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 257 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 $477.1 million, a decrease of 2.3% compared to the previous year. The return on average assets was 1.49% in 2023, and the return on average common equity was 17.94%. Diluted earnings per share decreased .8% in 2023 compared to 2022.
• Total revenue — Total revenue is comprised of net interest income and non-interest income. Total revenue in 2023 increased $82.5 million, or 5.5%, from 2022, as net interest income grew $55.9 million, and non-interest income increased $26.5 million. Growth in net interest income resulted principally from increases in interest income from loans, partly offset by an increase in interest expense on deposits and borrowings. The increase in non-interest income in 2023 was mainly due to higher bankcard transaction fees and trust fees.
• Non-interest expense — Total non-interest expense increased 9.7% this year compared to 2022, mainly due to higher salaries and employee benefits expense and higher deposit insurance expense due to a special FDIC assessment accrued in 2023.
• Asset quality — Net loan charge-offs totaled $31.1 million in 2023, an increase of $12.0 million from those recorded in 2022, and averaged .19% of loans in 2023, as compared to .12% of loans in 2022. Total non-performing assets, which include non-accrual loans and foreclosed real estate, amounted to $7.6 million at December 31, 2023, compared to $8.4 million at December 31, 2022, and represented .04% of loans outstanding at December 31, 2023.
• Shareholder return — During 2023, the Company paid cash dividends of $1.03 per share on its common stock, representing an increase of 7.1% over the previous year. In 2023, the Company issued its 30th consecutive annual 5% common stock dividend, and in February 2024, the Company's Board of Directors authorized an increase of 5.1% in
22
Table of Contents
the common cash dividend. The Company purchased 1,354,811 shares in 2023. Total shareholder return, including the change in stock price and dividend reinvestment, was 5.7%, 8.7%, and 8.7% 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 total 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.
Less preferred stock — — — — 144,784
* Intangible assets other than mortgage servicing rights.
23
Table of Contents
Results of Operations
$ Change % Change
N.M. - Not meaningful.
Net income attributable to Commerce Bancshares, Inc. (net income) for 2023 was $477.1 million, a decrease of $11.3 million, or 2.3%, compared to $488.4 million in 2022. Diluted income per common share was $3.64 in 2023, compared to $3.67 in 2022. The decrease in net income resulted mainly from an increase of $82.2 million in non-interest expense, partly offset by increases in net interest income of $55.9 million and non-interest income of $26.5 million. The return on average assets was 1.49% in 2023 compared to 1.45% in 2022, and the return on average common equity was 17.94% in 2023 compared to 17.31% in 2022. At December 31, 2023, the ratio of tangible common equity to tangible assets increased to 8.85%, compared to 7.32% at year end 2022.
During 2023, net interest income grew mainly due to increases of $338.1 million in interest income earned on loans and $88.2 million in interest income earned on deposits with banks, mainly due to higher average rates, partly offset by increases in interest expense on deposits and borrowings of $215.7 million and $110.2 million, respectively, mainly due to higher average rates paid. Total rates earned on average interest earning assets increased 134 basis points this year, while funding costs for deposits and borrowings increased 156 basis points. The provision for credit losses increased mainly due to higher net loan charge-offs and an increase in the estimate of the allowance for credit losses this year compared to last year. Net loan charge-offs increased $12.0 million, mainly due to higher credit card, consumer and business loan net charge-offs in 2023.
Non-interest income grew 4.9% in 2023, mainly due to increases in bank card and trust fees. Net investment securities gains of $15.0 million were recorded in 2023 and were comprised mainly of net fair value gains on the Company's private equity investment portfolio, partly offset by losses on sales of available for sale securities. Non-interest expense increased $82.2 million in 2023 compared to 2022, mainly due to higher salaries and benefits expense and deposit insurance expense.
Net income attributable to Commerce Bancshares, Inc. (net income) for 2022 was $488.4 million, a decrease of $42.4 million, or 8.0%, compared to $530.8 million in 2021. Diluted income per common share was $3.67 in 2022, compared to $3.91 in 2021. The decrease in net income resulted from an increase of $94.4 million in the provision for credit losses, as well as an increase of $42.9 million in non-interest expense and a decrease of $13.9 million in non-interest income. These decreases to net income were partly offset by increases in net interest income of $106.8 million and a decrease in income tax expense of $13.4 million. The return on average assets was 1.45% in 2022 compared to 1.55% in 2021, and the return on average common equity was 17.31% in 2022 compared to 15.37% in 2021. At December 31, 2022, the ratio of tangible common equity to assets decreased to 7.32%, compared to 9.01% at year end 2021.
During 2022, net interest income grew mainly due to increases of $77.6 million in interest income earned on investment securities, due to higher average rates earned and higher average balances, and $75.5 million in interest income earned on loans, mainly due to higher average rates earned, partly offset by an increase in interest expense on deposits and borrowings of $43.9 million, due to higher average rates paid. Total rates earned on average interest earning assets increased 41 basis points in 2022, while funding costs for deposits and borrowings increased 23 basis points. The provision for credit losses increased in 2022 compared to 2021 due to a significant reduction in the allowance for credit losses on loans during 2021, which did not reoccur in 2022. In addition, there was an increase in the liability for unfunded lending commitments during 2022, compared to a decrease in 2021. Net loan charge-offs increased $496 thousand, mainly due to business loan net charge-offs in 2022, compared to net loan recoveries recorded in 2021, partly offset by lower credit card loan net charge-offs in 2022.
Non-interest income fell 2.5% in 2022, mainly due to a decrease in loan fees and sales income. Net investment securities gains of $20.5 million were recorded in 2022 and were comprised mainly of net fair value gains on the Company's private
24
Table of Contents
equity investment portfolio, partly offset by losses on sales of available for sale securities. Non-interest expense increased $42.9 million in 2022 compared to 2021, mainly due to higher salaries and benefits expense and data processing and software expense.
The Company distributed a 5% stock dividend for the 30th consecutive year on December 19, 2023. All per share and average share data in this report has been restated for the 2023 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 debt securities 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 judgments 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.
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
25
Table of Contents
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 judgment 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 require a reduction in the allowance for credit losses. 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.
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 those which 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. Certain securities are analyzed using a projected cash flow model, discounted to present value, and compared to the current amortized cost bases of the securities. The model uses input factors such as cash flow projections, contractual payments required, expected delinquency rates, credit support from other tranches, prepayment speeds, collateral loss severity rates (including loan to values), and various other information related to the underlying collateral. Securities not analyzed using the cash flow model are analyzed by reviewing risk ratings, credit support agreements, and industry knowledge to project future cash flows and any possible credit impairment.
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 securities portfolio, but significant change in interest rates and deterioration in economic conditions could result in a requirement for additional allowance. Likewise, an increase in interest rates and improved economic conditions may require a reduction in the allowance for credit losses. In either instance, anticipated changes could have a significant impact on our financial condition and results of operations.
26
Table of Contents
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, 2023, assets and liabilities measured using observable inputs that are classified as either Level 1 or Level 2 represented 98.2% and 99.6% 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 $177.8 million, or 1.8% 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.
27
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 $998.1 million in 2023, increasing $55.9 million, or 5.9%, compared to $942.2 million in 2022. On a fully taxable-equivalent (FTE) basis, net interest income totaled $1.0 billion, and increased $54.9 million over 2022. This growth was mainly due to increases of $339.4 million in interest earned on loans and $88.2 million in interest earned on balances at the Federal Reserve, both mainly due to higher average rates earned. These increases were partly offset by an increase of $325.9 million in interest expense on deposits and borrowings, mainly due to higher average rates paid, and lower interest earned on investment securities of $38.0 million, mainly due to lower average balances. The net yield on earning assets (FTE) was 3.16% in 2023 compared with 2.85% in 2022. The fully taxable-equivalent basis uses a federal income tax rate of 21%.
28
Table of Contents
During 2023, loan interest income (FTE) grew $339.4 million over 2022 mainly due to an increase in rates earned for all loan categories and a $1.2 billion, or 7.8%, increase in average loan balances. The average fully taxable-equivalent rate earned on the loan portfolio increased 172 basis points to 5.90% in 2023 compared to 4.18% in 2022. The higher rates earned on the loan portfolio were partly related to actions taken by the Federal Reserve to raise short-term interest rates, which caused most of the Company's variable rate loan portfolio to re-price higher. Additionally, fixed rate loans were generally originated in 2023 at higher interest rates than the weighted-average of the portfolio of fixed rate loans. Increased interest earned on business, business real estate and construction and land loans was the main driver of overall higher interest income. Business loan interest income increased $128.3 million due to a 196 basis point increase in the average rate earned and an increase of $405.2 million, or 7.5%, in average balances. Business real estate loan interest grew $80.2 million in 2023 compared to 2022 as a result of an increase of 181 basis points in the average rate earned and higher average balances of $372.0 million, or 11.6%. Interest earned on construction and land loans increased $55.3 million due to an increase of 292 basis points in the average rate earned and growth of $243.8 million, or 19.8%, in average balances. Interest on personal real estate loans increased $15.9 million as the average rate earned increased 38 basis points and the average balance grew $137.4 million. Interest on consumer loans grew $37.3 million over the prior year as the average rate earned increased 174 basis points. Revolving home equity loan interest increased $10.2 million due to an increase of 301 basis points in the average rate earned and growth in average balances of $22.7 million. Interest on consumer credit card loans was higher by $12.4 million due to an increase of 191 basis points in the average rate earned and a $14.0 million increase in average balances.
Fully taxable-equivalent interest income on total investment securities decreased $38.0 million during 2023, as average balances declined $2.6 billion, while the average rate earned increased 14 basis points. The average rate on the total investment securities portfolio was 2.29% in 2023 compared to 2.15% in 2022, while the average balance of the total investment securities portfolio (excluding unrealized fair value adjustments on available for sale debt securities) was $12.4 billion in 2023 compared to an average balance of $14.9 billion in 2022. The decrease in interest income was mainly due to lower interest income earned on U.S. government securities, state and municipal securities and mortgage-backed securities. Interest earned on U.S. government securities decreased $16.2 million mainly due to lower treasury inflation-protected securities (TIPS) interest income of $14.3 million. Average balances of U.S. government securities decreased $96.0 million and the average rate earned declined 125 basis points. The decrease of $15.8 million in interest earned on state and municipal securities was due to a decrease of $542.8 million in average balances and a decline of 23 basis points in average rate earned. Interest earned on mortgage-backed securities decreased $7.0 million due to a lower average balances of $742.6 million, partly offset by an increase of 12 basis points in the average rate earned. Interest earned on asset-backed securities decreased $398 thousand, due to a decline in average balances of $1.2 billion, mostly offset by an increase of 62 basis points in the average rate earned.
Interest on securities purchased under resell agreements decreased $9.0 million compared to 2022 due to a decrease in average balances of $793.8 million, partly offset by growth of 43 basis points in the average rate. Interest income on balances at the Federal Reserve increased $88.2 million over 2022, mainly due to a 416 basis point increase in the average rate earned and growth in average balances of $597.3 million.
During 2023, interest expense on deposits increased $215.7 million over 2022 and resulted mainly from a 126 basis point increase in the overall average rate paid on deposits. Interest expense on interest checking and money market accounts increased $121.3 million mainly due to higher rates paid, which grew 94 basis points, slightly offset by lower average balances of $1.4 billion. Interest expense on certificates of deposit grew $94.4 million, mainly due to a 350 basis point increase in the average rate paid, coupled with a $1.4 billion increase in average balances. The overall rate paid on total deposits increased from .18% in 2022 to 1.44% in the current year. Interest expense on borrowings increased $110.2 million mainly due to a 210 basis point increase in the rate paid on securities sold under repurchase agreements and an increase in $711.3 million in average Federal Home Loan Bank (FHLB) borrowings. The Company did not have any outstanding FHLB borrowings at December 31, 2023. The overall average rate incurred on all interest bearing liabilities was 1.86% in 2023, compared to .30% in 2022.
Net interest income totaled $942.2 million in 2022, increasing $106.8 million, or 12.8%, compared to $835.4 million in 2021. On an FTE basis, net interest income totaled $951.8 million, and increased $104.7 million over 2021. This growth was mainly due to an increase of $75.7 million in interest earned on loans, due to higher average rates earned and an increase of $76.9 million in interest earned on investment securities, due to higher rates and average balances, partly offset by an increase of $45.3 million in interest expense on deposits and borrowings, due to higher average rates paid. The net yield on earning assets (FTE) was 2.85% in 2022 compared with 2.58% in 2021.
29
Table of Contents
During 2022, loan interest income (FTE) grew $75.7 million over 2021 mainly due to an increase in rates earned for all loan categories. The average fully taxable-equivalent rate earned on the loan portfolio increased 51 basis points to 4.18% in 2022 compared to 3.67% in 2021. The higher rates earned on the loan portfolio were mostly related to actions taken by the Federal Reserve in 2022 to raise short-term interest rates, which caused most of the Company's variable rate loan portfolio to re-price higher. Additionally, fixed rate loans were generally originated in 2022 at higher interest rates than the weighted-average of the portfolio of fixed rate loans. The increase in interest rates earned was partly offset a decline in average loan balances of $102.4 million, or .7%, in 2022. Increased interest earned on business real estate and construction and land loans was the main driver of overall higher interest income. Business real estate loan interest grew $29.6 million in 2022 compared to 2021 as a result of an increase of 71 basis points in the average rate earned and higher average balances of $199.1 million, or 6.6%. Interest earned on construction and land loans increased $21.2 million due to an increase of 147 basis points in the average rate earned and growth of $85.2 million, or 7.4%, in average balances. Business loan interest income increased $11.3 million mainly due to a 49 basis point increase in the average rate earned, partly offset by a decrease of $462.1 million in average balances. Average balances of business loans included average balances of $41.9 million in Paycheck Protection Program (PPP) loans at December 31, 2022, which was a decline of $812.2 million from balances of $854.1 million at December 31, 2021. Interest on personal real estate loans increased $2.6 million as the average balance grew $44.0 million and the average rate earned increased four basis points. Interest on consumer loans grew $7.7 million over 2021 as the average rate earned increased 25 basis points and average balances were higher by $66.2 million. Revolving home equity loan interest increased $2.8 million due to an increase of 108 basis points in the average rate earned, slightly offset by lower average balances of $5.8 million. Interest on consumer credit card loans was higher by $558 thousand due to an increase of 72 basis points in the average rate earned, mostly offset by a decline of $30.3 million, or 5.3%, in average balances.
Fully taxable-equivalent interest income on total investment securities increased $76.9 million during 2022, as average balances grew $1.5 billion and the average rate earned increased 34 basis points. The average rate on the total investment securities portfolio was 2.15% in 2022 compared to 1.81% in 2021, while the average balance of the total investment securities portfolio (excluding unrealized fair value adjustments on available for sale debt securities) was $14.9 billion in 2022 compared to an average balance of $13.5 billion in 2021. The increase in interest income was mainly due to higher interest income earned on mortgage-backed, asset-backed and U.S. government securities. Interest earned on mortgage-backed securities increased $40.7 million due to a 59 basis point increase in the average rate earned. The increase of $26.0 million in interest earned on asset-backed securities was due to an increase of 35 basis points in the average rate earned coupled with growth of $1.1 billion in average balances. Interest earned on U.S. government securities grew $8.2 million and was mainly impacted by growth of $7.3 million in inflation income on TIPS. Average balances of U.S. government securities increased $301.9 million, while the average rate earned declined 39 basis points.
Interest on securities purchased under resell agreements decreased $14.7 million compared to 2021 due to a decrease of 142 basis points in the average rate, partly offset by growth in average balances of $220.1 million. Interest earned on deposits with banks increased $11.9 million over 2021, mainly due to a 98 basis point increase in the average rate earned, partly offset by a decline in average balances of $1.1 billion.
During 2022, interest expense on deposits increased $19.2 million over 2021 and resulted mainly from an 11 basis point increase in the overall average rate paid on deposits. Interest expense on interest checking and money market accounts increased $18.0 million mainly due to higher rates paid, which grew 12 basis points, coupled with higher average balances of $1.1 billion. Interest expense on certificates of deposit over $100,000 grew $1.3 million, mainly due to a 37 basis point increase in the average rate paid. The overall rate paid on total deposits increased from .07% in 2021 to .18% in the current year. Interest expense on borrowings increased $26.0 million mainly due to a 95 basis point increase in the rate paid on securities sold under repurchase agreements. The overall average rate incurred on all interest bearing liabilities was .30% in 2022, compared to .07% in 2021.
Provision for Credit Losses
The provision for credit losses is comprised of provisions for credit losses on loans and 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 $35.5 million in 2023, an increase of $7.4 million over the 2022 provision.
The provision for credit losses on loans for the year ended December 31, 2023 was $43.3 million, compared to $19.2 million in 2022. The allowance for credit losses on loans totaled $162.4 million at December 31, 2023, an increase of $12.3 million compared to the prior year, and represented .94% of loans at year end 2023, compared to .92% at December 31, 2022.
30
Table of Contents
The provision for unfunded lending commitments was a benefit of $7.9 million during 2023, compared to a provision of $8.9 million in 2022. The liability for unfunded lending commitments was $25.2 million at December 31, 2023, compared to $33.1 million at December 31, 2022.
Non-Interest Income
% Change
Non-interest income as a % of total revenue* 36.5 % 36.7 % 40.1 %
Total revenue per full-time equivalent employee $ 333.0 $ 324.1 $ 305.6
* 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, 2023, 2022 and 2021, respectively.
% Change
Non-interest income totaled $573.0 million, an increase of $26.5 million, or 4.9%, compared to $546.5 million in 2022. Bank card fees increased $15.0 million, or 8.5%, over the prior year, mainly due to increases in net corporate card fees of $10.6 million, net debit card fees of $2.9 million and net merchant fees of $1.6 million. The growth in net corporate card fees over the prior year was mainly due to lower rewards and network expense coupled with higher interchange income. Net debit card fees increased mainly due to lower network expense, while net merchant fees increased mainly due to higher merchant discount fees. Trust fee income increased $6.2 million, or 3.4%, as a result of higher private client trust fees (up 4.3%), which comprised 80.4% of trust fee income in 2023. The market value of total customer trust assets totaled $68.9 billion at year end 2023, which was an increase of 14.2% over year end 2022 balances. Deposit account fees decreased $3.4 million, or 3.6%, mainly due to lower overdraft and return item fees of $8.3 million, partly offset by growth in corporate cash management fees of $3.8 million. In 2023, corporate cash management fees comprised 61.9% of total deposit fees, while overdraft fees comprised 12.8% of total deposit fees. Revenue from consumer brokerage services decreased $1.9 million, or 9.9%, mainly due to lower annuity fees, while loan fees and sales decreased $2.0 million, or 15.0%, mainly due to lower mortgage banking revenue. Other non-interest income increased $12.7 million, or 28.2%, over the prior year mainly due to higher letter of credit fees of $3.2 million, cash sweep commissions of $2.9 million, gains on the sale of real estate of $2.1 million and swap fees of $1.1 million. In addition, increases of $6.4 million in fair value adjustments were recorded on the Company's deferred compensation plan, which are held in a trust and recorded as both an asset and a liability, affecting both other income and other expense. These increases were partly offset by lower tax credit sales income of $2.4 million.
During 2022, non-interest income totaled $546.5 million, a decrease of $13.9 million, or 2.5%, compared to $560.4 million in 2021. Trust fee income decreased $3.5 million, or 1.9%, as a result of lower institutional (down 7.0%), mutual fund (down 10.9%) and private client trust fees (down .3%). Private client trust fees comprised 79.7% of trust fee income in 2022. The market value of total customer trust assets totaled $60.3 billion at year end 2022, which was a decrease of 13.0% from year end 2021 balances. Bank card fees increased $8.3 million, or 4.9%, over 2021, mainly due to an increase in net corporate card fees of $8.3 million. The growth in net corporate card fees over 2021 was mainly due to higher interchange income, partly offset by higher rewards expense. Deposit account fees decreased $2.8 million, or 2.9%, mainly due to lower overdraft and return item fees of $4.2 million and personal account deposit fees of $1.2 million, partly offset by growth in corporate cash management
31
Table of Contents
fees of $2.5 million. In 2022, corporate cash management fees comprised 55.6% of total deposit fees, while overdraft fees comprised 21.1% of total deposit fees. In September 2022, the Company implemented enhancements to consumer checking accounts that eliminated return items fees and lowered overdraft fees. Capital market fees decreased $1.7 million, or 10.7%, compared to 2021, while revenue from consumer brokerage services increased $755 thousand, or 4.1%, mainly due to growth in annuity fees. Loan fees and sales decreased $16.6 million, or 55.8%, mainly due to lower mortgage banking revenue. Other non-interest income increased $1.8 million, or 4.1%, over 2021 mainly due to higher cash sweep commissions of $8.2 million and lease income of $1.3 million, income of $2.2 million from a life insurance death benefit recorded in the second quarter of 2022, a $2.6 million loss on an equity method investment recorded in 2021 and a lease impairment of $1.1 million recorded in 2021. These increases were partly offset by gains of $5.6 million recorded mainly on the sales of branch properties in 2021. In addition, a decrease of $6.6 million in fair value adjustments was recorded on the Company's deferred compensation plan.
Investment Securities Gains (Losses), Net
Net gains (losses) on sales of equity securities — 17 —
Fair value adjustments on equity securities, net (487) (943) 187
Net gains (losses) on sales of private equity investments (100) (2,128) 1,452
Net gains and losses on investment securities during 2023, 2022 and 2021 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 $4.8 million in 2023, $8.5 million in 2022, and $6.5 million in 2021.
Net securities gains of $15.0 million were recorded in 2023, which included net gains of $24.0 million in fair value adjustments on private equity investments. This increase was partly offset by net losses of $8.4 million realized on sales resulting from the Company's sale of approximately $1.1 billion (book value) in bonds, mainly state and municipal securities and asset-backed securities, net losses of $100 thousand on sales of private equity investments, and net losses of $487 thousand in fair value adjustments on equity securities.
Net securities gains of $20.5 million were recorded in 2022, which included net gains of $43.8 million in fair value adjustments on private equity investments. This increase was partly offset by losses of $20.3 million realized on sales resulting from the Company's sale of approximately $105 million (book value) in bonds, mainly mortgage-backed and corporate bond securities, net losses of $2.1 million on sales of private equity investments, and net losses of $943 thousand in fair value adjustments on equity securities.
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 of $31.7 million in fair value adjustments on private equity investments, and net gains of $187 thousand in 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 and municipal securities.
32
Table of Contents
Non-Interest Expense
% Change
Salaries and benefits as a % of total non-interest expense 62.7 % 65.3 % 65.2 %
Non-interest expense was $931.0 million in 2023, an increase of $82.2 million, or 9.7%, over the previous year. Salaries and benefits expense increased $30.0 million, or 5.4%, mainly due to higher costs for full-time salaries, healthcare expense and payroll taxes, partly offset by lower incentive compensation expense. Full-time equivalent employees totaled 4,718 at December 31, 2023, compared to 4,594 at December 31, 2022. Data processing and software expense increased $8.1 million, or 7.3%, primarily due to increased costs for service providers and higher bank card processing fees. Net occupancy expense increased $4.5 million, or 9.2%, mainly due to higher depreciation expense and real estate taxes, partly offset by higher rent income. Deposit insurance expense increased $22.6 million due to a $16.0 million accrual during the fourth quarter of 2023 for a one-time special assessment by the FDIC to replenish the Deposit Insurance Fund. Marketing expense increased $684 thousand, or 2.9%, while supplies and communication expense increased $1.3 million, or 7.3%, mainly due to higher postage expense, bank card reissuance fees and office supplies expense. Other non-interest expense increased $14.8 million, or 23.5%, mainly due to higher costs for travel and entertainment expense (up $1.9 million), miscellaneous losses (up $2.1 million), pension plan expense ($1.5 million) and lower deferred origination costs (up $1.6 million). In addition, an increase of $6.4 million in fair value adjustments were recorded on the Company's deferred compensation plan, and deconversion costs of $2.1 million relating to the transition of Commerce Financial Advisors support to LPL Financial's Institution Services platform were recorded in 2023.
In 2022, non-interest expense was $848.8 million, an increase of $42.9 million, or 5.3%, over 2021. Salaries and benefits expense increased $28.8 million, or 5.5%, mainly due to higher costs for full-time salaries, incentive compensation, stock compensation, payroll taxes and 401(k) expense. Salaries expense included expense of $5.4 million for special bonuses paid to non-incentivized full-time and part-time employees in 2022. Full-time equivalent employees totaled 4,594 at December 31, 2022, reflecting a 1% increase over 2021. Data processing and software expense increased $8.9 million, or 8.7%, primarily due to higher bank card processing fees, software amortization and expense, and increased costs for service providers. Net occupancy expense increased $932 thousand, or 1.9%, mainly due to higher depreciation, utilities and outside services expense, partly offset by lower real estate taxes expense. Equipment expense increased $1.3 million, or 7.0%, mainly due to higher depreciation and equipment service contract expense, while marketing expense increased $2.0 million, or 9.0%. Supplies and communication expense increased $983 thousand, or 5.7%, mainly due to higher postage and courier expense and bank card reissuance fees, partly offset by lower data network expense. Other non-interest expense increased slightly over 2021. Higher costs for travel and entertainment expense (up $5.1 million), insurance expense (up $1.9 million), depreciation expense on leased assets (up $958 thousand) and airplane expense (up $864 thousand) were offset by $8.2 million in non-recurring litigation settlement costs recorded in 2021. In addition, the previously mentioned fair value adjustments on the Company's deferred compensation plan assets decreased $6.6 million from 2021.
Income Taxes
Income tax expense was $134.5 million in 2023, compared to $132.4 million in 2022 and $145.7 million in 2021. The effective tax rate, including the effect of non-controlling interest, was 22.0% in 2023 compared to 21.3% in 2022 and 21.5% in 2021. Additional information about income tax expense is provided in Note 9 to the consolidated financial statements.
33
Table of Contents
Financial Condition
Loan Portfolio Analysis
Classifications of consolidated loans by major category at December 31, 2023 and 2022 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 table below presents contractual maturities of the loan portfolio, based on payment due dates, as well as a breakdown of fixed rate and floating rate loans at December 31, 2023.
Principal Payments Due
Commercial:
Personal banking:
34
Table of Contents
The following table shows loan balances at December 31, 2023, 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, 2023 were $17.2 billion, an increase of $902.3 million, or 5.5%, over balances at December 31, 2022. The increase in loans during 2023 occurred in all categories over the previous year, with the exception of overdrafts. Business loans increased $357.3 million, or 6.3%, mainly due to a $173.9 million increase in commercial and industrial loans and a $95.1 million increase in lease loans. Commercial card and tax-advantaged lending, included within business loans, also increased during 2023. Construction loans increased $85.7 million, or 6.3%, mainly due to growth in commercial construction lending. Business real estate loans increased $312.3 million, or 9.2%, due mainly to increases in industrial, hotel and senior living lending, while multi-family and office building lending declined. Personal real estate loans increased $108.0 million, or 3.7%. The Company sells certain long-term fixed rate mortgage loans to the secondary market, and loan sales in 2023 totaled $29.9 million, compared to $111.3 million in 2022. Consumer loans increased $18.6 million, or .9%, mainly due to growth in consumer auto lending. Health services financing and fixed rate home equity loans also increased, offset by declines in other vehicle and equipment lending (mostly comprised of motorcycle loans) and continued run off of marine and recreational vehicle loan balances. Consumer credit card loans increased $5.9 million, or 1.0%, and revolving home equity loan balances increased $22.7 million, or 7.6%, compared to balances at year end 2022.
The Company currently holds approximately 31% of its loan portfolio in the Kansas City market, 25% in the St. Louis market, and 44% in other regional markets. The portfolio is diversified from a business and retail standpoint, with 65% in loans to businesses and 35% in loans to consumers. The Company believes a diversified approach to loan portfolio management, strong underwriting criteria and an aversion toward credit concentrations from an industry, geographic and product perspective, have contributed to low levels of problem loans and credit losses on loans experienced over the last several years.
The Company participates in credits of large, publicly traded companies which are defined by regulation as shared national credits, or SNCs. Regulations define SNCs as loans exceeding $100 million that are shared by three or more financial institutions. The Company typically participates in these loans when business operations are maintained in the local communities or regional markets and opportunities to provide other banking services are present. At December 31, 2023, the balance of SNC loans totaled approximately $1.5 billion, with an additional $2.2 billion in unfunded commitments, compared to a balance of $1.4 billion, with an additional $2.0 billion in unfunded commitments, at year end 2022.
Commercial Loans
Business
Total business loans amounted to $6.0 billion at December 31, 2023 and includes 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 $666.1 million at December 31, 2023, an increase of $48.0 million, or 7.8%, from December 31, 2022 balances. In addition to tax-advantaged leases, the business loan portfolio also includes other direct financing and sales type leases totaling $709.7 million at December 31, 2023, an increase of $95.1 million, or 15.5%, from December 31, 2022. These loans are used by commercial customers to finance capital purchases ranging from computer equipment to office and transportation equipment. Additionally, the Company has $260.8 million of outstanding loans included within its $272.0 million oil and gas energy-related loan portfolio at December 31, 2023, which is further discussed within the Oil and Gas Energy Lending section of the Risk Elements of Loan Portfolio section located within Management's Discussion and Analysis of Financial Condition and Results of Operations. Also included in the business portfolio are corporate card loans, which totaled $407.6 million at December 31, 2023 and are made in conjunction with the Company’s corporate card
35
Table of Contents
business for corporate trade purchases. Corporate card loans are made to corporate, non-profit and government customers nationwide, but have very short-term maturities, which limits credit risk.
Business loans, excluding corporate card loans, are made primarily to customers in the regional trade area of the Company, generally the central Midwest, encompassing the states of Missouri, Kansas, Illinois, and nearby Midwestern markets, including Iowa, Oklahoma, Colorado, Texas, Tennessee, Michigan, Indiana, and Ohio. This portfolio is diversified from an industry standpoint and includes businesses engaged in manufacturing, wholesaling, retailing, agribusiness, insurance, financial services, public utilities, health care, and other service businesses. Emphasis is upon middle-market and community businesses with known local management and financial stability. Consistent with management’s strategy and emphasis upon relationship banking, most borrowing customers also maintain deposit accounts and utilize other banking services. Net loan charge-offs in this category totaled $3.1 million in 2023 compared to $1.1 million in 2022. Non-accrual business loans were $3.6 million (.1% of business loans) at December 31, 2023 compared to $6.8 million at December 31, 2022.
Real Estate-Construction and Land
The portfolio of loans in this category amounted to $1.4 billion at December 31, 2023, an increase of $85.7 million, or 6.3%, from the prior year and comprised 8.4% of the Company’s total loan portfolio. Commercial construction and land development loans totaled $1.3 billion, or 88.0% of total construction loans at December 31, 2023. These loans increased $100.9 million from 2022 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, 2023 totaled $173.1 million, or 12.0% of total construction loans. A stable construction market has contributed to low loss rates on these loans, with net loan recoveries of $115 thousand and no net loan charge-offs in 2023 and 2022, respectively.
Real Estate-Business
Total business real estate loans were $3.7 billion at December 31, 2023 and comprised 21.6% of the Company’s total loan portfolio. This category includes mortgage loans for small and medium-sized office and medical buildings, manufacturing and warehouse facilities, 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 (31.6% 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, 2023, balances of non-accrual loans amounted to $60 thousand, less than .1% of business real estate loans, down from $189 thousand at year end 2022. The Company experienced net loan charge-offs of $104 thousand in 2023, compared to net loan recoveries of $20 thousand in 2022.
Personal Banking Loans
Real Estate-Personal
At December 31, 2023, there were $3.0 billion in outstanding personal real estate loans, which comprised 17.6% 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, 2023, 39% of the portfolio was comprised of adjustable rate loans, while 61% was comprised of fixed rate loans. The Company does not purchase any loans from outside parties or brokers.
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 $510 million of mortgage loans originated in 2023, $29.9 million were sold to the secondary market. This compares to $699 million of mortgage loans originated and $111.3 million of loans sold to the secondary market in 2022. The decrease in loan sales during 2023 compared to 2022 was mainly due to lower demand for mortgage loans. Net loan recoveries in 2023 totaled $37 thousand, and net loan recoveries were $74 thousand in 2022. Balances of non-accrual loans in this category were $1.7 million at December 31, 2023, compared to $1.4 million at year end 2022.
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 $2.1 billion at
36
Table of Contents
December 31, 2023. Approximately 39% of the consumer portfolio consists of automobile loans, 32% in private banking loans, 11% in fixed rate home equity loans, and 10% in healthcare financing loans. Total consumer loans increased $18.6 million at year end 2023 compared to year end 2022. Growth of $21.7 million in auto loans was supplemented by increases of $13.7 million and $4.5 million in patient healthcare financing and fixed rate home equity loans, respectively. These increases in consumer loan balances were partially offset by declines of $13.7 million in other vehicle and equipment loans and $3.7 million in marine and RV loans. Net charge-offs on total consumer loans were $6.2 million in 2023, compared to $3.8 million in 2022, averaging .30% and .18% of consumer loans in 2023 and 2022, respectively.
Revolving Home Equity
Revolving home equity loans, of which 100% are adjustable rate loans, totaled $319.9 million at year end 2023. An additional $900.0 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 recoveries were $57 thousand in 2023, compared to net loan recoveries of $60 thousand in 2022.
Consumer Credit Card
Total consumer credit card loans amounted to $589.9 million at December 31, 2023 and comprised 3.4% 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 37% 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 2023, unchanged from year end 2022. Net charge-offs amounted to $19.1 million in 2023, an increase of $6.4 million from $12.7 million in 2022.
Loans Held for Sale
At December 31, 2023, 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 $1.6 million at December 31, 2023. The student loans, carried at the lower of cost or fair value, totaled $2.2 million at December 31, 2023. This portfolio is further discussed in Note 2 to the consolidated financial statements.
37
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 the 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.
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 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.
At December 31, 2023, the allowance for credit losses on loans was $162.4 million, compared to $150.1 million at December 31, 2022. The allowance for credit losses related to commercial loans increased $4.9 million during 2023, while the allowance for credit losses related to personal banking loans increased $7.4 million. The increase in the allowance for credit losses was due to an increase in outstanding loan balances, slower prepayment speeds, changes in forecast assumptions, and increases in past due consumer and consumer credit card loans. The percentage of allowance to loans increased to .94% at December 31, 2023, compared to .92% at December 31, 2022. See Note 2 to the consolidated financial statements for the various model assumptions utilized in the Company's CECL estimate at December 31, 2023.
Net loan charge-offs totaled $31.1 million in 2023, representing a $12.0 million increase compared to net charge-offs of $19.1 million in 2022. The increase was largely due to higher net charge-offs of $6.4 million, $2.5 million, $2.1 million, and $1.1 million on consumer credit card loans, consumer loans, business loans, and overdrafts, respectively, during 2023. Consumer credit card loan net charge-offs were 3.40% of average consumer credit card loans in 2023, compared to 2.31% in 2022, and consumer loan net charge-offs were .30% of average consumer loans in 2023, compared to .18% in 2022. The ratio of net loan charge-offs to total average loans outstanding was .19% in 2023 and .12% in both 2022 and 2021.
Total loans delinquent 90 days or more and still accruing were $21.9 million at December 31, 2023, an increase of $6.0 million compared to year end 2022. The increase was mainly driven by growth of $2.9 million in personal real estate loans. Non-accrual loans at December 31, 2023 were $7.3 million, a decrease of $994 thousand from the prior year, mainly due to a decrease in business non-accrual loans of $3.1 million, partly offset by an increase of $2.0 million in revolving home equity non-accrual loans. The allowance for credit losses as a percentage of non-accrual loans was 2,220.9% at December 31, 2023, compared to 1,807.6% at December 31, 2022. The increase in the ratio of the allowance to non-accrual loans was driven by the decrease in non-accrual loans outstanding and an increase in the allowance for credit losses. The 2023 year-end balance of non-accrual loans was comprised of $3.6 million of business loans, $1.7 million of personal real estate loans, $2.0 million of revolving home equity loans, and $60 thousand of business real estate loans.
At December 31, 2023, the liability for unfunded lending commitments was $25.2 million, an decrease of $7.9 million compared to December 31, 2022. The decrease in the liability for unfunded lending commitments during 2023 was driven primarily by decreases in the balance of unfunded lending commitments. 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.
38
Table of Contents
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, 2023.
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
Recoveries of loans previously charged off:
Real estate — construction and land 115 — 2
Ratio of allowance to loans at end of year .94 % .92 % .99 %
Ratio of provision to average loans outstanding .26 % .12 % (.33) %
Ratio of non-accrual loans to total loans outstanding .04 % .05 % .06 %
(A) Net of unearned income, before deducting allowance for credit losses on loans, excluding loans held for sale.
39
Table of Contents
Years Ended December 31
Real estate — construction and land (.01) — —
Revolving home equity (.02) (.02) —
Average loans outstanding by loan class are listed on the Company's average balance sheet on page 60.
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.
The following schedule shows the liability for unfunded lending commitments.
Years Ended December 31
LIABILITY FOR UNFUNDED LENDING COMMITMENTS
40
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 $7.3 million at year end 2023, a decrease of $994 thousand from the balance at year end 2022. The decrease from December 31, 2022 occurred mainly in business loans, which decreased $3.1 million. This decrease was partially offset by an increase in revolving home equity loans of $2.0 million. At December 31, 2023, non-accrual loans were comprised of business (49.6%), revolving home equity (27.0%), personal real estate (22.6%), and business real estate (0.8%) loans. Foreclosed real estate totaled $270 thousand at December 31, 2023, an increase of $174 thousand when compared to December 31, 2022. Total non-performing assets remain low compared to the overall banking industry in 2023, with the non-performing assets to total loans ratio at .04% at December 31, 2023. Total loans past due 90 days or more and still accruing interest were $21.9 million as of December 31, 2023, an increase of $6.0 million when compared to December 31, 2022. 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 $216.4 million at December 31, 2023, compared with $259.7 million at December 31, 2022, resulting in a decrease of $43.3 million or 16.7%. The decrease in potential problem loans was largely driven by a $47.5 million decrease in construction and land loans and a $41.7 million decrease in business real estate loans, partly offset by a $45.3 million increase in business loans.
December 31
Potential problem loans:
Real estate – construction and land — 47,493
41
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 8.4% of total loans outstanding at December 31, 2023. The largest component of construction and land loans was commercial construction, which increased $100.9 million during the year ended December 31, 2023. At December 31, 2023, multi-family residential construction loans totaled approximately $414.6 million, or 33.9%, of the commercial construction loan portfolio.
Real Estate – Business Loans
Total business real estate loans were $3.7 billion at December 31, 2023 and comprised 21.6% 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, which have historically resulted in lower net charge-off rates than non-owner-occupied commercial real estate loans. Approximately 31.6% of these loans were for owner-occupied real estate properties, which have historically resulted in lower net charge-off rates than non-owner-occupied commercial real estate loans.
42
Table of Contents
Information about the credit quality of the Company's business real estate loan portfolio as of December 31, 2023 and December 31, 2022 is provided in the table below.
(Dollars in thousands) Pass Special Mention Substandard Non-Accrual Total
Revolving Home Equity Loans
The Company has revolving home equity loans that are generally collateralized by residential real estate. Most of these loans (91.9%) 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, 2023 was 785. 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 17.3% of the Company's current outstanding balances are expected to mature. Of these balances, 84.0% 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 $319.9 million at December 31, 2023.
43
Table of Contents
Loans with LTV:
* Percentage of total principal outstanding of $297.2 million at December 31, 2022.
Consumer Loans
The Company's consumer loans totaled $2.1 billion and comprised 12% of total loans outstanding at December 31, 2023. 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 39% of the consumer loan portfolio at December 31, 2023, and outstanding balances in the auto loan portfolio were $820.3 million and $798.6 million at December 31, 2023 and 2022, respectively. The balances over 30 days past due amounted to $9.5 million at December 31, 2023, compared to $9.9 million at the end of 2022, and comprised 1.2% of the outstanding balances of these loans at both December 31, 2023 and 2022. For the year ended December 31, 2023, $364.9 million of new auto loans were originated, compared to $329.3 million during 2022. At December 31, 2023, the automobile loan portfolio had a weighted average FICO score of 756, and net charge-offs on auto loans were .5% of average auto loans.
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, 2023. Losses on these loans have historically been low, and the Company had net recoveries of $68 thousand in 2023. Private banking loans comprised 32% of the consumer loan portfolio at December 31, 2023. The Company's private banking loans are generally well-collateralized and at December 31, 2023 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 $2.4 million in 2023 and were .3% of the average balances of these loans at December 31, 2023.
Consumer Credit Card Loans
The Company offers low introductory rates on selected consumer credit card products. Out of a portfolio at December 31, 2023 of $589.9 million in consumer credit card loans outstanding, approximately $114.8 million, or 19.5%, carried a low promotional rate. Within the next six months, $47.8 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 $272.0 million at December 31, 2023, a decrease of $24.4 million from year end 2022, as shown in the table below.
44
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, decreased 20.6% during 2023 to $10.9 billion (excluding unrealized gains/losses in fair value) at year end 2023. During 2023, debt securities of $138.8 million were purchased, which included $100.3 million in U.S. government and federal agency obligations and $37.6 million in government-sponsored enterprise obligations. Total sales, maturities and pay downs of available for sale debt securities were $3.0 billion during 2023. During 2024, maturities and pay downs of approximately $1.8 billion are expected to occur. The Company's tax-exempt investment portfolio is primarily comprised of tax-exempt municipal bonds. In 2023 the Company's tax-exempt investment portfolio represented 30% of the Company's total state and municipal investment portfolio, as compared to 50% in 2022. The average tax equivalent yield earned on total investment securities was 2.29% in 2023 and 2.15% in 2022.
At December 31, 2023, the fair value of available for sale securities was $9.7 billion, which included a net unrealized loss in fair value of $1.2 billion, compared to a net unrealized loss of $1.5 billion at December 31, 2022. The overall unrealized loss in fair value at December 31, 2023 included net losses of $24.8 million is U.S. government and federal agency obligations, net losses of $149.2 million in state and municipal securities, and net losses of $987.1 million in mortgage and asset-backed securities. For the year ended December 31, 2023, 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 $ 841,267 $ 1,078,807
Government-sponsored enterprise obligations 55,658 55,729
Fair Value
U.S. government and federal agency obligations $ 816,514 $ 1,035,406
Government-sponsored enterprise obligations 43,962 43,108
At December 31, 2023, the available for sale portfolio included $3.9 billion of agency mortgage-backed securities, which are collateralized bonds issued by agencies including FNMA, GNMA, FHLMC, FHLB, and Federal Farm Credit Banks. Non-agency mortgage-backed securities totaled $1.2 billion and included $336.0 million collateralized by commercial mortgages and $821.9 million collateralized by residential mortgages at December 31, 2023.
At December 31, 2023, U.S. government obligations included TIPS of $404.4 million, at fair value. Other debt securities include corporate bonds, notes and commercial paper.
45
Table of Contents
The types of securities held in the available for sale security portfolio at year end 2023 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 8.4 % 1.19 % 2.3 years
Government-sponsored enterprise obligations 0.5 2.38 12.4
State and municipal obligations 12.2 1.78 7.0
Agency mortgage-backed securities 40.3 2.10 6.9
Non-agency mortgage-backed securities 12.0 2.37 5.9
*Based on call provisions and estimated prepayment speeds.
Equity securities include common and preferred stock with readily determinable fair values that totaled $5.7 million at December 31, 2023, compared to $6.2 million at December 31, 2022.
Other securities totaled $222.5 million at December 31, 2023 and $225.0 million at December 31, 2022. 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. Also included in other securities are private equity investments which are held by a subsidiary qualified as a Small Business Investment Company. These investments are carried at estimated fair value, but are not readily marketable. While the nature of these investments carries a higher degree of risk than the normal lending portfolio, this risk is mitigated by the overall size of the investments and oversight provided by management, and management believes the potential for long-term gains in these investments outweighs the potential risks.
Other securities at year end for the past two years are shown below:
December 31
Equity method investments — 1,434
Private equity investments in debt securities 67,322 66,899
Private equity investments in equity securities 109,345 111,228
In addition to its holdings in the investment securities portfolio, the Company invests in securities purchased under agreements to resell, which totaled $450.0 million at December 31, 2023 and $825.0 million at December 31, 2022. Of the total resale agreements outstanding at December 31, 2023, $325.0 million mature in 2024 and $125.0 million mature in 2025. The resale agreements 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 $479.0 million in marketable investment securities at December 31, 2023. The average rate earned on these agreements during 2023 was 1.9%, compared to 1.5% in 2022.
At December 31, 2022, the Company also held offsetting repurchase and resale agreements totaling $200.0 million, 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 matured in 2023 and earned an average of 30 basis points during 2023, compared to 29 basis points in 2022.
46
Table of Contents
Deposits and Borrowings
Deposits, including both individual and corporate customer deposits, are the primary funding source for the Bank and are acquired from a broad base of local markets. Total period-end deposits were $25.4 billion at December 31, 2023, compared to $26.2 billion last year, reflecting a decrease of $823.5 million, or 3.1%.
Average deposits decreased $2.8 billion, or 9.9%, in 2023 compared to 2022, resulting from decreases of $6.1 billion and $2.7 billion in money market account balances and business demand deposits, respectfully. Partially offsetting these decreases were increases in interest checking and certificate of deposit account balances of $4.7 billion and $1.4 billion, respectively.
The following table shows year end deposit balances by type, as a percentage of total deposits.
December 31
Non-interest bearing 31.4 % 38.4 %
Savings, interest checking and money market 57.2 57.8
Certificates of deposit of less than $100,000 3.7 1.5
Certificates of deposit of $100,000 and over 7.7 2.3
Core deposits, which include non-interest bearing, interest checking, savings, and money market deposits, supported 72% and 81% of average earning assets in 2023 and 2022, 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. A maturity schedule of all certificates of deposits outstanding at December 31, 2023 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 $10.8 billion and $11.0 billion at December 31, 2023 and December 31, 2022. The following table shows a detailed breakdown of the maturities of uninsured certificates of deposit at December 31, 2023. The Company estimated 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, 2023
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, 2023 were $2.9 billion, comprised of federal funds purchased of $261.3 million and repurchase agreements of $2.6 billion. Compared to balances at December 31, 2022, December 31, 2023 balances of federal funds purchased increased $101.4 million and repurchase agreements outstanding decreased $34.4 million. On an average basis, these borrowings increased $400.4 million, or 16.4%, during 2023, due to an increase of $412.5 million in average federal funds purchased and a decrease of $12.2 million (average) in repurchase agreements. The average rates paid on federal funds purchased and repurchase agreements were 5.1% and 3.12%, respectively, during 2023, compared to rates of 2.21% on federal funds purchased and 1.02% paid on repurchase agreements during 2022.
In addition to the funding sources above, the Company may borrow from the FHLB on a short-term basis or long-term basis. During 2023, the Company had average short-term borrowings from the FHLB of $756.4 million. All of the short-term borrowings were repaid by the Company before December 31, 2023, and the average rate paid on the FHLB borrowings during 2023 was 5.22%. During 2022, the Company had average short-term borrowings from the FHLB of $45.1 million. All of the
47
Table of Contents
short-term borrowings were repaid by the Company before December 31, 2022, and the average rate paid on the FHLB borrowings was 4.02%. The Company did not borrow any long-term funds from the FHLB during 2023 or 2022.
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 or to replace deposit runoff during periods of stress and uncertainty in the banking industry. The Company manages its liquidity position through a variety of actions and sources including:
•A portfolio of liquid investments with overnight maturities,
•A portfolio of liquid available for sale debt securities,
•A diversified customer deposit base spread across three business segments,
•Access to the brokered certificate of deposit market,
•A loan to deposit ratio lower than industry average,
•Maintaining excellent debt ratings from both Standard & Poor's and Moody's national rating services,
•Available borrowing capacity of unsecured, overnight federal funds purchased, and
•Available borrowing capacity from the FHLB and Federal Reserve Bank.
The Company’s most liquid assets include balances at the Federal Reserve Bank, federal funds sold, available for sale debt securities, and securities purchased under agreements to resell. At December 31, 2023 and 2022, such assets were as follows:
Securities purchased under agreements to resell 450,000 825,000
Interest earning balances at the Federal Reserve Bank, which have overnight maturities and are used for general liquidity purposes, totaled $2.2 billion at December 31, 2023. There were $5.0 million federal funds sold at December 31, 2023, which are funds lent to the Company’s correspondent bank customers with overnight maturities. The fair value of the available for sale debt portfolio was $9.7 billion at December 31, 2023 and included an unrealized loss of $1.2 billion. The total net unrealized loss included net losses of $987.1 million on mortgage-backed and asset-backed securities, $149.2 million on state and municipal obligations, and $47.3 million on other debt securities.
Resale agreements totaled $450.0 million at December 31, 2023, with $325.0 million of the agreements maturing in the first quarter of 2024 and $125.0 million maturing in the first quarter of 2025. 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 $479.0 million in fair value at December 31, 2023.
48
Table of Contents
The available for sale debt securities portfolio has a diverse mix of high quality and liquid investment securities with a duration of 4.1 years. Approximately $1.8 billion of the available for sale debt portfolio is expected to mature or pay down during 2024, and these funds offer substantial resources to meet either new loan demand or 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 FHLB and the Federal Reserve Bank. At December 31, 2023 and 2022, total investment securities pledged for these purposes were as follows:
Investment securities pledged for the purpose of securing:
FHLB borrowings and letters of credit 301,617 1,817
Total available for sale debt securities, at fair value $ 9,684,760 $ 12,238,316
* 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 66.3% for the year ended December 31, 2023. Core customer deposits, defined as non-interest bearing, interest checking, savings, and money market deposit accounts, totaled $22.5 billion and represented 88.7% of the Company’s total deposits at December 31, 2023. 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 decreased $2.7 billion at year end 2023 compared to year end 2022, primarily due to decreases in consumer and commercial deposits of $1.6 billion and $935 million, 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 deteriorates and companies experience lower cash inflows, reducing deposit balances. If these corporate deposits decline, the Company's funding needs may be met by liquidity supplied by investment security maturities and pay downs expected to total $1.8 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 $6.8 billion through advances from the FHLB and the Federal Reserve.
Core deposit base:
Certificates of deposit of $100,000 or greater totaled $1.9 billion at December 31, 2023. These deposits are normally considered more volatile and higher costing, and comprised 7.7% of total deposits at December 31, 2023.
Amid the banking sector's period of uncertainty during the second quarter of 2023, the Company issued several tranches of short-term brokered certificates of deposit totaling $1.2 billion, which all matured by December 31, 2023. While it is not clear how many brokered certificates of deposit the market would allow the Company to issue, the Company believes brokered certificates of deposits may be an additional, reliable source of liquidity during periods of stress in the banking industry.
49
Table of Contents
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 $261.3 million at December 31, 2023, are unsecured overnight borrowings obtained mainly from upstream correspondent banks with which the Company maintains approved lines of credit. At December 31, 2023, the Company had approved lines of credit totaling $4.0 billion. Since these borrowings are unsecured and limited by market trading activity, their availability may be less certain than collateralized sources of borrowings. 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, 2023 were comprised of non-insured customer funds totaling $2.6 billion, and securities pledged as collateral for these retail agreements totaled $2.7 billion.
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, 2023.
(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 A3
Baseline credit assessment a2
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.
50
Table of Contents
The cash flows from the operating, investing and financing activities of the Company resulted in a net increase in cash, cash equivalents and restricted cash of $1.8 billion in 2023, 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 $488.8 million and has historically been a stable source of funds. Investing activities provided cash of $2.2 billion. Sales and maturities proceeds (net of purchases) of investment securities provided cash of $2.8 billion, repayments of securities purchased under agreements to resell (net of securities purchased under agreements to resell) provided cash of $375.0 million, and a net increase in the loan portfolio used cash of $933.7 million. 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 2023, financing activities used cash of $883.1 million. This decrease in cash was largely driven by a decline in deposits, which used cash of $730.8 million. The Company paid cash dividends of $134.7 million on common stock, and treasury stock purchases used cash of $76.4 million during 2023. Federal funds purchases and short-term securities sold under agreements to repurchase provided cash of $67.1 million. 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.
Cash outflows resulting from the Company’s transactions in its common stock were as follows:
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, 2023, the Parent’s investment securities totaled $16.5 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 2023 or 2022.
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.
51
Table of Contents
A table summarizing contractual cash obligations of the Company at December 31, 2023, 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 $14.5 billion (including approximately $5.4 billion in unused, approved credit card lines) and the contractual amount of standby letters of credit totaling $590.6 million at December 31, 2023. As many commitments expire unused or only partially used, these totals do not necessarily reflect future cash requirements. The allowance for these commitments is recorded in the Company’s liability for unfunded lending commitments within other liabilities on its consolidated balance sheets. At December 31, 2023, the liability for unfunded commitments totaled $25.2 million. See further discussion of the liability for unfunded lending commitments in Note 2 to the consolidated financial statements.
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 2023, 2022 or 2021, and the Company is not required nor does it expect to make a contribution in 2024.
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 19 years.At December 31, 2023, the investments totaled $76.6 million and are recorded as other assets in the Company’s consolidated balance sheet. Unfunded commitments, which are recorded as liabilities, amounted to $48.4 million at December 31, 2023.
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 2023, purchases and sales of tax credits amounted to $112.1 million and $54.0 million, respectively. Income from the sales of tax credits were $3.1 million, $5.4 million and $4.5 million in 2023, 2022 and 2021, respectively. At December 31, 2023, the Company had outstanding purchase commitments totaling $187.1 million that it expects to fund in 2024. These commitments, along with the commitments for the next five years, are included in the table above.
Through the various sources of liquidity described above, the Company maintains a liquidity position that it believes will adequately satisfy its financial obligations.
52
Table of Contents
Capital Management
Under Basel III capital guidelines, at December 31, 2023 and 2022, 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 8.85 7.32
* 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 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 elected to utilize this option. As a result, the two year deferral period for the Company extended through December 31, 2021. Beginning on January 1, 2022, the Company was 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 2022, the Company purchased 2.7 million shares, and during 2023 the Company purchased 1.4 million shares. At December 31, 2023, 1.8 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 7.1% in 2023 compared with 2022, and the Company increased its first quarter 2024 cash dividend 5.1%, making 2024 the Company's 56th consecutive year of regular cash dividend increases. The Company also distributed its 30th consecutive annual 5% stock dividend in December 2023.
53
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.
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. The simulation presents three rising rate scenarios and three falling rate scenarios and in each scenario, rates are assumed to change evenly over 12 months. In these scenarios, the current balance sheet is held constant.
The Company utilizes this simulation for monitoring interest rate risk. While the future effects of rising and falling 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 the simulation, in the three rising rate scenarios interest rate risk is less rate sensitive and in the three falling rate scenarios interest rate risk is more rate sensitive than the previous quarter. This is mainly due to a change in the funding mix. The Company has less wholesale borrowings, which are more rate sensitive, and higher deposits, which are less rate sensitive. Deposits are held constant for this simulation in both the current and previous quarters.
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, 2023 and 2022. 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 in the consolidated financial statements.
Mortgage loan commitments 3,004 89 (1) — — —
Mortgage loan forward sale contracts 1,349 8 — — — —
Forward TBA contracts 3,000 1 (18) — — —
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
55
Table of Contents
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.
The table below is a summary of segment pre-tax income results for the past three years.
Investment securities gains (losses), net — — — — 14,985 14,985
Investment securities gains (losses), net — — — — 20,506 20,506
Increase (decrease) in income before income taxes:
Investment securities gains (losses), net — — — — 30,059 30,059
Increase (decrease) in income before income taxes:
Consumer
The Consumer segment includes consumer deposits, consumer finance, and consumer debit and credit cards. During 2023, income before income taxes for the Consumer segment increased $12.9 million, or 8.8%, compared to 2022. This increase was due to growth in net interest income of $47.1 million, or 12.8%, partly offset by higher non-interest expense of $17.9 million, or 5.8%, an increase in the provision for credit losses of $9.6 million, or 54.0%, and a decline in non-interest income of $6.6 million, or 6.2%. Net interest income increased due to a $59.3 million increase in net allocated funding credits assigned to the Consumer segment's loan and deposit portfolios and a $41.8 million increase in loan interest income, partly offset by an increase of $54.0 million in deposit interest expense. Non-interest income decreased mainly due to lower deposit account fees (mainly overdraft and return item fees) and mortgage banking revenue, partly offset by growth in net debit card fees. Non-interest expense increased over the previous year mainly due to higher salaries and benefits expense, FDIC insurance expense, data processing and software expense and allocated support costs for consumer administration and operations and information technology. The provision for credit losses totaled $27.5 million, a $9.6 million increase over the prior year, which resulted mainly from higher consumer credit card and personal loan net charge-offs. Total average loans in this segment increased $127.4 million, or 3.4%, in 2023 compared to 2022 mainly due to increases in personal real estate loans and revolving and fixed
56
Table of Contents
rate home equity loans. Average deposits decreased $1.2 billion, or 8.8%, from the prior year, resulting from declines in money market, interest checking and savings deposit account balances, partly offset by growth in certificate of deposit account balances.
During 2022, income before income taxes for the Consumer segment decreased $5.0 million, or 3.3%, compared to 2021. This decrease was due to a decline in non-interest income of $19.7 million, or 23.2%, and higher non-interest expense of $8.9 million, or 3.0%. These decreases to income were partly offset by growth in net interest income of $18.1 million, or 5.2%, and a decrease in the provision for credit losses of $5.4 million, or 23.2%. Net interest income increased due to an $18.7 million increase in net allocated funding credits assigned to the Consumer segment's loan and deposit portfolios. Non-interest income decreased mainly due to declines of $13.2 million in mortgage banking revenue and $4.0 million in overdraft and return item fees. Non-interest expense increased over the prior year mainly due to higher occupancy expense, insurance expense and allocated service and support costs (mainly bank card fraud operations and information technology), partly offset by lower allocated service costs for branch employees and mortgage operations. The provision for credit losses totaled $17.8 million, a $5.4 million decrease from 2021, which resulted mainly from lower credit card loan net charge-offs, slightly offset by higher consumer loan net charge-offs. Total average loans in this segment decreased $145.3 million, or 3.8%, in 2022 compared to 2021 mainly due to declines in consumer credit card and auto loans. Average deposits increased $561.0 million, or 4.4%, over 2021, resulting from growth in personal demand, savings and interest checking and money market deposit account balances.
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 2023 increased $22.0 million, or 7.1%, compared to 2022, mainly due to increases net interest income and non-interest income, partly offset by increases in non-interest expense and the provision for credit losses. Net interest income increased $29.7 million, or 6.6%, due to higher loan interest income of $272.9 million. This increase was partly offset by a decrease of $78.1 million in net allocated funding credits assigned to the Commercial segment's loan and deposit portfolios and increases in interest expense on customer repurchase agreements and deposits of $49.4 million and $116.4 million, respectively. Non-interest income increased $21.3 million, or 9.5%, over 2022 due to growth in net bank card fees (mainly corporate card and merchant fees), deposit account fees (mainly corporate cash management fees), letter of credit fees and cash sweep commissions, partly offset by a decline in tax credit sales fees. Non-interest expense increased $26.7 million, or 7.3%, mainly due to higher salaries and benefits expense, FDIC insurance expense and allocated service and support costs (mainly bank operations, commercial payments and products and credit administration). These increases were partly offset by lower allocated support costs for information technology. The provision for credit losses increased $2.3 million over the same period last year, mainly due to higher business loan net charge-offs. Average segment loans increased $1.0 billion, or 10.4%, compared to 2022, mainly due to increases in business, business real estate, and construction loans. Average deposits decreased $1.6 billion, or 13.1%, mainly due to declines in business demand and money market deposit account balances, partly offset by increases in interest checking and certificate of deposit account balances.
Pre-tax income for 2022 decreased $29.2 million, or 8.6%, compared to 2021, mainly due to increases in non-interest expense and the provision for credit losses, partly offset by an increase in non-interest income. Net interest income decreased $1.0 million, or .2%, due to a $21.4 million decrease in net allocated funding credits, coupled with higher interest expense on customer repurchase agreements and deposits of $22.6 million and 18.5 million, respectively. The decreases were partly offset by a $61.2 million increase in loan interest income. The provision for credit losses increased $6.0 million due to net charge-offs recorded on business loans in 2022 compared to net recoveries recorded in 2021. Non-interest income increased $13.8 million, or 6.6%, over 2021 due to higher net bank card fees (mainly corporate card), deposit account fees (mainly corporate cash management fees), and higher cash sweep commissions. These increases were partly offset by lower capital market fees. Non-interest expense increased $36.0 million, or 10.9%, during 2022, mainly due to higher salaries and benefits expense, data processing and software expense, travel and entertainment expense, and allocated service and support costs (mainly bank operations expense, branch employee expense, and commercial banking expense). Average segment loans decreased $216.9 million, or 2.1%, compared to 2021, mainly due to a decline in business loans, partly offset by increases in business real estate and construction loans. Average deposits decreased $49.4 million, or .4%, mainly due to declines in business demand and certificate of deposit account balances, offset by increases in interest checking and money market deposit account balances.
Wealth
The Wealth segment provides traditional trust and estate planning, advisory and discretionary investment management services, brokerage services, and includes Private Banking accounts. At December 31, 2023, the Trust group managed investments with a market value of $41.2 billion and administered an additional $27.7 billion in non-managed assets. It also
57
Table of Contents
provides investment management services to The Commerce Funds, a series of mutual funds with $2.6 billion in total assets at December 31, 2023. In 2023, pre-tax income for the Wealth segment was $133.8 million, compared to $142.9 million in 2022, a decrease of $9.1 million, or 6.4%. Net interest income decreased $1.2 million, or 1.6%, mainly due to a $26.2 million increase in deposit interest expense and a $7.2 million decline in net allocated funding credits assigned to the Wealth segment's loan and deposit portfolios, partly offset by a $32.3 million increase in loan interest income. Non-interest income increased $4.9 million, or 2.3%, over the prior year mainly due to higher private client trust fees and cash sweep commissions, partly offset by lower brokerage fees (mainly annuity fees). Non-interest expense increased $12.8 million, or 8.8%, mainly due to higher salaries and benefits expense and the deconversion costs previously mentioned. The provision for credit losses increased $20 thousand over the prior year. Average assets increased $54.9 million, or 3.0%, during 2023 mainly due to higher personal real estate loan balances, partly offset by lower business and fixed rate home equity loan balances. Average deposits decreased $427.4 million, or 15.2%, due to declines in interest checking and money market deposit account balances, partly offset by growth in certificate of deposit account balances.
In 2022, pre-tax income for the Wealth segment was $142.9 million, compared to $148.7 million in 2021, a decrease of $5.8 million, or 3.9%. Net interest income increased $2.9 million, or 4.0%, mainly due to a $16.4 million increase in loan interest income, partly offset by a $12.5 million decrease in net allocated funding credits and a $1.0 million increase in deposit interest expense. Non-interest income decreased $229 thousand, or .1%, from the prior year due to higher cash sweep commissions and brokerage fees, partly offset by lower mortgage banking revenue and trust fees. Non-interest expense increased $8.6 million, or 6.3%, resulting from higher salaries and benefits expense, travel and entertainment expense, and marketing expense. The provision for credit losses decreased $44 thousand, mainly due to net recoveries on revolving home equity loans. Average assets increased $253.3 million, or 16.0%, during 2022 mainly due to higher personal real estate and consumer loan balances. Average deposits decreased $161.0 million, or 5.4%, due to a decline in interest checking and money market deposit account balances.
The segment activity, as shown above, includes both direct and allocated items. Amounts in the “Other/Elimination” column include the activity of various support and overhead operating units of the Company, in addition to the investment securities portfolio, brokered deposits and other items not allocated 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 2023, the pre-tax net loss in this category was $6.6 million, compared to net income of $31.8 million in 2022. Unallocated securities gains were $15.0 million in 2023, compared to securities gains of $20.5 million in 2022. Additionally, non-interest expense increased $24.8 million and net interest income decreased $19.7 million. These decreases were partly offset by a $7.0 million increase in non-interest income and a decrease in the provision for credit losses of $4.6 million. The decrease in the unallocated provision for credit losses was primarily driven by a decrease in the liability for unfunded lending commitments, partly offset by an increase in the provision for credit losses on loans, which are both not allocated to the segments for management reporting purposes. Net charge-offs are allocated to segments when incurred for management reporting purposes. For the year ended December 31, 2023, the Company's provision for credit losses on unfunded lending commitments was a benefit $7.9 million, compared to a provision of $8.9 million in 2022. The provision for credit losses on loans was $12.3 million in excess of net-charge offs in 2023, due to an increase in the allowance for credit losses on loans, while the provision was $92 thousand higher than net charge-offs in 2022.
58
Table of Contents
Impact of Recently Issued Accounting Standards
Reference Rate Reform The Financial Accounting Standards Board ("FASB") issued ASU 2020-04, "Reference Rate Reform (Topic 848) - Facilitation of the Effects of Reference Rate Reform on Financial Reporting", in March 2020, and has been followed by additional clarifying guidance related to derivatives that are modified as a result of reference rate reform. The guidance provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if they reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. Further, the guidance applies to derivative instruments that use an interest rate for margining, discounting, or contract price alignment that is modified as a result of reference rate reform. The expedients and exceptions provided by the new guidance do not apply to contract modifications made and hedging relationships entered into or evaluated for effectiveness after December 31, 2022, except for certain hedging relationships existing as of December 31, 2022. In December 2022, the FASB issued ASU 2022-06 which extended the sunset date under Topic 848 to December 31, 2024. The change is to align the temporary accounting relief guidance with the expected cessation date of LIBOR, which was postponed by administrators in 2021 to June 2023, a year after the current sunset date of ASU 2020-04. The Company's LIBOR Transition Steering Committee completed the Company's transition from LIBOR during the first half of 2023.
Disclosure Improvements The FASB issued ASU 2023-06, "Disclosure Improvements: Codification Amendments in Response to the SEC's Disclosure Update and Simplification Initiative", in October 2023. The amendments in this Update modify the disclosure or presentation requirements of a variety of topics in the Codification. Certain of the amendments represent clarifications to or technical corrections of the current requirements. The effective date for each amendment will be the date on which the SEC's removal of that related disclosure from Regulation S-X or Regulation S-K becomes effective, with early adoption prohibited. The adoption is not expected to have a significant effect on the Company's consolidated financial statements.
Segment Reporting The FASB issued ASU 2023-07, "Segment Reporting (Topic 280) - Improvements to Reportable Segment Disclosures", in November 2023. The amendments require disclosure of significant segment expenses and other segment items on an annual and interim basis. Public entities are required to disclose significant expense categories and amounts for each reportable segment, as well as the amount and a description of the composition of other segment items. Significant expense categories are derived from expenses that are regularly provided to an entity’s chief operating decision-maker (“CODM”), and included in a segment’s reported measures of profit or loss. Public entities are also required to disclose the title and position of the CODM and explain how the CODM uses the reported measures of profit or loss in assessing segment performance and deciding how to allocate resources. This Update requires interim disclosures of certain segment-related disclosures that previously were only required annually. This Update requires annual disclosures for fiscal years beginning January 1, 2024 and interim disclosures for fiscal years beginning January 1, 2025. Early adoption is permitted. The Company is required to apply the amendments in this Update retrospectively to all prior periods presented in the financial statements. Other than the inclusion of additional disclosures, the adoption of this ASU is not expected to have a significant effect on the Company's consolidated financial statements.
Income Taxes The FASB issued ASU 2023-09, "Income Taxes (Topic 740) - Improvements to Income Tax Disclosures", in December 2023. The amendments in this Update require additional disclosures regarding the rate reconciliation and income taxes paid. This Update also removed certain existing disclosure requirements. This Update is effective for annual periods beginning January 1, 2025. Early adoption is permitted. The amendments in this Update should be applied on a prospective basis, though retrospective application is permitted. Other than the inclusion of additional disclosures, the adoption is not expected to have a significant effect on the Company's consolidated financial statements.
Corporate Governance
The Company has adopted a number of corporate governance measures. These include corporate governance guidelines, a code of ethics that applies to its senior financial officers and the charters for its audit and risk committee, its committee on compensation and human resources, and its committee on governance/directors. This information is available on the Company’s investor relations website at investor.commercebank.com/overview/corporate-governance.
59
Table of Contents
AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
Years Ended December 31
ASSETS
Loans:(A)
Investment securities:
LIABILITIES AND EQUITY
Interest bearing deposits:
Borrowings:
Net yield on interest earning assets 3.16 % 2.85 % 2.58 %
(A) Loans on non-accrual status are included in the computation of average balances. Included in interest income above are loan fees and late charges, net of amortization of deferred loan origination fees and costs, which are immaterial. Credit card income from merchant discounts and net interchange fees are not included in loan income.E — A
VERAGE RATES AND
60
Table of Contents
YI
Years Ended December 31
(B) Interest income and yields are presented on a fully taxable-equivalent basis using a federal income tax rate of 21%. Loan interest income includes tax free loan income (categorized as business loan income) which includes tax equivalent adjustments of $5,467,000 in 2023, $4,126,000 in 2022, $4,176,000 in 2021, $4,916,000 in 2020, $6,282,000 in 2019, and $5,931,000 in 2018. Investment securities interest income includes tax equivalent adjustments of $3,983,000 in 2023, $6,874,000 in 2022, $7,546,000 in 2021, $8,042,000 in 2020, $7,845,000 in 2019, and $10,306,000 in 2018. These adjustments relate to state and municipal obligations, trading securities, equity securities, and other securities.
(C) Interest expense of $903,000, $1,370,000, $29,000 and $14,000, which was capitalized on construction projects in 2023, 2022, 2021, and 2020, respectively,is not deducted from the interest expense shown above.
61
Table of Contents
QUARTERLY AVERAGE BALANCE SHEETS — AVERAGE RATES AND YIELDS
Fourth Quarter Third Quarter Second Quarter First Quarter
ASSETS
Loans:
Overdrafts 5 — 5 — 5 — 4 —
Investment securities:
LIABILITIES AND EQUITY
Interest bearing deposits:
Borrowings:
Net yield on interest earning assets 3.17 % 3.11 % 3.12 % 3.26 %
(A) Stated on a fully taxable-equivalent basis using a federal income tax rate of 21%.
62
Table of Contents
— AVERAGE RATES AND YIELDS
Fourth Quarter Third Quarter Second Quarter First Quarter
ASSETS
Loans:
Overdrafts 7 — 4 — 6 — 5 —
Investment securities:
LIABILITIES AND EQUITY
Interest bearing deposits:
Borrowings:
Net yield on interest earning assets 3.18 % 3.01 % 2.79 % 2.45 %
(A) Stated on a fully taxable-equivalent basis using a federal income tax rate of 21%.
63
Table of Contents
SUMMARY OF QUARTERLY STATEMENTS OF INCOME
Year ended December 31, 2023 For the Quarter Ended
Net income per common share — basic* $ .84 $ .92 $ .97 $ .91
Net income per common share — diluted* $ .84 $ .92 $ .97 $ .91
Year ended December 31, 2022 For the Quarter Ended
Net income per common share — basic* $ 1.00 $ .93 $ .87 $ .88
Net income per common share — diluted* $ 1.00 $ .92 $ .87 $ .88
Year ended December 31, 2021 For the Quarter Ended
Net income per common share — basic* $ .85 $ .91 $ 1.20 $ .96
Net income per common share — diluted* $ .85 $ .91 $ 1.19 $ .96
* Restated for the 5% stock dividend distributed in 2023.
64
Table of Contents
Item 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is disclosed within the Interest Rate Sensitivity section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Commerce Bancshares, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Commerce Bancshares, Inc. and subsidiaries (the Company) as of December 31, 2023 and 2022, the related consolidated statements of income, comprehensive income, changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2023, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2023, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2023, based on criteria established in
Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 22, 2024 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Assessment for credit losses related to loans collectively evaluated for impairment
As discussed in Notes 1 and 2 to the consolidated financial statements, the allowance for credit losses related to loans evaluated on a collective basis (the December 31, 2023 collective ACL) was $161.2 million of a total allowance for credit losses of $162.4 million as December 31, 2023. The allowance for credit losses on loans and leases is measured on a collective (pool) basis whereas loans are aggregated into pools based on similar risk characteristics. The Company estimates the collective ACL utilizing average historical loss rates, calculated using historical net charge-offs and
65
Table of Contents
outstanding loan balances during a lookback period for each pool. In certain pools, if the Company’s own historical loss rate is not reflective of loss expectations, the historical loss rate is augmented by industry and peer data. The calculated average net charge-off rate is then adjusted for current conditions and reasonable and supportable forecasts (forecast adjusted loss rate). These adjustments increase or decrease the average historical loss rate to reflect expectations of future losses given a single path economic forecast of key macroeconomic variables. The adjustments are based on results from various regression models projecting the impact of the macroeconomic variables to loss rates. The forecast is used for a reasonable and supportable period before reverting back to historical averages using a straight-line method. The forecast adjustment loss rate is applied to the amortized cost of loans over the remaining contractual lives, adjusted for expected prepayments. The allowance is further adjusted for certain qualitative factors not included in historical loss rates or the macroeconomic forecast, which include changes in portfolio composition and characteristics, underwriting practices, watchlist trends, or significant unique events or conditions.
We identified the assessment of the December 31, 2023 collective ACL as a critical audit matter. A high degree of audit effort, including specialized skills and knowledge, and subjective and complex auditor judgement was involved in the assessment due to significant measurement uncertainty. Specifically, this assessment encompassed the evaluation of the conceptual soundness of the average historical loss model used to estimate the collective ACL, including the following key factors and assumptions (1) historical losses, (2) the reasonable and supportable forecast period, and (3) the development and evaluation of qualitative adjustments. In addition, auditor judgement was required to evaluate the sufficiency of audit evidence obtained.