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
Management relies primarily on an internal risk rating system, in addition to delinquency status, to assess risk in the loan portfolio, and these statistics are presented in Note 2 to the consolidated financial statements. However, certain types of loans are considered at high risk of loss due to their terms, location, or special conditions. Construction and land loans and business real estate loans are subject to higher risk because of the impact that volatile interest rates and a changing economy can have on real estate value, and because of the potential volatility of the real estate industry. Certain home equity loans have contractual features that could increase credit exposure in a market of declining real estate prices, when interest rates are steadily increasing, or when a geographic area experiences an economic downturn. For these home equity loans, higher risks could exist when 1) loan terms require a minimum monthly payment that covers only interest, or 2) loan-to-collateral value (LTV) ratios at origination are above 80%, with no private mortgage insurance. Information presented below for home equity loans is based on LTV ratios which were calculated with valuations at loan origination date. The Company does not attempt to obtain updated appraisals or valuations unless the loans become significantly delinquent or are in the process of being foreclosed upon. For credit monitoring purposes, the Company analyzes delinquency information, current FICO scores, and line utilization. This has remained an effective means of evaluating credit trends and identifying problem loans, partly because the Company offers standard, conservative lending products.
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Real Estate - Construction and Land Loans
The Company’s portfolio of construction and land loans, as shown in the table below, amounted to 6.3% of total loans outstanding at December 31, 2020. The largest component of construction and land loans was commercial construction, which increased $157.0 million during the year ended December 31, 2020. At December 31, 2020, multi-family residential construction loans totaled approximately $238.0 million, or 28.8%, of the commercial construction loan portfolio.
Real Estate – Business Loans
Total business real estate loans were $3.0 billion at December 31, 2020 and comprised 18.5% of the Company’s total loan portfolio. These loans include properties such as manufacturing and warehouse buildings, distribution facilities, small office and medical buildings, churches, hotels and motels, shopping centers, and other commercial properties. Approximately 37.9% of these loans were for owner-occupied real estate properties, which present lower risk profiles.
Revolving Home Equity Loans
The Company has revolving home equity loans that are generally collateralized by residential real estate. Most of these loans (93.2%) are written with terms requiring interest-only monthly payments. These loans are offered in three main product lines: LTV up to 80%, 80% to 90%, and 90% to 100%. As shown in the following tables, the percentage of loans with LTV ratios greater than 80% has remained a small segment of this portfolio, and delinquencies have been low and stable. The weighted average FICO score for the total portfolio balance at December 31, 2020 was 793. At maturity, the accounts are re-underwritten and if they qualify under the Company's credit, collateral and capacity policies, the borrower is given the option to renew the line of credit or to convert the outstanding balance to an amortizing loan. If criteria are not met, amortization is required, or the borrower may pay off the loan. Over the next three years, approximately 15.9% of the Company's current outstanding balances are expected to mature. Of these balances, 90.1% have a FICO score above 700. The Company does not expect a significant increase in losses as these loans mature, due to their high FICO scores, low LTVs, and low historical loss levels.
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Loans with LTV:
* Percentage of total principal outstanding of $307.1 million at December 31, 2020.
Loans with LTV:
* Percentage of total principal outstanding of $349.3 million at December 31, 2019.
Consumer Loans
Within the consumer loan portfolio are several direct and indirect product lines comprised mainly of loans secured by automobiles, motorcycles, marine, and RVs. Auto loans comprised 45% of the consumer loan portfolio at December 31, 2020, and outstanding balances in the auto loan portfolio were $879.9 million and $908.3 million at December 31, 2020 and 2019, respectively. The balances over 30 days past due amounted to $9.2 million at December 31, 2020, compared to $13.2 million at the end of 2019, and comprised 1.0% of the outstanding balances of these loans at December 31, 2020 compared to 1.5% at December 31, 2019. For the year ended December 31, 2020, $399.3 million of new auto loans were originated, compared to $414.9 million during 2019. At December 31, 2020, the automobile loan portfolio had a weighted average FICO score of 758, and net charge-offs on auto loans were .32% of average auto loans at December 31, 2020.
The Company's consumer loan portfolio also includes fixed rate home equity loans, typically for home repair or remodeling, and these loans comprised 13% of the consumer loan portfolio at December 31, 2020. Losses on these loans have historically been low, and the Company saw recoveries of $70 thousand in 2020. Private banking loans comprised 24% of the consumer loan portfolio at December 31, 2020. The Company's private banking loans are generally well-collateralized and at December 31, 2020 were secured primarily by assets held by the Company's trust department. The remaining portion of the Company's consumer loan portfolio is comprised of health services financing, motorcycles, marine and RV loans. Net charge-offs on private banking, health services financing, motorcycle and marine and RV loans totaled $1.6 million in 2020 and were .20% of the average balances of these loans at December 31, 2020.
Consumer Credit Card Loans
The Company offers low introductory rates on selected consumer credit card products. Out of a portfolio at December 31, 2020 of $655.1 million in consumer credit card loans outstanding, approximately $106.6 million, or 16.3%, carried a low promotional rate. Within the next six months, $36.9 million of these loans are scheduled to convert to the ongoing higher contractual rate. To mitigate some of the risk involved with this credit card promotional feature, the Company performs credit checks and detailed analysis of the customer borrowing profile before approving the loan application. Management believes that the risks in the consumer loan portfolio are reasonable and the anticipated loss ratios are within acceptable parameters.
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Oil and Gas Energy Lending
The Company's energy lending portfolio was comprised of lending to the petroleum and natural gas sectors and totaled $178.7 million at December 31, 2020, a decrease of $18.7 million from year end 2019, as shown in the table below.
Information about the credit quality of the Company's energy lending portfolio as of December 31, 2020 and December 31, 2019 is provided in the table below.
Energy lending balances classified as substandard and non-accrual represented 17.7% and 1.5% respectively, of total energy lending loan balances at December 31, 2020. The Company recorded $15 thousand of net loan charge-offs on energy loans for the year ended December 31, 2020. There were no net loan charge-offs on energy loans for the year ended December 31, 2019.
Pandemic-Sensitive Industry Lending
As a result of the ongoing COVID-19 global pandemic, the U.S. economy is currently in an unprecedented state of uncertainty. While nearly every industry has been impacted to some degree by business disruptions, the Company identified the following industries and lending exposures, excluding PPP loans, within its loan portfolio at December 31, 2020 and December 31, 2019.
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Due to the significant deterioration of the U.S. economy resulting from the COVID-19 pandemic, the Company saw an increase in loan payment deferral requests through the end of the second quarter of 2020. Loans on active deferral decreased significantly in the second half of the year. A summary of loan balances related to active loan payment deferral requests as of December 31, 2020 are shown in the table below.
Consumer credit card 93 $ 610 .1 %
(1) Excludes deferrals offered through the Company's skip pay program.
(2) Excludes commercial card payment deferral requests.
Active payment deferral requests on commercial loans as of December 31, 2020, categorized by industry, are listed below:
Credit intermediation 1 $ 40,789
Nursing and residential care facilities 1 15,130
Building materials 1 309
Real estate developer/owner 2 301
Animal production 1 31
Social assistance 1 21
Restaurants and dining 1 16
(1) As of January 25, 2021, $55.9 million of commercial requests have been deferred more than 90 days.
Small Business Lending
During April 2020, in response to the COVID-19 crisis, the federal government created the Paycheck Protection Program, sponsored by the Small Business Administration ("SBA"), under the CARES Act. As a participating lender under the program, the Company funded loans of $1.5 billion for 7,618 customers, with a median loan size of $33 thousand. The Company understands that the loans are fully guaranteed by the SBA. Therefore, there was no increase in the allowance for credit losses on loans related to these loans as there is no expectation of credit loss. The maximum term of the loans range from two to five years, however, the Company believes that the majority of the loan balances are expected to be forgiven by the SBA. The process of loan forgiveness began during the third quarter of 2020, and the Company believes the majority of loan balances will be forgiven in 2021.
Investment Securities Analysis
Investment securities are comprised of securities that are classified as available for sale, equity, trading or other. The largest component, available for sale debt securities, increased 43.4% during 2020 to $12.1 billion (excluding unrealized gains/losses in fair value) at year end 2020. During 2020, debt securities of $7.0 billion were purchased, which included $4.5 billion in agency mortgage-backed securities, $997.7 million in asset-backed securities, $894.0 million in state and municipal securities, $300.8 million in non-agency mortgage-based securities, and $275.5 million in other debt securities. Total sales, maturities and pay downs were $3.3 billion during 2020. During 2021, maturities and pay downs of approximately $2.0 billion are expected to occur. The average tax equivalent yield earned on total investment securities was 2.19% in 2020 and 2.81% in 2019.
At December 31, 2020, the fair value of available for sale securities was $12.4 billion, which included a net unrealized gain in fair value of $351.7 million, compared to a net unrealized gain of $136.1 million at December 31, 2019. The overall unrealized gain in fair value at December 31, 2020 included net gains of $77.1 million in state and municipal securities and net gains of $186.4 million in mortgage and asset-backed securities. The portfolio also included unrealized net gains of $62.5 million and $22.1 million on U.S. government and federal agency obligations and other debt securities, respectively. As described in Note 1, the Company adopted ASU 2016-13, Measurement of Credit Losses on Financial Instruments, on January 1, 2020, and the current expected credit loss model (CECL) implemented by the Company requires that lifetime expected credit
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losses on securities be recorded in current earnings. For the year ended December 31, 2020, the Company did not recognize a credit loss expense on any available for sale debt securities.
Available for sale investment securities at year end for the past two years are shown below:
December 31
Amortized Cost
U.S. government and federal agency obligations $ 775,592 $ 827,861
Government-sponsored enterprise obligations 50,803 138,734
Fair Value
U.S. government and federal agency obligations $ 838,059 $ 851,776
Government-sponsored enterprise obligations 54,485 139,277
At December 31, 2020, the available for sale portfolio included $6.7 billion of agency mortgage-backed securities, which are collateralized bonds issued by agencies including FNMA, GNMA, FHLMC, FHLB, Federal Farm Credit Banks and FDIC. Non-agency mortgage-backed securities totaled $361.1 million and included $64.4 million collateralized by commercial mortgages and $296.5 million collateralized by residential mortgages at December 31, 2020.
At December 31, 2020, U.S. government obligations included TIPS of $434.6 million, at fair value. Other debt securities include corporate bonds, notes and commercial paper.
The types of securities held in the available for sale security portfolio at year end 2020 are presented in the table below. Additional detail by maturity category is provided in Note 3 to the consolidated financial statements.
Available for sale debt securities:
U.S. government and federal agency obligations 6.7 % 1.66 % 3.5 years
Government-sponsored enterprise obligations 0.4 2.32 10.3
State and municipal obligations 16.5 2.06 6.4
Agency mortgage-backed securities 53.9 2.00 4.1
Non-agency mortgage-backed securities 2.9 2.39 2.9
*Based on call provisions and estimated prepayment speeds.
Equity securities include common and preferred stock with readily determinable fair values that totaled $3.0 million at December 31, 2020, compared to $2.9 million at December 31, 2019.
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Other securities totaled $156.7 million at December 31, 2020 and $137.9 million at December 31, 2019. These include Federal Reserve Bank stock and Federal Home Loan Bank (Des Moines) stock held by the bank subsidiary in accordance with debt and regulatory requirements. These are restricted securities and are carried at cost. The Company's equity method investments are carried at cost, adjusted to reflect the Company's portion of income, loss, or dividends of the investee. Also included in other securities are private equity investments which are held by a subsidiary qualified as a Small Business Investment Company. These investments are carried at estimated fair value, but are not readily marketable. While the nature of these investments carries a higher degree of risk than the normal lending portfolio, this risk is mitigated by the overall size of the investments and oversight provided by management, and management believes the potential for long-term gains in these investments outweighs the potential risks.
Other securities at year end for the past two years are shown below:
December 31
Equity method investments 18,000 —
Private equity investments in debt securities 43,609 44,635
Private equity investments in equity securities 50,759 49,487
In addition to its holdings in the investment securities portfolio, the Company invests in long-term securities purchased under agreements to resell, which totaled $850.0 million at both December 31, 2020 and December 31, 2019. These investments mature in 2021 through 2023 and have fixed rates or variable rates that fluctuate with published indices. The counterparties to these agreements are other financial institutions from whom the Company has accepted collateral of $899.1 million in marketable investment securities at December 31, 2020. The average rate earned on these agreements during 2020 was 4.7%, compared to 2.0% in 2019.
The Company also holds offsetting repurchase and resale agreements totaling $200.0 million at December 31, 2020 and December 31, 2019, which are further discussed in Note 20 to the consolidated financial statements. These agreements involve the exchange of collateral under simultaneous repurchase and resale agreements with the same financial institution counterparty. These repurchase and resale agreements have been offset against each other in the balance sheet, as permitted under current accounting guidance. The agreements mature in 2021 and earned an average of 41 basis points during 2020, compared to 45 basis points in 2019.
Deposits and Borrowings
Deposits, including both individual and corporate customers, are the primary funding source for the Bank and are acquired from a broad base of local markets. Total period-end deposits were $26.9 billion at December 31, 2020, compared to $20.5 billion last year, reflecting an increase of $6.4 billion, or 31.3%.
Average deposits increased $3.6 billion, or 18.0%, in 2020 compared to 2019, resulting from increases in average demand deposits, which increased $2.5 billion, primarily driven by higher balances in business demand deposits. Additionally, average money market deposit account balances increased $985.8 million in 2020 and savings account balances increased $204.5 million. Partially offsetting these increases in deposit balances were declines in average certificates of deposit balances, which decreased $63.5 million in 2020.
The following table shows year end deposit balances by type, as a percentage of total deposits.
December 31
Non-interest bearing 38.9 % 33.6 %
Savings, interest checking and money market 54.2 56.6
Certificates of deposit of less than $100,000 2.0 3.1
Certificates of deposit of $100,000 and over 4.9 6.7
Core deposits, which include non-interest bearing, interest checking, savings, and money market deposits, supported 77% and 75% of average earning assets in 2020 and 2019, respectively. Average balances by major deposit category for the last six
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years are disclosed in the Average Balance Sheets section of Management's Discussion and Analysis of Financial Condition and Results of Operations below. A maturity schedule of certificates of deposits outstanding at December 31, 2020 is included in Note 7 on Deposits in the consolidated financial statements.
The Company’s primary sources of overnight borrowings are federal funds purchased and securities sold under agreements to repurchase (repurchase agreements). Balances in these accounts can fluctuate significantly on a day-to-day basis and generally have one day maturities. Total balances of federal funds purchased and repurchase agreements outstanding at December 31, 2020 were $2.1 billion, a $247.6 million increase from the $1.9 billion balance outstanding at year end 2019. On an average basis, these borrowings increased $144.4 million, or 7.9%, during 2020, due to an increase of $265.3 million in repurchase agreements, partially offset by a decrease of $120.9 million in federal funds purchased. The average rate paid on total federal funds purchased and repurchase agreements was .31% during 2020 and 1.61% during 2019.
Historically, the majority of the Company’s long-term debt has been comprised of fixed rate advances from the FHLB. In March 2020, the Company borrowed $750.0 million of short-term funds from the FHLB, and all of those borrowings were repaid by the Company during the second quarter of 2020. During 2019, $250.0 million of advances were taken and subsequently repaid by the Company in October 2019. The average rate paid on FHLB advances was .82% and 2.19% during 2020 and 2019, respectively.
Liquidity and Capital Resources
Liquidity Management
Liquidity is managed within the Company in order to satisfy cash flow requirements of deposit and borrowing customers while at the same time meeting its own cash flow needs. The Company has taken numerous steps to address liquidity risk and has developed a variety of liquidity sources which it believes will provide the necessary funds for future growth. The Company manages its liquidity position through a variety of sources including:
• A portfolio of liquid assets including marketable investment securities and overnight investments,
• A large customer deposit base and limited exposure to large, volatile certificates of deposit,
• Lower long-term borrowings that might place demands on Company cash flow,
• Relatively low loan to deposit ratio promoting strong liquidity,
• Excellent debt ratings from both Standard & Poor’s and Moody’s national rating services, and
• Available borrowing capacity from outside sources.
The Company’s most liquid assets include available for sale debt securities, federal funds sold, balances at the Federal Reserve Bank, and securities purchased under agreements to resell. At December 31, 2020 and 2019, such assets were as follows:
Long-term securities purchased under agreements to resell 850,000 850,000
There were no federal funds sold at December 31, 2020, which are funds lent to the Company’s correspondent bank customers with overnight maturities. At December 31, 2020, the Company had lent funds totaling $850.0 million under long-term resale agreements to other large financial institutions and $450.0 million, $325.0 million, and $75.0 million of these agreements mature in years 2021, 2022, and 2023, respectively. Under these agreements, the Company holds marketable securities, safekept by a third-party custodian, as collateral. This collateral totaled $899.1 million in fair value at December 31, 2020. Interest earning balances at the Federal Reserve Bank, which have overnight maturities and are used for general liquidity purposes, totaled $1.7 billion at December 31, 2020. The Company’s available for sale investment portfolio includes scheduled maturities and expected pay downs of approximately $2.0 billion during 2021, and these funds offer substantial resources to meet either new loan demand or help offset reductions in the Company’s deposit funding base. The Company pledges portions of its investment securities portfolio to secure public fund deposits, repurchase agreements, trust funds, letters of credit issued by the FHLB, and borrowing capacity at the Federal Reserve Bank.
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At December 31, 2020 and 2019, total investment securities pledged for these purposes were as follows:
Investment securities pledged for the purpose of securing:
FHLB borrowings and letters of credit 5,376 7,637
Total available for sale debt securities, at fair value $ 12,449,264 $ 8,571,626
* Includes securities pledged for collateral swaps, as discussed in Note 20 to the consolidated financial statements
The average loans to deposits ratio is a measure of a bank's liquidity, and the Company’s average loans to deposits ratio was 67.7% for the year ended December 31, 2020. Core customer deposits, defined as non-interest bearing, interest checking, savings, and money market deposit accounts, totaled $25.1 billion and represented 93.2% of the Company’s total deposits at December 31, 2020. These core deposits are normally less volatile, often with customer relationships tied to other products offered by the Company promoting long lasting relationships and stable funding sources. Core deposits increased $6.6 billion at year end 2020 compared to year end 2019, with increases in commercial, consumer, and wealth management deposits of $3.1 billion, $2.0 billion, and $1.5 billion, respectively. While the Company considers core consumer and wealth management deposits less volatile, corporate deposits could decline if interest rates increase significantly, encouraging corporate customers to increase investing activities, or if the economy declines and companies experience lower cash inflows, reducing deposit balances. If these corporate deposits decline, the Company's funding needs can be met by liquidity supplied by investment security maturities and pay downs expected to total $2.0 billion over the next year, as noted above. In addition, as shown in the table of collateral available for future advances below, the Company has borrowing capacity of $3.2 billion through advances from the FHLB and the Federal Reserve.
Core deposit base:
Certificates of deposit of $100,000 or greater totaled $1.3 billion at December 31, 2020. These deposits are normally considered more volatile and higher costing, and comprised 4.9% of total deposits at December 31, 2020.
Other important components of liquidity are the level of borrowings from third party sources and the availability of future credit. The Company’s outside borrowings are mainly comprised of federal funds purchased, and repurchase agreements, as follows:
Borrowings:
Federal funds purchased, which totaled $42.3 million at December 31, 2020, are unsecured overnight borrowings obtained mainly from upstream correspondent banks with which the Company maintains approved lines of credit. Retail repurchase agreements are offered to customers wishing to earn interest in highly liquid balances and are used by the Company as a funding source considered to be stable, but short-term in nature. Repurchase agreements are collateralized by securities in the Company’s investment portfolio. Total repurchase agreements at December 31, 2020 were comprised of non-insured customer funds totaling $2.1 billion, and securities pledged for these retail agreements totaled $2.1 billion.
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The Company pledges certain assets, including loans and investment securities to both the Federal Reserve Bank and the FHLB as security to establish lines of credit and borrow from these entities. Based on the amount and type of collateral pledged, the FHLB establishes a collateral value from which the Company may draw advances against the collateral. Additionally, this collateral is used to enable the FHLB to issue letters of credit in favor of public fund depositors of the Company. The Federal Reserve Bank also establishes a collateral value of assets pledged and permits borrowings from the discount window. The following table reflects the collateral value of assets pledged, borrowings, and letters of credit outstanding, in addition to the estimated future funding capacity available to the Company at December 31, 2020.
(In thousands) FHLB Federal Reserve Total
The Company receives outside ratings from both Standard & Poor’s and Moody’s on both the consolidated company and its subsidiary bank, Commerce Bank. These ratings are as follows:
Standard & Poor’s Moody’s
Commerce Bancshares, Inc.
Issuer rating A-
Rating outlook Stable
Commerce Bank
Issuer rating A A2
Baseline credit assessment a1
Short-term rating A-1 P-1
Rating outlook Stable Stable
The Company considers these ratings to be indications of a sound capital base and strong liquidity and believes that these ratings would help ensure the ready marketability of its commercial paper, should the need arise. No commercial paper has been outstanding during the past ten years. The Company has no subordinated or hybrid debt instruments which would affect future borrowing capacity. Because of its lack of significant long-term debt, the Company believes that, through its Capital Markets Group or in other public debt markets, it could generate additional liquidity from sources such as jumbo certificates of deposit, privately-placed corporate notes or other forms of debt.
The cash flows from the operating, investing and financing activities of the Company resulted in a net increase in cash, cash equivalents and restricted cash of $1.3 billion in 2020, as reported in the consolidated statements of cash flows. Operating activities, consisting mainly of net income adjusted for certain non-cash items, provided cash flow of $624.0 million and has historically been a stable source of funds. Investing activities used cash of $5.4 billion, mainly from an increase in the investment securities portfolio as well as an increase in the loan portfolio. Purchases (net of sales and maturities proceeds) of investment securities used cash of $3.7 billion, and growth in the loan portfolio used cash of $1.6 billion. Investing activities are somewhat unique to financial institutions in that, while large sums of cash flow are normally used to fund growth in investment securities, loans, or other bank assets, they are normally dependent on the financing activities described below.
During 2020, financing activities provided cash of $6.1 billion. This increase in cash was largely driven by growth in deposits, which provided cash of $6.2 billion. Federal funds purchases and short-term securities sold under agreements to repurchase provided cash in the amount of $247.6 million. The Company paid cash dividends of $127.6 million on common and preferred stock. Treasury stock purchases used cash of $54.2 million during 2020, and the Company used cash of $150.0 million to redeem its preferred stock. Future short-term liquidity needs for daily operations are not expected to vary significantly, and the Company believes it maintains adequate liquidity to meet these cash flows. The Company’s sound equity base, along with its long-term low debt level, common and preferred stock availability, and excellent debt ratings, provide several alternatives for future financing. Future acquisitions may utilize partial funding through one or more of these options.
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Cash outflows resulting from the Company’s transactions in its common and preferred stock were as follows:
Accelerated share repurchase agreements — 150.0 —
Preferred stock redemption* 150.0 — —
Preferred cash dividends paid 6.8 9.0 9.0
*The period ended December 31, 2020 includes $5.2 million of excess redemption costs over the book value of the preferred stock. This excess payment considered a dividend.
The Parent faces unique liquidity constraints due to legal limitations on its ability to borrow funds from its bank subsidiary. The Parent obtains funding to meet its obligations from two main sources: dividends received from bank and non-bank subsidiaries (within regulatory limitations) and management fees charged to subsidiaries as reimbursement for services provided by the Parent, as presented below:
These sources of funds are used mainly to pay cash dividends on outstanding stock, pay general operating expenses, and purchase treasury stock. At December 31, 2020, the Parent’s investment securities totaled $7.9 million at fair value, consisting mainly of corporate bonds and preferred stock. To support its various funding commitments, the Parent maintains a $20.0 million line of credit with its subsidiary bank. There were no borrowings outstanding under the line during 2020 or 2019.
Company senior management is responsible for measuring and monitoring the liquidity profile of the organization with oversight by the Company’s Asset/Liability Committee. This is done through a series of controls, including a written Contingency Funding Policy and risk monitoring procedures, which include daily, weekly and monthly reporting. In addition, the Company prepares forecasts to project changes in the balance sheet affecting liquidity and to allow the Company to better plan for forecasted changes.
Capital Management
Under Basel III capital guidelines, at December 31, 2020 and 2019, the Company met all capital adequacy requirements and had regulatory capital ratios in excess of the levels established for well-capitalized institutions, as shown in the following table.
Tangible common equity to tangible assets 9.92 10.99
* Under Prompt Corrective Action requirements
The Company is subject to a 2.5% capital conservation buffer, which is an amount above the minimum ratios under capital adequacy guidelines, and is required under Basel III. The capital conservation buffer is intended to absorb losses during
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periods of economic stress. Failure to maintain the buffer will result in constraints on dividends, share repurchases, and executive compensation.
In the first quarter of 2020, the interim final rule of the Federal Reserve Bank and other U.S. banking agencies became effective, providing banks that adopted CECL (ASU 2016-13) during the 2020 calendar year the option to delay recognizing the estimated impact on regulatory capital until after a two year deferral period, followed by a three year transition period. In connection with the adoption of CECL on January 1, 2020, the Company has elected to utilize this option. As a result, the two year deferral period for the Company extends through December 31, 2021. Beginning on January 1, 2022, the Company will be required to phase in 25% of the previously deferred estimated capital impact of CECL, with an additional 25% to be phased in at the beginning of each subsequent year until fully phased in by the first quarter of 2025.
The Company maintains a treasury stock buyback program under authorizations by its Board of Directors and periodically purchases stock in the open market. During 2019, the Company purchased 4.7 million shares, including 2.4 million shares purchased under an accelerated share repurchase (ASR) agreement. The ASR agreement is further discussed in Note 14 to the consolidated financial statements. During 2020, the Company purchased 886 thousand shares. At December 31, 2020, 3.5 million shares remained available for purchase under the current Board authorization.
The Company’s common stock dividend policy reflects its earnings outlook, desired payout ratios, the need to maintain adequate capital levels and alternative investment options. Per share cash dividends paid by the Company increased 9.1% in 2020 compared with 2019, and the Company increased its first quarter 2021 cash dividend 2.1%, making 2021 the Company's 53rd consecutive year of regular cash dividend increases. The Company also distributed its 27th consecutive annual 5% stock dividend in December 2020.
On September 1, 2020, the Company redeemed all 6,000 outstanding shares of its 6.00% Series B Non-Cumulative Perpetual Preferred Stock and the corresponding depositary shares representing fractional interests in the Series B Preferred Stock at a redemption price of $25 per depositary share (equivalent to $1,000 per share of preferred stock). Regular dividends on the outstanding shares of the Series B Preferred Stock were paid separately on September 1, 2020 to holders of record as of the close of business on August 14, 2020, in the customary manner. On and after September 1, 2020, all dividends on the shares of Series B Preferred Stock ceased to accrue.
Commitments, Contractual Obligations, and Off-Balance Sheet Arrangements
In the normal course of business, various commitments and contingent liabilities arise that are not required to be recorded on the balance sheet. The most significant of these are loan commitments totaling $13.0 billion (including approximately $5.0 billion in unused, approved credit card lines) and the contractual amount of standby letters of credit totaling $357.1 million at December 31, 2020. As many commitments expire unused or only partially used, these totals do not necessarily reflect future cash requirements. Management does not anticipate any material losses arising from commitments or contingent liabilities and believes there are no material commitments to extend credit that represent risks of an unusual nature.
A table summarizing contractual cash obligations of the Company at December 31, 2020 and the expected timing of these payments follows:
Payments Due by Period
* Includes operating leases signed but not yet commenced.
** Includes principal payments only.
The Company funds a defined benefit pension plan for a portion of its employees. Under the funding policy for the plan, contributions are made as necessary to provide for current service and for any unfunded accrued actuarial liabilities over a reasonable period. No contributions to the defined benefit plan were made in 2020, 2019 or 2018, and the Company is not required nor does it expect to make a contribution in 2021.
The Company has investments in low-income housing partnerships generally within the areas it serves. These partnerships supply funds for the construction and operation of apartment complexes that provide affordable housing to that segment of the
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population with lower family income. If these developments successfully attract a specified percentage of residents falling in that lower income range, federal (and sometimes state) income tax credits are made available to the partners. The tax credits are normally recognized over ten years, and they play an important part in the anticipated yield from these investments. In order to continue receiving the tax credits each year over the life of the partnership, the low-income residency targets must be maintained.Under the terms of the partnership agreements, the Company has a commitment to fund a specified amount that will be due in installments over the life of the agreements, which ranges from 3 to 17 years.At December 31, 2020, the investments totaled $47.6 million and are recorded as other assets in the Company’s consolidated balance sheet. Unfunded commitments, which are recorded as liabilities, amounted to $29.3 million at December 31, 2020.
During the third quarter of 2020, the Company signed a $106.6 million agreement with U.S. Capital Development to develop a 280,000 square foot commercial office building in a two building complex in Clayton, Missouri. While the Company intends to occupy a portion of the office building for executive offices, a 15 year lease agreement has been signed by an anchor tenant to lease approximately 40% of the office building. The commitments related to the construction of the commercial office building are included in the table above.
The Company regularly purchases various state tax credits arising from third-party property redevelopment. These credits are either resold to third parties or retained for use by the Company. During 2020, purchases and sales of tax credits amounted to $151.2 million and $131.4 million, respectively. Fees from the sales of tax credits were $4.2 million, $3.5 million and $4.9 million in 2020, 2019 and 2018, respectively. At December 31, 2020, the Company had outstanding purchase commitments totaling $141.3 million that it expects to fund in 2021. These commitments, along with the commitments for the next five years, are included in the table above.
Interest Rate Sensitivity
The Company’s Asset/Liability Management Committee (ALCO) measures and manages the Company’s interest rate risk on a monthly basis to identify trends and establish strategies to maintain stability in net interest income throughout various rate environments. Analytical modeling techniques provide management insight into the Company’s exposure to changing rates. These techniques include net interest income simulations and market value analysis. Management has set guidelines specifying acceptable limits within which net interest income and market value may change under various rate change scenarios. These measurement tools indicate that the Company is currently within acceptable risk guidelines as set by management.
The Company’s main interest rate measurement tool, income simulation, projects net interest income under various rate change scenarios in order to quantify the magnitude and timing of potential rate-related changes. Income simulations are able to capture option risks within the balance sheet where expected cash flows may be altered under various rate environments. Modeled rate movements include “shocks, ramps and twists.” Shocks are intended to capture interest rate risk under extreme conditions by immediately shifting rates up and down, while ramps measure the impact of gradual changes and twists measure yield curve risk. The size of the balance sheet is assumed to remain constant so that results are not influenced by growth predictions.
The Company also employs a sophisticated simulation technique known as a stochastic income simulation. This technique allows management to see a range of results from hundreds of income simulations. The stochastic simulation creates a vector of potential rate paths around the market’s best guess (forward rates) concerning the future path of interest rates and allows rates to randomly follow paths throughout the vector. This allows for the modeling of non-biased rate forecasts around the market consensus. Results give management insight into a likely range of rate-related risk as well as worst and best-case rate scenarios.
Additionally, the Company uses market value analyses to help identify longer-term risks that may reside on the balance sheet. This is considered a secondary risk measurement tool by management. The Company measures the market value of equity as the net present value of all asset and liability cash flows discounted along the current swap curve plus appropriate market risk spreads. It is the change in the market value of equity under different rate environments, or effective duration, that gives insight into the magnitude of risk to future earnings due to rate changes. Market value analyses also help management understand the price sensitivity of non-marketable bank products under different rate environments.
The tables below show the effects of gradual shifts in interest rates over a twelve month period on the Company’s net interest income versus the Company's net interest income in a flat rate scenario. Simulation A presents three rising rate scenarios and in each scenario, rates are assumed to change evenly over 12 months. In these scenarios, the balance sheet remains flat with the exception of deposit balances, which may fluctuate based on changes in rates. For instance, the Company may experience deposit disintermediation if the spread between market rates and bank deposit rates widens as rates rise.
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The sensitivity of deposit balances to changes in rates is particularly difficult to estimate in exceptionally low rate environments. Since the future effects of changes in rates on deposit balances cannot be known with certainty, the Company conservatively models alternate scenarios with greater deposit attrition as rates rise. Simulation B illustrates results from these higher attrition scenarios to provide added perspective on potential effects of higher rates.
The Company utilizes these simulations both for monitoring interest rate risk and for liquidity planning purposes. While the future effects of rising rates on deposit balances cannot be known, the Company maintains a practice of running multiple rate scenarios to better understand interest rate risk and its effect on the Company’s performance.
Under Simulation A, in the three rising rate scenarios, interest income increases more quickly than funding costs. The increase is predominately due to interest earning deposits with the Federal Reserve and variable rate loan rates repricing up with market rates, while deposit rates only partially reprice higher. Higher deposits and balances at the Federal Reserve during the current quarter resulted in improved rising rate scenarios. PPP loans were not included in the simulation and contributed to higher deposit balances at the Federal Reserve. The Company did not model a 100 basis point falling scenario due to the already low interest rate environment.
In Simulation B, the assumed higher levels of deposit attrition were modeled to capture the results of a shrinking balance sheet.
Projecting deposit activity in a historically low interest rate environment is difficult, and the Company cannot predict how deposits will react to shifting rates. The comparison provided above provides insight into potential effects of changes in rates and deposit levels on net interest income. The Company believes that its approach to interest rate risk has appropriately considered its susceptibility to both rising and falling rates and has adopted strategies which minimize the impact of interest rate risk.
Derivative Financial Instruments
The Company maintains an overall interest rate risk management strategy that permits the use of derivative instruments to modify exposure to interest rate risk. Such instruments include interest rate swaps, interest rate floors, interest rate caps, credit risk participation agreements, foreign exchange contracts, mortgage loan commitments, forward sale contracts, and forward to-be-announced (TBA) contracts. The Company’s interest rate risk management strategy includes the ability to modify the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not adversely affect the net interest margin and cash flows. All of these derivative instruments utilized by the Company are further discussed in Note 19 on Derivative Instruments.
In all of these contracts, the Company is exposed to credit risk in the event of nonperformance by counterparties, who may be bank customers or other financial institutions. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures. Because the Company generally enters into transactions only with high quality counterparties, there have been no losses associated with counterparty nonperformance on derivative financial instruments.
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The following table summarizes the notional amounts and estimated fair values of the Company’s derivative instruments at December 31, 2020 and 2019. Notional amount, along with the other terms of the derivative, is used to determine the amounts to be exchanged between the counterparties. Because the notional amount does not represent amounts exchanged by the parties, it is not a measure of loss exposure related to the use of derivatives nor of exposure to liquidity risk.
Mortgage loan forward sale contracts — — — 1,943 6 (2)
Operating Segments
The Company segregates financial information for use in assessing its performance and allocating resources among three operating segments. The results are determined based on the Company’s management accounting process, which assigns balance sheet and income statement items to each responsible segment. These segments are defined by customer base and product type. The management process measures the performance of the operating segments based on the management structure of the Company and is not necessarily comparable with similar information for any other financial institution. Each segment is managed by executives who, in conjunction with the Chief Executive Officer, make strategic business decisions regarding that segment. The three reportable operating segments are Consumer, Commercial, and Wealth. Additional information is presented in Note 13 on Segments in the consolidated financial statements.
The Company uses a funds transfer pricing method to value funds used (e.g., loans, fixed assets, cash, etc.) and funds provided (deposits, borrowings, and equity) by the business segments and their components. This process assigns a specific value to each new source or use of funds with a maturity, based on current swap rates, thus determining an interest spread at the time of the transaction. Non-maturity assets and liabilities are valued using weighted average pools. The funds transfer pricing process attempts to remove interest rate risk from valuation, allowing management to compare profitability under various rate environments. The Company also assigns loan charge-offs and recoveries (labeled in the table below as “provision for credit losses”) directly to each operating segment instead of allocating an estimated credit loss provision. The operating segments also include a number of allocations of income and expense from various support and overhead centers within the Company.
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The table below is a summary of segment pre-tax income results for the past three years.
Investment securities gains, net — — — — 11,032 11,032
Investment securities gains, net — — — — 3,626 3,626
Increase (decrease) in income before income taxes:
Investment securities losses, net — — — — (488) (488)
Increase (decrease) in income before income taxes:
Consumer
The Consumer segment includes consumer deposits, consumer finance, and consumer debit and credit cards. During 2020, income before income taxes for the Consumer segment increased $32.0 million, or 29.5%, compared to 2019. This increase was due to growth of $5.3 million, or 1.7%, in net interest income, $13.3 million, or 9.8%, in non-interest income, and a decrease to the provision for credit losses of $13.8 million. Net interest income increased due to an $18.0 million increase in net allocated funding credits assigned to the Consumer segment's loan and deposit portfolios and lower deposit interest expense of $7.3 million, partly offset by a decrease in interest income on loans of $20.1 million. Non-interest income increased mainly due to growth in mortgage banking revenue, partly offset by declines in deposit fees (mainly overdraft and return item fees) and net credit and debit card fees (mainly lower interchange fees, partly offset by lower rewards expense). These increases to income were partly offset by growth of $326 thousand, or .1%, in non-interest expense. Non-interest expense increased over the prior year due to higher incentive compensation expense, allocated teller servicing costs, intangible asset amortization and an impairment on mortgage servicing rights. These increases were partly offset by lower supplies and communication expense, marketing expense, and bank card processing fees. The provision for credit losses totaled $31.2 million, a $13.8 million decrease from the prior year, which resulted mainly from lower net charge-offs on consumer credit card and consumer loans. Total average loans in this segment decreased $139.3 million, or 6.2%, in 2020 compared to 2019 mainly due to declines in consumer credit card and fixed and revolving home equity loans. Average deposits increased $1.0 billion over the prior year, resulting from growth in personal demand, savings, interest checking and money market deposit accounts.
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During 2019, income before income taxes for the Consumer segment increased $14.4 million, or 15.2%, compared to 2018. This increase was due to growth of $21.0 million, or 7.1%, in net interest income and an increase in non-interest income of $9.0 million, or 7.1%. Net interest income increased due to a $27.8 million increase in net allocated funding credits and growth of $3.4 million in loan interest income, partly offset by an increase of $10.1 million in deposit interest expense. Non-interest income increased mainly due to growth in mortgage banking revenue and net credit card fees, (mainly higher interchange fees and lower rewards expense), partly offset by a decline in deposit fees (mainly overdraft and return item fees and deposit account service fees). These increases to income were partly offset by growth of $11.2 million, or 3.9%, in non-interest expense. Non-interest expense increased over 2018 due to higher salaries and benefits expense, data processing and software expense and allocated servicing and support costs (mainly teller services, online banking, installment loan and management fees). The provision for loan losses totaled $45.0 million, a $4.4 million increase over 2018, which was mainly due to higher net charge-offs on consumer credit card loans. Total average loans in this segment decreased $107.1 million, or 4.6%, in 2019 compared to 2018 mainly due to a decline in auto and other consumer loans. Average deposits increased $25.8 million over 2018, resulting from growth in interest checking, savings, and certificate of deposit balances, partly offset by a decline in money market deposit accounts.
Commercial
The Commercial segment provides corporate lending (including the Small Business Banking product line within the branch network), leasing, international services, and business, government deposit, and related commercial cash management services, as well as merchant and commercial bank card products. The segment includes the Capital Markets Group, which sells fixed-income securities to correspondent banks, corporations, public institutions, municipalities, and individuals and also provides securities safekeeping and bond accounting services. Pre-tax income for 2020 increased $55.6 million, or 23.8%, compared to 2019, mainly due to an increase in net interest income, partly offset by a decrease in non-interest income and an increase non-interest expense. Net interest income increased $71.5 million, or 20.8%, due to growth of $75.7 million in net allocated funding credits and lower interest expense of $46.2 million on deposits and customer repurchase agreements, partly offset by a decrease of $50.3 million in loan interest income. The provision for credit losses decreased $480 thousand from the prior year due to lower lease loan net charge-offs. Non-interest income decreased $9.4 million, or 4.6%, from 2019 due to lower net corporate card fees (driven by lower transaction volume), lower swap fees and lower gains on sales of leased assets. These decreases were partly offset by higher deposit account fees (mainly corporate cash management) and capital market fees. Non-interest expense increased $6.9 million, or 2.2%, during 2020, mainly due to higher salaries and incentive compensation expense and allocated service and support costs (mainly information technology and commercial loan servicing). These increases were partly offset by decreases in travel and entertainment expense and allocated teller services costs, as well as higher deferred origination costs. Average segment loans increased $1.3 billion, or 14.2%, compared to 2019, with growth occurring in business (mainly PPP loans) and business real estate loans. Average deposits increased $2.1 billion, or 26.6%, mainly due to growth in business demand accounts.
Pre-tax income for 2019 decreased $14.7 million, or 5.9%, compared to 2018, mainly due to an increase in non-interest expense. A decline in net interest income and an increase in the provision for loan losses further decreased pre-tax net income compared to 2018. Net interest income decreased $1.7 million, or .5%, due to a decline of $12.7 million in net allocated funding credits and higher interest expense of $18.4 million on deposits and customer repurchase agreements, partly offset by an increase of $29.3 million in loan interest income. The provision for loan losses increased $3.1 million over 2018, due to higher business loan net charge-offs (related to a charge-off on a single lease loan). Non-interest income increased $1.4 million, or .7%, over 2018 due to higher deposit account fees (mainly corporate cash management), cash sweep commissions, and gains on sales of leased assets to customers upon lease termination. These increases were partly offset by lower net corporate card fees (driven by lower interchange income and higher network and rewards expense) and lower tax credit sales fees. Non-interest expense increased $11.3 million, or 3.8%, during 2019, mainly due to increases in salaries expense and allocated support costs (mainly information technology, marketing and commercial sales and product support). These increases were partly offset by lower deposit insurance expense and allocated servicing costs (mainly teller services and deposit operations). Average segment loans increased $310.9 million, or 3.5%, compared to 2018, with growth occurring in business and business real estate loans. Average deposits decreased $180.9 million, or 2.3%, due to declines in business demand and money market deposit accounts, partly offset by growth in certificate of deposit balances.
Wealth
The Wealth segment provides traditional trust and estate planning, advisory and discretionary investment management services, brokerage services, and includes Private Banking accounts. At December 31, 2020, the Trust group managed investments with a market value of $38.3 billion and administered an additional $22.9 billion in non-managed assets. It also provides investment management services to The Commerce Funds, a series of mutual funds with $3.2 billion in total assets at December 31, 2020. In 2020, pre-tax income for the Wealth segment was $121.9 million, compared to $105.7 million in 2019, an increase of $16.2 million, or 15.3%. Net interest income increased $10.1 million, or 21.0%, due to a $14.4 million increase
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in net allocated funding credits and lower deposit interest expense of $2.8 million, partly offset by a decline in loan interest income of $7.2 million. Non-interest income increased $8.1 million, or 4.5%, over the prior year largely due to higher private client and institutional trust fees and mortgage banking revenue. Non-interest expense increased $2.2 million, or 1.8%, resulting from higher salaries expense and higher allocated service and support costs (mainly mortgage loan processing and information technology), partly offset by lower costs for travel and entertainment. The provision for credit losses decreased $186 thousand, mainly due to net recoveries on revolving home equity loans. Average assets increased $118.0 million, or 9.2%, during 2020 mainly due to growth in personal real estate and consumer loan balances. Average deposits increased $438.7 million, or 23.9%, due to growth in interest checking and money market account balances.
In 2019, pre-tax income for the Wealth segment was $105.7 million, compared to $94.6 million in 2018, an increase of $11.1 million, or 11.8%. Net interest income increased $873 thousand, or 1.9%, due to a $4.3 million increase in loan interest income and a $1.5 million increase in net allocated funding credits, partly offset by higher interest expense of $4.9 million. Non-interest income increased $11.0 million, or 6.5%, over 2018 largely due to higher private client fund trust fees and cash sweep commissions. Non-interest expense increased $537 thousand, or .4%, resulting from higher salaries and benefits expense and higher allocated costs for information technology. The provision for loan losses increased $206 thousand, mainly due to higher revolving home equity loan net charge-offs. Average assets increased $45.1 million, or 3.6%, during 2019 mainly due to growth in personal real estate and consumer loan balances. Average deposits decreased $39.2 million, or 2.1%, due to declines in interest checking account balances, partially offset by higher balances of demand deposits.
The segment activity, as shown above, includes both direct and allocated items. Amounts in the “Other/Elimination” column include activity not related to the segments, such as certain administrative functions, the investment securities portfolio, and the effect of certain expense allocations to the segments. In accordance with the Company's transfer pricing procedures, the difference between the total provision and total net charge-offs/recoveries is not allocated to a business segment and is included in this category. In 2020, the pre-tax net loss in this category was $110.9 million, compared to net income of $83.6 million in 2019. This decrease was due to lower net interest income of $78.3 million and lower non-interest income of $30.8 million, partly offset by a decrease in non-interest expense of $8.4 million. Unallocated securities gains were $11.0 million in 2020, compared to securities gains of $3.6 million in 2019. Also, the unallocated provision for credit losses increased $101.2 million, primarily driven by an increase in the allowance for credit losses on loans and the liability for unfunded lending commitments, which are not allocated to segments for management reporting purposes. Net charge-off are allocated to segments when incurred for management reporting purposes. For the year ended December 31, 2020, the Company's provision for credit losses on unfunded lending commitments was $21.1 million. Additionally, the provision for credit losses on loans was $81.2 million in excess of net charge-offs in 2020, while the provision was $750 thousand in excess of net charge-offs in 2019.
Impact of Recently Issued Accounting Standards
Financial Instruments ASU 2016-13, "Measurement of Credit Losses on Financial Instruments", known as the CECL model, was issued in June 2016, and has been followed by additional clarifying guidance on specified implementation issues. This new standard is effective for fiscal years beginning after December 15, 2019 and was adopted by the Company on January 1, 2020 using the modified retrospective method.
This new measurement approach requires the calculation of expected lifetime credit losses and is applied to financial assets measured at amortized cost, including loans and held-to-maturity securities as well as certain unfunded lending commitments such as loan commitments. The standard also changes the impairment model of available for sale debt securities.
The allowance for loan losses under the previously required incurred loss model that is reported on the Company's consolidated balance sheet is different under the requirements of the CECL model. At adoption, a cumulative-effect adjustment for the change in the allowance for credit losses increased retained earnings by $3.8 million. The cumulative-effect adjustment to retained earnings, net of taxes, was comprised of the impact to the allowance for credit losses on outstanding loans and the impact to the liability for unfunded lending commitments. There is no implementation impact on held-to-maturity debt securities as the Company does not hold any held-to-maturity debt securities.
The new accounting standard does not require the use of a specific loss estimation method for purposes of determining the allowance for credit losses. The Company selected a methodology that uses historical net charge-off rates, adjusted by the impacts of a reasonable and supportable forecast and the impacts of other qualitative factors to determine the expected credit losses. 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. The forecast is determined using projections of certain macroeconomic variables, such as, unemployment rate, prime rate, BBB corporate yield, and house price index. The model design and methodology requires management judgment.
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The allowance for credit losses on the commercial portfolio decreased due to the relatively short contractual lives of the commercial loan portfolios coupled with an economic forecast predicting stable macroeconomic factors similar to the current environment at adoption. The allowance for credit losses on the personal banking portfolio increased due to the relatively longer contractual lives of certain portfolios, primarily those collateralized with personal real estate. Because the commercial loan portfolio represented 63% of total loans at December 31, 2019, the change in its allowance for credit losses had a more significant impact on the total allowance for credit losses, and resulted in a net reduction in the allowance for credit losses. The Company's allowance for loan losses to total loans ratio declined from 1.09% at December 31, 2019, to .95% at adoption. Offsetting the overall reduction in the allowance for credit losses for outstanding loans was an increase in the liability for unfunded lending commitments. The liability increased as the loss estimation was required to be expanded over the contractual commitment period. The adoption also resulted in an immaterial adjustment to retained earnings at January 1, 2020. Further discussion of the accounting impact of the Company's adoption is included in Note 1 to the consolidated financial statements.
Additionally, the Company elected to phase the estimated impact of CECL into regulatory capital in accordance with the interim final rule of the Federal Reserve Bank and other U.S. banking agencies. Further discussion of the impact of this election is discussed above in Capital Management within Liquidity and Capital Resources.
Intangible Assets The FASB issued ASU 2017-04, "Simplifying the Test for Goodwill Impairment", in January 2017. Under current guidance, a goodwill impairment loss is measured by comparing the implied fair value of a reporting unit's goodwill with the carrying amount of that goodwill by following procedures that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Under the new amendments, the goodwill impairment test compares the fair value of a reporting unit with its carrying amount and an impairment charge is measured as the amount by which the carrying amount exceeds the reporting unit's fair value. The amendments were effective for impairment tests beginning January 1, 2020, and the Company adopted them on that date. The adoption did not have a significant effect on the Company's consolidated financial statements.
Financial Instruments The FASB issued ASU 2018-13, "Changes to the Disclosure Requirements of Fair Value Measurement", in August 2018. The amendments in the ASU eliminate or modify certain disclosure requirements for fair value measurements in Topic 820, Fair Value Measurement. In addition, the amendments in the ASU also require the addition of new disclosure requirements on fair value measurement, including the disclosure of changes in unrealized gains and losses for the period included in AOCI for recurring Level 3 fair value measurements and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The guidance was effective January 1, 2020, and the Company adopted the new guidance on that date. The adoption did not have a significant effect on the Company's consolidated financial statements.
Retirement Benefits The FASB issued ASU 2018-14, "Compensation - Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20)", in August 2018. The amendments in the ASU eliminate disclosures that are no longer considered cost beneficial and clarify specific requirements of disclosures. In addition, the amendments in the ASU also add new disclosures, including the explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. The amendments were effective January 1, 2020, and the Company adopted them on that date. The adoption did not have a significant effect on the Company's consolidated financial statements.
Intangible Assets The FASB issued ASU 2018-15, "Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract", in August 2018. Under current guidance, the accounting for implementation costs of a hosting arrangement that is a service contract is not specifically addressed. Under the new amendments, the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract are aligned with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software or hosting arrangements that include an internal-use software license. The guidance was effective January 1, 2020, and the Company adopted it on that date. The adoption did not have a significant effect on the Company's consolidated financial statements.
Income Taxes The FASB issued ASU 2019-12, "Simplifying the Accounting for Income Taxes", in December 2019. The amendments in the ASU eliminate certain exceptions under current guidance for investments, intraperiod allocations, and the methodology for calculating interim income tax. In addition, the amendments also add new guidance to simplify accounting for income taxes. The amendments were effective January 1, 2021, and the Company adopted them on that date. The adoption did not have a significant effect on the Company's consolidated financial statements.
Investment Securities The FASB issued ASU 2020-08, "Codification Improvements to Subtopic 310-20, Receivables - Nonrefundable Fees and Other Costs", in October 2020. The amendments in the ASU clarify that for each reporting period an entity should evaluate whether a callable debt security that has multiple call dates may consider estimates of future principal
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prepayments when applying the interest method. The guidance was effective January 1, 2021, and the Company adopted it on that date. The adoption did not have a significant effect on the Company's consolidated financial statements.
Reference Rate Reform The FASB issued ASU 2020-04, "Reference Rate Reform (Topic 848) - Facilitation of the Effects of Reference Rate Reform on Financial Reporting", in March 2020, and has been followed by additional clarifying guidance related to derivatives that are modified as a result of reference rate reform. The new guidance provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if they reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. Further, the guidance applies to derivative instruments that use an interest rate for margining, discounting, or contract price alignment that is modified as a result of reference rate reform. The expedients and exceptions provided by the new guidance do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, except for certain hedging relationships existing as of December 31, 2022. 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 Committee 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.
Corporate Governance
The Company has adopted a number of corporate governance measures. These include corporate governance guidelines, a code of ethics that applies to its senior financial officers and the charters for its audit and risk committee, its committee on compensation and human resources, and its committee on governance/directors. This information is available on the Company’s website www.commercebank.com under "Social Responsibility".
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AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
Years Ended December 31
ASSETS
Loans:(A)
Investment securities:
LIABILITIES AND EQUITY
Interest bearing deposits:
Borrowings:
Net yield on interest earning assets 2.99 % 3.48 % 3.53 %
(A) Loans on non-accrual status are included in the computation of average balances. Included in interest income above are loan fees and late charges, net of amortization of deferred loan origination fees and costs, which are immaterial. Credit card income from merchant discounts and net interchange fees are not included in loan income.E SHEETS — AVERAGE RATES AND YIELDS
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Years Ended December 31
(B) Interest income and yields are presented on a fully-taxable equivalent basis using a federal income tax rate of 21% in 2020, 2019 and 2018, and 35% in prior periods. Loan interest income includes tax free loan income (categorized as business loan income) which includes tax equivalent adjustments of $4,916,000 in 2020, $6,282,000 in 2019, $5,931,000 in 2018, $10,357,000 in 2017, $9,537,000 in 2016 and $8,332,000 in 2015. Investment securities interest income includes tax equivalent adjustments of $8,042,000 in 2020, $7,845,000 in 2019, $10,306,000 in 2018, $22,565,000 in 2017, $21,847,000 in 2016 and $21,386,000 in 2015. These adjustments relate to state and municipal obligations, trading securities, equity securities, and other securities.
(C) Interest expense of $14,000, which was capitalized on construction projects in 2020, is not deducted from the interest expense shown above.
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QUARTERLY AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
Fourth Quarter Third Quarter Second Quarter First Quarter
ASSETS
Loans:
Overdrafts 4 — 3 — 3 — 4 —
Investment securities:
LIABILITIES AND EQUITY
Interest bearing deposits:
Borrowings:
Net yield on interest earning assets 2.80 % 2.97 % 2.94 % 3.33 %
(A) Includes tax equivalent calculations.
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QUARTERLY AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
Fourth Quarter Third Quarter Second Quarter First Quarter
ASSETS
Loans:
Overdrafts 18 — 9 — 5 — 4 —
Investment securities:
Unrealized gain (loss) on debt securities 150 153 42 (49)
LIABILITIES AND EQUITY
Interest bearing deposits:
Borrowings:
Net yield on interest earning assets 3.36 % 3.43 % 3.61 % 3.52 %
(A) Includes tax equivalent calculations.
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SUMMARY OF QUARTERLY STATEMENTS OF INCOME
Year ended December 31, 2020 For the Quarter Ended
Net income per common share — basic* $ 1.11 $ 1.06 $ .32 $ .42
Net income per common share — diluted* $ 1.11 $ 1.06 $ .32 $ .42
Year ended December 31, 2019 For the Quarter Ended
Net income per common share — basic* $ .89 $ .89 $ .87 $ .77
Net income per common share — diluted* $ .88 $ .89 $ .87 $ .77
Year ended December 31, 2018 For the Quarter Ended
Net income per common share — basic* $ .87 $ .90 $ .87 $ .80
Net income per common share — diluted* $ .87 $ .89 $ .87 $ .80
* Restated for the 5% stock dividend distributed in 2020.
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