cbsh-20201231
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
☑ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
________________________________________________________
For the Fiscal Year Ended December 31, 2020
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
________________________________________________________
For the transition period from to
Commission File No. 001-36502
COMMERCE BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
(State of Incorporation) (IRS Employer Identification No.)
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (816) 234-2000
Securities registered pursuant to Section 12(b) of the Act:
Title of class Trading symbol(s) Name of exchange on which registered
$5 Par Value Common Stock CBSH 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. Yesþ No ̈
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ̈Noþ
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. Yesþ No ̈
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).
Yesþ No ̈
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 filerþ Accelerated Filer ̈ Non-accelerated filer ̈ Smaller reporting company ☐ Emerging growth 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. ̈
Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☑
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐No ☑
As of June 30, 2020, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $6,146,000,000.
As of February 18, 2021, there were 117,078,437 shares of Registrant’s $5 Par Value Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s definitive proxy statement for its 2021 annual meeting of shareholders, which will be filed within 120 days of December 31, 2020, are incorporated by reference into Part III of this Report.
Commerce Bancshares, Inc.
INDEX Page
PART I Item 1. Business 3
Item 1a. Risk Factors 9
Item 1b. Unresolved Staff Comments 15
Item 2. Properties 15
Item 3. Legal Proceedings 15
Item 4. Mine Safety Disclosures 15
Item 6. Selected Financial Data 18
Item 7a. Quantitative and Qualitative Disclosures about Market Risk 63
Item 8. Financial Statements and Supplementary Data 63
Item 9a. Controls and Procedures 137
Item 9b. Other Information 139
PART III Item 10. Directors, Executive Officers and Corporate Governance 139
Item 11. Executive Compensation 139
Item 14. Principal Accounting Fees and Services 139
PART IV Item 15. Exhibits and Financial Statement Schedules 140
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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 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, specialty lending, 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, 2020, the Company had consolidated assets of $32.9 billion, loans of $16.4 billion, deposits of $26.9 billion, and equity of $3.4 billion. The Company’s operations are consolidated for purposes of preparing the Company’s consolidated financial statements. The Company's principal markets, which are served by 157 branch facilities, are located throughout Missouri, Kansas, and central Illinois, as well as Tulsa and Oklahoma City, Oklahoma and Denver, Colorado. Its two largest markets are St. Louis and Kansas City, which serve as central hubs for the Company. The Company also has offices supporting its commercial customers in Dallas, Houston, Cincinnati, Nashville, Des Moines, Indianapolis, and Grand Rapids, and operates a commercial payments business with sales representatives covering the continental United States of America (“U.S.”).
The Company’s goal is to be the preferred provider of financial services in its communities, based on strong customer relationships built through providing top quality service with a strong risk management culture, and employing a strong balance sheet with strong capital levels. The Company operates under a super-community banking format which incorporates large bank product offerings coupled with deep local market knowledge, augmented by experienced, centralized support in select, critical areas. The Company’s focus on local markets is supported by an experienced team of bankers assigned to each market coupled with industry specialists. The Company also uses regional advisory boards, comprised of local business persons, professionals and other community representatives, who assist the Company in responding to local banking needs. In addition to this local market, community-based focus, the Company offers sophisticated financial products usually only available at much larger financial institutions.
The markets the Bank serves are mainly located in the lower Midwest, which provides natural sites for production and distribution facilities and serve as transportation hubs. The economy has been well-diversified in these markets with many major industries represented, including telecommunications, automobile, technology, financial services, aircraft and general manufacturing, health care, numerous service industries, and food and agricultural production. The personal real estate lending operations of the Bank are predominantly centered in its lower Midwestern markets.
From time to time, the Company evaluates the potential acquisition of various financial institutions. In addition, the Company regularly considers the purchase and disposition of real estate assets and branch locations. The Company seeks merger or acquisition partners that are culturally similar, have experienced management and either possess significant market presence or have potential for improved profitability through financial management, economies of scale and expanded services. The Company has not completed any bank acquisitions since 2013.
Employees and Human Capital
The Company employed 4,404 persons on a full-time basis and 184 persons on a part-time basis at December 31, 2020. None of the Company's employees are represented by collective bargaining agreements.
Attracting and retaining talented team members is key to the Company’s ability to execute its strategy and compete effectively. The Company values the unique combination of talents and experiences each team member contributes toward the Company’s success and strives to offer rewards that meet team members’ individual, evolving needs. Well-being is much more than a paycheck and that’s why the Company takes a comprehensive approach to Total Rewards, supporting team members’ physical well-being, financial well-being, and emotional well-being and career development. The Company’s financial well-being program includes a company-matching 401(k) plan and health savings accounts, educational and adoption assistance programs. Emotional well-being programs include paid time off, an employee assistance program (EAP) and company-paid membership to Care.com. Physical well-being is supported by the Company’s health, dental, vision, life and various other insurances, and a wellness program that incentivizes team members to live a healthy and balanced lifestyle. Career development is also a key component of the Company’s Total Rewards, and the Company has a variety of programs to support team
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members as they continue to grow within their current role or develop for their next role. Job shadowing, leadership development programs, Aspiring Managers program, Managing at Commerce, competency assessments and education assistance are just a few of the ways the Company helps team members excel.
During 2020, the Coronavirus Disease 2019 (COVID-19) pandemic created new challenges for the Company and for its team members. The Company focused efforts on providing team members support and resources to navigate the unprecedented environment. Initiatives included daily communications providing relevant updates and information, resources for leaders to help keep their teams engaged and connected, new resources for working parents, and access to emotional support resources. The Company also provided premium pay to team members who were required to work onsite and 5 additional paid days off to team members experiencing COVID-19 related issues.
The Company believes diversity, equity, and inclusion builds stronger companies with better results. In 2020, the Company formalized and extended its commitment to focusing on diversity, equity, and inclusion (DEI) by elevating initiatives in this area as strategic priorities, also known as “blue chips". The Company’s commitment to diversity, equity, and inclusion focuses on four core pillars – people, customers, vendors, and community – while building on the foundation it has already established. The Company has launched a variety of Employee Resource Groups (ERGs) to support its diverse workforce. RISE (empowering women), EMERGE (connecting young professionals), VIBE (valuing multicultural perspectives), and PRIDE (engaging the LGBTQIA+ community) are important forums that provide team members opportunities to connect, learn, and encourage diverse perspectives. Other internal DEI efforts have included unconscious bias training, book clubs, listen, talk, and learn sessions, courageous conversation training, mentoring programs, and review of talent at all levels of the organization. The Company’s longstanding approach of “doing what’s right” continues to guide its focus on its team members and communities.
The Company’s robust listening strategy allows it to stay connected to the team member experience to understand the evolving needs of its team members and to focus on what matters most to them. This strategy includes a balance of surveys, focus groups, and one on one conversations to allow for two-way conversation and provides trends over time by key demographics. The Company’s goal is to create a sense of belonging which it believes is connected to high levels of engagement, enablement, retention, and results. The Company’s intentional strategy has allowed it to maintain levels of engagement that have been recognized by its annual survey partner, Korn Ferry, for being “best-in-class”.
Competition
The Company operates in the highly competitive environment of financial services. The Company regularly faces competition from banks, savings and loan associations, credit unions, brokerage companies, mortgage companies, insurance companies, trust companies, credit card companies, private equity firms, leasing companies, securities brokers and dealers, financial technology companies, e-commerce companies, mutual fund companies, and other companies providing financial services. Some of these competitors are not subject to the same regulatory restrictions as domestic banks and bank holding companies. Some other competitors are significantly larger than the Company, and therefore have greater economies of scale, greater financial resources, higher lending limits, and may offer products and services that the Company does not provide. The Company competes by providing a broad offering of products and services to support the needs of customers, matched with a strong commitment to customer service. The Company also competes based on quality, innovation, convenience, reputation, industry knowledge, and price. In its two largest markets, the Company has approximately 12% of the deposit market share in Kansas City and approximately 8% of the deposit market share in St. Louis.
Operating Segments
The Company is managed in three operating segments: Commercial, Consumer, and Wealth. The Commercial segment provides a full array of corporate lending, merchant and commercial bank card products, payment solutions, leasing, and international services, as well as business and government deposit, investment, and cash management services. The Consumer segment includes the retail branch network, consumer installment lending, personal mortgage banking, and consumer debit and credit bank card activities. The Wealth segment provides traditional trust and estate planning services, brokerage services, and advisory and discretionary investment portfolio management services to both personal and institutional corporate customers. In 2020, the Commercial, Consumer and Wealth segments contributed 52%, 25% and 22% of total segment pre-tax income, respectively. See the section captioned "Operating Segments" in Item 7, Management's Discussion and Analysis, of this report and Note 13 to the consolidated financial statements for additional discussion on operating segments.
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
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Reserve System, United States fiscal policy, international currency regulations and monetary policies, the U.S. Patriot Act, and capital adequacy and liquidity constraints imposed by federal and state bank regulatory agencies.
Supervision and Regulation
The following information summarizes existing laws and regulations that materially affect the Company's operations. It does not discuss all provisions of these laws and regulations, and it does not include all laws and regulations that affect the Company presently or may affect the Company in the future.
General
The Company, as a bank holding company, is primarily regulated by the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, as amended (BHC Act). Under the BHC Act, the Federal Reserve Board’s prior approval is required in any case in which the Company proposes to acquire all or substantially all the assets of any bank, acquire direct or indirect ownership or control of more than 5% of the voting shares of any bank, or merge or consolidate with any other bank holding company. With certain exceptions, the BHC Act also prohibits the Company from acquiring direct or indirect ownership or control of more than 5% of any class of voting shares of any non-banking company. Under the BHC Act, the Company may not engage in any business other than managing and controlling banks or furnishing certain specified services to subsidiaries, and may not acquire voting control of non-banking companies unless the Federal Reserve Board determines such businesses and services to be closely related to banking. When reviewing bank acquisition applications for approval, the Federal Reserve Board considers, among other things, the Bank’s record in meeting the credit needs of the communities it serves in accordance with the Community Reinvestment Act of 1977, as amended (CRA). Under the terms of the CRA, banks have a continuing obligation, consistent with safe and sound operation, to help meet the credit needs of their communities, including providing credit to individuals residing in low- and moderate-income areas. The Bank has a current CRA rating of “outstanding.”
The Company is required to file various reports and additional information with the Federal Reserve Board. The Federal Reserve Board regularly performs examinations of the Company. The Bank is a state-chartered Federal Reserve member bank and is subject to regulation, supervision and examination by the Federal Reserve Bank of Kansas City and the Missouri Division of Finance. The Bank is also subject to regulation by the Federal Deposit Insurance Corporation (FDIC). In addition, there are numerous other federal and state laws and regulations which control the activities of the Company, including requirements and limitations relating to capital and reserve requirements, permissible investments and lines of business, transactions with affiliates, loan limits, mergers and acquisitions, issuance of securities, dividend payments, and extensions of credit. The Bank is subject to federal and state consumer protection laws, including laws designed to protect customers and promote fair lending. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, and their respective state law counterparts. If the Company fails to comply with these or other applicable laws and regulations, it may be subject to civil monetary penalties, imposition of cease and desist orders or other written directives, removal of management and, in certain circumstances, criminal penalties. This regulatory framework is intended primarily for the protection of depositors and the preservation of the federal deposit insurance funds. Statutory and regulatory controls increase a bank holding company’s cost of doing business and limit the options of its management to employ assets and maximize income.
In addition to its regulatory powers, the Federal Reserve Bank affects the conditions under which the Company operates by its influence over the national supply of bank credit. The Federal Reserve Board employs open market operations in U.S. government securities and oversees changes in the discount rate on bank borrowings, changes in the federal funds rate on overnight inter-bank borrowings, and changes in reserve requirements on bank deposits in implementing its monetary policy objectives. These methods are used in varying combinations to influence the overall level of the interest rates charged on loans and paid for deposits, the price of the dollar in foreign exchange markets, and the level of inflation. The monetary policies of the Federal Reserve have a significant effect on the operating results of financial institutions, most notably on the interest rate environment. In view of changing conditions in the national economy and in the money markets, as well as the effect of credit policies of monetary and fiscal authorities, the Company makes no prediction as to possible future changes in interest rates, deposit levels or loan demand, or their effect on the financial statements of the Company.
The financial industry operates under laws and regulations that are under regular review by various agencies and legislatures and are subject to change. The Company currently operates as a bank holding company, as defined by the Gramm-Leach-Bliley Financial Modernization Act of 1999 (GLB Act), and the Bank qualifies as a financial subsidiary under the GLB Act, which allows it to engage in investment banking, insurance agency, brokerage, and underwriting activities that were not available to banks prior to the GLB Act. The GLB Act also included privacy provisions that limit banks’ abilities to disclose non-public information about customers to non-affiliated entities.
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The Company must also comply with the requirements of the Bank Secrecy Act (BSA). The BSA is designed to help fight drug trafficking, money laundering, and other crimes. Compliance is monitored by the Federal Reserve. The BSA was enacted to prevent banks and other financial service providers from being used as intermediaries for, or to hide the transfer or deposit of money derived from, criminal activity. Since its passage, the BSA has been amended several times. These amendments include the Money Laundering Control Act of 1986 which made money laundering a criminal act, as well as the Money Laundering Suppression Act of 1994 which required regulators to develop enhanced examination procedures and increased examiner training to improve the identification of money laundering schemes in financial institutions.
The USA PATRIOT Act, established in 2001, substantially broadened the scope of U.S. anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the U.S. The regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent, and report money laundering and terrorist financing. The regulations include significant penalties for non-compliance.
The Company is subject to regulation under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2011 (Dodd-Frank Act). Among its many provisions, the Dodd-Frank Act required stress-testing for certain financial services companies and established a new council of “systemic risk” regulators. The Dodd-Frank Act also established the Consumer Financial Protection Bureau (CFPB) which is authorized to supervise certain financial services companies and has responsibility to implement, examine for compliance with, and enforce “Federal consumer financial law.” The Company is subject to examinations by the CFPB. The Dodd-Frank Act, through Title VI, commonly known as the Volcker Rule, placed trading restrictions on financial institutions and separated investment banking, private equity and proprietary trading (hedge fund) sections of financial institutions from their consumer lending arms. The Volcker Rule also restricts financial institutions from investing in and sponsoring certain types of investments.
In May 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act was signed into law which provides a number of limited amendments to the Dodd-Frank Act. Notable provisions of the legislation include: an increase in the asset threshold from $50 billion to $250 billion, above which the Federal Reserve is required to apply enhanced prudential standards; an exemption from the Volcker Rule for insured depository institutions with less than $10 billion in consolidated assets; modifications to the Liquidity Coverage and Supplementary Leverage ratios; and the elimination of Dodd-Frank company-run stress tests for banks and bank holding companies with less than $250 billion in assets. Most of these provisions affect institutions larger than the Company, and the Company is not required to prepare stress testing as specified by the Dodd-Frank Act.
Subsidiary Bank
Under Federal Reserve policy, the bank holding company, Commerce Bancshares, Inc. (the "Parent"), is expected to act as a source of financial strength to its bank subsidiary and to commit resources to support it in circumstances when it might not otherwise do so. In addition, loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Deposit Insurance
Substantially all of the deposits held by the Bank are insured up to applicable limits (generally $250,000 per depositor for each account ownership category) by the FDIC's Deposit Insurance Fund (DIF) and are subject to deposit insurance assessments to maintain the DIF. In 2011, the FDIC released a final rule to implement provisions of the Dodd-Frank Act that affected deposit insurance assessments. Among other things, the Dodd-Frank Act raised the minimum designated reserve ratio from 1.15% to 1.35% of estimated insured deposits, removed the upper limit of the designated reserve ratio, required that the designated reserve ratio reach 1.35% by September 30, 2020, and required the FDIC to offset the effect of increasing the minimum designated reserve ratio on depository institutions with total assets of less than $10 billion. The Dodd-Frank Act provided the FDIC flexibility in the implementation of the increase in the designated reserve ratio and also required that the FDIC redefine the assessment base to average consolidated assets minus average tangible equity.
On June 30, 2016, the DIF rose above 1.15%, resulting in a reduction of the initial assessment rate for all banks and implementing a 4.5 basis point surcharge on insured depository institutions with total consolidated assets of $10 billion or more. Effective October 1, 2018, this surcharge was eliminated as the DIF reached its required level of 1.35% of estimated insured deposits. This had the effect of reducing the Company’s insurance costs by $1.5 million in the fourth quarter of 2018. The Company's deposit insurance expense was $7.8 million and $6.7 million in 2020 and 2019, respectively. The increase in the
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Company's 2020 deposit insurance expense was partly due to a higher assessment rate but was primarily driven by growth in the Company's assessment base.
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 comprehensive capital framework was established by the Basel Committee on Banking Supervision, which was effective for large and internationally active U.S. banks and bank holding companies on January 1, 2015. A key goal of the Basel III framework 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 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 is intended to absorb losses during periods of economic stress. Failure to maintain the buffer will result in constraints on dividends, stock repurchases and executive compensation. The rule also adjusted the methodology for calculating risk-weighted assets to enhance risk sensitivity. At December 31, 2020, the Company's capital ratios are well in excess of those minimum ratios required by Basel III.
The Federal Deposit Insurance Corporation Improvement Act (FDICIA) requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. Pursuant to FDICIA, the FDIC promulgated regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Under the prompt corrective action provisions of FDICIA, an insured depository institution generally will be classified as well-capitalized (under 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 above the “well-capitalized” standards.
Stress Testing
As required by the Dodd-Frank Act, the Company performed stress tests as specified by the Federal Reserve requirement and published results beginning in 2014 through 2017. On May 24, 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act was enacted, which eliminated the required stress testing under the Dodd-Frank Act for banks with consolidated assets of less than $250 billion. The Company continues to perform periodic stress-testing based on its own internal criteria.
Executive and Incentive Compensation
Guidelines adopted by federal banking agencies prohibit excessive compensation as an unsafe and unsound practice, and describe compensation as "excessive" when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal shareholder. The Federal Reserve Board has issued comprehensive
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guidance on incentive compensation intended to ensure that the incentive compensation policies do not undermine safety and soundness by encouraging excessive risk taking. This guidance covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, based on key principles that (i) incentives do not encourage risk-taking beyond the organization's ability to identify and manage risk, (ii) compensation arrangements are compatible with effective internal controls and risk management, and (iii) compensation arrangements are supported by strong corporate governance, including active and effective board oversight. Deficiencies in compensation practices may affect supervisory ratings and enforcement actions may be taken if incentive compensation arrangements pose a risk to safety and soundness.
Transactions with Affiliates
The Federal Reserve Board regulates transactions between the Bank and its subsidiaries. Generally, the Federal Reserve Act and Regulation W, as amended by the Dodd-Frank Act, limit the Company’s banking subsidiary and its subsidiaries to lending and other “covered transactions” with affiliates. The aggregate amount of covered transactions a banking subsidiary or its subsidiaries may enter into with an affiliate may not exceed 10% of the capital stock and surplus of the banking subsidiary. The aggregate amount of covered transactions with all affiliates may not exceed 20% of the capital stock and surplus of the banking subsidiary.
Covered transactions with affiliates are also subject to collateralization requirements and must be conducted on arm’s length terms. Covered transactions include (a) a loan or extension of credit by the banking subsidiary, including derivative contracts, (b) a purchase of securities issued to a banking subsidiary, (c) a purchase of assets by the banking subsidiary unless otherwise exempted by the Federal Reserve, (d) acceptance of securities issued by an affiliate to the banking subsidiary as collateral for a loan, and (e) the issuance of a guarantee, acceptance or letter of credit by the banking subsidiary on behalf of an affiliate.
Certain transactions with the Company's directors, officers or controlling persons are also subject to conflicts of interest regulations. Among other things, these regulations require that loans to such persons and their related interests be made on terms substantially the same as for loans to unaffiliated individuals, and must not create an abnormal risk of repayment or other unfavorable features for the financial institution. See Note 2 to the consolidated financial statements for additional information on loans to related parties.
Available Information
The Company’s principal offices are located at 1000 Walnut Street, Kansas City, Missouri (telephone number 816-234-2000). The Company makes available free of charge, through its website at www.commercebank.com, reports filed with the Securities and Exchange Commission as soon as reasonably practicable after the electronic filing. Additionally, a copy of our electronically filed materials can be found at www.sec.gov. 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
III. Loan Portfolio
Types of Loans 30
Maturities and Sensitivities of Loans to Changes in Interest Rates 30-31
IV. Summary of Credit Loss Experience 33-37
VI. Return on Equity and Assets 19
VII. Short-Term Borrowings 99
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Item 1a. RISK FACTORS
Making or continuing an investment in securities issued by the Company, including its common stock, involves certain risks that you should carefully consider. If any of the following risks actually occur, the Company's 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.
Market Risks
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. During 2020, the U.S. economy has suffered adverse economic conditions as a result of the COVID-19 pandemic. Almost a year into the COVID-19 pandemic, the uncertainty in the economic outlook as of December 31, 2020 continued to affect the Company's financial results and operations.
In particular, the Company may face the following risks in connection with market conditions:
•In 2020, the U.S. economy entered a recession, which ended the longest expansion in its history. Brought on by the COVID-19 pandemic late in the first quarter of 2020, the U.S. economy saw significant declines in employment and production, which contributed to the start of the recession. Although the unemployment rate has decreased during 2020 to 6.7% in December 2020, from a high of nearly 15% in April 2020, it is still almost twice as high as the rate at the end of 2019.
•The U.S. economy is affected by global events and conditions, including the COVID-19 pandemic. Although the Company does not directly hold foreign debt or have significant activities with foreign customers, the global economy, the strength of the U.S. dollar, international trade conditions, and oil prices may ultimately affect interest rates, business import/export activity, capital expenditures by businesses, and investor confidence. Unfavorable changes in these factors may result in declines in consumer credit usage, adverse changes in payment patterns, reduced loan demand, and higher loan delinquencies and default rates. These could impact the Company’s future credit losses and provision for credit losses, as a significant part of the Company’s business includes consumer and credit card lending.
•In addition to the COVID-19 slowdown noted above, further slowdowns in economic activity may cause additional 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 expected in the Company’s loan portfolio requires difficult, subjective, and complex judgments, including consideration of economic conditions and how these economic predictions might impair the ability of its borrowers to repay their loans. If an instance occurs that renders these predictions no longer capable of accurate estimation, this may in turn impact the reliability of the process.
•Competition in the industry could intensify as a result of the increasing consolidation of financial services companies in connection with current market conditions, thereby reducing market prices for various products and services which could in turn reduce the Company’s revenues.
The performance of the Company is dependent on the economic conditions of the markets in which the Company operates.
The Company’s success is heavily influenced by the general economic conditions of the specific markets in which it operates. Unlike larger national or other regional banks that are more geographically diversified, the Company provides financial services primarily throughout the states of Missouri, Kansas, central Illinois, Oklahoma, and Colorado. It also has a growing presence in additional states through its commercial banking offices in: Texas, Iowa, Indiana, Michigan, Ohio, and Tennessee. As the Company does not have a significant banking presence in other parts of the country, a prolonged economic downturn in these markets could have a material adverse effect on the Company’s financial condition and results of operations.
The Company operates in a highly competitive industry and market area.
The Company operates in the financial services industry and has numerous competitors including other banks and insurance companies, securities dealers, brokers, trust and investment companies, mortgage bankers, and financial technology companies. Consolidation among financial service providers and new changes in technology, product offerings and regulation continue to challenge the Company's marketplace position. As consolidation occurs, larger regional and national banks may enter the Company's markets and add to existing competition. Large, national financial institutions have substantial capital, technology and marketing resources. These new competitors may lower fees to grow market share, which could result in a loss of
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customers and lower fee revenue for the Company. They may have greater access to capital at a lower cost than the Company, and may have higher loan limits, both of which may adversely affect the Company’s ability to compete effectively. The Company must continue to make investments in its products and delivery systems to stay competitive with the industry, or its financial performance may suffer.
The soundness of other financial institutions could adversely affect the Company.
The Company’s ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institution counterparties. Financial services institutions are interrelated because of trading, clearing, counterparty or other relationships. The Company has exposure to many different industries and counterparties and routinely executes transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual funds, and other institutional clients. Transactions with these institutions include overnight and term borrowings, interest rate swap agreements, securities purchased and sold, short-term investments, and other such transactions. Because of this exposure, defaults by, or rumors or questions about, one or more financial services institutions or the financial services industry in general, could lead to market-wide liquidity problems and defaults by other institutions. Many of these transactions expose the Company to credit risk in the event of default of its counterparty or client, while other transactions expose the Company to liquidity risks should funding sources quickly disappear. In addition, the Company’s credit risk may be exacerbated when the collateral held cannot be realized or is liquidated at prices not sufficient to recover the full amount of the exposure due to the Company. Any such losses could materially and adversely affect results of operations.
Regulatory and Compliance Risks
The Company is subject to extensive government regulation and supervision.
As part of the financial services industry, the Company is subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds, and the banking system, not shareholders. These regulations affect the Company’s lending practices, capital structure, investment practices, dividend policy, and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations, and policies for possible changes. Changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to additional costs, limit the types of financial services and products it may offer, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations, or policies could result in sanctions by regulatory agencies, civil money penalties, and/or reputation damage, which could have a material adverse effect on the Company’s business, financial condition, and results of operations. While the Company has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.
Significant changes in federal monetary policy could materially affect the Company’s business.
The Federal Reserve System regulates the supply of money and credit in the United States. Its policies determine in large part the cost of funds for lending and interest rates earned on loans and paid on borrowings and interest-bearing deposits. Credit conditions are influenced by its open market operations in U.S. government securities, changes in the member bank discount rate, and bank reserve requirements. Changes in Federal Reserve Board policies are beyond the Company’s control and difficult to predict, and such changes may result in lower interest margins and a lack of demand for credit products.
Liquidity and Capital Risks
The Company is subject to both interest rate and liquidity risk.
With oversight from its Asset-Liability Management Committee, the Company devotes substantial resources to monitoring its liquidity and interest rate risk on a monthly basis. The Company's net interest income is the largest source of overall revenue to the Company, representing 62% of total revenue for the year ended December 31, 2020. The interest rate environment in which the Company operates fluctuates in response to general economic conditions and policies of various governmental and regulatory agencies, particularly the Federal Reserve Board, which regulates the supply of money and credit in the U.S. Changes in monetary policy, including changes in interest rates, will influence loan originations, deposit generation, demand for investments and revenues and costs for earning assets and liabilities, and could significantly impact the Company’s net interest income.
As a result of the COVID-19 pandemic, the Federal Reserve Board lowered the benchmark interest rate to between zero and 0.25%. Future economic conditions or other factors could shift monetary policy resulting in increases or additional decreases in the benchmark rate. Furthermore, changes in interest rates could result in unanticipated changes to customer deposit balances and funding costs and affect the Company’s source of funds for future loan growth.
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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 common stock and to meet its other cash needs. In the event the subsidiary bank is unable to pay dividends, the Company may not be able to pay dividends or other obligations, which would have a material adverse effect on the Company's financial condition and results of operations.
Operational Risks
The impact of the phase-out of LIBOR is uncertain.
In 2017, the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that LIBOR would likely be discontinued at the end of 2021 as panel banks would no longer be required to submit estimates that are used to construct LIBOR. U.S. regulatory authorities have voiced similar support for phasing out LIBOR. The Company has a significant number of loans, derivative contracts, and other financial instruments with attributes that are either directly or indirectly dependent on LIBOR. As of December 31, 2020, the Company had $2.4 billion of commercial loans, $1.4 billion of notional value of derivative contracts, and $783.6 million of investment securities that mature after December 31, 2021. These amounts will vary in future periods as current contracts payoff or terminate early and either new or replacement contracts use LIBOR or an alternative reference rate. The impact of alternatives to LIBOR on the valuations, pricing and operation of the Company's financial instruments is not yet known. The Company is coordinating with industry groups to identify an appropriate replacement rate for contracts expiring after 2021, as well as preparing for this transition as it relates to new and existing contracts and customers. The Company has established a LIBOR Transition Program, which is led by the LIBOR Transition Steering Committee (Committee) whose purpose is to guide the overall transition process for the Company. The Committee is an internal, cross-functional team with representatives from all relevant business lines, support functions and legal counsel. An initial LIBOR impact and risk assessment has been performed, and the Company has developed and prioritized action items. Changes to the Company's systems have been identified and the process of installing and testing code has started. All financial contracts that reference LIBOR have been identified and are being monitored on an ongoing basis. Remediation of these contracts is expected to be consistent with industry timing. LIBOR fallback language has been included in key loan provisions of new and renewed loans in preparation for transition from LIBOR to the new benchmark rate when such transition occurs.
The Company may be adversely affected if the interest rates currently tied to LIBOR on the Company's loans, derivatives, and other financial instruments are not able to be transitioned to an alternative rate. Furthermore, the Company may be faced with disputes or litigation with counterparties regarding interpretation and enforcement of fallback language in new and renewed loans as the transition to a new benchmark rate continues to evolve.
The Company’s asset valuation may include methodologies, models, estimations and assumptions which are subject to differing interpretations and could result in changes to asset valuations that may materially adversely affect its results of operations or financial condition.
The Company uses estimates, assumptions, and judgments when certain financial assets and liabilities are measured and reported at fair value. Assets and liabilities carried at fair value inherently result in greater financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices and/or other observable inputs provided by independent third-party sources, when available. When such third-party information is not available, fair value is estimated primarily by using cash flow and other financial modeling techniques utilizing assumptions such as credit quality, liquidity, interest rates and other relevant inputs. Changes in underlying factors, assumptions, or estimates in any of these areas could materially impact the Company’s future financial condition and results of operations. Furthermore, if models used to calculate fair value of financial instruments are inadequate or inaccurate due to flaws in their design or execution, upon sale, the Company may not realize the cash flows of a financial instrument as modeled and could incur material, unexpected losses.
During periods of market disruption, including periods of significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, it may be difficult to value certain assets if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes in active markets with significant observable data that become illiquid due to the current financial environment. In such cases, certain asset valuations may require more subjectivity and management judgment. As such, valuations may include inputs and assumptions that are less observable or require greater estimation. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of assets as reported within the Company’s consolidated financial statements, and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on results of operations or financial condition.
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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, financial condition and results of operations. 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 plans to convert its core customer and deposit systems during 2021 and may encounter significant adverse developments.
The Company plans to replace its core customer and deposit systems and other ancillary systems (collectively referred to as core system). The core system is used to track customer relationships and deposit accounts. The core system is integrated with channel applications that are used to service customer requests by bank personnel or directly by customers (such as online banking and mobile applications). The new core system will provide a new platform based on current technology, will enable the Company to integrate other systems more efficiently, and is a significant improvement compared to our current core system. However, changing the core system will subject the Company to operational risks during and after the conversion, including disruptions to its technology systems, which may adversely impact our customers. The Company has plans, policies and procedures designed to prevent or limit the risks of a failure during or after the conversion of our core system. However, there can be no assurance that any such adverse development will not occur or, if they do occur, that they will be timely and adequately remediated. The ultimate impact of any adverse development could damage the Company's reputation, result in a loss of customer business, subject the Company to regulatory scrutiny, or expose it to civil litigation and possibly financial liability, any of which could have a material effect on the Company’s business, financial condition, and results of operations.
Credit Risks
The allowance for credit losses may be insufficient or future credit losses could increase.
The allowance for credit losses on loans and the liability for unfunded lending commitments at December 31, 2020 reflect management's estimate of credit losses expected in the loan portfolio, including unfunded lending commitments, as of the balance sheet date. See Note 2 to the consolidated financial statements and the section captioned “Allowance for Credit Losses on Loans and Liability for Unfunded Lending Commitments” 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 credit losses on loans and the liability for unfunded lending commitments at December 31, 2020.
In 2016, the Financial Accounting Standards Board (FASB) issued a new accounting standard "Measurement of Credit Losses on Financial Instruments" (ASU 2016-13), which became effective January 1, 2020 and was adopted by the Company at that time. This new standard significantly altered the way the allowance for credit losses is determined. The new standard utilizes a life of loan loss concept and required significant operational changes, especially in data collection and analysis. The level of the allowance is based on management’s methodology that utilizes historical net charge-off rates, and adjusts for the impacts in the reasonable and supportable forecast and other qualitative factors. Key assumptions include the application of historical loss rates, prepayment speeds, forecast results of a reasonable and supportable period, the period to revert to historical loss rates, and qualitative factors. As a result of COVID-19, the allowance for credit losses on loans and the liability for unfunded lending commitments increased substantially during the year, which negatively affected the Company's results of operations, as the U.S. economy suddenly and dramatically deteriorated. The Company’s allowance level is subject to review by regulatory agencies, and that review could also result in adjustments to the allowance for credit losses. Additionally, the Company's provision for credit losses may be more volatile in the future under the new standard, due to macroeconomic variables that influence the Company's loss estimates, and the volatility in credit losses may be material to the Company's earnings.
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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 liquid, investment grade securities, however, these securities are subject to changes in market value due to changing interest rates and implied credit spreads. While the Company maintains prudent risk management practices over bonds issued by municipalities and other issuers, 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 an available for sale debt security is in an unrealized loss position, the entire loss in fair value is required to be recognized in current earnings if the Company intends to sell the security or believes it is probable that the Company will be required to sell the security before the value recovers. Additionally, the current expected credit loss model (CECL) implemented by the Company on January 1, 2020, requires that lifetime expected credit losses on securities be recorded in current earnings. This could result in significant losses.
Strategic Risk
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.
General Risks
A successful cyber attack or other computer system breach could significantly harm the Company, its reputation and its customers.
The Company relies heavily on communications and information systems to conduct its business, and as part of its business, the Company maintains significant amounts of data about its customers and the products they use. Information security risks continue to increase due to new technologies, the increasing use of the Internet and telecommunication technologies (including mobile devices) to conduct financial and other business transactions, and the increased sophistication and activities of organized crime, perpetrators of fraud, hackers, and others. The Company makes significant investments in various technology to identify and prevent intrusions into its information system. The Company also has policies and procedures designed to prevent or limit the effect of failure, interruption or security breach of its information systems, offers ongoing training to employees, hosts tabletop exercises to test response readiness, and performs regular audits using both internal and outside resources. However, there can be no assurance that any such failures, interruptions or security breaches will not occur, or if they do occur, that they will be adequately addressed. In addition to unauthorized access, denial-of-service attacks or other operational disruptions could overwhelm Company websites and prevent the Company from adequately serving customers. Should any of the Company's systems become compromised or customer information be obtained by unauthorized parties, the reputation of the Company could be damaged, relationships with existing customers may be impaired, and the Company could be subject to lawsuits, all of which could result in lost business and have a material adverse effect on the Company’s business, financial condition and results of operations.
The Company continually encounters technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services, including the entrance of financial technology companies offering new financial service products. The Company regularly upgrades or replaces technological systems to increase efficiency, enhance product and service capabilities, eliminate risks of end-of-lifecycle products, reduce costs, and better serve our customers. The Company’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in the Company’s operations. Many of the Company’s competitors have substantially greater resources to invest in technological improvements. The Company may encounter significant problems and may not be able to effectively implement new technology-driven products and services and may not be successful in marketing the new products and services to its customers. These problems might include significant time delays, cost overruns, loss of key people, and technological system failures. Failure to successfully keep pace with technological change affecting the financial services industry or failure to successfully complete
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the replacement of technological systems could have a material adverse effect on the Company’s business, financial condition and results of operations.
The Company must attract and retain skilled employees.
The Company’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people can be intense, and the Company spends considerable time and resources attracting, hiring, and retaining qualified people for its various business lines and support units. The unexpected loss of the services of one or more of the Company’s key personnel could have a material adverse impact on the Company’s business because of their skills, knowledge of the Company’s market, and years of industry experience, as well as the difficulty of promptly finding qualified replacement personnel.
Public health threats or outbreaks of communicable diseases have adversely affected, and are expected to continue to adversely effect, the Company's operations and financial results.
The Company may face risks related to public health threats or outbreaks of communicable diseases. A widespread healthcare crisis, such as an outbreak of a communicable disease could adversely affect the global economy and the Company’s financial performance. For example, the ongoing global COVID-19 pandemic has destabilized the financial markets in which the Company operates and likely will continue to cause significant disruption in the global economies and financial markets, including the Company's local markets. The Company is dependent upon the willingness and ability of its customers to conduct banking and other financial transactions. In reaction to and as preventative measure to attempt to slow the spread of the pandemic, government authorities have in many states and municipalities implemented mandatory closures, shelter-in-place orders, and social distancing protocols, including orders within many of the geographic areas that the Company operates. Although the Company is considered an essential business, access to its branches and office locations have been restricted, for the safety of its employees and customers. Limiting customers' access to the Company's physical business has prevented some customers from transacting with the Company and lowered demand for lending and other services offered by the Company, adversely affecting its cash flows, financial condition, results of operations, profitability and asset quality and could continue to do so for an indefinite period of time. This could have a material adverse effect on the Company’s results of operations, financial condition, and liquidity. In particular, the continued spread of COVID-19 and efforts to contain the virus could:
•continue to impact customer demand of the Company’s lending and related services, leading to lower revenue;
•cause the Company to experience an increase in costs as a result of the Company implementing operational changes to accommodate its remote workforce;
•cause delayed payments from customers and uncollectible accounts, defaults, foreclosures, and declining collateral values, resulting in losses to the Company;
•result in losses on the Company's investment portfolio, due to volatility in the markets and lower trading volume driven by economic uncertainty;
•cause market interest rates to continue to decline, which could adversely affect the Company's net interest income and profitability;
•cause the Company's credit losses to grow substantially;
•impact availability of qualified personnel; and
•cause other unpredictable events.
The situation surrounding COVID-19 remains uncertain and the potential for a material impact on the Company’s results of operations, financial condition, and liquidity increases the longer the virus impacts activity levels in the United States and globally. The ultimate extent of the impact on the Company's business, financial condition, liquidity, results of operations and cash flows will depend on future developments, which are highly uncertain and cannot be predicted. The Company continues to adapt to the changing dynamics of the COVID-19 impacts to the economy, needs of its employees and customers, and authoritative measures mandated by federal, state, and local governments. However, there is no assurance that the Company's business continuity and disaster recovery program can adequately mitigate the risks of such business disruptions and interruptions. New information regarding the severity of the COVID-19 pandemic and ongoing reactions to the pandemic by customers and government authorities will continue to impact access to the Company's business, as well as the economies and markets in which the Company operates. The COVID-19 pandemic may cause prolonged global or national recessionary economic conditions or longer lasting effects on economic conditions than currently exist, which could have a material adverse effect on the Company's business, results of operations and financial condition. Beyond the current COVID-19 pandemic, the potential impacts of epidemics, pandemics, or other outbreaks of an illness, disease, or virus could therefore materially and adversely affect the Company's business, revenue, operations, financial condition, liquidity and cash flows.
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Item 1b. UNRESOLVED STAFF COMMENTS
None
Item 2. PROPERTIES
The main offices of the Company are located in Kansas City and St. Louis, Missouri. The Company 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
The Company has an additional 153 branch locations in Missouri, Illinois, Kansas, Oklahoma and Colorado which are owned or leased.
Item 3. LEGAL PROCEEDINGS
Item 4. MINE SAFETY DISCLOSURES
Not applicable
Information about the Company's Executive Officers
The following are the executive officers of the Company as of February 24, 2021, 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.
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Name and Age Positions with Registrant
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PART II
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Commerce Bancshares, Inc.
Common Stock Data
Commerce Bancshares, Inc. common shares are listed on the Nasdaq Global Select Market (NASDAQ) under the symbol CBSH. The Company had 3,561 common shareholders of record as of December 31, 2020. Certain of the Company's shares are held in "nominee" or "street" name and the number of beneficial owners of such shares is approximately 110,500.
Performance Graph
The following graph presents a comparison of Company (CBSH) performance to the indices named below. It assumes $100 invested on December 31, 2015 with dividends invested on a cumulative total shareholder return basis.
The Company has a long history of paying dividends. 2020 marked the 52nd consecutive year of growth in our regular common dividend, and the Company has also issued an annual 5% common stock dividend for the past 27 years. However, payment of future dividends is within the discretion of the Board of Directors and will depend, among other factors, on earnings, capital requirements, and the operating and financial condition of the Company. The Board of Directors makes the dividend determination quarterly.
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The following table sets forth information about the Company’s purchases of its $5 par value common stock, its only class of common stock registered pursuant to Section 12 of the Exchange Act, during the fourth quarter of 2020.
The Company’s stock purchases shown above were made under authorizations by the Board of Directors. Under the most recent authorization in November 2019 of 5,000,000 shares, 3,544,579 shares remained available for purchase at December 31, 2020.
Item 6. SELECTED FINANCIAL DATA
The required information is set forth below in Item 7.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
This report may contain “forward-looking statements” that are subject to risks and uncertainties and include information about possible or assumed future results of operations. Many possible events or factors could affect the future financial results and performance of Commerce Bancshares, Inc. and its subsidiaries (the "Company"). This could cause results or performance to differ materially from those expressed in the forward-looking statements. Words such as “expects”, “anticipates”, “believes”, “estimates”, variations of such words and other similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in, or implied by, such forward-looking statements. Readers should not rely solely on the forward-looking statements and should consider all uncertainties and risks discussed throughout this report. Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. Such possible events or factors include the risk factors identified in Item 1a Risk Factors and the following: changes in economic conditions in the Company’s market area; changes in policies by regulatory agencies, governmental legislation and regulation; fluctuations in interest rates; changes in liquidity requirements; demand for loans in the Company’s market area; changes in accounting and tax principles; estimates made on income taxes; failure of litigation settlement agreements to become final in accordance with their terms; and competition with other entities that offer financial services.
Overview
The Company operates as a super-community bank and offers a broad range of financial products to consumer and commercial customers, delivered with a focus on high-quality, personalized service. The Company is headquartered in Missouri, with its principal offices in Kansas City and St. Louis, Missouri. Customers are served from 306 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, a mobile application, and a centralized 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.
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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 $354.1 million, a decrease of 15.9% compared to the previous year. The return on average assets was 1.20% in 2020, and the return on average common equity was 10.64%. Diluted earnings per share decreased 14.7% in 2020 compared to 2019.
• Total revenue — Total revenue is comprised of net interest income and non-interest income. Total revenue in 2020 decreased $10.3 million, or .8%, from 2019, as net interest income grew $8.6 million, while non-interest income fell $18.8 million. Growth in net interest income resulted principally from a decrease in interest expense, while the decline in non-interest income in 2020 was mainly due to a one-time gain of $11.5 million on the sale of our corporate trust business in 2019.
• Non-interest expense — Total non-interest expense increased .1% this year compared to 2019, mainly due to higher salaries and employee benefits expense, partially offset by higher deferred loan origination costs and lower supplies and communication and travel and entertainment expense.
• Asset quality — Net loan charge-offs totaled $34.9 million in 2020, a decrease of $14.8 million from those recorded in 2019, and averaged .22% of loans compared to .35% in the previous year. Total non-performing assets, which include non-accrual loans and foreclosed real estate, amounted to $26.6 million at December 31, 2020, compared to $10.6 million at December 31, 2019, and represented .16% of loans outstanding at December 31, 2020.
• Shareholder return — During 2020, the Company paid cash dividends of $1.03 per share on its common stock, representing an increase of 9.1% over the previous year. In 2020, the Company issued its 27th consecutive annual 5% common stock dividend, and in February 2021, the Company's Board of Directors authorized an increase of 2.1% in the common cash dividend. The Company purchased 886,379 shares of treasury stock, mostly in the first quarter of 2020. Total shareholder return, including the change in stock price and dividend reinvestment, was 16.5%, 13.0%, and 9.1% over the past 5, 10, and 15 years, respectively.
The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes. The historical trends reflected in the financial information presented below are not necessarily reflective of anticipated future results.
Key Ratios
(Based on average balances)
(Based on end of period data)
(1) Includes loans held for sale.
(2) Revenue includes net interest income and non-interest income.
(3) The efficiency ratio is calculated as non-interest expense (excluding intangibles amortization) as a percent of revenue.
(4)The tangible common equity to tangible assets ratio is a measurement which management believes is a useful indicator of capital adequacy and utilization. It provides a meaningful basis for period to period and company to company comparisons, and also 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.
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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.
* Intangible assets other than mortgage servicing rights.
Selected Financial Data
* Restated for the 5% stock dividend distributed in December 2020.
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Results of Operations
$ Change % Change
N.M. - Not meaningful.
Net income attributable to Commerce Bancshares, Inc. (net income) for 2020 was $354.1 million, a decrease of $67.2 million, or 15.9%, compared to $421.2 million in 2019. Diluted income per common share was $2.91 in 2020, compared to $3.41 in 2019. The decline in net income resulted from an increase of $86.8 million in the provision for credit losses, as well as a decrease of $18.8 million in non-interest income. These decreases in net income were partly offset by increases of $8.6 million in net interest income and $7.4 million in investment securities gains, coupled with decreases of $21.8 million in income taxes and $1.7 million in non-controlling interest expense. The return on average assets was 1.20% in 2020 compared to 1.67% in 2019, and the return on average common equity was 10.64% in 2020 compared to 14.06% in 2019. At December 31, 2020, the ratio of tangible common equity to assets decreased to 9.92%, compared to 10.99% at year end 2019.
During 2020, net interest income grew mainly due to an increase of $24.7 million in interest income on long-term securities purchased under agreements to resell, mainly due to higher rates earned, coupled with a decrease of $60.6 million in interest expense on deposits and borrowings, due to lower rates paid. These increases in net interest income were partly offset by declines in interest earned on loans and investment securities, resulting mainly from lower yields. Total rates earned on average earning assets fell 76 basis points this year, while funding costs for deposits and borrowings decreased 41 basis points. The provision for credit losses totaled $137.2 million, reflecting an increase in the provision for credit losses on the Company's loan portfolio and liability for unfunded loan commitments, resulting from deteriorating economic conditions driven by the COVID-19 pandemic. Net loan charge-offs decreased $14.8 million in 2020 compared to 2019, mainly due to lower credit card net charge-offs.
Non-interest income fell 3.6% in 2020, mainly due to a one-time gain of $11.5 million resulting from the sale of the Company's corporate trust business in the fourth quarter of 2019, coupled with a decline in bank card fees. Net investment securities gains of $11.0 million were recorded in 2020 and were comprised mainly of net gains realized on sales of mortgage-backed securities. Non-interest expense grew $980 thousand in 2020 compared to 2019, largely due to higher salaries and benefits expense, mostly offset by higher deferred loan origination costs and lower supplies and communication and travel and entertainment expense.
Net income for 2019 was $421.2 million, a decrease of $12.3 million, or 2.8%, compared to $433.5 million in 2018. Diluted income per common share was $3.41 in 2019, compared to $3.43 in 2018. The decline in net income resulted from a decrease of $2.5 million in net interest income, as well as increases of $29.6 million in non-interest expense, $7.7 million in the provision for loan losses and $3.1 million in income taxes. These decreases in net income were partly offset by increases of $23.4 million in non-interest income and $4.1 million in investment securities gains, coupled with a decrease of $3.2 million in non-controlling interest expense. The return on average assets was 1.67% in 2019 compared to 1.76% in 2018, and the return on average common equity was 14.06% in 2019 compared to 16.16% in 2018. At December 31, 2019, the ratio of tangible common equity to assets increased to 10.99%, compared to 10.45% at year end 2018.
As compared to 2018, the decrease in net interest income in 2019 resulted mainly from increased rates on the Company’s interest-bearing deposits and borrowings, coupled with lower average balances on investment securities. These declines in net interest income were partially offset by growth in interest earned on loans as a result of higher loan yields and average balances. Total rates earned on average earning assets grew 10 basis points in 2019, while funding costs for deposits and borrowings increased 23 basis points. The provision for loan losses totaled $50.4 million, an increase of $7.7 million over the previous year and exceeded net loan charge-offs by $750 thousand. Net loan charge-offs increased $7.4 million in 2019 compared to 2018,
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mainly due to higher credit card and business loan net charge-offs. The increase in business loan net charge-offs was primarily the result of a loan charge-off related to a single leasing customer.
Non-interest income grew 4.7% in 2019, mainly due to growth in trust fees, loan fees and sales, and gains on sales of assets. Net investment securities gains of $3.6 million were recorded in 2019 and were mainly comprised of net gains realized on sales of equity investments. Non-interest expense grew $29.6 million in 2019 compared to 2018, largely due to higher salaries and benefits and data processing and software expense, which increased $24.7 million and $6.9 million, respectively.
The Company distributed a 5% stock dividend for the 27th consecutive year on December 18, 2020. All per share and average share data in this report has been restated for the 2020 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 credit losses and fair value measurement.
Allowance for Credit Losses
The Company's Allowance for Credit Losses policy covers the collectability of its loan portfolio, the exposure of its unfunded lending commitments, and the potential for credit losses in its available for sale investment portfolio.The Company performs periodic and systematic detailed reviews of its loan portfolio and unfunded lending commitments to assess overall collectability. The level of the allowance for credit losses on loans and unfunded lending commitments reflects the Company's estimate of the losses expected in the loan portfolio and unfunded lending commitments 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, as well as for their related unfunded lending commitments. These loans and commitments 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. Additionally, the allowance for credit losses requires the calculation of expected lifetime credit losses utilizing a forward-looking forecast of macroeconomic conditions, which may differ significantly from actual results. Further discussion of the methodology used in establishing the allowance is provided in the Allowance for Credit Losses on Loans and Liability for Unfunded Lending Commitments section of Item 7 and in Note 1 to the consolidated financial statements.
The level of the allowance for credit losses on available for sale securities reflects the Company’s estimate of the losses expected in the available for sale debt security portfolio. In order to estimate the allowance for credit losses on available for sale debt securities, the Company performs quarterly reviews of its investment portfolio to identify securities in an unrealized loss position. If the unrealized loss is not expected to be recovered, the Company performs further analyses to determine whether any portion of the unrealized loss indicates that a credit loss exists. Further discussion of the methodology used in establishing the allowance for credit losses on available for sale securities is provided in Note 1 to the consolidated financial statements.
Fair Value Measurement
Investment securities, including available-for-sale, trading, equity and other securities, residential mortgage loans held for sale, derivatives and deferred compensation plan assets and associated liabilities are recorded at fair value on a recurring basis. Additionally, from time to time, other assets and liabilities may be recorded at fair value on a nonrecurring basis, such as loan values that have been reduced based on the fair value of the underlying collateral, other real estate (primarily foreclosed property), non-marketable equity securities and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve write-downs of individual assets or application of lower of cost or fair value accounting.
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Fair value is an estimate of the exchange price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (i.e., not a forced transaction, such as a liquidation or distressed sale) between market participants at the measurement date and is based on the assumptions market participants would use when pricing an asset or liability. Fair value measurement and disclosure guidance establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The fair value hierarchy, the extent to which fair value is used to measure assets and liabilities and the valuation methodologies and key inputs used are discussed in Note 17 on Fair Value Measurements.
At December 31, 2020, assets and liabilities measured using observable inputs that are classified as either Level 1 or Level 2 represented 99.2% and 98.2% of total assets and liabilities recorded at fair value, respectively. Valuations generated from model-based techniques that use at least one significant assumption not observable in the market are considered Level 3, and the Company's Level 3 assets totaled $105.8 million, or 0.8% of total assets recorded at fair value on a recurring basis. Unobservable assumptions reflect estimates of assumptions market participants would use in pricing the asset or liability. Fair value measurements for assets and liabilities where limited or no observable market data exists often involves significant judgments about assumptions, such as determining an appropriate discount rate that factors in both liquidity and risk premiums, and in many cases may not reflect amounts exchanged in a current sale of the financial instrument. In addition, changes in market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. Therefore, when market data is not available, the Company would use valuation techniques requiring more management judgment to estimate the appropriate fair value.
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Net Interest Income
Net interest income, the largest source of revenue, results from the Company’s lending, investing, borrowing, and deposit gathering activities. It is affected by both changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest bearing liabilities. The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates. Changes not solely due to volume or rate changes are allocated to rate.
Change due to Change due to
Interest income, fully taxable equivalent basis
Loans:
Investment securities:
Interest expense
Interest bearing deposits:
Net interest income totaled $829.8 million in 2020, increasing $8.6 million, or 1.0%, compared to $821.3 million in 2019. On a tax equivalent (T/E) basis, net interest income totaled $842.8 million, and increased $7.4 million over 2019. This increase was mainly due to a decline of $60.6 million in interest expense on deposits and borrowings, due to lower average rates paid, as well as an increase of $24.7 million in interest earned on long-term securities purchased under agreements to resell. These increases to net interest income (T/E) were largely offset by lower interest earned on loans and investment securities, which declined $52.6 million and $20.5 million, respectively, mainly due to lower rates earned. The net yield on earning assets (T/E) was 2.99% in 2020 compared with 3.48% in 2019.
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During 2020, loan interest income (T/E) fell $52.6 million from 2019 mainly due to lower rates earned, partly offset by higher average balances for business, personal real estate, business real estate, consumer and construction and land loan categories. The average tax equivalent rate earned on the loan portfolio decreased 83 basis points to 3.88% in 2020 compared to 4.71% in 2019. The Federal Reserve lowered short-term interest rates during the first quarter of 2020, which impacted the Company's interest income on loans, as many of its loans contain variable interest rate terms. Partly offsetting lower interest rates were increases in average loan balances of $1.7 billion, or 11.8%, this year. The largest decrease in loan interest income (T/E) occurred in business real estate loans, which was lower by $17.6 million as a result of a decline in the average rate earned of 74 basis points, partly offset by growth of $100.1 million in average balances. Business loan interest income declined $6.1 million mainly due to an 81 basis point decrease in the average rate earned, partly offset by an increase of $1.2 billion in average balances. Average balances of business real estate loans included average balances of $1.1 billion in Paycheck Protection Program (PPP) loans at December 31, 2020. Interest income on consumer credit card loans declined $15.1 million as a result of a decreases in the average balance of $96.0 million and the average rate of 49 basis points. Construction and land loan interest income decreased $11.1 million, mainly due to a 143 basis point decrease in the average rate earned, partly offset by growth in average balances of $47.6 million. Interest on consumer loans declined $6.3 million from the prior year as the average rate earned decreased 41 basis points, but was partly offset by growth in average balances of $36.3 million. These decreases to loan interest income (T/E) were partly offset by an increase of $9.2 million in interest earned on personal real estate loans. This increase resulted from higher average balances of $440.5 million, partly offset by a 31 basis point decrease in the average rate earned.
Tax equivalent interest income on total investment securities decreased $20.5 million during 2020, as the average rate earned decreased 62 basis points, while average balances grew $1.5 billion. The average rate on the total investment securities portfolio was 2.19% in 2020 compared to 2.81% in 2019, while the average balance of the total investment securities portfolio (excluding unrealized fair value adjustments on available for sale debt securities) was $10.3 billion in 2020 compared to an average balance of $8.7 billion in 2019. The decrease in interest income was mainly due to lower interest income earned on mortgage-backed securities, asset-backed securities, U.S. government securities and government-sponsored enterprise (GSE) obligations. Interest income on mortgage-backed securities decreased $14.0 million, due to a decrease of 77 basis points in the average rate earned, partly offset by higher average balances of $1.1 billion. Interest on asset-backed securities decreased $7.7 million mainly due to a 70 basis point decrease in the average rate earned, partly offset by a $94.9 million increase in the average balance. Interest earned on U.S. government securities fell $3.6 million and was mainly impacted by a decline of $3.0 million in inflation income on treasury inflation-protected securities (TIPS). Average balances of U.S. government securities declined $70.2 million and the average rated earned decreased 24 basis points. Interest income on GSE's decreased $1.2 million, due to a decline in average balances of $86.3 million, partly offset by an increase of 80 basis points in the average rate earned. Partly offsetting these decreases in interest income was growth of $3.9 million and $1.8 million in interest earned on state and municipal obligations and other debt securities, respectively. The growth in interest earned on state and municipal obligations resulted mainly from an increase of $341.5 million in average balances, partly offset a 44 basis point decrease in the average rate earned. Other debt securities interest increased due to growth of $111.4 million in average balances, partly offset by a decline of 27 basis points in the average rate earned.
Interest on long-term securities purchased under resell agreements increased $24.7 million compared to 2019 due to an increase in the average rate of 263 basis points, as these assets were structured with floor spreads to protect against falling interest rates. Of the $850.0 million in securities purchased under agreements to resell held by the Company throughout 2020, $450.0 million and $325.0 million of those agreements will mature throughout 2021 and 2022, respectively. Interest earned on deposits with banks fell $4.4 million from 2019, mainly due to a 192 basis point decrease in the average rate earned, partly offset by an increase in average balances of $799.3 million.
During 2020, interest expense on deposits decreased $37.3 million from 2019 and resulted mainly from a 30 basis point decrease in the overall average rate paid on deposits. Interest expense on interest checking and money market accounts decreased $21.9 million due to lower rates paid, which fell 21 basis points, while interest expense on certificates of deposit over $100,000 declined $14.0 million, mainly due to a 98 basis point decline in the average rate paid. The overall rate paid on total deposits decreased from .54% in 2019 to .24% in the current year. Interest expense on borrowings decreased $23.4 million mainly due to lower rates paid on federal funds purchased and customer repurchase agreements. The overall average rate incurred on all interest bearing liabilities was .26% in 2020, compared to .67% in 2019.
Net interest income totaled $821.3 million in 2019, decreasing $2.5 million compared to $823.8 million in 2018. On a tax equivalent (T/E) basis, net interest income totaled $835.4 million, and decreased $4.6 million from 2018. This decrease included combined growth of $38.0 million in interest expense on deposits and borrowings, due to higher average rates paid and higher average balances. In addition, interest earned on investment securities decreased $5.2 million, mainly due to lower average balances, while loan interest income (T/E) grew $38.6 million due to higher rates earned and higher average balances. The net yield on earning assets (T/E) was 3.48% in 2019 compared with 3.53% in 2018.
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During 2019, loan interest income (T/E) grew $38.6 million over 2018 mainly due to higher rates earned coupled with increased average balances for business, business real estate and personal real estate loan categories. The average tax equivalent rate earned on the loan portfolio increased 18 basis points to 4.71% in 2019 compared to 4.53% in 2018. In addition, average loan balances increased 2.1%, or $298.6 million, in 2019. Increased interest of $17.5 million earned on business loans was the main driver of overall higher loan interest income, due to growth of $251.1 million in average business loan balances and a 16 basis point increase in the average rate. While higher rates also contributed to the increase in interest income, rates were impacted by actions taken by the Federal Reserve during the second half of 2019 to lower interest rates. Business real estate interest was higher by $10.1 million as a result of an increase in average balances of $121.2 million, along with an increase in the average rate of 17 basis points. Personal real estate loan interest income increased $5.2 million and resulted from growth in average balances of $84.9 million and a nine basis point increase in the average rate earned. Interest on consumer loans increased $3.3 million as the average rate grew 36 basis points, but was partly offset by a decline in average balances of $79.9 million, or 4.0%. Interest on consumer credit card loans grew $1.5 million over 2018 as the average rate earned increased 26 basis points, while average balances declined $4.0 million.
Tax equivalent interest income on total investment securities decreased $5.2 million during 2019, as average balances declined $74.4 million and the average rate earned decreased three basis points. The average rate on the total investment portfolio was 2.81% in 2019 compared to 2.84% in 2018, while the average balance of the total investment securities portfolio (excluding unrealized fair value adjustments on available for sale debt securities) was $8.7 billion in 2019 compared to an average balance of $8.8 billion in 2018. The decrease in interest income was mainly due to lower interest and dividend income earned on equity and other securities, coupled with decreases in interest earned on state and municipal obligations, GSE's and U.S. government securities. Interest income on equity securities decreased $10.0 million, due to the receipt of $8.9 million in dividend income in the second quarter of 2018, which was related to a liquidated equity security that was carried at fair value. Interest on other securities decreased $3.9 million mainly due to receipts of non-recurring equity investment dividends in 2018, but was partly offset by higher average balances. Interest income on state and municipal obligations decreased $4.5 million, due to lower average balances of $189.7 million, partly offset by an increase of 10 basis points in the average rate earned. Interest income on GSE's decreased $1.5 million, due to a decline in average balances of $117.1 million, partly offset by an increase of 40 basis points in the average rate earned. Interest earned on U.S. government securities fell $752 thousand and was mainly impacted by a decline of $3.0 million in inflation income on TIPS. In addition, average balances declined $70.6 million, while the average rate earned increased 10 basis points. Partly offsetting these decreases in interest income was growth of $12.1 million and $3.3 million in interest earned on mortgage-backed and asset-backed securities, respectively. The growth in mortgage-backed interest resulted mainly from an increase of $391.0 million in average balances, coupled with a three basis point increase in the average rate earned. Asset-backed securities interest increased due to growth of 38 basis points in the average rate earned, partly offset by a decline of $83.1 million in average balances.
During 2019, interest expense on deposits increased $27.3 million over 2018 and resulted mainly from a 20 basis point increase in the overall average rate paid on deposits. Interest expense on interest checking and money market accounts increased $11.9 million due to higher rates paid, which rose 11 basis points. The growth in interest expense on certificates of deposit was due to both higher rates paid on all certificates of deposit and higher average balances in certificates of deposit over $100,000, which grew $281.9 million, or 25.3%. The overall rate paid on total deposits increased from .34% in 2018 to .54% in 2019. Interest expense on borrowings increased $10.7 million due to both higher rates paid and higher average balances of federal funds purchased and customer repurchase agreements. The overall average rate incurred on all interest bearing liabilities was .67% in 2019, compared to .44% in 2018.
Provision for Credit Losses
The provision for credit losses is recorded to bring the allowance for credit losses on loans and the liability for unfunded lending commitments to a level deemed adequate by management based on the factors mentioned in the “Allowance for Credit Losses on Loans and Liability for Unfunded Lending Commitments” section of this discussion. The provision for credit losses totaled $137.2 million in 2020, an increase of $86.8 million from the 2019 provision of $50.4 million. In 2019, the provision for credit losses on loans exceeded net loan charge-offs by $750 thousand, increasing the allowance for credit losses on loans by the same amount, whereas the 2020 provision for credit losses on loans was $81.2 million greater than net loan charge-offs for the year. In 2020, the provision for credit losses on unfunded lending commitments totaled $21.1 million.
Net loan charge-offs for the year totaled $34.9 million and decreased $14.8 million compared to $49.7 million in 2019. The decrease in net loan charge-offs from the previous year was mainly the result of lower net charge-offs on credit card loans and consumer loans, which decreased $9.4 million and $4.1 million, respectively. In addition, business loan net charge-offs decreased $437 thousand, while revolving home equity loan and personal real estate loan net recoveries increased $375 thousand and $347 thousand, respectively. The allowance for credit losses on loans totaled $220.8 million at December 31, 2020, an increase of $60.2 million compared to the prior year, and represented 1.35% of loans at year end 2020, compared to 1.09% at December 31, 2019. The liability for unfunded lending commitments totaled $38.3 million at December 31, 2020.
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Non-Interest Income
% Change
Non-interest income as a % of total revenue* 37.9 % 39.0 % 37.8 %
Total revenue per full-time equivalent employee $ 280.3 $ 277.1 $ 276.4
* Total revenue is calculated as net interest income plus non-interest income.
Below is a summary of net bank card transaction fees for the years ended December 31, 2020, 2019 and 2018, respectively.
% Change
Non-interest income totaled $505.9 million, a decrease of $18.8 million, or 3.6%, compared to $524.7 million in 2019. Bank card fees decreased $16.1 million, or 9.6%, from the prior year, due to declines in net corporate card fees of $12.0 million, net debit card fees of $2.4 million, net merchant fees of $903 thousand and net credit card fees of $784 thousand. The decline in net corporate card fees from the prior year was due to lower transaction volume, partly offset by lower network and rewards expense. The decline in net credit and debit card fees was mainly due to lower interchange income. The decline in net credit card fees was partly offset by lower rewards expense. Net merchant fees fell due to lower merchant discount fees, partly offset by higher interchange income and lower network expense. Trust fee income increased $5.0 million, or 3.2%, as a result of continued growth in private client trust fees (up 4.3%), which comprised 77.2% of trust fee income in 2020. The market value of total customer trust assets totaled $61.2 billion at year end 2020, which was an increase of 7.9% over year end 2019 balances. Deposit account fees decreased $2.8 million, or 2.9%, mainly due to a decline of $7.6 million in overdraft and return item fees, partly offset by growth of $5.3 million in corporate cash management fees. In 2020, corporate cash management fees comprised 50.2% of total deposit fees, while overdraft fees comprised 24.6% of total deposit fees. Capital market fees grew $6.4 million, or 79.0%, compared to the prior year, mostly due to higher sales volume, while consumer brokerage services fell $709 thousand, or 4.5%. Loan fees and sales increased $10.9 million, or 69.2%, mainly due to growth in mortgage banking revenue. Mortgage banking revenue totaled $20.7 million in 2020 compared to $10.8 million in 2019 and increased as a result of higher loan originations in 2020. Other non-interest income decreased $21.7 million, or 33.1%, mainly due to a one-time gain of $11.5 million resulting from the sale of the Company's corporate trust business in the fourth quarter of 2019.In addition, cash sweep commissions and interest rate swap fees decreased $2.1 million and $4.4 million, respectively.
During 2019, non-interest income increased $23.4 million, or 4.7%, to $524.7 million compared to $501.3 million in 2018. Bank card fees decreased $3.7 million, or 2.2%, from 2018. This decrease included a decline in net corporate card fees of $5.3 million, partly offset by growth in net credit card fees of $1.2 million and net debit card fees of $287 thousand. Trust fee income increased $7.7 million, or 5.2%, as a result of growth in private client trust fees (up 6.5%), which comprised 76.4% of trust fee income in 2019.The market value of total customer trust assets totaled $56.7 billion at year end 2019, which was an increase of 13.3% over year end 2018 balances. Deposit account fees increased $1.5 million, or 1.6%, mainly due to growth of $3.0 million in corporate cash management fees. This increase was partly offset by declines of $872 thousand in overdraft and return item fees and $636 thousand in deposit account service charges. Capital market fees grew $425 thousand, or 5.5%, compared to the prior year, while loan fees and sales increased $3.0 million, or 23.9%, mainly due to growth in mortgage banking revenue as a result of higher loan originations in 2019. Other non-interest income increased $14.5 million, or 28.3%, mainly due to the one-time gain of $11.5 million, mentioned above. In addition, cash sweep commissions increased $2.7 million and higher gains of $2.4 million were recorded on sales of leased assets to customers upon lease termination. These increases were partly offset by gains of $6.6 million recorded on the sales of branch properties in 2018.
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Investment Securities Gains (Losses), Net
Adjustment for dividend income on a liquidated equity investment — — (8,917)
Total investment securities gains (losses), net $ 11,032 $ 3,626 $ (488)
Net gains and losses on investment securities during 2020, 2019 and 2018 are shown in the table above. Included in these amounts are gains and losses arising from sales of securities from the Company’s available for sale debt portfolio and gains and losses relating to private equity investments, which are primarily held by the Parent’s majority-owned private equity subsidiary. The gains and losses on private equity investments 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 $1.4 million in 2020, compared to expense of $348 thousand in 2019 and expense of $2.8 million in 2018.
Net securities gains of $11.0 million were recorded in 2020, which included $21.1 million in net gains realized on bond sales resulting from the Company's sale of approximately $602 million (book value) of bonds, mainly mortgage-backed securities and municipal securities. These gains were offset by net losses totaling $10.1 million of fair value adjustments on private equity investments, in addition to net gains totaling $37 thousand of fair value adjustments on equity investments.
Net securities gains of $3.6 million were recorded in 2019, which included $214 thousand in net losses realized on bond sales resulting from the Company's sale of approximately $400 million (book value) of bonds, mainly municipal securities, treasuries and asset-backed securities. Net securities gains also included $3.3 million in gains from sales of equity investments, net gains of $344 thousand in fair value adjustments on equity investments, and a $1.1 million in gain from the sale of a private equity investment. These gains were offset by net losses totaling $727 thousand of fair value adjustments on private equity investments.
Net securities losses of $488 thousand were recorded in 2018, which included $9.7 million in net losses realized on bond sales resulting from the Company's sale of approximately $680 million (book value) of bonds, mainly mortgage and asset-backed securities. Net securities losses also included $8.9 million in losses related to an adjustment for dividend income on a liquidated investment. These losses were offset by net gains totaling $13.8 million of fair value adjustments on private equity investments, in addition to fair value adjustments and net gains realized on sales of equity investments.
Non-Interest Expense
% Change
Salaries and benefits as a % of total non-interest expense 66.8 % 64.2 % 63.5 %
Non-interest expense was $768.4 million in 2020, an increase of $980 thousand, or .1%, over the previous year. Salaries and benefits expense increased $20.1 million, or 4.1%, mainly due to higher costs for full-time salaries and incentive compensation. Full-time salaries expense increased due to growth in commercial, information technology, wealth management
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and other support unit salaries expense, while incentive compensation saw increases in mortgage, capital markets, and in association with the origination of PPP loans. Full-time equivalent employees totaled 4,766 at December 31, 2020, reflecting a 1.9% decrease from 2019. Occupancy expense decreased $512 thousand, or 1.1%, mainly due to lower utilities and outside services expense, partly offset by higher building depreciation expense. Equipment expense decreased $222 thousand, or 1.2%, while supplies and communication expense decreased $3.0 million, or 14.6%, as a result of lower supplies, postage and bank card issuance fees. Data processing and software expense increased $2.4 million, or 2.6%, primarily due to higher costs for service providers and software expense, partly offset by lower bank card processing fees, while marketing expense decreased $2.2 million, or 9.9%. Other non-interest expense decreased $15.6 million, or 21.4%, from the prior year mainly due to higher deferred origination costs (up $3.7 million) and lower travel and entertainment (down $8.7 million) and education expense (down $1.2 million). These decreases were partly offset by higher deposit insurance expense (up $1.2 million), as well as higher impairment expense (up $1.8 million) and amortization (up $2.4 million) on the Company's mortgage servicing rights.
In 2019, non-interest expense was $767.4 million in 2019, an increase of $29.6 million, or 4.0%, over 2018. Salaries and benefits expense increased $24.7 million, or 5.3%, mainly due to higher full-time salaries and medical expense. Full-time salaries expense increased due to growth in consumer, commercial, information technology and other support unit salaries expense. Full-time equivalent employees totaled 4,858 at December 31, 2019, reflecting a 1.3% increase over 2018. Occupancy expense increased $1.1 million, or 2.4%, mainly due to higher real estate taxes and building depreciation expense, partly offset by a decline in utilities expense. Equipment expense increased $936 thousand, or 5.2%, due to higher equipment depreciation expense. Data processing and software expense increased $6.9 million, or 8.0%, primarily due to higher costs for service providers and higher bank card processing expense. Marketing expense increased $1.4 million, or 6.6%, due to increased marketing efforts to support consumer and healthcare banking initiatives, partly offset by bank card marketing initiatives in 2018. Other expense declined $5.2 million, or 6.7%, from 2018 mainly due to lower deposit insurance expense as a result of reduced FDIC insurance rates.
Income Taxes
Income tax expense was $87.3 million in 2020, compared to $109.1 million in 2019 and $105.9 million in 2018. The effective tax rate, including the effect of non-controlling interest, was 19.8% in 2020 compared to 20.6% in 2019 and 19.6% in 2018. The decrease in effective tax rate in 2020 compared to 2019 was primarily driven by lower state and local income taxes. Additional information about income tax expense is provided in Note 9 to the consolidated financial statements.
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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 is disclosed within the Average Balance Sheets section of Management's Discussion and Analysis of Financial Condition and Results of Operations below.
Balance at December 31
Commercial:
Personal banking:
The contractual maturities of business and real estate loan categories at December 31, 2020, and a breakdown of those loans between fixed rate and floating rate loans are as follows.
Principal Payments Due
Business and real estate loans:
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The following table shows loan balances at December 31, 2020, 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
Total loans at December 31, 2020 were $16.3 billion, an increase of $1.6 billion, or 10.8%, over balances at December 31, 2019. The growth in loans during 2020 occurred in the business, construction, business real estate and personal real estate loan categories, while consumer, consumer credit card, revolving home equity and overdraft loan categories declined from the prior year. Business loans increased $980.6 million, or 17.6%, reflecting growth in commercial and industrial loans and commercial card, while lease lending and tax-advantaged lending remained mostly flat. The Company funded $1.5 billion of PPP loans during 2020, all of which were fixed rate loans carrying a 1% interest rate. For these loans, the Company collected fees paid by the SBA totaling $41.0 million, of which $21.4 million were recognized in net interest income during 2020. Construction loans increased $122.2 million, or 13.6% mainly due to growth in commercial construction lending. Business real estate loans increased $192.6 million, or 6.8%, due mainly to increases in owner-occupied and office lending. Business real estate hotel, senior living, and industrial lending also grew this year, while retail lending declined. Personal real estate loans increased $465.3 million, or 19.8%, due to continued strong demand for residential mortgage loans. The Company sells certain long-term fixed rate mortgage loans to the secondary market, and loan sales in 2020 totaled $275.1 million, compared to $239.0 million in 2019. Consumer loans decreased $13.6 million, or .7%, due to decreases in auto lending, fixed rate home equity loans, and health service financing lending, along with continued run off of marine and recreational vehicle loan balances. These decreases were partly offset by an increase in private banking loans. Consumer credit card loans decreased $109.9 million, or 14.4% and revolving home equity loan balances declined $42.2 million, or 12.1%, compared to balances at year end 2019.
The Company currently holds approximately 29% of its loan portfolio in the Kansas City market, 29% in the St. Louis market, and 42% in other regional markets. The portfolio is diversified from a business and retail standpoint, with 65% in loans to businesses and 35% in loans to consumers. The Company believes a diversified approach to loan portfolio management, strong underwriting criteria and an aversion toward credit concentrations, from an industry, geographic and product perspective, have contributed to low levels of problem loans and credit losses on loans experienced over the last several years.
The Company participates in credits of large, publicly traded companies which are defined by regulation as shared national credits, or SNCs. Regulations define SNCs as loans exceeding $100 million that are shared by three or more financial institutions. The Company typically participates in these loans when business operations are maintained in the local communities or regional markets and opportunities to provide other banking services are present. At December 31, 2020, the balance of SNC loans totaled approximately $1.0 billion, with an additional $1.7 billion in unfunded commitments, compared to a balance of $1.1 billion, with an additional $1.4 billion in unfunded commitments, at year end 2019.
Commercial Loans
Business
Total business loans amounted to $6.5 billion at December 31, 2020 and include loans used mainly to fund customer accounts receivable, inventories, and capital expenditures. The business loan portfolio includes tax-advantaged loans and leases which carry tax free interest rates. These loans totaled $861.0 million at December 31, 2020, an increase of $2.9 million, or .3%, from December 31, 2019 balances. The business loan portfolio also includes direct financing and sales type leases totaling $584.3 million, which are used by commercial customers to finance capital purchases ranging from computer equipment to office and transportation equipment. These lease-related loans were flat compared to 2019. Additionally, the Company has outstanding oil and gas energy-related loans totaling $178.7 million at December 31, 2020, which are further discussed within the Oil and Gas Energy Lending section of the Risk Elements of Loan Portfolio section located within Management's Discussion and Analysis of Financial Condition and Results of Operations. Also included in the business
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portfolio are corporate card loans, which totaled $333.2 million at December 31, 2020 and are made in conjunction with the Company’s corporate card business for corporate trade purchases. Corporate card loans are made to corporate, non-profit and government customers nationwide, but have very short-term maturities, which limits credit risk.
Business loans, excluding corporate card loans, are made primarily to customers in the regional trade area of the Company, generally the central Midwest, encompassing the states of Missouri, Kansas, Illinois, and nearby Midwestern markets, including Iowa, Oklahoma, Colorado, Texas, Tennessee, Michigan, Indiana, 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 $3.7 million in 2020 compared to net loan charge-offs of $4.1 million recorded in 2019. Non-accrual business loans were $22.5 million (.3% of business loans) at December 31, 2020 compared to $7.5 million at December 31, 2019.
Real Estate-Construction and Land
The portfolio of loans in this category amounted to $1.0 billion at December 31, 2020, which was an increase of $122.2 million, or 13.6%, from the prior year and comprised 6.3% of the Company’s total loan portfolio. Commercial construction and land development loans totaled $867.6 million, or 84.9% of total construction loans at December 31, 2020. These loans increased $162.5 million from 2019 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, 2020 totaled $154.0 million, or 15.1% of total construction loans. A stable construction market has contributed to low loss rates on these loans, with net loan recoveries of $3 thousand and $117 thousand recorded in 2020 and 2019, respectively.
Real Estate-Business
Total business real estate loans were $3.0 billion at December 31, 2020 and comprised 18.5% 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, distribution facilities, multi-family housing, farms, shopping centers, hotels and motels, churches, and other commercial properties. The business real estate borrowers and/or properties are generally located in local and regional markets where Commerce does business, and emphasis is placed on owner-occupied lending (37.9% of this portfolio), which presents lower risk levels. Additional information about business real estate loans by borrower is disclosed within the Real Estate - Business Loans section of the Risk Elements of Loan Portfolio section located within Management's Discussion and Analysis of Financial Condition and Results of Operations. At December 31, 2020, balances of non-accrual loans amounted to $2.2 million, up from $1.0 million at year end 2019, but less than .1% of business real estate loans at year end 2020. The Company experienced net loan recoveries of $47 thousand in 2020, compared to net loan recoveries of $60 thousand in 2019.
Personal Banking Loans
Real Estate-Personal
At December 31, 2020, there were $2.8 billion in outstanding personal real estate loans, which comprised 17.3% of the Company’s total loan portfolio. The mortgage loans in this category are mainly for owner-occupied residential properties. The Company originates both adjustable and fixed rate mortgage loans, and at December 31, 2020, 27% of the portfolio was comprised of adjustable rate loans, while 73% was comprised of fixed rate loans. The Company does not purchase any loans from outside parties or brokers, and has never maintained no-document products. Levels of mortgage loan origination activity increased in 2020, with originations of $1.5 billion in 2020 compared to $871.6 million in 2019. Net loans retained by the Company increased $465.3 million, driven by growth in new loan production aided by the lower interest rate environment. Loans sold to the secondary market increased $36.1 million. The loan sales were made under an initiative to originate and sell certain long term fixed rate loans, resulting in sales of $275.1 million in 2020 compared to $239.0 million in 2019. The Company has experienced lower credit losses on loans in this category than many others in the industry and believes this is partly because of its conservative underwriting culture and the fact that it does not purchase loans from brokers. Net loan recoveries in 2020 totaled $291 thousand, and net loan charge-offs were $56 thousand in 2019. Balances of non-accrual loans in this category were $1.8 million at December 31, 2020, compared to $1.7 million at year end 2019.
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Consumer
Consumer loans consist of private banking, automobile, motorcycle, marine, tractor/trailer, recreational vehicle (RV), fixed rate home equity, patient health care financing and other types of consumer loans. These loans totaled $2.0 billion at year end 2020. Approximately 45% of the consumer portfolio consists of automobile loans, 24% in private banking loans, 13% in fixed rate home equity loans, 10% in healthcare financing loans, 3% in motorcycle loans, and 1% in marine and RV loans. Total consumer loans decreased $13.6 million at year end 2020 compared to year end 2019. Growth of $65.3 million in private banking loans was offset by declines of $28.3 million in automobile loans, $21.7 million in fixed rate home equity loans, $11.1 million in patient healthcare financing, $10.3 million in marine and RV loans, and $4.3 million in motorcycle loans. Net charge-offs on total consumer loans were $4.4 million in 2020, compared to $8.6 million in 2019, averaging .23% and .44% of consumer loans in 2020 and 2019, respectively.
Revolving Home Equity
Revolving home equity loans, of which 99% are adjustable rate loans, totaled $307.1 million at year end 2020. An additional $773.5 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 recoveries totaled $166 thousand in 2020, compared to net charge-offs of $209 thousand in 2019.
Consumer Credit Card
Total consumer credit card loans amounted to $655.1 million at December 31, 2020 and comprised 4.0% 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 40% of the households that own a Commerce credit card product also maintain a deposit relationship with the subsidiary bank. At December 31, 2020, approximately 95% of the outstanding credit card loan balances had a floating interest rate, compared to 93% in the prior year. Net charge-offs amounted to $26.0 million in 2020, a decrease of $9.4 million from $35.4 million in 2019.
Loans Held for Sale
At December 31, 2020, 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 $39.4 million at December 31, 2020. The student loans, carried at the lower of cost or fair value, totaled $5.7 million at December 31, 2020. Both of these portfolios are further discussed in Note 2 to the consolidated financial statements.
Allowance for Credit Losses on Loans and Liability for Unfunded Lending Commitments
The Company has an established process to determine the amount of the allowance for credit losses on loans and the liability for unfunded lending commitments, which assesses the risks and losses expected in its portfolios. This process provides an allowance based on estimates of allowances for pools of loans and unfunded lending commitments, as well as a second, smaller component based on certain individually evaluated loans and unfunded lending commitments. The Company's policies and processes for determining the allowance for credit losses on loans and the liability for unfunded lending commitments are discussed in Note 1 to the consolidated financial statements and in the "Allowance for Credit Losses" discussion within Critical Accounting Policies above.
Loans subject to individual evaluation generally consist of business, construction, business real estate and personal real estate loans on non-accrual status. These non-accrual loans are evaluated individually for impairment based on factors such as payment history, borrower financial condition and collateral. For collateral dependent loans, appraisals of collateral (including exit costs) are normally obtained annually but discounted based on date last received and market conditions. From these evaluations of expected cash flows and collateral values, specific allowances are determined.
Loans which are not individually evaluated are segregated by loan type and sub-type and are collectively evaluated. These loans consist of commercial loans (business, construction and business real estate) which have been graded pass, special mention, or substandard, and also include 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.
The Company adopted ASU 2016-13, known as the current expected credit loss (CECL) model, on January 1, 2020. Upon adoption, the allowance for credit losses on loans was reduced $21.0 million and the liability for unfunded lending
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commitments increased $16.1 million. The decrease in the allowance for credit losses on loans at the time of adoption was significantly influenced by the forecasted economic environment used in the estimation process as required by CECL, which was characterized by low unemployment. As the estimation model for credit losses on lending commitments became governed by CECL, the Company increased the related liability for unfunded lending commitments (mostly related to construction lending), as the Company expected to fully fund the commitments under these contracts.
The table below shows the composition of the allowance by loan class at December 31, 2019, January 1, 2020 (at the adoption of CECL), and December 31, 2020.
Commercial:
Personal Banking:
The allowance for credit losses on loans and the liability for unfunded lending commitments are estimates that require significant judgment including projections of the macro-economic environment. The Company utilizes a third-party macro-economic forecast that continuously changes due to economic conditions and events. These changes in the forecast cause fluctuations in the allowance for credit losses on loans and the liability for unfunded lending commitments. The Company used its best judgment to assess the macro-economic forecast and internal loss data in estimating the allowance for credit losses on loans and the liability for unfunded lending commitments. These estimates are subject to periodic refinement based on changes in the underlying external and internal data. Events such as government-required business lock downs, trends in infection and mortality rates, government stimulus payments, and widespread vaccinations could significantly modify the economic projections used in the forecast to estimate the allowance for credit losses on loans and the liability for unfunded lending commitments.
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. 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, 2020, the allowance for credit losses on loans was $220.8 million, compared to $139.6 million at January 1, 2020, the adoption of CECL. The allowance for credit losses related to commercial loans increased $59.5 million, due to increases in the allowance on business, construction and business real estate loans of $25.7 million, $18.6 million, and $15.1 million, respectively. Compared to January 1, 2020, the allowance for credit losses on consumer credit card, personal real estate, and consumer loans increased $17.5 million, $3.4 million, and $726 thousand, respectively. These large increases resulted from the sudden entrance into a sharp recession brought on by an unprecedented pandemic. The economic outlook shifted from a stable economy with low unemployment at January 1, 2020 to an uncertain economic projection at December 31, 2020, defined by higher unemployment and other business and personal disruptions caused by COVID-19. Given the significant uncertainty of the economic projections of a pandemic-induced recession, the credit loss estimate utilized in the Company's CECL model uses a short reasonable and supportable forecasted period. As businesses navigate through the current recession, key assumptions utilized in the Company's CECL model may be modified. Traditional credit quality indicators, such as net charge-off experience, greater than 90 days delinquent statistics and decreases in the internal risk rating to special mention or substandard ratings, are lagging credit quality indicators and do not yet reflect the expected impacts of the crisis, as
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changes in these indicators may be delayed by the Company's offering of certain assistance programs to impacted customers as allowed by various regulations and as customers are able to participate in various governmental support programs. See Note 2 for further discussion of the credit quality indicators, and refer to Risk Elements of the Loan Portfolio, Loans with Special Risk Characteristics for further information about the assistance programs offered by the Company to its customers. See Note 2 to the consolidated financial statements for the various model assumptions utilized in the Company's CECL estimate at December 31, 2020.
The percentage of allowance to loans increased to 1.35% at December 31, 2020, compared to .95% at the implementation of CECL, for the reasons described above. Included within business loans at December 31, 2020 are approximately $1.4 billion PPP loans that are fully guaranteed by the government, and therefore, no allowance for credit losses was estimated for these loans. Excluding the PPP loans, the allowance for credit losses on loans was 1.48% of loans at December 31, 2020.
Total loans delinquent 90 days or more and still accruing were $22.2 million at December 31, 2020, an increase of $2.3 million compared to year end 2019. The increase was mainly driven by increases of $2.7 million in business, $1.1 million in personal real estate, and $1.3 million in consumer loans delinquent 90 days or more, partly offset by a decrease of $3.5 million in construction loan delinquencies. Non-accrual loans at December 31, 2020 were $26.5 million, an increase of $16.3 million over the prior year, mainly due to an increase in business and business real-estate non-accrual loans of $15.0 million and $1.2 million, respectively. The 2020 year end balance of non-accrual loans was comprised of $22.5 million of business loans, $2.2 million of business real estate loans and $1.8 million of personal real estate loans.
Net loan charge-offs totaled $34.9 million in 2020, representing a $14.8 million decrease compared to net charge-offs of $49.7 million in 2019. The decrease was largely due to lower credit card loan and consumer loan net charge-offs of $9.4 million and $4.1 million, respectively. In addition, business loan net charge-offs decreased $437 thousand, while revolving home equity loan and personal real estate loan net recoveries increased $375 thousand and $347 thousand, respectively. The decreases in net charge-offs on consumer credit card, consumer and business loans were primarily the result of various COVID-19 relief programs that allowed customers to defer loan payments without advancing in past due or charge-off status. Many of these customers have resumed to normal scheduled payments. See Risk Elements of the Loan Portfolio, Loans with Special Characteristics for further information. Consumer credit card net charge-offs were 3.88% of average consumer credit card loans in 2020 compared to 4.63% in 2019. Consumer credit card loan net charge-offs as a percentage of total net charge-offs increased to 74.5% in 2020 compared to 71.3% in 2019. Consumer loan net charge-offs were .23% of average consumer loans in 2020, compared to .44% in 2019, and represented 12.7% of total net loan charge-offs in 2020. The ratio of net charge-offs to total average loans outstanding in 2020 was .22%, compared to .35% in 2019 and .30% in 2018.
As noted above, on January 1, 2020, the estimation model for credit losses on lending commitments became governed by CECL, and at adoption, the Company increased the related liability for unfunded lending commitments by $16.1 million to $17.2 million. At December 31, 2020, the liability for unfunded lending commitments was $38.3 million, an increase of $21.1 million compared to January 1, 2020. The Company's unfunded lending commitments primarily relate to construction loans. The increase in the liability for unfunded lending commitments during 2020 was driven by the impact of the pandemic-driven recession on the economy. The Company's estimate for credit losses in its unfunded lending commitments utilizes the same model and forecast as its estimate for credit losses on loans. See Note 2 for further discussion of the model inputs utilized in the Company's estimate of credit losses.
The provision for credit losses, which includes the provision for loans and unfunded lending commitments, was $137.2 million in 2020, compared to $50.4 million in 2019 and $42.7 million in 2018.
The Company considers the allowance for credit losses on loans and the liability for unfunded lending commitments adequate to cover losses expected in the loan portfolio, including unfunded commitments, at December 31, 2020.
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The schedules which follow summarize the relationship between loan balances and activity in the allowance for credit losses on loans:
Years Ended December 31
Allowance for credit losses:
Loans charged off:
Real estate — construction and land — 7 — 1 515
Recoveries of loans previously charged off:
Ratio of allowance to loans at end of year 1.35 % 1.09 % 1.13 % 1.14 % 1.16 %
Ratio of provision to average loans outstanding .73 % .35 % .31 % .33 % 0.28 %
(A) Net of unearned income, before deducting allowance for credit losses on loans, excluding loans held for sale.
Years Ended December 31
Real estate — construction and land — (.01) (.07) (.14) (.48)
Real estate — business — — (.01) (.01) (.05)
Real estate — personal (.01) — (.02) (.02) —
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The following schedule provides a breakdown of the allowance for credit losses on loans by loan category and the percentage of each loan category to total loans outstanding at year end.
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 credit 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. During 2020, Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was signed into law and provided financial institutions the option to suspend the requirement to categorize certain modifications related to the COVID-19 pandemic as troubled debt restructurings. The 2021 Consolidated Appropriations Act signed on December 27, 2020 extends this temporary suspension through January 1, 2022. The Company follows the guidance under the CARES Act when determining if a customer’s modification is subject to troubled debt restructuring classification. Refer to Note 2 for additional information.
The following schedule shows non-performing assets and loans past due 90 days and still accruing interest.
December 31
The table below shows the effect on interest income in 2020 of loans on non-accrual status at year end.
(In thousands)
Gross amount of interest that would have been recorded at original rate $ 1,820
Interest that was reflected in income 522
Interest income not recognized $ 1,298
Non-accrual loans totaled $26.5 million at year end 2020, an increase of $16.3 million from the balance at year end 2019. The increase from December 31, 2019 occurred mainly in business loans, which increased $15.0 million, and business real
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estate loans, which increased $1.2 million. At December 31, 2020, non-accrual loans were comprised of business (84.9%), business real estate (8.4%), and personal real estate (6.7%) loans. Foreclosed real estate totaled $93 thousand at December 31, 2020, a decrease of $272 thousand when compared to December 31, 2019. Total non-performing assets remain low compared to the overall banking industry in 2020, with the non-performing assets to total loans ratio at .08% at December 31, 2020. Total loans past due 90 days or more and still accruing interest were $22.2 million as of December 31, 2020, an increase of $2.3 million when compared to December 31, 2019. 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 $361.8 million at December 31, 2020, compared with $164.8 million at December 31, 2019, resulting in an increase of $197.0 million or 119.6%. The increase in potential problem loans was largely driven by a $118.6 million increase in business real estate loans, a $49.1 million increase in business loans, and a $28.9 million increase in construction loans.
December 31
Potential problem loans:
Real estate – construction and land 29,378 470
At December 31, 2020, the Company had $140.6 million of loans whose terms have been modified or restructured, meeting the definition of 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 $117.7 million, which are classified as substandard and included in the table above because of this classification.
Loans with Special Risk Characteristics