- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- FORM 10-Q ---------------- (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1999 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File No. 0-2989 Commerce Bancshares, Inc. (Exact name of registrant as specified in its charter) Missouri 43-0889454 (State of Incorporation) (IRS Employer Identification No.) 1000 Walnut, Kansas City, MO 64106 (Address of principal executive offices and Zip Code) (816) 234-2000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes [X] No___ As of August 5, 1999, the registrant had outstanding 60,018,756 shares of its $5 par value common stock, registrant's only class of common stock. - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
Part I: FINANCIAL INFORMATION In the opinion of management, the consolidated financial statements of Commerce Bancshares, Inc. and Subsidiaries as of June 30, 1999 and December 31, 1998 and the related notes include all material adjustments which were regularly recurring in nature and necessary for fair presentation of the financial condition and the results of operations for the periods shown. The consolidated financial statements of Commerce Bancshares, Inc. and Subsidiaries and management's discussion and analysis of financial condition and results of operations are presented in the schedules as follows: Schedule 1: Consolidated Balance Sheets Schedule 2: Consolidated Statements of Income Schedule 3: Statements of Changes in Stockholders' Equity Schedule 4: Consolidated Statements of Cash Flows Schedule 5: Notes to Consolidated Financial Statements Schedule 6: Management's Discussion and Analysis of Financial Condition and Results of Operations, including Quantitative and Qualitative Disclosures about Market Risk Part II: OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders. The annual meeting of shareholders of Commerce Bancshares, Inc. was held on April 21, 1999. Proxies for the meeting were solicited pursuant to Regulation 14 of the Securities Exchange Act of 1934, and there was no solicitation in opposition to management's nominees, as listed in the proxy statement. The five nominees for the five directorships (constituting one-third of the Board of Directors) being elected at this meeting received the following votes: <TABLE> <CAPTION> Name of Director Votes For Votes Abstain ---------------- ---------- ------------- <S> <C> <C> W. Thomas Grant, II.............................. 40,976,220 9,277,030 James B. Hebenstreit............................. 49,997,908 255,342 John H. Robinson, Jr............................. 40,942,622 9,310,628 Dolph C. Simons, Jr.............................. 44,113,633 6,139,617 William A. Sullins, Jr........................... 50,066,518 186,732 </TABLE> At the same meeting, the shareholders approved, as set forth in the proxy statement for the meeting, the adoption of an amendment to the Articles of Incorporation to increase the authorized shares of Common Stock from 80,000,000 to 100,000,000 shares with a par value of $5.00 per share. The amendment to the Articles of Incorporation was approved with a vote of 47,822,284 shares (representing 95.3% of the shares present or represented and entitled to vote) voting in favor; 1,923,744 shares voting against; 447,222 shares abstaining; and no shares representing broker non-votes. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits (3)(i) Restated Articles of Incorporation, as amended (27) Financial Data Schedule (b) No reports on Form 8-K were filed during the quarter ended June 30, 1999. 2
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Commerce Bancshares, Inc. /s/ J. Daniel Stinnett By __________________________________ J. Daniel Stinnett Vice President & Secretary Date: August 10, 1999 /s/ Jeffery D. Aberdeen By __________________________________ Jeffery D. Aberdeen Controller (Chief Accounting Officer) Date: August 10, 1999 3
Schedule 1 COMMERCE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> June 30 December 31 1999 1998 ----------- ----------- (Unaudited) (In thousands) <S> <C> <C> ASSETS Loans, net of unearned income........................ $ 7,175,890 $ 7,046,852 Allowance for loan losses............................ (120,225) (117,092) ----------- ----------- Net loans........................................ 7,055,665 6,929,760 ----------- ----------- Investment securities: Available for sale................................. 2,708,409 2,988,230 Trading account.................................... 22,562 14,210 Other non-marketable............................... 30,341 29,276 ----------- ----------- Total investment securities...................... 2,761,312 3,031,716 ----------- ----------- Federal funds sold and securities purchased under agreements to resell................................ 140,125 261,535 Cash and due from banks.............................. 702,609 738,672 Land, buildings and equipment, net................... 226,731 222,129 Goodwill and core deposit premium, net............... 72,743 77,009 Customers' acceptance liability...................... 830 808 Other assets......................................... 106,997 140,394 ----------- ----------- Total assets..................................... $11,067,012 $11,402,023 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Non-interest bearing demand........................ $ 1,367,630 $ 1,657,037 Savings and interest bearing demand................ 5,416,581 5,295,897 Time open and C.D.'s of less than $100,000......... 2,160,274 2,269,835 Time open and C.D.'s of $100,000 and over.......... 284,309 307,428 ----------- ----------- Total deposits................................... 9,228,794 9,530,197 Federal funds purchased and securities sold under agreements to repurchase............................ 618,171 617,830 Long-term debt and other borrowings.................. 26,201 27,130 Accrued interest, taxes and other liabilities........ 117,440 145,273 Acceptances outstanding.............................. 830 808 ----------- ----------- Total liabilities................................ 9,991,436 10,321,238 ----------- ----------- Stockholders' equity: Preferred stock, $1 par value. Authorized and unissued 2,000,000 shares......................... -- -- Common stock, $5 par value. Authorized 100,000,000 shares; issued 61,352,684 shares.................. 306,763 306,763 Capital surplus.................................... 102,126 106,159 Retained earnings.................................. 686,547 624,256 Treasury stock of 1,041,103 shares in 1999 and 193,208 shares in 1998, at cost................... (43,124) (8,561) Unearned employee benefits......................... (991) (904) Accumulated other comprehensive income............. 24,255 53,072 ----------- ----------- Total stockholders' equity....................... 1,075,576 1,080,785 ----------- ----------- Total liabilities and stockholders' equity....... $11,067,012 $11,402,023 =========== =========== </TABLE> See accompanying notes to financial statements. 4
Schedule 2 COMMERCE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME <TABLE> <CAPTION> For the Three Months For the Six Months Ended June 30 Ended June 30 ------------------- ------------------- 1999 1998 1999 1998 --------- --------- --------- --------- (Unaudited) (In thousands, except per share data) <S> <C> <C> <C> <C> INTEREST INCOME Interest and fees on loans............. $ 139,299 $ 137,740 $ 277,039 $ 272,060 Interest on investment securities...... 41,378 39,553 82,093 78,741 Interest on federal funds sold and securities purchased under agreements to resell............................. 3,478 2,858 9,521 6,903 --------- --------- --------- --------- Total interest income.............. 184,155 180,151 368,653 357,704 --------- --------- --------- --------- INTEREST EXPENSE Interest on deposits: Savings and interest bearing demand.. 32,004 35,673 65,087 70,496 Time open and C.D.'s of less than $100,000............................ 27,676 29,507 56,605 58,486 Time open and C.D.'s of $100,000 and over................................ 3,671 3,356 7,453 6,462 Interest on federal funds purchased and securities sold under agreements to repurchase............................ 5,520 6,309 11,830 12,773 Interest on long-term debt and other borrowings............................ 214 110 442 217 --------- --------- --------- --------- Total interest expense............. 69,085 74,955 141,417 148,434 --------- --------- --------- --------- Net interest income................ 115,070 105,196 227,236 209,270 Provision for loan losses.............. 8,741 11,410 17,291 22,126 --------- --------- --------- --------- Net interest income after provision for loan losses................... 106,329 93,786 209,945 187,144 --------- --------- --------- --------- NON-INTEREST INCOME Trust fees............................. 14,212 13,073 28,124 24,726 Deposit account charges and other fees.................................. 17,109 15,718 33,350 30,107 Credit card transaction fees........... 11,007 8,901 19,907 15,996 Trading account profits and commissions........................... 2,620 1,827 5,405 4,108 Net gains on securities transactions... 357 4,667 993 6,088 Other.................................. 16,131 11,555 31,113 24,675 --------- --------- --------- --------- Total non-interest income.......... 61,436 55,741 118,892 105,700 --------- --------- --------- --------- NON-INTEREST EXPENSE Salaries and employee benefits......... 53,369 49,879 107,394 98,385 Net occupancy.......................... 6,827 6,366 13,486 11,659 Equipment.............................. 5,780 4,399 10,655 8,665 Supplies and communication............. 8,386 7,101 16,546 14,199 Data processing........................ 9,020 7,117 17,231 14,054 Marketing.............................. 2,915 3,479 6,166 6,238 Goodwill and core deposit.............. 2,133 2,295 4,266 4,591 Other.................................. 16,177 12,698 31,564 25,964 --------- --------- --------- --------- Total non-interest expense......... 104,607 93,334 207,308 183,755 --------- --------- --------- --------- Income before income taxes............. 63,158 56,193 121,529 109,089 Less income taxes...................... 21,387 18,699 41,073 37,112 --------- --------- --------- --------- Net income......................... $ 41,771 $ 37,494 $ 80,456 $ 71,977 ========= ========= ========= ========= Net income per share--basic............ $ .69 $ .61 $ 1.32 $ 1.18 ========= ========= ========= ========= Net income per share--diluted.......... $ .68 $ .60 $ 1.30 $ 1.16 ========= ========= ========= ========= Cash dividends per common share........ $ .150 $ .138 $ .300 $ .276 ========= ========= ========= ========= </TABLE> See accompanying notes to financial statements. 5
Schedule 3 COMMERCE BANCSHARES, INC. AND SUBSIDIARIES STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY <TABLE> <CAPTION> Accumulated Number of Unearned Other Shares Common Capital Retained Treasury Employee Comprehensive Issued Stock Surplus Earnings Stock Benefits Income Total ---------- -------- -------- -------- -------- -------- ------------- ---------- (Unaudited) (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> Balance January 1, 1999. 61,352,684 $306,763 $106,159 $624,256 $ (8,561) $ (904) $53,072 $1,080,785 Net income............. 80,456 80,456 Change in unrealized gain (loss) on available for sale securities............ (28,817) (28,817) ---------- Total comprehensive income................ 51,639 ---------- Purchase of treasury stock................. (42,809) (42,809) Sales under option and benefit plans......... (4,014) 7,957 3,943 Issuance of stock under restricted stock award plan.................. (19) 289 (270) -- Restricted stock award amortization.......... 183 183 Cash dividends paid ($.30 per share)...... (18,165) (18,165) ---------- -------- -------- -------- -------- ------- ------- ---------- Balance June 30, 1999... 61,352,684 $306,763 $102,126 $686,547 $(43,124) $ (991) $24,255 $1,075,576 ========== ======== ======== ======== ======== ======= ======= ========== Balance January 1, 1998. 58,285,813 $291,429 $ 48,704 $626,387 $(14,252) $ (601) $29,117 $ 980,784 Net income............. 71,977 71,977 Change in unrealized gain (loss) on available for sale securities............ 5,839 5,839 ---------- Total comprehensive income................ 77,816 ---------- Pooling acquisition.... 360,000 1,800 (11,346) 7,639 16,101 139 14,333 Purchase of treasury stock................. (36,834) (36,834) Sales under option and benefit plans......... (2,893) 6,512 3,619 Issuance of stock under restricted stock award plan.................. 12 528 (540) -- Restricted stock award amortization.......... 141 141 Cash dividends paid ($.276 per share)..... (16,923) (16,923) ---------- -------- -------- -------- -------- ------- ------- ---------- Balance June 30, 1998... 58,645,813 $293,229 $ 34,477 $689,080 $(27,945) $(1,000) $35,095 $1,022,936 ========== ======== ======== ======== ======== ======= ======= ========== </TABLE> See accompanying notes to financial statements. 6
Schedule 4 COMMERCE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> For the Six Months Ended June 30 -------------------- 1999 1998 --------- --------- (Unaudited) (In thousands) <S> <C> <C> OPERATING ACTIVITIES: Net income .............................................. $ 80,456 $ 71,977 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses ............................. 17,291 22,126 Provision for depreciation and amortization ........... 17,317 16,171 Accretion of investment security discounts ............ (1,591) (2,340) Amortization of investment security premiums .......... 5,809 4,235 Net gains on sales of investment securities (A) ....... (993) (6,088) Net increase in trading account securities............. (10,035) (11,682) (Increase) decrease in interest receivable ............ 520 (2,006) Decrease in interest payable .......................... (6,769) (1,956) Other changes, net .................................... 34,871 (22,481) --------- --------- Net cash provided by operating activities ........... 136,876 67,956 --------- --------- INVESTING ACTIVITIES: Net cash received in acquisition......................... -- 4,044 Proceeds from sales of investment securities (A)......... 103,837 186,309 Proceeds from maturities of investment securities (A).... 920,732 535,052 Purchases of investment securities (A) .................. (805,208) (602,339) Net decrease in federal funds sold and securities purchased under agreements to resell ................... 121,410 41,170 Net increase in loans.................................... (137,611) (340,125) Purchases of premises and equipment...................... (17,268) (12,515) Sales of premises and equipment.......................... 1,008 1,697 --------- --------- Net cash provided (used) by investing activities..... 186,900 (186,707) --------- --------- FINANCING ACTIVITIES: Net decrease in non-interest bearing demand, savings, and interest bearing demand deposits.................... (168,723) (140,572) Net increase (decrease) in time open and C.D.'s.......... (132,759) 13,506 Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase ..... 341 (913) Repayment of long-term debt ............................. (818) (3,326) Purchases of treasury stock ............................. (41,285) (35,977) Exercise of stock options by employees .................. 1,570 1,595 Cash dividends paid on common stock ..................... (18,165) (16,923) --------- --------- Net cash used by financing activities ............... (359,839) (182,610) --------- --------- Decrease in cash and cash equivalents................ (36,063) (301,361) Cash and cash equivalents at beginning of year........... 738,672 978,239 --------- --------- Cash and cash equivalents at June 30................. $ 702,609 $ 676,878 ========= ========= </TABLE> - -------- (A) Available for sale and other non-marketable securities, excluding trading account securities. Net cash payments of income taxes for the six month period were $53,413,000 in 1999 and $34,842,000 in 1998. Interest paid on deposits and borrowings for the six month period was $148,106,000 in 1999 and $150,304,000 in 1998. See accompanying notes to financial statements. 7
Schedule 5 COMMERCE BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 1999 (Unaudited) 1. Principles of Consolidation and Presentation The accompanying consolidated financial statements include the accounts of Commerce Bancshares, Inc. and all majority-owned subsidiaries (the Company). All significant intercompany accounts and transactions have been eliminated. Certain reclassifications were made to 1998 data to conform to current year presentation. Results of operations for the six month period ended June 30, 1999 are not necessarily indicative of results to be attained for any other period. The significant accounting policies followed in the preparation of the quarterly financial statements are the same as those disclosed in the 1998 Annual Report to stockholders to which reference is made. 2. Allowance for Loan Losses The following is a summary of the allowance for loan losses. <TABLE> <CAPTION> For the Three Months For the Ended Six Months Ended June 30 June 30 ----------------- ----------------- 1999 1998 1999 1998 -------- -------- -------- -------- (In thousands) <S> <C> <C> <C> <C> Balance, beginning of period......... $119,557 $108,569 $117,092 $105,918 -------- -------- -------- -------- Additions: Provision for loan losses.......... 8,741 11,410 17,291 22,126 Allowance for loan losses of acquired banks.................... -- -- -- 964 -------- -------- -------- -------- Total additions.................. 8,741 11,410 17,291 23,090 -------- -------- -------- -------- Deductions: Loan losses........................ 10,663 9,965 19,702 20,956 Less recoveries on loans........... 2,590 2,976 5,544 4,938 -------- -------- -------- -------- Net loan losses.................. 8,073 6,989 14,158 16,018 -------- -------- -------- -------- Balance, June 30..................... $120,225 $112,990 $120,225 $112,990 ======== ======== ======== ======== </TABLE> At June 30, 1999, non-performing assets were $36,402,000, which was .51% of total loans and .33% of total assets. This balance consisted of $12,760,000 in loans not accruing interest, $21,970,000 in loans past due 90 days and still accruing interest, and $1,672,000 in foreclosed real estate. 8
3. Investment Securities Investment securities, at fair value, consist of the following at June 30, 1999 and December 31, 1998. <TABLE> <CAPTION> June 30 December 1999 31 1998 ---------- ---------- (In thousands) <S> <C> <C> Available for sale: U.S. government and federal agency obligations.... $1,242,421 $1,448,547 State and municipal obligations................... 95,357 101,785 CMO's and asset-backed securities................. 1,238,419 974,377 Other debt securities............................. 81,529 419,413 Equity securities................................. 50,683 44,108 Trading account securities.......................... 22,562 14,210 Other non-marketable securities..................... 30,341 29,276 ---------- ---------- Total investment securities..................... $2,761,312 $3,031,716 ========== ========== </TABLE> 4. Common Stock The shares used in the calculation of basic and diluted income per share are shown below. <TABLE> <CAPTION> For the Three Months For the Six Months Ended June 30 Ended June 30 --------------------- ------------------- 1999 1998 1999 1998 ---------- ---------- --------- --------- (In thousands) <S> <C> <C> <C> <C> Weighted average common shares outstanding.................. 60,618 61,371 60,831 61,205 Stock options................. 823 1,114 847 1,104 ---------- ---------- --------- --------- 61,441 62,485 61,678 62,309 ========== ========== ========= ========= </TABLE> 5. Comprehensive Income SFAS No. 130, "Reporting Comprehensive Income", requires the reporting of comprehensive income and its components. Comprehensive income is defined as the change in equity from transactions and other events and circumstances from non-owner sources, and excludes investments by and distributions to owners. Comprehensive income includes net income and other items of comprehensive income meeting the above criteria. The Company's only component of other comprehensive income is the unrealized holding gains and losses on available for sale securities. <TABLE> <CAPTION> For the Three Months For the Six Months Ended June 30 Ended June 30 ---------------------- -------------------- 1999 1998 1999 1998 ---------- ---------- --------- --------- (In thousands) <S> <C> <C> <C> <C> Unrealized holding gains (losses).. $ (28,934) $ (10,531) $ (55,257) $ 14,525 Less: reclassification adjustment for gains included in net income.. 357 3,687 993 5,108 ---------- ---------- --------- -------- Net unrealized gains (losses) on securities........................ (29,291) (14,218) (56,250) 9,417 Income tax expense (benefit)....... (17,170) (5,317) (27,433) 3,578 ---------- ---------- --------- -------- Other comprehensive income (loss).. $(12,121) $ (8,901) $ (28,817) $ 5,839 ========== ========== ========= ======== </TABLE> 9
6. Segments Management has established three operating segments within the Company. The Consumer segment includes the retail branch network, consumer finance, bankcard, student loans and discount brokerage services. The Commercial segment provides corporate lending, leasing, and international services, as well as business, government deposit and cash management services. The Money Management segment provides traditional trust and estate tax planning services, and advisory and discretionary investment management services. The following table presents selected financial information by segment and reconciliations of combined segment totals to consolidated totals. There were no material intersegment revenues between the three segments. Financial data for 1998 bank acquisitions which have not yet been assimilated into the business segment and cost allocation systems are included in the Consumer segment and are not considered material. <TABLE> <CAPTION> Money Segment Other/ Consolidated Consumer Commercial Management Totals Elimination Totals -------- ---------- ---------- -------- ----------- ------------ (In thousands) <S> <C> <C> <C> <C> <C> <C> Six Months Ended June 30, 1999 - ------------------------ Net interest income after loan loss expense................ $ 12,760 $121,901 $(9,058) $125,603 $ 84,342 $209,945 Cost of funds allocation............. 100,057 (46,744) 11,820 65,133 (65,133) -- Non-interest income..... 62,417 13,796 36,441 112,654 6,238 118,892 -------- -------- ------- -------- -------- -------- Total net revenue....... 175,234 88,953 39,203 303,390 25,447 328,837 Non-interest expense.... 130,281 39,261 25,519 195,061 12,247 207,308 -------- -------- ------- -------- -------- -------- Income before income taxes.................. $ 44,953 $ 49,692 $13,684 $108,329 $ 13,200 $121,529 ======== ======== ======= ======== ======== ======== Six Months Ended June 30, 1998 - ------------------------ Net interest income after loan loss expense................ $ 695 $120,586 $(8,591) $112,690 $ 74,454 $187,144 Cost of funds allocation............. 111,093 (50,033) 10,887 71,947 (71,947) -- Non-interest income..... 53,525 12,544 31,706 97,775 7,925 105,700 -------- -------- ------- -------- -------- -------- Total net revenue....... 165,313 83,097 34,002 282,412 10,432 292,844 Non-interest expense.... 110,247 36,481 23,018 169,746 14,009 183,755 -------- -------- ------- -------- -------- -------- Income before income taxes.................. $ 55,066 $ 46,616 $10,984 $112,666 $(3,577) $109,089 ======== ======== ======= ======== ======== ======== Three Months Ended June 30, 1999 - ------------------------ Net interest income after loan loss expense................ $ 6,544 $ 61,738 $(4,349) $ 63,933 $ 42,396 $106,329 Cost of funds allocation............. 49,436 (23,807) 5,668 31,297 (31,297) -- Non-interest income..... 31,612 6,864 17,988 56,464 4,972 61,436 -------- -------- ------- -------- -------- -------- Total net revenue....... 87,592 44,795 19,307 151,694 16,071 167,765 Non-interest expense.... 65,713 19,905 12,791 98,409 6,198 104,607 -------- -------- ------- -------- -------- -------- Income before income taxes.................. $ 21,879 $ 24,890 $ 6,516 $ 53,285 $ 9,873 $ 63,158 ======== ======== ======= ======== ======== ======== Three Months Ended June 30, 1998 - ------------------------ Net interest income after loan loss expense................ $ 174 $ 62,360 $(4,351) $ 58,183 $ 35,603 $ 93,786 Cost of funds allocation............. 55,191 (25,751) 5,460 34,900 (34,900) -- Non-interest income..... 27,256 6,307 16,262 49,825 5,916 55,741 -------- -------- ------- -------- -------- -------- Total net revenue....... 82,621 42,916 17,371 142,908 6,619 149,527 Non-interest expense.... 56,207 17,974 11,857 86,038 7,296 93,334 -------- -------- ------- -------- -------- -------- Income before income taxes.................. $ 26,414 $ 24,942 $ 5,514 $ 56,870 $ (677) $ 56,193 ======== ======== ======= ======== ======== ======== </TABLE> The segment activity, as shown above, includes both direct and allocated items. Amounts in the "Other/Elimination" column include activity not related to the segments, such as that relating to administrative functions, and the effect of certain expense allocations to the segments. 10
Schedule 6 COMMERCE BANCSHARES, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS June 30, 1999 (Unaudited) The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes and with the statistical information and financial data appearing in this report as well as the Company's 1998 Annual Report on Form 10-K. Results of operations for the six month period ended June 30, 1999 are not necessarily indicative of results to be attained for any other period. <TABLE> <CAPTION> Three Months Ended June Six Months 30 Ended June 30 ------------ -------------- 1999 1998 1999 1998 ----- ----- ------ ------ <S> <C> <C> <C> <C> Per Share Data Net income--basic........................ $ .69 $ .61 $ 1.32 $ 1.18 Net income--diluted...................... .68 .60 1.30 1.16 Cash dividends........................... .150 .138 .300 .276 Book value............................... 17.83 16.78 Market price............................. 40.25 46.49 Selected Ratios (Based on average balance sheets) Loans to deposits........................ 75.85% 75.30% 75.45% 74.71% Non-interest bearing deposits to total deposits................................ 14.52 21.87 14.69 21.86 Equity to loans.......................... 15.32 15.76 15.37 15.79 Equity to deposits....................... 11.62 11.86 11.60 11.80 Equity to total assets................... 9.78 9.97 9.72 9.91 Return on total assets................... 1.52 1.46 1.46 1.42 Return on realized stockholders' equity.. 16.02 15.18 15.60 14.86 Return on total stockholders' equity..... 15.53 14.63 15.03 14.32 (Based on end-of-period data) Efficiency ratio......................... 58.17 58.26 58.83 58.00 Tier I capital ratio..................... 11.87 12.28 Total capital ratio...................... 13.14 13.38 Leverage ratio........................... 8.98 8.94 </TABLE> Summary Consolidated net income for the second quarter of 1999 was $41.8 million; a $4.3 million or 11.4% increase over the second quarter of 1998. Diluted earnings per share increased 13.3% to $.68 for the second quarter of 1999 compared to $.60 for the second quarter of 1998. The second quarter of 1999 was the Company's thirteenth consecutive quarter of double-digit growth in earnings per share. Return on average assets for the quarter was 1.52% compared to 1.46% for the second quarter of 1998 and 1.40% for the first quarter of 1999. Return on average realized stockholders' equity for the second quarter was 16.02% compared to 15.18% last year. The Company's efficiency ratio was 58.17% for the second quarter of 1999 compared to 58.26% for the second quarter of 1998 and 59.51% for the first quarter of 1999. Consolidated net income for the first six months of 1999 was $80.5 million, an 11.8% increase over the first six months of 1998. Diluted earnings per share was $1.30 compared to $1.16 for the first six months of last year. The Company achieved balanced growth in net interest income, which grew 8.6%, and core fee income. Core 11
fee income, which excludes gains on securities sales and certain other security valuation income, increased 15.1% over last year. Growth strategies have produced double digit growth in fee revenues from the bankcard, trust and money management products. Non-interest expense increased 12.8% over the first six months of 1998, which included the effects of adding 166 full-time equivalent employees and rising health insurance costs. Net Interest Income The following table summarizes the changes in net interest income on a fully tax 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. Management believes this allocation method, applied on a consistent basis, provides meaningful comparisons between the respective periods. Analysis of Changes in Net Interest Income <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, 1999 vs. 1998 June 30, 1999 vs. 1998 -------------------------- -------------------------- Change due to Change due to ----------------- ----------------- Average Average Average Average Volume Rate Total Volume Rate Total ------- -------- ------- ------- -------- ------- (In thousands) <S> <C> <C> <C> <C> <C> <C> Interest income, fully taxable equivalent basis: Loans................. $10,449 $ (8,869) $ 1,580 $24,099 $(19,078) $ 5,021 Investment securities: U.S. government and federal agency securities......... (2,306) (653) (2,959) (3,315) (1,471) (4,786) State and municipal obligations........ (139) 8 (131) (98) (2) (100) CMO's and asset- backed securities.. 6,040 (557) 5,483 8,552 (871) 7,681 Other securities.... (535) (71) (606) 896 (338) 558 Federal funds sold and securities purchased under agreements to resell............... 1,102 (482) 620 4,119 (1,501) 2,618 ------- -------- ------- ------- -------- ------- Total interest income........... 14,611 (10,624) 3,987 34,253 (23,261) 10,992 ------- -------- ------- ------- -------- ------- Interest expense: Deposits: Savings............. 149 (613) (464) 318 (973) (655) Interest bearing demand............. 9,053 (12,258) (3,205) 14,070 (18,824) (4,754) Time open & C.D.'s of less than $100,000........... 253 (2,084) (1,831) 1,361 (3,242) (1,881) Time open & C.D.'s of $100,000 and over............... 654 (339) 315 1,637 (646) 991 Federal funds purchased and securities sold under agreements to repurchase........... 294 (1,083) (789) 1,426 (2,369) (943) Long-term debt and other borrowings..... 378 (281) 97 747 (554) 193 ------- -------- ------- ------- -------- ------- Total interest expense.......... 10,781 (16,658) (5,877) 19,559 (26,608) (7,049) ------- -------- ------- ------- -------- ------- Net interest income, fully taxable equivalent basis....... $ 3,830 $ 6,034 $ 9,864 $14,694 $ 3,347 $18,041 ======= ======== ======= ======= ======== ======= </TABLE> Net interest income for the second quarter of 1999 was $115.1 million, a 9.4% increase over the second quarter of 1998, and for the first six months was $227.2 million, an 8.6% increase over last year. For the quarter, the net interest rate margin was 4.61% compared with 4.58% last year, while the six month margin was 4.55% in 1999 and 4.62% in 1998. 12
Total interest income increased $4.0 million, or 2.2%, over the second quarter of 1998, mainly due to increases of $520.0 million in average loans and $382.7 million in average CMO's and asset-backed securities. Partially offsetting these increases were a 53 basis point decline in average rates earned on loans and a decrease of $149.4 million in average balances in U.S. government and federal agency securities. The average tax equivalent yield on interest earning assets was 7.36% for the second quarter of 1999 compared to 7.81% last year. Compared to the first six months of 1998, total interest income increased $10.9 million, or 3.1%. Average loan balances increased $605.2 million, which contributed income of $24.1 million. In addition, average investment securities and short-term investments increased $340.2 million. These increases were partially offset by the effect of decreases in average loan rates. Total interest expense (net of capitalized interest) decreased $5.9 million, or 7.8%, compared to the second quarter of 1998 due mainly to lower rates paid on deposits, partially offset by growth in the Company's Premium Money Market deposit accounts. The average cost of funds was 3.26% for the second quarter of 1999 and 4.13% for the second quarter of 1998. Total interest expense decreased $7.0 million, or 4.7%, in the first six months of 1999 compared to 1998. Lower rates paid on deposits were partially offset by higher average balances in the Premium Money Market deposit accounts. Average core deposits (deposits excluding short-term certificates of deposit over $100,000) for the first six months of 1999 increased 8.3% compared to the same period last year. Core deposits supported 91% of average earning assets in 1999 compared with 92% in 1998. Summaries of average assets and liabilities and the corresponding average rates earned/paid appear on pages 20 and 21. Risk Elements of Loan Portfolio Non-performing assets include impaired loans (non-accrual loans and loans 90 days delinquent and still accruing interest) and foreclosed real estate. Loans are placed on non-accrual status when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment (generally, loans that are 90 days past due as to principal and/or interest payments). These loans were made primarily to borrowers in Missouri, Kansas and Illinois. The following table presents non-performing assets. <TABLE> <CAPTION> June 30, 1999 December 31, 1998 ------------- ----------------- (In thousands) <S> <C> <C> Non-accrual loans........................ $12,760 $17,831 Past due 90 days and still accruing interest................................ 21,970 24,529 ------- ------- Total impaired loans................. 34,730 42,360 Foreclosed real estate................... 1,672 2,521 ------- ------- Total non-performing assets.......... $36,402 $44,881 ======= ======= Non-performing assets to total loans..... .51% .64% Non-performing assets to total assets.... .33% .39% </TABLE> The level of non-performing assets decreased $8.5 million, or 18.9%, from year end 1998 totals. Most of the decrease occurred in the non-accrual loan category. Non-accrual loans at June 30, 1999 consisted mainly of business loans ($7.0 million), construction and land development loans ($2.4 million), and business real estate loans ($2.8 million). Loans which were 90 or more days past due included business loans of $6.9 million, credit card loans of $5.6 million and personal real estate loans of $4.2 million. A subsidiary bank issues Visa and MasterCard credit cards, and credit card loans outstanding were $497.7 million at June 30, 1999. Because credit card loans traditionally have a higher than average ratio of net charge-offs to loans outstanding, management requires that a specific allowance for losses on credit card loans be maintained, which was $14.8 million, or 3.0% of credit card loans at June 30, 1999. The annualized net charge- 13
off ratio for credit card loans was 3.47% for the first six months of 1999 compared to 3.89% for the first six months of 1998. The risk presented by the above loans and foreclosed real estate is not considered by management to be materially adverse in relation to normal credit risks generally taken by lenders. Provision/Allowance for Loan Losses <TABLE> <CAPTION> Six Months Ended Three Months Ended June 30 ----------------------------------------- ------------------ Mar. 31, 1999 June 30, 1999 June 30, 1998 1999 1998 ------------- ------------- ------------- -------- -------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> Provision for loan losses................. $8,550 $8,741 $11,410 $ 17,291 $ 22,126 Net charge-offs......... 6,085 8,073 6,989 14,158 16,018 Net annualized charge- offs as a percentage of average loans.......... .35% .46% .43% .41% .50% </TABLE> Management records the provision for loan losses, on an individual bank basis, in amounts that result in an allowance for loan losses sufficient to cover current net charge-offs and risks believed to be inherent in the loan portfolio of each bank. Management's evaluation includes such factors as past loan loss experience, current loan portfolio mix, evaluation of actual and potential losses in the loan portfolio, prevailing regional and national economic conditions that might have an impact on the portfolio, regular reviews and examinations of the loan portfolio conducted by internal loan reviewers supervised by Commerce Bancshares, Inc. (the Parent), and reviews and examinations by bank regulatory authorities. The allowance for loan losses as a percentage of loans outstanding was 1.68% at June 30, 1999, compared to 1.66% at year end 1998 and 1.71% at June 30, 1998. The allowance at June 30, 1999 was 330% of non-performing assets. Management believes that the allowance for loan losses, which is a general reserve, is adequate to cover actual and potential losses in the loan portfolio under current conditions. Other than as previously noted, management is not aware of any significant risks in the current loan portfolio due to concentrations of loans within any particular industry, nor of any separate types of loans within a particular category of non-performing loans that are unusually significant as to possible loan losses when compared to the entire loan portfolio. Non-Interest Income <TABLE> <CAPTION> Three Months Ended June 30 Six Months Ended June 30 -------------------------- ---------------------------- 1999 1998 % Change 1999 1998 % Change ------- ------- -------- -------- -------- -------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Trust fees.............. $14,212 $13,073 8.7% $ 28,124 $ 24,726 13.7% Deposit account charges and other fees......... 17,109 15,718 8.8 33,350 30,107 10.8 Credit card transaction fees................... 11,007 8,901 23.7 19,907 15,996 24.4 Trading account profits and commissions........ 2,620 1,827 43.4 5,405 4,108 31.6 Net gains on securities transactions........... 357 4,667 (92.4) 993 6,088 (83.7) Other................... 16,131 11,555 39.6 31,113 24,675 26.1 ------- ------- -------- -------- Total non-interest income............. $61,436 $55,741 10.2 $118,892 $105,700 12.5 ======= ======= ======== ======== As a % of operating income (net interest income plus non- interest income)....... 34.8% 34.6% 34.3% 33.6% ======= ======= ======== ======== </TABLE> Non-interest income rose $13.2 million over the first six months of last year and $5.7 million over the second quarter of last year. Trust fees increased $3.4 million over the six months of 1998 and $1.1 million over the second quarter of 1998, mainly due to account growth and increases in the value of assets managed. Deposit account charges are up due to strong growth in overdraft and account analysis fee income. Increases in credit card transaction fees were due to growth in merchant income, sales volumes, and pricing changes. Gains on securities transactions declined in 1999 because of the substantial gains recorded by the parent and a venture capital subsidiary on 1998 equity sales. Other income increased mainly due to net unrealized investment gains recorded by a partnership venture fund in which the Company participates. Other income also included increases in cash management income and brokerage-related fees and commissions. 14
Non-Interest Expense <TABLE> <CAPTION> Three Months Ended June 30 Six Months Ended June 30 ------------------------- -------------------------- 1999 1998 % Change 1999 1998 % Change -------- ------- -------- -------- -------- -------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Salaries and employee benefits................. $ 53,369 $49,879 7.0% $107,394 $ 98,385 9.2% Net occupancy............. 6,827 6,366 7.2 13,486 11,659 15.7 Equipment................. 5,780 4,399 31.4 10,655 8,665 23.0 Supplies and communication............ 8,386 7,101 18.1 16,546 14,199 16.5 Data processing........... 9,020 7,117 26.7 17,231 14,054 22.6 Marketing................. 2,915 3,479 (16.2) 6,166 6,238 (1.2) Goodwill and core deposit. 2,133 2,295 (7.1) 4,266 4,591 (7.1) Other..................... 16,177 12,698 27.4 31,564 25,964 21.6 -------- ------- -------- -------- Total non-interest expense.............. $104,607 $93,334 12.1 $207,308 $183,755 12.8 ======== ======= ======== ======== Full-time equivalent employees................ 5,312 5,169 2.8 5,319 5,153 3.2 ======== ======= ======== ======== </TABLE> Non-interest expense rose $23.6 million, or 12.8%, compared to the first six months of 1998 and increased $11.3 million, or 12.1%, compared to the second quarter of 1998. Salaries and employee benefits increased $9.0 million over the first six months of 1998 and increased $3.5 million over the second quarter of 1998. Additional employees, contract programming costs, merit increases, and higher health insurance costs contributed to the increases. Equipment costs partly reflect higher costs of branch technology expenditures made over the last year. Increases in supplies and communication expense were due to higher telephone expense, office supplies and express/courier service. Data processing expense increased $3.2 million and $1.9 million over the 1998 year and quarter to date periods, partly because of account growth and higher charges by information service providers. Other expense included increases in professional fees, processing losses, and sales tax expense. The efficiency ratio was 58.17% in the second quarter of 1999 compared to 58.26% in the second quarter of 1998 and 59.51% in the first quarter of 1999. Income Taxes The Company's income tax expense was $41.1 million for the first six months of 1999 and $37.1 million for the same period in 1998, resulting in effective tax rates of 33.8% and 34.0%, respectively. The 1999 second quarter effective tax rate was 33.9% compared to 33.3% for the second quarter of 1998. The lower 1998 second quarter rate was partially due to the contribution of an appreciated equity security. 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 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 Money Management. Consumer The Consumer segment includes the retail branch network, consumer finance, bankcard, student loans and discount brokerage. At June 30, 1999, it employed 2,396 full-time equivalent employees, up 4.6% over the previous year. For the six months ended June 30, 1999, pre-tax earnings amounted to $45.0 million, down 18.4% from the previous year. Direct net interest income grew $10.7 million over the previous year due to growth in loans of 10.2% coupled with lower deposit costs. The acquisition of three new banks in 1998 also increased net interest income for the segment. These revenues, however, were offset by lower funding credits assigned to 15
the segment, which declined 9.9% and offset most of the growth in direct net interest income. Costs for loan charge-offs declined 9.0% mainly due to improved credit results in the bankcard loan sector. Non-interest income grew by 16.6% mainly as a result of higher fees from deposit account, credit card, and brokerage-related fees. Non-interest expense for the first six months increased 18.2% over the same period in the previous year partly due to the bank acquisitions mentioned previously but also due to higher costs for data processing, occupancy and assigned management costs. Commercial The Commercial segment provides corporate lending, leasing, international services, and corporate cash management services. For the six months ended June 30, 1999, pre-tax earnings amounted to $49.7 million, up 6.6% over the previous year. Direct net interest income was flat compared to the previous year partly due to loan growth of 8.8% but offset by lower loan rates. Assigned costs of funding declined 6.6% as a result of lower overall interest rates during the last half of 1998 and first six months of 1999. Cost for loan charge-offs declined by 44.0% to $705 thousand. Non-interest income grew by 10.0% mainly due to higher loan commitment and international fee income, coupled with commercial deposit fee growth of 3.6%. Non-interest expense grew by 7.6% mainly as a result of higher costs for check processing, data processing and salaries. Money Management The Money Management segment consists of the Investment Management Group (IMG) and the Capital Markets Group (CMG). IMG provides trust and estate planning services, and advisory and discretionary investment management services. CMG sells fixed-income securities for personal and commercial customers. For the six months ended June 30, 1999, pre-tax earnings amounted to $13.7 million, an increase of $2.7 million or 24.6%. The increase in pre- tax earnings was mainly due to growth in trust and bond fees which grew by 15.1% or $4.3 million. Non-interest expense also grew by 10.9% with higher costs for salaries, data processing and other expense. Year 2000 Readiness Disclosure* Introduction As discussed in the 1998 Annual Report to shareholders, the Company has developed a comprehensive plan to attain Year 2000 compliance. The plan has four general phases: (1) assessment, which includes inventorying and evaluating business processes and elements that must be modified, (2) renovation, which includes the modification, replacement or elimination of non-compliant items, (3) validation, or testing; and (4) implementation, which involves putting the renovated systems and equipment into operation. As the last phase is completed, integrated testing is performed to ensure that validated items operate correctly in relation with one another. State of Readiness Mission critical items (defined to be those programs and processes that are essential to activities which present significant financial risk or risk in reputation) were identified in the assessment phase. At June 30, 1999, all of the identified mission critical items (165 total) had been assessed for Year 2000 issues, renovated where necessary, and tested. Of these items, 99% had been implemented. The Company has completed integrated testing of internal mission critical software systems. The Company has also substantially completed the renovation, testing and implementation of high-priority, non- mission critical items. - -------- *This statement is made pursuant to the Year 2000 Information and Readiness Disclosure Act. This statement originated from the Company and concerns (1) assessments, projections, or estimates of year 2000 processing capabilities; (2) plans, objectives, or timetables for implementing or verifying year 2000 processing capabilities; (3) test plans, dates, or results; and/or (4) reviews and comments concerning year 2000 processing capabilities as defined by the Act. 16
The Company interfaces with many third parties, including customers, supply vendors, service providers, and counterparties. Some of its major systems are provided by third parties. The Company has communicated with significant third parties to determine the extent to which the Company may be affected by those third parties' failure to remediate their own Year 2000 issues. Assessments have been prepared for all of the Company's largest customers and counterparties. The Company will continue to monitor the progress of third party testing and implementation procedures throughout 1999, but cannot at this time determine the financial effect if significant third party remediation efforts fail. Costs to Address Year 2000 Issues The total cost of the Company's Year 2000 project is currently estimated to range between $5.5 and $6.5 million. Since inception through June 30, 1999, the cost has totaled approximately $4.1 million. This cost does not include computer equipment and software that is replaced within scheduled time frames in the normal course of business. A significant portion of these costs are not likely to be incremental costs to the Company, but rather will represent the redeployment of existing Company resources. System renovation costs for the Company are relatively low because a significant portion of the Company's software is vendor-supplied. Risks of Company's Year 2000 Issues The Company's estimate of Year 2000 project costs are based on management's best current estimates. Actual results could differ from those anticipated. The failure to correct a material Year 2000 problem could result in an interruption in, or a failure of, certain normal business activities or operations. Such failures could materially and adversely affect the Company's results of operations, liquidity and financial condition. The Company is unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on the Company's results of operations, liquidity and financial condition due to the general uncertainty inherent in the Year 2000 problem. The Company believes that, with the completion of the Year 2000 project as scheduled, the possibility of significant interruptions and failures of normal operations should be reduced. Year 2000 Contingency Plans The Company has developed Year 2000 business resumption contingency plans. These plans address Year 2000 problems that occur notwithstanding the remediation efforts of the Company and third parties. They include issues like liquidity needs and dependence on utility, postal and other service providers. Independent testing of these plans has been completed. Readers are cautioned that forward-looking statements contained in the Year 2000 discussion above should be read in conjunction with the Company's disclosures under the heading: "Cautionary Statement Pursuant to Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995". Liquidity and Capital Resources The liquid assets of the Parent consist primarily of commercial paper, overnight repurchase agreements and equity securities, most of which are readily marketable. The fair value of these investments was $114.3 million at June 30, 1999 compared to $119.0 million at December 31, 1998. Included in the fair values were unrealized net gains of $28.3 million at June 30, 1999 and $26.6 million at December 31, 1998. The Parent's liabilities totaled $58.0 million at June 30, 1999, compared to $14.2 million at December 31, 1998. Liabilities at June 30, 1999 included $40.2 million advanced mainly from subsidiary bank holding companies in order to combine resources for short-term investment in liquid assets. The Parent had no short-term borrowings from affiliate banks or long-term debt during 1999. The Parent's commercial paper, which management believes is readily marketable, has a P1 rating from Moody's and an A1 rating from Standard & Poor's. The Company is also rated A by Thomson BankWatch with a corresponding short-term rating of TBW-1. This credit availability should provide adequate funds to meet any outstanding or future commitments of the Parent. 17
The liquid assets held by bank subsidiaries include federal funds sold and securities purchased under agreements to resell and available for sale investment securities. These liquid assets had a fair value of $2.72 billion at June 30, 1999 and $3.11 billion at December 31, 1998. The available for sale bank portfolio included an unrealized net loss in fair value of $2.1 million at June 30, 1999 compared to an unrealized net gain of $55.2 million at December 31, 1998. U.S. government and federal agency securities comprised 48% and CMO's and asset-backed securities comprised 48% of the banking subsidiaries' available for sale portfolio at June 30, 1999. The estimated average maturity of the available for sale investment portfolio is 3.2 years at June 30, 1999 and 2.3 years at December 31, 1998. In February 1999, the Board of Directors announced the approval of additional purchases of the Company's common stock, bringing the total purchase authorization to 3,000,000 shares. At June 30, 1999, the Company had acquired 848,949 shares under this authorization. The Company had an equity to asset ratio of 9.72% based on 1999 average balances. As shown in the following table, the Company's capital exceeded the minimum risk-based capital and leverage requirements of the regulatory agencies. <TABLE> <CAPTION> June 30, Min. Ratios for 1999 December 31, 1998 Well-Capitalized Banks ---------- ----------------- ---------------------- (Dollars in thousands) <S> <C> <C> <C> Risk-Adjusted Assets.... $8,253,812 $8,426,289 Tier I Capital.......... 980,137 952,488 Total Capital........... 1,084,354 1,060,692 Tier I Capital Ratio.... 11.87% 11.30% 6.00% Total Capital Ratio..... 13.14% 12.59% 10.00% Leverage Ratio.......... 8.98% 8.80% 5.00% </TABLE> The Company's cash and cash equivalents (defined as "Cash and due from banks") decreased $36.1 million from $738.7 million at December 31, 1998 to $702.6 million at June 30, 1999. Contributing to the net cash outflow were an increase in loans of $137.6 million (net of repayments), treasury stock purchases of $41.3 million and a net decrease in deposits of $301.5 million. Partially offsetting these net cash outflows were $219.4 million in maturities and sales of investment securities (net of purchases), a net decrease of $121.4 million in short-term investments, and $136.9 million generated from operating activities. Total assets decreased $335.0 million from December 31, 1998. The Company has various commitments and contingent liabilities which are properly not reflected on the balance sheet. Loan commitments (excluding lines of credit related to credit card loan agreements) totaled approximately $2.88 billion, standby letters of credit totaled $232.2 million, and commercial letters of credit totaled $40.2 million at June 30, 1999. The Company has little risk exposure in off-balance-sheet derivative contracts. The notional value of these contracts (interest rate and foreign exchange rate contracts) was $186.7 million at June 30, 1999. The current credit exposure (or replacement cost) across all off-balance-sheet derivative contracts covered by the risk-based capital standards was $3.5 million at June 30, 1999. Management does not anticipate any material losses to arise from these contingent items and believes there are no material commitments to extend credit that represent risks of an unusual nature. Quantitative and Qualitative Disclosures about Market Risk The Company's assets and liabilities are principally financial in nature and the resulting net interest income thereon is subject to changes in market interest rates and the mix of various assets and liabilities. Interest rates in the financial markets affect the Company's decisions on pricing its assets and liabilities which impacts net interest income, a significant cash flow source for the Company. As a result, a substantial portion of the Company's risk management activities relates to managing interest rate risk. 18
The Company's Asset/Liability Management Committee monitors the interest rate sensitivity of the Company's balance sheet monthly using earnings simulation models and interest sensitivity GAP analysis. Using these tools, management attempts to optimize the asset/liability mix to minimize the impacts of significant rate movements within a broad range of interest rate scenarios. One set of simulation models is prepared to determine the impact on net interest income for the coming twelve months under several interest rate scenarios. One such scenario uses rates and volumes at June 30, 1999 for the twelve month projection. When this position is subjected to a graduated shift in interest rates of 100 basis points rising and 100 basis points falling, the annual impact to the Company's net interest income is as follows: <TABLE> <CAPTION> $ in % of Net Scenario millions Int. Income -------- -------- ----------- <S> <C> <C> 100 basis points rising.............................. $ 3.0 1% 100 basis points falling............................. (1.1) -- </TABLE> Currently, the Company does not have significant risks related to foreign exchange, commodities or equity risk exposures. Impact of Accounting Standards Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities", will be adopted by the Company on January 1, 2001. SFAS No. 137, an amendment of SFAS No. 133, deferred its effective date for one year. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and hedging activities. All derivatives must be recognized on the balance sheet at fair value, with special accounting requirements for designated hedging activities. Certain changes in fair value must be adjusted through income. Because of the Company's minimal use of derivatives, management does not anticipate that the adoption of the new Statement will have a significant effect on earnings or the financial position of the Company. Cautionary Statement Pursuant to Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 This report contains "forward-looking statements" within the meaning of the federal securities laws. Such statements are subject to certain risks and uncertainties, including changes in economic conditions in the Company's market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the Company's market area, and competition, that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. 19
AVERAGE BALANCE SHEETS--AVERAGE RATES AND YIELDS Six Months Ended June 30, 1999 and 1998 <TABLE> <CAPTION> Six Months 1999 Six Months 1998 -------------------------------- -------------------------------- Interest Avg. Rates Interest Avg. Rates Average Income/ Earned/ Average Income/ Earned/ Balance Expense Paid Balance Expense Paid ----------- -------- ---------- ----------- -------- ---------- (Unaudited) (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> ASSETS: Loans: Business (A)........... $ 2,358,751 $ 84,287 7.21% $ 2,160,814 $ 84,327 7.87% Construction and development........... 352,348 13,464 7.71 237,979 9,916 8.40 Real estate--business.. 1,023,920 40,567 7.99 942,440 39,461 8.44 Real estate--personal.. 1,329,476 48,463 7.35 1,217,314 46,485 7.70 Personal banking....... 1,456,611 58,774 8.14 1,342,874 57,241 8.60 Credit card............ 500,925 32,084 12.92 515,377 35,188 13.77 ----------- -------- ----- ----------- -------- ----- Total loans.......... 7,022,031 277,639 7.97 6,416,798 272,618 8.57 ----------- -------- ----- ----------- -------- ----- Investment securities: U.S. government & federal agency........ 1,330,118 39,748 6.03 1,437,077 44,534 6.25 State & municipal obligations (A)....... 93,797 3,724 8.01 96,256 3,824 8.01 CMO's and asset-backed securities............ 1,131,930 34,834 6.21 860,762 27,153 6.36 Trading account securities............ 14,860 398 5.41 9,991 246 4.97 Other marketable securities (A)........ 142,990 4,031 5.68 118,564 3,546 6.03 Other non-marketable securities............ 32,921 847 5.19 31,363 926 5.95 ----------- -------- ----- ----------- -------- ----- Total investment securities.......... 2,746,616 83,582 6.14 2,554,013 80,229 6.33 ----------- -------- ----- ----------- -------- ----- Federal funds sold and securities purchased under agreements to resell................. 397,294 9,521 4.83 249,700 6,903 5.57 ----------- -------- ----- ----------- -------- ----- Total interest earning assets...... 10,165,941 370,742 7.35 9,220,511 359,750 7.87 -------- ----- -------- ----- Less allowance for loan losses................. (118,309) (107,875) Unrealized gain on investment securities.. 63,727 58,648 Cash and due from banks. 594,494 630,674 Land, buildings and equipment, net......... 224,008 216,204 Other assets............ 179,153 211,835 ----------- ----------- Total assets......... $11,109,014 $10,229,997 =========== =========== LIABILITIES AND EQUITY: Interest bearing deposits: Savings................ $ 341,006 3,102 1.83 $ 314,378 3,757 2.41 Interest bearing demand................ 5,071,428 61,985 2.46 3,985,321 66,739 3.38 Time open & C.D.'s of less than $100,000.... 2,229,891 56,605 5.12 2,174,831 58,486 5.42 Time open & C.D.'s of $100,000 and over..... 297,244 7,453 5.06 237,339 6,462 5.49 ----------- -------- ----- ----------- -------- ----- Total interest bearing deposits.... 7,939,569 129,145 3.28 6,711,869 135,444 4.07 ----------- -------- ----- ----------- -------- ----- Borrowings: Federal funds purchased and securities sold under agreements to repurchase............ 566,299 11,830 4.21 508,547 12,773 5.06 Long-term debt and other borrowings...... 26,688 442 3.34 6,678 249 7.53 ----------- -------- ----- ----------- -------- ----- Total borrowings..... 592,987 12,272 4.17 515,225 13,022 5.10 ----------- -------- ----- ----------- -------- ----- Total interest bearing liabilities. 8,532,556 141,417 3.34% 7,227,094 148,466 4.14% -------- ----- -------- ----- Non-interest bearing demand deposits........ 1,367,431 1,877,153 Other liabilities....... 129,477 112,467 Stockholders' equity.... 1,079,550 1,013,283 ----------- ----------- Total liabilities and equity.............. $11,109,014 $10,229,997 =========== =========== Net interest margin (T/E).................. $229,325 $211,284 ======== ======== Net yield on interest earning assets......... 4.55% 4.62% ===== ===== </TABLE> - -------- (A) Stated on a tax equivalent basis using a federal income tax rate of 35%. 20
AVERAGE BALANCE SHEETS--AVERAGE RATES AND YIELDS Three Months Ended June 30, 1999 and 1998 <TABLE> <CAPTION> Second Quarter 1999 Second Quarter 1998 -------------------------------- -------------------------------- Interest Avg. Rates Interest Avg. Rates Average Income/ Earned/ Average Income/ Earned/ Balance Expense Paid Balance Expense Paid ----------- -------- ---------- ----------- -------- ---------- (Unaudited) (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> ASSETS: Loans: Business (A)........... $ 2,351,562 $ 42,445 7.24% $ 2,232,693 $ 43,691 7.85% Construction and development........... 354,362 6,774 7.67 241,610 5,009 8.32 Real estate--business.. 1,047,351 20,944 8.02 948,825 19,876 8.40 Real estate--personal.. 1,328,633 24,207 7.31 1,250,376 23,591 7.57 Personal banking....... 1,469,527 29,512 8.06 1,345,300 28,870 8.61 Credit card............ 492,995 15,713 12.78 505,593 16,978 13.47 ----------- -------- ----- ----------- -------- ----- Total loans.......... 7,044,430 139,595 7.95 6,524,397 138,015 8.48 ----------- -------- ----- ----------- -------- ----- Investment securities: U.S. government & federal agency........ 1,290,084 19,247 5.98 1,439,511 22,206 6.19 State & municipal obligations (A)....... 93,086 1,835 7.91 100,163 1,966 7.87 CMO's and asset-backed securities............ 1,250,621 19,188 6.15 867,915 13,705 6.33 Trading account securities............ 11,940 135 4.54 11,325 118 6.00 Other marketable securities (A)........ 88,229 1,277 5.81 123,321 1,979 6.44 Other non-marketable securities............ 33,225 420 5.07 31,455 341 4.35 ----------- -------- ----- ----------- -------- ----- Total investment securities.......... 2,767,185 42,102 6.10 2,573,690 40,315 6.28 ----------- -------- ----- ----------- -------- ----- Federal funds sold and securities purchased under agreements to resell................. 286,125 3,478 4.88 206,497 2,858 5.55 ----------- -------- ----- ----------- -------- ----- Total interest earning assets...... 10,097,740 185,175 7.36 9,304,584 181,188 7.81 -------- ----- -------- ----- Less allowance for loan losses................. (119,117) (109,973) Unrealized gain on investment securities.. 53,281 60,349 Cash and due from banks. 610,158 624,396 Land, buildings and equipment, net......... 225,654 216,839 Other assets............ 168,290 215,009 ----------- ----------- Total assets......... $11,036,006 $10,311,204 =========== =========== LIABILITIES AND EQUITY: Interest bearing deposits: Savings............... $ 346,697 1,458 1.69 $ 321,854 1,922 2.40 Interest bearing demand............... 5,091,924 30,546 2.41 4,014,399 33,751 3.37 Time open & C.D.'s of less than $100,000... 2,206,836 27,676 5.03 2,188,059 29,507 5.41 Time open & C.D.'s of $100,000 and over.... 293,343 3,671 5.02 245,489 3,356 5.48 ----------- -------- ----- ----------- -------- ----- Total interest bearing deposits.... 7,938,800 63,351 3.20 6,769,801 68,536 4.06 ----------- -------- ----- ----------- -------- ----- Borrowings: Federal funds purchased and securities sold under agreements to repurchase........... 526,212 5,520 4.21 502,729 6,309 5.03 Long-term debt and other borrowings..... 26,388 214 3.25 6,273 117 7.53 ----------- -------- ----- ----------- -------- ----- Total borrowings..... 552,600 5,734 4.16 509,002 6,426 5.06 ----------- -------- ----- ----------- -------- ----- Total interest bearing liabilities. 8,491,400 69,085 3.26% 7,278,803 74,962 4.13% -------- ----- -------- ----- Non-interest bearing demand deposits........ 1,348,366 1,894,598 Other liabilities....... 117,173 109,834 Stockholders' equity.... 1,079,067 1,027,969 ----------- ----------- Total liabilities and equity.............. $11,036,006 $10,311,204 =========== =========== Net interest margin (T/E).................. $116,090 $106,226 ======== ======== Net yield on interest earning assets......... 4.61% 4.58% ===== ===== </TABLE> - -------- (A) Stated on a tax equivalent basis using a federal income tax rate of 35%. 21