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US Bancorp/DE – ‘10-K’ for 12/31/07 – EX-13

On:  Monday, 2/25/08, at 3:13pm ET   ·   For:  12/31/07   ·   Accession #:  950124-8-806   ·   File #:  1-06880

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 2/25/08  US Bancorp/DE                     10-K       12/31/07    9:4.6M                                   Bowne - Bde

Annual Report   —   Form 10-K
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K        Annual Report for Fiscal Year Ended December 31,    HTML    129K 
                          2007                                                   
 2: EX-10.37    Employment Agreement With Pamela A. Joseph          HTML     97K 
 3: EX-12       Statement Re: Computation of Ratio of Earnings to   HTML     17K 
                          Fixed Charges                                          
 4: EX-13       2007 Annual Report                                  HTML   2.71M 
 5: EX-21       Subsidiaries of the Registrant                      HTML      7K 
 6: EX-23.1     Consent of Ernst & Young LLP                        HTML     14K 
 7: EX-31.1     Certification of Chief Executive Officer Pursuant   HTML     13K 
                          to Rule 13A-14(A)                                      
 8: EX-31.2     Certification of Chief Financial Officer Pursuant   HTML     13K 
                          to Rule 13A-14(A)                                      
 9: EX-32       Certification of Chief Executive Officer and Chief  HTML      9K 
                          Financial Officer Pursuant to Section                  
                          906                                                    


EX-13   —   2007 Annual Report


This exhibit is an HTML Document rendered as filed.  [ Alternative Formats ]



  exv13  

 

Management’s Discussion and Analysis
 
OVERVIEW
 
In 2007, U.S. Bancorp and its subsidiaries (the “Company”) continued to demonstrate its financial strength and shareholder focus, despite a particularly challenging economic environment for the banking industry. Throughout 2007, the mortgage lending and homebuilding industries experienced stress resulting in higher delinquencies, net charge-offs and nonperforming loans for the industry, especially within the sub-prime mortgage sector. The financial markets experienced significant turbulence during the second half of 2007 as the impact of sub-prime mortgage delinquencies, defaults and foreclosures adversely affected investor confidence in a broad range of investment sectors and asset classes. Despite these challenges, the Company’s prudent credit culture, balance sheet strength and capital management enabled it to manage through the turbulent market conditions. The Company’s financial strength enabled it to remain focused on organic growth and investing in business initiatives that strengthen its presence and product offerings for customers. This focus over the past several years has created a well diversified business, generating strong fee-based revenues that represented over 50 percent of total net revenue in 2007. While net interest income declined in 2007 due to lower net interest margins, average earning assets increased 4.5 percent year-over-year, despite a very competitive credit environment in the first half of the year. By the end of 2007, the Company’s net interest margin was beginning to stabilize and average earning assets grew by 11.1 percent, on an annualized basis, in the fourth quarter, compared with the third quarter of 2007. The Company’s performance was also driven by the continued strong credit quality of the Company’s loan portfolios, despite stress in the mortgage lending and homebuilding industries and an anticipated increase in consumer charge-offs, primarily related to credit cards. The ratio of nonperforming assets to total loans and other real estate was .45 percent at December 31, 2007, compared with .41 percent at December 31, 2006. Total net charge-offs were .54 percent of average loans outstanding in 2007, compared with .39 percent in 2006. In 2008, credit quality within the industry is expected to continue to deteriorate. While the Company’s loan portfolios are not immune to these economic factors and will deteriorate somewhat, credit quality trends of the Company are expected to be manageable through the foreseeable business cycle. Finally, the Company’s efficiency ratio (the ratio of noninterest expense to taxable-equivalent net revenue excluding net securities gains or losses) was 49.3 percent in 2007, compared with 45.4 percent in 2006, and continues to be an industry leader. The Company’s ability to effectively manage its cost structure has provided a strategic advantage in this highly competitive environment. As a result of these factors, the Company achieved a return on average common equity of 21.3 percent in 2007.
The Company’s strong performance is also reflected in its capital levels and the favorable credit ratings assigned by various credit rating agencies. Equity capital of the Company continued to be strong at 5.1 percent of tangible assets at December 31, 2007, compared with 5.5 percent at December 31, 2006. The Company’s regulatory Tier 1 capital ratio was 8.3 percent at December 31, 2007, compared with 8.8 percent at December 31, 2006. In 2007, the Company’s credit ratings were upgraded by Standard & Poor’s Ratings Services. Credit ratings assigned by various credit rating agencies reflect the rating agencies’ recognition of the Company’s industry-leading earnings performance and credit risk profile.
In concert with this financial performance, the Company achieved its objective of returning at least 80 percent of earnings to shareholders in the form of dividends and share repurchases by returning 111 percent of 2007 earnings to shareholders. In December 2007, the Company increased its cash dividend by 6.3 percent from the dividend rate of the fourth quarter of 2006. During 2007, the Company continued to repurchase common shares under the share repurchase program announced in August 2006.
The Company’s financial and strategic objectives are unchanged from those goals that have enabled it to deliver industry-leading financial performance. While net income declined in 2007 and is expected to grow somewhat moderately in 2008, the Company’s financial objectives are to achieve 10 percent long-term growth in earnings per common share and a return on common equity of at least 20 percent. The Company will continue to focus on effectively managing credit quality and maintaining an acceptable level of credit and earnings volatility. The Company intends to achieve these financial objectives by providing high-quality customer service and continuing to make strategic investments in businesses that diversify and generate fee-based revenues, enhance the Company’s distribution network or expand its product offerings. Finally, the Company continues to target an 80 percent return of earnings to its shareholders through dividends or share repurchases.
 
Earnings Summary The Company reported net income of $4.3 billion in 2007, or $2.43 per diluted common share, compared with $4.8 billion, or $2.61 per diluted common

18  U.S. BANCORP



 

share, in 2006. Return on average assets and return on average common equity were 1.93 percent and 21.3 percent, respectively, in 2007, compared with returns of 2.23 percent and 23.6 percent, respectively, in 2006. The decline in the Company’s net income was driven by several significant items discussed below and management’s decision to further invest in payment services businesses, geographical presence, technology, relationship management and other customer service initiatives and product innovations. Also, credit losses increased in 2007 due to loan portfolio growth, somewhat higher levels of nonperforming assets from stress in the mortgage lending and homebuilding industries and deterioration in consumer credit quality experienced throughout the banking industry.

 

Table 1    SELECTED FINANCIAL DATA
 
                                         
Year Ended December 31
                             
(Dollars and Shares in Millions, Except Per Share Data)   2007     2006     2005     2004     2003  
   
 
Condensed Income Statement
                                       
Net interest income (taxable-equivalent basis) (a)
  $ 6,764     $ 6,790     $ 7,088     $ 7,140     $ 7,217  
Noninterest income
    7,157       6,832       6,151       5,624       5,068  
Securities gains (losses), net
    15       14       (106 )     (105 )     245  
     
     
Total net revenue
    13,936       13,636       13,133       12,659       12,530  
Noninterest expense
    6,862       6,180       5,863       5,785       5,597  
Provision for credit losses
    792       544       666       669       1,254  
     
     
Income from continuing operations before taxes
    6,282       6,912       6,604       6,205       5,679  
Taxable-equivalent adjustment
    75       49       33       29       28  
Applicable income taxes
    1,883       2,112       2,082       2,009       1,941  
     
     
Income from continuing operations
    4,324       4,751       4,489       4,167       3,710  
Discontinued operations (after-tax)
                            23  
     
     
Net income
  $ 4,324     $ 4,751     $ 4,489     $ 4,167     $ 3,733  
     
     
Net income applicable to common equity
  $ 4,264     $ 4,703     $ 4,489     $ 4,167     $ 3,733  
     
     
Per Common Share
                                       
Earnings per share from continuing operations
  $ 2.46     $ 2.64     $ 2.45     $ 2.21     $ 1.93  
Diluted earnings per share from continuing operations
    2.43       2.61       2.42       2.18       1.92  
Earnings per share
    2.46       2.64       2.45       2.21       1.94  
Diluted earnings per share
    2.43       2.61       2.42       2.18       1.93  
Dividends declared per share
    1.625       1.390       1.230       1.020       .855  
Book value per share
    11.60       11.44       11.07       10.52       10.01  
Market value per share
    31.74       36.19       29.89       31.32       29.78  
Average common shares outstanding
    1,735       1,778       1,831       1,887       1,924  
Average diluted common shares outstanding
    1,758       1,804       1,857       1,913       1,936  
Financial Ratios
                                       
Return on average assets
    1.93 %     2.23 %     2.21 %     2.17 %     1.99 %
Return on average common equity
    21.3       23.6       22.5       21.4       19.2  
Net interest margin (taxable-equivalent basis) (a)
    3.47       3.65       3.97       4.25       4.49  
Efficiency ratio (b)
    49.3       45.4       44.3       45.3       45.6  
Average Balances
                                       
Loans
  $ 147,348     $ 140,601     $ 131,610     $ 120,670     $ 116,937  
Loans held for sale
    4,298       3,663       3,290       3,079       5,041  
Investment securities
    41,313       39,961       42,103       43,009       37,248  
Earning assets
    194,683       186,231       178,425       168,123       160,808  
Assets
    223,621       213,512       203,198       191,593       187,630  
Noninterest-bearing deposits
    27,364       28,755       29,229       29,816       31,715  
Deposits
    121,075       120,589       121,001       116,222       116,553  
Short-term borrowings
    28,925       24,422       19,382       14,534       10,503  
Long-term debt
    44,560       40,357       36,141       35,115       33,663  
Shareholders’ equity
    20,997       20,710       19,953       19,459       19,393  
Period End Balances
                                       
Loans
  $ 153,827     $ 143,597     $ 136,462     $ 124,941     $ 116,811  
Allowance for credit losses
    2,260       2,256       2,251       2,269       2,369  
Investment securities
    43,116       40,117       39,768       41,481       43,334  
Assets
    237,615       219,232       209,465       195,104       189,471  
Deposits
    131,445       124,882       124,709       120,741       119,052  
Long-term debt
    43,440       37,602       37,069       34,739       33,816  
Shareholders’ equity
    21,046       21,197       20,086       19,539       19,242  
Regulatory capital ratios
                                       
Tier 1 capital
    8.3 %     8.8 %     8.2 %     8.6 %     9.1 %
Total risk-based capital
    12.2       12.6       12.5       13.1       13.6  
Leverage
    7.9       8.2       7.6       7.9       8.0  
Tangible common equity
    5.1       5.5       5.9       6.4       6.5  
 
 
(a) Presented on a fully taxable-equivalent basis utilizing a tax rate of 35 percent.
(b) Computed as noninterest expense divided by the sum of net interest income on a taxable-equivalent basis and noninterest income excluding securities gains (losses), net.

U.S. BANCORP  19



 

Total net revenue, on a taxable-equivalent basis for 2007, was $300 million (2.2 percent) higher than 2006, primarily reflecting a 4.8 percent increase in noninterest income, partially offset by a .4 percent decline in net interest income from a year ago. Noninterest income growth was driven primarily by organic growth in fee-based revenue of 8.6 percent, muted somewhat by $107 million of market valuation losses related to securities purchased during 2007 from certain money market funds managed by an affiliate. Refer to the “Market Risk Management” section for further information on securities purchased from certain money market funds managed by an affiliate. The fee-based revenue growth was further offset by the net favorable impact in 2006 of $142 million from several previously reported items, including a $50 million gain related to certain derivatives, $67 million of gains from the initial public offering and subsequent sale of equity interests in a cardholder association, a $52 million gain from the sale of a 401(k) defined contribution recordkeeping business and a $10 million gain related to a favorable settlement in the merchant processing business, offset by a $37 million reduction in mortgage banking revenue due principally to the adoption of fair value accounting for mortgage servicing rights (“MSRs”). The modest decline in net interest income reflected growth in average earning assets, more than offset by a lower net interest margin. In 2007, average earning assets increased $8.5 billion (4.5 percent), compared with 2006, primarily due to growth in total average loans of $6.7 billion (4.8 percent) and investment securities of $1.4 billion (3.4 percent). The net interest margin in 2007 was 3.47 percent, compared with 3.65 percent in 2006. The year-over-year decline in net interest margin reflected lower credit spreads given the competitive environment, a flat yield curve during early 2007 and lower net free funds relative to a year ago. In addition, funding costs were higher as rates paid on interest-bearing deposits increased and the funding mix continued to shift toward higher cost deposits and wholesale funding sources. These adverse factors impacting the net interest margin were offset somewhat by higher loan fees.
Total noninterest expense in 2007 increased $682 million (11.0 percent), compared with 2006, representing an efficiency ratio of 49.3 percent in 2007, compared with 45.4 percent in 2006. The increase included $330 million of charges recognized in 2007 for the Company’s proportionate share of a contingent obligation to indemnify Visa Inc. for certain litigation matters, including the settlement between Visa U.S.A. Inc. and American Express (collectively “Visa Charge”). For more information on the Visa Charge, refer to Note 21 of the Notes to Consolidated Financial Statements. Additionally, the increase in noninterest expense was caused by specific management decisions to make further investments in revenue-enhancing business initiatives designed to expand the Company’s geographical presence, strengthen corporate and commercial banking relationship management, capitalize on current product offerings, further improve technology and support innovation of products and services for customers. Growth in expenses from a year ago also included costs related to acquired payments businesses, investments in affordable housing and other tax-advantaged products, an increase in credit-related costs for other real estate owned and collection activities, and an increase in merchant airline processing expenses primarily due to sales volumes and business expansion with a major airline. The increase in these costs was partially offset by a $33 million debt prepayment charge recorded in 2006.
The provision for credit losses was $792 million for 2007, an increase of $248 million (45.6 percent) from 2006, reflecting growth in credit card accounts, increasing retail loan delinquencies and higher commercial and consumer credit losses from a year ago. In addition, the provision for credit losses in 2006 partially reflected the favorable residual impact on net charge-offs, principally for credit cards and other retail charge-offs, resulting from changes in bankruptcy laws enacted in the fourth quarter of 2005.
 
STATEMENT OF INCOME ANALYSIS
 
Net Interest Income Net interest income, on a taxable-equivalent basis, was $6.8 billion in 2007, $6.8 billion in 2006 and $7.1 billion in 2005. Average earning assets were $194.7 billion for 2007, compared with $186.2 billion and $178.4 billion for 2006 and 2005, respectively. The $8.5 billion (4.5 percent) increase in average earning assets for 2007, compared with 2006, was primarily driven by growth in total average loans of $6.7 billion (4.8 percent) and average investment securities of $1.4 billion (3.4 percent). The positive impact on net interest income from growth in earning assets was more than offset by a lower net interest margin from a year ago. The net interest margin in 2007 was 3.47 percent, compared with 3.65 percent and 3.97 percent in 2006 and 2005, respectively. The 18 basis point decline in 2007 net interest margin, compared with 2006, reflected the competitive business environment in 2007, the impact of a flat yield curve during the first half of the year and declining net free funds relative to a year ago. Compared with 2006, credit spreads tightened by approximately 6 basis points across most lending products due to competitive loan pricing. The reduction in net free funds was primarily due to a decline in non-interest bearing deposits, an investment in bank-owned life insurance, share repurchases through mid-third quarter 2007 and the impact of acquisitions. In addition, funding costs were higher as rates paid on interest-bearing deposits

20  U.S. BANCORP



 

 

Table 2    ANALYSIS OF NET INTEREST INCOME
                                         
                      2007
    2006
 
(Dollars in Millions)   2007     2006     2005     v 2006     v 2005  
Components of Net Interest Income
                                       
Income on earning assets (taxable-equivalent basis) (a)
  $ 13,309     $ 12,351     $ 10,584     $ 958     $ 1,767  
Expense on interest-bearing liabilities (taxable-equivalent basis)
    6,545       5,561       3,496       984       2,065  
                                         
Net interest income (taxable-equivalent basis)
  $ 6,764     $ 6,790     $ 7,088     $ (26 )   $ (298 )
                                         
                                         
Net interest income, as reported
  $ 6,689     $ 6,741     $ 7,055     $ (52 )   $ (314 )
                                         
                                         
Average Yields and Rates Paid
                                       
Earning assets yield (taxable-equivalent basis)
    6.84 %     6.63 %     5.93 %     .21 %     .70 %
Rate paid on interest-bearing liabilities (taxable-equivalent basis)
    3.91       3.55       2.37       .36       1.18  
                                         
Gross interest margin (taxable-equivalent basis)
    2.93 %     3.08 %     3.56 %     (.15 )%     (.48 )%
                                         
Net interest margin (taxable-equivalent basis)
    3.47 %     3.65 %     3.97 %     (.18 )%     (.32 )%
                                         
                                         
Average Balances
                                       
Investment securities
  $ 41,313     $ 39,961     $ 42,103     $ 1,352     $ (2,142 )
Loans
    147,348       140,601       131,610       6,747       8,991  
Earning assets
    194,683       186,231       178,425       8,452       7,806  
Interest-bearing liabilities
    167,196       156,613       147,295       10,583       9,318  
Net free funds (b)
    27,487       29,618       31,130       (2,131 )     (1,512 )
                                         
                                         
(a) Interest and rates are presented on a fully taxable-equivalent basis utilizing a federal tax rate of 35 percent.
(b) Represents noninterest-bearing deposits, allowance for loan losses, unrealized gain (loss) on available-for-sale securities, non-earning assets, other noninterest-bearing liabilities and equity.

increased and the funding mix continued to shift toward higher cost deposits and other funding sources. An increase in loan fees partially offset these factors. During the second half of 2007, the financial markets experienced significant turbulence as the impact of sub-prime mortgage delinquencies, defaults and foreclosures adversely affected investor confidence in a broad range of investment sectors and asset classes. In response to certain liquidity disruptions, the increasing risk of a credit crunch and other economic factors, the Federal Reserve Bank began to reduce interest rates beginning in September 2007, in an effort to stimulate the economy and restore investor confidence in the financial markets. Since that time, the target Federal Fund rate declined 100 basis points through year-end and another 125 basis points during January 2008. If the Federal Reserve Bank leaves rates unchanged from the current Federal Funds rate of 3.00 percent, the Company would expect the net interest margin to remain relatively stable at levels similar to 2007. This outlook is based on expectations that credit spreads will improve slightly, higher yielding retail loans will continue to grow, funding and liquidity in the overnight financial markets will normalize and the Company will resume its share repurchase program after the first quarter of 2008.
Average loans in 2007 were $6.7 billion (4.8 percent) higher than 2006, driven by growth in retail loans, commercial loans and residential mortgages of $3.5 billion (7.7 percent), $2.4 billion (5.2 percent) and $1.0 billion (4.9 percent), respectively, partially offset by a modest decline in commercial real estate loans of $.2 billion (.6 percent). The favorable change in average retail loans included strong growth in credit card balances of 25.4 percent as a result of growth in branch originated, co-branded and financial institution partner portfolios. Average installment loans, including automobile loans, increased 11.2 percent from a year ago. Average home equity loans increased at a more moderate growth rate of 5.1 percent, impacted somewhat by the changing trends in residential home valuations, while retail leasing balances declined approximately 8.4 percent from a year ago. The increase in average commercial loans was principally due to growth in corporate and industrial lending, equipment leasing and corporate payments product offerings. The decline in average commercial real estate balances reflected customer refinancing activities in the capital markets during the first half of 2007, a decision by the Company to reduce condominium construction financing and the impact of a economic slowdown in residential homebuilding since 2006.
Average investment securities were $1.4 billion (3.4 percent) higher in 2007, compared with 2006. The increase principally reflected higher balances in the municipal securities portfolio and the purchase in the fourth quarter of 2007 of securities from certain money market funds managed by an affiliate. This increase was partially offset by a reduction in mortgage-backed assets due to prepayments. Refer to the “Interest Rate Risk Management” section for further information on the sensitivity of net interest income to changes in interest rates.
Average noninterest-bearing deposits in 2007 were $1.4 billion (4.8 percent) lower than 2006. The year-over-

U.S. BANCORP  21



 

 

Table 3    NET INTEREST INCOME — CHANGES DUE TO RATE AND VOLUME (a)
 
                                                 
    2007 v 2006     2006 v 2005  
(Dollars in Millions)   Volume     Yield/Rate     Total     Volume     Yield/Rate     Total  
                                                 
Increase (decrease) in
                                               
Interest Income
                                               
Investment securities
  $ 70     $ 106     $ 176     $ (100 )   $ 201     $ 101  
Loans held for sale
    41             41       20       35       55  
                                                 
Loans
                                               
Commercial
    155       19       174       164       304       468  
Commercial real estate
    (12 )     (13 )     (25 )     51       249       300  
Residential mortgages
    60       70       130       167       56       223  
Retail
    279       199       478       167       410       577  
                                                 
Total loans
    482       275       757       549       1,019       1,568  
Other earning assets
    (22 )     6       (16 )     45       (2 )     43  
                                                 
Total earning assets
    571       387       958       514       1,253       1,767  
Interest Expense
                                               
Interest-bearing deposits
                                               
Interest checking
    25       93       118       5       93       98  
Money market savings
    (28 )     110       82       (32 )     243       211  
Savings accounts
    (1 )     1             (1 )     5       4  
Time certificates of deposit less than $100,000
    34       86       120       17       118       135  
Time deposits greater than $100,000
    2       43       45       51       331       382  
                                                 
Total interest-bearing deposits
    32       333       365       40       790       830  
Short-term borrowings
    229       60       289       179       373       552  
Long-term debt
    201       129       330       145       538       683  
                                                 
Total interest-bearing liabilities
    462       522       984       364       1,701       2,065  
                                                 
Increase (decrease) in net interest income
  $ 109     $ (135 )   $ (26 )   $ 150     $ (448 )   $ (298 )
                                                 
                                                 
(a) This table shows the components of the change in net interest income by volume and rate on a taxable-equivalent basis utilizing a tax rate of 35 percent. This table does not take into account the level of noninterest-bearing funding, nor does it fully reflect changes in the mix of assets and liabilities. The change in interest not solely due to changes in volume or rates has been allocated on a pro-rata basis to volume and yield/rate.

year decrease reflected a decline in personal and business demand deposits, partially offset by higher trust deposits. The decline in personal demand deposit balances occurred within the Consumer Banking business line. The decline in business demand deposits occurred within most business lines as business customers utilized deposit balances to fund business growth and meet other liquidity requirements.
Average total savings products increased $.9 billion (1.7 percent) in 2007, compared with 2006, as increases in interest checking balances more than offset declines in money market and savings balances, primarily within Consumer Banking. Interest checking balances increased $2.6 billion (10.9 percent) in 2007, compared with 2006, due to higher broker-dealer, government and institutional trust balances. Average money market savings balances declined year-over-year by $1.3 billion (5.0 percent) as a result of the Company’s deposit pricing decisions for money market products in relation to other fixed-rate deposit products. During 2007, a portion of branch-based money market savings accounts migrated to fixed-rate time certificates, as customers took advantage of higher interest rates for these products.
Average time certificates of deposit less than $100,000 were $.9 billion (6.5 percent) higher in 2007, compared with 2006. The year-over-year growth in time certificates less than $100,000 was primarily due to branch-based time deposits, reflecting customer migration to higher rate deposit products and pricing decisions for these products. Average time deposits greater than $100,000 were basically unchanged in 2007, compared with 2006. Time deposits greater than $100,000 are largely viewed as purchased funds and are managed at levels deemed appropriate, given alternative funding sources.
The decline in net interest income in 2006, compared with 2005, reflected growth in average earning assets, more than offset by a lower net interest margin. The $7.8 billion (4.4 percent) increase in average earning assets for 2006, compared with 2005, was primarily driven by growth in average loans, partially offset by a decrease in average investment securities. The 32 basis point decline in net interest margin in 2006, compared with 2005, reflected the competitive lending environment and the impact of a flatter yield curve. The net interest margin also declined due to funding incremental asset growth with higher cost wholesale funding, share repurchases and asset/liability decisions. An

22  U.S. BANCORP



 

increase in the margin benefit of net free funds and loan fees partially offset these factors.
Average loans in 2006 were higher by $9.0 billion (6.8 percent), compared with 2005, driven by growth in residential mortgages, commercial loans and retail loans. Average investment securities were $2.1 billion (5.1 percent) lower in 2006, compared with 2005, principally reflecting asset/liability management decisions to reduce the focus on residential mortgage-backed assets given the rising interest rate environment in 2006 and the mix of loan growth experienced by the Company. Average noninterest-bearing deposits in 2006 were $.5 billion (1.6 percent) lower than in 2005. The year-over-year decrease reflected a decline in personal and business demand deposits, partially offset by higher corporate trust deposits resulting from acquisitions. Average total savings products declined $2.1 billion (3.6 percent) in 2006, compared with 2005, due to reductions in average money market savings and other savings accounts, partially offset by an increase in interest checking balances. Average money market savings account balances declined from 2005 to 2006 by $2.6 billion (9.0 percent), primarily due to a decline in branch-based balances. The decline was primarily the result of the Company’s deposit pricing decisions for money market products in relation to other fixed-rate deposit products offered. During 2006, a portion of branch-based money market savings balances migrated to fixed-rate time certificates to take advantage of higher interest rates for these products. Average time certificates of deposit less than $100,000 and average time deposits greater than $100,000 grew $.6 billion (4.3 percent) and $1.6 billion (7.7 percent), respectively, in 2006 compared with 2005, primarily driven by the migration of money market balances within the Consumer Banking and Wealth Management & Securities Services business lines, as customers migrated balances to higher rate deposits.
 
Provision for Credit Losses The provision for credit losses is recorded to bring the allowance for credit losses to a level deemed appropriate by management, based on factors discussed in the “Analysis and Determination of Allowance for Credit Losses” section.
In 2007, the provision for credit losses was $792 million, compared with $544 million and $666 million in 2006 and 2005, respectively. The $248 million (45.6 percent) increase in the provision for credit losses in 2007 reflected growth in credit card accounts, increasing loan delinquencies and nonperforming loans, and higher commercial and consumer credit losses from a year ago. In addition, the provision for 2006 partially reflected the favorable residual impact on net charge-offs, principally for credit cards and other retail charge-offs, resulting from changes in bankruptcy laws enacted in the fourth quarter of 2005. Nonperforming loans increased $87 million (18.5 percent) from December 31, 2006, as a result of stress in condominium and other residential home construction. Accruing loans ninety days past due increased $235 million (67.3 percent), primarily related to residential mortgages, credit cards and home equity loans. Restructured loans that continue to accrue interest increased $127 million (31.3 percent), reflecting the impact of programs for certain credit card and sub-prime residential mortgage customers in light of current economic conditions. Net charge-offs increased $248 million (45.6 percent) from 2006, primarily due to an anticipated increase in consumer charge-offs principally related to growth in credit card balances, and somewhat higher commercial loan net charge-offs. In addition, net charge-offs were lower during 2006, reflecting the beneficial impact of bankruptcy legislation that went into effect during the fourth quarter of 2005.
The $122 million (18.3 percent) decrease in the provision for credit losses in 2006, compared with 2005, reflected stable credit quality in 2006 and the adverse impact in the fourth quarter of 2005 on net charge-offs from changes in bankruptcy laws enacted in 2005. Nonperforming loans, principally reflecting favorable changes in the quality of commercial loans, declined $74 million from December 31, 2005. However, accruing loans ninety days past due and restructured loans that continue to accrue interest increased by $186 million over this same period. Net charge-offs declined $141 million from 2005, principally due to the impact of changes in bankruptcy laws that went into effect during the fourth quarter of 2005. In 2005, approximately $64 million of incremental net charge-offs occurred due to the change in bankruptcy laws and a separate policy change related to overdraft balances. As a result of these changes, bankruptcy charge-offs were lower in 2006, while customers experiencing credit deterioration migrated further through contractual delinquencies. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and other factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.
 
Noninterest Income Noninterest income in 2007 was $7.2 billion, compared with $6.8 billion in 2006 and $6.0 billion in 2005. The $326 million (4.8 percent) increase in 2007 over 2006, was driven by strong organic fee-based revenue growth (8.6 percent) in most fee categories, offset somewhat by the $107 million in valuation losses related to securities purchased from certain money market funds managed by an affiliate. Additionally, 2006 included several significant items representing approximately $142 million of incremental revenue, including: higher trading income related to gains from the termination of certain interest rate swaps, equity gains from the initial public offering and

U.S. BANCORP  23



 

 

Table 4    NONINTEREST INCOME
                                     
                  2007
    2006
 
(Dollars in Millions)   2007   2006   2005     v 2006     v 2005  
Credit and debit card revenue
  $ 949   $ 800   $ 713       18.6 %     12.2 %
Corporate payment products revenue
    631     557     488       13.3       14.1  
ATM processing services
    245     243     229       .8       6.1  
Merchant processing services
    1,101     963     770       14.3       25.1  
Trust and investment management fees
    1,339     1,235     1,009       8.4       22.4  
Deposit service charges
    1,058     1,023     928       3.4       10.2  
Treasury management fees
    472     441     437       7.0       .9  
Commercial products revenue
    433     415     400       4.3       3.8  
Mortgage banking revenue
    259     192     432       34.9       (55.6 )
Investment products fees and commissions
    146     150     152       (2.7 )     (1.3 )
Securities gains (losses), net
    15     14     (106 )     7.1       *  
Other
    524     813     593       (35.5 )     37.1  
                                     
Total noninterest income
  $ 7,172   $ 6,846   $ 6,045       4.8 %     13.3 %
                                     
                                     
* Not meaningful

subsequent sale of the equity interests in a cardholder association, a gain on the sale of a 401(k) defined contribution recordkeeping business, and a favorable settlement in the merchant processing business, offset by lower mortgage banking revenue due to adopting fair value accounting standards for MSRs.
The growth in credit and debit card revenue of 18.6 percent was primarily driven by an increase in customer accounts and higher customer transaction volumes from a year ago. The increase coincides with the strong organic growth in credit card balances during the year. The corporate payment products revenue growth of 13.3 percent reflected growth in customer sales volumes and card usage, and the impact of an acquired business. Merchant processing services revenue was 14.3 percent higher in 2007, compared with 2006, reflecting an increase in customers and sales volumes on both a domestic and global basis. Trust and investment management fees increased 8.4 percent primarily due to core account growth and favorable equity market conditions during the year. Deposit service charges were 3.4 percent higher year-over-year due primarily to increased transaction-related fees and the impact of continued growth in net new checking accounts. This growth in deposit account-related revenue was muted somewhat as service charges, traditionally reflected in this fee category, continued to migrate to yield-related loan fees as customers utilized new consumer products. Treasury management fees increased 7.0 percent over the prior year due, in part, to new customer account growth, new product offerings and higher transaction volumes. Commercial products revenue increased 4.3 percent over the prior year due to higher syndication fees, and foreign exchange and commercial leasing revenue. Mortgage banking revenue increased 34.9 percent in 2007, compared with 2006, due to an increase in mortgage originations and servicing income, partially offset by an adverse net change in the valuation of MSRs and related economic hedging activities given changing interest rates. In 2006, mortgage banking revenue included a valuation loss of $37 million related to the adoption of fair value accounting for MSRs.
Growth in these fee-based revenue categories was partially offset by slightly lower investment products fees and commissions and a decline in other income. The 35.5 percent reduction of other revenue in 2007, compared with 2006, included $107 million in valuation losses recognized in 2007, related to securities purchased from certain money market funds managed by an affiliate. In addition, 2006 results reflected a $52 million gain on the sale of a 401(k) defined contribution recordkeeping business, $67 million of gains on the initial public offering and subsequent sale of the equity interests in a cardholder association, a $10 million favorable legal settlement within the merchant processing business and a $50 million trading gain related to terminating certain interest rate swaps.
The $801 million (13.3 percent) increase in 2006 over 2005, was driven by organic business growth in several fee categories, expansion in trust and payment processing businesses, a favorable change of $120 million in net securities gains (losses) and other gains recorded in 2006 of $179 million. These included the gains from terminated interest rate swaps, equity gains from the initial public offering and subsequent sale of the equity interests in a cardholder association, gains from the sale of a 401(k) defined contribution recordkeeping business and a favorable legal settlement in the merchant processing business. The growth in credit and debit card revenue was principally driven by higher customer transaction sales volumes and fees related to cash advances, balance transfers and over-limit positions. The corporate payment products revenue growth reflected organic growth in sales volumes and card usage, enhancements in product pricing and acquired business expansion. ATM processing services revenue was higher due

24  U.S. BANCORP



 

to an ATM business acquisition in May 2005. Merchant processing services revenue reflected an increase in sales volume driven by acquisitions, higher same store sales, new merchant signings and associated equipment fees. The increase in trust and investment management fees was primarily due to organic customer account growth, improving asset management fees given favorable equity market conditions, and incremental revenue generated by acquisitions of corporate and institutional trust businesses. Deposit service charges grew due to increased transaction-related fees and the impact of net new checking accounts. Mortgage banking revenue declined primarily due to the adoption of fair value accounting for MSRs. Other income increased primarily due to the notable asset gains previously discussed.
 
Noninterest Expense Noninterest expense in 2007 was $6.9 billion, compared with $6.2 billion and $5.9 billion in 2006 and 2005, respectively. The Company’s efficiency ratio increased to 49.3 percent in 2007 from 45.4 percent in 2006. The change in the efficiency ratio and the $682 million (11.0 percent) increase in noninterest expenses in 2007, compared with 2006, was principally due to a $330 million Visa Charge recognized in 2007 for the contingent obligation for certain Visa U.S.A. Inc. litigation matters. The remaining expense increase was principally related to higher credit costs, incremental growth in tax-advantaged projects or specific management investment in revenue-enhancing business initiatives designed to expand the Company’s geographical presence, strengthen corporate and commercial banking relationship management, capitalize on current product offerings, further improve technology and support innovation of products and services for customers. The impact of these factors was reflected in various expense categories.
Compensation expense was 5.1 percent higher year-over-year primarily due to investment in personnel within the branch distribution network, Wholesale Banking and Payment Services in connection with various business initiatives, including the Company’s PowerBank initiative with Consumer Banking, expanding its corporate banking team, enhancing relationship management processes and supporting organic business growth and acquired businesses. Employee benefits expense increased 2.7 percent year-over-year as higher medical costs were partially offset by lower pension costs. Net occupancy and equipment expense increased 3.9 percent primarily due to bank acquisitions and investments in branches. Professional services expense was 17.1 percent higher due to revenue enhancing business initiatives, higher litigation-related costs, and higher legal fees associated with the establishment of a bank charter in Ireland to support pan-European payment processing. Marketing and business development expense increased 11.5 percent over the prior year due to higher customer promotion, solicitation and advertising activities. Postage, printing and supplies increased 6.8 percent due to increasing customer promotional mailings and changes in postal rates from a year ago. Other intangibles expense increased 5.9 percent year-over-year due to recent acquisitions in Consumer Banking, Wealth Management & Securities Services and Payment Services. Other expense increased $444 million (46.6 percent) over the prior year primarily due to the $330 million Visa Charge, higher costs related to affordable housing and other tax-advantaged investments, an increase in merchant processing expenses to support organic growth in Payment Services, integration expenses related to recent acquisitions and higher credit-related costs for other real estate owned and loan collection activities. These increases were partially offset by $33 million of debt prepayment charges recorded during 2006.
The $317 million (5.4 percent) increase in noninterest expenses in 2006, compared with 2005, was primarily driven by incremental operating and business integration costs associated with acquisitions, increased pension costs and higher expense related to certain tax-advantaged

 

Table 5    NONINTEREST EXPENSE
                                         
                      2007
    2006
 
(Dollars in Millions)   2007     2006     2005     v 2006     v 2005  
Compensation
  $ 2,640     $ 2,513     $ 2,383       5.1 %     5.5 %
Employee benefits
    494       481       431       2.7       11.6  
Net occupancy and equipment
    686       660       641       3.9       3.0  
Professional services
    233       199       166       17.1       19.9  
Marketing and business development
    242       217       235       11.5       (7.7 )
Technology and communications
    512       505       466       1.4       8.4  
Postage, printing and supplies
    283       265       255       6.8       3.9  
Other intangibles
    376       355       458       5.9       (22.5 )
Debt prepayment
          33       54       *       (38.9 )
Other (a)
    1,396       952       774       46.6       23.0  
                                         
Total noninterest expense
  $ 6,862     $ 6,180     $ 5,863       11.0 %     5.4 %
                                         
                                         
Efficiency ratio (b)
    49.3 %     45.4 %     44.3 %                
                                         
                                         
(a) Included in other expense in 2007 was a $330 million charge related to the Company’s contingent obligation to Visa U.S.A. Inc for indemnification of certain litigation matters.
(b) Computed as noninterest expense divided by the sum of net interest income on a taxable-equivalent basis and noninterest income excluding securities gains (losses), net.
* Not meaningful

U.S. BANCORP  25



 

investments. This was partially offset by a reduction in other intangibles expense and lower debt prepayment charges in 2006. Compensation expense was higher primarily due to corporate and institutional trust and payments processing acquisitions and other growth initiatives undertaken by the Company. Employee benefits increased primarily as a result of higher pension expense. Net occupancy and equipment expense increased primarily due to business expansion. Professional services expense was higher primarily due to revenue enhancement-related business initiatives and higher legal costs. Technology and communications expense rose, reflecting higher outside data processing expense principally associated with expanding a prepaid gift card program and acquisitions. Other intangibles expense decreased in connection with the adoption of fair value accounting for MSRs in 2006, and the impact of eliminating the amortization and related impairments or reparations of these servicing rights. Debt prepayment charges declined from 2005 and were related to longer-term callable debt that was prepaid by the Company as part of asset/liability decisions to improve funding costs and reposition the Company’s interest rate risk position. Other expense increased primarily due to increased investments in tax-advantaged projects and business integration costs.
 
Pension Plans Because of the long-term nature of pension plans, the administration and accounting for pensions is complex and can be impacted by several factors, including investment and funding policies, accounting methods and the plans’ actuarial assumptions. Refer to Note 16 of the Notes to Consolidated Financial Statements for further information on funding practices, investment policies and asset allocation strategies.
The Company’s pension accounting policy follows generally accepted accounting standards and reflects the long-term nature of benefit obligations and the investment horizon of plan assets. Actuarial gains and losses include the impact of plan amendments and various unrecognized gains and losses related to differences in actual plan experience compared with actuarial assumptions, which are deferred and amortized over the future service periods of active employees. The actuarially derived market-related value utilized to determine the expected return on plan assets is based on fair value, adjusted for the difference between expected returns and actual performance of plan assets. The unrealized difference between actual experience and expected returns is included in the actuarially derived market-related value and amortized as a component of pension expense ratably over a five-year period. At September 30, 2007, this accumulated unrecognized gain approximated $358 million, compared with $249 million at September 30, 2006. The impact on pension expense of the unrecognized asset gains will incrementally decrease pension costs in each year from 2008 to 2012, by approximately $38 million, $29 million, $24 million, $15 million and $12 million, respectively. This assumes that the performance of plan assets in 2008 and beyond equals the assumed long-term rate of return (“LTROR”). Actual results will vary depending on the performance of plan assets and changes to assumptions required in the future. Refer to Note 1 of the Notes to Consolidated Financial Statements for further discussion of the Company’s accounting policies for pension plans.
In 2008, the Company anticipates that pension costs will decrease by approximately $36 million. The decrease will be primarily driven by utilizing a higher discount rate and amortization of unrecognized actuarial gains from prior years, accounting for approximately $14 million and $37 million of the anticipated decrease, respectively, partially offset by a $15 million increase related to a change in the assumption of future salary growth.
Due to the complexity of forecasting pension plan activities, the accounting method utilized for pension plans, management’s ability to respond to factors impacting the plans and the hypothetical nature of this information, the actual changes in periodic pension costs could be different than the information provided in the sensitivity analysis below.
 
Note 16 of the Notes to Consolidated Financial Statements provides a summary of the significant pension plan assumptions. Because of the subjective nature of plan assumptions, a sensitivity analysis to hypothetical changes in the LTROR and the discount rate is provided below:
                         
        Base
   
LTROR (Dollars in Millions)   7.9%   8.9%   9.9%
 
Incremental benefit (cost)
  $ (25 )   $     $ 25  
Percent of 2007 net income
    (.36 )%     %     .36 %
 
 
        Base
   
Discount Rate (Dollars in Millions)   5.3%   6.3%   7.3%
 
Incremental benefit (cost)
  $ (56 )   $     $ 42  
Percent of 2007 net income
    (.80 )%     %     .60 %
 
 
 
Income Tax Expense The provision for income taxes was $1,883 million (an effective rate of 30.3 percent) in 2007, compared with $2,112 million (an effective rate of 30.8 percent) in 2006 and $2,082 million (an effective rate of 31.7 percent) in 2005. The decrease in the effective tax rate from 2006 primarily reflected higher tax exempt income from investment securities and insurance products as well as incremental tax credits from affordable housing and other tax-advantaged investments.
Included in 2006 was a reduction of income tax expense of $61 million related to the resolution of federal income tax examinations covering substantially all of the Company’s legal entities for all years through 2004 and $22 million related to certain state examinations. Included in the determination of income taxes for 2005 was a reduction

26  U.S. BANCORP



 

of income tax expense of $94 million related to the resolution of income tax examinations. The Company anticipates that its effective tax rate for the foreseeable future will remain stable relative to the full year rate for 2007 of 30.3 percent of pretax earnings.
For further information on income taxes, refer to Note 18 of the Notes to Consolidated Financial Statements.
 
BALANCE SHEET ANALYSIS
 
Average earning assets were $194.7 billion in 2007, compared with $186.2 billion in 2006. The increase in average earning assets of $8.5 billion (4.5 percent) was due to growth in total average loans (4.8 percent), investment securities (3.4 percent) and loans held-for-sale (17.3 percent), partially offset by slightly lower trading and other earning assets. The change in total average earning assets was principally funded by increases in wholesale funding.
For average balance information, refer to Consolidated Daily Average Balance Sheet and Related Yields and Rates on pages 112 and 113.
 
Loans The Company’s loan portfolio was $153.8 billion at December 31, 2007, an increase of $10.2 billion (7.1 percent) from December 31, 2006. The increase was driven by growth in all major loan categories with strong growth in commercial loans (10.6 percent), retail loans (6.9 percent), and residential mortgages (7.0 percent) and more moderate

 

Table 6    LOAN PORTFOLIO DISTRIBUTION
 
                                                                                 
    2007     2006     2005     2004     2003  
          Percent
          Percent
          Percent
          Percent
          Percent
 
At December 31 (Dollars in Millions)   Amount     of Total     Amount     of Total     Amount     of Total     Amount     of Total     Amount     of Total  
Commercial
                                                                               
Commercial
  $ 44,832       29.1 %   $ 40,640       28.3 %   $ 37,844       27.7 %   $ 35,210       28.2 %   $ 33,536       28.7 %
Lease financing
    6,242       4.1       5,550       3.9       5,098       3.7       4,963       4.0       4,990       4.3  
                                                                                 
Total commercial
    51,074       33.2       46,190       32.2       42,942       31.4       40,173       32.2       38,526       33.0  
Commercial Real Estate
                                                                               
Commercial mortgages
    20,146       13.1       19,711       13.7       20,272       14.9       20,315       16.3       20,624       17.6  
Construction and development
    9,061       5.9       8,934       6.2       8,191       6.0       7,270       5.8       6,618       5.7  
                                                                                 
Total commercial real estate
    29,207       19.0       28,645       19.9       28,463       20.9       27,585       22.1       27,242       23.3  
Residential Mortgages
                                                                               
Residential mortgages
    17,099       11.1       15,316       10.7       14,538       10.7       9,722       7.8       7,332       6.3  
Home equity loans, first liens
    5,683       3.7       5,969       4.1       6,192       4.5       5,645       4.5       6,125       5.2  
                                                                                 
Total residential mortgages
    22,782       14.8       21,285       14.8       20,730       15.2       15,367       12.3       13,457       11.5  
Retail
                                                                               
Credit card
    10,956       7.1       8,670       6.0       7,137       5.2       6,603       5.3       5,933       5.1  
Retail leasing
    5,969       3.9       6,960       4.9       7,338       5.4       7,166       5.7       6,029       5.2  
Home equity and second mortgages
    16,441       10.7       15,523       10.8       14,979       11.0       14,851       11.9       13,210       11.3  
Other retail
                                                                               
Revolving credit
    2,731       1.8       2,563       1.8       2,504       1.8       2,541       2.0       2,540       2.2  
Installment
    5,246       3.4       4,478       3.1       3,582       2.6       2,767       2.2       2,380       2.0  
Automobile
    8,970       5.8       8,693       6.1       8,112       6.0       7,419       5.9       7,165       6.1  
Student
    451       .3       590       .4       675       .5       469       .4       329       .3  
                                                                                 
Total other retail
    17,398       11.3       16,324       11.4       14,873       10.9       13,196       10.5       12,414       10.6  
                                                                                 
Total retail
    50,764       33.0       47,477       33.1       44,327       32.5       41,816       33.4       37,586       32.2  
                                                                                 
Total loans
  $ 153,827       100.0 %   $ 143,597       100.0 %   $ 136,462       100.0 %   $ 124,941       100.0 %   $ 116,811       100.0 %
                                                                                 
                                                                                 
 

Table 7    SELECTED LOAN MATURITY DISTRIBUTION
                           
          Over One
       
    One Year
    Through
  Over Five
   
December 31, 2007 (Dollars in Millions)   or Less     Five Years   Years   Total
 
 
Commercial
  $ 21,999     $ 25,092   $ 3,983   $ 51,074
Commercial real estate
    9,308       13,182     6,717     29,207
Residential mortgages
    899       2,540     19,343     22,782
Retail
    18,661       18,607     13,496     50,764
     
     
Total loans
  $ 50,867     $ 59,421   $ 43,539   $ 153,827
Total of loans due after one year with
                         
Predetermined interest rates
                      $ 52,001
Floating interest rates
                      $ 50,959
 
 

U.S. BANCORP  27



 

growth in commercial real estate loans (2.0 percent). Table 6 provides a summary of the loan distribution by product type, while Table 7 provides a summary of selected loan maturity distribution by loan category. Average total loans increased $6.7 billion (4.8 percent) in 2007, compared with 2006. The increase was due to strong growth in retail loans and moderate growth in commercial loans and residential mortgages, while average commercial real estate loans were essentially unchanged from a year ago.
 
Commercial Commercial loans, including lease financing, increased $4.9 billion (10.6 percent) as of December 31, 2007, compared with December 31, 2006. During 2007, the Company made certain personnel investments and organizational changes to better emphasize corporate banking, with an enhanced focus on relationship banking. As a result of these business initiatives and changing economic conditions, the Company experienced growth in commercial loans driven by new customer relationships, utilization of lines of credit and growth in commercial leasing and corporate payment card balances. Average commercial loans increased $2.4 billion (5.2 percent) in 2007, compared with 2006, primarily due to these initiatives and an increase in commercial loan demand driven by general economic conditions in 2007.
Table 8 provides a summary of commercial loans by industry and geographical locations.
 
Commercial Real Estate The Company’s portfolio of commercial real estate loans, which includes commercial mortgages and construction loans, was essentially unchanged from a year ago. Total commercial real estate balances increased $.6 billion (2.0 percent) at December 31, 2007, compared with December 31, 2006. Average commercial real estate loans decreased $.2 billion (.6 percent) in 2007, compared with 2006. Since 2006, growth in commercial real estate balances has been limited due to capital market

 

Table 8    COMMERCIAL LOANS BY INDUSTRY GROUP AND GEOGRAPHY
 
                               
    December 31, 2007     December 31, 2006  
Industry Group (Dollars in Millions)   Loans     Percent     Loans   Percent  
Consumer products and services
  $ 9,576       18.8 %   $ 9,303     20.1 %
Financial services
    7,693       15.1       6,375     13.8  
Commercial services and supplies
    4,144       8.1       4,645     10.1  
Capital goods
    3,982       7.8       3,872     8.4  
Property management and development
    3,239       6.3       3,104     6.7  
Agriculture
    2,746       5.4       2,436     5.3  
Healthcare
    2,521       4.9       2,328     5.0  
Paper and forestry products, mining and basic materials
    2,289       4.5       2,190     4.7  
Consumer staples
    2,197       4.3       1,749     3.8  
Transportation
    1,897       3.7       1,662     3.6  
Private investors
    1,685       3.3       1,565     3.4  
Energy
    1,576       3.1       1,104     2.4  
Information technology
    1,085       2.1       821     1.8  
Other
    6,444       12.6       5,036     10.9  
                               
Total
  $ 51,074       100.0 %   $ 46,190     100.0 %
                               
                               
Geography
                             
                               
California
  $ 5,091       10.0 %   $ 4,112     8.9 %
Colorado
    2,490       4.9       2,958     6.4  
Illinois
    2,899       5.7       2,789     6.0  
Minnesota
    6,254       12.2       6,842     14.8  
Missouri
    1,690       3.3       1,862     4.0  
Ohio
    2,554       5.0       2,672     5.8  
Oregon
    2,021       4.0       1,870     4.0  
Washington
    2,364       4.6       2,212     4.8  
Wisconsin
    2,337       4.6       2,295     5.0  
Iowa, Kansas, Nebraska, North Dakota, South Dakota
    5,150       10.1       4,308     9.3  
Arkansas, Indiana, Kentucky, Tennessee
    2,066       4.0       2,070     4.5  
Idaho, Montana, Wyoming
    1,033       2.0       1,015     2.2  
Arizona, Nevada, Utah
    1,947       3.8       1,602     3.5  
                               
Total banking region
    37,896       74.2       36,607     79.2  
Outside the Company’s banking region
    13,178       25.8       9,583     20.8  
                               
Total
  $ 51,074       100.0 %   $ 46,190     100.0 %
                               
                               

28  U.S. BANCORP



 

 

Table 9    COMMERCIAL REAL ESTATE BY PROPERTY TYPE AND GEOGRAPHY
                               
    December 31, 2007     December 31, 2006  
Property Type (Dollars in Millions)   Loans     Percent     Loans   Percent  
Business owner occupied
  $ 10,340       35.4 %   $ 10,027     35.0 %
Commercial property
                             
Industrial
    818       2.8       939     3.3  
Office
    2,424       8.3       2,226     7.8  
Retail
    2,979       10.2       2,732     9.5  
Other commercial
    3,184       10.9       2,745     9.6  
Homebuilders
                             
Condominiums
    1,081       3.7       1,117     3.9  
Other residential
    3,008       10.3       3,440     12.0  
Multi-family
    4,001       13.7       3,850     13.4  
Hotel/motel
    1,051       3.6       1,126     3.9  
Health care facilities
    321       1.1       443     1.6  
                               
Total
  $ 29,207       100.0 %   $ 28,645     100.0 %
                               
 
Geography
                             
                               
California
  $ 5,783       19.8 %   $ 6,044     21.1 %
Colorado
    1,577       5.4       1,404     4.9  
Illinois
    1,110       3.8       1,060     3.7  
Minnesota
    1,723       5.9       1,833     6.4  
Missouri
    1,577       5.4       1,461     5.1  
Ohio
    1,314       4.5       1,375     4.8  
Oregon
    1,840       6.3       1,747     6.1  
Washington
    2,950       10.1       3,065     10.7  
Wisconsin
    1,460       5.0       1,547     5.4  
Iowa, Kansas, Nebraska, North Dakota, South Dakota
    2,103       7.2       1,948     6.8  
Arkansas, Indiana, Kentucky, Tennessee
    1,402       4.8       1,404     4.9  
Idaho, Montana, Wyoming
    1,227       4.2       1,060     3.7  
Arizona, Nevada, Utah
    2,629       9.0       2,406     8.4  
                               
Total banking region
    26,695       91.4       26,354     92.0  
Outside the Company’s banking region
    2,512       8.6       2,291     8.0  
                               
Total
  $ 29,207       100.0 %   $ 28,645     100.0 %
                               
 

conditions in early 2007 that enabled customer refinancing of projects, a management decision to reduce condominium construction financing in selected markets, and a slowdown in residential homebuilding impacting construction lending. During the fourth quarter of 2007, the Company experienced growth of 2.4 percent in commercial real estate loans as developers sought bank financing as liquidity disruptions in the capital markets occurred. Table 9 provides a summary of commercial real estate by property type and geographical locations.
The Company maintains the real estate construction designation until the completion of the construction phase and, if retained, the loan is reclassified to the commercial mortgage category. Approximately $107 million of construction loans were permanently financed and reclassified to the commercial mortgage loan category in 2007. At December 31, 2007, $231 million of tax-exempt industrial development loans were secured by real estate. The Company’s commercial real estate mortgages and construction loans had unfunded commitments of $8.9 billion at December 31, 2007 and 2006. The Company also finances the operations of real estate developers and other entities with operations related to real estate. These loans are not secured directly by real estate and are subject to terms and conditions similar to commercial loans. These loans were included in the commercial loan category and totaled $1.8 billion at December 31, 2007.
 
Residential Mortgages Residential mortgages held in the loan portfolio at December 31, 2007, increased $1.5 billion (7.0 percent) from December 31, 2006. The growth was principally the result of an increase in consumer finance originations during the year. The majority of loans retained in the portfolio represented originations to customers with better than sub-prime credit risk ratings. Average residential mortgages increased 1.0 billion (4.9 percent) in 2007, compared with 2006. The growth in average residential mortgages from the consumer finance distribution channel was offset somewhat by lower balances from traditional branch and mortgage banking channels.
 
Retail Total retail loans outstanding, which include credit card, retail leasing, home equity and second mortgages and other retail loans, increased $3.3 billion (6.9 percent) at December 31, 2007, compared with December 31, 2006.

U.S. BANCORP  29



 

 

Table 10    RESIDENTIAL MORTGAGES AND RETAIL LOANS BY GEOGRAPHY
                             
    December 31, 2007     December 31, 2006  
(Dollars in Millions)   Loans   Percent     Loans   Percent  
Residential Mortgages
                           
California
  $ 1,426     6.2 %   $ 1,356     6.4 %
Colorado
    1,566     6.9       1,480     6.9  
Illinois
    1,450     6.3       1,359     6.4  
Minnesota
    2,292     10.1       2,287     10.7  
Missouri
    1,562     6.9       1,516     7.1  
Ohio
    1,605     7.0       1,529     7.2  
Oregon
    968     4.2       952     4.5  
Washington
    1,266     5.6       1,273     6.0  
Wisconsin
    1,142     5.0       1,100     5.2  
Iowa, Kansas, Nebraska, North Dakota, South Dakota
    1,502     6.6       1,512     7.1  
Arkansas, Indiana, Kentucky, Tennessee
    1,886     8.3       1,676     7.9  
Idaho, Montana, Wyoming
    521     2.3       470     2.2  
Arizona, Nevada, Utah
    1,267     5.6       1,168     5.5  
                             
Total banking region
    18,453     81.0       17,678     83.1  
Outside the Company’s banking region
    4,329     19.0       3,607     16.9  
                             
Total
  $ 22,782     100.0 %   $ 21,285     100.0 %
                             
                             
Retail Loans
                           
California
  $ 6,261     12.3 %   $ 5,769     12.1 %
Colorado
    2,427     4.8       2,284     4.8  
Illinois
    2,614     5.1       2,429     5.1  
Minnesota
    5,247     10.3       5,075     10.7  
Missouri
    2,522     5.0       2,464     5.2  
Ohio
    3,276     6.5       3,224     6.8  
Oregon
    2,244     4.4       2,024     4.3  
Washington
    2,492     4.9       2,278     4.8  
Wisconsin
    2,529     5.0       2,454     5.2  
Iowa, Kansas, Nebraska, North Dakota, South Dakota
    3,203     6.3       3,096     6.5  
Arkansas, Indiana, Kentucky, Tennessee
    3,748     7.4       3,588     7.6  
Idaho, Montana, Wyoming
    1,564     3.1       1,339     2.8  
Arizona, Nevada, Utah
    2,231     4.4       1,964     4.1  
                             
Total banking region
    40,358     79.5       37,988     80.0  
Outside the Company’s banking region
    10,406     20.5       9,489     20.0  
                             
Total
  $ 50,764     100.0 %   $ 47,477     100.0 %
                             
                             

The increase was primarily driven by growth in credit card, installment and home equity loans, partially offset by decreases in retail leasing and student loan balances. Average retail loans increased $3.5 billion (7.7 percent) in 2007, principally reflecting growth in credit card and installment loans. Strong growth in credit cards occurred in branch originated, co-branded and financial institution partner portfolios.
Of the total retail loans and residential mortgages outstanding, approximately 80.0 percent were to customers located in the Company’s primary banking region. Table 10 provides a geographic summary of residential mortgages and retail loans outstanding as of December 31, 2007 and 2006.
 
Loans Held for Sale Loans held for sale, consisting primarily of residential mortgages and student loans to be sold in the secondary market, were $4.8 billion at December 31, 2007, compared with $3.3 billion at December 31, 2006. The increase in loans held for sale was principally due to an increase in residential mortgage loan balances. Average loans held for sale were $4.3 billion in 2007, compared with $3.7 billion in 2006. During 2007, certain companies in the mortgage banking industry experienced significant disruption due to their inability to access financing through the capital markets as investor concerns increased related to the quality of sub-prime loan originations and related securitizations. The Company’s primary focus of originating conventional mortgages packaged through government agencies enabled it to avoid these issues impacting other mortgage banking firms. Given these market conditions and the nature of the Company’s mortgage banking business, residential mortgage originations increased in 2007 by 21.2 percent as customers sought more reliable financing alternatives.
 
Investment Securities The Company uses its investment securities portfolio for several purposes. It serves as a vehicle to manage interest rate risk, generates interest and dividend income from the investment of excess funds depending on

30  U.S. BANCORP



 

loan demand, provides liquidity and is used as collateral for public deposits and wholesale funding sources. While it is the Company’s intent to hold its investment securities indefinitely, the Company may take actions in response to structural changes in the balance sheet and related interest rate risk and to meet liquidity requirements, among other factors.
At December 31, 2007, investment securities, both available-for-sale and held-to-maturity, totaled $43.1 billion, compared with $40.1 billion at December 31, 2006. The $3.0 billion (7.5 percent) increase reflected securities purchases of $9.7 billion partially offset by securities sales, maturities and prepayments. Included in purchases during 2007, were approximately $3.0 billion of securities from certain money market funds managed by an affiliate of the Company. These securities primarily represent beneficial interests in structured investment vehicles or similar

 

Table 11    INVESTMENT SECURITIES
 
                                                       
    Available-for-Sale     Held-to-Maturity  
              Weighted-
                Weighted-
     
              Average
  Weighted-
            Average
  Weighted-
 
    Amortized
    Fair
  Maturity in
  Average
    Amortized
  Fair
  Maturity in
  Average
 
December 31, 2007 (Dollars in Millions)   Cost     Value   Years   Yield (d)     Cost   Value   Years   Yield (d)  
U.S. Treasury and Agencies
                                                     
Maturing in one year or less
  $ 134     $ 134     .1     5.82 %   $   $         %
Maturing after one year through five years
    27       27     3.2     6.54                    
Maturing after five years through ten years
    21       21     6.2     5.52                    
Maturing after ten years
    225       223     12.4     6.00                    
                                                       
Total
  $ 407     $ 405     7.5     5.95 %   $   $         %
                                                       
Mortgage-Backed Securities (a)
                                                     
Maturing in one year or less
  $ 261     $ 258     .6     5.91 %   $   $         %
Maturing after one year through five years
    15,804       15,476     3.4     4.72       6     6     3.1     6.29  
Maturing after five years through ten years
    12,114       11,765     6.7     5.31                    
Maturing after ten years
    3,121       3,104     12.5     6.36                    
                                                       
Total
  $ 31,300     $ 30,603     5.6     5.12 %   $ 6   $ 6     3.1     6.29 %
                                                       
Asset-Backed Securities (a)(e)
                                                     
Maturing in one year or less
  $ 5     $ 5     .1     5.63 %   $   $         %
Maturing after one year through five years
    1,657       1,663     4.8     5.73                    
Maturing after five years through ten years
    1,260       1,260     5.8     5.71                    
Maturing after ten years
                                     
                                                       
Total
  $ 2,922     $ 2,928     5.2     5.72 %   $   $         %
                                                       
Obligations of State and Political Subdivisions (b)
                                                     
Maturing in one year or less
  $ 42     $ 42     .3     6.83 %   $ 4   $ 4     .5     5.77 %
Maturing after one year through five years
    25       26     3.2     6.31       9     10     2.7     6.29  
Maturing after five years through ten years
    5,603       5,565     8.3     6.86       16     18     7.8     6.90  
Maturing after ten years
    1,461       1,422     20.4     6.49       27     28     15.8     5.45  
                                                       
Total
  $ 7,131     $ 7,055     10.7     6.78 %   $ 56   $ 60     10.2     6.03 %
                                                       
Other Debt Securities
                                                     
Maturing in one year or less
  $ 127     $ 127     .1     3.80 %   $ 4   $ 4     .5     4.88 %
Maturing after one year through five years
    46       37     3.9     6.27       8     8     2.4     5.43  
Maturing after five years through ten years
    100       90     9.2     6.32                    
Maturing after ten years
    1,567       1,349     34.2     6.37                    
                                                       
Total
  $ 1,840     $ 1,603     29.8     6.19 %   $ 12   $ 12     1.8     5.26 %
                                                       
Other Investments
  $ 506     $ 448         7.16 %   $   $         %
                                                       
Total investment securities (c)
  $ 44,106     $ 43,042     7.4     5.51 %   $ 74   $ 78     8.3     5.92 %
                                                       
                                                       
(a) Information related to asset and mortgage-backed securities included above is presented based upon weighted-average maturities anticipating future prepayments.
(b) Information related to obligations of state and political subdivisions is presented based upon yield to first optional call date if the security is purchased at a premium, yield to maturity if purchased at par or a discount.
(c) The weighted-average maturity of the available-for-sale investment securities was 6.6 years at December 31, 2006, with a corresponding weighted-average yield of 5.32 percent. The weighted-average maturity of the held-to-maturity investment securities was 8.4 years at December 31, 2006, with a corresponding weighted-average yield of 6.03 percent.
(d) Average yields are presented on a fully-taxable equivalent basis under a tax rate of 35 percent. Yields on available-for-sale and held-to-maturity securities are computed based on historical cost balances. Average yield and maturity calculations exclude equity securities that have no stated yield or maturity.
(e) Primarily includes investments in structured investment vehicles with underlying collateral that includes a mix of various mortgage and other asset-backed securities.
 
                             
    2007     2006  
    Amortized
  Percent
    Amortized
  Percent
 
December 31 (Dollars in Millions)   Cost   of Total     Cost   of Total  
U.S. Treasury and agencies
  $ 407     .9 %   $ 472     1.2 %
Mortgage-backed securities
    31,306     70.9       34,472     84.7  
Asset-backed securities
    2,922     6.6       7      
Obligations of state and political subdivisions
    7,187     16.3       4,530     11.1  
Other debt securities and investments
    2,358     5.3       1,236     3.0  
                             
Total investment securities
  $ 44,180     100.0 %   $ 40,717     100.0 %
                             
                             

U.S. BANCORP  31



 

structures and are classified as asset-backed securities within the consolidated financial statements.
At December 31, 2007, approximately 39 percent of the investment securities portfolio represented adjustable-rate financial instruments, compared with 37 percent at December 31, 2006. Adjustable-rate financial instruments include variable-rate collateralized mortgage obligations, mortgage-backed securities, agency securities, adjustable-rate money market accounts, asset-backed securities, corporate debt securities and floating-rate preferred stock. Average investment securities were $1.4 billion (3.4 percent) higher in 2007, compared with 2006, driven primarily by an increase in the municipal securities portfolio, partially offset by a reduction in mortgage-backed assets. The weighted-average yield of the available-for-sale portfolio was 5.51 percent at December 31, 2007, compared with 5.32 percent at December 31, 2006. The average maturity of the available-for-sale portfolio increased to 7.4 years at December 31, 2007, up from 6.6 years at December 31, 2006. The relative mix of the type of investment securities maintained in the portfolio is provided in Table 11.
The Company conducts a regular assessment of its investment portfolios to determine whether any securities are other-than-temporarily impaired considering, among other factors, the nature of the investments, credit ratings or financial condition of the issuer, the extent and duration of the unrealized loss, expected cash flows of underlying collateral, market conditions and the Company’s ability to hold the securities through the anticipated recovery period.
At December 31, 2007, the available-for-sale securities portfolio included a $1.1 billion net unrealized loss, compared with a net unrealized loss of $600 million at December 31, 2006. The substantial portion of securities with unrealized losses were either government securities, issued by government-backed agencies or privately issued securities with high investment grade credit ratings and limited, if any, credit exposure. Some securities classified within obligations of state and political subdivisions are supported by mono-line insurers that have recently experienced credit rating downgrades. Based on management’s evaluation, the impact of these changes is expected to be minimal to the Company. The majority of asset-backed securities at December 31, 2007, represented structured investments. The valuation of these securities is determined through estimates of expected cash flows, discount rates and management’s assessment of various

 

Table 12    DEPOSITS
 
The composition of deposits was as follows:
                                                                               
    2007       2006       2005       2004       2003  
        Percent
          Percent
          Percent
          Percent
          Percent
 
December 31 (Dollars in Millions)   Amount   of Total       Amount   of Total       Amount   of Total       Amount   of Total       Amount   of Total  
Noninterest-bearing deposits
  $ 33,334     25.4 %     $ 32,128     25.7 %     $ 32,214     25.8 %     $ 30,756     25.5 %     $ 32,470     27.3 %
Interest-bearing savings deposits
                                                                             
Interest checking
    28,996     22.0         24,937     20.0         23,274     18.7         23,186     19.2         21,404     18.0  
Money market savings
    24,301     18.5         26,220     21.0         27,934     22.4         30,478     25.2         34,025     28.6  
Savings accounts
    5,001     3.8         5,314     4.2         5,602     4.5         5,728     4.8         5,630     4.7  
                                                                               
Total of savings deposits
    58,298     44.3         56,471     45.2         56,810     45.6         59,392     49.2         61,059     51.3  
Time certificates of deposit less than $100,000
    14,160     10.8         13,859     11.1         13,214     10.6         12,544     10.4         13,690     11.5  
Time deposits greater than $100,000
                                                                             
Domestic
    15,351     11.7         14,868     11.9         14,341     11.5         11,956     9.9         5,902     4.9  
Foreign
    10,302     7.8         7,556     6.1         8,130     6.5         6,093     5.0         5,931     5.0  
                                                                               
Total interest-bearing deposits
    98,111     74.6         92,754     74.3         92,495     74.2         89,985     74.5         86,582     72.7  
                                                                               
Total deposits
  $ 131,445     100.0 %     $ 124,882     100.0 %     $ 124,709     100.0 %     $ 120,741     100.0 %     $ 119,052     100.0 %
                                                                               
                                                                               
 
The maturity of time deposits was as follows:
 
                   
    Certificates
  Time Deposits
   
December 31, 2007 (Dollars in Millions)   Less Than $100,000   Greater Than $100,000   Total
 
 
Three months or less
    $  4,809     $19,196     $24,005
Three months through six months
    3,827     3,528     7,355
Six months through one year
    2,728     1,537     4,265
2009
    1,663     746     2,409
2010
    386     272     658
2011
    506     242     748
2012
    234     129     363
Thereafter
    7     3     10
   
Total
    $14,160     $25,653     $39,813
 
 

32  U.S. BANCORP



 

market factors, which are judgmental in nature. Based on management’s review as of the reporting date, the Company expected to receive all principal and interest related to securities within its investment portfolios.
During January 2008, actions by the Federal Reserve Bank and a related rally in the fixed income markets caused the fair value of a substantial portion of investment securities to recover somewhat from their unrealized loss position. However, credit spreads for certain structured investment securities widened during the month causing their values to decline. Given the nature of these structured investments, the Company is likely to recognize further impairment of these investments during the next few quarters.
 
Deposits Total deposits were $131.4 billion at December 31, 2007, compared with $124.9 billion at December 31, 2006. The $6.5 billion (5.3 percent) increase in total deposits was primarily the result of increases in interest checking, time deposits and noninterest-bearing deposits, partially offset by a decrease in money market savings accounts. Average total deposits increased $.5 billion (.4 percent) from 2006, reflecting an increase in average interest checking and personal certificates of deposit, partially offset by a decrease in average noninterest-bearing deposits and money market savings accounts.
Noninterest-bearing deposits at December 31, 2007, increased $1.2 billion (3.8 percent) from December 31, 2006. The increase was primarily attributed to an increase in corporate trust deposits, partially offset by a decline in consumer and business demand deposits as these customers utilized deposit balances to fund business growth and meet other liquidity requirements. Average noninterest-bearing deposits in 2007 decreased $1.4 billion (4.8 percent), compared with 2006, due primarily to a decline in business demand deposits.
Interest-bearing savings deposits increased $1.8 billion (3.2 percent) at December 31, 2007, compared with December 31, 2006. The increase in these deposit balances was primarily related to higher interest checking account balances, partially offset by a reduction in money market savings balances. The $4.1 billion (16.2 percent) increase in interest checking account balances was due to higher broker-dealer, government and institutional trust balances. The $1.9 billion (7.3 percent) decrease in money market savings account balances reflected the Company’s deposit pricing decisions for money market products in relation to fixed-rate time deposit products and business customer decisions to utilize deposit liquidity to fund business requirements. Average interest-bearing savings deposits in 2007 increased $.9 billion (1.7 percent), compared with 2006, primarily driven by higher interest checking account balances of $2.6 billion (10.9 percent), partially offset by a reduction in money market savings account balances of $1.3 billion (5.0 percent).
Interest-bearing time deposits at December 31, 2007, increased $3.5 billion (9.7 percent), compared with December 31, 2006, primarily driven by an increase in time deposits greater than $100,000. Time deposits greater than $100,000 increased $3.2 billion (14.4 percent), including a $.4 billion (8.9 percent) increase in personal certificates of deposit, compared with December 31, 2006, as customers migrated money market balances to these products. Average time certificates of deposit less than $100,000 increased $.9 billion (6.5 percent) and average time deposits greater than $100,000 were basically unchanged in 2007, compared with 2006. Time deposits greater than $100,000 are largely viewed as purchased funds and are managed to levels deemed appropriate given alternative funding sources.
 
Borrowings The Company utilizes both short-term and long-term borrowings to fund growth of assets in excess of deposit growth. Short-term borrowings, which include federal funds purchased, commercial paper, repurchase agreements, borrowings secured by high-grade assets and other short-term borrowings, were $32.4 billion at December 31, 2007, compared with $26.9 billion at December 31, 2006. Short-term funding is managed within approved liquidity policies. The increase of $5.5 billion in short-term borrowings reflected wholesale funding associated with the Company’s asset growth and asset/liability management activities.
Long-term debt was $43.4 billion at December 31, 2007, compared with $37.6 billion at December 31, 2006, reflecting the issuances of $3.0 billion of convertible senior debentures, $1.3 billion of subordinated notes, $1.4 billion of medium-term notes and $.5 billion of junior subordinated debentures, and the net addition of $10.1 billion of Federal Home Loan Bank (“FHLB”) advances, partially offset by long-term debt maturities and repayments. The $5.8 billion (15.5 percent) increase in long-term debt reflected wholesale funding associated with the Company’s asset growth and asset/liability management activities. Refer to Note 12 of the Notes to Consolidated Financial Statements for additional information regarding long-term debt and the “Liquidity Risk Management” section for discussion of liquidity management of the Company.
 
CORPORATE RISK PROFILE
 
Overview Managing risks is an essential part of successfully operating a financial services company. The most prominent risk exposures are credit, residual value, operational, interest rate, market and liquidity risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Residual value risk is the potential reduction in the end-of-term value of leased assets or the residual cash flows related to asset securitization and other off-balance sheet structures. Operational risk includes

U.S. BANCORP  33



 

risks related to fraud, legal and compliance risk, processing errors, technology, breaches of internal controls and business continuation and disaster recovery risk. Interest rate risk is the potential change of net interest income as a result of changes in interest rates, which can affect the repricing of assets and liabilities differently, as well as their market value. Market risk arises from fluctuations in interest rates, foreign exchange rates, and security prices that may result in changes in the values of financial instruments, such as trading and available-for-sale securities that are accounted for on a mark-to-market basis. Liquidity risk is the possible inability to fund obligations to depositors, investors or borrowers. In addition, corporate strategic decisions, as well as the risks described above, could give rise to reputation risk. Reputation risk is the risk that negative publicity or press, whether true or not, could result in costly litigation or cause a decline in the Company’s stock value, customer base or revenue.
 
Credit Risk Management The Company’s strategy for credit risk management includes well-defined, centralized credit policies, uniform underwriting criteria, and ongoing risk monitoring and review processes for all commercial and consumer credit exposures. The strategy also emphasizes diversification on a geographic, industry and customer level, regular credit examinations and management reviews of loans exhibiting deterioration of credit quality. The credit risk management strategy also includes a credit risk assessment process, independent of business line managers, that performs assessments of compliance with commercial and consumer credit policies, risk ratings, and other critical credit information. The Company strives to identify potential problem loans early, record any necessary charge-offs promptly and maintain adequate reserve levels for probable loan losses inherent in the portfolio. Commercial banking operations rely on prudent credit policies and procedures and individual lender and business line manager accountability. Lenders are assigned lending authority based on their level of experience and customer service requirements. Credit officers reporting to an independent credit administration function have higher levels of lending authority and support the business units in their credit decision process. Loan decisions are documented as to the borrower’s business, purpose of the loan, evaluation of the repayment source and the associated risks, evaluation of collateral, covenants and monitoring requirements, and risk rating rationale. The Company utilizes a credit risk rating system to measure the credit quality of individual commercial loans, including the probability of default of an obligor and the loss given default of credit facilities. The Company uses the risk rating system for regulatory reporting, determining the frequency of review of the credit exposures, and evaluation and determination of the specific allowance for commercial credit losses. The Company regularly forecasts potential changes in risk ratings, nonperforming status and potential for loss and the estimated impact on the allowance for credit losses. In the Company’s retail banking operations, standard credit scoring systems are used to assess credit risks of consumer, small business and small-ticket leasing customers and to price consumer products accordingly. The Company conducts the underwriting and collections of its retail products in loan underwriting and servicing centers specializing in certain retail products. Forecasts of delinquency levels, bankruptcies and losses in conjunction with projection of estimated losses by delinquency categories and vintage information are regularly prepared and are used to evaluate underwriting and collection and determine the specific allowance for credit losses for these products. Because business processes and credit risks associated with unfunded credit commitments are essentially the same as for loans, the Company utilizes similar processes to estimate its liability for unfunded credit commitments. The Company also engages in non-lending activities that may give rise to credit risk, including interest rate swap and option contracts for balance sheet hedging purposes, foreign exchange transactions, deposit overdrafts and interest rate swap contracts for customers, and settlement risk, including Automated Clearing House transactions, and the processing of credit card transactions for merchants. These activities are also subject to credit review, analysis and approval processes.
 
Economic and Other Factors In evaluating its credit risk, the Company considers changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, the level of allowance coverage relative to similar banking institutions and macroeconomic factors.
During 2005 through mid-2007, economic conditions steadily improved as reflected in strong expansion of the gross domestic product index, relatively low unemployment rates, expanding retail sales levels, favorable trends related to corporate profits and consumer spending for retail goods and services. Beginning in mid-2004 through the second quarter of 2006, the Federal Reserve Bank pursued a measured approach to increasing short-term rates in an effort to prevent an acceleration of inflation and maintain a moderate rate of economic growth. The rising interest rate environment caused some softening of residential home and condominium sales. Nationwide sales of condominium units reached a peak in mid-2005 and have declined since that timeframe.
During 2007, economic conditions were mixed. While gross domestic product continued to expand at a slower rate, unemployment rates have risen somewhat, inflation continues to be problematic, retail sales have slowed and vehicle sales levels continue to decline. Both consumer and business bankruptcies have continued to rise from levels experienced in 2006 and industrial production and corporate profit levels have began to slow or decline somewhat from prior years. In

34  U.S. BANCORP



 

addition, the mortgage lending and homebuilding industries continued to experience increased levels of stress. With respect to residential homes, inventory levels approximated a 9.5 month supply at the end of 2007, up from 4.5 months in the third quarter of 2005. Median home prices, which peaked in mid-2006, have declined across most domestic markets with more severe price reductions in California and the Northeast and Southeast regions.
The decline in residential home values and rising interest rates through September 2007 began to have a significant adverse impact on residential mortgage loans. While residential mortgage delinquencies have been increasing, these adverse market conditions particularly affected sub-prime borrowers. In August 2007, the securitization markets began to experience significant liquidity disruptions as investor confidence in the credit quality of asset-backed securitization programs began to decline. During the fourth quarter of 2007, certain asset-backed commercial paper programs and other structured investment vehicles have been unable to remarket their commercial paper creating further deterioration in the capital markets. In response to these economic factors, the Federal Reserve Bank’s monetary policies changed in September 2007. Since that time, the Federal Reserve Bank has decreased the target Federal Funds interest rate several times from its high of 5.25 percent to a rate of 3.00 percent at January 31, 2008, in an effort to improve liquidity in the capital markets and investor confidence. Currently, there is heightened concern that the domestic economy may experience a recession over the next several quarters. As a result of this expectation, the equity markets have experienced significant volatility.
In addition to economic factors, changes in regulations and legislation can have an impact on the credit performance of the loan portfolios. Beginning in 2005, the Company implemented higher minimum balance payment requirements for its credit card customers in response to industry guidance issued by the banking regulatory agencies. This industry guidance was provided to minimize the likelihood that minimum balance payments would not be sufficient to cover interest, fees and a portion of the principal balance of a credit card loan resulting in negative amortization, or increasing account balances. Also, new bankruptcy legislation was enacted in October 2005, making it more difficult for borrowers to have their debts forgiven during bankruptcy proceedings. As a result of the changes in bankruptcy laws, the levels of consumer and business bankruptcy filings increased dramatically in the fourth quarter of 2005 and declined in early 2006 to levels that were a third of average bankruptcy filings during 2004 and early 2005. While consumer bankruptcies have increased since early 2006, bankruptcy filings in the fourth quarter of 2007 approximated only 50 percent to 60 percent of pre-2005 levels. In response to the recent sub-prime lending and market disruption issues, regulators and legislators have encouraged mortgage servicers to implement restructuring programs to enable borrowers to continue loan repayments and dampen the impact of interest rates on homeowners.
 
Credit Diversification The Company manages its credit risk, in part, through diversification of its loan portfolio. As part of its normal business activities, it offers a broad array of traditional commercial lending products and specialized products such as asset-based lending, commercial lease financing, agricultural credit, warehouse mortgage lending, commercial real estate, health care and correspondent banking. The Company also offers an array of retail lending products including credit cards, retail leases, home equity, revolving credit, lending to students and other consumer loans. These retail credit products are primarily offered through the branch office network, home mortgage and loan production offices, indirect distribution channels, such as automobile dealers, and a consumer finance division. The Company monitors and manages the portfolio diversification by industry, customer and geography. Table 6 provides information with respect to the overall product diversification and changes in the mix during 2007.
The commercial portfolio reflects the Company’s focus on serving small business customers, middle market and larger corporate businesses throughout its 24-state banking region, as well as large national customers. The commercial loan portfolio is diversified among various industries with somewhat higher concentrations in consumer products and services, financial services, commercial services and supplies, capital goods (including manufacturing and commercial construction-related businesses), property management and development and agricultural industries. Additionally, the commercial portfolio is diversified across the Company’s geographical markets with 74.2 percent of total commercial loans within the 24-state banking region. Credit relationships outside of the Company’s banking region are reflected within the corporate banking, mortgage banking, auto dealer and leasing businesses focusing on large national customers and specifically targeted industries. Loans to mortgage banking customers are primarily warehouse lines which are collateralized with the underlying mortgages. The Company regularly monitors its mortgage collateral position to manage its risk exposure. Table 8 provides a summary of significant industry groups and geographic locations of commercial loans outstanding at December 31, 2007 and 2006.
The commercial real estate portfolio reflects the Company’s focus on serving business owners within its geographic footprint as well as regional and national investment-based real estate owners. At December 31, 2007, the Company had commercial real estate loans of

U.S. BANCORP  35



 

$29.2 billion, or 19.0 percent of total loans, compared with $28.6 billion at December 31, 2006. Within commercial real estate loans, different property types have varying degrees of credit risk. Table 9 provides a summary of the significant property types and geographical locations of commercial real estate loans outstanding at December 31, 2007 and 2006. At December 31, 2007, approximately 35.4 percent of the commercial real estate loan portfolio represented business owner-occupied properties that tend to exhibit credit risk characteristics similar to the middle market commercial loan portfolio. Generally, the investment-based real estate mortgages are diversified among various property types with somewhat higher concentrations in office and retail properties. While investment-based commercial real estate continues to perform well with relatively strong occupancy levels and cash flows, these categories of loans can be adversely impacted during a rising rate environment. During 2007, the Company continued to reduce its level of exposure to homebuilders, given the stress in the homebuilding industry sector. Beginning in mid-2006, construction financing of condominium projects was significantly curtailed, given the deterioration in unit pricing in several regions of the country. From a geographical perspective, the Company’s commercial real estate portfolio is generally well diversified. However, at December 31, 2007, the Company had 19.8 percent of its portfolio within California, which has experienced higher delinquency levels and credit quality deterioration due to excess home inventory levels and declining valuations. Credit losses may increase within this portfolio. Included in commercial real estate at year end 2007 was approximately $.9 billion in loans related to land held for development and $2.6 billion of loans related to residential and commercial acquisition and development properties. These loans are subject to quarterly monitoring for changes in local market conditions due to a higher credit risk profile. Acquisition and development loans continued to perform well, despite a slow down in the housing market and softening of demand. The commercial real estate portfolio is diversified across the Company’s geographical markets with 91.4 percent of total commercial real estate loans outstanding at December 31, 2007, within the 24-state banking region.
The Company’s retail lending business utilizes several distinct business processes and channels to originate retail credit, including traditional branch lending, indirect lending, portfolio acquisitions and a consumer finance division. Each distinct underwriting and origination activity manages unique credit risk characteristics and prices its loan production commensurate with the differing risk profiles. Within Consumer Banking, U.S. Bank Consumer Finance (“USBCF”), a division of the Company, participates in substantially all facets of the Company’s consumer lending activities. USBCF specializes in serving channel-specific and alternative lending markets in residential mortgages, home equity and installment loan financing. USBCF manages loans originated through a broker network, correspondent relationships and U.S. Bank branch offices. Generally, loans managed by the Company’s consumer finance division exhibit higher credit risk characteristics, but are priced commensurate with the differing risk profile.
Residential mortgages represent an important financial product for consumer customers of the Company and are originated through the Company’s branches, loan production offices, a wholesale network of originators and the consumer finance division. With respect to residential mortgages originated through these channels, the Company may either retain the loans on its balance sheet or sell its interest in the balances into the secondary market while retaining the servicing rights and customer relationships. Utilizing the secondary markets enables the Company to effectively reduce its credit and other asset/liability risks. For residential mortgages that are retained in the Company’s portfolio, credit risk is also diversified by geography and by monitoring loan-to-values during the underwriting process.
 
The following table provides summary information of the loan-to-values of residential mortgages by distribution channel and type at December 31, 2007:
                           
    Interest
          Percent
 
(Dollars in Millions)   Only   Amortizing   Total   of Total  
   
 
Consumer Finance
                         
Less than or equal to 80%
  $ 730   $ 2,279   $ 3,009     30.9 %
Over 80% through 90%
    819     1,637     2,456     25.2  
Over 90% through 100%
    831     3,354     4,185     42.9  
Over 100%
        97     97     1.0  
     
     
Total
  $ 2,380   $ 7,367   $ 9,747     100.0 %
Other Retail
                         
Less than or equal to 80%
  $ 2,164   $ 9,335   $ 11,499     88.2 %
Over 80% through 90%
    273     637     910     7.0  
Over 90% through 100%
    132     494     626     4.8  
Over 100%
                 
     
     
Total
  $ 2,569   $ 10,466   $ 13,035     100.0 %
Total Company
                         
Less than or equal to 80%
  $ 2,894   $ 11,614   $ 14,508     63.7 %
Over 80% through 90%
    1,092     2,274     3,366     14.8  
Over 90% through 100%
    963     3,848     4,811     21.1  
Over 100%
        97     97     .4  
     
     
Total
  $ 4,949   $ 17,833   $ 22,782     100.0 %
 
 
Note: loan-to-values determined as of the date of origination and consider mortgage  insurance, as applicable.
Within the consumer finance division approximately $3.3 billion, or 33.5 percent of that division, represents residential mortgages to customers that may be defined as sub-prime borrowers. Of these loans, 34.0 percent had a loan-to-value of less than or equal to 80 percent of the origination amount, while 24.9 percent had loan-to-values of over 80 percent through 90 percent and 39.1 percent had loan-to-values of over 90 percent through 100 percent.

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Table 13    DELINQUENT LOAN RATIOS AS A PERCENT OF ENDING LOAN BALANCES
 
                                         
At December 31,
                             
90 days or more past due excluding nonperforming loans   2007     2006     2005     2004     2003  
   
Commercial
                                       
Commercial
    .08 %     .06 %     .06 %     .05 %     .06 %
Lease financing
                      .02       .04  
     
     
Total commercial
    .07       .05       .05       .05       .06  
Commercial Real Estate
                                       
Commercial mortgages
    .02       .01                   .02  
Construction and development
    .02       .01                   .03  
     
     
Total commercial real estate
    .02       .01                   .02  
Residential Mortgages
    .86       .42       .32       .46       .61  
Retail
                                       
Credit card
    1.94       1.75       1.26       1.74       1.68  
Retail leasing
    .10       .03       .04       .08       .14  
Other retail
    .37       .24       .23       .30       .43  
     
     
Total retail
    .68       .49       .37       .49       .58  
     
     
Total loans
    .38 %     .24 %     .19 %     .24 %     .28 %
 
 
At December 31,
                             
90 days or more past due including nonperforming loans   2007     2006     2005     2004     2003  
   
Commercial
    .43 %     .57 %     .69 %     .99 %     1.97 %
Commercial real estate
    1.02       .53       .55       .73       .82  
Residential mortgages (a)
    1.10       .59       .55       .74       .91  
Retail
    .73       .59       .52       .53       .65  
     
     
Total loans
    .74 %     .57 %     .58 %     .75 %     1.16 %
 
 
(a) Delinquent loan ratios exclude advances made pursuant to servicing agreements to Government National Mortgage Association (“GNMA”) mortgage pools whose repayments are insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs. Including the guaranteed amounts, the ratio of residential mortgages 90 days or more past due was 3.78 percent, 3.08 percent, 4.35 percent, 5.19 percent and 6.07 percent at December 31, 2007, 2006, 2005, 2004 and 2003, respectively.
 

 
The following table provides further information on residential mortgages for the consumer finance division:
 
                           
                Percent
 
    Interest
          of
 
(Dollars in Millions)   Only   Amortizing   Total   Division  
   
 
Sub-Prime Borrowers
                         
Less than or equal to 80%
  $ 4   $ 1,108   $ 1,112     11.4 %
Over 80% through 90%
    6     809     815     8.4  
Over 90% through 100%
    25     1,252     1,277     13.1  
Over 100%
        66     66     .7  
     
     
Total
  $ 35   $ 3,235   $ 3,270     33.6 %
Other Borrowers
                         
Less than or equal to 80%
  $ 726   $ 1,171   $ 1,897     19.5 %
Over 80% through 90%
    813     828     1,641     16.8  
Over 90% through 100%
    806     2,102     2,908     29.8  
Over 100%
        31     31     .3  
     
     
Total
  $ 2,345   $ 4,132   $ 6,477     66.4 %
     
     
Total Consumer Finance
  $ 2,380   $ 7,367   $ 9,747     100.0 %
 
 
 
In addition to residential mortgages, the consumer finance division had $.9 billion of home equity and second mortgage loans to customers that may be defined as sub-prime borrowers at December 31, 2007. Including residential mortgages, and home equity and second mortgage loans, the total amount of loans to customers that may be defined as sub-prime borrowers, represented only 1.7 percent of total assets of the Company at December 31, 2007. The Company does not have any residential mortgages whose payment schedule would cause balances to increase over time.
The retail loan portfolio principally reflects the Company’s focus on consumers within its footprint of branches and certain niche lending activities that are nationally focused. Within the Company’s retail loan portfolio approximately 77.4 percent of the credit card balances relate to bank branch, co-branded and affinity programs that generally experience better credit quality performance than portfolios generated through national direct mail programs.
Table 10 provides a geographical summary of the residential mortgage and retail loan portfolios.

U.S. BANCORP  37



 

Loan Delinquencies Trends in delinquency ratios represent an indicator, among other considerations, of credit risk within the Company’s loan portfolios. The entire balance of an account is considered delinquent if the minimum payment contractually required to be made is not received by the specified date on the billing statement. The Company measures delinquencies, both including and excluding nonperforming loans, to enable comparability with other companies. Advances made pursuant to servicing agreements to Government National Mortgage Association (“GNMA”) mortgage pools whose repayments of principal and interest are substantially insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs are excluded from delinquency statistics. In addition, under certain situations, a retail customer’s account may be re-aged to remove it from delinquent status. Generally, the intent of a re-aged account is to assist customers who have recently overcome temporary financial difficulties, and have demonstrated both the ability and willingness to resume regular payments. To qualify for re-aging, the account must have been open for at least one year and cannot have been re-aged during the preceding 365 days. An account may not be re-aged more than two times in a five-year period. To qualify for re-aging, the customer must also have made three regular minimum monthly payments within the last 90 days. In addition, the Company may re-age the retail account of a customer who has experienced longer-term financial difficulties and apply modified, concessionary terms and conditions to the account. Such additional re-ages are limited to one in a five-year period and must meet the qualifications for re-aging described above. All re-aging strategies must be independently approved by the Company’s credit administration function and are limited to credit card and credit line accounts. Commercial loans are not subject to re-aging policies.
Accruing loans 90 days or more past due totaled $584 million at December 31, 2007, compared with $349 million at December 31, 2006, and $253 million at December 31, 2005. The increase in 90 day delinquent loans from December 31, 2006, to December 31, 2007, was primarily related to residential mortgages, credit cards and home equity loans. These loans were not included in nonperforming assets and continue to accrue interest because they are adequately secured by collateral, and/or are in the process of collection and are reasonably expected to result in repayment or restoration to current status. The ratio of 90 day delinquent loans to total loans was .38 percent at December 31, 2007, compared with .24 percent at December 31, 2006.
 
To monitor credit risk associated with retail loans, the Company also monitors delinquency ratios in the various stages of collection, including nonperforming status. The following table provides summary delinquency information for residential mortgages and retail loans:
 
                                   
          As a Percent of
              Ending
    Amount     Loan Balances
December 31,
       
(Dollars in Millions)   2007   2006     2007   2006
Residential Mortgages
                                 
30-89 days
  $ 233     $ 140         1.02 %     .66 %
90 days or more
    196       89         .86       .42  
Nonperforming
    54       36         .24       .17  
                                   
Total
  $ 483     $ 265         2.12 %     1.25 %
                                   
                                   
Retail
                                 
Credit card
                                 
30-89 days
  $ 268     $ 204         2.44 %     2.35 %
90 days or more
    212       152         1.94       1.75  
Nonperforming
    14       31         .13       .36  
                                   
Total
  $ 494     $ 387         4.51 %     4.46 %
Retail leasing
                                 
30-89 days
  $ 39     $ 34         .65 %     .49 %
90 days or more
    6       2         .10       .03  
Nonperforming
                         
                                   
Total
  $ 45     $ 36         .75 %     .52 %
Home equity and second mortgages
                                 
30-89 days
  $ 107     $ 93         .65 %     .60 %
90 days or more
    64       34         .39       .22  
Nonperforming
    11       14         .07       .09  
                                   
Total
  $ 182     $ 141         1.11 %     .91 %
Other retail
                                 
30-89 days
  $ 177     $ 131         1.02 %     .80 %
90 days or more
    62       44         .36       .27  
Nonperforming
    4       3         .02       .02  
                                   
Total
  $ 243     $ 178         1.40 %     1.09 %
                                   
                                   

38  U.S. BANCORP



 

While delinquency ratios have increased, the accelerating trend in residential and retail delinquency ratios has occurred primarily within the portfolios originated by the consumer finance division.
Within these product categories, the following table provides information on delinquent and nonperforming loans as a percent of ending loan balances, by channel:
 
                                   
    Consumer Finance       Other Retail  
December 31,   2007     2006       2007     2006  
Residential Mortgages
                                 
30-89 days
    1.58 %     .83 %       .61 %     .55 %
90 days or more
    1.33       .64         .51       .28  
Nonperforming
    .31       .19         .18       .16  
                                   
Total
    3.22 %     1.66 %       1.30 %     .99 %
                                   
                                   
Retail
                                 
Credit card
                                 
30-89 days
    %     %       2.44 %     2.35 %
90 days or more
                  1.94       1.75  
Nonperforming
                  .13       .36  
                                   
Total
    %     %       4.51 %     4.46 %
                                   
Retail leasing
                                 
30-89 days
    %     %       .65 %     .49 %
90 days or more
                  .10       .03  
Nonperforming
                         
                                   
Total
    %     %       .75 %     .52 %
Home equity and second mortgages
                                 
30-89 days
    2.53 %     1.64 %       .41 %     .35 %
90 days or more
    1.78       .79         .21       .14  
Nonperforming
    .11       .11         .06       .09  
                                   
Total
    4.42 %     2.54 %       .68 %     .58 %
Other retail
                                 
30-89 days
    6.38 %     4.30 %       .88 %     .71 %
90 days or more
    1.66       .76         .33       .26  
Nonperforming
                  .02       .02  
                                   
Total
    8.04 %     5.06 %       1.23 %     .99 %
                                   
                                   
 
Within the consumer finance division at December 31, 2007, approximately $227 million and $89 million of these delinquent and nonperforming residential mortgages and other retail loans, respectively, were to customers that may be defined as sub-prime borrowers, compared with $105 million and $50 million, respectively at December 31, 2006.
The Company expects the accelerating trends in delinquencies to continue during 2008 as residential home valuations continue to decline and economic factors affect the consumer sectors.
 
Restructured Loans Accruing Interest On a case-by-case basis, management determines whether an account that experiences financial difficulties should be modified as to its interest rate or repayment terms to maximize the Company’s collection of its balance. Loans restructured at a rate equal to or greater than that of a new loan with comparable risk at the time the contract is modified are excluded from restructured loans once repayment performance, in accordance with the modified agreement, has been demonstrated over several payment cycles. Loans that have interest rates reduced below comparable market rates remain classified as restructured loans; however, interest income is accrued at the reduced rate as long as the customer complies with the revised terms and conditions.
In late 2007, the Company began implementing a mortgage loan restructuring program for certain qualifying borrowers. In general, borrowers with sub-prime credit quality, that are current in their repayment status, will be allowed to retain the lower of their existing interest rate or the market interest rate as of their interest reset date. The following table provides a summary of restructured loans that continue to accrue interest:
                               
          As a Percent
 
              of Ending
 
    Amount     Loan Balances  
December 31
         
(Dollars in Millions)   2007   2006     2007     2006  
Commercial
  $ 21   $ 18       .04 %     .04 %
Commercial real estate
        1              
Residential mortgages
    157     80       .69       .38  
Credit card
    324     267       2.96       3.08  
Other retail
    49     39       .12       .10  
                               
Total
  $ 551   $ 405       .36 %     .28 %
                               
                               
                               
 
Restructured loans that accrue interest were higher at December 31, 2007, compared with December 31, 2006, reflecting the impact of restructurings for certain residential mortgage customers in light of current economic conditions. The Company expects this trend to continue during 2008 as residential home valuations continue to decline and certain borrowers take advantage of the Company’s mortgage loan restructuring programs.
 
Nonperforming Assets The level of nonperforming assets represents another indicator of the potential for future credit losses. Nonperforming assets include nonaccrual loans, restructured loans not performing in accordance with modified terms, other real estate and other nonperforming assets owned by the Company. Interest payments collected from assets on nonaccrual status are typically applied against the principal balance and not recorded as income.

U.S. BANCORP  39



 

At December 31, 2007, total nonperforming assets were $690 million, compared with $587 million at year-end 2006 and $644 million at year-end 2005. The ratio of total nonperforming assets to total loans and other real estate was .45 percent at December 31, 2007, compared with .41 percent and .47 percent at the end of 2006 and 2005, respectively. The $103 million increase in total nonperforming assets in 2007 primarily reflected higher levels of nonperforming loans resulting from stress in residential construction, associated homebuilding industries and financial services companies. Partially offsetting the increase in total nonperforming loans, was a decrease in nonperforming loans in manufacturing and transportation industry sectors within the commercial loan portfolio. Other real estate included in nonperforming assets was $111 million at December 31, 2007, compared with $95 million at December 31, 2006, and was primarily related to properties that the Company has taken ownership of that once secured residential mortgages and home equity and second mortgage loan balances. Other real estate assets were also higher in 2007 due to higher residential mortgage loan foreclosures as consumers experienced financial difficulties given inflationary factors, changing interest rates and other current economic conditions. The following table provides an analysis of other real estate owned (“OREO”) as a percent of their related loan balances, including further detail for

 

Table 14    NONPERFORMING ASSETS (a)
 
                                         
At December 31, (Dollars in Millions)   2007     2006     2005     2004     2003  
   
 
Commercial
                                       
Commercial
    $128       $196       $231       $289       $624  
Lease financing
    53       40       42       91       113  
     
     
Total commercial
    181       236       273       380       737  
Commercial Real Estate
                                       
Commercial mortgages
    84       112       134       175       178  
Construction and development
    209       38       23       25       40  
     
     
Total commercial real estate
    293       150       157       200       218  
Residential Mortgages
    54       36       48       43       40  
Retail
                                       
Credit card
    14       31       49              
Retail leasing
                             
Other retail
    15       17       17       17       25  
     
     
Total retail
    29       48       66       17       25  
     
     
Total nonperforming loans
    557       470       544       640       1,020  
Other Real Estate (b)
    111       95       71       72       73  
Other Assets
    22       22       29       36       55  
     
     
Total nonperforming assets
    $690       $587       $644       $748       $1,148  
     
     
Accruing loans 90 days or more past due
    $584       $349       $253       $294       $329  
Nonperforming loans to total loans
    .36 %     .33 %     .40 %     .51 %     .87 %
Nonperforming assets to total loans plus other real estate (b)
    .45 %     .41 %     .47 %     .60 %     .98 %
Net interest lost on nonperforming loans
    $ 41       $ 39       $ 30       $ 42       $ 67  
 
 
 
Changes In Nonperforming Assets
                         
    Commercial and
    Retail and
       
(Dollars in Millions)   Commercial Real Estate     Residential Mortgages (d)     Total  
   
  $ 406     $ 181     $ 587  
Additions to nonperforming assets
                       
New nonaccrual loans and foreclosed properties
    572       65       637  
Advances on loans
    12             12  
                         
Total additions
    584       65       649  
Reductions in nonperforming assets
                       
Paydowns, payoffs
    (176 )     (23 )     (199 )
Net sales
    (95 )           (95 )
Return to performing status
    (49 )     (3 )     (52 )
Charge-offs (c)
    (185 )     (15 )     (200 )
                         
Total reductions
    (505 )     (41 )     (546 )
                         
Net additions to nonperforming assets
    79       24       103  
                         
  $ 485     $ 205     $ 690  
 
 
(a) Throughout this document, nonperforming assets and related ratios do not include accruing loans 90 days or more past due.
(b) Excludes $102 million and $83 million at December 31, 2007 and 2006, respectively, of foreclosed GNMA loans which continue to accrue interest.
(c) Charge-offs exclude actions for certain card products and loan sales that were not classified as nonperforming at the time the charge-off occurred.
(d) Residential mortgage information excludes changes related to residential mortgages serviced by others.

40  U.S. BANCORP



 

residential mortgages and home equity and second mortgage loan balances by geographical location:
                               
              As a Percent of Ending
 
    Amount     Loan Balances  
December 31,
         
(Dollars in Millions)   2007   2006     2007     2006  
Residential
                             
Michigan
  $ 22   $ 17       3.47 %     2.90 %
Minnesota
    12     11       .23       .21  
Ohio
    10     12       .40       .48  
Colorado
    7     7       .25       .28  
Missouri
    6     6       .22       .25  
All other states
    53     38       .21       .16  
                               
Total residential
    110     91       .28       .25  
Commercial
    1     4             .01  
                               
Total OREO
  $ 111   $ 95       .07 %     .07 %
                               
                               
 
Within other real estate in the table above, approximately $61 million at December 31, 2007, and $41 million at December 31, 2006, were from portfolios defined as sub-prime.
The Company expects nonperforming assets to increase moderately over the next several quarters due to continued stress in residential mortgages and residential construction.
The $57 million decrease in total nonperforming assets in 2006, as compared with 2005, reflected decreases in nonperforming commercial, residential mortgages and retail loans, partially offset by an increase in other real estate assets as a result of taking more ownership of residential properties. The decrease in nonperforming commercial loans in 2006 was also broad-based across most industry sectors within the commercial loan portfolio. The decrease in nonperforming retail loans during 2006 was primarily due to the run-off of nonaccrual accounts from a discontinued workout program for customers having financial difficulties meeting recent minimum balance payment requirements.
Included in nonperforming loans were restructured loans of $17 million and $38 million at December 31, 2007 and 2006, respectively. At December 31, 2007 and 2006, the Company had no commitments to lend additional funds under restructured loans. Restructured loans performing under the restructured terms beyond a specified timeframe are reported as “Restructured Loans Accruing Interest.”
 
Analysis of Loan Net Charge-Offs Total loan net charge-offs were $792 million in 2007, compared with $544 million in 2006 and $685 million in 2005. The ratio of total loan net charge-offs to average loans was .54 percent in 2007, compared with .39 percent in 2006 and .52 percent in 2005. The year-over-year increase in net charge-offs in 2007, compared with 2006, was due primarily to an anticipated increase in consumer charge-offs, primarily related to credit cards, and somewhat higher commercial loan net charge-offs. In addition, net charge-offs during 2006 reflected the beneficial impact of bankruptcy legislation that went into effect in the fourth quarter of 2005.
Commercial and commercial real estate loan net charge-offs for 2007 were $159 million (.21 percent of average loans outstanding), compared with $88 million (.12 percent of average loans outstanding) in 2006 and $90 million (.13 percent of average loans outstanding) in 2005. The year-over-year increase in net charge-offs primarily reflected higher levels of nonperforming loans and delinquencies within these portfolios, especially residential homebuilding and related industry sectors. Given the continuing stress in the homebuilding and commercial home supplier industry, the Company expects commercial and commercial real estate net charge-offs to continue to increase moderately over the next several quarters. The decrease in commercial and commercial real estate loan net charge-offs in 2006 compared with 2005, reflected lower gross charge-offs, partially offset by a lower level of recoveries.
Retail loan net charge-offs in 2007 were $572 million (1.17 percent of average loans outstanding), compared with $415 million (.92 percent of average loans outstanding) in 2006 and $559 million (1.30 percent of average loans outstanding) in 2005. The increase in retail loan net charge-offs in 2007, compared with 2006, reflected growth in the credit card and installment loan portfolios of 25.4 percent and 11.2 percent, respectively. It also reflected higher retail loan delinquency ratios, compared with the prior year. In addition, net charge-offs for 2006 reflected the beneficial impact of bankruptcy legislation changes that occurred in the fourth quarter of 2005. The Company anticipates higher delinquency levels in the retail portfolios and that the trend in retail net charge-offs will accelerate, but remain in a manageable range during 2008. The decrease in retail loan net charge-offs in 2006, compared with 2005, reflected the impact of the bankruptcy legislation enacted in the fourth quarter of 2005 and improved retail portfolio performance.

U.S. BANCORP  41



 

 

Table 15    NET CHARGE-OFFS AS A PERCENT OF AVERAGE LOANS OUTSTANDING
 
                                         
Year Ended December 31   2007     2006     2005     2004     2003  
   
Commercial
                                       
Commercial
    .24 %     .15 %     .12 %     .29 %     1.34 %
Lease financing
    .61       .46       .85       1.42       1.65  
     
     
Total commercial
    .29       .18       .20       .43       1.38  
Commercial Real Estate
                                       
Commercial mortgages
    .06       .01       .03       .09       .14  
Construction and development
    .11       .01       (.04 )     .13       .16  
     
     
Total commercial real estate
    .08       .01       .01       .10       .14  
Residential Mortgages
    .28       .19       .20       .20       .23  
Retail
                                       
Credit card
    3.34       2.88       4.20       4.14       4.62  
Retail leasing
    .25       .20       .35       .59       .86  
Home equity and second mortgages
    .46       .33       .46       .54       .70  
Other retail
    .96       .85       1.33       1.35       1.79  
     
     
Total retail
    1.17       .92       1.30       1.36       1.68  
     
     
Total loans
    .54 %     .39 %     .52 %     .64 %     1.07 %
 
 

The following table provides an analysis of net charge-offs as a percent of average loans outstanding managed by the consumer finance division, compared with other retail loans:
                               
              Percent of
 
    Average Loans     Average Loans  
Year Ended December 31
         
(Dollars in Millions)   2007   2006     2007     2006  
Consumer Finance (a)
                             
Residential mortgages
  $ 9,129   $ 7,414       .58 %     .51 %
Home equity and second mortgages
    1,850     1,971       2.70       1.42  
Other retail
    414     399       3.38       4.76  
Other Retail
                             
Residential mortgages
  $ 12,956   $ 13,639       .06 %     .02 %
Home equity and second mortgages
    14,073     13,175       .17       .17  
Other retail
    16,437     15,057       .90       .74  
Total Company
                             
Residential mortgages
  $ 22,085   $ 21,053       .28 %     .19 %
Home equity and second mortgages
    15,923     15,146       .46       .33  
Other retail
    16,850     15,456       .96       .85  
                               
                               
(a) Consumer Finance category included credit originated and managed by USBCF, as well as home equity and second mortgages with a loan-to-value greater than 100 percent that were originated in the branches.
Within the consumer finance division, the Company originates loans to customers that may be defined as sub-prime borrowers. The following table provides further information on net charge-offs as a percent of average loans outstanding for this division:
                                   
                  Percent of
 
    Average Loans       Average Loans  
Year Ended December 31
           
(Dollars in Millions)   2007     2006       2007     2006  
Residential Mortgages
                                 
Sub-prime borrowers
  $ 3,158     $ 2,602         1.17 %     .95 %
Other borrowers
    5,971       4,812         .27       .27  
                                   
Total
  $ 9,129     $ 7,414         .58 %     .51 %
Home Equity And Second Mortgages
                                 
Sub-prime borrowers
  $ 908     $ 842         3.41 %     1.72 %
Other borrowers
    942       1,129         2.02       1.20  
                                   
Total
  $ 1,850     $ 1,971         2.70 %     1.42 %
                                   
                                   
 
Analysis and Determination of the Allowance for Credit Losses The allowance for loan losses provides coverage for probable and estimable losses inherent in the Company’s loan and lease portfolio. Management evaluates the allowance each quarter to determine that it is adequate to cover these inherent losses. The evaluation of each element and the overall allowance is based on a continuing assessment of problem loans, recent loss experience and other factors, including regulatory guidance and economic conditions. Because business processes and credit risks associated with unfunded credit commitments are essentially the same as for loans, the Company utilizes similar processes to estimate its liability for unfunded credit commitments, which is included in other liabilities in the Consolidated Balance Sheet. Both the allowance for loan losses and the liability for unfunded credit commitments are included in the Company’s analysis of credit losses.
At December 31, 2007, the allowance for credit losses was $2,260 million (1.47 percent of loans), compared with an allowance of $2,256 million (1.57 percent of loans) at December 31, 2006, and $2,251 million (1.65 percent of loans) at December 31, 2005. The ratio of the allowance for credit losses to nonperforming loans was 406 percent at December 31, 2007, compared with 480 percent and 414 percent at December 31, 2006 and 2005, respectively. The ratio of the allowance for credit losses to loan net charge-offs at December 31, 2007, was 285 percent, compared with 415 percent and 329 percent at December 31, 2006 and 2005, respectively. Management determined that the allowance for credit losses was adequate at December 31, 2007.
Several factors were taken into consideration in evaluating the allowance for credit losses at December 31, 2007, including the risk profile of the portfolios, loan net charge-offs during the period, the level of nonperforming

42  U.S. BANCORP



 

 

Table 16    SUMMARY OF ALLOWANCE FOR CREDIT LOSSES
 
                                         
(Dollars in Millions)   2007     2006     2005     2004     2003  
   
 
Balance at beginning of year
  $ 2,256     $ 2,251     $ 2,269     $ 2,369     $ 2,422  
Charge-Offs
                                       
Commercial
                                       
Commercial
    154       121       140       244       556  
Lease financing
    63       51       76       110       139  
     
     
Total commercial
    217       172       216       354       695  
Commercial real estate
                                       
Commercial mortgages
    16       11       16       29       44  
Construction and development
    10       1       3       13       13  
     
     
Total commercial real estate
    26       12       19       42       57  
Residential mortgages
    63       43       39       33       30  
Retail
                                       
Credit card
    389       256       313       282       282  
Retail leasing
    23       25       38       49       57  
Home equity and second mortgages
    82       62       83       89       105  
Other retail
    232       193       241       225       268  
     
     
Total retail
    726       536       675       645       712  
     
     
Total charge-offs
    1,032       763       949       1,074       1,494  
Recoveries
                                       
Commercial
                                       
Commercial
    52       61       95       144       70  
Lease financing
    28       27       34       41       55  
     
     
Total commercial
    80       88       129       185       125  
Commercial real estate
                                       
Commercial mortgages
    4       8       10       11       16  
Construction and development
                6       4       2  
     
     
Total commercial real estate
    4       8       16       15       18  
Residential mortgages
    2       2       3       4       3  
Retail
                                       
Credit card
    69       36       35       30       27  
Retail leasing
    7       11       12       10       7  
Home equity and second mortgages
    8       12       15       13       12  
Other retail
    70       62       54       50       50  
     
     
Total retail
    154       121       116       103       96  
     
     
Total recoveries
    240       219       264       307       242  
Net Charge-Offs
                                       
Commercial
                                       
Commercial
    102       60       45       100       486  
Lease financing
    35       24       42       69       84  
     
     
Total commercial
    137       84       87       169       570  
Commercial real estate
                                       
Commercial mortgages
    12       3       6       18       28  
Construction and development
    10       1       (3 )     9       11  
     
     
Total commercial real estate
    22       4       3       27       39  
Residential mortgages
    61       41       36       29       27  
Retail
                                       
Credit card
    320       220       278       252       255  
Retail leasing
    16       14       26       39       50  
Home equity and second mortgages
    74       50       68       76       93  
Other retail
    162       131       187       175       218  
     
     
Total retail
    572       415       559       542       616  
     
     
Total net charge-offs
    792       544       685       767       1,252  
     
     
Provision for credit losses
    792       544       666       669       1,254  
Acquisitions and other changes
    4       5       1       (2 )     (55 )
     
     
Balance at end of year
  $ 2,260     $ 2,256     $ 2,251     $ 2,269     $ 2,369  
     
     
Components
                                       
Allowance for loan losses
  $ 2,058     $ 2,022     $ 2,041     $ 2,080     $ 2,184  
Liability for unfunded credit commitments
    202       234       210       189       185  
     
     
Total allowance for credit losses
  $ 2,260     $ 2,256     $ 2,251     $ 2,269     $ 2,369  
     
     
Allowance for credit losses as a percentage of
                                       
Period-end loans
    1.47 %     1.57 %     1.65 %     1.82 %     2.03 %
Nonperforming loans
    406       480       414       355       232  
Nonperforming assets
    328       384       350       303       206  
Net charge-offs
    285       415       329       296       189  
 
 

assets, accruing loans 90 days or more past due, delinquency ratios and changes in restructured loan balances compared with December 31, 2006. Management also considered the uncertainty related to certain industry sectors, and the extent of credit exposure to specific borrowers within the portfolio. In addition, concentration risks associated with commercial

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Table 17      ELEMENTS OF THE ALLOWANCE FOR CREDIT LOSSES
 
                                                                       
    Allowance Amount   Allowance as a Percent of Loans  
December 31 (Dollars in Millions)   2007   2006   2005   2004   2003   2007     2006     2005     2004     2003  
Commercial
                                                                     
Commercial
  $ 860   $ 665   $ 656   $ 664   $ 696     1.92 %     1.64 %     1.73 %     1.89 %     2.08 %
Lease financing
    146     90     105     106     90     2.34       1.62       2.06       2.14       1.80  
                                                                       
Total commercial
    1,006     755     761     770     786     1.97       1.63       1.77       1.92       2.04  
                                                                       
Commercial Real Estate
                                                                     
Commercial mortgages
    150     126     115     131     170     .74       .64       .57       .64       .82  
Construction and development
    108     74     53     40     59     1.19       .83       .65       .55       .89  
                                                                       
Total commercial real estate
    258     200     168     171     229     .88       .70       .59       .62       .84  
Residential Mortgages
    131     58     39     33     33     .58       .27       .19       .21       .25  
Retail
                                                                     
Credit card
    487     298     284     283     268     4.45       3.44       3.98       4.29       4.52  
Retail leasing
    17     15     24     44     47     .28       .22       .33       .61       .78  
Home equity and second mortgages
    114     52     62     88     101     .69       .33       .41       .59       .76  
Other retail
    247     177     188     195     235     1.42       1.08       1.26       1.48       1.89  
                                                                       
Total retail
    865     542     558     610     651     1.70       1.14       1.26       1.46       1.73  
                                                                       
Total allocated allowance
    2,260     1,555     1,526     1,584     1,699     1.47       1.08       1.12       1.27       1.46  
Available for other factors
        701     725     685     670           .49       .53       .55       .57  
                                                                       
Total allowance
  $ 2,260   $ 2,256   $ 2,251   $ 2,269   $ 2,369     1.47 %     1.57 %     1.65 %     1.82 %     2.03 %
                                                                       
                                                                       

real estate and the mix of loans, including credit cards, loans originated through the consumer finance division and residential mortgages balances, and their relative credit risks were evaluated. Finally, the Company considered current economic conditions that might impact the portfolio. Management determines the allowance that is required for specific loan categories based on relative risk characteristics of the loan portfolio. On an ongoing basis, management evaluates its methods for determining the allowance for each element of the portfolio and makes enhancements considered appropriate. Table 17 shows the amount of the allowance for credit losses by portfolio category.
Regardless of the extent of the Company’s analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolios. This is due to several factors, including inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions, the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses from larger non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogeneous groups of loans, loan portfolio concentrations, and other subjective considerations are among other factors. Because of these subjective factors, the process utilized to determine each element of the allowance for credit losses by specific loan category has some imprecision. As such, the Company estimates a range of inherent losses in the portfolio based on statistical analyses and management judgment. A statistical analysis attempts to measure the extent of imprecision and other uncertainty by determining the volatility of losses over time, across loan categories. Also, management judgmentally considers loan concentrations, risks associated with specific industries, the stage of the business cycle, economic conditions and other qualitative factors. In 2007, this element of the allowance was specifically assigned to each portfolio type to better reflect the Company’s risk in the specific portfolios. In prior years, this element of the allowance was separately disclosed as “allowance available for other factors”.
The allowance recorded for commercial and commercial real estate loans is based, in part, on a regular review of individual credit relationships. The Company’s risk rating process is an integral component of the methodology utilized to determine these elements of the allowance for credit losses. An allowance for credit losses is established for pools of commercial and commercial real estate loans and unfunded commitments based on the risk ratings assigned. An analysis of the migration of commercial and commercial real estate loans and actual loss experience throughout the business cycle is conducted quarterly to assess the exposure for credits with similar risk characteristics. In addition to its risk rating process, the Company separately analyzes the carrying value of impaired loans to determine whether the carrying value is less than or equal to the appraised collateral value or the present value of expected cash flows. Based on this analysis, an allowance for credit losses may be specifically established for impaired loans. The allowance established for commercial

44  U.S. BANCORP



 

and commercial real estate loan portfolios, including impaired commercial and commercial real estate loans, was $1,264 million at December 31, 2007, compared with $955 million and $929 million at December 31, 2006 and 2005, respectively. The increase in the allowance for commercial and commercial real estate loans of $309 million at December 31, 2007, compared with December 31, 2006, reflected the impact of growth in the portfolios and the change in the process of allocating the allowance for credit losses to the specific loan portfolios during 2007, partially offset by a reduction in net inherent loss rates.
The allowance recorded for the residential mortgages and retail loan portfolios is based on an analysis of product mix, credit scoring and risk composition of the portfolio, loss and bankruptcy experiences, economic conditions and historical and expected delinquency and charge-off statistics for each homogenous group of loans. Based on this information and analysis, an allowance was established approximating a rolling twelve-month estimate of net charge-offs. The allowance established for residential mortgages was $131 million at December 31, 2007, compared with $58 million and $39 million at December 31, 2006 and 2005, respectively. The increase in the allowance for the residential mortgages portfolio year-over-year was driven by portfolio growth, deterioration in the resale value of real estate collateral due to the housing market and the change in the process of allocating the allowance for credit losses to the specific loan portfolios during 2007. The allowance established for retail loans was $865 million at December 31, 2007, compared with $542 million and $558 million at December 31, 2006 and 2005, respectively. The increase in the allowance for the retail portfolio in 2007 reflected foreclosures in the home equity portfolio, growth in the credit card and other retail portfolios and the change in the process of allocating the allowance for credit losses to the specific loan portfolios during 2007.
Although the Company determines the amount of each element of the allowance separately and this process is an important credit management tool, the entire allowance for credit losses is available for the entire loan portfolio. The actual amount of losses incurred can vary significantly from the estimated amounts.
 
Residual Value Risk Management The Company manages its risk to changes in the residual value of leased assets through disciplined residual valuation setting at the inception of a lease, diversification of its leased assets, regular residual asset valuation reviews and monitoring of residual value gains or losses upon the disposition of assets. Commercial lease originations are subject to the same well-defined underwriting standards referred to in the “Credit Risk Management” section which includes an evaluation of the residual risk. Retail lease residual risk is mitigated further by originating longer-term vehicle leases and effective end-of-term marketing of off-lease vehicles. Also, to reduce the financial risk of potential changes in vehicle residual values, the Company maintains residual value insurance. The catastrophic insurance maintained by the Company provides for the potential recovery of losses on individual vehicle sales in an amount equal to the difference between: (a) 105 percent or 110 percent of the average wholesale auction price for the vehicle at the time of sale and (b) the vehicle residual value specified by the Automotive Lease Guide (an authoritative industry source) at the inception of the lease. The potential recovery is calculated for each individual vehicle sold in a particular policy year and is reduced by any gains realized on vehicles sold during the same period. The Company will receive claim proceeds under this insurance program if, in the aggregate, there is a net loss for such period. In addition, the Company obtains separate residual value insurance for all vehicles at lease inception where end of lease term settlement is based solely on the residual value of the individual leased vehicles. Under this program, the potential recovery is computed for each individual vehicle sold and does not allow the insurance carrier to offset individual determined losses with gains from other leases. This individual vehicle coverage is included in the calculation of minimum lease payments when making the capital lease assessment. To reduce the risk associated with collecting insurance claims, the Company monitors the financial viability of the insurance carrier based on insurance industry ratings and available financial information.
Included in the retail leasing portfolio was approximately $3.8 billion of retail leasing residuals at December 31, 2007, compared with $4.3 billion at December 31, 2006. The Company monitors concentrations of leases by manufacturer and vehicle “make and model.” As of December 31, 2007, vehicle lease residuals related to sport utility vehicles were 42.2 percent of the portfolio while upscale and mid-range vehicle classes represented approximately 23.1 percent and 13.9 percent, respectively. At year-end 2007, the largest vehicle-type concentration represented approximately 7.8 percent of the aggregate residual value of the vehicles in the portfolio. No other vehicle-type exceeded five percent of the aggregate residual value of the portfolio. Because retail residual valuations tend to be less volatile for longer-term leases, relative to the estimated residual at inception of the lease, the Company actively manages lease origination production to achieve a longer-term portfolio. At December 31, 2007, the weighted-average origination term of the portfolio was 49 months, compared with 50 months at December 31, 2006. During the past several years, new vehicles sales volumes experienced strong growth driven by manufacturer incentives, consumer spending levels and strong economic conditions. In 2007, sales of new cars have softened

U.S. BANCORP  45



 

somewhat relative to a year ago. In part, this is due to manufacturers reducing sales incentives to consumers, as well as the overall general weakening of the economy. Current expectations are that sales of new vehicles will trend downward in 2008. Given that manufacturers’ inventories of vehicles have declined somewhat during this period, this trend in sales should provide support of residual valuations. With respect to used vehicles, wholesale values for automobiles during 2004 and 2005 performed better than wholesale values for trucks resulting in car prices becoming somewhat inflated and truck prices declining over this period. This has led to a shift in the comparative performance of these two segments, resulting in car values experiencing a decrease of .9 percent in 2007, while truck values have experienced an improvement of 1.1 percent over the same timeframe. The overall stability in the used car marketplace combined with the mix of the Company’s lease residual portfolio have caused the exposure to retail lease residual impairments to be relatively stable relative to a year ago.
At December 31, 2007, the commercial leasing portfolio had $660 million of residuals, compared with $636 million at December 31, 2006. At year-end 2007, lease residuals related to trucks and other transportation equipment were 26.6 percent of the total residual portfolio. Railcars represented 17.5 percent of the aggregate portfolio, while business and office equipment and aircraft were 16.7 percent and 12.9 percent, respectively. No other significant concentrations of more than 10 percent existed at December 31, 2007. In 2007, residual values in general remained stable or were favorable. The transportation industry residual values improved for marine, rail and aircraft.
 
Operational Risk Management Operational risk represents the risk of loss resulting from the Company’s operations, including, but not limited to, the risk of fraud by employees or persons outside the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements and business continuation and disaster recovery. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity.
The Company operates in many different businesses in diverse markets and relies on the ability of its employees and systems to process a high number of transactions. Operational risk is inherent in all business activities, and the management of this risk is important to the achievement of the Company’s objectives. In the event of a breakdown in the internal control system, improper operation of systems or improper employees’ actions, the Company could suffer financial loss, face regulatory action and suffer damage to its reputation.
The Company manages operational risk through a risk management framework and its internal control processes. Within this framework, the Corporate Risk Committee (“Risk Committee”) provides oversight and assesses the most significant operational risks facing the Company within its business lines. Under the guidance of the Risk Committee, enterprise risk management personnel establish policies and interact with business lines to monitor significant operating risks on a regular basis. Business lines have direct and primary responsibility and accountability for identifying, controlling, and monitoring operational risks embedded in their business activities. Business managers maintain a system of controls with the objective of providing proper transaction authorization and execution, proper system operations, safeguarding of assets from misuse or theft, and ensuring the reliability of financial and other data. Business managers ensure that the controls are appropriate and are implemented as designed.
Each business line within the Company has designated risk managers. These risk managers are responsible for, among other things, coordinating the completion of ongoing risk assessments and ensuring that operational risk management is integrated into business decision-making activities. Business continuation and disaster recovery planning is also critical to effectively managing operational risks. Each business unit of the Company is required to develop, maintain and test these plans at least annually to ensure that recovery activities, if needed, can support mission critical functions including technology, networks and data centers supporting customer applications and business operations. The Company’s internal audit function validates the system of internal controls through risk-based, regular and ongoing audit procedures and reports on the effectiveness of internal controls to executive management and the Audit Committee of the Board of Directors.
Customer-related business conditions may also increase operational risk, or the level of operational losses in certain transaction processing business units, including merchant processing activities. Ongoing risk monitoring of customer activities and their financial condition and operational processes serve to mitigate customer-related operational risk. Refer to Note 21 of the Notes to Consolidated Financial Statements for further discussion on merchant processing.
While the Company believes that it has designed effective methods to minimize operational risks, there is no absolute assurance that business disruption or operational losses would not occur in the event of a disaster. On an ongoing basis, management makes process changes and investments to enhance its systems of internal controls and business continuity and disaster recovery plans.
 
Interest Rate Risk Management In the banking industry, changes in interest rates are a significant risk that can

46  U.S. BANCORP



 

impact earnings, market valuations and safety and soundness of an entity. To minimize the volatility of net interest income and the market value of assets and liabilities, the Company manages its exposure to changes in interest rates through asset and liability management activities within guidelines established by its Asset Liability Policy Committee (“ALPC”) and approved by the Board of Directors. ALPC has the responsibility for approving and ensuring compliance with ALPC management policies, including interest rate risk exposure. The Company uses Net Interest Income Simulation Analysis and Market Value of Equity Modeling for measuring and analyzing consolidated interest rate risk.
 
Net Interest Income Simulation Analysis One of the primary tools used to measure interest rate risk and the effect of interest rate changes on net interest income is simulation analysis. The monthly analysis incorporates substantially all of the Company’s assets and liabilities and off-balance sheet instruments, together with forecasted changes in the balance sheet and assumptions that reflect the current interest rate environment. Through this simulation, management estimates the impact on net interest income of a 200 basis point upward or downward gradual change of market interest rates over a one-year period. The simulation also estimates the effect of immediate and sustained parallel shifts in the yield curve of 50 basis points as well as the effect of immediate and sustained flattening or steepening of the yield curve. This simulation includes assumptions about how the balance sheet is likely to be affected by changes in loan and deposit growth. Assumptions are made to project interest rates for new loans and deposits based on historical analysis, management’s outlook and repricing strategies. These assumptions are validated on a periodic basis. A sensitivity analysis is provided for key variables of the simulation. The results are reviewed by ALPC monthly and are used to guide asset/liability management strategies.
The table below summarizes the interest rate risk of net interest income based on forecasts over the succeeding 12 months. At December 31, 2007, based on the rate environment at that time, the Company’s overall interest rate risk position was liability sensitive to changes in interest rates. In January 2008, the Federal Reserve Bank lowered the Federal Funds rate by 125 basis points to 3.00 percent, which resulted in the overall interest rate risk position of the Company being slightly liability sensitive. The Company manages its interest rate risk position by holding assets on the balance sheet with desired interest rate risk characteristics, implementing certain pricing strategies for loans and deposits and through the selection of derivatives and various funding and investment portfolio strategies. The Company manages the overall interest rate risk profile within policy limits. ALPC policy limits the estimated change in net interest income to 4.0 percent of forecasted net interest income over the succeeding 12 months. At December 31, 2007, and 2006, the Company was within its ALPC policy.
 
Market Value of Equity Modeling The Company also utilizes the market value of equity as a measurement tool in managing interest rate sensitivity. The market value of equity measures the degree to which the market values of the Company’s assets and liabilities and off-balance sheet instruments will change given a change in interest rates. ALPC policy limits the change in market value of equity in a 200 basis point parallel rate shock to 15 percent of the market value of equity assuming interest rates at December 31, 2007. The up 200 basis point scenario resulted in a 7.6 percent decrease in the market value of equity at December 31, 2007, compared with a 6.7 percent decrease at December 31, 2006. The down 200 basis point scenario resulted in a 3.5 percent decrease in the market value of equity at December 31, 2007, compared with a 1.8 percent decrease at December 31, 2006. At December 31, 2007 and 2006, the Company was within its ALPC policy.
The valuation analysis is dependent upon certain key assumptions about the nature of assets and liabilities with non-contractual maturities. Management estimates the average life and rate characteristics of asset and liability accounts based upon historical analysis and management’s expectation of rate behavior. These assumptions are validated on a periodic basis. A sensitivity analysis of key variables of the valuation analysis is provided to ALPC monthly and is used to guide asset/liability management strategies. The Company also uses duration of equity as a measure of interest rate risk. The duration of equity is a measure of the net market value sensitivity of the assets, liabilities and derivative positions of the Company. The duration of assets was 1.8 years at December 31, 2007 and 2006. The duration of liabilities was 1.9 years at December 31, 2007 and 2006. At December 31, 2007, the duration of equity was 1.2 years, compared with 1.6 years at December 31, 2006. The duration of equity measures shows that sensitivity of the market value of equity of the Company was liability sensitive to changes in interest rates.
 
Use of Derivatives to Manage Interest Rate and Other Risks In the ordinary course of business, the Company enters into

 
SENSITIVITY OF NET INTEREST INCOME
                                                                   
    December 31, 2007       December 31, 2006  
    Down 50
    Up 50
    Down 200
    Up 200
      Down 50
    Up 50
    Down 200
    Up 200
 
    Immediate     Immediate     Gradual     Gradual       Immediate     Immediate     Gradual     Gradual  
Net interest income
    .54 %     (1.01 )%     1.28 %     (2.55 )%       .42 %     (1.43 )%     .92 %     (2.95 )%
                                                                   
                                                                   

U.S. BANCORP  47



 

derivative transactions to manage its interest rate, prepayment, credit, price and foreign currency risks (“asset and liability management positions”) and to accommodate the business requirements of its customers (“customer-related positions”). To manage its interest rate risk, the Company may enter into interest rate swap agreements and interest rate options such as caps and floors. Interest rate swaps involve the exchange of fixed-rate and variable-rate payments without the exchange of the underlying notional amount on which the interest payments are calculated. Interest rate caps protect against rising interest rates while interest rate floors protect against declining interest rates. In connection with its mortgage banking operations, the Company enters into forward commitments to sell mortgage loans related to fixed-rate mortgage loans held for sale and fixed-rate mortgage loan commitments. The Company also acts as a seller and buyer of interest rate contracts and foreign exchange rate contracts on behalf of customers. The Company minimizes its market and liquidity risks by taking similar offsetting positions.
All interest rate derivatives that qualify for hedge accounting are recorded at fair value as other assets or liabilities on the balance sheet and are designated as either “fair value” or “cash flow” hedges. The Company performs an assessment, both at inception and quarterly thereafter, when required, to determine whether these derivatives are highly effective in offsetting changes in the value of the hedged items. Hedge ineffectiveness for both cash flow and fair value hedges is recorded in noninterest income. Changes in the fair value of derivatives designated as fair value hedges, and changes in the fair value of the hedged items, are recorded in earnings. Changes in the fair value of derivatives designated as cash flow hedges are recorded in other comprehensive income until income from the cash flows of the hedged items is realized. Customer-related interest rate swaps, foreign exchange rate contracts, and all other derivative contracts that do not qualify for hedge accounting are recorded at fair value and resulting gains or losses are recorded in trading account gains or losses or mortgage banking revenue. Gains or losses on customer-related derivative positions were not material in 2007.
By their nature, derivative instruments are subject to market risk. The Company does not utilize derivative instruments for speculative purposes. Of the Company’s $57.5 billion of total notional amount of asset and liability management positions at December 31, 2007, $24.4 billion was designated as either fair value or cash flow hedges or net investment hedges of foreign operations. The cash flow hedge derivative positions are interest rate swaps that hedge the forecasted cash flows from the underlying variable-rate debt. The fair value hedges are primarily interest rate swaps that hedge the change in fair value related to interest rate changes of underlying fixed-rate debt and subordinated obligations.
The Company uses forward commitments to sell residential mortgage loans to hedge its interest rate risk related to residential mortgage loans held-for-sale. The Company commits to sell the loans at specified prices in a future period, typically within 90 days. The Company is exposed to interest rate risk during the period between issuing a loan commitment and the sale of the loan into the secondary market. In connection with its mortgage banking operations, the Company held $2.8 billion of forward commitments to sell mortgage loans and $3.7 billion of unfunded mortgage loan commitments at December 31, 2007, that were derivatives in accordance with the provisions of the Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedge Activities.” The unfunded mortgage loan commitments are reported at fair value as options in Table 18. The Company also utilizes U.S. Treasury futures, options on U.S. Treasury futures contracts, interest rate swaps and forward commitments to buy residential mortgage loans to economically hedge the change in fair value of its residential MSRs.
Derivative instruments are also subject to credit risk associated with counterparties to the derivative contracts. Credit risk associated with derivatives is measured based on the replacement cost should the counterparties with contracts in a gain position to the Company fail to perform under the terms of the contract. The Company manages this risk through diversification of its derivative positions among various counterparties, requiring collateral agreements with credit-rating thresholds, entering into master netting agreements in certain cases and entering into interest rate swap risk participation agreements. These agreements transfer the credit risk related to interest rate swaps from the Company to an unaffiliated third-party. The Company also provides credit protection to third-parties with risk participation agreements, for a fee, as part of a loan syndication transaction.
At December 31, 2007, the Company had $219 million in accumulated other comprehensive income related to realized and unrealized losses on derivatives classified as cash flow hedges. Unrealized gains and losses are reflected in earnings when the related cash flows or hedged transactions occur and offset the related performance of the hedged items. The estimated amount to be reclassified from accumulated other comprehensive income into earnings during the next 12 months is a loss of $106 million.
The change in the fair value of all other asset and liability management derivative positions attributed to hedge ineffectiveness recorded in noninterest income was not material for 2007.

48  U.S. BANCORP



 

 

Table 18      DERIVATIVE POSITIONS
ASSET AND LIABILITY MANAGEMENT POSITIONS
 
                                                                       
                                                    Weighted-
                                                    Average
    Maturing                 Remaining
                                              Fair
    Maturity
December 31, 2007 (Dollars in Millions)   2008     2009     2010     2011     2012     Thereafter     Total     Value     In Years
 
 
Interest Rate Contracts
                                                                     
Receive fixed/pay floating swaps
                                                                     
Notional amount
  $     $     $     $     $     $ 3,750     $ 3,750     $ 17       40.87
Weighted-average
                                                                     
Receive rate
    %     %     %     %     %     6.32 %     6.32 %              
Pay rate
                                  5.41       5.41                
Pay fixed/receive floating swaps
                                                                     
Notional amount
  $ 7,550     $ 4,000     $     $     $     $ 4,429     $ 15,979     $ (307 )     3.00
Weighted-average
                                                                     
Receive rate
    5.15 %     5.11 %     %     %     %     5.08 %     5.12 %              
Pay rate
    5.13       4.49                         5.22       4.99                
Futures and forwards
                                                                     
Buy
  $ 12,459     $     $     $     $     $     $ 12,459     $ (51 )     .12
Sell
    11,427                                     11,427       (33 )     .16
Options
                                                                     
Written
  $ 10,689     $     $     $     $     $     $ 10,689     $ 10       .12
Foreign Exchange Contracts
                                                                     
Cross-currency swaps
                                                                     
Notional amount
  $     $     $     $     $     $ 1,913     $ 1,913     $ 196       8.80
Weighted-average
                                                                     
Receive rate
    %     %     %     %     %     4.24 %     4.24 %              
Pay rate
                                  4.87       4.87                
Forwards
  $ 1,111     $     $     $     $     $     $ 1,111     $ (15 )     .03