UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the Fiscal Year Ended December 31, 2008 — Commission File No. 0-2989

 

COMMERCE BANCSHARES, INC.

 

(Exact name of registrant as specified in its charter)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

 

NONE

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

 

Yes þ  No o

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.

 

Yes o  No þ

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  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):

 

 

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 June 30, 2008, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $2,352,000,000.

 

As of February 11, 2009, there were 75,911,939 shares of Registrant’s $5 Par Value Common Stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

 

Portions of the Registrant’s definitive proxy statement for its 2009 annual meeting of shareholders, which will be filed within 120 days of December 31, 2008, are incorporated by reference into Part III of this Report.

 

 

Commerce Bancshares, Inc.

 

Form 10-K

 

 

 

General

 

Commerce Bancshares, Inc. (the “Company”), a bank holding company as defined in the Bank Holding Company Act of 1956, as amended, was incorporated under the laws of Missouri on August 4, 1966. The Company presently owns all of the outstanding capital stock of one national banking association, which is headquartered in Missouri (the “Bank”). During 2008, two former banking subsidiaries, located in Kansas and Nebraska, were merged into the Bank. The Bank engages in general banking business, providing a broad range of retail, corporate, investment, trust, and asset management products and services to individuals and businesses. The Company also owns, directly or through the Bank, various non-banking subsidiaries. Their activities include underwriting credit life and credit accident and health insurance, selling property and casualty insurance (relating to consumer loans made by the Bank), venture capital investment, securities brokerage, mortgage banking, and leasing activities. The Company owns a second tier holding company that is the direct owner of the Bank. A list of the Company’s subsidiaries is included as Exhibit 21.

 

The Company is one of the nation’s top 50 bank holding companies, based on asset size. At December 31, 2008, the Company had consolidated assets of $17.5 billion, loans of $11.6 billion, deposits of $12.9 billion, and stockholders’ equity of $1.6 billion. All of the Company’s operations conducted by subsidiaries are consolidated for purposes of preparing the Company’s consolidated financial statements. The Company does not utilize unconsolidated subsidiaries or special purpose entities to provide off-balance sheet borrowings or securitizations.

 

The Company’s goal is to be the preferred provider of targeted financial services in its communities, based on strong customer relationships. It believes in building long-term relationships based on top quality service, high ethical standards and safe, sound assets. The Company operates under a super-community banking format with a local orientation, augmented by experienced, centralized support in select critical areas. The Company’s local market orientation is reflected in its financial centers and regional advisory boards, which are comprised of local business persons, professionals and other community representatives, that assist the Company in responding to local banking needs. In addition to this local market, community-based focus, the Company offers sophisticated financial products available at much larger financial institutions.

 

The Bank’s facilities are located throughout Missouri, Kansas, and central Illinois, and it entered markets in Tulsa, Oklahoma and Denver, Colorado during 2007. Its two largest markets include St. Louis and Kansas City, which serve as the central hubs for the entire company.

 

The markets the Bank serves, being located in the lower Midwest, provide natural sites for production and distribution facilities and also serve as transportation hubs. The economy has been well-diversified in these markets with many major industries represented, including telecommunications, automobile, aircraft and general manufacturing, health care, numerous service industries, food production, and agricultural production and related industries. In addition, several of the Illinois markets are located in areas with some of the most productive farmland in the world. The real estate operations of the Bank are centered in its lower Midwestern markets. Historically, these markets have generally tended to be less volatile than in other parts of the country. While a declining national real estate market has resulted in significantly higher real estate loan losses in 2008 for the banking industry, the Bank has avoided much of the market deterioration seen in other areas of the country.

 

The Company regularly evaluates the potential acquisition of, and holds discussions with, various financial institutions eligible for bank holding company ownership or control. In addition, the Company regularly considers the potential disposition of certain of its assets and branches. The Company seeks merger or acquisition partners that are culturally similar and have experienced management and possess either significant market presence or have potential for improved profitability through financial management, economies of scale and expanded services. During 2007 the Company completed two acquisitions; acquiring the outstanding stock of South Tulsa Financial Corporation, located in Tulsa, Oklahoma, and Commerce

Bank, located in Denver, Colorado. The Company also completed two acquisitions in 2006; a purchase and assumption transaction with Boone National Savings and Loan Association in Columbia, Missouri, and the acquisition of the outstanding stock of West Pointe Bancorp, Inc. in Belleville, Illinois. For additional information on acquisition and branch disposition activity, refer to pages 18 and 71.

 

Operating Segments

 

The Company is managed in three operating segments. The Consumer segment includes the retail branch network, consumer installment lending, personal mortgage banking, bank card activities, student lending, and discount brokerage services. It provides services through a network of 217 full-service branches, a widespread ATM network of 404 machines, and the use of alternative delivery channels such as extensive online banking and telephone banking services. In 2008 this retail segment contributed 52% of total segment pre-tax income. The Commercial segment provides a full array of corporate lending, leasing, and international services, as well as business and government deposit and cash management services. In 2008 it contributed 46% of total segment pre-tax income. The Money Management segment provides traditional trust and estate tax planning services, and advisory and discretionary investment portfolio management services to both personal and institutional corporate customers. This segment also manages the Company’s family of proprietary mutual funds, which are available for sale to both trust and general retail customers. Fixed income investments are sold to individuals and institutional investors through the Capital Markets group, which is also included in this segment. At December 31, 2008 the Money Management segment managed investments with a market value of $10.9 billion and administered an additional $8.5 billion in non-managed assets. Additional information relating to operating segments can be found on pages 48 and 94.

 

Supervision and Regulation

 

General

 

The Company, as a bank holding company, is primarily regulated by the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956 (BHC Act). Under the BHC Act, the Federal Reserve Board’s prior approval is required in any case in which the Company proposes to acquire all or substantially all of the assets of any bank, acquire direct or indirect ownership or control of more than 5% of the voting shares of any bank, or merge or consolidate with any other bank holding company. The BHC Act also prohibits, with certain exceptions, the Company from acquiring direct or indirect ownership or control of more than 5% of any class of voting shares of any non-banking company. Under the BHC Act, the Company may not engage in any business other than managing and controlling banks or furnishing certain specified services to subsidiaries and may not acquire voting control of non-banking companies unless the Federal Reserve Board determines such businesses and services to be closely related to banking. When reviewing bank acquisition applications for approval, the Federal Reserve Board considers, among other things, the Bank’s record in meeting the credit needs of the communities it serves in accordance with the Community Reinvestment Act of 1977, as amended (CRA). The Bank has a current CRA rating of “outstanding”.

 

The Company is required to file with the Federal Reserve Board various reports and such additional information as the Federal Reserve Board may require. The Federal Reserve Board also makes regular examinations of the Company and its subsidiaries. The Company’s banking subsidiary is organized as a national banking association and is subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (OCC). The Bank is also subject to regulation by the Federal Deposit Insurance Corporation (FDIC). In addition, there are numerous other federal and state laws and regulations which control the activities of the Company and the Bank, including requirements and limitations relating to capital and reserve requirements, permissible investments and lines of business, transactions with affiliates, loan limits, mergers and acquisitions, issuance of securities, dividend payments, and extensions of credit. If the Company fails to comply with these or other applicable laws and regulations, it may be subject to civil monetary penalties, imposition of cease and desist orders or other written directives, removal of management and, in certain circumstances, criminal penalties. This regulatory framework is intended primarily for the protection of depositors and the preservation of the federal deposit insurance funds, and not for the protection

of security holders. Statutory and regulatory controls increase a bank holding company’s cost of doing business and limit the options of its management to employ assets and maximize income.

 

In addition to its regulatory powers, the Federal Reserve Bank impacts the conditions under which the Company operates by its influence over the national supply of bank credit. The Federal Reserve Board employs open market operations in U.S. government securities, changes in the discount rate on bank borrowings, changes in the federal funds rate on overnight inter-bank borrowings, and changes in reserve requirements on bank deposits in implementing its monetary policy objectives. These instruments are used in varying combinations to influence the overall level of the interest rates charged on loans and paid for deposits, the price of the dollar in foreign exchange markets and the level of inflation. The monetary policies of the Federal Reserve have a significant effect on the operating results of financial institutions, most notably on the interest rate environment. In view of changing conditions in the national economy and in the money markets, as well as the effect of credit policies of monetary and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels or loan demand, or their effect on the financial statements of the Company.

 

Subsidiary Bank

 

Under Federal Reserve policy, the Company is expected to act as a source of financial strength to its bank subsidiary and to commit resources to support it in circumstances when it might not otherwise do so. In addition, any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.

 

Substantially all of the deposits of the Bank are insured up to the applicable limits by the Bank Insurance Fund of the FDIC. Until recently these limits were $100,000 per insured depositor and $250,000 for retirement accounts. The Emergency Economic Stabilization Act of 2008 (discussed further under “Legislation”) temporarily increased the general depositor limit from $100,000 to $250,000, through December 31, 2009. The Bank also participates in the FDIC’s Transaction Account Guarantee Program. Under that program, through December 31, 2009, all non-interest bearing transaction accounts are fully guaranteed by the FDIC for the entire amount of the account. Coverage under this program is in addition to and separate from the coverage available under the FDIC’s general deposit insurance rules. The Bank pays deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC for Bank Insurance Fund member institutions. The FDIC has established a risk-based assessment system under which institutions are classified and pay premiums according to their perceived risk to the federal deposit insurance funds. The Bank’s premiums have been relatively low in recent years. However, the Bank expects premiums to rise to approximately $15.6 million in 2009, as the FDIC replenishes the deposit insurance fund in the wake of recent bank failures and expectations of future failures.

 

Payment of Dividends

 

The principal source of the Company’s cash revenues is dividends paid by the Bank. The Federal Reserve Board may prohibit the payment of dividends by bank holding companies if their actions constitute unsafe or unsound practices. The OCC limits the payment of dividends by the Bank in any calendar year to the net profit of the current year combined with the retained net profits of the preceding two years. Permission must be obtained from the OCC for dividends exceeding these amounts. The payment of dividends by the Bank may also be affected by factors such as the maintenance of adequate capital.

 

Capital Adequacy

 

The Company is required to comply with the capital adequacy standards established by the Federal Reserve. These capital adequacy guidelines generally require bank holding companies to maintain minimum total capital equal to 8% of total risk-adjusted assets and off-balance sheet items (the “Total Risk-Based Capital Ratio”), with at least one-half of that amount consisting of Tier I, or core capital, and the remaining

amount consisting of Tier II, or supplementary capital. Tier I capital for bank holding companies generally consists of the sum of common shareholders’ equity, qualifying non-cumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill and other non-qualifying intangible assets. Tier II capital generally consists of hybrid capital instruments, term subordinated debt and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics.

 

In addition, the Federal Reserve also requires bank holding companies to comply with minimum leverage ratio requirements. The leverage ratio is the ratio of a banking organization’s Tier I capital to its total consolidated quarterly average assets (as defined for regulatory purposes), net of the allowance for loan losses, goodwill and certain other intangible assets. The minimum leverage ratio for bank holding companies is 4%. At December 31, 2008 the Bank was “well-capitalized” under regulatory capital adequacy standards, as further discussed on page 97.

 

Legislation

 

These laws and regulations are under constant review by various agencies and legislatures, and are subject to sweeping change. The Gramm-Leach-Bliley Financial Modernization Act of 1999 (GLB Act) contained major changes in laws that previously kept the banking industry largely separate from the securities and insurance industries. The GLB Act authorized the creation of a new kind of financial institution, known as a “financial holding company” and a new kind of bank subsidiary called a “financial subsidiary”, which may engage in a broader range of investment banking, insurance agency, brokerage, and underwriting activities. The GLB Act also included privacy provisions that limit banks’ abilities to disclose non-public information about customers to non-affiliated entities. Banking organizations are not required to become financial holding companies, but instead may continue to operate as bank holding companies, providing the same services they were authorized to provide prior to the enactment of the GLB Act.

 

The Company must also comply with the requirements of the Bank Secrecy Act (BSA). The BSA is designed to help fight drug trafficking, money laundering, and other crimes. Compliance is monitored by the OCC. The BSA was enacted to prevent banks and other financial service providers from being used as intermediaries for, or to hide the transfer or deposit of money derived from, criminal activity. Since its passage, the BSA has been amended several times. These amendments include the Money Laundering Control Act of 1986 which made money laundering a criminal act, as well as the Money Laundering Suppression Act of 1994 which required regulators to develop enhanced examination procedures and increased examiner training to improve the identification of money laundering schemes in financial institutions.

 

In 2001, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA Patriot Act) was signed into law. The USA Patriot Act substantially broadened the scope of U.S. anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The U.S. Treasury department issued a number of regulations implementing the USA Patriot Act that apply certain of its requirements to financial institutions such as the Company’s broker-dealer subsidiary. The regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing.

 

In October 2008, the Emergency Economic Stabilization Act of 2008 was enacted in response to a global financial crisis spurred by frozen credit markets, institution failures and loss of investor confidence. Under the Act, the Troubled Asset Relief Program (TARP) was created, which authorizes the U.S. Treasury department to spend up to $700 billion to purchase distressed assets and make capital injections into banks. The stated goal of TARP is to improve the liquidity of targeted illiquid, difficult-to-value assets by purchasing them from banks and other financial institutions. Another important goal of TARP is to encourage banks to resume lending again at levels seen before the crisis, loosening credit and improving the market order and investor confidence. The first $350 billion of TARP funds were primarily used to buy preferred stock and warrants of bank applicants. The Company studied the program and made a business decision not to apply

for funds under the TARP, believing its earnings, capital and liquidity were strong and sufficient to grow its business in the current challenging banking environment.

 

As mentioned earlier, the Company has chosen to participate in the FDIC’s Temporary Liquidity Guarantee Program. Under this program, the Company may in future issue senior unsecured debt whose principal and interest payments would be guaranteed by the FDIC. All newly issued debt must be issued on or before June 30, 2009 to be covered. The expiration date of the FDIC’s guarantee is the earlier of the maturity date of the debt or June 30, 2012. The Company has not issued debt under the program. Its debt guarantee limit is 2% of consolidated total liabilities, or approximately $300 million.

 

Competition

 

The Company’s locations in regional markets throughout Missouri, Kansas, central Illinois, Tulsa, Oklahoma, and Denver, Colorado, face intense competition from hundreds of financial service providers. The Company competes with national and state banks for deposits, loans and trust accounts, and with savings and loan associations and credit unions for deposits and consumer lending products. In addition, the Company competes with other financial intermediaries such as securities brokers and dealers, personal loan companies, insurance companies, finance companies, and certain governmental agencies. The passage of the GLB Act, which removed barriers between banking and the securities and insurance industries, has resulted in greater competition among these industries. The Company generally competes on the basis of customer services and responsiveness to customer needs, interest rates on loans and deposits, lending limits and customer convenience, such as location of offices.

 

Employees

 

The Company and its subsidiaries employed 4,666 persons on a full-time basis and 674 persons on a part-time basis at December 31, 2008. The Company provides a variety of benefit programs including a 401K plan as well as group life, health, accident, and other insurance. The Company also maintains training and educational programs designed to prepare employees for positions of increasing responsibility.

 

Available Information

 

The Company’s principal offices are located at 1000 Walnut, Kansas City, Missouri (telephone number 816-234-2000). The Company makes available free of charge, through its web site at www.commercebank.com, reports filed with the Securities and Exchange Commission as soon as reasonably practicable after the electronic filing. These filings include the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports.

 

Statistical Disclosure

 

The information required by Securities Act Guide 3 — “Statistical Disclosure by Bank Holding Companies” is located on the pages noted below.

 

 

Making or continuing an investment in securities issued by Commerce Bancshares, Inc., including its common stock, involves certain risks that you should carefully consider. The risks and uncertainties described below are not the only risks that may have a material adverse effect on the Company. Additional risks and uncertainties also could adversely affect its business and financial results. If any of the following risks actually occur, its business, financial condition or results of operations could be negatively affected, the market price for your securities could decline, and you could lose all or a part of your investment. Further, to the extent that any of the information contained in this Annual Report on Form 10-K constitutes forward-looking statements, the risk factors set forth below also are cautionary statements identifying important factors that could cause the Company’s actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of Commerce Bancshares, Inc.

 

Difficult market conditions have adversely affected the Company’s industry and may continue to do so.

 

Given the concentration of the Company’s banking business in the United States, it is particularly exposed to downturns in the U.S. economy. Recent dramatic declines in the housing market, falling home prices, increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities, as well as major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to other complex financial instruments and various classes of loans, in turn, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased to provide funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets has adversely affected our business, financial condition and results of operations. Management does not expect that the difficult conditions in the financial markets are likely to improve in the near future and could likely worsen, further negatively affecting the Company’s financial results. In particular, the Company may face the following risks in connection with these events:

 

 

 

The performance of the Company is dependent on the economic conditions of the markets in which the Company operates.

 

The Company’s success is heavily influenced by the general economic conditions of the specific markets in which it operates. Unlike larger national or other regional banks that are more geographically diversified, the Company provides financial services primarily throughout the states of Missouri, Kansas, and central Illinois, and has recently begun to expand into Oklahoma, Colorado and other surrounding states. Since the Company does not have significant presence in other parts of the country, a prolonged economic downturn in these markets could have a material adverse effect on the Company’s financial condition and results of operations.

 

The soundness of other financial institutions could adversely affect the Company.

 

The Company’s ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. The Company has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual funds, and other institutional clients. Transactions with these institutions include overnight and term borrowings, interest rate swap agreements, securities purchased and sold, short-term investments, and other such transactions. As a result of this exposure, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by the Company or by other institutions. Many of these transactions expose the Company to credit risk in the event of default of its counterparty or client, while other transactions expose the Company to liquidity risks should funding sources quickly disappear. In addition, the Company’s credit risk may be exacerbated when the collateral held cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to the Company. There is no assurance that any such losses would not materially and adversely affect results of operations.

 

Liquidity is essential to the Company’s businesses and it relies on the securities market and other external sources to finance a significant portion of its operations.

 

Liquidity affects the Company’s ability to meet its financial commitments. The Company’s main source of funding comes from customer deposits, which comprise 82% of its total funding at December 31, 2008. The Company’s other funding sources include the Federal Home Loan Bank and other wholesale providers. Its liquidity could be negatively affected if these funding sources diminish or cease to be available. Factors that the Company cannot control, such as disruption of the financial markets or negative views about the general financial services industry could impair its ability to raise or maintain funding. If it is unable to raise funding, it would likely need to sell assets, such as its investment and trading portfolios, to meet maturing liabilities. The Company may be unable to sell some of its assets on a timely basis, or it may have to sell assets at a discount from market value, either of which could adversely affect results of operations. The Company’s liquidity and funding policies have been designed to ensure that it maintains sufficient liquid financial resources to continue to conduct its business for an extended period in a stressed liquidity environment. If its liquidity and funding policies are not adequate, it may be unable to access sufficient financing to service its financial obligations when they come due, which could have a material adverse franchise or business impact. See “Liquidity and Capital Resources” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this report for a discussion of how the Company monitors and manages liquidity risk.

The Company’s asset valuation may include methodologies, estimations and assumptions which are subject to differing interpretations and could result in changes to asset valuations that may materially adversely affect its results of operations or financial condition.

 

The Company uses estimates, assumptions, and judgments when financial assets and liabilities are measured and reported at fair value. Assets and liabilities carried at fair value inherently result in a higher degree of financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices and/or other observable inputs provided by independent third-party sources, when available. When such third-party information is not available, fair value is estimated primarily by using cash flow and other financial modeling techniques utilizing assumptions such as credit quality, liquidity, interest rates and other relevant inputs. Changes in underlying factors, assumptions, or estimates in any of these areas could materially impact the Company’s future financial condition and results of operations.

 

During periods of market disruption, including periods of significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, it may be difficult to value certain assets if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the current financial environment. In such cases, certain asset valuations may require more subjectivity and management judgment. As such, valuations may include inputs and assumptions that are less observable or require greater estimation. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of assets as reported within our consolidated financial statements and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on results of operations or financial condition.

 

Valuation methodologies which are particularly susceptible to the conditions mentioned above include those used to value certain securities in the Company’s available for sale investment portfolio such as auction rate securities and non-agency mortgage and asset-backed securities, in addition to non-marketable private equity securities, loans held for sale and intangible assets.

 

The Company’s investment portfolio values may be adversely impacted by changing interest rates and deterioration in the credit quality of underlying collateral within mortgage and other asset-backed investment securities.

 

The Company generally invests in securities issued by government-backed agencies or privately issued securities that are highly rated by credit rating agencies at the time of purchase, but are subject to changes in market value due to changing interest rates and implied credit spreads. Certain mortgage and asset-backed securities represent beneficial interests which are collateralized by residential mortgages, credit cards, automobiles, mobile homes or other assets. While these investment securities are highly rated at the time of initial investment, the value of these securities may decline significantly due to actual or expected deterioration in the underlying collateral, especially residential mortgage collateral. Recent market conditions have seen deterioration in fair values for certain types of non-guaranteed mortgage-backed securities. Furthermore, under impairment accounting rules, securities that are determined to have some level of other-than-temporary impairment due to declining expected cash flows, etc., are required to be adjusted to fair value through current earnings, which could result in significant non-cash losses beyond calculated impairments.

 

The Company is subject to interest rate risk.

 

The Company’s net interest income is the largest source of overall revenue to the Company, representing 61% of total revenue. Interest rates are beyond the Company’s control, and they fluctuate in response to general economic conditions and the policies of various governmental and regulatory agencies, in particular, the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, will influence the origination of loans, the purchase of investments, the generation of deposits, and the rates received on loans and investment securities and paid on deposits. Management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on the

Company’s results of operations. However, any substantial, prolonged change in market interest rates could have a material adverse effect on the Company’s financial condition and results of operations.

 

Future loan losses could increase.

 

The Company maintains an allowance for loan losses that represents management’s best estimate of probable losses that have been incurred at the balance sheet date within the existing portfolio of loans. The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The Company has seen significant increases in losses in its loan portfolio, particularly in residential construction, consumer, and credit card loans, due to the deterioration in the housing industry and general economic conditions. Until the housing sector and overall economy begin to recover, it is likely that these losses will continue. While the Company’s credit loss ratios remain below industry averages, continued economic deterioration and further loan losses may negatively affect its results of operations and could further increase levels of its allowance. In addition, the Company’s allowance level is subject to review by regulatory agencies, that could require adjustments to the allowance. See the section captioned “Allowance for Loan Losses” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this report for further discussion related to the Company’s process for determining the appropriate level of the allowance for possible loan loss.

 

The Company operates in a highly competitive industry and market area.

 

The Company operates in the financial services industry, a rapidly changing environment having numerous competitors including other banks and insurance companies, securities dealers, brokers, trust and investment companies and mortgage bankers. The pace of consolidation among financial service providers is accelerating and there are many new changes in technology, product offerings and regulation. New entrants offering competitive products continually penetrate our markets. The Company must continue to make investments in its products and delivery systems to stay competitive with the industry as a whole or its financial performance may suffer.

 

The Company’s reputation and future growth prospects could be impaired if events occurred which breached our customers’ privacy.

 

The Company relies heavily on communications and information systems to conduct its business, and as part of our business we maintain significant amounts of data about our customers and the products they use. While the Company has policies and procedures designed to prevent or limit the effect of failure, interruption or security breach of its information systems, there can be no assurances that any such failures, interruptions or security breaches will not occur, or if they do occur, that they will be adequately addressed. Should any of these systems become compromised, the reputation of the Company could be damaged, relationships with existing customers impaired and result in lost business and incur significant expenses trying to remedy the compromise.

 

The Company may not attract and retain skilled employees.

 

The Company’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities engaged in by the Company can be intense, and the Company spends considerable time and resources attracting and hiring qualified people for its various business lines and support units. The unexpected loss of the services of one or more of the Company’s key personnel could have a material adverse impact on the Company’s business because of their skills, knowledge of the Company’s market, years of industry experience, and the difficulty of promptly finding qualified replacement personnel.

 

 

None

 

 

The main offices of the Bank are located in the larger metropolitan areas of its markets in various multi-story office buildings. The Bank owns its main offices and leases unoccupied premises to the public. The larger offices include:

 

 

The Bank leases offices in Omaha, Nebraska which house its credit card operations. Additionally, certain other installment loan, trust and safe deposit functions operate out of leased offices in downtown Kansas City. The Company has an additional 211 branch locations in Missouri, Illinois, Kansas, Oklahoma and Colorado which are owned or leased, and 151 off-site ATM locations.

 

 

The information required by this item is set forth in Item 8 under Note 19, Commitments, Contingencies and Guarantees on page 107.

 

 

No matters were submitted during the fourth quarter of 2008 to a vote of security holders through the solicitation of proxies or otherwise.

 

Executive Officers of the Registrant

 

The following are the executive officers of the Company, each of whom is designated annually, and there are no arrangements or understandings between any of the persons so named and any other person pursuant to which such person was designated an executive officer.

 

 

 

Commerce Bancshares, Inc.

Common Stock Data

 

The following table sets forth the high and low prices of actual transactions for the Company’s common stock and cash dividends paid for the periods indicated (restated for the 5% stock dividend distributed in December 2008).

 

 

Commerce Bancshares, Inc. common shares are listed on the Nasdaq Global Select Market under the symbol CBSH. The Company had 4,512 shareholders of record as of December 31, 2008.

 

The following table sets forth information about the Company’s purchases of its $5 par value common stock, its only class of stock registered pursuant to Section 12 of the Exchange Act, during the fourth quarter of 2008. This information has not been restated for the 5% stock dividend in December 2008.

 

 

The Company’s stock purchases shown above were made under a 3,000,000 share authorization by the Board of Directors on February 1, 2008. Under this authorization, 2,877,552 shares remained available for purchase at December 31, 2008.

Performance Graph

 

The following graph presents a comparison of Company (CBSH) performance to the indices named below. It assumes $100 invested on December 31, 2003 with dividends invested on a Total Return basis.

 

 

 

The required information is set forth below in Item 7.

 

 

Overview

 

Commerce Bancshares, Inc. (the Company) operates as a super-community bank offering an array of sophisticated financial products delivered with high-quality, personal customer service. It is the largest bank holding company headquartered in Missouri, with its principal offices in Kansas City and St. Louis, Missouri. Customers are served from approximately 360 locations in Missouri, Kansas, Illinois, Oklahoma and Colorado using delivery platforms which include an extensive network of branches and ATM machines, full-featured online banking, and a central contact center.

The core of the Company’s competitive advantage is its focus on the local markets it services and its concentration on relationship banking, with high service levels and competitive products. In order to enhance shareholder value, the Company grows its core revenue by expanding new and existing customer relationships, utilizing improved technology, and enhancing customer satisfaction.

 

Various indicators are used by management in evaluating the Company’s financial condition and operating performance. Among these indicators are the following:

 

 

The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes. The historical trends reflected in the financial information presented below are not necessarily reflective of anticipated future results.

 

Key Ratios

 

 

Selected Financial Data

 

 

Results of Operations

 

 

For the year ended December 31, 2008, net income amounted to $188.7 million, a decrease of $18.0 million, or 8.7%, compared to $206.7 million in 2007. The decline in net income was mainly the result of an increase in the provision for loan losses of $66.2 million coupled with a 7.2% increase in non-interest expense, but partly offset by increases in net interest income, investment securities gains and non-interest income. Net interest income increased $54.7 million, or 10.2%, in 2008 compared to 2007, mainly as a result of growth in loans and investment securities, coupled with a large reduction in rates paid on interest bearing liabilities. These effects were partly offset by lower loan yields and higher borrowings. In 2008, net investment securities gains totaled $30.3 million compared to $8.2 million in 2007. Gains in 2008 included a $22.2 million gain on the redemption of Visa, Inc. (Visa) stock and a gain of $7.9 million on the sale of certain auction rate securities (ARS), further described in the Investment Securities Gains section of this discussion.

 

Non-interest income totaled $375.7 million in 2008, an increase of $4.1 million, or 1.1%, over amounts reported in the previous year and included a $9.4 million impairment charge on certain loans held for sale. Non-interest expense totaled $616.1 million, an increase of $41.4 million, or 7.2%, over 2007. Included in non-interest expense was a non-cash loss of $33.3 million as a result of the Company’s purchase of ARS from its customers in the third quarter of 2008. Non-interest expense also included a $9.6 million reduction in an

indemnification obligation for the Company’s share of certain Visa litigation costs, which is discussed further in the Non-Interest Expense section of this discussion. The provision for loan losses totaled $108.9 million in 2008, an increase of $66.2 million, and reflected higher net loan charge-offs, mainly in consumer and consumer credit card loans, and the need to increase loan loss reserves to address inherent risk in the loan portfolio. Income tax expense declined 9.2% in 2008 and resulted in an effective tax rate of 31.1%, which was slightly lower than the effective tax rate of 31.2% in the previous year. The decrease in income tax expense in 2008 compared to 2007 was mainly due to lower pre-tax earnings.

 

For the year ended December 31, 2007, net income amounted to $206.7 million, a decrease of $13.2 million, or 6.0%, from 2006. Net income in 2007 included a pre-tax charge of $21.0 million recorded in the fourth quarter, related to the Company’s share of certain Visa litigation costs. Exclusive of this item, net income in 2007 amounted to $219.9 million, virtually the same as in 2006. Net interest income increased $24.9 million, or 4.8%, reflecting growth in average loan balances and higher average overall rates earned on loans and investment securities, partly offset by declining average balances in investment securities. Countering these effects was a rise in interest expense on deposit accounts and short-term borrowings, resulting from increases in interest rates on virtually all deposit accounts, coupled with growth in certificate of deposit balances and higher average short-term borrowings. Non-interest income rose $19.0 million, or 5.4%, largely due to increases of 9.1% in bank card fees, 1.6% in deposit account fees, and 9.2% in trust revenues. Exclusive of the Visa charge, non-interest expense grew $28.4 million, or 5.4%, which was mainly the result of a 7.1% increase in salaries and benefits. The provision for loan losses increased $17.1 million to $42.7 million, reflecting higher incurred losses in nearly all loan categories, with the largest increases in business, consumer, and consumer credit card loans. Income tax expense declined 9.8% in 2007 and resulted in an effective tax rate of 31.2%, compared to an effective tax rate of 32.1% in the prior year. The decrease in income tax expense in 2007 occurred mainly due to the change in the mix of taxable and non-taxable income.

 

The Company acquired two banking franchises during 2007. In April 2007, the Company acquired South Tulsa Financial Corporation. In this transaction, the Company acquired the outstanding stock of South Tulsa and issued shares of Company stock valued at $27.6 million. The Company’s acquisition of South Tulsa added two branch locations in Tulsa, Oklahoma. In July 2007, the Company acquired Commerce Bank in Denver, Colorado. In this transaction, the Company acquired all of the outstanding stock of Commerce Bank for $29.5 million in cash. The acquisition added the Company’s first location in Colorado.

 

During 2006, the Company also acquired two banks. The first acquisition was in July 2006, when the Company, through a bank subsidiary, acquired certain assets and assumed certain liabilities of Boone National Savings and Loan Association in a purchase and assumption agreement for cash of $19.1 million. Boone operated four branches in central Missouri. In September 2006, the Company acquired the outstanding stock of West Pointe Bancorp, Inc. in Belleville, Illinois, which operated five branch locations in the greater St. Louis area. The total purchase price of $80.5 million consisted of cash of $13.1 million and shares of Company stock valued at $67.5 million.

 

The transactions discussed above are collectively referred to as “bank acquisitions” throughout the remainder of this report. Additional information about acquired balances and intangible assets recognized is presented below.

 

The Company continually evaluates the profitability of its network of bank branches throughout its markets. As a result of this evaluation process, the Company may periodically sell the assets and liabilities of certain branches, or may sell the premises of specific banking facilities. In May 2008, the Company sold its banking branch, including the facility, in Independence, Kansas. In this transaction, approximately $23.3 million in loans, $85.0 million in deposits, and various other assets and liabilities were sold. The Company paid $54.1 million in cash, representing the net liabilities sold, and recorded a pre-tax gain of $6.9 million, representing the approximate premium paid by the buyer. During 2007 and 2006, the Company sold several bank facilities each year, realizing pre-tax gains on these sales of $1.6 million and $579 thousand, respectively.

 

In February 2009, the Company sold its branch in Lakin, Kansas. In this transaction, the Company sold the bank facility and certain deposits of approximately $6.9 million, and paid cash of approximately $5.6 million.

 

The Company distributed a 5% stock dividend for the fifteenth consecutive year on December 1, 2008. All per share and average share data in this report has been restated to reflect the 2008 stock dividend.

 

Critical Accounting Policies

 

The Company’s consolidated financial statements are prepared based on the application of certain accounting policies, the most significant of which are described in Note 1 to the consolidated financial statements. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or be subject to variations which may significantly affect the Company’s reported results and financial position for the current period or future periods. The use of estimates, assumptions, and judgments are necessary when financial assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. Current economic conditions may require the use of additional estimates, and some estimates may be subject to a greater degree of uncertainty due to the current instability of the economy. The Company has identified several policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for loan losses, the valuation of certain investment securities, and accounting for income taxes.

 

Allowance for Loan Losses

 

The Company performs periodic and systematic detailed reviews of its loan portfolio to assess overall collectability. The level of the allowance for loan losses reflects the Company’s estimate of the losses inherent in the loan portfolio at any point in time. While these estimates are based on substantive methods for determining allowance requirements, actual outcomes may differ significantly from estimated results, especially when determining allowances for business, lease, construction and business real estate loans. These loans are normally larger and more complex, and their collection rates are harder to predict. Personal loans, including personal mortgage, credit card and consumer loans, are individually smaller and perform in a more homogenous manner, making loss estimates more predictable. Further discussion of the methodologies used in establishing the allowance is provided in the Provision and Allowance for Loan Losses section of this discussion.

 

Valuation of Investment Securities

 

The Company carries its investment securities at fair value, and in accordance with the requirements of Statement of Financial Accounting Standards (SFAS) No. 157, the Company employs valuation techniques which utilize observable inputs when those inputs are available. These observable inputs reflect assumptions market participants would use in pricing the security, developed based on market data obtained from sources independent of the Company. When such information is not available, the Company employs valuation techniques which utilize unobservable inputs, or those which reflect the Company’s own assumptions about market participants, based on the best information available in the circumstances. These valuation methods typically involve cash flow and other financial modeling techniques. Changes in underlying factors, assumptions, estimates, or other inputs to the valuation techniques could have a material impact on the Company’s

future financial condition and results of operations. Assets and liabilities carried at fair value inherently result in more financial statement volatility. SFAS 157, which requires fair value measurements to be classified as Level 1 (quoted prices), Level 2 (based on observable inputs) or Level 3 (based on unobservable, internally-derived inputs) is discussed in more detail in Note 16 to the consolidated financial statements.

 

Available for sale securities are reported at fair value, with changes in fair value reported in other comprehensive income. Most of the portfolio is priced utilizing industry-standard models that consider various assumptions which are observable in the marketplace, or can be derived from observable data. Such securities totaled approximately $3.4 billion, or 94.6% of the portfolio at December 31, 2008, and were classified as Level 2 measurements. The Company also holds $168.0 million in auction rate securities. These were classified as Level 3 measurements, as no market currently exists for these securities, and fair values were derived from internally generated cash flow valuation models which used unobservable inputs which were significant to the overall measurement. The Company periodically evaluates the available for sale portfolio for other-than-temporary impairment. Impairment which is deemed other-than-temporary is reflected in current earnings and reported in investment securities gains and losses in the consolidated statements of income. Evaluation for other-than-temporary impairment includes an analysis of the facts and circumstances of each individual security such as the severity of loss, the length of time the fair value has been below cost, the creditworthiness of the issuer, and the Company’s intent and ability to hold the security to maturity. Impairment is measured using a cash flows modeling technique whose results are highly dependent on estimates of default rates, loss severities, and prepayment speeds. Future economic trends which signal changes to these estimates may have a negative effect on results of operations.

 

The Company, through its direct holdings and its Small Business Investment subsidiaries, has numerous private equity and venture capital investments, categorized as non-marketable securities in the accompanying consolidated balance sheets. These investments are reported at fair value, and totaled $55.4 million at December 31, 2008. Changes in fair value are reflected in current earnings, and reported in investment securities gains and losses in the consolidated statements of income. Because there is no observable market data for these securities, their fair values are internally developed using available information and management’s judgment. Although management believes its estimates of fair value reasonably reflect the fair value of these securities, key assumptions regarding the projected financial performance of these companies, the evaluation of the investee company’s management team, and other economic and market factors may affect the amounts that will ultimately be realized from these investments.

 

Accounting for Income Taxes

 

As more fully discussed in Notes 1 and 9 of the consolidated financial statements, the Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”. Accrued income taxes represent the net amount of current income taxes which are expected to be paid attributable to operations as of the balance sheet date. Deferred income taxes represent the expected future tax consequences of events that have been recognized in the financial statements or income tax returns. Current and deferred income taxes are reported as either a component of other assets or other liabilities in the consolidated balance sheets, depending on whether the balances are assets or liabilities. Judgment is required in applying the principles of SFAS No. 109. The Company regularly monitors taxing authorities for changes in laws and regulations and their interpretations by the judicial systems. The aforementioned changes, and changes that may result from the resolution of income tax examinations by federal and state taxing authorities, may impact the estimate of accrued income taxes and could materially impact the Company’s financial position and results of operations.

Net Interest Income

 

Net interest income, the largest source of revenue, results from the Company’s lending, investing, borrowing, and deposit gathering activities. It is affected by both changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest bearing liabilities. The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates. Changes not solely due to volume or rate changes are allocated to rate.

 

 

Net interest income totaled $592.7 million in 2008, representing an increase of $54.7 million, or 10.2%, compared to $538.1 million in 2007. On a tax equivalent basis, net interest income totaled $604.1 million and increased $57.2 million, or 10.5%, over the previous year. This increase was mainly the result of lower rates paid on deposits and other borrowings, coupled with higher average loan and investment securities balances during the year. The net yield on earning assets (tax equivalent) was 3.93% in 2008 compared with 3.80% in the previous year.

 

Interest income on loans (tax equivalent) declined $86.6 million due to lower rates earned on virtually all lending products but offset by higher loan balances, especially in business, consumer and consumer credit card loans. The lower rates earned on the loan portfolio were related to the actions taken by the Federal Reserve Bank during 2008 to reduce interest rate levels, which caused the Company’s portfolio to re-price

quickly. Tax equivalent interest earned on investment securities increased by $20.3 million, or 12.7%, due to higher average balances of mortgage-backed and municipal securities, coupled with higher rates earned on these investments. Included in municipal securities were the Company’s purchases of auction rate securities in the third quarter of 2008, which increased interest income. The majority of these securities were sold in the fourth quarter. Interest earned on federal funds sold and resale agreement assets declined $17.6 million, mainly due to lower average balances coupled with much lower overnight rates. Average rates (tax equivalent) earned on interest earning assets in 2008 decreased to 5.60% compared to 6.56% in the previous year, or a decline of 96 basis points.

 

Interest expense on deposits decreased $106.7 million, mainly the result of much lower rates paid on all deposit products but partly offset by the effects of higher average balances of money market accounts and certificates of deposit of $100,000 and over. Average rates paid on deposit balances declined 100 basis points from 2.68% in 2007 to 1.68% in 2008. Interest expense on borrowings declined $34.2 million, or 35.2%, mainly as a result of lower rates paid and lower average balances of federal funds purchased and repurchase agreement borrowings. Also, while advances from the Federal Home Loan Bank and the Federal Reserve’s Term Auction Facility increased on average by $788.3 million, rates on these borrowings dropped significantly in 2008. The average rate paid on interest bearing liabilities decreased to 1.83% compared to 3.01% in 2007.

 

Net interest income in 2007 increased $24.9 million, or 4.8%, to $538.1 million, compared to $513.2 million in 2006. On a tax equivalent basis, net interest income increased $26.5 million, or 5.1%, in 2007 compared to 2006. The increase in net interest income in 2007 compared to 2006 was due mainly to growth in interest on loans, investment securities and short-term investments, offset by higher interest expense on deposit accounts and borrowings. The increase in interest income on loans was the result of increases in both rates and balances of virtually all loan products. The effect on rates was mainly due to Federal Reserve rate increases in 2006 which impacted average balances and earnings for the full year in 2007. The growth in average balances partly resulted from bank acquisitions occurring in 2007 and 2006, which increased average loan balances by $337.8 million in 2007. Tax equivalent interest earned on investment securities increased by 1.8% due to higher rates earned on mortgage and asset-backed securities and U.S. government and federal agency securities, but was partly offset by lower overall average balances. Interest earned on federal funds sold and resale agreement assets rose by $10.2 million, mainly due to higher average balances in overnight resale agreements. Average rates earned on total interest earning assets in 2007 increased to 6.56% compared to 6.32% in the previous year.

 

Interest expense on deposits increased $60.5 million in 2007 over 2006 due to higher average balances of money market accounts and short-term certificates of deposit, in addition to higher rates paid on most deposit products. Interest expense on borrowings increased $18.4 million over 2006. This growth resulted from an increase of $350.6 million in average balances, mainly in securities sold under repurchase agreements and Federal Home Loan Bank advances, coupled with higher average rates paid on the repurchase agreements. The average rate paid on interest bearing liabilities increased to 3.01% compared to 2.63% in 2006. The tax adjusted net yield on earning assets totaled 3.80% in 2007 and 3.92% in 2006.

 

Provision for Loan Losses

 

The provision for loan losses totaled $108.9 million in 2008, up from $42.7 million in the previous year, or an increase of $66.2 million. In 2006 the provision totaled $25.6 million. The growth in the provision in 2008 was the result of deteriorating economic conditions affecting the Company’s loan portfolio, higher watch list loans totals, and increasing loan losses experience, especially in consumer and consumer credit card loans, during 2008. As a result, the Company increased its allowance for loan losses by $39.0 million in 2008. The provision for loan losses is recorded to bring the allowance for loan losses to a level deemed adequate by management based on the factors mentioned in the following “Allowance for Loan Losses” section of this discussion.

Non-Interest Income

 

 

Non-interest income totaled $375.7 million, an increase of $4.1 million or 1.1%, compared to $371.6 million in 2007. Non-interest income included an impairment charge of $9.4 million, recorded in loan fees and sales, on certain student loans held for sale. The Company has agreements to sell its portfolio of originated student loans to various student loan servicing agencies. Due to uncertainties surrounding some of these agencies’ ability to fulfill these contracts in the future, the Company adjusted a portion of the portfolio, totaling $206.1 million, to fair value, and recorded the above mentioned impairment charge. Bank card fee income grew by $10.2 million, or 9.9%, due to solid growth in debit card and corporate credit card fee income, which grew by 9.4% and 28.6%, respectively. However, deposit fees declined by $7.0 million, or 6.0%, mainly due to a decrease of $10.4 million in deposit account overdraft fees. This decline was partly offset by growth in corporate cash management fee income, which increased $4.5 million, or 17.2%. Trust fee income grew by $1.5 million, or 1.8%, and was especially affected in the fourth quarter by lower market values of the trust assets on which fees are based. Market values of total trust assets at year end 2008 were 14.6% lower than at year end 2007. Consumer brokerage services revenue grew by $1.1 million, or 8.9%, on higher bond sales and annuity commissions. Bond trading income increased $5.6 million, or 65.0%, due to increased sales volumes from its correspondent bank and commercial customers. Other non-interest income rose $3.9 million over the prior year, largely due to a $6.9 million gain on the sale of a bank branch. Additional increases occurred in cash sweep commission income and fair value gains on interest rate swaps. These were partly offset by a $1.1 million impairment charge on an office building held for sale, in addition to declines in official check sales and equipment rental income.

 

In 2007, non-interest income increased $19.0 million, or 5.4%, to $371.6 million. Compared to 2006, deposit account fees increased $1.9 million, or 1.6%, as a result of higher corporate cash management fees, which grew by $2.8 million, or 12.2%. This growth was partly offset by a slight decline in deposit account overdraft fees. Bank card fees rose $8.7 million, or 9.1% overall, primarily due to growth in debit card and corporate card fee income, which grew by 12.2% and 30.0%, respectively. Trust fees increased $6.7 million, or 9.2%, due to an 8.3% increase in private client account fees and a 14.7% increase in corporate and institutional trust account fees. Bond trading income rose $515 thousand due to an increase in underwriting fees on customer debt issues, in addition to higher corporate and correspondent bank sales. Consumer brokerage services revenue rose $2.5 million, or 25.0%, mainly due to growth in annuity commissions and mutual fund fees. Loan fees and sales decreased by $1.7 million as gains on sales of student loans declined from $6.3 million in 2006 to $4.5 million in 2007, which resulted from narrowing profit margins on loans sold to various servicing agencies. Other non-interest income rose $415 thousand over the prior year, largely due to increases of $1.1 million in cash sweep commission income and $1.0 million in gains on sales of various bank facilities. These increases were partly offset by impairment losses of $1.3 million recorded on several properties and the receipt in 2006 of $1.2 million in non-recurring income from an equity investment held by Commerce Bancshares, Inc., the parent holding company (the “Parent”).

Investment Securities Gains, Net

 

Net gains and losses on investment securities during 2008, 2007 and 2006 are shown in the table below. Included in these amounts are gains and losses arising from sales of bonds from the Bank’s available for sale portfolio and sales of publicly traded equity securities held by the Parent. Also shown are gains and losses relating to non-marketable private equity and venture capital investments, which are primarily held by the Parent’s majority-owned venture capital subsidiaries. These include fair value adjustments, in addition to gains and losses realized upon disposition. Minority interest expense pertaining to these net gains is reported in other non-interest expense, and totaled $299 thousand, $389 thousand, and $2.2 million in 2008, 2007 and 2006, respectively.

 

Net securities gains of $30.3 million were recorded in 2008, compared to $8.2 million in 2007 and $9.0 million in 2006. Most of the net gain in 2008 occurred because of Visa’s redemption of certain Class B stock held by its former member banks. The redemption occurred in conjunction with an initial public offering by Visa in March 2008. Approximately 500 thousand shares of the Company’s Class B stock were redeemed, which resulted in a $22.2 million gain. Also, in December 2008, $341.4 million in auction rate securities were sold in exchange for federally guaranteed student loans, resulting in a gain of $7.9 million. Preferred equity securities issued by the Student Loan Marketing Association and the Federal National Mortgage Association, totaling $20.7 million, were sold early in the year for a loss of $3.5 million.

 

 

Non-Interest Expense

 

Non-interest expense was $616.1 million in 2008, an increase of 7.2% over the previous year. Salaries and benefits expense grew by $24.8 million, or 8.0%, due to merit increases, higher incentive payments, and increased medical insurance costs. In addition, increased salary costs resulted from higher staffing in areas such as commercial bank card, private banking, and commercial banking, which were part of certain growth initiatives established by the Company in 2007. Occupancy, supplies and communication, and equipment costs grew by 1.2%, 3.4%, and 1.9%, respectively, and were well controlled. Occupancy costs increased mainly as a result of higher building services and repairs expense. Equipment expense grew mainly due to higher repairs and maintenance expense, partly offset by a decline in equipment depreciation expense. Supplies and communication costs were higher due to increased costs for supplies and courier expense. Data processing and software expense increased $6.0 million, or 12.0%, mainly due to higher bank card processing costs which increased in relation to higher bank card revenues. Exclusive of bank card costs, core data processing expense increased $2.1 million, or 6.7%, over the prior year due to investments in new software and servicing systems. Marketing expense also rose by $1.8 million, or 9.9%, over the prior year mainly related to deposit account product marketing and other campaigns supporting Company initiatives. Other non-interest expense increased $3.8 million, or 5.3%, in 2008 partly due to an impairment charge of $2.5 million related to foreclosed land sold in the third quarter of 2008. Other increases occurred in travel and entertainment, FHLB letter of credit fees, and credit card rewards expense. Partly offsetting these increases were declines in professional fees and leased equipment depreciation.

 

Non-interest expense in 2008 included a $33.3 million non-cash loss related to the purchase of auction rate securities from customers in the third quarter. The securities were purchased at par value from the customers, and this loss represents the amount by which par value exceeded estimated fair value on the purchase date. Most of these securities were subsequently sold in the fourth quarter, and the gain relating to that transaction was recorded in investments securities gains, as noted above.

 

Also included in non-interest expense are adjustments to the Company’s estimate of its share of certain litigation costs arising from its member bank relationship with Visa. A non-cash expense charge of $21.0 million was recorded in the fourth quarter of 2007 to establish the Company’s obligation for its portion of litigation costs relating to various suits against Visa. The obligation was reduced in the first quarter of 2008 upon the funding of an escrow account for these suits, in conjunction with Visa’s initial public offering. The obligation was subsequently adjusted during the year to reflect changes in estimates of litigation costs and additional escrow funding. As a result of these adjustments, an overall reduction in the obligation of $9.6 million was recorded during 2008.

 

In 2007, non-interest expense was $574.8 million, which included the charge of $21.0 million related to the Visa indemnification obligation. Excluding this charge, non-interest expense was $553.8 million in 2007, and grew 5.4% over 2006. Salaries and benefits expense grew by $20.5 million, or 7.1%, due to merit increases, incentive compensation, payroll taxes and the effects of the 2007 and 2006 bank acquisitions, which contributed $5.4 million of this increase. Partly offsetting these increases was a decline in employee group medical plan expense, resulting from favorable claims experience. Occupancy expense increased by $2.5 million, or 5.8%, over 2006 mainly as a result of seasonal maintenance costs, higher building depreciation and real estate taxes. Higher rent income from tenants, resulting from an increase in overall building occupancy, partly offset these expenses. Equipment expense declined by $1.5 million, or 6.0%, mainly due to declines in depreciation expense on data processing equipment and maintenance contract expense, in addition to relocation costs of a check processing function in 2006. Supplies and communication costs grew by $1.5 million, or 4.6%, mainly due to higher costs for supplies, postage and courier expense, partly offset by a decline in data network expense. Data processing and software expense declined $1.3 million, or 2.4%, mainly due to lower license costs related to online banking systems and a decline in bank card processing fees. A smaller variance occurred in marketing expense, which increased $882 thousand, or 5.1%, over the prior year. Other non-interest expense increased $5.8 million, or 8.7%, in 2007 due to increases in intangible asset amortization (resulting from recent bank acquisitions), bank card and other fraud losses, and dues and subscription expense. Partly offsetting these increases were declines in minority interest expense and foreclosed property expense.

Income Taxes

 

Income tax expense was $85.1 million in 2008, compared to $93.7 million in 2007 and $103.9 million in 2006. Income tax expense in 2008 decreased 9.2% from 2007, compared to an 8.9% decrease in pre-tax income. The effective tax rate was 31.1%, 31.2% and 32.1% in 2008, 2007 and 2006, respectively. The Company’s effective tax rates in those years were lower than the federal statutory rate of 35% mainly due to tax-exempt interest on state and municipal obligations.

 

Financial Condition

 

Loan Portfolio Analysis

 

A schedule of average balances invested in each category of loans appears on page 56. Classifications of consolidated loans by major category at December 31 for each of the past five years are as follows. In 2008, the Company acquired a portfolio of student loans which it intends to hold until maturity, which is shown in the table below. The Company’s portfolio of originated student loans was classified as held for sale in 2006, and is included in the table below only for years 2004 and 2005. Refer to the following section, Loans Held for Sale, for information regarding originated student loans.

 

 

In December 2008, the Company elected to reclassify certain segments of its real estate, business, and consumer portfolios. The reclassifications were made to better align the loan reporting with its related collateral and purpose. Amounts reclassified to real estate construction and land pertained mainly to commercial or residential land and lots which were held by borrowers for future development. Amounts reclassified to personal real estate related mainly to one to four family rental property secured by residential mortgages. The table below shows the effect of the reclassifications on the various lending categories as of the transfer date. Because the information was not readily available and it was impracticable to do so, prior periods were not restated.

 

The contractual maturities of loan categories at December 31, 2008, and a breakdown of those loans between fixed rate and floating rate loans are as follows:

 

(1) Consumer loans with floating rates totaled $88.5 million.

(2) Home equity loans with floating rates totaled $497.1 million.

(3) All student loans have floating rates.

(4) Consumer credit card loans with floating rates totaled $709.0 million.

 

Total loans at December 31, 2008 were $11.3 billion, an increase of $677.9 million, or 6.4%, over balances at December 31, 2007. Excluding the effects of the reclassification mentioned above, loan growth during 2008 came principally from business, business real estate, and student loans. Business loans grew $203.3 million, or 6.2%, reflecting continued customer demand and higher line of credit usage. Lease balances, which are included in the business category, increased $32.2 million, or 11.7%, compared with the previous year end balance, as equipment financing remained strong. Business real estate loans rose $112.0 million, or 5.0%, and construction loans increased $10.4 million, or 1.6%. The increase in construction loans pertained to commercial construction, as opposed to land development and residential construction, which declined approximately $40 million in 2008. Consumer loans declined $2.3 million, partly as a result of a decline in automobile lending, but offset by growth in marine and recreational vehicle loans, which grew $27.6 million. Beginning in the third quarter, the Company elected to reduce its originations of certain types of marine and recreational vehicle loans due to current market conditions. Personal real estate loans decreased by $43.8 million, or 2.8%, while consumer credit card loans decreased slightly by $518 thousand. During 2008, home equity loans increased $43.9 million, or 9.5%, due to an increase in new account activations. In December 2008, the Company acquired $358.5 million of federally guaranteed student loans from a student loan agency in exchange for certain auction rate securities acquired by the Company in the previous quarter, and issued by that agency. The loans, which have an average estimated life of approximately seven years, were recorded at fair value, which resulted in a discount from their face value of approximately 2.5%. The Company intends to hold these loans to maturity.

 

Period end loans increased $923.8 million, or 9.5%, in 2007 compared to 2006, resulting from increases in business, business real estate, personal real estate, consumer and credit card loans.

 

The Company currently generates approximately 31% of its loan portfolio in the St. Louis market, 30% in the Kansas City market, and 39% in various other regional markets. The portfolio is diversified from a business and retail standpoint, with 57% in loans to businesses and 43% in loans to consumers. A balanced

approach to loan portfolio management and an historical aversion toward credit concentrations, from an industry, geographic and product perspective, have contributed to low levels of problem loans and loan losses.

 

Business

 

Total business loans amounted to $3.4 billion at December 31, 2008 and include loans used mainly to fund customer accounts receivable, inventories, and capital expenditures. This portfolio also includes sales type and direct financing leases totaling $308.2 million, which are used by commercial customers to finance capital purchases ranging from computer equipment to office and transportation equipment. These leases comprise 2.7% of the Company’s total loan portfolio. Business loans are made primarily to customers in the regional trade area of the Company, generally the central Midwest, encompassing the states of Missouri, Kansas, Illinois, and nearby Midwestern markets, including Iowa, Oklahoma, Colorado and Ohio. The portfolio is diversified from an industry standpoint and includes businesses engaged in manufacturing, wholesaling, retailing, agribusiness, insurance, financial services, public utilities, and other service businesses. Emphasis is upon middle-market and community businesses with known local management and financial stability. The Company participates in credits of large, publicly traded companies when business operations are maintained in the local communities or regional markets and opportunities to provide other banking services are present. Consistent with management’s strategy and emphasis upon relationship banking, most borrowing customers also maintain deposit accounts and utilize other banking services. Net loan charge-offs in this category totaled $4.4 million in both 2008 and in 2007. Non-accrual business loans were $4.0 million (.1% of business loans) at December 31, 2008 compared to $4.7 million at December 31, 2007. Included in these totals were non-accrual lease-related loans of $1.0 million and $167 thousand at December 31, 2008 and 2007, respectively. Growth opportunities in business loans will largely depend on economic and market conditions affecting businesses and their ability to grow and invest in new capital, and the Company’s own solicitation efforts in attracting new, high quality loans. Asset quality is, in part, a function of management’s consistent application of underwriting standards and credit terms through stages in economic cycles. Therefore, portfolio growth in 2009 will be dependent upon 1) the strength of the economy, 2) the actions of the Federal Reserve with regard to targets for economic growth, interest rates, and inflationary tendencies, and 3) the competitive environment.

 

Real Estate-Construction and Land

 

The portfolio of loans in this category amounted to $837.4 million at December 31, 2008 and comprised 7.4% of the Company’s total loan portfolio. The table below shows the Company’s holdings of the major types of construction loans.

 

 

These loans are predominantly made to businesses in the local markets of the Company’s banking subsidiaries. Commercial construction loans are made during the construction phase for small and medium-sized office and medical buildings, manufacturing and warehouse facilities, apartment complexes, shopping centers, hotels and motels, and other commercial properties. Exposure to larger speculative office properties remains low. Commercial land and land development loans relate to land owned or developed for use in conjunction with business properties. The largest percentage of residential construction and land development loans are for projects located in the Kansas City and St. Louis metropolitan areas. Credit exposure in this sector has risen over the last two years, especially in residential construction and land development lending, as a result of the slowdown in the housing industry and worsening economic conditions. Net loan charge-offs increased to $6.2 million in 2008, compared to net charge-offs of $2.0 million in 2007. The increase

in net charge-offs in 2008 was mainly related to charge-offs of $4.3 million on four specific loans. In addition, construction and land loans on non-accrual status rose to $48.9 million at year end 2008, compared to $7.8 million at year end 2007. Much of the increase was the result of placing a $19.9 million residential construction loan within our market on non-accrual status in December 2008. The remainder of the non-accrual balance is composed of approximately 14 borrowers, whose loan balances range from $700 thousand to $6.6 million. The Company’s watch list, which includes special mention and substandard categories, includes $124.7 million of residential land and construction loans which are being closely monitored.

 

Real Estate-Business

 

Total business real estate loans were $2.1 billion at December 31, 2008 and comprised 18.9% of the Company’s total loan portfolio. This category includes mortgage loans for small and medium-sized office and medical buildings, manufacturing and warehouse facilities, shopping centers, hotels and motels, and other commercial properties. Emphasis is placed on owner-occupied and income producing commercial real estate properties, which present lower risk levels. The borrowers and/or the properties are generally located in the local and regional markets of the affiliate banks. At December 31, 2008, non-accrual balances amounted to $13.1 million, or .6% of the loans in this category, up from $5.6 million at year end 2007. The Company experienced net charge-offs of $2.2 million in 2008, compared to net charge-offs of $1.1 million in 2007.

 

Real Estate-Personal

 

At December 31, 2008, there were $1.6 billion in outstanding personal real estate loans, which comprised 14.5% of the Company’s total loan portfolio. The mortgage loans in this category are mainly for owner-occupied residential properties. The Company originates both adjustable rate and fixed rate mortgage loans. The Company retains adjustable rate mortgage loans, and may from time to time retain certain fixed rate loans (typically 15-year fixed rate loans) as directed by its Asset/Liability Management Committee. Other fixed rate loans in the portfolio have resulted from previous bank acquisitions. The Company does not purchase loans from outside parties or brokers, and has never maintained or promoted subprime or reduced document products. At December 31, 2008, 59% of the portfolio was comprised of adjustable rate loans while 41% was comprised of fixed rate loans. Levels of mortgage loan origination activity declined in 2008 compared to 2007, with originations of $181 million in 2008 compared with $283 million in 2007. Growth in mortgage loan originations was constrained in 2008 as a result of the deteriorating economy, slower housing starts, and lower resales within the Company’s markets. The Company has not experienced significant loan losses in this category, and believes this is partly because it does not offer subprime lending products or purchase loans from brokers. While loan losses have remained low during the year, the Company saw an increase in losses in the fourth quarter of 2008, and recorded net loan charge-offs of $1.4 million in that quarter. Net loan charge-offs for 2008 amounted to $1.7 million, compared to $139 thousand in the previous year. The non-accrual balances of loans in this category increased to $8.4 million at December 31, 2008, compared to $1.1 million at year end 2007.

 

Personal Banking

 

Total personal banking loans, which include consumer, student and revolving home equity loans, totaled $2.5 billion at December 31, 2008 and, excluding the reclassification mentioned above, increased 19.0% during 2008. These categories comprised 22.0% of the total loan portfolio at December 31, 2008. Consumer loans consist of auto, marine, tractor/trailer, recreational vehicle (RV) and fixed rate home equity loans, and totaled $1.6 billion at year end 2008. Approximately 70% of consumer loans outstanding were originated indirectly from auto and other dealers, while the remaining 30% were direct loans made to consumers. Approximately 29% of the consumer portfolio consists of automobile loans, 51% in marine and RV loans and 9% in fixed rate home equity lending. As mentioned above, total consumer loans declined $2.3 million in 2008 as a result of a decline in auto lending, which decreased $15.6 million, or 3.2%, but was offset by a $27.6 million increase in marine and RV lending. Since July 2008 and in conjunction with the Company’s decision to reduce marine and RV originations, these loans have declined $38.7 million. Net charge-offs on consumer loans were $21.4 million in 2008 compared to $9.5 million in 2007. Net charge-offs increased to 1.3% of average consumer loans in 2008 compared to .6% in 2007. The increase in net charge-offs in 2008 compared to 2007 was mainly due to higher marine and RV charge-offs. Net charge-offs on marine and RV

loans were $9.9 million higher in 2008 compared to 2007, and were 1.7% of average marine and RV loans in 2008 compared to .6% in 2007.

 

Revolving home equity loans, of which 99% are adjustable rate loans, totaled $504.1 million at year end 2008. An additional $690.8 million was outstanding in unused lines of credit, which can be drawn at the discretion of the borrower. Home equity loans are secured mainly by second mortgages (and less frequently, first mortgages) on residential property of the borrower. The underwriting terms for the home equity line product permit borrowing availability, in the aggregate, generally up to 80% or 90% of the appraised value of the collateral property at the time of origination, although a small percentage may permit borrowing up to 100% of appraised value.

 

As mentioned previously, in December 2008, the Company acquired federally guaranteed student loans from a student loan agency in exchange for certain auction rate securities issued by that agency. At December 31, 2008, these student loans totaled $358.0 million.

 

Consumer Credit Card

 

Total consumer credit card loans amounted to $779.7 million at December 31, 2008 and comprised 6.9% of the Company’s total loan portfolio. The credit card portfolio is concentrated within regional markets served by the Company. The Company offers a variety of credit card products, including affinity cards, rewards cards, and standard and premium credit cards, and emphasizes its credit card relationship product, Special Connections. Approximately 63% of the households in Missouri that own a Commerce credit card product also maintain a deposit relationship with the subsidiary bank. Approximately 91% of the outstanding credit card loans have a floating interest rate. Net charge-offs amounted to $31.5 million in 2008, which was a $7.8 million increase over 2007. While the annual ratio of net credit card loan charge-offs to total average credit card loans totaled 4.1% in 2008 compared to 3.6% in 2007, annualized 2008 fourth quarter net credit card charge-offs on average loans increased to 4.5%. These ratios, however, remain below national loss averages.

 

Loans Held for Sale

 

Total loans held for sale at December 31, 2008 were $361.3 million, an increase of $125.4 million, or 53.2%, from $235.9 million at year end 2007. Loans classified as held for sale consist of residential mortgage loans and student loans.

 

Mortgage loans are fixed rate loans, which are sold in the secondary market, generally within three months of origination, and totaled $2.7 million and $6.9 million at December 31, 2008 and 2007, respectively.

 

The Company originates loans to students attending colleges and universities and these loans are normally sold to the secondary market when the student graduates and the loan enters into repayment status. Nearly all of these loans are based on variable rates. The Company maintains agreements to sell these student loans to various student loan servicing agencies, including the Missouri Higher Education Loan Authority and the Student Loan Marketing Association. In mid 2008, the Company also entered into an agreement with the Department of Education (DOE) which covers all new loans originated beginning July 1, 2008. Under this agreement, loans originated for the school year 2008-2009 are expected to be sold in September 2009.

 

Due to uncertainties surrounding some of the student loan agencies’ ability to fulfill these contracts in the future, the Company adjusted loans totaling $206.1 million to fair value and recorded impairment charges of $9.4 million during the second half of 2008. Student loan balances grew by $129.5 million, or 56.6%, to $358.6 million at year end 2008, compared to $229.0 million at year end 2007. This growth was mainly due to continued loan originations under the DOE agreement, coupled with fewer sales of those loans originated prior to July 1, 2008. At December 31, 2008, student loans held for sale to the DOE totaled $158.2 million.

 

Allowance for Loan Losses

 

The Company has an established process to determine the amount of the allowance for loan losses, which assesses the risks and losses inherent in its portfolio. This process provides an allowance consisting of a

specific allowance component based on certain individually evaluated loans and a general component based on estimates of reserves needed for pools of loans with similar risk characteristics.

 

Loans subject to individual evaluation are defined by the Company as impaired, and generally consist of business, construction, commercial real estate and personal real estate loans on non-accrual status. These loans are evaluated individually for the impairment of repayment potential and collateral adequacy, and in conjunction with current economic conditions and loss experience, allowances are estimated. Loans not individually evaluated are aggregated and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type, delinquencies, current economic factors, loan risk ratings and industry concentrations.

 

The Company’s estimate of the allowance for loan losses and the corresponding provision for loan losses rests upon various judgments and assumptions made by management. Factors that influence these judgments include past loan loss experience, current loan portfolio composition and characteristics, trends in portfolio risk ratings, levels of non-performing assets, prevailing regional and national economic conditions, and the Company’s ongoing examination process including that of its regulators. The Company has internal credit administration and loan review staffs that continuously review loan quality and report the results of their reviews and examinations to the Company’s senior management and Board of Directors. Such reviews also assist management in establishing the level of the allowance. The Company’s subsidiary bank continues to be subject to examination by the Office of the Comptroller of the Currency (OCC) and examinations are conducted throughout the year, targeting various segments of the loan portfolio for review. In addition to the examination of the subsidiary bank by the OCC, the parent holding company and its non-bank subsidiaries are examined by the Federal Reserve Bank.

 

At December 31, 2008, the allowance for loan losses was $172.6 million compared to a balance at year end 2007 of $133.6 million. The $39.0 million, or 29.2%, increase in the allowance for loan losses during 2008 was primarily a result of increasing levels of watch list loans and deteriorating general economic conditions. Loans delinquent 90 days or more increased $19.1 million in 2008 compared to 2007 primarily due to the acquisition of a $358.5 million, federally guaranteed, student loan portfolio in the fourth quarter of 2008 that had $13.9 million of loans in 90 days past due status. Delinquencies of 90 days or more on consumer credit card loans increased $3.3 million, or 30.5% compared to 2007. Loans on non-accrual status increased $53.2 million to $72.9 million in 2008 from $19.7 million in 2007. This growth included increases of $41.1 million in non-accrual construction and land loans, $7.5 million in non-accrual business real estate loans, and $5.7 million in non-accrual personal real estate loans. Other loans identified as potential future problem loans increased $211.5 million, primarily due to increases in business loans and construction and land loans. These trends were reflective of the economic downturn experienced in 2008. The Company’s analysis of the allowance considered these trends, which resulted in an increase in the allowance balance during 2008. The percentage of allowance to loans increased to 1.53% in 2008 compared to 1.26% in 2007 as a result of the increase in the allowance balance, offset slightly by an increase in loan balances of 6.4%.

 

Net charge-offs totaled $69.9 million in 2008, and increased $27.1 million, or 63.5%, compared to net charge-offs of $42.7 million in 2007. Net charge-offs related to business loans were $4.4 million annually in 2008 and 2007. Construction and land loans incurred net charge-offs of $6.2 million in 2008 compared to $2.0 million in 2007. Certain construction and land loans have experienced lower credit quality in 2008 resulting from the slowdown in the housing market, which has affected the construction business. Net charge-offs related to consumer loans increased by $11.9 million to $21.4 million at December 31, 2008, representing 30.7% of total net charge-offs during 2008. This increase was due primarily to a $9.9 million increase in net charge-offs related to marine and recreational vehicle loans. Additionally, net charge-offs related to consumer credit cards increased $7.8 million to $31.5 million in 2008 compared to $23.7 million in 2007. Approximately 45.1% of total net loan charge-offs during 2008 were related to consumer credit card loans compared to 55.5% during 2007. Net consumer credit card charge-offs increased to 4.1% of average consumer credit card loans in 2008 compared to 3.6% in 2007. At year end 2008, the ratio of consumer credit card loans 30 days or more delinquent to the total outstanding balance was 3.9%, compared to 2.8% at year end 2007.

The ratio of net charge-offs to average loans outstanding in 2008 was .64% compared to .42% in 2007 and .29% in 2006. The provision for loan losses was $108.9 million, compared to a provision of $42.7 million in 2007 and $25.6 million in 2006.

 

The Company considers the allowance for loan losses of $172.6 million adequate to cover losses inherent in the loan portfolio at December 31, 2008.

 

The schedules which follow summarize the relationship between loan balances and activity in the allowance for loan losses: