed securities, as part of a strategy to extend the duration of the securities portfolio and improve net interest margins. Net securities losses also included $8.9 million in losses related to an adjustment for dividend income on a liquidated investment. These losses were offset by net gains totaling $13.8 million of fair value adjustments on private equity investments, in addition to fair value adjustments and net gains realized on sales of equity investments.
Net securities gains of $25.1 million were recorded in 2017, which included $31.1 million in gains realized upon donation of appreciated stock and $10.6 million in net gains realized on sales of equity securities. These gains were offset by net losses of $9.7 million realized on sales of available for sale debt securities, resulting from the Company's sale of approximately $790 million of bonds, mainly mortgage and asset-backed securities. Additionally, net securities losses included $499 thousand in net losses realized on the sale of private equity investments and $5.8 million in losses related to fair value adjustments on private equity investments.
Net securities losses of $53 thousand were recorded in 2016. The 2016 net loss included $1.9 million in gains realized upon dispositions of private equity investments, offset by net losses in fair value totaling $3.7 million on the Company's private equity investment portfolio. Additionally, the Company realized gains on sales of equity securities, including a $1.8 million gain resulting from the Parent's withdrawal from a private equity fund as required under the Volcker Rule investment prohibitions.


26

Non-Interest Expense
 
 
 
 
% Change
(Dollars in thousands)
2018
2017
2016
'18-'17
'17-'16
Salaries
$
396,897

$
380,945

$
360,840

4.2
 %
5.6
 %
Employee benefits
71,297

67,376

66,470

5.8

1.4

Net occupancy
46,044

45,612

46,290

.9

(1.5
)
Equipment
18,125

18,568

19,141

(2.4
)
(3.0
)
Supplies and communication
20,637

22,790

24,135

(9.4
)
(5.6
)
Data processing and software
85,978

80,998

79,589

6.1

1.8

Marketing
20,548

16,325

16,032

25.9

1.8

Deposit insurance
11,546

13,986

13,327

(17.4
)
4.9

Community service
2,445

34,377

3,906

(92.9
)
N.M.

Other
64,304

63,366

59,499

1.5

6.5

Total non-interest expense
$
737,821

$
744,343

$
689,229

(.9
)%
8.0
 %
Efficiency ratio
55.6
%
62.2
%
61.0
%
 
 
Salaries and benefits as a % of total non-interest expense
63.5
%
60.2
%
62.0
%
 
 
Number of full-time equivalent employees
4,795

4,800

4,784

 
 
     
Non-interest expense was $737.8 million in 2018, a decrease of $6.5 million, or .9%, from the previous year. Salaries and benefits expense increased $19.9 million, or 4.4%, mainly due to higher full-time salaries and medical expense. Growth in salaries expense was driven by increases in full-time salaries in information technology, consumer, wealth, commercial and other support units, while incentive compensation expense declined slightly from 2017. Full-time equivalent employees totaled 4,795 at December 31, 2018, reflecting a small decrease from 2017. Occupancy expense increased $432 thousand, or .9%, mainly due to higher rent, utilities and building services expense, while equipment expense decreased $443 thousand, or 2.4%, due to lower equipment depreciation expense. Supplies and communication expense decreased $2.2 million, or 9.4%, mainly due to lower voice and data network costs. Data processing and software expense increased $5.0 million, or 6.1%, primarily due to higher third party processing costs. Marketing expense increased $4.2 million, or 25.9%, due to new bank card initiatives and consumer marketing initiatives in 2018. Deposit insurance expense declined $2.4 million, or 17.4%, from the prior year mainly due to decreases in average assets, a lower assessment rate, and the elimination of the special FDIC surcharge in the fourth quarter of 2018. Community service costs decreased $31.9 million due to the contribution of appreciated securities to a related foundation in 2017, which did not recur in 2018. Other non-interest expense increased $938 thousand, or 1.5%, over the prior year mainly due to higher costs for professional fees (up $2.4 million) and directors fees (up $936 thousand). These increases were partly offset by lower bank card fraud losses (down $961 thousand).

In 2017, non-interest expense was $744.3 million, an increase of $55.1 million, or 8.0%, over 2016. Salaries and benefits expense increased $21.0 million, or 4.9%, mainly due to higher full-time salaries, incentive compensation, and payroll taxes. Incentive compensation included the accrual of a discretionary bonus of $3.3 million in December 2017 that was paid to approximately 75% of all employees. Growth in salaries expense resulted partly from staffing additions in commercial and consumer, information technology, and other support units. Full-time equivalent employees totaled 4,800 at December 31, 2017, an increase of .3% over 2016. Occupancy expense decreased $678 thousand, mainly due to higher net rental income and lower demolition costs on a branch replacement project. Supplies and communication expense decreased by $1.3 million, or 5.6%, mainly due to reissuance costs for new chip cards distributed to customers in 2016 and lower office supplies expense. Data processing and software expense increased $1.4 million, or 1.8%, mainly due to higher online subscription services and outsourced data provider fees, partly offset by lower bank card processing costs. Equipment expense decreased by $573 thousand, or 3.0%, while deposit insurance expense was higher by $659 thousand, or 4.9%, due to higher insurance rates. Costs for marketing increased slightly compared to 2016. Community service costs increased $30.5 million due to the contribution of $32.0 million of appreciated securities to a related foundation during 2017. Other non-interest expense increased $3.9 million, or 6.5%, over 2016 mainly due to higher costs for legal and professional fees (up $1.2 million), impairment losses on surplus branch sites (up $1.2 million), and lower deferred origination costs (down $1.5 million).
    
Income Taxes
Income tax expense was $105.9 million in 2018, compared to $110.5 million in 2017 and $124.2 million in 2016. The effective tax rate, including the effect of non-controlling interest, was 19.6% in 2018 compared to 25.7% in 2017 and 31.1% in 2016.


27

Due to the enactment of new federal tax reform legislation in December 2017, federal tax rates were lowered from 35% to 21%, which lowered the Company's effective tax rate in 2018. Additionally, the Company adopted ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting," on January 1, 2017, which requires all excess tax benefits (net of tax deficiencies) to be recognized as income tax expense or benefit in the income statement. The amount of excess tax benefits (net of tax deficiencies) recognized as a reduction to income tax expense totaled $4.7 million and $7.3 million in 2018 and 2017, respectively. In 2017, the Company also recorded income tax benefits of $11.8 million resulting from the contribution of appreciated securities to a charitable foundation.

Financial Condition
Loan Portfolio Analysis
Classifications of consolidated loans by major category at December 31 for each of the past five years are shown in the table below. This portfolio consists of loans which were acquired or originated with the intent of holding to their maturity. Loans held for sale are separately discussed in a following section. A schedule of average balances invested in each loan category below appears on page 54.
 
Balance at December 31
(In thousands)
2018
2017
2016
2015
2014
Commercial:
 
 
 
 
 
Business
$
5,106,427

$
4,958,554

$
4,776,365

$
4,397,893

$
3,969,952

Real estate — construction and land
869,659

968,820

791,236

624,070

403,507

Real estate — business
2,875,788

2,697,452

2,643,374

2,355,544

2,288,215

Personal banking:
 
 
 
 
 
Real estate — personal
2,127,083

2,062,787

2,010,397

1,915,953

1,883,092

Consumer
1,955,572

2,104,487

1,990,801

1,924,365

1,705,134

Revolving home equity
376,399

400,587

413,634

432,981

430,873

Consumer credit card
814,134

783,864

776,465

779,744

782,370

Overdrafts
15,236

7,123

10,464

6,142

6,095

Total loans
$
14,140,298

$
13,983,674

$
13,412,736

$
12,436,692

$
11,469,238


The contractual maturities of business and real estate loan categories at December 31, 2018, and a breakdown of those loans between fixed rate and floating rate loans are as follows.
 
Principal Payments Due
 
(In thousands)
In
One Year
or Less
After One
Year Through
Five Years
After
Five
Years
Total
Business
$
2,503,345

$
2,153,729

$
449,353

$
5,106,427

Real estate — construction and land
524,674

322,426

22,559

869,659

Real estate — business
516,579

1,750,781

608,428

2,875,788

Real estate — personal
165,134

510,971

1,450,978

2,127,083

Total business and real estate loans
$
3,709,732

$
4,737,907

$
2,531,318

$
10,978,957

 
 
 
 
 
Business and real estate loans:
 
 
 
 
Loans with fixed rates
23.8
%
48.4
%
55.2
%
41.7
%
Loans with floating rates
76.2
%
51.6
%
44.8
%
58.3
%
Total business and real estate loans
100.0
%
100.0
%
100.0
%
100.0
%


28

The following table shows loan balances at December 31, 2018, segregated between those with fixed interest rates and those with variable rates that fluctuate with an index.
(In thousands)
Fixed Rate Loans
Variable Rate Loans
Total
% Variable Rate Loans
Business
$
1,856,806

$
3,249,621

$
5,106,427

63.6
%
Real estate — construction and land
46,693

822,966

869,659

94.6

Real estate — business
1,224,106

1,651,682

2,875,788

57.4

Real estate — personal
1,445,600

681,483

2,127,083

32.0

Consumer
1,373,478

582,094

1,955,572

29.8

Revolving home equity
7,171

369,228

376,399

98.1

Consumer credit card
61,878

752,256

814,134

92.4

Overdrafts
15,236

—

15,236

—

Total loans
$
6,030,968

$
8,109,330

$
14,140,298

57.3
%

Total loans at December 31, 2018 were $14.1 billion, an increase of $156.6 million, or 1.1%, over balances at December 31, 2017. The growth in loans during 2018 occurred in the business, business real estate, personal real estate, credit card and overdraft loan categories, while construction, consumer and revolving home equity loans declined from the prior year. Business loans increased $147.9 million, or 3.0%, reflecting growth in commercial and industrial loans, while commercial card and tax-advantaged lending declined. Business real estate loans increased $178.3 million, or 6.6%, due to the improved loan demand and the transfer of certain outstanding construction loans into this category. Construction loans decreased $99.2 million, or 10.2% mainly due to pay downs on certain completed projects and transfers to the business real estate loan category. Personal real estate loans increased $64.3 million, or 3.1%, on origination growth and demand for adjustable rate mortgages, which are retained on the balance sheet. The Company sells certain long-term fixed rate mortgage loans to the secondary market, and loan sales in 2018 totaled $193.5 million, compared to $199.8 million in 2017. Consumer loans decreased $148.9 million, or 7.1%, due to declines in automobile, fixed rate home equity and other consumer loans, along with continued run off of marine and recreational vehicle loan balances. Consumer credit card loans increased $30.3 million, or 3.9%, as a result of new account activity, while revolving home equity loan balances declined $24.2 million compared to balances at year end 2017.

The Company currently holds approximately 30% of its loan portfolio in the Kansas City market, 29% in the St. Louis market, and 41% in other regional markets. The portfolio is diversified from a business and retail standpoint, with 63% in loans to businesses and 37% in loans to consumers. The Company believes a diversified approach to loan portfolio management, strong underwriting criteria and an aversion toward credit concentrations, from an industry, geographic and product perspective, have contributed to low levels of problem loans and loan losses experienced over the last several years.

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. At December 31, 2018, the balance of SNC loans totaled approximately $830.2 million, with an additional $1.3 billion in unfunded commitments.

Commercial Loans
Business
Total business loans amounted to $5.1 billion at December 31, 2018 and include loans used mainly to fund customer accounts receivable, inventories, and capital expenditures. The business loan portfolio includes tax-advantaged loans and leases which carry tax free interest rates. These loans totaled $902.5 million at December 31, 2018, a decline of $32.6 million, or 3.5%, from December 31, 2017 balances. The business loan portfolio also includes direct financing and sales type leases totaling $557.3 million, which are used by commercial customers to finance capital purchases ranging from computer equipment to office and transportation equipment. These leases increased $25.8 million, or 4.9%, over 2017. The Company has outstanding energy-related loans totaling $143.8 million at December 31, 2018, which are further discussed on page 38. Also included in the business portfolio are corporate card loans, which totaled $297.0 million at December 31, 2018 and are made in conjunction with the Company’s corporate card business for corporate trade purchases. Corporate card loans are made to corporate, non-profit and government customers nationwide, but have very short-term maturities, which limit risk.

Business loans, excluding corporate card loans, are made primarily to customers in the regional trade area of the Company, generally the central Midwest, encompassing the states of Missouri, Kansas, Illinois, and nearby Midwestern markets, including

29

Iowa, Oklahoma, Colorado, Texas and Ohio. This portfolio is diversified from an industry standpoint and includes businesses engaged in manufacturing, wholesaling, retailing, agribusiness, insurance, financial services, public utilities, health care, and other service businesses. Emphasis is upon middle-market and community businesses with known local management and financial stability. Consistent with management’s strategy and emphasis upon relationship banking, most borrowing customers also maintain deposit accounts and utilize other banking services. Net loan charge-offs in this category totaled $2.1 million in 2018 (mainly representing a charge-off on one larger loan placed on non-accrual late in the year), compared to net loan charge-offs of $1.4 million recorded in 2017. Non-accrual business loans were $9.0 million (.2% of business loans) at December 31, 2018 compared to $5.9 million at December 31, 2017.

Real Estate-Construction and Land
The portfolio of loans in this category amounted to $869.7 million at December 31, 2018, which was a decrease of $99.2 million, or 10.2%, from the prior year and comprised 6.2% of the Company’s total loan portfolio. Commercial construction and land development loans totaled $664.6 million, or 76.4% of total construction loans at December 31, 2018. These loans decreased $101.3 million from 2017 year end balances; driving the decline in the total construction portfolio. Commercial construction loans are made during the construction phase for small and medium-sized office and medical buildings, manufacturing and warehouse facilities, apartment complexes, shopping centers, hotels and motels, and other commercial properties. Commercial land development loans relate to land owned or developed for use in conjunction with business properties. Residential construction and land development loans at December 31, 2018 totaled $205.1 million, or 23.6% of total construction loans. A stable construction market has contributed to improved loss trends, with net loan recoveries of $635 thousand and $1.2 million recorded in 2018 and 2017, respectively.

Real Estate-Business
Total business real estate loans were $2.9 billion at December 31, 2018 and comprised 20.3% of the Company’s total loan portfolio. This category includes mortgage loans for small and medium-sized office and medical buildings, manufacturing and warehouse facilities, shopping centers, hotels and motels, churches, and other commercial properties. The business real estate borrowers and/or properties are generally located in local and regional markets where Commerce does business, and emphasis is placed on owner-occupied lending (36.1% of this portfolio), which presents lower risk levels. Additional information about business real estate loans by borrower is presented on page 36. At December 31, 2018, non-accrual balances amounted to $1.7 million, or .1% of business real estate loans, down from $2.7 million at year end 2017. The Company experienced net loan recoveries of $378 thousand in 2018, compared to net loan recoveries of $203 thousand in 2017.

Personal Banking Loans
Real Estate-Personal
At December 31, 2018, there were $2.1 billion in outstanding personal real estate loans, which comprised 15.0% of the Company’s total loan portfolio. The mortgage loans in this category are mainly for owner-occupied residential properties. The Company originates both adjustable and fixed rate mortgage loans, and at December 31, 2018, 32% of the portfolio was comprised of adjustable rate loans, while 68% was comprised of fixed rate loans. The Company does not purchase any loans from outside parties or brokers, and has never maintained or promoted subprime or reduced-document products. Levels of mortgage loan origination activity increased slightly in 2018, with originations of $563.0 million in 2018 compared with $560.8 million in 2017. Net loans retained by the Company increased $64.3 million, driven by increased demand for adjustable rate mortgage loans, which the Company retains, while loans sold to the secondary market decreased $6.3 million. The loan sales were made under a 2015 initiative to originate and sell certain long term fixed rate loans, resulting in sales of $199.8 million in 2017 and $193.5 million in 2018. The Company has experienced lower loan losses in this category than many others in the industry and believes this is partly because of its conservative underwriting culture, stable markets, and the fact that it does not offer subprime lending products or purchase loans from brokers. Net loan recoveries for 2018 amounted to $335 thousand, compared to net loan recoveries of $305 thousand in the previous year. The non-accrual balances of loans in this category decreased to $1.8 million at December 31, 2018, compared to $2.5 million at year end 2017.

Consumer
Consumer loans consist of private banking, automobile, motorcycle, marine, tractor/trailer, recreational vehicle (RV), fixed rate home equity, patient health care financing and other types of consumer loans. These loans totaled $2.0 billion at year end 2018. Approximately 47% of the consumer portfolio consists of automobile loans, 20% in private banking loans, 5% in motorcycle loans, 14% in fixed rate home equity loans, 9% in heathcare financing loans and 3% in marine and RV loans. Total consumer loans decreased $148.9 million at year end in 2018 compared to year end 2017. Declines of $99.4 million in automobile loan originations, $28.5 million in fixed rate home equity loans, $20.9 million in marine and RV loans and $42.2 million in motorcycle loans were partly offset by growth of $25.3 million in patient health care financing and $12.4 million in private banking loans.

30

Also, auto loans totaling $25.9 million were sold to another institution this year. Net charge-offs on total consumer loans were $9.3 million in 2018, compared to $10.0 million in 2017, averaging .5% of consumer loans in both years. Consumer loan net charge-offs included marine and RV loan net charge-offs of $710 thousand, which were 1.2% of average marine and RV loans in 2018, compared to 1.4% in 2017.

Revolving Home Equity
Revolving home equity loans, of which 98% are adjustable rate loans, totaled $376.4 million at year end 2018. An additional $709.4 million was available in unused lines of credit, which can be drawn at the discretion of the borrower. Home equity loans are secured mainly by second mortgages (and less frequently, first mortgages) on residential property of the borrower. The underwriting terms for the home equity line product permit borrowing availability, in the aggregate, generally up to 80% or 90% of the appraised value of the collateral property at the time of origination. Net charge-offs totaled $55 thousand in 2018, compared to $185 thousand in 2017.

Consumer Credit Card
Total consumer credit card loans amounted to $814.1 million at December 31, 2018 and comprised 5.8% of the Company’s total loan portfolio. The credit card portfolio is concentrated within regional markets served by the Company. The Company offers a variety of credit card products, including affinity cards, rewards cards, and standard and premium credit cards, and emphasizes its credit card relationship product, Special Connections. Approximately 41% of the households that own a Commerce credit card product also maintain a deposit relationship with the subsidiary bank. At December 31, 2018, approximately 92% of the outstanding credit card loan balances had a floating interest rate, compared to 91% in the prior year. Net charge-offs amounted to $30.6 million in 2018, an increase of $325 thousand over $30.3 million in 2017.

Loans Held for Sale
At December 31, 2018, loans held for sale were comprised of certain long-term fixed rate personal real estate loans and loans extended to students while attending colleges and universities. The personal real estate loans are carried at fair value and totaled $13.5 million at December 31, 2018. The student loans, carried at the lower of cost or fair value, totaled $7.2 million at December 31, 2018. Both of these portfolios are further discussed in Note 2 to the consolidated financial statements.

Allowance for Loan Losses
The Company has an established process to determine the amount of the allowance for loan losses which assesses the risks and losses inherent in its portfolio. This process provides an allowance consisting of a specific allowance component based on certain individually evaluated loans and a general component based on estimates of reserves needed for pools of loans.

Loans subject to individual evaluation generally consist of business, construction, business real estate and personal real estate loans on non-accrual status, and include troubled debt restructurings that are on non-accrual status. These non-accrual loans are evaluated individually for impairment based on factors such as payment history, borrower financial condition and collateral. For collateral dependent loans, appraisals of collateral (including exit costs) are normally obtained annually but discounted based on date last received and market conditions. From these evaluations of expected cash flows and collateral values, specific allowances are determined.
Loans which are not individually evaluated are segregated by loan type and sub-type and are collectively evaluated. These loans include commercial loans (business, construction and business real estate) which have been graded pass, special mention, or substandard, and also includes all personal banking loans except personal real estate loans on non-accrual status. Collectively-evaluated loans include certain troubled debt restructurings with similar risk characteristics. Allowances for both personal banking and commercial loans use methods which consider historical and current loss trends, loss emergence periods, delinquencies, industry concentrations and unique risks. Economic conditions throughout the Company's market place, as monitored by Company credit officers, are also considered in the allowance determination process.
The Company’s estimate of the allowance for loan losses and the corresponding provision for loan losses rest upon various judgments and assumptions made by management. In addition to past loan loss experience, various qualitative factors are considered, such as current loan portfolio composition and characteristics, trends in delinquencies, portfolio risk ratings, levels of non-performing assets, credit concentrations, collateral values, and prevailing regional and national economic conditions. The Company has internal credit administration and loan review staff that continuously review loan quality and report the results of their reviews and examinations to the Company’s senior management and Board of Directors. Such reviews also assist management in establishing the level of the allowance. In using this process and the information available, management must consider various assumptions and exercise considerable judgment to determine the overall level of the allowance for loan losses. Because of these subjective factors, actual outcomes of inherent losses can differ from original estimates. The Company’s subsidiary bank continues

31

to be subject to examination by several regulatory agencies, and examinations are conducted throughout the year, targeting various segments of the loan portfolio for review. Refer to Note 1 to the consolidated financial statements for additional discussion on the allowance and charge-off policies.

At December 31, 2018, the allowance for loan losses was $159.9 million, compared to $159.5 million at December 31, 2017. The percentage of allowance to loans decreased slightly to 1.13% at December 31, 2018 compared to 1.14% at year end 2017. Total loans delinquent 90 days or more and still accruing were $16.7 million at December 31, 2018, a decrease of $1.5 million compared to year end 2017, mainly driven by a $2.2 million decrease in personal real estate loans delinquent 90 days or more, partly offset by an increase of $1.5 million in consumer credit card loan delinquencies. Non-accrual loans at December 31, 2018 were $12.5 million, an increase of $553 thousand over the prior year, mainly due to an increase in business non-accrual loans of $3.0 million. This increase was partially offset by decreases in business real estate and consumer non-accrual loans of $1.0 million and $834 thousand, respectively. The 2018 year end balance of non-accrual loans was comprised of $9.0 million of business loans, $1.7 million of business real estate loans and $1.8 million of personal real estate loans.

Net loan charge-offs totaled $42.3 million in 2018, representing a $650 thousand increase compared to net charge-offs of $41.6 million in 2017. The increase was largely due to higher business loan net charge-offs of $724 thousand and was mainly the result of a charge-off recorded on one larger loan, which was subsequently placed on non-accrual. In addition, consumer credit card loan net charge-offs increased $325 thousand, while net recoveries on construction loans declined $556 thousand. Partly offsetting these increases in net charge-offs were lower net loan charge-offs of $693 thousand on consumer loans. Consumer credit card net charge-offs were 3.98% of average consumer credit card loans in 2018 compared to 4.07% in 2017. Consumer credit card loan net charge-offs as a percentage of total net charge-offs decreased to 72.3% in 2018 compared to 72.6% in 2017. Consumer loan net charge-offs were .46% of average consumer loans in 2018, compared to .49% in 2017, and represented 22.0% of total net loan charge-offs in 2018.

The ratio of net charge-offs to total average loans outstanding in 2018 was .30%, compared to .31% in 2017 and .25% in 2016. The provision for loan losses in 2018 was $42.7 million, compared to provisions of $45.2 million in 2017 and $36.3 million in 2016.

The Company considers the allowance for loan losses of $159.9 million adequate to cover losses inherent in the loan portfolio at December 31, 2018.


32

The schedules which follow summarize the relationship between loan balances and activity in the allowance for loan losses:
 
Years Ended December 31
(Dollars in thousands)
2018
2017
2016
2015
2014
Loans outstanding at end of year(A)
$
14,140,298

$
13,983,674

$
13,412,736

$
12,436,692

$
11,469,238

Average loans outstanding(A)
$
13,926,079

$
13,611,699

$
12,927,778

$
11,869,276

$
11,260,233

Allowance for loan losses:
 
 
 
 
 
Balance at beginning of year
$
159,532

$
155,932

$
151,532

$
156,532

$
161,532

Additions to allowance through charges to expense
42,694

45,244

36,318

28,727

29,531

Loans charged off:
 
 
 
 
 
Business
3,144

2,410

2,549

2,295

2,646

Real estate — construction and land


1

515

499

794

Real estate — business
20

127

194

1,263

1,108

Real estate — personal
176

417

556

1,037

844

Consumer
12,897

13,415

12,711

11,708

12,214

Revolving home equity
357

488

860

722

783

Consumer credit card
36,931

36,114

31,616

31,326

32,424

Overdrafts
2,296

2,207

1,977

2,200

1,960

Total loans charged off
55,821

55,179

50,978

51,050

52,773

Recoveries of loans previously charged off:
 
 
 
 
 
Business
1,042

1,032

1,933

2,683

2,181

Real estate — construction and land
635

1,192

4,227

1,761

2,323

Real estate — business
398

330

1,475

1,396

681

Real estate — personal
511

722

562

596

317

Consumer
3,611

3,436

3,664

3,430

3,409

Revolving home equity
302

303

375

320

743

Consumer credit card
6,353

5,861

6,186

6,287

7,702

Overdrafts
675

659

638

850

886

Total recoveries
13,527

13,535

19,060

17,323

18,242

Net loans charged off
42,294

41,644

31,918

33,727

34,531

Balance at end of year
$
159,932

$
159,532

$
155,932

$
151,532

$
156,532

Ratio of allowance to loans at end of year
1.13
%
1.14
%
1.16
%
1.22
%
1.36
%
Ratio of provision to average loans outstanding
.31
%
.33
%
.28
%
.24
%
.26
%
(A)
Net of unearned income, before deducting allowance for loan losses, excluding loans held for sale.
 
Years Ended December 31
 
2018
2017
2016
2015
2014
Ratio of net charge-offs (recoveries) to average loans outstanding, by loan category:
 
 
 
 
 
Business
.04
 %
.03
 %
.01
 %
(.01
)%
.01
 %
Real estate — construction and land
(.07
)
(.14
)
(.48
)
(.26
)
(.37
)
Real estate — business
(.01
)
(.01
)
(.05
)
(.01
)
.02

Real estate — personal
(.02
)
(.02
)
—

.02

.03

Consumer
.46

.49

.46

.45

.54

Revolving home equity
.01

.05

.12

.09

.01

Consumer credit card
3.98

4.07

3.39

3.35

3.28

Overdrafts
33.93

33.71

28.42

24.93

21.97

Ratio of total net charge-offs to total average loans outstanding
.30
 %
.31
 %
.25
 %
.28
 %
.31
 %


33

The following schedule provides a breakdown of the allowance for loan losses by loan category and the percentage of each loan category to total loans outstanding at year end.
(Dollars in thousands)
2018
2017
2016
2015
2014
 
 
 
Loan Loss Allowance Allocation
% of Loans to Total Loans
Loan Loss Allowance Allocation
% of Loans to Total Loans
Loan Loss Allowance Allocation
% of Loans to Total Loans
Loan Loss Allowance Allocation
% of Loans to Total Loans
Loan Loss Allowance Allocation
% of Loans to Total Loans
Business
$
42,890

36.1
%
$
44,462

35.4
%
$
43,910

35.6
%
$
43,617

35.4
%
$
40,881

34.6
%
RE — construction and land
22,515

6.2

24,432

6.9

21,841

5.9

16,312

5.0

13,584

3.5

RE — business
27,717

20.3

24,810

19.3

25,610

19.7

22,157

18.9

35,157

20.0

RE — personal
3,250

15.0

4,201

14.8

4,110

15.0

6,680

15.4

7,343

16.4

Consumer
18,007

13.8

19,509

15.0

18,935

14.8

21,717

15.5

16,822

14.9

Revolving home equity
825

2.7

1,189

2.9

1,164

3.1

1,393

3.5

2,472

3.7

Consumer credit card
43,755

5.8

40,052

5.6

39,530

5.8

38,764

6.3

39,541

6.8

Overdrafts
973

.1

877

.1

832

.1

892

—

732

.1

Total
$
159,932

100.0
%
$
159,532

100.0
%
$
155,932

100.0
%
$
151,532

100.0
%
$
156,532

100.0
%

Risk Elements of Loan Portfolio
Management reviews the loan portfolio continuously for evidence of problem loans. During the ordinary course of business, management becomes aware of borrowers that may not be able to meet the contractual requirements of loan agreements. Such loans are placed under close supervision with consideration given to placing the loan on non-accrual status, the need for an additional allowance for loan loss, and (if appropriate) partial or full loan charge-off. Loans are placed on non-accrual status when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment. After a loan is placed on non-accrual status, any interest previously accrued but not yet collected is reversed against current income. Interest is included in income only as received and only after all previous loan charge-offs have been recovered, so long as management is satisfied there is no impairment of collateral values. The loan is returned to accrual status only when the borrower has brought all past due principal and interest payments current, and, in the opinion of management, the borrower has demonstrated the ability to make future payments of principal and interest as scheduled. 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 comprised of those personal banking loans that are exempt under regulatory rules from being classified as non-accrual. Consumer installment loans and related accrued interest are normally charged down to the fair value of related collateral (or are charged off in full if no collateral) once the loans are more than 120 days delinquent. Credit card loans and the related accrued interest are charged off when the receivable is more than 180 days past due.
The following schedule shows non-performing assets and loans past due 90 days and still accruing interest.
 
December 31
(Dollars in thousands)
2018
2017
2016
2015
2014
Total non-accrual loans
$
12,536

$
11,983

$
14,283

$
26,575

$
40,775

Real estate acquired in foreclosure
1,413

681

366

2,819

5,476

Total non-performing assets
$
13,949

$
12,664

$
14,649

$
29,394

$
46,251

Non-performing assets as a percentage of total loans
.10
%
.09
%
.11
%
.24
%
.40
%
Non-performing assets as a percentage of total assets
.05
%
.05
%
.06
%
.12
%
.19
%
Loans past due 90 days and still accruing interest
$
16,658

$
18,127

$
16,396

$
16,467

$
13,658

    
The table below shows the effect on interest income in 2018 of loans on non-accrual status at year end.
(In thousands)
 
Gross amount of interest that would have been recorded at original rate
$
1,339

Interest that was reflected in income
392

Interest income not recognized
$
947


Non-accrual loans, which are also classified as impaired, totaled $12.5 million at year end 2018, an increase of $553 thousand from the balance at year end 2017. The increase from December 31, 2017 occurred mainly in business loans, which increased $3.0 million but was partially offset by decreases in business real estate, consumer, and personal real estate non-accrual loans. At December 31, 2018, non-accrual loans were comprised primarily of business (71.7%), personal real estate (14.6%), and business real estate (13.7%) loans. Foreclosed real estate totaled $1.4 million at December 31, 2018, an increase of $732 thousand when compared to December 31, 2017. Total non-performing assets remain low compared to the overall banking industry in 2018, with

34

the non-performing loans to total loans ratio at .10% at December 31, 2018. Total loans past due 90 days or more and still accruing interest were $16.7 million as of December 31, 2018, a decrease of $1.5 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 of 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 $145.7 million at December 31, 2018, compared with $213.4 million at December 31, 2017, resulting in a decrease of $67.7 million. The decrease in potential problem loans was seen in all loan classes but was largely driven by a $55.4 million decline in business loans, mainly due to loans paying off and the upgrade of certain large commercial and industrial and lease loans.
 
December 31
(In thousands)
2018
2017
Potential problem loans:
 
 
Business
$
98,009

$
153,417

Real estate – construction and land
1,211

2,702

Real estate – business
44,854

51,134

Real estate – personal
1,586

6,121

Total potential problem loans
$
145,660

$
213,374


At December 31, 2018, the Company had $75.8 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 $50.9 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. Construction and land loans and business real estate loans are subject to higher risk because of the impact that volatile interest rates and a changing economy can have on real estate value, and because of the potential volatility of the real estate industry. Certain personal real estate products (residential first mortgages and home equity loans) have contractual features that could increase credit exposure in a market of declining real estate prices, when interest rates are steadily increasing, or when a geographic area experiences an economic downturn. For these personal real estate loans, higher risks could exist when 1) loan terms require a minimum monthly payment that covers only interest, or 2) loan-to-collateral value (LTV) ratios at origination are above 80%, with no private mortgage insurance. Information presented below for personal real estate and home equity loans is based on LTV ratios which were calculated with valuations at loan origination date. The Company does not attempt to obtain updated appraisals or valuations unless the loans become significantly delinquent or are in the process of being foreclosed upon. For credit monitoring purposes, the Company analyzes delinquency information and current FICO scores. For home equity loans, the line utilization is also analyzed. This has remained an effective means of evaluating credit trends and identifying problem loans, partly because the Company offers standard, conservative lending products.


35

Real Estate - Construction and Land Loans
The Company’s portfolio of construction loans, as shown in the table below, amounted to 6.2% of total loans outstanding at December 31, 2018. The largest component of construction and land loans was commercial construction, which decreased $98.0 million during the year ended December 31, 2018. At December 31, 2018, multi-family residential construction loans totaled approximately $146.6 million, or 23.5%, of the commercial construction loan portfolio.

(Dollars in thousands)
December 31, 2018
% of Total
% of Total Loans
December 31, 2017
% of Total
% of Total Loans
Residential land
 and land development
$
81,740

9.4
%
.6
%
$
81,859

8.5
%
.6
%
Residential construction
123,369

14.2

.9

121,138

12.5

.9

Commercial land
 and land development
45,180

5.2

.3

48,474

5.0

.3

Commercial construction
619,370

71.2

4.4

717,349

74.0

5.1

Total real estate – construction and land loans
$
869,659

100.0
%
6.2
%
$
968,820

100.0
%
6.9
%

Real Estate – Business Loans
Total business real estate loans were $2.9 billion at December 31, 2018 and comprised 20.3% 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. Approximately 36.1% of these loans were for owner-occupied real estate properties, which present lower risk profiles.
(Dollars in thousands)
December 31, 2018
% of Total
% of Total Loans
December 31, 2017
% of Total
% of Total Loans
Owner-occupied
$
1,038,589

36.1
%
7.3
%
$
1,010,786

37.5
%
7.2
%
Multi-family
408,151

14.2

2.9

298,605

11.1

2.1

Office
356,733

12.4

2.5

373,301

13.8

2.7

Retail
307,915

10.7

2.2

338,937

12.6

2.4

Hotels
209,693

7.3

1.5

181,704

6.7

1.3

Farm
160,935

5.6

1.1

161,972

6.0

1.2

Industrial
109,391

3.8

.8

73,078

2.7

.5

Other
284,381

9.9

2.0

259,069

9.6

1.9

Total real estate - business loans
$
2,875,788

100.0
%
20.3
%
$
2,697,452

100.0
%
19.3
%

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. The majority of this portfolio is comprised of approximately $1.9 billion of loans made to the retail customer base and includes both adjustable rate and fixed rate mortgage loans. As shown in Note 2 to the consolidated financial statements, 2.9% of this portfolio has FICO scores of less than 660, and delinquency levels have been low. Loans of approximately $31.6 million in this personal real estate portfolio were structured with interest only payments. Interest only 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.  A small portion of the total portfolio is comprised of personal real estate loans made to individuals employed by commercial customers which totaled $201.7 million at December 31, 2018.


36

The following table presents information about the retail-based personal real estate loan portfolio for 2018 and 2017.
 
2018
 
2017
(Dollars in thousands)
Principal Outstanding at December 31
% of Loan Portfolio
 
Principal Outstanding at December 31
% of Loan Portfolio
Loans with interest only payments
$
31,613

1.6
%
 
$
29,919

1.6
%
Loans with no insurance and LTV:
 
 
 
 
 
Between 80% and 90%
111,164

5.7

 
110,272

5.9

Between 90% and 95%
30,595

1.6

 
28,774

1.6

Over 95%
46,624

2.4

 
44,529

2.4

Over 80% LTV with no insurance
188,383

9.7

 
183,575

9.9

Total loan portfolio from which above loans were identified
1,947,202

 
 
1,855,779

 

Revolving Home Equity Loans
The Company also has revolving home equity loans that are generally collateralized by residential real estate. Most of these loans (91.7%) 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 shown in the following tables, the percentage of loans with LTV ratios greater than 80% has remained a small segment of this portfolio, and delinquencies have been low and stable. The weighted average FICO score for the total current portfolio balance is 793. At maturity, the accounts are re-underwritten and if they qualify under the Company's credit, collateral and capacity policies, the borrower is given the option to renew the line of credit or to convert the outstanding balance to an amortizing loan.  If criteria are not met, amortization is required, or the borrower may pay off the loan. Over the next three years, approximately 9% of the Company's current outstanding balances are expected to mature. Of these balances, 89% have a FICO score above 700. 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.
(Dollars in thousands)
Principal Outstanding at December 31, 2018
*
New Lines Originated During 2018
*
Unused Portion of Available Lines at December 31, 2018
*
Balances Over 30 Days Past Due
*
Loans with interest only payments
$
345,302

91.7
%

$198,875

52.8
%

$692,293

183.9
%

$1,274

.3
%
Loans with LTV:
 
 
 
 
 
 
 
 
Between 80% and 90%
40,327

10.7

19,608

5.2

38,960

10.4

375

.1

Over 90%
4,785

1.3

675

.2

4,176

1.1

56

—

Over 80% LTV
45,112

12.0

20,283

5.4

43,136

11.5

431

.1

Total loan portfolio from which above loans were identified
376,399

 
209,569

 
725,733

 
 
 
* Percentage of total principal outstanding of $376.4 million at December 31, 2018.

(Dollars in thousands)
Principal Outstanding at December 31, 2017



*
New Lines Originated During 2017
*
Unused Portion of Available Lines at December 31, 2017
*
Balances Over 30 Days Past Due
*
Loans with interest only payments
$
369,846

92.3
%

$160,111

40.0
%

$680,826

170.0
%

$2,977

.7
%
Loans with LTV:
 
 
 
 
 
 
 
 
Between 80% and 90%
43,493

10.9

19,537

4.9

40,750

10.2

514

.1

Over 90%
7,849

1.9

—

—

5,452

1.3

85

—

Over 80% LTV
51,342

12.8

19,537

4.9

46,202

11.5

599

.1

Total loan portfolio from which above loans were identified
400,587

 
172,511

 
713,934

 
 
 
* Percentage of total principal outstanding of $400.6 million at December 31, 2017.


37

Other Consumer Loans
Within the consumer loan portfolio are several direct and indirect product lines comprised mainly of loans secured by automobiles, motorcycles, marine, and RVs. Outstanding balances for auto loans were $910.5 million and $1.0 billion at December 31, 2018 and 2017, respectively. The balances over 30 days past due amounted to $17.8 million at December 31, 2018, compared to $18.4 million at the end of 2017, and comprised 2.0% of the outstanding balances of these loans at December 31, 2018 compared to 1.8% at December 31, 2017. For the year ended December 31, 2018, $365.0 million of new auto loans were originated, compared to $464.3 million during 2017. At December 31, 2018, the automobile loan portfolio had a weighted average FICO score of 757.

Outstanding balances for motorcycle loans were $89.4 million at December 31, 2018, compared to $129.5 million at December 31, 2017. The balances over 30 days past due amounted to $2.1 million and $2.5 million at December 31, 2018 and 2017, respectively, and comprised 2.4% of the outstanding balances of these loans at December 31, 2018, compared to 1.9% at December 31, 2017. For the year ended December 31, 2018, $15.0 million of new motorcycle loans were originated, compared to $55.3 million during 2017.

Marine and RV loan production has been significantly curtailed since 2008 with few new originations. While loss rates have remained low over the last five years, the loss ratios experienced for marine and RV loans in 2017 increased over the prior year and have been higher than for other consumer loan products, at 1.2% and 1.4% in 2018 and 2017, respectively. Balances over 30 days past due for marine and RV loans increased $1.6 million at year end 2018 compared to 2017.

The table below provides the total outstanding principal and other data for this group of direct and indirect lending products at December 31, 2018 and 2017.
 
2018
 
2017
(In thousands)
Principal Outstanding at December 31
New Loans Originated
Balances Over 30 Days Past Due
 
Principal Outstanding at December 31
New Loans Originated
Balances Over 30 Days Past Due
Automobiles
$
910,478

$
364,955

$
17,790

 
$
1,009,880

$
464,253

$
18,396

Motorcycles
89,443

14,992

2,109

 
129,530

55,253

2,496

Marine
13,003

1,603

647

 
17,776

997

846

RV
37,914

1,276

1,887

 
54,070

29

109

Total
$
1,050,838

$
382,826

$
22,433

 
$
1,211,256

$
520,532

$
21,847


Additionally, the Company offers low promotional rates on selected consumer credit card products. Out of a portfolio at December 31, 2018 of $814.1 million in consumer credit card loans outstanding, approximately $188.7 million, or 23.2%, carried a low promotional rate. Within the next six months, $74.3 million of these loans are scheduled to convert to the ongoing higher contractual rate. To mitigate some of the risk involved with this credit card product, the Company performs credit checks and detailed analysis of the customer borrowing profile before approving the loan application. Management believes that the risks in the consumer loan portfolio are reasonable and the anticipated loss ratios are within acceptable parameters.

Energy Lending
The Company's energy lending portfolio was comprised of lending to the petroleum and natural gas sectors and totaled $143.8 million at December 31, 2018, an increase of $9.3 million from year end 2017, as shown in the table below.
(In thousands)
December 31, 2018
December 31, 2017
 
Unfunded commitments at December 31, 2018
Extraction
$
114,152

$
86,040

 
$
70,155

Downstream distribution and refining

17,300

25,329

 
19,358

Mid-stream shipping and storage
3,483

9,310

 
57,047

Support activities
8,892

13,811

 
14,898

Total energy lending portfolio
$
143,827

$
134,490

 
$
161,458



38

Investment Securities Analysis
Investment securities are comprised of securities which are classified as available for sale, equity, trading or other. The largest component, available for sale debt securities, decreased 1.3% during 2018 to $8.6 billion (excluding unrealized gains/losses in fair value) at year end 2018. During 2018, debt securities of $2.1 billion were purchased, which included $526.1 million in U.S. government securities, $707.5 million in agency mortgage-backed securities, $320.9 million in non-agency mortgage-based securities, and $418.2 million in asset-backed securities. Total sales, maturities and pay downs were $2.2 billion during 2018. During 2019, maturities and pay downs of approximately $1.0 billion are expected to occur. The average tax equivalent yield earned on total investment securities was 2.84% in 2018 and 2.51% in 2017.

At December 31, 2018, the fair value of available for sale securities was $8.5 billion, which included a net unrealized loss in fair value of $64.6 million, compared to a net unrealized gain of $10.0 million at December 31, 2017. The overall unrealized loss in fair value at December 31, 2018 included net gains of $5.3 million in state and municipal securities, offset by net losses of $51.9 million in mortgage and asset-backed securities. The portfolio also included unrealized net losses of $6.8 million, $3.7 million, and $7.3 million on U.S. government and federal agency obligations, government-sponsored enterprise obligations, and other debt securities, respectively.

Available for sale investment securities at year end for the past two years are shown below:
 
December 31
(In thousands)
2018
2017
Amortized Cost
 
 
U.S. government and federal agency obligations
$
914,486

$
917,494

Government-sponsored enterprise obligations
199,470

408,266

State and municipal obligations
1,322,785

1,592,707

Agency mortgage-backed securities
3,253,433

3,046,701

Non-agency mortgage-backed securities
1,053,854

903,920

Asset-backed securities
1,518,976

1,495,380

Other debt securities
339,595

350,988

Total available for sale debt securities
$
8,602,599

$
8,715,456

Fair Value
 
 
U.S. government and federal agency obligations
$
907,652

$
917,147

Government-sponsored enterprise obligations
195,778

406,363

State and municipal obligations
1,328,039

1,611,366

Agency mortgage-backed securities
3,214,985

3,040,913

Non-agency mortgage-backed securities
1,047,716

905,793

Asset-backed securities
1,511,614

1,492,800

Other debt securities
332,257

351,060

Total available for sale debt securities
$
8,538,041

$
8,725,442


At December 31, 2018, the available for sale portfolio included $3.2 billion of agency mortgage-backed securities, which are collateralized bonds issued by agencies including FNMA, GNMA, FHLMC, FHLB, Federal Farm Credit Banks and FDIC. Non-agency mortgage-backed securities totaled $1.0 billion and included $714.4 million collateralized by commercial mortgages and $333.3 million collateralized by residential mortgages at December 31, 2018. Certain non-agency mortgage-backed securities are other-than-temporarily impaired, and the processes for determining impairment and the related losses are discussed in Note 3 to the consolidated financial statements.

At December 31, 2018, U.S. government obligations included TIPS of $434.4 million, at fair value. Other debt securities include corporate bonds, notes and commercial paper.



39

The types of securities held in the available for sale security portfolio at year end 2018 are presented in the table below. Additional detail by maturity category is provided in Note 3 to the consolidated financial statements.
 
December 31, 2018



Percent of Total Debt Securities
Weighted Average Yield
Estimated Average Maturity*
Available for sale debt securities:
 
 
 
 
U.S. government and federal agency obligations
10.6
%
1.63
%
5.0

years
Government-sponsored enterprise obligations
2.3

2.32

4.9

 
State and municipal obligations
15.5

2.50

5.2

 
Agency mortgage-backed securities
37.7

2.85

4.6

 
Non-agency mortgage-backed securities
12.3

2.85

3.1

 
Asset-backed securities
17.7

2.62

2.8

 
Other debt securities
3.9

2.65

3.8

 
*Based on call provisions and estimated prepayment speeds.


Equity securities include common and preferred stock with readily determinable fair values that totaled $2.6 million at December 31, 2018, compared to $48.8 million at December 31, 2017. The decrease is 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.

Other securities totaled $129.2 million at December 31, 2018 and $99.0 million at December 31, 2017. These include Federal Reserve Bank stock and Federal Home Loan Bank (Des Moines) stock held by the bank subsidiary in accordance with debt and regulatory requirements. These are restricted securities and are carried at cost. Also included are private equity investments which are held by a subsidiary qualified as a Small Business Investment Company. These investments are carried at estimated fair value, but are not readily marketable. While the nature of these investments carries a higher degree of risk than the normal lending portfolio, this risk is mitigated by the overall size of the investments and oversight provided by management, and management believes the potential for long-term gains in these investments outweighs the potential risks.

Other securities at year end for the past two years are shown below:
 
December 31
(In thousands)
2018
2017
Federal Reserve Bank stock
$
33,498

$
33,253

Federal Home Loan Bank stock
10,000

10,000

Private equity investments in debt securities
39,831

31,734

Private equity investments in equity securities
45,828

24,018

Total other securities
$
129,157

$
99,005


In addition to its holdings in the investment securities portfolio, the Company invests in long-term securities purchased under agreements to resell, which totaled $700.0 million at both December 31, 2018 and December 31, 2017. These investments mature in 2020 through 2022 and have fixed rates or variable rates that fluctuate with published indices. The counterparties to these agreements are other financial institutions from whom the Company has accepted collateral of $712.3 million in marketable investment securities at December 31, 2018. The average rate earned on these agreements during 2018 was 1.83%.

The Company also holds offsetting repurchase and resale agreements totaling $450.0 million at December 31, 2018 and $650.0 million at December 31, 2017, which are further discussed in Note 19 to the consolidated financial statements. 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 been offset against each other in the balance sheet, as permitted under current accounting guidance. The agreements mature in 2019 and earned an average of 53 basis points during 2018.

Deposits and Borrowings
Deposits are the primary funding source for the Bank and are acquired from a broad base of local markets, including both individual and corporate customers. Total period-end deposits were $20.3 billion at December 31, 2018, compared to $20.4 billion last year, reflecting a decrease of $101.8 million, or 0.5%.


40

Average deposits declined $463.5 million, or 2.3%, in 2018 compared to 2017, resulting from declines in average demand deposits, which decreased $447.3 million, driven by lower balances in business, personal, and government demand deposits. Additionally, average certificates of deposit balances decreased $363.3 million in 2018. These decreases were partially offset by growth in average interest checking and money market deposit accounts, which increased $299.4 million in 2018 over 2017 average balances.

The following table shows year end deposit balances by type, as a percentage of total deposits.
 
December 31
 
2018
2017
Non-interest bearing
34.3
%
35.1
%
Savings, interest checking and money market
57.5

56.3

Certificates of deposit of less than $100,000
2.9

3.1

Certificates of deposit of $100,000 and over
5.3

5.5

Total deposits
100.0
%
100.0
%

Core deposits, which include non-interest bearing, interest checking, savings, and money market deposits, supported 77% of average earning assets in both 2018 and 2017. Average balances by major deposit category for the last six years appear on page 54. A maturity schedule of certificates of deposits outstanding at December 31, 2018 is included in Note 6 on Deposits in the consolidated financial statements.
    
The Company’s primary sources of overnight borrowings are federal funds purchased and securities sold under agreements to repurchase (repurchase agreements). Balances in these accounts can fluctuate significantly on a day-to-day basis and generally have one day maturities. Total balances of federal funds purchased and repurchase agreements outstanding at December 31, 2018 were $2.0 billion, a $449.3 million decrease from the $1.5 billion balance outstanding at year end 2017. On an average basis, these borrowings increased $51.8 million, or 3.5%, during 2018, mainly due to an increase of $133.7 million in repurchase agreements, partly offset by a decrease of $82.0 million in federal funds purchased. The average rate paid on total federal funds purchased and repurchase agreements was 1.30% during 2018 and .67% during 2017.
    
The majority of the Company’s long-term debt has been comprised of fixed rate advances from the FHLB. The Company repaid the advances in November 2017 and no new advances were taken in 2018. The average rate paid on the FHLB advances during 2017 was 3.55%.

Liquidity and Capital Resources
Liquidity Management
Liquidity is managed within the Company in order to satisfy cash flow requirements of deposit and borrowing customers while at the same time meeting its own cash flow needs. The Company has taken numerous steps to address liquidity risk and has developed a variety of liquidity sources which it believes will provide the necessary funds for future growth. The Company manages its liquidity position through a variety of sources including:
•
A portfolio of liquid assets including marketable investment securities and overnight investments,
•
A large customer deposit base and limited exposure to large, volatile certificates of deposit,
•
Lower long-term borrowings that might place demands on Company cash flow,
•
Relatively low loan to deposit ratio promoting strong liquidity,
•
Excellent debt ratings from both Standard & Poor’s and Moody’s national rating services, and
•
Available borrowing capacity from outside sources.

41

The Company’s most liquid assets include available for sale debt securities, federal funds sold, balances at the Federal Reserve Bank, and securities purchased under agreements to resell. At December 31, 2018 and 2017, such assets were as follows:
(In thousands)
2018
2017
Available for sale debt securities
$
8,538,041

$
8,725,442

Federal funds sold
3,320

42,775

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

700,000

Balances at the Federal Reserve Bank
689,876

30,631

Total
$
9,931,237

$
9,498,848


Federal funds sold are funds lent to the Company’s correspondent bank customers with overnight maturities, and totaled $3.3 million at December 31, 2018. At December 31, 2018, the Company had lent funds totaling $700.0 million under long-term resale agreements to other large financial institutions. The agreements mature in years 2020 through 2022. Under these agreements, the Company holds marketable securities, safekept by a third-party custodian, as collateral. This collateral totaled $712.3 million in fair value at December 31, 2018. Interest earning balances at the Federal Reserve Bank, which have overnight maturities and are used for general liquidity purposes, totaled $689.9 million at December 31, 2018. The Company’s available for sale investment portfolio includes scheduled maturities and expected pay downs of approximately $1.0 billion during 2019, and these funds offer substantial resources to meet either 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, repurchase agreements, trust funds, letters of credit issued by the FHLB, and borrowing capacity at the Federal Reserve Bank. At December 31, 2018 and 2017, total investment securities pledged for these purposes were as follows:

(In thousands)
2018
2017
Investment securities pledged for the purpose of securing:
 
 
Federal Reserve Bank borrowings
$
67,675

$
84,946

FHLB borrowings and letters of credit
9,974

13,332

Repurchase agreements *
2,469,432

2,001,401

Other deposits
1,784,020

1,679,024

Total pledged securities
4,331,101

3,778,703

Unpledged and available for pledging
2,872,562

3,346,826

Ineligible for pledging
1,334,378

1,599,913

Total available for sale debt securities, at fair value
$
8,538,041

$
8,725,442

* Includes securities pledged for collateral swaps, as discussed in Note 19 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 December 31, 2018, such deposits totaled $18.7 billion and represented 91.8% of the Company’s total deposits. These core deposits are normally less volatile, often with customer relationships tied to other products offered by the Company promoting long lasting relationships and stable funding sources. Total core deposits increased $7.0 million at year end 2018 compared to year end 2017, with growth of $105.5 million in corporate core deposits, offset by declines of $94.5 million in consumer deposits and $83.3 million in private banking deposits. While the Company considers core consumer and private banking deposits less volatile, corporate deposits could decline if interest rates increase significantly or if corporate customers increase investing activities and reduce deposit balances. If these corporate deposits decline, the Company's funding needs can be met by liquidity supplied by investment security maturities and pay downs expected to total $1.0 billion over the next year, as noted above. In addition, as shown on page 43, the Company has borrowing capacity of $3.6 billion through advances from the FHLB and the Federal Reserve.
(In thousands)
2018
2017
Core deposit base:
 
 
Non-interest bearing
$
6,980,298

$
7,158,962

Interest checking
2,090,936

1,533,904

Savings and money market
9,594,303

9,965,716

Total
$
18,665,537

$
18,658,582



42

Certificates of deposit of $100,000 or greater totaled $1.1 billion at December 31, 2018. These deposits are normally considered more volatile and higher costing, and comprised 5.3% of total deposits at December 31, 2018.

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, and repurchase agreements, as follows:
(In thousands)
2018
2017
Borrowings:
 
 
Federal funds purchased
$
13,170

$
202,370

Securities sold under agreements to repurchase
1,943,219

1,304,768

Other debt
8,702

1,758

Total
$
1,965,091

$
1,508,896


Federal funds purchased, which totaled $13.2 million at December 31, 2018, are unsecured overnight borrowings obtained mainly from upstream correspondent banks with which the Company maintains approved lines of credit. Retail repurchase agreements are offered to customers wishing to earn interest in highly liquid balances and are used by the Company as a funding source considered to be stable, but short-term in nature. Repurchase agreements are collateralized by securities in the Company’s investment portfolio. Total repurchase agreements at December 31, 2018 were comprised of non-insured customer funds totaling $2.0 billion, and securities pledged for these retail agreements totaled $1.9 billion.

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. Additionally, this collateral is used to enable the FHLB to issue letters of credit in favor of public fund depositors of the Company. The Federal Reserve Bank also establishes a collateral value of assets pledged and permits borrowings from 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 December 31, 2018.

 
December 31, 2018
(In thousands)
FHLB
Federal Reserve
Total
Total collateral value pledged
$
2,461,457

$
1,318,138

$
3,779,595

Advances outstanding
—

—

—

Letters of credit issued
(217,406
)
—

(217,406
)
Available for future advances
$
2,244,051

$
1,318,138

$
3,562,189


The Company’s average loans to deposits ratio was 69.3% at December 31, 2018, which is considered in the banking industry to be a measure of strong liquidity. Also, the Company receives outside ratings from both Standard & Poor’s and Moody’s on both the consolidated company and its subsidiary bank, Commerce Bank. These ratings are as follows:
 
Standard & Poor’s
Moody’s
Commerce Bancshares, Inc.
 
 
Issuer rating
A-
 
Preferred stock
BBB-
Baa1
Rating outlook
Stable
Stable
Commerce Bank
 
 
Issuer rating
A
A2
Baseline credit assessment
 
a1
Short-term rating
A-1
P-1
Rating outlook
Stable
Stable


43

The Company considers these ratings to be indications of a sound capital base and strong liquidity and believes that these ratings would help ensure the ready marketability of its commercial paper, should the need arise. No commercial paper has been outstanding during the past ten years. The Company has no subordinated or hybrid debt instruments which would affect future borrowing capacity. Because of its lack of significant long-term debt, the Company believes that, through its Capital Markets Group or in other public debt markets, it could generate additional liquidity from sources such as jumbo certificates of deposit, privately-placed corporate notes or other forms of debt.

The cash flows from the operating, investing and financing activities of the Company resulted in a net increase in cash, cash equivalents and restricted cash of $684.9 million in 2018, as reported in the consolidated statements of cash flows on page 63 of this report. Operating activities, consisting mainly of net income adjusted for certain non-cash items, provided cash flow of $552.7 million and has historically been a stable source of funds. Investing activities used total cash of $91.0 million, mainly from an increase in the loan portfolio, offset by sales and maturities (net of purchases) of investment securities. Growth in the loan portfolio used cash of $200.7 million and net purchases of land, buildings and equipment used $19.9 million, while activity in the investment securities portfolio provided cash of $129.5 million. Investing activities are somewhat unique to financial institutions in that, while large sums of cash flow are normally used to fund growth in investment securities, loans, or other bank assets, they are normally dependent on the financing activities described below.

During 2018, financing activities provided total cash of $223.3 million, primarily resulting from a $449.3 million increase in federal funds purchases and short-term securities sold under agreements to repurchase, offset by a $48.5 million decrease in deposits. Cash dividend payments of $109.2 million were paid on common and preferred stock, while treasury stock purchases totaled $75.2 million. Future short-term liquidity needs for daily operations are not expected to vary significantly, and the Company believes it maintains adequate liquidity to meet these cash flows. The Company’s sound equity base, along with its low debt level, common and preferred stock availability, and excellent debt ratings, provide several alternatives for future financing. Future acquisitions may utilize partial funding through one or more of these options.

Cash outflows resulting from the Company’s transactions in its common and preferred stock were as follows:
(In millions)
2018
2017
2016
Purchases of treasury stock
$
75.2

$
17.8

$
39.4

Common cash dividends paid
100.2

91.6

87.1

Preferred cash dividends paid
9.0

9.0

9.0

Cash used
$
184.4

$
118.4

$
135.5


The Parent faces unique liquidity constraints due to legal limitations on its ability to borrow funds from its bank subsidiary. The Parent obtains funding to meet its obligations from two main sources: dividends received from bank and non-bank subsidiaries (within regulatory limitations) and management fees charged to subsidiaries as reimbursement for services provided by the Parent, as presented below:
(In millions)
2018
2017
2016
Dividends received from subsidiaries
$
200.0

$
160.0

$
160.0

Management fees
37.7

30.4

31.0

Total
$
237.7

$
190.4

$
191.0


These sources of funds are used mainly to pay cash dividends on outstanding stock, pay general operating expenses, and purchase treasury stock. At December 31, 2018, the Parent’s investment securities totaled $5.8 million at fair value, consisting mainly of preferred stock and non-agency mortgage-backed securities. To support its various funding commitments, the Parent maintains a $20.0 million line of credit with its subsidiary bank. There were no borrowings outstanding under the line during 2018 or 2017.

Company senior management is responsible for measuring and monitoring the liquidity profile of the organization with oversight by the Company’s Asset/Liability Committee. This is done through a series of controls, including a written Contingency Funding Policy and risk monitoring procedures, which include daily, weekly and monthly reporting. In addition, the Company prepares forecasts to project changes in the balance sheet affecting liquidity and to allow the Company to better plan for forecasted changes.


44

Capital Management
Under Basel III capital guidelines, at December 31, 2018 and 2017, the Company met all capital adequacy requirements and had regulatory capital ratios in excess of the levels established for well-capitalized institutions, as shown in the following table.
(Dollars in thousands)
2018
2017
Minimum Ratios under Capital Adequacy Guidelines*
Minimum Ratios for Well-Capitalized Banks**
Risk-adjusted assets
$
19,103,966

$
19,149,949

 
 
Tier I common risk-based capital
2,716,232

2,422,480

 
 
Tier I risk-based capital
2,861,016

2,567,264

 
 
Total risk-based capital
3,022,023

2,747,863

 
 
Tier I common risk-based capital ratio
14.22
%
12.65
%
7.00
%
6.50
%
Tier I risk-based capital ratio
14.98

13.41

8.50

8.00

Total risk-based capital ratio
15.82

14.35

10.50

10.00

Tier I leverage ratio
11.52

10.39

4.00

5.00

Tangible common equity to tangible assets
10.45

9.84

 
 
Dividend payout ratio
23.61

29.52

 
 
* 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 periodically purchases stock in the open market. During 2017 and 2018, respectively, the Company purchased 315 thousand and 1.2 million shares through market purchases. At December 31, 2018, 2.2 million 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 levels and alternative investment options. Per share cash dividends paid by the Company increased 9.7% in 2018 compared with 2017, and the Company increased its first quarter 2019 cash dividend 16%, making 2019 the Company's 51st consecutive year of regular cash dividend increases. The Company also distributed its 25th consecutive annual 5% stock dividend in December 2018.

Commitments, Contractual Obligations, and Off-Balance Sheet Arrangements
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 totaling $11.2 billion (including approximately $5.3 billion in unused approved credit card lines) and the contractual amount of standby letters of credit totaling $353.9 million at December 31, 2018. As many commitments expire unused or only partially used, these totals do not necessarily reflect future cash requirements. Management does not anticipate any material losses arising from commitments or contingent liabilities and believes there are no material commitments to extend credit that represent risks of an unusual nature.

A table summarizing contractual cash obligations of the Company at December 31, 2018 and the expected timing of these payments follows:
 
Payments Due by Period
 
 
(In thousands)
In One Year or Less
After One Year Through Three Years
After Three Years Through Five Years
After Five Years
 
Total
Long-term debt obligations*
$
218

$
458

$
275

$
—

 
$
951

Operating lease obligations
5,763

8,872

6,871

15,161

 
36,667

Purchase obligations
255,861

270,790

51,209

2,370

 
580,230

Certificates of Deposit*
1,286,425

336,656

34,234

807

 
1,658,122

Total
$
1,548,267

$
616,776

$
92,589

$
18,338

 
$
2,275,970

* Includes principal payments only.

The Company funds a defined benefit pension plan for a portion of its employees. Under the funding policy for the plan, contributions are made as necessary to provide for current service and for any unfunded accrued actuarial liabilities over a reasonable period. No contributions to the defined benefit plan were made in 2018, and the Company is not required nor does it expect to make a contribution in 2019.

45

The Company has investments in several low-income housing partnerships within the areas it serves. These partnerships supply funds for the construction and operation of apartment complexes that provide affordable housing to that segment of the population with lower family income. If these developments successfully attract a specified percentage of residents falling in that lower income range, federal (and sometimes state) income tax credits are made available to the partners. The tax credits are normally recognized over ten years, and they play an important part in the anticipated yield from these investments. In order to continue receiving the tax credits each year over the life of the partnership, the low-income residency targets must be maintained. Under the terms of the partnership agreements, the Company has a commitment to fund a specified amount that will be due in installments over the life of the agreements, which ranges from 10 to 15 years. At December 31, 2018, the investments totaled $36.8 million and are recorded as other assets in the Company’s consolidated balance sheet. Unfunded commitments, which are recorded as liabilities, amounted to $24.7 million at December 31, 2018.

The Company regularly purchases various state tax credits arising from third-party property redevelopment. These credits are either resold to third parties or retained for use by the Company. During 2018, purchases and sales of tax credits amounted to $80.9 million and $71.6 million, respectively. Fees from the sales of tax credits were $4.9 million, $3.3 million and $3.1 million in 2018, 2017 and 2016, respectively. At December 31, 2018, the Company had outstanding purchase commitments totaling $180.5 million that it expects to fund in 2019. These commitments, along with the commitments for the next five years, are included in the table above.

Interest Rate Sensitivity
The Company’s Asset/Liability Management Committee (ALCO) measures and manages the Company’s interest rate risk on a monthly basis to identify trends and establish strategies to maintain stability in net interest income throughout various rate environments. Analytical modeling techniques provide management insight into the Company’s exposure to changing rates. These techniques include net interest income simulations and market value analysis. Management has set guidelines specifying acceptable limits within which net interest income and market value may change under various rate change scenarios. These measurement tools indicate that the Company is currently within acceptable risk guidelines as set by management.

The Company’s main interest rate measurement tool, income simulations, projects net interest income under various rate change scenarios in order to quantify the magnitude and timing of potential rate-related changes. Income simulations are able to capture option risks within the balance sheet where expected cash flows may be altered under various rate environments. Modeled rate movements include “shocks, ramps and twists.” Shocks are intended to capture interest rate risk under extreme conditions by immediately shifting rates up and down, while ramps measure the impact of gradual changes and twists measure yield curve risk. The size of the balance sheet is assumed to remain constant so that results are not influenced by growth predictions.

The Company also employs a sophisticated simulation technique known as a stochastic income simulation. This technique allows management to see a range of results from hundreds of income simulations. The stochastic simulation creates a vector of potential rate paths around the market’s best guess (forward rates) concerning the future path of interest rates and allows rates to randomly follow paths throughout the vector. This allows for the modeling of non-biased rate forecasts around the market consensus. Results give management insight into a likely range of rate-related risk as well as worst and best-case rate scenarios.

Additionally, the Company uses market value analyses to help identify longer-term risks that may reside on the balance sheet. This is considered a secondary risk measurement tool by management. The Company measures the market value of equity as the net present value of all asset and liability cash flows discounted along the current swap curve plus appropriate market risk spreads. It is the change in the market value of equity under different rate environments, or effective duration, that gives insight into the magnitude of risk to future earnings due to rate changes. Market value analyses also help management understand the price sensitivity of non-marketable bank products under different rate environments.

The 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 the simulations below, three rising rate scenarios and one falling rate scenario were selected 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 borrowed funds. 

The simulations shown below reflect 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

46

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
December 31, 2018
 
September 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
$
5.0

.59
 %
 
$
(348.3
)
 
$
7.0

.85
%
 
$
(360.6
)
200 basis points rising
5.2

.62

 
(237.9
)
 
7.3

.88

 
(248.6
)
100 basis points rising
3.8

.45

 
(120.3
)
 
5.7

.69

 
(128.9
)
100 basis points falling
(17.2
)
(2.03
)
 
142.8

 
(13.0
)
1.56

 
139.3


Simulation B
December 31, 2018
 
September 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
$
(18.1
)
(2.13
)%
 
$
(936.4
)
 
$
(15.4
)
(1.85
)%
 
$
(947.2
)
200 basis points rising
(15.3
)
(1.81
)
 
(829.2
)
 
(12.7
)
(1.53
)
 
(838.8
)
100 basis points rising
(14.2
)
(1.68
)
 
(715.4
)
 
(11.8
)
(1.42
)
 
(723.3
)

The difference in Simulation A and B is the degree to which deposits are modeled to decline or increase as noted in the tables above.  Both simulations assume that a decline in deposits would be offset by an increase in borrowed funds, which are more rate sensitive and can result in higher interest costs in a rising rate environment.

Under Simulation A, in the three rising rate scenarios, interest income grows faster than funding costs as loan and investment balances remain constant but rates increase. The increase in interest income from higher rates is assisted by lower deposit balances, reducing interest expense but offset by higher short-term borrowed funds with higher market sensitive rates.  In Simulation B, the assumed higher levels of deposit attrition were modeled to be replaced by wholesale borrowed funds with higher costs than in Simulation A and resulted in a reduction in net interest income under all rising rate scenarios.  In the 100 basis point falling scenario shown in Simulation A, it is assumed that deposits would increase $142.8 million along with an increase in earning assets, but rates on loans would fall faster than deposit rates. In this scenario, additional borrowed funds would not be necessary.  Additionally, this scenario results in lower net interest income than in the base calculation.  The 100 basis point falling scenario is presented only in Simulation A as the results would be the same under Simulation B.

In both Simulations A and B, the change in net interest income from the base calculation at December 31, 2018 was lower than what was modeled at September 30, 2018 largely due to higher rates and balances of federal funds purchased and repurchase agreements, as well as higher deposit rates at year end.   The deposit attrition assumption used in both Simulations A and B was not materially different than what was modeled in the prior quarter.

Projecting deposit activity in a historically low interest rate environment is difficult, and the Company cannot predict how deposits will react to shifting rates.  The comparison provided above provides insight into potential effects of changes in rates and deposit levels on net interest income.

Derivative Financial Instruments
The Company maintains an overall interest rate risk management strategy that permits the use of derivative instruments to modify exposure to interest rate risk. Such instruments include interest rate swaps, interest rate floors, interest rate caps, credit risk participation agreements, foreign exchange contracts, mortgage loan commitments, forward sale contracts, and forward to be announced (TBA) contracts. The Company’s interest rate risk management strategy includes the ability to modify the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not adversely affect the net interest margin and

47

cash flows. Interest rate floors with a total notional amount of $1.0 billion were entered into during the year ended December 31, 2018 as part of this strategy to manage interest rate risk. All of these derivative instruments utilized by the Company are further discussed in Note 18 on Derivative Instruments.

In all of these contracts, the Company is exposed to credit risk in the event of nonperformance by counterparties, who may be bank customers or other financial institutions. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures. Because the Company generally enters into transactions only with high quality counterparties, there have been no losses associated with counterparty nonperformance on derivative financial instruments.

The following table summarizes the notional amounts and estimated fair values of the Company’s derivative instruments at December 31, 2018 and 2017. Notional amount, along with the other terms of the derivative, is used to determine the amounts to be exchanged between the counterparties. Because the notional amount does not represent amounts exchanged by the parties, it is not a measure of loss exposure related to the use of derivatives nor of exposure to liquidity risk.
 
2018
 
2017
(In thousands)
Notional Amount
 
Positive Fair Value
 
Negative Fair Value
 
 Notional Amount
 
Positive Fair Value
 
Negative Fair Value
Interest rate swaps
$
2,006,280

 
$
11,537

 
$
(13,110
)
 
$
1,741,412

 
$
7,674

 
$
(7,857
)
Interest rate floors
1,000,000

 
29,031

 
—

 
—

 
—

 
—

Interest rate caps
62,163

 
24

 
(24
)
 
31,776

 
16

 
(16
)
Credit risk participation agreements
143,460

 
47

 
(93
)
 
133,488

 
46

 
(123
)
Foreign exchange contracts
6,206

 
20

 
(8
)
 
11,826

 
21

 
(40
)
Mortgage loan commitments
14,544

 
536

 
—

 
17,110

 
580

 
—

Mortgage loan forward sale contracts
5,768

 
15

 
(8
)
 
2,566

 
8

 
(7
)
Forward TBA contracts
16,500

 
—

 
(178
)
 
25,000

 
4

 
(31
)
Total at December 31
$
3,254,921

 
$
41,210

 
$
(13,421
)
 
$
1,963,178

 
$
8,349

 
$
(8,074
)

Operating Segments
The Company segregates financial information for use in assessing its performance and allocating resources among three operating segments. The results are determined based on the Company’s management accounting process, which assigns balance sheet and income statement items to each responsible segment. These segments are defined by customer base and product type. The management process measures the performance of the operating segments based on the management structure of the Company and is not necessarily comparable with similar information for any other financial institution. Each segment is managed by executives who, in conjunction with the Chief Executive Officer, make strategic business decisions regarding that segment. The three reportable operating segments are Consumer, Commercial, and Wealth. Additional information is presented in Note 12 on Segments in the consolidated financial statements.
The Company uses a funds transfer pricing method to value funds used (e.g., loans, fixed assets, cash, etc.) and funds provided (deposits, borrowings, and equity) by the business segments and their components. This process assigns a specific value to each new source or use of funds with a maturity, based on current swap rates, thus determining an interest spread at the time of the transaction. Non-maturity assets and liabilities are valued using weighted average pools. The funds transfer pricing process attempts to remove interest rate risk from valuation, allowing management to compare profitability under various rate environments. The Company also assigns loan charge-offs and recoveries (labeled in the table below as “provision for loan losses”) directly to each operating segment instead of allocating an estimated loan loss provision. The operating segments also include a number of allocations of income and expense from various support and overhead centers within the Company.

48

The table below is a summary of segment pre-tax income results for the past three years.
(Dollars in thousands)
Consumer
Commercial
Wealth
Segment Totals
Other/Elimination
Consolidated Totals
Year ended December 31, 2018:
 
 
 
 
 
 
Net interest income
$
296,228

$
345,221

$
46,946

$
688,395

$
135,430

$
823,825

Provision for loan losses
(41,280
)
(1,134
)
32

(42,382
)
(312
)
(42,694
)
Non-interest income
126,253

202,527

173,026

501,806

(465
)
501,341

Investment securities losses, net
—

—

—

—

(488
)
(488
)
Non-interest expense
(287,473
)
(297,847
)
(123,576
)
(708,896
)
(28,925
)
(737,821
)
Income before income taxes
$
93,728

$
248,767

$
96,428

$
438,923

$
105,240

$
544,163

Year ended December 31, 2017:
 
 
 
 
 
 
Net interest income
$
279,031

$
329,087

$
47,264

$
655,382

$
78,297

$
733,679

Provision for loan losses
(41,829
)
205

(41
)
(41,665
)
(3,579
)
(45,244
)
Non-interest income
121,362

184,577

158,175

464,114

(2,851
)
461,263

Investment securities gains, net
—

—

—

—

25,051

25,051

Non-interest expense
(275,734
)
(281,845
)
(120,461
)
(678,040
)
(66,303
)
(744,343
)
Income before income taxes
$
82,830

$
232,024

$
84,937

$
399,791

$
30,615

$
430,406

2018 vs 2017
 
 
 
 
 
 
Increase in income before income taxes:
 
 
 
 
 
 
Amount
$
10,898

$
16,743

$
11,491

$
39,132

$
74,625

$
113,757

Percent
13.2
%
7.2
%
13.5
%
9.8
%
N.M.

26.4
%
Year ended December 31, 2016:
 
 
 
 
 
 
Net interest income
$
268,654

$
311,704

$
44,113

$
624,471

$
55,578

$
680,049

Provision for loan losses
(36,042
)
4,378

(122
)
(31,786
)
(4,532
)
(36,318
)
Non-interest income
116,185

187,350

144,661

448,196

(1,640
)
446,556

Investment securities losses, net
—

—

—

—

(53
)
(53
)
Non-interest expense
(266,258
)
(272,398
)
(113,888
)
(652,544
)
(36,685
)
(689,229
)
Income before income taxes
$
82,539

$
231,034

$
74,764

$
388,337

$
12,668

$
401,005

2017 vs 2016
 
 
 
 
 
 
Increase in income before income taxes:
 
 
 
 
 
 
Amount
$
291

$
990

$
10,173

$
11,454

$
17,947

$
29,401

Percent
.4
%
.4
%
13.6
%
2.9
%
N.M.

7.3
%

Consumer
The Consumer segment includes consumer deposits, consumer finance, and consumer debit and credit cards. During 2018, income before income taxes for the Consumer segment increased $10.9 million, or 13.2%, compared to 2017. This increase was mainly due to growth of $17.2 million, or 6.2%, in net interest income and an increase in non-interest income of $4.9 million, or 4.0%. Net interest income increased due to a $15.2 million increase in net allocated funding credits assigned to the Consumer segment's loan and deposit portfolios and growth of $3.5 million in loan interest income, partly offset by an increase of $1.6 million in deposit interest expense. Non-interest income increased mainly due to growth in net debit card fees, (mainly lower network expense and higher interchange fees), deposit fees (mainly deposit account service fees and overdraft and return item fees) and mortgage banking revenue, partly offset by higher credit card rewards expense. These increases to income were partly offset by growth of $11.7 million, or 4.3%, in non-interest expense. Non-interest expense increased over the prior year due to an increase in full-time salaries expense and higher allocated servicing and support costs, mainly marketing, information technology and management fees. The provision for loan losses totaled $41.3 million, a $549 thousand decrease from the prior year, which was mainly due to lower net charge-offs on marine & RV loans, partly offset by higher consumer credit card loan net charge-offs. Total average loans in this segment decreased $69.9 million, or 2.8%, in 2018 compared to the prior year mainly due to a decline in auto loans and the continued run off of marine and RV loans. Average deposits increased $19.9 million over the prior year, resulting from growth in interest checking and money market deposit accounts, partly offset by declines in demand and certificate of deposit balances.


49

During 2017, income before income taxes for the Consumer segment increased $291 thousand, or .4%, compared to 2016. This increase was mainly due to growth of $10.4 million, or 3.9%, in net interest income and an increase in non-interest income of $5.2 million, or 4.5%. Net interest income increased due to a $9.7 million increase in net allocated funding credits assigned to the Consumer segment's loan and deposit portfolios and a $670 thousand increase in loan interest income. Non-interest income increased mainly due to growth in deposit fees (mainly deposit account service fees and overdraft and return item fees) and bank card fees. These increases to income were partly offset by growth of $9.5 million, or 3.6%, in non-interest expense and $5.8 million in the provision for loan losses. Non-interest expense increased over the prior year due to an increase in full-time salaries expense and higher allocated support costs, mainly administrative, online banking and information technology, while supplies expense decreased due to higher chip card reissue costs in 2016. The provision for loan losses totaled $41.8 million, a $5.8 million increase over the prior year, which was mainly due to higher net charge-offs on consumer credit card loans. Total average loans in this segment decreased $62.0 million, or 2.4%, in 2017 compared to the prior year mainly due to a decline in marine and RV loans. Average deposits increased $234.3 million, or 2.4%, over the prior year, resulting from growth in money market deposit accounts, partly offset by a decline in certificate of deposit balances.
  
Commercial
The Commercial segment provides corporate lending (including the Small Business Banking product line within the branch network), leasing, international services, and business, government deposit, and related commercial cash management services, as well as merchant and commercial bank card products. The segment includes the Capital Markets Group, which sells fixed-income securities to individuals, corporations, correspondent banks, public institutions, and municipalities, and also provides investment safekeeping and bond accounting services. Pre-tax income for 2018 increased $16.7 million, or 7.2%, compared to 2017, mainly due to increases in net interest income and non-interest income, partly offset by higher non-interest expense and an increase in the provision for loan losses. Net interest income increased $16.1 million, or 4.9%, due to growth of $70.6 million in loan interest income, partly offset by a decrease of $32.1 million in net allocated funding credits and higher interest expense of $22.5 million on deposits and customer repurchase agreements. The provision for loan losses increased $1.3 million over last year, due to lower business and construction loan net recoveries, partly offset by lower commercial card loan net charge-offs. Non-interest income increased $18.0 million, or 9.7%, over the previous year due to higher net corporate card fees (driven by higher fees), swap fees, tax credit sales fees and deposit account fees (mainly corporate cash management). These increases were partly offset by lower gains on sales of leased assets to customers upon lease termination. Non-interest expense increased $16.0 million, or 5.7%, during 2018, mainly due to increases in salaries expense and allocated support and service costs (mainly information technology and commercial sales and product support fees). Average segment loans increased $304.7 million, or 3.5%, compared to 2017, with growth occurring in commercial and industrial, construction, and healthcare loans. Average deposits decreased $271.8 million, or 3.3%, due to declines in business demand deposits and certificates of deposit, partly offset by growth in interest checking deposits.
Pre-tax income for 2017 increased $990 thousand, or .4%, compared to 2016, mainly due to an increase in net interest income, partly offset by lower non-interest income, higher non-interest expense and an increase in the provision for loan losses. Net interest income increased $17.4 million, or 5.6%, due to growth of $45.9 million in loan interest income, partly offset by a decrease of $17.7 million in net allocated funding credits. In addition, customer repurchase agreement interest expense increased $5.5 million and deposit interest expense increased $5.2 million. The provision for loan losses increased $4.2 million over last year, as construction loan and business real estate loan net recoveries were lower by $2.5 million and $1.1 million, respectively. Non-interest income decreased $2.8 million, or 1.5%, from the previous year due to lower interest rate swap fees and capital market fees. Non-interest expense increased $9.4 million, or 3.5%, during 2017, mainly due to increases in full-time salaries expense and allocated support costs, partly offset by lower bank card processing costs and business line allocations. Average segment loans increased $562.5 million, or 7.0%, compared to 2016, with growth occurring in commercial and industrial, construction, and business real estate loans. Average deposits increased $57.6 million, or .7%, due to growth in governmental demand deposit accounts, partly offset by declines in certificates of deposit, money market deposit accounts, and business demand deposits.

Wealth
The Wealth segment provides traditional trust and estate planning, advisory and discretionary investment management services, brokerage services, and includes Private Banking accounts. At December 31, 2018, the Trust group managed investments with a market value of $30.3 billion and administered an additional $19.7 billion in non-managed assets. It also provides investment management services to The Commerce Funds, a series of mutual funds with $2.5 billion in total assets at December 31, 2018. In 2018, pre-tax income for the Wealth segment was $96.4 million, compared to $84.9 million in 2017, an increase of $11.5 million, or 13.5%. Net interest income decreased $318 thousand, or .7%, due to a $5.3 million decrease in net allocated funding credits, partly offset by a $5.5 million increase in loan interest income. Non-interest income increased $14.9 million, or 9.4%, over the prior year largely due to higher personal 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 $3.1 million, or 2.6%, resulting from higher salary and benefit costs, data processing expense and allocated support and corporate management fee costs, partly offset by lower

50

trust losses. The provision for loan losses decreased $73 thousand, mainly due to personal real estate loan net recoveries. Average assets increased $25.2 million, or 2.1%, during 2018 mainly due to higher personal real estate and consumer loans. Average deposits decreased $219.0 million, or 10.5%, due to declines in money market deposit accounts and long-term certificates of deposit over $100,000.

In 2017, pre-tax income for the Wealth segment was $84.9 million, compared to $74.8 million in 2016, an increase of $10.2 million, or 13.6%. Net interest income increased $3.2 million, or 7.1%, due to a $5.1 million increase in loan interest income, partly offset by a $2.1 million decline in net allocated funding credits. Non-interest income increased $13.5 million, or 9.3%, over the prior year largely due to higher personal and institutional trust fees, brokerage revenue and cash sweep fees, partly offset by a trust related settlement recorded in 2016. Non-interest expense increased $6.6 million, or 5.8%, resulting from higher incentive compensation and allocated support costs. The provision for loan losses decreased $81 thousand, mainly due to lower charge-offs on revolving home equity loans. Average assets increased $101.6 million, or 9.1%, during 2017 mainly due to higher personal real estate and consumer loans. Average deposits increased $5.6 million, or .3%, due to growth in money market deposit accounts and business demand deposits, partly offset by a decline in long-term certificates of deposit over $100,000.

The segment activity, as shown above, includes both direct and allocated items. Amounts in the “Other/Elimination” column include activity not related to the segments, such as certain administrative functions, the investment securities portfolio, and the effect of certain expense allocations to the segments. Also included in this category is the difference between the Company’s provision for loan losses and net loan charge-offs, which are generally assigned directly to the segments. In 2018, the pre-tax income in this category was $105.2 million, compared to $30.6 million in 2017. This increase was due to higher unallocated net interest income of $57.1 million and lower unallocated non-interest expense of $37.4 million. Non-interest expense for 2017 included contributions of $32.0 million to a related charitable foundation, which were not allocated to the segments. Unallocated securities losses were $488 thousand in 2018, compared to securities gains of $25.1 million in 2017. Also, the unallocated loan loss provision decreased $3.3 million, as the provision was $3.6 million in excess of charge-offs in 2017 compared to $312 thousand less than charge offs in 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 will be considered in the development of risk management strategies in the future.

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 15 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 are 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

51

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.

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 17 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.

Restricted Cash 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 previous 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 9 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 (ROU) asset and a liability to make lease payments for those leases classified as operating leases under previous GAAP. The ASU provides guidance as to the definition of a lease, identification of lease components, and sale and leaseback transactions. The FASB has issued elections and expedients within the original ASU and additional amendments, clarifying the lease guidance for certain implementation issues. The Company has adopted the package of expedients, the lease component expedient as well as the disclosure expedient. Additionally, for leases with a term of 12 months or less, an election was made not to recognize lease assets and lease liabilities. The ASU and the related amendments are effective for interim and annual periods beginning January 1, 2019. The Company is the lessee in less than 200 lease agreements, which will be recognized on the balance sheet. As of January 1, 2019, the Company adopted the new accounting standard, and a lease liability of $28.1 million and a ROU asset of $27.5 million were recognized, but 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

52

event has occurred. The new standard will require significant operational changes, especially in data collection and analysis. The ASU is effective for interim and annual periods beginning January 1, 2020, and is expected to increase the allowance upon adoption.

The Company established an internal CECL implementation team in 2017 and partnered with an outside vendor to implement the new standard. Software development and data collection has continued since that time and it's expected the preliminary CECL model will be ready for detailed testing during the second quarter of 2019. The Company continues to evaluate the impact the adoption of ASU 2016-13 will have on the Company's consolidated financial statements.

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 accumulated other comprehensive income (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 amendments are effective January 1, 2020 and are not expected to have a significant effect on the Company's consolidated financial statements.

Retirement Benefits The FASB issued ASU 2018-14, "Compensation - Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20)", in August 2018. The amendments in the ASU eliminate disclosures that are no longer considered cost beneficial and clarify specific requirements of disclosures. In addition, the amendments in the ASU also add new disclosures, including the explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. The amendments are effective January 1, 2021 and are not expected to have a significant effect 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. This new standard modifies existing guidance and clarifies the accounting for implementation costs of a hosting arrangement. 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 an internal-use software license. The amendments are effective January 1, 2020, but early adoption is permitted. The Company is still assessing the impact on the Company's consolidated financial statements.

Corporate Governance
The Company has adopted a number of corporate governance measures. These include corporate governance guidelines, a code of ethics that applies to its senior financial officers and the charters for its audit committee, its committee on compensation and human resources, and its committee on governance/directors. This information is available on the Company’s Web site www.commercebank.com under Investor Relations.


53

AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
 
Years Ended December 31
 
2018
 
2017
 
2016
(Dollars in thousands)
Average Balance
Interest Income/Expense
Average Rates Earned/Paid
 
Average Balance
Interest Income/Expense
Average Rates Earned/Paid
 
Average Balance
Interest Income/Expense
Average Rates Earned/Paid
ASSETS
 
 
 
 
 
 
 
 
 
 
 
Loans:(A)
 
 
 
 
 
 
 
 
 
 
 
Business(B)
$
4,963,029

$
184,837

3.72
%
 
$
4,832,045

$
154,681

3.20
%
 
$
4,652,526

$
134,438

2.89
%
Real estate – construction and land
967,320

49,440

5.11

 
881,879

37,315

4.23

 
778,822

27,452

3.52

Real estate – business
2,737,820

117,516

4.29

 
2,694,620

102,009

3.79

 
2,440,955

89,305

3.66

Real estate – personal
2,093,802

80,365

3.84

 
2,019,674

75,267

3.73

 
1,936,420

72,417

3.74

Consumer
2,010,826

89,074

4.43

 
2,036,393

81,065

3.98

 
1,947,240

75,076

3.86

Revolving home equity
379,715

17,513

4.61

 
398,611

15,516

3.89

 
417,514

14,797

3.54

Consumer credit card
768,789

92,269

12.00

 
743,885

88,329

11.87

 
749,589

86,008

11.47

Overdrafts
4,778

—

—

 
4,592

—

—

 
4,712

—

—

Total loans
13,926,079

631,014

4.53

 
13,611,699

554,182

4.07

 
12,927,778

499,493

3.86

Loans held for sale
19,493

1,298

6.66

 
17,452

1,000

5.73

 
25,710

1,317

5.12

Investment securities:
  

 
 

 
 
 
 
 
 
 
 
U.S. government & federal agency obligations
921,759

21,720

2.36

 
914,961

19,697

2.15

 
735,081

15,628

2.13

Government-sponsored enterprise obligations
308,520

6,098

1.98

 
452,422

7,321

1.62

 
591,785

13,173

2.23

State & municipal obligations(B)
1,410,700

42,867

3.04

 
1,720,723

62,073

3.61

 
1,753,727

63,261

3.61

Mortgage-backed securities
4,203,625

111,686

2.66

 
3,784,602

89,623

2.37

 
3,460,821

82,888

2.40

Asset-backed securities
1,455,690

34,223

2.35

 
2,083,611

36,757

1.76

 
2,418,118

35,346

1.46

Other debt securities
340,458

8,912

2.62

 
330,365

8,410

2.55

 
331,289

8,382

2.53

Trading debt securities(B)
24,731

759

3.07

 
21,929

583

2.66

 
19,722

489

2.48

Equity securities(B)
26,459

11,816

44.66

 
60,772

2,283

3.76

 
47,763

2,208

4.62

Other securities(B)
114,438

12,412

10.85

 
98,564

10,507

10.66

 
112,888

7,656

6.78

Total investment securities
8,806,380

250,493

2.84

 
9,467,949

237,254

2.51

 
9,471,194

229,031

2.42

Federal funds sold and short-term securities purchased under agreements to resell
27,026

519

1.92

 
18,518

230

1.24

 
12,660

78

.62

Long-term securities purchased under agreements to resell
696,438

15,881

2.28

 
688,147

15,440

2.24

 
791,392

13,544

1.71

Interest earning deposits with banks
319,948

6,233

1.95

 
207,269

2,223

1.07

 
188,581

973

.52

Total interest earning assets
23,795,364

905,438

3.81

 
24,011,034

810,329

3.37

 
23,417,315

744,436

3.18

Allowance for loan losses
(158,791
)
 
 
 
(156,572
)
 
 
 
(152,628
)
 
 
Unrealized gain (loss) on debt securities
(113,068
)
 
 
 
45,760

 
 
 
143,842

 
 
Cash and due from banks
360,732

 
 
 
361,414

 
 
 
381,822

 
 
Land, buildings and equipment - net
343,636

 
 
 
345,639

 
 
 
350,443

 
 
Other assets
438,362

 
 
 
424,333

 
 
 
415,677

 
 
Total assets
$
24,666,235

 
 
 
$
25,031,608

 
 
 
$
24,556,471

 
 
LIABILITIES AND EQUITY
 
 
 
 
 
 
 
 
 
 
 
Interest bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
Savings
$
867,150

973

.11

 
$
819,558

981

.12

 
$
775,121

923

.12

Interest checking and money market
10,817,169

26,830

.25

 
10,517,741

16,328

.16

 
10,285,288

13,443

.13

Certificates of deposit of less than $100,000
603,137

3,215

.53

 
676,272

2,645

.39

 
749,261

2,809

.37

Certificates of deposit of $100,000 and over
1,114,825

14,658

1.31

 
1,404,960

10,859

.77

 
1,471,610

8,545

.58

Total interest bearing deposits
13,402,281

45,676

.34

 
13,418,531

30,813

.23

 
13,281,280

25,720

.19

Borrowings:
 
 
 
 
 
 
 
 
 
 
 
Federal funds purchased and securities sold under agreements to repurchase
1,514,144

19,655

1.30

 
1,462,387

9,829

.67

 
1,266,093

3,315

.26

Other borrowings
1,747

45

2.58

 
87,696

3,086

3.52

 
171,255

3,968

2.32

Total borrowings
1,515,891

19,700

1.30

 
1,550,083

12,915

.83

 
1,437,348

7,283

.51

Total interest bearing liabilities
14,918,172

65,376

.44
%
 
14,968,614

43,728

.29
%
 
14,718,628

33,003

.22
%
Non-interest bearing deposits
6,728,971

 
 
 
7,176,255

 
 
 
7,049,633

 
 
Other liabilities
247,520

 
 
 
250,510

 
 
 
292,145

 
 
Equity
2,771,572

 
 
 
2,636,229

 
 
 
2,496,065

 
 
Total liabilities and equity
$
24,666,235



 
 
$
25,031,608

 
 
 
$
24,556,471

 
 
Net interest margin (T/E)
 
$
840,062

 
 
 
$
766,601

 
 
 
$
711,433

 
Net yield on interest earning assets
 
 
3.53
%
 
 
 
3.19
%
 
 
 
3.04
%
Percentage increase (decrease) in net interest margin (T/E) compared to the prior year
 
 
9.58
%
 
 
 
7.75
%
 
 
 
7.14
%
(A)
Loans on non-accrual status are included in the computation of average balances. Included in interest income above are loan fees and late charges, net of amortization of deferred loan origination fees and costs, which are immaterial. Credit card income from merchant discounts and net interchange fees are not included in loan income.


AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS

54

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Years Ended December 31
2015
 
2014
 
2013
 
 
Average Balance

Interest Income/Expense

Average Rates Earned/Paid

 
Average Balance
Interest Income/Expense
Average Rates Earned/Paid
 
Average Balance
Interest Income/Expense
Average Rates Earned/Paid
 
Average Balance Five Year Compound Growth Rate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
4,186,101

$
116,455

2.78
%
 
$
3,919,421

$
110,791

2.83
%
 
$
3,366,564

$
102,847

3.05
 %
 
8.07
%
477,320

17,075

3.58

 
418,702

15,826

3.78

 
378,896

15,036

3.97

 
20.62

2,293,839

85,751

3.74

 
2,300,855

88,206

3.83

 
2,251,113

92,555

4.11

 
3.99

1,899,234

71,666

3.77

 
1,818,125

69,054

3.80

 
1,694,955

66,353

3.91

 
4.32

1,829,830

72,625

3.97

 
1,617,039

68,434

4.23

 
1,437,270

67,299

4.68

 
6.95

431,033

15,262

3.54

 
426,720

16,188

3.79

 
424,358

16,822

3.96

 
(2.20
)
746,503

86,162

11.54

 
754,482

86,298

11.44

 
752,478

84,843

11.28

 
.43

5,416

—

—

 
4,889

—

—

 
6,020

—

—

 
(4.52
)
11,869,276

464,996

3.92

 
11,260,233

454,797

4.04

 
10,311,654

445,755

4.32

 
6.19

4,115

191

4.64

 
—

—

—

 
4,488

176

3.92

 
34.14

 
 
 
 
 
 
 
 
 
 
 
 
 
466,135

5,180

1.11

 
497,271

13,750

2.77

 
401,162

8,775

2.19

 
18.10

938,589

17,319

1.85

 
794,752

13,211

1.66

 
499,947

8,658

1.73

 
(9.20
)
1,786,235

63,054

3.53

 
1,715,493

61,593

3.59

 
1,617,814

58,522

3.62

 
(2.70
)
3,164,447

80,936

2.56

 
2,981,225

80,229

2.69

 
3,187,648

87,523

2.75

 
5.69

2,773,069

29,558

1.07

 
2,834,013

24,976

.88

 
3,061,415

27,475

.90

 
(13.82
)
255,558

6,191

2.42

 
141,266

3,287

2.33

 
166,113

4,990

3.00

 
15.43

20,517

562

2.74

 
18,423

411

2.23

 
20,986

472

2.25

 
3.34

45,200

1,805

3.99

 
48,847

1,448

2.96

 
54,754

1,316

2.40

 
(13.54
)
108,061

8,582

7.94

 
100,399

9,885

9.85

 
111,205

11,545

10.38

 
.57

9,557,811

213,187

2.23

 
9,131,689

208,790

2.29

 
9,121,044

209,276

2.29

 
(.70
)
16,184

60

.37

 
31,817

101

.32

 
24,669

106

.43

 
1.84

1,002,053

13,172

1.31

 
985,205

12,473

1.27

 
1,174,589

21,119

1.80

 
(9.93
)
206,115

528

.26

 
220,876

555

.25

 
155,885

387

.25

 
15.47

22,655,554

692,134

3.06

 
21,629,820

676,716

3.13

 
20,792,329

676,819

3.26

 
2.73

(152,690
)
 
 
 
(160,828
)
 
 
 
(166,846
)
 
 
 
(0.98
)
112,352

 
 
 
90,392

 
 
 
124,718

 
 
 
(198.06
)
378,803

 
 
 
382,207

 
 
 
382,500

 
 
 
(1.17
)
359,773

 
 
 
354,899

 
 
 
357,544

 
 
 
(.79
)
383,810

 
 
 
376,433

 
 
 
383,739

 
 
 
2.70

$
23,737,602

 
 
 
$
22,672,923

 
 
 
$
21,873,984

 
 
 
2.43

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
729,311

876

.12

 
$
670,650

855

.13

 
$
625,517

766

.12

 
6.75

9,752,794

12,498

.13

 
9,477,947

12,667

.13

 
9,059,524

13,589

.15

 
3.61

832,343

3,236

.39

 
935,387

4,137

.44

 
1,034,991

6,002

.58

 
(10.24
)
1,224,402

6,051

.49

 
1,372,509

5,926

.43

 
1,380,003

6,383

.46

 
(4.18
)
12,538,850

22,661

.18

 
12,456,493

23,585

.19

 
12,100,035

26,740

.22

 
2.07

 
 
 
 
 
 
 
 
 
 
 
 
 
1,654,860

1,861

.11

 
1,257,660

1,019

.08

 
1,294,691

809

.06

 
3.18

103,884

3,574

3.44

 
104,896

3,484

3.32

 
103,901

3,364

3.24

 
(55.83
)
1,758,744

5,435

.31

 
1,362,556

4,503

.33

 
1,398,592

4,173

.30

 
1.62

14,297,594

28,096

.20
%
 
13,819,049

28,088

.20
%
 
13,498,627

30,913

.23
 %
 
2.02

6,786,741

 
 
 
6,339,183

 
 
 
5,961,116

 
 
 
2.45

280,231

 
 
 
225,554

 
 
 
237,130

 
 
 
.86

2,373,036

 
 
 
2,289,137

 
 
 
2,177,111

 
 
 
4.95

$
23,737,602

 
 
 
$
22,672,923

 
 
 
$
21,873,984

 
 
 
2.43
%
 
$
664,038

 
 
 
$
648,628

 
 
 
$
645,906

 
 
 
 
 
2.93
%
 
 
 
3.00
%
 
 
 
3.11
 %
 
 
 
 
2.38
%
 
 
 
.42
%
 
 
 
(2.90
)%
 
 
(B)
Interest income and yields are presented on a fully-taxable equivalent basis using a federal income tax rate of 21% in 2018 and 35% in prior periods. Loan interest income includes tax free loan income (categorized as business loan income) which includes tax equivalent adjustments of $5,931,000 in 2018, $10,357,000 in 2017, $9,537,000 in 2016, $8,332,000 in 2015, $7,640,000 in 2014 and $6,673,000 in 2013. Investment securities interest income includes tax equivalent adjustments of $10,306,000 in 2018, $22,565,000 in 2017, $21,847,000 in 2016, $21,386,000 in 2015, $20,784,000 in 2014 and $19,861,000 in 2013. These adjustments relate to state and municipal obligations, trading securities, equity securities, and other securities.


55

QUARTERLY AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
 
Year ended December 31, 2018
 
Fourth Quarter
 
Third Quarter
 
Second Quarter
 
First Quarter
(Dollars in millions)
Average Balance
Average Rates Earned/Paid
 
Average Balance
Average Rates Earned/Paid
 
 Average Balance
Average Rates Earned/Paid
 
Average Balance
Average Rates Earned/Paid
ASSETS
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
 
 
Business(A)
$
5,030

3.93
%
 
$
4,925

3.80
%
 
$
4,962

3.69
%
 
$
4,934

3.48
%
Real estate – construction and land
953

5.47

 
992

5.21

 
972

5.06

 
952

4.69

Real estate – business
2,758

4.53

 
2,733

4.35

 
2,727

4.22

 
2,734

4.06

Real estate – personal
2,122

3.87

 
2,111

3.83

 
2,079

3.84

 
2,062

3.80

Consumer
1,962

4.62

 
1,985

4.46

 
2,026

4.39

 
2,072

4.25

Revolving home equity
374

4.98

 
374

4.72

 
378

4.51

 
393

4.25

Consumer credit card
788

11.91

 
775

11.99

 
754

12.05

 
758

12.06

Overdrafts
5

—

 
5

—

 
4

—

 
5

—

Total loans
13,992

4.72

 
13,900

4.59

 
13,902

4.49

 
13,910

4.33

Loans held for sale
18

6.59

 
18

6.87

 
22

6.72

 
19

6.45

Investment securities:
 
 
 
 

 

 
  

 

 
  

 

U.S. government & federal agency obligations
923

1.90

 
925

2.23

 
924

3.18

 
916

2.12

Government-sponsored enterprise obligations
215

2.24

 
262

2.10

 
354

1.88

 
406

1.84

State & municipal obligations(A)
1,361

3.06

 
1,376

2.98

 
1,395

3.06

 
1,513

3.06

Mortgage-backed securities
4,380

2.75

 
4,434

2.65

 
4,067

2.60

 
3,926

2.62

Asset-backed securities
1,519

2.55

 
1,427

2.42

 
1,407

2.32

 
1,469

2.11

Other debt securities
340

2.60

 
340

2.59

 
340

2.63

 
342

2.65

Trading debt securities(A)
26

3.21

 
24

3.13

 
26

3.15

 
22

2.73

Equity securities(A)
4

39.92

 
4

32.69

 
47

89.68

 
51

3.64

Other securities(A)
128

15.51

 
120

13.00

 
109

6.68

 
101

6.73

Total investment securities
8,896

2.86

 
8,912

2.76

 
8,669

3.19

 
8,746

2.58

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

2.56

 
13

2.10

 
37

1.93

 
44

1.65

Long-term securities purchased under agreements to resell
700

2.31

 
686

2.26

 
700

2.17

 
700

2.38

Interest earning deposits with banks
353

2.28

 
299

1.96

 
354

1.80

 
274

1.69

Total interest earning assets
23,973

3.92

 
23,828

3.80

 
23,684

3.90

 
23,693

3.59

Allowance for loan losses
(159
)
 
 
(159
)
 
 
(159
)
 
 
(159
)
 
Unrealized gain (loss) on debt securities
(166
)
 
 
(119
)
 
 
(122
)
 
 
(43
)
 
Cash and due from banks
365

 
 
357

 
 
357

 
 
364

 
Land, buildings and equipment – net
343

 
 
344

 
 
343

 
 
345

 
Other assets
452

 
 
445

 
 
419

 
 
437

 
Total assets
$
24,808

 
 
$
24,696

 
 
$
24,522

 
 
$
24,637

 
LIABILITIES AND EQUITY
 
 
 
 
 
 
 
 
 
 
 
Interest bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
Savings
$
871

.11

 
$
877

.11

 
$
881

.11

 
$
839

.12

Interest checking and money market
10,839

.30

 
10,840

.26

 
10,850

.23

 
10,738

.20

Certificates of deposit under $100,000
585

.70

 
594

.56

 
609

.46

 
625

.43

Certificates of deposit $100,000 & over
1,091

1.61

 
1,100

1.41

 
1,135

1.23

 
1,134

1.02

Total interest bearing deposits
13,386

.41

 
13,411

.35

 
13,475

.32

 
13,336

.28

Borrowings:
 
 
 
 
 
 
 
 
 
 
 
Federal funds purchased and securities sold under agreements to repurchase
1,656

1.60

 
1,500

1.33

 
1,339

1.18

 
1,560

1.04

Other borrowings
1

2.67

 
2

2.60

 
3

2.52

 
2

2.54

Total borrowings
1,657

1.60

 
1,502

1.33

 
1,342

1.19

 
1,562

1.04

Total interest bearing liabilities
15,043

.54
%
 
14,913

.45
%
 
14,817

.40
%
 
14,898

.36
%
Non-interest bearing deposits
6,667

 
 
6,678

 
 
6,749

 
 
6,825

 
Other liabilities
265

 
 
296

 
 
228

 
 
199

 
Equity
2,833

 
 
2,809

 
 
2,728

 
 
2,715

 
Total liabilities and equity
$
24,808

 
 
$
24,696

 

 
$
24,522

 

 
$
24,637

 

Net interest margin (T/E)
$
216

 
 
$
211

 

 
$
216

 

 
$
197

 

Net yield on interest earning assets
 
3.58
%
 
 

3.52
%
 
 
3.65
%
 
 
3.37
%
(A)
Includes tax equivalent calculations.

56

QUARTERLY AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
 
Year ended December 31, 2017
 
Fourth Quarter
 
Third Quarter
 
Second Quarter
 
First Quarter
(Dollars in millions)
Average Balance
Average Rates Earned/Paid
 
Average Balance
Average Rates Earned/Paid
 
Average Balance
Average Rates Earned/Paid
 
Average Balance
Average Rates Earned/Paid
ASSETS
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
 
 
Business(A)
$
4,818

3.32
%
 
$
4,778

3.25
%
 
$
4,828

3.21
%
 
$
4,907

3.02
%
Real estate – construction and land
948

4.41

 
888

4.31

 
862

4.30

 
828

3.85

Real estate – business
2,720

3.90

 
2,710

3.85

 
2,701

3.74

 
2,646

3.63

Real estate – personal
2,045

3.72

 
2,017

3.72

 
2,004

3.72

 
2,012

3.74

Consumer
2,101

4.07

 
2,070

4.02

 
1,998

3.94

 
1,975

3.89

Revolving home equity
394

4.06

 
395

4.03

 
400

3.84

 
405

3.64

Consumer credit card
757

11.90

 
740

12.03

 
731

11.90

 
748

11.66

Overdrafts
5

—

 
4

—

 
5

—

 
4

—

Total loans
13,788

4.18

 
13,602

4.13

 
13,529

4.06

 
13,525

3.92

Loans held for sale
18

5.55

 
21

5.36

 
18

5.75

 
12

6.64

Investment securities:
 

 

 
 

 

 
 

 

 
 

 
U.S. government & federal agency obligations
918

2.60

 
918

1.40

 
911

2.52

 
913

2.09

Government-sponsored enterprise obligations
452

1.69

 
457

1.61

 
450

1.59

 
450

1.58

State & municipal obligations(A)
1,631

3.60

 
1,699

3.57

 
1,772

3.61

 
1,783

3.65

Mortgage-backed securities
3,950

2.38

 
3,719

2.36

 
3,708

2.35

 
3,760

2.38

Asset-backed securities
1,623

1.94

 
2,025

1.82

 
2,335

1.72

 
2,360

1.63

Other debt securities
351

2.56

 
322

2.51

 
321

2.54

 
327

2.56

Trading debt securities(A)
20

2.63

 
21

2.51

 
21

2.70

 
25

2.77

Equity securities(A)
82

3.30

 
51

4.02

 
53

3.97

 
56

3.99

Other securities(A)
96

6.67

 
102

5.39

 
100

10.50

 
99

20.30

Total investment securities
9,123

2.58

 
9,314

2.37

 
9,671

2.50

 
9,773

2.57

Federal funds sold and short-term securities purchased under agreements to resell
27

1.35

 
24

1.30

 
13

1.13

 
10

.94

Long-term securities purchased under agreements to resell
700

2.36

 
662

2.28

 
666

2.22

 
725

2.12

Interest earning deposits with banks
270

1.18

 
211

1.24

 
139

1.04

 
208

.77

Total interest earning assets
23,926

3.48

 
23,834

3.36

 
24,036

3.36

 
24,253

3.29

Allowance for loan losses
(157
)
 
 
(157
)
 
 
(157
)
 
 
(155
)
 
Unrealized gain on debt securities
37

 
 
73

 
 
58

 
 
15

 
Cash and due from banks
372

 
 
349

 
 
349

 
 
376

 
Land, buildings and equipment – net
347

 
 
345

 
 
344

 
 
346

 
Other assets
438

 
 
429

 
 
413

 
 
417

 
Total assets
$
24,963

 
 
$
24,873

 
 
$
25,043

 
 
$
25,252

 
LIABILITIES AND EQUITY
 
 
 
 
 
 
 
 
 
 
 
Interest bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
Savings
$
822

.12

 
$
829

.12

 
$
831

.12

 
$
796

.13

Interest checking and money market
10,416

.17

 
10,387

.16

 
10,667

.15

 
10,604

.14

Certificates of deposit under $100,000
645

.40

 
668

.40

 
688

.39

 
705

.37

Certificates of deposit $100,000 & over
1,119

.88

 
1,326

.83

 
1,510

.75

 
1,671

.67

Total interest bearing deposits
13,002

.24

 
13,210

.24

 
13,696

.23

 
13,776

.21

Borrowings:
 
 
 
 
 
 
 
 
 
 
 
Federal funds purchased and securities sold under agreements to repurchase
1,626

.83

 
1,501

.75

 
1,363

.60

 
1,356

.46

Other borrowings
42

3.59

 
102

3.53

 
106

3.47

 
102

3.53

Total borrowings
1,668

.90

 
1,603

.93

 
1,469

.81

 
1,458

.67

Total interest bearing liabilities
14,670

.31
%
 
14,813

.31
%
 
15,165

.29
%
 
15,234

.26
%
Non-interest bearing deposits
7,257

 
 
7,136

 

 
7,066

 

 
7,247

 

Other liabilities
312

 
 
252

 

 
203

 

 
234

 

Equity
2,724

 
 
2,672

 

 
2,609

 

 
2,537

 

Total liabilities and equity
$
24,963

 
 
$
24,873

 

 
$
25,043

 

 
$
25,252

 

Net interest margin (T/E)
$
198

 
 
$
190



 
$
191



 
$
187

 

Net yield on interest earning assets
 
3.29
%
 
 
3.17
%
 
 
3.18
%
 
 
3.13
%
(A)
Includes tax equivalent calculations.

57

SUMMARY OF QUARTERLY STATEMENTS OF INCOME
Year ended December 31, 2018
For the Quarter Ended
(In thousands, except per share data)
12/31/2018
9/30/2018
6/30/2018
3/31/2018
Interest income
$
232,832

$
224,751

$
225,623

$
205,995

Interest expense
(20,612
)
(16,997
)
(14,664
)
(13,103
)
Net interest income
212,220

207,754

210,959

192,892

Non-interest income
133,087

123,714

124,850

119,690

Investment securities gains (losses), net
(7,129
)
4,306

(3,075
)
5,410

Salaries and employee benefits
(120,517
)
(116,194
)
(115,589
)
(115,894
)
Other expense
(68,108
)
(68,865
)
(66,271
)
(66,383
)
Provision for loan losses
(12,256
)
(9,999
)
(10,043
)
(10,396
)
Income before income taxes
137,297

140,716

140,831

125,319

Income taxes
(26,537
)
(26,647
)
(29,507
)
(23,258
)
Non-controlling interest
(1,108
)
(1,493
)
(994
)
(1,077
)
Net income attributable to Commerce Bancshares, Inc.
$
109,652

$
112,576

$
110,330

$
100,984

Net income per common share — basic*
$
.96

$
.99

$
.96

$
.88

Net income per common share — diluted*
$
.96

$
.98

$
.96

$
.88

Weighted average shares — basic*
110,477

110,889

110,970

110,916

Weighted average shares — diluted*
110,770

111,260

111,331

111,264

Year ended December 31, 2017
For the Quarter Ended
(In thousands, except per share data)
12/31/2017
9/30/2017
6/30/2017
3/31/2017
Interest income
$
201,572

$
194,244

$
193,594

$
187,997

Interest expense
(11,564
)
(11,653
)
(10,787
)
(9,724
)
Net interest income
190,008

182,591

182,807

178,273

Non-interest income
119,383

116,887

115,380

109,613

Investment securities gains (losses), net
27,209

(3,037
)
1,651

(772
)
Salaries and employee benefits
(115,741
)
(111,382
)
(108,829
)
(112,369
)
Other expense
(93,118
)
(67,835
)
(68,061
)
(67,008
)
Provision for loan losses
(12,654
)
(10,704
)
(10,758
)
(11,128
)
Income before income taxes
115,087

106,520

112,190

96,609

Income taxes
(20,104
)
(32,294
)
(33,201
)
(24,907
)
Non-controlling interest
(628
)
338

(29
)
(198
)
Net income attributable to Commerce Bancshares, Inc.
$
94,355

$
74,564

$
78,960

$
71,504

Net income per common share — basic*
$
.82

$
.65

$
.68

$
.62

Net income per common share — diluted*
$
.82

$
.64

$
.68

$
.62

Weighted average shares — basic*
110,900

110,909

110,862

110,658

Weighted average shares — diluted*
111,275

111,280

111,241

111,096

Year ended December 31, 2016
For the Quarter Ended
(In thousands, except per share data)
12/31/2016
9/30/2016
6/30/2016
3/31/2016
Interest income
$
181,498

$
179,361

$
180,065

$
172,128

Interest expense
(8,296
)
(8,118
)
(8,236
)
(8,353
)
Net interest income
173,202

171,243

171,829

163,775

Non-interest income
112,817

112,112

109,113

112,514

Investment securities gains (losses), net
3,651

(1,965
)
(744
)
(995
)
Salaries and employee benefits
(108,639
)
(107,004
)
(104,808
)
(106,859
)
Other expense
(65,960
)
(67,031
)
(64,824
)
(64,104
)
Provision for loan losses
(10,400
)
(7,263
)
(9,216
)
(9,439
)
Income before income taxes
104,671

100,092

101,350

94,892

Income taxes
(32,297
)
(30,942
)
(31,542
)
(29,370
)
Non-controlling interest
(795
)
(605
)
85

(148
)
Net income attributable to Commerce Bancshares, Inc.
$
71,579

$
68,545

$
69,893

$
65,374

Net income per common share — basic*
$
.62

$
.59

$
.61

$
.56

Net income per common share — diluted*
$
.62

$
.59

$
.60

$
.56

Weighted average shares — basic*
110,507

110,468

110,416

110,629

Weighted average shares — diluted*
110,866

110,749

110,704

110,880

* Restated for the 5% stock dividend distributed in 2018.

58

Item 7a.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is set forth on pages 46 through 47 of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm

To the Shareholders and Board of Directors
Commerce Bancshares, Inc.:

Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Commerce Bancshares, Inc. and subsidiaries (the Company) as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, cash flows, and changes in equity for each of the years in the three-year period ended December 31, 2018, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 21, 2019 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

                        kpmga01a01a05.gif

We have served as the Company’s auditor since 1971.
Kansas City, Missouri
February 21, 2019



59

Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
 
December 31
 
2018
2017
 
(In thousands)
ASSETS
 
 
Loans
$
14,140,298

$
13,983,674

Allowance for loan losses
(159,932
)
(159,532
)
Net loans
13,980,366

13,824,142

Loans held for sale (including $13,529,000 and $15,327,000 of residential mortgage loans carried at fair value at December 31, 2018 and 2017, respectively)
20,694

21,398

Investment securities:
 
 
Available for sale debt ($463,325,000 and $662,515,000 pledged at December 31, 2018 and
   2017, respectively, to secure swap and repurchase agreements)
8,538,041

8,725,442

Trading debt
27,059

18,269

Equity
4,409

50,591

Other
129,157

99,005

Total investment securities
8,698,666

8,893,307

Federal funds sold and short-term securities purchased under agreements to resell
3,320

42,775

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

700,000

Interest earning deposits with banks
689,876

30,631

Cash and due from banks
507,892

438,439

Land, buildings and equipment – net
333,119

335,110

Goodwill
138,921

138,921

Other intangible assets – net
8,794

7,618

Other assets
382,194

401,074

Total assets
$
25,463,842

$
24,833,415

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
Deposits:
 
 
Non-interest bearing
$
6,980,298

$
7,158,962

Savings, interest checking and money market
11,685,239

11,499,620

Certificates of deposit of less than $100,000
586,091

634,646

Certificates of deposit of $100,000 and over
1,072,031

1,132,218

Total deposits
20,323,659

20,425,446

Federal funds purchased and securities sold under agreements to repurchase
1,956,389

1,507,138

Other borrowings
8,702

1,758

Other liabilities
237,943

180,889

Total liabilities
22,526,693

22,115,231

Commerce Bancshares, Inc. stockholders’ equity:
 
 
Preferred stock, $1 par value
   Authorized 2,000,000 shares; issued 6,000 shares at December 31, 2018 and 2017
144,784

144,784

Common stock, $5 par value
   Authorized 120,000,000 shares; issued 111,886,450 shares at December 31, 2018 and 107,081,397 shares at December 31, 2017
559,432

535,407

Capital surplus
2,084,824

1,815,360

Retained earnings
241,163

221,374

Treasury stock of 555,100 shares at December 31, 2018 and 276,968 shares at December 31, 2017, at cost
(34,236
)
(14,473
)
Accumulated other comprehensive income (loss)
(64,669
)
14,108

Total Commerce Bancshares, Inc. stockholders’ equity
2,931,298

2,716,560

Non-controlling interest
5,851

1,624

Total equity
2,937,149

2,718,184

Total liabilities and equity
$
25,463,842

$
24,833,415

See accompanying notes to consolidated financial statements.

60

Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
 
For the Years Ended December 31
(In thousands, except per share data)
2018
2017
2016
INTEREST INCOME
 
 
 
Interest and fees on loans
$
625,083

$
543,825

$
489,956

Interest on loans held for sale
1,298

1,000

1,317

Interest on investment securities
240,187

214,689

207,184

Interest on federal funds sold and short-term securities purchased under agreements to resell
519

230

78

Interest on long-term securities purchased under agreements to resell
15,881

15,440

13,544

Interest on deposits with banks
6,233

2,223

973

Total interest income
889,201

777,407

713,052

INTEREST EXPENSE
 
 
 
Interest on deposits:
 
 
 
Savings, interest checking and money market
27,803

17,309

14,366

Certificates of deposit of less than $100,000
3,215

2,645

2,809

Certificates of deposit of $100,000 and over
14,658

10,859

8,545

Interest on federal funds purchased and securities sold under agreements to repurchase
19,655

9,829

3,315

Interest on other borrowings
45

3,086

3,968

Total interest expense
65,376

43,728

33,003

Net interest income
823,825

733,679

680,049

Provision for loan losses
42,694

45,244

36,318

Net interest income after provision for loan losses
781,131

688,435

643,731

NON-INTEREST INCOME
 
 
 
Bank card transaction fees
171,576

155,100

154,043

Trust fees
147,964

135,159

121,795

Deposit account charges and other fees
94,517

90,060

86,394

Capital market fees
7,721

7,996

10,655

Consumer brokerage services
15,807

14,630

13,784

Loan fees and sales
12,723

13,948

11,412

Other
51,033

44,370

48,473

Total non-interest income
501,341

461,263

446,556

INVESTMENT SECURITIES GAINS (LOSSES), NET
(488
)
25,051

(53
)
NON-INTEREST EXPENSE
 
 
 
Salaries and employee benefits
468,194

448,321

427,310

Net occupancy
46,044

45,612

46,290

Equipment
18,125

18,568

19,141

Supplies and communication
20,637

22,790

24,135

Data processing and software
85,978

80,998

79,589

Marketing
20,548

16,325

16,032

Deposit insurance
11,546

13,986

13,327

Community service
2,445

34,377

3,906

Other
64,304

63,366

59,499

Total non-interest expense
737,821

744,343

689,229

Income before income taxes
544,163

430,406

401,005

Less income taxes
105,949

110,506

124,151

Net income
438,214

319,900

276,854

Less non-controlling interest expense
4,672

517

1,463

Net income attributable to Commerce Bancshares, Inc.
433,542

319,383

275,391

Less preferred stock dividends
9,000

9,000

9,000

Net income available to common shareholders
$
424,542

$
310,383

$
266,391

Net income per common share - basic
$
3.79

$
2.77

$
2.38

Net income per common share - diluted
$
3.78

$
2.76

$
2.37

See accompanying notes to consolidated financial statements.

61

Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
 
For the Years Ended December 31
(In thousands)
 
2018
2017
2016
Net income
 
$
438,214

$
319,900

$
276,854

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
 
(277
)
412

(341
)
Net unrealized gains (losses) on other securities
 
(55,631
)
3,022

(22,422
)
Change in pension loss
 
664

(301
)
1,268

Unrealized gains on cash flow hedge derivatives
 
6,855

—

—

Other comprehensive income (loss)
 
(48,389
)
3,133

(21,495
)
Comprehensive income
 
389,825

323,033

255,359

Less non-controlling interest expense
 
4,672

517

1,463

Comprehensive income attributable to Commerce Bancshares, Inc.
 
$
385,153

$
322,516

$
253,896

See accompanying notes to consolidated financial statements.


62

Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
For the Years Ended December 31
(In thousands)
2018
2017
2016
OPERATING ACTIVITIES
 
 
 
Net income
$
438,214

$
319,900

$
276,854

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
42,694

45,244

36,318

Provision for depreciation and amortization
38,679

39,732

40,929

Amortization of investment security premiums, net
26,224

35,423

31,493

Deferred income tax (benefit) expense
5,336

13,617

(2,059
)
Investment securities (gains) losses, net (A)
488

(25,051
)
53

Net gains on sales of loans held for sale
(6,370
)
(8,008
)
(5,850
)
Proceeds from sales of loans held for sale
208,431

215,373

160,875

Originations of loans held for sale
(203,775
)
(216,064
)
(163,469
)
Net (increase) decrease in trading securities, excluding unsettled transactions
(14,277
)
7,585

73,780

Stock-based compensation
12,841

12,105

11,525

Increase in interest receivable
(4,258
)
(4,459
)
(3,642
)
Increase in interest payable
2,137

38

1,107

Increase (decrease) in income taxes payable
12,288

(27,685
)
4,509

Donation of securities
—

32,036

—

Other changes, net
(5,992
)
(13,259
)
(7,460
)
Net cash provided by operating activities
552,660

426,527

454,963

INVESTING ACTIVITIES
 
 
 
Proceeds from sales of investment securities (A)
708,864

792,380

24,380

Proceeds from maturities/pay downs of investment securities (A)
1,510,985

1,899,640

2,032,397

Purchases of investment securities (A)
(2,090,333
)
(1,853,817
)
(1,988,101
)
Net increase in loans
(200,673
)
(614,849
)
(1,009,523
)
Long-term securities purchased under agreements to resell
(100,000
)
(75,000
)
(250,000
)
Repayments of long-term securities purchased under agreements to resell
100,000

100,000

400,000

Purchases of land, buildings and equipment
(33,294
)
(30,824
)
(24,478
)
Sales of land, buildings and equipment
13,427

3,190

10,112

Net cash provided by (used in) investing activities
(91,024
)
220,720

(805,213
)
FINANCING ACTIVITIES
 
 
 
Net increase (decrease) in non-interest bearing, savings, interest checking and money market deposits
60,278

(15,036
)
782,846

Net increase (decrease) in certificates of deposit
(108,742
)
(474,044
)
243,199

Net increase (decrease) in federal funds purchased and short-term securities sold under agreements to repurchase
449,251

(216,767
)
(239,647
)
Net increase (decrease) in other borrowings
6,944

(100,291
)
(1,769
)
Purchases of treasury stock
(75,231
)
(17,771
)
(39,381
)
Issuance of stock under equity compensation plans
(10
)
(8
)
(6
)
Cash dividends paid on common stock
(100,238
)
(91,619
)
(87,070
)
Cash dividends paid on preferred stock
(9,000
)
(9,000
)
(9,000
)
Net cash provided by (used in) financing activities
223,252

(924,536
)
649,172

Increase (decrease) in cash, cash equivalents and restricted cash
684,888

(277,289
)
298,922

Cash, cash equivalents and restricted cash at beginning of year
524,352

801,641

502,719

Cash, cash equivalents and restricted cash at end of year
$
1,209,240

$
524,352

$
801,641

Income tax payments, net
$
84,172

$
120,744

$
119,596

Interest paid on deposits and borrowings
63,239

43,690

31,896

Loans transferred to foreclosed real estate
1,551

2,063

1,122

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

—

42,688

(A) Available for sale debt securities, equity securities, and other securities.
See accompanying notes to consolidated financial statements.




63

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
Balance, December 31, 2015
$
144,784

$
489,862

$
1,337,677

$
383,313

$
(26,116
)
$
32,470

$
5,428

$
2,367,418

Net income






275,391





1,463

276,854

Other comprehensive loss










(21,495
)


(21,495
)
Distributions to non-controlling interest












(1,542
)
(1,542
)
Purchases of treasury stock








(39,381
)




(39,381
)
Cash dividends paid on common stock ($.777 per share)






(87,070
)






(87,070
)
Cash dividends paid on preferred stock ($1.500 per depositary share)






(9,000
)






(9,000
)
Excess tax benefit related to equity compensation plans




3,390









3,390

Stock-based compensation




11,525









11,525

Issuance under stock purchase and equity compensation plans




(15,810
)


16,721





911

5% stock dividend, net


20,153

215,672

(269,785
)
33,482





(478
)
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



319,383



517

319,900

Other comprehensive income










3,133



3,133

Distributions to non-controlling interest






(1,293
)
(1,293
)
Sale of non-controlling interest of subsidiary


2,950




(2,949
)
1

Purchases of treasury stock




(17,771
)


(17,771
)
Cash dividends paid on common stock ($.816 per share)



(91,619
)



(91,619
)
Cash dividends paid on preferred stock ($1.500 per depositary share)



(9,000
)



(9,000
)
Stock-based compensation


12,105





12,105

Issuance under stock purchase and equity compensation plans


(17,734
)

18,592



858

5% stock dividend, net

25,392

262,144

(288,095
)



(559
)
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






433,542





4,672

438,214

Other comprehensive loss










(48,389
)


(48,389
)
Distributions to non-controlling interest












(445
)
(445
)
Purchases of treasury stock








(75,231
)




(75,231
)
Cash dividends paid on common stock ($.895 per share)






(100,238
)






(100,238
)
Cash dividends paid on preferred stock ($1.500 per depositary share)






(9,000
)






(9,000
)
Stock-based compensation




12,841









12,841

Issuance under stock purchase and equity compensation plans




(21,632
)


23,424





1,792

5% stock dividend, net


24,025

278,255

(334,903
)
32,044





(579
)
Balance, December 31, 2018
$
144,784

$
559,432

$
2,084,824

$
241,163

$
(34,236
)
$
(64,669
)
$
5,851

$
2,937,149

See accompanying notes to consolidated financial statements.

64

Commerce Bancshares, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
 
 
 
1. Summary of Significant Accounting Policies
Nature of Operations
Commerce Bancshares, Inc. and its subsidiaries (the Company) conducts its principal activities from approximately 320 branch and ATM locations throughout Missouri, Illinois, Kansas, Oklahoma and Colorado. Principal activities include retail and commercial banking, investment management, securities brokerage, mortgage banking, credit related insurance and private equity investment activities. The Company also maintains commercial banking offices in Dallas, Houston, Cincinnati, Nashville, Des Moines, Indianapolis, and Grand Rapids.
        
Basis of Presentation
The Company follows accounting principles generally accepted in the United States of America (GAAP) and reporting practices applicable to the banking industry. The preparation of financial statements under GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and notes. These estimates are based on information available to management at the time the estimates are made. While the consolidated financial statements reflect management’s best estimates and judgments, actual results could differ from those estimates. The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries (after elimination of all material intercompany balances and transactions). Certain prior year amounts have been reclassified to conform to the current year presentation. Such reclassifications had no effect on net income or total assets. Management has evaluated subsequent events for potential recognition or disclosure through the date these consolidated financial statements were issued.

The Company, in the normal course of business, engages in a variety of activities that involve variable interest entities (VIEs). A VIE is a legal entity that lacks equity investors or whose equity investors do not have a controlling financial interest in the entity through their equity investments. However, an enterprise is deemed to have a controlling financial interest and is the primary beneficiary of a VIE if it has both the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and an obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. An enterprise that is the primary beneficiary must consolidate the VIE. The Company’s interests in VIEs are evaluated to determine if the Company is the primary beneficiary both at inception and when there is a change in circumstances that requires a reconsideration.

The Company is considered to be the primary beneficiary in a rabbi trust related to a deferred compensation plan offered to certain employees. The assets and liabilities of this trust, which are included in the accompanying consolidated balance sheets, are not significant. The Company also has variable interests in certain entities in which it is not the primary beneficiary. These entities are not consolidated. These interests include affordable housing limited partnership interests, holdings in its investment portfolio of various asset and mortgage-backed bonds that are issued by securitization trusts, and managed discretionary trust assets that are not included in the accompanying consolidated balance sheets.

Cash, Cash Equivalents and Restricted Cash
In the accompanying consolidated statements of cash flows, cash and cash equivalents include “Cash and due from banks”, “Federal funds sold and short-term securities purchased under agreements to resell”, and “Interest earning deposits with banks” as segregated in the accompanying consolidated balance sheets. Restricted cash is comprised of cash collateral on deposit with another financial institution to secure interest rate swap transactions. Restricted cash is included in other assets in the consolidated balance sheets and totaled $8.2 million and $12.5 million at December 31, 2018 and 2017, respectively.

Regulations of the Federal Reserve System require cash balances to be maintained at the Federal Reserve Bank, based on certain deposit levels. The minimum reserve requirement for the Bank at December 31, 2018 totaled $228.3 million. Other interest earning cash balances held at the Federal Reserve Bank totaled $689.9 million.

Loans and Related Earnings
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal balances, net of undisbursed loan proceeds, the allowance for loan losses, and any deferred fees and costs on originated loans. Origination fee income received on loans and amounts representing the estimated direct costs of origination are deferred and amortized to interest income over the life of the loan using the interest method.
 

65

Interest on loans is accrued based upon the principal amount outstanding. Interest income is recognized primarily on the level yield method. Loan and commitment fees, net of costs, are deferred and recognized in income over the term of the loan or commitment as an adjustment of yield. Annual fees charged on credit card loans are capitalized to principal and amortized over 12 months to loan fees and sales. Other credit card fees, such as cash advance fees and late payment fees, are recognized in income as an adjustment of yield when charged to the cardholder’s account.

Non-Accrual Loans
Loans are placed on non-accrual status when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment. Business, construction real estate, business real estate, and personal real estate loans that are contractually 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. Consumer, revolving home equity and credit card loans are exempt under regulatory rules from being classified as non-accrual. When a loan is placed on non-accrual status, any interest previously accrued but not collected is reversed against current income, and the loan is charged off to the extent uncollectible. Principal and interest payments received on non-accrual loans are generally applied to principal. Interest is included in income only after all previous loan charge-offs have been recovered and is recorded only as received. The loan is returned to accrual status only when the borrower has brought all past due principal and interest payments current, and, in the opinion of management, the borrower has demonstrated the ability to make future payments of principal and interest as scheduled. A six month history of sustained payment performance is generally required before reinstatement of accrual status.

Troubled Debt Restructurings
A loan is accounted for as a troubled debt restructuring if the Company, for economic or legal reasons related to the borrowers’ financial difficulties, grants a concession to the borrower that it would not otherwise consider. A troubled debt restructuring typically involves (1) modification of terms such as a reduction of the stated interest rate, loan principal, or accrued interest, (2) a loan renewal at a stated interest rate lower than the current market rate for a new loan with similar risk, or (3) debt that was not reaffirmed in bankruptcy. Business, business real estate, construction real estate and personal real estate troubled debt restructurings with impairment charges are placed on non-accrual status. The Company measures the impairment loss of a troubled debt restructuring in the same manner as described below. Troubled debt restructurings which are performing under their contractual terms continue to accrue interest which is recognized in current earnings.

Impaired Loans
Loans are evaluated regularly by management for impairment. Included in impaired loans are all non-accrual loans, as well as loans that have been classified as troubled debt restructurings. Once a loan has been identified as impaired, impairment is measured based on either the present value of the expected future cash flows at the loan’s initial effective interest rate or the fair value of the collateral if collateral dependent. Factors considered in determining impairment include delinquency status, cash flow analysis, credit analysis, and collateral value and availability.

Loans Held For Sale
Loans held for sale include student loans and certain fixed rate residential mortgage loans. These loans are typically classified as held for sale upon origination based upon management's intent to sell the production of these loans. The student loans are carried at the lower of aggregate cost or fair value, and their fair value is determined based on sale contract prices. The mortgage loans are carried at fair value under the elected fair value option. Their fair value is based on secondary market prices for loans with similar characteristics, including an adjustment for embedded servicing value. Changes in fair value and gains and losses on sales are included in loan fees and sales. Deferred fees and costs related to these loans are not amortized but are recognized as part of the cost basis of the loan at the time it is sold. Interest income related to loans held for sale is accrued based on the principal amount outstanding and the loan's contractual interest rate.

Occasionally, other types of loans may be classified as held for sale in order to manage credit concentration. These loans are carried at the lower of cost or fair value with gains and losses on sales recognized in loan fees and sales.

Allowance/Provision for Loan Losses
The allowance for loan losses is maintained at a level believed to be appropriate by management to provide for probable loan losses inherent in the portfolio as of the balance sheet date, including losses on known or anticipated problem loans as well as for loans which are not currently known to require specific allowances. Management has established a process to determine the amount of the allowance for loan losses which assesses the risks and losses inherent in its portfolio. Business, construction real estate and business real estate loans are normally larger and more complex, and their collection rates are harder to predict. These loans are more likely to be collateral dependent and are allocated a larger reserve, due to their potential volatility. Personal real

66

estate, credit card, consumer and revolving home equity loans are individually smaller and perform in a more homogenous manner, making loss estimates more predictable. Management’s process provides an allowance consisting of a specific allowance component based on certain individually evaluated loans and a general component based on estimates of reserves needed for pools of loans.
 

Loans subject to individual evaluation generally consist of business, construction real estate, business real estate and personal real estate loans on non-accrual status. These impaired loans are evaluated individually for the impairment of repayment potential and collateral adequacy. Other impaired loans identified as performing troubled debt restructurings are collectively evaluated because they have similar risk characteristics. Loans which have not been identified as impaired are segregated by loan type and sub-type and are collectively evaluated. Reserves calculated for these loan pools are estimated using a consistent methodology that considers historical loan loss experience by loan type, loss emergence periods, delinquencies, current economic factors, loan risk ratings and industry concentrations.

The Company’s estimate of the allowance for loan losses and the corresponding provision for loan losses is based on various judgments and assumptions made by management. The amount of the allowance for loan losses is influenced by several qualitative factors which include collateral valuation, evaluation of performance and status, current loan portfolio composition and characteristics, trends in delinquencies, portfolio risk ratings, levels of non-performing assets, and prevailing regional and national economic and business conditions.

The estimates, appraisals, evaluations, and cash flows utilized by management may be subject to frequent adjustments due to changing economic prospects of borrowers or properties. These estimates are reviewed periodically and adjustments, if necessary, are recorded in the provision for loan losses in the periods in which they become known.

Loans, or portions of loans, are charged off to the extent deemed uncollectible. Loan charge-offs reduce the allowance for loan losses, and recoveries of loans previously charged off are added back to the allowance. Business, business real estate, construction real estate and personal real estate loans are generally charged down to estimated collectible balances when they are placed on non-accrual status. Consumer loans and related accrued interest are normally charged down to the fair value of related collateral (or are charged off in full if no collateral) once the loans are more than 120 days delinquent. Credit card loans are charged off against the allowance for loan losses when the receivable is more than 180 days past due. The interest and fee income previously capitalized but not collected on credit card charge-offs is reversed against interest income.

Operating, Direct Financing and Sales Type Leases
The net investment in direct financing and sales type leases is included in loans on the Company’s consolidated balance sheets and consists of the present values of the sum of the future minimum lease payments and estimated residual value of the leased asset. Revenue consists of interest earned on the net investment and is recognized over the lease term as a constant percentage return thereon. The net investment in operating leases is included in other assets on the Company’s consolidated balance sheets. It is carried at cost, less the amount depreciated to date. Depreciation is recognized on a straight-line basis over the lease term to the estimated residual value. Operating lease revenue consists of the contractual lease payments and is recognized over the lease term in other non-interest income. Estimated residual values are established at lease inception utilizing contract terms, past customer experience, and general market data and are reviewed and adjusted, if necessary, on an annual basis.

Investments in Debt and Equity Securities
The majority of the Company's investment portfolio is comprised of debt securities which are classified as available for sale. From time to time, the Company sells securities and utilizes the proceeds to reduce borrowings, fund loan growth, or modify its interest rate profile. Securities classified as available for sale are carried at fair value. Changes in fair value, excluding certain losses associated with other-than-temporary impairment (OTTI), are reported in other comprehensive income (loss), a component of stockholders’ equity. Securities are periodically evaluated for OTTI in accordance with guidance provided in ASC 320-10-35. For securities with OTTI, the entire loss in fair value is required to be recognized in current earnings if the Company intends to sell the securities or believes it likely that it will be required to sell the security before the anticipated recovery. If neither condition is met, but the Company does not expect to recover the amortized cost basis, the Company determines whether a credit loss has occurred, and the loss is then recognized in current earnings. The noncredit-related portion of the overall loss is reported in other comprehensive income (loss). Gains and losses realized upon sales of securities are calculated using the specific identification method and are included in investment securities gains (losses), net, in the consolidated statements of income. Purchase premiums and discounts are amortized to interest income using a level yield method over the estimated lives of the securities. For mortgage and asset-backed securities, prepayment experience is evaluated quarterly to determine the appropriate estimate of the future rate of prepayment. When a change in a bond's estimated remaining life is necessary, a corresponding adjustment is made in the related amortization of premium or discount accretion.


67

Equity securities include common and preferred stock with readily determinable fair values. These are also carried at fair value. Prior to January 1, 2018, changes in fair value were recorded in other comprehensive income. The Company's adoption of ASU 2016-01, "Recognition and Measurement of Financial Assets and Financial Liabilities", effective January 1, 2018, required that all subsequent changes in fair value be recorded in current earnings. The adoption also required a reclassification of the unrealized gain in fair value on equity securities (recorded in accumulated other comprehensive income at December 31, 2017) to retained earnings. The amount of this reclassification was $33.3 million, net of tax.

Certain equity securities do not have readily determinable fair values. The Company has elected under ASU 2016-01 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 has not recorded any impairment or other adjustments to the carrying amount of these investments.

Other securities include Federal Reserve Bank stock and Federal Home Loan Bank stock, which are held for debt and regulatory purposes. They are carried at cost and periodically evaluated for other-than-temporary impairment. Also included are investments in portfolio concerns held by the Company’s private equity subsidiaries, which consist of both debt and equity instruments. Private equity investments are carried at fair value in accordance with ASC 946-10-15, with changes in fair value reported in current earnings. In the absence of readily ascertainable market values, fair value is estimated using internally developed methods. Changes in fair value which are recognized in current earnings and gains and losses from sales are included in investment securities gains (losses), net in the consolidated statements of income.

Trading account securities, which are debt securities bought and held principally for the purpose of resale in the near term, are carried at fair value. Gains and losses, both realized and unrealized, are recorded in non-interest income.

Purchases and sales of securities are recognized on a trade date basis. A receivable or payable is recognized for pending transaction settlements.    

Securities Purchased under Agreements to Resell and Securities Sold under Agreements to Repurchase
Securities purchased under agreements to resell and securities sold under agreements to repurchase are treated as collateralized financing transactions, not as purchases and sales of the underlying securities. The agreements are recorded at the amount of cash advanced or received.
The Company periodically enters into securities purchased under agreements to resell with large financial institutions. Securities pledged by the counterparties to secure these agreements are delivered to a third party custodian.
Securities sold under agreements to repurchase are a source of funding to the Company and are offered to cash management customers as an automated, collateralized investment account. From time to time, securities sold may also be used by the Bank to obtain additional borrowed funds at favorable rates. These borrowings are secured by a portion of the Company's investment security portfolio and delivered either to the dealer custody account at the FRB or to the applicable counterparty.

The fair value of collateral either received from or provided to a counterparty is monitored daily, and additional collateral is obtained, returned, or provided by the Company in order to maintain full collateralization for these transactions.
As permitted by current accounting guidance, the Company offsets certain securities purchased under agreements to resell against securities sold under agreements to repurchase in its balance sheet presentation. These agreements are further discussed in Note 19, Resale and Repurchase Agreements.

Land, Buildings and Equipment
Land is stated at cost, and buildings and equipment are stated at cost, including capitalized interest when appropriate, less accumulated depreciation. Depreciation is computed using a straight-line method, utilizing estimated useful lives; generally 30 years for buildings, 10 years for building improvements, and 3 to 10 years for equipment. Leasehold improvements are amortized over the shorter of 10 years or the remaining lease term. Maintenance and repairs are charged to non-interest expense as incurred.


68

Foreclosed Assets
Foreclosed assets consist of property that has been repossessed and is comprised of commercial and residential real estate and other non-real estate property, including auto and recreational and marine vehicles. The assets are initially recorded at fair value less estimated selling costs, establishing a new cost basis. Initial valuation adjustments are charged to the allowance for loan losses. Fair values are estimated primarily based on appraisals, third-party price opinions, or internally developed pricing models. After initial recognition, fair value estimates are updated periodically. Declines in fair value below cost are recognized through valuation allowances which may be reversed when supported by future increases in fair value. These valuation adjustments, in addition to gains and losses realized on sales and net operating expenses, are recorded in other non-interest expense.

Goodwill and Intangible Assets
Goodwill is not amortized but is assessed for impairment on an annual basis or more frequently in certain circumstances. When testing for goodwill impairment, the Company may initially perform a qualitative assessment. Based on the results of this qualitative assessment, if the Company concludes it is more likely than not that a reporting unit's fair value is less than its carrying amount, a quantitative analysis is performed. Quantitative valuation methodologies include a combination of formulas using current market multiples, based on recent sales of financial institutions within the Company's geographic marketplace. If the fair value of a reporting unit is less than the carrying amount, additional analysis is required to measure the amount of impairment. The Company has not recorded impairment resulting from goodwill impairment tests. However, adverse changes in the economic environment, operations of the reporting unit, or other factors could result in a decline in fair value.

Intangible assets that have finite useful lives, such as core deposit intangibles and mortgage servicing rights, are amortized over their estimated useful lives. Core deposit intangibles are amortized over periods of 8 to 14 years, representing their estimated lives, using accelerated methods. Mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income, considering appropriate prepayment assumptions. Core deposit intangibles are reviewed for impairment whenever events or changes in circumstances indicate their carrying amount may not be recoverable. Impairment is indicated if the sum of the undiscounted estimated future net cash flows is less than the carrying value of the intangible asset. Mortgage servicing rights, while initially recorded at fair value, are subsequently amortized and carried at the lower of the initial capitalized amount (net of accumulated amortization), or estimated fair value. The Company evaluates its mortgage servicing rights for impairment on a quarterly basis, using estimated prepayment speeds of the underlying mortgage loans serviced and stratifications based on the risk characteristics of the underlying loans. A valuation allowance has been established, through a charge to earnings, to the extent the amortized cost exceeds the estimated fair value. However, the Company has not recorded other-than-temporary impairment losses on either of these types of intangible assets.

Income Taxes
Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income taxes are provided for temporary differences between the financial reporting bases and income tax bases of the Company’s assets and liabilities, net operating losses, and tax credit carryforwards. Deferred tax assets and liabilities are measured using the enacted tax rates that are expected to apply to taxable income when such assets and liabilities are anticipated to be settled or realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as tax expense or benefit in the period that includes the enactment date of the change. In determining the amount of deferred tax assets to recognize in the financial statements, the Company evaluates the likelihood of realizing such benefits in future periods. A valuation allowance is established if it is more likely than not that all or some portion of the deferred tax asset will not be realized. The Company recognizes interest and penalties related to income taxes within income tax expense in the consolidated statements of income.

The Company and its eligible subsidiaries file a consolidated federal income tax return. State and local income tax returns are filed on a combined, consolidated or separate return basis based upon each jurisdiction’s laws and regulations.

In December 2017, tax reform legislation was enacted which changed the maximum corporate tax rate for years 2018 and beyond. As such, deferred tax assets and liabilities were revalued in 2017 to account for the change in future tax rates. Additional information about current and deferred income taxes is provided in Note 8, Income Taxes.

Non-Interest Income
Non-interest income is mainly comprised of revenue from contracts with customers. For that revenue (excluding certain revenue associated with financial instruments, derivative and hedging instruments, guarantees, lease contracts, transferring and servicing of financial assets, and other specific revenue transactions), the Company applies the following five-step approach when recognizing revenue: (i) identify the contract with the customer, (ii) identify the performance obligations, (iii) determine the

69

transaction price, (iv) allocate the transaction price to the performance obligations, and (v) recognize revenue when (or as) the performance obligation is satisfied. The Company’s contracts with customers are generally short term in nature, with a duration of one year or less, and most contracts are cancellable by either the Company or its customer without penalty. Performance obligations for customer contracts are generally satisfied at a single point in time, typically when the transaction is complete and the customer has received the goods or service, or over time. For performance obligations satisfied over time, the Company recognizes the value of the goods or services transferred to the customer when the performance obligations have been transferred and received by the customer. Payments for satisfied performance obligations are typically due when or as the goods or services are completed, or shortly thereafter, which usually occurs within a single financial reporting period.

In situations where payment is made before the performance obligation is satisfied, the fees are deferred until the performance obligations pertaining to those goods or services are completed. In cases where payment has not been received despite satisfaction of its performance obligations, the Company accrues an estimate of the amount due in the period that the performance obligations have been satisfied. For contracts with variable components, the Company only recognizes revenue to the extent that it is probable that the cumulative amount recognized will not be subject to a significant reversal in future periods. Generally, the Company’s contracts do not include terms that require significant judgment to determine whether a variable component is included within the transaction price. The Company generally acts in a principal capacity, on its own behalf, in most of its contracts with customers. For these transactions, revenue and the related costs to provide the goods or services are presented on a gross basis in the financial statements. In some cases, the Company acts in an agent capacity, deriving revenue through assisting third parties in transactions with the Company’s customers. In such transactions, revenue and the related costs to provide services is presented on a net basis in the financial statements. These transactions primarily relate to fees earned from bank card and related network and rewards costs and the sales of annuities and certain limited insurance products.

Derivatives
Most of the Company's derivative contracts are accounted for as free-standing instruments. These instruments are carried at fair value, and changes in fair value are recognized in current earnings. They include interest rate swaps and caps, which are offered to customers to assist in managing their risks of adverse changes in interest rates. Each contract between the Company and a customer is offset by a contract between the Company and an institutional counterparty, thus minimizing the Company's exposure to rate changes. The Company also enters into certain contracts, known as credit risk participation agreements, to buy or sell credit protection on specific interest rate swaps. It also purchases and sells forward foreign exchange contracts, either in connection with customer transactions, or for its own trading purposes. In 2015, the Company began an origination and sales program of certain personal real estate mortgages. Derivative instruments under this program include mortgage loan commitments, forward loan sale contracts, and forward contracts to sell certain to-be-announced (TBA) securities.

The Company's interest rate risk management policy permits the use of hedge accounting for derivatives, and in 2018 the Company entered into interest rate floor contracts as protection from the potential for declining interest rates in the commercial loan portfolio. These floors were designated and qualified as cash flow hedges. In a cash flow hedge, the changes in fair value are recorded in accumulated other comprehensive income and recognized in the income statement when the hedged cash flows affect earnings. Both at hedge inception and on an ongoing basis, the Company assesses whether the interest rate floors used in the hedging relationships are highly effective in offsetting changes in the cash flows of the hedged items.

The Company has master netting arrangements with various counterparties but does not offset derivative assets and liabilities under these arrangements in its consolidated balance sheets. However, interest rate swaps that are executed under central clearing requirements are presented net of variation margin as mandated by the statutory terms of the Company's contract with its clearing counterparty.

Additional information about derivatives held by the Company and valuation methods employed is provided in Note 16, Fair Value Measurements and Note 18, Derivative Instruments.

Pension Plan
The Company’s pension plan is described in Note 9, Employee Benefit Plans. Historically, the Company has reported all components of net periodic pension cost in salaries and employee benefits in its consolidated statements of income. Upon the adoption of ASU 2017-07 "Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost", in 2018, only the service cost component of net periodic pension cost is reported in salaries and employee benefits in the accompanying consolidated statements of income, while the other components are reported in other non-interest expense. The funded status of the plan is recognized as an asset or liability in the consolidated balance sheets, and changes in that funded status are recognized in the year in which the changes occur through other comprehensive income. Plan assets and benefit obligations are measured as of the fiscal year end of the plan. The measurement of the projected benefit obligation and pension expense involve actuarial valuation methods and the use of various actuarial and economic assumptions. The Company monitors the assumptions

70

and updates them periodically. Due to the long-term nature of the pension plan obligation, actual results may differ significantly from estimations. Such differences are adjusted over time as the assumptions are replaced by facts and values are recalculated.

Stock-Based Compensation
The Company’s stock-based employee compensation plan is described in Note 10, Stock-Based Compensation and Directors Stock Purchase Plan. In accordance with the requirements of ASC 718-10-30-3 and 35-2, the Company measures the cost of stock-based compensation based on the grant-date fair value of the award, recognizing the cost over the requisite service period, which is generally the vesting period. The fair value of an option award is estimated using the Black-Scholes option-pricing model while the fair value of a nonvested stock award is the common stock (CBSH) market price. The expense recognized for stock-based compensation is included in salaries and benefits in the accompanying consolidated statements of income. In periods prior to 2017, expense was reduced for estimated forfeitures over the vesting period and adjusted for actual forfeitures as they occurred. Effective January 1, 2017, the Company elected to recognize forfeitures as a reduction to expense only when they have occurred, as allowed under the provisions of ASU 2016-09. The effect of this change, which was recognized as a cumulative-effect adjustment on January 1, 2017, increased equity and increased deferred tax assets by approximately $1.3 million.

Treasury Stock
Purchases of the Company’s common stock are recorded at cost. Upon re-issuance for acquisitions, exercises of stock-based awards or other corporate purposes, treasury stock is reduced based upon the average cost basis of shares held.

Income per Share
Basic income per share is computed using the weighted average number of common shares outstanding during each year. Diluted income per share includes the effect of all dilutive potential common shares (primarily stock appreciation rights) outstanding during each year. The Company applies the two-class method of computing income per share. The two-class method is an earnings allocation formula that determines income per share for common stock and for participating securities, according to dividends declared and participation rights in undistributed earnings. The Company’s nonvested stock awards are considered to be a class of participating security. All per share data has been restated to reflect the 5% stock dividend distributed in December 2018.



71

2. Loans and Allowance for Loan Losses
Major classifications within the Company’s held for investment loan portfolio at December 31, 2018 and 2017 are as follows:
(In thousands)
2018
2017
Commercial:
 
 
Business
$
5,106,427

$
4,958,554

Real estate — construction and land
869,659

968,820

Real estate — business
2,875,788

2,697,452

Personal Banking:
 
 
Real estate — personal
2,127,083

2,062,787

Consumer
1,955,572

2,104,487

Revolving home equity
376,399

400,587

Consumer credit card
814,134

783,864

Overdrafts
15,236

7,123

Total loans
$
14,140,298

$
13,983,674


Loans to directors and executive officers of the Parent and the Bank, and to their affiliates, are summarized as follows:
(In thousands)
 
Balance at January 1, 2018
$
47,225

Additions
127,253

Amounts collected
(128,540
)
Amounts written off
—

Balance, December 31, 2018
$
45,938


Management believes all loans to directors and executive officers have been made in the ordinary course of business with normal credit terms, including interest rate and collateral considerations, and do not represent more than a normal risk of collection. The activity in the table above includes draws and repayments on several lines of credit with business entities. There were no outstanding loans at December 31, 2018 to principal holders (over 10% ownership) of the Company’s common stock.

The Company’s lending activity is generally centered in Missouri, Illinois, Kansas and other nearby states including Oklahoma, Colorado, Iowa, Ohio, Texas, and others. The Company maintains a diversified portfolio with limited industry concentrations of credit risk. Loans and loan commitments are extended under the Company’s normal credit standards, controls, and monitoring features. Most loan commitments are short or intermediate term in nature. Commercial loan maturities generally range from one to seven years. Collateral is commonly required and would include such assets as marketable securities and cash equivalent assets, accounts receivable and inventory, equipment, other forms of personal property, and real estate. At December 31, 2018, unfunded loan commitments totaled $11.2 billion (which included $5.3 billion in unused approved lines of credit related to credit card loan agreements) which could be drawn by customers subject to certain review and terms of agreement. At December 31, 2018, loans totaling $3.7 billion were pledged at the FHLB as collateral for borrowings and letters of credit obtained to secure public deposits. Additional loans of $1.6 billion were pledged at the Federal Reserve Bank as collateral for discount window borrowings.

The Company has a net investment in direct financing and sales type leases to commercial and industrial and tax-exempt entities of $752.2 million and $737.7 million at December 31, 2018 and 2017, respectively, which is included in business loans on the Company’s consolidated balance sheets. This investment includes deferred income of $62.6 million and $52.1 million at December 31, 2018 and 2017, respectively. The net investment in operating leases amounted to $16.1 million and $17.4 million at December 31, 2018 and 2017, respectively, and is included in other assets on the Company’s consolidated balance sheets.


72

Allowance for loan losses

A summary of the activity in the allowance for losses during the previous three years follows:
(In thousands)
Commercial
Personal Banking
Total
Balance at December 31, 2015
$
82,086

$
69,446

$
151,532

Provision for loan losses
4,898

31,420

36,318

Deductions:
 
 
 
Loans charged off
3,258

47,720

50,978

Less recoveries
7,635

11,425

19,060

Net loans charged off (recoveries)
(4,377
)
36,295

31,918

Balance at December 31, 2016
91,361

64,571

155,932

Provision for loan losses
2,327

42,917

45,244

Deductions:
 
 
 
Loans charged off
2,538

52,641

55,179

Less recoveries
2,554

10,981

13,535

Net loans charged off (recoveries)
(16
)
41,660

41,644

Balance at December 31, 2017
93,704

65,828

159,532

Provision for loan losses
254

42,440

42,694

Deductions:
 
 
 
Loans charged off
3,164

52,657

55,821

Less recoveries
2,075

11,452

13,527

Net loans charged off (recoveries)
1,089

41,205

42,294

Balance at December 31, 2018
$
92,869

$
67,063

$
159,932


The following table shows the balance in the allowance for loan losses and the related loan balance at December 31, 2018 and 2017, disaggregated on the basis of impairment methodology. Impaired loans evaluated under ASC 310-10-35 include loans on non-accrual status which are individually evaluated for impairment and other impaired loans deemed to have similar risk characteristics, which 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
December 31, 2018
 
 
 
 
 
Commercial
$
1,780

$
61,496

 
$
91,089

$
8,790,378

Personal Banking
916

17,120

 
66,147

5,271,304

Total
$
2,696

$
78,616

 
$
157,236

$
14,061,682

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



73

Impaired loans
The table below shows the Company’s investment in impaired loans at December 31, 2018 and 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 under current accounting guidance. 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 78.
(In thousands)
2018
2017
Non-accrual loans
$
12,536

$
11,983

Restructured loans (accruing)
66,080

102,812

Total impaired loans
$
78,616

$
114,795


The following table provides additional information about impaired loans held by the Company at December 31, 2018 and 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
December 31, 2018
 
 
 
With no related allowance recorded:
 
 
 
Business
$
8,725

$
14,477

$
—

 
$
8,725

$
14,477

$
—

With an allowance recorded:
 
 
 
Business
$
40,286

$
40,582

$
1,223

Real estate – construction and land
416

421

11

Real estate – business
12,069

12,699

546

Real estate – personal
4,461

6,236

266

Consumer
5,510

5,510

38

Revolving home equity
40

40

1

Consumer credit card
7,109

7,109

611

 
$
69,891

$
72,597

$
2,696

Total
$
78,616

$
87,074

$
2,696

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



74

Total average impaired loans during 2018 and 2017 are shown in the table below.
 
2018
 
2017
(In thousands)
Commercial
Personal Banking
Total
 
Commercial
Personal Banking
Total
Average impaired loans:
 
 
 
 
 
 
 
Non-accrual loans
$
7,619

$
2,122

$
9,741

 
$
9,658

$
3,989

$
13,647

Restructured loans (accruing)
73,261

16,526

89,787

 
49,070

17,539

66,609

Total
$
80,880

$
18,648

$
99,528

 
$
58,728

$
21,528

$
80,256


The table below shows interest income recognized during the years ended December 31, 2018, 2017 and 2016 for impaired loans held at the end of each respective period. This interest relates to accruing restructured loans, as discussed previously.

 
Years Ended December 31
(In thousands)
2018
2017
2016
Interest income recognized on impaired loans:
 
 
 
Business
$
2,219

$
3,135

$
1,064

Real estate – construction and land
25

41

2

Real estate – business
558

514

171

Real estate – personal
139

402

152

Consumer
305

307

339

Revolving home equity
3

10

31

Consumer credit card
746

673

722

Total
$
3,995

$
5,082

$
2,481



75

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 December 31, 2018 and 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
December 31, 2018
 
 
 
 
 
Commercial:
 
 
 
 
 
Business
$
5,086,912

$
10,057

$
473

$
8,985

$
5,106,427

Real estate – construction and land
867,692

1,963

—

4

869,659

Real estate – business
2,867,347

6,704

22

1,715

2,875,788

Personal Banking:
 
 
 
 
 
Real estate – personal
2,118,045

6,041

1,165

1,832

2,127,083

Consumer
1,916,320

35,608

3,644

—

1,955,572

Revolving home equity
374,830

875

694

—

376,399

Consumer credit card
792,334

11,140

10,660

—

814,134

Overdrafts
14,937

299

—

—

15,236

Total
$
14,038,417

$
72,687

$
16,658

$
12,536

$
14,140,298

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 attached to loans where the borrower exhibits material 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, as discussed in Note 1.

76

 
Commercial Loans
(In thousands)
Business
Real Estate -Construction
Real Estate - Business
Total
December 31, 2018
 
 
 
 
Pass
$
4,915,042

$
866,527

$
2,777,374

$
8,558,943

Special mention
84,391

1,917

51,845

138,153

Substandard
98,009

1,211

44,854

144,074

Non-accrual
8,985

4

1,715

10,704

Total
$
5,106,427

$
869,659

$
2,875,788

$
8,851,874

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 section on "Delinquent and non-accrual loans". In addition, FICO scores are obtained and updated on a quarterly basis for most of the loans in the Personal Banking portfolio. 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 the loans generally pertain to commercial customer activities and are often underwritten with other collateral considerations. These loans totaled $201.7 million at December 31, 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 December 31, 2018 and $145.0 million at December 31, 2017. As the healthcare loans are guaranteed by the hospital, customer FICO scores are not obtained for these loans. 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 December 31, 2018 and 2017 by FICO score.
 
Personal Banking Loans
 
% of Loan Category


Real Estate - Personal
Consumer
Revolving Home Equity
Consumer Credit Card
December 31, 2018
 
 
 
 
FICO score:
 
 
 
 
Under 600
1.1
%
3.1
%
0.8
%
4.4
%
600 – 659
1.8

4.8

1.7

14.0

660 – 719
9.4

16.1

9.1

34.8

720 – 779
24.7

25.7

24.0

26.4

780 and over
63.0

50.3

64.4

20.4

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
%


77

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.
 
 
December 31
(In thousands)
2018
2017
Accruing loans:
 
 
 
Commercial
$
50,904

$
88,588

 
Assistance programs
7,410

6,941

 
Consumer bankruptcy
4,103

3,916

 
Other consumer
3,663

3,367

Non-accrual loans
9,759

7,796

Total troubled debt restructurings
$
75,839

$
110,608


The table below shows the balance of troubled debt restructurings by loan classification at December 31, 2018, in addition to the period end 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)
December 31, 2018
Balance 90 days past due at any time during previous 12 months
Commercial:
 
 
Business
$
48,777

$
25

Real estate – construction and land
412

—

Real estate – business
10,355

—

Personal Banking:
 
 
Real estate – personal
3,636

158

Consumer
5,510

50

Revolving home equity
40

—

Consumer credit card
7,109

670

Total troubled debt restructurings
$
75,839

$
903


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. However, the effects of modifications to loans under various debt management and assistance programs were estimated to decrease interest income by approximately $1.0 million 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.


78

The allowance for loan losses related to troubled debt restructurings on non-accrual status is determined by individual evaluation, including collateral adequacy, using the same process as loans on non-accrual status which are not classified as troubled debt restructurings. Those performing loans classified as troubled debt restructurings are accruing loans which management expects to collect under contractual terms. Performing commercial loans having no 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 begin.

The Company had commitments of $1.8 million at December 31, 2018 to lend additional funds to borrowers with restructured loans, compared to $7.6 million at December 31, 2017.

Loans held for sale
The Company designates certain long-term fixed rate personal real estate loan originations 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 18. The loans are primarily sold to FNMA, FHLMC, and GNMA. At December 31, 2018, the fair value of these loans was $13.5 million, and the unpaid principal balance was $13.0 million.

The Company also designates certain 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 December 31, 2018 totaled $7.2 million.

At December 31, 2018, none of the loans held for sale were past due or on non-accrual status.

Foreclosed real estate/repossessed assets
The Company’s holdings of foreclosed real estate totaled $1.4 million and $681 thousand at December 31, 2018 and 2017, respectively. Personal property acquired in repossession, generally autos and marine and recreational vehicles, totaled $2.0 million and $2.7 million at December 31, 2018 and 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.


79

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. Investment securities, at fair value, consisted of the following at December 31, 2018 and 2017:
 
(In thousands)
2018
2017
Available for sale debt securities
$
8,538,041

$
8,725,442

Trading debt securities
27,059

18,269

Equity securities:
 
 
   Readily determinable fair value
2,585

48,838

   No readily determinable fair value
1,824

1,753

Other:
 
 
   Federal Reserve Bank stock
33,498

33,253

   Federal Home Loan Bank stock
10,000

10,000

   Private equity investments
85,659

55,752

Total investment securities
$
8,698,666

$
8,893,307

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. Also, the unrealized gain of $33.3 million (net of tax) on fair value on equity securities, which was previously recorded in accumulated other comprehensive income at December 31, 2017, was reclassified to retained earnings on January 1, 2018.

Equity securities include common and preferred stock with readily determinable fair values that totaled $2.5 million at cost and $2.6 million at fair value at December 31, 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 year ended 2018, unrealized net losses of $332 thousand were recognized in current earnings on equity securities still held at December 31, 2018.
Equity securities also include securities with a carrying value of $1.8 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 December 31, 2018 is shown in the following table. The weighted average yield for each range of maturities was calculated using the yield on each security within that range weighted by the amortized cost of each security at December 31, 2018. Yields on tax exempt securities have not been adjusted for tax exempt status. The investment portfolio includes agency mortgage-backed securities, which are guaranteed by agencies such as FHLMC, FNMA, GNMA and FDIC, in addition to non-agency mortgage-backed securities, which have no guarantee but are collateralized by residential and commercial 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. The Company does not have exposure to subprime-originated mortgage-backed or collateralized debt obligation instruments, and does not hold any trust preferred securities.

80

(Dollars in thousands)
 Amortized Cost
Fair Value
Weighted Average Yield
U.S. government and federal agency obligations:
 
 
 
Within 1 year
$
23,577

$
23,518

(.04
)*%
After 1 but within 5 years
434,973

435,690

1.90
 *
After 5 but within 10 years
386,708

381,419

1.61
 *
After 10 years
69,228

67,025

.64
 *
Total U.S. government and federal agency obligations
914,486

907,652

1.63
 *
Government-sponsored enterprise obligations:
 
 
 
Within 1 year
24,991

24,743

1.53

After 1 but within 5 years
96,601

95,619

2.03

After 5 but within 10 years
34,985

34,460

2.71

After 10 years
42,893

40,956

3.10

Total government-sponsored enterprise obligations
199,470

195,778

2.32

State and municipal obligations:
 
 
 
Within 1 year
98,429

98,675

2.45

After 1 but within 5 years
656,762

659,525

2.37

After 5 but within 10 years
493,994

496,997

2.58

After 10 years
73,600

72,842

3.22

Total state and municipal obligations
1,322,785

1,328,039

2.50

Mortgage and asset-backed securities:
 
 
 
Agency mortgage-backed securities
3,253,433

3,214,985

2.85

Non-agency mortgage-backed securities
1,053,854

1,047,716

2.85

Asset-backed securities
1,518,976

1,511,614

2.62

Total mortgage and asset-backed securities
5,826,263

5,774,315

2.79

Other debt securities:
 
 
 
Within 1 year
16,500

16,418

 
After 1 but within 5 years
249,870

245,319

 
After 5 but within 10 years
73,225

70,520

 
Total other debt securities
339,595

332,257

 
Total available for sale debt securities
$
8,602,599

$
8,538,041

 
* Rate does not reflect inflation adjustment on inflation-protected securities

Investments in U.S. government and federal agency obligations include U.S. Treasury inflation-protected securities, which totaled $434.4 million, at fair value, at December 31, 2018. Interest paid on these securities increases with inflation and decreases with deflation, as measured by the Consumer Price Index. At maturity, the principal paid is the greater of an inflation-adjusted principal or the original principal. Included in state and municipal obligations are $14.2 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.




81

For debt 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
December 31, 2018
 
 
 
 
U.S. government and federal agency obligations
$
914,486

$
4,545

$
(11,379
)
$
907,652

Government-sponsored enterprise obligations
199,470

55

(3,747
)
195,778

State and municipal obligations
1,322,785

10,284

(5,030
)
1,328,039

Mortgage and asset-backed securities:
 
 
 
 
Agency mortgage-backed securities
3,253,433

9,820

(48,268
)
3,214,985

Non-agency mortgage-backed securities
1,053,854

6,641

(12,779
)
1,047,716

Asset-backed securities
1,518,976

3,849

(11,211
)
1,511,614

Total mortgage and asset-backed securities
5,826,263

20,310

(72,258
)
5,774,315

Other debt securities
339,595

72

(7,410
)
332,257

Total
$
8,602,599

$
35,266

$
(99,824
)
$
8,538,041

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 Baa3 (Moody's) or BBB- (Standard & Poor's), whose fair values have fallen more than 20% below purchase price for an extended period of time, or have been identified based on management’s judgment. These securities are placed on a watch list, and for all such securities, 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 December 31, 2018, the fair value of securities on this watch list was $57.7 million compared to $68.0 million at December 31, 2017.

As of December 31, 2018, the Company had recorded OTTI of $14.1 million on certain non-agency mortgage-backed securities with a current par value of $23.4 million. These securities, which are part of the watch list mentioned above, had an aggregate fair value of $18.4 million at December 31, 2018. 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 December 31, 2018 included the following:
Significant Inputs
Range
Prepayment CPR
0%
-
25%
Projected cumulative default
8%
-
52%
Credit support
0%
-
20%
Loss severity
13%
-
63%

82

The following table presents a rollforward of the cumulative OTTI credit losses recognized in earnings on all available for sale debt securities.
(In thousands)
2018
2017
2016
Cumulative OTTI credit losses at January 1
$
14,199

$
14,080

$
14,129

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

111

—

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

274

270

Increase in expected cash flows that are recognized over remaining life of security
(175
)
(266
)
(319
)
Cumulative OTTI credit losses at December 31
$
14,092

$
14,199

$
14,080


Debt 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    
December 31, 2018
 
 
 
 
 
 
 
 
U.S. government and federal agency obligations
$
317,699

$
6,515

 
$
116,728

$
4,864

 
$
434,427

$
11,379

Government-sponsored enterprise obligations
—

—

 
188,846

3,747

 
188,846

3,747

State and municipal obligations
157,838

704

 
257,051

4,326

 
414,889

5,030

Mortgage and asset-backed securities:




 




 
 
 
Agency mortgage-backed securities
330,933

1,502

 
1,927,268

46,766

 
2,258,201

48,268

Non-agency mortgage-backed securities
207,506

1,085

 
657,685

11,694

 
865,191

12,779

Asset-backed securities
147,997

728

 
813,427

10,483

 
961,424

11,211

Total mortgage and asset-backed securities
686,436

3,315

 
3,398,380

68,943

 
4,084,816

72,258

Other debt securities
51,836

564

 
260,682

6,846

 
312,518

7,410

Total
$
1,213,809

$
11,098

 
$
4,221,687

$
88,726

 
$
5,435,496

$
99,824

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 $5.4 billion of securities that were in a loss position at December 31, 2018, compared to $5.2 billion at December 31, 2017. The total amount of unrealized loss on these securities was $99.8 million at December 31, 2018, an increase of $55.7 million compared to the loss at December 31, 2017. This increase in losses was mainly due to a rising rate environment.




83

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 Year Ended December 31
(In thousands)
2018
2017
2016
Proceeds from sales of securities:
 
 
 
Available for sale debt securities
$
667,227

$
779,793

$
2,047

Equity securities
41,637

10,953

3,026

Other
—

1,634

19,307

Total proceeds
$
708,864

$
792,380

$
24,380

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

$
(254
)
$
—

Gains realized on sales
448

592

109

Losses realized on sales
(10,101
)
(10,287
)
—

Other-than-temporary impairment recognized on debt securities
(68
)
(385
)
(270
)
Equity securities:
 
 
 
Gains realized on donations of securities
—

31,074

—

Gains realized on sales
1,759

10,653

1,911

 Losses realized on sales
(8,917
)
(10
)
(7
)
 Fair value adjustments, net
2,542

—

—

Other:
 
 
 
 Gains realized on sales
—

381

2,442

 Losses realized on sales
—

(880
)
(499
)
Fair value adjustments, net
13,849

(5,833
)
(3,739
)
Total investment securities gains (losses), net
$
(488
)
$
25,051

$
(53
)

Investment securities with a fair value of $4.3 billion and $3.8 billion were pledged at December 31, 2018 and 2017, respectively, to secure public deposits, securities sold under repurchase agreements, trust funds, and borrowings at the Federal Reserve Bank. Securities pledged under agreements pursuant to which the collateral may be sold or re-pledged by the secured parties approximated $463.3 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.

4. Land, Buildings and Equipment
Land, buildings and equipment consist of the following at December 31, 2018 and 2017:
(In thousands)
2018
2017
Land
$
91,603

$
94,992

Buildings and improvements
545,510

540,204

Equipment
226,666

216,876

Total
863,779

852,072

Less accumulated depreciation
530,660

516,962

Net land, buildings and equipment
$
333,119

$
335,110


Depreciation expense of $28.6 million in 2018, $29.1 million in 2017 and $30.1 million in 2016, was included in occupancy expense and equipment expense in the consolidated statements of income. Repairs and maintenance expense of $16.9 million, $16.4 million and $16.2 million for 2018, 2017 and 2016, respectively, was included in occupancy expense and equipment expense. There has been no interest expense capitalized on construction projects in the past three years.


84

5. Goodwill and Other Intangible Assets
The following table presents information about the Company's intangible assets which have estimable useful lives.
 
 
December 31, 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

 
$
(28,954
)
 
$
—

 
$
2,316

 
$
31,270

 
$
(28,305
)
 
$
—

 
$
2,965

Mortgage servicing rights
 
10,339

 
(3,861
)
 
—

 
6,478

 
7,906

 
(3,244
)
 
(9
)
 
4,653

Total
 
$
41,609

 
$
(32,815
)
 
$
—

 
$
8,794

 
$
39,176

 
$
(31,549
)
 
$
(9
)
 
$
7,618

The carrying amount of goodwill and its allocation among segments at December 31, 2018 and 2017 is shown in the table below. As a result of ongoing assessments, no impairment of goodwill was recorded in 2018, 2017 or 2016. Further, the annual assessment of qualitative factors on January 1, 2019 revealed no likelihood of impairment as of that date.
(In thousands)
December 31, 2018
December 31, 2017
Consumer segment
$
70,721

$
70,721

Commercial segment
67,454

67,454

Wealth segment
746

746

Total goodwill
$
138,921

$
138,921

Changes in the net carrying amount of goodwill and other net intangible assets for the years ended December 31, 2018 and 2017 are shown in the following table.
(In thousands)
Goodwill
Core Deposit Premium
Mortgage Servicing Rights
Balance at December 31, 2016
$
138,921

$
3,841

$
2,868

Originations
—

—

2,234

Amortization
—

(876
)
(462
)
Impairment reversal
—

—

13

Balance at December 31, 2017
138,921

2,965

4,653

Originations
—

—

2,433

Amortization
—

(649
)
(617
)
Impairment reversal
—

—

9

Balance at December 31, 2018
$
138,921

$
2,316

$
6,478

Mortgage servicing rights (MSRs) are initially recorded at fair value and subsequently amortized over the period of estimated servicing income. They are periodically reviewed for impairment and if impairment is indicated, recorded at fair value. Temporary impairment, including impairment recovery, is effected through a change in a valuation allowance. At December 31, 2018, no temporary impairment had been recognized. The fair value of the MSRs is based on the present value of expected future cash flows, as further discussed in Note 16 on Fair Value Measurements.
Aggregate amortization expense on intangible assets for the years ended December 31, 2018, 2017 and 2016 was $1.3 million, $1.3 million and $1.5 million, respectively. The following table shows the estimated future amortization expense based on existing asset balances and the interest rate environment as of December 31, 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)
 
2019
$
1,273

2020
1,097

2021
957

2022
842

2023
732



85

6. Deposits
At December 31, 2018, the scheduled maturities of certificates of deposit were as follows:
(In thousands)
 
Due in 2019
$
1,286,425

Due in 2020
281,717

Due in 2021
54,939

Due in 2022
18,301

Due in 2023
15,933

Thereafter
807

Total
$
1,658,122


The following table shows a detailed breakdown of the maturities of certificates of deposit, by size category, at December 31, 2018.
    
(In thousands)
Certificates of Deposit under $100,000
Certificates of Deposit over $100,000
Total
Due in 3 months or less
$
116,068

$
446,300

$
562,368

Due in over 3 through 6 months
117,046

245,994

363,040

Due in over 6 through 12 months
176,591

184,426

361,017

Due in over 12 months
176,386

195,311

371,697

Total
$
586,091

$
1,072,031

$
1,658,122


The aggregate amount of certificates of deposit that exceeded the $250,000 FDIC insurance limit totaled $824.0 million at December 31, 2018.

7. Borrowings
At December 31, 2018, the Company's borrowings primarily consisted of federal funds purchased, securities sold under agreements to repurchase (repurchase agreements), and securities sold short. The following table sets forth selected information for federal funds purchased and repurchase agreements.
(Dollars in thousands)
 Year End Weighted Rate
 Average Weighted Rate
 Average Balance Outstanding
Maximum Outstanding at any Month End
Balance at December 31
Federal funds purchased and repurchase agreements:
 
 
 
 
 
2018
.9
%
1.3
%
$
1,514,144

$
1,981,761

$
1,956,389

2017
.8

.7

1,462,387

1,984,071

1,507,138

2016
.4

.3

1,266,093

1,723,905

1,723,905


Federal funds purchased and repurchase agreements comprised the majority of the Company's short-term borrowings (borrowings with an original maturity of less than one year) at December 31, 2018, and $1.9 billion of these borrowings were repurchase agreements, which generally have one day maturities and are mainly comprised of non-insured customer funds secured by a portion of the Company's investment portfolio. Additional information about the securities pledged for repurchase agreements is provided in Note 19 on Resale and Repurchase Agreements.

In addition to federal funds purchased and repurchase agreements, the Company's short-term borrowings at December 31, 2018 included $7.8 million of securities sold short.

The Bank is a member of the Des Moines FHLB and has access to term financing from the FHLB. These borrowings are secured under a blanket collateral agreement including primarily residential mortgages as well as all unencumbered assets and stock of the borrowing bank. At December 31, 2018, the Bank had no outstanding advances from the FHLB. The FHLB also issues letters of credit to secure the Bank's obligations to certain depositors of public funds, which totaled $217.4 million at December 31, 2018.


86

8. Income Taxes
The components of income tax expense from operations for the years ended December 31, 2018, 2017 and 2016 were as follows:
(In thousands)
Current
Deferred
Total
Year ended December 31, 2018:
 
 
 
U.S. federal
$
90,390

$
3,220

$
93,610

State and local
10,223

2,116

12,339

Total
$
100,613

$
5,336

$
105,949

Year ended December 31, 2017:
 
 
 
U.S. federal
$
89,154

$
12,190

$
101,344

State and local
7,735

1,427

9,162

Total
$
96,889

$
13,617

$
110,506

Year ended December 31, 2016:
 
 
 
U.S. federal
$
116,753

$
(2,036
)
$
114,717

State and local
9,457

(23
)
9,434

Total
$
126,210

$
(2,059
)
$
124,151


The components of income tax (benefit) expense recorded directly to stockholders’ equity for the years ended December 31, 2018, 2017 and 2016 were as follows:
(In thousands)
2018
2017
2016
Unrealized gain (loss) on available for sale debt securities
$
(18,634
)
$
2,104

$
(13,952
)
Change in fair value on cash flow hedges
2,286

—

—

Accumulated pension (benefit) loss
222

(184
)
778

Compensation expense for tax purposes in excess of amounts recognized for financial reporting purposes
—

—

(3,390
)
Income tax (benefit) expense allocated to stockholders’ equity
$
(16,126
)
$
1,920

$
(16,564
)

Significant components of the Company’s deferred tax assets and liabilities at December 31, 2018 and 2017 were as follows:
(In thousands)
2018
2017
Deferred tax assets:
 
 
Loans, principally due to allowance for loan losses
$
39,169

$
40,341

Unrealized loss on available for sale debt securities
16,140

—

Equity-based compensation
7,609

8,201

Deferred compensation
5,911

5,647

Unearned fee income
4,125

3,701

Accrued expenses
2,152

5,245

Private equity investments
2,008

5,473

Other
528

4,430

Total deferred tax assets
77,642

73,038

Deferred tax liabilities:
 
 
Equipment lease financing
55,738

45,825

Unrealized gain on available for sale debt securities
—

13,603

Land, buildings and equipment
14,207

8,592

Undistributed earnings of subsidiaries
—

7,094

Intangibles
5,973

5,732

Other
5,309

6,569

Total deferred tax liabilities
81,227

87,415

Net deferred tax liabilities
$
(3,585
)
$
(14,377
)

Management believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the total deferred tax assets.


87

As a result of the Tax Cuts and Jobs Act enacted on December 22, 2017, the Company revalued its deferred tax assets and liabilities using the highest maximum corporate tax rate of 21%. This change was reported as a reduction of deferred tax expense. The Company also adopted ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting," on January 1, 2017. This adoption required all excess tax benefits and tax deficiencies arising from share-based award payments to be recognized as income tax expense or benefit in the statements of income, while in previous periods these benefits and deficiencies were recognized in equity. In 2018 and 2017, net excess tax benefits resulted from share-based award payments. The effects on federal tax expense of both of these items are shown in the reconciliation below.

A reconciliation between the expected federal income tax expense using the federal statutory tax rate and the Company's actual income tax expense is provided below. The federal statutory tax rate was 21% in 2018 and 35% in 2017 and 2016. The effective tax rate is calculated by dividing income taxes by income before income taxes less the non-controlling interest expense.
(In thousands)
2018
2017
2016
Computed “expected” tax expense
$
113,293

$
150,461

$
139,840

Increase (decrease) in income taxes resulting from:
 
 
 
Tax-exempt interest, net of cost to carry
(11,502
)
(20,295
)
(20,033
)
Contribution of appreciated securities
—

(10,864
)
—

State and local income taxes, net of federal tax benefit
9,748

5,955

6,132

Tax reform enactment
—

(6,753
)
—

Share-based award payments
(3,928
)
(6,613
)
—

Other
(1,662
)
(1,385
)
(1,788
)
Total income tax expense
$
105,949

$
110,506

$
124,151


The gross amount of unrecognized tax benefits was $1.3 million and $1.2 million at December 31, 2018 and 2017, respectively, and the total amount of unrecognized tax benefits that would impact the effective tax rate, if recognized, was $993 thousand and $785 thousand, respectively. The activity in the accrued liability for unrecognized tax benefits for the years ended December 31, 2018 and 2017 was as follows:
(In thousands)
2018
2017
Unrecognized tax benefits at beginning of year
$
1,208

$
1,228

Gross increases – tax positions in prior period
31

5

Gross increases – current-period tax positions
322

268

Lapse of statute of limitations
(304
)
(293
)
Unrecognized tax benefits at end of year
$
1,257

$
1,208


The Company and its subsidiaries are subject to income tax by federal, state and local government taxing authorities. Tax years 2015 through 2018 remain open to examination for U.S. federal income tax, and tax years 2014 through 2018 remain open to examination in major state taxing jurisdictions.

9. Employee Benefit Plans
Employee benefits charged to operating expenses are summarized in the table below. Substantially all of the Company’s employees are covered by a defined contribution (401(k)) plan, under which the Company makes matching contributions.
(In thousands)
2018
2017
2016
Payroll taxes
$
25,712

$
24,402

$
23,210

Medical plans
27,030

25,143

25,497

401(k) plan
14,986

14,244

13,562

Pension plans
651

704

987

Other
2,918

2,883

3,214

Total employee benefits
$
71,297

$
67,376

$
66,470


The Company adopted ASU 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost”, on January 1, 2018, which required 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

88

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.
A portion of the Company’s employees are covered by a noncontributory defined benefit pension plan, however, participation in the pension plan is not available to employees hired after June 30, 2003. All participants are fully vested in their benefit payable upon normal retirement date, which is based on years of participation and compensation. Certain key executives also participate in a supplemental executive retirement plan (the CERP) that the Company funds only as retirement benefits are disbursed. The CERP carries no segregated assets. Since January 2011, all benefits accrued under the pension plan have been frozen. However, the accounts continue to accrue interest at a stated annual rate. The CERP continues to provide credits based on hypothetical contributions in excess of those permitted under the 401(k) plan. In the tables presented below, the pension plan and the CERP are presented on a combined basis.

Under the Company’s funding policy for the defined benefit pension plan, contributions are made to a trust as necessary to satisfy the statutory minimum required contribution as defined by the Pension Protection Act, which is intended to provide for current service accruals and for any unfunded accrued actuarial liabilities over a reasonable period. To the extent that these requirements are fully covered by assets in the trust, a contribution might not be made in a particular year. No contributions to the defined benefit plan were made in 2018. The Company made a discretionary contribution of $5.5 million to its defined benefit pension plan in 2017 in order to reduce pension guarantee premiums. The minimum required contribution for 2019 is expected to be zero. The Company does not expect to make any further contributions in 2019 other than the necessary funding contributions to the CERP. Contributions to the CERP were $24 thousand, $439 thousand and $21 thousand during 2018, 2017 and 2016, respectively.
 
The following items are components of the net pension cost for the years ended December 31, 2018, 2017 and 2016.
(In thousands)
2018
2017
2016
Service cost-benefits earned during the year
$
651

$
621

$
500

Interest cost on projected benefit obligation
3,756

3,826

3,944

Expected return on plan assets
(5,255
)
(5,785
)
(5,751
)
Amortization of prior service cost
(271
)
(271
)
(271
)
Amortization of unrecognized net loss
2,267

2,313

2,565

Net periodic pension cost
$
1,148

$
704

$
987


The following table sets forth the pension plans’ funded status, using valuation dates of December 31, 2018 and 2017.
(In thousands)
2018
2017
Change in projected benefit obligation
 
 
Projected benefit obligation at prior valuation date
$
120,667

$
116,695

Service cost
651

621

Interest cost
3,756

3,826

Benefits paid
(6,622
)
(6,780
)
Actuarial (gain) loss
(6,389
)
6,305

Projected benefit obligation at valuation date
112,063

120,667

Change in plan assets
 
 
Fair value of plan assets at prior valuation date
108,260

99,537

Actual return on plan assets
(2,244
)
9,564

Employer contributions
24

5,939

Benefits paid
(6,622
)
(6,780
)
Fair value of plan assets at valuation date
99,418

108,260

Funded status and net amount recognized at valuation date
$
(12,645
)
$
(12,407
)
 
The accumulated benefit obligation, which represents the liability of a plan using only benefits as of the measurement date, was $112.1 million and $120.7 million for the combined plans on December 31, 2018 and 2017, respectively.


89

Amounts not yet reflected in net periodic benefit cost and included in accumulated other comprehensive income (loss) at December 31, 2018 and 2017 are shown below, including amounts recognized in other comprehensive income during the periods. All amounts are shown on a pre-tax basis.
(In thousands)
2018
2017
Prior service cost
$
1,535

$
1,806

Accumulated loss
(32,342
)
(33,499
)
Accumulated other comprehensive loss
(30,807
)
(31,693
)
Cumulative employer contributions in excess of net periodic benefit cost
18,162

19,286

Net amount recognized as an accrued benefit liability on the December 31 balance sheet
$
(12,645
)
$
(12,407
)
Net loss arising during period
(1,110
)
(2,527
)
Amortization of net loss
2,267

2,313

Amortization of prior service cost
(271
)
(271
)
Total recognized in other comprehensive income
$
886

$
(485
)
Total expense recognized in net periodic pension cost and other comprehensive income
$
(262
)
$
(1,189
)

The estimated net loss and prior service cost to be amortized from accumulated other comprehensive income into net periodic pension cost in 2019 is $2.1 million.

The following assumptions, on a weighted average basis, were used in accounting for the plans.
 
2018
2017
2016
Determination of benefit obligation at year end:
 
 
 
Effective discount rate for benefit obligations
4.14
%
3.57
%
4.05
%
Assumed credit on cash balance accounts
5.00
%
5.00
%
5.00
%
Determination of net periodic benefit cost for year ended:
 
 
 
Effective discount rate for benefit obligations
3.57
%
3.95
%
4.16
%
Effective rate for interest on benefit obligations
3.28
%
3.28
%
3.38
%
Long-term rate of return on assets
5.00
%
6.00
%
6.00
%
Assumed credit on cash balance accounts
5.00
%
5.00
%
5.00
%


90

The following table shows the fair values of the Company’s pension plan assets by asset category at December 31, 2018 and 2017. Information about the valuation techniques and inputs used to measure fair value are provided in Note 16 on Fair Value Measurements.
 
 
Fair Value Measurements
(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)
December 31, 2018
 
 
 
 
Assets:
 
 
 
 
U.S. government obligations
$
2,994

$
2,994

$
—

$
—

Government-sponsored enterprise obligations (a)
1,200

—

1,200

—

State and municipal obligations
8,299

—

8,299

—

Agency mortgage-backed securities (b)
8,209

—

8,209

—

Non-agency mortgage-backed securities
4,398

—

4,398

—

Asset-backed securities
3,520

—

3,520

—

Corporate bonds (c)
37,207

—

37,207

—

Equity securities and mutual funds: (d)
 
 
 
 
Mutual funds
8,645

8,645

—

—

Common stocks
18,173

18,173

—

—

International developed markets funds
5,046

5,046

—

—

Emerging markets funds
1,727

1,727

—

—

Total
$
99,418

$
36,585

$
62,833

$
—

December 31, 2017
 
 
 
 
Assets:
 
 
 
 
U.S. government obligations
$
3,719

$
3,719

$
—

$
—

Government-sponsored enterprise obligations (a)
1,282

—

1,282

—

State and municipal obligations
8,527

—

8,527

—

Agency mortgage-backed securities (b)
7,896

—

7,896

—

Non-agency mortgage-backed securities
4,891

—

4,891

—

Asset-backed securities
3,833

—

3,833

—

Corporate bonds (c)
37,457

—

37,457

—

Equity securities and mutual funds: (d)
 
 
 
 
Mutual funds
6,979

6,979

—

—

Common stocks
23,744

23,744

—

—

International developed markets funds
7,870

7,870

—

—

Emerging markets funds
2,062

2,062

—

—

Total
$
108,260

$
44,374

$
63,886

$
—

(a)
This category represents bonds (excluding mortgage-backed securities) issued by agencies such as the Federal Home Loan Bank, the Federal Home Loan Mortgage Corp and the Federal National Mortgage Association.
(b)
This category represents mortgage-backed securities issued by the agencies mentioned in (a).
(c)
This category represents investment grade bonds issued in the U.S., primarily by domestic issuers, representing diverse industries.
(d)
This category represents investments in individual common stocks and equity funds. These holdings are diversified, largely across the financial services, technology services, healthcare, electronic technology, and consumer goods industries.

The investment policy of the pension plan is designed for growth in principal, within limits designed to safeguard against significant losses within the portfolio. The policy sets guidelines, which may change from time to time, regarding the types and percentages of investments held. Currently, the policy includes guidelines such as holding bonds rated investment grade or better and prohibiting investment in Company stock. The plan does not utilize derivatives. Management believes there are no significant concentrations of risk within the plan asset portfolio at December 31, 2018. Under the current policy, the long-term investment target mix for the plan is 35% equity securities and 65% fixed income securities. The Company regularly reviews its policies on investment mix and may make changes depending on economic conditions and perceived investment risk.


91

Effective January 1, 2016, the Company changed the method used to estimate the interest cost component of net periodic pension cost for its defined benefit pension plan. Prior to the change, the interest cost component was estimated by utilizing a single weighted average discount rate derived from the yield curve used to measure the projected benefit obligation. Under the new method, the interest cost component is estimated by applying the specific annual spot rates along the yield curve used in the determination of the projected benefit obligation to the relevant projected cash flows. This change provides a more precise measurement of the interest cost by improving the correlation between projected benefit cash flows and the corresponding spot yield curve rates. The Company accounted for this change prospectively as a change in accounting estimate. The change resulted in a decrease of approximately $900 thousand in the interest cost component of the estimated annual net periodic pension cost for 2016.

The assumed overall expected long-term rate of return on pension plan assets used in calculating 2018 pension plan expense was 5.0%. Determination of the plan’s expected rate of return is based upon historical and anticipated returns of the asset classes invested in by the pension plan and the allocation strategy currently in place among those classes. The rate used in plan calculations may be adjusted by management for current trends in the economic environment. The 10-year annualized return for the Company’s pension plan was 7.2%. During 2018, the plan’s assets lost 1.7% of their value, compared to a 9.6% rate of return in 2017. Returns for any plan year may be affected by changes in the stock market and interest rates. The Company expects to incur pension expense of $2.2 million in 2019, compared to $1.1 million in 2018.

The Company utilizes mortality tables published by the Society of Actuaries to incorporate mortality assumptions into the measurement of the pension benefit obligation. At December 31, 2018, the Company utilized an updated mortality projection scale, which decreased the pension benefit obligation on that date by approximately $300 thousand.

The following future benefit payments are expected to be paid:
(In thousands)
 
2019
$
7,163

2020
7,353

2021
7,510

2022
7,473

2023
7,509

2024 - 2028
36,468


10. Stock-Based Compensation and Directors Stock Purchase Plan*
The Company’s stock-based compensation is provided under a stockholder-approved plan which allows for issuance of various types of awards, including stock options, stock appreciation rights, restricted stock and restricted stock units, performance awards and stock-based awards. During the past three years, stock-based compensation has been issued in the form of nonvested stock awards and stock appreciation rights. At December 31, 2018, 2,515,678 shares remained available for issuance under the plan. The stock-based compensation expense that was charged against income was $12.8 million, $12.1 million and $11.5 million for the years ended December 31, 2018, 2017 and 2016, respectively. The total income tax benefit recognized in the income statement for share-based compensation arrangements was $3.2 million, $4.5 million and $4.3 million for the years ended December 31, 2018, 2017 and 2016, respectively.


92

Nonvested Restricted Stock Awards
Nonvested stock is awarded to key employees by action of the Company's Compensation and Human Resources Committee and Board of Directors. These awards generally vest after 4 to 7 years of continued employment, but vesting terms may vary according to the specifics of the individual grant agreement. There are 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 of restricted stock awards. A summary of the status of the Company’s nonvested share awards as of December 31, 2018 and changes during the year then ended is presented below.

  
 

Shares
Weighted Average Grant Date Fair Value
Nonvested at January 1, 2018
1,317,092

$
36.82

Granted
268,658

57.28

Vested
(376,489
)
30.73

Forfeited
(28,321
)
44.12

Canceled
—

—

Nonvested at December 31, 2018
1,180,940

$
43.24


The total fair value (at vest date) of shares vested during 2018, 2017 and 2016 was $21.5 million, $23.8 million and $10.9 million, respectively.

Stock Appreciation Rights
Stock appreciation rights (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 four years of continuous service and have 10-year contractual terms. All SARs must be settled in stock under provisions of the plan. A summary of SAR activity during 2018 is presented below.
(Dollars in thousands, except per share data)
Shares
Weighted Average Exercise Price
Weighted Average Remaining Contractual Term
Aggregate Intrinsic Value
Outstanding at January 1, 2018
1,237,804

$
35.36

 
 
Granted
177,001

55.63

 
 
Forfeited
(17,529
)
45.82

 
 
Expired
(607
)
43.14

 
 
Exercised
(330,231
)
29.96

 
 
Outstanding at December 31, 2018
1,066,438

$
40.22

6.7
years
$
17,218

Exercisable at December 31, 2018
561,527

$
34.57

5.6
years
$
12,239


In determining compensation cost, the Black-Scholes option-pricing model is used to estimate the fair value of SARs on date of grant. The Black-Scholes model is a closed-end model that uses various assumptions as shown in the following table. Expected volatility is based on historical volatility of the Company’s stock. The Company uses historical exercise behavior and other factors to estimate the expected term of the SARs, which represents the period of time that the SARs granted are expected to be outstanding. The risk-free rate for the expected term is based on the U.S. Treasury zero coupon spot rates in effect at the time of grant. The per share average fair value and the model assumptions for SARs granted during the past three years are shown in the table below.
 
2018
2017
2016
Weighted per share average fair value at grant date

$11.84


$11.37


$6.47

Assumptions:
 
 
 
Dividend yield
1.6
%
1.6
%
2.2
%
Volatility
20.6
%
21.1
%
21.2
%
Risk-free interest rate
2.7
%
2.4
%
1.8
%
Expected term
6.6 years

7.0 years

7.2 years



93

Additional information about stock options and SARs exercised is presented below.
(In thousands)
2018
2017
2016
Intrinsic value of options and SARs exercised
$
9,632

$
9,310

$
8,854

Tax benefit realized from options and SARs exercised
$
1,928

$
2,698

$
1,781

As of December 31, 2018, there was $27.3 million of unrecognized compensation cost related to unvested SARs and stock awards. This cost is expected to be recognized over a weighted average period of approximately 3.2 years.

Directors Stock Purchase Plan
The Company has a directors stock purchase plan whereby outside directors of the Company and its subsidiaries may elect to use their directors’ fees to purchase Company stock at market value each month end. Remaining shares available for issuance under this plan were 53,160 at December 31, 2018. In 2018, 31,235 shares were purchased at an average price of $57.69, and in 2017, 16,666 shares were purchased at an average price of $51.95.
* All share and per share amounts in this note have been restated for the 5% common stock dividend distributed in 2018.

11. Accumulated Other Comprehensive Income (Loss)
The table below shows the activity and accumulated balances for components of other comprehensive income (loss). 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 amortization from other comprehensive income of losses associated with pension benefits, which occurs as the amortization is included in current net periodic benefit cost. The remaining component is gains and losses in fair value on certain interest rate floors that have been designated as cash flow hedging instruments.
 
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 income (loss) before reclassifications
(438
)
 
(73,725
)
 
(1,110
)
8,381

 
(66,892
)
Amounts reclassified from accumulated other comprehensive income
68

 
(447
)
 
1,996

760

 
2,377

Current period other comprehensive income (loss), before tax
(370
)
 
(74,172
)
 
886

9,141

 
(64,515
)
Income tax (expense) benefit
93

 
18,541

 
(222
)
(2,286
)
 
16,126

Current period other comprehensive income (loss), net of tax
(277
)
 
(55,631
)
 
664

6,855

 
(48,389
)
Transfer of unrealized gain on securities for which impairment was not previously recognized
12

 
(12
)
 
—

—

 
—

Balance December 31, 2018
$
3,861

 
$
(52,278
)
 
$
(23,107
)
$
6,855

 
$
(64,669
)
Balance January 1, 2017
$
2,975

 
$
27,328

 
$
(19,328
)
$
—

 
$
10,975

Other comprehensive income (loss) before reclassifications
279

 
36,307

 
(2,527
)
—

 
34,059

Amounts reclassified from accumulated other comprehensive income
385

 
(31,433
)
 
2,042

—

 
(29,006
)
Current period other comprehensive income (loss), before tax
664

 
4,874

 
(485
)
—

 
5,053

Income tax (expense) benefit
(252
)
 
(1,852
)
 
184

—

 
(1,920
)
Current period other comprehensive income (loss), net of tax
412

 
3,022

 
(301
)
—

 
3,133

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

 
(24
)
 
—

—

 
—

Balance December 31, 2017
$
3,411

 
$
30,326

 
$
(19,629
)
$
—

 
$
14,108

(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.


94

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 (loss) (as shown in the table above) to retained earnings.
As mentioned in Note 1, new accounting guidance for investment securities, which was effective January 1, 2018, required the reclassification of unrealized gains on equity securities from accumulated other comprehensive income (loss) to retained earnings (also shown above).

12. 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 includes the consumer portion of the retail branch network (loans, deposits and other personal banking services), indirect and other consumer financing, and consumer 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 (including the Small Business Banking product line within the branch network), leasing, international services, and business, government deposit, and related commercial cash management services, as well as merchant and commercial bank card products. The Commercial segment also includes the Capital Markets Group, which sells fixed income securities and provides investment safekeeping and bond accounting services. 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 Company’s business line reporting system derives segment information 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. These 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 for (provided by) assets and liabilities based on their maturity, prepayment and/or repricing characteristics. Income and expense that directly relate to segment operations are recorded in the segment when incurred. Expenses that indirectly support the segments are allocated based on the most appropriate method available.

The Company uses a funds transfer pricing method to value funds used (e.g., loans, fixed assets, and cash) and funds provided (e.g., deposits, borrowings, and equity) by the business segments and their components. This process assigns a specific value to each new source or use of funds with a maturity, based on current swap rates, thus determining an interest spread at the time of the transaction. Non-maturity assets and liabilities are valued using weighted average pools. The funds transfer pricing process attempts to remove interest rate risk from valuation, allowing management to compare profitability under various rate environments.


95

The following tables present selected financial information by segment and reconciliations of combined segment totals to consolidated totals. There were no material intersegment revenues between 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.

Segment Income Statement Data
(In thousands)
Consumer
Commercial
Wealth
Segment Totals
Other/Elimination
Consolidated Totals
Year ended December 31, 2018:
 
 
 
 
 
 
Net interest income
$
296,228

$
345,221

$
46,946

$
688,395

$
135,430

$
823,825

Provision for loan losses
(41,280
)
(1,134
)
32

(42,382
)
(312
)
(42,694
)
Non-interest income
126,253

202,527

173,026

501,806

(465
)
501,341

Investment securities losses, net
—

—

—

—

(488
)
(488
)
Non-interest expense
(287,473
)
(297,847
)
(123,576
)
(708,896
)
(28,925
)
(737,821
)
Income before income taxes
$
93,728

$
248,767

$
96,428

$
438,923

$
105,240

$
544,163

Year ended December 31, 2017:
 
 
 
 
 
 
Net interest income
$
279,031

$
329,087

$
47,264

$
655,382

$
78,297

$
733,679

Provision for loan losses
(41,829
)
205

(41
)
(41,665
)
(3,579
)
(45,244
)
Non-interest income
121,362

184,577

158,175

464,114

(2,851
)
461,263

Investment securities gains, net
—

—

—

—

25,051

25,051

Non-interest expense
(275,734
)
(281,845
)
(120,461
)
(678,040
)
(66,303
)
(744,343
)
Income before income taxes
$
82,830

$
232,024

$
84,937

$
399,791

$
30,615

$
430,406

Year ended December 31, 2016:
 
 
 
 
 
 
Net interest income
$
268,654

$
311,704

$
44,113

$
624,471

$
55,578

$
680,049

Provision for loan losses
(36,042
)
4,378

(122
)
(31,786
)
(4,532
)
(36,318
)
Non-interest income
116,185

187,350

144,661

448,196

(1,640
)
446,556

Investment securities losses, net
—

—

—

—

(53
)
(53
)
Non-interest expense
(266,258
)
(272,398
)
(113,888
)
(652,544
)
(36,685
)
(689,229
)
Income before income taxes
$
82,539

$
231,034

$
74,764

$
388,337

$
12,668

$
401,005


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.

Segment Balance Sheet Data
(In thousands)
Consumer
Commercial
Wealth
Segment Totals
Other/Elimination
Consolidated Totals
Average balances for 2018:
 
 
 
 
 
 
Assets
$
2,541,627

$
9,115,738

$
1,243,806

$
12,901,171

$
11,765,064

$
24,666,235

Loans, including held for sale
2,401,657

8,939,696

1,233,780

12,575,133

1,370,439

13,945,572

Goodwill and other intangible assets
78,062

68,300

746

147,108

—

147,108

Deposits
10,210,506

8,029,248

1,871,596

20,111,350

19,902

20,131,252

Average balances for 2017:
 
 
 
 
 
 
Assets
$
2,610,045

$
8,830,584

$
1,218,598

$
12,659,227

$
12,372,381

$
25,031,608

Loans, including held for sale
2,471,578

8,635,035

1,209,792

12,316,405

1,312,746

13,629,151

Goodwill and other intangible assets
76,734

68,538

746

146,018

—

146,018

Deposits
10,190,613

8,301,004

2,090,582

20,582,199

12,587

20,594,786


The above segment balances include only those items directly associated with the segment. The “Other/Elimination” column includes unallocated bank balances not associated with a segment (such as investment securities and federal funds sold), balances relating to certain other administrative and corporate functions, and eliminations between segment and non-segment balances. This column also includes the resulting effect of allocating such items as float, deposit reserve and capital for the purpose of computing the cost or credit for funds used/provided.


96

The Company’s reportable segments are strategic lines of business that offer different products and services. They are managed separately because each line services a specific customer need, requiring different performance measurement analyses and marketing strategies. The performance measurement of the 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.

13. Common and Preferred Stock*
On December 17, 2018, the Company distributed a 5% stock dividend on its $5 par common stock for the 25th consecutive year. All per common share data in this report has been restated to reflect the stock dividend.

The Company applies the two-class method of computing income per share, as nonvested share-based awards that pay nonforfeitable common stock 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 following table. Nonvested share-based awards are further discussed in Note 10 on Stock-Based Compensation.

Basic income per share is based on the weighted average number of common shares outstanding during the year. Diluted income per share gives effect to all dilutive potential common shares that were outstanding during the year. Presented below is a summary of the components used to calculate basic and diluted income per common share, which have been restated for all stock dividends.
(In thousands, except per share data)
2018
2017
2016
Basic income per common share:
 
 
 
Net income attributable to Commerce Bancshares, Inc.
$
433,542

$
319,383

$
275,391

Less preferred stock dividends
9,000

9,000

9,000

Net income available to common shareholders
424,542

310,383

266,391

Less income allocated to nonvested restricted stock
4,558

3,848

3,698

Net income allocated to common stock
$
419,984

$
306,535

$
262,693

Weighted average common shares outstanding
110,812

110,833

110,505

Basic income per common share
$
3.79

$
2.77

$
2.38

Diluted income per common share:
 
 
 
Net income available to common shareholders
$
424,542

$
310,383

$
266,391

Less income allocated to nonvested restricted stock
4,547

3,838

3,692

Net income allocated to common stock
$
419,995

$
306,545

$
262,699

Weighted average common shares outstanding
110,812

110,833

110,505

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
343

391

295

Weighted average diluted common shares outstanding
111,155

111,224

110,800

Diluted income per common share
$
3.78

$
2.76

$
2.37

Unexercised stock appreciation rights of 223 thousand, 159 thousand and 88 thousand were excluded from the computation of diluted income per share for the years ended December 31, 2018, 2017 and 2016, respectively, because their inclusion would have been anti-dilutive.
The Company has 6,000,000 depositary shares outstanding, representing 6,000 shares of 6.00% Series B Non-Cumulative Perpetual Preferred Stock, par value $1.00 per share, having an aggregate liquidation preference of $150.0 million (“Series B Preferred Stock”). Each depositary share has a liquidation preference of $25 per share. Dividends on the Series B Preferred Stock, if declared, accrue and are payable quarterly, in arrears, at a rate of 6.00%. The Series B Preferred Stock qualifies as Tier 1 capital for the purposes of the regulatory capital calculations. In the event that the Company does not declare and pay dividends on the Series B Preferred Stock for the most recent dividend period, the ability of the Company to declare or pay dividends on, purchase, redeem or otherwise acquire shares of its common stock or any securities of the Company that rank junior to the Series B Preferred Stock is subject to certain restrictions under the terms of the Series B Preferred Stock.
The Company maintains a treasury stock buyback program authorized by its Board of Directors. The most recent authorization in October 2015 approved future purchases of 5,000,000 shares of the Company's common stock. At December 31, 2018, 2,249,563 shares of common stock remained available for purchase under the current authorization.

97

The table below shows activity in the outstanding shares of the Company’s common stock during the past three years. Shares in the table below are presented on an historical basis and have not been restated for the annual 5% stock dividends.
 
Years Ended December 31
(In thousands)
2018
2017
2016
Shares outstanding at January 1
106,615

101,461

97,226

Issuance of stock:
 
 
 
Awards and sales under employee and director plans
416

403

397

5% stock dividend
5,305

5,078

4,831

Other purchases of treasury stock
(1,194
)
(315
)
(959
)
Other
(13
)
(12
)
(34
)
Shares outstanding at December 31
111,129

106,615

101,461

* Except as noted in the above table, all share and per share amounts in this note have been restated for the 5% common stock dividend distributed in 2018.


98

14. Regulatory Capital Requirements
The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and additional discretionary actions by regulators that could have a direct material effect on the Company’s financial statements. The regulations require the Company to meet specific capital adequacy guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital classification is also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

The following tables show the capital amounts and ratios for the Company (on a consolidated basis) and the Bank, together with the minimum capital adequacy and well-capitalized capital requirements, at the last two year ends.
 
Actual
 
Minimum Capital Adequacy Requirement
 
Well-Capitalized Capital Requirement
(Dollars in thousands)
Amount
Ratio
 
Amount
Ratio
 
Amount
Ratio
December 31, 2018
 
 
 
 
 
 
 
 
Total Capital (to risk-weighted assets):
 
 
 
 
 
 
 
 
Commerce Bancshares, Inc. (consolidated)
$
3,022,023

15.82
%
 
$
1,528,317

8.00
%
 
N.A.

N.A.

Commerce Bank
2,655,591

13.98

 
1,519,169

8.00

 
$
1,898,962

10.00
%
Tier I Capital (to risk-weighted assets):
 
 
 
 
 
 
 
 
Commerce Bancshares, Inc. (consolidated)
$
2,861,016

14.98
%
 
$
1,146,238

6.00
%
 
N.A.

N.A.

Commerce Bank
2,494,584

13.14

 
1,139,377

6.00

 
$
1,519,169

8.00
%
Tier I Common Capital (to risk-weighted assets):
 
 
 
 
 
 
 
 
Commerce Bancshares, Inc. (consolidated)
$
2,716,232

14.22
%
 
$
859,678

4.50
%
 
N.A.

N.A.

Commerce Bank
2,494,584

13.14

 
854,533

4.50

 
$
1,234,325

6.50
%
Tier I Capital (to adjusted quarterly average assets):
 
 
 
 
 
 
 
 
(Leverage Ratio)
 
 
 
 
 
 
 
 
Commerce Bancshares, Inc. (consolidated)
$
2,861,016

11.52
%
 
$
993,564

4.00
%
 
N.A.

N.A.

Commerce Bank
2,494,584

10.07

 
991,185

4.00

 
$
1,238,981

5.00
%
December 31, 2017
 
 
 
 
 
 
 
 
Total Capital (to risk-weighted assets):
 
 
 
 
 
 
 
 
Commerce Bancshares, Inc. (consolidated)
$
2,747,863

14.35
%
 
$
1,531,996

8.00
%
 
N.A.

N.A.

Commerce Bank
2,428,789

12.76

 
1,522,361

8.00

 
$
1,902,951

10.00
%
Tier I Capital (to risk-weighted assets):
 
 
 
 
 
 
 
 
Commerce Bancshares, Inc. (consolidated)
$
2,567,264

13.41
%
 
$
1,148,997

6.00
%
 
N.A.

N.A.

Commerce Bank
2,268,131

11.92

 
1,141,771

6.00

 
$
1,522,361

8.00
%
Tier I Common Capital (to risk-weighted assets):
 
 
 
 
 
 
 
 
Commerce Bancshares, Inc. (consolidated)
$
2,422,480

12.65
%
 
$
861,748

4.50
%
 
N.A.

N.A.

Commerce Bank
2,268,131

11.92

 
856,328

4.50

 
$
1,236,918

6.50
%
Tier I Capital (to adjusted quarterly average assets):
 
 
 
 
 
 
 
 
(Leverage Ratio)
 
 
 
 
 
 
 
 
Commerce Bancshares, Inc. (consolidated)
$
2,567,264

10.39
%
 
$
988,653

4.00
%
 
N.A.

N.A.

Commerce Bank
2,268,131

9.20

 
986,240

4.00

 
$
1,232,800

5.00
%

The minimum required ratios for well-capitalized banks (under prompt corrective action provisions) are 6.5% for Tier I common capital, 8.0% for Tier I capital, 10.0% for Total capital and 5.0% for the leverage ratio.

At December 31, 2018 and 2017, the Company met all capital requirements to which it is subject, and the Bank’s capital position exceeded the regulatory definition of well-capitalized.





99

15. 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 year ended December 31, 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 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 years ended December 31, 2017 and 2016.
 
 
For the year ended December 31, 2017
 
For the Year Ended December 31, 2016
(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
 
$
180,441

$
(25,341
)
$
155,100

 
$
181,879

$
(27,836
)
$
154,043

 Total non-interest income
 
486,604

(25,341
)
461,263

 
474,392

(27,836
)
446,556

Non-interest expense:
 
 
 
 
 
 
 
 
Data processing and software
 
$
92,246

$
(11,248
)
$
80,998

 
$
92,722

$
(13,133
)
$
79,589

Other
 
77,459

(14,093
)
63,366

 
74,202

(14,703
)
59,499

 Total non-interest expense
 
769,684

(25,341
)
744,343

 
717,065

(27,836
)
689,229


The following table disaggregates non-interest income subject to ASU 2014-09 by major product line.
 
For the Year Ended December 31
(In thousands)
2018
2017
2016
Bank card transaction fees
$
171,576

$
155,100

$
154,043

Trust fees
147,964

135,159

121,795

Deposit account charges and other fees
94,517

90,060

86,394

Consumer brokerage services
15,807

14,630

13,784

Other non-interest income
37,440

30,128

31,326

Total non-interest income from contracts with customers
467,304

425,077

407,342

Other non-interest income (a)
34,037

36,186

39,214

Total non-interest income
$
501,341

$
461,263

$
446,556

(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 years ended December 31, 2018 and 2017 for the Company’s significant revenue categories subject to ASU 2014-09.
(In thousands)
December 31, 2018
December 31, 2017
December 31, 2016
Bank card transaction fees
$
13,035

$
13,315

$
14,686

Trust fees
2,721

2,802

2,681

Deposit account charges and other fees
6,107

5,597

5,735

Consumer brokerage services
559

380

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.

100

Bank Card Transaction Fees
The following table presents the components of bank card fee income.
 
For the Years Ended December 31
(In thousands)
2018
2017
2016
Debit card:
 
 
 
Fee income
$
41,522

$
40,134

$
39,430

Expense for network charges
(1,784
)
(4,498
)
(5,989
)
Net debit card fees
39,738

35,636

33,441

 
 
 
 
Credit card:
 
 
 
Fee income
26,799

25,275

24,650

Expense for network charges and rewards
(13,834
)
(10,699
)
(9,816
)
Net credit card fees
12,965

14,576

14,834

 
 
 
 
Corporate card:
 
 
 
Fee income
199,651

179,642

166,576

Expense for network charges and rewards
(100,011
)
(94,823
)
(83,851
)
Net corporate card fees
99,640

84,819

82,725

 
 
 
 
Merchant:
 
 
 
Fee income
30,241

31,863

37,407

Fees to cardholder banks
(7,831
)
(8,228
)
(9,585
)
Expense for network charges
(3,177
)
(3,566
)
(4,779
)
Net merchant fees
19,233

20,069

23,043

Total bank card transaction fees
$
171,576

$
155,100

$
154,043


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.


101

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.
 
For the Years Ended December 31
(In thousands)
2018
2017
2016
Private client
$
111,533

$
100,358

$
90,992

Institutional
29,241

27,477

24,565

Other
7,190

7,324

6,238

Total trust fees
$
147,964

$
135,159

$
121,795

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 according to the billing schedule.

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.
 
For the Years Ended December 31
(In thousands)
2018
2017
2016
Corporate cash management fees
$
38,468

$
36,044

$
36,131

Overdraft and return item fees
31,468

30,576

29,350

Other service charges on deposit accounts
24,581

23,440

20,913

Total deposit account charges and other fees
$
94,517

$
90,060

$
86,394

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

102

the customer is billed based on transaction volumes processed monthly. The customer is usually billed either monthly or quarterly, 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 foreign ATM processing 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.
 
For the Years Ended December 31
(In thousands)
2018
2017
2016
Commission income
$
8,956

$
8,400

$
8,170

Managed account services
6,851

6,230

5,614

Total consumer brokerage services
$
15,807

$
14,630

$
13,784

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.



103

16. 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 equity securities, available for sale debt securities, trading 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 loans held for sale, 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.
When determining the fair value measurements for assets and liabilities required or permitted to be recorded or disclosed at fair value, the Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability. When possible, the Company looks to active and observable markets to price identical assets or liabilities. When identical assets and liabilities are not traded in active markets, the Company looks to observable market data for similar assets and liabilities. Nevertheless, certain assets and liabilities are not actively traded in observable markets, and the Company must use alternative valuation techniques to derive an estimated fair value measurement.

104

Instruments Measured at Fair Value on a Recurring Basis
The table below presents the carrying values of assets and liabilities measured at fair value on a recurring basis at December 31, 2018 and 2017. There were no transfers among levels during these years.
 
 
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)
December 31, 2018
 
 
 
 
Assets:
 
 
 
 
Residential mortgage loans held for sale
$
13,529

$
—

$
13,529

$
—

Available for sale debt securities:
 
 
 
 
U.S. government and federal agency obligations
907,652

907,652

—

—

Government-sponsored enterprise obligations
195,778

—

195,778

—

State and municipal obligations
1,328,039

—

1,313,881

14,158

Agency mortgage-backed securities
3,214,985

—

3,214,985

—

Non-agency mortgage-backed securities
1,047,716

—

1,047,716

—

Asset-backed securities
1,511,614

—

1,511,614

—

Other debt securities
332,257

—

332,257

—

Trading debt securities
27,059

—

27,059

—

Equity securities
2,585

2,585

—

—

Private equity investments
85,659

—

—

85,659

Derivatives *
41,210

—

40,627

583

Assets held in trust for deferred compensation plan
12,968

12,968

—

—

Total assets
8,721,051

923,205

7,697,446

100,400

Liabilities:
 
 
 
 
Derivatives *
13,421

—

13,328

93

Liabilities held in trust for deferred compensation plan
12,968

12,968

—

—

Total liabilities
$
26,389

$
12,968

$
13,328

$
93

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 18.
.



105

Valuation methods for instruments measured at fair value on a recurring basis
Following is a description of the Company’s valuation methodologies used for instruments measured at fair value on a recurring basis:

Residential mortgage loans held for sale
The Company originates fixed rate, first lien residential mortgage loans that are intended for sale in the secondary market. Fair value is based on quoted secondary market prices for loans with similar characteristics, which are adjusted to include the embedded servicing value in the loans. This adjustment represents an unobservable input to the valuation but is not considered significant given the relative insensitivity of the valuation to changes in this input. Accordingly, these loan measurements are classified as Level 2.

Available for sale debt securities
For available for sale securities, changes in fair value, including that portion of other-than-temporary impairment unrelated to credit loss, are recorded in other comprehensive income. As mentioned in Note 3 on Investment Securities, the Company records the credit-related portion of other-than-temporary impairment in current earnings. This portfolio comprises the majority of the assets which the Company records at fair value. Most of the portfolio, which includes government-sponsored enterprise, mortgage-backed and asset-backed securities, are priced utilizing industry-standard models that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace. These measurements are classified as Level 2 in the fair value hierarchy. Where quoted prices are available in an active market, the measurements are classified as Level 1. Most of the Level 1 measurements apply to U.S. Treasury obligations.

The fair values of Level 1 and 2 securities in the available for sale portfolio are prices provided by a third-party pricing service. The prices provided by the third-party pricing service are based on observable market inputs, as described in the sections below. On a quarterly basis, the Company compares a sample of these prices to other independent sources for the same and similar securities. Variances are analyzed, and, if appropriate, additional research is conducted with the third-party pricing service. Based on this research, the pricing service may affirm or revise its quoted price. No significant adjustments have been made to the prices provided by the pricing service. The pricing service also provides documentation on an ongoing basis that includes reference data, inputs and methodology by asset class, which is reviewed to ensure that security placement within the fair value hierarchy is appropriate.
Valuation methods and inputs, by class of security:
•
U.S. government and federal agency obligations
U.S. treasury bills, bonds and notes, including inflation-protected securities, are valued using live data from active market makers and inter-dealer brokers. Valuations for stripped coupon and principal issues are derived from yield curves generated from various dealer contacts and live data sources.
•
Government-sponsored enterprise obligations
Government-sponsored enterprise obligations are evaluated using cash flow valuation models. Inputs used are live market data, cash settlements, Treasury market yields, and floating rate indices such as LIBOR, CMT, and Prime.
•
State and municipal obligations, excluding auction rate securities
A yield curve is generated and applied to bond sectors, and individual bond valuations are extrapolated. Inputs used to generate the yield curve are bellwether issue levels, established trading spreads between similar issuers or credits, historical trading spreads over widely accepted market benchmarks, new issue scales, and verified bid information. Bid information is verified by corroborating the data against external sources such as broker-dealers, trustees/paying agents, issuers, or non-affiliated bondholders.
•
Mortgage and asset-backed securities
Collateralized mortgage obligations and other asset-backed securities are valued at the tranche level. For each tranche valuation, the process generates predicted cash flows for the tranche, applies a market based (or benchmark) yield/spread for each tranche, and incorporates deal collateral performance and tranche level attributes to determine tranche-specific spreads to adjust the benchmark yield. Tranche cash flows are generated from new deal files and prepayment/default assumptions. Tranche spreads are based on tranche characteristics such as average life, type, volatility, ratings, underlying

106

collateral and performance, and prevailing market conditions. The appropriate tranche spread is applied to the corresponding benchmark, and the resulting value is used to discount the cash flows to generate an evaluated price.

Valuation of agency pass-through securities, typically issued under GNMA, FNMA, FHLMC, and SBA programs, are primarily derived from information from the To Be Announced (TBA) market. This market consists of generic mortgage pools which have not been received for settlement. Snapshots of the TBA market, using live data feeds distributed by multiple electronic platforms, are used in conjunction with other indices to compute a price based on discounted cash flow models.
•
Other debt securities
Other debt securities are valued using active markets and inter-dealer brokers as well as bullet spread scales and option adjusted spreads. The spreads and models use yield curves, terms and conditions of the bonds, and any special features (e.g., call or put options and redemption features).

The available for sale portfolio includes certain auction rate securities. Due to the illiquidity in the auction rate securities market in recent years, the fair value of these securities cannot be based on observable market prices. The fair values of these securities are estimated using a discounted cash flows analysis which is discussed more fully in the Level 3 Inputs section of this note. Because many of the inputs significant to the measurement are not observable, these measurements are classified as Level 3 measurements.
Equity securities with readily determinable fair values
Equity securities are priced using the market prices for each security from the major stock exchanges or other electronic quotation systems. These are generally classified as Level 1 measurements. Stocks which trade infrequently are classified as Level 2.

Trading debt securities
The securities in the Company’s trading portfolio are priced by averaging several broker quotes for similar instruments and are classified as Level 2 measurements.

Private equity investments
These securities are held by the Company’s private equity subsidiaries and are included in other investment securities in the consolidated balance sheets. Due to the absence of quoted market prices, valuation of these nonpublic investments requires significant management judgment. These fair value measurements, which are discussed in the Level 3 Inputs section of this note, are classified as Level 3.

Derivatives
The Company’s derivative instruments include interest rate swaps and floors, foreign exchange forward contracts, and certain credit risk guarantee agreements. When appropriate, the impact of credit standing as well as any potential credit enhancements, such as collateral, has been considered in the fair value measurement.
•
Valuations for interest rate swaps are derived from a proprietary model whose significant inputs are readily observable market parameters, primarily yield curves used to calculate current exposure. Counterparty credit risk is incorporated into the model and calculated by applying a net credit spread over LIBOR to the swap's total expected exposure over time. The net credit spread is comprised of spreads for both the Company and its counterparty, derived from probability of default and other loss estimate information obtained from a third party credit data provider or from the Company's Credit Department when not otherwise available. The credit risk component is not significant compared to the overall fair value of the swaps. The results of the model are constantly validated through comparison to active trading in the marketplace.
Parties to swaps requiring central clearing are required to post collateral (generally in the form of cash or marketable securities) to an authorized clearing agency that holds and monitors the collateral. In January 2017, the Company's clearing counterparty made rule changes to characterize a component of this collateral as a legal settlement of the derivative contract exposure. As a result, this component, known as variation margin, is no longer accounted for separately from the derivative as collateral, but is considered in determining the fair value of the derivative.
Valuations for interest rate floors are also derived from a proprietary model whose significant inputs are readily observable market parameters, primarily yield curves and volatility surfaces. The model uses market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates fall below the strike rates of the floors. The model also incorporates credit valuation adjustments of both the Company's and the counterparties' non-

107

performance risk. The credit valuation adjustment component is not significant compared to the overall fair value of the floors.
The fair value measurements of interest rate swaps and floors are classified as Level 2 due to the observable nature of the significant inputs utilized.
•
Fair value measurements for foreign exchange contracts are derived from a model whose primary inputs are quotations from global market makers and are classified as Level 2.
•
The Company’s contracts related to credit risk guarantees are valued under a proprietary model which uses unobservable inputs and assumptions about the creditworthiness of the counterparty (generally a Bank customer). Customer credit spreads, which are based on probability of default and other loss estimates, are calculated internally by the Company's Credit Department, as mentioned above, and are based on the Company's internal risk rating for each customer. Because these inputs are significant to the measurements, they are classified as Level 3.
•
Derivatives relating to residential mortgage loan sale activity include commitments to originate mortgage loans held for sale, forward loan sale contracts, and forward commitments to sell TBA securities. The fair values of loan commitments and sale contracts are estimated using quoted market prices for loans similar to the underlying loans in these instruments. The valuations of loan commitments are further adjusted to include embedded servicing value and the probability of funding. These assumptions are considered Level 3 inputs and are significant to the loan commitment valuation; accordingly, the measurement of loan commitments is classified as Level 3. The fair value measurement of TBA contracts is based on security prices published on trading platforms and is classified as Level 2.

Assets held in trust
Assets held in an outside trust for the Company’s deferred compensation plan consist of investments in mutual funds. The fair value measurements are based on quoted prices in active markets and classified as Level 1. The Company has recorded an asset representing the total investment amount. The Company has also recorded a corresponding liability, representing the Company’s liability to the plan participants.


108

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
Year ended December 31, 2018:
 
 
 
 
Balance at January 1, 2018
$
17,016

$
55,752

$
503

$
73,271

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

13,849

105

13,954

Included in other comprehensive income
(274
)
—

—

(274
)
Investment securities called
(2,616
)
—

—

(2,616
)
Discount accretion
32

—

—

32

Purchases of private equity securities
—

16,395

—

16,395

Sale / pay down of private equity securities
—

(371
)
—

(371
)
Capitalized interest/dividends
—

34

—

34

Purchase of risk participation agreement
—

—

61

61

Sale of risk participation agreement
—

—

(179
)
(179
)
Balance at December 31, 2018
$
14,158

$
85,659

$
490

$
100,307

Total gains or losses for the year included in earnings attributable to the change in unrealized gains or losses relating to assets still held at December 31, 2018
$
—

$
13,849

$
663

$
14,512

Year ended December 31, 2017:
 
 
 
 
Balance at January 1, 2017
$
16,682

$
50,820

$
258

$
67,760

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

(5,833
)
266

(5,567
)
Included in other comprehensive income
882

—

—

882

Investment securities called
(600
)
—

—

(600
)
Discount accretion
52

—

—

52

Purchases of private equity securities
—

13,352

—

13,352

Sale / pay down of private equity securities
—

(2,621
)
—

(2,621
)
Capitalized interest/dividends
—

34

—

34

Purchase of risk participation agreement
—

—

70

70

Sale of risk participation agreement
—

—

(91
)
(91
)
Balance at December 31, 2017
$
17,016

$
55,752

$
503

$
73,271

Total gains or losses for the year included in earnings attributable to the change in unrealized gains or losses relating to assets still held at December 31, 2017
$
—

$
(5,658
)
$
615

$
(5,043
)

Gains and losses on the Level 3 assets and liabilities in the table above are reported in the following income categories:
(In thousands)
Loan Fees and Sales
Other Non-Interest Income
Investment Securities Gains (Losses), Net
Total
Year ended December 31, 2018:
 
 
 
 
Total gains or losses included in earnings
$
(45
)
$
150

$
13,849

$
13,954

Change in unrealized gains or losses relating to assets still held at December 31, 2018
$
535

$
128

$
13,849

$
14,512

Year ended December 31, 2017:
 
 
 
 
Total gains or losses included in earnings
$
231

$
35

$
(5,833
)
$
(5,567
)
Change in unrealized gains or losses relating to assets still held at December 31, 2017
$
580

$
35

$
(5,658
)
$
(5,043
)


109

Level 3 Inputs
As shown above, 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 $14.2 million at December 31, 2018, while private equity investments, included in other securities, totaled $85.7 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
4
-
5 years
 
 
 
Estimated market rate
4.3%
-
4.8%
 
Private equity investments
Market comparable companies
EBITDA multiple
4.0
-
6.0
 
Mortgage loan commitments
Discounted cash flow
Probability of funding
53.7%
-
98.0%
78.6%
 
 
Embedded servicing value
.7%
-
2.3%
1.3%

The fair values of ARS are estimated using a discounted cash flows analysis in which estimated cash flows are based on mandatory interest rates paid under failing auctions and projected over an estimated market recovery period. Under normal conditions, ARS traded in weekly auctions and were considered liquid investments. The Company's estimate of when these auctions might resume is highly judgmental and subject to variation depending on current and projected market conditions. Few auctions of these securities have been successful in recent years, and most secondary transactions have been privately arranged. Estimated cash flows during the period over which the Company expects to hold the securities are discounted at an estimated market rate. These securities are comprised of bonds issued by various states and municipalities for healthcare and student lending purposes, and market rates are derived for each type. Market rates are calculated at each valuation date using a LIBOR or Treasury based rate plus spreads representing adjustments for liquidity premium and nonperformance risk. The spreads are developed internally by employees in the Company's bond department. An increase in the holding period alone would result in a higher fair value measurement, while an increase in the estimated market rate (the discount rate) alone would result in a lower fair value measurement. The valuation of the ARS portfolio is reviewed on a quarterly basis by the Company's chief investment officers.

The fair values of the Company's private equity investments are based on a determination of fair value of the investee company less preference payments assuming the sale of the investee company.  Investee companies are normally non-public entities.  The fair value of the investee company is determined by reference to the investee's total earnings before interest, depreciation/amortization, and income taxes (EBITDA) multiplied by an EBITDA factor.  EBITDA is normally determined based on a trailing prior period adjusted for specific factors including current economic outlook, investee management, and specific unique circumstances such as sales order information, major customer status, regulatory changes, etc.  The EBITDA multiple is based on management's review of published trading multiples for recent private equity transactions and other judgments and is derived for each individual investee.  The fair value of the Company's investment (which is usually a partial interest in the investee company) is then calculated based on its ownership percentage in the investee company. On a quarterly basis, these fair value analyses are reviewed by a valuation committee consisting of investment managers and senior Company management.

The significant unobservable inputs used in the fair value measurement of the Company’s derivative commitments to originate residential mortgage loans are the percentage of commitments that are actually funded and the mortgage servicing value that is inherent in the underlying loan value. A significant increase in the rate of loans that fund would result in a larger derivative asset or liability. A significant increase in the inherent mortgage servicing value would result in an increase in the derivative asset or a reduction in the derivative liability. The probability of funding and the inherent mortgage servicing values are directly impacted by changes in market rates and will generally move in the same direction as interest rates.


110

Instruments Measured at Fair Value on a Nonrecurring Basis
For assets measured at fair value on a nonrecurring basis during 2018 and 2017, and still held as of December 31, 2018 and 2017, the following table provides the adjustments to fair value recognized during the respective periods, the level of valuation assumptions used to determine each adjustment, and the carrying value of the related individual assets or portfolios at December 31, 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)
Balance at December 31, 2018
 
 
 
 
 
Collateral dependent impaired loans
$
294

$
—

$
—

$
294

$
(269
)
Mortgage servicing rights
6,478

—

—

6,478

9

Long-lived assets
914

—

—

914

(552
)
Balance at December 31, 2017
 
 
 
 
 
Collateral dependent impaired loans
$
1,236

$
—

$
—

$
1,236

$
(617
)
Mortgage servicing rights
4,653

—

—

4,653

13

Foreclosed assets
—

—

—

—

(9
)
Long-lived assets
3,378

—

—

3,378

(724
)

Valuation methods for instruments measured at fair value on a nonrecurring basis
Following is a description of the Company’s valuation methodologies used for other financial and nonfinancial instruments measured at fair value on a nonrecurring basis.

Collateral dependent impaired loans
While the overall loan portfolio is not carried at fair value, the Company periodically records nonrecurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Nonrecurring adjustments also include certain impairment amounts for collateral dependent loans when establishing the allowance for loan losses. Such amounts are generally based on the fair value of the underlying collateral supporting the loan. In determining the value of real estate collateral, the Company relies on external and internal appraisals of property values depending on the size and complexity of the real estate collateral. The Company maintains a staff of qualified appraisers who also review third party appraisal reports for reasonableness. In the case of non-real estate collateral, reliance is placed on a variety of sources, including external estimates of value and judgments based on the experience and expertise of internal specialists. Values of all loan collateral are regularly reviewed by credit administration. Unobservable inputs to these measurements, which include estimates and judgments often used in conjunction with appraisals, are not readily quantifiable. These measurements are classified as Level 3. Changes in fair value recognized for partial charge-offs of loans and loan impairment reserves on loans held by the Company at December 31, 2018 and 2017 are shown in the table above.

Mortgage servicing rights
The Company initially measures its mortgage servicing rights at fair value and amortizes them over the period of estimated net servicing income. They are periodically assessed for impairment based on fair value at the reporting date. Mortgage servicing rights do not trade in an active market with readily observable prices. Accordingly, the fair value is estimated based on a valuation model which calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, market discount rates, cost to service, float earnings rates, and other ancillary income, including late fees. The fair value measurements are classified as Level 3.

Foreclosed assets
Foreclosed assets consist of loan collateral which has been repossessed through foreclosure. This collateral is comprised of commercial and residential real estate and other non-real estate property, including auto, marine and recreational vehicles. Foreclosed assets are initially recorded as held for sale at the lower of the loan balance or fair value of the collateral less estimated selling costs. Subsequent to foreclosure, valuations are updated periodically, and the assets may be marked down further, reflecting

111

a new cost basis. Fair value measurements may be based upon appraisals, third-party price opinions, or internally developed pricing methods. These measurements are classified as Level 3.

Long-lived assets
When investments in branch facilities and various office buildings are determined to be impaired, their carrying values are written down to estimated fair value, or estimated fair value less cost to sell if the property is held for sale. Fair value is estimated in a process which considers current local commercial real estate market conditions and the judgment of the sales agent and often involves obtaining third party appraisals from certified real estate appraisers. The carrying amounts of these real estate holdings are regularly monitored by real estate professionals employed by the Company. These fair value measurements are classified as Level 3. Unobservable inputs to these measurements, which include estimates and judgments often used in conjunction with appraisals, are not readily quantifiable.


112

17. 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 December 31, 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.

The estimated fair values of the Company’s financial instruments and the classification of their fair value measurements within the valuation hierarchy are as follows at December 31, 2018 and 2017:
 
Carrying Amount
 
Estimated Fair Value at December 31, 2018

(In thousands)
 
Level 1
Level 2
Level 3
Total
Financial Assets
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
Business
$
5,106,427

 
$
—

$
—

$
5,017,694

$
5,017,694

Real estate - construction and land
869,659

 
—

—

868,274

868,274

Real estate - business
2,875,788

 
—

—

2,846,095

2,846,095

Real estate - personal
2,127,083

 
—

—

2,084,370

2,084,370

Consumer
1,955,572

 
—

—

1,916,627

1,916,627

Revolving home equity
376,399

 
—

—

365,069

365,069

Consumer credit card
814,134

 
—

—

756,651

756,651

Overdrafts
15,236

 
—

—

11,223

11,223

Total loans
14,140,298

 
—

—

13,866,003

13,866,003

Loans held for sale
20,694

 
—

20,694

—

20,694

Investment securities
8,698,666

 
910,237

7,643,290

145,139

8,698,666

Federal funds sold
3,320

 
3,320

—

—

3,320

Securities purchased under agreements to resell
700,000

 
—

—

693,228

693,228

Interest earning deposits with banks
689,876

 
689,876

—

—

689,876

Cash and due from banks
507,892

 
507,892

—

—

507,892

Derivative instruments
41,210

 
—

40,627

583

41,210

Assets held in trust for deferred compensation plan
12,968

 
12,968

—

—

12,968

       Total
$
24,814,924

 
$
2,124,293

$
7,704,611

$
14,704,953

$
24,533,857

Financial Liabilities
 
 
 
 
 
 
Non-interest bearing deposits
$
6,980,298

 
$
6,980,298

$
—

$
—

$
6,980,298

Savings, interest checking and money market deposits
11,685,239

 
11,685,239

—

—

11,685,239

Certificates of deposit
1,658,122

 
—

—

1,663,748

1,663,748

Federal funds purchased
13,170

 
13,170

—

—

13,170

Securities sold under agreements to repurchase
1,943,219

 
—

—

1,944,458

1,944,458

Other borrowings
8,702

 
—

—

8,702

8,702

Derivative instruments
13,421

 
—

13,328

93

13,421

Liabilities held in trust for deferred compensation plan
12,968

 
12,968

—

—

12,968

       Total
$
22,315,139

 
$
18,691,675

$
13,328

$
3,617,001

$
22,322,004



113

 
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

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


18. 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 December 31, 2018, with the exception of the interest rate floors (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.
 
    December 31
(In thousands)
2018
 
2017
Interest rate swaps
$
2,006,280

 
$
1,741,412

Interest rate floors
1,000,000

 
—

Interest rate caps
62,163

 
31,776

Credit risk participation agreements
143,460

 
133,488

Foreign exchange contracts
6,206

 
11,826

Mortgage loan commitments
14,544

 
17,110

Mortgage loan forward sale contracts
5,768

 
2,566

Forward TBA contracts
16,500

 
25,000

Total notional amount
$
3,254,921

 
$
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. The customers are engaged in a variety of businesses, including real estate, manufacturing, retail

114

product distribution, education, and retirement communities. These customer 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 clearing agency who becomes the Company's 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 arrangements 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 can require instant settlement of the contracts. The Company maintains debt ratings and capital well above these minimum requirements.

During the year ended December 31, 2018, the Company entered into interest rate floors, with a combined notional value of $1.0 billion, to hedge the potential risk of declining interest rates on certain floating rate commercial loans. The premiums paid for these floors totaled $20.7 million. As of December 31, 2018, the maximum length of time over which the Company is hedging its exposure to the variability in future cash flows is approximately 6 years, and the floors are forward starting, beginning in 2020. The interest rate floors qualified and were designated as cash flow hedges and were assessed for effectiveness using regression analysis. The change in the fair value of the interest rate floors are recorded in AOCI, net of the amortization of the premium paid, which is recorded against interest and fees on loans in the consolidated statements of income. As of December 31, 2018, net deferred gains on the interest rate floors totaled $9.1 million (pre-tax) and were recorded in AOCI in the consolidated balance sheet. As of December 31, 2018, it is expected that $2.8 million (pre-tax) of interest rate floor premium amortization will be reclassified from AOCI into earnings over the next twelve months.

The Company’s foreign exchange activity involves the purchase and sale of forward foreign exchange contracts, which are commitments to purchase or deliver a specified amount of foreign currency at a specific future date. This activity enables customers involved in international business to hedge their exposure to foreign currency exchange rate fluctuations. The Company minimizes its related exposure arising from these customer transactions with offsetting contracts for the same currency and time frame with approved, reputable counterparties. Risk arises from changes in the currency exchange rate and from the potential for counterparty nonperformance. These risks are controlled by adherence to a foreign exchange trading policy which contains control limits on currency amounts, open positions, maturities and losses, and procedures for approvals, record-keeping, monitoring and reporting. Hedge accounting has not been applied to these foreign exchange activities.

Credit risk participation agreements arise when the Company contracts, as a guarantor or beneficiary, with other financial institutions to share credit risk associated with certain interest rate swaps. These agreements provide for reimbursement of losses resulting from a third party default on the underlying swap. The Company’s risks and responsibilities as guarantor are further discussed in Note 20 on Commitments, Contingencies and Guarantees.
    
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 contracts. 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.


115

The fair values of the Company’s derivative instruments are shown in the table below. Information about the valuation methods used to measure fair value is provided in Note 16 on Fair Value Measurements. Derivative instruments with a positive fair value (asset derivatives) are reported in other assets in the consolidated balance sheets while derivative instruments with a negative fair value (liability derivatives) are reported in other liabilities in the consolidated balance sheets. As mentioned in Note 16, effective January 2017, certain collateral posted to and from the Company's clearing counterparty has been offset against the fair values of cleared swaps, such that at December 31, 2018 in the table below, the positive fair values of cleared swaps were reduced by $8.1 million and the negative fair values of cleared swaps were reduced by $6.5 million. 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
 
December 31
 
December 31
 
2018
 
2017
 
2018
 
2017
(In thousands)    
Fair Value
 
Fair Value
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Interest rate floors
$
29,031

 
$
—

 
$
—

 
$
—

Total derivatives designated as hedging instruments
$
29,031

 
$
—

 
$
—

 
$
—

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
Interest rate swaps
$
11,537

 
$
7,674

 
$
(13,110
)
 
$
(7,857
)
Interest rate caps
24

 
16

 
(24
)
 
(16
)
Credit risk participation agreements
47

 
46

 
(93
)
 
(123
)
Foreign exchange contracts
20

 
21

 
(8
)
 
(40
)
Mortgage loan commitments
536

 
580

 
—

 
—

Mortgage loan forward sale contracts
15

 
8

 
(8
)
 
(7
)
Forward TBA contracts
—

 
4

 
(178
)
 
(31
)
Total derivatives not designated as hedging instruments
$
12,179

 
$
8,349

 
$
(13,421
)
 
$
(8,074
)
Total
$
41,210

 
$
8,349

 
$
(13,421
)
 
$
(8,074
)


116

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 Year Ended December 31
 
For the Year Ended December 31
(In thousands)
2018
 
2018
Derivatives in cash flow hedging relationships:
 
 
 
Interest rate floors* (a)
$
8,381

Interest and fees on loans
$
(760
)
Total
$
8,381

 
$
(760
)
* No hedging relationship existed during 2017 and 2016.
(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 Derivative
Amount of Gain or (Loss) Recognized in Income on Derivative


 
For the Years
Ended December 31
(In thousands)
 
2018
 
2017
 
2016
Derivative instruments:
 
 
 
 
 
 
Interest rate swaps
Other non-interest income
$
3,914

 
$
1,978

 
$
5,927

Interest rate caps
Other non-interest income
11

 
—

 
—

Credit risk participation agreements
Other non-interest income
150

 
35

 
(44
)
Foreign exchange contracts:
Other non-interest income
31

 
(80
)
 
55

Mortgage loan commitments
Loan fees and sales
(45
)
 
231

 
87

Mortgage loan forward sale contracts
Loan fees and sales
5

 
64

 
(63
)
Forward TBA contracts
Loan fees and sales
414

 
(648
)
 
79

Total
 
$
4,480

 
$
1,580

 
$
6,041


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.

While the Company is party to master netting arrangements with most of its swap derivative counterparties, the Company does not offset derivative assets and liabilities under these arrangements on its consolidated balance sheet. Collateral, usually in the form of marketable securities, is exchanged between the Company and dealer bank counterparties and is generally subject to thresholds and transfer minimums. By contract, it may be sold or re-pledged by the secured party until recalled at a subsequent valuation date by the pledging party. For those swap transactions requiring central clearing, the Company posts cash to its clearing agency. 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.


117

 
 
 
 
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
December 31, 2018
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
Derivatives subject to master netting agreements
$
40,613

$
—

$
40,613

$
(2,992
)
$
(26,174
)
$
11,447

Derivatives not subject to master netting agreements
597

—

597

 
 
 
Total derivatives
41,210

—

41,210

 
 
 
Liabilities:
 
 
 
 
 
 
Derivatives subject to master netting agreements
13,333

—

13,333

(2,992
)
(261
)
10,080

Derivatives not subject to master netting agreements
88

—

88

 
 
 
Total derivatives
13,421

—

13,421

 
 
 
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

 
 
 



118

19. 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.

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 balance sheet, having met the accounting requirements for this treatment. The collateral swaps totaled $450.0 million at December 31, 2018 and $650.0 million at December 31, 2017. At December 31, 2018, the Company had posted collateral of $463.3 million in marketable securities, consisting of agency mortgage-backed bonds and treasuries, and had accepted $453.7 million in agency 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
December 31, 2018
 
 
 
 
 
 
Total resale agreements, subject to master netting arrangements
$
1,150,000

$
(450,000
)
$
700,000

$
—

$
(700,000
)
$
—

Total repurchase agreements, subject to master netting arrangements
2,393,219

(450,000
)
1,943,219

—

(1,943,219
)
—

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
)
—



119

The table below shows the remaining contractual maturities of repurchase agreements outstanding at December 31, 2018 and 2017, in addition to the various types of marketable securities that have been pledged by the Company 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
December 31, 2018
 
 
 
 
Repurchase agreements, secured by:
 
 
 
 
  U.S. government and federal agency obligations
$
387,541

$
150,000

$
100,000

$
637,541

  Government-sponsored enterprise obligations
18,466

—

—

18,466

  Agency mortgage-backed securities
882,744

31,774

213,752

1,128,270

  Non-agency mortgage-backed securities
187,740

—

—

187,740

  Asset-backed securities
322,680

—

—

322,680

  Other debt securities
98,522

—

—

98,522

   Total repurchase agreements, gross amount recognized
$
1,897,693

$
181,774

$
313,752

$
2,393,219

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


20. Commitments, Contingencies and Guarantees
The Company leases certain premises and equipment, all of which were classified as operating leases. The rent expense under such arrangements amounted to $7.7 million, $7.3 million and $7.1 million in 2018, 2017 and 2016, respectively. A summary of minimum lease commitments follows:
(In thousands)
Type of Property
 
Year Ended December 31
Real Property
Equipment
Total
2019
$
5,659

$
104

$
5,763

2020
4,766

51

4,817

2021
4,027

28

4,055

2022
3,598

—

3,598

2023
3,273

—

3,273

After
15,161

—

15,161

Total minimum lease payments
 
 
$
36,667


All leases expire prior to 2054. It is expected that in the normal course of business, leases that expire will be renewed or replaced by leases on other properties; thus, the future minimum lease commitments are not expected to be less than the amounts shown for 2019.

The Company engages in various transactions and commitments with off-balance sheet risk in the normal course of business to meet customer financing needs. The Company uses the same credit policies in making the commitments and conditional obligations described below as it does for on-balance sheet instruments. The following table summarizes these commitments at December 31:
(In thousands)
2018
2017
Commitments to extend credit:
 
 
Credit card
$
5,328,502

$
5,102,556

Other
5,840,967

5,737,181

Standby letters of credit, net of participations
353,905

387,811

Commercial letters of credit
13,774

4,498


120

Commitments to extend credit are legally binding agreements to lend to a borrower providing there are no violations of any conditions established in the contract. As many of the commitments are expected to expire without being drawn upon, the total commitment does not necessarily represent future cash requirements. Refer to Note 2 on Loans and Allowance for Loan Losses for further discussion.

Commercial letters of credit act as a means of ensuring payment to a seller upon shipment of goods to a buyer. The majority of commercial letters of credit issued are used to settle payments in international trade. Typically, letters of credit require presentation of documents which describe the commercial transaction, evidence shipment, and transfer title.

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 the customer, the Company has rights to the underlying collateral, which could include commercial real estate, physical plant and property, inventory, receivables, cash and marketable securities.

At December 31, 2018, the Company had recorded a liability in the amount of $2.7 million, representing the carrying value of the guarantee obligations associated with the standby letters of credit. This amount will be accreted into income over the remaining life of the respective commitments. Commitments outstanding under these letters of credit, which represent the maximum potential future payments guaranteed by the Company, were $353.9 million at December 31, 2018.

The Company regularly purchases various state tax credits arising from third-party property redevelopment. These credits are either resold to third parties or retained for use by the Company. During 2018, purchases and sales of tax credits amounted to $80.9 million and $71.6 million, respectively. At December 31, 2018, the Company had outstanding purchase commitments totaling $180.5 million that it expects to fund in 2019.

The Company periodically enters into 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 December 31, 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 December 31, 2018, the fair value of the Company's guarantee liability RPAs was $93 thousand, and the notional amount of the underlying swaps was $87.4 million. The maximum potential future payment guaranteed by the Company cannot be readily estimated and is dependent upon the fair value of the interest rate swaps at the time of default.

The Company has various legal proceedings pending at December 31, 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.


121

21. Related Parties
The Company’s Chief Executive Officer, its Executive Chairman, and its former Vice Chairman are directors of Tower Properties Company (Tower) and, together with members of their immediate families, beneficially own approximately 67% of the outstanding stock of Tower. At December 31, 2018, Tower owned 201,901 shares of Company stock. Tower is primarily engaged in the business of owning, developing, leasing and managing real property.

Payments from the Company and its affiliates to Tower are summarized below. These payments, with the exception of dividend payments, relate to property management services, including construction oversight, on three Company-owned office buildings and related parking garages in downtown Kansas City.
(In thousands)
2018
2017
2016
Leasing agent fees
$
133

$
32

$
101

Operation of parking garages
95

82

184

Building management fees
1,935

1,954

1,832

Property construction management fees
136

146

147

Dividends paid on Company stock held by Tower
181

232

221

Total
$
2,480

$
2,446

$
2,485


Tower has a $13.5 million line of credit with the Bank which is subject to normal credit terms and has a variable interest rate. The line of credit is collateralized by Company stock and based on collateral value had a maximum borrowing amount of approximately $9.1 million at December 31, 2018. There were no borrowings under this line during 2018, and there was no balance outstanding at December 31, 2018. The maximum borrowings during 2017 were $5.2 million, and there were no borrowings during 2016. There was no balance outstanding at December 31, 2017 or 2016. Interest paid on these borrowings during the last three years was not significant. Letters of credit may be collateralized under this line of credit; however, there were no letters of credit outstanding during 2018, 2017 or 2016, and thus, no fees were received during these periods. From time to time, the Bank extends additional credit to Tower for construction and development projects. No construction loans were outstanding during 2018, 2017 and 2016.

Tower leases office space in the Kansas City bank headquarters building owned by the Company. Rent paid to the Company totaled $74 thousand in 2018, $74 thousand in 2017, and $72 thousand in 2016, at $16.69, $15.75 and $15.67 per square foot, respectively.

Directors of the Company and their beneficial interests have deposit accounts with the Bank and may be provided with cash management and other banking services, including loans, in the ordinary course of business. Such loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other unrelated persons and did not involve more than the normal risk of collectability.

As discussed in Note 20 on Commitments, Contingencies and Guarantees, the Company regularly purchases various state tax credits arising from third-party property redevelopment and resells the credits to third parties.  During 2018, the Company sold state tax credits to its Executive Chairman, its former Vice Chairman, and its Chief Executive Officer in the amount of $831 thousand, $759 thousand, and $119 thousand, respectively, for personal tax planning. During 2017, the Company sold state tax credits to its Executive Chairman, its former Vice Chairman, and its Chief Executive Officer in the amount of $694 thousand, $598 thousand, and $67 thousand, respectively. During 2016, the Company sold state tax credits to its Executive Chairman, his father (a former Chief Executive Officer), its former Vice Chairman, and its Chief Executive Officer in the amount of $549 thousand, $191 thousand, $244 thousand, and $72 thousand, respectively. The terms of the sales and the amounts paid were the same as the terms and amounts paid for similar tax credits by persons not related to the Company.

122

22. Parent Company Condensed Financial Statements

Following are the condensed financial statements of Commerce Bancshares, Inc. (Parent only) for the periods indicated:
Condensed Balance Sheets
 
 
 
December 31
(In thousands)
2018
2017
Assets
 
 
Investment in consolidated subsidiaries:
 
 
Bank
$
2,587,489

$
2,409,098

Non-banks
67,538

52,479

Cash
207,462

151,607

Investment securities:
 
 
Available for sale debt
2,576

4,595

Equity
3,191

49,345

Note receivable due from bank subsidiary
50,000

50,000

Advances to subsidiaries, net of borrowings
19,867

14,571

Income tax benefits
8,590

8,279

Other assets
23,734

19,951

Total assets
$
2,970,447

$
2,759,925

Liabilities and stockholders’ equity
 
 
Pension obligation
$
12,645

$
12,407

Other liabilities
26,504

30,958

Total liabilities
39,149

43,365

Stockholders’ equity
2,931,298

2,716,560

Total liabilities and stockholders’ equity
$
2,970,447

$
2,759,925


Condensed Statements of Income
 
 
 
 
For the Years Ended December 31
(In thousands)
2018
2017
2016
Income
 
 
 
Dividends received from consolidated bank subsidiary
$
200,000

$
160,002

$
160,002

Earnings of consolidated subsidiaries, net of dividends
233,785

147,678

118,704

Interest and dividends on investment securities
10,698

2,099

2,364

Management fees charged to subsidiaries
37,688

30,431

30,965

Investment securities gains (losses)
(4,581
)
41,717

1,880

Net interest income on advances and note to subsidiaries
1,299

514

21

Other
2,390

3,346

2,720

Total income
481,279

385,787

316,656

Expense
 
 
 
Salaries and employee benefits
33,588

33,714

29,116

Professional fees
2,383

2,036

1,951

Data processing fees paid to affiliates
3,341

3,512

3,226

Community service
152

32,093

1,620

Other
10,729

10,671

9,849

Total expense
50,193

82,026

45,762

Income tax benefit
(2,456
)
(15,622
)
(4,497
)
Net income
$
433,542

$
319,383

$
275,391


123

Condensed Statements of Cash Flows
 
 
 
 
For the Years Ended December 31
(In thousands)
2018
2017
2016
Operating Activities
 
 
 
Net income
$
433,542

$
319,383

$
275,391

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Earnings of consolidated subsidiaries, net of dividends
(233,785
)
(147,678
)
(118,704
)
Other adjustments, net
2,505

(11,268
)
9,541

Net cash provided by operating activities
202,262

160,437

166,228

Investing Activities
 
 
 
(Increase) decrease in securities purchased under agreements to resell
—

155,775

(51,335
)
Decrease in investment in subsidiaries, net
—

11

4

Proceeds from sales of investment securities
41,638

11,006

2,949

Proceeds from maturities/pay downs of investment securities
1,988

2,295

4,105

Purchases of investment securities
(125
)
—

—

Note receivable due from bank subsidiary
—

(50,000
)
—

(Increase) decrease in advances to subsidiaries, net
(5,296
)
(9,518
)
13,507

Net purchases of building improvements and equipment
(133
)
(52
)
(3
)
Net cash provided by (used in) investing activities
38,072

109,517

(30,773
)
Financing Activities
 
 
 
Purchases of treasury stock
(75,231
)
(17,771
)
(39,381
)
Issuance of stock under equity compensation plans
(10
)
(8
)
(6
)
Cash dividends paid on common stock
(100,238
)
(91,619
)
(87,070
)
Cash dividends paid on preferred stock
(9,000
)
(9,000
)
(9,000
)
Net cash used in financing activities
(184,479
)
(118,398
)
(135,457
)
Increase (decrease) in cash
55,855

151,556

(2
)
Cash at beginning of year
151,607

51

53

Cash at end of year
$
207,462

$
151,607

$
51

Income tax receipts, net
$
(1,965
)
$
(8,991
)
$
(8,958
)

Dividends paid by the Parent to its shareholders were substantially provided from Bank dividends. The Bank may distribute common dividends without prior regulatory approval, provided that the dividends do not exceed the sum of net income for the current year and retained net income for the preceding two years, subject to maintenance of minimum capital requirements. The Parent charges fees to its subsidiaries for management services provided, which are allocated to the subsidiaries based primarily on total average assets. The Parent makes cash advances to its private equity subsidiaries for general short-term cash flow purposes. Advances may be made to the Parent by its subsidiary bank holding company for temporary investment of idle funds. Interest on such advances is based on market rates.

In 2017, the Bank borrowed $50.0 million from the Parent as part of its strategy to manage FDIC insurance premiums. The note has a rolling 13 month maturity, and the interest rate is a variable rate equal to the one year treasury rate.

For the past several years, the Parent has maintained a $20.0 million line of credit for general corporate purposes with the Bank. The line of credit is secured by investment securities. The Parent has not borrowed under this line during the past three years.

At December 31, 2018, the fair value of the investment securities held by the Parent consisted of investments of $2.5 million in common and preferred stock with readily determinable fair values, $720 thousand in equity securities that do not have readily determinable fair values, and $2.6 million in non-agency mortgage-backed securities. The decline in balances from the prior year 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.



124

Item 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There were no changes in or disagreements with accountants on accounting and financial disclosure.

Item 9a.
CONTROLS AND PROCEDURES
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this annual report.

Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control — Integrated Framework (2013), our management concluded that our internal control over financial reporting was effective as of December 31, 2018.

The Company’s internal control over financial reporting as of December 31, 2018 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report which follows.

Changes in Internal Control Over Financial Reporting
 No change in the Company’s internal control over financial reporting occurred that has materially affected, or is reasonably likely to materially affect, such controls during the last quarter of the period covered by this report.


125

Report of Independent Registered Public Accounting Firm

To the Shareholders and Board of Directors
Commerce Bancshares, Inc.:

Opinion on Internal Control Over Financial Reporting
We have audited Commerce Bancshares, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, cash flows, and changes in equity for each of the years in the three-year period ended December 31, 2018, and the related notes (collectively, the consolidated financial statements), and our report dated February 21, 2019 expressed an unqualified opinion on those consolidated financial statements.

Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

                        
                        kpmga01a01a05.gif
Kansas City, Missouri
February 21, 2019

126

Item 9b.
OTHER INFORMATION
None

PART III

Item 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Items 401, 405 and 407(c)(3), (d)(4) and (d)(5) of Regulation S-K regarding executive officers, directors, and corporate governance is included at the end of Part I of this Form 10-K under the caption “Executive Officers of the Registrant” and under the captions “Proposal One - Election of the 2022 Class of Directors”, “Section 16(a) Beneficial Ownership Reporting Compliance”, “Audit and Risk Committee Report”, “Committees of the Board" and "Shareholder Proposals and Nominations" in the definitive proxy statement, which is incorporated herein by reference.

The Company’s senior financial officer code of ethics for the chief executive officer and senior financial officers of the Company, including the chief financial officer, principal accounting officer or controller, or persons performing similar functions, is available at www.commercebank.com. Amendments to, and waivers of, the code of ethics are posted on this Web site.

Item 11.
EXECUTIVE COMPENSATION
The information required by Items 402 and 407(e)(4) and (e)(5) of Regulation S-K regarding executive compensation is included under the captions “Compensation Discussion and Analysis”, “Executive Compensation”, “Director Compensation”, “Compensation and Human Resources Committee Report”, and “Compensation and Human Resources Committee Interlocks and Insider Participation” in the definitive proxy statement, which is incorporated herein by reference.

Item 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by Items 201(d) and 403 of Regulation S-K is included under the captions “Equity Compensation Plan Information” and “Security Ownership of Certain Beneficial Owners and Management” in the definitive proxy statement, which is incorporated herein by reference.

Item 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by Items 404 and 407(a) of Regulation S-K is covered under the captions “Proposal One - Election of the 2022 Class of Directors” and “Corporate Governance” in the definitive proxy statement, which is incorporated herein by reference.

Item 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by Item 9(e) of Schedule 14A is included under the captions “Pre-approval of Services by the External Auditor” and “Fees Paid to KPMG LLP” in the definitive proxy statement, which is incorporated herein by reference.


127

PART IV

Item 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 
(a) The following documents are filed as a part of this report:
 
 
 
 
Page
 
 
(1)
Financial Statements:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(2)
Financial Statement Schedules:
 
 
 
 
All schedules are omitted as such information is inapplicable or is included in the financial statements.
 
 
 
 
 
 
 
(b) The exhibits filed as part of this report and exhibits incorporated herein by reference to other documents are listed below.

3 —Articles of Incorporation and By-Laws:
 
 
 
 
 
 
 
 
4 — Instruments defining the rights of security holders, including indentures:
 
 
 
(1) Pursuant to paragraph (b)(4)(iii) of Item 601 Regulation S-K, Registrant will furnish to the Commission upon request copies of long-term debt instruments.
 
 
10 — Material Contracts (Each of the following is a management contract or compensatory plan arrangement):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

128

 
 
 
 
 
 
 
 
 
 
(10) Commerce Bancshares, Inc. Stock Appreciation Rights Agreement and Commerce Bancshares, Inc. Restricted Stock Award Agreement, pursuant to the 2005 Equity Incentive Plan, were filed in current report on Form 8-K (Commission file number 0-2989) dated February 23, 2006, and the same are hereby incorporated by reference.
 
 
 
(11) Commerce Bancshares, Inc. Stock Appreciation Rights Agreement, Commerce Bancshares, Inc. Restricted Stock Award Agreements for Executive Officers, and Commerce Bancshares, Inc. Restricted Stock Award Agreements for Employees other than Executive Officers, pursuant to the 2005 Equity Incentive Plan, were filed in quarterly report on Form 10-Q (Commission file number 0-2989) dated May 6, 2013, and the same are hereby incorporated by reference.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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
 

Item 16.
FORM 10-K SUMMARY
None.    


129

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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 this 21st day of February 2019.

 
COMMERCE BANCSHARES, INC.
 
 
 
 
By:
/s/ THOMAS J. NOACK
 
 
Thomas J. Noack
 
 
Vice President and Secretary
        
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the 21st day of February 2019.

 
By:
/s/ JOHN W. KEMPER
 
 
John W. Kemper
 
 
Chief Executive Officer
 
 
 
 
By:
/s/ CHARLES G. KIM
 
 
Charles G. Kim
 
 
Chief Financial Officer
 
 
 
 
By:
/s/ JEFFERY D. ABERDEEN
 
 
Jeffery D. Aberdeen
 
 
Controller
 
 
(Chief Accounting Officer)
 
bracketsymbola05.jpg
 
David W. Kemper
 
Terry D. Bassham
 
John R. Capps
 
Earl H. Devanny, III
 
W. Thomas Grant, II
 
Karen L. Daniel
 
John W. Kemper
All the Directors on the Board of Directors*
Jonathan M. Kemper
 
Benjamin F. Rassieur, III
 
Todd R. Schnuck
 
Andrew C. Taylor
 
Kimberly G. Walker
 
 
 
 
 
____________
*
The Directors of Registrant listed executed a power of attorney authorizing Thomas J. Noack, their attorney-in-fact, to sign this report on their behalf.

 
By:
/s/ THOMAS J. NOACK
 
 
Thomas J. Noack
 
 
Attorney-in-Fact

130