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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
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Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the Fiscal Year Ended December 31, 2005 — Commission File No. 0-2989
COMMERCE BANCSHARES, INC.
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(Exact name of registrant as specified in its charter)
     
Missouri

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(State of Incorporation)
  43-0889454

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(IRS Employer Identification No.)
1000 Walnut,
Kansas City, MO

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(Address of principal executive offices)
  64106

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(Zip Code)
(816) 234-2000

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(Registrant’s telephone number, including area code)
   
Securities registered pursuant to Section 12(b) of the Act:
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NONE
Securities registered pursuant to Section 12(g) of the Act:
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Title of class
$5 Par Value Common Stock
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes  þ    No o
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Yes  o    No þ
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  þ    No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ        Accelerated filer o         Non-accelerated filer o
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o    No þ
As of February 9, 2006, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $2,707,000,000.
As of February 9, 2006, there were 66,865,364 shares of Registrant’s $5 Par Value Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
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Portions of the Registrant’s definitive proxy statement for its 2006 annual meeting of shareholders, which will be filed within 120 days of December 31, 2005, are incorporated by reference into Part III of this Report.
 


 

Commerce Bancshares, Inc.
Form 10-K
 
                 
INDEX            
            Page
             
Part I
   Item 1.    Business     3  
     Item 1a.    Risk Factors     7  
     Item 1b.    Unresolved Staff Comments     8  
     Item 2.    Properties     9  
     Item 3.    Legal Proceedings     9  
     Item 4.    Submission of Matters to a Vote of Security Holders     9  
 
 
Part II
   Item 5.    Market for Registrant’s Common Equity and Related Stockholder Matters     11  
     Item 6.    Selected Financial Data     12  
     Item 7.    Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations     12  
     Item 7a.    Quantitative and Qualitative Disclosures about Market Risk     47  
     Item 8.    Consolidated Financial Statements and Supplementary Data     47  
     Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     82  
     Item 9a.    Controls and Procedures     82  
     Item 9b.    Other Information     84  
 
 
Part III
   Item 10.    Directors and Executive Officers of the Registrant     84  
     Item 11.    Executive Compensation     84  
     Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     84  
     Item 13.    Certain Relationships and Related Transactions     84  
     Item 14.    Principal Accountant Fees and Services     84  
 
 
Part IV
   Item 15.    Exhibits and Financial Statement Schedules     85  
 
 Signatures     86  
 
 Index to Exhibits     E-1  
 Subsidiaires of the Registrant
 Consent of Independent Registered Public Accounting Firm
 Power of Attorney
 Certification of CEO Pursuant to Section 302
 Certification of CFO Pursuant to Section 302
 Certifications of CEO and CFO Pursuant to 18 U.S.C. Section 1350

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PART I
Item 1. BUSINESS
General
      Commerce Bancshares, Inc. (the “Company”), a bank holding company as defined in the Bank Holding Company Act of 1956, as amended, was incorporated under the laws of Missouri on August 4, 1966. The Company presently owns all of the outstanding capital stock of three national banking associations, which are headquartered in Missouri (the “Missouri bank”), Kansas (the “Kansas bank”), and Nebraska (the “Nebraska bank”). The Nebraska bank is limited in its activities to the issuance of credit cards. The remaining two banking subsidiaries engage in general banking business, providing a broad range of retail, corporate, investment, trust, and asset management products and services to individuals and businesses. The Company also owns, directly or through its banking subsidiaries, various non-banking subsidiaries. Their activities include owning real estate leased to the Company’s banking subsidiaries, underwriting credit life and credit accident and health insurance, selling property and casualty insurance (relating to consumer loans made by the banking subsidiaries), venture capital investment, securities brokerage, mortgage banking, and leasing activities. The Company owns a second tier holding company that is the direct owner of both the Missouri and Kansas banks. A list of the Company’s subsidiaries is included as Exhibit 21.
      The Company is the largest bank holding company headquartered in Missouri. At December 31, 2005, the Company had consolidated assets of $13.9 billion, loans of $8.9 billion, deposits of $10.9 billion, and stockholders’ equity of $1.3 billion.
      The Missouri bank is the Company’s largest, with total assets of $12.4 billion and comprising approximately 91% of the Company’s total banking assets. The bank’s facilities are located throughout Missouri, in eastern Kansas, and in the Peoria and Bloomington areas in Illinois. The Kansas bank has total assets of $1.2 billion. It has significant operations and banking facilities in the areas of Wichita, Hays, Hutchinson, and Garden City, Kansas.
      The markets these banks serve, being centrally located in the Midwest, provide natural sites for production and distribution facilities and also serve as transportation hubs. The economy has been well-diversified with many major industries represented, including telecommunications, automobile manufacturing, aircraft manufacturing, health care, numerous service industries, food production and agricultural production and related industries. In addition, several of the Illinois markets are located in areas with some of the most productive farmland in the world. The banks operate in areas with stable real estate markets, which in the past have avoided the volatile prices that other parts of the country have experienced.
      The Company regularly evaluates the potential acquisition of, and holds discussions with, various financial institutions eligible for bank holding company ownership or control. In addition, the Company regularly considers the potential disposition of certain of its assets and branches. The Company’s most recent acquisition was in January 2003 when it purchased The Vaughn Group, Inc., a direct equipment lessor based in Cincinnati, Ohio with a portfolio of direct financing, sales type and operating leases. The last bank acquisition was in March 2001, when the Company acquired Breckenridge Bancshares Company and its subsidiary, Centennial Bank. For additional information on acquisition and branch disposition activity, refer to pages 14 and 56.
Operating Segments
      The Company is managed in three operating segments. The Consumer segment includes the retail branch network, consumer installment lending, personal mortgage banking, bank card activities, student lending, and discount brokerage services. It provides services through a network of 191 full-service branches, a widespread ATM network of 385 machines, and the use of alternative delivery channels such as extensive online banking and telephone banking services. In 2005 this retail segment contributed 54% of total segment pre-tax income. The Commercial segment provides a full array of corporate lending,

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leasing, and international services, as well as business and government deposit and cash management services. In 2005 it contributed 37% of total segment pre-tax income. The Money Management segment provides traditional trust and estate tax planning services, and advisory and discretionary investment portfolio management services. This segment also manages the Company’s family of proprietary mutual funds, which are available for sale to both trust and general retail customers. Fixed income investments are sold to individuals and institutional investors through the Capital Markets group, which is also included in this segment. At December 31, 2005 the Money Management segment managed investments with a market value of $10.6 billion and administered an additional $9.1 billion in non-managed assets. Additional information relating to operating segments can be found on pages 37 and 71.
Supervision and Regulation
General
      The Company, as a bank holding company, is primarily regulated by the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956 (BHC Act). Under the BHC Act, the Federal Reserve Board’s prior approval is required in any case in which the Company proposes to acquire all or substantially all of the assets of any bank, acquire direct or indirect ownership or control of more than 5% of the voting shares of any bank, or merge or consolidate with any other bank holding company. The BHC Act also prohibits, with certain exceptions, the Company from acquiring direct or indirect ownership or control of more than 5% of any class of voting shares of any non-banking company. Under the BHC Act, the Company may not engage in any business other than managing and controlling banks or furnishing certain specified services to subsidiaries and may not acquire voting control of non-banking companies unless the Federal Reserve Board determines such businesses and services to be closely related to banking. When reviewing bank acquisition applications for approval, the Federal Reserve Board considers, among other things, each subsidiary bank’s record in meeting the credit needs of the communities it serves in accordance with the Community Reinvestment Act of 1977, as amended (CRA). The Missouri, Kansas and Nebraska bank charters have current CRA ratings of “outstanding”.
      The Company is required to file with the Federal Reserve Board various reports and such additional information as the Federal Reserve Board may require. The Federal Reserve Board also makes regular examinations of the Company and its subsidiaries. The Company’s three banking subsidiaries are organized as national banking associations and are subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (OCC). All banks are also subject to regulation by the Federal Deposit Insurance Corporation. In addition, there are numerous other federal and state laws and regulations which control the activities of the Company and its banking subsidiaries, including requirements and limitations relating to capital and reserve requirements, permissible investments and lines of business, transactions with affiliates, loan limits, mergers and acquisitions, issuance of securities, dividend payments, and extensions of credit. This regulatory framework is intended primarily for the protection of depositors and the preservation of the federal deposit insurance funds, and not for the protection of security holders. Statutory and regulatory controls increase a bank holding company’s cost of doing business and limit the options of its management to employ assets and maximize income.
      In addition to its regulatory powers, the Federal Reserve impacts the conditions under which the Company operates by its influence over the national supply of bank credit. The Federal Reserve Board employs open market operations in U.S. government securities, changes in the discount rate on bank borrowings, changes in the federal funds rate on overnight inter-bank borrowings, and changes in reserve requirements on bank deposits in implementing its monetary policy objectives. These instruments are used in varying combinations to influence the overall level of the interest rates charged on loans and paid for deposits, the price of the dollar in foreign exchange markets and the level of inflation. The monetary policies of the Federal Reserve have had a significant effect on the operating results of financial institutions in the past, most notably the low rate environment in recent years. In view of changing conditions in the national economy and in the money markets, as well as the effect of credit policies of monetary and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels or loan demand, or their effect on the financial statements of the Company.

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Subsidiary Banks
      Under Federal Reserve policy, the Company is expected to act as a source of financial strength to each of its bank subsidiaries and to commit resources to support each bank subsidiary in circumstances when it might not otherwise do so. In addition, any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Payment of Dividends
      The principal source of the Company’s cash revenues is dividends from the subsidiary banks. The Federal Reserve Board may prohibit the payment of dividends by bank holding companies if their actions constitute unsafe or unsound practices. The OCC limits the payment of dividends by bank subsidiaries in any calendar year to the net profit of the current year combined with the retained net profits of the preceding two years. Permission must be obtained from the OCC for dividends exceeding these amounts. The payment of dividends by the bank subsidiaries may also be affected by factors such as the maintenance of adequate capital.
Capital Adequacy
      The Company is required to comply with the capital adequacy standards established by the Federal Reserve. These capital adequacy guidelines generally require bank holding companies to maintain total capital equal to 8% of total risk-adjusted assets and off-balance sheet items (the “Total Risk-Based Capital Ratio”), with at least one-half of that amount consisting of Tier I or core capital and the remaining amount consisting of Tier II or supplementary capital. Tier I capital for bank holding companies generally consists of the sum of common shareholders’ equity, qualifying non-cumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill and other non-qualifying intangible assets. Tier II capital generally consists of hybrid capital instruments, term subordinated debt and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics.
      In addition, the Federal Reserve also requires bank holding companies to comply with minimum leverage ratio requirements. The leverage ratio is the ratio of a banking organization’s Tier I capital to its total consolidated quarterly average assets (as defined for regulatory purposes), net of the allowance for loan losses, goodwill and certain other intangible assets. The minimum leverage ratio for bank holding companies is 4%. At December 31, 2005 all of the subsidiary banks were “well-capitalized” under regulatory capital adequacy standards, as further discussed on page 74.
Legislation
      These laws and regulations are under constant review by various agencies and legislatures, and are subject to sweeping change. The Gramm-Leach-Bliley Financial Modernization Act of 1999 (GLB Act) contained major changes in laws that previously kept the banking industry largely separate from the securities and insurance industries. The GLB Act authorized the creation of a new kind of financial institution, known as a “financial holding company” and a new kind of bank subsidiary called a “financial subsidiary”, which may engage in a broader range of investment banking, insurance agency, brokerage, and underwriting activities. The GLB Act also included privacy provisions that limit banks’ abilities to disclose non-public information about customers to non-affiliated entities. Banking organizations are not required to become financial holding companies, but instead may continue to operate as bank holding companies, providing the same services they were authorized to provide prior to the enactment of the GLB Act.

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      In 2001, President Bush signed into law comprehensive anti-terrorism legislation known as the USA Patriot Act. Title III of the USA Patriot Act substantially broadened the scope of U.S. anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The U.S. Treasury Department issued a number of regulations implementing the USA Patriot Act that apply certain of its requirements to financial institutions such as the Company’s broker-dealer subsidiary. The regulations impose new obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing. In December 2005, Congress voted to extend some expiring provisions of the Patriot Act for six months.
      The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, a major reform of the bankruptcy system, was passed by Congress and signed into law by President Bush in April 2005. Changes instituted by this new law took effect on October 17, 2005. Under the new bankruptcy law, bankruptcy applicants who wish to file under Chapter 7 must meet certain eligibility requirements under a “means test”. While the immediate impact on the banking industry was a surge in bankruptcy filings in the fourth quarter of 2005, the long-term effect of the change is expected to be a reduction in bankruptcy filings, thereby limiting bankruptcy-related loan charge-offs.
Competition
      The Company’s locations in regional markets throughout Missouri, Kansas and central Illinois face intense competition from hundreds of financial service providers. The Company competes with national and state banks for deposits, loans and trust accounts, and with savings and loan associations and credit unions for deposits. In addition, the Company competes with other financial intermediaries such as securities brokers and dealers, personal loan companies, insurance companies, finance companies, and certain governmental agencies. The methods of competition center around various factors, such as customer services, interest rates on loans and deposits, lending limits and customer convenience, such as location of offices. The passage of the GLB Act, which removed barriers between banking and the securities and insurance industries, has resulted in greater competition among these industries.
Employees
      The Company and its subsidiaries employed 4,397 persons on a full-time basis and 662 persons on a part-time basis at December 31, 2005. The Company provides a variety of benefit programs including retirement and 401K plans as well as group life, health, accident, and other insurance. The Company also maintains training and educational programs designed to prepare employees for positions of increasing responsibility.
Available Information
      The Company’s principal offices are located at 1000 Walnut, Kansas City, Missouri (telephone number 816-234-2000). The Company makes available free of charge, through its web site at www.commercebank.com, reports filed with the Securities and Exchange Commission as soon as reasonably practicable after the electronic filing. These filings include the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports.

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Statistical Disclosure
      The information required by Securities Act Guide 3 – “Statistical Disclosure by Bank Holding Companies” is located on the pages noted below.
             
        Page
         
I.
 
Distribution of Assets, Liabilities and Stockholders’ Equity; Interest Rates and Interest Differential
    16, 42-45  
II.
 
Investment Portfolio
    28-30, 59-61  
III.
 
Loan Portfolio
       
   
Types of Loans
    20  
   
Maturities and Sensitivities of Loans to Changes in Interest Rates
    21  
   
Risk Elements
    26-28  
IV.
 
Summary of Loan Loss Experience
    24-26  
V.
 
Deposits
    42-43, 63  
VI.
 
Return on Equity and Assets
    13  
VII.
 
Short-Term Borrowings
    63-65  
Item 1a. RISK FACTORS
      Investments in Commerce Bancshares, Inc. common stock involve risk. The market price of the Company’s common stock may fluctuate significantly in response to a number of factors, including:
  •  Changes in securities analysts’ estimates of financial performance
 
  •  Volatility of stock market prices and volumes
 
  •  Rumors or erroneous information
 
  •  Changes in market valuations of similar companies
 
  •  Changes in interest rates
 
  •  New developments in the banking industry
 
  •  Variations in quarterly or annual operating results
 
  •  New litigation or changes in existing litigation
 
  •  Regulatory actions
 
  •  Changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board or other regulatory agencies
Geographical Risk
      The Company’s main markets are included in the states of Missouri, Kansas and central Illinois. Since the Company does not have significant presence in other parts of the country, a prolonged economic downturn in these markets could negatively impact the Company.
Industry Risk
      The Company operates in the financial services industry, a rapidly changing environment having numerous competitors including other banks and insurance companies, securities dealers, brokers, trust and investment companies and mortgage bankers. The pace of consolidation among financial service providers is accelerating and there are many new changes in technology, product offerings and regulation.

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The Company must continue to make investments in its products and delivery systems to stay competitive with the industry as a whole or its financial performance may suffer.
Regulatory Risk
      The Company and its subsidiaries are subject to extensive state and federal regulation, supervision and legislation that govern nearly every aspect of its operations. Changes to these laws could affect the Company’s ability to deliver or expand its services and diminish the value of its business.
Interest Rate Risk
      The Company’s net interest income is the largest source of overall revenue to the Company and is mainly based on the difference between interest earned on loans and investment securities, and the interest paid on deposits and other borrowings. Interest rates are beyond the Company’s control, and they fluctuate in response to general economic conditions and the policies of various governmental and regulatory agencies, in particular, the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, will influence the origination of loans, the purchase of investments, the generation of deposits, and the rates received on loans and investment securities and paid on deposits. Refer to page 35 for a discussion of the Company’s interest rate sensitivity and interest rate risk.
Lending Risk
      There are inherent risks associated with the Company’s lending activities. Changes in economic conditions and changes in interest rates among other things could impact borrowers’ capabilities to repay the Company outstanding loans. For a complete discussion of the risk elements of the Company’s loan portfolio, please refer to page 26.
Litigation Risk
      From time to time, the Company is subject to claims and litigation from customers and other individuals. Whether such claims and legal action are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to the Company, they may result in significant financial liability and/or adversely affect the market perception of the Company and its products and services. Any financial liability or reputation damage could have a material adverse effect on the Company’s business and financial performance.
Item 1b. UNRESOLVED STAFF COMMENTS
      None

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Item 2. PROPERTIES
      The bank subsidiaries maintain their main offices in various multi-story office buildings. The Missouri bank owns its main offices and leases unoccupied premises to the public. The larger offices include:
                         
 
    Net rentable   % occupied   % occupied
Building   square footage   in total   by bank
 
922 Walnut
Kansas City, MO
    256,000       93 %     91 %
1000 Walnut
Kansas City, MO
    403,000       77       34  
720 Main
Kansas City, MO
    194,000       100       100  
811 Main
Kansas City, MO
    225,000       23       23  
8000 Forsyth
Clayton, MO
    178,000       95       93  
1551 N. Waterfront Pkwy
  Wichita, KS
    120,000       100       34  
 
      The Nebraska credit card bank leases its offices in Omaha, Nebraska. Additionally, certain other installment loan, trust and safe deposit functions operate out of leased offices in downtown Kansas City. The Company has an additional 184 branch locations in Missouri, Illinois and Kansas which are owned or leased, and 151 off-site ATM locations.
      In 2005, the Missouri bank purchased a multi-story office building at 811 Main, which is currently undergoing renovation. The bank expects to move its backroom check operations from its building at 720 Main to the new facility and eventually sell the 720 Main building. Also in 2005, the Kansas bank completed construction on a new multi-story building in Wichita and moved its principal operations staff to this location.
Item 3. LEGAL PROCEEDINGS
      The information required by this item is set forth in Item 8 under Note 18, Commitments, Contingencies and Guarantees on page 79.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
      No matters were submitted during the fourth quarter of 2005 to a vote of security holders through the solicitation of proxies or otherwise.

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Executive Officers of the Registrant
      The following are the executive officers of the Company, each of whom is designated annually, and there are no arrangements or understandings between any of the persons so named and any other person pursuant to which such person was designated an executive officer.
         
 
Name and Age   Positions with Registrant
 
  Jeffery D. Aberdeen, 52     Controller of the Company since December 1995. Prior thereto he was Assistant Controller of the Company. He is Controller of the Company’s subsidiary banks, Commerce Bank, N.A. (Missouri, Kansas and Omaha).
 
  Kevin G. Barth, 45     Executive Vice President of the Company since April 2005 and Executive Vice President of Commerce Bank, N.A. (Missouri), since October 1998. Senior Vice President of the Company and Officer of Commerce Bank, N.A. (Missouri) prior thereto.
 
  A. Bayard Clark, 60     Chief Financial Officer, Executive Vice President and Treasurer of the Company since December 1995. Executive Vice President of the Company prior thereto.
 
  Sara E. Foster, 45     Senior Vice President of the Company since February 1998 and Vice President of the Company prior thereto.
 
  David W. Kemper, 55     Chairman of the Board of Directors of the Company since November 1991, Chief Executive Officer of the Company since June 1986, and President of the Company since April 1982. He is Chairman of the Board, President and Chief Executive Officer of Commerce Bank, N.A. (Missouri). He is the son of James M. Kemper, Jr. (a former Director and former Chairman of the Board of the Company) and the brother of Jonathan M. Kemper, Vice Chairman of the Company.
 
  Jonathan M. Kemper, 52     Vice Chairman of the Company since November 1991 and Vice Chairman of Commerce Bank, N.A. (Missouri) since December 1997. Prior thereto, he was Chairman of the Board, Chief Executive Officer, and President of Commerce Bank, N.A. (Missouri). He is the son of James M. Kemper, Jr. (a former Director and former Chairman of the Board of the Company) and the brother of David W. Kemper, Chairman, President, and Chief Executive Officer of the Company.
 
  Charles G. Kim, 45     Executive Vice President of the Company since April 1995 and Executive Vice President of Commerce Bank, N.A. (Missouri) since January 2004. Prior thereto, he was Senior Vice President of Commerce Bank, N.A. (Clayton, MO), a former subsidiary of the Company.
 
  Seth M. Leadbeater, 55     Vice Chairman of the Company since January 2004. Prior thereto he was Executive Vice President of the Company. He has been Vice Chairman of Commerce Bank, N.A. (Missouri) since September 2004. Prior thereto he was Executive Vice President of Commerce Bank, N.A. (Missouri) and President of Commerce Bank, N.A. (Clayton, MO).
 
  Robert C. Matthews, Jr., 58     Executive Vice President of the Company since December 1989. Executive Vice President of Commerce Bank, N.A. (Missouri) since December 1997.
 
  Michael J. Petrie, 49     Senior Vice President of the Company since April 1995. Prior thereto, he was Vice President of the Company.

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Name and Age   Positions with Registrant
 
  Robert J. Rauscher, 48     Senior Vice President of the Company since October 1997. Senior Vice President of Commerce Bank, N.A. (Missouri) prior thereto.
 
  V. Raymond Stranghoener, 54     Executive Vice President of the Company since July 2005 and Senior Vice President of the Company prior thereto. Prior to his employment with the Company in October 1999, he was employed at BankAmerica Corp. as National Executive of the Bank of America Private Bank Wealth Strategies Group. He joined Boatmen’s Trust Company in 1993, which subsequently merged with BankAmerica Corp.
PART II
Item 5.  MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Commerce Bancshares, Inc.
Common Stock Data
      The following table sets forth the high and low prices of actual transactions for the Company’s common stock (CBSH) and cash dividends paid for the periods indicated (restated for the 5% stock dividend distributed in December 2005).
                             
                Cash
    Quarter   High   Low   Dividends
 
2005
  First   $ 47.62     $ 44.11     $ .229  
    Second     48.50       43.94       .229  
    Third     52.11       47.22       .229  
    Fourth     53.63       47.57       .229  
 
2004
  First   $ 45.35     $ 40.59     $ .209  
    Second     43.69       39.91       .209  
    Third     44.66       40.15       .209  
    Fourth     47.85       42.46       .209  
 
2003
  First   $ 35.57     $ 30.41     $ .143  
    Second     35.85       30.84       .143  
    Third     39.56       33.08       .194  
    Fourth     44.75       37.72       .194  
 
      Commerce Bancshares, Inc. common shares are publicly traded on The Nasdaq Stock Market (NASDAQ). NASDAQ is a highly-regulated electronic securities market comprised of competing Market Makers whose trading is supported by a communications network linking them to quotation dissemination, trade reporting, and order execution systems. In January 2006, the Securities and Exchange Commission approved its application to become a registered national securities exchange. The Company had 4,522 shareholders of record as of December 31, 2005.

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      The following table sets forth information about the Company’s purchases of its $5 par value common stock, its only class of stock registered pursuant to Section 12 of the Exchange Act.
                                 
 
    Total       Total Number of    
    Number   Average   Shares Purchased   Maximum Number that
    of Shares   Price Paid   as Part of Publicly   May Yet Be Purchased
Period   Purchased   per Share   Announced Program   Under the Program
 
October 1–31, 2005
    304,361     $ 51.53       304,361       4,944,096  
November 1–30, 2005
    521,421     $ 53.99       521,421       4,422,675  
December 1–31, 2005
    334,459     $ 52.81       334,459       4,088,216  
 
Total
    1,160,241     $ 53.00       1,160,241       4,088,216  
 
      On October 21, 2005, the Company announced that its Board of Directors had approved a new authorization for the purchase of up to 5,000,000 shares of Company common stock. The Company had recently completed the repurchase of 5,000,000 shares pursuant to a prior authorization by the Board of Directors.
Item 6.  SELECTED FINANCIAL DATA
      The required information is set forth below in Item 7.
Item 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
      Commerce Bancshares, Inc. (the Company) operates as a super-community bank offering an array of sophisticated financial products delivered with high-quality, personal customer service. It is the largest bank holding company headquartered in Missouri, with its principal offices in Kansas City and St. Louis, Missouri. Customers are served from approximately 340 locations in Missouri, Kansas, and Illinois, using delivery platforms which include an extensive network of branches and ATM machines, full-featured online banking, and a central contact center.
      The core of the Company’s competitive advantage is its concentration on relationship banking with high service levels and competitive products. In order to enhance shareholder value, the Company focuses on growing its core revenue by expanding new and existing customer relationships, utilizing improved technology, and enhancing customer satisfaction.
      Various indicators are used by management in evaluating the Company’s financial condition and operating performance. Among these indicators are the following:
  •  Growth in earnings per share – Diluted earnings per share rose 7.1% over 2004 and has risen 8.2%, compounded annually, over the last 5 years.
 
  •  Growth in total revenue – Total revenue is comprised of net interest income and non-interest income, and grew 2.3% over 2004. It has risen 2.7%, compounded annually, over the last five years. The growth in total revenue during 2005 resulted from modest growth in net interest income, coupled with 4.4% growth in non-interest income.
 
  •  Expense control – Total non-interest expense grew by 2.9% this year due to prudent management oversight and expanded use of technology, creating productivity enhancements. Salaries and employee benefits, the largest expense component, grew by 2.8%. The efficiency ratio was 59.3% in 2005.
 
  •  Asset quality – Net loan charge-offs in 2005 were $446 thousand less than in 2004, and averaged .38% of loans compared to .41% in the previous year. Non-performing assets at year end 2005 declined 38% compared to the previous year.

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  •  Shareholder return – Total shareholder return, including the stock price and dividends, totaled 11.3% over the past 5 years and 14.7% over the past 10 years.
      The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes. The historical trends reflected in the financial information presented below are not necessarily reflective of anticipated future results.
Key Ratios
                                         
 
(Based on average balance sheets):   2005   2004   2003   2002   2001
 
Return on total assets
    1.60 %     1.56 %     1.52 %     1.58 %     1.52 %
Return on stockholders’ equity
    16.19       15.19       14.27       14.42       14.56  
Tier I capital ratio
    12.21       12.21       12.31       12.67       12.28  
Total capital ratio
    13.63       13.57       13.70       14.05       13.64  
Leverage ratio
    9.43       9.60       9.71       10.18       9.81  
Efficiency ratio*
    59.30       59.16       58.83       58.62       58.79  
Loans to deposits
    81.34       78.71       79.96       79.29       82.49  
Net yield on interest earning assets (tax equivalent basis)
    3.89       3.81       4.04       4.39       4.35  
Non-interest bearing deposits to total deposits
    6.23       12.47       10.81       9.96       11.63  
Equity to total assets
    9.87       10.25       10.68       10.97       10.46  
Cash dividend payout ratio
    28.92       28.26       25.19       21.78       22.76  
 
The efficiency ratio is calculated as non-interest expense (excluding intangibles amortization) as a percent of net interest income and non-interest income (excluding gains/losses on securities transactions).
Selected Financial Data
                                         
 
(In thousands, except per share data)   2005   2004   2003   2002   2001
 
Net interest income
  $ 501,702     $ 497,331     $ 502,392     $ 499,965     $ 468,775  
Provision for loan losses
    28,785       30,351       40,676       34,108       36,423  
Non-interest income
    341,199       326,931       301,667       280,572       274,999  
Non-interest expense
    496,522       482,769       472,144       458,200       443,097  
Net income
    223,247       220,341       206,524       196,310       178,712  
Net income per share-basic*
    3.21       3.00       2.71       2.49       2.23  
Net income per share-diluted*
    3.16       2.95       2.67       2.46       2.20  
Cash dividends
    63,421       61,135       51,266       42,185       40,254  
Cash dividends per share*
    .914       .834       .674       .535       .501  
Market price per share*
    52.12       47.81       44.46       33.94       32.08  
Book value per share*
    19.79       19.91       19.38       18.33       16.07  
Common shares outstanding*
    67,609       71,670       74,850       77,595       79,456  
Total assets
    13,885,545       14,250,368       14,287,164       13,308,415       12,908,146  
Loans
    8,899,183       8,305,359       8,142,679       7,875,944       7,638,482  
Investment securities
    3,770,181       4,837,368       5,039,194       4,275,248       3,732,257  
Deposits
    10,851,813       10,434,309       10,206,208       9,913,311       10,031,885  
Long-term debt
    269,390       389,542       300,977       338,457       392,586  
Stockholders’ equity
    1,337,838       1,426,880       1,450,954       1,422,452       1,277,157  
Non-performing assets
    11,713       18,775       33,685       29,539       30,768  
 
Restated for the 5% stock dividend distributed in December 2005.
Results of Operations
                                                         
 
    $ Change   % Change
         
(Dollars in thousands)   2005   2004   2003   ’05-’04   ’04-’03   ’05-’04   ’04-’03
 
Net interest income
  $ 501,702     $ 497,331     $ 502,392     $ 4,371     $ (5,061 )     .9 %     (1.0 )%
Provision for loan losses
    (28,785 )     (30,351 )     (40,676 )     (1,566 )     (10,325 )     (5.2 )     (25.4 )
Non-interest income
    341,199       326,931       301,667       14,268       25,264       4.4       8.4  
Non-interest expense
    (496,522 )     (482,769 )     (472,144 )     13,753       10,625       2.8       2.3  
Income taxes
    (94,347 )     (90,801 )     (84,715 )     3,546       6,086       3.9       7.2  
 
Net income
  $ 223,247     $ 220,341     $ 206,524     $ 2,906     $ 13,817       1.3 %     6.7 %
 

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      The Company’s fully diluted earnings per share amounted to $3.16 in 2005 compared to $2.95 in 2004, an increase of 7.1%. Net income for 2005 was $223.2 million, which increased 1.3% over 2004, making 2005 the 21st consecutive year of record earnings. Return on assets amounted to 1.60% compared with 1.56% last year and the return on equity totaled 16.19% compared to 15.19% last year. The efficiency ratio was 59.30% in 2005 compared with 59.16% in 2004.
      The increase in net income in 2005 compared to 2004 was due to growth in non-interest income and an improving net interest margin, combined with effective expense management and a lower loan loss provision. Non-interest income rose $14.3 million, or 4.4%, largely due to increases of 10.3% in bank card fees, 7.2% in deposit account fees, and 6.3% in trust revenues. The growth in non-interest expense was constrained to 2.8%, mainly the result of lower costs for supplies and communications (down 1.2%), coupled with increases in salaries and benefits (up 2.9%) and modest increases in occupancy, equipment, and data processing and software costs. Net interest income increased $4.4 million, reflecting the effects of higher average overall rates earned on loans and growth in average loan balances, partly offset by declining average balances in investment securities. Also, interest expense on deposit transaction accounts and short-term borrowings rose, mainly related to increases by the Federal Reserve in short-term interest rates during 2005. The provision for loan losses decreased $1.6 million to $28.8 million, reflecting lower business loan net charge-offs, partly offset by higher credit card and personal banking net loan charge-offs. Income tax expense increased 3.9% in 2005 and resulted in an effective tax rate of 29.7%, which was comparable to 29.2% in the prior year. Income tax expense in 2005 included the recognition of tax benefits of $13.7 million, representing the effects of certain corporate restructuring initiatives, and compares to $18.9 million of similar benefits recorded in 2004.
      Net income in 2004 was $220.3 million, which was a $13.8 million, or 6.7%, increase over 2003. Diluted earnings per share increased 10.5% to $2.95 compared to $2.67 in 2003. The increase in net income over 2003 was mainly due to growth in non-interest income of $25.3 million, or 8.4%, coupled with lower credit costs and strong expense control. The increase in non-interest income was largely due to increases in bank card fees of 16.6% and deposit account fees of 7.9%, partly offset by declines in bond trading account revenue and loan fees and sales. Non-interest expense increased 2.3%, mainly due to increases in data processing costs (up 13.4%) and marketing costs (up 15.9%). Net interest income declined $5.1 million from 2003, partly due to slower growth in business and business real estate loans. In addition, interest expense on deposits and borrowings rose, as the Federal Reserve began a series of short-term rate increases in the second half of 2004. The provision for loan losses decreased $10.3 million to $30.4 million, largely due to decreases in business real estate, overdraft and consumer net loan charge-offs. Income tax expense increased 7.2% and included tax benefits of $18.9 million relating to the initiatives mentioned above, compared to similar benefits of $15.2 million in 2003.
      Effective January 2003, the Company acquired The Vaughn Group, Inc. (Vaughn), a direct equipment lessor based in Cincinnati, Ohio. At acquisition, Vaughn had a lease portfolio that was principally comprised of $32.8 million of direct financing leases. These leases are secured mainly by computer hardware and office equipment. In addition, at the date of acquisition Vaughn serviced approximately $350 million of lease agreements for other institutions involving capital equipment, ranging from production machinery to transportation equipment. The Company issued a combination of cash and stock to complete this purchase. Goodwill of $5.3 million was recognized in the transaction and recorded in the 2003 consolidated balance sheet.
      The Company continually evaluates its network of bank branches throughout Missouri, Kansas and Illinois. As a result of this evaluation process, the Company may periodically sell the assets and liabilities of certain branches, or may sell specific banking facilities. In 2005, the Company sold four bank facilities, realizing pre-tax gains of $802 thousand on the sales. The Company sold three bank facilities during 2004, compared to two in 2003. The gains and losses realized on the sales of those premises in 2004 and 2003 were not significant. During 2004, the Company sold a branch with loans of $12.9 million and deposits of $16.5 million, realizing a pre-tax gain of $1.1 million.

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      The Company distributed a 5% stock dividend for the twelfth consecutive year on December 13, 2005. All per share and average share data in this report has been restated to reflect the 2005 stock dividend.
Critical Accounting Policies
      The Company’s consolidated financial statements are prepared based on the application of certain accounting policies, the most significant of which are described in Note 1 to the consolidated financial statements. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or be subject to variations which may significantly affect the Company’s reported results and financial position for the period or in future periods. The use of estimates, assumptions, and judgments are necessary most often when financial assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. Assets and liabilities carried at fair value inherently result in more financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on either quoted market prices or are provided by other independent third-party sources, when available. When such information is not available, management estimates valuation adjustments primarily by using internal cash flow and other financial modeling techniques. Changes in underlying factors, assumptions, or estimates in any of these areas could have a material impact on the Company’s future financial condition and results of operations.
      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 and accounting for income taxes.
      The Company performs periodic and systematic detailed reviews of its loan portfolio to assess overall collectability. The level of the allowance for loan losses reflects the Company’s estimate of the losses inherent in the loan portfolio at any point in time. While these estimates are based on substantive methods for determining allowance requirements, nevertheless, actual outcomes may differ significantly from estimated results, especially in the areas of determining allowances for business, lease, construction and business real estate loans. These loan types are normally larger and more complex, and their collection rates are harder to predict. Consumer loans, including personal mortgage, credit card and personal loans, are individually smaller and perform in a more homogenous manner, making loss estimates more predictable. Extensive explanation of the methodologies used in establishing the allowance is provided in the Allowance for Loan Losses section of this discussion.
      The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences, including the effects of IRS examinations and examinations by other state agencies, could materially impact the Company’s financial position and its results of operations. Discussion of income taxes is presented on page 20 of this discussion and in Note 9 on Income Taxes in the consolidated financial statements.

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Net Interest Income
      Net interest income, the largest source of revenue, results from the Company’s lending, investing, borrowing, and deposit gathering activities. It is affected by both changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest bearing liabilities. The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates. Changes not solely due to volume or rate changes are allocated to rate.
                                                   
    2005   2004
 
    Change due to       Change due to    
                 
    Average   Average       Average   Average    
(In thousands)   Volume   Rate   Total   Volume   Rate   Total
 
Interest income, fully taxable equivalent basis
                                               
Loans
  $ 22,000     $ 74,224     $ 96,224     $ 9,864     $ (18,049 )   $ (8,185 )
Investment securities:
                                               
 
U.S. government and federal agency obligations
    (25,872 )     (2,148 )     (28,020 )     7,762       (7,010 )     752  
 
State and municipal obligations
    3,182       (682 )     2,500       (506 )     (223 )     (729 )
 
Mortgage and asset-backed securities
    (1,240 )     10,391       9,151       14,141       (11,995 )     2,146  
 
Other securities
    1,238       5,342       6,580       (1,222 )     (1,191 )     (2,413 )
Federal funds sold and securities purchased under agreements to resell
    543       2,247       2,790       266       215       481  
 
Total interest income
    (149 )     89,374       89,225       30,305       (38,253 )     (7,948 )
 
Interest expense
                                               
Interest bearing deposits:
                                               
 
Savings
    4       5       9       78       (179 )     (101 )
 
Interest checking and money market
    189       25,216       25,405       538       (1,222 )     (684 )
 
Time open and C.D.’s of less than $100,000
    247       11,426       11,673       (3,520 )     (5,996 )     (9,516 )
 
Time open and C.D.’s of $100,000 and over
    2,861       13,006       15,867       2,073       (1,439 )     634  
Federal funds purchased and securities sold under agreements to repurchase
    (2,270 )     28,486       26,216       3,185       4,086       7,271  
Other borrowings
    (1,021 )     4,966       3,945       498       (248 )     250  
 
Total interest expense
    10       83,105       83,115       2,852       (4,998 )     (2,146 )
 
Net interest income, fully taxable equivalent basis
  $ (159 )   $ 6,269     $ 6,110     $ 27,453     $ (33,255 )   $ (5,802 )
 
      Net interest income amounted to $501.7 million in 2005, representing an increase of $4.4 million, or less than 1%, compared to $497.3 million in 2004. Net interest income decreased $5.1 million, or 1.0%, in 2004 compared to $502.4 million in 2003. The increase in net interest income in 2005 was the result of growth of $96.2 million in tax equivalent loan interest income as a result of higher rates and higher average balances, partly offset by a decline of $9.8 million in tax equivalent interest earned on investment securities due principally to lower average balances. Interest on deposits and total borrowings also grew by a combined $83.1 million as a result of higher rates on all categories of deposits and borrowings. The increase in rates on both interest earning assets and interest bearing liabilities was the result of eight 25 basis point rate increases initiated by the Federal Reserve in 2005. As a result of these rate changes and the change in the mix of assets and liabilities on the Company’s balance sheet, the net yield on interest earning assets was 3.89% in 2005 compared to 3.81% in 2004.

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      During 2004, net interest income decreased slightly from amounts recorded in 2003 mainly because of downward re-pricing of interest earning assets during the first half of 2004, and lower rates on securities purchased during the year. However, during the second half of 2004, the Federal Reserve initiated five 25 basis point increases, which raised rates earned on many loans in the Company’s loan portfolio tied to variable rates. The increase in loan yields, however, was partially offset by an increase in the borrowing costs of federal funds purchased due to increases in short-term interest rates. Yields on earning assets declined 29 basis points from 2003, while rates paid on deposits decreased 12 basis points and rates paid on other borrowings increased 17 basis points. As a result, the Company’s net interest margin narrowed to 3.81% from 4.04% in 2003.
      Total interest income was $697.6 million in 2005 compared to $610.1 million in 2004 and $617.4 million in 2003. Tax equivalent interest income did not materially differ. Interest income increased in 2005 by $87.5 million, or 14.3%, as a result of a $95.9 million increase in income from loans offset slightly by an $11.3 million decrease in interest income from investment securities. The tax equivalent average rate earned on interest earning assets was 5.40% in 2005 compared to 4.67% in 2004, representing a 73 basis point increase. Interest income on loans increased as a result of an 86 basis point increase in the average yield, coupled with a $431.4 million, or 5.3%, increase in the average balance in 2005 compared to 2004. The increase in interest income on loans was offset slightly by a decrease in interest income on investment securities. The tax equivalent average yield on investment securities increased 27 basis points, which was offset by a $569.5 million, or 11.6%, decrease in the investment securities average balance, resulting in an overall decrease in interest income earned on the investment portfolio in 2005 compared to 2004. Because of its strong liquidity position during 2005, the Company has funded its loan growth principally by reducing its investment securities portfolio through both maturities and sales. This strategy improved the overall mix of earning assets and was a contributor to the increase in net interest margin in 2005.
      Interest expense increased $83.1 million, or 73.7%, in 2005 compared to 2004 and was impacted by the rising rate environment noted above. Interest expense on deposits increased $53.0 million in 2005 over the previous year as a result of a 47 basis point average rate increase, coupled with 9.2% growth in average interest bearing deposit balances. Average rates paid on premium money market accounts increased 99 basis points, and both average rates and average balances of short-term certificates of deposit increased. Additionally, interest expense on other borrowings grew by $30.2 million, resulting mainly from an increase in rates of 184 basis points on federal funds purchased. Interest rates paid on interest bearing deposits and short-term borrowings will continue to be impacted by the changing interest rate environment as the Company competes for funding sources to support loan growth.
      Total interest income declined $7.3 million, or 1.2%, in 2004 compared to 2003. The decline was primarily due to decreases in rates on loans and investment securities. Average loan balances increased $120.7 million during 2004 compared to 2003 and this growth generated $9.9 million of interest income; however, this increase was offset by the effect of lower rates which reduced interest income by over $18 million. Yields on investment securities were lower, as maturing securities were reinvested in lower earning securities. Additional purchases of securities, funded by growth in deposits and other borrowed funds, increased the average by $451.4 million and contributed $20.2 million in additional interest income.
      The average rate incurred on interest bearing liabilities was 1.00% in 2004 compared to 1.06% in 2003. The lower interest rate environment experienced in the first half of 2004 resulted in an interest rate decline of 12 basis points on deposits offset by an increase of 24 basis points on short-term borrowings. The largest decline in deposit rates was on the Company’s retail (under $100,000) certificate of deposit accounts, where rates declined 32 basis points. In addition, rates on the Company’s jumbo (over $100,000) certificates of deposit decreased 15 basis points. The re-pricing of short-term borrowings as a result of the changing interest rate environment experienced in 2004, primarily federal funds purchased, resulted in an increase of $4.1 million in interest expense. Growth of $277.2 million in the average balance of short-term borrowings caused interest expense to increase $3.2 million.

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Provision for Loan Losses
      The provision for loan losses was $28.8 million in 2005, compared with $30.4 million in 2004 and $40.7 million in 2003. The $1.6 million decline in the 2005 provision for loan losses reflected lower business loan net charge-offs, partly offset by increases in credit card and personal banking loan charge-offs. The provision for loan losses is recorded to bring the allowance for loan losses to a level deemed adequate by management based on the factors mentioned in the following “Allowance for Loan Losses” section of this discussion.
Non-Interest Income
                                             
 
    % Change
     
(Dollars in thousands)   2005   2004   2003   ’05-’04   ’04-’03    
 
Deposit account charges and other fees
  $ 112,979     $ 105,382     $ 97,711       7.2 %     7.9 %    
Bank card transaction fees
    86,310       78,253       67,102       10.3       16.6      
Trust fees
    68,316       64,257       60,921       6.3       5.5      
Trading account profits and commissions
    9,650       12,288       14,740       (21.5 )     (16.6 )    
Consumer brokerage services
    9,909       9,846       9,415       .6       4.6      
Loan fees and sales
    12,838       13,654       14,109       (6.0 )     (3.2 )    
Net gains on securities transactions
    6,362       11,092       4,560       (42.6 )     143.2      
Other
    34,835       32,159       33,109       8.3       (2.9 )    
 
Total non-interest income
  $ 341,199     $ 326,931     $ 301,667       4.4 %     8.4 %    
 
Total non-interest income excluding net gains on securities transactions
  $ 334,837     $ 315,839     $ 297,107       6.0 %     6.3 %    
 
Non-interest income as a % of total revenue*
    40.5 %     39.7 %     37.5 %                    
Total revenue per full-time equivalent employee
  $ 174.2     $ 171.0     $ 161.9                      
 
Total revenue is calculated as net interest income plus non-interest income.
     Non-interest income was $341.2 million in 2005, which was a $14.3 million, or 4.4%, increase over 2004, and included net securities gains of $6.4 million in 2005 and $11.1 million in 2004. Excluding these net securities gains, non-interest income grew 6.0%. In 2005, deposit account fees increased 7.2%, or $7.6 million, due to a $15.5 million increase in overdraft and return item fees, partly offset by a $4.9 million decline in fees earned on commercial cash management accounts. The growth in overdraft and return item fees over last year was the result of increasing transaction volumes during the year and pricing changes initiated in the third quarter of 2005. The decline in corporate cash management fee income was largely the effect of the rising interest rate environment. Compared to the previous year, bank card fees increased $8.1 million, or 10.3%, mainly due to higher fees earned on debit, credit and corporate card transactions, which grew by 14.3%, 10.3% and 16.3%, respectively. The strong growth in corporate card fees was attributable to transaction fees from commercial businesses and non-profit enterprises who are utilizing these electronic transactions in greater proportions. Debit and credit card transaction fees continue to grow as a result of greater utilization rates and related retail sales. Merchant fee income was flat compared with the previous year and was impacted by narrowing margins on a growing transaction base.
      Trust fees increased $4.1 million, or 6.3%, as a result of increasing market values of trust account assets and new business, occurring largely in private client trust product lines. Private client sales efforts in 2005 resulted in new annualized fees of $5.0 million, an increase of 37.0% over sales results in the previous year. Total trust assets, including managed and custodial accounts, grew to $19.7 billion, an increase of 7.7%. Trading account fees, consisting of fees from sales of fixed income securities, declined 21.5% in 2005 due to lower demand by business and correspondent bank customers. Consumer brokerage service fees increased slightly, mainly due to higher revenues from mutual fund and insurance sales, partly offset by lower annuity sales. Loan fees and sales declined $816 thousand as gains on student loan sales declined from $8.5 million in 2004 to $8.0 million in 2005. Net gains on securities transactions amounted to $6.4 million in 2005, which was a decrease of $4.7 million compared to the previous year. During 2005, the Company undertook initiatives to review and re-position its investment securities portfo-

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lio to address such things as concentration, duration and interest rate risk. Consequently, during 2005 the Company sold available for sale securities totaling $1.8 billion and recorded net gains of $5.1 million. These sales were comprised mainly of $533.9 million in U.S. government agency securities, $768.4 million in asset-backed securities, and $359.1 million in inflation-indexed treasury securities. Also included in 2005 activity were net gains of $1.3 million recognized on market adjustments and sales of private equity investments.
      In 2004, non-interest income increased $25.3 million, or 8.4%, to $326.9 million. Deposit account fees increased 7.9%, or $7.7 million, due to a $9.8 million increase in overdraft and return item fees, partly offset by a $1.5 million decline in fees earned on commercial cash management accounts. Bank card fees increased $11.2 million, or 16.6%, mainly due to growth in fees on credit cardholder transactions, which rose 17.1% over the previous year. Also, merchant fees and debit card fees increased 18.7% and 14.8%, respectively. In 2004, trust fees increased $3.3 million, or 5.5%, because of growth in institutional and private client trust product lines. Trading account fees declined 16.6% in 2004 due to lower sales activity. Consumer brokerage service fees increased 4.6% mainly due to higher revenues from equity security sales. Loan fees and sales declined slightly mainly due to lower personal mortgage loan originations, partly offset by higher gains on the sales of student loans, which increased from $7.0 million in 2003 to $8.5 million in 2004. Net gains on securities transactions amounted to $11.1 million in 2004, an increase of $6.5 million over the previous year. The 2004 activity included gains of $11.2 million resulting mainly from sales of inflation-indexed bonds from the banks’ securities portfolios, and losses of $317 thousand recognized on private equity investments. Other non-interest income included a $1.1 million gain on a bank branch sale in the second quarter of 2004. In addition, farm management fees declined $1.2 million due to the sale of the farm management business in the third quarter of 2003.
Non-Interest Expense
                                             
 
    % Change
     
(Dollars in thousands)   2005   2004   2003   ’05-’04   ’04-’03    
 
Salaries
  $ 234,440     $ 225,526     $ 224,884       4.0 %     .3 %    
Employee benefits
    38,737       39,943       39,715       (3.0 )     .6      
Net occupancy
    40,621       39,558       38,736       2.7       2.1      
Equipment
    23,201       22,903       24,104       1.3       (5.0 )    
Supplies and communication
    33,342       33,760       33,474       (1.2 )     .9      
Data processing and software
    48,244       46,000       40,567       4.9       13.4      
Marketing
    17,294       16,688       14,397       3.6       15.9      
Other
    60,643       58,391       56,267       3.9       3.8      
 
Total non-interest expense
  $ 496,522     $ 482,769     $ 472,144       2.8 %     2.3 %    
 
Efficiency ratio
    59.3 %     59.2 %     58.8 %                    
Salaries and benefits as a % of total non-interest expense
    55.0 %     55.0 %     56.0 %                    
Number of full-time equivalent employees
    4,839       4,821       4,967                      
 
      Non-interest expense was $496.5 million in 2005, an increase of $13.8 million, or 2.8%, over 2004. Compared with the prior year, salary and employee benefits expense increased $7.7 million, or 2.9%, as a result of higher staff salaries expense, partly offset by declines in retirement and medical insurance costs. Net occupancy expense rose 2.7% over the prior year, mainly as a result of higher depreciation and utilities expense on two new office buildings. These increases were partly offset by lower net rent expense as certain banking offices were moved from leased facilities to the new buildings and office space was leased to outside tenants. Equipment expense increased 1.3%, with the slight increase due to higher costs for small equipment purchases and maintenance contract expense. Data processing costs increased $2.2 million, or 4.9%, due to higher bank card processing costs (up $1.8 million and related to the higher bank card revenues) and higher online banking processing fees, partly offset by lower software license fees. Marketing expense increased only $606 thousand, or 3.6%, compared to the previous year. Other non-interest

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expense increased $2.3 million, or 3.9%, over the prior year mainly due to increases in proprietary mutual fund expense subsidies, operating losses (mostly bank card fraud), and minority interest expense relating to investment gains recorded by venture capital affiliates. These increases were partly offset by decreases in loan collection expense and professional fees, in addition to higher capitalized loan costs.
      Non-interest expense rose 2.3% in 2004 to a total of $482.8 million, compared to $472.1 million in 2003. Compared with the prior year, salary and employee benefits expense grew slightly as a result of higher staff salaries expense and workman’s compensation insurance expense, offset by declines in incentive payments and pension plan expense. Net occupancy expense rose 2.1% over the prior year, mainly due to higher net rent expense resulting from the sale of a bank facility early in 2004, which resulted in lower outside tenant rent income and higher rent expense as banking operations in this facility were moved to other leased facilities. Equipment expense declined $1.2 million, or 5.0%, due to lower depreciation expense on computer hardware. Data processing costs increased $5.4 million, or 13.4%, due to higher bank card processing costs (up $2.3 million) and higher technology software expense. Marketing expense increased $2.3 million, or 15.9%, compared to the previous year as a result of incentives paid on new product offerings and expanded marketing efforts. Other non-interest expense increased $2.2 million over the prior period mainly due to lower capitalized loan costs and increases in loan collection expense and operating losses. These increases were partly offset by lower professional fees, operating lease depreciation, and minority interest expense resulting from venture capital activity.
Income Taxes
      Income tax expense was $94.3 million, compared to $90.8 million in 2004 and $84.7 million in 2003. Income tax expense in 2005 increased 3.9% over 2004, compared to a 2.1% increase in pre-tax income. The effective tax rate on income from operations was 29.7%, 29.2% and 29.1% in 2005, 2004 and 2003, respectively. The Company’s effective tax rates were lower than the federal statutory rate of 35% mainly due to tax exempt interest on state and municipal obligations, state and federal tax credits realized and the recognition of additional tax benefits from various corporate reorganization initiatives.
      In 2005, the Company recognized certain net tax benefits associated with various corporate reorganization initiatives amounting to $13.7 million. Similar tax benefits amounting to $18.9 million and $15.2 million were recognized in 2004 and 2003, respectively. It is not expected that material tax benefits of this nature will continue beyond 2005.
Financial Condition
Loan Portfolio Analysis
      A schedule of average balances invested in each category of loans appears on page 42. Classifications of consolidated loans by major category at December 31 for each of the past five years are as follows:
                                         
 
    Balance at December 31
     
(In thousands)   2005   2004   2003   2002   2001
 
Business
  $ 2,527,654     $ 2,246,287     $ 2,102,605     $ 2,277,365     $ 2,402,932  
Real estate – construction
    424,561       427,124       427,083       404,519       412,700  
Real estate – business
    1,919,045       1,743,293       1,875,069       1,736,646       1,505,443  
Real estate – personal
    1,358,511       1,340,574       1,338,604       1,282,223       1,287,954  
Consumer
    1,287,348       1,193,822       1,150,732       1,088,808       1,021,195  
Home equity
    448,507       411,541       352,047       305,274       256,906  
Student
    330,238       357,991       355,763       268,719       236,549  
Credit card
    592,465       561,054       526,653       502,058       483,219  
Overdrafts
    10,854       23,673       14,123       10,332       31,584  
 
Total loans, net of unearned income
  $ 8,899,183     $ 8,305,359     $ 8,142,679     $ 7,875,944     $ 7,638,482  
 

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      The contractual maturities of loan categories at December 31, 2005, and a breakdown of those loans between fixed rate and floating rate loans are as follows:
                                 
 
    Principal Payments Due    
         
    In   After One   After    
    One Year   Year Through   Five    
(In thousands)   or Less   Five Years   Years   Total
 
Business
  $ 1,428,534     $ 1,024,159     $ 74,961     $ 2,527,654  
Real estate – construction
    211,111       210,930       2,520       424,561  
Real estate – business
    548,778       1,206,500       163,767       1,919,045  
Real estate – personal
    107,402       277,457       973,652       1,358,511  
 
Total business and real estate loans
  $ 2,295,825     $ 2,719,046     $ 1,214,900       6,229,771  
 
Consumer(1)
                            1,287,348  
Home equity(2)
                            448,507  
Student(3)
                            330,238  
Credit card(4)
                            592,465  
Overdrafts
                            10,854  
 
Total loans, net of unearned income
                          $ 8,899,183  
 
Loans with fixed rates
  $ 393,496     $ 1,291,689     $ 413,219     $ 2,098,404  
Loans with floating rates
    1,902,329       1,427,357       801,681       4,131,367  
 
Total business and real estate loans
  $ 2,295,825     $ 2,719,046     $ 1,214,900     $ 6,229,771  
 
  (1)  Consumer loans with floating rates totaled $104.2 million
  (2)  Home equity loans with floating rates totaled $442.7 million
  (3)  Student loans with floating rates totaled $327.4 million
  (4)  Credit card loans with floating rates totaled $470.5 million
     Total period end loans increased $593.8 million, or 7.1%, during 2005 compared to an increase of $162.7 million, or 2.0%, during 2004. Growth in these loan balances at December 31, 2005 compared to the previous year end came principally from business, business real estate and consumer loans. At the end of the third quarter of 2005, the Company elected to make certain reclassifications among loan categories to better realign loan reporting with related collateral and purpose and to reclassify certain construction loans that had moved into amortizing term loans following project completion. The reclassifications transferred approximately $11 million and $27 million, respectively, from the business and construction loan categories to the business real estate loan category.
      Excluding these reclassification effects, business loans grew $292.5 million, or 13.0%, and business real estate loans grew $137.7 million, or 7.9%, both mainly as a result of improving economic conditions, with added borrowings from existing customers and new customer activity. The growth in business real estate loans occurred mainly during the fourth quarter of 2005; balances during the first three quarters of 2005 were stable but lower than in 2004. Lease balances, included in the business category, increased $38.5 million, or 21.1%, compared with the previous year end balance. Construction loans rose $24.1 million, or 5.7%. Consumer loans grew $93.5 million, or 7.8%, during the year mainly as a result of continued growth in marine and recreational vehicle lending. Home equity loans grew to $448.5 million, an increase of $37.0 million, or 9.0%, over year end 2004. Personal real estate loans grew by $17.9 million, as customer originations in 2005 were slightly higher than in 2004. Credit card loans increased $31.4 million, or 5.6%, and saw solid growth, especially at year end when holiday activity is normally at its peak. Student loans declined by $27.8 million, or 7.8%, mainly due to loan sales from the portfolio.
      The growth in total loans in 2004 compared to 2003 was primarily the result of increases in business, consumer, home equity and credit card loans.

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      The Company currently generates approximately 31% of its loan portfolio in the St. Louis regional market and 29% in the Kansas City regional market. The portfolio is diversified from a business and retail standpoint, with 55% in loans to businesses and 45% in loans to consumers. A balanced approach to loan portfolio management and an historical aversion toward credit concentrations, from an industry, geographic and product perspective, have contributed to low levels of problem loans and loan losses.
Business
      Total business loans amounted to $2.5 billion at December 31, 2005 and include loans used mainly to fund customer accounts receivable, inventories, and capital expenditures. This portfolio also includes sales type and direct financing leases totaling $221.3 million, which are used by commercial customers to finance capital purchases ranging from computer equipment to office and transportation equipment. These leases comprise 2.5% of the Company’s total loan portfolio. Business loans are made primarily to customers in the regional trade area of the Company, generally the central Midwest, encompassing the states of Missouri, Kansas, Illinois, and nearby Midwestern markets, including Iowa, Oklahoma and Indiana. The portfolio is diversified from an industry standpoint and includes businesses engaged in manufacturing, wholesaling, retailing, agribusiness, insurance, financial services, public utilities, and other service businesses. Emphasis is upon middle-market and community businesses with known local management and financial stability. The Company participates in credits of large, publicly traded companies when business operations are maintained in the local communities or regional markets and opportunities to provide other banking services are present. Consistent with management’s strategy and emphasis upon relationship banking, most borrowing customers also maintain deposit accounts and utilize other banking services. There were net loan recoveries in this category of $3.0 million in 2005 compared to net charge-offs of $5.6 million in 2004, mainly because a $6.0 million charge-off in 2004 on a single business loan was partially recovered in 2005. Non-accrual business loans decreased to $5.9 million (.2% of business loans) at December 31, 2005, and included $2.8 million in leases. Total business non-accrual loans were $9.5 million (.4% of business loans) at December 31, 2004. Opportunities for growth in business loans will be based upon strong solicitation efforts in a highly competitive market environment for quality loans. Asset quality is, in part, a function of management’s consistent application of underwriting standards and credit terms through stages in economic cycles. Therefore, portfolio growth in 2006 will be dependent upon 1) the strength of the economy, 2) the actions of the Federal Reserve with regard to targets for economic growth, interest rates, and inflationary tendencies, and 3) the competitive environment.
Real Estate-Construction
      The portfolio of loans in this category amounted to $424.6 million at December 31, 2005 and comprised 4.8% of the Company’s total loan portfolio. This group of loans includes residential construction loans totaling $113.0 million at December 31, 2005, or 27% of the category, and commercial construction and land development loans totaling $311.6 million, or 73%. These loans are predominantly made to businesses in the local markets of the Company’s banking subsidiaries. Commercial construction loans are made during the construction phase for small and medium-sized office and medical buildings, manufacturing and warehouse facilities, apartment complexes, shopping centers, hotels and motels, and other commercial properties. Exposure to larger speculative office properties remains low. Residential construction and land development loans are primarily for projects located in the Kansas City and St. Louis metropolitan areas. Credit losses in this portfolio are normally low, and there were no net charge-offs in 2005 compared to $4 thousand net charge-offs in 2004. No construction loans were on non-accrual status at year end 2005, compared to $685 thousand at year end 2004.
Real Estate-Business
      Total business real estate loans were $1.9 billion at December 31, 2005 and comprised 21.6% of the Company’s total loan portfolio. This category includes mortgage loans for small and medium-sized office and medical buildings, manufacturing and warehouse facilities, shopping centers, hotels and motels, and other commercial properties. Emphasis is placed on owner-occupied and income producing commercial real

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estate properties which present lower risk levels. The borrowers and/or the properties are generally located in the local and regional markets of the affiliate banks. At December 31, 2005, non-accrual balances amounted to $3.1 million, or .2% of the loans in this category, compared to $6.6 million at year end 2004. The Company experienced $497 thousand net charge-offs in 2005 compared to net recoveries of $231 thousand in 2004.
Real Estate-Personal
      At December 31, 2005, there were $1.4 billion in outstanding personal real estate loans, which comprised 15.3% of the Company’s total loan portfolio. The mortgage loans in this category are extended, predominately, for owner-occupied residential properties. The Company originates both adjustable rate and fixed rate mortgage loans. The Company retains adjustable rate mortgage loans, and may from time to time retain certain fixed rate loans (typically 15-year fixed rate loans) as directed by its Asset/ Liability Management Committee. Other fixed rate loans in the portfolio have resulted from previous bank acquisitions. At December 31, 2005, 63% of the portfolio was comprised of adjustable rate loans while 37% was comprised of fixed rate loans. Levels of mortgage loan origination activity were virtually the same in both 2005 and 2004, with originations of $367 million in 2005 compared with $366 million in 2004. Growth in mortgage loan originations was limited in 2005 as a result of the rising interest rate environment. The Company typically does not experience significant loan losses in this category. There were net charge-offs of $30 thousand in 2005 compared to $217 thousand in 2004. The non-accrual balances of loans in this category decreased to $261 thousand at December 31, 2005, compared to $458 thousand at year end 2004. The five year history of net charge-offs in the personal real estate loan category reflects nominal losses, and the credit quality of these loans is considered to be strong.
Personal Banking
      Total personal banking loans, which include consumer, revolving home equity and student loans, totaled $2.1 billion at December 31, 2005 and increased on average 7.1% during 2005. These categories comprised 23.2% of the total loan portfolio at December 31, 2005. Consumer loans consist of auto, marine, recreational vehicle (RV) and fixed rate home equity loans, and totaled $1.3 billion at year end 2005. Approximately 65% are originated indirectly from auto and other dealers, while the remaining 35% are direct loans made to consumers. Approximately 50% of the consumer portfolio consists of automobile loans, 26% in marine and RV loans and 7% in fixed rate home equity lending. Revolving home equity loans, of which 99% are adjustable rate loans, totaled $448.5 million at year end 2005. An additional $567.6 million was outstanding in unused lines of credit, which can be drawn at the discretion of the borrower. Home equity loans are secured mainly by second mortgages (and less frequently, first mortgages) on residential property of the borrower. The underwriting terms for the home equity line product permit borrowing availability, in the aggregate, generally up to 80% or 90% of the appraised value of the collateral property, although a small percentage may permit borrowing up to 100% of appraised value. Given reasonably stable real estate values over time, the collateral margin improves with the regular amortization of mortgages against the properties. The Company originates loans to students attending colleges and universities, which totaled $330.2 million at year end 2005. These loans are normally sold to the secondary market when the students graduate and the loans enter into repayment status. Nearly all of these loans are based on a variable rate.
      Net charge-offs for total personal banking loans were $8.8 million in 2005 compared to $7.5 million in 2004. Net charge-offs increased to .43% of average personal banking loans in 2005 compared to .39% in 2004. Consistent with industry trends, the higher personal banking loan net charge-offs occurred from an increase in bankruptcy notices received mainly in the fourth quarter 2005 in conjunction with the enactment of new bankruptcy legislation, which took effect during the same quarter.
Credit Card
      Total credit card loans amounted to $592.5 million at December 31, 2005 and comprised 6.7% of the Company’s total loan portfolio. The credit card portfolio is concentrated within regional markets served by

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the Company. The Company offers a variety of credit card products, including affinity cards, corporate purchase cards, and standard and premium credit cards. It emphasizes its credit card relationship product, Special Connections, in which the customer maintains a deposit relationship with a subsidiary bank. The Special Connections product allows the customer ATM access using the same card. The Company has found this product to be more profitable by incurring fewer credit losses than other card products, and it allows for better cross sale into other bank products. Approximately 61% of the households in Missouri that own a Commerce credit card product also maintain a deposit relationship with a subsidiary bank. Approximately 79% of the outstanding credit card loans have a floating interest rate. Net charge-offs amounted to $24.4 million in 2005, which was a $5.0 million increase over 2004. The increase in credit card loan net charge-offs occurred mainly in the fourth quarter 2005 and was reflective of higher bankruptcy notices received in conjunction with the new bankruptcy legislation noted above. The ratio of net loan charge-offs to total average loans of 4.4% in 2005 and 3.8% in 2004 remained below national loss averages. The Company refrains from national pre-approved mailing techniques which have caused some of the credit card problems experienced by other banking companies. With bankruptcy legislation now in place which makes bankruptcy filings more difficult, the Company believes this new environment will result in lower loan losses in the future.
Allowance for Loan Losses
      The Company has an established process to determine the amount of the allowance for loan losses, which assesses the risks and losses inherent in its portfolio. This process provides an allowance consisting of an allocated and an unallocated component. To determine the allocated component of the allowance, the Company combines estimates of the reserves needed for loans evaluated on an individual basis with estimates of reserves needed for pools of loans with similar risk characteristics.
      Loans subject to individual evaluation are defined by the Company as impaired, and generally consist of commercial and commercial real estate loans on non-accrual status or graded substandard and delinquent 60 days or more. These loans are evaluated individually for the impairment of repayment potential and collateral adequacy, and in conjunction with current economic conditions and loss experience, allowances are estimated. Loans not individually evaluated are aggregated and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type, delinquencies, current economic factors, loan risk categories and industry concentrations. Although management has allocated a portion of the allowance to specific loan categories, the adequacy of the allowance must be considered in its entirety.
      The Company’s estimate of the allowance for loan losses and the corresponding provision for loan losses rests upon various judgments and assumptions made by management. Factors that influence these judgments include past loan loss experience, current loan portfolio composition and characteristics, trends in portfolio risk ratings, levels of non-performing assets, prevailing regional and national economic conditions, and the Company’s ongoing examination process including that of its regulators. 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. The Company’s subsidiary banks continue to be subject to examination by the Office of the Comptroller of the Currency (OCC) and examinations are conducted throughout the year targeting various segments of the loan portfolio for review. In addition to the examination of subsidiary banks by the OCC, the parent holding company and its non-bank subsidiaries are examined by the Federal Reserve Bank.
      The allowance for loan losses was $128.4 million and $132.4 million at December 31, 2005 and 2004, respectively, and was 1.44% and 1.59% of loans outstanding. The decline in the allowance in 2005 resulted mainly from an improvement in the credit quality of the loan portfolio, evidenced by a decrease in net loan charge-offs and a 38% decrease in non-performing assets. The allowance for loan losses covered non-performing loans by 1305% at year end 2005 and 751% at year end 2004. Net charge-offs totaled $32.7 million in 2005, and decreased $446 thousand compared to $33.2 million in 2004. The ratio of net charge-offs to average loans outstanding in 2005 was .38% compared to .41% in 2004 and .46% in 2003. The provision

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for loan losses was $28.8 million, compared to a provision of $30.4 million in 2004 and $40.7 million in 2003.
      Approximately 75% of total net loan charge-offs were related to credit card loans. Net credit card charge-offs increased to 4.40% of average credit card loans in 2005 compared to 3.77% in 2004. This increase was partially a result of the increased bankruptcies claimed in 2005 as a result of the new bankruptcy legislation, which took effect in the fourth quarter. The delinquency rate on credit card loans at year end 2005 was 2.76% compared to 2.45% at year end 2004.
      Net charge-offs for overdrafts increased $1.4 million in 2005 compared to 2004 as a result of an increase in charge-offs coupled with a decrease in recoveries. Charge-offs increased partially due to the increase in bankruptcies filed in 2005 and partially due to the Company’s increased efforts to charge accounts off when the account becomes 60 days past due as opposed to its previous practice of charging off accounts at 90 days past due.
      Business loan charge-offs decreased $8.7 million during 2005 compared with 2004, mainly the result of one large loan charge-off of $6.0 million recorded in 2004. In 2005, recoveries of $2.4 million on this loan and previously charged off lease loans were recorded, resulting in the significant increase in loan recoveries compared with the previous year.
      The Company considers the allowance for loan losses of $128.4 million adequate to cover losses inherent in the loan portfolio at December 31, 2005.
      The following schedule provides a breakdown of the allowance for loan losses by loan category and the percentage of each loan category to total loans outstanding at year end:
                                                                                 
 
(Dollars in thousands)   2005   2004   2003   2002   2001
 
    Loan Loss   % of Loans   Loan Loss   % of Loans   Loan Loss   % of Loans   Loan Loss   % of Loans   Loan Loss   % of Loans
    Allowance   to Total   Allowance   to Total   Allowance   to Total   Allowance   to Total   Allowance   to Total
    Allocation   Loans   Allocation   Loans   Allocation   Loans   Allocation   Loans   Allocation   Loans
 
Business
  $ 26,211       28.4 %   $ 39,312       27.0 %   $ 39,411       25.8 %   $ 36,359       28.9 %   $ 36,245       31.5 %
RE – construction
    3,375       4.8       1,420       5.2       4,717       5.3       4,731       5.1       4,732       5.4  
RE – business
    19,432       21.6       15,910       21.0       20,971       23.0       20,913       22.1       20,907       19.7  
RE – personal
    4,815       15.3       7,620       16.1       4,423       16.4       3,871       16.3       3,367       16.9  
Personal banking
    25,364       23.2       22,652       23.6       21,793       22.8       20,343       21.1       18,710       19.8  
Credit card
    35,513       6.6       28,895       6.8       26,544       6.5       23,337       6.4       21,004       6.3  
Overdrafts
    2,739       .1       4,895       .3       4,796       .2       4,498       .1       4,442       .4  
Unallocated
    10,998             11,690             12,566             16,566             20,566        
 
Total
  $ 128,447       100.0 %   $ 132,394       100.0 %   $ 135,221       100.0 %   $ 130,618       100.0 %   $ 129,973       100.0 %
 

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      The schedule which follows summarizes the relationship between loan balances and activity in the allowance for loan losses:
                                               
 
    Years Ended December 31
     
(Dollars in thousands)   2005   2004   2003   2002   2001
 
Net loans outstanding at end of year(A)
  $ 8,899,183     $ 8,305,359     $ 8,142,679     $ 7,875,944     $ 7,638,482  
 
Average loans outstanding(A)
  $ 8,561,482     $ 8,130,113     $ 8,009,459     $ 7,761,742     $ 7,809,931  
 
Allowance for loan losses:
                                       
 
Balance at beginning of year
  $ 132,394     $ 135,221     $ 130,618     $ 129,973     $ 128,445  
 
 
Additions to allowance through charges to expense
    28,785       30,351       40,676       34,108       36,423  
 
Allowances of acquired companies
                500             2,519  
 
 
Loans charged off:
                                       
   
Business
    1,083       8,047       9,297       7,324       7,554  
   
Real estate – construction
          7             65       127  
   
Real estate – business
    827       747       1,525       973       751  
   
Real estate – personal
    87       355       660       296       389  
   
Personal banking(B)
    13,475       12,764       13,856       11,979       13,959  
   
Credit card
    28,263       23,682       23,689       22,305       23,030  
   
Overdrafts
    3,485       2,551       4,830       4,943       4,985  
 
     
Total loans charged off
    47,220       48,153       53,857       47,885       50,795  
 
 
Recovery of loans previously charged off:
                                       
   
Business
    4,099       2,405       4,192       1,283       1,667  
   
Real estate – construction
          3       122       123       78  
   
Real estate – business
    330       978       1,009       677       661  
   
Real estate – personal
    57       138       196       66       19  
   
Personal banking(B)
    4,675       5,288       5,386       5,080       5,144  
   
Credit card
    3,851       4,249       4,202       5,164       4,150  
   
Overdrafts
    1,476       1,914       2,177       2,029       1,662  
 
     
Total recoveries
    14,488       14,975       17,284       14,422       13,381  
 
   
Net loans charged off
    32,732       33,178       36,573       33,463       37,414  
 
 
Balance at end of year
  $ 128,447     $ 132,394     $ 135,221     $ 130,618     $ 129,973  
 
Ratio of net charge-offs to average loans outstanding
    .38%       .41%       .46%       .43%       .48%  
Ratio of allowance to loans at end of year
    1.44%       1.59%       1.66%       1.66%       1.70%  
Ratio of provision to average loans outstanding
    .34%       .37%       .51%       .44%       .47%  
 
(A)  Net of unearned income; before deducting allowance for loan losses
(B)  Personal banking loans include consumer, home equity, and student
Risk Elements Of Loan Portfolio
      Management reviews the loan portfolio continuously for evidence of problem loans. During the ordinary course of business, management becomes aware of borrowers that may not be able to meet the contractual requirements of loan agreements. Such loans are placed under close supervision with consideration given to placing the loan on non-accrual status, the need for an additional allowance for loan loss, and (if appropriate) partial or full loan charge-off. Loans are placed on non-accrual status when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment. 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 1-4 family first mortgage loans or consumer loans that are exempt under regulatory rules from being classified as non-accrual.

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Accrual of interest on consumer installment loans is suspended when any payment of principal or interest is more than 120 days delinquent. Credit card loans and the related accrued interest are charged off when the receivable is more than 180 days past due. After a loan is placed on non-accrual status, any interest previously accrued but not yet collected is reversed against current income. Interest is included in income only as received and only after all previous loan charge-offs have been recovered, so long as management is satisfied there is no impairment of collateral values. The loan is returned to accrual status only when the borrower has brought all past due principal and interest payments current and, in the opinion of management, the borrower has demonstrated the ability to make future payments of principal and interest as scheduled.
      The following schedule shows non-performing assets and loans past due 90 days and still accruing interest.
                                           
 
    December 31
     
(Dollars in thousands)   2005   2004   2003   2002   2001
 
Non-accrual loans:
                                       
 
Business
  $ 5,916     $ 9,547     $ 19,162     $ 15,224     $ 22,633  
 
Real estate – construction
          685       795       301       501  
 
Real estate – business
    3,149       6,558       9,372       10,646       5,377  
 
Real estate – personal
    261       458       2,447       1,428       147  
 
Consumer
    519       370       747       466       161  
 
Total non-accrual loans
    9,845       17,618       32,523       28,065       28,819  
 
Real estate acquired in foreclosure
    1,868       1,157       1,162       1,474       1,949  
 
 
Total non-performing assets
  $ 11,713     $ 18,775     $ 33,685     $ 29,539     $ 30,768  
 
Non-performing assets as a percentage of total loans
    .13%       .23%       .41%       .38%       .40%  
 
Non-performing assets as a percentage of total assets
    .08%       .13%       .24%       .22%       .24%  
 
Past due 90 days and still accruing interest:
                                       
 
Business
  $ 1,026     $ 357     $ 817     $ 4,777     $ 1,715  
 
Real estate – construction
                38             554  
 
Real estate – business
    1,075       520       3,934       3,734       1,790  
 
Real estate – personal
    2,998       3,165       5,750       4,727       6,116  
 
Consumer
    813       916       1,079       1,282       1,144  
 
Home equity
    685       317       218       91       127  
 
Student
    74       199       1,252       27       533  
 
Credit card
    7,417       7,311       7,735       7,734       7,647  
 
Overdrafts
          282       78       56       73  
 
Total past due 90 days and still accruing interest
  $ 14,088     $ 13,067     $ 20,901     $ 22,428     $ 19,699  
 
      The effect on interest income in 2005 of loans on non-accrual status at year end is presented below:
             
 
(In thousands)        
 
Gross amount of interest that would have been recorded at original rate
  $ 1,140      
Interest that was reflected in income
    123      
 
Interest income not recognized
  $ 1,017      
 
      Total non-accrual loans at year end 2005 decreased $7.8 million from 2004 levels. This decline resulted from reductions of $3.6 million in business non-accrual loans, $3.4 million in business real estate loans, and $685 thousand in construction loans. The overall decline in non-accrual loans was due to sales to other financial institutions, charge-offs, or transference to foreclosure status. Real estate that was acquired in foreclosure, which is comprised mainly of small residential properties, increased $711 thousand over year end 2004. Total non-performing assets remain low compared to the Company’s peers, with the non-performing loans to total loans ratio at .11%. Loans past due 90 days and still accruing interest increased $1.0 million at year end 2005 compared to 2004. This increase was mainly due to higher delinquencies in business, business real estate and home equity loans.

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      In addition to the non-accrual 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. These loans totaled $52.8 million at December 31, 2005 compared with $63.9 million at December 31, 2004. These loans are primarily classified as substandard for regulatory purposes. 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.
      At December 31, 2005, the banking subsidiaries held fixed rate residential real estate loans of approximately $6.2 million at lower of cost or market, which are to be sold to secondary markets within approximately three months.
      There were no loan concentrations of multiple borrowers in similar activities at December 31, 2005, which exceeded 10% of total loans. The Company’s aggregate legal lending limit to any single or related borrowing entities is in excess of $175 million. The largest exposures generally do not exceed $70 million.
Investment Securities Analysis
      During 2005, total investment securities decreased $997.1 million to $3.8 billion (excluding unrealized gains/losses) compared to $4.8 billion at the previous year end. The decrease was due to higher sales and maturities of securities during the year, with the proceeds used to fund loan growth and reduce the level of short-term borrowings. Also during 2005, the Company undertook initiatives to review and re-position its investment securities portfolio to address such things as concentration, duration and interest rate risk. Consequently, during 2005, the Company sold available for sale securities totaling $1.8 billion and recorded net gains of $5.1 million. These sales were comprised mainly of $533.9 million in U.S. government agency securities, $768.4 million in asset-backed securities, and $359.1 million in inflation-indexed treasury securities. Also as a result of the re-positioning, the Company purchased $2.0 billion of available for sale securities during the year. The purchases were comprised mainly of $1.0 billion in mortgage-backed securities, $518.1 million in other asset-backed securities, and $202.3 million in municipal securities. The average tax equivalent yield on total investment securities was 4.05% in 2005 and 3.78% in 2004.
      At December 31, 2005, the fair value of available for sale securities was $3.7 billion, and included a net unrealized loss in fair value of $6.3 million, compared to a net gain of $63.8 million at December 31, 2004. The amount of the related after tax unrealized loss reported in stockholders’ equity was $3.9 million at year end 2005. The unrealized loss in fair value was the result of unrealized losses of $53.2 million in the bank portfolios, partly offset by unrealized gains of $42.9 million on marketable equity securities held by Commerce Bancshares, Inc., the parent holding company (the “Parent”). Most of the unrealized loss in fair value on available for sale investment securities related to mortgage and asset-backed securities and federal agency securities in the bank portfolios. The market value of the available for sale portfolio will vary according to changes in market interest rates and the mix and duration of investments in the portfolio. Available for sale securities which are due during the next 12 months total approximately $649 million, and management expects these proceeds to meet most of the Company’s liquidity needs.
      Non-marketable securities, which totaled $77.3 million at December 31, 2005, included $45.4 million in Federal Reserve Bank stock and Federal Home Loan Bank stock held by bank subsidiaries in accordance with debt and regulatory requirements. These are restricted securities which, lacking a market, are carried at cost. Other non-marketable securities are generally held by the Parent and non-bank subsidiaries and include non-marketable venture capital investments, which are carried at estimated fair value.

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      Investment securities at year end for the past two years are shown below:
                 
 
    December 31
     
(In thousands)   2005   2004
 
Amortized Cost
               
U.S. government and federal agency obligations*
  $ 845,612     $ 1,716,937  
State and municipal obligations
    251,803       65,549  
Mortgage-backed securities
    1,662,454       1,337,951  
Other asset-backed securities
    691,877       1,325,804  
Other debt securities
    57,485       61,400  
Equity securities
    242,254       256,502  
Trading securities
    24,959       9,403  
 
Total
  $ 3,776,444     $ 4,773,546  
 
Fair Value
               
U.S. government and federal agency obligations*
  $ 834,657     $ 1,746,365  
State and municipal obligations
    249,018       66,389  
Mortgage-backed securities
    1,631,675       1,336,982  
Other asset-backed securities
    684,724       1,323,999  
Other debt securities
    56,583       61,083  
Equity securities
    288,565       293,147  
Trading securities
    24,959       9,403  
 
Total
  $ 3,770,181     $ 4,837,368  
 
  This category includes obligations of government sponsored enterprises, such as FNMA and FHLMC, which are not backed by the full faith and credit of the United States government. Such obligations are separately disclosed in Note 4 on Investment Securities in the consolidated financial statements.  
     A summary of maturities by category of investment securities and the weighted average yield for each range of maturities as of December 31, 2005, is presented in Note 4 on Investment Securities in the consolidated financial statements. Mortgage and asset-backed securities comprised 61% of the investment portfolio at December 31, 2005, with a weighted average yield of 4.22% and an estimated average maturity of 2.5 years; U.S. government and federal agency obligations comprised 22% with a weighted average yield of 3.58% and an estimated average maturity of 2.4 years.
      Other debt securities, as shown in the table above, include corporate bonds, notes, commercial paper and debentures related to venture capital funding. Equity securities are comprised of short-term investments in money market mutual funds (which totaled $111.7 million at year end 2005), Federal Reserve Bank stock, Federal Home Loan Bank stock, publicly traded stock and venture capital equity investments. Investments in mutual funds and traded equities are primarily held by the Parent. During 2005, the average yield on other debt securities was 5.14%, and the average tax equivalent yield on equity securities was 4.60%.
      The Company engages in private equity and venture capital activities through direct venture investments and three venture capital subsidiaries. CFB Venture Fund I, Inc., a wholly-owned subsidiary, held $4.7 million in venture capital investments at December 31, 2005. Another subsidiary, CFB Venture Fund II, L.P. is a limited partnership venture fund with 47% outside ownership. This partnership held venture capital investments of $4.4 million at year end 2005 and is fully funded. A new series partnership, CFB Venture Fund, L.P., was organized in 2005 with approximately 20% outside ownership. Two new funds are active in this partnership, which held combined investments of $21.7 million at December 31, 2005. The Company plans to fund an additional $21.1 million to the new partnership in the future. In addition to investments held by its venture capital subsidiaries, the Company has direct investments in several private equity concerns, which totaled $5.8 million at year end 2005. Most of the venture capital and private equity investments are not readily marketable. While the nature of these investments carries a higher degree of risk than the normal lending portfolio, this risk is mitigated by the overall size of the

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investments and oversight provided by management, which believes the potential for long-term gains in these investments outweighs the potential risks.
Deposits and Borrowings
      Deposits are the primary funding source for the Company’s banks, and are acquired from a broad base of local markets, including both individual and corporate customers. Total deposits were $10.9 billion at December 31, 2005, compared to $10.4 billion last year, reflecting an increase of $417.5 million, or 4.0%. On a yearly average basis, deposits increased $195.8 million during 2005 compared to 2004. At the beginning of 2005, the Company re-characterized certain additional demand and interest checking accounts as money market accounts, in accordance with Federal Reserve rules. As a result, an additional $530 million of demand deposits and $344 million of interest checking accounts were reclassified as money market accounts during the first quarter of 2005. Excluding these and other ongoing reclassifications permissible under Federal Reserve rules, the increase in average deposits in 2005 compared to 2004 grew 1.9% and was fueled by growth in short-term certificate of deposit accounts and interest checking accounts, partly offset by a decline in money market accounts.
      The following table shows year end deposits by type as a percentage of total deposits.
                     
 
    December 31    
     
    2005   2004    
 
Non-interest bearing demand
    12.9 %     18.6 %    
Savings, interest checking and money market
    59.8       58.2      
Time open and C.D.’s of less than $100,000
    16.9       15.9      
Time open and C.D.’s of $100,000 and over
    10.4       7.3      
 
Total deposits
    100.0 %     100.0 %    
 
      Core deposits (defined as all non-interest and interest bearing deposits, excluding short-term C.D.’s of $100,000 and over) supported 76% of average earning assets in 2005 and 75% in 2004. Average balances by major deposit category for the last six years appear at the end of this discussion. A maturity schedule of time deposits outstanding at December 31, 2005 is included in Note 7 on Deposits in the consolidated financial statements.
      Short-term borrowings consist of federal funds purchased and securities sold under agreements to repurchase. Balances outstanding at year end 2005 were $1.3 billion, a $587.5 million decrease from $1.9 billion outstanding at year end 2004. Balances in these accounts, which generally have overnight maturities, can fluctuate significantly on a day-to-day basis. The average balance of federal funds purchased and repurchase agreements was $1.6 billion during 2005, decreasing $217.6 million from 2004 averages. The average rate paid on these borrowings was 3.03% during 2005 and 1.23% during 2004.
      Subsidiary banks also borrow from the Federal Home Loan Bank (FHLB). At year end 2005 these advances totaled $251.8 million, of which $238.2 million is due in 2006. The debt maturing in 2006 may be refinanced or may be repaid with funds generated by maturities of loans or investment securities or by deposit growth. Of the FHLB advances outstanding at year end, $200.0 million had a floating rate and $51.8 million had a fixed rate. The average rate paid on FHLB advances was 3.40% during 2005 and 1.94% during 2004. The weighted average year end rate on outstanding FHLB advances at December 31, 2005 was 4.19%. Long-term debt also includes $11.1 million borrowed from insurance companies by a venture capital subsidiary in order to fund certain investing activity as a Missouri Certified Capital Company.

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Liquidity and Capital Resources
Liquidity Management
      Liquidity is managed within the Company in order to satisfy cash flow requirements of deposit and borrowing customers while at the same time meeting its own cash flow needs. The Company maintains its liquidity position by providing a variety of sources including:
  •  A portfolio of liquid assets including marketable investment securities and overnight investments,
 
  •  A large customer deposit base and limited exposure to large, volatile certificates of deposit,
 
  •  Lower long-term borrowings that might place a demand on Company cash flow,
 
  •  Low relative loan to deposit ratio promoting strong liquidity,
 
  •  Excellent debt ratings from both Standard & Poor’s and Moody’s national rating services, and
 
  •  Available borrowing capacity from outside sources.
      The Company’s most liquid assets include available for sale marketable investment securities, federal funds sold, and securities purchased under agreements to resell (resale agreements). At December 31, 2005 and 2004, such assets were as follows:
                 
 
(In thousands)   2005   2004
 
Available for sale investment securities
  $ 3,667,901     $ 4,754,941  
Federal funds sold and resale agreements
    128,862       68,905  
 
Total
  $ 3,796,763     $ 4,823,846  
 
      Federal funds sold and resale agreements normally have overnight maturities and are used for general daily liquidity purposes. The Company’s available for sale investment portfolio has maturities of approximately $649 million which come due during 2006 and offers substantial resources to meet either new loan demand or reductions in the Company’s deposit funding base. Furthermore, in the normal course of business the Company pledges portions of its investment securities portfolio to secure public fund deposits, securities sold under agreements to repurchase, trust funds, and borrowing capacity at the Federal Reserve. Total pledged investment securities for these purposes comprised 64% of the total investment portfolio, leaving approximately $1.4 billion of unpledged securities.
      Additionally, the Company maintains a large base of core customer deposits, defined as demand, interest checking, savings, and money market deposit accounts. At December 31, 2005, such deposits totaled $7.9 billion and represented 73% of the Company’s total deposits. At December 31, 2004 these deposits totaled $8.0 billion. These core deposits are normally less volatile, often with customer relationships tied to other products offered by the Company promoting long lasting relationships and stable funding sources. Time open and certificates of deposit of $100,000 or greater totaled $1.1 billion and $762.4 million at December 31, 2005 and 2004, respectively. These deposits are normally considered more volatile and higher costing, but comprised just 10.4% and 7.3% of total deposits at December 31, 2005 and 2004, respectively.
      At December 31, 2005 and 2004, the Company’s outside borrowings were comprised of federal funds purchased, securities sold under agreements to repurchase, and longer-term debt as follows:
                 
 
(In thousands)   2005   2004
 
Federal funds purchased
  $ 849,504     $ 1,557,635  
Securities sold under agreements to repurchase
    476,923       356,243  
Other borrowings
    269,390       389,542  
 
Total
  $ 1,595,817     $ 2,303,420  
 
      Federal funds purchased are funds generally borrowed overnight and are obtained mainly from upstream correspondent banks to assist in balancing overall bank liquidity needs. Securities sold under agreements to repurchase are comprised mainly of non-insured customer funds, normally with overnight maturities, and the Company pledges portions of its own investment portfolio to secure these deposits.

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These funds are offered to customers wishing to earn interest in highly liquid balances and are used by the Company as a funding source considered to be stable, but short-term in nature. The increase in securities sold under agreements to repurchase in 2005 was partly due to funds received from a single customer, while the level of federal funds borrowings was lowered with the proceeds of maturities and sales from the investment securities portfolio. The Company has relationships with various correspondent banks that are considered sources of overnight federal funds borrowings.
      The Company’s long-term debt is comprised mainly of borrowings from the FHLB and other debt related to the Company’s leasing and venture capital business. At December 31, 2005 and 2004, debt from the FHLB amounted to $251.8 million and $366.9 million respectively. Most of the FHLB debt outstanding at year end 2005 is based on variable rates and matures in 2006. The overall long-term debt position of the Company is small relative to the Company’s overall liability position.
      In addition to the sources and uses of funds as noted above, the Company had an average loans to deposits ratio of 81% at December 31, 2005, which is considered in the banking industry to be a conservative measure of good liquidity. Also, the Company receives outside ratings from both Standard & Poor’s and Moody’s on both the consolidated company and its lead bank, Commerce Bank, N.A. (Missouri). These ratings are as follows:
                   
 
    Standard &    
    Poor’s   Moody’s
 
Commerce Bancshares, Inc.
               
 
Short term/commercial paper
    A-1       Prime-1  
Commerce Bank, N. A.
               
 
Counterparty credit rating
    A/A-1          
 
Deposits
            Aa-3  
 
      The Company considers these ratings to be indications of a sound capital base and good liquidity. The Company believes that these ratings would enable its commercial paper to be readily marketable should the need arise. No commercial paper was outstanding over the past three years.
      In addition to the sources of liquidity as noted above, the Company has temporary borrowing capacity at the Federal Reserve discount window of $1.1 billion, for which it has pledged $339.2 million in loans and $862.0 million in investment securities. Also, because of its lack of significant long-term debt, the Company believes that, through its Capital Markets Group, it could generate additional liquidity from sources such as jumbo certificates of deposit or privately-placed corporate notes.
      The cash flows from the operating, investing and financing activities of the Company resulted in a net increase in cash and cash equivalents of $19.4 million in 2005, as reported in the consolidated statements of cash flows on page 50 of this report. Operating activities, consisting mainly of net income adjusted for certain non-cash items, provided cash flow of $293.6 million and has historically been a stable source of funds. Investing activities, consisting mainly of purchases and maturities of available for sale investment securities and changes in the level of the Company’s loan portfolio, provided total cash of $308.8 million in 2005. Investing activities are somewhat unique to financial institutions in that, while large sums of cash flow are normally used to fund growth in investment securities, loans, or other bank assets, they are normally dependent on financing activities described below.
      Financing activities used total cash of $583.0 million, resulting from a $587.5 million decrease in borrowings of federal funds purchased and securities sold under agreements to repurchase and repayments of $115.2 million on FHLB advances. In addition, the Company’s treasury stock repurchase program required $234.5 million, and cash dividend payments amounted to $63.4 million. Partly offsetting these cash outflows was a $399.7 million increase in deposits. Future short-term liquidity needs for daily operations are not expected to vary significantly and the Company maintains adequate liquidity to meet these cash flows. The Company’s sound equity base, along with its low debt level, common and preferred stock availability, and excellent debt ratings, provide several alternatives for future financing. Future acquisitions may utilize partial funding through one or more of these options.

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      Cash requirements for treasury stock purchases, net of cash received in connection with stock programs, and dividend payments were as follows:
                         
 
(In millions)   2005   2004   2003
 
Purchases of treasury stock
  $ 234.5     $ 173.8     $ 125.7  
Exercise of stock options and sales to affiliate non- employee directors
    (18.4 )     (15.3 )     (8.7 )
Cash dividends
    63.4       61.1       51.3  
 
Total
  $ 279.5     $ 219.6     $ 168.3  
 
      The Parent faces unique liquidity constraints due to legal limitations on its ability to borrow funds from its banking subsidiaries. The Parent obtains funding to meet its obligations from two main sources: dividends received from bank and non-bank subsidiaries (within regulatory limitations) and from management fees charged to subsidiaries as reimbursement for services provided by the Parent, as presented below:
                 
 
(In millions)   2005   2004
 
Dividends received from subsidiaries
  $ 220.0     $ 253.3  
Management fees
    33.0       33.0  
 
Total
  $ 253.0     $ 286.3  
 
      These sources of funds are used mainly to purchase treasury stock and pay cash dividends on outstanding common stock as noted above. At December 31, 2005, the Parent had no third party short-term borrowings or long-term debt and maintained $223.0 million in available for sale investment securities. This portfolio consisted of money market mutual funds, publicly traded stock, and debt securities, of which 39% is expected to mature in 2006.
      Company senior management is responsible for measuring and monitoring the liquidity profile of the organization with oversight by the Company’s Asset/Liability Committee (ALCO). This is done through a series of controls, including a written Contingency Funding Policy and risk monitoring procedures, including daily, weekly and monthly reporting. In addition, the Company prepares forecasts which project changes in the balance sheet affecting liquidity, and which allow the Company to better plan for forecasted changes.
Capital Management
      The Company maintains strong regulatory capital ratios, including those of its principal banking subsidiaries, in excess of the “well-capitalized” guidelines under federal banking regulations. The Company’s capital ratios at the end of the last three years are as follows:
                                   
 
    Well-Capitalized
    Regulatory
    2005   2004   2003   Guidelines
 
Risk-based capital ratios:
                               
 
Tier I capital
    12.21 %     12.21 %     12.31 %     6.00 %
 
Total capital
    13.63       13.57       13.70       10.00  
 
Leverage ratio
    9.43       9.60       9.71       5.00  
 
Common equity/assets
    9.87       10.25       10.68          
 
Dividend payout ratio
    28.92       28.26       25.19          
 

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      The components of the Company’s regulatory risked-based capital and risk-weighted assets at the end of the last three years are as follows:
                           
 
(In thousands)   2005   2004   2003
 
Regulatory risk-based capital:
                       
 
Tier I capital
  $ 1,295,898     $ 1,342,275     $ 1,331,439  
 
Tier II capital
    150,510       149,734       150,161  
 
Total capital
    1,446,408       1,492,009       1,481,600  
 
Total risk-weighted assets
    10,611,322       10,993,542       10,813,111  
 
      In October 2005, the Board of Directors authorized the Company to purchase additional shares of common stock under its repurchase program, which brought the total purchase authorization to 5,000,000 shares. The Company has routinely used these shares to fund the Company’s annual 5% stock dividend and various stock option programs. During 2005, approximately 4,643,000 shares were acquired under Board authorizations at an average price of $50.51.
      The Company’s common stock dividend policy reflects its earnings outlook, desired payout ratios, the need to maintain adequate capital levels and alternative investment options. Per share cash dividends paid by the Company increased 9.6% during 2005 compared with 2004.
Commitments, Contractual Obligations, and Off-Balance Sheet Arrangements
      Various commitments and contingent liabilities arise in the normal course of business, which are not required to be recorded on the balance sheet. The most significant of these are loan commitments totaling $6.9 billion (including approximately $3.4 billion in unused approved credit card lines) and standby letters of credit totaling $412.0 million at December 31, 2005. The Company has various other financial instruments with off-balance sheet risk, such as commercial letters of credit and commitments to purchase and sell when-issued securities. Since many commitments expire unused or only partially used, these totals do not necessarily reflect future cash requirements. Management does not anticipate any material losses arising from commitments and contingent liabilities and believes there are no material commitments to extend credit that represent risks of an unusual nature.
      A table summarizing contractual cash obligations of the Company at December 31, 2005 and the expected timing of these payments follows:
                                         
    Payments Due by Period
 
    After One   After Three    
    In One   Year   Years   After    
    Year or   Through   Through   Five    
(In thousands)   Less   Three Years   Five Years   Years   Total
 
Long-term debt obligations*
  $ 238,875     $ 18,571     $     $ 11,944     $ 269,390  
Operating lease obligations
    5,178       8,705       5,853       25,264       45,000  
Purchase obligations
    21,012       15,561       1,520             38,093  
Time open and C.D.’s *
    2,441,267       423,675       94,104       2,507       2,961,553  
 
Total
  $ 2,706,332     $ 466,512     $ 101,477     $ 39,715     $ 3,314,036  
 
Includes principal payments only.
     The Company has investments in several low-income housing partnerships within the area served by the banking affiliates. At December 31, 2005, these investments totaled $3.5 million and were recorded as other assets in the Company’s consolidated balance sheet. These partnerships supply funds for the construction and operation of apartment complexes that provide affordable housing to that segment of the population with lower family income. If these developments successfully attract a specified percentage of residents falling in that lower income range, state and/or federal income tax credits are made available to the partners. The tax credits are normally recognized over ten years, and they play an important part in the anticipated yield from these investments. In order to continue receiving the tax credits each year over the life of the partnership, the low-income residency targets must be maintained. Under the terms of the partnership agreements, the Company has a commitment to fund a specified amount that will be due in

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installments over the life of the agreements, which ranges from 10 to 15 years. These unfunded commitments are recorded as liabilities on the Company’s consolidated balance sheet, and aggregated $2.5 million at December 31, 2005.
      The Company periodically purchases various state tax credits arising from third-party property redevelopment. Most of the tax credits are resold to third parties, although some are retained for use by the Company. During 2005, purchases and sales of tax credits amounted to $22.5 million and $20.3 million, respectively, generating combined gains on sales and tax savings of $1.3 million. At December 31, 2005, the Company had outstanding purchase commitments totaling $59.2 million.
      The Parent has investments in several private equity concerns which are classified as non-marketable securities in the Company’s consolidated balance sheet. Under the terms of the agreements with six of these concerns, the Parent has unfunded commitments outstanding of $3.4 million at December 31, 2005. The Parent also plans to fund $21.1 million to venture capital subsidiaries over the next several years.
Interest Rate Sensitivity
      The Company’s Asset/Liability Management Committee (ALCO) measures and manages the Company’s interest rate risk on a monthly basis to identify trends and establish strategies to maintain stability in earnings throughout various rate environments. Analytical modeling techniques provide management insight into the Company’s exposure to changing rates. These techniques include net interest income simulations and market value analyses. Management has set guidelines specifying acceptable limits within which net interest income and market value may change under various rate change scenarios. These measurement tools indicate that the Company is currently within acceptable risk guidelines as set by management.
      The Company’s main interest rate measurement tool, income simulations, projects net interest income under various rate change scenarios in order to quantify the magnitude and timing of potential rate-related changes. Income simulations are able to capture option risks within the balance sheet where expected cash flows may be altered under various rate environments. Modeled rate movements include “shocks, ramps and twists”. Shocks are intended to capture interest rate risk under extreme conditions by immediately shifting rates up and down, while ramps measure the impact of gradual changes and twists measure yield curve risk. The size of the balance sheet is assumed to remain constant so that results are not influenced by growth predictions. The table below shows the expected effect that gradual basis point shifts in the LIBOR/swap curve over a twelve month period would have on the Company’s net interest income, given a static balance sheet.
                                                 
 
    December 31, 2005   September 30, 2005   December 31, 2004
             
    Increase   % of Net Interest   Increase   % of Net Interest   Increase   % of Net Interest
(Dollars in millions)   (Decrease)   Income   (Decrease)   Income   (Decrease)   Income
 
200 basis points rising
  $ (5.8 )     (1.14 )%   $ (7.0 )     (1.40 )%   $ (8.7 )     (1.78 )%
100 basis points rising
    (1.9 )     (.37 )     (2.9 )     (.58 )     (4.3 )     (.88 )
100 basis points falling
    (1.7 )     (.33 )     (.4 )     (.07 )     2.6       .53  
 
      The Company also employs a sophisticated simulation technique known as a stochastic income simulation. This technique allows management to see a range of results from hundreds of income simulations. The stochastic simulation creates a vector of potential rate paths around the market’s best guess (forward rates) concerning the future path of interest rates and allows rates to randomly follow paths throughout the vector. This allows for the modeling of non-biased rate forecasts around the market consensus. Results give management insight into a likely range of rate-related risk as well as worst and best-case rate scenarios.
      The Company also uses market value analyses to help identify longer-term risks that may reside on the balance sheet. This is considered a secondary risk measurement tool by management. The Company measures the market value of equity as the net present value of all asset and liability cash flows dis-

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counted along the current LIBOR/swap curve plus appropriate market risk spreads. It is the change in the market value of equity under different rate environments, or effective duration, that gives insight into the magnitude of risk to future earnings due to rate changes. Market value analyses also help management understand the price sensitivity of non-marketable bank products under different rate environments.
      The Company continues to be susceptible to lower net interest income in a rising rate environment. However, this risk has been reduced over the last four quarters of 2005. At December 31, 2005, the Company calculated that a gradual increase in rates of 100 basis points would reduce net interest income by $1.9 million, or .37%, compared with a reduction of $4.3 million calculated at December 31, 2004. Also, a 200 basis point gradual rise in rates calculated at December 31, 2005 would reduce net interest income by $5.8 million, or 1.1%, down from a reduction of $8.7 million last year.
      The improvement in the overall interest rate risk is the result of several changes in 2005, including a $569.0 million reduction in average available for sale investment securities, which carry mostly fixed rate investments, and growth of $431.4 million in average loans, which have greater re-pricing opportunities. Also, the average balance of short-term borrowings, mostly federal funds purchased, declined by $217.6 million in 2005, thereby limiting the expense impact of rising short-term interest rates. The Company remains somewhat susceptible to interest rate risk from falling rates because of 2005 growth in both certificates of deposit with fixed interest costs and the loan portfolio with its ability to re-price downward. The current size and characteristics of the investment portfolio help to provide a natural hedge in limiting this risk.
      Overall, the Company’s balance sheet remains well-diversified with moderate interest rate risk and is well-positioned for future growth. The use of derivative products is limited and the deposit base is strong and stable. The loan to deposit ratio is still at relatively low levels, which should present the Company with opportunities to fund future loan growth at reasonable costs as a strong economy increases business borrowing.
Derivative Financial Instruments
      The Company maintains an overall interest rate risk management strategy that permits the use of derivative instruments to modify exposure to interest rate risk. The Company’s interest rate risk management strategy includes the ability to modify the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not adversely affect the net interest margin and cash flows. Interest rate swaps are used on a limited basis as part of this strategy. As of December 31, 2005, the Company had entered into two interest rate swaps with a notional amount of $15.4 million which are designated as fair value hedges of certain fixed rate loans. The Company also sells swap contracts to customers who wish to modify their interest rate sensitivity. These swaps are offset by matching contracts purchased by the Company from other financial institutions. Because of the matching terms of the offsetting contracts, the effect of these transactions on net income is minimal. The notional amount of these types of swaps at December 31, 2005 was $147.3 million.
      The Company enters into foreign exchange derivative instruments as an accommodation to customers and offsets the related foreign exchange risk by entering into offsetting third-party forward contracts with approved reputable counterparties. In addition, the Company takes proprietary positions in such contracts based on market expectations. This trading activity is managed within a policy of specific controls and limits. Most of the foreign exchange contracts outstanding at December 31, 2005 mature within 90 days, and the longest period to maturity is 6 months.
      Additionally, interest rate lock commitments issued on residential mortgage loans held for resale are considered derivative instruments. The interest rate exposure on these commitments is economically hedged primarily with forward sale contracts in the secondary market.
      The Company is exposed to credit risk in the event of nonperformance by counterparties to financial instruments. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures. Because the Company generally enters into transactions only with high

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quality counterparties, there have been no losses associated with counterparty nonperformance on derivative financial instruments. The amount of credit risk associated with these instruments is limited to the cost of replacing a contract in a gain position, on which a counterparty may default.
      The following table summarizes the notional amounts and estimated fair values of the Company’s derivative instruments at December 31, 2005 and 2004. Notional amount, along with the other terms of the derivative, is used to determine the amounts to be exchanged between the counterparties. Because the notional amount does not represent amounts exchanged by the parties, it is not a measure of loss exposure related to the use of derivatives nor of exposure to liquidity risk. Positive fair values are recorded in other assets and negative fair values are recorded in other liabilities in the consolidated balance sheets.
                                                   
 
    2005   2004
         
        Positive   Negative       Positive   Negative
    Notional   Fair   Fair   Notional   Fair   Fair
(In thousands)   Amount   Value   Value   Amount   Value   Value
 
Interest rate contracts:
                                               
 
Swap contracts
  $ 162,698     $ 798     $ (1,782 )   $ 49,963     $ 649     $ (1,273 )
 
Option contracts
    6,970       6       (6 )                  
Foreign exchange contracts:
                                               
 
Forward contracts
    14,184       159       (77 )     13,031       171       (173 )
 
Option contracts
    2,560       3       (3 )     2,853       12       (12 )
Mortgage loan commitments
    5,353       12             8,319       1       (13 )
Mortgage loan forward sale contracts
    9,251       7       (18 )     15,728       39       (4 )
 
Total at December 31
  $ 201,016     $ 985     $ (1,886 )   $ 89,894     $ 872     $ (1,475 )
 
Operating Segments
      The Company segregates financial information for use in assessing its performance and allocating resources among three operating segments. The results are determined based on the Company’s management accounting process, which assigns balance sheet and income statement items to each responsible segment. These segments are defined by customer base and product type. The management process measures the performance of the operating segments based on the management structure of the Company and is not necessarily comparable with similar information for any other financial institution. Each segment is managed by executives who, in conjunction with the Chief Executive Officer, make strategic business decisions regarding that segment. The three reportable operating segments are Consumer, Commercial and Money Management. Additional information is presented in Note 13 on Segments in the consolidated financial statements.
      The Company uses a funds transfer pricing method to value funds used (e.g., loans, fixed assets, cash, etc.) and funds provided (deposits, borrowings, and equity) by the business segments and their components. This process assigns a specific value to each new source or use of funds with a maturity, based on current LIBOR interest rates, thus determining an interest spread at the time of the transaction. Non-maturity assets and liabilities are assigned to LIBOR based funding pools. This method helps to provide a more accurate means of valuing fund sources and uses in a varying interest rate environment. The Company also assigns loan charge-offs and recoveries directly to each operating segment instead of allocating a portion of actual loan loss provision to the segments. The operating segments also include a number of allocations of income and expense from various support and overhead centers within the Company. Management periodically makes changes to the method of assigning costs and income to its business segments to better reflect operating results. If appropriate, these changes are reflected in the prior year information in the table below.

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      The table below is a summary of segment pre-tax income for the past three years.
                                           
 
    % Change
     
(Dollars in thousands)   2005   2004   2003   ’05-’04   ’04-’03
 
Consumer
  $ 192,717     $ 138,646     $ 109,220       39.0 %     26.9 %
Commercial
    133,527       114,881       121,190       16.2       (5.2 )
Money management
    32,199       29,136       26,846       10.5       8.5  
 
 
Total segments
    358,443       282,663       257,256       26.8       9.9  
 
Other/elimination
    (40,849 )     28,479       33,983       NM       (16.2 )
 
Income before income taxes
  $ 317,594     $ 311,142     $ 291,239       2.1 %     6.8 %
 
Consumer
      The Consumer segment includes the retail branch network, consumer finance, bankcard, student loans and discount brokerage services. Pre-tax income for 2005 was $192.7 million, an increase of $54.1 million, or 39.0%, over 2004. This growth was mainly due to growth in net interest income of $52.1 million and an $18.9 million increase in non-interest income. Partly offsetting these increases were a $9.6 million increase in non-interest expense and a $7.3 million increase in net loan charge-offs. The increase in net interest income resulted mainly from a $93.7 million increase in allocated funding credits assigned to the deposit portfolio, which more than offset growth in deposit interest. The rising interest rate environment assigns a greater value, and thus income, to customer deposits in this segment. Non-interest income increased 12.2%, primarily due to higher overdraft and return item fees and bank card fees. Non-interest expense increased 3.6% over the prior year due to higher salaries expense, bankcard processing expense, online banking processing costs, and corporate management fees. These increases were partly offset by decreases in assigned overhead costs. Net loan charge-offs increased $7.3 million in 2005 over the previous year and were directly related to the higher consumer and credit card loan charge-offs in the fourth quarter as a result of higher bankruptcy notices received. Total average assets directly related to the segment rose 3.3% over 2004. Average segment loans increased 5.2% compared to 2004 mainly as a result of growth in consumer, home equity and credit card loans, while average deposits increased only slightly.
      Pre-tax income for 2004 was $138.6 million, an increase of $29.4 million, or 26.9%, over 2003. This increase was due in part to improved net interest income, growth in non-interest income and lower net loan charge-offs, but offset by higher non-interest expense. Net interest income increased $20.2 million, or 7.8%, as a result of lower deposit interest expense coupled with a decline in funding costs allocated to the loan portfolio and loan growth. Net charge-offs decreased $3.4 million, mainly due to lower consumer loan losses. Non-interest income increased $13.2 million, mainly due to higher overdraft and return item fees and bank card fees. Also, higher gains were reported on sales of student loans and fixed assets. This increase in revenue was partly offset by lower mortgage banking revenue. Non-interest expense increased $7.3 million due to higher management fees, marketing expense, loan servicing fees, occupancy expense, lower deferred loan origination costs, and a higher allocation for online banking expenses than in 2003. These increases were partly offset by decreases in check processing and data processing charges. Total average assets directly related to the segment rose 5.0% over 2003. Average segment loans increased 5.2% compared to 2003 mainly as a result of growth in consumer loans, while average deposits remained flat.
Commercial
      The Commercial segment provides corporate lending, leasing, international services, and corporate cash management services. Pre-tax income increased $18.6 million, or 16.2%, over 2004. This increase resulted from growth in net interest income and lower net loan charge-offs, coupled with well-controlled expense growth but lower non-interest income. The growth in net interest income, as in the Consumer segment, resulted from an increase in the cost of funds credit assigned to the segment’s deposits due to the rising rate environment in 2005. This credit increased by $22.2 million in 2005 compared with the growth in deposit interest expense of $4.8 million, thus creating a larger interest spread on deposits. Net loan charge-offs were $5.6 million in 2004 compared to net recoveries of $2.3 million in 2005, and resulted from

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a large loan charge-off in 2004 which was partly recovered in 2005. Non-interest income decreased $3.2 million, or 4.1%, as a result of lower commercial cash management fees, partly offset by growth in commercial bank card transaction fee income. Non-interest expense increased $2.0 million, or 1.5%, due to higher salaries expense, commercial deposit account processing fees and overhead cost allocations. Partly offsetting these expense increases were lower operating losses and higher deferred loan origination costs. During 2005, total average loans increased 5.2%, compared to a 1.6% decrease during 2004. The increase in loans during 2005 resulted mainly from growth in business loans and construction real estate loans, partly offset by a decline in business real estate loans. Average deposits increased 1.8% during 2005 compared to a 9.0% increase during 2004, as growth in business demand accounts slowed in 2005.
      In 2004, pre-tax income decreased $6.3 million, or 5.2%, from 2003 primarily due to an increase in non-interest expense, which grew $16.7 million, or 14.2%. Net interest income increased $5.5 million, or 3.2%, due to an increase in the credit for funds assigned to the segment’s deposit portfolio due to strong growth in average deposits. Non-interest income grew $4.8 million, or 6.8%, and resulted from higher commercial bank card fee income offset by lower commercial cash management fees. Non-interest expense increased $16.7 million due to higher assigned costs for check processing, internal management, and bank card and commercial loan servicing. During 2004, total average loans decreased 1.6%, compared to a 1.4% increase during 2003. Average deposits increased 9.0% during 2004, compared to a 9.4% increase during 2003.
Money Management
      The Money Management segment consists of the trust and capital markets activities. The Trust group provides trust and estate planning services, and advisory and discretionary investment management services. It also provides investment management services to The Commerce Funds, a series of mutual funds with $1.8 billion in total assets. The Capital Markets Group sells primarily fixed-income securities to individuals, corporations, correspondent banks, public institutions, and municipalities, and also provides investment safekeeping and bond accounting services. Pre-tax income for the segment was $32.2 million in 2005 compared to $29.1 million in 2004, an increase of $3.1 million, or 10.5%. The increase was due to growth in net interest income coupled with higher non-interest income of $1.5 million and slightly lower non-interest expense. The improvement in net interest income resulted from higher funding credits assigned to the deposit portfolio of this segment. The growth in non-interest income occurred mainly in private client revenues and proprietary mutual fund administration fees, partly offset by lower bond trading revenues in the Capital Markets Group. Non-interest expense decreased slightly due to lower incentive compensation costs and trust processing costs, partly offset by higher proprietary mutual funds expense subsidies. Average assets decreased $9.3 million during 2005 because of lower trading account investments and overnight investments of liquid funds. Average deposits increased $84.2 million during 2005, mainly due to continuing growth in short-term certificates of deposit over $100,000.
      Pre-tax income for the segment was $29.1 million in 2004 compared to $26.8 million in 2003, an increase of $2.3 million, or 8.5%. The increase was due to a reduction in non-interest expense of $2.4 million which was directly related to lower costs for salaries and benefits of $1.9 million. While non-interest income was essentially flat with the previous year, trust revenue grew $3.3 million, or 5.4%, but was offset by lower bond trading revenue, which declined $2.0 million, or 14.3%. Average assets decreased slightly during 2004 because of lower trading account investments, partly offset by higher overnight investments of liquid funds. Average deposits increased $62.6 million during 2004, mainly due to higher balances in short-term certificates of deposit over $100,000 and non-interest bearing demand deposit accounts.
      The Other/elimination category shown in the table above includes various support and overhead operating units which are mainly comprised of various operating expenses such as salaries, occupancy, etc. Also included in this category is the Company’s investment securities portfolio, which totaled $3.8 billion at December 31, 2005. The pre-tax profitability in the Other/elimination category decreased $69.3 million in 2005 compared to 2004. This decline was mainly the result of higher cost of funds charges assigned to this category and allocated to the investment portfolio, coupled with lower net gains on securities transactions. Interest earned on the investment portfolio is primarily based on fixed rates. However, the cost of

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funds charges assigned are variable and in a rising rate environment have increased significantly this year, causing most of the decline in pre-tax profitability for this category.
Impact of Recently Issued Accounting Standards
      The Financial Accounting Standards Board (FASB) issued Interpretation No. 46R (FIN 46R), “Consolidation of Variable Interest Entities”, in December 2003. FIN 46R clarified the requirements that investments in variable interest entities (VIE) be consolidated by the entity that has a variable interest that will absorb a majority of the VIE’s expected losses if they occur, receive a majority of the VIE’s expected returns, or both. Public companies were required to apply the unmodified provisions of the Interpretation to “special-purpose entities” by the end of the first reporting period ending after December 15, 2003. Public companies, other than small business issuers, were required to apply the revised Interpretation by the end of the first reporting period beginning after March 15, 2004 to all entities that were not special-purpose entities.
      As mentioned in last year’s Annual Report on Form 10-K, the Company has several Small Business Investment Company (SBIC) related private equity investments and other investments in low-income housing partnerships which would receive consolidated treatment under provisions of FIN 46R. The FASB, however, has elected to reconsider provisions of FIN 46R concerning SBIC related private equity investments. The FASB does not currently require these types of investments to be consolidated and has not resolved the accounting treatment for the investments. If consolidation is ultimately required for any of these investments, the Company’s assets, liabilities, revenues and expenses would be adjusted to reflect the consolidation of these investments; however, it is not expected that net income would be significantly affected. The Company does not have any other significant investments in unconsolidated entities meeting the requirements of FIN 46R.
      In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position (SOP) 03-03, “Accounting for Certain Loans and Debt Securities Acquired in a Transfer”. SOP 03-03 addresses the accounting for acquired loans that show evidence of having deteriorated in terms of credit quality since their origination (i.e. impaired loans). SOP 03-03 requires acquired loans to be recorded at their fair value, defined as the present value of future cash flows. SOP 03-03 prohibits the carryover of an allowance for loan loss on certain acquired loans, as credit losses are considered in the future cash flows assessment. SOP 03-03 is effective for loans that are acquired in fiscal years beginning after December 15, 2004. The adoption of this Statement did not have an impact on the Company’s financial statements.
      In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised), “Share-Based Payment”. The revision requires entities to recognize the cost in their statements of income of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards. The Statement requires several accounting changes in the areas of award modifications and forfeitures. It contains additional guidance in several areas, including measuring fair value, classifying an award as equity or as a liability, and attributing compensation cost to reporting periods. For calendar year companies, the Statement is effective January 1, 2006. The Company implemented provisions of the original Statement 123 beginning in 2003 and has recorded the cost of such awards in its statements of income. The Company does not expect that adoption of the revised Statement will have a material effect on its consolidated financial statements in 2006.
      In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections”. The Statement changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. The Statement carries forward previously issued guidance on reporting changes in accounting estimate (which

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shall be accounted for in the period of change and future periods, if affected) and errors in previously issued financial statements (which shall be reported as a prior period adjustment by restating the prior period financial statements). For calendar year companies, the Statement is effective for accounting changes and corrections of errors made after January 1, 2006. The Company does not expect that adoption of the Statement will have a material effect on its consolidated financial statements.
Effects of Inflation
      The impact of inflation on financial institutions differs significantly from that exerted on industrial entities. Financial institutions are not heavily involved in large capital expenditures used in the production, acquisition or sale of products. Virtually all assets and liabilities of financial institutions are monetary in nature and represent obligations to pay or receive fixed and determinable amounts not affected by future changes in prices. Changes in interest rates have a significant effect on the earnings of financial institutions. Higher interest rates generally follow the rising demand of borrowers and the corresponding increased funding requirements of financial institutions. Although interest rates are viewed as the price of borrowing funds, the behavior of interest rates differs significantly from the behavior of the prices of goods and services. Prices of goods and services may be directly related to that of other goods and services while the price of borrowing relates more closely to the inflation rate in the prices of those goods and services. As a result, when the rate of inflation slows, interest rates tend to decline while absolute prices for goods and services remain at higher levels. Interest rates are also subject to restrictions imposed through monetary policy, usury laws and other artificial constraints.
Corporate Governance
      The Company has adopted a number of corporate governance measures. Information on corporate governance is available on the Company’s web site www.commercebank.com under Investor Relations.
Forward-Looking Statements
      This report may contain “forward-looking statements” that are subject to risks and uncertainties and include information about possible or assumed future results of operations. Many possible events or factors could affect the future financial results and performance of the Company. This could cause results or performance to differ materially from those expressed in the forward-looking statements. Words such as “expects”, “anticipates”, “believes”, “estimates”, variations of such words and other similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in, or implied by, such forward-looking statements. Readers should not rely solely on the forward-looking statements and should consider all uncertainties and risks discussed throughout this report. Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. Such possible events or factors include: 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; and competition with other entities that offer financial services.

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AVERAGE BALANCE SHEETS – AVERAGE RATES AND YIELDS
                                                                           
 
    Years Ended December 31
     
    2005   2004   2003
             
        Average       Average       Average
        Interest   Rates       Interest   Rates       Interest   Rates
    Average   Income/   Earned/   Average   Income/   Earned/   Average   Income/   Earned/
(Dollars in thousands)   Balance   Expense   Paid   Balance   Expense   Paid   Balance   Expense   Paid
 
ASSETS
                                                                       
Loans:(A)
                                                                       
 
Business(B)
  $ 2,336,681     $ 125,417       5.37 %   $ 2,119,823     $ 88,199       4.16 %   $ 2,173,765     $ 90,860       4.18 %
 
Real estate – construction
    480,864       28,422       5.91       427,976       18,068       4.22       404,058       17,324       4.29  
 
Real estate – business
    1,794,269       106,167       5.92       1,823,302       90,601       4.97       1,831,575       93,731       5.12  
 
Real estate – personal
    1,351,809       71,879       5.32       1,334,859       69,273       5.19       1,304,677       73,568       5.64  
 
Consumer
    1,242,163       80,431       6.48       1,188,018       75,633       6.37       1,129,267       79,571       7.05  
 
Home equity
    429,911       26,463       6.16       381,111       17,481       4.59       324,375       14,372       4.43  
 
Student
    357,319       17,050       4.77       326,120       9,790       3.00       339,577       9,606       2.83  
 
Credit card
    554,471       66,552       12.00       515,585       57,112       11.08       490,534       55,310       11.28  
 
Overdrafts
    13,995                   13,319                   11,631              
 
Total loans
    8,561,482       522,381       6.10       8,130,113       426,157       5.24       8,009,459       434,342       5.42  
 
Investment securities:
                                                                       
 
U.S. government & federal agency
    1,066,304       39,968       3.75       1,721,301       67,988       3.95       1,543,269       67,236       4.36  
 
State & municipal obligations(B)
    137,007       5,910       4.31       70,846       3,410       4.81       80,687       4,139       5.13  
 
Mortgage and asset-backed securities
    2,812,757       114,978       4.09       2,846,093       105,827       3.72       2,504,514       103,681       4.14  
 
Trading securities
    10,624       422       3.98       14,250       498       3.50       17,003       662       3.90  
 
Other marketable securities(B)
    216,984       9,316       4.29       163,843       3,747       2.29       220,499       4,603       2.09  
 
Non-marketable securities
    78,709       4,617       5.87       75,542       3,530       4.67       74,501       4,923       6.61  
 
Total investment securities
    4,322,385       175,211       4.05       4,891,875       185,000       3.78       4,440,473       185,244       4.17  
 
Federal funds sold and securities purchased under agreements to resell
    116,553       4,102       3.52       84,113       1,312       1.56       63,232       831       1.31  
 
Total interest earning assets
    13,000,420       701,694       5.40       13,106,101       612,469       4.67       12,513,164       620,417       4.96  
 
Less allowance for loan losses
    (129,272 )                     (132,554 )                     (132,057 )                
Unrealized gain (loss) on investment securities
    22,607                       90,692                       143,309                  
Cash and due from banks
    508,389                       553,074                       513,733                  
Land, buildings and equipment – net
    369,471                       340,188                       336,665                  
Other assets
    201,829                       191,655                       167,944                  
                                                 
Total assets
  $ 13,973,444                     $ 14,149,156                     $ 13,542,758                  
                                                 
LIABILITIES AND EQUITY
                                                                       
Interest bearing deposits:
                                                                       
 
Savings
  $ 403,158       1,259       .31     $ 401,935       1,250       .31     $ 380,323       1,351       .36  
 
Interest checking and money market
    6,745,714       52,112       .77       6,171,456       26,707       .43       6,015,827       27,391       .46  
 
Time open & C.D.’s of less than $100,000
    1,736,804       50,597       2.91       1,678,659       38,924       2.32       1,838,137       48,440       2.64  
 
Time open & C.D.’s of $100,000 and over
    983,703       30,779       3.13       788,800       14,912       1.89       699,241       14,278       2.04  
 
Total interest bearing deposits
    9,869,379       134,747       1.37       9,040,850       81,793       .90       8,933,528       91,460       1.02  
 
Borrowings:
                                                                       
 
Federal funds purchased and securities sold under agreements to repurchase
    1,609,868       48,776       3.03       1,827,428       22,560       1.23       1,550,211       15,289       .99  
 
Other borrowings(C)
    366,072       12,464       3.40       419,215       8,519       2.03       395,026       8,269       2.09  
 
Total borrowings
    1,975,940       61,240       3.10       2,246,643       31,079       1.38       1,945,237       23,558       1.21  
 
Total interest bearing liabilities
    11,845,319       195,987       1.65 %     11,287,493       112,872       1.00 %     10,878,765       115,018       1.06 %
 
Non-interest bearing demand deposits
    655,729                       1,288,434                       1,083,207                  
Other liabilities
    93,708                       123,048                       133,813                  
Stockholders’ equity
    1,378,688                       1,450,181                       1,446,973                  
                                                 
Total liabilities and equity
  $ 13,973,444                     $ 14,149,156                     $ 13,542,758                  
 
Net interest margin (T/E)
          $ 505,707                     $ 499,597                     $ 505,399          
 
Net yield on interest earning assets
                    3.89 %                     3.81 %                     4.04 %
 
Percentage increase (decrease) in net interest margin (T/E) compared to the prior year
                    1.22 %                     (1.15 )%                     .69 %
 
(A) Loans on non-accrual status are included in the computation of average balances. Included in interest income above are loan fees and late charges, net of amortization of deferred loan origination costs, which are immaterial. Credit card income from merchant discounts and net interchange fees are not included in loan income.
(B) Interest income and yields are presented on a fully-taxable equivalent basis using the Federal statutory income tax rate. Business loan interest income includes tax free loan income of $2,393,000 in 2005, $2,379,000 in 2004, $2,466,000 in 2003, $3,355,000 in 2002 and $3,937,000 in 2001, including tax equivalent adjustments of $1,097,000 in 2005, $819,000 in 2004, $847,000 in 2003,

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Years Ended December 31    
     
2002   2001   2000    
            Average
    Average       Average       Average   Balance
    Interest   Rates       Interest   Rates       Interest   Rates   Five Year
Average   Income/   Earned/   Average   Income/   Earned/   Average   Income/   Earned/   Compound
Balance   Expense   Paid   Balance   Expense   Paid   Balance   Expense   Paid   Growth Rate
 
$ 2,433,041     $ 115,058       4.73 %   $ 2,566,503     $ 169,747       6.61 %   $ 2,636,931     $ 216,146       8.20 %     (2.39 )%
  474,307       23,894       5.04       409,262       29,598       7.23       382,106       33,364       8.73       4.71  
  1,483,012       88,645       5.98       1,398,366       103,551       7.41       1,267,872       104,757       8.26       7.19  
  1,247,209       82,382       6.61       1,339,436       98,283       7.34       1,417,548       105,229       7.42       (.95 )
  1,046,173       83,266       7.96       1,095,809       92,339       8.43       1,126,886       94,084       8.35       1.97  
  283,466       14,336       5.06       239,599       18,077       7.54       214,655       20,364       9.49       14.90  
  316,910       13,124       4.14       280,846       18,223       6.49       267,254       21,717       8.13       5.98  
  463,474       52,337       11.29       460,157       61,789       13.43       469,401       69,309       14.77       3.39  
  14,150                   19,953                   19,388                   (6.31 )
 
  7,761,742       473,042       6.09       7,809,931       591,607       7.58       7,802,041       664,970       8.52       1.88  
 
  1,233,040       57,159       4.64       892,248       48,666       5.45       913,285       56,486       6.18       3.15  
  41,103       3,079       7.49       55,379       4,225       7.63       72,209       5,641       7.81       13.67  
  2,118,460       112,703       5.32       1,284,355       77,066       6.00       1,034,172       64,336       6.22       22.15  
  10,931       532       4.86       15,924       774       4.86       11,000       765       6.95       (.69 )
  124,648       4,258       3.42       159,897       6,742       4.22       86,133       5,895       6.84       20.30  
  66,666       2,781       4.17       68,299       3,246       4.75       68,013       3,786       5.57       2.96  
 
  3,594,848       180,512       5.02       2,476,102       140,719       5.68       2,184,812       136,909       6.27       14.62  
 
  84,278       1,486       1.76       541,930       22,386       4.13       227,623       14,517       6.38       (12.53 )
 
  11,440,868       655,040       5.73       10,827,963       754,712       6.97       10,214,476       816,396       7.99       4.94  
 
  (129,960 )                     (129,978 )                     (125,887 )                     .53  
  114,908                       56,296                       (3,146 )                     NM  
  511,798                       532,715                       533,028                       (.94 )
  329,553                       286,166                       244,877                       8.57  
  146,671                       162,661                       162,709                       4.40  
                                                         
$ 12,413,838                     $ 11,735,823                     $ 11,026,057                       4.85 %
                                                         
$ 353,779       2,146       .61     $ 323,462       3,345       1.03     $ 316,532       5,484       1.73       4.96 %
  5,762,465       43,101       .75       5,253,024       97,746       1.86       4,896,337       144,398       2.95       6.62  
  2,046,041       70,367       3.44       2,259,161       121,851       5.39       2,068,653       112,182       5.42       (3.44 )
  651,336       18,252       2.80       530,874       27,699       5.22       328,652       18,275       5.56       24.52  
 
  8,813,621       133,866       1.52       8,366,521       250,641       3.00       7,610,174       280,339       3.68       5.34  
 
  771,646       9,853       1.28       601,865       19,164       3.18       772,296       44,594       5.77       15.82  
  371,902       9,363       2.52       301,363       13,956       4.63       110,444       6,955       6.30       27.08  
 
  1,143,548       19,216       1.68       903,228       33,120       3.67       882,740       51,549       5.84       17.49  
 
  9,957,169       153,082       1.54 %     9,269,749       283,761       3.06 %     8,492,914       331,888       3.91 %     6.88  
 
  974,941                       1,101,174                       1,331,220                       (13.20 )
  120,143                       137,832                       98,208                       (.93 )
  1,361,585                       1,227,068                       1,103,715                       4.55  
                                                         
$ 12,413,838                     $ 11,735,823                     $ 11,026,057                       4.85 %
 
        $ 501,958                     $ 470,951                     $ 484,508                  
 
                  4.39 %                     4.35 %                     4.74 %        
 
                  6.58 %                     (2.80 )%                     2.88 %        
 
$1,142,000 in 2002 and $1,266,000 in 2001. State and municipal interest income includes tax equivalent adjustments of $1,445,000 in 2005, $1,093,000 in 2004, $1,301,000 in 2003, $999,000 in 2002 and $1,325,000 in 2001. Interest income on other marketable securities includes tax equivalent adjustments of $1,586,000 in 2005, $467,000 in 2004, $859,000 in 2003, $346,000 in 2002 and $332,000 in 2001.
(C) Interest expense of $123,000, $113,000, $494,000 and $747,000 which was capitalized on construction projects in 2005, 2004, 2002 and 2001, respectively, is not deducted from the interest expense shown above.

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QUARTERLY AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
 
                                                                   
    Year Ended December 31, 2005
     
    Fourth Quarter   Third Quarter   Second Quarter   First Quarter
                 
        Average       Average       Average       Average
        Rates       Rates       Rates       Rates
    Average   Earned/   Average   Earned/   Average   Earned/   Average   Earned/
(Dollars in millions)   Balance   Paid   Balance   Paid   Balance   Paid   Balance   Paid
 
ASSETS
                                                               
Loans:
                                                               
 
Business(A)
  $ 2,436       5.84 %   $ 2,357       5.50 %   $ 2,305       5.12 %   $ 2,246       4.96 %
 
Real estate – construction
    483       6.58       519       6.10       479       5.68       443       5.19  
 
Real estate – business
    1,877       6.32       1,775       6.02       1,766       5.74       1,758       5.56  
 
Real estate – personal
    1,361       5.37       1,367       5.31       1,344       5.28       1,335       5.30  
 
Consumer
    1,281       6.67       1,268       6.52       1,225       6.38       1,193       6.31  
 
Home equity
    447       6.84       437       6.34       423       5.89       413       5.47  
 
Student
    325       5.27       321       5.08       374       4.57       410       4.31  
 
Credit card
    561       12.36       556       12.20       554       11.82       547       11.61  
 
Overdrafts
    13             15             12             16        
 
Total loans
    8,784       6.47       8,615       6.21       8,482       5.93       8,361       5.76  
 
Investment securities:
                                                               
 
U.S. government & federal agency
    849       3.58       919       3.47       1,130       4.58       1,374       3.35  
 
State & municipal obligations(A)
    246       4.32       164       4.21       71       4.44       64       4.43  
 
Mortgage and asset-backed securities
    2,574       4.24       2,905       4.14       2,925       4.11       2,848       3.87  
 
Trading securities
    13       4.24       11       4.01       8       3.98       11       3.66  
 
Other marketable securities(A)
    210       5.55       222       4.68       219       3.82       218       3.13  
 
Non-marketable securities
    81       8.77       81       3.51       76       5.45       77       5.67  
 
Total investment securities
    3,973       4.26       4,302       4.02       4,429       4.24       4,592       3.72  
 
Federal funds sold and securities purchased under agreements to resell
    109       4.23       127       3.74       145       3.22       85       2.79  
 
Total interest earning assets
    12,866       5.77       13,044       5.46       13,056       5.33       13,038       5.02  
 
Less allowance for loan losses
    (127 )             (128 )             (130 )             (132 )        
Unrealized gain (loss) on investment securities
    (3 )             20               26               48          
Cash and due from banks
    493               478               503               560          
Land, buildings and equipment – net
    377               376               370               354          
Other assets
    209               197               199               202          
 
Total assets
  $ 13,815             $ 13,987             $ 14,024             $ 14,070          
 
 
LIABILITIES AND EQUITY
                                                               
Interest bearing deposits:
                                                               
 
Savings
  $ 388       .31     $ 404       .31     $ 417       .31     $ 404       .31  
 
Interest checking and money market
    6,701       .94       6,759       .83       6,821       .70       6,702       .61  
 
Time open & C.D.’s under $100,000
    1,796       3.27       1,753       3.02       1,732       2.79       1,665       2.53  
 
Time open & C.D.’s $100,000 & over
    968       3.71       903       3.26       1,086       2.95       979       2.63  
 
Total interest bearing deposits
    9,853       1.62       9,819       1.42       10,056       1.29       9,750       1.13  
 
Borrowings:
                                                               
 
Federal funds purchased and securities sold under agreements to repurchase
    1,579       3.76       1,724       3.27       1,481       2.75       1,655       2.31  
 
Other borrowings
    325       3.96       371       3.53       380       3.24       389       2.96  
 
Total borrowings
    1,904       3.80       2,095       3.32       1,861       2.85       2,044       2.43  
 
Total interest bearing liabilities
    11,757       1.97 %     11,914       1.76 %     11,917       1.53 %     11,794       1.36 %
 
Non-interest bearing demand deposits
    617               602               633               773          
Other liabilities
    90               96               92               95          
Stockholders’ equity
    1,351               1,375               1,382               1,408          
 
Total liabilities and equity
  $ 13,815             $ 13,987             $ 14,024             $ 14,070          
 
Net interest margin (T/E)
  $ 129             $ 127             $ 128             $ 122          
 
Net yield on interest earning assets
            3.97 %             3.86 %             3.93 %             3.79 %
 
(A) Includes tax equivalent calculations.

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    Year Ended December 31, 2004
     
    Fourth Quarter   Third Quarter   Second Quarter   First Quarter
                 
        Average       Average       Average       Average
        Rates       Rates       Rates       Rates
    Average   Earned/   Average   Earned/   Average   Earned/   Average   Earned/
(Dollars in millions)   Balance   Paid   Balance   Paid   Balance   Paid   Balance   Paid
 
ASSETS
                                                               
Loans:
                                                               
 
Business(A)
  $ 2,185       4.53 %   $ 2,083       4.14 %   $ 2,125       4.00 %   $ 2,086       3.96 %
 
Real estate – construction
    420       4.73       427       4.21       439       3.95       426       4.00  
 
Real estate – business
    1,756       5.24       1,806       4.99       1,851       4.80       1,881       4.86  
 
Real estate – personal
    1,340       5.17       1,339       5.15       1,329       5.20       1,331       5.25  
 
Consumer
    1,205       6.32       1,210       6.25       1,184       6.35       1,152       6.55  
 
Home equity
    406       4.91       390       4.64       371       4.37       357       4.38  
 
Student
    344       3.71       290       3.09       289       2.58       382       2.61  
 
Credit card
    522       11.30       520       11.06       509       10.76       511       11.19  
 
Overdrafts
    14             11             11             18        
 
Total loans
    8,192       5.47       8,076       5.24       8,108       5.11       8,144       5.15  
 
Investment securities:
                                                               
 
U.S. government & federal agency
    1,717       3.85       1,637       3.84       1,756       4.58       1,776       3.53  
 
State & municipal obligations(A)
    69       4.46       72       4.87       70       4.97       72       4.95  
 
Mortgage and asset-backed securities
    2,726       3.67       2,829       3.76       2,986       3.65       2,845       3.79  
 
Trading securities
    13       3.10       10       3.45       25       3.67       8       3.67  
 
Other marketable securities(A)
    195       2.78       158       2.23       138       2.08       164       1.92  
 
Non-marketable securities
    75       4.70       75       5.23       78       4.18       75       4.59  
 
Total investment securities
    4,795       3.73       4,781       3.77       5,053       3.96       4,940       3.66  
 
Federal funds sold and securities purchased under agreements to resell
    64       2.23       101       1.69       111       1.23       61       1.24  
 
Total interest earning assets
    13,051       4.81       12,958       4.67       13,272       4.64       13,145       4.57  
 
Less allowance for loan losses
    (132 )             (132 )             (133 )             (133 )        
Unrealized gain on investment securities
    81               55               97               131          
Cash and due from banks
    576               557               550               529          
Land, buildings and equipment – net
    344               341               338               337          
Other assets
    192               190               200               185          
 
Total assets
  $ 14,112             $ 13,969             $ 14,324             $ 14,194          
 
 
LIABILITIES AND EQUITY
                                                               
Interest bearing deposits:
                                                               
 
Savings
  $ 398       .31     $ 406       .31     $ 411       .31     $ 393       .31  
 
Interest checking and money market
    6,205       .51       6,205       .44       6,164       .39       6,111       .39  
 
Time open & C.D.’s under $100,000
    1,657       2.38       1,657       2.29       1,686       2.29       1,715       2.32  
 
Time open & C.D.’s $100,000 & over
    754       2.21       815       1.90       841       1.71       745       1.76  
 
Total interest bearing deposits
    9,014       .99       9,083       .90       9,102       .86       8,964       .87  
 
Borrowings:
                                                               
 
Federal funds purchased and securities sold under agreements to repurchase
    1,792       1.82       1,662       1.31       1,912       .93       1,947       .92  
 
Other borrowings
    390       2.53       392       1.96       454       1.84       441       1.85  
 
Total borrowings
    2,182       1.95       2,054       1.43       2,366       1.11       2,388       1.09  
 
Total interest bearing liabilities
    11,196       1.18 %     11,137       1.00 %     11,468       .91 %     11,352       .91 %
 
Non-interest bearing demand deposits
    1,351               1,292               1,276               1,234          
Other liabilities
    110               111               128               143          
Stockholders’ equity
    1,455               1,429               1,452               1,465          
 
Total liabilities and equity
  $ 14,112             $ 13,969             $ 14,324             $ 14,194          
 
Net interest margin (T/E)
  $ 125             $ 124             $ 127             $ 124          
 
Net yield on interest earning assets
            3.80 %             3.82 %             3.85 %             3.78 %
 
(A) Includes tax equivalent calculations.

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SUMMARY OF QUARTERLY STATEMENTS OF INCOME
                                 
 
    For the Quarter Ended
Year Ended December 31, 2005    
(In thousands, except per share data)   12/31/05   9/30/05   6/30/05   3/31/05
 
Interest income
  $ 185,343     $ 178,570     $ 172,800     $ 160,853  
Interest expense
    (58,337 )     (52,738 )     (45,413 )     (39,376 )
 
Net interest income
    127,006       125,832       127,387       121,477  
Non-interest income
    88,633       86,895       84,980       80,691  
Salaries and employee benefits
    (68,730 )     (66,682 )     (67,585 )     (70,180 )
Other expense
    (58,471 )     (55,705 )     (55,427 )     (53,742 )
Provision for loan losses
    (11,980 )     (8,934 )     (5,503 )     (2,368 )
 
Income before income taxes
    76,458       81,406       83,852       75,878  
Income taxes
    (20,216 )     (18,615 )     (29,484 )     (26,032 )
 
Net income
  $ 56,242     $ 62,791     $ 54,368     $ 49,846  
 
Net income per share – basic*
  $ .83     $ .90     $ .78     $ .70  
Net income per share – diluted*
  $ .81     $ .89     $ .77     $ .69  
 
Weighted average shares – basic*
    68,210       69,244       70,071       71,023  
Weighted average shares – diluted*
    69,040       70,194       71,036       72,011  
 
                                 
 
    For the Quarter Ended
Year Ended December 31, 2004    
(In thousands, except per share data)   12/31/04   9/30/04   6/30/04   3/31/04
 
Interest income
  $ 157,271     $ 151,592     $ 152,440     $ 148,787  
Interest expense
    (33,069 )     (27,908 )     (25,979 )     (25,803 )
 
Net interest income
    124,202       123,684       126,461       122,984  
Non-interest income
    77,753       78,920       84,289       85,969  
Salaries and employee benefits
    (66,208 )     (65,549 )     (65,696 )     (68,016 )
Other expense
    (56,221 )     (54,943 )     (55,240 )     (50,896 )
Provision for loan losses
    (7,215 )     (6,606 )     (6,280 )     (10,250 )
 
Income before income taxes
    72,311       75,506       83,534       79,791  
Income taxes
    (19,651 )     (12,987 )     (29,696 )     (28,467 )
 
Net income
  $ 52,660     $ 62,519     $ 53,838     $ 51,324  
 
Net income per share – basic*
  $ .73     $ .85     $ .73     $ .69  
Net income per share – diluted*
  $ .71     $ .84     $ .72     $ .68  
 
Weighted average shares – basic*
    72,422       73,190       73,873       74,643  
Weighted average shares – diluted*
    73,530       74,235       74,901       75,827  
 
                                 
 
    For the Quarter Ended
Year Ended December 31, 2003    
(In thousands, except per share data)   12/31/03   9/30/03   6/30/03   3/31/03
 
Interest income
  $ 153,649     $ 148,529     $ 159,648     $ 155,584  
Interest expense
    (26,142 )     (26,541 )     (30,961 )     (31,374 )
 
Net interest income
    127,507       121,988       128,687       124,210  
Non-interest income
    76,420       76,940       73,701       74,606  
Salaries and employee benefits
    (64,964 )     (65,036 )     (66,006 )     (68,593 )
Other expense
    (51,801 )     (51,394 )     (52,209 )     (52,141 )
Provision for loan losses
    (11,002 )     (9,655 )     (9,999 )     (10,020 )
 
Income before income taxes
    76,160       72,843       74,174       68,062  
Income taxes
    (22,299 )     (17,895 )     (23,687 )     (20,834 )
 
Net income
  $ 53,861     $ 54,948     $ 50,487     $ 47,228  
 
Net income per share – basic*
  $ .72     $ .72     $ .66     $ .61  
Net income per share – diluted*
  $ .70     $ .71     $ .66     $ .60  
 
Weighted average shares – basic*
    75,321       76,102       76,581       77,402  
Weighted average shares – diluted*
    76,497       77,104       77,388       78,224  
 
Restated for the 5% stock dividend distributed in 2005.

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Item 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
      The information required by this item is set forth on pages 35 through 37 of Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations.
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Commerce Bancshares, Inc.:
      We have audited the accompanying consolidated balance sheets of Commerce Bancshares, Inc. and Subsidiaries (the Company) as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
      We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
      In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
      We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 27, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
(-s- KPMG LLP)
Kansas City, Missouri
February 27, 2006

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Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
 
                     
    December 31
     
    2005   2004
     
    (In thousands)
ASSETS
               
Loans, net of unearned income
  $ 8,899,183     $ 8,305,359  
Allowance for loan losses
    (128,447 )     (132,394 )
 
Net loans
    8,770,736       8,172,965  
 
Investment securities:
               
 
Available for sale
    3,667,901       4,754,941  
 
Trading
    24,959       9,403  
 
Non-marketable
    77,321       73,024  
 
Total investment securities
    3,770,181       4,837,368  
 
Federal funds sold and securities purchased under agreements to resell
    128,862       68,905  
Cash and due from banks
    545,273       585,815  
Land, buildings and equipment – net
    374,192       336,446  
Goodwill
    48,522       48,522  
Other assets
    247,779       200,347  
 
Total assets
  $ 13,885,545     $ 14,250,368  
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Deposits:
               
 
Non-interest bearing demand
  $ 1,399,934     $ 1,943,771  
 
Savings, interest checking and money market
    6,490,326       6,072,115  
 
Time open and C.D.’s of less than $100,000
    1,831,980       1,656,002  
 
Time open and C.D.’s of $100,000 and over
    1,129,573       762,421  
 
Total deposits
    10,851,813       10,434,309  
 
Federal funds purchased and securities sold under agreements to repurchase
    1,326,427       1,913,878  
Other borrowings
    269,390       389,542  
Other liabilities
    100,077       85,759  
 
Total liabilities
    12,547,707       12,823,488  
 
Stockholders’ equity:
               
 
Preferred stock, $1 par value
               
   
Authorized and unissued 2,000,000 shares
           
 
Common stock, $5 par value
               
   
Authorized 100,000,000 shares; issued 69,409,882 shares in 2005 and 2004
    347,049       347,049  
 
Capital surplus
    388,552       388,614  
 
Retained earnings
    693,021       703,293  
 
Treasury stock of 1,716,413 shares in 2005 and 1,072,098 shares in 2004, at cost
    (86,901 )     (51,646 )
 
Accumulated other comprehensive income (loss)
    (3,883 )     39,570  
 
Total stockholders’ equity
    1,337,838       1,426,880  
 
Total liabilities and stockholders’ equity
  $ 13,885,545     $ 14,250,368  
 
See accompanying notes to consolidated financial statements.

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Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
                           
 
    For the Years Ended December 31
     
(In thousands, except per share data)   2005   2004   2003
 
INTEREST INCOME
                       
Interest and fees on loans
  $ 521,283     $ 425,338     $ 433,495  
Interest on investment securities
    172,181       183,440       183,084  
Interest on federal funds sold and securities purchased under agreements to resell
    4,102       1,312       831  
 
Total interest income
    697,566       610,090       617,410  
 
INTEREST EXPENSE
                       
Interest on deposits:
                       
 
Savings, interest checking and money market
    53,371       27,957       28,742  
 
Time open and C.D.’s of less than $100,000
    50,597       38,924       48,440  
 
Time open and C.D.’s of $100,000 and over
    30,779       14,912       14,278  
Interest on federal funds purchased and securities sold under agreements to repurchase
    48,776       22,560       15,289  
Interest on other borrowings
    12,341       8,406       8,269  
 
Total interest expense
    195,864       112,759       115,018  
 
Net interest income
    501,702       497,331       502,392  
Provision for loan losses
    28,785       30,351       40,676  
 
Net interest income after provision for loan losses
    472,917       466,980       461,716  
 
NON-INTEREST INCOME
                       
Deposit account charges and other fees
    112,979       105,382       97,711  
Bank card transaction fees
    86,310       78,253       67,102  
Trust fees
    68,316       64,257       60,921  
Trading account profits and commissions
    9,650       12,288       14,740  
Consumer brokerage services
    9,909       9,846       9,415  
Loan fees and sales
    12,838       13,654       14,109  
Net gains on securities transactions
    6,362       11,092       4,560  
Other
    34,835       32,159       33,109  
 
Total non-interest income
    341,199       326,931       301,667  
 
NON-INTEREST EXPENSE
                       
Salaries and employee benefits
    273,177       265,469       264,599  
Net occupancy
    40,621       39,558       38,736  
Equipment
    23,201       22,903       24,104  
Supplies and communication
    33,342       33,760       33,474  
Data processing and software
    48,244       46,000       40,567  
Marketing
    17,294       16,688       14,397  
Other
    60,643       58,391       56,267  
 
Total non-interest expense
    496,522       482,769       472,144  
 
Income before income taxes
    317,594       311,142       291,239  
Less income taxes
    94,347       90,801       84,715  
 
Net income
  $ 223,247     $ 220,341     $ 206,524  
 
Net income per share – basic
  $ 3.21     $ 3.00     $ 2.71  
Net income per share – diluted
  $ 3.16     $ 2.95     $ 2.67  
 
See accompanying notes to consolidated financial statements.

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Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
                           
 
    For the Years Ended December 31
     
(In thousands)   2005   2004   2003
 
OPERATING ACTIVITIES
                       
Net income
  $ 223,247     $ 220,341     $ 206,524  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
 
Provision for loan losses
    28,785       30,351       40,676  
 
Provision for depreciation and amortization
    42,318       41,562       41,378  
 
Amortization of investment security premiums, net
    16,730       25,840       29,646  
 
Provision (benefit) for deferred income taxes
    (1,757 )     2,717       (11,626 )
 
Net gains on securities transactions
    (6,362 )     (11,092 )     (4,560 )
 
Net gains on sales of mortgage loans held for sale
    (1,401 )     (1,535 )     (4,016 )
 
Proceeds from sales of mortgage loans held for sale
    94,763       98,792       238,002  
 
Originations of mortgage loans held for sale
    (88,504 )     (95,802 )     (205,393 )
 
Net (increase) decrease in trading securities
    (15,536 )     1,289       (633 )
 
Stock based compensation
    6,628       6,465       6,092  
 
Decrease in interest receivable
    676       1,630       392  
 
Increase (decrease) in interest payable
    16,213       (372 )     (8,837 )
 
Increase (decrease) in income taxes payable
    22       (20,039 )     6,993  
 
Net tax benefit related to stock option plans
    (4,288 )     (2,305 )     (1,524 )
 
Other changes, net
    (17,900 )     (33,187 )     (35,898 )
 
Net cash provided by operating activities
    293,634       264,655       297,216  
 
INVESTING ACTIVITIES
                       
Net cash received in acquisitions
                5,199  
Cash paid in sales of branches
          (2,280 )      
Proceeds from sales of available for sale securities
    1,816,865       252,464       243,456  
Proceeds from maturities of available for sale securities
    1,197,556       1,451,726       1,683,626  
Purchases of available for sale securities
    (2,012,483 )     (1,570,659 )     (2,755,260 )
Net increase in loans
    (631,391 )     (210,252 )     (290,450 )
Purchases of land, buildings and equipment
    (64,231 )     (33,471 )     (36,111 )
Sales of land, buildings and equipment
    2,475       2,260       3,373  
 
Net cash provided by (used in) investing activities
    308,791       (110,212 )     (1,146,167 )
 
FINANCING ACTIVITIES
                       
Net increase (decrease) in non-interest bearing demand, savings, interest checking and money market deposits
    (143,463 )     233,672       447,080  
Net increase (decrease) in time open and C.D.’s
    543,130       15,042       (146,750 )
Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase
    (587,451 )     (192,166 )     654,110  
Repayment of long-term borrowings
    (119,985 )     (111,260 )     (285,186 )
Additional long-term borrowings
          100,000       225,248  
Net increase (decrease) in short-term borrowings
          (2,876 )     69,125  
Purchases of treasury stock
    (234,501 )     (173,829 )     (125,724 )
Issuance of stock under stock purchase and option plans
    18,393       15,281       8,682  
Net tax benefit related to stock option plans
    4,288       2,305       1,524  
Cash dividends paid on common stock
    (63,421 )     (61,135 )     (51,266 )
 
Net cash provided by (used in) financing activities
    (583,010 )     (174,966 )     796,843  
 
Increase (decrease) in cash and cash equivalents
    19,415       (20,523 )     (52,108 )
Cash and cash equivalents at beginning of year
    654,720       675,243       727,351  
 
Cash and cash equivalents at end of year
  $ 674,135     $ 654,720     $ 675,243  
 
See accompanying notes to consolidated financial statements.

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Commerce Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
                                                 
 
    Accumulated    
    Other    
    Common   Capital   Retained   Treasury   Comprehensive    
(In thousands, except per share data)   Stock   Surplus   Earnings   Stock   Income (Loss)   Total
 
Balance, December 31, 2002
  $ 336,192     $ 288,241     $ 707,433     $ (5,507 )   $ 96,093     $ 1,422,452  
 
Net income
                    206,524                       206,524  
Change in unrealized gain (loss) on available for sale securities, net of tax
                                    (23,222 )     (23,222 )
                                     
Total comprehensive income
                                            183,302  
                                     
Purchase of treasury stock
                            (125,724 )             (125,724 )
Cash dividends paid ($.674 per share)
                    (51,266 )                     (51,266 )
Net tax benefit related to stock option plans
            1,524                               1,524  
Stock based compensation
            6,092                               6,092  
Issuance under stock purchase, option and award plans, net
            (9,706 )             18,388               8,682  
Purchase acquisition
    748       5,252                               6,000  
5% stock dividend, net
    6,243       65,934       (155,555 )     83,270               (108 )
 
Balance, December 31, 2003
    343,183       357,337       707,136       (29,573 )     72,871       1,450,954  
 
Net income
                    220,341                       220,341  
Change in unrealized gain (loss) on available for sale securities, net of tax
                                    (33,301 )     (33,301 )
                                     
Total comprehensive income
                                            187,040  
                                     
Purchase of treasury stock
                            (173,829 )             (173,829 )
Cash dividends paid ($.834 per share)
                    (61,135 )                     (61,135 )
Net tax benefit related to stock option plans
            2,305                               2,305  
Stock based compensation
            6,465                               6,465  
Issuance under stock purchase, option and award plans, net
            (17,850 )             33,131               15,281  
5% stock dividend, net
    3,866       40,357       (163,049 )     118,625               (201 )
 
Balance, December 31, 2004
    347,049       388,614       703,293       (51,646 )     39,570       1,426,880  
 
Net income
                    223,247                       223,247  
Change in unrealized gain (loss) on available for sale securities, net of tax
                                    (43,453 )     (43,453 )
                                     
Total comprehensive income
                                            179,794  
                                     
Purchase of treasury stock
                            (234,501 )             (234,501 )
Cash dividends paid ($.914 per share)
                    (63,421 )                     (63,421 )
Net tax benefit related to stock option plans
            4,288                               4,288  
Stock based compensation
            6,628                               6,628  
Issuance under stock purchase, option and award plans, net
            (18,656 )             37,049               18,393  
5% stock dividend, net
            7,678       (170,098 )     162,197               (223 )
 
Balance, December 31, 2005
  $ 347,049     $ 388,552     $ 693,021     $ (86,901 )   $ (3,883 )   $ 1,337,838  
 
See accompanying notes to consolidated financial statements.

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Commerce Bancshares, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1. Summary of Significant Accounting Policies
Nature of Operations
      Commerce Bancshares, Inc. (the Company) conducts its principal activities through its banking and non-banking subsidiaries from approximately 340 locations throughout Missouri, Illinois and Kansas. Principal activities include retail and commercial banking, investment management, securities brokerage, mortgage banking, credit related insurance, venture capital and real estate activities.
Basis of Presentation
      The Company follows accounting principles generally accepted in the United States of America (GAAP) and reporting practices applicable to the banking industry. The preparation of financial statements under GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and notes. While the consolidated financial statements reflect management’s best estimates and judgment, actual results could differ from those estimates. The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries (after elimination of all material intercompany balances and transactions). Certain amounts for prior years have been reclassified to conform to the current year presentation.
Cash and Cash Equivalents
      In the accompanying consolidated statements of cash flows, cash and cash equivalents include “Cash and due from banks” and “Federal funds sold and securities purchased under agreements to resell” as segregated in the accompanying consolidated balance sheets.
Loans and Related Earnings
      Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal balances, net of undisbursed loan proceeds, the allowance for loan losses, and any deferred fees and costs on originated loans. Origination fee income received on loans and amounts representing the estimated direct costs of origination are deferred and amortized to interest income over the life of the loan using the interest method, or recognized when the loan is sold.
      Interest on loans is accrued based upon the principal amount outstanding. Interest income is recognized primarily on the level yield method. Loan and commitment fees on commercial and consumer loans, net of costs, are deferred and recognized in income over the term of the loan or commitment as an adjustment of yield. Annual fees charged on certain credit card loans are capitalized to principal and amortized over 12 months to loan fees and sales in the accompanying consolidated income statements. Other credit card fees, such as cash advance fees and late payment fees, are recognized in income as an adjustment of yield when charged to the cardholder’s account.
      Residential mortgage loans held for sale are valued at the lower of aggregate cost or fair value. The Company generally has commitments to sell fixed rate residential mortgage loans held for sale in the secondary market. Gains or losses on sales are recognized upon delivery and included in loan fees and sales.
      Loans, including those that are considered to be impaired, are evaluated regularly by management. Business, lease, construction and business real estate loans are placed on non-accrual status when the collection of interest or principal is 90 days or more past due, unless the loan is adequately secured and in the process of collection. Accrual of interest on consumer installment loans is suspended when any payment of principal or interest is more than 120 days delinquent. When a loan is placed on non-accrual status, any interest previously accrued but not collected is reversed against current income. Loans are

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returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Interest payments received on non-accrual loans are generally applied to principal unless the remaining principal balance has been determined to be fully collectible. Credit card loans are charged off against the allowance for loan losses when the receivable is more than 180 days past due. The interest and fee income previously capitalized but not collected on credit card charge-offs is reversed against interest income.
Allowance/Provision for Loan Losses
      The allowance for loan losses is maintained at a level believed to be appropriate by management to provide for probable loan losses inherent in the portfolio as of the balance sheet date, including known or anticipated problem loans as well as for loans which are not currently known to require specific allowances. Management’s judgment as to the amount of the allowance, including the allocated and unallocated elements, is a result of ongoing review of larger individual loans, collateral values, the overall risk characteristics of the portfolio, changes in the character or size of the portfolio, the level of impaired and non-performing assets, historical charge-off amounts, geographic location, prevailing economic conditions and other relevant factors. Loans are considered impaired when it becomes probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Included in impaired loans are all non-accrual business, lease, construction, and business real estate loans. Consumer, personal real estate, home equity, student and credit card loans (collectively personal loans) are excluded from the definition of an impaired loan. Impairment is measured as the present value of the expected future cash flows at the loan’s initial effective interest rate or the fair value of the collateral for collateral-dependent loans. Personal loans are segregated by loan type and by sub-type, and are evaluated on a group basis. Loans are charged off to the extent they are deemed to be uncollectible. The amount of the allowance for loan losses is highly dependent on management’s estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amount and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations, and cash flows may be subject to frequent adjustments due to changing economic prospects of borrowers or properties. These estimates are reviewed periodically and adjustments, if necessary, are recorded in the provision for loan losses in the periods in which they become known.
Operating, Direct Financing and Sales Type Leases
      The net investment in direct financing and sales type leases is included in loans on the Company’s consolidated balance sheet, and consists of the present value of the future minimum lease payments plus the present value of the estimated residual. Revenue consists of interest earned on the present value of the lease payments and residual, and is recognized over the lease term as a constant percentage return on the net investment. The net investment in operating leases is included in other assets on the Company’s consolidated balance sheet. It is carried at cost, less the amount depreciated to date. Depreciation is recognized, on the straight-line basis, over the lease term to the Company’s estimate of the equipment’s residual value at lease termination. Operating lease revenue consists of the contractual lease payments and is recognized over the lease term in other non-interest income. Residual value, representing the estimated value of the equipment upon termination of the lease, is recorded at the inception of each lease based on an amount estimated by management utilizing contract terms, past customer experience, and general market data. It is reviewed, and adjusted if necessary, on an annual basis.
Investments in Debt and Equity Securities
      The Company has classified the majority of its investment portfolio as available for sale. From time to time, the Company sells securities and utilizes the proceeds to reduce borrowings, fund loan growth, or modify its interest rate profile. Securities classified as available for sale are carried at fair value. Their related unrealized gains and losses, net of tax, are reported in accumulated other comprehensive income, a component of stockholders’ equity. Premiums and discounts are amortized to interest income over the

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estimated lives of the securities. Realized gains and losses, including other-than-temporary declines in value, are calculated using the specific identification method and included in non-interest income.
      Non-marketable securities include certain venture capital investments, consisting of both debt and equity instruments, which are accounted for at fair value. Fair value is determined based on observable market values or at estimated fair values, in the absence of readily ascertainable market values. Changes in fair value and gains and losses from sales are recognized in non-interest income. Other non-marketable securities acquired for debt and regulatory purposes are accounted for at cost.
      Trading account securities, which are bought and held principally for the purpose of resale in the near term, are carried at fair value. Gains and losses, both realized and unrealized, are recorded in non-interest income.
Land, Buildings and Equipment
      Land is stated at cost, and buildings and equipment are stated at cost less accumulated depreciation. Depreciation is computed using straight-line and accelerated methods. The Company generally assigns depreciable lives of 30 years for buildings, 10 years for building improvements, and 3 to 8 years for equipment. Maintenance and repairs are charged to expense as incurred.
Foreclosed Assets
      Foreclosed assets consist of property that has been repossessed. Collateral obtained through foreclosure is comprised of commercial and residential real estate and other non-real estate property, including automobiles. The assets are initially recorded at the lower of the related loan balance or market value of the collateral less estimated selling costs, with any valuation adjustments charged to the allowance for loan losses. Market values are estimated primarily based on appraisals when available or quoted market prices of liquid assets. Subsequently, foreclosed assets are valued at the lower of the amount recorded at acquisition date or the current market value less estimated costs to sell. Further valuation adjustments on these assets and gains and losses realized on sales are recorded in other non-interest expense.
Intangible Assets
      Goodwill and intangible assets that have indefinite useful lives are not amortized, but are tested at least annually for impairment. Intangible assets that have finite useful lives, such as core deposit intangibles and mortgage servicing rights, are amortized over their estimated useful lives. Core deposit intangibles, which were fully amortized at December 31, 2005, were amortized over a maximum of 10 years using accelerated methods for all periods presented.
      When facts and circumstances indicate potential impairment of amortizable intangible assets, the Company evaluates the recoverability of the asset carrying value, using estimates of undiscounted future cash flows over the remaining asset life. Any impairment loss is measured by the excess of carrying value over fair value. Goodwill impairment tests are performed on an annual basis or when events or circumstances dictate. In these tests, the fair values of each reporting unit, or segment, is compared to the carrying amount of that reporting unit in order to determine if impairment is indicated. If so, the implied fair value of the reporting unit’s goodwill is compared to its carrying amount and the impairment loss is measured by the excess of the carrying value over fair value.
Income Taxes
      Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income taxes are provided for temporary differences between the financial reporting bases and income tax bases of the Company’s assets and liabilities. Deferred tax assets and liabilities are measured using the tax rates and laws that are expected to be in effect when the differences are anticipated to reverse. The effect on

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deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the change.
      The Company and its eligible subsidiaries file consolidated income tax returns. Accordingly, amounts equal to tax benefits of those subsidiaries having taxable losses or credits are reimbursed by other subsidiaries that incur tax liabilities. A valuation allowance is recorded when necessary to reduce deferred tax assets to amounts which are deemed more likely than not to be realized.
Derivatives
      The Company is exposed to market risk, including changes in interest rates and currency exchange rates. To manage the volatility relating to these exposures, the Company’s risk management policies permit its use of derivative products. The Company manages potential credit exposure through established credit approvals, risk control limits and other monitoring procedures. The Company uses derivatives on a limited basis mainly to stabilize interest rate margins and hedge against interest rate movements. The Company more often manages normal asset and liability positions by altering the products it offers and by selling portions of specific loan or investment portfolios as necessary.
      Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities”, requires that all derivative financial instruments be recorded on the balance sheet at fair value, with the adjustment to fair value recorded in current earnings. Derivatives that qualify under the Statement in a hedging relationship can be designated, based on the exposure being hedged, as fair value or cash flow hedges. Under the fair value hedging model, gains or losses attributable to the change in fair value of the derivative, as well as gains and losses attributable to the change in fair value of the hedged item, are recognized in current earnings. Under the cash flow hedging model, the effective portion of the gain or loss related to the derivative is recognized as a component of other comprehensive income. The ineffective portion is recognized in current earnings.
      To be eligible for hedge accounting treatment the Company must specifically designate a derivative as a hedging instrument as well as identify the exact risk being hedged. The derivative instrument then must meet explicit effectiveness requirements under Statement 133 to qualify for hedge accounting. At December 31, 2005, the Company had two interest rate swaps designated as fair value hedges.
      Derivative contracts are also offered to customers to assist in hedging their risks of adverse changes in interest rates and foreign exchange rates. The Company serves as an intermediary between its customers and the markets. Each contract between the Company and its customers is offset by a contract between the Company and various counterparties. These contracts do not qualify for hedge accounting. They are carried at fair value with changes in fair value recorded in other non-interest income. Since each customer contract is paired with an offsetting contract, there is no significant impact to net income.
      The Company enters into interest rate lock commitments on mortgage loans, which are commitments to originate loans whereby the interest rate on the loan is determined prior to funding. The Company also has corresponding forward sales contracts related to these interest rate lock commitments. Both the mortgage loan commitments and the related sales contracts are accounted for as derivatives and carried at fair value with changes in fair value recorded in loan fees and sales.
      Staff Accounting Bulletin No. 105, “Application of Accounting Principles to Loan Commitments” (SAB 105) provided additional guidance in determining the fair value of mortgage loan commitments. The guidance prohibits the inclusion of the expected cash flows related to the associated servicing of the loan when determining the fair value of the loan commitment. This change in accounting tends to reduce the fair value of the loan commitment and defers the income recognition resulting from the valuation of the commitment. SAB 105 was effective for loan commitments accounted for as derivatives and entered into on or after April 1, 2004, at which time the Company began excluding these expected cash flows in its determination of fair value.

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Stock-Based Compensation
      The Company has several stock-based employee compensation plans, which are described more fully in Note 11, Stock Option Plans, Restricted Stock Awards and Directors Stock Purchase Plan. The Company accounts for these plans under the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation”.
      In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (revised), “Share-Based Payment”. The revision disallows the expense recognition alternatives permitted in the original statement and requires entities to recognize stock-based compensation cost in their statements of income. The revision contains additional guidance in several areas including award modifications and forfeitures, measuring fair value, classifying an award as equity or as a liability, and attributing compensation cost to reporting periods. It also contains additional disclosure requirements. The Company does not expect that adoption of the revision in January 2006 will have a material effect on its consolidated financial statements.
Treasury Stock
      Purchases of the Company’s common stock are recorded at cost. Upon re-issuance, treasury stock is reduced based upon the average cost basis of shares held.
Income per Share
      Basic income per share is computed using the weighted average number of common shares outstanding during each year. Diluted income per share includes the effect of all dilutive potential common shares (primarily stock options) outstanding during each year. All per share data has been restated to reflect the 5% stock dividend distributed in December 2005.
2.  Acquisitions
      Effective January 1, 2003, the Company acquired 100% of the outstanding stock of The Vaughn Group, Inc. (Vaughn), a direct equipment lessor based in Cincinnati, Ohio. At acquisition, Vaughn had a lease portfolio which included direct financing leases, sales type leases, and operating leases. The largest component was direct financing leases of $32.8 million, consisting mainly of data processing hardware. In addition, Vaughn serviced approximately $350 million of lease agreements for other institutions involving capital equipment, ranging from production machinery to transportation equipment. The Company issued stock valued at $6.0 million and paid cash of $2.5 million in the acquisition. The acquisition was accounted for as a purchase. Goodwill of $5.3 million was recognized as a result of the transaction. No other separately identified intangible assets were recorded in connection with the acquisition.
3.  Loans and Allowance for Loan Losses
      Major classifications of loans at December 31, 2005 and 2004 are as follows:
                 
 
(In thousands)   2005   2004
 
Business
  $ 2,527,654     $ 2,246,287  
Real estate – construction
    424,561       427,124  
Real estate – business
    1,919,045       1,743,293  
Real estate – personal
    1,358,511       1,340,574  
Consumer
    1,287,348       1,193,822  
Home equity
    448,507       411,541  
Student
    330,238       357,991  
Credit card
    592,465       561,054  
Overdrafts
    10,854       23,673  
 
Total loans
  $ 8,899,183     $ 8,305,359  
 

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      Loans to directors and executive officers of the Parent and its significant subsidiaries and to their associates are summarized as follows:
         
 
(In thousands)    
 
Balance at January 1, 2005
  $ 103,780  
Additions
    117,363  
Amounts collected
    (128,121 )
Amounts written off
     
 
Balance at December 31, 2005
  $ 93,022  
 
      Management believes all loans to directors and executive officers have been made in the ordinary course of business with normal credit terms, including interest rate and collateral considerations, and do not represent more than a normal risk of collection. There were no outstanding loans at December 31, 2005 to principal holders of the Company’s common stock.
      The Company’s lending activity is generally centered in Missouri, Illinois, Kansas and other nearby states including Iowa, Oklahoma, Colorado, Indiana, and others. The Company maintains a diversified portfolio with limited industry concentrations of credit risk. Loans and loan commitments are extended under the Company’s normal credit standards, controls, and monitoring features. Most loan commitments are short and intermediate term in nature. Loan maturities, with the exception of residential mortgages, generally do not exceed five years. Collateral is commonly required and would include such assets as marketable securities and cash equivalent assets, accounts receivable and inventory, equipment, other forms of personal property, and real estate. At December 31, 2005, unfunded loan commitments totaled $6,889,826,000 (which included $3,355,751,000 in unused approved lines of credit related to credit card loan agreements) which could be drawn by customers subjec