10-Q
Table of Contents


 

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

For the quarterly period ended March 31, 2016

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

For the transition period from           to          
Commission File No. 0-2989
 
COMMERCE BANCSHARES, INC.
 
(Exact name of registrant as specified in its charter)
Missouri
 
43-0889454
(State of Incorporation)
 
(IRS Employer Identification No.)
 
 
 
1000 Walnut,
Kansas City, MO
 
64106
(Address of principal executive offices)
 
(Zip Code)
 
 
 
(816) 234-2000
 
 
(Registrant’s telephone number, including area code)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ     No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes þ     No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o
Smaller reporting company £
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 April 29, 2016, the registrant had outstanding 96,547,944 shares of its $5 par value common stock, registrant’s only class of common stock.



Commerce Bancshares, Inc. and Subsidiaries

Form 10-Q
 

 
 
 
Page
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2

Table of Contents


PART I: FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
 
 
March 31, 2016
 
December 31, 2015
 
(Unaudited)
 
 
 
(In thousands)
ASSETS
 
 
 
Loans
$
12,697,870

 
$
12,436,692

  Allowance for loan losses
(152,132
)
 
(151,532
)
Net loans
12,545,738

 
12,285,160

Loans held for sale (including $4,505,000 of residential mortgage loans carried at fair value at March 31, 2016 and $4,981,000 at December 31, 2015)
60,078

 
7,607

Investment securities:
 
 
 

Available for sale ($581,035,000 pledged at March 31, 2016 and $568,257,000 at
 
 
 
    December 31, 2015 to secure swap and repurchase agreements)
9,552,179

 
9,777,004

 Trading
23,130

 
11,890

 Non-marketable
117,259

 
112,786

Total investment securities
9,692,568

 
9,901,680

Federal funds sold and short-term securities purchased under agreements to resell
9,075

 
14,505

Long-term securities purchased under agreements to resell
825,000

 
875,000

Interest earning deposits with banks
171,651

 
23,803

Cash and due from banks
375,481

 
464,411

Land, buildings and equipment, net
350,423

 
352,581

Goodwill
138,921

 
138,921

Other intangible assets, net
6,539

 
6,669

Other assets
331,478

 
534,625

Total assets
$
24,506,952

 
$
24,604,962

LIABILITIES AND EQUITY
 
 
 
Deposits:
 
 
 

   Non-interest bearing
$
7,065,066

 
$
7,146,398

   Savings, interest checking and money market
11,205,357

 
10,834,746

   Time open and C.D.'s of less than $100,000
766,810

 
785,191

   Time open and C.D.'s of $100,000 and over
1,649,076

 
1,212,518

Total deposits
20,686,309

 
19,978,853

Federal funds purchased and securities sold under agreements to repurchase
957,388

 
1,963,552

Other borrowings
103,806

 
103,818

Other liabilities
312,167

 
191,321

Total liabilities
22,059,670

 
22,237,544

Commerce Bancshares, Inc. stockholders’ equity:
 
 
 

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

 
144,784

   Common stock, $5 par value
 
 
 

 Authorized 120,000,000 shares;
 
 
 
   issued 97,972,433 shares
489,862

 
489,862

   Capital surplus
1,332,429

 
1,337,677

   Retained earnings
424,677

 
383,313

   Treasury stock of 1,267,747 shares at March 31, 2016
 
 
 
     and 603,003 shares at December 31, 2015, at cost
(52,653
)
 
(26,116
)
   Accumulated other comprehensive income
102,929

 
32,470

Total Commerce Bancshares, Inc. stockholders' equity
2,442,028

 
2,361,990

Non-controlling interest
5,254

 
5,428

Total equity
2,447,282

 
2,367,418

Total liabilities and equity
$
24,506,952

 
$
24,604,962

See accompanying notes to consolidated financial statements.

3

Table of Contents


Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
 
For the Three Months Ended March 31
(In thousands, except per share data)
2016
2015
 
(Unaudited)
INTEREST INCOME
 
 
Interest and fees on loans
$
119,333

$
111,286

Interest and fees on loans held for sale
135

21

Interest on investment securities
48,891

38,436

Interest on federal funds sold and short-term securities purchased under
 
 
   agreements to resell
24

9

Interest on long-term securities purchased under agreements to resell
3,475

3,051

Interest on deposits with banks
270

179

Total interest income
172,128

152,982

INTEREST EXPENSE
 
 
Interest on deposits:
 
 
   Savings, interest checking and money market
3,484

3,308

   Time open and C.D.'s of less than $100,000
742

880

   Time open and C.D.'s of $100,000 and over
1,986

1,410

Interest on federal funds purchased and securities sold under
 
 
   agreements to repurchase
888

367

Interest on other borrowings
1,253

879

Total interest expense
8,353

6,844

Net interest income
163,775

146,138

Provision for loan losses
9,439

4,420

Net interest income after provision for loan losses
154,336

141,718

NON-INTEREST INCOME
 
 
Bank card transaction fees
44,470

42,299

Trust fees
30,370

29,586

Deposit account charges and other fees
20,691

18,499

Capital market fees
2,725

3,002

Consumer brokerage services
3,509

3,336

Loan fees and sales
2,510

2,089

Other
14,749

7,763

Total non-interest income
119,024

106,574

INVESTMENT SECURITIES GAINS (LOSSES), NET
(995
)
6,035

NON-INTEREST EXPENSE
 
 
Salaries and employee benefits
106,859

98,074

Net occupancy
11,303

11,561

Equipment
4,634

4,703

Supplies and communication
6,829

5,581

Data processing and software
22,899

19,506

Marketing
3,813

3,918

Deposit insurance
3,165

3,001

Other
17,971

17,501

Total non-interest expense
177,473

163,845

Income before income taxes
94,892

90,482

Less income taxes
29,370

28,468

Net income
65,522

62,014

Less non-controlling interest expense
148

959

Net income attributable to Commerce Bancshares, Inc.
65,374

61,055

Less preferred stock dividends
2,250

2,250

Net income available to common shareholders
$
63,124

$
58,805

Net income per common share — basic
$
.65

$
.58

Net income per common share — diluted
$
.65

$
.58

See accompanying notes to consolidated financial statements.

4

Table of Contents


Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
 
For the Three Months Ended March 31
(In thousands)
 
2016
2015
 
 
(Unaudited)
Net income
 
$
65,522

$
62,014

Other comprehensive income (loss):
 
 
 
Net unrealized losses on securities for which a portion of an other-than-temporary impairment has been recorded in earnings
 
(398
)
(128
)
Net unrealized gains on other securities
 
70,495

29,346

Pension loss amortization
 
362

406

Other comprehensive income
 
70,459

29,624

Comprehensive income
 
135,981

91,638

Less non-controlling interest expense
 
148

959

Comprehensive income attributable to Commerce Bancshares, Inc.
$
135,833

$
90,679

See accompanying notes to consolidated financial statements.














5

Table of Contents


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

(In thousands, except per share data)
Preferred Stock
Common Stock
Capital Surplus
Retained Earnings
Treasury Stock
Accumulated Other Comprehensive Income (Loss)
Non-Controlling Interest
Total
 
(Unaudited)
Balance January 1, 2016
$
144,784

$
489,862

$
1,337,677

$
383,313

$
(26,116
)
$
32,470

$
5,428

$
2,367,418

Net income
 




65,374





148

65,522

Other comprehensive income
 








70,459



70,459

Distributions to non-controlling interest
 










(322
)
(322
)
Purchases of treasury stock
 






(36,432
)




(36,432
)
Issuance of stock under purchase and equity compensation plans
 


(9,895
)


9,895






Excess tax benefit related to equity compensation plans
 


1,236









1,236

Stock-based compensation
 


3,411









3,411

Cash dividends on common stock ($.225 per share)
 




(21,760
)






(21,760
)
Cash dividends on preferred stock ($.375 per depositary share)






(2,250
)






(2,250
)
Balance March 31, 2016
$
144,784

$
489,862

$
1,332,429

$
424,677

$
(52,653
)
$
102,929

$
5,254

$
2,447,282

Balance January 1, 2015
$
144,784

$
484,155

$
1,229,075

$
426,648

$
(16,562
)
$
62,093

$
4,053

$
2,334,246

Net income
 




61,055





959

62,014

Other comprehensive income
 








29,624



29,624

Distributions to non-controlling interest
 










(219
)
(219
)
Purchases of treasury stock
 






(1,718
)




(1,718
)
Issuance of stock under purchase and equity compensation plans
 


(9,547
)


11,412





1,865

Excess tax benefit related to equity compensation plans
 


857









857

Stock-based compensation
 


2,740









2,740

Cash dividends on common stock ($.214 per share)
 




(21,752
)






(21,752
)
Cash dividends on preferred stock ($.375 per depositary share)
 
 
 
(2,250
)
 
 
 
(2,250
)
Balance March 31, 2015
$
144,784

$
484,155

$
1,223,125

$
463,701

$
(6,868
)
$
91,717

$
4,793

$
2,405,407

See accompanying notes to consolidated financial statements.



6

Table of Contents


Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
For the Three Months Ended March 31
(In thousands)
2016
 
2015
 
(Unaudited)
OPERATING ACTIVITIES:
 
 
 
Net income
$
65,522

 
$
62,014

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
  Provision for loan losses
9,439

 
4,420

  Provision for depreciation and amortization
10,146

 
10,694

  Amortization of investment security premiums, net
11,188

 
15,099

  Investment securities (gains) losses, net (A)
995

 
(6,035
)
  Net gains on sales of loans held for sale
(969
)
 
(467
)
  Originations of loans held for sale
(24,009
)
 
(17,806
)
  Proceeds from sales of loans held for sale
22,666

 
15,575

  Net (increase) decrease in trading securities, excluding unsettled transactions
76,143

 
(4,361
)
  Stock-based compensation
3,411

 
2,740

  Increase in interest receivable
(473
)
 
(788
)
  Increase in interest payable
280

 
27

  Increase in income taxes payable
26,133

 
24,904

  Excess tax benefit related to equity compensation plans
(1,236
)
 
(857
)
  Other changes, net
(3,352
)
 
(9,642
)
Net cash provided by operating activities
195,884

 
95,517

INVESTING ACTIVITIES:
 
 
 
Proceeds from sales of investment securities (A)
94

 
185,732

Proceeds from maturities/pay downs of investment securities (A)
542,059

 
609,144

Purchases of investment securities (A)
(180,774
)
 
(1,125,969
)
Net increase in loans
(320,987
)
 
(260,799
)
Repayments of long-term securities purchased under agreements to resell
50,000

 

Purchases of land, buildings and equipment
(7,389
)
 
(8,575
)
Sales of land, buildings and equipment
520

 
3

Net cash provided by (used in) investing activities
83,523

 
(600,464
)
FINANCING ACTIVITIES:
 
 
 
Net increase in non-interest bearing, savings, interest checking and money market deposits
421,286

 
218,837

Net increase in time open and C.D.'s
418,177

 
12,921

Net decrease in federal funds purchased and short-term securities sold under agreements to repurchase
(1,006,164
)
 
(252,055
)
Repayment of other long-term borrowings
(12
)
 
(204
)
Purchases of treasury stock
(36,432
)
 
(1,718
)
Issuance of stock under equity compensation plans

 
1,865

Excess tax benefit related to equity compensation plans
1,236

 
857

Cash dividends paid on common stock
(21,760
)
 
(21,752
)
Cash dividends paid on preferred stock
(2,250
)
 
(2,250
)
Net cash used in financing activities
(225,919
)
 
(43,499
)
Increase (decrease) in cash and cash equivalents
53,488

 
(548,446
)
Cash and cash equivalents at beginning of year
502,719

 
1,100,717

Cash and cash equivalents at March 31
$
556,207

 
$
552,271

(A) Available for sale and non-marketable securities
 
 
 
Income tax payments, net
$
2,658

 
$
2,953

Interest paid on deposits and borrowings
$
8,073

 
$
6,817

Loans transferred to foreclosed real estate
$
471

 
$
482

Loans transferred from held for investment to held for sale
$
50,360

 
$

See accompanying notes to consolidated financial statements.

7

Table of Contents


Commerce Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2016 (Unaudited)
 
1. Principles of Consolidation and Presentation

The accompanying consolidated financial statements include the accounts of Commerce Bancshares, Inc. and all majority-owned subsidiaries (the Company). Most of the Company's operations are conducted by its subsidiary bank, Commerce Bank (the Bank). The consolidated financial statements in this report have not been audited by an independent registered public accounting firm, but in the opinion of management, all adjustments necessary to present fairly the financial position and the results of operations for the interim periods have been made. All such adjustments are of a normal recurring nature. All significant intercompany accounts and transactions have been eliminated. Certain reclassifications were made to 2015 data to conform to current year presentation. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Management has evaluated subsequent events for potential recognition or disclosure. The results of operations for the three month period ended March 31, 2016 are not necessarily indicative of results to be attained for the full year or any other interim period.

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


2. Loans and Allowance for Loan Losses

Major classifications within the Company’s held for investment loan portfolio at March 31, 2016 and December 31, 2015 are as follows:

(In thousands)
 
March 31, 2016
 
December 31, 2015
Commercial:
 
 
 
 
Business
 
$
4,575,081

 
$
4,397,893

Real estate – construction and land
 
745,369

 
624,070

Real estate – business
 
2,395,933

 
2,355,544

Personal Banking:
 
 
 
 
Real estate – personal
 
1,903,969

 
1,915,953

Consumer
 
1,904,320

 
1,924,365

Revolving home equity
 
423,005

 
432,981

Consumer credit card
 
744,364

 
779,744

Overdrafts
 
5,829

 
6,142

Total loans
 
$
12,697,870

 
$
12,436,692


At March 31, 2016, loans of $3.7 billion were pledged at the Federal Home Loan Bank as collateral for borrowings and letters of credit obtained to secure public deposits. Additional loans of $1.5 billion were pledged at the Federal Reserve Bank as collateral for discount window borrowings.


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Table of Contents


Allowance for loan losses    
A summary of the activity in the allowance for loan losses during the three months ended March 31, 2016 and 2015, respectively, follows:
 
 
For the Three Months Ended March 31
(In thousands)
 
Commercial
Personal Banking

Total
Balance January 1
$
82,086

$
69,446

$
151,532

Provision
4,151

5,288

9,439

Deductions:
 
 
 
   Loans charged off
1,513

11,777

13,290

   Less recoveries on loans
1,303

3,148

4,451

Net loan charge-offs (recoveries)
210

8,629

8,839

Balance March 31, 2016
$
86,027

$
66,105

$
152,132

Balance January 1
$
89,622

$
66,910

$
156,532

Provision
(1,752
)
6,172

4,420

Deductions:
 
 
 
   Loans charged off
724

11,576

12,300

   Less recoveries on loans
1,760

3,120

4,880

Net loan charge-offs (recoveries)
(1,036
)
8,456

7,420

Balance March 31, 2015
$
88,906

$
64,626

$
153,532


The following table shows the balance in the allowance for loan losses and the related loan balance at March 31, 2016 and December 31, 2015, disaggregated on the basis of impairment methodology. Impaired loans evaluated under ASC 310-10-35 include loans on non-accrual status, which are individually evaluated for impairment, and other impaired loans discussed below, which are deemed to have similar risk characteristics and are collectively evaluated. All other loans are collectively evaluated for impairment under ASC 450-20.
 
Impaired Loans
 
All Other Loans

(In thousands)
Allowance for Loan Losses
Loans Outstanding
 
Allowance for Loan Losses
Loans Outstanding
March 31, 2016
 
 
 
 
 
Commercial
$
2,963

$
58,199

 
$
83,064

$
7,658,184

Personal Banking
1,385

22,188

 
64,720

4,959,299

Total
$
4,348

$
80,387

 
$
147,784

$
12,617,483

December 31, 2015
 
 
 
 
 
Commercial
$
1,927

$
43,027

 
$
80,159

$
7,334,480

Personal Banking
1,557

22,287

 
67,889

5,036,898

Total
$
3,484

$
65,314

 
$
148,048

$
12,371,378


Impaired loans
The table below shows the Company’s investment in impaired loans at March 31, 2016 and December 31, 2015. These loans consist of all loans on non-accrual status and other restructured loans whose terms have been modified and classified as troubled debt restructurings. These restructured loans are performing in accordance with their modified terms, and because the Company believes it probable that all amounts due under the modified terms of the agreements will be collected, interest on these loans is being recognized on an accrual basis. They are discussed further in the "Troubled debt restructurings" section on page 13.
(In thousands)
 
Mar. 31, 2016
 
Dec. 31, 2015
Non-accrual loans
 
$
29,367

 
$
26,575

Restructured loans (accruing)
 
51,020

 
38,739

Total impaired loans
 
$
80,387

 
$
65,314



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The following table provides additional information about impaired loans held by the Company at March 31, 2016 and December 31, 2015, 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
March 31, 2016
 
 
 
With no related allowance recorded:
 
 
 
Business
$
10,381

$
12,874

$

Real estate – construction and land
2,335

3,307


Real estate – business
3,593

4,739


Real estate – personal
362

373


 
$
16,671

$
21,293

$

With an allowance recorded:
 
 
 
Business
$
34,821

$
36,845

$
2,328

Real estate – construction and land
546

6,962

67

Real estate – business
6,523

8,773

568

Real estate – personal
7,377

10,291

656

Consumer
5,945

5,945

119

Revolving home equity
541

592

31

Consumer credit card
7,963

7,963

579

 
$
63,716

$
77,371

$
4,348

Total
$
80,387

$
98,664

$
4,348

December 31, 2015
 
 
 
With no related allowance recorded:
 
 
 
Business
$
9,330

$
11,777

$

Real estate – construction and land
2,961

8,956


Real estate – business
4,793

6,264


Real estate – personal
373

373


 
$
17,457

$
27,370

$

With an allowance recorded:
 
 
 
Business
$
18,227

$
20,031

$
1,119

Real estate – construction and land
1,227

2,804

63

Real estate – business
6,489

9,008

745

Real estate – personal
7,667

10,530

831

Consumer
5,599

5,599

63

Revolving home equity
704

852

67

Consumer credit card
7,944

7,944

596

 
$
47,857

$
56,768

$
3,484

Total
$
65,314

$
84,138

$
3,484



Total average impaired loans for the three month periods ended March 31, 2016 and 2015, respectively, are shown in the table below.

(In thousands)
Commercial
Personal Banking
Total
Average Impaired Loans:
 
 
 
For the three months ended March 31, 2016
 
 
 
Non-accrual loans
$
21,004

$
4,623

$
25,627

Restructured loans (accruing)
27,179

17,701

44,880

Total
$
48,183

$
22,324

$
70,507

For the three months ended March 31, 2015
 
 
 
Non-accrual loans
$
31,281

$
6,258

$
37,539

Restructured loans (accruing)
22,280

19,386

41,666

Total
$
53,561

$
25,644

$
79,205



10

Table of Contents


The table below shows interest income recognized during the three month periods ended March 31, 2016 and 2015, respectively, for impaired loans held at the end of each respective period. This interest all relates to accruing restructured loans, as discussed in the "Troubled debt restructurings" section on page 13.
 
For the Three Months Ended March 31
(In thousands)
2016
2015
Interest income recognized on impaired loans:
 
 
Business
$
274

$
135

Real estate – construction and land
2

80

Real estate – business
36

15

Real estate – personal
46

53

Consumer
90

52

Revolving home equity
5

4

Consumer credit card
146

174

Total
$
599

$
513


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 March 31, 2016 and December 31, 2015.




(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
March 31, 2016
 
 
 
 
 
Commercial:
 
 
 
 
 
Business
$
4,551,468

$
6,806

$
709

$
16,098

$
4,575,081

Real estate – construction and land
734,547

8,112


2,710

745,369

Real estate – business
2,379,738

9,961


6,234

2,395,933

Personal Banking:
 
 
 
 
 
Real estate – personal
1,890,775

6,477

2,512

4,205

1,903,969

Consumer
1,884,817

16,726

2,777


1,904,320

Revolving home equity
419,114

2,147

1,624

120

423,005

Consumer credit card
728,741

7,885

7,738


744,364

Overdrafts
5,593

236



5,829

Total
$
12,594,793

$
58,350

$
15,360

$
29,367

$
12,697,870

December 31, 2015
 
 
 
 
 
Commercial:
 
 
 
 
 
Business
$
4,384,149

$
2,306

$
564

$
10,874

$
4,397,893

Real estate – construction and land
617,838

3,142


3,090

624,070

Real estate – business
2,340,919

6,762


7,863

2,355,544

Personal Banking:
 
 
 
 
 
Real estate – personal
1,901,330

7,117

3,081

4,425

1,915,953

Consumer
1,903,389

18,273

2,703


1,924,365

Revolving home equity
427,998

2,641

2,019

323

432,981

Consumer credit card
762,750

8,894

8,100


779,744

Overdrafts
5,834

308



6,142

Total
$
12,344,207

$
49,443

$
16,467

$
26,575

$
12,436,692



Credit quality
The following table provides information about the credit quality of the Commercial loan portfolio, using the Company’s internal rating system as an indicator. The internal rating system is a series of grades reflecting management’s risk assessment, based on its analysis of the borrower’s financial condition. The “pass” category consists of a range of loan grades that reflect increasing, though still acceptable, risk. Movement of risk through the various grade levels in the “pass” category is monitored for early identification of credit deterioration. The “special mention” rating is applied to loans where the borrower exhibits negative financial trends due to borrower specific or systemic conditions that, if left uncorrected, threaten its capacity to meet its debt obligations.

11

Table of Contents


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.
Commercial Loans


(In thousands)


Business
Real
 Estate-Construction
Real
Estate-
Business


Total
March 31, 2016
 
 
 
 
Pass
$
4,435,061

$
733,542

$
2,318,735

$
7,487,338

Special mention
64,964

8,026

20,180

93,170

Substandard
58,958

1,091

50,784

110,833

Non-accrual
16,098

2,710

6,234

25,042

Total
$
4,575,081

$
745,369

$
2,395,933

$
7,716,383

December 31, 2015
 
 
 
 
Pass
$
4,278,857

$
618,788

$
2,281,565

$
7,179,210

Special mention
49,302

1,033

15,009

65,344

Substandard
58,860

1,159

51,107

111,126

Non-accrual
10,874

3,090

7,863

21,827

Total
$
4,397,893

$
624,070

$
2,355,544

$
7,377,507


The credit quality of Personal Banking loans is monitored primarily on the basis of aging/delinquency, and this information is provided in the table in the above "Delinquent and non-accrual loans" section. In addition, FICO scores are obtained and updated on a quarterly basis for most of the loans in the Personal Banking portfolio. This is a published credit score designed to measure the risk of default by taking into account various factors from a borrower's financial history. The Bank normally obtains a FICO score at the loan's origination and renewal dates, and updates are obtained on a quarterly basis. Excluded from the table below are certain Personal Banking loans for which FICO scores are not obtained because they generally pertain to commercial customer activities and are often underwritten with other collateral considerations. At March 31, 2016, these were comprised of $250.2 million in personal real estate loans, or 5.0% of the Personal Banking portfolio, compared to $257.8 million at December 31, 2015. For the remainder of loans in the Personal Banking portfolio, the table below shows the percentage of balances outstanding at March 31, 2016 and December 31, 2015 by FICO score.
   Personal Banking Loans
 
% of Loan Category
 
Real Estate - Personal
Consumer
Revolving Home Equity
Consumer Credit Card
March 31, 2016
 
 
 
 
FICO score:
 
 
 
 
Under 600
1.4
%
4.6
%
1.4
%
4.3
%
600 - 659
2.8

9.2

3.9

12.5

660 - 719
9.8

22.1

15.1

32.7

720 - 779
24.7

26.5

27.1

27.9

780 and over
61.3

37.6

52.5

22.6

Total
100.0
%
100.0
%
100.0
%
100.0
%
December 31, 2015
 
 
 
 
FICO score:
 
 
 
 
Under 600
1.5
%
4.5
%
1.5
%
3.9
%
600 - 659
3.0

9.7

3.9

12.0

660 - 719
9.1

21.8

13.6

31.7

720 - 779
25.0

26.4

28.4

27.9

780 and over
61.4

37.6

52.6

24.5

Total
100.0
%
100.0
%
100.0
%
100.0
%





12

Table of Contents


Troubled debt restructurings
As mentioned previously, the Company's impaired loans include loans which have been classified as troubled debt restructurings. Total restructured loans amounted to $66.4 million at March 31, 2016. Restructured loans are those extended to borrowers who are experiencing financial difficulty and who have been granted a concession. Restructured loans are placed on non-accrual status if the Company does not believe it probable that amounts due under the contractual terms will be collected, and those non-accrual loans totaled $15.4 million at March 31, 2016. Other performing restructured loans totaled $51.0 million at March 31, 2016. These include certain business, construction and business real estate loans classified as substandard. Upon maturity, the loans renewed at interest rates judged not to be market rates for new debt with similar risk and as a result the loans were classified as troubled debt restructurings. These commercial loans totaled $33.9 million at March 31, 2016. These restructured loans are performing in accordance with their modified terms, and because the Company believes it probable that all amounts due under the modified terms of the agreements will be collected, interest on these loans is being recognized on an accrual basis. Troubled debt restructurings also include certain credit card loans under various debt management and assistance programs, which totaled $8.0 million at March 31, 2016. Modifications to credit card loans generally involve removing the available line of credit, placing loans on amortizing status, and lowering the contractual interest rate. The Company has classified additional loans as troubled debt restructurings because they were not reaffirmed by the borrower in bankruptcy proceedings. At March 31, 2016, these loans totaled $8.8 million in personal real estate, revolving home equity, and consumer loans. Interest on these loans is being recognized on an accrual basis, as the borrowers are continuing to make payments under the terms of the loan agreements.

The following table shows the outstanding balances of loans classified as troubled debt restructurings at March 31, 2016, in addition to the outstanding balances of these restructured loans which the Company considers to have been in default at any time during the past twelve months. For purposes of this disclosure, the Company considers "default" to mean 90 days or more past due as to interest or principal.
(In thousands)
March 31, 2016
Balance 90 days past due at any time during previous 12 months
Commercial:
 
 
Business
$
39,577

$

Real estate - construction and land
2,849

81

Real estate - business
4,587


Personal Banking:
 
 
Real estate - personal
4,995

370

Consumer
5,969

465

Revolving home equity
431

63

Consumer credit card
7,963

547

Total restructured loans
$
66,371

$
1,526


For those loans on non-accrual status also classified as restructured, the modification did not create any further financial effect on the Company as those loans were already recorded at net realizable value. For those performing commercial loans classified as restructured, there were no concessions involving forgiveness of principal or interest and, therefore, there was no financial impact to the Company as a result of modification to these loans. No financial impact resulted from those performing loans where the debt was not reaffirmed in bankruptcy, as no changes to loan terms occurred in that process. The effects of modifications to consumer credit card loans were estimated to decrease interest income by approximately $927 thousand on an annual, pre-tax basis, compared to amounts contractually owed.

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

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

13

Table of Contents


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

The Company had commitments of $12.6 million at March 31, 2016 to lend additional funds to borrowers with restructured loans.

Loans held for sale
Beginning January 1, 2015, certain long-term fixed rate personal real estate loan originations have been designated as held for sale, and the Company has elected the fair value option for these loans. The election of the fair value option aligns the accounting for these loans with the related economic hedges discussed in Note 10. At March 31, 2016, the fair value of these loans was $4.5 million, and the unpaid principal balance was $4.3 million.

Beginning in the third quarter of 2015, the Company has designated 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 at various times while the student is attending school or shortly after graduation. At March 31, 2016, the balance of these loans was $5.2 million. These loans are carried at lower of cost or fair value.
 
In March 2016, the Company designated certain loans secured by automobiles, totaling $50.4 million, as held for sale. The loans are being marketed to other financial institutions such as regional banks and credit unions, and the amount expected to be sold approximates nearly 5% of the total auto loan portfolio. The group of loans held for sale are representative of the overall auto loan portfolio. These loans are carried at lower of cost or fair value.

At March 31, 2016, none of the loans held for sale were on non-accrual status or 90 days past due and still accruing. Interest income with respect to loans held for sale is accrued based on the principal amount outstanding and the loan's contractual interest rate. Gains and losses in fair value resulting from the application of the fair value option, or lower of cost or fair value accounting, are recognized in loan fees and sales in the consolidated statements of income.

Foreclosed real estate/repossessed assets
The Company’s holdings of foreclosed real estate totaled $2.0 million and $2.8 million at March 31, 2016 and December 31, 2015, respectively. Personal property acquired in repossession, generally autos and marine and recreational vehicles, totaled $2.6 million and $3.3 million at March 31, 2016 and December 31, 2015, respectively. Upon acquisition, these assets are recorded at fair value less estimated selling costs at the date of foreclosure, establishing a new cost basis. They are subsequently carried at the lower of this cost basis or fair value less estimated selling costs.

3. Investment Securities

Investment securities, at fair value, consisted of the following at March 31, 2016 and December 31, 2015.
 
(In thousands)
Mar. 31, 2016
Dec. 31, 2015
Available for sale
$
9,552,179

$
9,777,004

Trading
23,130

11,890

Non-marketable
117,259

112,786

Total investment securities
$
9,692,568

$
9,901,680


Most of the Company’s investment securities are classified as available for sale, and this portfolio is discussed in more detail below. The available for sale and the trading portfolios are carried at fair value. Securities which are classified as non-marketable include Federal Home Loan Bank (FHLB) stock and Federal Reserve Bank stock held for debt and regulatory purposes, which totaled $46.9 million at March 31, 2016 and $46.8 million at December 31, 2015. Investment in Federal Reserve Bank stock is based on the capital structure of the investing bank, and investment in FHLB stock is tied to the level of borrowings from the FHLB. These holdings are carried at cost. Non-marketable securities also include private equity investments, which amounted to $70.0 million at March 31, 2016 and $65.6 million at December 31, 2015. In the absence of readily ascertainable market values, these securities are carried at estimated fair value.


14

Table of Contents


A summary of the available for sale investment securities by maturity groupings as of March 31, 2016 is shown below. The investment portfolio includes agency mortgage-backed securities, which are guaranteed by agencies such as the FHLMC, FNMA, GNMA and FDIC, in addition to non-agency mortgage-backed securities, which have no guarantee but are collateralized by residential mortgages. Also included are certain other asset-backed securities, which are primarily collateralized by credit cards, automobiles, student loans, and commercial loans. These securities differ from traditional debt securities primarily in that they may have uncertain maturity dates and are priced based on estimated prepayment rates on the underlying collateral.
(In thousands)
Amortized Cost
Fair Value
U.S. government and federal agency obligations:
 
 
Within 1 year
$
58,866

$
60,127

After 1 but within 5 years
498,613

514,076

After 5 but within 10 years
104,754

108,327

After 10 years
35,444

32,780

Total U.S. government and federal agency obligations
697,677

715,310

Government-sponsored enterprise obligations:
 
 
Within 1 year
10,680

10,754

After 1 but within 5 years
572,163

579,157

After 5 but within 10 years
125,012

126,156

After 10 years
5,630

5,591

Total government-sponsored enterprise obligations
713,485

721,658

State and municipal obligations:
 
 
Within 1 year
99,478

99,618

After 1 but within 5 years
680,866

698,660

After 5 but within 10 years
916,693

948,352

After 10 years
64,768

66,161

Total state and municipal obligations
1,761,805

1,812,791

Mortgage and asset-backed securities:
 
 
  Agency mortgage-backed securities
2,538,407

2,611,384

  Non-agency mortgage-backed securities
852,059

863,158

  Asset-backed securities
2,445,528

2,440,055

Total mortgage and asset-backed securities
5,835,994

5,914,597

Other debt securities:
 
 
Within 1 year
9,327

9,341

After 1 but within 5 years
94,819

95,938

After 5 but within 10 years
222,744

227,750

After 10 years
12,000

11,748

Total other debt securities
338,890

344,777

Equity securities
5,678

43,046

Total available for sale investment securities
$
9,353,529

$
9,552,179


Investments in U.S. government and federal agency obligations include U.S. Treasury inflation-protected securities, which totaled $397.4 million, at fair value, at March 31, 2016. Interest paid on these securities increases with inflation and decreases with deflation, as measured by the Consumer Price Index. Included in equity securities is common and preferred stock held by the holding company, Commerce Bancshares, Inc. (the Parent), with a fair value of $43.0 million at March 31, 2016.


15

Table of Contents


For securities classified as available for sale, the following table shows the unrealized gains and losses (pre-tax) in accumulated other comprehensive income, by security type.
 
 
(In thousands)
Amortized Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
March 31, 2016
 
 
 
 
U.S. government and federal agency obligations
$
697,677

$
20,297

$
(2,664
)
$
715,310

Government-sponsored enterprise obligations
713,485

8,353

(180
)
721,658

State and municipal obligations
1,761,805

52,229

(1,243
)
1,812,791

Mortgage and asset-backed securities:
 
 
 
 
  Agency mortgage-backed securities
2,538,407

73,025

(48
)
2,611,384

  Non-agency mortgage-backed securities
852,059

12,341

(1,242
)
863,158

  Asset-backed securities
2,445,528

7,493

(12,966
)
2,440,055

Total mortgage and asset-backed securities
5,835,994

92,859

(14,256
)
5,914,597

Other debt securities
338,890

6,673

(786
)
344,777

Equity securities
5,678

37,368


43,046

Total
$
9,353,529

$
217,779

$
(19,129
)
$
9,552,179

December 31, 2015
 
 
 
 
U.S. government and federal agency obligations
$
729,846

$
5,051

$
(7,821
)
$
727,076

Government-sponsored enterprise obligations
794,912

2,657

(4,546
)
793,023

State and municipal obligations
1,706,635

37,061

(1,739
)
1,741,957

Mortgage and asset-backed securities:
 
 
 
 
  Agency mortgage-backed securities
2,579,031

47,856

(8,606
)
2,618,281

  Non-agency mortgage-backed securities
879,186

8,596

(7,819
)
879,963

  Asset-backed securities
2,660,201

1,287

(17,107
)
2,644,381

Total mortgage and asset-backed securities
6,118,418

57,739

(33,532
)
6,142,625

Other debt securities
335,925

377

(4,982
)
331,320

Equity securities
5,678

35,325


41,003

Total
$
9,691,414

$
138,210

$
(52,620
)
$
9,777,004


The Company’s impairment policy requires a review of all securities for which fair value is less than amortized cost. Special emphasis and analysis is placed on securities whose credit rating has fallen below A3 (Moody's) or A- (Standard & Poor's), whose fair values have fallen more than 20% below purchase price for an extended period of time, or have been identified based on management’s judgment. These securities are placed on a watch list, and for all such securities, 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 March 31, 2016, the fair value of securities on this watch list was $85.9 million compared to $95.8 million at December 31, 2015.

As of March 31, 2016, the Company had recorded other-than-temporary impairment (OTTI) on certain non-agency mortgage-backed securities, part of the watch list mentioned above, which had an aggregate fair value of $39.9 million. The cumulative credit-related portion of the impairment on these securities, which was recorded in earnings, totaled $14.2 million. The Company does not intend to sell these securities and believes it is not likely that it will be required to sell the securities before the recovery of their amortized cost.

The credit-related portion of the loss on these securities was based on the cash flows projected to be received over the estimated life of the securities, discounted to present value, and compared to the current amortized cost bases of the securities. Significant inputs to the cash flow models used to calculate the credit losses on these securities at March 31, 2016 included the following:

Significant Inputs
Range
Prepayment CPR
0%
-
25%
Projected cumulative default
17%
-
53%
Credit support
0%
-
25%
Loss severity
19%
-
68%

16

Table of Contents


The following table presents a rollforward of the cumulative OTTI credit losses recognized in earnings on all available for sale debt securities.
 
For the Three Months Ended March 31
(In thousands)
2016
2015
Cumulative OTTI credit losses at January 1
$
14,129

$
13,734

Credit losses on debt securities for which impairment was previously recognized
123

17

Increase in expected cash flows that are recognized over remaining life of security
(18
)
(29
)
Cumulative OTTI credit losses at March 31
$
14,234

$
13,722


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
March 31, 2016
 
 
 
 
 
 
 
 
U.S. government and federal agency obligations
$

$

 
$
32,780

$
2,664

 
$
32,780

$
2,664

Government-sponsored enterprise obligations


 
15,445

180

 
15,445

180

State and municipal obligations
31,624

512

 
10,997

731

 
42,621

1,243

Mortgage and asset-backed securities:
 
 
 
 
 
 
 
 
   Agency mortgage-backed securities
33,723

40

 
2,819

8

 
36,542

48

   Non-agency mortgage-backed securities
155,845

752

 
66,103

490

 
221,948

1,242

   Asset-backed securities
1,000,464

9,430

 
172,710

3,536

 
1,173,174

12,966

Total mortgage and asset-backed securities
1,190,032

10,222

 
241,632

4,034

 
1,431,664

14,256

Other debt securities
20,356

276

 
13,425

510

 
33,781

786

Total
$
1,242,012

$
11,010

 
$
314,279

$
8,119

 
$
1,556,291

$
19,129

December 31, 2015
 
 
 
 
 
 
 
 
U.S. government and federal agency obligations
$
491,998

$
3,098

 
$
31,012

$
4,723

 
$
523,010

$
7,821

Government-sponsored enterprise obligations
157,830

1,975

 
110,250

2,571

 
268,080

4,546

State and municipal obligations
66,998

544

 
31,120

1,195

 
98,118

1,739

Mortgage and asset-backed securities:
 
 
 
 
 
 
 
 
   Agency mortgage-backed securities
530,035

2,989

 
291,902

5,617

 
821,937

8,606

   Non-agency mortgage-backed securities
653,603

7,059

 
54,536

760

 
708,139

7,819

   Asset-backed securities
2,207,922

12,492

 
223,311

4,615

 
2,431,233

17,107

Total mortgage and asset-backed securities
3,391,560

22,540

 
569,749

10,992

 
3,961,309

33,532

Other debt securities
244,452

3,687

 
25,218

1,295

 
269,670

4,982

Total
$
4,352,838

$
31,844

 
$
767,349

$
20,776

 
$
5,120,187

$
52,620


The total available for sale portfolio consisted of approximately 2,000 individual securities at March 31, 2016. The portfolio included 228 securities, having an aggregate fair value of $1.6 billion, that were in an unrealized loss position at March 31, 2016, compared to 466 securities, with a fair value of $5.1 billion, at December 31, 2015. The total amount of unrealized losses on these securities decreased $33.5 million to $19.1 million at March 31, 2016, largely due to a lower rate environment. At March 31, 2016, the fair value of securities in an unrealized loss position for 12 months or longer totaled $314.3 million, or 3.3% of the total portfolio value.

The Company’s holdings of state and municipal obligations included gross unrealized losses of $1.2 million at March 31, 2016. Of these losses, $1.1 million related to auction rate securities and $171 thousand related to other state and municipal obligations. This portfolio, exclusive of auction rate securities, totaled $1.8 billion at fair value, or 18.8% of total available for sale securities. The average credit quality of the portfolio, excluding auction rate securities, is Aa2 as rated by Moody’s. The portfolio is diversified in order to reduce risk, and the Company has processes and procedures in place to monitor its holdings, identify signs of financial distress and, if necessary, exit its positions in a timely manner.

    

17

Table of Contents


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 Three Months Ended March 31
(In thousands)
2016
2015
Proceeds from sales of available for sale securities
$

$
185,053

Proceeds from sales of non-marketable securities
94

679

Total proceeds
$
94

$
185,732

Available for sale:
 
 
Gains realized on sales
$

$
2,526

Other-than-temporary impairment recognized on debt securities
(123
)
(17
)
 Non-marketable:
 
 
 Gains realized on sales
42

226

Fair value adjustments, net
(914
)
3,300

Investment securities gains (losses), net
$
(995
)
$
6,035


At March 31, 2016, securities totaling $3.9 billion in fair value were pledged to secure public fund deposits, securities sold under agreements to repurchase, trust funds, and borrowings at the Federal Reserve Bank and FHLB. Securities pledged under agreements pursuant to which the collateral may be sold or re-pledged by the secured parties approximated $581.0 million, while the remaining securities were pledged under agreements pursuant to which the secured parties may not sell or re-pledge the collateral. Except for obligations of various government-sponsored enterprises such as FNMA, FHLB and FHLMC, no investment in a single issuer exceeded 10% of stockholders’ equity.

18

Table of Contents


4. Goodwill and Other Intangible Assets

The following table presents information about the Company's intangible assets which have estimable useful lives.
 
March 31, 2016
 
December 31, 2015
 
 
(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

$
(26,574
)
$

$
4,696

 
$
31,270

$
(26,239
)
$

$
5,031

Mortgage servicing rights
4,904

(3,031
)
(30
)
1,843

 
4,638

(2,971
)
(29
)
1,638

Total
$
36,174

$
(29,605
)
$
(30
)
$
6,539

 
$
35,908

$
(29,210
)
$
(29
)
$
6,669


Aggregate amortization expense on intangible assets was $395 thousand and $473 thousand for the three month periods ended March 31, 2016 and 2015, respectively. The following table shows the estimated annual amortization expense for the next five fiscal years. This expense is based on existing asset balances and the interest rate environment as of March 31, 2016. 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)
 
2016
$
1,457

2017
1,105

2018
846

2019
700

2020
572



Changes in the carrying amount of goodwill and net other intangible assets for the three month period ended March 31, 2016 is as follows:
(In thousands)
Goodwill
Core Deposit Premium
Mortgage Servicing Rights
Balance January 1, 2016
$
138,921

$
5,031

$
1,638

Originations


266

Amortization

(335
)
(60
)
Impairment


(1
)
Balance March 31, 2016
$
138,921

$
4,696

$
1,843



Goodwill allocated to the Company’s operating segments at March 31, 2016 and December 31, 2015 is shown below.
(In thousands)
 
Consumer segment
$
70,721

Commercial segment
67,454

Wealth segment
746

Total goodwill
$
138,921


5. Guarantees

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

Upon issuance of standby letters of credit, the Company recognizes a liability for the fair value of the obligation undertaken, which is estimated to be equivalent to the amount of fees received from the customer over the life of the agreement. At March 31,

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2016, that net liability was $2.7 million, which will be accreted into income over the remaining life of the respective commitments. The contractual amount of these letters of credit, which represents the maximum potential future payments guaranteed by the Company, was $346.6 million at March 31, 2016.

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 March 31, 2016, believes sufficient collateral is available to cover potential swap losses. The RPAs are carried at fair value throughout their term with all changes in fair value, including those due to a change in the third party’s creditworthiness, recorded in current earnings. The terms of the RPAs, which correspond to the terms of the underlying swaps, range from 3 to 11 years. At March 31, 2016, the fair value of the Company's guarantee liabilities for RPAs was $267 thousand, and the notional amount of the underlying swaps was $58.6 million. The maximum potential future payment guaranteed by the Company cannot be readily estimated but is dependent upon the fair value of the interest rate swaps at the time of default.

6. Pension

The amount of net pension cost is shown in the table below:
 
For the Three Months Ended March 31
(In thousands)
2016
2015
Service cost - benefits earned during the period
$
133

$
126

Interest cost on projected benefit obligation
967

1,216

Expected return on plan assets
(1,437
)
(1,523
)
Amortization of prior service cost
(68
)

Amortization of unrecognized net loss
651

655

Net periodic pension cost
$
246

$
474


Substantially all benefits accrued under the Company’s defined benefit pension plan were frozen effective January 1, 2005, and the remaining benefits were frozen effective January 1, 2011. During the first three months of 2016, the Company made no funding contributions to its defined benefit pension plan and made minimal funding contributions to a supplemental executive retirement plan (the CERP), which carries no segregated assets. The Company has no plans to make any further contributions, other than those related to the CERP, during the remainder of 2016.

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.



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7. Common and Preferred Stock *

Presented below is a summary of the components used to calculate basic and diluted income per share. The Company applies the two-class method of computing income per share, as nonvested share-based awards that contain nonforfeitable rights to dividends are considered securities which participate in undistributed earnings with common stock. The two-class method requires the calculation of separate income per share amounts for the nonvested share-based awards and for common stock. Income per share attributable to common stock is shown in the table below. Nonvested share-based awards are further discussed in Note 12.
 
For the Three Months Ended March 31
(In thousands, except per share data)
2016
2015
Basic income per common share:
 
 
Net income attributable to Commerce Bancshares, Inc.
$
65,374

$
61,055

Less preferred stock dividends
2,250

2,250

Net income available to common shareholders
63,124

58,805

Less income allocated to nonvested restricted stock
894

796

  Net income allocated to common stock
$
62,230

$
58,009

Weighted average common shares outstanding
95,566

100,053

   Basic income per common share
$
.65

$
.58

Diluted income per common share:
 
 
Net income available to common shareholders
$
63,124

$
58,805

Less income allocated to nonvested restricted stock
893

794

  Net income allocated to common stock
$
62,231

$
58,011

Weighted average common shares outstanding
95,566

100,053

  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
216

314

  Weighted average diluted common shares outstanding
95,782

100,367

    Diluted income per common share
$
.65

$
.58


Unexercised stock options and stock appreciation rights of 468 thousand and 322 thousand were excluded in the computation of diluted income per common share for the three month periods ended March 31, 2016 and 2015, respectively, because their inclusion would have been anti-dilutive.
The Company also 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 $25.00 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.
* All prior year share and per share amounts in this note have been restated for the 5% common stock dividend distributed in December 2015.
  

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8. Accumulated Other Comprehensive Income

The table below shows the activity and accumulated balances for components of other comprehensive income. The largest component is the unrealized holding gains and losses on available for sale securities. Unrealized gains and losses on debt securities for which an other-than-temporary impairment (OTTI) has been recorded in current earnings are shown separately below. The other component is the amortization from other comprehensive income of losses associated with pension benefits, which occurs as the losses are included in current net periodic pension cost.
 
Unrealized Gains (Losses) on Securities (1)
Pension Loss (2)
Total Accumulated Other Comprehensive Income
(In thousands)
OTTI
Other
Balance January 1, 2016
$
3,316

$
49,750

$
(20,596
)
$
32,470

Other comprehensive income (loss) before reclassifications
(765
)
113,702


112,937

Amounts reclassified from accumulated other comprehensive income
123


583

706

Current period other comprehensive income (loss), before tax
(642
)
113,702

583

113,643

Income tax (expense) benefit
244

(43,207
)
(221
)
(43,184
)
Current period other comprehensive income (loss), net of tax
(398
)
70,495

362

70,459

Balance March 31, 2016
$
2,918

$
120,245

$
(20,234
)
$
102,929

Balance January 1, 2015
$
3,791

$
81,310

$
(23,008
)
$
62,093

Other comprehensive income (loss) before reclassifications
(223
)
49,859


49,636

Amounts reclassified from accumulated other comprehensive income
17

(2,526
)
655

(1,854
)
Current period other comprehensive income (loss), before tax
(206
)
47,333

655

47,782

Income tax (expense) benefit
78

(17,987
)
(249
)
(18,158
)
Current period other comprehensive income (loss), net of tax
(128
)
29,346

406

29,624

Balance March 31, 2015
$
3,663

$
110,656

$
(22,602
)
$
91,717

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

9. Segments

The Company segregates financial information for use in assessing its performance and allocating resources among three operating segments: Consumer, Commercial and Wealth. The Consumer segment 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 bank cards.  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 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 tax planning, advisory and discretionary investment management, and brokerage services, and includes the Private Banking product portfolio.

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

(In thousands)
Consumer
Commercial
Wealth
Segment Totals
Other/Elimination
Consolidated Totals
Three Months Ended March 31, 2016
 
 
 
 
 
 
Net interest income
$
66,570

$
75,911

$
10,875

$
153,356

$
10,419

$
163,775

Provision for loan losses
(8,725
)
19

(106
)
(8,812
)
(627
)
(9,439
)
Non-interest income
29,896

51,119

34,402

115,417

3,607

119,024

Investment securities losses, net




(995
)
(995
)
Non-interest expense
(68,976
)
(69,757
)
(28,540
)
(167,273
)
(10,200
)
(177,473
)
Income before income taxes
$
18,765

$
57,292

$
16,631

$
92,688

$
2,204

$
94,892

Three Months Ended March 31, 2015
 
 
 
 
 
 
Net interest income
$
65,664

$
71,111

$
10,742

$
147,517

$
(1,379
)
$
146,138

Provision for loan losses
(8,323
)
877

7

(7,439
)
3,019

(4,420
)
Non-interest income
26,612

47,581

33,659

107,852

(1,278
)
106,574

Investment securities gains, net




6,035

6,035

Non-interest expense
(66,692
)
(64,770
)
(27,270
)
(158,732
)
(5,113
)
(163,845
)
Income before income taxes
$
17,261

$
54,799

$
17,138

$
89,198

$
1,284

$
90,482


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

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

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


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10. Derivative Instruments

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

(In thousands)
March 31, 2016
December 31, 2015
Interest rate swaps
$
1,162,638

$
1,020,310

Interest rate caps
64,543

66,118

Credit risk participation agreements
64,085

62,456

Foreign exchange contracts
5,278

15,535

 Mortgage loan commitments
20,160

8,605

Mortgage loan forward sale contracts
1,643

642

Forward TBA contracts
22,000

11,000

Total notional amount
$
1,340,347

$
1,184,666


The largest group of notional amounts relate to interest rate swap contracts sold to commercial customers who wish to modify their interest rate sensitivity. These swaps are offset by matching contracts purchased by the Company from other financial dealer institutions. Contracts with dealers that require central clearing are novated to a 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 contracts with large financial institutions contain contingent features relating to debt ratings or capitalization levels. Under these provisions, if the Company’s debt rating falls below investment grade or if the Company ceases to be “well-capitalized” under risk-based capital guidelines, certain counterparties can require immediate and ongoing collateralization on interest rate swaps in net liability positions or instant settlement of the contracts. The Company maintains debt ratings and capital well above these minimum requirements.

The banking customer counterparties are engaged in a variety of businesses, including real estate and building materials, manufacturing, education, communications, retail product distribution, and retirement communities. At March 31, 2016, the largest potential loss exposures were in the groups related to retirement communities, real estate, and distribution. If the counterparties in these groups failed to perform, and if the underlying collateral proved to be of no value, the Company estimates that it would incur losses of $2.9 million (retirement communities), $12.7 million (real estate), and $3.2 million (distribution) at March 31, 2016.

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

In 2015, the Company initiated a program of secondary market sales of residential mortgage loans and has designated certain newly-originated residential mortgage loans as held for sale. Derivative instruments arising from this activity include mortgage loan commitments and forward loan sale commitments. Changes in the fair values of the loan commitments and funded loans prior to sale that are due to changes in interest rates are economically hedged with forward contracts to sell residential mortgage-backed securities in the to-be-announced (TBA) market. These forward TBA contracts are also considered to be derivatives and are settled in cash at the security settlement date.


24

Table of Contents


The fair values of the Company's derivative instruments, whose notional amounts are listed above, are shown in the table below. Derivative instruments with a positive fair value (asset derivatives) are reported in other assets in the consolidated balance sheets, while derivative instruments with a negative fair value (liability derivatives) are reported in other liabilities in the consolidated balance sheets. Information about the valuation methods used to determine fair value is provided in Note 13 on Fair Value Measurements.
 
Asset Derivatives
 
Liability Derivatives
 
Mar. 31, 2016
Dec. 31, 2015
 
Mar. 31, 2016
Dec. 31, 2015
(In thousands)    
  Fair Value
 
  Fair Value
Derivative instruments:
 
 
 
 
 
   Interest rate swaps
$
26,743

$
11,993

 
$
(26,700
)
$
(11,993
)
   Interest rate caps
44

73

 
(44
)
(73
)
   Credit risk participation agreements
1

1

 
(266
)
(195
)
   Foreign exchange contracts
8

437

 
(50
)
(430
)
   Mortgage loan commitments
771

263

 


   Mortgage loan forward sale contracts
1


 
(2
)

   Forward TBA contracts

4

 
(133
)
(38
)
 Total
$
27,568

$
12,771

 
$
(27,195
)
$
(12,729
)

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



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


 
For the Three Months Ended March 31
(In thousands)
 
2016
2015
Derivative instruments:
 
 
 
  Interest rate swaps
Other non-interest income
$
2,226

$
1,183

  Credit risk participation agreements
Other non-interest income
(35
)
(27
)
  Foreign exchange contracts
Other non-interest income
(49
)
(439
)
  Mortgage loan commitments
Loan fees and sales
508

408

  Mortgage loan forward sale contracts
Loan fees and sales
(1
)
(3
)
  Forward TBA contracts
Loan fees and sales
(329
)
(5
)
Total
 
$
2,320

$
1,117


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.

The Company is party to master netting arrangements with most of its swap derivative counterparties; however, the Company does not offset derivative assets and liabilities under these arrangements on its consolidated balance sheet. Collateral, usually in the form of marketable securities, is exchanged between the Company and dealer bank counterparties and is generally subject to thresholds and transfer minimums. By contract, it may be sold or re-pledged by the secured party until recalled at a subsequent valuation date by the pledging party. For those swap transactions requiring central clearing, the Company posts cash and securities to its clearing agency. At March 31, 2016, the Company had a net liability position with dealer bank and clearing agency counterparties totaling $26.7 million, and had posted securities with a fair value of $5.1 million and cash totaling $26.6 million. 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.

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Table of Contents


 
 
 
 
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
March 31, 2016
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
Derivatives subject to master netting agreements
$
26,788

$

$
26,788

$
(44
)
$

$
26,744

Derivatives not subject to master netting agreements
780


780

 
 
 
Total derivatives
27,568


27,568

 
 
 
Liabilities:
 
 
 
 
 
 
Derivatives subject to master netting agreements
$
27,143

$

$
27,143

$
(44
)
$
(25,633
)
$
1,466

Derivatives not subject to master netting agreements
52


52

 
 
 
Total derivatives
27,195


27,195

 
 
 
December 31, 2015
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
Derivatives subject to master netting agreements
$
12,071

$

$
12,071

$
(94
)
$

$
11,977

Derivatives not subject to master netting agreements
700


700

 
 
 
Total derivatives
12,771


12,771

 
 
 
Liabilities:
 
 
 
 
 
 
Derivatives subject to master netting agreements
$
12,299

$

$
12,299

$
(94
)
$
(10,927
)
$
1,278

Derivatives not subject to master netting agreements
430


430

 
 
 
Total derivatives
12,729


12,729

 
 
 

11. Resale and Repurchase Agreements

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

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


26

Table of Contents


The Company is party to several agreements commonly known as collateral swaps. These agreements involve the exchange of collateral under simultaneous repurchase and resale agreements with the same financial institution counterparty. These repurchase and resale agreements have the same principal amounts, inception dates, and maturity dates and have been offset against each other in the consolidated balance sheets, as permitted under the netting provisions of ASC 210-20-45. The collateral swaps totaled $550.0 million at both March 31, 2016 and December 31, 2015. At March 31, 2016, the Company had posted collateral of $576.0 million in marketable securities, consisting mainly of agency mortgage-backed bonds and treasuries, and had accepted $570.3 million in investment grade asset-backed, commercial mortgage-backed, and corporate bonds.
 
 
 
 
Gross Amounts Not Offset in the Balance Sheet
 
(In thousands)
Gross Amount Recognized
Gross Amounts Offset in the Balance Sheet
Net Amounts Presented in the Balance Sheet
Financial Instruments Available for Offset
Securities Collateral Received/Pledged
Net Amount
March 31, 2016
 
 
 
 
 
 
Total resale agreements, subject to master netting arrangements
$
1,375,000

$
(550,000
)
$
825,000

$

$
(825,000
)
$

Total repurchase agreements, subject to master netting arrangements
1,503,503

(550,000
)
953,503


(953,503
)

December 31, 2015
 
 
 
 
 
 
Total resale agreements, subject to master netting arrangements
$
1,425,000

$
(550,000
)
$
875,000

$

$
(875,000
)
$

Total repurchase agreements, subject to master netting arrangements
1,956,582

(550,000
)
1,406,582


(1,406,582
)


The table below shows the remaining contractual maturities of repurchase agreements outstanding at March 31, 2016 and December 31, 2015, in addition to the various types of marketable securities that have been pledged as collateral for these borrowings.

Remaining Contractual Maturity of the Agreements

(In thousands)
Overnight and continuous
Up to 90 days
Greater than 90 days
Total
March 31, 2016




Repurchase agreements, secured by:




  U.S. government and federal agency obligations
$
253,016

$
315

$
300,000

$
553,331

  Government-sponsored enterprise obligations
288,370

24,095


312,465

  Agency mortgage-backed securities
336,448

28,917

200,000

565,365

  Asset-backed securities
7,342

65,000


72,342

   Total repurchase agreements, gross amount recognized
$
885,176

$
118,327

$
500,000

$
1,503,503

December 31, 2015
 
 
 
 
Repurchase agreements, secured by:
 
 
 
 
  U.S. government and federal agency obligations
$
210,346

$

$
300,000

$
510,346

  Government-sponsored enterprise obligations
356,970


24,096

381,066

  Agency mortgage-backed securities
579,974

2,292

225,904

808,170

  Asset-backed securities
212,000

45,000


257,000

   Total repurchase agreements, gross amount recognized
$
1,359,290

$
47,292

$
550,000

$
1,956,582



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12. Stock-Based Compensation

The Company issues stock-based compensation in the form of nonvested restricted stock and stock appreciation rights (SARs). Most of the awards are issued during the first quarter of each year. The stock-based compensation expense that has been charged against income was $3.4 million and $2.7 million in the three month periods ended March 31, 2016 and 2015, respectively.

Nonvested stock awards generally vest in 4 to 7 years and contain restrictions as to transferability, sale, pledging, or assigning, among others, prior to the end of the vesting period. Dividend and voting rights are conferred upon grant. A summary of the status of the Company’s nonvested share awards as of March 31, 2016, and changes during the three month period then ended, is presented below.
 
 
 

Shares
 Weighted Average Grant Date Fair Value
Nonvested at January 1, 2016
1,384,417

$34.38
Granted
196,625

41.50
Vested
(215,838
)
30.05
Forfeited
(9,647
)
37.93
Nonvested at March 31, 2016
1,355,557

$36.08

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

$7.48

Assumptions:
 
Dividend yield
2.2
%
Volatility
21.2
%
Risk-free interest rate
1.8
%
Expected term
7.2 years


A summary of SAR activity during the first three months of 2016 is presented below.
 
 
 
 
(Dollars in thousands, except per share data)
Rights
Weighted Average Exercise Price
Weighted Average Remaining Contractual Term
Aggregate Intrinsic Value
Outstanding at January 1, 2016
1,588,457

$33.74
 
 
Granted
250,482

41.32
 
 
Forfeited
(4,986
)
38.06

 
 
Expired
(811
)
37.45

 
 
Exercised
(208,418
)
31.54
 
 
Outstanding at March 31, 2016
1,624,724

$35.17
5.4 years
$
15,882





28

Table of Contents


13. Fair Value Measurements

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

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Depending on the nature of the asset or liability, the Company uses various valuation techniques and assumptions when estimating fair value. For accounting disclosure purposes, a three-level valuation hierarchy of fair value measurements has been established. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:
Level 1 – inputs to the valuation methodology are quoted prices for identical assets or liabilities in active markets.
Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and inputs that are observable for the assets or liabilities, either directly or indirectly (such as interest rates, yield curves, and prepayment speeds).
Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value. These may be internally developed, using the Company’s best information and assumptions that a market participant would consider.
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.


29

Table of Contents


Instruments Measured at Fair Value on a Recurring Basis

The table below presents the March 31, 2016 and December 31, 2015 carrying values of assets and liabilities measured at fair value on a recurring basis. There were no transfers among levels during the first three months of 2016 or the year ended December 31, 2015.
 
 
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)
March 31, 2016
 
 
 
 
Assets:
 
 
 
 
  Residential mortgage loans held for sale
$
4,505

$

$
4,505

$

  Available for sale securities:
 
 
 
 
     U.S. government and federal agency obligations
715,310

715,310



     Government-sponsored enterprise obligations
721,658


721,658


     State and municipal obligations
1,812,791


1,795,582

17,209

     Agency mortgage-backed securities
2,611,384


2,611,384


     Non-agency mortgage-backed securities
863,158


863,158


     Asset-backed securities
2,440,055


2,440,055


     Other debt securities
344,777


344,777


     Equity securities
43,046

21,217

21,829


  Trading securities
23,130


23,130


  Private equity investments
67,432



67,432

  Derivatives *
27,568


26,796

772

  Assets held in trust
9,449

9,449



  Total assets
9,684,263

745,976

8,852,874

85,413

Liabilities:
 
 
 
 
  Derivatives *
27,195


26,929

266

  Total liabilities
$
27,195

$

$
26,929

$
266

December 31, 2015
 
 
 
 
Assets:
 
 
 
 
  Residential mortgage loans held for sale
$
4,981

$

$
4,981

$

  Available for sale securities:
 
 
 
 
     U.S. government and federal agency obligations
727,076

727,076



     Government-sponsored enterprise obligations
793,023


793,023


     State and municipal obligations
1,741,957


1,724,762

17,195

     Agency mortgage-backed securities
2,618,281


2,618,281


     Non-agency mortgage-backed securities
879,963


879,963


     Asset-backed securities
2,644,381


2,644,381


     Other debt securities
331,320


331,320


     Equity securities
41,003

20,263

20,740


  Trading securities
11,890


11,890


  Private equity investments
63,032



63,032

  Derivatives *
12,771


12,507

264

  Assets held in trust
9,278

9,278



  Total assets
9,878,956

756,617

9,041,848

80,491

Liabilities:
 
 
 
 
  Derivatives *
12,729


12,534

195

  Total liabilities
$
12,729

$

$
12,534

$
195

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








30

Table of Contents


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 investment 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 common stock and U.S. Treasury obligations.

The fair values of Level 1 and 2 securities (excluding equity 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/

31

Table of Contents


default assumptions. Tranche spreads are based on tranche characteristics such as average life, type, volatility, ratings, underlying 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, and in conjunction with other indices, are used 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 (i.e., call or put options, redemption features, etc.).

Equity securities
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.

The available for sale portfolio includes certain auction rate securities. The auction process by which auction rate securities are normally priced has not functioned in recent years, and due to the illiquidity in the market, the fair value of these securities cannot be based on observable market prices. The fair values of the auction rate securities are estimated using a discounted cash flows analysis which is discussed more fully in the Level 3 Inputs section of this note. Because several of the inputs significant to the measurement are not observable, these measurements are classified as Level 3 measurements.

Trading 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 non-marketable 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, foreign exchange forward contracts, certain credit risk guarantee agreements, and various instruments related to residential loan sale activity. 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. These fair value measurements are classified as Level 2.

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

32

Table of Contents


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 nonfinancial liability, representing the Company’s liability to the plan participants.

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


(In thousands)
State and Municipal Obligations
Private Equity
Investments
Derivatives
Total
For the three months ended March 31, 2016
 
 
 
 
Balance January 1, 2016
$
17,195

$
63,032

$
69

$
80,296

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

(914
)
473

(441
)
   Included in other comprehensive income *
101



101

Investment securities called
(100
)


(100
)
Discount accretion
13



13

Purchases of private equity investments

5,266


5,266

Capitalized interest/dividends

48


48

Sale of risk participation agreement


(36
)
(36
)
Balance March 31, 2016
$
17,209

$
67,432

$
506

$
85,147

Total gains or losses for the three months included in earnings attributable to the change in unrealized gains or losses relating to assets still held at March 31, 2016
$

$
(914
)
$
736

$
(178
)
For the three months ended March 31, 2015
 
 
 
 
Balance January 1, 2015
$
95,143

$
57,581

$
(223
)
$
152,501

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

3,300

381

3,681

   Included in other comprehensive income *
(2
)


(2
)
Investment securities called
(2,000
)


(2,000
)
Discount accretion
130



130

Purchases of private equity investments

216


216

Capitalized interest/dividends

65


65

Balance March 31, 2015
$
93,271

$
61,162

$
158

$
154,591

Total gains or losses for the three months included in earnings attributable to the change in unrealized gains or losses relating to assets still held at March 31, 2015
$

$
3,300

$
381

$
3,681

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

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Table of Contents


Gains and losses included in earnings for the Level 3 assets and liabilities in the previous table are reported in the following line items in the consolidated statements of income:
(In thousands)
Loan Fees and Sales
Other Non-Interest Income
Investment Securities Gains (Losses), Net
Total
For the three months ended March 31, 2016
 
 
 
 
Total gains or losses included in earnings
$
508

$
(35
)
$
(914
)
$
(441
)
Change in unrealized gains or losses relating to assets still held at March 31, 2016
$
771

$
(35
)
$
(914
)
$
(178
)
For the three months ended March 31, 2015
 
 
 
 
Total gains or losses included in earnings
$
408

$
(27
)
$
3,300

$
3,681

Change in unrealized gains or losses relating to assets still held at March 31, 2015
$
408

$
(27
)
$
3,300

$
3,681


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 $17.2 million at March 31, 2016, while private equity investments, included in non-marketable securities, totaled $67.4 million.
Information about these inputs is presented in the table and discussions below.
Quantitative Information about Level 3 Fair Value Measurements
 
 
 
Weighted
 
Valuation Technique
Unobservable Input
Range
 
Average
Auction rate securities
Discounted cash flow
Estimated market recovery period


5 years
 
 
 
 
Estimated market rate
2.9%
-
3.7%
 
 
Private equity investments
Market comparable companies
EBITDA multiple
4.0
-
5.5
 
 
Mortgage loan commitments
Discounted cash flow
Probability of funding
61.7%
-
97.0%
 
82.8%
 
 
Embedded servicing value
.9%
-
1.0%
 
1.0%

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 are held, and most sales are 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.


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Table of Contents


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.

Instruments Measured at Fair Value on a Nonrecurring Basis

For assets measured at fair value on a nonrecurring basis during the first three months of 2016 and 2015, and still held as of March 31, 2016 and 2015, the following table provides the adjustments to fair value recognized during the respective periods, the level of valuation inputs used to determine each adjustment, and the carrying value of the related individual assets or portfolios at March 31, 2016 and 2015.
 
 
Fair Value Measurements Using
 
(In thousands)

Fair Value
Quoted Prices in Active Markets for Identical Assets
(Level 1)
Significant Other Observable Inputs
(Level 2)
Significant Unobservable Inputs
(Level 3)
Total Gains (Losses) Recognized During the Three Months Ended March 31
March 31, 2016
 
 
 
 
 
  Collateral dependent impaired loans
$
4,710

$

$

$
4,710

$
(2,043
)
  Mortgage servicing rights
1,843



1,843

(1
)
  Foreclosed assets
62



62

(36
)
 
 
 
 
 
 
March 31, 2015
 
 
 
 
 
  Collateral dependent impaired loans
$
729

$

$

$
729

$
(398
)
  Mortgage servicing rights
994



994

15

  Foreclosed assets
23



23

(25
)
  Long-lived assets
4,996



4,996

(1,742
)

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 March 31, 2016 and 2015 are shown in the table above.

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Table of Contents


Private equity investments and restricted stock

These assets are included in non-marketable investment securities in the consolidated balance sheets.  They include certain investments in private equity concerns held by the Parent company which are carried at cost, reduced by other-than-temporary impairment. These investments are periodically evaluated for impairment based on their estimated fair value as determined by review of available information, most of which is provided as monthly or quarterly internal financial statements, annual audited financial statements, investee tax returns, and in certain situations, through research into and analysis of the assets and investments held by those private equity concerns.   Restricted stock consists of stock issued by the Federal Reserve Bank and FHLB and is held by the bank subsidiary as required for regulatory purposes.  Generally, there are restrictions on the sale and/or liquidation of these investments, and they are carried at cost, reduced by other-than-temporary impairment.  Fair value measurements for these securities are classified as Level 3.

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 recorded as held for sale initially 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 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

Investments in branch facilities and various office buildings are written down to estimated fair value, or if the property is held for sale, they are written down to estimated fair value less cost to sell. 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.

14. Fair Value of Financial Instruments

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

The methods and inputs used in the estimation of fair value for the financial instruments in the table below are discussed in the preceding Fair Value Measurements note and in the Fair Value of Financial Instruments note in the Company's 2015 Annual Report on Form 10-K. There have been no significant changes in these methods and inputs since December 31, 2015.


36

Table of Contents


The estimated fair values of the Company’s financial instruments and the classification of their fair value measurement within the valuation hierarchy are as follows:
 
Fair Value Hierarchy Level
March 31, 2016
 
December 31, 2015

(In thousands)
Carrying
Amount
Estimated
Fair Value
 
Carrying
Amount
Estimated
Fair Value
Financial Assets
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
Business
Level 3
$
4,575,081

$
4,626,980

 
$
4,397,893

$
4,421,237

Real estate - construction and land
Level 3
745,369

754,959

 
624,070

633,083

Real estate - business
Level 3
2,395,933

2,442,752

 
2,355,544

2,387,101

Real estate - personal
Level 3
1,903,969

1,948,143

 
1,915,953

1,940,863

Consumer
Level 3
1,904,320

1,907,623

 
1,924,365

1,916,747

Revolving home equity
Level 3
423,005

425,568

 
432,981

434,607

Consumer credit card
Level 3
744,364

760,353

 
779,744

793,428

Overdrafts
Level 3
5,829

5,829

 
6,142

6,142

Loans held for sale
Level 2
60,078

60,092

 
7,607

7,607

Investment securities:
 
 
 
 
 
 
Available for sale
Level 1
736,527

736,527

 
747,339

747,339

Available for sale
Level 2
8,798,443

8,798,443

 
9,012,470

9,012,470

Available for sale
Level 3
17,209

17,209

 
17,195

17,195

Trading
Level 2
23,130

23,130

 
11,890

11,890

Non-marketable
Level 3
117,259

117,259

 
112,786

112,786

Federal funds sold
Level 1
9,075

9,075

 
14,505

14,505

Securities purchased under agreements to resell
Level 3
825,000

832,942

 
875,000

879,546

Interest earning deposits with banks
Level 1
171,651

171,651

 
23,803

23,803

Cash and due from banks
Level 1
375,481

375,481

 
464,411

464,411

Derivative instruments
Level 2
26,796

26,796

 
12,507

12,507

Derivative instruments
Level 3
772

772

 
264

264

Financial Liabilities
 
 
 
 
 
 
Non-interest bearing deposits
Level 1
$
7,065,066

$
7,065,066

 
$
7,146,398

$
7,146,398

Savings, interest checking and money market deposits
Level 1
11,205,357

11,205,357

 
10,834,746
10,834,746
Time open and certificates of deposit
Level 3
2,415,886

2,414,609

 
1,997,709

1,993,521

Federal funds purchased
Level 1
3,885

3,885

 
556,970

556,970

Securities sold under agreements to repurchase
Level 3
953,503

953,589

 
1,406,582

1,406,670

Other borrowings
Level 3
103,806

108,456

 
103,818

108,542

Derivative instruments
Level 2
26,929

26,929

 
12,534

12,534

Derivative instruments
Level 3
266

266

 
195

195


15. Legal Proceedings
On August 15, 2014, a customer filed a class action complaint against the Bank in the Circuit Court, Jackson County, Missouri.  The case is Cassandra Warren, et al v. Commerce Bank (Case No. 1416-CV19197).  In the case, the customer alleges violation of the Missouri usury statute in connection with the Bank charging overdraft fees in connection with point-of-sale/debit and automated-teller machine cards. The class was certified and consists of Missouri customers of the Bank who may have been similarly affected. The case has been stayed pending the final outcome of a similar case in which a ruling has been made in favor of the bank defendant. The Company believes that the stay will remain in effect until any appeals in the similar case have run their course.  The Company believes the Warren complaint lacks merit and will defend itself vigorously. The amount of any ultimate exposure cannot be determined with certainty at this time.

The Company has various other legal proceedings pending at March 31, 2016, 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 matters for which it deems a loss is probable and can be reasonably estimated. Some legal matters, which are at early stages in the legal process, have not yet progressed to the point where a loss amount can be determined to be probable and estimable.


37

Table of Contents


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

The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes and with the statistical information and financial data appearing in this report as well as the Company's 2015 Annual Report on Form 10-K. Results of operations for the three month period ended March 31, 2016 are not necessarily indicative of results to be attained for any other period.

Forward-Looking Information

This report may contain "forward-looking statements" that are subject to risks and uncertainties and include information about possible or assumed future results of operations. Many possible events or factors could affect the future financial results and performance of the Company. This could cause results or performance to differ materially from those expressed in the forward-looking statements. Words such as "expects", "anticipates", "believes", "estimates", variations of such words and other similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in, or implied by, such forward-looking statements. Readers should not rely solely on the forward-looking statements and should consider all uncertainties and risks discussed throughout this report. Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. Such possible events or factors include: changes in economic conditions in the Company's market area, changes in policies by regulatory agencies, governmental legislation and regulation, fluctuations in interest rates, changes in liquidity requirements, demand for loans in the Company's market area, changes in accounting and tax principles, estimates made on income taxes, competition with other entities that offer financial services, and such other factors as discussed in Part I Item 1A - "Risk Factors" and Part II Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's 2015 Annual Report on Form 10-K.

Critical Accounting Policies

The Company has identified several policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for loan losses, the valuation of certain investment securities, and accounting for income taxes. A discussion of these policies can be found in the sections captioned "Critical Accounting Policies" and "Allowance for Loan Losses" in Management's Discussion and Analysis of Financial Condition and Results of Operations included in the Company's 2015 Annual Report on Form 10-K. There have been no changes in the Company's application of critical accounting policies since December 31, 2015.


38

Table of Contents


Selected Financial Data

 
 
Three Months Ended March 31
 
 
2016
2015
Per Share Data
 
 
 
   Net income per common share — basic
 
$
.65

$
.58
*
   Net income per common share — diluted
 
.65

.58
*
   Cash dividends on common stock
 
.225

.214
*
   Book value per common share
 
23.85

22.30
*
   Market price
 
44.95

40.30
*
Selected Ratios
 
 
 
(Based on average balance sheets)
 
 
 
   Loans to deposits (1)
 
62.81
%
59.71
%
   Non-interest bearing deposits to total deposits
 
34.44

34.31

   Equity to loans (1)
 
19.15

20.62

   Equity to deposits
 
12.03

12.31

   Equity to total assets
 
9.84

10.05

   Return on total assets
 
1.07

1.05

   Return on common equity
 
11.20

10.69

(Based on end-of-period data)
 
 
 
   Non-interest income to revenue (2)
 
42.09

42.17

   Efficiency ratio (3)
 
62.62

64.65

   Tier I common risk-based capital ratio
 
11.51

12.10

   Tier I risk-based capital ratio
 
12.32

12.96

   Total risk-based capital ratio
 
13.27

13.98

   Tangible common equity to tangible assets ratio (4)
 
8.84

8.83

   Tier I leverage ratio 
 
9.11

9.31


* Restated for the 5% stock dividend distributed in December 2015.
(1) Includes loans held for sale.
(2) Revenue includes net interest income and non-interest income.
(3) The efficiency ratio is calculated as non-interest expense (excluding intangibles amortization) as a percent of revenue.
(4) The tangible common equity to tangible assets ratio is a measurement which management believes is a useful indicator of capital adequacy and utilization. It provides a meaningful basis for period to period and company to company comparisons, and also assists regulators, investors and analysts in analyzing the financial position of the Company. Tangible common equity and tangible assets are non-GAAP measures and should not be viewed as substitutes for, or superior to, data prepared in accordance with GAAP.

The following table is a reconciliation of the GAAP financial measures of total equity and total assets to the non-GAAP measures of total tangible common equity and total tangible assets.
 
March 31
(Dollars in thousands)
2016
2015
Total equity
$
2,447,282

$
2,405,407

Less non-controlling interest
5,254

4,793

Less preferred stock
144,784

144,784

Less goodwill
138,921

138,921

Less core deposit premium
4,696

6,149

Total tangible common equity (a)
$
2,153,627

$
2,110,760

Total assets
$
24,506,952

$
24,049,483

Less goodwill
138,921

138,921

Less core deposit premium
4,696

6,149

Total tangible assets (b)
$
24,363,335

$
23,904,413

Tangible common equity to tangible assets ratio (a)/(b)
8.84
%
8.83
%

39

Table of Contents


Results of Operations

Summary
  
Three Months Ended March 31
 
Increase (Decrease)
(Dollars in thousands)
2016
2015
 
Amount
% change
Net interest income
$
163,775

$
146,138

 
$
17,637

12.1
 %
Provision for loan losses
(9,439
)
(4,420
)
 
5,019

113.6

Non-interest income
119,024

106,574

 
12,450

11.7

Investment securities gains (losses), net
(995
)
6,035

 
(7,030
)
N.M.

Non-interest expense
(177,473
)
(163,845
)
 
13,628

8.3

Income taxes
(29,370
)
(28,468
)
 
902

3.2

Non-controlling interest expense
(148
)
(959
)
 
(811
)
(84.6
)
Net income attributable to Commerce Bancshares, Inc.
65,374

61,055

 
4,319

7.1

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


Net income available to common shareholders
$
63,124

$
58,805

 
$
4,319

7.3
 %

For the quarter ended March 31, 2016, net income attributable to Commerce Bancshares, Inc. (net income) amounted to $65.4 million, an increase of $4.3 million, or 7.1%, compared to the first quarter of the previous year. For the current quarter, the annualized return on average assets was 1.07%, the annualized return on average common equity was 11.20%, and the efficiency ratio was 62.62%. Diluted earnings per common share was $.65, an increase of 12.1% compared to $.58 per share in the first quarter of 2015.

Compared to the first quarter of last year, net interest income increased $17.6 million, or 12.1%, mainly due to growth of $10.5 million in interest income on investment securities and $8.0 million in interest income on loans. The provision for loan losses totaled $9.4 million for the current quarter, representing an increase of $5.0 million over the first quarter of 2015. Non-interest income increased $12.5 million, or 11.7%, mainly due to higher deposit, bank card, trust and swap fees, as well as higher sales of tax credits. Additionally, a former branch property was sold in the first quarter of 2016 for a pre-tax gain of $3.3 million. Non-interest expense increased $13.6 million, or 8.3%, over the first quarter of 2015, primarily due to increases in salaries and benefits, data processing costs, and supplies and communications expense. Net investment securities losses totaled $995 thousand in the current quarter compared to gains of $6.0 million in the same quarter last year. The current quarter losses were mainly comprised of fair value adjustments to the Company's private equity portfolio.


40

Table of Contents


Net Interest Income

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

Analysis of Changes in Net Interest Income
 
Three Months Ended March 31, 2016 vs. 2015
 
Change due to
 
 
(In thousands)
Average
Volume
Average
Rate

Total
Interest income, fully taxable equivalent basis:
 
 
 
Loans:
 
 
 
  Business
$
3,239

$
803

$
4,042

  Real estate - construction and land
2,529

(461
)
2,068

  Real estate - business
930

9

939

  Real estate - personal
304

(142
)
162

  Consumer
2,049

(745
)
1,304

  Revolving home equity
(8
)
(87
)
(95
)
  Consumer credit card
94

(194
)
(100
)
     Total interest on loans
9,137

(817
)
8,320

Loans held for sale
120

(6
)
114

Investment securities:
 
 
 
  U.S. government and federal agency securities
(3,275
)
9,945

6,670

  Government-sponsored enterprise obligations
(1,328
)
88

(1,240
)
  State and municipal obligations
(361
)
609

248

  Mortgage-backed securities
3,167

(1,308
)
1,859

  Asset-backed securities
(1,319
)
3,294

1,975

  Other securities
1,416

(306
)
1,110

     Total interest on investment securities
(1,700
)
12,322

10,622

Federal funds sold and short-term securities purchased under
 
 
 
   agreements to resell
4

11

15

Long-term securities purchased under agreements to resell
(586
)
1,010

424

Interest earning deposits with banks
(43
)
134

91

Total interest income
6,932

12,654

19,586

Interest expense:
 
 
 
Deposits:
 
 
 
  Savings
18

7

25

  Interest checking and money market
51

100

151

  Time open & C.D.'s of less than $100,000
(90
)
(48
)
(138
)
  Time open & C.D.'s of $100,000 and over
(7
)
583

576

     Total interest on deposits
(28
)
642

614

Federal funds purchased and securities sold under
 
 
 
   agreements to repurchase
(32
)
553

521

Other borrowings
2,373

(1,999
)
374

Total interest expense
2,313

(804
)
1,509

Net interest income, fully taxable equivalent basis
$
4,619

$
13,458

$
18,077


Net interest income in the first quarter of 2016 was $163.8 million, an increase of $17.6 million over the first quarter of 2015. On a tax equivalent (T/E) basis, net interest income totaled $171.4 million in the first quarter of 2016, up $18.1 million over the same period last year and up $1.3 million over the previous quarter.  The increase in net interest income compared to the first quarter of 2015 was mainly due to higher interest on investment securities of $10.6 million, coupled with higher interest income on loans of $8.3 million. Securities interest includes inflation-related interest on the Company's holdings of U.S. Treasury inflation-protected securities (TIPS), which is tied to the Consumer Price Index. Interest income related to TIPS increased $5.5 million in the first three months of 2016 compared to the same period in 2015, and totaled negative $1.5 million in the current quarter,

41

Table of Contents


negative $1.4 million in the prior quarter and negative $7.0 million in the first quarter of 2015.  The Company's net yield on earning assets was 2.95% in the current quarter, compared to 2.94% in the previous quarter and 2.76% in the first quarter of 2015. Excluding the effects of inflation income, the net yield on earning assets would have been 2.98% in the current quarter, 2.97% in the previous quarter and 2.89% in the first quarter of 2015.
 
Total interest income (T/E) increased $19.6 million over the first quarter of 2015. Interest income on loans (T/E) increased $8.3 million due to an increase of $1.1 billion, or 9.2%, in average loan balances, partly offset by a 10 basis point decrease in average rates earned. The higher balances contributed $9.1 million to interest income; however, the lower rates depressed interest income by $817 thousand, resulting in an $8.3 million net increase in interest income. Most of the increase in interest income occurred in the business, construction, business real estate and consumer loan categories. The largest increase to interest income occurred in business loan interest, which grew $4.0 million due to higher average balances of $459.7 million, or 11.4%, coupled with a five basis point increase in the average rate earned. Construction loan interest grew $2.1 million, as average balances increased $267.6 million, or 64.5%, partly offset by a decline of 30 basis points in the average rate earned. Business real estate and consumer loan interest grew $939 thousand and $1.3 million, respectively, over the same period last year. Average balances of business real estate loans increased $100.3 million, or 4.4%, while the average rate earned declined three basis points. The average balance of consumer loans grew $203.4 million, or 11.8%, partly offset by a decline of 18 basis points in the average rate earned. Most of the increase in average consumer loan balances resulted from growth of $240.4 million in auto loans and other consumer loans, partly offset by a decrease of $48.5 million in marine and recreational vehicle (RV) loans, as that portfolio continues to pay down.

Interest income on investment securities (T/E) was $54.3 million during the first quarter of 2016, which was an increase of $10.6 million over the same quarter last year. The increase resulted mainly from higher TIPS interest of $5.5 million coupled with higher interest on mortgage-backed, asset-backed, and corporate debt securities. Higher interest income on mortgage-backed securities resulted from higher average balances, while growth in interest income on asset-backed securities resulted from higher rates earned, offset by lower balances. The average balance of the total investment portfolio (excluding fair value adjustments) was $9.6 billion in the first quarters of both 2016 and 2015. During the current quarter, adjustments to premium amortization expense due to changes in prepayment speeds on various mortgage and asset-backed securities were not significant.

Interest income on long-term securities purchased under agreements to resell increased $424 thousand over the first quarter of 2015, due to an increase in average rates earned of 46 basis points, partly offset by a decrease in average balances invested of $199.7 million.

The average tax equivalent yield on total interest earning assets was 3.10% in the first quarter of 2016, up from 2.89% in the first quarter of 2015.

Total interest expense increased $1.5 million compared to the first quarter of 2015, due to a $614 thousand increase in interest expense on interest bearing deposits and an $895 thousand increase in interest expense on borrowings. The increase in deposit expense resulted from a slight increase in overall average rates paid, in addition to increases of $284.8 million in average money market account balances and $243.6 million in short-term jumbo C.D. balances. Interest expense on borrowings increased due to higher rates paid on repurchase agreements and higher average FHLB borrowings, partly offset by lower rates paid on the FHLB borrowings. The overall average rate incurred on all interest bearing liabilities was .23% and .19% in the first quarters of 2016 and 2015, respectively.

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


42

Table of Contents


Non-Interest Income
  
Three Months Ended March 31
 
Increase (Decrease)
(Dollars in thousands)
2016
2015
 
Amount
% change
Bank card transaction fees
$
44,470

$
42,299

 
$
2,171

5.1
 %
Trust fees
30,370

29,586

 
784

2.6

Deposit account charges and other fees
20,691

18,499

 
2,192

11.8

Capital market fees
2,725

3,002

 
(277
)
(9.2
)
Consumer brokerage services
3,509

3,336

 
173

5.2

Loan fees and sales
2,510

2,089

 
421

20.2

Other
14,749

7,763

 
6,986

90.0

Total non-interest income
$
119,024

$
106,574

 
$
12,450

11.7
 %
Non-interest income as a % of total revenue*
42.1
%
42.2
%
 
 
 
* Total revenue includes net interest income and non-interest income.

For the first quarter of 2016, total non-interest income amounted to $119.0 million compared with $106.6 million in the same quarter last year, which was an increase of $12.5 million, or 11.7%. This increase was mainly due to higher bank card, trust, deposit, swap, and tax credit fee income. Additionally, a former branch property was sold for a pre-tax gain of $3.3 million, while in 2015, write-downs on branch properties held for sale totaled $1.6 million.

Bank card transaction fees for the current quarter increased $2.2 million, or 5.1%, over the same period last year. The increase was mainly the result of growth in merchant, debit, and corporate card interchange fees of 16.8%, 5.3% and 2.0%, respectively. Credit card fees also increased 4.3% this quarter. The table below is a summary of bank card transaction fees for the three month periods ended March 31, 2016 and 2015.
 
Three Months Ended March 31
 
Increase (Decrease)
(Dollars in thousands)
2016
2015
 
Amount
% change
Debit card fees
$
9,385

$
8,915

 
$
470

5.3
%
Credit card fees
5,645

5,412

 
233

4.3

Merchant fees
7,118

6,092

 
1,026

16.8

Corporate card fees
22,322

21,880

 
442

2.0

Total bank card transaction fees
$
44,470

$
42,299

 
$
2,171

5.1
%

Trust fees for the quarter increased $784 thousand, or 2.6%, over the same quarter last year, resulting mainly from continued growth in personal (1.7%) and institutional (5.8%) trust fees. Deposit account fees increased $2.2 million, or 11.8%, over the same period last year, as deposit account service charges increased $1.4 million, or 38.2%, and overdraft fees increased $468 thousand, or 7.5%. Capital market fees declined $277 thousand to $2.7 million in the current quarter as a result of continued lower sales demand, while consumer brokerage services revenue increased $173 thousand. Loan fees and sales increased $421 thousand this quarter mainly due to higher mortgage banking revenue, which resulted from higher sales of newly originated residential mortgages under the Company's sale program that began in 2015. Other non-interest income increased $7.0 million over the same quarter last year, mainly due to the branch property activity mentioned above. In addition, fees from the sales of interest rate swaps increased $1.0 million and fees from the sales of tax credits increased $678 thousand.

Investment Securities Gains (Losses), Net
 
Three Months Ended March 31
(In thousands)
2016
2015
Available for sale:
 
 
U.S. government bonds
$

$
1,263

Municipal securities

1,260

Asset-backed securities

3

OTTI losses on non-agency mortgage-backed bonds
(123
)
(17
)
Non-marketable:
 
 
Common stock
23


Private equity investments
(895
)
3,526

Total investment securities gains (losses), net
$
(995
)
$
6,035


43

Table of Contents


Net gains and losses on investment securities which were recognized in earnings during the three months ended March 31, 2016 and 2015 are shown in the table above. Net securities losses amounted to $995 thousand in the first quarter of 2016 compared to net gains of $6.0 million in the first quarter of 2015. Included in these net gains and losses are credit-related impairment losses on certain non-agency guaranteed mortgage-backed securities which have been identified as other-than-temporarily impaired. These identified securities had a total fair value of $39.9 million at March 31, 2016.

Also shown above are net gains and losses relating to non-marketable private equity investments, which are primarily held by the Parent's majority-owned private equity subsidiaries. These include fair value adjustments and gains and losses realized upon disposition. The portion of the private equity activity attributable to minority interests is reported as non-controlling interest in the consolidated statements of income and resulted in income of $154 thousand during the first quarter of 2016 and expense of $704 thousand during the first quarter of 2015.

During the first quarter of 2015, the Company sold $114.4 million of municipal bonds and $48.1 million of U.S. Treasury inflation-protected bonds, as part of plan to extend the duration of the securities portfolio. Gains of $2.5 million were realized on these sales.

Non-Interest Expense
  
Three Months Ended March 31
 
Increase (Decrease)
(Dollars in thousands)
2016
2015
 
Amount
% change
Salaries and employee benefits
$
106,859

$
98,074

 
$
8,785

9.0
 %
Net occupancy
11,303

11,561

 
(258
)
(2.2
)
Equipment
4,634

4,703

 
(69
)
(1.5
)
Supplies and communication
6,829

5,581

 
1,248

22.4

Data processing and software
22,899

19,506

 
3,393

17.4

Marketing
3,813

3,918

 
(105
)
(2.7
)
Deposit insurance
3,165

3,001

 
164

5.5

Other
17,971

17,501

 
470

2.7

Total non-interest expense
$
177,473

$
163,845

 
$
13,628

8.3
 %

Non-interest expense for the first quarter of 2016 amounted to $177.5 million, an increase of $13.6 million, or 8.3%, compared with $163.8 million in the first quarter of last year. Salaries expense increased $6.1 million, or 7.5%, mainly due to higher full-time salaries and incentives expense. Employee benefits expense also increased $2.7 million, or 16.3%, mostly due to higher medical and payroll tax costs. Growth in salaries expense resulted partly from higher staffing costs, mainly in the areas of residential lending, commercial card, trust, information technology and other supporting units, partially offset by lower staffing in branches and deposit operations. Full-time equivalent employees totaled 4,765 at March 31, 2016 compared to 4,769 at March 31, 2015. Compared to the first quarter of last year, occupancy expense decreased 2.2% and equipment expense declined 1.5%, while supplies and communication expense increased $1.2 million, or 22.4%, mainly due to higher reissuance costs for new chip cards distributed to customers. Data processing and software costs increased by $3.4 million, or 17.4%, mainly due to higher bank card processing costs, software expense and outsourced lockbox costs. Other non-interest expense increased $470 thousand, or 2.7%, compared to the previous year. This increase was mainly due to a recovery of $468 thousand in litigation costs recorded in the first quarter of 2015 that did not reoccur. In addition, higher costs were recorded in bank card rewards expense and charitable contribution expense. These increases were partly offset by higher deferrals of loan origination costs and lower costs for operating lease depreciation.


44

Table of Contents


Provision and Allowance for Loan Losses
 
Three Months Ended
(In thousands)
Mar. 31, 2016
Dec. 31, 2015
Mar. 31, 2015
Provision for loan losses
$
9,439

$
9,186

$
4,420

Net loan charge-offs (recoveries):
 
 
 
Commercial:
 
 
 
  Business
463

(133
)
159

  Real estate-construction and land
(11
)
60

(946
)
  Real estate-business
(242
)
(626
)
(249
)
Personal Banking:
 
 
 
  Real estate-personal
(195
)
458

99

  Consumer
2,599

2,251

1,743

  Revolving home equity
88

210

40

  Consumer credit card
5,918

6,479

6,352

  Overdrafts
219

487

222

Total net loan charge-offs
$
8,839

$
9,186

$
7,420


 
Three Months Ended
 
Mar. 31, 2016
Dec. 31, 2015
Mar. 31, 2015
Annualized net loan charge-offs (recoveries)*:
 
 
 
Commercial:
 
 
 
  Business
.04
 %
(.01
)%
.02
 %
  Real estate-construction and land
(.01
)
.04

(.92
)
  Real estate-business
(.04
)
(.11
)
(.04
)
Personal Banking:
 
 
 
  Real estate-personal
(.04
)
.09

.02

  Consumer
.54

.47

.41

  Revolving home equity
.08

.19

.04

  Consumer credit card
3.16

3.40

3.44

  Overdrafts
18.46

30.65

16.04

Total annualized net loan charge-offs
.28
 %
.30
 %
.26
 %
* as a percentage of average loans (excluding loans held for sale)

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

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 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

45

Table of Contents


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 staffs that continuously review loan quality and report the results of their reviews and examinations to the Company’s senior management and Board of Directors. Such reviews also assist management in establishing the level of the allowance. 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 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. Note 1 in the 2015 Annual Report on Form 10-K contains additional discussion on the allowance and charge-off policies.

Net loan charge-offs in the first quarter of 2016 amounted to $8.8 million, compared with $9.2 million in the prior quarter and $7.4 million in the first quarter of last year. The decrease in current quarter net charge-offs from the previous quarter was mainly due to declines in personal real estate, consumer credit card, and overdraft net loan charge-offs of $653 thousand, $561 thousand, and $268 thousand, respectively. These decreases in net loan charge-offs were partially offset by an increase of $596 thousand in net loan charge-offs on business loans, as well as increases on net loan charge-offs on business real estate and consumer loans of $384 thousand and $348 thousand, respectively. Compared to the first quarter of 2015, net loan charge-offs grew $1.4 million in the current quarter. The increase in net loan charge-offs this quarter compared to the same quarter last year was primarily due to increases of $935 thousand and $856 thousand in net loan charge-offs on construction and consumer loans, respectively.

For the three months ended March 31, 2016, the ratio of annualized total net loan charge-offs to total average loans was .28%, compared to .30% in the previous quarter and .26% in the same quarter last year. Annualized net charge-offs on average consumer credit card loans were 3.16% in the current quarter, compared with 3.40% in the previous quarter and 3.44% in the same period last year. Consumer loan net charge-offs in the current quarter amounted to .54% of average consumer loans, compared to .47% in the previous quarter and .41% in the same quarter last year.

The provision for loan losses in the current quarter totaled $9.4 million and was $600 thousand higher than net loan charge-offs in the quarter. Compared to the previous quarter, the provision for loan losses for the first quarter of 2016 increased $253 thousand and was $5.0 million higher than the provision for loan losses for the three months ended March 31, 2015. The increase in the provision for loan losses was driven by growth in loans and higher net charge-offs in the first quarter of 2016 compared to the same quarter of the previous year, as described above. Additionally, the allowance for loan losses was lowered by $3.0 million during the first quarter of 2015, which reduced the provision during that period.

At March 31, 2016, the allowance for loan losses amounted to $152.1 million and was 1.20% of total loans and 518% of total non-accrual loans. At December 31, 2015, the allowance for loan losses amounted to $151.5 million and was 1.22% of total loans and 570% of total non-accrual loans.


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Table of Contents


Risk Elements of Loan Portfolio

The following table presents non-performing assets and loans which are past due 90 days and still accruing interest. Non-performing assets include non-accruing loans and foreclosed real estate. Loans are placed on non-accrual status when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment. Loans that are 90 days past due as to principal and/or interest payments are generally placed on non-accrual, unless they are both well-secured and in the process of collection, or they are personal banking loans that are exempt under regulatory rules from being classified as non-accrual.
(Dollars in thousands)
March 31, 2016
December 31, 2015
Non-accrual loans
$
29,367

$
26,575

Foreclosed real estate
1,997

2,819

Total non-performing assets
$
31,364

$
29,394

Non-performing assets as a percentage of total loans
.25
%
.24
%
Non-performing assets as a percentage of total assets
.13
%
.12
%
Total loans past due 90 days and still accruing interest
$
15,360

$
16,467


Non-accrual loans, which are also classified as impaired, totaled $29.4 million at March 31, 2016, and increased $2.8 million over balances at December 31, 2015. The increase occurred mainly in business loans, which increased $5.2 million largely due to the addition of a single automobile floor plan loan. At March 31, 2016, non-accrual loans were comprised mainly of business (54.8%), business real estate (21.2%), and personal real estate (14.3%) loans. Foreclosed real estate totaled $2.0 million at March 31, 2016, a decrease of $822 thousand when compared to December 31, 2015. Total loans past due 90 days or more and still accruing interest were $15.4 million as of March 31, 2016, a decrease of $1.1 million when compared to December 31, 2015. Balances by class for non-accrual loans and loans past due 90 days and still accruing interest are shown in the "Delinquent and non-accrual loans" section in Note 2 to the consolidated financial statements.

In addition to the non-performing and past due loans mentioned above, the Company also has identified loans for which management has concerns about the ability of the borrowers to meet existing repayment terms. They are classified as substandard under the Company's internal rating system. The loans are generally secured by either real estate or other borrower assets, reducing the potential for loss should they become non-performing. Although these loans are generally identified as potential problem loans, they may never become non-performing. Such loans totaled $112.8 million at March 31, 2016 compared with $113.1 million at December 31, 2015, resulting in a decrease of $355 thousand, or .3%.


(In thousands)
March 31, 2016
December 31, 2015
Potential problem loans:
 
 
  Business
$
58,866

$
58,860

  Real estate – construction and land
1,091

1,159

  Real estate – business
50,784

51,107

  Real estate – personal
2,047

1,755

  Consumer

262

Total potential problem loans
$
112,788

$
113,143


At March 31, 2016, the Company had $66.4 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 $33.9 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. Additional information about the major types of loans in these categories and their risk features are provided below. Information based on loan-to-value (LTV) ratios was generally calculated with valuations at loan origination date. The Company does not attempt to obtain updated appraisals or valuations unless the loans become significantly delinquent or are in the process of being foreclosed upon.


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Table of Contents


Real Estate – Construction and Land Loans
The Company's portfolio of construction and land loans, as shown in the table below, amounted to 5.9% of total loans outstanding at March 31, 2016.
(Dollars in thousands)
March 31, 2016


% of Total
% of
Total
Loans
December 31, 2015
    

% of Total
% of
Total
Loans
Residential land and land development
$
79,566

10.7
%
.6
%
$
72,622

11.6
%
.6
%
Residential construction
144,030

19.3

1.2

131,943

21.2

1.1

Commercial land and land development
63,552

8.5

.5

54,176

8.7

.4

Commercial construction
458,221

61.5

3.6

365,329

58.5

2.9

Total real estate - construction and land loans
$
745,369

100.0
%
5.9
%
$
624,070

100.0
%
5.0
%

Real Estate – Business Loans
Total business real estate loans were $2.4 billion at March 31, 2016 and comprised 18.9% of the Company's total loan portfolio. These loans include properties such as manufacturing and warehouse buildings, small office and medical buildings, churches, hotels and motels, shopping centers, and other commercial properties. At March 31, 2016, 42.0% of business real estate loans were for owner-occupied real estate properties, which present lower risk profiles.

(Dollars in thousands)
March 31, 2016


% of Total
% of
Total
Loans
December 31, 2015


% of Total
% of
Total
Loans
Owner-occupied
$
1,007,335

42.0
%
7.9
%
$
983,844

41.8
%
7.9
%
Retail
325,214

13.6

2.6

322,644

13.7

2.6

Office
230,432

9.6

1.8

218,018

9.3

1.8

Multi-family
212,421

8.9

1.7

196,212

8.3

1.6

Farm
165,488

6.9

1.3

167,344

7.1

1.3

Hotels
155,130

6.5

1.2

157,317

6.7

1.2

Industrial
108,609

4.5

.9

112,261

4.7

.9

Other
191,304

8.0

1.5

197,904

8.4

1.6

Total real estate - business loans
$
2,395,933

100.0
%
18.9
%
$
2,355,544

100.0
%
18.9
%

Real Estate – Personal Loans
The Company's $1.9 billion personal real estate loan portfolio is composed mainly of residential first mortgage real estate loans. As shown on page 45, recent loss rates have remained low, and at March 31, 2016, loans past due over 30 days decreased $1.2 million and non-accrual loans decreased $220 thousand compared to December 31, 2015. Also, as shown in Note 2, only 4.2% of this portfolio has FICO scores of less than 660. Approximately $15.9 million, or .8%, of personal real estate loans were structured with interest only payments. These loans are typically made to high net-worth borrowers and generally have low LTV ratios at origination or have additional collateral pledged to secure the loan. Therefore, they are not perceived to represent above normal credit risk. Loans originated with interest only payments were not made to "qualify" the borrower for a lower payment amount. At March 31, 2016, loans with no mortgage insurance and an original LTV higher than 80% totaled $150.9 million compared to $146.8 million at December 31, 2015.

Revolving Home Equity Loans
The Company had $423.0 million in revolving home equity loans at March 31, 2016 that were generally collateralized by residential real estate. Most of these loans (93.8%) are written with terms requiring interest only monthly payments. These loans are offered in three main product lines: LTV up to 80%, 80% to 90%, and 90% to 100%. As of March 31, 2016, the outstanding principal of loans with an original LTV higher than 80% was $67.9 million, or 16.1% of the portfolio, compared to $68.1 million as of December 31, 2015. Total revolving home equity loan balances over 30 days past due or on non-accrual status were $3.9 million at March 31, 2016 compared to $5.0 million at December 31, 2015.  The weighted average FICO score for the total current portfolio balance is 770. At maturity, the accounts are re-underwritten, and if they qualify under the Company's credit, collateral and capacity policies, the borrower is given the option to renew the line of credit or convert the outstanding balance to an amortizing loan.  If criteria are not met, amortization is required, or the borrower may pay off the loan. During the remainder of 2016 through 2018, approximately 30% of the Company's current outstanding balances are expected to mature. Of these balances, approximately 81% have a FICO score of 700 or higher. The Company does not expect a significant increase in losses as these loans mature, due to their high FICO scores, low LTVs, and low historical loss levels.

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Table of Contents


Fixed Rate Home Equity Loans
In addition to the residential real estate mortgage and the revolving home equity products mentioned above, the Company offers a third choice to those consumers desiring a fixed rate home equity loan with a fixed maturity date and a determined amortization schedule. The fixed rate home equity loan is typically used to finance a specific home repair or remodeling project. This portfolio of loans approximated $305.8 million and $304.5 million at March 31, 2016 and December 31, 2015, respectively. At March 31, 2016, $81.6 million of this portfolio had an LTV higher than 80% compared to a balance of $83.0 million at the end of 2015.

At times, these loans are written with interest only monthly payments and a balloon payoff at maturity; however, such loans totaled less than 1% of the outstanding balance of fixed rate home equity loans at March 31, 2016. The Company limits the offering of fixed rate home equity loans with LTV ratios over 90%, and only $591 thousand in new fixed rate home equity loans were written with these LTV ratios during the first three months of 2016.

Management does not believe these loans collateralized by real estate (personal real estate, revolving home equity, and fixed rate home equity) represent any unusual concentrations of risk, as evidenced by the net charge-offs (recoveries) on these loans in the first three months of 2016 of ($195 thousand), $88 thousand, and ($7 thousand), respectively. The amount of any increased potential loss on high LTV agreements relates mainly to amounts advanced that are in excess of the 80% collateral calculation, not the entire approved line. The Company currently offers no subprime first mortgage or home equity loans, which are characterized as new loans to customers with FICO scores below 660. The Company does not purchase brokered loans.

Other Consumer Loans
Within the consumer loan portfolio are several direct and indirect product lines, which include loans for the purchase of automobiles, marine and RVs. Outstanding balances for auto loans were $962.1 million and $996.0 million at March 31, 2016 and December 31, 2015, respectively. The balances over 30 days past due amounted to $8.3 million at March 31, 2016 compared to $10.8 million at the end of 2015, and comprised .9% and 1.1% of the outstanding balances of these loans at March 31, 2016 and December 31, 2015, respectively. For the three months ended March 31, 2016, $120.9 million of new auto loans were originated, compared to $497.2 million during the full year of 2015.  At March 31, 2016, the automobile loan portfolio had a weighted average FICO score of 728.
The Company's balance of marine and RV loans totaled $131.8 million at March 31, 2016, compared to $143.1 million at December 31, 2015, and the balances over 30 days past due amounted to $4.0 million at March 31, 2016 compared to $5.1 million at the end of 2015. The net charge-offs on marine and RV loans declined from $459 thousand in the first three months of 2015, to $140 thousand in the first three months of the current year.

Additionally, the Company offers low promotional rates on selected consumer credit card products. Out of a portfolio at March 31, 2016 of $744.4 million in consumer credit card loans outstanding, approximately $174.5 million, or 23.4%, carried a low promotional rate. Within the next six months, $53.6 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 $144.8 million at March 31, 2016, as shown in the table below. As of March 31, 2016, there were $11.0 million energy loans, or 7.6% of the energy portfolio, with a "substandard" rating or on non-accrual status, and there were no energy loans 90 days past due and still accruing interest.
(In thousands)
March 31, 2016
December 31, 2015
 
Unfunded commitments at March 31, 2016
Extraction
$
75,387

$
65,649

 
$
14,164

Mid-stream shipping and storage
25,258

28,678

 
49,539

Downstream distribution and refining
29,105

27,246

 
16,026

Support activities
15,061

14,946

 
7,302

Total energy lending portfolio
$
144,811

$
136,519

 
$
87,031





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Table of Contents


Shared National Credits
The Company participates in credits of large, publicly traded companies which are defined by regulation as shared national credits, or SNCs. Regulations define SNCs as loans exceeding $20 million that are shared by three or more financial institutions. The Company typically participates in these loans when business operations are maintained in the local communities or regional markets and opportunities to provide other banking services are present. The balance of SNC loans totaled $784.9 million at March 31, 2016, compared to $656.0 million at December 31, 2015. Additional unfunded commitments at March 31, 2016 totaled $1.2 billion.

Income Taxes
Income tax expense was $29.4 million in the first quarter of 2016, compared to $27.7 million in the fourth quarter of 2015 and $28.5 million in the first quarter of 2015. The Company's effective tax rate, including the effect of non-controlling interest, was 31.0% in the first quarter of 2016, compared to 30.3% in the fourth quarter of 2015 and 31.8% in the first quarter of 2015.

Financial Condition

Balance Sheet

Total assets of the Company were $24.5 billion at March 31, 2016 and $24.6 billion December 31, 2015. Earning assets (excluding fair value adjustments on investment securities) amounted to $23.3 billion at March 31, 2016 and $23.2 billion at December 31, 2015, and consisted of 55% in loans and 41% in investment securities.

During the first quarter of 2016, average total loans increased $313.1 million, or 10% annualized, compared to the previous quarter and increased $1.1 billion, or 9.2%, compared to the same period last year. Compared to the previous quarter, the increase in average loans resulted mainly from growth in business of $139.8 million, construction of $98.4 million, business real estate of $61.7 million, and consumer loans of $26.0 million. The increase in business loans came from continued growth in commercial and industrial, leasing and tax-free lending activities, while commercial construction projects continued to drive growth in construction loans. Average consumer loan growth was largely the result of continued demand for automobile and other consumer type loans, which grew $36.4 million, partly offset by a decline of $9.6 million in marine and RV loans. Average personal real estate loans declined $6.7 million this quarter; however, the Company also sold certain fixed rate loans totaling $22.0 million during the quarter, as part of an origination initiative that began in 2015. In March 2016, the Company identified certain automobile loans totaling $50.4 million which it intends to sell, and reclassified these loans as held for sale.

During the first quarter of 2016, total average available for sale investment securities, at fair value, increased $90.0 million to $9.7 billion. Purchases of securities totaled $215.1 million in the first quarter of 2016 and were offset by sales, maturities and pay downs of $541.9 million. U.S. government and federal agency securities increased on average by $122.4 million, while mortgage-backed securities increased $89.1 million. At March 31, 2016, the duration of the investment portfolio was 2.8 years, and maturities and pay downs of approximately $1.6 billion are expected to occur during the next 12 months.

Total average deposits increased $499.8 million, or 2.6%, this quarter compared to the previous quarter. The increase in average deposits resulted mainly from increases in money market, savings, and short-term jumbo certificate of deposit accounts, which increased $324.6 million, $24.2 million, and $264.7 million, respectively. Business demand deposits declined $159.6 million this quarter. Compared to the previous quarter, total average commercial, consumer and private banking deposits increased $250.7 million, $172.4 million, and $80.7 million, respectively. The average loans to deposits ratio was 62.8% in both the current quarter and in the prior quarter.

The Company’s average borrowings totaled $1.8 billion in the current quarter, and declined $28.8 million compared to the prior quarter. The decline resulted from a decrease of $302.7 million in average balances of federal funds purchased and repurchase agreements, partly offset by an increase in average FHLB borrowings of $272.5 million. The additional FHLB borrowings were repaid as of March 31, 2016.


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Table of Contents


Liquidity and Capital Resources

Liquidity Management
The Company’s most liquid assets are comprised of available for sale investment securities, federal funds sold, securities purchased under agreements to resell (resale agreements), and balances at the Federal Reserve Bank, as follows:
(In thousands)
 
March 31, 2016
 
March 31, 2015
 
December 31, 2015
Liquid assets:
 
 
 
 
 
 
  Available for sale investment securities
 
$
9,552,179

 
$
9,917,242

 
$
9,777,004

  Federal funds sold
 
9,075

 
12,450

 
14,505

  Long-term securities purchased under agreements to resell
 
825,000

 
1,050,000

 
875,000

  Balances at the Federal Reserve Bank
 
171,651

 
123,712

 
23,803

  Total
 
$
10,557,905

 
$
11,103,404

 
$
10,690,312


Federal funds sold, which are funds lent to the Company's correspondent bank customers with overnight maturities, totaled $9.1 million as of March 31, 2016. Long-term resale agreements, maturing in 2016 through 2018, totaled $825.0 million at March 31, 2016. Under these agreements, the Company lends funds to upstream financial institutions and holds marketable securities, safe-kept by a third-party custodian, as collateral. This collateral totaled $866.0 million in fair value at March 31, 2016. Interest earning balances at the Federal Reserve Bank, which have overnight maturities and are used for general liquidity purposes, totaled $171.7 million at March 31, 2016. The fair value of the available for sale investment portfolio was $9.6 billion at March 31, 2016 and included an unrealized net gain in fair value of $198.7 million. The total net unrealized gain included net gains of $78.6 million on mortgage and asset-backed securities, $51.0 million on state and municipal obligations, and $37.3 million on common and preferred stock held by the Parent.

Approximately $1.6 billion of the available for sale investment portfolio is expected to mature or pay down during the next 12 months, and these funds offer substantial resources to meet new loan demand or help offset reductions in the Company's deposit funding base. The Company pledges portions of its investment securities portfolio to secure public fund deposits, securities sold under agreements to repurchase, trust funds, letters of credit issued by the FHLB, and borrowing capacity at the Federal Reserve Bank. Total investment securities pledged for these purposes were as follows:
(In thousands)
March 31, 2016
March 31, 2015
December 31, 2015
Investment securities pledged for the purpose of securing:
    
 
 
  Federal Reserve Bank borrowings
$
150,544

$
307,534

$
166,153

  FHLB borrowings and letters of credit
28,822

38,728

31,095

  Securities sold under agreements to repurchase
1,632,978

2,284,774

2,116,537

  Other deposits and swaps
2,124,074

2,055,315

1,827,195

  Total pledged securities
3,936,418

4,686,351

4,140,980

  Unpledged and available for pledging
3,800,391

3,473,037

3,886,219

  Ineligible for pledging
1,815,370

1,757,854

1,749,805

  Total available for sale securities, at fair value
$
9,552,179

$
9,917,242

$
9,777,004


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 March 31, 2016, such deposits totaled $18.3 billion and represented 88.3% of total deposits. These core deposits are normally less volatile, as they are often with customer relationships tied to other products offered by the Company, promoting long lasting relationships and stable funding sources. Time open and certificates of deposit of $100,000 and over totaled $1.6 billion at March 31, 2016. These accounts are normally considered more volatile and higher costing and comprised 8.0% of total deposits at March 31, 2016.
(In thousands)
March 31, 2016
March 31, 2015
December 31, 2015
Core deposit base:
 
 
 
 Non-interest bearing
$
7,065,066

$
6,785,221

$
7,146,398

 Interest checking
1,064,499

1,013,569

1,267,757

 Savings and money market
10,140,858

9,642,570

9,566,989

 Total
$
18,270,423

$
17,441,360

$
17,981,144



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Table of Contents


Other important components of liquidity are the level of borrowings from third party sources and the availability of future credit. The Company's outside borrowings are mainly comprised of federal funds purchased, securities sold under agreements to repurchase, and advances from the FHLB, as follows:
(In thousands)
March 31, 2016
March 31, 2015
December 31, 2015
Borrowings:
 
 
 
 Federal funds purchased
$
3,885

$
13,588

$
556,970

 Securities sold under agreements to repurchase
953,503

1,596,875

1,406,582

 FHLB advances
103,806

103,854

103,818

 Total
$
1,061,194

$
1,714,317

$
2,067,370


Federal funds purchased are unsecured overnight borrowings obtained mainly from upstream correspondent banks with which the Company maintains approved lines of credit. Securities sold under agreements to repurchase are secured by a portion of the Company's investment portfolio and are comprised of non-insured customer funds totaling $953.5 million, which generally mature overnight. The Company also borrows on a secured basis through advances from the FHLB, which totaled $103.8 million at March 31, 2016. These advances have fixed interest rates, and all mature in or before 2017.

The Company pledges certain assets, including loans and investment securities, to both the Federal Reserve Bank and the FHLB as security to establish lines of credit and borrow from these entities. Based on the amount and type of collateral pledged, the FHLB establishes a collateral value from which the Company may draw advances against the collateral. Also, this collateral is used to enable the FHLB to issue letters of credit in favor of public fund depositors of the Company. The Federal Reserve Bank also establishes a collateral value of assets pledged to support borrowings from the discount window. The following table reflects the collateral value of assets pledged, borrowings, and letters of credit outstanding, in addition to the estimated future funding capacity available to the Company at March 31, 2016.
 
March 31, 2016
(In thousands)

FHLB
Federal Reserve

Total
Collateral value pledged
$
2,434,054

$
1,234,749

$
3,668,803

Advances outstanding
(103,806
)

(103,806
)
Letters of credit issued
(178,050
)

(178,050
)
Available for future advances
$
2,152,198

$
1,234,749

$
3,386,947


In addition to those mentioned above, several other sources of liquidity are available. The Bank has strong issuer ratings of A from Standard & Poor's and A2 from Moody's. Additionally, the Parent's sound commercial paper rating of P-1 from Moody's would help ensure the ready marketability of its commercial paper, should the need arise. No commercial paper has been issued or outstanding during the past ten years. The Company has no subordinated debt or hybrid instruments which could affect future borrowing capacity. Because of its lack of significant long-term debt, the Company believes that it could generate additional liquidity through its Capital Markets Group from sources such as jumbo certificates of deposit or privately placed corporate debt.

The cash flows from the operating, investing and financing activities of the Company resulted in a net increase in cash and cash equivalents of $53.5 million during the first three months of 2016, as reported in the consolidated statements of cash flows in this report. Operating activities, consisting mainly of net income adjusted for certain non-cash items, provided cash flow of $195.9 million and has historically been a stable source of funds. Investing activities, which occur mainly in the loan and investment securities portfolios, provided cash of $83.5 million. These activities included $542.2 million in sales, maturity and pay downs of investment securities, offset by purchases of $180.8 million, and a net increase in loans of $321.0 million. Additionally, repayments of long-term securities purchased under agreements to resell provided cash of $50.0 million. Financing activities used cash of $225.9 million, resulting from a net decrease in borrowings of federal funds purchased and securities sold under agreements to repurchase of $1.0 billion. In addition, cash was used to fund dividends paid on common and preferred stock of $24.0 million, and $36.4 million was used to purchase treasury stock. These cash outlays were partially offset by a net increase of $839.5 million in deposits. Future short-term liquidity needs arising from daily operations are not expected to vary significantly, and the Company believes it will be able to meet these cash flow needs.


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Capital Management

The Company met all capital adequacy requirements and had regulatory capital ratios in excess of the levels established for well-capitalized institutions at March 31, 2016 and December 31, 2015, as shown in the following table.

(Dollars in thousands)
March 31, 2016
December 31, 2015
Minimum Ratios under Capital Adequacy Guidelines *
Minimum Ratios
for
Well-Capitalized
Banks **
Risk-adjusted assets
$
17,900,988

$
17,809,554

 
 
Tier I common risk-based capital
2,060,741

2,051,474

 
 
Tier I risk-based capital
2,205,525

2,196,258

 
 
Total risk-based capital
2,375,549

2,364,761

 
 
Tier I common risk-based capital ratio
11.51
%
11.52
%
7.00
%
6.50
%
Tier I risk-based capital ratio
12.32
%
12.33
%
8.50
%
8.00
%
Total risk-based capital ratio
13.27
%
13.28
%
10.50
%
10.00
%
Tier I leverage ratio
9.11
%
9.23
%
4.00
%
5.00
%
* as of the fully phased-in date of Jan. 1, 2019, including capital conservation buffer
**under Prompt Corrective Action requirements

The Company maintains a treasury stock buyback program under authorizations by its Board of Directors and normally purchases stock in the open market, and during the first quarter of 2016, the Company purchased 900,929 shares of treasury stock at an average price of $40.44. At March 31, 2016, 3,817,015 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. The Company paid a $.225 per share cash dividend on its common stock in the first quarter of 2016, which was a 5% increase compared to its 2015 quarterly dividend.

Commitments, Off-Balance Sheet Arrangements and Contingencies

In the normal course of business, various commitments and contingent liabilities arise which are not required to be recorded on the balance sheet. The most significant of these are loan commitments, which at March 31, 2016 totaled $10.0 billion (including approximately $4.8 billion in unused approved credit card lines). In addition, the Company enters into standby and commercial letters of credit. These contracts totaled $346.6 million and $3.6 million, respectively, at March 31, 2016. As many commitments expire unused or only partially used, these totals do not necessarily reflect future cash requirements. The carrying value of the guarantee obligations associated with the standby letters of credit, which has been recorded as a liability on the consolidated balance sheet, amounted to $2.7 million at March 31, 2016.

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 the first three months of 2016, purchases and sales of tax credits amounted to $13.8 million and $12.9 million, respectively. At March 31, 2016, the Company expected to fund outstanding purchase commitments of $62.5 million during the remainder of 2016.


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Segment Results

The table below is a summary of segment pre-tax income results for the first three months of 2016 and 2015.

(Dollars in thousands)
Consumer
Commercial
Wealth
Segment
Totals    
Other/ Elimination
Consolidated Totals
Three Months Ended March 31, 2016
    
    
    
    
    
    
Net interest income
$
66,570

$
75,911

$
10,875

$
153,356

$
10,419

$
163,775

Provision for loan losses
(8,725
)
19

(106
)
(8,812
)
(627
)
(9,439
)
Non-interest income
29,896

51,119

34,402

115,417

3,607

119,024

Investment securities losses, net




(995
)
(995
)
Non-interest expense
(68,976
)
(69,757
)
(28,540
)
(167,273
)
(10,200
)
(177,473
)
Income before income taxes
$
18,765

$
57,292

$
16,631

$
92,688

$
2,204

$
94,892

Three Months Ended March 31, 2015
    
    
    
    
    
    
Net interest income
$
65,664

$
71,111

$
10,742

$
147,517

$
(1,379
)
$
146,138

Provision for loan losses
(8,323
)
877

7

(7,439
)
3,019

(4,420
)
Non-interest income
26,612

47,581

33,659

107,852

(1,278
)
106,574

Investment securities gains, net




6,035

6,035

Non-interest expense
(66,692
)
(64,770
)
(27,270
)
(158,732
)
(5,113
)
(163,845
)
Income before income taxes
$
17,261

$
54,799

$
17,138

$
89,198

$
1,284

$
90,482

Increase (decrease) in income before income taxes:
 
 
 
 
 
 
   Amount
$
1,504

$
2,493

$
(507
)
$
3,490

$
920

$
4,410

   Percent
8.7
%
4.5
%
(3.0
)%
3.9
%
71.7
%
4.9
%

Consumer

For the three months ended March 31, 2016, income before income taxes for the Consumer segment increased $1.5 million, or 8.7%, compared to the first three months of 2015. This increase was mainly due to growth in non-interest income of $3.3 million, or 12.3%, and net interest income of $906 thousand, or 1.4%. These increases were partly offset by higher non-interest expense of $2.3 million, or 3.4%, and an increase in the provision for loan losses of $402 thousand, or 4.8%. Net interest income increased due to a $916 thousand increase in net allocated funding credits assigned to the Consumer segment's loan and deposit portfolios. Non-interest income increased mainly due to growth in deposit fees (mainly deposit account service fees and overdraft and return item fees), mortgage banking revenue and bank card fees. Non-interest expense increased over the same period in the previous year due to higher bank card processing costs and supplies and communication expense. Supplies and communication expense increased over the prior year due to higher reissuance costs for new chip cards distributed to customers. The provision for loan losses totaled $8.7 million, a $402 thousand increase over the first three months of 2015, which was mainly due to higher personal loan net charge-offs resulting from growth in the auto loan portfolio, partly offset by lower credit card and marine and RV loan net charge-offs.

Commercial

For the three months ended March 31, 2016, income before income taxes for the Commercial segment increased $2.5 million, or 4.5%, compared to the same period in the previous year. This increase was mainly due to growth in net interest income and non-interest income, partly offset by higher non-interest expense and provision for loan losses. Net interest income increased $4.8 million, or 6.8%, due to an increase in loan interest income, partly offset by a decline in net allocated funding credits and higher deposit interest expense. Non-interest income increased by $3.5 million, or 7.4%, over the previous year due to growth in corporate and merchant bank card fees, swap fees and tax credit sales fees. Non-interest expense increased $5.0 million, or 7.7%, mainly due to increases in salaries expense, bank card processing costs, and allocated servicing and support costs. The provision for loan losses increased $858 thousand over the same period last year, due to lower construction loan net recoveries, partly offset by net recoveries on personal real estate loans.

Wealth

Wealth segment pre-tax profitability for the three months ended March 31, 2016 decreased $507 thousand, or 3.0%, from the same period in the previous year. Net interest income increased $133 thousand, mainly due to an increase in loan interest income, offset by lower net allocated funding credits. Non-interest income increased $743 thousand, or 2.2%, over the prior year largely due to higher personal and institutional trust fees. Non-interest expense increased $1.3 million, or 4.7%, mainly due to higher

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full-time salary costs and incentive compensation. The provision for loan losses increased $113 thousand, mainly due to higher revolving home equity loan net charge-offs.

The Other/Elimination category in the preceding table includes the activity of various support and overhead operating units of the Company, in addition to the investment securities portfolio and other items not allocated to the segments. In accordance with the Company’s transfer pricing procedures, the difference between the total provision and total net charge-offs/recoveries is not allocated to a business segment and is included in this category. The pre-tax profitability of this category was higher than in the same period last year by $920 thousand. This increase was partly due to higher unallocated net interest income of $11.8 million and non-interest income of $4.9 million, offset by higher non-interest expense of $5.1 million. Unallocated securities losses were $995 thousand in the first quarter of 2016 compared to gains of $6.0 million in 2015. Also, the unallocated loan loss provision increased $3.6 million, largely due to the $3.0 million excess of total net charge-offs over total provision in the first three months of 2015.

Regulatory Changes Affecting the Banking Industry

In accordance with the Dodd-Frank Act, the Company began submitting its stress test results to the Federal Reserve in March 2014 and publicly disclosed the results of its stress testing for the first time in June 2015. In 2016, the Company expects to submit its stress test report to the Federal Reserve in July and will publicly disclose the results in October.

The Volcker Rule of the Dodd-Frank Act, effective on April 1, 2014, places trading restrictions on financial institutions and separates investment banking, private equity and proprietary trading (hedge fund) sections of financial institutions from their consumer lending arms. Key provisions restrict banks from simultaneously entering into advisory and creditor roles with their clients, such as with private equity firms. The Volcker Rule also restricts financial institutions from investing in and sponsoring certain types of investments, which must be divested by July 21, 2016. The Federal Reserve has announced its intention to grant an additional one-year extension to July 21,2017. The Company does not believe it will be significantly affected by the Volcker Rule provisions.

Impact of Recently Issued Accounting Standards

Revenue from Contracts with Customers The FASB issued ASU 2014-09, "Revenue from Contracts with Customers", in May 2014. The ASU supersedes revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific revenue recognition guidance in the FASB Accounting Standards Codification. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance identifies specific steps that entities should apply in order to achieve this principle. Under the ASU, the amendments are effective for interim and annual periods beginning January 1, 2018 and must be applied retrospectively. The Company is in the process of evaluating the impact of the ASU's adoption on the Company's consolidated financial statements, including potential changes to the Company's accounting for brokerage commissions, investment and trust fees, real-estate sales, and credit card loyalty programs.

In 2016, the FASB began to issue targeted guidance to clarify specific implementation issues of ASU 2014-09. In March 2016, the FASB issued ASU 2016-08, "Principal versus Agent Considerations (Reporting Revenue Gross versus Net)", which provides guidance on determining an entity's role in providing goods and services as a principal versus an agent, and whether it controls each specified good or service before it is transferred to the customer. In April 2016, ASU 2016-10, "Identifying Performance Obligations and Licensing", was issued, which clarifies the guidance related to whether goods or services are distinct within the contract and therefore are a performance obligation, and clarifies the timing and pattern of revenue recognition for licenses of intellectual property. The effective date and transition requirements of these ASUs are the same as those of ASU 2014-09.

Derivatives The FASB issued ASU 2014-16, "Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share is More Akin to Debt or to Equity", in November 2014. The ASU provides guidance relating to certain hybrid financial instruments when determining whether the characteristics of the embedded derivative feature are clearly and closely related to the host contract. In making that evaluation, the characteristics of the entire hybrid instrument should be considered, including the embedded derivative feature that is being evaluated for separate accounting from the host contract. The amendments were effective January 1, 2016 and the adoption did not have a significant effect on the Company's consolidated financial statements.

In March 2016, the FASB issued ASU 2016-05, "Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships", which clarifies that a change in the counterparty to a derivative instruments that has been designated as the hedging instrument does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting

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criteria continue to be met. The amendments are effective January 1, 2017 and are not expected to have a significant effect on the Company's consolidated financial statements.

The FASB issued ASU 2016-06, "Contingent Put and Call Options in Debt Instruments", in March 2016. The ASU clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. Under the new guidance, the embedded options should be assessed solely in accordance with a four-step decision sequence, with no additional assessment of whether the triggering event is indexed to interest rates or credit risk. The amendments are effective January 1, 2017 and are not expected to have a significant effect on the Company's consolidated financial statements.
 
Consolidation The FASB issued ASU 2015-02, "Amendments to the Consolidation Analysis", in February 2015. The amendments require an evaluation of whether certain legal entities should be consolidated and modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities or voting interest entities. The amendments were effective for interim and annual periods beginning January 1, 2016. The adoption did not have a significant effect on the Company's consolidated financial statements.

Intangible Assets The FASB issued ASU 2015-05, "Customer's Accounting for Fees Paid in a Cloud Computing Arrangement", in April 2015. The amendments provide guidance to customers about whether a cloud computing arrangement includes a software license. Arrangements containing a license should be recorded as consistent with the acquisition of software licenses, whereas arrangements that do not include a software license should be recorded as consistent with the accounting for service contracts. These amendments were effective for interim and annual periods beginning January 1, 2016. The adoption 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. Additionally, these amendments require presentation in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk for those liabilities measured at fair value. The amendments also require use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes. These amendments are effective for interim and annual periods beginning January 1, 2018. The Company is in the process of evaluating the impact of the ASU's adoption on the Company's consolidated financial statements, including potential changes to the Company's note disclosure of the fair value of its loan portfolio.

Leases In February 2016, the FASB issued ASU 2016-02, "Leases", in order to increase transparency and comparability by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The ASU primarily affects lessee accounting, which requires the lessee to recognize a right-of-use asset and a liability to make lease payments for those leases classified as operating leases under previous GAAP. For leases with a term of 12 months or less, an election by class of underlying asset not to recognize lease assets and lease liabilities is permitted. The ASU also provides additional guidance as to the definition of a lease, identification of lease components, and sale and leaseback transactions. The amendments in the ASU are effective for interim and annual periods beginning January 1, 2019. The Company is in the process of evaluating the impact of the ASU's adoption on the Company's consolidated financial statements.

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

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

Stock Compensation The FASB issued ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting", in March 2016, in order to reduce complexity in this area and improve the usefulness of information provided to users. Amendments

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which will affect public companies include the recognition of excess tax benefits and deficiencies in income tax expense or benefit in the income statement, guidance as to the classification of excess tax benefits on the the statement of cash flows, an election to account for award forfeitures as they occur, and the ability to withhold taxes up to the maximum statutory rate in the applicable jurisdictions without triggering liability classification of the award. The amendments are effective January 1, 2017. The Company is in the process of evaluating the impact of the ASU's adoption on the Company's consolidated financial statements.





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AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
Three Months Ended March 31, 2016 and 2015
 
First Quarter 2016
 
First Quarter 2015
(Dollars in thousands)
Average Balance
Interest Income/Expense
Avg. Rates Earned/Paid
 
Average Balance
Interest Income/Expense
Avg. Rates Earned/Paid
ASSETS:
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
Business(A)
$
4,491,556

$
32,093

2.87
%
 
$
4,031,904

$
28,051

2.82
%
Real estate — construction and land
682,557

5,961

3.51

 
414,908

3,893

3.81

Real estate — business
2,382,094

21,941

3.70

 
2,281,777

21,002

3.73

Real estate — personal
1,909,532

17,901

3.77

 
1,877,580

17,739

3.83

Consumer
1,934,577

18,592

3.87

 
1,731,146

17,288

4.05

Revolving home equity
429,682

3,761

3.52

 
430,525

3,856

3.63

Consumer credit card
752,098

21,355

11.42

 
748,831

21,455

11.62

Overdrafts
4,772



 
5,612



Total loans
12,586,868

121,604

3.89

 
11,522,283

113,284

3.99

Loans held for sale
9,360

135

5.80

 
1,851

21

4.65

Investment securities:
  
 
 
 
 
 
 
U.S. government and federal agency obligations
703,212

693

.40

 
455,633

(5,977
)
(5.32
)
Government-sponsored enterprise obligations
776,488

3,721

1.93

 
1,057,666

4,961

1.90

State and municipal obligations(A)
1,718,587

15,642

3.66

 
1,759,511

15,394

3.55

Mortgage-backed securities
3,424,716

20,836

2.45

 
2,938,575

18,977

2.62

Asset-backed securities
2,537,472

8,795

1.39

 
3,140,086

6,820

.88

Other marketable securities(A)
342,382

2,376

2.79

 
160,634

989

2.50

Trading securities(A)
18,190

130

2.87

 
16,719

113

2.74

Non-marketable securities(A)
127,769

2,077

6.54

 
107,511

2,371

8.94

Total investment securities
9,648,816

54,270

2.26

 
9,636,335

43,648

1.84

Federal funds sold and short-term securities
 
 
 
 
 
 
 
purchased under agreements to resell
17,378

24

.56

 
12,092

9

.30

Long-term securities purchased
 
 
 
 
 
 
 
under agreements to resell
850,275

3,475

1.64

 
1,049,998

3,051

1.18

Interest earning deposits with banks
219,636

270

.49

 
288,589

179

.25

Total interest earning assets
23,332,333

179,778

3.10

 
22,511,148

160,192

2.89

Allowance for loan losses
(151,308
)
 
 
 
(156,097
)
 
 
Unrealized gain on investment securities
149,319

 
 
 
169,486

 
 
Cash and due from banks
420,801

 
 
 
388,617

 
 
Land, buildings and equipment, net
356,989

 
 
 
361,646

 
 
Other assets
395,126

 
 
 
377,601

 
 
Total assets
$
24,503,260

 
 
 
$
23,652,401

 
 
LIABILITIES AND EQUITY:
 
 
 
 
 
 
 
Interest bearing deposits:
 
 
 
 
 
 
 
Savings
$
761,020

228

.12

 
$
701,987

203

.12

Interest checking and money market
10,128,543

3,256

.13

 
9,828,203

3,105

.13

Time open & C.D.'s of less than $100,000
775,221

742

.38

 
868,179

880

.41

Time open & C.D.'s of $100,000 and over
1,483,700

1,986

.54

 
1,280,110

1,410

.45

Total interest bearing deposits
13,148,484

6,212

.19

 
12,678,479

5,598

.18

Borrowings:
 
 
 
 
 
 
 
Federal funds purchased and securities sold
 
 
 
 
 
 
 
under agreements to repurchase
1,404,754

888

.25

 
1,558,118

367

.10

Other borrowings
377,711

1,253

1.33

 
103,999

879

3.43

Total borrowings
1,782,465

2,141

.48

 
1,662,117

1,246

.30

Total interest bearing liabilities
14,930,949

8,353

.23
%
 
14,340,596

6,844

.19
%
Non-interest bearing deposits
6,905,673

 
 
 
6,621,110

 
 
Other liabilities
254,437

 
 
 
314,163

 
 
Equity
2,412,201

 
 
 
2,376,532

 
 
Total liabilities and equity
$
24,503,260

 
 
 
$
23,652,401

 
 
Net interest margin (T/E)
 
$
171,425

 
 
 
$
153,348

 
Net yield on interest earning assets
 
 
2.95
%
 
 
 
2.76
%
(A) Stated on a tax equivalent basis using a federal income tax rate of 35%.


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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest rate risk management focuses on maintaining consistent growth in net interest income within Board-approved policy limits. The Company primarily uses earnings simulation models to analyze net interest sensitivity to movement in interest rates. The Company performs monthly simulations which model interest rate movements and risk in accordance with changes to its balance sheet composition. For further discussion of the Company’s market risk, see the Interest Rate Sensitivity section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s 2015 Annual Report on Form 10-K.

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

The simulations reflect two different assumptions related to deposit attrition. The Company utilizes these simulations both for monitoring interest rate risk and for liquidity planning purposes. While the future effects of rising rates on deposit balances cannot be known, the Company maintains a practice of running multiple rate scenarios to better understand interest rate risk and their 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
March 31, 2016
 
December 31, 2015
 (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
$
20.7

3.04
%
 
$
(382.6
)
 
$
9.1

1.36
%
 
$
(375.1
)
200 basis points rising
18.5

2.73

 
(270.4
)
 
10.3

1.54

 
(264.8
)
100 basis points rising
11.9

1.75

 
(144.1
)
 
8.4

1.26

 
(142.7
)

Simulation B
March 31, 2016
 
December 31, 2015
 (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
$
(5.3
)
(.80
)%
 
$
(1,644.6
)
 
$
(15.6
)
(2.33
)%
 
$
(1,543.0
)
200 basis points rising
(2.3
)
(.35
)
 
(1,538.0
)
 
(7.7
)
(1.15
)
 
(1,438.4
)
100 basis points rising
(3.8
)
(.58
)
 
(1,420.2
)
 
(2.7
)
(.41
)
 
(1,323.7
)

The difference in these two simulations is the degree in which deposits are modeled to decline as noted in the above table.  Both simulations assume that a decline in deposits would be offset by increased short-term borrowings, which are more rate sensitive and can result in higher interest costs in a rising rate environment.  Under Simulation A, a gradual increase in interest rates of 100 basis points is expected to increase net interest income from the base calculation by $11.9 million, while a gradual increase in rates of 200 basis points would increase net interest income by $18.5 million.  An increase in rates of 300 basis points would result an increase in net interest income of $20.7 million.  The change in net interest income from the base calculation at March 31, 2016 was higher than projections made at December 31, 2015 largely due to growth in deposits during the first quarter of 2016, combined with decreased short-term borrowings at higher rates.  Also, the Company's investment securities portfolio had fewer variable rate securities at March 31, 2016 than at December 31, 2015, which results in the portfolio being less rate sensitive in a rising rate environment.
Under Simulation B, the same assumptions utilized in Simulation A were applied. However, in Simulation B, deposit attrition was accelerated to consider the effects that large deposit outflows might have on net interest income and liquidity planning purposes.  The effect of higher deposit attrition was that greater reliance was placed on short-term borrowings at higher rates, which are more

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

An evaluation was performed under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of March 31, 2016. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective. There were no changes in the Company's internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.


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PART II: OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

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


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

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

 
 
 
Period
Total Number of Shares Purchased
 Average Price Paid per Share
Total Number of Shares Purchased as part of Publicly Announced Program
 Maximum Number that May Yet Be Purchased Under the Program
January 1 — 31, 2016
368,425

 
$
39.19

368,425

4,349,519

February 1 — 29, 2016
500,527

 
$
41.07

500,527

3,848,992

March 1 — 31, 2016
31,977

 
$
44.94

31,977

3,817,015

Total
900,929

 
$
40.44

900,929

3,817,015


The Company's stock purchases shown above were made under authorizations by the Board of Directors. Under the most recent authorization in October 2015 of 5,000,000 shares, 3,817,015 shares remained available for purchase at March 31, 2016.


Item 6. EXHIBITS

See Index to Exhibits.




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SIGNATURES

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


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

Date: May 6, 2016
By 
/s/  JEFFERY D. ABERDEEN
 
Jeffery D. Aberdeen
 
Controller
 
(Chief Accounting Officer)

Date: May 6, 2016


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INDEX TO EXHIBITS


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

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

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

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









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