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 287 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.
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 $530.8 million, an increase of 49.9% compared to the previous year. The return on average assets was 1.55% in 2021, and the return on average common equity was 15.37%. Diluted earnings per share increased 55.6% in 2021 compared to 2020.
• Total revenue — Total revenue is comprised of net interest income and non-interest income. Total revenue in 2021 increased $60.1 million, or 4.5%, from 2020, as net interest income grew $5.6 million, and non-interest income grew $54.5 million. Growth in net interest income resulted principally from a decrease in interest expense, while the increase in non-interest income in 2021 was mainly due to growth in trust fees and bank card fees.
• Non-interest expense — Total non-interest expense increased 4.9% this year compared to 2020, mainly due to higher salaries and employee benefits expense, data processing and software expense and other non-interest expense.
• Asset quality — Net loan charge-offs totaled $18.6 million in 2021, a decrease of $16.3 million from those recorded in 2020, and averaged .12% of loans compared to .22% in the previous year. Total non-performing assets, which include non-accrual loans and foreclosed real estate, amounted to $9.3 million at December 31, 2021, compared to $26.6 million at December 31, 2020, and represented .06% of loans outstanding at December 31, 2021.
• Shareholder return — During 2021, the Company paid cash dividends of $1.00 per share on its common stock, representing an increase of 2.0% over the previous year. In 2021, the Company issued its 28th consecutive annual 5% common stock dividend, and in February 2022, the Company's Board of Directors authorized an increase of 6.0% in the common cash dividend. The Company purchased 1,807,257 shares in 2021. Total shareholder return, including
19
Table of Contents
the change in stock price and dividend reinvestment, was 10.5%, 13.9%, and 9.9% 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.
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.
20
Table of Contents
Results of Operations
$ Change % Change
N.M. - Not meaningful.
Net income attributable to Commerce Bancshares, Inc. (net income) for 2021 was $530.8 million, an increase of $176.7 million, or 49.9%, compared to $354.1 million in 2020. Diluted income per common share was $4.31 in 2021, compared to $2.77 in 2020. The increase in net income resulted from a decrease of $203.5 million in the provision for credit losses, as well as an increase of $54.5 million in non-interest income. These increases in net income were partly offset by increases in non-interest expense and income tax expense of $37.5 million and $58.4 million, respectively. The return on average assets was 1.55% in 2021 compared to 1.20% in 2020, and the return on average common equity was 15.37% in 2021 compared to 10.64% in 2020. At December 31, 2021, the ratio of tangible common equity to assets decreased to 9.01%, compared to 9.92% at year end 2020.
During 2021, net interest income grew mainly due to a decrease of $29.9 million in interest expense on deposits and borrowings, due to lower average rates paid, coupled with an increase of $19.5 million in interest income earned on investment securities, mainly due to higher average balances. These increases in net interest income were partly offset by a decline of $41.5 million in interest earned on loans, mainly due to lower rates earned. Total rates earned on average interest earning assets fell 53 basis points this year, while funding costs for deposits and borrowings decreased 19 basis points. The provision for credit losses decreased due to an improved credit outlook and the release of loan loss reserves provided for anticipated credit losses in the prior year, which did not occur. Net loan charge-offs decreased $16.3 million in 2021 compared to 2020, mainly due to lower credit card loan net charge-offs and net recoveries on business loans.
Non-interest income grew 10.8% in 2021, mainly due to growth in trust and net bank card fee income. Net gains on investment securities in 2021 were comprised mainly of net fair value gains on the Company's private equity investment portfolio, partly offset by net losses on bond sales. Non-interest expense increased $37.5 million in 2021 compared to 2020, largely due to higher salaries and benefits expense and data processing and software expense, as well as lower deferred loan origination costs and non-recurring litigation settlement costs recorded in the third quarter of 2021.
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 $2.77 in 2020, compared to $3.25 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 to 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.
As compared to 2019, the growth in net interest income in 2020 resulted mainly from an increase of $24.7 million in interest income on 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 in 2020, 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
21
Table of Contents
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 loan 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 net 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 originations costs and lower supplies and communication expense and travel and entertainments expense.
The Company distributed a 5% stock dividend for the 28th consecutive year on December 17, 2021. All per share and average share data in this report has been restated for the 2021 stock dividend.
Critical Accounting Estimates and Related 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 estimates and related policies are the Company's allowance for credit losses and fair value measurement policies.
Allowance for Credit Losses
The Company's Allowance for Credit Losses policies govern the processes and procedures used to estimate the collectability of its loan portfolio and unfunded lending commitments, and the potential for credit losses in its available for sale investment portfolio.
Allowance for Credit Losses – Loans and Unfunded Lending Commitments
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 over the assets’ contractual term.
The allowance for credit loss is an estimate that is subject to uncertainty due to the various assumptions and judgements used in the estimation process.
The allowance for credit losses is measured on a collective (pool) basis. Loans are aggregated into pools based on similar risk characteristics including borrower type, collateral type and expected credit loss patterns. Loans that do not share similar risk characteristics, primarily large loans on non-accrual status, are evaluated on an individual basis.
The allowance for credit losses is measured using an average historical loss model which incorporates relevant information about past events (including historical credit loss experience on loans with similar risk characteristics), current conditions, and an economic forecast that may affect the collectability of the remaining cash flows over the contractual term of the loans. The calculated loss rate is increased or decreased to reflect expectations of future losses given a single path economic forecast. These adjustments to the loss rate are based on results from various regression models projecting the impact of the macroeconomic variables. The forecast is used for a reasonable and supportable period before reverting to historical averages using a straight-line method.
Additionally, the allowance for credit losses considers other qualitative factors not included in historical loss rates or macroeconomic forecast such as changes in portfolio composition, underwriting practices, or significant unique events or conditions.
22
Table of Contents
Adjustments to the allowance for credit losses are made by increases to or reductions in the provision for credit losses, which are reflected in the consolidated statements of income.
Assumptions, Judgments, and Uncertainties: The uncertainty in the estimation of the allowance for credit losses is created because key assumptions and judgements are applied throughout the process. Key assumptions include segmentation of the portfolio into pools, calculations of life of a loan using a combination of contractual terms and expected prepayment speeds and forecast of macroeconomic conditions. The Company utilizes a third-party macro-economic forecast that continuously changes due to economic conditions and events. The single path economic forecast includes key macroeconomic variables including GDP, disposable income, unemployment rate, various interest rates, consumer price index (CPI) inflation rate, housing price index (HPI), commercial real estate price index (CREPI) and market volatility. Each reporting period, the base macroeconomic forecast scenario is evaluated to ensure it is not inconsistent with management’s expectations. Changes in the forecast cause fluctuations in the estimates of the allowance for credit losses on loans and the liability for unfunded lending commitments. Potential changes in any one economic variable may or may not affect the overall allowance because a variety of economic variables and inputs are considered in estimating the allowance, and changes in those variables and inputs may not occur at the same rate, may not be consistent across product types and may have offsetting impacts to other changing variables and inputs.
Data points such as loan mix, level of loan balances outstanding, portfolio performance, line utilization trends and risk ratings change throughout the life of a portfolio which could cause changes to the expected credit losses.
Qualitative factors not included in historical information or macroeconomic forecast require significant judgement to identify and determine how to apply to the estimate for credit losses. The qualitative factors continuously evolve in reaction to other changing assumptions, data inputs and industry trends.
The Company uses its best judgment to assess the macroeconomic forecast, key assumptions and internal and external data in estimating the allowance for credit losses on loans and the liability for unfunded lending commitments. These estimates are subject to continuous refinement based on changes in the underlying external and internal data.
Impact if actual results differ from assumptions: The allowance for credit losses represents management’s best estimate of expected current credit losses in the loan portfolio and within the Company’s unfunded lending commitments, but changes in the inputs and assumptions described above could significantly impact the calculated estimated credit losses. Therefore, actual credit losses may differ significantly from estimated results. Significant deterioration in circumstances relating to loan quality and economic conditions could result in a requirement for additional allowance. Likewise, an upturn in loan quality and improved economic conditions may allow a reduction in the required allowance. In either instance, changes could have a significant impact on our financial condition and results of operations.
Allowance for Credit Losses - Available for Sale Debt Securities
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.
Changes to the allowance for credit losses are made by changes to or reductions in the provision for credit losses, which are reflected in the consolidated statements of income.
Assumptions, Judgments, and Uncertainties: The Company’s model for establishing its allowance for credit losses uses cash flows projected to be received over the estimated life of the securities, discounted to present value, and compared to the current amortized cost bases of the securities. Securities for which fair value is less than amortized cost are reviewed for impairment. Special emphasis is placed on securities whose credit rating has fallen below Baa3 (Moody's) or BBB- (Standard & Poor's), whose fair values have fallen more than 20% below purchase price, or who have been identified based on management’s judgment. These securities are placed on a watch list and cash flow analyses are prepared on an individual security basis. Credit impairment is determined using input factors such as contractual payments required, expected delinquency rates, credit support from other tranches, prepayment speeds, collateral loss severity rates, and various other information related to the underlying collateral.
Impact if actual results differ from assumptions: The allowance for credit losses represents management’s best estimate of expected credit losses in the available for sale debt portfolio, but significant deterioration in interest rates and economic
23
Table of Contents
conditions could result in a requirement for additional allowance. Likewise, an increase in interest rates and improved economic conditions may allow a reduction in the required allowance. In either instance, anticipated changes could have a significant impact on our financial condition and results of operations.
Fair Value Measurement
Investment securities, including available-for-sale debt, 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.
Assumptions, Judgments, and Uncertainties: 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.
Fair value is measured based on a variety of inputs. Fair value may be based on quoted market prices for identical assets or liabilities traded in active markets (Level 1 valuations). If market prices are not available, quoted market prices for similar instruments traded in active markets, quoted prices for identical or similar instruments in markets that are not active, or model-based valuation techniques for which all significant assumptions are observable in the market are used (Level 2 valuations). Where observable market data is not available, the valuation is generated from model-based techniques that use significant assumptions not observable in the market (Level 3 valuations). Unobservable assumptions reflect the Company’s estimates for assumptions that market participants would use in pricing the asset or liability. Valuation techniques typically include discounted cash flow models and similar techniques, but may also include the use of market prices of assets or liabilities that are not directly comparable to the subject asset or liability.
The selection and weighting of the various fair value techniques may result in a fair value higher or lower than carrying value. Considerable judgment may be involved in determining the amount that is most representative of fair value.
For assets and liabilities recorded at fair value, the Company looks to active and observable market data when developing fair value measurements for those items where there is an active market. Certain assets and liabilities are not actively traded in observable markets, and the Company must use alternative valuation techniques to derive an estimated fair value measurement. In doing so, the Company may be required to make judgments about assumptions market participants would use in estimating the fair value of the financial instrument. The assumptions used to determine fair value adjustments are regularly evaluated by management for relevance under current facts and circumstances.
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. When market data is not available, the Company uses valuation techniques requiring more management judgment to estimate the appropriate fair value.
Impairment analysis also relates to long-lived assets and core deposit and other intangible assets. An impairment loss is recognized if the carrying amount of the asset is not likely to be recoverable and exceeds its fair value. In determining the fair value, management uses models and applies the techniques and assumptions previously discussed.
At December 31, 2021, assets and liabilities measured using observable inputs that are classified as either Level 1 or Level 2 represented 98.9% and 99.2% 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 $150.2 million, or 1.0% of total assets recorded at fair value on a recurring basis. 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.
Impact if actual results differ from assumptions: Changes in fair value are recorded either in earnings or accumulated other comprehensive income. Adjustments in the inputs and assumptions described above could significantly impact the fair values of the Company’s assets and liabilities and have a significant impact on our financial condition and results of operations.
24
Table of Contents
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 $835.4 million in 2021, increasing $5.6 million, or .7%, compared to $829.8 million in 2020. On a tax equivalent (T/E) basis, net interest income totaled $847.1 million, and increased $4.3 million over 2020. This increase was mainly due to a decline of $29.9 million in interest expense on deposits and borrowings, due to lower average rates paid, coupled with an increase of $19.0 million in interest earned on investment securities, mainly due to higher average balances. These increases to net interest income (T/E) were partly offset by lower interest earned on loans, which declined $42.3 million, mainly due to lower rates earned. The net yield on earning assets (T/E) was 2.58% in 2021 compared with 2.99% in 2020.
25
Table of Contents
During 2021, loan interest income (T/E) fell $42.3 million from 2020 mainly due to a decline in rates earned for most loan categories and lower average business and consumer credit card loan balances. The average tax equivalent rate earned on the loan portfolio decreased 21 basis points to 3.67% in 2021 compared to 3.88% in 2020. Average loan balances decreased $232.5 million, or 1.5%, this year. The decrease in consumer credit card loan interest income was the main driver of overall lower interest income. Consumer credit card loan interest declined $14.4 million due to lower average balances of $91.4 million and a decrease of 64 basis points in the average rate earned. Business loan interest income declined $9.3 million mainly due to a decrease of $548.7 million in average balances, partly offset by a 13 basis point increase in the average rate earned. Average balances of business loans included average balances of $854.1 million in Paycheck Protection Program (PPP) loans at December 31, 2021, which was a decline of $204.9 million from balances of $1.1 billion at December 31, 2020. The average rate earned on PPP loans increased 193 basis points to 4.81% in 2021 compared to 2.88% in 2020, partly offsetting the decline in average balances. During 2021, the Company recognized $41.0 million in interest income on PPP loans. As of December 31, 2021, 93% of the PPP loans originated by the Company had been forgiven, and the Company expects almost all of the remaining loans to be forgiven in 2022. Business real estate loan interest was lower by $5.8 million in 2021 compared to 2020 as a result of a decrease of 25 basis points in the average rate, partly offset by higher average balances of $46.9 million. Interest on personal real estate loans decreased $2.6 million as the average rate earned declined 32 basis points, while average balances increased $178.4 million. Interest on consumer loans declined $9.7 million from the prior year as the average rate earned decreased 58 basis points, but was partly offset by growth in average balances of $42.4 million. These decreases to loan interest income (T/E) were partly offset by an increase of $2.1 million in interest earned on construction and land loans. This increase resulted from higher average balances of $187.7 million, partly offset by a 48 basis point decrease in the average rate earned.
Tax equivalent interest income on total investment securities increased $19.0 million during 2021, as average balances grew $3.2 billion, while the average rate earned decreased 38 basis points. The average rate on the total investment securities portfolio was 1.81% in 2021 compared to 2.19% in 2020, while the average balance of the total investment securities portfolio (excluding unrealized fair value adjustments on available for sale debt securities) was $13.5 billion in 2021 compared to an average balance of $10.3 billion in 2020. The increase in interest income was mainly due to higher interest income earned on U.S. government securities, state and municipal obligations, asset-backed securities and other securities. Interest earned on U.S. government securities grew $15.5 million and was mainly impacted by growth of the same amount in inflation income on treasury inflation-protected securities (TIPS). Average balances of U.S. government securities increased $15.1 million and the average rated earned grew 191 basis points. The increase in interest earned on state and municipal obligations resulted mainly from growth of $453.2 million in average balances, partly offset by a 33 basis point decrease in the average rate earned. Interest on asset-backed securities increased $2.9 million mainly due to growth of $1.4 billion in the average balance, partly offset by an 87 basis point decrease in the average rate earned. Other securities interest increased $11.9 million mainly due to higher interest earned on equity securities, largely as a result of one-time dividend payments of $5.5 million received on private equity portfolio investments in 2021. Partly offsetting these increases in interest income was a decline of $14.7 million in interest income on mortgage-backed securities, due to a decrease of 56 basis points in the average rate earned, partly offset by higher average balances of $1.3 billion.
Interest on securities purchased under resell agreements decreased $3.3 million compared to 2020 due to a decrease of 185 basis points in the average rate, partly offset by growth in balances of $425.8 million. Interest earned on deposits with banks increased $929 thousand over 2020, mainly due to growth in average balances of $1.3 billion, partly offset by a seven basis point decrease in the average rate earned.
During 2021, interest expense on deposits decreased $24.5 million from 2020 and resulted mainly from a 17 basis point decrease in the overall average rate paid on deposits. Interest expense on interest checking and money market accounts decreased $10.4 million mainly due to lower rates paid, which fell 10 basis points, but was partly offset by higher average balances of $1.8 billion. Interest expense on certificates of deposit over $100,000 declined $10.4 million, mainly due to a 74 basis point decline in the average rate paid. The overall rate paid on total deposits decreased from .24% in 2020 to .07% in the current year. Interest expense on borrowings decreased $5.5 million mainly due to lower rates paid on securities sold under repurchase agreements, partly offset by higher average balances. The overall average rate incurred on all interest bearing liabilities was .07% in 2021, compared to .26% in 2020.
During 2020, net interest income totaled $829.8 million, 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 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.
26
Table of Contents
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 loans included average balances of $1.1 billion in 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 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 by 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 securities purchased under resell agreements increased $24.7 million in 2020 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 of those agreements matured in 2021. 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 2020. 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.
27
Table of Contents
Provision for Credit Losses
The provision for credit losses is comprised of provisions for credit losses on loans and for unfunded lending commitments and is recorded to adjust 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 was a recovery of $66.3 million in 2021, which was a decrease of $203.5 million from the 2020 provision of $137.2 million.
The provision for credit losses on loans in 2021 was a recovery of $52.2 million, compared to a provision for credit losses on loans of $116.1 million in 2020. The allowance for credit losses on loans totaled $150.0 million at December 31, 2021, a decrease of $70.8 million compared to the prior year, and represented .99% of loans at year end 2021, compared to 1.35% at December 31, 2020.
The provision for unfunded lending commitments was a recovery of $14.1 million during 2021, compared to a provision of $21.1 million in 2020, and the liability for unfunded lending commitments was $24.2 million at December 31, 2021, compared to $38.3 million at December 31, 2020.
Non-Interest Income
% Change
Non-interest income as a % of total revenue* 40.1 % 37.9 % 39.0 %
Total revenue per full-time equivalent employee $ 305.6 $ 280.3 $ 277.1
* 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, 2021, 2020 and 2019, respectively.
% Change
Non-interest income totaled $560.4 million, an increase of $54.5 million, or 10.8%, compared to $505.9 million in 2020. Bank card fees increased $16.1 million, or 10.6%, over the prior year, due to increases in net corporate card fees of $9.3 million, net debit card fees of $3.4 million, net credit card fees of $1.8 million and net merchant fees of $1.7 million. The growth in net corporate and credit card fees over the prior year was due to higher interchange income, partly offset by higher rewards expense. Net debit card fees increased due to higher interchange income, partly offset by an increase in network expense. Net merchant fees were up due to an increase in merchant discount fees, partly offset by higher rewards expense. Trust fee income increased $27.6 million, or 17.2%, as a result of continued growth in private client trust fees (up 19.1%) and higher institutional trust fees (up 11.0%). Private client trust fees comprised 78.4% of trust fee income in 2021. The market value of total customer trust assets totaled $69.3 billion at year end 2021, which was an increase of 13.2% over year end 2020 balances. Deposit account fees increased $4.0 million, or 4.3%, mainly due to growth in corporate cash management fees and overdraft and return item fees of $3.3 million and $1.2 million, respectively, partly offset by lower personal deposit account service charge fees of $1.2 million. In 2021, corporate cash management fees comprised 51.5% of total deposit fees, while overdraft fees comprised 24.8% of total deposit fees. Capital market fees grew $1.4 million, or 9.3%, compared to the prior year, while revenue from consumer brokerage services increased $3.3 million, or 21.6%, due to growth in advisory and annuity
28
Table of Contents
fees. Loan fees and sales increased $3.0 million, or 11.4%, mainly due to growth in mortgage banking revenue and loan commitment fees. Mortgage banking revenue was stronger in the first half of 2021 than during the second half of the year. As interest rates and competition for mortgage loans increased during 2021, loan fees and sales declined in the second half of 2021. Other non-interest income decreased $812 thousand, or 1.9%, from the prior year mainly due to lower cash sweep commissions of $7.9 million and a $2.2 million loss recorded on an equity method investment in 2021. These decreases were partly offset by gains of $5.6 million recorded mainly on sales of branch properties during 2021 and increases in interest rate swap fees and check sales and wire fees of $2.2 million and $1.0 million, respectively.
During 2020, 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 2019, 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 2019 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 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 2019, mostly due to higher sales volume, while consumer brokerage services fees 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.
29
Table of Contents
Investment Securities Gains (Losses), Net
Net gains on sales and fair value adjustments of equity securities 187 39 3,606
Net gains and losses on investment securities during 2021, 2020 and 2019 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 expense of $6.5 million in 2021, compared to income of $1.4 million in 2020 and expense of $348 thousand in 2019.
Net securities gains of $30.1 million were recorded in 2021, which included $1.5 million in net gains realized on sales of private equity investments, net gains totaling $31.7 million of fair value adjustments on private equity investments, and $187 thousand of fair value adjustments on equity investments. These net gains were offset by losses of $3.3 million realized on bond sales resulting from the Company's sale of approximately $73 million (book value) of bonds, mainly mortgage-backed securities.
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.
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.
30
Table of Contents
Non-Interest Expense
% Change
Salaries and benefits as a % of total non-interest expense 65.2 % 66.8 % 64.2 %
Non-interest expense was $805.9 million in 2021, an increase of $37.5 million, or 4.9%, over the previous year. Salaries and benefits expense increased $12.3 million, or 2.4%, mainly due to higher incentive compensation and healthcare expense, partly offset by lower salaries expense. Incentive compensation increased due to higher incentives in wealth and commercial, while full-time and part-time salaries expense declined mainly due to lower retail banking salaries expense. Full-time equivalent employees totaled 4,567 at December 31, 2021, reflecting a 4.2% decrease from 2020. Net occupancy expense increased $1.5 million, or 3.3%, mainly due to lower external rent income. Equipment expense decreased $750 thousand, or 4.0%, mainly due to lower depreciation and equipment service expense, while supplies and communication expense decreased $301 thousand, or 1.7%. Data processing and software expense increased $6.5 million, or 6.8%, primarily due to higher costs for service providers, bank card processing fees and software expense, while marketing expense increased $2.1 million, or 10.8%. Other non-interest expense increased $16.2 million, or 28.2%, over the prior year mainly due to $8.2 million in non-recurring litigation settlement costs recorded in the third quarter of 2021. In addition, deferred origination costs declined $3.5 million and deposit insurance expense increased $1.3 million. These increases were partly offset by a reduction in impairment expense of $3.6 million on the Company's mortgage servicing rights.
In 2020, non-interest expense was $768.4 million in 2020, an increase of $980 thousand, or .1%, over 2019. 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 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 2019 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.
Income Taxes
Income tax expense was $145.7 million in 2021, compared to $87.3 million in 2020 and $109.1 million in 2019. The effective tax rate, including the effect of non-controlling interest, was 21.5% in 2021 compared to 19.8% in 2020 and 20.6% in 2019. The increase in effective tax rate in 2021 compared to 2020 was primarily driven by higher net income before taxes. Additional information about income tax expense is provided in Note 9 to the consolidated financial statements.
31
Table of Contents
Financial Condition
Loan Portfolio Analysis
Classifications of consolidated loans by major category at December 31, 2021 and 2020 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 the loan portfolio at December 31, 2021, and a breakdown of those loans between fixed rate and floating rate loans are as follows.
Principal Payments Due
Commercial:
Personal banking:
32
Table of Contents
The following table shows loan balances at December 31, 2021, 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, 2021 were $15.2 billion, a decrease of $1.2 billion, or 7.1%, over balances at December 31, 2020. The decline in loans during 2021 occurred in the business, consumer credit card, revolving home equity and personal real estate loan categories, while construction, consumer, business real estate and overdraft loan categories increased from the prior year. Business loans decreased $1.2 billion, or 19.0%, mainly due to a $1.2 billion decline in PPP loan balances. As of December 31, 2021, 93% of PPP loan balances have been forgiven. Excluding PPP loans, business loans increased $204.5 million, or 4.1%, over balances at December 31, 2020. Lease lending and tax-advantaged lending, included within Business loans, declined during 2021, but these declines were partly offset by growth in commercial card lending. Construction loans increased $96.7 million, or 9.5% mainly due to growth in commercial construction lending. Business real estate loans increased $32.7 million, or 1.1%, due mainly to increases in multi-family, owner-occupied, and industrial lending, while hotel and senior living lending declined. Personal real estate loans declined $14.6 million, or .5%. The Company sells certain long-term fixed rate mortgage loans to the secondary market, and loan sales in 2021 totaled $547.1 million, compared to $275.1 million in 2020. Consumer loans increased $81.7 million, or 4.2%, mainly due to growth in private banking lending. Other vehicle and equipment lending (mostly comprised of motorcycle loans) also increased, offset by declines in auto lending, fixed rate home equity loans and continued run off of marine and recreational vehicle loan balances. Consumer credit card loans decreased $79.7 million, or 12.2%, and revolving home equity loan balances declined $31.1 million, or 10.1%, compared to balances at year end 2020.
The Company currently holds approximately 31% of its loan portfolio in the Kansas City market, 26% in the St. Louis market, and 43% in other regional markets. The portfolio is diversified from a business and retail standpoint, with 62% in loans to businesses and 38% in loans to consumers. 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, 2021, the balance of SNC loans totaled approximately $1.2 billion, with an additional $1.9 billion in unfunded commitments, compared to a balance of $1.0 billion, with an additional $1.7 billion in unfunded commitments, at year end 2020.
Commercial Loans
Business
Total business loans amounted to $5.3 billion at December 31, 2021 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 $729.9 million at December 31, 2021, a decrease of $131.1 million, or 15.2%, from December 31, 2020 balances. In addition to tax-advantaged leases, the business loan portfolio also includes other direct financing and sales type leases totaling $536.9 million at December 31, 2021, a decrease of $47.4 million, or 8.1%, from December 31, 2020. These loans are used by commercial customers to finance capital purchases ranging from computer equipment to office and transportation equipment. Additionally, the Company has outstanding oil and gas energy-related loans totaling $260.6 million at December 31, 2021, which are further discussed within the Oil and Gas Energy Lending section of
33
Table of Contents
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 portfolio are corporate card loans, which totaled $346.9 million at December 31, 2021 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 recoveries in this category totaled $4.8 million in 2021 compared to net loan charge-offs of $3.7 million in 2020. Non-accrual business loans were $7.3 million (.1% of business loans) at December 31, 2021 compared to $22.5 million at December 31, 2020.
Real Estate-Construction and Land
The portfolio of loans in this category amounted to $1.1 billion at December 31, 2021, an increase of $96.7 million, or 9.5%, from the prior year and comprised 7.4% of the Company’s total loan portfolio. Commercial construction and land development loans totaled $971.1 million, or 86.8% of total construction loans at December 31, 2021. These loans increased $103.6 million from 2020 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, 2021 totaled $147.1 million, or 13.2% of total construction loans. A stable construction market has contributed to low loss rates on these loans, with net loan charge-offs of nearly zero in both 2021 and 2020.
Real Estate-Business
Total business real estate loans were $3.1 billion at December 31, 2021 and comprised 20.2% 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 (38.9% 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, 2021, balances of non-accrual loans amounted to $214 thousand, less than .1% of business real estate loans, down from $2.2 million at year end 2020. The Company experienced net loan recoveries of $64 thousand in 2021, compared to net loan recoveries of $47 thousand in 2020.
Personal Banking Loans
Real Estate-Personal
At December 31, 2021, there were $2.8 billion in outstanding personal real estate loans, which comprised 18.5% 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, 2021, 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.
The Company originates certain mortgage loans with the intent to sell to the secondary market, generally FNMA or FHLMC conforming fixed rate loans. The remaining loans are originated with the intent to hold to maturity. Of the $1.3 billion of mortgage loans originated in 2021, $547.1 million were sold to the secondary market. This compares to $1.5 billion of mortgage loans originated and $275.1 million of loans sold to the secondary market in 2020. The increase in loan sales during 2021 compared to 2020 was partly due to the Company temporarily pausing loan sales for the second quarter of 2020.
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
34
Table of Contents
recoveries in 2021 totaled $98 thousand, and net loan recoveries were $291 thousand in 2020. Balances of non-accrual loans in this category were $1.6 million at December 31, 2021, compared to $1.8 million at year end 2020.
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 December 31, 2021. Approximately 42% of the consumer portfolio consists of automobile loans, 29% in private banking loans, 11% in fixed rate home equity loans, and 9% in healthcare financing loans. Total consumer loans increased $81.7 million at year end 2021 compared to year end 2020. Growth of $109.6 million in private banking loans was supplemented by increases in other executive lines of credit and motorcycle loans. These increases in consumer loan balances were partially offset by declines of $24.5 million in automobile loans, $19.3 million in fixed rate home equity loans, $7.3 million in marine and RV loans, and $1.5 million in patient healthcare financing. Net charge-offs on total consumer loans were $2.6 million in 2021, compared to $4.4 million in 2020, averaging .13% and .23% of consumer loans in 2021 and 2020, respectively.
Revolving Home Equity
Revolving home equity loans, of which more than 99% are adjustable rate loans, totaled $275.9 million at year end 2021. An additional $784.3 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 loan charge-offs were nearly zero in 2021, compared to net loan recoveries of $166 thousand in 2020.
Consumer Credit Card
Total consumer credit card loans amounted to $575.4 million at December 31, 2021 and comprised 3.8% 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 39% of the households that own a Commerce credit card product also maintain a deposit relationship with the subsidiary bank. Approximately 95% of the outstanding credit card loan balances had a floating interest rate at year end 2021, unchanged from year end 2020. Net charge-offs amounted to $20.0 million in 2021, a decrease of $6.0 million from $26.0 million in 2020.
Loans Held for Sale
At December 31, 2021, 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 $5.6 million at December 31, 2021. The student loans, carried at the lower of cost or fair value, totaled $3.0 million at December 31, 2021. Both of these portfolios are further discussed in Note 2 to the consolidated financial statements.
35
Table of Contents
Allowance for Credit Losses on Loans and Liability for Unfunded Lending Commitments
To determine the amount of the allowance for credit losses on loans and the liability for unfunded lending commitments, the Company has established a process 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 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 uses 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.
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, 2021, the allowance for credit losses on loans was $150.0 million, compared to $220.8 million at December 31, 2020. The allowance for credit losses related to commercial loans decreased $23.8 million during 2021, due to decreases in the allowance for business and construction loans of $19.7 million and $4.7 million, respectively. Compared to December 31, 2020, the allowance for credit losses on consumer credit card, personal real estate, and consumer loans decreased $38.5 million, $3.0 million, and $5.2 million, respectively. These large decreases resulted from an improved forecast utilized in the Company’s estimate of future credit losses at December 31, 2021, coupled with lower than projected net loan charge-offs during the year. The allowance for credit losses at December 31, 2020 included an uncertain economic projection defined by high unemployment and other business and personal disruptions caused by COVID-19. Through various governmental stimulus programs and improvements in the public health crisis due to the development and increasing availability of a COVID-19 vaccine, the projected net charge-offs were not realized and the economic forecast improved, thus allowing the release of the allowance for credit losses during 2021. As a result, the provision for credit losses, which includes the provision for loans and unfunded lending commitments, was a benefit of $66.3 million for the year, compared to a provision of $137.2 million in 2020. See Note 2 to the consolidated financial statements for the various model assumptions utilized in the Company's CECL estimate at December 31, 2021.
The percentage of allowance to loans decreased to .99% at December 31, 2021, compared to 1.35% at December 30, 2020. The percentage of allowance to commercial portfolio loans decreased to 1.03% at December 31, 2021, compared to 1.15% at December 30, 2020, and the percentage of allowance to personal banking loans decreased to .92% at December 31, 2021 from 1.73% at December 31, 2020. The allowance fell as a percentage of loans at December 31, 2021 because the economic forecast utilized in the Company’s CECL model improved over the forecast utilized at December 31, 2020, and the net charge-offs projected at December 31, 2020 did not come to fruition. Additionally, 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. At December 31, 2021, PPP loans outstanding were approximately $129.2 million.
36
Table of Contents
Excluding the PPP loans, the allowance for credit losses on loans was 1.00% of loans at December 31, 2021 and 1.48% at December 31, 2020. Most of the PPP loans originated by the Company during 2020 and 2021 have been forgiven, and the Company expects nearly all of the remaining outstanding PPP loans to be forgiven during 2022.
Total loans delinquent 90 days or more and still accruing were $11.7 million at December 31, 2021, a decrease of $10.5 million compared to year end 2020. The decrease was mainly driven by decreases of $7.0 million in consumer credit card, $3.0 million in business, and $1.1 million in consumer loans delinquent 90 days or more, partly offset by an increase of $411 thousand in revolving home equity loan delinquencies. Non-accrual loans at December 31, 2021 were $9.2 million, a decrease of $17.4 million over the prior year, mainly due to a decrease in business and business real-estate non-accrual loans of $15.2 million and $2.0 million, respectively. The allowance for credit losses as a percentage of non-accrual loans was 1,638.6% at December 31, 2021, compared to 832.1% at December 31, 2020. The increase in the ratio of the allowance to non-accrual loans was driven by the decrease in non-accrual loans outstanding. The 2021 year-end balance of non-accrual loans was comprised of $7.3 million of business loans, $1.6 million of personal real estate loans, and $214 thousand of business real estate loans.
Net loan charge-offs totaled $18.6 million in 2021, representing a $16.3 million decrease compared to net charge-offs of $34.9 million in 2020. The decrease was largely due net recoveries of $4.8 million on business loans during 2021, compared to net charge-offs of $3.7 million in the prior year, and lower net charge-offs in consumer credit card and consumer loans of $6.0 million and $1.9 million, respectively. Consumer credit card net charge-offs were 3.47% of average consumer credit card loans in 2021, compared to 3.88% in 2020. Consumer credit card loan net charge-offs as a percentage of total net charge-offs increased to 107.8% in 2021, compared to 74.5% in 2020. Consumer loan net charge-offs were .13% of average consumer loans in 2021, compared to .23% in 2020, and represented 13.8% of total net loan charge-offs in 2021. The ratio of net charge-offs to total average loans outstanding in 2021 was .12%, compared to .22% in 2020 and .35% in 2019.
At December 31, 2021, the liability for unfunded lending commitments was $24.2 million, a decrease of $14.1 million compared to December 31, 2020. The decrease in the liability for unfunded lending commitments during 2021 was driven by the improved economic forecast. The Company's unfunded lending commitments primarily relate to construction loans, and 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 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, 2021.
37
Table of Contents
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 3 — 7
Real estate — business 155 — 82
Recoveries of loans previously charged off:
Real estate — construction and land 2 3 124
Ratio of allowance to loans at end of year .99 % 1.35 % 1.09 %
Ratio of provision to average loans outstanding -.33 % .73 % .35 %
Ratio of non-accrual loans to total loans outstanding .06 % .16 % .07 %
(A) Net of unearned income, before deducting allowance for credit losses on loans, excluding loans held for sale.
38
Table of Contents
Years Ended December 31
Real estate — construction and land — — (.01)
Real estate — business — — —
Real estate — personal — (.01) —
Revolving home equity — (.05) .06
Average loans outstanding by loan class are listed on the Company's average balance sheet on page 62.
The following schedule provides a breakdown of the allowance for credit losses on loans (ACL) by loan category and the percentage of each loan category to total loans outstanding at year end.
39
Table of Contents
Risk Elements of the 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.
The following schedule shows non-performing assets and loans past due 90 days and still accruing interest.
December 31
Non-accrual loans totaled $9.2 million at year end 2021, a decrease of $17.4 million from the balance at year end 2020. The decrease from December 31, 2020 occurred mainly in business loans, which decreased $15.2 million, and business real estate loans, which decreased $2.0 million. At December 31, 2021, non-accrual loans were comprised of business (79.9%), personal real estate (17.8%), and business real estate (2.3%) loans. Foreclosed real estate totaled $115 thousand at December 31, 2021, an increase of $22 thousand when compared to December 31, 2020. Total non-performing assets remain low compared to the overall banking industry in 2021, with the non-performing assets to total loans ratio at .06% at December 31, 2021. Total loans past due 90 days or more and still accruing interest were $11.7 million as of December 31, 2021, a decrease of $10.5 million when compared to December 31, 2020. 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 $278.7 million at December 31, 2021, compared with $361.8 million at December 31, 2020, resulting in a decrease of $83.1 million or 23.0%. The decrease in potential problem loans was largely driven by a $95.9 million decrease in business loans, partly offset by a $10.9 million and $2.1 million increase in construction loans and business real estate loans, respectively.
December 31
Potential problem loans:
40
Table of Contents
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 a higher 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 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.
Real Estate - Construction and Land Loans
The Company’s portfolio of construction and land loans, as shown in the table below, amounted to 7.4% of total loans outstanding at December 31, 2021. The largest component of construction and land loans was commercial construction, which increased $95.1 million during the year ended December 31, 2021. At December 31, 2021, multi-family residential construction loans totaled approximately $155.9 million, or 16.9%, of the commercial construction loan portfolio.
Real Estate – Business Loans
Total business real estate loans were $3.1 billion at December 31, 2021 and comprised 20.2% 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 38.9% of these loans were for owner-occupied real estate properties, which present lower risk profiles.
41
Table of Contents
Revolving Home Equity Loans
The Company has revolving home equity loans that are generally collateralized by residential real estate. Most of these loans (92.6%) 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, 2021 was 792. 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 18.7% of the Company's current outstanding balances are expected to mature. Of these balances, 85.9% 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.
Loans with LTV:
* Percentage of total principal outstanding of $275.9 million at December 31, 2021.
Loans with LTV:
* Percentage of total principal outstanding of $307.1 million at December 31, 2020.
Consumer Loans
The Company's consumer loans totaled $2.0 billion and comprised 13.4% of total loans outstanding at December 31, 2021. 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 42% of the consumer loan portfolio at December 31, 2021, and outstanding balances in the auto loan portfolio were $855.4 million and $879.9 million at December 31, 2021 and 2020, respectively. The balances over 30 days past due amounted to $9.0 million at December 31, 2021, compared to $9.2 million at the end of 2020, and comprised 1.1% of the outstanding balances of these loans at December 31, 2021 compared to 1.0% at December 31, 2020. For the year ended December 31, 2021, $400.8 million of new auto loans were originated, compared to $399.3 million during 2020. At December 31, 2021, the automobile loan portfolio had a weighted average FICO score of 757, and net charge-offs on auto loans were .13% of average auto loans at December 31, 2021.
The Company's consumer loan portfolio also includes fixed rate home equity loans, typically for home repair or remodeling, and these loans comprised 11% of the consumer loan portfolio at December 31, 2021. Losses on these loans have historically been low, and the Company saw a net charge-off of $47 thousand in 2021. Private banking loans comprised 29% of the consumer loan portfolio at December 31, 2021. The Company's private banking loans are generally well-collateralized and at December 31, 2021 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 $1.4 million in 2021 and were .16% of the average balances of these loans at December 31, 2021.
42
Table of Contents
Consumer Credit Card Loans
The Company offers low introductory rates on selected consumer credit card products. Out of a portfolio at December 31, 2021 of $575.4 million in consumer credit card loans outstanding, approximately $87.9 million, or 15.3%, carried a low promotional rate. Within the next six months, $34.9 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.
Oil and Gas Energy Lending
The Company's energy lending portfolio was comprised of lending to the petroleum and natural gas sectors and totaled $260.6 million at December 31, 2021, an increase of $81.9 million from year end 2020, as shown in the table below.
Information about the credit quality of the Company's energy lending portfolio as of December 31, 2021 and December 31, 2020 is provided in the table below.
Energy lending balances classified as non-accrual represented .9% of total energy lending loan balances at December 31, 2021. There were no balances classified as substandard at December 31, 2021. The Company recorded $10 thousand of recoveries on energy loans for the year ended December 31, 2021, compared to $15 thousand of net loan charge-offs on energy loans for the year ended December 31, 2020.
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 Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"). As a participating lender under the program, the Company funded $1.9 billion in loans for customers. From the start of the PPP through December 31, 2021, the Company has recognized in income $57.2 million out of $60.4 million total fees that it expects to earn from the program.
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 originated loans is five years, however, as of December 31, 2021, 93% of the PPP loans have been forgiven by the SBA. Almost all of the remaining loans are expected to be forgiven during 2022.
43
Table of Contents
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 19.2% during 2021 to $14.4 billion (excluding unrealized gains/losses in fair value) at year end 2021. During 2021, debt securities of $5.9 billion were purchased, which included $1.5 billion in agency mortgage-backed securities, $2.4 billion in asset-backed securities, $286.7 million in state and municipal securities, and $1.3 billion in non-agency mortgage-based securities. Total sales, maturities and pay downs of available for sale debt securities were $3.5 billion during 2021. During 2022, maturities and pay downs of approximately $3.0 billion are expected to occur. The Company's tax-exempt investment portfolio is primarily comprised of tax-exempt municipal bonds and certain equity securities in its private equity investment portfolio. There were no significant changes to the Company's tax-exempt investment portfolio during 2021. The average tax equivalent yield earned on total investment securities was 1.81% in 2021 and 2.19% in 2020.
At December 31, 2021, the fair value of available for sale securities was $14.5 billion, which included a net unrealized gain in fair value of $30.9 million, compared to a net unrealized gain of $351.7 million at December 31, 2020. The overall unrealized gain in fair value at December 31, 2021 included net gains of $45.2 million is U.S. government and federal agency obligations and net gains of $24.6 million in state and municipal securities. These unrealized gains were partly offset by net losses of $38.5 million in mortgage and asset-backed securities. 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 losses on securities be recorded in current earnings. For the year ended December 31, 2021, 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 $ 1,035,477 $ 775,592
Government-sponsored enterprise obligations 50,773 50,803
Fair Value
U.S. government and federal agency obligations $ 1,080,720 $ 838,059
Government-sponsored enterprise obligations 51,755 54,485
At December 31, 2021, the available for sale portfolio included $5.7 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 $1.4 billion and included $329.3 million collateralized by commercial mortgages and $1.0 billion collateralized by residential mortgages at December 31, 2021.
At December 31, 2021, U.S. government obligations included TIPS of $390.9 million, at fair value. Other debt securities include corporate bonds, notes and commercial paper.
44
Table of Contents
The types of securities held in the available for sale security portfolio at year end 2021 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 7.5 % 1.34 % 2.6 years
Government-sponsored enterprise obligations 0.4 2.32 15.0
State and municipal obligations 14.4 1.97 6.6
Agency mortgage-backed securities 39.3 1.94 5.2
Non-agency mortgage-backed securities 9.5 1.84 3.7
*Based on call provisions and estimated prepayment speeds.
Equity securities include common and preferred stock with readily determinable fair values that totaled $7.2 million at December 31, 2021, compared to $3.0 million at December 31, 2020.
Other securities totaled $194.0 million at December 31, 2021 and $156.7 million at December 31, 2020. 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
Private equity investments in debt securities 63,416 43,609
Private equity investments in equity securities 83,990 50,759
In addition to its holdings in the investment securities portfolio, the Company invests in securities purchased under agreements to resell, which totaled $1.6 billion at December 31, 2021 and $850.0 million at December 31, 2020. These investments mature in 2022 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 $1.7 billion in marketable investment securities at December 31, 2021. The average rate earned on these agreements during 2021 was 2.9%, compared to 4.7% in 2020.
The Company also holds offsetting repurchase and resale agreements totaling $400.0 million at December 31, 2021 and $200.0 million at December 31, 2020, 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 2022 and earned an average of 30 basis points during 2021, compared to 41 basis points in 2020.
45
Table of Contents
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 $29.8 billion at December 31, 2021, compared to $26.9 billion last year, reflecting an increase of $2.9 billion, or 10.6%.
Average deposits increased $4.3 billion, or 18.2%, in 2021 compared to 2020, resulting from increases in average demand deposits, which increased $2.4 billion, primarily driven by higher balances in business demand deposits. Additionally, average money market deposit account balances increased $1.8 billion in 2021, and savings account balances increased $327.1 million. Partially offsetting these increases in deposit balances were declines in average certificates of deposit balances, which decreased $221.0 million in 2021.
The following table shows year end deposit balances by type, as a percentage of total deposits.
December 31
Non-interest bearing 39.4 % 38.9 %
Savings, interest checking and money market 55.7 54.2
Certificates of deposit of less than $100,000 1.5 2.0
Certificates of deposit of $100,000 and over 3.4 4.9
Core deposits, which include non-interest bearing, interest checking, savings, and money market deposits, supported 79% and 77% of average earning assets in 2021 and 2020, respectively. Average balances by major deposit category for the last six 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 all certificates of deposits outstanding at December 31, 2021 is included in Note 7 on Deposits in the consolidated financial statements.
Total uninsured deposits were calculated using the same methodology that the Company uses to determine uninsured deposits for regulatory reporting and amounted to $14.6 billion and $12.7 billion at December 31, 2021 and December 31, 2020. The following table shows a detailed breakdown of the maturities of uninsured certificates of deposit at December 31, 2021. The Company calculated the uninsured deposits in the following table by aggregating all deposit balances by customer and assuming federal deposit insurance would first apply to demand deposits, followed by savings deposits, and lastly to time deposits (beginning with the earliest maturity deposits).
(In thousands) Uninsured Certificates of Deposit at December 31, 2021
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, 2021 were $3.0 billion, comprised of federal funds purchased of $43.4 million and repurchase agreements of $3.0 billion. These balances increased $1.1 million and $923.5 million from the federal funds purchased and repurchase agreements outstanding at December 31, 2020. On an average basis, these borrowings increased $368.4 million, or 18.7%, during 2021, due to an increase of $470.9 million in repurchase agreements, partially offset by a decrease of $102.6 million in federal funds purchased. The average rate paid on both federal funds purchased and repurchase agreements was .07% during 2021, compared to rates of .63% paid on federal funds purchased and .29% paid on repurchase agreements during 2020.
Historically, the majority of the Company’s long-term debt has been comprised of fixed rate advances from the FHLB. There were no FHLB borrowings during 2021. 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. The average rate paid on FHLB advances was .82% during 2020.
46
Table of Contents
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, 2021 and 2020, such assets were as follows:
Federal funds sold 2,800 —
There were $2.8 million federal funds sold at December 31, 2021, which are funds lent to the Company’s correspondent bank customers with overnight maturities. Resale agreements, maturing through 2023, totaled $1.6 billion at December 31, 2021. Under these agreements, the Company lends funds to upstream financial institutions and holds marketable securities, safe-kept by a third-party custodian, as collateral. This collateral totaled $1.7 billion in fair value at December 31, 2021. Interest earning balances at the Federal Reserve Bank, which have overnight maturities and are used for general liquidity purposes, totaled $4.0 billion at December 31, 2021. The fair value of the available for sale debt portfolio was $14.5 billion at December 31, 2021 and included an unrealized net gain of $30.9 million. The total net unrealized gain included net gains of $45.2 million on U.S. government and federal agency obligations and $24.6 million on state and municipal obligations. These net gains were partially offset by net unrealized losses of $38.5 million on mortgage-backed and asset-backed securities.
Approximately $3.0 billion of the available for sale debt portfolio is expected to mature or pay down during 2022, and these funds offer substantial resources to meet either new loan demand or help offset potential reductions in the Company’s deposit funding base. The Company pledges portions of its investment securities portfolio to secure public fund deposits, securities sold under agreements to repurchase, trust funds, letters of credit issued by the FHLB, and borrowing capacity at the Federal Reserve Bank. At December 31, 2021 and 2020, total investment securities pledged for these purposes were as follows:
47
Table of Contents
Investment securities pledged for the purpose of securing:
FHLB borrowings and letters of credit 3,218 5,376
* 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 56.5% for the year ended December 31, 2021. Core customer deposits, defined as non-interest bearing, interest checking, savings, and money market deposit accounts, totaled $28.4 billion and represented 95.2% of the Company’s total deposits at December 31, 2021. 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 $3.3 billion at year end 2021 compared to year end 2020, primarily due to increases in commercial and consumer deposits of $2.0 billion and $1.4 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 $3.0 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 $2.6 billion through advances from the FHLB and the Federal Reserve.
Core deposit base:
Certificates of deposit of $100,000 or greater totaled $1.0 billion at December 31, 2021. These deposits are normally considered more volatile and higher costing, and comprised 3.4% of total deposits at December 31, 2021.
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 $43.4 million at December 31, 2021, 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, 2021 were comprised of non-insured customer funds totaling $3.0 billion, and securities pledged for these retail agreements totaled $3.1 billion.
48
Table of Contents
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, 2021.
(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 $2.1 billion in 2021, 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 $597.7 million and has historically been a stable source of funds. Investing activities used cash of $2.1 billion. Purchases (net of sales and maturities proceeds) of investment securities used cash of $2.4 billion, securities purchased under agreements to resell used cash of $900.0 million, and a net decrease in the loan portfolio provided cash of $1.1 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 2021, financing activities provided cash of $3.6 billion. This increase in cash was largely driven by growth in deposits, which provided cash of $2.9 billion. Federal funds purchases and short-term securities sold under agreements to repurchase provided cash in the amount of $924.6 million. The Company paid cash dividends of $122.7 million on common stock, and treasury stock purchases used cash of $129.4 million during 2021. 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.
49
Table of Contents
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
*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, 2021, the Parent’s investment securities totaled $12.8 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 2021 or 2020.
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.
Material Cash Requirements, Contractual Obligations, Commitments, and Off-Balance Sheet Arrangements
The Company's material cash requirements include commitments for contractual obligations (both short-term and long-term), commitments to extend credit, and off-balance sheet arrangements. The Company's material cash requirements for the next 12 months are primarily to fund loan growth. Additionally, the Company will utilize cash to fund deposit maturities and withdrawals that may occur in the next 12 months. Other contractual obligations, purchase commitments, lease obligations, and unfunded commitments may require cash payments by the Company within the next 12 months, and these, along with longer-term obligations, are discussed below.
A table summarizing contractual cash obligations of the Company at December 31, 2021, and the expected timing of these payments follows:
Payments Due by Period
*Includes principal payments only.
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 $13.3 billion (including approximately $5.0
50
Table of Contents
billion in unused, approved credit card lines) and the contractual amount of standby letters of credit totaling $418.3 million at December 31, 2021. 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.
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 2021, 2020 or 2019, and the Company is not required nor does it expect to make a contribution in 2022.
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 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, 2021, the investments totaled $60.0 million and are recorded as other assets in the Company’s consolidated balance sheet. Unfunded commitments, which are recorded as liabilities, amounted to $40.6 million at December 31, 2021.
During the third quarter of 2020, the Company signed a $106.7 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. As of December 31, 2021, the Company has made payments totaling $55.2 million. While the Company intends to occupy a portion of the office building for executive offices, a 15 year lease has been signed by an anchor tenant to lease approximately 50% of the office building.
The Company regularly purchases various state tax credits arising from third-party property redevelopment. These credits are either resold to third parties for a profit or retained for use by the Company. During 2021, purchases and sales of tax credits amounted to $113.5 million and $108.1 million, respectively. Income from the sales of tax credits were $4.5 million, $4.2 million and $3.5 million in 2021, 2020 and 2019, respectively. At December 31, 2021, the Company had outstanding purchase commitments totaling $186.0 million that it expects to fund in 2022. These commitments, along with the commitments for the next five years, are included in the table above.
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. Through the various sources of liquidity described above, the Corporation maintains a liquidity position that it believes will adequately satisfy its financial obligations. The Company is not aware of any trends, events, or commitments that are reasonably likely to increase or decrease its liquidity in a material way.
51
Table of Contents
Capital Management
Under Basel III capital guidelines, at December 31, 2021 and 2020, 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 9.01 9.92
* 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 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 2020, the Company purchased 886 thousand shares, and during 2021 the Company purchased 1.8 million shares. There were no shares purchased under an accelerated share repurchase (ASR) agreement in 2021 or 2020. The ASR agreement is further discussed in Note 14 to the consolidated financial statements. At December 31, 2021, 1.7 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 2.0% in 2021 compared with 2020, and the Company increased its first quarter 2022 cash dividend 6.0%, making 2022 the Company's 54th consecutive year of regular cash dividend increases. The Company also distributed its 28th consecutive annual 5% stock dividend in December 2021.
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.
52
Table of Contents
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.
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 rate risk is slightly more asset sensitive than the previous quarter, which resulted mainly from an increase in interest earning deposits with the Federal Reserve. Deposit attrition was removed from the simulation in both the current and previous quarters. The Company did not model a 100 basis point falling scenario due to the already low interest rate environment.
53
Table of Contents
In Simulation B, the assumed higher levels of deposit attrition were modeled to capture the results of a shrinking balance sheet. Under this Simulation, in the three rising rate scenarios, interest rate risk is slightly less asset sensitive than the previous quarter, which primarily resulted from an increase in surge deposits.
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.
54
Table of Contents
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, 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.
In addition to using derivatives to manage interest rate risk, the Company enters into foreign exchange derivative instruments as an accommodation to customers and offsets the related foreign exchange risk by entering into offsetting third-party forward contracts with approved, reputable counterparties. This trading activity is managed within a policy of specific controls and limits.
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 only enters into transactions with high quality counterparties, there have been no losses associated with counterparty nonperformance on derivative financial instruments.
The following table summarizes the notional amounts and estimated fair values of the Company’s derivative instruments at December 31, 2021 and 2020. 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. All of these derivative instruments utilized by the Company are further discussed in Note 19 on Derivative Instruments.
Mortgage loan forward sale contracts 1,165 5 (1) — — —
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.
55
Table of Contents
The table below is a summary of segment pre-tax income results for the past three years.
Investment securities gains, net — — — — 30,059 30,059
Investment securities gains, net — — — — 11,032 11,032
Increase in income before income taxes:
Investment securities gains, net — — — — 3,626 3,626
Increase (decrease) in income before income taxes:
Consumer
The Consumer segment includes consumer deposits, consumer finance, and consumer debit and credit cards. During 2021, income before income taxes for the Consumer segment increased $9.3 million, or 6.6%, compared to 2020. This increase was due to a decrease in non-interest expense of $4.3 million, or 1.4%, and a decrease in the provision for credit losses of $8.0 million. These increases to income were partly offset by a $1.6 million, or .5%, decrease in net interest income and a $1.3 million, or .9%, decrease to non-interest income. Net interest income decreased due to a $21.9 million decline in loan interest income, partly offset by a $9.1 million increase in net allocated funding credits assigned to the Consumer segment's loan and deposit portfolios, and lower deposit interest expense of $11.2 million. Non-interest income decreased mainly due to a decline in mortgage banking revenue, partly offset by growth in net credit and debit card fees (mainly higher interchange fees, partly offset by higher credit card rewards expense) and check sales and wire fees. Non-interest expense decreased from the prior year mainly due to lower salaries and benefits expense, occupancy expense, allocated servicing costs for mortgage operations and a reduction in impairment expense on mortgage servicing rights. These decreases were partly offset by higher marketing expense and higher allocated costs for information technology. The provision for credit losses totaled $23.2 million, an $8.0 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 $178.3 million, or 8.5%, in 2021 compared to 2020 mainly due to declines in consumer credit card, auto and fixed and revolving home equity loans. Average deposits increased $1.6 billion, or 13.8%, over the prior year, resulting from growth in personal demand, savings and interest checking and money market deposit accounts.
56
Table of Contents
During 2020, income before income taxes for the Consumer segment increased $32.1 million, or 29.6%, compared to 2019. This increase was due to growth of $5.3 million, or 1.7% in net interest income, non interest income of $13.3 million, or 9.9%, 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 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 $260 thousand, or .1%, in non-interest expense. Non-interest expense increased over 2019 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 2019, 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 2019, resulting from growth in personal demand, savings, interest checking and money market deposit accounts.
Commercial
The Commercial segment provides 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 2021 increased $50.8 million, or 17.5%, compared to 2020, mainly due to increases in net interest income and non-interest income and a decline in the provision for credit losses, partly offset by an increase in non-interest expense. Net interest income increased $39.0 million, or 9.4%, due to higher net allocated funding credits of $56.9 million and lower interest expense of $12.9 million on deposits and customer repurchase agreements, partly offset by a decrease of $30.9 million in loan interest income. The provision for credit losses decreased $8.6 million due to recoveries recorded on business loans in the current year compared to net charge-offs recorded in the prior year. Non-interest income increased $16.5 million, or 8.5%, over 2020 due to higher net bank card fees (mainly corporate card and merchant fees), deposit account fees (mainly corporate cash management fees), and higher interest rate swap fees. These increases were partly offset by lower cash sweep commissions. Non-interest expense increased $13.3 million, or 4.2%, during 2021, mainly due to higher salaries and benefits expense (mainly incentive compensation), data processing and software expense, allocated support costs for information technology and commercial banking, and lower deferred origination costs. These increases were partly offset by lower allocated service costs (mainly lockbox). Average segment loans decreased $327.8 million, or 3.1%, compared to 2020, with the decline occurring in business loans (mainly PPP loans), partly offset by an increase in construction loans. Average deposits increased $2.1 billion, or 20.7%, mainly due to growth in business demand deposits.
Pre-tax income for 2020 increased $55.7 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 in 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 $50.4 million in loan interest income. The provision for credit losses decreased $480 thousand from 2019 due to lower lease loan net charge-offs, partly offset by higher business 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 $6.8 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.
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, 2021, the Trust group managed investments with a market value of $42.9 billion and administered an additional $26.4 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, 2021. In 2021, pre-tax income for the Wealth segment was $148.7 million, compared to $121.9 million in 2020,
57
Table of Contents
an increase of $26.8 million, or 22.0%. Net interest income increased $13.6 million, or 23.5%, due to an $11.0 million increase in net allocated funding credits and lower deposit interest expense of $4.0 million, slightly offset by a decline in loan interest income of $1.3 million. Non-interest income increased $24.7 million, or 13.1%, over the prior year largely due to higher private client and institutional trust fees and brokerage fees, partly offset by lower cash sweep commissions. Non-interest expense increased $11.4 million, or 9.1%, resulting from higher salaries expense (mainly incentive compensation) and higher allocated support costs for information technology. The provision for credit losses increased $64 thousand, mainly due to higher net charge-offs on revolving home equity loans. Average assets increased $178.3 million, or 12.7%, during 2021 mainly due to higher personal real estate and consumer loan balances. Average deposits increased $694.7 million, or 30.6%, due to growth in business demand and interest checking and money market account deposit balances.
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 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.
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 2021, the pre-tax net income in this category was $47.3 million, compared to a net loss of $110.9 million in 2020. This increase was due to higher non-interest income of $14.6 million, partly offset by a decrease in net interest income of $45.4 million, and an increase in non-interest expense of $17.1 million. Unallocated securities gains were $30.1 million in 2021, compared to securities gains of $11.0 million in 2020. Also, the unallocated provision for credit losses decreased $187.0 million, primarily driven by a decrease 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, 2021, the Company's provision for credit losses on unfunded lending commitments, which is not allocated to the segments for management reporting, was a benefit of $14.1 million. Additionally, the provision for credit losses on loans was $70.8 million lower than net charge-offs, as the provision was a benefit in 2021, while the provision was $81.2 million in excess of net charge-offs in 2020.
58
Table of Contents
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.
CECL 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 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 was no implementation impact on held-to-maturity debt securities as the Company does not hold any held-to-maturity debt securities.
CECL 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.
Upon adoption of CECL, 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. The allowance for credit losses on the personal banking portfolio increased upon adoption of CECL, 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. As a result, the Company's allowance for loan losses to total loans ratio declined from 1.09% at December 31, 2019, to .95% at the time of the Company's adoption of CECL. Offsetting the overall reduction in the allowance for credit losses for outstanding loans was an increase in the liability for unfunded lending commitments, as the loss estimation was required to be expanded over the contractual commitment period. 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.
59
Table of Contents
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.