10-K 1 cbsh1231201710k.htm 10-K Document

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549
FORM 10-K

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

For the Fiscal Year Ended December 31, 2017 — Commission File No. 0-2989

COMMERCE BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
Missouri
 
43-0889454
(State of Incorporation)
 
(IRS Employer Identification No.)
1000 Walnut,

 
 
Kansas City, MO

 
64106
(Zip Code)
(Address of principal executive offices)
 
(Zip Code)
(816) 234-2000
 
 
(Registrant’s telephone number, including area code)
 
 
Securities registered pursuant to Section 12(b) of the Act:
 
 
 
Title of class
 
Name of exchange on which registered
$5 Par Value Common Stock
 
NASDAQ Global Select Market
Depositary Shares, each representing a 1/1000th interest in a share of 6.0% Series B Non-Cumulative Perpetual Preferred Stock
 
NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No þ
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
Emerging growth company o
 
 
 (Do not check if a smaller reporting company)
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of June 30, 2017, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $5,271,000,000.
As of February 9, 2018, there were 106,710,134 shares of Registrant’s $5 Par Value Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s definitive proxy statement for its 2018 annual meeting of shareholders, which will be filed within 120 days of December 31, 2017, are incorporated by reference into Part III of this Report.
 



Commerce Bancshares, Inc.
 
 
 
 
 
 
Form 10-K
 
 
 
 
 
 
 
INDEX
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



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

Commerce Bancshares, Inc. and its subsidiaries (collectively, the "Company") is one of the nation’s top 50 bank holding companies, based on asset size. At December 31, 2017, the Company had consolidated assets of $24.8 billion, loans of $14.0 billion, deposits of $20.4 billion, and equity of $2.7 billion. All of the Company’s operations conducted by its subsidiaries are consolidated for purposes of preparing the Company’s consolidated financial statements. The Company's principal markets, which are served by 176 branch facilities, are located throughout Missouri, Kansas, and central Illinois, as well as Tulsa and Oklahoma City, Oklahoma and Denver, Colorado. Its two largest markets include St. Louis and Kansas City, which serve as the central hubs for the entire Company. The Company also has commercial loan production offices in Dallas, Nashville, Cincinnati, Des Moines, Grand Rapids, and Indianapolis, and operates a national payments business with sales representatives covering 48 states.

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

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

From time to time, the Company evaluates the potential acquisition of various financial institutions. In addition, the Company regularly considers the potential disposition of certain assets and branches. The Company seeks merger or acquisition partners that are culturally similar, have experienced management and either possess significant market presence or have potential for improved profitability through financial management, economies of scale and expanded services. The Company has not completed any significant transactions or sales during the past several years.

Employees
The Company employed 4,502 persons on a full-time basis and 355 persons on a part-time basis at December 31, 2017. The Company provides a variety of benefit programs including a 401(k) savings plan with a company matching contribution, as well as group life, health, accident, and other insurance. The Company also maintains training and educational programs designed to address the significant and changing regulations facing the financial services industry and prepare employees for positions of increasing responsibility. None of the Company's employees are represented by collective bargaining agreements.

Competition
The Company faces intense competition from hundreds of financial service providers in its markets and around the United States. It competes with national and state banks for deposits, loans and trust accounts, and with savings and loan associations and credit unions for deposits and consumer lending products. In addition, the Company competes with other financial intermediaries such as securities brokers and dealers, personal loan companies, insurance companies, finance companies, and

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certain governmental agencies. Some of these competitors are not subject to the same regulatory restrictions as domestic banks and bank holding companies. The Company generally competes by providing sophisticated financial products with a strong commitment to customer service, convenience of locations, reputation, and price of service, including interest rates on loan and deposit products. In its two largest markets, the Company has approximately 13% of the deposit market share in Kansas City and approximately 7% of the deposit market share in St. Louis.

Operating Segments
The Company is managed in three operating segments. The Consumer segment includes the retail branch network, consumer installment lending, personal mortgage banking, and consumer debit and credit bank card activities. It provides services through a network of 176 full-service branches, a widespread ATM network of 376 machines, and the use of alternative delivery channels such as extensive online banking, mobile, and telephone banking services. In 2017, this retail segment contributed 21% of total segment pre-tax income. The Commercial segment provides a full array of corporate lending, merchant and commercial bank card products, leasing, and international services, as well as business and government deposit and cash management services. Fixed-income investments are sold to individuals and institutional investors through the Capital Markets Group, which is also included in this segment. In 2017, the Commercial segment contributed 58% of total segment pre-tax income. The Wealth segment provides traditional trust and estate planning services, brokerage services, and advisory and discretionary investment portfolio management services to both personal and institutional corporate customers and contributed 21% of total segment 2017 pre-tax income. At December 31, 2017, the Trust group managed investments with a market value of $30.0 billion and administered an additional $18.8 billion in non-managed assets. This segment also manages the Company’s family of proprietary mutual funds, which are available for sale to both trust and general retail customers. Additional information relating to operating segments can be found on pages 48 and 95.

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

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

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

4


state consumer protection laws, including laws designed to protect customers and promote lending to various sectors of the economy and population. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, and their respective state law counterparts. If the Company fails to comply with these or other applicable laws and regulations, it may be subject to civil monetary penalties, imposition of cease and desist orders or other written directives, removal of management and, in certain circumstances, criminal penalties. This regulatory framework is intended primarily for the protection of depositors and the preservation of the federal deposit insurance funds, 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 Bank affects the conditions under which the Company operates by its influence over the national supply of bank credit. The Federal Reserve Board employs open market operations in U.S. government securities and oversees changes in the discount rate on bank borrowings, changes in the federal funds rate on overnight inter-bank borrowings, and changes in reserve requirements on bank deposits in implementing its monetary policy objectives. These methods are used in varying combinations to influence the overall level of the interest rates charged on loans and paid for deposits, the price of the dollar in foreign exchange markets, and the level of inflation. The monetary policies of the Federal Reserve have a significant effect on the operating results of financial institutions, most notably on the interest rate environment. In view of changing conditions in the national economy and in the money markets, as well as the effect of credit policies of monetary and fiscal authorities, 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.

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

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

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

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2011 (Dodd-Frank Act) was sweeping legislation intended to overhaul regulation of the financial services industry. Among its many provisions, the Dodd-Frank Act established a new council of “systemic risk” regulators, empowers the Federal Reserve to supervise the largest, most complex financial companies, allows the government to seize and liquidate failing financial companies, and gives regulators new powers to oversee the derivatives market. The Dodd-Frank Act also established the Consumer Financial Protection Bureau (CFPB) and authorized it to supervise certain consumer financial services companies and large depository institutions and their affiliates for consumer protection purposes. Subject to the provisions of the Dodd-Frank Act, the CFPB has responsibility to implement, examine for compliance with, and enforce “Federal consumer financial law.” As a depository institution, the Company is subject to examinations by the CFPB, which focus on the Company’s ability to detect, prevent, and correct practices that present a significant risk of violating the law and causing consumer harm. Title VI of the Dodd-Frank Act, commonly known as the Volcker Rule, placed trading restrictions on financial institutions and separated investment banking, private equity and proprietary trading (hedge fund) sections of financial institutions from their consumer lending arms. Key provisions restrict banks from simultaneously entering into advisory and creditor roles with their clients, such as with private equity firms. The Volcker Rule also restricts financial institutions from investing in and sponsoring certain types of investments, and required divestment by July 21, 2017. In 2016, the Company withdrew from a private equity fund investment to comply with the Volcker Rule requirement and realized a gain of $1.8 million upon divestiture. The Company did not hold other significant investments requiring disposal.



5


While the Company remains subject to regulation under the Dodd-Frank Act and related regulatory requirements, the current presidential administration has instructed federal agencies to consider ways to reduce the impact of federal regulation on financial institutions. It is not possible at this time to determine the extent to which this goal will be accomplished nor its impact on the Company.

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

Deposit Insurance
Substantially all of the deposits of the Bank are insured up to the applicable limits by the Deposit Insurance Fund of the FDIC, generally up to $250,000 per depositor, for each account ownership category. The Bank pays deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC for Deposit Insurance Fund member institutions. The FDIC classifies institutions under a risk-based assessment system based on their perceived risk to the federal deposit insurance funds. The current assessment base is defined as average total assets minus average tangible equity, with other adjustments for heavy use of unsecured liabilities, secured liabilities, brokered deposits, and holdings of unsecured bank debt. For banks with more than $10 billion in assets, the FDIC uses a scorecard designed to measure financial performance and ability to withstand stress, in addition to measuring the FDIC’s exposure should the bank fail. FDIC insurance expense also includes assessments to fund the interest on outstanding bonds issued in the 1980s in connection with the failures in the thrift industry. The Company's FDIC insurance expense was $14.0 million in 2017, $13.3 million in 2016, and $12.1 million in 2015.

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

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

A new comprehensive capital framework was established by the Basel Committee on Banking Supervision, which was effective for banks and bank holding companies on January 1, 2015. A key goal of the new framework, known as "Basel III" was to strengthen the capital resources of banking organizations during normal and challenging business environments. Basel III increased minimum requirements for both the quantity and quality of capital held by banking organizations. The rule includes a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets. The capital conservation buffer, which is being phased in during 2016-2019, is intended to absorb losses during periods of economic stress. Failure to maintain the buffer will result in constraints on dividends, equity repurchases and executive compensation. The rule also adjusted the methodology for calculating risk-weighted assets to enhance risk sensitivity. At December 31, 2017, the Company met all capital adequacy requirements under Basel III on a fully phased-in basis as if such requirements had been in effect.

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

6


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

Stress Testing
As required by the Dodd-Frank Act, the Federal Reserve published capital stress testing regulations applicable to certain financial companies with total consolidated assets of more than $10 billion but less than $50 billion. The rule requires that these financial companies, including the Company, conduct annual stress tests based on factors provided by the Federal Reserve, supplemented by institution-specific factors. The stress test is designed to assess the potential impact of different economic scenarios on earnings, credit losses and capital over a set time period. In accordance with the Dodd-Frank Act, the Company began submitting its stress test results to the Federal Reserve in March 2014 and publicly disclosed the results of its stress testing for the first time in June 2015. In 2017, the Company submitted its stress test report to the Federal Reserve in July and publicly disclosed the results in October.

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

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

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

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

Available Information
The Company’s principal offices are located at 1000 Walnut, 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

7


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.

Statistical Disclosure
The information required by Securities Act Guide 3 — “Statistical Disclosure by Bank Holding Companies” is located on the pages noted below.
 
 
 
Page
I.
 
Distribution of Assets, Liabilities and Stockholders’ Equity; Interest Rates and Interest Differential
22, 56-59

II.
 
Investment Portfolio
39-40, 80-84

III.
 
Loan Portfolio
 
 
 
Types of Loans

 
 
Maturities and Sensitivities of Loans to Changes in Interest Rates
29

 
 
Risk Elements
34-38

IV.
 
Summary of Loan Loss Experience
31-34

V.
 
Deposits

VI.
 
Return on Equity and Assets
17

VII.
 
Short-Term Borrowings


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

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

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

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

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

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

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


9


The Company is subject to both interest rate and liquidity risk.
With oversight from its Asset-Liability Management Committee, the Company devotes substantial resources to monitoring its liquidity and interest rate risk on a monthly basis. The Company's net interest income is the largest source of overall revenue to the Company, representing 59% of total revenue for the year ended at December 31, 2017. The interest rate environment in which the Company operates fluctuates in response to general economic conditions and policies of various governmental and regulatory agencies, particularly the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, will influence loan originations, deposit generation, demand for investments and revenues and costs for earning assets and liabilities.
The Federal Reserve Board raised the benchmark interest rate three times during 2017 for a total of 75 basis points. Further rate increases are expected in 2018. The Company saw only a slight decline in period end deposit balances; however, additional rate increases may result in customer deposit withdrawals which, if significant, may affect the Company’s source of funds for future loan growth. These actions may include reductions in its investment portfolio or higher borrowings, and could reduce net interest income and related margins.

The Company’s asset valuation may include methodologies, models, estimations and assumptions which are subject to differing interpretations and could result in changes to asset valuations that may materially adversely affect its results of operations or financial condition.
The Company uses estimates, assumptions, and judgments when certain financial assets and liabilities are measured and reported at fair value. Assets and liabilities carried at fair value inherently result in a higher degree of financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices and/or other observable inputs provided by independent third-party sources, when available. When such third-party information is not available, fair value is estimated primarily by using cash flow and other financial modeling techniques utilizing assumptions such as credit quality, liquidity, interest rates and other relevant inputs. Changes in underlying factors, assumptions, or estimates in any of these areas could materially impact the Company’s future financial condition and results of operations.
During periods of market disruption, including periods of significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, it may be difficult to value certain assets if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes in active markets with significant observable data that become illiquid due to the current financial environment. In such cases, certain asset valuations may require more subjectivity and management judgment. As such, valuations may include inputs and assumptions that are less observable or require greater estimation. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of assets as reported within the Company’s consolidated financial statements, and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on results of operations or financial condition.
The processes the Company uses to estimate the fair value of financial instruments, as well as the processes used to estimate the effects of changing interest rates and other market measures on the Company’s financial condition and results of operations, depend upon the use of analytical and forecasting models. If these models are inadequate or inaccurate due to flaws in their design or implementation, the fair value of such financial instruments may not accurately reflect what the Company could realize upon sale or settlement of such financial instruments, or the Company may incur increased or unexpected losses upon changes in market interest rates or other market measures. Any such failure in the Company's analytical or forecasting models could have a material adverse effect on the Company business, financial condition and results of operations.

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

Future loan losses could increase.
The Company maintains an allowance for loan losses that represents management’s best estimate of probable losses that have been incurred at the balance sheet date within the existing portfolio of loans. The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience including emergence periods, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan

10


portfolio. Although the loan losses have been stable during the past several years, an unforeseen deterioration of financial market conditions could result in larger loan losses, which may negatively affect the Company's results of operations and could further increase levels of its allowance. In addition, the Company’s allowance level is subject to review by regulatory agencies, and that review could result in adjustments to the allowance. See the section captioned “Allowance for Loan Losses” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this report for further discussion related to the Company’s process for determining the appropriate level of the allowance for probable loan loss.

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

The Company’s reputation and future growth prospects could be impaired if cyber-security attacks or other computer system breaches occur.
The Company relies heavily on communications and information systems to conduct its business, and as part of its business, the Company maintains significant amounts of data about its customers and the products they use. Information security risks for financial institutions have increased recently due to new technologies, the use of the Internet and telecommunications technologies (including mobile devices) to conduct financial and other business transactions, and the increased sophistication and activities of organized crime, perpetrators of fraud, hackers, and others. While the Company has policies and procedures and safeguards designed to prevent or limit the effect of failure, interruption or security breach of its information systems, there can be no assurances that any such failures, interruptions or security breaches will not occur; or if they do occur, that they will be adequately addressed. In addition to unauthorized access, denial-of-service attacks could overwhelm Company Web sites and prevent the Company from adequately serving customers. Should any of the Company's systems become compromised, the reputation of the Company could be damaged, relationships with existing customers may be impaired, and the Company could be subject to lawsuits, all of which could result in lost business, and as a result, the Company could incur significant expenses trying to remedy the incident.

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

The Company continually encounters technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services, including the entrance of financial technology companies offering new financial service products. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. The Company’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in the Company’s operations. Many of the Company’s competitors have substantially greater resources to invest in technological improvements. The Company may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse effect on the Company’s business, financial condition and results of operations.

11


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

The Company may not attract and retain skilled employees.
The Company’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people can be intense, and the Company spends considerable time and resources attracting and hiring qualified people for its various business lines and support units. The unexpected loss of the services of one or more of the Company’s key personnel could have a material adverse impact on the Company’s business because of their skills, knowledge of the Company’s market, and years of industry experience, as well as the difficulty of promptly finding qualified replacement personnel.

The Tax Cuts and Jobs Act of 2017 may have unexpected consequences for the Company.
In December 2017, the Tax Cuts and Jobs Act of 2017 ("the Act") was passed. Among other elements, the Act reduces income tax rates for businesses and individuals. While the Act significantly lowers the Company's income tax expense, the effect of lower tax rates on customer behavior remains uncertain. Lowering the business and individual income tax rates may reduce demand for loans and impact deposit balances, which may negatively affect the Company's financial position.

Item 1b.
UNRESOLVED STAFF COMMENTS
None

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

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

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

86

45

811 Main
Kansas City, MO
237,000

100

100

8000 Forsyth
Clayton, MO
178,000

100

100

1551 N. Waterfront Pkwy
Wichita, KS
124,000

96

34


The Company has an additional 171 branch locations in Missouri, Illinois, Kansas, Oklahoma and Colorado which are owned or leased, and 151 off-site ATM locations.

Item 3.
LEGAL PROCEEDINGS
The information required by this item is set forth in Item 8 under Note 19, Commitments, Contingencies and Guarantees on page 113.


Item 4.
MINE SAFETY DISCLOSURES
Not applicable    


12


Executive Officers of the Registrant
The following are the executive officers of the Company as of February 22, 2018, each of whom is designated annually. There are no arrangements or understandings between any of the persons so named and any other person pursuant to which such person was designated an executive officer.
Name and Age
Positions with Registrant
Jeffery D. Aberdeen, 63
Controller of the Company since December 1995. He is also Controller of the Company's subsidiary bank, Commerce Bank.
 
 
Kevin G. Barth, 57
Executive Vice President of the Company since April 2005, and Community President and Chief Executive Officer of Commerce Bank since October 1998. Senior Vice President of the Company and Officer of Commerce Bank prior thereto.
 
 
Jeffrey M. Burik, 59
Senior Vice President of the Company since February 2013. Executive Vice President of Commerce Bank since November 2007.
 
 
Daniel D. Callahan, 61
Executive Vice President and Chief Credit Officer of the Company since December 2010 and Senior Vice President of the Company prior thereto. Executive Vice President of Commerce Bank since May 2003.
 
 
Sara E. Foster, 57
Executive Vice President of the Company since February 2012 and Senior Vice President of the Company prior thereto. Executive Vice President of Commerce Bank since January 2016 and Senior Vice President of Commerce Bank prior thereto.
 
 
John K. Handy, 55
Executive Vice President of the Company since January 2018 and Senior Vice President of the Company prior thereto. Community President and Chief Executive Officer of Commerce Bank since January 2018 and Senior Vice President of Commerce Bank prior thereto.
 
 
Robert S. Holmes, 54
Executive Vice President of the Company since April 2015, and Community President and Chief Executive Officer of Commerce Bank since January 2016. Prior to his employment with Commerce Bank in March 2015, he was employed at a Midwest regional bank where he served as managing director and head of Regional Banking.
 
 
Patricia R. Kellerhals, 60
Senior Vice President of the Company since February 2016 and Vice President of the Company prior thereto. Executive Vice President of Commerce Bank since 2005.
 
 
David W. Kemper, 67
Chairman of the Board of Directors of the Company since November 1991, and Chief Executive Officer of the Company since June 1986. He was President of the Company from April 1982 until February 2013. He is Chairman of the Board and Chief Executive Officer of Commerce Bank. He is the brother of Jonathan M. Kemper, Vice Chairman of the Company, and father of John W. Kemper, President and Chief Operating Officer of the Company.
 
 
John W. Kemper, 40
President and Chief Operating Officer of the Company since February 2013, and President of Commerce Bank since March 2013. Prior thereto, and since October 2010, he was Executive Vice President and Chief Administrative Officer of the Company and Senior Vice President of Commerce Bank. Member of Board of Directors since September 2015. He is the son of David W. Kemper, Chairman and Chief Executive Officer of the Company and nephew of Jonathan M. Kemper, Vice Chairman of the Company.
 
 
Jonathan M. Kemper, 64
Vice Chairman of the Company since November 1991 and Vice Chairman of Commerce Bank since December 1997. Prior thereto, he was Chairman of the Board, Chief Executive Officer, and President of Commerce Bank. He is the brother of David W. Kemper, Chairman and Chief Executive Officer of the Company, and uncle of John W. Kemper, President and Chief Operating Officer of the Company.
 
 
Charles G. Kim, 57
Chief Financial Officer of the Company since July 2009. Executive Vice President of the Company since April 1995 and Executive Vice President of Commerce Bank since January 2004. Prior thereto, he was Senior Vice President of Commerce Bank.
 
 
Paula S. Petersen, 51
Senior Vice President of the Company since July 2016 and Executive Vice President of Commerce Bank since March 2012.
 
 
Michael J. Petrie, 61
Senior Vice President of the Company since April 1995. Prior thereto, he was Vice President of the Company.
 
 
David L. Roller, 47
Senior Vice President of the Company since July 2016 and Senior Vice President of Commerce Bank since September 2010.
 
 

13


PART II

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

Commerce Bancshares, Inc.
Common Stock Data
The following table sets forth the high and low prices of actual transactions in the Company’s common stock and cash dividends paid for the periods indicated (restated for the 5% stock dividend distributed in December 2017).

 
 
Quarter
High
Low
Cash
Dividends
2017
First
$
57.72

$
50.62

$
.214

 
Second
55.18

49.54

.214

 
Third
56.42

49.43

.214

 
Fourth
57.91

52.07

.214

2016
First
$
41.69

$
33.96

$
.204

 
Second
44.82

38.98

.204

 
Third
46.53

41.49

.204

 
Fourth
56.40

43.21

.204

2015
First
$
37.97

$
34.15

$
.194

 
Second
41.46

35.88

.194

 
Third
42.07

36.67

.194

 
Fourth
42.72

37.55

.194


Commerce Bancshares, Inc. common shares are listed on the Nasdaq Global Select Market (NASDAQ) under the symbol CBSH. The Company had 3,750 common shareholders of record as of December 31, 2017. Certain of the Company's shares are held in "nominee" or "street" name and the number of beneficial owners of such shares is approximately 60,000.


14


Performance Graph
The following graph presents a comparison of Company (CBSH) performance to the indices named below. It assumes $100 invested on December 31, 2012 with dividends invested on a cumulative total shareholder return basis.
chart-87cad14c0b0d542a983.jpg
 
2012
2013
2014
2015
2016
2017
Commerce (CBSH)
100.00

137.30

142.35

149.14

216.71

223.28

NASDAQ OMX Global-Bank
100.00

136.62

152.78

156.15

197.60

233.94

S&P 500
100.00

132.37

150.48

152.55

170.73

207.99


The following table sets forth information about the Company’s purchases of its $5 par value common stock, its only class of common stock registered pursuant to Section 12 of the Exchange Act, during the fourth quarter of 2017.
Period
Total Number of Shares Purchased
Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Program
 Maximum Number that May Yet Be Purchased Under the Program
October 1—31, 2017
11,331


$57.91

11,331

3,547,014

November 1—30, 2017
55,600


$56.96

55,600

3,491,414

December 1—31, 2017
47,891


$54.86

47,891

3,443,523

Total
114,822


$56.18

114,822

3,443,523


The Company’s stock purchases shown above were made under authorizations by the Board of Directors. Under the most recent authorization in October 2015 of 5,000,000 shares, 3,443,523 shares remained available for purchase at December 31, 2017.

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



15


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

Forward-Looking Statements
This report may contain “forward-looking statements” that are subject to risks and uncertainties and include information about possible or assumed future results of operations. Many possible events or factors could affect the future financial results and performance of Commerce Bancshares, Inc. and its subsidiaries (the "Company"). This could cause results or performance to differ materially from those expressed in the forward-looking statements. Words such as “expects”, “anticipates”, “believes”, “estimates”, variations of such words and other similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in, or implied by, such forward-looking statements. Readers should not rely solely on the forward-looking statements and should consider all uncertainties and risks discussed throughout this report. Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. Such possible events or factors include the risk factors identified in Item 1a Risk Factors and the following: changes in economic conditions in the Company’s market area; changes in policies by regulatory agencies, governmental legislation and regulation; fluctuations in interest rates; changes in liquidity requirements; demand for loans in the Company’s market area; changes in accounting and tax principles; estimates made on income taxes; failure of litigation settlement agreements to become final in accordance with their terms; and competition with other entities that offer financial services.
Overview
The Company operates as a super-community bank and offers a broad range of financial products to consumer and commercial customers, delivered with a focus on high-quality, personalized service. It is the largest bank holding company headquartered in Missouri, with its principal offices in Kansas City and St. Louis, Missouri. Customers are served from 327 locations in Missouri, Kansas, Illinois, Oklahoma and Colorado and commercial offices throughout the nation's midsection. A variety of delivery platforms are utilized, including an extensive network of branches and ATM machines, full-featured online banking, and a central contact center.

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

Various indicators are used by management in evaluating the Company’s financial condition and operating performance. Among these indicators are the following:
Net income and earnings per share — Net income attributable to Commerce Bancshares, Inc. was $319.4 million, an increase of 16.0% compared to the previous year. The return on average assets was 1.28% in 2017, and the return on average common equity was 12.46%. Diluted earnings per share increased 16.1% in 2017 compared to 2016.
Total revenue — Total revenue is comprised of net interest income and non-interest income. Total revenue in 2017 increased $65.8 million over 2016, driven by growth in both net interest income and non-interest income of $53.6 million and $12.2 million, respectively. Net interest income increased over 2016 due in part to higher average loan balances, which grew 5.2%, as well as higher average rates earned on loans, as average rates earned during 2017 increased 21 basis points over 2016. Higher average rates earned on investment securities, which increased 9 basis points over 2016, also contributed to the growth in net interest income. The growth was partly offset by higher average rates paid on deposits and borrowings. Overall, the net interest margin (tax equivalent) increased to 3.20% in 2017, a 16 basis point increase over 2016. Growth in non-interest income resulted principally from increases in trust fees, deposit fees, and loan fees and sales.
Non-interest expense — Total non-interest expense grew 7.3% this year compared to 2016, mainly as a result of higher costs for salaries and employee benefits and due to donations of $32.0 million to a related foundation during 2017. Excluding the current year donations, total non-interest expense grew 2.9% over the prior year.
Asset quality — Net loan charge-offs in 2017 increased $9.7 million over those recorded in 2016 and averaged .31% of loans compared to .25% in the previous year. Total non-performing assets, which include non-accrual loans and foreclosed

16


real estate, amounted to $12.7 million at December 31, 2017, a decrease of $2.0 million from balances at the previous year end, and represented .09% of loans outstanding.
Shareholder return — Total shareholder return, including the change in stock price and dividend reinvestment, was 3.0% over the past year and 17.4% over the past five years. The Company's shareholder return was 10.1% over the past 10 years compared to the KBW Bank Index return of 4.1%. During 2017, the Company paid cash dividends of $.857 per share on its common stock, representing an increase of 5% over the previous year, and paid dividends of 6% on its preferred stock. In 2017, the Company issued its 24th consecutive annual 5% common stock dividend, and in January 2018, the Company's Board of Directors authorized an increase of nearly 10% in the common cash dividend, which is its 50th consecutive annual increase.
    
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
 
2017
2016
2015
2014
2013
(Based on average balances)
 
 
 
 
 
Return on total assets
1.28
%
1.12
%
1.11
%
1.15
%
1.19
%
Return on common equity
12.46

11.33

11.43

11.65

11.99

Equity to total assets
10.53

10.16

10.00

10.10

9.95

Loans to deposits (1)
66.18

63.71

61.44

59.91

57.12

Non-interest bearing deposits to total deposits
34.85

34.67

35.12

33.73

33.01

Net yield on interest earning assets (tax equivalent basis)
3.20

3.04

2.94

3.00

3.11

(Based on end of period data)
 
 
 
 
 
Non-interest income to revenue (2)
39.88

41.09

41.40

41.31

40.34

Efficiency ratio (3)
62.97

61.98

62.34

61.96

60.42

Tier I common risk-based capital ratio (4)
12.65

11.62

11.52

NA

NA

Tier I risk-based capital ratio (4)
13.41

12.38

12.33

13.74

14.06

Total risk-based capital ratio (4)
14.35

13.32

13.28

14.86

15.28

Tier I leverage ratio (4)
10.39

9.55

9.23

9.36

9.43

Tangible common equity to tangible assets ratio (5)
9.84

8.66

8.48

8.55

9.00

Common cash dividend payout ratio
29.52

32.69

33.35

32.69

31.46

(1)
Includes loans held for sale.
(2)
Revenue includes net interest income and non-interest income.
(3)
The efficiency ratio is calculated as non-interest expense (excluding intangibles amortization) as a percent of revenue.
(4)
Risk-based capital information at December 31, 2017, 2016 and 2015 was prepared under Basel III requirements, which were effective January 1, 2015. Risk-based capital information for prior years was prepared under Basel I requirements.
(5)
The tangible common equity to tangible assets ratio is a measurement which management believes is a useful indicator of capital adequacy and utilization. It provides a meaningful basis for period to period and company to company comparisons, and also assist regulators, investors and analysts in analyzing the financial position of the Company. Tangible common equity and tangible assets are non-GAAP measures and should not be viewed as substitutes for, or superior to, data prepared in accordance with GAAP.



17


The following table is a reconciliation of the GAAP financial measures of total equity and total assets to the non-GAAP measures of total tangible common equity and total tangible assets.

(Dollars in thousands)
2017
2016
2015
2014
2013
Total equity
$
2,718,184

$
2,501,132

$
2,367,418

$
2,334,246

$
2,214,397

Less non-controlling interest
1,624

5,349

5,428

4,053

3,755

Less preferred stock
144,784

144,784

144,784

144,784


Less goodwill
138,921

138,921

138,921

138,921

138,921

Less core deposit premium
2,965

3,841

5,031

6,572

8,489

Total tangible common equity (a)
$
2,429,890

$
2,208,237

$
2,073,254

$
2,039,916

$
2,063,232

Total assets
$
24,833,415

$
25,641,424

$
24,604,962

$
23,994,280

$
23,072,036

Less goodwill
138,921

138,921

138,921

138,921

138,921

Less core deposit premium
2,965

3,841

5,031

6,572

8,489

Total tangible assets (b)
$
24,691,529

$
25,498,662

$
24,461,010

$
23,848,787

$
22,924,626

Tangible common equity to tangible assets ratio (a)/(b)
9.84
%
8.66
%
8.48
%
8.55
%
9.00
%

Selected Financial Data
(In thousands, except per share data)
2017
2016
2015
2014
2013
Net interest income
$
733,679

$
680,049

$
634,320

$
620,204

$
619,372

Provision for loan losses
45,244

36,318

28,727

29,531

20,353

Non-interest income
486,604

474,392

448,139

436,506

418,865

Investment securities gains (losses), net
25,051

(53
)
6,320

14,124

(4,425
)
Non-interest expense
769,684

717,065

676,487

656,870

629,147

Net income attributable to Commerce Bancshares, Inc.
319,383

275,391

263,730

261,754

260,961

Net income available to common shareholders
310,383

266,391

254,730

257,704

260,961

Net income per common share-basic*
2.90

2.50

2.33

2.27

2.24

Net income per common share-diluted*
2.89

2.49

2.32

2.26

2.23

Cash dividends on common stock
91,619

87,070

84,961

84,241

82,104

Cash dividends per common share*
.857

.816

.777

.740

.705

Market price per common share*
55.84

55.06

38.59

37.57

36.95

Book value per common share*
24.14

22.12

20.74

19.63

19.00

Common shares outstanding*
106,615

106,534

107,192

111,511

116,544

Total assets
24,833,415

25,641,424

24,604,962

23,994,280

23,072,036

Loans, including held for sale
14,005,072

13,427,192

12,444,299

11,469,238

10,956,836

Investment securities
8,893,307

9,770,986

9,901,680

9,645,792

9,042,997

Deposits
20,425,446

21,101,095

19,978,853

19,475,778

19,047,348

Long-term debt
1,758

102,049

103,818

104,058

455,310

Equity
2,718,184

2,501,132

2,367,418

2,334,246

2,214,397

Non-performing assets
12,664

14,649

29,394

46,251

55,439

*
Restated for the 5% stock dividend distributed in December 2017.



18


Results of Operations
 
 
 
 
$ Change
 
% Change
(Dollars in thousands)
2017
2016
2015
'17-'16
'16-'15
 
'17-'16
'16-'15
Net interest income
$
733,679

$
680,049

$
634,320

$
53,630

$
45,729

 
7.9
%
7.2
%
Provision for loan losses
(45,244
)
(36,318
)
(28,727
)
8,926

7,591

 
24.6

26.4

Non-interest income
486,604

474,392

448,139

12,212

26,253

 
2.6

5.9

Investment securities gains (losses), net
25,051

(53
)
6,320

25,104

(6,373
)
 
N.M.

N.M.

Non-interest expense
(769,684
)
(717,065
)
(676,487
)
52,619

40,578

 
7.3

6.0

Income taxes
(110,506
)
(124,151
)
(116,590
)
(13,645
)
7,561

 
(11.0
)
6.5

Non-controlling interest expense
(517
)
(1,463
)
(3,245
)
(946
)
(1,782
)
 
(64.7
)
(54.9
)
Net income attributable to Commerce Bancshares, Inc.
319,383

275,391

263,730

43,992

11,661

 
16.0

4.4

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


 
N.M.

N.M.

Net income available to common shareholders
$
310,383

$
266,391

$
254,730

$
43,992

$
11,661

 
16.5
%
4.6
%

Net income attributable to Commerce Bancshares, Inc. for 2017 was $319.4 million, an increase of $44.0 million, or 16.0%, compared to $275.4 million in 2016. Diluted income per common share increased 16.1% to $2.89 in 2017, compared to $2.49 in 2016. The increase in net income resulted from increases of $53.6 million in net interest income, $12.2 million in non-interest income, and $25.1 million in investment securities gains, as well as a decrease of $13.6 million in income tax expense. These increases in net income were partly offset by increases of $52.6 million in non-interest expense and $8.9 million in the provision for loan losses. The return on average assets was 1.28% in 2017 compared to 1.12% in 2016, and the return on average common equity was 12.46% in 2017 compared to 11.33% in 2016. At December 31, 2017, the ratio of tangible common equity to assets increased to 9.84%, compared to 8.66% at year end 2016.

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

Non-interest income in 2017 was $486.6 million, an increase of $12.2 million, or 2.6%, compared to $474.4 million in 2016. This increase resulted mainly from growth in trust fees, deposit account fees, and loan fees and sales, which increased $13.4 million, $3.7 million, and $2.5 million, respectively. Non-interest expense in 2017 was $769.7 million, an increase of $52.6 million over $717.1 million in 2016. The increase in non-interest expense included a $21.0 million, or 4.9%, increase in salaries and benefits expense due to higher full-time salaries, incentive compensation, and payroll taxes. Current period expense also included $32.0 million of contribution expense resulting from the donation of appreciated securities to a charitable foundation, as mentioned earlier. Investment securities net gains in 2017 totaled $25.1 million, largely resulting from these donations.

Net income attributable to Commerce Bancshares, Inc. for 2016 was $275.4 million, an increase of $11.7 million, or 4.4%, compared to $263.7 million in 2015. Diluted income per common share increased 7.3% to $2.49 in 2016, compared to $2.32 in 2015. The increase in net income resulted from increases of $45.7 million in net interest income and $26.3 million in non-interest income. These increases in net income were partly offset by increases of $40.6 million in non-interest expense, $7.6 million in the provision for loan losses, and $7.6 million in income tax expense, as well as a decrease of $6.4 million in investment securities gains. The return on average assets was 1.12% in 2016 compared to 1.11% in 2015, and the return on average common equity was 11.33% in 2016 compared to 11.43% in 2015. At December 31, 2016, the ratio of tangible common equity to assets increased to 8.66%, compared to 8.48% at year end 2015.

During 2016, net interest income increased $45.7 million compared to 2015. This increase reflected growth of $33.3 million in interest on loans, resulting from higher average balances. In addition, interest on investment securities grew by $15.4 million due to higher rates earned, which included $6.4 million in additional inflation income earned on the Company's portfolio of TIPS. Interest expense on deposits rose by $3.1 million due to higher balances and a slight increase in overall rates paid. The provision for loan losses increased $7.6 million over the previous year, totaling $36.3 million in 2016, and was $4.4 million higher than net

19


loan charge-offs. Net charge-offs decreased by $1.8 million in 2016 compared to 2015, mainly due to higher recoveries in construction and business real estate loans.

Non-interest income in 2016 was $474.4 million, an increase of $26.3 million, or 5.9%, compared to $448.1 million in 2015. This increase resulted mainly from growth in deposit account fees, trust fees, loan fees and sales, and bank card fees, which increased $6.0 million, $3.4 million, $3.2 million, and $3.0 million, respectively. Non-interest expense in 2016 was $717.1 million, an increase of $40.6 million over $676.5 million in 2015. The increase in non-interest expense included a $26.6 million, or 6.6%, increase in salaries and benefits expense due to higher full-time salaries, incentives, and medical plan costs. The net loss on investment securities transactions in 2016 was minimal, while a net gain of $6.3 million was recorded in 2015 that resulted from sales of available for sale securities and fair value adjustments and dispositions of private equity investments.

The Company distributed a 5% stock dividend for the 24th consecutive year on December 18, 2017. All per share and average share data in this report has been restated for the 2017 stock dividend.

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

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

Valuation of Investment Securities
The Company carries its investment securities at fair value and employs valuation techniques which utilize observable inputs when those inputs are available. These observable inputs reflect assumptions market participants would use in pricing the security and are developed based on market data obtained from sources independent of the Company. When such information is not available, the Company employs valuation techniques which utilize unobservable inputs, or those which reflect the Company’s own assumptions about market participants, based on the best information available in the circumstances. These valuation methods typically involve cash flow and other financial modeling techniques. Changes in underlying factors, assumptions, estimates, or other inputs to the valuation techniques could have a material impact on the Company's future financial condition and results of operations. Assets and liabilities carried at fair value inherently result in more financial statement volatility. Under the fair value measurement hierarchy, fair value measurements are classified as Level 1 (quoted prices), Level 2 (based on observable inputs) or Level 3 (based on unobservable, internally-derived inputs), as discussed in more detail in Note 15 on Fair Value Measurements. Most of the available for sale investment portfolio is priced utilizing industry-standard models that consider various assumptions observable in the marketplace or which can be derived from observable data. Such securities totaled approximately $7.8 billion, or 89.1%, of the available for sale portfolio at December 31, 2017, and were classified as Level 2 measurements. The Company also holds $17.0 million in auction rate securities. These were classified as Level 3 measurements, as no liquid market currently exists for these securities, and fair values were derived from internally generated cash flow valuation models which used unobservable inputs significant to the overall measurement.

Changes in the fair value of available for sale securities, excluding credit losses relating to other-than-temporary impairment, are reported in other comprehensive income. The Company periodically evaluates the available for sale portfolio for other-than-

20


temporary impairment. Evaluation for other-than-temporary impairment is based on the Company’s intent to sell the security and whether it is likely that it will be required to sell the security before the anticipated recovery of its amortized cost basis. If either of these conditions is met, the entire loss (the amount by which the amortized cost exceeds the fair value) must be recognized in current earnings. If neither condition is met, but the Company does not expect to recover the amortized cost basis, the Company must determine whether a credit loss has occurred. This credit loss is the amount by which the amortized cost basis exceeds the present value of cash flows expected to be collected from the security. The credit loss, if any, must be recognized in current earnings, while the remainder of the loss, related to all other factors, is recognized in other comprehensive income.

The estimation of whether a credit loss exists and the period over which the security is expected to recover requires significant judgment. The Company must consider available information about the collectability of the security, including information about past events, current conditions, and reasonable forecasts, which includes payment structure, prepayment speeds, expected defaults, and collateral values. Changes in these factors could result in additional impairment, recorded in current earnings, in future periods.

At December 31, 2017, certain non-agency guaranteed mortgage-backed securities with a fair value of $26.2 million were identified as other-than-temporarily impaired. The cumulative credit-related impairment loss recorded on these securities amounted to $14.2 million, which was recorded in the consolidated statements of income.

The Company, through its direct holdings and its private equity subsidiaries, has numerous private equity investments, categorized as non-marketable securities in the accompanying consolidated balance sheets. These investments are reported at fair value and totaled $57.2 million at December 31, 2017. Changes in fair value are reflected in current earnings and reported in investment securities gains (losses), net, in the consolidated statements of income. Because there is no observable market data for these securities, fair values are internally developed using available information and management’s judgment, and the securities are classified as Level 3 measurements. Although management believes its estimates of fair value reasonably reflect the fair value of these securities, key assumptions regarding the projected financial performance of these companies, the evaluation of the investee company’s management team, and other economic and market factors may affect the amounts that will ultimately be realized from these investments.

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


21


Net Interest Income
Net interest income, the largest source of revenue, results from the Company’s lending, investing, borrowing, and deposit gathering activities. It is affected by both changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest bearing liabilities. The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates. Changes not solely due to volume or rate changes are allocated to rate.
 
2017
2016
 
Change due to
 
Change due to
 
(In thousands)
Average Volume
Average Rate
 Total
Average Volume
Average Rate
Total
Interest income, fully taxable equivalent basis
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
Business
$
5,190

$
15,053

$
20,243

$
13,067

$
4,916

$
17,983

Real estate- construction and land
3,628

6,235

9,863

10,794

(417
)
10,377

Real estate - business
9,284

3,420

12,704

5,502

(1,948
)
3,554

Real estate - personal
3,114

(264
)
2,850

1,402

(651
)
751

Consumer
3,441

2,548

5,989

4,661

(2,210
)
2,451

Revolving home equity
(669
)
1,388

719

(479
)
14

(465
)
Consumer credit card
(654
)
2,975

2,321

356

(510
)
(154
)
Total interest on loans
23,334

31,355

54,689

35,303

(806
)
34,497

Loans held for sale
(368
)
51

(317
)
1,175

(49
)
1,126

Investment securities:
 
 
 
 
 
 
U.S. government and federal agency obligations
3,831

238

4,069

2,985

7,463

10,448

Government-sponsored enterprise obligations
(3,108
)
(2,744
)
(5,852
)
(6,416
)
2,270

(4,146
)
State and municipal obligations
(1,191
)
3

(1,188
)
(1,148
)
1,355

207

Mortgage-backed securities
7,771

(1,036
)
6,735

7,587

(5,635
)
1,952

Asset-backed securities
(4,884
)
6,295

1,411

(3,798
)
9,586

5,788

Other securities
(1,151
)
4,199

3,048

1,993

(398
)
1,595

Total interest on investment securities
1,268

6,955

8,223

1,203

14,641

15,844

Federal funds sold and short-term securities purchased
   under agreements to resell
36

116

152

(13
)
31

18

Long-term securities purchased under agreements to
   resell
(1,765
)
3,661

1,896

(2,760
)
3,132

372

Interest earning deposits with banks
97

1,153

1,250

(46
)
491

445

Total interest income
22,602

43,291

65,893

34,862

17,440

52,302

Interest expense
 
 
 
 
 
 
Interest bearing deposits:
 
 
 
 
 
 
Savings
53

5

58

55

(8
)
47

Interest checking and money market
235

2,650

2,885

546

399

945

Time open and C.D.’s of less than $100,000
(272
)
108

(164
)
(318
)
(109
)
(427
)
Time open and C.D.’s of $100,000 and over
(439
)
2,753

2,314

264

2,230

2,494

Federal funds purchased and securities sold under agreements to repurchase
463

6,051

6,514

(447)

1,901

1,454

Other borrowings
(1,955
)
1,073

(882
)
2,347

(1,953
)
394

Total interest expense
(1,915
)
12,640

10,725

2,447

2,460

4,907

Net interest income, fully taxable equivalent basis
$
24,517

$
30,651

$
55,168

$
32,415

$
14,980

$
47,395


Net interest income totaled $733.7 million in 2017, increasing $53.6 million, or 7.9%, compared to $680.0 million in 2016. On a tax equivalent (T/E) basis, net interest income totaled $766.6 million, and increased $55.2 million over 2016. This increase included growth of $54.7 million in loan interest, resulting from higher average loan balances and higher rates earned. In addition, interest earned on investment securities increased $8.2 million, mainly due to higher rates earned. Interest expense on deposits and borrowings combined was $43.7 million, and increased $10.7 million compared to 2016 largely due to higher rates paid. The net yield on earning assets (T/E) was 3.20% in 2017 compared with 3.04% in 2016.

During 2017, loan interest income (T/E) grew $54.7 million over 2016 due to average loan growth of $683.9 million, or 5.3%. The average tax equivalent rate earned on the loan portfolio was 4.07% in 2017 compared to 3.86% in 2016. The higher rates

22


earned on the loan portfolio were partly related to actions taken by the Federal Reserve during 2017 to increase interest rate levels, which caused the Company's portfolio to re-price. The largest increase in loan interest occurred in business loans, which was higher by $20.2 million as a result of growth in the average rate earned of 31 basis points. Also contributing to the increase were higher average business loan balances of $179.5 million, or 3.9%, as growth trends continued in commercial and industrial, tax-free, and lease loans. Construction and land loan interest grew $9.9 million due to a 71 basis point increase in average rates and a $103.1 million, or 13.2%, increase in average balances. Business real estate interest was higher by $12.7 million as a result of an increase in average balances of $253.7 million, or 10.4%, along with an increase in average rates of 13 basis points. Interest earned on consumer loans increased $6.0 million over the prior year as the average rate increased 12 basis points and average balances increased $89.2 million. Personal real estate loan interest was higher by $2.9 million and resulted from growth in average balances of $83.3 million. Interest on consumer credit card loans rose $2.3 million due to a 40 basis point increase in the average rate earned.

Tax equivalent interest income on total investment securities increased $8.2 million during 2017, as the average rate earned increased nine basis points, while total average balances declined slightly. The average rate earned on the total investment portfolio was 2.52% in 2017 compared to 2.43% in 2016, while the average balance of the total investment securities portfolio (at amortized cost) was approximately $9.4 billion during both years. The increase in interest income was mainly due to higher interest earned on U.S. government obligations, mortgage-backed securities, and other non-marketable investments. Interest earned on U.S. government securities grew $4.1 million, which included growth of $2.0 million in inflation-adjusted interest on TIPS. In addition, average balances rose $179.9 million, or 24.5%. Interest income on mortgage-backed securities increased $6.7 million, due to an increase in average balances of $323.8 million, partly offset by a decline of three basis points in the average rate earned. Interest earned on asset-backed securities increased $1.4 million, mainly due to an increase of 30 basis points in the average rate earned, partly offset by a decline in average balances of $334.5 million. Interest income on non-marketable securities increased $3.1 million, largely due to one-time interest payments received on a private equity investment in 2017. Partly offsetting these increases in interest income were declines of $5.9 million and $1.2 million in interest on government-sponsored enteprise (GSE) and state and municipal securities, respectively. The decline in GSE interest resulted from a $139.4 million decline in average balances coupled with a rate decrease of 61 basis points, while state and municipal interest was lower due to a decrease of $33.0 million in average balances. Interest earned on deposits with banks increased $1.3 million mainly due to a 55 basis point increase in average rates earned. Interest on long-term securities purchased under resell agreements increased $1.9 million in 2017 compared to the prior year due to an increase in the average rate of 53 basis points, partly offset by a $103.2 million decrease in the average balances of these instruments.

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

During 2016, net interest income totaled $680.0 million, increasing $45.7 million, or 7.2%, compared to $634.3 million in 2015. On a tax equivalent (T/E) basis, net interest income totaled $711.4 million, and increased $47.4 million over 2015. This increase included growth of $34.5 million in loan interest, resulting from higher loan balances. In addition, interest earned on investment securities increased $15.8 million, due mainly to higher average rates earned. Interest expense on deposits and borrowings combined was $33.0 million in 2016, an increase of $4.9 million over 2015. The net yield on earning assets (T/E) was 3.04% in 2016 compared with 2.94% in 2015.

During 2016, loan interest income (T/E) grew $34.5 million over 2015 due to average loan growth of $1.1 billion, or 8.9%. The average tax equivalent rate earned on the loan portfolio was 3.86% in 2016 compared to 3.92% in 2015. The largest increase in loan interest occurred in business loans, which was higher by $18.0 million as a result of growth in average balances of $466.4 million, or 11.1%, further increased by higher average rates of 11 basis points. Construction and land loan interest grew $10.4 million due to a $301.5 million, or 63.2%, increase in average balances, partly offset by a six basis point decline in average rates. Business real estate interest was higher by $3.6 million as a result of an increase in average balances of $147.1 million, or 6.4%, partly offset by a decrease in average rates of eight basis points. Higher levels of interest were earned on consumer and personal real estate loans, which increased $2.5 million and $751 thousand, respectively. These increases were due to higher average balances, which increased 6.4% in consumer loans and 2.0% in personal real estate loans, partly offset by lower average rates earned. Partially offsetting the increases in interest earned, interest on revolving home equity loans decreased $465 thousand due

23


to lower average balances, while interest on consumer credit card loans decreased slightly due to a seven basis point decline in rates.

Tax equivalent interest income on total investment securities increased $15.8 million during 2016, as the average rate earned increased 19 basis points, while average balances declined $91.3 million, or 1.0%, from 2015. The average balance of the total investment securities portfolio (at amortized cost) was $9.4 billion and the average rate earned was 2.43% in 2016, compared to an average balance of $9.5 billion and an average rate earned of 2.24% in 2015. The increase in interest income was mainly due to higher interest earned on most security types, except for a decline of $4.1 million in interest on GSE obligations. Interest earned on U.S. government securities grew by $10.4 million, which included growth of $6.4 million in inflation-adjusted interest on TIPS. In addition, average balances rose $268.9 million, or 57.7%. Interest earned on asset-backed securities increased $5.8 million, mainly due to an increase of 39 basis points in the average rate earned, partly offset by a decline in the average balance of $355.0 million. Interest income on corporate debt securities increased $2.2 million, mainly due to growth of $75.7 million in average balances. Interest income on mortgage-backed securities increased $2.0 million, due to an increase in average balances of $296.4 million, partly offset by a decline of 16 basis points in average rates. Partly offsetting these increases in interest was the decline in GSE interest, resulting from a $346.8 million decline in average balances, but partly offset by a rate increase of 38 basis points. Interest earned on deposits with banks increased $445 thousand mainly due to a 26 basis point increase in average rates earned. Interest on long-term securities purchased under resell agreements increased $372 thousand in 2016 compared to 2015 due to an increase in the average rate of 40 basis points, partly offset by a $210.7 million decrease in average balances.

During 2016, interest expense on deposits increased $3.1 million over 2015. This growth was largely due to higher interest on certificates of deposit of $2.1 million and higher interest expense on money market and interest checking accounts of $945 thousand. The growth in certificate of deposit interest expense was largely due to higher rates paid on certificates of deposit over $100,000, which increased nine basis points. The increase in money market and interest checking interest expense resulted from both higher balances and rates paid. The overall rate paid on total deposits increased from .18% in 2015 to .19% in 2016. Interest expense on borrowings increased $1.8 million, due to higher average rates paid on repurchase agreements during 2016 and higher FHLB borrowings during the first quarter of 2016. The overall average rate incurred on all interest bearing liabilities was .22% in 2016, compared to .20% in 2015.

Provision for Loan Losses
The provision for loan losses totaled $45.2 million in 2017, an increase of $8.9 million over the 2016 provision of $36.3 million. The increase in the provision resulted mainly from a higher allowance for loan losses associated with loan portfolio growth and an increase in net loan charge-offs compared to the prior year.
Net loan charge-offs for the year totaled $41.6 million and increased $9.7 million compared to net loan charge-offs of $31.9 million in 2016. The increase in net loan charge-offs over the previous year was mainly the result of lower recoveries on commercial portfolio loans, which decreased $5.1 million, and higher net charge-offs on consumer credit card and consumer loans, which increased $4.8 million and $932 thousand, respectively. Partly offsetting these increases in net charge-offs were lower net loan charge-offs on revolving home equity and personal real estate loans. The allowance for loan losses totaled $159.5 million at December 31, 2017, an increase of $3.6 million compared to the prior year, and represented 1.14% of outstanding loans at year end 2017, compared to 1.16% at year end 2016. 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.


24


Non-Interest Income
 
 
 
 
% Change
(Dollars in thousands)
2017
2016
2015
'17-'16
'16-'15
Bank card transaction fees
$
180,441

$
181,879

$
178,926

(.8
)%
1.7
 %
Trust fees
135,159

121,795

118,437

11.0

2.8

Deposit account charges and other fees
90,060

86,394

80,416

4.2

7.4

Capital market fees
7,996

10,655

11,476

(25.0
)
(7.2
)
Consumer brokerage services
14,630

13,784

13,784

6.1


Loan fees and sales
13,948

11,412

8,228

22.2

38.7

Other
44,370

48,473

36,872

(8.5
)
31.5

Total non-interest income
$
486,604

$
474,392

$
448,139

2.6
 %
5.9
 %
Non-interest income as a % of total revenue*
39.9
%
41.1
%
41.4
%
 
 
Total revenue per full-time equivalent employee
$
254.2

$
241.3

$
226.9

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

Non-interest income totaled $486.6 million, an increase of $12.2 million, or 2.6%, compared to $474.4 million in 2016. Bank card fees decreased $1.4 million, or .8%, compared to the prior year, largely due to a decline in merchant fees of $4.2 million, resulting from the loss of several large customers over the last twelve months. This decline was partly offset by growth in debit card fees of $704 thousand, credit card fees of $625 thousand, and corporate card fees of $1.4 million. The table below is a summary of bank card transaction fees for the last three years.
 
 
 
 
% Change
(Dollars in thousands)
2017
2016
2015
'17-'16
'16-'15
Debit card fees
$
40,134

$
39,430

$
38,330

1.8
 %
2.9
%
Credit card fees
25,275

24,650

24,202

2.5

1.9

Merchant fees
23,680

27,840

26,784

(14.9
)
3.9

Corporate card fees
91,352

89,959

89,610

1.5

.4

Total bank card transaction fees
$
180,441

$
181,879

$
178,926

(.8
)%
1.7
%
     
Trust fee income increased $13.4 million, or 11.0%, as a result of continued growth in both personal (up 10.3%) and institutional (up 11.9%) trust fees. The market value of total customer trust assets totaled $48.7 billion at year end 2017, which was an increase of 13.1% over year end 2016 balances. Deposit account fees increased $3.7 million, or 4.2%, mainly due to growth in service charges on deposits of $2.5 million, or 12.1%. In addition, overdraft fees increased $1.2 million, or 4.2%, while corporate cash management fees were flat. In 2017, overdraft fees comprised 34.0% of total deposit fees, while corporate cash management fees comprised 40.0% of total deposit fees. Capital market fees declined $2.7 million, or 25.0%, due to continued lower sales volumes, while consumer brokerage services revenue increased $846 thousand, or 6.1%, due to a growth in advisory fees. Loan fees and sales increased $2.5 million this year mainly due to higher mortgage banking revenue related to the Company's fixed rate residential mortgage sale program. Total mortgage banking revenue totaled $9.2 million in 2017 compared to $6.6 million in 2016. Other non-interest income decreased $4.1 million, or 8.5%, from the prior year. This decrease was due in part to a decline in interest rate swap fees of $3.9 million due to lower origination volume. In addition, a large gain on a branch sale and a trust settlement were recorded in 2016 (mentioned below) which did not recur in 2017. These declines in current income were partly offset by higher gains of $1.2 million on sales of leased assets to customers upon lease termination.

During 2016, non-interest income increased $26.3 million, or 5.9%, compared to $448.1 million in 2015. Bank card fees increased $3.0 million, or 1.7%, over 2015. This growth included increases of $1.1 million, or 2.9%, in debit card fees, $1.1 million, or 3.9%, in merchant fees, and smaller increases in credit card and corporate card fees. Trust fee income increased $3.4 million, or 2.8%, as a result of growth in both personal (up 2.0%) and institutional (up 3.7%) trust fees. The market value of total customer trust assets totaled $43.1 billion at year end 2016, which was an increase of 12.2% over year end 2015 balances. Deposit account fees increased $6.0 million, or 7.4%, mainly due to growth in service charges on deposits of $4.4 million, or 26.3%. In addition, corporate cash management fees increased $1.4 million, or 4.1%, and overdraft fees increased $206 thousand. Capital market fees declined $821 thousand, or 7.2%, due to lower sales volumes, while consumer brokerage services revenue was unchanged. Loan fees and sales increased $3.2 million in 2016 compared to 2015, mainly due to $2.7 million in higher mortgage banking revenue. Other non-interest income increased $11.6 million, or 31.5%, over 2015. This increase was due in part to a gain of $3.3 million on the sale of a former branch property recorded in 2016. In addition, an accrual for a trust related settlement of $897 thousand was recorded in 2016. Cash sweep commissions, interest rate swap fees, and fees from sales of tax credits

25


increased $4.8 million, $1.5 million, and $942 thousand, respectively, over 2015. The increases were partly offset by lower operating lease revenue of $1.1 million.

Investment Securities Gains (Losses), Net
(In thousands)
2017
2016
2015
Net gains (losses) on sales of available for sale bonds
$
(9,695
)
$
109

$
2,925

Loss on called bond
(254
)


Net gains on sales of available for sale stock
10,054



Gains on donations of available for sale stock
31,074



Net gains (losses) on sales and fair value adjustments of private equity investments
(5,743
)
108

3,878

Other
(385
)
(270
)
(483
)
Total investment securities gains (losses), net
$
25,051

$
(53
)
$
6,320

Net gains and losses on investment securities during 2017, 2016 and 2015 are shown in the table above. Included in these amounts are gains and losses arising from sales of securities from the Company’s available for sale portfolio, including credit-related losses on debt securities identified as other-than-temporarily impaired. Also shown are gains and losses relating to non-marketable private equity investments, which are primarily held by the Parent’s majority-owned private equity subsidiaries. These include fair value adjustments, in addition to gains and losses realized upon disposition. The portions of private equity investment gains and losses that are attributable to minority interests are reported as non-controlling interest in the consolidated statements of income, and resulted in income of $575 thousand in 2017, compared to expense of $573 thousand and $2.3 million in 2016 and 2015, respectively.
Net securities gains of $25.1 million were recorded in 2017, which included $31.1 million in gains realized upon donation of available for sale stock, in addition to $10.1 million in gains on stock sales. These gains were offset by net losses in fair value totaling $5.8 million on private equity investments, in addition to net losses of $9.7 million on bond sales. The Company sold approximately $790 million of bonds, mainly mortgage and asset-backed securities, as part of a strategy to extend the duration of the securities portfolio and improve net interest margins. During 2017, credit-related impairment losses of $385 thousand were recorded on certain non-agency guaranteed mortgage-backed securities which have been identified as other-than-temporarily impaired. These identified securities had a total fair value of $26.2 million at December 31, 2017, compared to $31.2 million at December 31, 2016.
Net securities losses of $53 thousand were recorded in 2016, compared to net gains of $6.3 million in 2015. The 2016 net loss included $3.8 million in gains realized upon dispositions of private equity investments, including a $1.8 million gain resulting from the Parent's withdrawal from a private equity fund as required under the Volcker Rule investment prohibitions. These gains were offset by net losses in fair value totaling $3.7 million.
In 2015, the Company sold asset-backed securities, municipal securities, and TIPs from the portfolio, realizing gains of $2.8 million. Most of these sales were also part of a plan to extend the portfolio duration. In addition, net gains of $3.9 million on dispositions and fair value adjustments were recognized on private equity investments.


26


Non-Interest Expense
 
 
 
 
% Change
(Dollars in thousands)
2017
2016
2015
'17-'16
'16-'15
Salaries
$
380,945

$
360,840

$
340,521

5.6
 %
6.0
 %
Employee benefits
67,376

66,470

60,180

1.4

10.5

Net occupancy
45,612

46,290

44,788

(1.5
)
3.4

Equipment
18,568

19,141

19,086

(3.0
)
.3

Supplies and communication
22,790

24,135

22,970

(5.6
)
5.1

Data processing and software
92,246

92,722

83,944

(.5
)
10.5

Marketing
16,325

16,032

16,107

1.8

(.5
)
Deposit insurance
13,986

13,327

12,146

4.9

9.7

Community service
34,377

3,906

3,180

N.M.

22.8

Other
77,459

74,202

73,565

4.4

.9

Total non-interest expense
$
769,684

$
717,065

$
676,487

7.3
 %
6.0
 %
Efficiency ratio
63.0
%
62.0
%
62.3
%
 
 
Salaries and benefits as a % of total non-interest expense
58.2
%
59.6
%
59.2
%
 
 
Number of full-time equivalent employees
4,800

4,784

4,770

 
 
     
Non-interest expense was $769.7 million in 2017, an increase of $52.6 million, or 7.3%, over the previous year. Salaries and benefits expense increased $21.0 million, or 4.9%, mainly due to higher full-time salaries, incentive compensation, and payroll taxes. Incentive compensation included the accrual of a discretionary bonus of $3.3 million in December 2017 that will be paid to approximately 75% of all employees. Growth in salaries expense resulted partly from staffing additions in commercial and consumer, information technology, and other support units. Full-time equivalent employees totaled 4,800 at December 31, 2017, an increase of .3% over 2016. Occupancy expense decreased $678 thousand, mainly due to higher net rental income and lower demolition costs on a branch replacement project. Supplies and communication expense decreased by $1.3 million, or 5.6%, mainly due to reissuance costs for new chip cards distributed to customers in 2016 and lower office supplies expense. Data processing and software expense decreased $476 thousand, or .5%, mainly due to lower bank card processing costs resulting from a new vendor contract negotiated in the third quarter of 2017. This effect was partly offset by higher online subscription services and outsourced data provider fees. Equipment expense decreased by $573 thousand, or 3.0%, while deposit insurance expense was higher by $659 thousand, or 4.9%, due to higher insurance rates that were effective July 1, 2016. Costs for marketing increased slightly compared to the prior year. Community service costs increased $30.5 million due to the contribution of $32.0 million of appreciated securities to a related foundation during the current year. Other non-interest expense increased $3.3 million, or 4.4%, over the prior year mainly due to higher costs for legal and professional fees (up $1.2 million), bank card rewards expense (up $1.5 million), impairment losses on surplus branch sites (up $1.2 million), and lower deferred origination costs (down $1.5 million). These increases were partly offset by lower bank card operating costs of $2.2 million, also due to the new contract.

In 2016, non-interest expense was $717.1 million, an increase of $40.6 million, or 6.0%, over 2015. Salaries and benefits expense increased $26.6 million, or 6.6%, mainly due to higher full-time salaries, incentives, stock-based compensation, payroll taxes, and medical plan costs. Growth in salaries expense resulted partly from staffing additions in commercial banking, commercial card, residential mortgage, trust, and other support units. Full-time equivalent employees totaled 4,784 at December 31, 2016, an increase of .3% over 2015. Occupancy expense increased $1.5 million, mainly due to lower net rental income and the demolition costs associated with a branch building which was being replaced. Supplies and communication expense increased by $1.2 million, or 5.1%, mainly due to reissuance costs for new chip cards distributed to customers and higher data network expense. Data processing and software expense increased $8.8 million, or 10.5%, mainly due to higher software license costs, outsourced data provider fees, online subscription services, and bank card processing costs. Deposit insurance expense was higher by $1.2 million, or 9.7%, due to higher average assets and higher insurance rates that were effective July 1, 2016. Costs for marketing and equipment were relatively flat compared to 2015. Community service expense grew $726 thousand over 2015, mainly due to higher foundation contributions. Other non-interest expense increased $637 thousand in 2016 compared to 2015, partly due to a recovery of $2.8 million in 2015 related to a letter of credit exposure which had been drawn upon and subsequently paid off. In addition, higher costs were recorded for bank card rewards expense (up $2.4 million), loan collection fees (up $1.8 million), and legal and professional fees (up $1.2 million). These increases were partly offset by lower bank card fraud losses (down $3.8 million), lease asset depreciation expense (down $1.3 million), and higher deferred origination costs (up $2.6 million) in 2016.
    

27


Income Taxes
Income tax expense was $110.5 million in 2017, compared to $124.2 million in 2016 and $116.6 million in 2015. The effective tax rate, including the effect of non-controlling interest, was 25.7% in 2017 compared to 31.1% in 2016 and 30.7% in 2015. The declines in tax expense and the effective tax rate in 2017 compared to 2016 and 2015 were largely due to the items mentioned below.

The Company adopted ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting," on January 1, 2017, which requires all excess tax benefits (net of tax deficiencies) to be recognized as income tax expense or benefit in the income statement. The amount of excess tax benefits (net of tax deficiencies) recognized as a reduction to income tax expense totaled $7.3 million in 2017. In addition, income tax benefits of $11.8 million were recorded in 2017, resulting from the contribution of $32.0 million of appreciated securities to a charitable foundation.

New federal tax reform legislation was enacted in December 2017, which reduced income tax rates applied to the Company's deferred tax assets and liabilities at December 31, 2017. As part of the enactment, tax benefits of $6.8 million were recorded as a reduction of income tax expense in 2017, mostly as a result of revaluing deferred tax assets and liabilities at the new lower tax rates. The Company’s effective tax rate in 2018 is likely to be reduced to a range of 19-21% as a result of this new tax legislation. Additional information about income tax expense is provided in Note 8 to the consolidated financial statements.

Financial Condition
Loan Portfolio Analysis
Classifications of consolidated loans by major category at December 31 for each of the past five years are shown in the table below. This portfolio consists of loans which were acquired or originated with the intent of holding to their maturity. Loans held for sale are separately discussed in a following section. A schedule of average balances invested in each loan category below appears on page 56.
 
Balance at December 31
(In thousands)
2017
2016
2015
2014
2013
Commercial:
 
 
 
 
 
Business
$
4,958,554

$
4,776,365

$
4,397,893

$
3,969,952

$
3,715,319

Real estate — construction and land
968,820

791,236

624,070

403,507

406,197

Real estate — business
2,697,452

2,643,374

2,355,544

2,288,215

2,313,550

Personal banking:
 
 
 
 
 
Real estate — personal
2,062,787

2,010,397

1,915,953

1,883,092

1,787,626

Consumer
2,104,487

1,990,801

1,924,365

1,705,134

1,512,716

Revolving home equity
400,587

413,634

432,981

430,873

420,589

Consumer credit card
783,864

776,465

779,744

782,370

796,228

Overdrafts
7,123

10,464

6,142

6,095

4,611

Total loans
$
13,983,674

$
13,412,736

$
12,436,692

$
11,469,238

$
10,956,836


The contractual maturities of business and real estate loan categories at December 31, 2017, and a breakdown of those loans between fixed rate and floating rate loans are as follows.

28


 
Principal Payments Due
 
(In thousands)
In
One Year
or Less
After One
Year Through
Five Years
After
Five
Years
Total
Business
$
2,581,850

$
1,943,129

$
433,575

$
4,958,554

Real estate — construction and land
383,983

550,930

33,907

968,820

Real estate — business
598,587

1,507,896

590,969

2,697,452

Real estate — personal
181,223

506,033

1,375,531

2,062,787

Total business and real estate loans
$
3,745,643

$
4,507,988

$
2,433,982

10,687,613

 
 
 
 
 
Business and real estate loans:
 
 
 
 
Loans with fixed rates
24.3
%
49.6
%
58.2
%
42.7
%
Loans with floating rates
75.7
%
50.4
%
41.8
%
57.3
%
Total business and real estate loans
100.0
%
100.0
%
100.0
%
100.0
%

The following table shows loan balances at December 31, 2017, segregated between those with fixed interest rates and those with variable rates that fluctuate with an index.
(In thousands)
Fixed Rate Loans
Variable Rate Loans
Total
% Variable Rate Loans
Business
$
1,727,430

$
3,231,124

$
4,958,554

65.2
%
Real estate — construction and land
64,884

903,936

968,820

93.3

Real estate — business
1,275,537

1,421,915

2,697,452

52.7

Real estate — personal
1,497,030

565,757

2,062,787

27.4

Consumer
1,561,174

543,313

2,104,487

25.8

Revolving home equity
7,830

392,757

400,587

98.0

Consumer credit card
70,392

713,472

783,864

91.0

Overdrafts
7,123


7,123


Total loans
$
6,211,400

$
7,772,274

$
13,983,674

55.6
%

Total loans at December 31, 2017 were $14.0 billion, an increase of $570.9 million, or 4.3%, over balances at December 31, 2016. The growth in loans during 2017 occurred in all loan categories, with the exception of revolving home equity loans and overdrafts, which declined from the prior year. Business loans increased $182.2 million, or 3.8%, reflecting growth in commercial and industrial loans, commercial card loans and tax-advantaged lending. Business real estate loans increased $54.1 million, or 2.0%, due to continued demand for commercial real estate loans during 2017. Construction loans increased $177.6 million, or 22.4% due to continued growth in commercial construction projects and advances on existing projects. Personal real estate loans retained by the Company increased $52.4 million, or 2.6%, on solid origination growth. The Company sells certain long-term fixed rate mortgage loans to the secondary market, and these loan sales totaled $199.8 million in 2017. Consumer loans were higher by $113.7 million, or 5.7%, which was largely driven by growth in patient health care, automobile and other consumer loans, while motorcycle and fixed rate home equity loans declined and marine and recreational vehicle loan balances continued to run off during the year. Consumer credit card loans increased $7.4 million, while revolving home equity loan balances declined $13.0 million, compared to balances at year end 2016.

The Company currently holds approximately 29% of its loan portfolio in the St. Louis market, 31% in the Kansas City market, and 40% in other regional markets. The portfolio is diversified from a business and retail standpoint, with 62% in loans to businesses and 38% 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.

The Company participates in credits of large, publicly traded companies which are defined by regulation as shared national credits, or SNCs. Regulations define SNCs as loans exceeding $20 million that are shared by three or more financial institutions. The Company typically participates in these loans when business operations are maintained in the local communities or regional markets and opportunities to provide other banking services are present. At December 31, 2017, the balance of SNC loans totaled approximately $1.1 billion, with an additional $1.4 billion in unfunded commitments, compared to $836.1 million in loans and $1.4 billion in unfunded commitments at December 31, 2016.

29


Commercial Loans
Business
Total business loans amounted to $5.0 billion at December 31, 2017 and include loans used mainly to fund customer accounts receivable, inventories, and capital expenditures. The business loan portfolio includes tax-advantaged financings which carry tax free interest rates. These loans totaled $728.9 million at December 31, 2017, which was a $53.5 million, or 7.9%, increase over December 31, 2016 balances, and comprised 5.2% of the Company's total loan portfolio. The business loan portfolio also includes direct financing and sales type leases totaling $737.7 million, which are used by commercial and tax-exempt customers to finance capital purchases ranging from computer equipment to office and transportation equipment. These leases increased $12.4 million, or 1.7%, over 2016 and comprised 5.3% of the Company’s total loan portfolio. The Company has outstanding energy-related loans totaling $134.5 million at December 31, 2017, which are further discussed on page 38. Also included in the business portfolio are corporate card loans, which totaled $300.8 million at December 31, 2017 and increased $76.6 million, or 34.1%, over the prior year. These loans are made in conjunction with the Company’s corporate card business. They are generally for corporate trade purchases and are short-term, with outstanding balances averaging between 7 to 30 days in duration, which helps to limit risk in these loans.

Business loans, excluding corporate card loans, are made primarily to customers in the regional trade area of the Company, generally the central Midwest, encompassing the states of Missouri, Kansas, Illinois, and nearby Midwestern markets, including Iowa, Oklahoma, Colorado, Texas and Ohio. This portfolio is diversified from an industry standpoint and includes businesses engaged in manufacturing, wholesaling, retailing, agribusiness, insurance, financial services, public utilities, health care, and other service businesses. Emphasis is upon middle-market and community businesses with known local management and financial stability. Consistent with management’s strategy and emphasis upon relationship banking, most borrowing customers also maintain deposit accounts and utilize other banking services. Net loan charge-offs in this category totaled $1.4 million in 2017, compared to net loan charge-offs of $616 thousand recorded in 2016. Non-accrual business loans were $5.9 million (.1% of business loans) at December 31, 2017 compared to $8.7 million at December 31, 2016.

Real Estate-Construction and Land
The portfolio of loans in this category amounted to $968.8 million at December 31, 2017, which was an increase of $177.6 million, or 22.4%, over the prior year and comprised 6.9% of the Company’s total loan portfolio. Commercial construction and land development loans totaled $765.8 million, or 79.0% of total construction loans at December 31, 2017. These loans increased $193.3 million over 2016 year end balances; driving the growth in the total construction portfolio. Commercial construction loans are made during the construction phase for small and medium-sized office and medical buildings, manufacturing and warehouse facilities, apartment complexes, shopping centers, hotels and motels, and other commercial properties. Commercial land development loans relate to land owned or developed for use in conjunction with business properties. Residential construction and land development loans at December 31, 2017 totaled $203.0 million, or 21.0% of total construction loans. A stable construction market has contributed to improved loss trends, with net loan recoveries of $1.2 million and $3.7 million recorded in 2017 and 2016, respectively. Construction and land loans on non-accrual status declined to $5 thousand at year end 2017 compared to $564 thousand at year end 2016.

Real Estate-Business
Total business real estate loans were $2.7 billion at December 31, 2017 and comprised 19.3% of the Company’s total loan portfolio. This category includes mortgage loans for small and medium-sized office and medical buildings, manufacturing and warehouse facilities, shopping centers, hotels and motels, churches, and other commercial properties. Emphasis is placed on owner-occupied lending (37.5% of this portfolio), which presents lower risk levels. The borrowers and/or the properties are generally located in local and regional markets. Additional information about loans by category is presented on page 36. At December 31, 2017, non-accrual balances amounted to $2.7 million, or .1% of the loans in this category, up from $1.6 million at year end 2016. The Company experienced net loan recoveries of $203 thousand in 2017, compared to net loan recoveries of $1.3 million in 2016.

Personal Banking Loans
Real Estate-Personal
At December 31, 2017, there were $2.1 billion in outstanding personal real estate loans, which comprised 14.8% of the Company’s total loan portfolio. The mortgage loans in this category are mainly for owner-occupied residential properties. The Company originates both adjustable rate and fixed rate mortgage loans, and at December 31, 2017, 27% of the portfolio was comprised of adjustable rate loans and 73% was comprised of fixed rate loans. The Company does not purchase any loans from outside parties or brokers, and has never maintained or promoted subprime or reduced-document products. Levels of mortgage loan origination activity decreased in 2017 compared to 2016, with originations of $560.8 million in 2017 compared with $574.7

30


million in 2016. Net loans retained by the Company increased $52.4 million and loans sold to the secondary market increased $50.2 million. The loan sales were made under a 2015 initiative to originate and sell certain long term fixed rate loans, resulting in sales of $149.6 million in 2016 and $199.8 million in 2017. The Company has experienced lower loan losses in this category than many others in the industry and believes this is partly because of its conservative underwriting culture, stable markets, and the fact that it does not offer subprime lending products or purchase loans from brokers. Net loan recoveries for 2017 amounted to $305 thousand, compared to net loan recoveries of $6 thousand in the previous year. The non-accrual balances of loans in this category decreased to $2.5 million at December 31, 2017, compared to $3.4 million at year end 2016.

Consumer
Consumer loans consist of automobile, motorcycle, marine, tractor/trailer, recreational vehicle (RV), fixed rate home equity, patient health care financing and other types of consumer loans. These loans totaled $2.1 billion at year end 2017. Approximately 48% of the consumer portfolio consists of automobile loans, 6% in motorcycle loans, 15% in fixed rate home equity loans, 7% in heathcare financing loans and 3% in marine and RV loans. Total consumer loans increased by $113.7 million at year end in 2017 compared to year end 2016. Growth of $69.6 million in patient health care financing and $37.3 million in automobile loan originations was partly offset by the run-off of $30.6 million in marine and RV loans and lower motorcycle and fixed rate home equity loans of $10.9 million and $8.7 million, respectively. Loans for other general consumer purposes increased $57.0 million over year end 2016. Net charge-offs on total consumer loans were $10.0 million in 2017, compared to $9.0 million in 2016, averaging .5% of consumer loans in both years. Consumer loan net charge-offs included marine and RV loan net charge-offs of $1.2 million, which were 1.4% of average marine and RV loans in 2017, compared to .9% in 2016.

Revolving Home Equity
Revolving home equity loans, of which 98% are adjustable rate loans, totaled $400.6 million at year end 2017. An additional $698.6 million was available in unused lines of credit, which can be drawn at the discretion of the borrower. Home equity loans are secured mainly by second mortgages (and less frequently, first mortgages) on residential property of the borrower. The underwriting terms for the home equity line product permit borrowing availability, in the aggregate, generally up to 80% or 90% of the appraised value of the collateral property at the time of origination. Net charge-offs totaled $185 thousand in 2017, compared to $485 thousand in 2016.

Consumer Credit Card
Total consumer credit card loans amounted to $783.9 million at December 31, 2017 and comprised 5.6% of the Company’s total loan portfolio. The credit card portfolio is concentrated within regional markets served by the Company. The Company offers a variety of credit card products, including affinity cards, rewards cards, and standard and premium credit cards, and emphasizes its credit card relationship product, Special Connections. Approximately 42% of the households that own a Commerce credit card product also maintain a deposit relationship with the subsidiary bank. At December 31, 2017, approximately 91% of the outstanding credit card loan balances had a floating interest rate, compared to 90% in the prior year. Net charge-offs amounted to $30.3 million in 2017, an increase of $4.8 million over $25.4 million in 2016. The ratio of credit card loan net charge-offs to total average credit card loans was 4.1% in 2017 and 3.4% in 2016.

Loans Held for Sale
At December 31, 2017, loans held for sale were comprised of certain long-term fixed rate personal real estate loans and loans extended to students while attending colleges and universities. The personal real estate loans are carried at fair value and totaled $15.3 million at December 31, 2017. The student loans, carried at the lower of cost or fair value, totaled $6.1 million at December 31, 2017. Both of these portfolios are further discussed in Note 2 to the consolidated financial statements.

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

Loans subject to individual evaluation generally consist of business, construction, business real estate and personal real estate loans on non-accrual status, and include troubled debt restructurings that are on non-accrual status. These non-accrual loans are evaluated individually for impairment based on factors such as payment history, borrower financial condition and collateral. For collateral dependent loans, appraisals of collateral (including exit costs) are normally obtained annually but discounted based on date last received and market conditions. From these evaluations of expected cash flows and collateral values, specific allowances are determined.

31


Loans which are not individually evaluated are segregated by loan type and sub-type and are collectively evaluated. These loans include commercial loans (business, construction and business real estate) which have been graded pass, special mention or substandard, and all personal banking loans except personal real estate loans on non-accrual status. Collectively-evaluated loans include certain troubled debt restructurings with similar risk characteristics. Allowances for both personal banking and commercial loans use methods which consider historical and current loss trends, loss emergence periods, delinquencies, industry concentrations and unique risks. Economic conditions throughout the Company's market place, as monitored by Company credit officers, are also considered in the allowance determination process.
The Company’s estimate of the allowance for loan losses and the corresponding provision for loan losses rest upon various judgments and assumptions made by management. In addition to past loan loss experience, various qualitative factors are considered, such as current loan portfolio composition and characteristics, trends in delinquencies, portfolio risk ratings, levels of non-performing assets, credit concentrations, collateral values, and prevailing regional and national economic conditions. The Company has internal credit administration and loan review staff that continuously review loan quality and report the results of their reviews and examinations to the Company’s senior management and Board of Directors. Such reviews also assist management in establishing the level of the allowance. In using this process and the information available, management must consider various assumptions and exercise considerable judgment to determine the overall level of the allowance for loan losses. Because of these subjective factors, actual outcomes of inherent losses can differ from original estimates. The Company’s subsidiary bank continues to be subject to examination by several regulatory agencies, and examinations are conducted throughout the year, targeting various segments of the loan portfolio for review. Refer to Note 1 to the consolidated financial statements for additional discussion on the allowance and charge-off policies.

At December 31, 2017, the allowance for loan losses was $159.5 million compared to $155.9 million at December 31, 2016. The percentage of allowance to loans decreased slightly to 1.14% at December 31, 2017 compared to 1.16% at year end 2016. Total loans delinquent 90 days or more and still accruing were $18.1 million at December 31, 2017, an increase of $1.7 million compared to year end 2016, mainly driven by a $1.2 million increase in personal real estate loans delinquent 90 days or more. Non-accrual loans at December 31, 2017 were $12.0 million, a decrease of $2.3 million from the prior year, mainly comprised of decreases in business and personal real estate non-accrual loans of $2.7 million and $942 thousand, respectively. These decreases were partially offset by an increase in business real estate non-accrual loans of $1.1 million. The 2017 year end balance of non-accrual loans was comprised of $5.9 million of business loans, $2.7 million of business real estate loans, $2.5 million of personal real estate loans, and $834 thousand of consumer loans.

Net loan charge-offs totaled $41.6 million in 2017, representing a $9.7 million increase compared to net charge-offs of $31.9 million in 2016. The increase was largely due to lower recoveries on commercial loans, which saw $5.1 million fewer recoveries in 2017 compared to 2016, as well as $4.8 million and $932 thousand higher net charge-offs on consumer credit card and consumer loans, respectively. Partly offsetting these increases in net charge-offs were lower net loan charge-offs on revolving home equity and personal real estate loans. Consumer credit card net charge-offs were 4.07% of average consumer credit card loans in 2017 compared to 3.39% in 2016. Consumer credit card loan net charge-offs as a percentage of total net charge-offs decreased to 72.6% in 2017 compared to 79.7% in 2016. Consumer loan net charge-offs were .49% of average consumer loans in 2017, compared to .46% in 2016, and represented 24.0% of total net loan charge-offs in 2017.

The ratio of net charge-offs to total average loans outstanding in 2017 was .31%, compared to .25% in 2016 and .28% in 2015. The provision for loan losses in 2017 was $45.2 million, compared to provisions of $36.3 million in 2016 and $28.7 million in 2015.

The Company considers the allowance for loan losses of $159.5 million adequate to cover losses inherent in the loan portfolio at December 31, 2017.


32


The schedules which follow summarize the relationship between loan balances and activity in the allowance for loan losses:
 
Years Ended December 31
(Dollars in thousands)
2017
2016
2015
2014
2013
Loans outstanding at end of year(A)
$
13,983,674

$
13,412,736

$
12,436,692

$
11,469,238

$
10,956,836

Average loans outstanding(A)
$
13,611,699

$
12,927,778

$
11,869,276

$
11,260,233

$
10,311,654

Allowance for loan losses:
 
 
 
 
 
Balance at beginning of year
$
155,932

$
151,532

$
156,532

$
161,532

$
172,532

Additions to allowance through charges to expense
45,244

36,318

28,727

29,531

20,353

Loans charged off:
 
 
 
 
 
Business
2,410

2,549

2,295

2,646

1,869

Real estate — construction and land
1

515

499

794

621

Real estate — business
127

194

1,263

1,108

2,680

Real estate — personal
417

556

1,037

844

1,570

Consumer
13,415

12,711

11,708

12,214

11,029

Revolving home equity
488

860

722

783

1,200

Consumer credit card
36,114

31,616

31,326

32,424

33,206

Overdrafts
2,207

1,977

2,200

1,960

2,024

Total loans charged off
55,179

50,978

51,050

52,773

54,199

Recoveries of loans previously charged off:
 
 
 
 
 
Business
1,032

1,933

2,683

2,181

2,736

Real estate — construction and land
1,192

4,227

1,761

2,323

5,313

Real estate — business
330

1,475

1,396

681

1,728

Real estate — personal
722

562

596

317

343

Consumer
3,436

3,664

3,430

3,409

3,489

Revolving home equity
303

375

320

743

214

Consumer credit card
5,861

6,186

6,287

7,702

8,085

Overdrafts
659

638

850

886

938

Total recoveries
13,535

19,060

17,323

18,242

22,846

Net loans charged off
41,644

31,918

33,727

34,531

31,353

Balance at end of year
$
159,532

$
155,932

$
151,532

$
156,532

$
161,532

Ratio of allowance to loans at end of year
1.14
%
1.16
%
1.22
%
1.36
%
1.47
%
Ratio of provision to average loans outstanding
.33
%
.28
%
.24
%
.26
%
.20
%
(A)
Net of unearned income, before deducting allowance for loan losses, excluding loans held for sale.
 
Years Ended December 31
 
2017
2016
2015
2014
2013
Ratio of net charge-offs (recoveries) to average loans outstanding, by loan category:
 
 
 
 
 
Business
.03
 %
.01
 %
(.01
)%
.01
 %
(.03
)%
Real estate — construction and land
(.14
)
(.48
)
(.26
)
(.37
)
(1.24
)
Real estate — business
(.01
)
(.05
)
(.01
)
.02

.04

Real estate — personal
(.02
)

.02

.03

.07

Consumer
.49

.46

.45

.54

.52

Revolving home equity
.05

.12

.09

.01

.23

Consumer credit card
4.07

3.39

3.35

3.28

3.34

Overdrafts
33.71

28.42

24.93

21.97

18.04

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


33


The following schedule provides a breakdown of the allowance for loan losses by loan category and the percentage of each loan category to total loans outstanding at year end.
(Dollars in thousands)
2017
2016
2015
2014
2013
 
 
 
Loan Loss Allowance Allocation
% of Loans to Total Loans
Loan Loss Allowance Allocation
% of Loans to Total Loans
Loan Loss Allowance Allocation
% of Loans to Total Loans
Loan Loss Allowance Allocation
% of Loans to Total Loans
Loan Loss Allowance Allocation
% of Loans to Total Loans
Business
$
44,462

35.4
%
$
43,910

35.6
%
$
43,617

35.4
%
$
40,881

34.6
%
$
43,146

33.9
%
RE — construction and land
24,432

6.9

21,841

5.9

16,312

5.0

13,584

3.5

18,617

3.7

RE — business
24,810

19.3

25,610

19.7

22,157

18.9

35,157

20.0

32,426

21.1

RE — personal
4,201

14.8

4,110

15.0

6,680

15.4

7,343

16.4

4,490

16.3

Consumer
19,509

15.0

18,935

14.8

21,717

15.5

16,822

14.9

15,440

13.8

Revolving home equity
1,189

2.9

1,164

3.1

1,393

3.5

2,472

3.7

3,152

3.8

Consumer credit card
40,052

5.6

39,530

5.8

38,764

6.3

39,541

6.8

43,360

7.3

Overdrafts
877

.1

832

.1

892


732

.1

901

.1

Total
$
159,532

100.0
%
$
155,932

100.0
%
$
151,532

100.0
%
$
156,532

100.0
%
$
161,532

100.0
%

Risk Elements of Loan Portfolio
Management reviews the loan portfolio continuously for evidence of problem loans. During the ordinary course of business, management becomes aware of borrowers that may not be able to meet the contractual requirements of loan agreements. Such loans are placed under close supervision with consideration given to placing the loan on non-accrual status, the need for an additional allowance for loan loss, and (if appropriate) partial or full loan charge-off. Loans are placed on non-accrual status when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment. After a loan is placed on non-accrual status, any interest previously accrued but not yet collected is reversed against current income. Interest is included in income only as received and only after all previous loan charge-offs have been recovered, so long as management is satisfied there is no impairment of collateral values. The loan is returned to accrual status only when the borrower has brought all past due principal and interest payments current, and, in the opinion of management, the borrower has demonstrated the ability to make future payments of principal and interest as scheduled. Loans that are 90 days past due as to principal and/or interest payments are generally placed on non-accrual, unless they are both well-secured and in the process of collection, or they are comprised of those personal banking loans that are exempt under regulatory rules from being classified as non-accrual. Consumer installment loans and related accrued interest are normally charged down to the fair value of related collateral (or are charged off in full if no collateral) once the loans are more than 120 days delinquent. Credit card loans and the related accrued interest are charged off when the receivable is more than 180 days past due.
The following schedule shows non-performing assets and loans past due 90 days and still accruing interest.
 
December 31
(Dollars in thousands)
2017
2016
2015
2014
2013
Total non-accrual loans
$
11,983

$
14,283

$
26,575

$
40,775

$
48,814

Real estate acquired in foreclosure
681

366

2,819

5,476

6,625

Total non-performing assets
$
12,664

$
14,649

$
29,394

$
46,251

$
55,439

Non-performing assets as a percentage of total loans
.09
%
.11
%
.24
%
.40
%
.51
%
Non-performing assets as a percentage of total assets
.05
%
.06
%
.12
%
.19
%
.24
%
Loans past due 90 days and still accruing interest
$
18,127

$
16,396

$
16,467

$
13,658

$
13,966

    
The table below shows the effect on interest income in 2017 of loans on non-accrual status at year end.
(In thousands)
 
Gross amount of interest that would have been recorded at original rate
$
1,067

Interest that was reflected in income
58

Interest income not recognized
$
1,009


Non-accrual loans, which are also classified as impaired, totaled $12.0 million at year end 2017, a decrease of $2.3 million from the balance at year end 2016. The decline from December 31, 2016 occurred mainly in business, personal real estate, and construction loans, which decreased $2.7 million, $942 thousand, and $559 thousand, respectively, but was partially offset by increases in business real estate and consumer non-accrual loans. At December 31, 2017, non-accrual loans were comprised primarily of business (49.6%), business real estate (22.8%), and personal real estate (20.5%) loans. Foreclosed real estate totaled $681 thousand at December 31, 2017, an increase of $315 thousand when compared to December 31, 2016. Total non-performing

34


assets remain low compared to the overall banking industry in 2017, with the non-performing loans to total loans ratio at .09% at December 31, 2017. Total loans past due 90 days or more and still accruing interest were $18.1 million as of December 31, 2017, an increase of $1.7 million when compared to December 31, 2016. Balances by class for non-accrual loans and loans past due 90 days and still accruing interest are shown in the "Delinquent and non-accrual loans" section of Note 2 to the consolidated financial statements.

In addition to the non-performing and past due loans mentioned above, the Company also has identified loans for which management has concerns about the ability of the borrowers to meet existing repayment terms. They are classified as substandard under the Company’s internal rating system. The loans are generally secured by either real estate or other borrower assets, reducing the potential for loss should they become non-performing. Although these loans are generally identified as potential problem loans, they may never become non-performing. Such loans totaled $213.4 million at December 31, 2017, compared with $99.5 million at December 31, 2016, resulting in an increase of $113.9 million. The change in potential problem loans was largely comprised of an increase of $110.0 million in business loans, mainly due to the downgrade of several large commercial and industrial and lease loans.
 
December 31
(In thousands)
2017
2016
Potential problem loans:
 
 
Business
$
153,417

$
43,438

Real estate – construction and land
2,702

1,172

Real estate – business
51,134

52,913

Real estate – personal
6,121

1,955

Total potential problem loans
$
213,374

$
99,478


At December 31, 2017, the Company had $110.6 million of loans whose terms have been modified or restructured under a troubled debt restructuring. These loans have been extended to borrowers who are experiencing financial difficulty and who have been granted a concession, as defined by accounting guidance, and are further discussed in the "Troubled debt restructurings" section in Note 2 to the consolidated financial statements. This balance includes certain commercial loans totaling $88.6 million which are classified as substandard and included in the table above because of this classification.

Loans with Special Risk Characteristics
Management relies primarily on an internal risk rating system, in addition to delinquency status, to assess risk in the loan portfolio, and these statistics are presented in Note 2 to the consolidated financial statements. However, certain types of loans are considered at high risk of loss due to their terms, location, or special conditions. Construction and land loans and business real estate loans are subject to higher risk because of the impact that volatile interest rates and a changing economy can have on real estate value, and because of the potential volatility of the real estate industry. Certain personal real estate products (residential first mortgages and home equity loans) have contractual features that could increase credit exposure in a market of declining real estate prices, when interest rates are steadily increasing, or when a geographic area experiences an economic downturn. For these personal real estate loans, higher risks could exist when 1) loan terms require a minimum monthly payment that covers only interest, or 2) loan-to-collateral value (LTV) ratios at origination are above 80%, with no private mortgage insurance. Information presented below for personal real estate and home equity loans is based on LTV ratios which were calculated with valuations at loan origination date. The Company does not attempt to obtain updated appraisals or valuations unless the loans become significantly delinquent or are in the process of being foreclosed upon. For credit monitoring purposes, the Company relies on delinquency monitoring along with obtaining refreshed FICO scores, and in the case of home equity loans, reviewing line utilization and credit bureau information annually. This has remained an effective means of evaluating credit trends and identifying problem loans, partly because the Company offers standard, conservative lending products.


35


Real Estate - Construction and Land Loans
The Company’s portfolio of construction loans, as shown in the table below, amounted to 6.9% of total loans outstanding at December 31, 2017. The largest component of construction and land loans was commercial construction, which grew $213.9 million during the year ended December 31, 2017. At December 31, 2017, multi-family residential construction loans totaled approximately $252.8 million, or 35.2%, of the commercial construction loan portfolio.

(Dollars in thousands)
December 31, 2017
% of Total
% of Total Loans
December 31, 2016
% of Total
% of Total Loans
Residential land
 and land development
$
81,859

8.5
%
.6
%
$
86,373

10.9
%
.6
%
Residential construction
121,138

12.5

.9

132,334

16.8

1.0

Commercial land
 and land development
48,474

5.0

.3

69,057

8.7

.5