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Commerce Bancshares 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32
  5. Ex-32
e10vq
Table of Contents

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 
Washington, D.C. 20549
 
 
 
         
(Mark One)        
 
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011
OR
            
         
         
         
o
  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
 
 
(Exact name of registrant as specified in its charter)
 
     
Missouri
(State of Incorporation)
  43-0889454
(IRS Employer Identification No.)
     
1000 Walnut,
Kansas City, MO
(Address of principal executive offices)
 
64106
(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 þ     No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
  Yes þ     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer þ Accelerated filer o Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
  Yes o     No þ
 
As of July 21, 2011, the registrant had outstanding 86,852,616 shares of its $5 par value common stock, registrant’s only class of common stock.
 
 


 

 
Commerce Bancshares, Inc. and Subsidiaries
 
 
                 
INDEX           Page
 
  Financial Information        
                 
    Item 1.   Financial Statements        
                 
        Consolidated Balance Sheets as of June 30, 2011 (unaudited) and December 31, 2010     3  
                 
        Consolidated Statements of Income for the Three and Six Months Ended June 30, 2011 and 2010 (unaudited)     4  
                 
        Consolidated Statements of Changes in Equity for the Six Months Ended June 30, 2011 and 2010 (unaudited)     5  
                 
        Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2011 and 2010 (unaudited)     6  
                 
        Notes to Consolidated Financial Statements     7  
                 
    Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations     39  
                 
    Item 3.   Quantitative and Qualitative Disclosures about Market Risk     64  
                 
    Item 4.   Controls and Procedures     64  
             
  Other Information        
                 
    Item 1.   Legal Proceedings     65  
                 
    Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds     65  
                 
    Item 6.   Exhibits     65  
Signatures     66  
         
    67  
 EX-31.1
 EX-31.2
 EX-32
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT


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Table of Contents

 
PART I: FINANCIAL INFORMATION
 
Item 1.   FINANCIAL STATEMENTS
 
Commerce Bancshares, Inc. and Subsidiaries
 
                 
 
    June 30
  December 31
    2011   2010
 
    (Unaudited)    
    (In thousands)
 
ASSETS
Loans
  $ 9,237,078     $ 9,410,982  
Allowance for loan losses
    (191,538 )     (197,538 )
 
 
Net loans
    9,045,540       9,213,444  
 
 
Loans held for sale
    42,359       63,751  
Investment securities:
               
Available for sale ($425,864,000 and $429,439,000 pledged in 2011 and 2010, respectively, to secure structured repurchase agreements)
    7,717,634       7,294,303  
Trading
    32,074       11,710  
Non-marketable
    109,867       103,521  
 
 
Total investment securities
    7,859,575       7,409,534  
 
 
Short-term federal funds sold and securities purchased under agreements to resell
    10,845       10,135  
Long-term securities purchased under agreements to resell
    850,000       450,000  
Interest earning deposits with banks
    535,696       122,076  
Cash and due from banks
    340,594       328,464  
Land, buildings and equipment, net
    374,732       383,397  
Goodwill
    125,585       125,585  
Other intangible assets, net
    9,394       10,937  
Other assets
    376,540       385,016  
 
 
Total assets
  $ 19,570,860     $ 18,502,339  
 
 
 
LIABILITIES AND EQUITY
Deposits:
               
Non-interest bearing
  $ 4,834,750     $ 4,494,028  
Savings, interest checking and money market
    8,139,989       7,846,831  
Time open and C.D.’s of less than $100,000
    1,273,961       1,465,050  
Time open and C.D.’s of $100,000 and over
    1,407,866       1,279,112  
 
 
Total deposits
    15,656,566       15,085,021  
 
 
Federal funds purchased and securities sold under agreements to repurchase
    1,282,470       982,827  
Other borrowings
    111,929       112,273  
Other liabilities
    388,328       298,754  
 
 
Total liabilities
    17,439,293       16,478,875  
 
 
Commerce Bancshares, Inc. 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 87,296,284 shares in 2011 and 86,788,322 shares in 2010
    436,481       433,942  
Capital surplus
    979,247       971,293  
Retained earnings
    645,155       555,778  
Treasury stock of 355,116 shares in 2011 and 61,839 shares in 2010, at cost
    (14,515 )     (2,371 )
Accumulated other comprehensive income
    83,000       63,345  
 
 
Total Commerce Bancshares, Inc. stockholders’ equity
    2,129,368       2,021,987  
Non-controlling interest
    2,199       1,477  
 
 
Total equity
    2,131,567       2,023,464  
 
 
Total liabilities and equity
  $ 19,570,860     $ 18,502,339  
 
 
See accompanying notes to consolidated financial statements.


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Commerce Bancshares, Inc. and Subsidiaries
                                 
   
    For the Three Months
    For the Six Months
 
    Ended June 30     Ended June 30  
(In thousands, except per share data)   2011     2010     2011     2010  
   
    (Unaudited)  
 
INTEREST INCOME
                               
Interest and fees on loans
  $ 116,769     $ 128,781     $ 235,146     $ 259,703  
Interest and fees on loans held for sale
    309       2,261       607       4,165  
Interest on investment securities
    57,712       53,801       112,601       108,964  
Interest on short-term federal funds sold and securities purchased under agreements to resell
    22       13       32       28  
Interest on long-term securities purchased under agreements to resell
    3,165             5,327        
Interest on deposits with banks
    110       201       200       266  
 
 
Total interest income
    178,087       185,057       353,913       373,126  
 
 
INTEREST EXPENSE
                               
Interest on deposits:
                               
Savings, interest checking and money market
    6,372       7,711       13,272       14,807  
Time open and C.D.’s of less than $100,000
    2,965       6,059       6,708       12,874  
Time open and C.D.’s of $100,000 and over
    2,434       3,562       5,107       7,485  
Interest on federal funds purchased and securities sold under agreements to repurchase
    687       826       1,309       1,646  
Interest on other borrowings
    919       3,791       1,834       10,496  
 
 
Total interest expense
    13,377       21,949       28,230       47,308  
 
 
Net interest income
    164,710       163,108       325,683       325,818  
Provision for loan losses
    12,188       22,187       27,977       56,509  
 
 
Net interest income after provision for loan losses
    152,522       140,921       297,706       269,309  
 
 
NON-INTEREST INCOME
                               
Bank card transaction fees
    41,304       37,659       78,766       70,149  
Trust fees
    22,544       20,358       44,116       39,676  
Deposit account charges and other fees
    20,789       25,472       40,089       49,453  
Bond trading income
    4,979       5,387       9,699       10,391  
Consumer brokerage services
    2,880       2,372       5,543       4,489  
Loan fees and sales
    2,075       3,472       3,899       5,311  
Other
    6,773       6,738       15,138       15,178  
 
 
Total non-interest income
    101,344       101,458       197,250       194,647  
 
 
INVESTMENT SECURITIES GAINS (LOSSES), NET
                               
Impairment (losses) reversals on debt securities
    (2,119 )     4,415       4,186       5,710  
Noncredit-related losses (reversals) on securities not expected to be sold
    1,469       (5,091 )     (5,110 )     (7,843 )
 
 
Net impairment losses
    (650 )     (676 )     (924 )     (2,133 )
Realized gains (losses) on sales and fair value adjustments
    2,606       1,336       4,207       (872 )
 
 
Investment securities gains (losses), net
    1,956       660       3,283       (3,005 )
 
 
NON-INTEREST EXPENSE
                               
Salaries and employee benefits
    84,223       87,108       171,615       174,546  
Net occupancy
    11,213       11,513       23,250       23,611  
Equipment
    5,702       5,938       11,279       11,839  
Supplies and communication
    5,692       6,829       11,224       14,167  
Data processing and software
    17,531       17,497       33,998       34,103  
Marketing
    4,495       5,002       8,753       9,720  
Deposit insurance
    2,780       4,939       7,671       9,689  
Indemnification obligation
          (1,683 )     (1,359 )     (1,683 )
Other
    21,877       18,650       41,042       35,525  
 
 
Total non-interest expense
    153,513       155,793       307,473       311,517  
 
 
Income before income taxes
    102,309       87,246       190,766       149,434  
Less income taxes
    32,692       27,428       60,199       45,805  
 
 
Net income
    69,617       59,818       130,567       103,629  
Less non-controlling interest expense (income)
    583       84       1,080       (275 )
 
 
Net income attributable to Commerce Bancshares, Inc. 
  $ 69,034     $ 59,734     $ 129,487     $ 103,904  
 
 
Net income per common share – basic
  $ .80     $ .69     $ 1.49     $ 1.19  
Net income per common share – diluted
  $ .79     $ .68     $ 1.48     $ 1.18  
 
 
See accompanying notes to consolidated financial statements.


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Commerce Bancshares, Inc. and Subsidiaries
                                                         
   
    Commerce Bancshares, Inc. Shareholders              
                            Accumulated
             
                            Other
    Non-
       
(In thousands,
  Common
    Capital
    Retained
    Treasury
    Comprehensive
    Controlling
       
except per share data)   Stock     Surplus     Earnings     Stock     Income (Loss)     Interest     Total  
   
    (Unaudited)  
 
Balance January 1, 2011
  $ 433,942     $ 971,293     $ 555,778     $ (2,371 )   $ 63,345     $ 1,477     $ 2,023,464  
 
 
Net income
                    129,487                       1,080       130,567  
Change in unrealized gain (loss) related to available for sale securities for which a portion of an other-than-temporary impairment has been recorded in earnings, net of tax
                                    3,511               3,511  
Change in unrealized gain (loss) on all other available for sale securities, net of tax
                                    15,474               15,474  
Amortization of pension loss, net of tax
                                    670               670  
                                                         
Total comprehensive income
                                                    150,222  
                                                         
Distributions to non-controlling interest
                                            (358 )     (358 )
Purchase of treasury stock
                            (18,341 )                     (18,341 )
Issuance of stock under purchase and equity compensation plans
    1,563       5,483               6,317                       13,363  
Net tax benefit related to equity compensation plans
            955                                       955  
Stock-based compensation
            2,372                                       2,372  
Issuance of nonvested stock awards
    976       (856 )             (120 )                      
Cash dividends paid ($.460 per share)
                    (40,110 )                             (40,110 )
 
 
Balance June 30, 2011
  $ 436,481     $ 979,247     $ 645,155     $ (14,515 )   $ 83,000     $ 2,199     $ 2,131,567  
 
 
Balance January 1, 2010
  $ 415,637     $ 854,490     $ 568,532     $ (838 )   $ 46,407     $ 1,677     $ 1,885,905  
 
 
Net income
                    103,904                       (275 )     103,629  
Change in unrealized gain (loss) related to available for sale securities for which a portion of an other-than-temporary impairment has been recorded in earnings, net of tax
                                    7,420               7,420  
Change in unrealized gain (loss) on all other available for sale securities, net of tax
                                    21,267               21,267  
Amortization of pension loss, net of tax
                                    703               703  
                                                         
Total comprehensive income
                                                    133,019  
                                                         
Distributions to non-controlling interest
                                            (235 )     (235 )
Purchase of treasury stock
                            (943 )                     (943 )
Issuance of stock under purchase and equity compensation plans
    1,229       4,640               (198 )                     5,671  
Net tax benefit related to equity compensation plans
            1,026                                       1,026  
Stock-based compensation
            3,386                                       3,386  
Issuance of nonvested stock awards
    751       (577 )             (174 )                      
Cash dividends paid ($.448 per share)
                    (39,215 )                             (39,215 )
 
 
Balance June 30, 2010
  $ 417,617     $ 862,965     $ 633,221     $ (2,153 )   $ 75,797     $ 1,167     $ 1,988,614  
 
 
See accompanying notes to consolidated financial statements.


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Commerce Bancshares, Inc. and Subsidiaries
                 
   
    For the Six Months
 
    Ended June 30  
(In thousands)   2011     2010  
   
    (Unaudited)  
 
OPERATING ACTIVITIES:
               
Net income
  $ 130,567     $ 103,629  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
    27,977       56,509  
Provision for depreciation and amortization
    23,732       24,864  
Amortization of investment security premiums, net
    2,413       8,752  
Investment securities (gains) losses, net(A)
    (3,283 )     3,005  
Net gains on sales of loans held for sale
    (1,147 )     (2,466 )
Originations of loans held for sale
    (28,631 )     (288,903 )
Proceeds from sales of loans held for sale
    51,297       146,747  
Net increase in trading securities
    (374 )     (2,121 )
Stock-based compensation
    2,372       3,386  
Increase in interest receivable
    (1,095 )     (512 )
Decrease in interest payable
    (2,686 )     (3,829 )
Increase in income taxes payable
    5,594       7,598  
Net tax benefit related to equity compensation plans
    (955 )     (1,026 )
Other changes, net
    (10,912 )     39,097  
 
 
Net cash provided by operating activities
    194,869       94,730  
 
 
INVESTING ACTIVITIES:
               
Proceeds from sales of investment securities(A)
    11,202       64,087  
Proceeds from maturities/pay downs of investment securities(A)
    1,400,631       954,133  
Purchases of investment securities(A)
    (1,809,501 )     (1,040,529 )
Net decrease in loans
    139,927       356,824  
Long-term securities purchased under agreements to resell
    (500,000 )      
Repayments of long-term securities purchased under agreements to resell
    100,000        
Purchases of land, buildings and equipment
    (11,133 )     (9,395 )
Sales of land, buildings and equipment
    1,711       377  
 
 
Net cash provided by (used in) investing activities
    (667,163 )     325,497  
 
 
FINANCING ACTIVITIES:
               
Net increase in non-interest bearing,
savings, interest checking and money market deposits
    705,923       295,593  
Net decrease in time open and C.D.’s
    (62,335 )     (25,649 )
Net increase (decrease) in short-term federal funds purchased and securities sold
under agreements to repurchase
    299,643       (96,835 )
Repayment of long-term borrowings
    (352 )     (372,065 )
Net increase in short-term borrowings
    8        
Purchases of treasury stock
    (18,341 )     (943 )
Issuance of stock under stock purchase and equity compensation plans
    13,363       5,671  
Net tax benefit related to equity compensation plans
    955       1,026  
Cash dividends paid on common stock
    (40,110 )     (39,215 )
 
 
Net cash provided by (used in) financing activities
    898,754       (232,417 )
 
 
Increase in cash and cash equivalents
    426,460       187,810  
Cash and cash equivalents at beginning of year
    460,675       463,834  
 
 
Cash and cash equivalents at June 30
  $ 887,135     $ 651,644  
 
 
(A) Available for sale and non-marketable securities
               
 
 
Income tax net payments
  $ 54,661     $ 38,182  
Interest paid on deposits and borrowings
  $ 30,916     $ 51,137  
Loans transferred to foreclosed real estate
  $ 18,343     $ 8,982  
 
 
See accompanying notes to consolidated financial statements.


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Commerce Bancshares, Inc. and Subsidiaries
 
 
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). The consolidated financial statements in this report have not been audited. All significant intercompany accounts and transactions have been eliminated. Certain reclassifications were made to 2010 data to conform to current year presentation. These included the reclassification of certain non-interest bearing deposits from money market accounts to non-interest bearing deposits, in order to more accurately present the Company’s balances of non-interest bearing deposits. In the opinion of management, all adjustments necessary to present fairly the financial position and the results of operations for the interim periods have been made. All such adjustments are of a normal recurring nature. The results of operations for the three and six month periods ended June 30, 2011 are not necessarily indicative of results to be attained for the full year or any other interim periods.
 
The significant accounting policies followed in the preparation of the quarterly financial statements are disclosed in the 2010 Annual Report on Form 10-K.
 
2.  Loans and Allowance for Loan Losses
 
Major classifications within the Company’s held to maturity loan portfolio at June 30, 2011 and December 31, 2010 are as follows:
 
                 
   
    June 30
    December 31
 
(In thousands)   2011     2010  
   
 
Commercial:
               
Business
  $ 2,921,556     $ 2,957,043  
Real estate – construction and land
    433,464       460,853  
Real estate – business
    2,097,691       2,065,837  
Personal Banking:
               
Real estate – personal
    1,438,030       1,440,386  
Consumer
    1,108,909       1,164,327  
Revolving home equity
    467,391       477,518  
Consumer credit card
    764,844       831,035  
Overdrafts
    5,193       13,983  
 
 
Total loans
  $ 9,237,078     $ 9,410,982  
 
 
 
At June 30, 2011, loans of $3.0 billion were pledged at the Federal Home Loan Bank as collateral for borrowings and letters of credit obtained to secure public deposits. Additional loans of $1.2 billion were pledged at the Federal Reserve Bank as collateral for discount window borrowings.


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A summary of the activity in the allowance for loan losses during the three and six months ended June 30, 2011 follows:
 
                                                 
   
    For the Three Months Ended June 30     For the Six Months Ended June 30  
(In thousands)   Commercial     Personal Banking     Total     Commercial     Personal Banking     Total  
   
 
Balance at beginning of period
  $ 128,351     $ 66,187     $ 194,538     $ 119,946     $ 77,592     $ 197,538  
Provision
    1,815       10,373       12,188       15,280       12,697       27,977  
Deductions:
                                               
Loans charged off
    3,946       15,656       19,602       10,310       32,681       42,991  
Less recoveries on loans
    1,043       3,371       4,414       2,347       6,667       9,014  
 
 
Net loans charged off
    2,903       12,285       15,188       7,963       26,014       33,977  
 
 
Balance at June 30, 2011
  $ 127,263     $ 64,275     $ 191,538     $ 127,263     $ 64,275     $ 191,538  
 
 
 
A summary of the activity in the allowance for loan losses during the three and six months ended June 30, 2010 follows:
 
                 
   
    For the Three Months
    For the Six Months
 
(In thousands)   Ended June 30     Ended June 30  
   
 
Balance at beginning of period
  $ 197,538     $ 194,480  
Provision for loan losses
    22,187       56,509  
Deductions:
               
Loans charged off
    26,818       62,338  
Less recoveries on loans
    4,631       8,887  
 
 
Net loans charged off
    22,187       53,451  
 
 
Balance at June 30, 2010
  $ 197,538     $ 197,538  
 
 
 
The following table shows the balance in the allowance for loan losses and the related loan balance at June 30, 2011 and December 31, 2010, disaggregated on the basis of impairment methodology. Impaired loans evaluated under ASC 310-10-35 include loans on non-accrual status which are individually evaluated for impairment, and other impaired loans deemed to have similar risk characteristics, which are collectively evaluated. All other loans are collectively evaluated for impairment under ASC 450-20.
 
                         
   
          Personal
       
(In thousands)   Commercial     Banking     Total  
   
 
June 30, 2011
                       
Allowance for loan losses:
                       
Impaired loans
  $ 6,862     $ 3,599     $ 10,461  
All other loans
    120,401       60,676       181,077  
 
 
Loans outstanding:
                       
Impaired loans
    119,133       30,464       149,597  
All other loans
    5,333,578       3,753,903       9,087,481  
 
 
December 31, 2010
                       
Allowance for loan losses:
                       
Impaired loans
  $ 6,127     $ 3,243     $ 9,370  
All other loans
    113,819       74,349       188,168  
 
 
Loans outstanding:
                       
Impaired loans
    118,532       26,828       145,360  
All other loans
    5,365,201       3,900,421       9,265,622  
 
 


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Impaired loans
 
The table below shows the Company’s investment in impaired loans at June 30, 2011 and December 31, 2010. These loans consist of loans on non-accrual status and other restructured loans whose terms have been modified and classified as troubled debt restructurings under ASC 310-40. The restructured loans have been extended to borrowers who are experiencing financial difficulty and who have been granted a concession. They are largely comprised of certain business, construction and business real estate loans classified as substandard. Upon maturity, the loans renewed at interest rates judged not to be market rates for new debt with similar risk, and as a result were classified as troubled debt restructurings. These loans totaled $48.5 million and $41.3 million at June 30, 2011 and December 31, 2010, respectively. These restructured loans are performing in accordance with their modified terms, and because the Company believes it probable that all amounts due under the modified terms of the agreements will be collected, interest on these loans is being recognized on an accrual basis. Troubled debt restructurings also include certain credit card loans under various debt management and assistance programs, which totaled $21.4 million at June 30, 2011 and $18.8 million at December 31, 2010.
 
                 
   
    June 30
    December 31
 
(In thousands)   2011     2010  
   
 
Non-accrual loans
  $ 79,717     $ 85,275  
Restructured loans
    69,880       60,085  
 
 
Total impaired loans
  $ 149,597     $ 145,360  
 
 
 
The Company had commitments of $11.4 million at June 30, 2011 to lend additional funds to borrowers with impaired loans, of which $2.5 million relate to restructured loans.


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The following table provides additional information about impaired loans held by the Company at June 30, 2011 and December 31, 2010, segregated between loans for which an allowance for credit losses has been provided and loans for which no allowance has been provided.
 
                                         
   
                      Interest Income Recognized *
 
          Unpaid
          For the Period Ended
 
    Recorded
    Principal
    Related
    June 30, 2011  
(In thousands)   Investment     Balance     Allowance     Three Months     Six Months  
   
 
June 30, 2011
                                       
With no related allowance recorded:
                                       
Business
  $ 12,315     $ 14,189     $     $     $  
Real estate – construction and land
    21,943       49,812                    
Real estate – business
    6,876       9,009                    
Real estate – personal
    757       757                    
 
 
    $ 41,891     $ 73,767     $     $     $  
 
 
With an allowance recorded:
                                       
Business
  $ 24,961     $ 28,128     $ 2,192     $ 85     $ 170  
Real estate – construction and land
    25,576       30,928       2,097       186       373  
Real estate – business
    27,462       31,126       2,573       204       407  
Real estate – personal
    8,311       10,555       1,019       7       14  
Consumer credit card
    21,396       21,396       2,580       447       894  
 
 
    $ 107,706     $ 122,133     $ 10,461     $ 929     $ 1,858  
 
 
Total
  $ 149,597     $ 195,900     $ 10,461     $ 929     $ 1,858  
 
 
December 31, 2010
                                       
With no related allowance recorded:
                                       
Business
  $ 3,544     $ 5,095     $                  
Real estate – construction and land
    30,979       55,790                        
Real estate – business
    4,245       5,295                        
Real estate – personal
    755       755                        
                 
                 
    $ 39,523     $ 66,935     $                  
                 
                 
With an allowance recorded:
                                       
Business
  $ 18,464     $ 21,106     $ 1,665                  
Real estate – construction and land
    39,719       52,587       2,538                  
Real estate – business
    21,581       25,713       1,924                  
Real estate – personal
    7,294       9,489       936                  
Consumer credit card
    18,779       18,779       2,307                  
                 
                 
    $ 105,837     $ 127,674     $ 9,370                  
                 
                 
Total
  $ 145,360     $ 194,609     $ 9,370                  
                 
                 
 
 
Represents interest income recognized on impaired loans held at June 30, 2011. Interest shown is interest recognized on accruing restructured loans as noted above.


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Total average impaired loans, shown in the table below, were $143.9 million and $144.8 million, respectively, during the three and six month periods ended June 30, 2011, compared to total average impaired loans of $173.0 million during the entire year ended December 31, 2010.
 
                         
   
          Personal
       
(In thousands)   Commercial     Banking     Total  
   
 
Average impaired loans:
                       
For the three months ended June 30, 2011:
                       
Non-accrual loans
  $ 69,104     $ 7,063     $ 76,167  
Restructured loans
    46,037       21,679       67,716  
 
 
Total
  $ 115,141     $ 28,742     $ 143,883  
 
 
For the six months ended June 30, 2011:
                       
Non-accrual loans
  $ 72,186     $ 7,045     $ 79,231  
Restructured loans
    44,495       21,107       65,602  
 
 
Total
  $ 116,681     $ 28,152     $ 144,833  
 
 
 
Delinquent and non-accrual loans
 
The following table provides aging information on the Company’s past due and accruing loans, in addition to the balances of loans on non-accrual status, at June 30, 2011 and December 31, 2010.
 
                                         
   
    Current or
          90 Days
             
    Less Than
    30 – 89
    Past Due
             
    30 Days Past
    Days Past
    and Still
             
(In thousands)   Due     Due     Accruing     Non-accrual     Total  
   
 
June 30, 2011
                                       
Commercial:
                                       
Business
  $ 2,884,367     $ 10,404     $ 755     $ 26,030     $ 2,921,556  
Real estate – construction and land
    399,555       4,329       871       28,709       433,464  
Real estate – business
    2,058,387       15,960       6,564       16,780       2,097,691  
Personal Banking:
                                       
Real estate – personal
    1,414,558       10,713       4,561       8,198       1,438,030  
Consumer
    1,094,631       12,790       1,488             1,108,909  
Revolving home equity
    465,795       836       760             467,391  
Consumer credit card
    746,505       9,740       8,599             764,844  
Overdrafts
    4,809       384                   5,193  
 
 
Total
  $ 9,068,607     $ 65,156     $ 23,598     $ 79,717     $ 9,237,078  
 
 
December 31, 2010
                                       
Commercial:
                                       
Business
  $ 2,927,403     $ 19,853     $ 854     $ 8,933     $ 2,957,043  
Real estate – construction and land
    400,420       7,464       217       52,752       460,853  
Real estate – business
    2,040,794       8,801             16,242       2,065,837  
Personal Banking:
                                       
Real estate – personal
    1,413,905       15,579       3,554       7,348       1,440,386  
Consumer
    1,145,561       15,899       2,867             1,164,327  
Revolving home equity
    475,764       929       825             477,518  
Consumer credit card
    806,373       12,513       12,149             831,035  
Overdrafts
    13,555       428                   13,983  
 
 
Total
  $ 9,223,775     $ 81,466     $ 20,466     $ 85,275     $ 9,410,982  
 
 


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Credit quality
 
The following table provides information about the credit quality of the Commercial loan portfolio, using the Company’s internal rating system as an indicator. The information below was updated as of June 30, 2011 and December 31, 2010 for this indicator. The credit quality of Personal Banking loans is monitored on the basis of aging/delinquency, and this information is provided in the table above.
 
The internal rating system is a series of grades reflecting management’s risk assessment, based on its analysis of the borrower’s financial condition. The “pass” category consists of a range of loan grades that reflect increasing, though still acceptable, risk. Movement of risk through the various grade levels in the “pass” category is monitored for early identification of credit deterioration. The “special mention” rating is attached to loans where the borrower exhibits material negative financial trends due to borrower specific or systemic conditions that, if left uncorrected, threaten its capacity to meet its debt obligations. The borrower is believed to have sufficient financial flexibility to react to and resolve its negative financial situation. It is a transitional grade that is closely monitored for improvement or deterioration. The “substandard” rating is applied to loans where the borrower exhibits well-defined weaknesses that jeopardize its continued performance and are of a severity that the distinct possibility of default exists. Loans are placed on “non-accrual” when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment.
 
                                 
   
    Commercial Loans  
   
          Real
    Real
       
          Estate-
    Estate-
       
(In thousands)   Business     Construction     Business     Total  
   
 
June 30, 2011
                               
Pass
  $ 2,768,123     $ 334,465     $ 1,904,087     $ 5,006,675  
Special mention
    50,266       9,751       50,274       110,291  
Substandard
    77,137       60,539       126,550       264,226  
Non-accrual
    26,030       28,709       16,780       71,519  
 
 
Total
  $ 2,921,556     $ 433,464     $ 2,097,691     $ 5,452,711  
 
 
December 31, 2010
                               
Pass
  $ 2,801,328     $ 327,167     $ 1,878,005     $ 5,006,500  
Special mention
    67,142       29,345       77,527       174,014  
Substandard
    79,640       51,589       94,063       225,292  
Non-accrual
    8,933       52,752       16,242       77,927  
 
 
Total
  $ 2,957,043     $ 460,853     $ 2,065,837     $ 5,483,733  
 
 
 
The Company’s holdings of foreclosed real estate totaled $23.6 million and $12.0 million at June 30, 2011 and December 31, 2010, respectively. Personal property acquired in repossession, generally autos and marine and recreational vehicles, totaled $4.5 million and $10.4 million at June 30, 2011 and December 31, 2010, respectively. These assets are carried at the lower of the amount recorded at acquisition date or the current fair value less estimated costs to sell.
 
 
In addition to the portfolio of loans which are intended to be held to maturity, the Company originates loans which it intends to sell in secondary markets. Loans classified as held for sale primarily consist of loans originated to students while attending colleges and universities. Most of this portfolio was sold in 2010 under contracts with the Federal Department of Education and various student loan agencies. Significant future student loan originations are not anticipated, because under statutory requirements effective July 1, 2010, the Company is prohibited from making federally guaranteed student loans. Also included as held for sale are certain fixed rate residential mortgage loans which are sold in the secondary market, generally within three months of origination. The following table presents information about loans held for sale, including an


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impairment valuation allowance resulting from declines in fair value below cost, which is further discussed in Note 13 on Fair Value Measurements.
 
                 
   
    June 30
    December 31
 
(In thousands)   2011     2010  
   
 
Balance outstanding:
               
Student loans, at cost
  $ 38,079     $ 53,901  
Residential mortgage loans, at cost
    4,459       10,419  
Valuation allowance on student loans
    (179 )     (569 )
 
 
Total loans held for sale, at lower of cost or fair value
  $ 42,359     $ 63,751  
 
 
 
                 
   
    For the Six
 
    Months
 
    Ended June 30  
(In thousands)   2011     2010  
   
 
Net gains on sales:
               
Student loans
  $ 386     $ 1,689  
Residential mortgage loans
    761       777  
 
 
Total gains on sales of loans held for sale, net
  $ 1,147     $ 2,466  
 
 
 
3.  Investment Securities
 
Investment securities, at fair value, consisted of the following at June 30, 2011 and December 31, 2010.
 
                 
   
    June 30
    December 31
 
(In thousands)   2011     2010  
   
 
Available for sale:
               
U.S. government and federal agency obligations
  $ 356,246     $ 455,537  
Government-sponsored enterprise obligations
    264,553       201,895  
State and municipal obligations
    1,193,561       1,119,485  
Agency mortgage-backed securities
    2,913,805       2,491,199  
Non-agency mortgage-backed securities
    385,937       455,790  
Other asset-backed securities
    2,394,627       2,354,260  
Other debt securities
    168,859       176,964  
Equity securities
    40,046       39,173  
 
 
Total available for sale
    7,717,634       7,294,303  
 
 
Trading
    32,074       11,710  
Non-marketable
    109,867       103,521  
 
 
Total investment securities
  $ 7,859,575     $ 7,409,534  
 
 
 
Most of the Company’s investment securities are classified as available for sale, and this portfolio is discussed in more detail below. Securities which are classified as non-marketable include Federal Home Loan Bank (FHLB) stock and Federal Reserve Bank (FRB) stock held for debt and regulatory purposes, which totaled $45.2 million at both June 30, 2011 and December 31, 2010. Investment in FRB stock is based on the capital structure of the investing bank, and investment in FHLB stock is tied to the level of borrowings from the FHLB. Non-marketable securities also include private equity investments, which amounted to $64.6 million and $58.2 million at June 30, 2011 and December 31, 2010, respectively.
 
A summary of the available for sale investment securities by maturity groupings as of June 30, 2011 is shown below. The investment portfolio includes agency mortgage-backed securities, which are guaranteed by agencies such as the FHLMC, FNMA, GNMA and FDIC, in addition to non-agency mortgage-backed securities, which have no guarantee. Also included are certain other asset-backed securities, which are


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primarily collateralized by credit cards, automobiles, student loans, and commercial loans. These securities differ from traditional debt securities primarily in that they may have uncertain maturity dates and are priced based on estimated prepayment rates on the underlying collateral. The Company does not have exposure to subprime originated mortgage-backed or collateralized debt obligation instruments.
 
                 
   
    Amortized
       
(Dollars in thousands)   Cost     Fair Value  
   
 
U.S. government and federal agency obligations:
               
Within 1 year
  $ 2,365     $ 2,367  
After 1 but within 5 years
    135,522       147,445  
After 5 but within 10 years
    190,441       206,434  
 
 
Total U.S. government and federal agency obligations
    328,328       356,246  
 
 
Government-sponsored enterprise obligations:
               
Within 1 year
    85,130       86,384  
After 1 but within 5 years
    107,184       108,351  
After 5 but within 10 years
    58,727       58,863  
After 10 years
    11,000       10,955  
 
 
Total government-sponsored enterprise obligations
    262,041       264,553  
 
 
State and municipal obligations:
               
Within 1 year
    135,296       136,620  
After 1 but within 5 years
    459,340       472,245  
After 5 but within 10 years
    355,389       357,330  
After 10 years
    234,770       227,366  
 
 
Total state and municipal obligations
    1,184,795       1,193,561  
 
 
Mortgage and asset-backed securities:
               
Agency mortgage-backed securities
    2,845,564       2,913,805  
Non-agency mortgage-backed securities
    383,271       385,937  
Other asset-backed securities
    2,383,208       2,394,627  
 
 
Total mortgage and asset-backed securities
    5,612,043       5,694,369  
 
 
Other debt securities:
               
Within 1 year
    61,531       62,499  
After 1 but within 5 years
    98,445       106,360  
 
 
Total other debt securities
    159,976       168,859  
 
 
Equity securities
    10,291       40,046  
 
 
Total available for sale investment securities
  $ 7,557,474     $ 7,717,634  
 
 
 
Included in U.S. government securities are $346.4 million, at fair value, of U.S. Treasury inflation-protected securities (TIPS). Interest paid on these securities increases with inflation and decreases with deflation, as measured by the Consumer Price Index. Included in state and municipal obligations are $141.9 million, at fair value, of auction rate securities, which were purchased from bank customers in 2008. Included in equity securities is common stock held by the holding company, Commerce Bancshares, Inc. (the Parent), with a fair value of $33.1 million at June 30, 2011.


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For securities classified as available for sale, the following table shows the unrealized gains and losses (pre-tax) in accumulated other comprehensive income, by security type.
 
                                 
   
          Gross
    Gross
       
    Amortized
    Unrealized
    Unrealized
       
(In thousands)   Cost     Gains     Losses     Fair Value  
   
 
June 30, 2011
                               
U.S. government and federal agency obligations
  $ 328,328     $ 27,918     $     $ 356,246  
Government-sponsored enterprise obligations
    262,041       2,843       (331 )     264,553  
State and municipal obligations
    1,184,795       22,365       (13,599 )     1,193,561  
Mortgage and asset-backed securities:
                               
Agency mortgage-backed securities
    2,845,564       69,910       (1,669 )     2,913,805  
Non-agency mortgage-backed securities
    383,271       10,653       (7,987 )     385,937  
Other asset-backed securities
    2,383,208       11,797       (378 )     2,394,627  
 
 
Total mortgage and asset-backed securities
    5,612,043       92,360       (10,034 )     5,694,369  
 
 
Other debt securities
    159,976       8,883             168,859  
Equity securities
    10,291       29,755             40,046  
 
 
Total
  $ 7,557,474     $ 184,124     $ (23,964 )   $ 7,717,634  
 
 
December 31, 2010
                               
U.S. government and federal agency obligations
  $ 434,878     $ 20,659     $     $ 455,537  
Government-sponsored enterprise obligations
    200,061       2,364       (530 )     201,895  
State and municipal obligations
    1,117,020       19,108       (16,643 )     1,119,485  
Mortgage and asset-backed securities:
                               
Agency mortgage-backed securities
    2,437,123       57,516       (3,440 )     2,491,199  
Non-agency mortgage-backed securities
    459,363       10,940       (14,513 )     455,790  
Other asset-backed securities
    2,342,866       12,445       (1,051 )     2,354,260  
 
 
Total mortgage and asset-backed securities
    5,239,352       80,901       (19,004 )     5,301,249  
 
 
Other debt securities
    165,883       11,081             176,964  
Equity securities
    7,569       31,604             39,173  
 
 
Total
  $ 7,164,763     $ 165,717     $ (36,177 )   $ 7,294,303  
 
 
 
The Company’s impairment policy requires a review of all securities for which fair value is less than amortized cost. Special emphasis and analysis is placed on securities whose credit rating has fallen below A3/A-, whose fair values have fallen more than 20% below purchase price for an extended period of time, or have been identified based on management’s judgment. These securities are placed on a watch list, and for all such securities, detailed cash flow models are prepared which use inputs specific to each security. Inputs to these models include factors such as cash flow received, contractual payments required, and various other information related to the underlying collateral (including current delinquencies), collateral loss severity rates (including loan to values), expected delinquency rates, credit support from other tranches, and prepayment speeds. Stress tests are performed at varying levels of delinquency rates, prepayment speeds and loss severities in order to gauge probable ranges of credit loss. At June 30, 2011, the fair value of securities on this watch list was $258.4 million.
 
As of June 30, 2011, the Company had recorded other-than-temporary impairment (OTTI) on certain non-agency mortgage-backed securities, part of the watch list mentioned above, which had an aggregate fair value of $146.9 million. The credit-related portion of the impairment totaled $8.5 million and was recorded in earnings. The noncredit-related portion of the impairment totaled $6.5 million on a pre-tax basis, and has been recognized in accumulated other comprehensive income. The Company does not intend to sell these securities and believes it is not more likely than not that it will be required to sell the securities before the recovery of their amortized cost bases.


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The credit portion of the loss on these securities was based on the cash flows projected to be received over the estimated life of the securities, discounted to present value, and compared to the current amortized cost bases of the securities. Significant inputs to the cash flow models used to calculate the credit losses on these securities included the following:
 
         
 
Significant Inputs   Range
 
 
Prepayment CPR
    7% - 25%  
Projected cumulative default
    11% - 51%  
Credit support
    0% - 18%  
Loss severity
    33% - 57%  
 
 
 
The following table shows changes in the credit losses recorded in the six months ended June 30, 2011 and 2010, for which a portion of an OTTI was recognized in other comprehensive income.
 
                 
   
    For the
 
    Six Months
 
    Ended June 30  
(In thousands)   2011     2010  
   
 
Balance at January 1
  $ 7,542     $ 2,473  
Credit losses on debt securities for which impairment was not previously recognized
    53       88  
Credit losses on debt securities for which impairment was previously recognized
    871       2,045  
Increase in expected cash flows that are recognized over remaining life of security
    (53 )      
 
 
Balance at June 30
  $ 8,413     $ 4,606  
 
 
 
Securities with unrealized losses recorded in accumulated other comprehensive income are shown in the table below, along with the length of the impairment period.
 
                                                 
   
    Less than 12 months     12 months or longer     Total  
          Unrealized
          Unrealized
          Unrealized
 
(In thousands)   Fair Value     Losses     Fair Value     Losses     Fair Value     Losses  
   
 
June 30, 2011
                                               
Government-sponsored enterprise obligations
  $ 42,078     $ 331     $     $     $ 42,078     $ 331  
State and municipal obligations
    177,677       2,453       96,602       11,146       274,279       13,599  
Mortgage and asset-backed securities:
                                               
Agency mortgage-backed securities
    238,483       1,669                   238,483       1,669  
Non-agency mortgage-backed securities
    38,749       250       139,127       7,737       177,876       7,987  
Other asset-backed securities
    299,909       378                   299,909       378  
 
 
Total mortgage and asset-backed securities
    577,141       2,297       139,127       7,737       716,268       10,034  
 
 
Total
  $ 796,896     $ 5,081     $ 235,729     $ 18,883     $ 1,032,625     $ 23,964  
 
 
December 31, 2010
                                               
Government-sponsored enterprise obligations
  $ 10,850     $ 530     $     $     $ 10,850     $ 530  
State and municipal obligations
    345,775       7,470       82,269       9,173       428,044       16,643  
Mortgage and asset-backed securities:
                                               
Agency mortgage-backed securities
    660,326       3,440                   660,326       3,440  
Non-agency mortgage-backed securities
    15,893       36       170,545       14,477       186,438       14,513  
Other asset-backed securities
    487,822       1,029       24,928       22       512,750       1,051  
 
 
Total mortgage and asset-backed securities
    1,164,041       4,505       195,473       14,499       1,359,514       19,004  
 
 
Total
  $ 1,520,666     $ 12,505     $ 277,742     $ 23,672     $ 1,798,408     $ 36,177  
 
 


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The total available for sale portfolio consisted of approximately 1,400 individual securities at June 30, 2011. The portfolio included 186 securities, having an aggregate fair value of $1.0 billion that were in a loss position at June 30, 2011. Securities identified as other-than-temporarily impaired which have been in a loss position for 12 months or longer totaled $121.4 million at fair value, or 1.6% of the total available for sale portfolio value. Securities with temporary impairment which have been in a loss position for 12 months or longer totaled $114.4 million, or 1.5% of the total portfolio value.
 
The Company’s holdings of state and municipal obligations included gross unrealized losses of $13.6 million at June 30, 2011. Of these losses, $11.1 million related to auction rate securities (ARS) and $2.5 million related to other state and municipal obligations. This portfolio, exclusive of ARS, totaled $1.1 billion at fair value, or 13.6% of total available for sale securities. The average credit quality of the portfolio, excluding ARS, is Aa2 as rated by Moody’s. The portfolio is diversified in order to reduce risk, and information about the largest holdings, by state and economic sector, is shown in the table below.
 
                         
   
          Average
    Average
 
    % of
    Life
    Rating
 
    Portfolio     (in years)     (Moody’s)  
   
 
At June 30, 2011
                       
Texas
    10.3 %     5.6       Aa1  
Florida
    8.2       5.2       Aa3  
Washington
    7.0       3.3       Aa2  
Arizona
    5.1       3.7       Aa3  
Illinois
    5.1       5.2       Aa2  
 
 
General obligation
    26.0 %     3.7       Aa2  
Housing
    18.5       4.9       Aa1  
Transportation
    16.3       4.0       Aa3  
Lease
    12.8       3.3       Aa2  
Refunded
    6.7       2.0       Aaa  
 
 
 
The remaining unrealized losses on the Company’s investments, as shown in the preceding tables, are largely contained in the portfolio of non-agency mortgage-backed securities. These securities are not guaranteed by an outside agency and are dependent on payments received from the underlying mortgage collateral. While virtually all of these securities, at purchase date, were comprised of senior tranches and were highly rated by various rating agencies, the adverse housing market and overall economic climate has resulted in low fair values for these securities. Also, as mentioned above, the Company maintains a watch list comprised mostly of these securities, and has recorded OTTI losses on certain of these securities. The Company continues to closely monitor the performance of these securities. Additional OTTI losses may arise in future periods due to further deterioration in expected cash flows, loss severities and delinquency levels of the securities’ underlying collateral, which would negatively affect the Company’s financial results.
 
The following table presents proceeds from sales of securities and the components of investment securities gains and losses which have been recognized in earnings.
 
                 
   
    For the Six
 
    Months Ended
 
    June 30  
(In thousands)   2011     2010  
   
 
Proceeds from sales of available for sale securities
  $ 11,202     $ 64,087  
 
 
Available for sale:
               
Gains realized on sales
  $ 177     $ 1,920  
Losses realized on sales
          (151 )
Other-than-temporary impairment recognized on debt securities
    (924 )     (2,133 )
Non-marketable:
               
Fair value adjustments, net
    4,030       (2,641 )
 
 
Investment securities gains (losses), net
  $ 3,283     $ (3,005 )
 
 


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At June 30, 2011, securities carried at $3.7 billion were pledged to secure public fund deposits, securities sold under agreements to repurchase, trust funds, and borrowings at the FRB and FHLB. Securities pledged under agreements pursuant to which the collateral may be sold or re-pledged by the secured parties approximated $425.9 million, while the remaining securities were pledged under agreements pursuant to which the secured parties may not sell or re-pledge the collateral. Except for obligations of various government-sponsored enterprises such as FNMA, FHLB and FHLMC, no investment in a single issuer exceeds 10% of stockholders’ equity.
 
4.  Goodwill and Other Intangible Assets
 
The following table presents information about the Company’s intangible assets which have estimable useful lives.
 
                                                                 
   
    June 30, 2011     December 31, 2010  
    Gross
                      Gross
                   
    Carrying
    Accumulated
    Valuation
    Net
    Carrying
    Accumulated
    Valuation
    Net
 
(In thousands)   Amount     Amortization     Allowance     Amount     Amount     Amortization     Allowance     Amount  
   
 
Amortizable intangible assets:
                                                               
Core deposit premium
  $ 25,720     $ (17,521 )   $     $ 8,199     $ 25,720     $ (16,108 )   $     $ 9,612  
Mortgage servicing rights
    3,092       (1,723 )     (174 )     1,195       3,082       (1,572 )     (185 )     1,325  
 
 
Total
  $ 28,812     $ (19,244 )   $ (174 )   $ 9,394     $ 28,802     $ (17,680 )   $ (185 )   $ 10,937  
 
 
 
Aggregate amortization expense on intangible assets was $751 thousand and $911 thousand, respectively, for the three month periods ended June 30, 2011 and 2010, and $1.6 million and $1.8 million for the six month periods ended June 30, 2011 and 2010. The following table shows the estimated annual amortization expense for the next five fiscal years. This expense is based on existing asset balances and the interest rate environment as of June 30, 2011. The Company’s actual amortization expense in any given period may be different from the estimated amounts depending upon the acquisition of intangible assets, changes in mortgage interest rates, prepayment rates and other market conditions.
 
         
   
(In thousands)      
   
 
2011
  $ 2,870  
2012
    2,331  
2013
    1,795  
2014
    1,315  
2015
    967  
 
 
 
Changes in the carrying amount of goodwill and net other intangible assets for the six month period ended June 30, 2011 is as follows.
 
                         
   
                Mortgage
 
          Core Deposit
    Servicing
 
(In thousands)   Goodwill     Premium     Rights  
   
 
Balance at January 1, 2011
  $ 125,585     $ 9,612     $ 1,325  
Originations
                10  
Amortization
          (1,413 )     (151 )
Impairment reversal
                11  
 
 
Balance at June 30, 2011
  $ 125,585     $ 8,199     $ 1,195  
 
 


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Goodwill allocated to the Company’s operating segments at June 30, 2011 and December 31, 2010 is shown below.
 
         
   
(In thousands)      
   
 
Consumer segment
  $ 67,765  
Commercial segment
    57,074  
Wealth segment
    746  
 
 
Total goodwill
  $ 125,585  
 
 
 
5.  Guarantees
 
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.
 
Upon issuance of standby letters of credit, the Company recognizes a liability for the fair value of the obligation undertaken, which is estimated to be equivalent to the amount of fees received from the customer over the life of the agreement. At June 30, 2011 that net liability was $3.9 million, which will be accreted into income over the remaining life of the respective commitments. The contractual amount of these letters of credit, which represents the maximum potential future payments guaranteed by the Company, was $319.6 million at June 30, 2011.
 
The Company periodically enters into risk participation agreements (RPAs) as a guarantor to other financial institutions, in order to mitigate those institutions’ credit risk associated with interest rate swaps with third parties. The RPA stipulates that, in the event of default by the third party on the interest rate swap, the Company will reimburse a portion of the loss borne by the financial institution. These interest rate swaps are normally collateralized (generally with real property, inventories and equipment) by the third party, which limits the credit risk associated with the Company’s RPAs. The third parties usually have other borrowing relationships with the Company. The Company monitors overall borrower collateral, and at June 30, 2011, believes sufficient collateral is available to cover potential swap losses. The RPAs are carried at fair value throughout their term, with all changes in fair value, including those due to a change in the third party’s creditworthiness, recorded in current earnings. The terms of the RPAs, which correspond to the terms of the underlying swaps, range from 5 to 10 years. At June 30, 2011, the liability recorded for guarantor RPAs was $373 thousand, and the notional amount of the underlying swaps was $79.4 million. The maximum potential future payment guaranteed by the Company cannot be readily estimated, but is dependent upon the fair value of the interest rate swaps at the time of default. If an event of default on all contracts had occurred at June 30, 2011, the Company would have been required to make payments of approximately $4.6 million.
 
At December 31, 2010, the Company carried a liability of $4.4 million representing its obligation to share certain estimated litigation costs of Visa, Inc. (Visa). An escrow account established by Visa is used to fund actual litigation settlements as they occur. The escrow account was funded initially with proceeds from an initial public offering and subsequently funded with contributions by Visa. The Company’s indemnification obligation is periodically adjusted to reflect changes in estimates of litigation costs, and is reduced as funding occurs in the escrow account. Additional funding occurred during March 2011 when Visa contributed $400 million to the escrow account. As a result, the Company reduced its obligation by $1.4 million at that time, bringing its liability balance to $3.1 million as of June 30, 2011. The Company currently anticipates


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that its proportional share of eventual escrow funding will more than offset its liability related to the Visa litigation.
6.  Pension
 
The amount of net pension cost is shown in the table below:
 
                                 
   
    For the
    For the
 
    Three Months
    Six Months
 
    Ended June 30     Ended June 30  
(In thousands)   2011     2010     2011     2010  
   
 
Service cost – benefits earned during the period
  $ 88     $ 183     $ 176     $ 366  
Interest cost on projected benefit obligation
    1,362       1,367       2,724       2,734  
Expected return on plan assets
    (1,675 )     (1,640 )     (3,350 )     (3,280 )
Amortization of unrecognized net loss
    540       567       1,080       1,134  
 
 
Net periodic pension cost
  $ 315     $ 477     $ 630     $ 954  
 
 
 
Substantially all benefits accrued under the Company’s defined benefit pension plan were frozen effective January 1, 2005, and the remaining benefits were frozen effective January 1, 2011. During the first six months of 2011, the Company made no funding contributions to its defined benefit pension plan and made minimal funding contributions to a supplemental executive retirement plan (the CERP), which carries no segregated assets. The Company has no plans to make any further contributions, other than those related to the CERP, during the remainder of 2011.


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7.  Common Stock
 
Presented below is a summary of the components used to calculate basic and diluted income per share. The Company applies the two-class method of computing income per share, as nonvested share-based awards that contain nonforfeitable rights to dividends are considered securities which participate in undistributed earnings with common stock. The two-class method requires the calculation of separate income per share amounts for the nonvested share-based awards and for common stock. Income per share attributable to common stock is shown in the table below. Nonvested share-based awards are further discussed in Note 12.
 
                                 
   
    For the
    For the
 
    Three Months
    Six Months
 
    Ended June 30     Ended June 30  
(In thousands, except per share data)   2011     2010     2011     2010  
   
 
Basic income per common share:
                               
Net income attributable to Commerce Bancshares, Inc. 
  $ 69,034     $ 59,734     $ 129,487     $ 103,904  
Less income allocated to nonvested restricted stockholders
    501       331       905       565  
 
 
Net income available to common stockholders
  $ 68,533     $ 59,403     $ 128,582     $ 103,339  
 
 
Distributed income
  $ 19,909     $ 19,505     $ 39,816     $ 38,992  
Undistributed income
  $ 48,624     $ 39,898     $ 88,766     $ 64,347  
 
 
Weighted average common shares outstanding
    86,539       87,139       86,504       87,079  
 
 
Distributed income per share
  $ .23     $ .23     $ .46     $ .45  
Undistributed income per share
    .57       .46       1.03       .74  
 
 
Basic income per common share
  $ .80     $ .69     $ 1.49     $ 1.19  
 
 
Diluted income per common share:
                               
Net income attributable to Commerce Bancshares, Inc. 
  $ 69,034     $ 59,734     $ 129,487     $ 103,904  
Less income allocated to nonvested restricted stockholders
    499       329       902       563  
 
 
Net income available to common stockholders
  $ 68,535     $ 59,405     $ 128,585     $ 103,341  
 
 
Distributed income
  $ 19,909     $ 19,505     $ 39,816     $ 38,992  
Undistributed income
  $ 48,626     $ 39,900     $ 88,769     $ 64,349  
 
 
Weighted average common shares outstanding
    86,539       87,139       86,504       87,079  
Net effect of the assumed exercise of stock-based awards – based on the treasury stock method using the average market price for the respective periods
    388       415       378       444  
 
 
Weighted average diluted common shares outstanding
    86,927       87,554       86,882       87,523  
 
 
Distributed income per share
  $ .23     $ .23     $ .46     $ .45  
Undistributed income per share
    .56       .45       1.02       .73  
 
 
Diluted income per common share
  $ .79     $ .68     $ 1.48     $ 1.18  
 
 
 
The diluted income per common share computations for the six month period ended June 30, 2010 excluded 1.7 million in unexercised stock options and stock appreciation rights because their inclusion would have been anti-dilutive to income per share. Nearly all unexercised options and rights were dilutive for the comparable period in 2011.
 
8.  Other Comprehensive Income
 
Activity in other comprehensive income (loss) for the three and six months ended June 30, 2011 and 2010 is shown in the table below. The first component of other comprehensive income is the unrealized holding gains and losses on available for sale securities. These gains and losses have been separated into two groups


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in the table below, as required by current accounting guidance for other-than-temporary impairment (OTTI) on debt securities. Under this guidance, credit-related losses on debt securities with OTTI are recorded in current earnings, while the noncredit-related portion of the overall gain or loss in fair value is recorded in other comprehensive income (loss). Changes in the noncredit-related gain or loss in fair value of these securities, after OTTI was initially recognized, are shown separately in the table below. The remaining unrealized holding gains and losses shown in the table apply to available for sale investment securities for which OTTI has not been recorded (and include holding gains and losses on certain securities prior to the recognition of OTTI).
 
In the calculation of other comprehensive income, certain reclassification adjustments are made to avoid double counting gains and losses that are included as part of net income for a period that also had been included as part of other comprehensive income in that period or earlier periods. These reclassification amounts are shown separately in the table below.
 
The second component of other comprehensive income is pension gains and losses that arise during the period but are not recognized as components of net periodic benefit cost, and corresponding adjustments when these gains and losses are subsequently amortized to net periodic benefit cost.
 
                                 
   
    For the
    For the
 
    Three Months
    Six Months
 
    Ended June 30     Ended June 30  
(In thousands)   2011     2010     2011     2010  
   
 
Available for sale debt securities for which a portion of OTTI has been recorded in earnings:
                               
Unrealized holding gains (losses) subsequent to initial OTTI recognition
  $ (812 )   $ 5,665     $ 5,663     $ 11,967  
Income tax (expense) benefit
    309       (2,153 )     (2,152 )     (4,547 )
 
 
Net unrealized gains (losses)
    (503 )     3,512       3,511       7,420  
 
 
Other available for sale investment securities:
                               
Unrealized holding gains
    35,540       23,693       25,135       36,073  
Reclassification adjustment for gains included in net income
    (1 )     (1,362 )     (177 )     (1,770 )
 
 
Net unrealized gains on securities
    35,539       22,331       24,958       34,303  
Income tax expense
    (13,505 )     (8,486 )     (9,484 )     (13,036 )
 
 
Net unrealized gains
    22,034       13,845       15,474       21,267  
 
 
Prepaid pension cost:
                               
Amortization of accumulated pension loss
    540       567       1,080       1,134  
Income tax expense
    (205 )     (215 )     (410 )     (431 )
 
 
Pension loss amortization
    335       352       670       703  
 
 
Other comprehensive income
  $ 21,866     $ 17,709     $ 19,655     $ 29,390  
 
 
 
At June 30, 2011, accumulated other comprehensive income was $83.0 million, net of tax. It was comprised of $4.0 million in unrealized holding losses on available for sale debt securities for which a portion of OTTI has been recorded in earnings, $103.3 million in unrealized holding gains on other available for sale securities, and $16.3 million in accumulated pension loss.
 
9.  Segments
 
The Company segregates financial information for use in assessing its performance and allocating resources among three operating segments: Consumer, Commercial and Wealth. The Consumer segment includes the consumer portion of the retail branch network (loans, deposits, and other personal banking services), indirect and other consumer financing, consumer debit and credit bank cards, and student lending. The Commercial segment provides corporate lending (including the Small Business Banking product line


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within the branch network), leasing, international services, and business, government deposit, and related commercial cash management services, as well as Merchant and Commercial bank card products. The Wealth segment provides traditional trust and estate tax planning, advisory and discretionary investment management, as well as discount brokerage services, and the Private Banking product portfolio. The Capital Markets Group, which sells fixed income securities and provides investment safekeeping and bond accounting services, was transferred from the Wealth segment to the Commercial segment effective January 1, 2011. The information for 2010 in the table below has been revised to reflect this transfer.
 
The following table presents selected financial information by segment and reconciliations of combined segment totals to consolidated totals. There were no material intersegment revenues among the three segments.
 
                                                 
   
                      Segment
    Other/
    Consolidated
 
(In thousands)   Consumer     Commercial     Wealth     Totals     Elimination     Totals  
   
 
Three Months Ended June 30, 2011:
                                               
Net interest income
  $ 72,086     $ 69,520     $ 9,688     $ 151,294     $ 13,416     $ 164,710  
Provision for loan losses
    (11,694 )     (3,378 )           (15,072 )     2,884       (12,188 )
Non-interest income
    34,813       40,309       26,229       101,351       (7 )     101,344  
Investment securities gains, net
                            1,956       1,956  
Non-interest expense
    (68,559 )     (53,479 )     (23,099 )     (145,137 )     (8,376 )     (153,513 )
 
 
Income before income taxes
  $ 26,646     $ 52,972     $ 12,818     $ 92,436     $ 9,873     $ 102,309  
 
 
Six Months Ended June 30, 2011:
                                               
Net interest income
  $ 143,608     $ 137,679     $ 19,237     $ 300,524     $ 25,159     $ 325,683  
Provision for loan losses
    (25,331 )     (8,497 )     (28 )     (33,856 )     5,879       (27,977 )
Non-interest income
    66,807       79,455       51,415       197,677       (427 )     197,250  
Investment securities gains, net
                            3,283       3,283  
Non-interest expense
    (138,386 )     (109,193 )     (45,314 )     (292,893 )     (14,580 )     (307,473 )
 
 
Income before income taxes
  $ 46,698     $ 99,444     $ 25,310     $ 171,452     $ 19,314     $ 190,766  
 
 
Three Months Ended June 30, 2010:
                                               
Net interest income
  $ 80,444     $ 64,537     $ 9,799     $ 154,780     $ 8,328     $ 163,108  
Provision for loan losses
    (17,713 )     (4,193 )     (163 )     (22,069 )     (118 )     (22,187 )
Non-interest income
    39,517       39,044       23,493       102,054       (596 )     101,458  
Investment securities gains, net
                            660       660  
Non-interest expense
    (73,908 )     (55,379 )     (21,466 )     (150,753 )     (5,040 )     (155,793 )
 
 
Income before income taxes
  $ 28,340     $ 44,009     $ 11,663     $ 84,012     $ 3,234     $ 87,246  
 
 
Six Months Ended June 30, 2010:
                                               
Net interest income
  $ 161,477     $ 127,671     $ 18,812     $ 307,960     $ 17,858     $ 325,818  
Provision for loan losses
    (36,991 )     (16,121 )     (221 )     (53,333 )     (3,176 )     (56,509 )
Non-interest income
    73,897       74,351       45,722       193,970       677       194,647  
Investment securities losses, net
                            (3,005 )     (3,005 )
Non-interest expense
    (147,737 )     (109,415 )     (43,277 )     (300,429 )     (11,088 )     (311,517 )
 
 
Income before income taxes
  $ 50,646     $ 76,486     $ 21,036     $ 148,168     $ 1,266     $ 149,434  
 
 
 
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 and assignment of overhead costs among segments. Funds transfer pricing was used in the determination of net interest income by assigning a standard cost (credit) for funds used (provided) by assets and liabilities based on their maturity, prepayment and/or repricing characteristics.


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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, the investment securities portfolio, and the effect of certain expense allocations to the segments. The provision for loan losses in this category contains the difference between loan charge-offs and recoveries assigned directly to the segments and the recorded provision for loan loss expense. Included in this category’s net interest income are earnings of the investment portfolio, which are not allocated to a segment.
 
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.
 
10.  Derivative Instruments
 
The notional amounts of the Company’s derivative instruments are shown in the table below. These contractual amounts, along with other terms of the derivative, are used to determine amounts to be exchanged between counterparties, and are not a measure of loss exposure. The largest group of notional amounts relate to interest rate swaps, which are discussed in more detail below. Through its International Department, the Company enters into foreign exchange contracts consisting mainly of contracts to purchase or deliver foreign currencies for customers at specific future dates. Also, mortgage loan commitments and forward sales contracts result from the Company’s mortgage banking operation, in which fixed rate personal real estate loans are originated and sold to other institutions. The Company also contracts with other financial institutions, as a guarantor or beneficiary, to share credit risk associated with certain interest rate swaps. The Company’s risks and responsibilities as guarantor are further discussed in Note 5 on Guarantees.
 
                 
   
    June 30
    December 31
 
(In thousands)   2011     2010  
   
 
Interest rate swaps
  $ 531,487     $ 498,071  
Interest rate caps
    30,736       31,736  
Credit risk participation agreements
    83,101       40,661  
Foreign exchange contracts:
               
Forward contracts
    64,581       25,867  
Option contracts
    3,100        
Mortgage loan commitments
    8,241       12,125  
Mortgage loan forward sale contracts
    13,349       24,112  
 
 
Total notional amount
  $ 734,595     $ 632,572  
 
 
 
The Company’s interest rate risk management strategy includes the ability to modify the repricing characteristics of certain assets and liabilities so that changes in interest rates do not adversely affect the net interest margin and cash flows. Interest rate swaps are used on a limited basis as part of this strategy. At June 30, 2011, the Company had entered into three interest rate swaps with a notional amount of $15.1 million, included in the table above, which are designated as fair value hedges of certain fixed rate loans. Gains and losses on these derivative instruments, as well as the offsetting loss or gain on the hedged loans attributable to the hedged risk, are recognized in current earnings. These gains and losses are reported in interest and fees on loans in the accompanying statements of income. The table below shows gains and losses related to fair value hedges.
 
                                 
   
    For the Three Months Ended
    For the Six Months Ended
 
    June 30     June 30  
(In thousands)   2011     2010     2011     2010  
   
 
Gain (loss) on interest rate swaps
  $ (117 )   $ (309 )   $ 70     $ (390 )
Gain (loss) on loans
    117       299       (64 )     372  
 
 
Amount of hedge ineffectiveness
  $     $ (10 )   $ 6     $ (18 )
 
 


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The Company’s other derivative instruments are accounted for as free-standing derivatives, and changes in their fair value are recorded in current earnings. These instruments include interest rate swap contracts sold to customers who wish to modify their interest rate sensitivity. These swaps are offset by matching contracts purchased by the Company from other financial institutions. Because of the matching terms of the offsetting contracts, in addition to collateral provisions which mitigate the impact of non-performance risk, changes in fair value subsequent to initial recognition have a minimal effect on earnings. The notional amount of these types of swaps at June 30, 2011 was $516.4 million. The Company is party to master netting arrangements; however, the Company does not offset assets and liabilities under these arrangements. Collateral, usually in the form of marketable securities, is posted by the counterparty with liability positions, in accordance with contract thresholds. At June 30, 2011, the Company had net liability positions with its financial institution counterparties totaling $16.9 million and had posted $16.9 million in collateral.
 
Many of the Company’s interest rate swap contracts with large financial institutions contain contingent features relating to debt ratings or capitalization levels. Under these provisions, if the Company’s debt rating falls below investment grade or if the Company ceases to be “well-capitalized” under risk-based capital guidelines, certain counterparties can require immediate and ongoing collateralization on interest rate swaps in net liability positions, or can require instant settlement of the contracts. The Company maintains debt ratings and capital well above these minimum requirements.
 
The banking customer counterparties are engaged in a variety of businesses, including real estate, building materials, communications, consumer products, and manufacturing. The manufacturing group is the largest, with a combined notional amount of 24.3% of the total customer swap portfolio. If this group of manufacturing counterparties failed to perform, and if the underlying collateral proved to be of no value, the Company would incur a loss of $2.8 million, based on amounts at June 30, 2011.
 
The fair values of the Company’s derivative instruments, whose notional amounts are listed above, are shown in the table below. Information about the valuation methods used to determine fair value is provided in Note 13 on Fair Value Measurements.
 
                                         
   
    Asset Derivatives     Liability Derivatives  
        June 30
    Dec. 31
        June 30
    Dec. 31
 
        2011     2010         2011     2010  
                     
    Balance
        Balance
     
    Sheet
        Sheet
     
(In thousands)   Location   Fair Value     Location   Fair Value  
   
 
Derivatives designated as hedging instruments:
                                       
Interest rate swaps
  Other assets   $     $     Other liabilities   $ (1,090 )   $ (1,159 )
 
 
Total derivatives designated as hedging instruments
      $     $         $ (1,090 )   $ (1,159 )
 
 
Derivatives not designated as hedging instruments:
                                       
Interest rate swaps
  Other assets   $ 17,121     $ 17,712     Other liabilities   $ (17,220 )   $ (17,799 )
Interest rate caps
  Other assets     45       84     Other liabilities     (45 )     (84 )
Credit risk participation agreements
  Other assets     6           Other liabilities     (373 )     (130 )
Foreign exchange contracts:
                                       
Forward contracts
  Other assets     1,190       492     Other liabilities     (905 )     (359 )
Option contracts
  Other assets     1           Other liabilities     (1 )      
Mortgage loan commitments
  Other assets     102       101     Other liabilities     (2 )     (30 )
Mortgage loan forward sale contracts
  Other assets     30       434     Other liabilities     (51 )     (23 )
 
 
Total derivatives not designated as hedging instruments
      $ 18,495     $ 18,823         $ (18,597 )   $ (18,425 )
 
 
Total derivatives
      $ 18,495     $ 18,823         $ (19,687 )   $ (19,584 )
 
 


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The effects of derivative instruments on the consolidated statements of income are shown in the table below.
 
                                     
   
    Location of Gain or
     
    (Loss) Recognized in
  Amount of Gain or (Loss)
 
    Income on Derivative   Recognized in Income on Derivative  
       
        For the Three Months
    For the Six Months
 
        Ended
    Ended
 
        June 30     June 30  
(In thousands)       2011     2010     2011     2010  
   
 
Derivatives in fair value hedging relationships:
                                   
Interest rate swaps
  Interest and fees on loans   $ (117 )   $ (309 )   $ 70     $ (390 )
 
 
Total
      $ (117 )   $ (309 )   $ 70     $ (390 )
 
 
Derivatives not designated as hedging instruments:
                                   
Interest rate swaps
  Other non-interest income   $ 167     $ 269     $ 556     $ 459  
Interest rate caps
  Other non-interest income           32             32  
Credit risk participation agreements
  Other non-interest income     29       8       35       13  
Foreign exchange contracts:
                                   
Forward contracts
  Other non-interest income     (11 )     138       153       414  
Option contracts
  Other non-interest income                        
Mortgage loan commitments
  Loan fees and sales     (15 )     156       29       240  
Mortgage loan forward sale contracts
  Loan fees and sales     (19 )     (259 )     (432 )     (361 )
 
 
Total
      $ 151     $ 344     $ 341     $ 797  
 
 
 
11.  Income Taxes
 
For the second quarter of 2011, income tax expense amounted to $32.7 million compared to $27.4 million in the second quarter of 2010. The effective tax rate for the Company, including the effect of non-controlling interest, was 32.1% in the current quarter compared to 31.5% in the same quarter last year. For the six months ended June 30, 2011 and 2010, income tax expense amounted to $60.2 million and $45.8 million, resulting in effective tax rates of 31.7% and 30.6%, respectively.
 
12.  Stock-Based Compensation
 
Stock-based compensation expense that has been charged against income was $1.1 million and $1.5 million in the three months ended June 30, 2011 and 2010, respectively, and $2.4 million and $3.4 million in the six months ended June 30, 2011 and 2010, respectively. The Company has historically issued stock-based compensation in the form of options, stock appreciation rights (SARs) and nonvested stock. During 2010 and the first six months of 2011, stock-based compensation was issued solely in the form of nonvested stock awards.


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The 2011 stock awards generally vest in 5 to 7 years and contain restrictions as to transferability, sale, pledging, or assigning, among others, prior to the end of the vesting period. Dividend and voting rights are conferred upon grant. A summary of the status of the Company’s nonvested share awards as of June 30, 2011, and changes during the six month period then ended is presented below.
 
                 
   
          Weighted
 
          Average
 
          Grant Date
 
    Shares     Fair Value  
   
 
Nonvested at January 1, 2011
    470,406     $ 36.00  
Granted
    198,459       40.62  
Vested
    (24,562 )     40.28  
Forfeited
    (6,398 )     37.33  
 
 
Nonvested at June 30, 2011
    637,905     $ 37.24  
 
 
 
SARs and stock options are granted with an exercise price equal to the market price of the Company’s stock at the date of grant and have 10-year contractual terms. SARs, which the Company granted in 2006 and subsequent years, vest on a graded basis over 4 years of continuous service. All SARs must be settled in stock under provisions of the plan. Stock options, which were granted in 2005 and previous years, vest on a graded basis over 3 years of continuous service. In determining compensation cost, the Black-Scholes option-pricing model is used to estimate the fair value of SARs and options on date of grant.
 
A summary of option activity during the first six months of 2011 is presented below.
 
                                 
   
                Weighted
       
          Weighted
    Average
       
          Average
    Remaining
    Aggregate
 
          Exercise
    Contractual
    Intrinsic
 
(Dollars in thousands, except per share data)   Shares     Price     Term     Value  
   
 
Outstanding at January 1, 2011
    1,806,110     $ 30.96                  
Granted
                           
Forfeited
                           
Expired
                           
Exercised
    (474,289 )     28.94                  
 
 
Outstanding at June 30, 2011
    1,331,821     $ 31.68       2.4 years     $ 15,079  
 
 
 
A summary of SAR activity during the first six months of 2011 is presented below.
 
                                 
   
                Weighted
       
          Weighted
    Average
       
          Average
    Remaining
    Aggregate
 
          Exercise
    Contractual
    Intrinsic
 
(Dollars in thousands, except per share data)   Shares     Price     Term     Value  
   
 
Outstanding at January 1, 2011
    1,710,108     $ 39.71                  
Granted
                           
Forfeited
    (2,952 )     37.74                  
Expired
    (5,156 )     40.28                  
Exercised
    (28,793 )     38.81                  
 
 
Outstanding at June 30, 2011
    1,673,207     $ 39.72       5.7 years     $ 5,482  
 
 
 
13.  Fair Value Measurements
 
The Company uses fair value measurements to record fair value adjustments to certain financial and nonfinancial assets and liabilities and to determine fair value disclosures. Various financial instruments such as available for sale and trading securities, certain non-marketable securities relating to private equity activities, and derivatives are recorded at fair value on a recurring basis. Additionally, from time to time,


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the Company may be required to record at fair value other assets and liabilities on a nonrecurring basis, such as loans held for sale, mortgage servicing rights and certain other investment securities. These nonrecurring fair value adjustments typically involve lower of cost or fair value accounting, or write-downs of individual assets.
 
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Depending on the nature of the asset or liability, the Company uses various valuation techniques and assumptions when estimating fair value. For accounting disclosure purposes, a three-level valuation hierarchy of fair value measurements has been established. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:
 
  •  Level 1 – inputs to the valuation methodology are quoted prices for identical assets or liabilities in active markets.
 
  •  Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and inputs that are observable for the assets or liabilities, either directly or indirectly (such as interest rates, yield curves, and prepayment speeds).
 
  •  Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value. These may be internally developed, using the Company’s best information and assumptions that a market participant would consider.
 
When determining the fair value measurements for assets and liabilities required or permitted to be recorded or disclosed at fair value, the Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability. When possible, the Company looks to active and observable markets to price identical assets or liabilities. When identical assets and liabilities are not traded in active markets, the Company looks to observable market data for similar assets and liabilities. Nevertheless, certain assets and liabilities are not actively traded in observable markets and the Company must use alternative valuation techniques to derive an estimated fair value measurement.
 
Valuation methods for instruments measured at fair value on a recurring basis
 
Following is a description of the Company’s valuation methodologies used for instruments measured at fair value on a recurring basis:
 
 
For available for sale securities, changes in fair value, including that portion of other-than-temporary impairment unrelated to credit loss, are recorded in other comprehensive income. As mentioned in Note 3 on Investment Securities, the Company records the credit-related portion of other-than-temporary impairment in current earnings. This portfolio comprises the majority of the assets which the Company records at fair value. Most of the portfolio, which includes government-sponsored enterprise, mortgage-backed and asset-backed securities, are priced utilizing industry-standard models that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace. These measurements are classified as Level 2 in the fair value hierarchy. Where quoted prices are available in an active market, the measurements are classified as Level 1. Most of the Level 1 measurements apply to common stock and U.S. Treasury obligations.
 
Valuation methods and inputs, by class of security:
 
  •  U.S. government and federal agency obligations
U.S. treasury bills, bonds and notes, including TIPS, are valued using live data from active market


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  makers and inter-dealer brokers. Valuations for stripped coupon and principal issues are derived from yield curves generated from various dealer contacts and live data sources.
 
  •  Government-sponsored enterprise obligations
Government-sponsored enterprise obligations are evaluated using cash flow valuation models. Inputs used are live market data, cash settlements, Treasury market yields, and floating rate indices such as LIBOR, CMT, and Prime.
 
  •  State and municipal obligations, excluding auction rate securities
A yield curve is generated and applied to bond sectors, and individual bond valuations are extrapolated. Inputs used to generate the yield curve are bellwether issue levels, established trading spreads between similar issuers or credits, historical trading spreads over widely accepted market benchmarks, new issue scales, and verified bid information. Bid information is verified by corroborating the data against external sources such as broker-dealers, trustees/paying agents, issuers, or non-affiliated bondholders.
 
  •  Mortgage and asset-backed securities
Collateralized mortgage obligations and other asset-backed securities are valued at the tranche level. For each tranche valuation, the process generates predicted cash flows for the tranche, applies a market based (or benchmark) yield/spread for each tranche, and incorporates deal collateral performance and tranche level attributes to determine tranche-specific spreads to adjust the benchmark yield. Tranche cash flows are generated from new deal files and prepayment/default assumptions. Tranche spreads are based on tranche characteristics such as average life, type, volatility, ratings, underlying collateral and performance, and prevailing market conditions. The appropriate tranche spread is applied to the corresponding benchmark, and the resulting value is used to discount the cash flows to generate an evaluated price.
 
Valuation of agency pass-through securities, typically issued under GNMA, FNMA, FHLMC, and SBA programs, are primarily derived from information from the To Be Announced (TBA) market. This market consists of generic mortgage pools which have not been received for settlement. Snapshots of the TBA market, using live data feeds distributed by multiple electronic platforms, and in conjunction with other indices, are used to compute a price based on discounted cash flow models.
 
  •  Other debt securities
Other debt securities are valued using active markets and inter-dealer brokers as well as bullet spread scales and option adjusted spreads. The spreads and models use yield curves, terms and conditions of the bonds, and any special features (i.e., call or put options, redemption features, etc.).
 
  •  Equity securities
Equity securities are priced using the market prices for each security from the major stock exchanges or other electronic quotation systems. These are generally classified as Level 1 measurements. Stocks which trade infrequently are classified as Level 2.
 
At June 30, 2011, the Company held certain auction rate securities (ARS) in its available for sale portfolio, totaling $141.9 million. The auction process by which the ARS are normally priced has not functioned since 2008, and the fair value of these securities cannot be based on observable market prices due to the illiquidity in the market. The fair values of the ARS are estimated using a discounted cash flows analysis. Estimated cash flows are based on mandatory interest rates paid under failing auctions and projected over an estimated market recovery period. The cash flows are discounted at an estimated market rate reflecting adjustments for liquidity premium and nonperformance risk. Because many of the inputs significant to the measurement are not observable, these measurements are classified as Level 3 measurements.
 
 
The securities in the Company’s trading portfolio are priced by averaging several broker quotes for similar instruments, and are classified as Level 2 measurements.


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These securities are held by the Company’s venture capital subsidiaries and are included in non-marketable investment securities in the consolidated balance sheets. Valuation of these nonpublic investments requires significant management judgment due to the absence of quoted market prices. Each quarter, valuations are performed utilizing available market data and other factors. Market data includes published trading multiples for private equity investments of similar size. The multiples are considered in conjunction with current operating performance, future expectations, financing and sales transactions, and other investment-specific issues. The Company applies its valuation methodology consistently from period to period, and believes that its methodology is similar to that used by other market participants. These fair value measurements are classified as Level 3.
 
 
The Company’s derivative instruments include interest rate swaps, foreign exchange forward contracts, commitments and sales contracts related to personal mortgage loan origination activity, and certain credit risk guarantee agreements. When appropriate, the impact of credit standing as well as any potential credit enhancements, such as collateral, has been considered in the fair value measurement.
 
  •  Valuations for interest rate swaps are derived from proprietary models whose significant inputs are readily observable market parameters, primarily yield curves. The results of the models are constantly validated through comparison to active trading in the marketplace. These fair value measurements are classified as Level 2.
 
  •  Fair value measurements for foreign exchange contracts are derived from a model whose primary inputs are quotations from global market makers, and are classified as Level 2.
 
  •  The fair values of mortgage loan commitments and forward sales contracts on the associated loans are based on quoted prices for similar loans in the secondary market. However, these prices are adjusted by a factor which considers the likelihood that a commitment will ultimately result in a closed loan. This estimate is based on the Company’s historical data and its judgment about future economic trends. Based on the unobservable nature of this adjustment, these measurements are classified as Level 3.
 
  •  The Company’s contracts related to credit risk guarantees are valued under a proprietary model which uses significant unobservable inputs and assumptions about the creditworthiness of the counterparty to the guaranteed interest rate swap contract. Consequently, these measurements are classified as Level 3.
 
Assets held in trust
 
Assets held in an outside trust for the Company’s deferred compensation plan consist of investments in mutual funds. The fair value measurements are based on quoted prices in active markets and classified as Level 1. The Company has recorded an asset representing the total investment amount. The Company has also recorded a corresponding nonfinancial liability, representing the Company’s liability to the plan participants.


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The table below presents the June 30, 2011 and December 31, 2010 carrying values of assets and liabilities measured at fair value on a recurring basis. There were no transfers among levels during the first six months of 2011 or the twelve months ended December 31, 2010.
 
                                 
   
          Fair Value Measurements Using  
          Quoted
             
          Prices in
             
          Active
             
          Markets
    Significant
       
          for
    Other
    Significant
 
          Identical
    Observable
    Unobservable
 
    Total Fair
    Assets
    Inputs
    Inputs
 
(In thousands)   Value     (Level 1)     (Level 2)     (Level 3)  
   
 
June 30, 2011
                               
Assets:
                               
Available for sale securities:
                               
U.S. government and federal agency obligations
  $ 356,246     $ 348,751     $ 7,495     $  
Government-sponsored enterprise obligations
    264,553             264,553        
State and municipal obligations
    1,193,561             1,051,621       141,940  
Agency mortgage-backed securities
    2,913,805             2,913,805        
Non-agency mortgage-backed securities
    385,937             385,937        
Other asset-backed securities
    2,394,627             2,394,627        
Other debt securities
    168,859             168,859        
Equity securities
    40,046