SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
For the Transition Period from to
Commission File No. 0-2989
COMMERCE BANCSHARES, INC.
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
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). þ
As of August 5, 2003, the registrant had outstanding 65,824,388 shares of its $5 par value common stock, registrant’s only class of common stock.
TABLE OF CONTENTS
Commerce Bancshares, Inc. and Subsidiaries
Form 10-Q
Item 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
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CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 2002 data to conform to current year presentation. Results of operations for the three and six month periods ended June 30, 2003, 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 2002 Annual Report on Form 10-K.
The Company has various stock option plans offered to certain key employees of the Company and its subsidiaries. Prior to 2003, the Company accounted for those plans under the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related Interpretations. No stock-based employee compensation cost was reflected in previously reported results, as all options granted under those plans had an exercise price equal to the fair value of the underlying common stock on the date of grant. Effective January 1, 2003, the Company voluntarily adopted the provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation”, in which the cost of stock options are expensed. In accordance with the transition provisions of Statement of Financial Accounting Standards No. 148, the Company has elected to restate all prior periods to reflect the compensation expense that would have been recognized had the recognition provisions of Statement No. 123 been applied to all options granted to employees after January 1, 1995. The after-tax per share impact for the six months ended June 30, 2003 and 2002 was a decline of $.03 in each period. The Company expects the overall annual impact of applying the statement to be $.05 per share in 2003.
Effective January 1, 2003, the Company acquired The Vaughn Group, Inc., a direct equipment lessor based in Cincinnati, Ohio. At acquisition, The Vaughn Group, Inc. (Vaughn) had a lease portfolio of approximately $38.7 million consisting mainly of data processing hardware. In addition, Vaughn serviced approximately $425 million of lease agreements for other institutions involving capital equipment, ranging from production machinery to transportation equipment. The Company issued stock valued at $6.0 million and paid cash of $2.5 million in the acquisition. The acquisition was accounted for as a purchase, and accordingly, the consolidated results include Vaughn for the entire six months of 2003. Goodwill of $5.3 million was recognized in the transaction and recorded in the 2003 consolidated financial statements.
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The following is a summary of the allowance for loan losses.
Investment securities, at fair value, consist of the following at June 30, 2003, and December 31, 2002.
Equity securities included short term investments in money market mutual funds of $228,666,000 at June 30, 2003, and $150,905,000 at December 31, 2002.
The following table presents information about the Company’s intangible assets which have estimable useful lives.
The Company does not have any intangible assets that are not currently being amortized. Aggregate amortization expense on intangible assets was $449,000 and $668,000, respectively, for the three month
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The Company, as a provider of financial services, routinely issues financial guarantees in the form of financial and performance standby letters of credit. Standby letters of credit are contingent commitments issued by the Company generally to guarantee the payment or performance obligation of a customer to a third party. While these represent a potential outlay by the Company, a significant amount of the commitments may expire without being drawn upon. The Company has recourse against the customer for any amount it is required to pay to a third party under a standby letter of credit. The letters of credit are subject to the same credit policies, underwriting standards and approval process as loans made by the Company. Most of the standby letters of credit are secured and in the event of nonperformance by the customers, the Company has rights to the underlying collateral, which could include commercial real estate, physical plant and property, inventory, receivables, cash and marketable securities.
At June 30, 2003, a liability in the amount of $6.5 million, representing the carrying value of the guarantee obligations associated with the standby letters of credit, was recorded in accordance with Financial Accounting Standards Board Interpretation 45. This amount will be amortized into income over the life of the commitment. The contract amount of these letters of credit, which represents the maximum potential future payments guaranteed by the Company, was $384.2 million at June 30, 2003.
The Company guarantees payments to holders of certain trust preferred securities issued by a wholly owned grantor trust subsidiary. The securities are due in 2030 and are redeemable beginning in 2010. The maximum potential future payments guaranteed by the Company, which includes future interest and principal payments through maturity, was approximately $15.7 million at June 30, 2003. At June 30, 2003, the Company had a recorded liability of $4.1 million in principal and accrued interest to date, representing amounts owed to the security holders.
The shares used in the calculation of basic and diluted income per share are shown below.
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The Company’s only component of other comprehensive income during the periods presented below was the unrealized holding gains and losses on available for sale investment securities.
The Company segregates financial information for use in assessing its performance and allocating resources among three operating segments. 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.
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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.
The information presented above was derived from the internal profitability reporting system used by management to monitor and manage the financial performance of the Company. This information is based on internal management accounting policies, which have been developed to reflect the underlying economics of the businesses. The policies address the methodologies applied in connection with funds transfer pricing. Funds transfer pricing was used in the determination of net interest income by assigning a standard cost (credit) for funds used (provided) to assets and liabilities based on their maturity, prepayment and/or repricing characteristics.
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The performance measurement of the operating segments is based on the management structure of the Company and is not necessarily comparable with similar information for any other financial institution. The information is also not necessarily indicative of the segments’ financial condition and results of operations if they were independent entities.
The Company uses derivative instruments, on a limited basis, primarily to hedge the variability in interest payments or protect the value of certain assets and liabilities recorded in its balance sheet from changes in interest rates. The Company has interest rate swaps with a total notional amount of $40.9 million, of which three swaps with a notional amount of $22.5 million are designated as fair value hedges of certain fixed rate loans. Through its International Department, the Company enters into foreign exchange contracts consisting mainly of contracts to purchase or deliver foreign currency transactions for customers at a specific future date. Also, mortgage loan commitments and forward sales contracts are derived from the Company’s mortgage banking operation in which fixed rate personal real estate loans are originated and sold to other institutions.
The Company’s usage of derivative instruments is detailed below.
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 2002 Annual Report on Form 10-K. Results of operations for the three and six month periods ended June 30, 2003, are not necessarily indicative of results to be attained for any other periods.
Forward Looking Information
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 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 that 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
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Critical Accounting Policies
Critical accounting policies are those which are both most important to the portrayal of the Company’s financial condition and results, and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company’s critical accounting policies relate to the allowance for loan losses, the valuation of certain non-marketable investments, and accounting for income taxes, all of which involve significant judgment by management.
The Company performs periodic and systematic detailed reviews of its lending portfolio to assess overall collectability. The level of the allowance for loan losses reflects the Company’s estimate of the collectability of the loan portfolio. While these estimates are based on substantive methods for determining allowance requirements, nevertheless, actual outcomes may differ significantly from estimated results. Further discussion of the methodologies used in establishing this reserve is provided in the Provision and Allowance for Loan Losses section of this discussion.
The parent holding company and its Small Business Investment subsidiaries have made numerous private equity and venture capital investments, which totaled $26.7 million at June 30, 2003. These private equity and venture capital securities are reported at estimated fair values in the absence of readily ascertainable fair values. Where no market quotation exists, management believes that the cost of an investment is initially the best indication of estimated fair value unless there have been significant subsequent positive or negative developments that justify an adjustment to the fair value estimate. The values assigned to these securities where no market quotations exist are based upon available information and management’s judgment. Although management believes its estimates of fair value are reasonable and conservatively reflect the fair value of these securities, key assumptions regarding the projected financial performance of these companies, the evaluation of the investee company’s management team and other economic and market factors may affect the amounts that will ultimately be realized from these investments.
The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences, including the effects of examinations by the IRS and state agencies, could materially impact the Company’s financial position and its results of operations.
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Selected Financial Data
Results of Operations
Summary
For the quarter ended June 30, 2003, net income amounted to $50.5 million, an increase of 2.0% over the second quarter of the previous year. Diluted earnings per share increased 5.6% to $.75 for the second quarter of 2003, compared to $.71 for the second quarter of 2002. The return on average assets for the current quarter was 1.49% compared to 1.63% for the second quarter of 2002. The return on average equity was 14.02% compared to 14.81% in 2002. The Company’s efficiency ratio rose slightly to 58.82% for the current quarter, compared to 58.03% in the second quarter of 2002. The increase in net income over the second quarter of last year was the result of a 3.3% increase in net interest income, coupled with growth in non-interest income of 6.2%. Non-interest expense increased 3.9% compared to the same quarter last year and the provision for loan losses also grew by $3.3 million.
Net income for the first six months of 2003 was $97.7 million, a 2.9% increase over the first six months of 2002. Diluted earnings per share were $1.45 compared to $1.36 for the first six months of last year, an increase of 6.6%. Net interest income rose $7.6 million, or 3.1%, and non-interest income grew 7.1%. Non-
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Effective January 1, 2003, the Company elected to expense the cost of stock options by retroactively applying the rules of Financial Accounting Statement 123. The after-tax per share impact for the six months ended June 30, 2003 and 2002 was a decline of $.03 in each period. The Company expects the overall annual impact of expensing the cost of stock options to be $.05 per share for 2003.
Effective January 1, 2003, the Company acquired The Vaughn Group, Inc. (Vaughn), a leasing company based in Cincinnati, Ohio. Vaughn was a direct lessor with a lease portfolio at December 31, 2002 of approximately $38.7 million consisting mainly of data processing hardware. In addition, Vaughn serviced approximately $425 million of lease agreements for other institutions. The Company issued common stock valued at $6.0 million and paid cash of $2.5 million in the acquisition.
Net Interest Income
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.
Analysis of Changes in Net Interest Income
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Net interest income for the second quarter of 2003 was $128.7 million, an increase of $4.1 million, or 3.3%, compared with the same period last year. For the first six months of 2003, net interest income totaled $252.9 million, an increase of $7.6 million, or 3.1%, compared with the first six months of last year. The net interest margin for the second quarter of 2003 was 4.15% compared with 4.47% in the second quarter of last year, while the net interest margin for the first six months of 2003 was 4.17% compared with 4.40% last year.
Compared with the second quarter of 2002, the increase in net interest income was the result of higher average balances of loans and investment securities, coupled with lower deposit rates offset by lower yields on most loan categories. Also, average long-term debt and other borrowings (mainly federal funds purchased and securities sold under repurchase agreements) increased by $1.04 billion, increasing interest expense. During the last eighteen months, the Federal Reserve lowered rates 50 basis points in November 2002 and another 25 basis points in June 2003. With this lower rate environment in 2003 compared with 2002, earning assets have re-priced downward faster than interest bearing liabilities, causing the net interest margin to decline. Rates earned on earning assets in the second quarter 2003 declined 71 basis points from the same period last year, while rates paid on interest bearing liabilities dropped 45 basis points. The effect of the decline in rates was most evident on the loan portfolio (rates declined 70 basis points) that has large segments of loans with variable rates. Also rates on investment securities dropped 66 basis points as new securities purchased during the last twelve months were acquired at lower rates. Rates on deposits fell by only 47 basis points on average because deposit account balances such as interest checking were already at low rates and the Federal Reserve’s rate changes could not be fully passed onto these balances. Rates on long-term debt and other borrowings fell 49 basis points but the increase in average balances caused net interest income to decline.
Total interest income in the current quarter decreased $3.4 million compared with the second quarter of 2002. This decline was the result of lower yields, as noted above, on both loans and investment securities, offset by higher average balances for these assets. While the decline in average rates on loans impacted virtually all loan categories, this decline was partly offset by growth in average loan balances that increased $365.6 million, or 4.8%, over the same period last year. Interest income on investment securities increased $5.2 million in the second quarter of 2003 compared with the same period last year as a result of an increase in average balances of $955.2 million, partly offset by lower rates earned on mortgage-backed and short-term money market securities. The increase in average balances was the result
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During the second quarter of 2003, inflation adjustments related to certain inflation-indexed treasury securities increased $4.8 million over adjustments made in the second quarter of last year, thus helping to mitigate the effects of lower rates. Also during the quarter, an adjustment of $783 thousand was made, reducing interest income on the Company’s CMO, mortgage-backed and asset-backed securities to recognize the result of faster principal payments received on these securities.
Compared to the first six months of 2002, total interest income decreased $11.7 million. The decline reflects the same trends noted above in the quarterly comparison, with declines in average overall yields due to the lower interest rate environment, partly offset by higher balances in loans and investment securities. Average tax equivalent yields on interest earning assets for the six months were 5.19% in 2003 and 5.87% in 2002.
For the three months ended June 30, 2003, total interest expense decreased $7.5 million compared to the same quarter last year. This was due mainly to a reduction in deposit rates in all interest bearing deposit categories, which had the effect of reducing interest expense by $9.2 million, offset by higher average total borrowings. The average balance of federal funds purchased, which have overnight maturities, increased by $801.7 million while securities sold under agreements to repurchase increased by $213.7 million. Much of the proceeds of these borrowings were used to fund loan growth or the purchase of investment securities. Average interest bearing deposits increased $124.9 million compared with the same quarter last year, with the increase occurring in the money market deposit account category.
For the first six months of 2003, total interest expense decreased $19.3 million compared with 2002. Average rates paid on deposit balances declined 52 basis points, and rates paid on total borrowings declined 53 basis points. Higher balances in both federal funds purchased and securities sold under repurchase agreements partly offset the decline in rates. The overall average cost of total interest bearing liabilities was 1.17% for the first six months of 2003 compared to 1.68% for the same period in 2002.
Summaries of average assets and liabilities and the corresponding average rates earned/paid are located at the end of this discussion.
Non-Interest Income
For the second quarter of 2003, total non-interest income amounted to $73.7 million compared with $69.4 million in the same quarter last year, an increase of 6.2%. This increase resulted from growth in bank card, deposit account, and mortgage banking revenue, in addition to higher gains on securities
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Non-interest income for the six months ended June 30, 2003, increased $9.8 million, or 7.1%, over the first six months of 2002. Deposit account charges rose 4.8% due to higher cash management fee revenue. Bank card transaction fees rose 12.6% ($715 thousand in merchant, $1.3 million in credit card, and $1.5 million in debit card fees) over the prior period. Mortgage banking revenue rose $1.0 million, mainly due to higher sales volumes. Partly offsetting these increases were a $1.6 million decline in trust fees and a $617 thousand decline in consumer brokerage revenue, which saw lower bond, equity and mutual fund activity, offset by higher annuity sales.
Net securities gains amounted to $2.2 million and $4.4 million, respectively, in the second quarter and first six months of 2003. In comparison, net losses of $955 thousand and $840 thousand, respectively, occurred in the second quarter and first six months of 2002. The gains in 2003 resulted mainly from sales from the banks’ available for sale portfolio, while the losses in 2002 were the result of impairment charges on several private equity investments.
As was mentioned in a previous report, in April 2003 VISA USA Inc. reached an agreement to settle litigation concerning debit card interchange fees with a large group of retailers. As a result of this litigation, the Company estimates that debit card revenue, based on current volumes, could decline by approximately $6.2 million on an annualized basis beginning in August 2003. Conditions of the settlement permit VISA to renegotiate debit card interchange rates as of January 1, 2004, which may affect this estimate. The Company is in the process of evaluating various initiatives which could partly reduce the impact of this lost revenue.
Non-Interest Expense
Non-interest expense for the quarter amounted to $118.2 million, an increase of $4.4 million, or 3.9%, compared with $113.8 million recorded in the second quarter of last year. Compared with the second quarter of last year, salaries and benefits expense increased 6.3% mainly due to normal merit increases, higher costs for incentive payments, and pension plan expense which was up $713 thousand. Full time equivalent employees totaled 4,982 and 5,021 at June 30, 2003 and 2002, respectively. Occupancy costs grew $1.2 million, or 15.0%, mainly as a result of higher depreciation and operating costs resulting from a
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Non-interest expense rose $8.8 million, or 3.8%, over the first six months of 2002. Salaries and employee benefits increased $6.6 million, or 5.2%, due to salary merit increases, higher incentive expense, and higher pension plan expense. Occupancy expense increased $3.1 million, or 18.9%, largely due to the building renovation noted above. Other non-interest expense increased $2.3 million, or 9.2%, due largely to new leasing-related costs of $1.8 million. These increases were partly offset by a decline in data processing and software expense of $4.6 million, or 18.8%, resulting mainly from the internalization of the Company’s mainframe computer operations in the second quarter of 2002.
Provision and Allowance for Loan Losses
The Company has an established process to determine the amount of the allowance for loan losses, which assesses the risks and losses inherent in its portfolio. The Company combines estimates of the reserves needed for loans evaluated on an individual basis for impairment with estimates of the reserves needed for pools of loans with similar risk characteristics. The process to determine reserves uses such tools as the Company’s “watch loan list”, migration models and actual loss experiences to identify both individual loans and pools of loans and the amount of reserves that are needed. Additionally, management determines the amount of reserves necessary to offset credit risk issues associated with loan concentrations, economic uncertainties, industry concerns, adverse market changes in estimated or appraised collateral values, and other subjective factors.
In using this process and the information available, management must use various assumptions and considerable judgment to determine the overall level of the allowance for loan losses. Because of these subjective factors, actual outcomes of inherent losses can differ from original estimates. The process of determining adequate levels of the allowance for loan losses is subject to regular review by the Company’s internal loan review team and by outside regulators.
Net loan charge-offs for the second quarter of 2003 amounted to $9.5 million compared with $9.0 million in the first quarter of 2003 and $6.7 million in the second quarter of last year. The ratio of net charge-offs to total average loans this quarter was .47%, compared with .35% in the same quarter last year and .46% in the first quarter of 2003. The $2.8 million increase in net charge-offs compared with the second quarter last year was mainly the result of the charge down of two lease-related loans by a total of $2.0 million, coupled with a charge down of a business loan by $500 thousand.
For the second quarter of 2003, net credit card charge-offs increased 7.7% compared to the second quarter of last year, and totaled 3.59% of average credit card loans. Also, net personal loan charge-offs
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The provision for loan losses for the quarter totaled $10.0 million, consistent with the provision recorded in the first quarter of this year, but up from $6.7 million in the second quarter of last year. The provision for loan losses was $20.0 million in the first six months of 2003 compared to $14.1 million in the same period in 2002. During the first six months of 2003, the provision exceeded total net loan charge-offs by $1.6 million.
The allowance for loan losses at June 30, 2003, amounted to $132.7 million, or 1.64% of total loans, and represented 436% of total non-performing loans. The Company considers the allowance for loan losses adequate to cover losses inherent in the loan portfolio at June 30, 2003.
Risk Elements of Loan Portfolio
The following table presents non-performing assets and loans which are past due 90 days and still accruing interest. Non-performing assets include non-accruing loans and foreclosed real estate. Loans are placed on non-accrual status when principal or interest is past due 90 days or more unless the loan is well-secured and in the process of collection or when, in the opinion of management, full collection of principal or interest is unlikely. Consumer loans are exempt under regulatory rules from being classified as non-accrual since they are normally charged off when they become 120 days past due. Those loans, anticipated to be collected, are included in the totals below for loans past due 90 days and still accruing interest.
Non-accrual loans at June 30, 2003, totaled $30.4 million, an increase of $2.4 million over amounts recorded at December 31, 2002. Lease-related loans comprise 38.5% of the current non-accrual total, with the remainder primarily relating to business or business real estate loans. Total loans past due 90 days or more and still accruing interest amounted to $20.2 million as of June 30, 2003, and have decreased $2.2 million since December 31, 2002. The decline in past due loans has occurred mainly in business and business real estate loans, while past due personal mortgages, consumer and credit card loans have remained fairly constant over the past six months.
Income Taxes
The Company’s income tax expense was $44.5 million in the first six months of 2003 and $44.6 million in the first six months of 2002, resulting in effective tax rates of 31.3% and 31.9%, respectively. The effective tax rate for the second quarter of 2003 was 31.9% compared with 30.6% in the first quarter of 2003 and 32.7% in the second quarter of 2002. The reduction in the effective rates in 2003 was mainly due to the utilization of state tax credits purchased by a subsidiary bank and the contribution of appreciated art that provided a reduction of tax expense.
Financial Condition
Balance Sheet
Total assets of the Company were $13.96 billion at June 30, 2003, compared to $13.31 billion at December 31, 2002, an increase of 4.9%. Average earning assets during the six months ended June 30,
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During the first six months of 2003, total loans increased $237.4 million, or 3.0%, over balances at December 31, 2002. The increase was the result of growth of $119.4 million in business real estate loans, $23.8 million in personal real estate loans, and $137.3 million in personal banking loans, partly offset by a $59.2 million decline in business loans. Lower interest rates continued to create demand for business real estate loans that are financed using variable rates or shorter maturities. Mortgage loan originations remained at higher than historical levels due to lower rates, and growth in personal mortgages was the result of the Company retaining adjustable rate and 15 year fixed rate mortgages on its balance sheet. Personal banking loans showed increases in home equity, student, and other consumer loans, as demand for such products remained steady. However, economic uncertainty continued to limit growth in business loans as businesses have refrained from growing inventories and receivables, which drive commercial borrowings.
Available for sale investment securities, excluding fair value adjustments, increased $430.0 million, or 10.6%, at June 30, 2003 over December 31, 2002. The increase resulted from purchases of new securities with liquidity obtained from increases in short-term borrowings and deposits. The growth occurred mainly in inflation-indexed treasuries and asset-backed auto and credit card securities. The adjustment to fair value at June 30, 2003, amounted to a net unrealized gain of $189.2 million, which was an increase of $34.2 million over the year end fair value adjustment. The total investment securities portfolio, at fair value, amounted to $4.76 billion at June 30, 2003, and was comprised mainly of U.S. government and federal agencies (35.2%), mortgage-backed (28.5%), and other asset-backed (26.5%) investment securities.
Total deposits increased $314.6 million, or 3.2%, at June 30, 2003 compared to December 31, 2002. The increase was due mainly to increases of $183.9 million in non-interest bearing demand deposits, $100.5 million in interest checking and $117.8 million in C.D.’s of $100,000 and over, partly offset by a decrease of $112.6 million in C.D.’s of less than $100,000.
Compared to 2002 year end balances, total borrowings at June 30, 2003 increased $299.1 million. The Company’s short-term borrowings of federal funds purchased and securities sold under agreements to repurchase vary depending on daily liquidity requirements. These borrowings rose $224.4 million during the first six months of 2003 to a balance of $1.68 billion at June 30, 2003. Longer-term borrowings rose $74.7 million due to additional FHLB advances of $49.9 million and lease financing debt of $24.8 million assumed in the Company’s 2003 acquisition of a leasing subsidiary.
Liquidity and Capital Resources
Liquidity represents the Company’s ability to obtain cost-effective funding to meet the needs of customers as well as the Company’s financial obligations. Liquidity can be provided through adjustment of the level of short-term overnight investments such as federal funds sold and securities purchased under agreements to resell, in addition to the available for sale investment securities held by the banks. These liquid assets had a fair value of $4.41 billion at June 30, 2003, which included $1.77 billion pledged to secure public deposits, discount window borrowings, and other purposes as required by law. Within the next twelve months, approximately $1.10 billion of the banks’ available for sale portfolio is expected to mature or pay down. The available for sale bank portfolio included an unrealized net gain in fair value of $154.4 million at June 30, 2003, compared to an unrealized net gain of $119.4 million at December 31, 2002. Liquidity can also be obtained through secured advances from the FHLB, of which certain subsidiary banks are members. These borrowings are secured under a blanket collateral agreement including primarily residential mortgages as well as all unencumbered assets and stock of the borrowing bank. Advances outstanding approximated $372.7 million at June 30, 2003, compared to $322.7 million at December 31, 2002. Of the outstanding FHLB advances, $100.1 million are payable during the next 12 months. An additional $75.2 million is available under FHLB lines of credit at June 30, 2003.
The liquid assets of the parent bank holding company Commerce Bancshares, Inc. (Parent) consist primarily of short-term money market mutual funds, corporate bonds and stock, U.S. government and
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The Company maintains a treasury stock buyback program; and effective January 2003, was authorized by the Board of Directors to repurchase up to 4 million shares of its common stock. During the first six months of 2003, the Company purchased approximately 1.5 million shares at an average cost of $38.49. The Company has routinely used these reacquired shares to fund annual stock dividends and various stock option programs.
In July 2003, the Board of Directors approved an increase in the Company’s regular quarterly cash dividend. Holders of record at the close of business on September 12, 2003, will receive $.225 per share, a 36.4% increase compared to the $.165 per share paid in the first and second quarters of 2003. The increase is expected to add approximately $4 million to the quarterly cash payment, which will be funded by current operations.
The Company had an equity to asset ratio of 10.81% based on 2003 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.
The following discussion is based on cash flow amounts that exclude changes resulting from bank acquisitions and branch dispositions. The Company’s cash and cash equivalents (defined as “Cash and due from banks” on the accompanying balance sheets) were $661.3 million at June 30, 2003, a decrease of $49.1 million from December 31, 2002. Contributing to the net cash outflow were $446.6 million in purchases of investment securities, net of sales and maturities, and an increase of $218.3 million in loans, net of repayments. These cash outflows were partly offset by deposit growth of $350.4 million, a net increase in total borrowings of $250.7 million, and $111.8 million generated from operating activities.
The Company has various commitments and contingent liabilities which are properly not reflected on the balance sheet. Loan commitments (excluding derivative instruments and lines of credit related to credit cards) totaled approximately $3.03 billion, and commercial letters of credit totaled $29.3 million at June 30, 2003.
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Impact of Recently Issued Accounting Standards
As discussed in the Company’s 2002 Annual Report on Form 10-K, the Financial Accounting Standards Board issued Interpretation No. 46, “Consolidation of Variable Interest Entities”, in January 2003, which requires that investments in variable interest entities (VIE) be consolidated by the entity that has a variable interest that will absorb a majority of the VIE’s expected losses if they occur, receive a majority of the VIE’s expected returns, or both. The consolidation requirements of Interpretation No. 46 are effective September 30, 2003 for investments in VIE’s made prior to February 1, 2003 and effective March 31, 2003 for investments in VIE’s made on February 1, 2003 or thereafter. The Company has several private equity investments as noted in the previous section entitled “Critical Accounting Policies” and several other investments in low income housing partnerships. The Company is currently evaluating the requirements of Interpretation No. 46 for these investments to determine if any such investment might qualify as a VIE requiring consolidation. If consolidation is required for any of these investments, the Company’s assets, liabilities, revenues and expenses would be adjusted to reflect the consolidation of these investments; however, it is not expected that net income would be significantly affected.
The Financial Accounting Standards Board issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity”, in May 2003. Statement No. 150 establishes standards for how an issuer classifies, measures and discloses in its financial statements certain financial instruments with characteristics of both liabilities and equity. The Statement requires that an issuer classify financial instruments that are within its scope as a liability (or an asset in some circumstances). Such financial instruments include (i) financial instruments that are issued in the form of shares that are mandatorily redeemable; (ii) financial instruments that embody an obligation to repurchase the issuer’s equity shares, or are indexed to such an obligation, and that require the issuer to settle the obligation by transferring assets; and (iii) financial instruments that embody an obligation that the issuer may settle by issuing a variable number of its equity shares if, at inception, the monetary value of the obligation is predominately based on a fixed amount, variations in something other than the fair value of the issuer’s equity shares, or variations inversely related to changes in the fair value of the issuer’s equity shares. Statement No. 150 is effective for contracts entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. Adoption of the Statement on July 1, 2003, did not have a significant impact on the Company’s financial statements.
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AVERAGE BALANCE SHEETS – AVERAGE RATES AND YIELDS
(B) Interest expense capitalized on construction projects is not deducted from the interest expense shown above.
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Interest rate risk management focuses on maintaining consistent growth in net interest income within Board-approved policy limits. The Company mainly uses earnings simulation models to analyze net interest sensitivity to movement in interest rates. In the table below, management has estimated the potential effect that gradual rising and/or falling interest rates over a twelve month period would have on the Company’s net interest income, given a static balance sheet.
During the second quarter of 2003, the net interest margin continued to be affected by low interest rates and a sluggish economy. In June 2003, the Federal Reserve lowered interest rates by 25 basis points, further encouraging borrowers to pay-off or re-finance both personal real estate and business real estate loans. As a result, the Company experienced slower loan growth and higher levels of prepayments. Also, certain mortgage-backed related investment securities experienced the same principal prepayment effects and proceeds from these payments were reinvested at lower rates. The weak economy has limited loan growth in the business loan area where rates are typically higher. As a result, the rates on total earning assets declined 10 basis points from the previous quarter.
Rates paid on deposits continued to decline, partly the result of the lowered rates mentioned above, and also because of the downward re-pricing of certificates of deposit. These rate reductions, however, could not be entirely passed on to other non-maturity deposit customers since those rates were already at historically low levels. In response to this low rate environment, during the second quarter the Company elected to increase its short-term borrowings on average by $223.3 million and, together with other deposit growth, invested the proceeds in additional investment securities totaling on average $310.8 million. These additional securities consisted mainly of U.S. treasury and agency and other asset-backed securities.
As shown in the table above, as of June 30, 2003, the Company has reduced its interest rate exposure to a further fall in rates compared with the previous quarter, while somewhat reducing the potential growth in net interest income should rates rise. The reduced risk from lower rates is the result of a larger investment securities portfolio with fixed rates, coupled with higher short-term borrowings much of which had variable rates. The effects of these positions help to offset large portions of the loan portfolio tied to variable rates and low rate deposits, which are limited in their ability to re-price downward. While these activities have reduced the Company’s asset sensitivity and limited risk against further rate reductions, the larger investment portfolio with fixed rates reduces the potential growth in net interest income should rates rise. This growth limitation, however, is mitigated by the fact that the investment portfolio has a duration of less than 1.75 years, which will allow the Company to reinvest future maturities at higher rates should they occur. Also the loan portfolio, with significant portions tied to variable rates, would re-price upward as well. With future improvements to the economy, loan demand could become more robust and allow the Company to re-invest its earning assets in higher yielding loan products.
For further discussion of the Company’s market risk, see Management’s Discussion and Analysis of Financial Condition and Results of Operations — Interest Rate Sensitivity included in the Company’s 2002 Annual Report on Form 10-K.
An evaluation was performed under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effective-
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The annual meeting of shareholders of Commerce Bancshares, Inc. was held on April 16, 2003. Proxies for the meeting were solicited pursuant to Regulation 14A 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 six nominees for the six directorships being elected to the class of 2006 (except as otherwise noted) at this meeting received the following votes:
(a) Exhibits:
(b) The Registrant filed a report on Form 8-K on April 21, 2003, which included its first quarter earnings release on April 15, 2003, and various information presented at its annual shareholders meeting held on April 16, 2003.
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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.
Date: August 12, 2003
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