“Safe Harbor” Statement under the Private Securities Litigation Reform Act of 1995:Statements in this report regarding U.S. Bancorp’s business which are not historical facts are “forward-looking statements” that involve risks and uncertainties. For a discussion of such risks and uncertainties, which could cause actual results to differ from those contained in the forward-looking statements, see the “Forward-Looking Statements” disclosure on page 17 of this report.
CORPORATE PROFILE
U.S. Bancorp, headquartered in Minneapolis, is the 6th largest financial holding company in the United States, with total assets exceeding $195 billion at year-end 2004. U.S. Bancorp, the parent company of U.S. Bank, serves 13.1 million customers and operates 2,370 branch offices in 24 states. U.S. Bancorp customers also access their accounts through 4,620 U.S. Bank ATMs, U.S. Bank Internet Banking and telephone banking. A network of specialized U.S. Bancorp offices across the nation, inside and outside our 24-state footprint, provides a comprehensive
line of banking, brokerage, insurance, investment, mortgage, trust and payment services products to consumers, businesses, governments and institutions.
Major lines of business provided by U.S. Bancorp through U.S. Bank and other subsidiaries include Wholesale Banking; Payment Services; Private Client, Trust & Asset Management; and Consumer Banking. U.S. Bank is home of the exclusive Five Star Service Guarantee. Visit U.S. Bancorp on the web at usbank.com.
U.S. BANCORP 1
SELECTED FINANCIAL HIGHLIGHTS
2 U.S. BANCORP
FINANCIAL SUMMARY
U.S. BANCORP 3
Fellow Shareholders:
I am pleased to tell you that in 2004, U.S. Bancorp achieved its goals for the year and delivered on its promises to you.
STRONG FINANCIAL RESULTS WITH AFOCUS ON REVENUE GROWTH
During the coming year, we will act to sustain those successes. Revenue growth is our primary focus, particularly net interest income from improved commercial lending results. Our consumer lending business continues to grow, and we have made a number of changes surrounding our commercial banking and small business banking lines of business to increase commercial loan growth. We saw middle market commercial loan balances move upward in fourth quarter 2004.
We are very disciplined in our acquisitions, focusing only on those which will enhance revenue growth, create operating scale, build a more profitable business line or strengthen a critical competitive advantage. This strategy has proved very successful, most notably in our payments business, which reported 10.6 percent net revenue growth in 2004.
Our capital position remains strong, and we repurchased 93.8 million shares during 2004.
INVESTING FOR GROWTH AND SERVICE
We continue to support our pledge of guaranteed high levels of customer service. Investments in delivery and operational systems allowed us to unify systems, simplify procedures, streamline processes and increase the ease of numerous customer transactions and communications. These investments improved customer service and increased customer satisfaction and loyalty, contributing significantly to our ability to attract and retain customers. We have also improved hiring and training practices, and service quality is an integral part of our employees’ performance evaluation and incentive programs.
RATING AGENCIES VIEW U.S. BANK FAVORABLY
4 U.S. BANCORP
upgrade was Moody’s view that the corporation’s business model will generate strong profitability, and the consistency of that profitability performance is supported by improving risk management and maintenance of very good liquidity.
We were also pleased that on September 27, 2004, Fitch’s rating agency upgraded U.S. Bank’s ratings. Long- and short-term senior debt at the holding company, U.S. Bancorp, were upgraded to AA- and F1+, respectively, from A+ and F1, respectively. The long-term ratings of its subsidiary bank, U.S. Bank National Association, were upgraded to AA from AA-. The main driver behind the upgrade was Fitch’s view of the corporation’s solid net interest margin, diverse sources of non-interest income, disciplined expense management and improved asset quality.
The debt ratings established for U.S. Bank by Moody’s, Standard and Poor’s, and Fitch reflect the ratings agencies’ recognition of the strong, consistent financial performance of the company and the quality of the balance sheet.
U.S. BANCORP IS A CORPORATIONBUILT ON INTEGRITY
CREATING SHAREHOLDER VALUEIS OUR PRIORITY
This corporation has paid a cash dividend for 142 consecutive years, and we have increased the dividend for 33 consecutive years. That long-time record of dividend increases earned U.S. Bancorp the designation of one of the S&P’s 58 “Dividend Aristocrats.” Only nine other issues have paid a dividend longer than U.S. Bancorp, which first paid a dividend in 1863.
We manage this corporation to increase the value of your investment in U.S. Bancorp. It’s the reason we come to work each day.
Sincerely,
Jerry A. GrundhoferChairman and Chief Executive OfficerU.S. BancorpFebruary 28, 2005
U.S. BANCORP 5
WHOLESALE BANKING
With relationship managers who understand the companies, the markets and the industries of our commercial, corporate and correspondent customers, no bank brings more to the table than U.S. Bank.
Whether it’s finding the right financing and capital for growth and expansion, accelerating receivables, expediting transactions, managing employee benefits programs or structuring transactions to finance foreign trade, U.S. Bank has the business solutions that build businesses and futures.
After several years of lackluster demand, in 2004 we saw an increase, albeit modest, in commercial and corporate lending, particularly in the areas of commercial and industrial lending and commercial real estate. Economic trends across most markets are positive overall and we expect to see continued improvement in 2005. Interest rates, while rising, are affordable, and companies appear more ready than at any time in the past several years to invest in their businesses.
Significant changes within our organization position us well to be more visible and active in every market, with more streamlined procedures and more competitive pricing. These changes augment the high level of customer service and industry expertise already provided to our customers.
KEY BUSINESS UNITS
10 U.S. BANCORP
PAYMENT SERVICES
U.S. Bancorp is a recognized leader in the rapidly growing payments business, with customers ranging from individual credit and debit cardholders and ATM users to local and global merchants, fleet enterprises and multinational corporations with complex payment and payment processing needs.
We provide innovative card-based programs, internet-based reporting tools, fully integrated payment solutions and electronic payments settlement answers across the country and around the world.
Payment Services is a higher growth, higher return line of business for U.S. Bancorp. We will continue to invest in the technology, acquisitions, product development and sales promotion needed to support its continued growth.
There is strong momentum in merchant processing, especially related to our new NOVA processing capabilities in Europe. Both our retail payments and corporate payments businesses are focusing on the expansion of existing relationships with current
customers. Additionally, corporate payment products and merchant processing can provide valuable benefits to middle market and small business companies, and we are increasing penetration of those customer segments for payments and processing services.
We are also investing in the hardware and technology to expand and enhance our network of U.S. Bank ATMs. Our newest generation of ATMs are among the most highly functional in the industry, with vivid, striking graphics and transaction screens and customization capabilities so that customers’ transactions are faster, easier and individualized.
THE PRIVATE CLIENT GROUP, TRUST & ASSET MANAGEMENT
U.S. Bancorp understands what it takes to build, manage and preserve our clients’ wealth. From sensitive and personalized family financial management and estate planning to sophisticated corporate trust transactions to expert advice on investments, we prepare clients for today’s realities and tomorrow’s goals.
The Private Client Group works with affluent individuals and families, professional service corporations and non-profit organizations as a bank within a bank, providing tailored programs to meet specialized needs. Recognizing that many more U.S. Bank customers could benefit from the financial planning, investment management, personal trust and private banking expertise of The Private Client Group, this group is building stronger bank-wide partnerships with other U.S. Bank lines of business to identify Private Client Group referral opportunities.
Built on our strong technology platform and superior management, Corporate Trust Services is leveraging its distribution and scale following our two most recent acquisitions. We reported to you last year about our acquisition of the State Street corporate trust business, and in June 2004 we completed the acquisition of National City’s corporate trust division, a transaction that brought
the bank $34 billion in assets under administration and 3,800 corporate clients throughout the Midwest. It is our sixth corporate trust acquisition since 1999, reflecting our approach of acquisitions to grow revenue and businesses capable of competing with anyone.
U.S. Bancorp Asset Management, Inc., a subsidiary of U.S. Bank National Association, serves as the investment advisor to the First American Funds. It provides investment management services to individuals and institutions including corporations, foundations, pension funds, public funds, and retirement plans. The firm has offices in 24 states. Asset Management distribution is expanding through increased penetration of the Institutional Market and third-party distribution. In 2004, U.S. Bancorp Asset Management launched two new mutual funds—the First American Inflation Protected Securities Fund and the First American U.S. Treasury Money Market Fund. A retirement (R) share class was also added to a number of funds in the fund family.
CONSUMER BANKING
Our customers want convenience, accessibility, quality products and outstanding service. Our distribution channels—full-service banking offices, ATMs, telephone banking, and internet banking—deliver the deposit, credit, mortgage, investment and insurance products that support the goals and visions of personal and small business customers.
Business momentum in Consumer Banking is strong, and we continue to invest in technologies and initiatives that enhance distribution and deliver on customer expectations.
Customer satisfaction remains our top priority, and new Consumer Banking product initiatives are positively impacting customer satisfaction. Enhancements to internet banking on usbank.com, again ranked number one by Speer and Associates, provide even greater flexibility, customization and functionality.
Significant investment in innovative image technology enables U.S. Bank Internet Banking customers to instantly view more than 3.5 million check and deposit slip images per month on their computer screens. A wide range of operational procedures have also been simplified and streamlined.
We continue to expand our unique Checking That Pays® rewards program, which gives customers who use their U.S. Bank Visa®Check Card the choice of four different reward options. In 2004, U.S. Bank rewarded customers more than $26 million in annual cash rebates, five times the $5 million rewarded in 2000.
MARKET PENETRATION
In Consumer Banking, we have improved our automated capability to identify product recommendation and customer service opportunities at the individual customer level so we can provide more personalized service and recommend the most appropriate products.
In Corporate Payment Systems, we are dedicating resources to build middle market relationships. We have redesigned and simplified processes, applications and contracts and have been pursuing new client categories among companies with annual sales between $20 and $500 million. Our new One Card for the middle market combines the best features from our corporate and purchasing cards into one easy-to-manage program.
NOVA’s new Electronic Check Service processing streamlines check acceptance and mitigates risk for our customers so they can accept checks as safely and easily as card payment alternatives.
Gift card industry sales reached $45 billion in 2003 and are forecast to double by 2007. NOVA’s growing gift card program meets the needs of merchants in a cost-effective manner, and NOVA gift cards are processed using the same point-of-sale systems used for credit and debit card processing, further controlling costs.
14 U.S. BANCORP
The Private Client Group has several initiatives in progress which leverage the franchise to develop new client relationships. Our focus is on building stronger internal partnerships with other U.S. Bancorp lines of business. We recognize that many customers already doing business with U.S. Bank could benefit from the comprehensive and specialized expertise of our Financial Planning, Private Banking, Personal Trust, Investment and Insurance experts in The Private Client Group.
Retail Payment Solutions has increased penetration of personal and small business checking account customers with U.S. Bank-branded credit and debit cards by investing in sales and training opportunities with our expanded branch network.
services. SinglePointSM allows business customers to access information and reports, initiate and manage ACH transactions and wires, view check and deposit images and manage check fraud programs at one source.
We have upgraded and image-enabled key lockbox sites for both wholesale and retail payment processing, and introduced a suite of check conversion products and services including On-Site Electronic Deposit and Electronic Cash Letter.
Institutional Trust has launched Health Savings Accounts (HSA) to client companies. HSAs are tax-exempt trust or custodial accounts to be used exclusively for future medical expenses. Similar to IRAs, they are special tax-sheltered savings accounts for medical bills for those employees who qualify.
FORWARD-LOOKING STATEMENTS This Annual Report and Form 10-K contains forward-looking statements. Statements that are not historical or current facts, including statements about beliefs and expectations, are forward-looking statements. These statements often include the words “may,” “could,” “would,” “should,” “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions. These forward-looking statements cover, among other things, anticipated future revenue and expenses and the future prospects of U.S. Bancorp. Forward-looking statements involve inherent risks and uncertainties, and important factors could cause actual results to differ materially from those anticipated, including the following, in addition to those contained in U.S. Bancorp’s reports on file with the SEC: (i) general economic or industry conditions could be less favorable than expected, resulting in a deterioration in credit quality, a change in the allowance for credit losses, or a reduced demand for credit or fee-based products and services; (ii) changes in the domestic interest rate environment could reduce net interest income and could increase credit losses; (iii) inflation, changes in securities market conditions and monetary fluctuations could adversely affect the value or credit quality of our assets, or the availability and terms of funding necessary to meet our liquidity needs; (iv) changes in the extensive laws, regulations and policies governing financial services companies could alter our business environment or affect operations; (v) the potential need to adapt to industry changes in information technology systems, on which we are highly dependent, could present operational issues or require significant capital spending; (vi) competitive pressures could intensify and affect our profitability, including as a result of continued industry consolidation, the increased availability of financial services from non-banks, technological developments or bank regulatory reform; (vii) changes in consumer spending and savings habits could adversely affect our results of operations; (viii) changes in the financial performance and condition of our borrowers could negatively affect repayment of such borrowers’ loans; (ix) acquisitions may not produce revenue enhancements or cost savings at levels or within time frames originally anticipated, or may result in unforeseen integration difficulties; (x) capital investments in our businesses may not produce expected growth in earnings anticipated at the time of the expenditure; and (xi) acts or threats of terrorism, and/or political and military actions taken by the U.S. or other governments in response to acts or threats of terrorism or otherwise could adversely affect general economic or industry conditions. Forward-looking statements speak only as of the date they are made, and U.S. Bancorp undertakes no obligation to update them in light of new information or future events.
U.S. BANCORP 17
MANAGEMENT’S DISCUSSION AND ANALYSIS" -->
OVERVIEW
In 2004, U.S. Bancorp and its subsidiaries (the “Company”) continued to demonstrate its financial strength and shareholder focus. We began the year with several specific financial objectives. The first goal was a focus on organic revenue growth. While growth in net interest income has been challenging for the banking industry due to rising interest rates and sluggish commercial loan growth, the Company experienced strong growth in its fee-based revenues, particularly in payment processing services. The Company generated fee-based revenue growth of 11.0 percent in 2004. By year-end, commercial loan balances also displayed encouraging trends as the Company experienced its first year-over-year growth in quarterly average balances since mid-2001. Retail loans continued to display strong growth in 2004. In 2005, the Company will continue to focus on revenue growth driven by disciplined strategic business initiatives, customer service and an emphasis on payment processing, retail banking and commercial lending. The second goal was to continue improving the credit quality of our loan portfolios. During the year nonperforming assets declined 34.8 percent from a year ago and total net charge-offs decreased to .63 percent of average loans outstanding in 2004, compared with 1.06 percent in 2003. By year end 2004, the credit risk profile of the Company had improved to pre-2001 levels. In 2005, the Company will continue to focus on credit quality and minimizing volatility of credit-related losses. Finally, effectively managing costs is always a goal for the Company. During 2004, our efficiency ratio (the ratio of noninterest expense to taxable-equivalent net revenue excluding net securities gains or losses) improved to 45.3 percent, compared with 45.6 percent in 2003, and continues to be a leader in the banking industry. The Company’s results for 2004 reflect the achievement of these operating objectives and help to position the Company to achieve its long-term goal of 10 percent or greater growth in earnings per diluted share.
Earnings Summary The Company reported net income of $4.2 billion in 2004, or $2.18 per diluted share, compared with $3.7 billion, or $1.93 per diluted share, in 2003. The 13.0 percent increase in earnings per diluted share principally reflected growth in fee-based revenues and lower credit costs. Return on average assets and return on average equity were 2.17 percent and 21.4 percent, respectively, in 2004, compared with returns of 1.99 percent and 19.2 percent, respectively, in 2003. Net income in 2003 included after-tax income from discontinued operations of $22.5 million, or $.01 per diluted share.
Acquisition and Divestiture ActivityOn December 31, 2003, the Company announced that it had completed the tax-free distribution of Piper Jaffray Companies representing substantially all of the Company’s capital markets business line. The Company distributed to our shareholders one share of Piper Jaffray common stock for every 100 shares of U.S. Bancorp common stock, by means of a special dividend of $685 million. This distribution did not include brokerage, financial advisory or asset management services offered to customers through other business units. The Company continues to provide asset management services to its customers through the Private Client, Trust and Asset Management business segment and access to investment products and services through its extensive network of licensed financial advisors within the retail brokerage platform of the Consumer Banking business segment. In connection with the spin-off of Piper Jaffray, historical financial results related to Piper Jaffray have been segregated and accounted for in the Company’s financial statements as discontinued operations.
STATEMENT OF INCOME ANALYSIS
Net Interest IncomeNet interest income, on a taxable-equivalent basis, was $7.1 billion in 2004, compared with $7.2 billion in 2003 and $6.8 billion in 2002. The decline in net interest income in 2004 reflected modest growth in average earning assets, more than offset by lower net interest margins. Also contributing to the year-over-year decline in net interest income was a $37.6 million reduction in loan fees, the result of fewer loan prepayments in a rising rate environment. Average earning assets were $168.1 billion for 2004, compared with $160.8 billion and $147.4 billion for 2003 and 2002, respectively. The $7.3 billion (4.5 percent) increase in average earning assets for 2004, compared with 2003, was primarily driven by increases in residential mortgages, retail loans and investment securities, partially offset by a decline in commercial loans and loans held for sale related to mortgage banking activities. The decline in average commercial loans from a year ago reflected soft loan demand in 2003 and through the third quarter of 2004. The Company began to experience growth in commercial
Provision for Credit LossesThe 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. The provision for credit losses was $669.6 million in 2004, compared with $1,254.0 million and $1,349.0 million in 2003 and 2002, respectively.
Noninterest IncomeNoninterest income in 2004 was $5.5 billion, compared with $5.3 billion in 2003 and $5.2 billion in 2002. The increase in noninterest income of $206.2 million (3.9 percent) in 2004, compared with 2003, was driven by strong organic growth in most fee-based products and services categories (11.0 percent), particularly in payment processing revenue. Partially offsetting the increase in fee-based revenue growth in 2004 was a year-over-year reduction in net securities gains (losses) of $349.7 million.
Noninterest ExpenseNoninterest expense in 2004 was $5.8 billion, compared with $5.6 billion and $5.7 billion in 2003 and 2002, respectively. The increase of $187.6 million (3.4 percent) in 2004, compared with 2003, principally reflected a $154.8 million charge related to the prepayment of a portion of the Company’s long-term debt, costs related to business initiatives and incremental expenses of $62.8 million due to the expansion of EuroConex. These increases were offset somewhat by a net reduction in MSR impairments of $151.9 million and lower merger and restructuring-related charges. In 2003, noninterest expense included $46.2 million of merger and restructuring-related costs related to acquisitions completed in prior years. Compensation expense increased in 2004, compared with 2003, due to increases in salaries and stock-based compensation. The increase in salaries reflected business
Pension PlansBecause 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 plan’s actuarial assumptions. The Company and its Compensation Committee have an established process for evaluating the plans, their performance and significant plan assumptions, including the assumed discount rate and the long-term rate of return (“LTROR”). At least annually, an independent consultant is engaged to assist U.S. Bancorp’s Compensation Committee in evaluating plan objectives, funding policies and investment policies considering its long-term investment time horizon and asset allocation strategies. Note 19 of the Notes to Consolidated Financial Statements provides further information on funding practices, investment policies and asset allocation strategies.
Note 19 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:
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 significantly different than the information provided in the sensitivity analysis.
Income Tax ExpenseThe provision for income taxes was $2,009.6 million (an effective rate of 32.5 percent) in 2004, compared with $1,941.3 million (an effective rate of 34.4 percent) in 2003 and $1,707.5 million (an effective rate of 34.6 percent) in 2002. The improvement in the effective tax rate in 2004, compared with 2003, was primarily due to changes in estimated tax liabilities of $90.0 million related to the resolution of federal tax examinations covering substantially all of the Company’s legal entities for the years 1995 through 1999 and $16.3 million related to the resolution of a state tax examination for tax years through 2000. The improvement in the effective tax rate in 2003, compared with 2002, was primarily driven by a change in unitary state tax apportionment factors driven by a shift in business mix as a result of the impact of acquisitions, market demographics, the mix of product revenue and an increase in federal and state tax credits.
BALANCE SHEET ANALYSIS
Average earning assets were $168.1 billion in 2004, compared with $160.8 billion in 2003. The increase in average earning assets of $7.3 billion (4.5 percent) was primarily driven by growth in residential mortgages, retail loans and investment securities, partially offset by a decline in commercial loans and loans held for sale related to mortgage banking activities. The increase in average earning assets was principally funded by increases of $1.6 billion in interest-bearing deposits and $5.5 billion in wholesale funding.
Loans The Company’s total loan portfolio was $126.3 billion at December 31, 2004, an increase of $8.1 billion (6.8 percent) from December 31, 2003. The increase in total loans was driven by strong growth in retail loans (10.7 percent) and residential mortgages (14.2 percent) and to a lesser extent by commercial loans (4.3 percent) and commercial real estate loans (1.3 percent). The increase in retail loans was across most loan categories while the increase in residential mortgages was primarily the result of asset/liability management decisions to retain a greater portion of the Company’s adjustable-rate loan production. Table 6 provides a summary of the loan distribution by product type. Table 8 provides a summary of selected loan maturity distribution by loan category. Average total loans increased $3.8 billion (3.2 percent) in 2004, compared with 2003. Growth in average retail loans and residential mortgages, compared to 2003, was partially offset by a decline in average commercial loans.
CommercialCommercial loans, including lease financing, totaled $40.2 billion at December 31, 2004, compared with $38.5 billion at December 31, 2003, an increase of
Commercial Real EstateThe Company’s portfolio of commercial real estate loans, which includes commercial mortgages and construction loans, was $27.6 billion at December 31, 2004, compared with $27.2 billion at December 31, 2003, a modest increase of $343 million (1.3 percent). Specifically, construction and development loans increased by $652 million (9.9 percent) as developers continued to take advantage of relatively low interest rates. Commercial mortgages outstanding decreased modestly by $309 million (1.5 percent) as growth in Small Business Administration (“SBA”) real estate mortgages was more than offset by reductions in traditional commercial real estate mortgages. Average commercial real estate loans increased by $125 million (.5 percent) in 2004, compared with 2003, primarily driven by growth in SBA commercial real estate mortgage loans. Table 9 provides a summary of commercial real estate by property type and geographical locations.
Residential MortgagesResidential mortgages held in the loan portfolio were $15.4 billion at December 31, 2004, an increase of $1.9 billion (14.2 percent) from December 31,
Retail Total retail loans outstanding, which include credit card, retail leasing, home equity and second mortgages and other retail loans, were $43.2 billion at December 31, 2004, compared with $39.0 billion at December 31, 2003. The increase of $4.2 billion (10.7 percent) was driven by an increase in home equity lines of credit, credit cards, retail leasing, automobile loans and installment loans, which increased $2,275 million, $670 million, $1,137 million, $254 million and $387 million, respectively, during 2004. The increases in these loan categories were offset somewhat by a reduction in home equity loans of $634 million during the year. Average retail loans increased $3.0 billion (7.9 percent) to $41.2 billion in 2004, reflecting growth in home equity lines, retail leasing, installment loans and credit card. Of the total retail loans and residential mortgages outstanding, approximately 87.4 percent are to customers located in the Company’s primary banking regions.
Loans Held for SaleAt December 31, 2004, loans held for sale, consisting of residential mortgages to be sold in the secondary market, were $1.4 billion. This asset category was essentially unchanged relative to loans held for sale at December 31, 2003, despite $4.4 billion of mortgage loan production during the fourth quarter of 2004, compared with $3.9 billion in fourth quarter 2003. Average loans held for sale declined to $1.6 billion in 2004, compared with $3.6 billion in 2003, due to the impact of rising interest rates on mortgage loan production.
Investment SecuritiesThe Company uses its investment securities portfolio for several purposes. It serves as a vehicle to manage interest rate and prepayment risk, generates interest and dividend income from the investment of excess funds depending on 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 interest rate risks and to meet liquidity requirements.
Deposits Total deposits were $120.7 billion at December 31, 2004, an increase of $1.7 billion (1.4 percent) from December 31, 2003. The increase in total deposits was primarily the result of an increase in time deposits greater than $100,000, partially offset by decreases in noninterest-bearing deposits, savings deposits and time certificates of deposit less than $100,000. Average total deposits were $116.2 billion in 2004, declining $331 million from $116.6 billion in 2003. The decline in average total deposits was primarily due to lower average noninterest-bearing deposits and time certificates of deposit less than $100,000. The reductions in these categories were offset somewhat by growth in average savings deposits and time deposits greater than $100,000.
Borrowings The Company utilizes both short-term and long-term borrowings to fund growth of earning assets in excess of deposit growth. Short-term borrowings, which include federal funds purchased, securities sold under agreements to repurchase and other short-term borrowings, were $13.1 billion at December 31, 2004, compared with $10.9 billion at December 31, 2003. Short-term funding is managed to levels deemed appropriate given alternative funding sources. The increase of $2.2 billion in short-term borrowings reflected wholesale funding associated with the Company’s earning asset growth.
The composition of deposits was as follows:
The maturity of time certificates of deposit less than $100,000 and time deposits greater than $100,000 was as follows:
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, 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 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 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 reduction of net interest income as a result of changes in interest rates. Rate movements 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 equity 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 ManagementThe 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 experiencing 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, take any necessary charge-offs promptly and maintain adequate reserve levels for probable loan losses inherent in the portfolio. Commercial banking operations rely on a strong credit culture that combines prudent credit policies and individual lender accountability. Lenders are assigned lending grades based on their level of experience and customer service requirements. Lending grades represent the level of approval authority for the amount of credit exposure and level of risk. Credit officers reporting to an independent credit administration function have higher levels of lending grades 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 loan transactions. The Company uses the risk rating system for regulatory reporting, determining the frequency of review of the credit exposures, and evaluation and determination of 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 OverviewIn 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. Beginning in 2000, the domestic economy experienced slower growth. During 2001, corporate earnings weakened and credit quality indicators among certain industry sectors deteriorated. The stagnant economic growth was evidenced by the Federal Reserve Board’s (“FRB”) actions to stimulate economic growth through a series of interest rate reductions from mid-2001 through late 2002. In addition, events of September 11, 2001, had a profound impact on credit quality due to changes in consumer confidence and related spending, governmental priorities and business activities. In response to declining economic conditions, company-specific portfolio trends, and the Firstar/ USBM merger, the Company initiated several actions during 2001 including aligning the risk management practices and charge-off policies of the companies and restructuring and disposing of certain portfolios that did not align with the credit risk profile of the combined company. The Company also implemented accelerated loan workout strategies for certain commercial credits and increased the provision for credit losses in 2001.
Credit DiversificationThe 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, specialized trust, 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 2004.
Analysis of Nonperforming AssetsThe level of nonperforming assets represents a key indicator, among other considerations, of the potential for future credit losses. Nonperforming assets include nonaccrual loans, restructured loans not performing in accordance with modified terms and 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. At December 31, 2004, total nonperforming assets were $748.4 million, compared with $1,148.1 million at year-end 2003 and $1,373.5 million at year-end 2002. The ratio of total nonperforming assets to total loans and other real estate decreased to .59 percent at December 31, 2004, compared with .97 percent and 1.18 percent at the end of 2003 and 2002, respectively.
Changes in Nonperforming Assets
Analysis of Loan Net Charge-OffsTotal loan net charge-offs decreased $484.6 million to $767.1 million in 2004, compared with $1,251.7 million in 2003 and $1,373.0 million in 2002. The ratio of total loan net charge-offs to average loans was .63 percent in 2004, compared with 1.06 percent in 2003 and 1.20 percent in 2002. The overall level of net charge-offs in 2004 reflected the Company’s ongoing efforts to reduce the overall risk profile of the organization, improved economic conditions, higher commercial loan recoveries, refinancing by higher risk customers with other companies and higher asset valuations. Net charge-offs are expected to increase modestly as the level of commercial loan recoveries declines to more normalized levels in 2005. The improvement in net charge-offs in 2003, compared with 2002, was due to credit risk management initiatives taken by the Company that improved the credit risk profile of the loan portfolio. These initiatives along with better economic conditions resulted in improving credit risk classifications and lower levels of nonperforming assets and consumer loan delinquencies.
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, 2004, the allowance for credit losses was $2,269.3 million (1.80 percent of loans). This compares with an allowance of $2,368.6 million (2.00 percent of loans) at December 31, 2003, and $2,422.0 million (2.08 percent of loans) at December 31, 2002. The ratio of the allowance for credit losses to nonperforming loans was 354 percent at year-end 2004, compared with 232 percent at year-end 2003 and 196 percent at year-end 2002. The ratio of the allowance for credit losses to loan net charge-offs was 296 percent at year-end 2004, compared with 189 percent at year-end 2003 and 176 percent at year-end 2002. Management determined that the allowance for credit losses was adequate at December 31, 2004.
Residual Risk ManagementThe Company manages its risk to changes in the residual value of leased assets through disciplined residual valuation setting at the inception of a
Operational Risk ManagementOperational 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.
Interest Rate Risk ManagementIn the banking industry, a significant risk exists related to changes in interest rates. To minimize the volatility of net interest income and of 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 AnalysisOne of the primary tools used to measure interest rate risk and the effect of interest rate changes on rate sensitive income and 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 these simulations, management estimates the impact on interest rate sensitive income of a 300 basis point upward or downward gradual change of market interest rates over a one-year period. The simulations also estimate 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
Sensitivity of Net Interest Income and Rate Sensitive Income
Market Value of Equity ModelingThe 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 guidelines limit 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, 2004. The up 200 basis point scenario resulted in a 2.7 percent decrease in the market value of equity at December 31, 2004, compared with a 3.1 percent decrease at December 31, 2003. The down 200 basis point scenario resulted in a 4.2 percent decrease in the market value of equity at December 31, 2004. Given the low level of interest rates, the down 200 basis point scenario was not computed for December 31, 2003. ALPC reviews other down rate scenarios to evaluate the impact of falling interest rates. The down 100 basis point scenario resulted in a ..7 percent decrease at December 31, 2004, and a 1.3 percent increase at December 31, 2003. At December 31, 2004 and 2003, the Company was within its policy guidelines.
Use of Derivatives to Manage Interest Rate Risk In the ordinary course of business, the Company enters into derivative transactions to manage its interest rate, prepayment 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
Asset and Liability Management Positions
Customer-related Positions
Market Risk ManagementIn addition to interest rate risk, the Company is exposed to other forms of market risk as a consequence of conducting normal trading activities. Business activities that contribute to market risk include, among other things, proprietary trading and foreign exchange positions. Value at Risk (“VaR”) is a key measure of market risk for the Company. Theoretically, VaR represents the maximum amount that the Company has placed at risk of loss, with a ninety-ninth percentile degree of confidence, to adverse market movements in the course of its risk taking activities.
Liquidity Risk ManagementALPC establishes policies, as well as analyzes and manages liquidity, to ensure that adequate funds are available to meet normal operating requirements in addition to unexpected customer demands for funds, such as high levels of deposit withdrawals or loan demand, in a timely and cost-effective manner. The most important factor in the preservation of liquidity is maintaining public confidence that facilitates the retention and growth of a large, stable supply of core deposits and wholesale funds. Ultimately, public confidence is generated through profitable operations, sound credit quality and a strong capital position. The Company’s performance in these areas has enabled it to develop a large and reliable base of core funding within its market areas and in domestic and global capital markets. Liquidity management is viewed from long-term and short-term perspectives, as well as from an asset and liability perspective. Management monitors liquidity through a regular review of maturity profiles, funding sources, and loan and deposit forecasts to minimize funding risk.
Off-Balance Sheet ArrangementsOff-balance sheet arrangements include any contractual arrangement to which an unconsolidated entity is a party, under which the Company has an obligation to provide credit or liquidity enhancements or market risk support. Off-balance sheet arrangements include certain defined guarantees, asset securitization trusts and conduits. Off-balance sheet arrangements also include any obligation under a variable interest held by an unconsolidated entity that provides financing, liquidity, credit enhancement or market risk support.
Capital ManagementThe Company is committed to managing capital for maximum shareholder benefit and maintaining strong protection for depositors and creditors. The Company has targeted returning 80 percent of earnings to our shareholders through a combination of dividends and share repurchases. In keeping with this target, the Company returned 109 percent of earnings in 2004. The Company continually assesses its business risks and capital position. The Company also manages its capital to exceed regulatory capital requirements for well-capitalized bank holding companies. To achieve these capital goals, the Company employs a variety of capital management tools including dividends, common share repurchases, and the issuance of subordinated debt and other capital instruments. Total shareholders’ equity was $19.5 billion at December 31, 2004, compared with $19.2 billion at December 31, 2003. The increase was the result of corporate earnings and option exercises, offset primarily by the payment of dividends and the repurchase of common stock.
FOURTH QUARTER SUMMARY
The Company reported net income of $1,056.0 million for the fourth quarter of 2004, or $.56 per diluted share, compared with $977.0 million, or $.50 per diluted share, for the fourth quarter of 2003. Return on average assets and return on average equity were 2.16 percent and 21.2 percent, respectively, for the fourth quarter of 2004, compared with returns of 2.05 percent and 19.4 percent, respectively, for the fourth quarter of 2003. The Company’s results for the fourth quarter of 2004 improved over the fourth quarter of 2003, primarily due to lower credit costs and growth in fee-based products and services. Net income from continuing operations was $1,056.0 million, or $.56 per diluted share, compared with $970.3 million, or $.50 per diluted share for the fourth quarter of 2003, representing an 8.8 percent annual growth rate. Net income for the fourth quarter of 2003 also included after-tax merger and restructuring-related items of $5.0 million ($7.6 million on a pre-tax basis).
LINE OF BUSINESS FINANCIAL REVIEW
Within the Company, financial performance is measured by major lines of business, which include Wholesale Banking, Consumer Banking, Private Client, Trust and Asset Management, Payment Services, and Treasury and Corporate Support. These operating segments are components of the Company about which financial information is available and is evaluated regularly in deciding how to allocate resources and assess performance.
Basis for Financial PresentationBusiness line results are derived from the Company’s business unit profitability reporting systems by specifically attributing managed balance sheet assets, deposits and other liabilities and their related income or expense. Funds transfer-pricing methodologies are utilized to allocate a cost of funds used or credit for funds provided to all business line assets and liabilities using a matched funding concept. Also, the business unit is allocated the taxable-equivalent benefit of tax-exempt products. Noninterest income and expenses directly managed by each business line, including fees, service charges, salaries and benefits, and other direct costs are accounted for within each segment’s financial results in a manner similar to the consolidated financial statements. Occupancy costs are allocated based on utilization of facilities by the lines of business. Noninterest expenses incurred by centrally managed operations or business lines that directly support another business line’s operations are charged to the applicable business line based on its utilization of those services primarily measured by the volume of customer activities. These allocated expenses are reported as net shared services expense. Certain corporate activities that do not directly support the operations of the lines of business are not charged to the lines of business. Goodwill and other intangible assets are assigned to the lines of business based on the mix of business of the acquired entity. The provision for credit losses within the Wholesale Banking, Consumer Banking, Private Client, Trust and Asset Management and Payment Services lines of business is based on net charge-offs, while Treasury and Corporate Support reflects the residual component of the Company’s total consolidated provision for credit losses determined in accordance with accounting principles generally accepted in the United States. Income taxes are assessed to each line of business at a standard tax rate with the residual tax expense or benefit to arrive at the consolidated effective tax rate included in Treasury and Corporate Support. Merger and restructuring-related charges, discontinued operations and cumulative effects of changes in accounting principles are not identified by or allocated to lines of business. Within the Company, capital levels are evaluated and managed centrally; however, capital is allocated to the operating segments to support evaluation of business performance. Capital allocations to the business lines are based on the amount of goodwill and other intangibles, the extent of off-balance sheet managed assets and lending commitments and the ratio of on-balance sheet assets relative to the total Company. Certain lines of business, such as Trust and Asset Management, have no significant balance sheet components. For these business
Wholesale Bankingoffers lending, depository, treasury management and other financial services to middle market, large corporate and public sector clients. Wholesale Banking contributed $1,079.6 million of the Company’s operating earnings in 2004 and $850.3 million in 2003. The increase in operating earnings in 2004 was driven by reductions in the provision for credit losses and total noninterest expense, partially offset by a decline in total net revenue, compared with 2003.
Consumer Bankingdelivers products and services to the broad consumer market and small businesses through banking offices, telemarketing, on-line services, direct mail and automated teller machines (“ATMs”). It encompasses community banking, metropolitan banking, small business banking, including lending guaranteed by the Small Business Administration, small-ticket leasing, consumer lending, mortgage banking, workplace banking, student banking, 24-hour banking and investment product and insurance sales. Consumer Banking contributed $1,465.0 million of the Company’s operating earnings for 2004 and $1,333.7 million for 2003, a 9.8 percent increase over 2003. The increase in operating earnings in 2004 was driven by strong fee-based revenues, lower noninterest expense and reductions in the provision for credit losses, compared with 2003. Within Consumer Banking, the retail banking business grew operating earnings by 23.1 percent, offset somewhat by a lower contribution from the mortgage banking business, compared with the same periods of 2003.
Private Client, Trust and Asset Managementprovides trust, private banking, financial advisory, investment management and mutual fund servicing through five businesses: Private Client Group, Corporate Trust, Asset Management, Institutional Trust and Custody and Fund Services, LLC. Private Client, Trust and Asset Management contributed $439.5 million of the Company’s operating earnings in 2004 and $388.6 million in 2003, an increase of $50.9 million (13.1 percent) compared with 2003. The growth was attributable to higher total net revenue and lower noninterest expense, partially offset by an increase in the provision for credit losses.
Payment Servicesincludes consumer and business credit cards, debit cards, corporate and purchasing card services, consumer lines of credit, ATM processing and merchant processing. Payment Services contributed $716.5 million of the Company’s operating earnings in 2004 and $596.0 million in 2003, a 20.2 percent increase over 2003. The increases were due to growth in total net revenue driven by higher transaction volumes and reductions in the provision for credit losses, partially offset by increases in total noninterest expense.
Treasury and Corporate Supportincludes the Company’s investment portfolios, funding, capital management and asset securitization activities, interest rate risk management, the net effect of transfer pricing related to average balances and the residual aggregate of expenses associated with business activities managed on a corporate basis, including enterprise-wide operations and administrative support functions. Operational expenses incurred by Treasury and Corporate Support on behalf of the other business lines are allocated back primarily based on customer transaction volume and account activities to the appropriate business unit and are identified as net shared services expense. Treasury and Corporate Support recorded operating earnings of $466.2 million in 2004, a decrease of 18.5 percent, compared with 2003.
ACCOUNTING CHANGES
Note 2 of the Notes to Consolidated Financial Statements discusses accounting standards recently issued but not yet required to be adopted and the expected impact of the changes in accounting standards. To the extent the adoption of new accounting standards affects the Company’s financial condition, results of operations or liquidity, the impacts are discussed in the applicable section(s) of the Management’s Discussion and Analysis and the Notes to Consolidated Financial Statements.
CRITICAL ACCOUNTING POLICIES
The accounting and reporting policies of the Company comply with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions, which are integral to understanding the Company’s financial statements. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and require management to make estimates that are difficult, subjective or complex. Most accounting policies are not considered by management to be critical accounting policies. Several factors are considered in determining whether or not a policy is critical in the preparation of financial statements. These factors include, among other things, whether the estimates are significant to the financial statements, the nature of the estimates, the ability to readily validate the estimates with other information including third-parties or available prices, and sensitivity of the estimates to changes in economic conditions and whether alternative accounting methods may be utilized under generally accepted accounting principles. Management has discussed the development and the selection of critical accounting policies with the Company’s Audit Committee.
Allowance for Credit LossesThe allowance for credit losses is established to provide for probable losses inherent in the Company’s credit portfolio. The methods utilized to estimate the allowance for credit losses, key assumptions and quantitative and qualitative information considered by management in determining the adequacy of the allowance for credit losses are discussed in the “Credit Risk Management” section.
Mortgage Servicing RightsMSRs are capitalized as separate assets when loans are sold and servicing is retained. The total cost of loans sold is allocated between the loans sold and the servicing assets retained based on their relative fair values. MSRs that are purchased from others are initially recorded at cost. The carrying value of the MSRs is amortized in proportion to and over the period of estimated net servicing revenue and recorded in noninterest expense as amortization of intangible assets. The carrying value of these assets is periodically reviewed for impairment using a lower of carrying value or fair value methodology. For purposes of measuring impairment, the servicing rights are stratified based on the underlying loan type and note rate and the carrying value for each stratum is compared to fair value based on a discounted cash flow analysis, utilizing current prepayment speeds and discount rates. Events that may significantly affect the estimates used are changes in interest rates and the related impact on mortgage loan prepayment speeds and the payment performance of the underlying loans. If the carrying value is greater than fair value, impairment is recognized through a valuation allowance for each impaired stratum and recorded as amortization of intangible assets. The reduction in the fair value of MSRs at December 31, 2004, to immediate 25 and 50 basis point adverse changes in interest rates would be approximately $133 million and $258 million, respectively. An upward movement in interest rates at December 31, 2004, of 25 and 50 basis points would increase the value of the MSRs by approximately $109 million and $177 million, respectively. Refer to Note 12 of the Notes to Consolidated Financial Statements for additional information regarding MSRs.
Goodwill and Other IntangiblesThe Company records all assets and liabilities acquired in purchase acquisitions, including goodwill and other intangibles, at fair value as required by Statement of Financial Accounting Standards No. 141, “Goodwill and Other Intangible Assets.” Goodwill and indefinite-lived assets are no longer amortized but are subject, at a minimum, to annual tests for impairment. Under certain situations, interim impairment tests may be required if events occur or circumstances change that would more likely than not reduce the fair value of a reporting segment below its carrying amount. Other intangible assets are amortized over their estimated useful lives using straight-line and accelerated methods and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount.
Income TaxesThe Company estimates income tax expense based on amounts expected to be owed to various tax jurisdictions. Currently, the Company files tax returns in approximately 140 federal, state and local domestic jurisdictions and 6 foreign jurisdictions. The estimated income tax expense is reported in the Consolidated Statement of Income. Accrued taxes represent the net estimated amount due or to be received from taxing jurisdictions either currently or in the future and are reported in other assets or other liabilities on the Consolidated Balance Sheet. In estimating accrued taxes, the Company assesses the relative merits and risks of the appropriate tax treatment considering statutory, judicial and regulatory guidance in the context of the tax position. Because of the complexity of tax laws and regulations, interpretation can be difficult and subject to legal judgment given specific facts and circumstances. It is possible that others, given the same information, may at any point in time reach different reasonable conclusions regarding the estimated amounts of accrued taxes.
CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company’s management, including its principal executive officer and principal financial officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based upon this evaluation, the principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS" -->
U.S. Bancorp and its subsidiaries (the “Company”) is a multi-state financial services holding company headquartered in Minneapolis, Minnesota. The Company provides a full range of financial services including lending and depository services through banking offices principally in 24 states. The Company also engages in credit card, merchant, and ATM processing, mortgage banking, insurance, trust and investment management, brokerage, and leasing activities principally in domestic markets.
Basis of PresentationThe consolidated financial statements include the accounts of the Company and its subsidiaries. The consolidation eliminates all significant intercompany accounts and transactions. Certain items in prior periods have been reclassified to conform to the current presentation.
Uses of EstimatesThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual experience could differ from those estimates.
BUSINESS SEGMENTS
Within the Company, financial performance is measured by major lines of business based on the products and services provided to customers through its distribution channels. The Company has five reportable operating segments:
Wholesale Bankingoffers lending, depository, treasury management and other financial services to middle market, large corporate and public sector clients.
Consumer Bankingdelivers products and services to the broad consumer market and small businesses through banking offices, telemarketing, on-line services, direct mail and automated teller machines (“ATMs”).
Private Client, Trust and Asset Managementprovides trust, private banking, financial advisory, investment management and mutual fund servicing to affluent individuals, businesses, institutions and mutual funds.
Payment Servicesincludes consumer and business credit cards, debit cards, corporate and purchasing card services, consumer lines of credit, ATM processing and merchant processing. Customized products and services, coupled with cutting-edge technology are provided to consumer and business customers, government clients, correspondent financial institutions, merchants and co-brand partners.
Treasury and Corporate Supportincludes the Company’s investment portfolios, funding, capital management and asset securitization activities, interest rate risk management, the net effect of transfer pricing related to average balances, and the residual aggregate of expenses associated with business activities managed on a corporate basis, including enterprise-wide operations and administrative support functions.
Segment ResultsAccounting policies for the lines of business are the same as those used in preparation of the consolidated financial statements with respect to activities specifically attributable to each business line. However, the preparation of business line results requires management to establish methodologies to allocate funding costs and benefits, expenses and other financial elements to each line of business. For details of these methodologies and segment results, see “Basis for Financial Presentation” and Table 22 “Line of Business Financial Performance” included in Management’s Discussion and Analysis which is incorporated by reference into these Notes to Consolidated Financial Statements.
SECURITIES
Realized gains or losses on securities are determined on a trade date basis based on the specific carrying value of the investments being sold.
Trading SecuritiesDebt and equity securities held for resale are classified as trading securities and reported at fair value. Realized gains or losses are reported in noninterest income.
Available-for-sale SecuritiesThese securities are not trading securities but may be sold before maturity in response to changes in the Company’s interest rate risk profile, funding needs or demand for collateralized deposits by public entities. Available-for-sale securities are carried at fair value with unrealized net gains or losses reported within other comprehensive income in shareholders’ equity. When sold, the amortized cost of the specific securities is used to compute the gain or loss. Declines in fair value that are deemed other-than-temporary, if any, are reported in noninterest income.
Held-to-maturity SecuritiesDebt securities for which the Company has the positive intent and ability to hold to maturity are reported at historical cost adjusted for amortization of premiums and accretion of discounts.
Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to RepurchaseSecurities purchased under agreements to resell and securities sold under agreements to repurchase are generally accounted for as collateralized financing transactions and are recorded at the amounts at which the securities were acquired or sold, plus accrued interest. Securities pledged as collateral under these financing arrangements cannot be sold or repledged by the secured party. The fair value of collateral received is continually monitored and additional collateral obtained or requested to be returned to the Company as deemed appropriate.
EQUITY INVESTMENTS IN OPERATING ENTITIES
Equity investments in public entities in which ownership is less than 20 percent are accounted for as available-for-sale securities and carried at fair value. Similar investments in private entities are accounted for using the cost method. Investments in entities where ownership interest is between 20 percent and 50 percent are accounted for using the equity method with the exception of limited partnerships and limited liability companies where an ownership interest of greater than 5 percent requires the use of the equity method. If the Company has a voting interest greater than 50 percent, the consolidation method is used. All equity investments are evaluated for impairment at least annually and more frequently if certain criteria are met.
LOANS
Loans are reported net of unearned income. Interest income is accrued on the unpaid principal balances as earned. Loan and commitment fees and certain direct loan origination costs are deferred and recognized over the life of the loan and/or commitment period as yield adjustments.
Commitments to Extend CreditUnfunded residential mortgage loan commitments entered into in connection with mortgage banking activities are considered derivatives and recorded on the balance sheet at fair value with changes in fair value recorded in income. All other unfunded loan commitments are generally related to providing credit facilities to customers of the bank and are not actively traded financial instruments. These unfunded commitments are disclosed as off-balance sheet financial instruments in Note 24 in the Notes to Consolidated Financial Statements.
Allowance for Credit LossesManagement determines the adequacy of the allowance based on evaluations of the loan portfolio, recent loss experience, and other pertinent factors, including economic conditions. This evaluation is inherently subjective as it requires estimates, including amounts of future cash collections expected on nonaccrual loans, which may be susceptible to significant change. The allowance for credit losses relating to impaired loans is based on the loan’s observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan’s effective interest rate.
Nonaccrual LoansGenerally commercial loans (including impaired loans) are placed on nonaccrual status when the collection of interest or principal has become 90 days past due or is otherwise considered doubtful. When a loan is placed on nonaccrual status, unpaid accrued interest is reversed. Future interest payments are generally applied against principal. Revolving consumer lines and credit cards are charged off by 180 days past due and closed-end consumer loans other than loans secured by 1-4 family properties are charged off at 120 days past due and are, therefore, generally not placed on nonaccrual status.
Impaired Loans A loan is considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due (both interest and principal) according to the contractual terms of the loan agreement.
Restructured LoansIn cases where a borrower experiences financial difficulties and the Company makes certain concessionary modifications to contractual terms, the loan is classified as a restructured loan. 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 may be excluded from restructured loans in the calendar years subsequent to the restructuring if they are in compliance with the modified terms.
Leases The Company engages in both direct and leveraged lease financing. The net investment in direct financing leases is the sum of all minimum lease payments and estimated residual values, less unearned income. Unearned income is added to interest income over the terms of the leases to produce a level yield.
Loans Held for SaleLoans held for sale (“LHFS”) represent mortgage loan originations intended to be sold in the secondary market and other loans that management has an active plan to sell. LHFS are carried at the lower of cost or market value as determined on an aggregate basis by type of loan. In the event management decides to sell loans receivable, the loans are transferred at the lower of cost or fair value. The Interagency Guidance on Certain Loans Held for Sale, dated March 26, 2001, requires loans transferred to LHFS to be marked-to-market (“MTM”) at the time of transfer. MTM losses related to the sale/transfer of non-homogeneous loans that are predominantly credit-related are reflected in charge-offs. With respect to homogeneous loans, the amount of “probable” credit loss determined in accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies,” methodologies utilized to determine the specific allowance allocation for the portfolio is also included in charge-offs. Any incremental loss determined in accordance with MTM accounting, that includes consideration of other factors such as estimates of inherent losses, is reported separately from charge-offs as a reduction to the allowance for credit losses. Subsequent decreases in fair value are recognized in noninterest income.
Other Real EstateOther real estate (“ORE”), which is included in other assets, is property acquired through foreclosure or other proceedings. ORE is carried at fair value, less estimated selling costs. The property is evaluated regularly and any decreases in the carrying amount are included in noninterest expense.
DERIVATIVE FINANCIAL INSTRUMENTS
In the ordinary course of business, the Company enters into derivative transactions to manage its interest rate, foreign currency and prepayment risk and to accommodate the business requirements of its customers. All derivative instruments are recorded as either other assets, other liabilities or short-term borrowings at fair value. Subsequent changes in a derivative’s fair value are recognized currently in earnings unless specific hedge accounting criteria are met.
OTHER SIGNIFICANT POLICIES
Intangible AssetsThe price paid over the net fair value of the acquired businesses (“goodwill”) is not amortized. Other intangible assets are amortized over their estimated useful lives, using straight-line and accelerated methods. The recoverability of goodwill and other intangible assets is evaluated annually, at a minimum, or on an interim basis if events or circumstances indicate a possible inability to realize the carrying amount. The evaluation includes assessing the estimated fair value of the intangible asset based on market prices for similar assets, where available, and the present value of the estimated future cash flows associated with the intangible asset.
Income TaxesDeferred taxes are recorded to reflect the tax consequences on future years of differences between the tax basis of assets and liabilities and the financial reporting amounts at each year-end.
Mortgage Servicing RightsMortgage servicing rights (“MSRs”) are capitalized as separate assets when loans are sold and servicing is retained. The total cost of loans sold is allocated between the loans sold and the servicing assets retained based on their relative fair values. MSRs that are purchased from others are initially recorded at cost. The carrying value of the MSRs is amortized in proportion to, and over the period of, estimated net servicing revenue and recorded in noninterest expense as amortization of intangible assets. The carrying value of these assets is periodically reviewed for impairment using a lower of carrying value or fair value methodology. For purposes of measuring impairment, the servicing rights are stratified based on the underlying loan type and note rate and the carrying value of each stratum is compared to fair value based on a discounted cash flow analysis, utilizing current prepayment speeds and discount rates. Events that may significantly affect the estimates used are changes in interest rates and the related impact on mortgage loan prepayment speed and the payment performance of the underlying loans. If the carrying value is greater than fair value, impairment is recognized through a valuation allowance for each impaired stratum and recorded as amortization of intangible assets. The valuation allowance is adjusted each subsequent period to reflect any increase or decrease in the indicated impairment. The Company reviews mortgage servicing rights for other-than-temporary impairment each quarter and recognizes a direct write-down when the recoverability of a recorded valuation allowance is determined to be remote. In determining whether other-than-temporary impairment has taken place, the Company considers historical trends in pay off activity and the potential for impairment recovery. Unlike a valuation allowance, a direct write-down permanently reduces the carrying value of the mortgage servicing rights, precluding subsequent reversals.
Pensions For purposes of its retirement plans, the Company utilizes a measurement date of September 30. At the measurement date, plan assets are determined based on fair value, generally representing observable market prices. The actuarial cost method used to compute the pension liabilities and related expense is the projected unit credit method. The projected benefit obligation is principally determined based on the present value of projected benefit distributions at an assumed discount rate. The discount rate utilized is based on match-funding maturities and interest payments of high quality corporate bonds available in the market place to projected cash flows as of the measurement date for future benefit payments. Periodic pension expense (or credits) includes service costs, interest costs based on the assumed discount rate, the expected return on plan assets based on an actuarially derived market-related value and amortization of actuarial gains and losses. Pension accounting reflects the long-term nature of benefit obligations and the investment horizon of plan assets and can have the effect of reducing earnings volatility related to short-term changes in interest rates and market valuations. Actuarial gains and losses include the impact of plan amendments and various unrecognized gains and losses which are deferred and amortized over the future service periods of active employees. The 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 market-related value ratably over a five-year period.
Premises and EquipmentPremises and equipment are stated at cost less accumulated depreciation and depreciated primarily on a straight-line basis over the estimated life of the assets. Estimated useful lives range up to 40 years for newly constructed buildings and from 3 to 20 years for furniture and equipment.
Statement of Cash FlowsFor purposes of reporting cash flows, cash and cash equivalents include cash and money market investments, defined as interest-bearing amounts due
Stock-Based CompensationThe Company grants stock awards including restricted stock and options to purchase common stock of the Company. Stock option grants are for a fixed number of shares to employees and directors with an exercise price equal to the fair value of the shares at the date of grant. The Company recognizes stock-based compensation in its results of operations utilizing the fair value method under Statement of Financial Accounting Standard No. 123, “Accounting for Stock-based Compensation” (“SFAS 123”). Stock-based compensation is recognized using an accelerated method of amortization for awards with graded vesting features and on a straight-line basis for awards with cliff vesting. The amortization of stock-based compensation reflects estimated forfeitures adjusted for actual forfeiture experience. As compensation expense is recognized, a deferred tax asset is recorded that represents an estimate of the future tax deduction from exercise or release of restrictions. At the time stock options are exercised, cancelled or expire, the Company may be required to recognize an adjustment to tax expense.
Per Share CalculationsEarnings per share is calculated by dividing net income by the weighted average number of common shares outstanding during the year. Diluted earnings per share is calculated by adjusting income and outstanding shares, assuming conversion of all potentially dilutive securities, using the treasury stock method. All per share amounts have been restated for stock splits.
Stock-Based CompensationIn December 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 148 (“SFAS 148”), “Accounting for Stock-Based Compensation — Transition and Disclosure,” an amendment of SFAS 123. SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In previous years, the Company accounted for stock-based employee compensation under the intrinsic based method and provided disclosure of the impact of the fair value based method on reported income. For its 2003 financial statements, the Company elected to adopt the fair value method using the retroactive restatement approach. All prior periods presented have been restated to reflect the compensation cost that would have been recognized had the recognition provisions of SFAS 123 been applied to all awards granted to employees after January 1, 1995, that remained unvested at the beginning of the first period presented.
Loan Commitments On March 9, 2004, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 105 (“SAB 105”), “Application of Accounting Principles to Loan Commitments,” which provides guidance regarding loan commitments accounted for as derivative instruments and is effective for commitments entered into after March 31, 2004. The guidance clarifies that expected future cash flows related to the servicing of the loan may be recognized only when the servicing asset has been contractually separated from the underlying loan by sale with servicing retained. The adoption of SAB 105 did not have a material impact on the Company’s financial statements.
On June 29, 2004, the Company purchased the remaining 50 percent ownership interest of EuroConex Technologies Ltd (“EuroConex”) from the Bank of Ireland. In addition, during the second and fourth quarter of 2004, the Company completed three separate transactions to acquire merchant processing businesses in Poland, the United Kingdom and Norway. In connection with these transactions, EuroConex and its affiliates provide debit and credit card processing services to merchants, directly and through alliances with banking partners in these European markets. These transactions represented total assets acquired of $377 million and total liabilities assumed of $115 million at the closing date. Included in total assets were contract and other intangibles with a fair value of $163 million and goodwill of $105 million. The goodwill reflected the strategic value of these businesses to the Company’s European merchant processing business and anticipated economies of scale that will result from these transactions.
The following table summarizes significant acquisitions by the Company completed since January 1, 2002:
On December 31, 2003, the Company completed the distribution of all the outstanding shares of common stock of Piper Jaffray Companies to its shareholders. This non-cash distribution was tax-free to the Company, its shareholders and Piper Jaffray Companies. In connection with the December 31, 2003 distribution, the results of Piper Jaffray Companies are reported in the Company’s Consolidated Statement of Income separately as discontinued operations.
The following table represents the condensed results of operations for discontinued operations:
Following the distribution, the Company’s wholly-owned subsidiary, USB Holdings, Inc. holds a $180 million subordinated debt facility with Piper Jaffray & Co., a broker-dealer subsidiary of Piper Jaffray Companies. In addition, the Company provides an indemnification in an amount up to $17.5 million with respect to certain specified liabilities resulting from third-party claims relating to research analyst independence and from certain regulatory investigations, as defined in the separation and distribution agreement entered into with Piper Jaffray Companies at the time of the distribution. Through December 31, 2004, the Company has paid approximately $3.3 million to Piper Jaffray Companies under this indemnification agreement.
The Company recorded pre-tax merger and restructuring-related charges of $46.2 million and $321.2 million in 2003 and 2002, respectively. In 2003, merger-related items were incurred in connection with the NOVA Corporation acquisition and the Company’s various other acquisitions, primarily Bay View and State Street Corporate Trust. In 2002, merger-related items included costs associated with the Firstar/ former U.S. Bancorp of Minneapolis (“USBM”) merger, NOVA and other smaller acquisitions.
The components of the merger and restructuring-related items are shown below:
The Company determines merger and restructuring-related items and related accruals based on its integration strategy and formulated plans. These plans are established as of the acquisition date and are regularly evaluated during the integration process.
The merger and restructuring-related accruals by significant acquisition or business restructuring was as follows:
At December 31, 2002, the integration of Firstar and USBM was completed. The only activity in the USBM liability during 2004 was related to the payout of severance costs. In 2003, the integration of merchant processing platforms and business processes of U.S Bank National Association and NOVA, as well as systems conversions for the acquisitions of the State Street Corporate Trust business and Bay View were completed.
Bank subsidiaries are required to maintain minimum average reserve balances with the Federal Reserve Bank. The amount of those reserve balances was approximately $169 million at December 31, 2004.
The detail of the amortized cost, gross unrealized holding gains and losses, and fair value of held-to-maturity and available-for-sale securities at December 31 was as follows:
The fair value of available-for-sale securities shown above includes securities totaling $4.8 billion with unrealized losses of $148.8 million which have been in an unrealized loss position for greater than 12 months. All principal and interest payments on available-for-sale debt securities in an unrealized loss position for greater than 12 months are expected to be collected given the high credit quality of the U.S. government agency debt securities and
The following table provides information as to the amount of interest income from taxable and non-taxable investment securities:
The following table provides information as to the amount of gross gains and losses realized through the sales of available-for-sale investment securities.
For amortized cost, fair value and yield by maturity date of held-to-maturity and available-for-sale securities outstanding at December 31, 2004, refer to Table 10 included in Management’s Discussion and Analysis which is incorporated by reference into these Notes to Consolidated Financial Statements.
The composition of the loan portfolio at December 31 was as follows:
Loans are presented net of unearned interest and deferred fees and costs, which amounted to $1.4 billion and $1.5 billion at December 31, 2004 and 2003, respectively. The Company had loans of $38.3 billion at December 31, 2004, and $28.7 billion at December 31, 2003, pledged at the Federal Home Loan Bank. Loans of $10.3 billion at December 31, 2004, and $12.1 billion at December 31, 2003, were pledged at the Federal Reserve Bank.
The following table lists information related to nonperforming loans as of December 31:
Activity in the allowance for credit losses was as follows:
A portion of the allowance for credit losses is allocated to loans deemed impaired. All impaired loans are included in nonperforming assets. A summary of these loans and their related allowance for credit losses is as follows:
Commitments to lend additional funds to customers whose loans were classified as nonaccrual or restructured at December 31, 2004, totaled $61.2 million. During 2004 there were $10.2 million of loans that were restructured at market interest rates and returned to an accruing status.
The components of the net investment in sales-type and direct financing leases at December 31 were as follows:
The amount of future minimum lease payments included the following at December 31:
The minimum future lease payments to be received from sales-type and direct financing leases were as follows at December 31, 2004:
FINANCIAL ASSET SALES
When the Company sells financial assets, it may retain interest-only strips, servicing rights, residual rights to a cash reserve account, and/or other retained interests in the sold financial assets. The gain or loss on sale depends in part on the previous carrying amount of the financial assets involved in the transfer and is allocated between the assets sold and the retained interests based on their relative fair values at the date of transfer. Quoted market prices are used to determine retained interest fair values when readily available. Since quotes are generally not available for retained interests, the Company estimates fair value based on the present value of future expected cash flows using management’s best estimates of the key assumptions including credit losses, prepayment speeds, forward yield curves, and discount rates commensurate with the risks involved. Retained interests and liabilities are recorded at fair value using a discounted cash flow methodology at inception and are evaluated at least quarterly thereafter.
Conduits and SecuritizationThe Company sponsors an off-balance sheet conduit to which it transferred high-grade investment securities, funded by the issuance of commercial paper. The conduit, a qualifying special purpose entity, held assets of $5.7 billion at December 31, 2004 and $7.3 billion in assets at December 31, 2003. These investment securities include primarily (i) private label asset-backed securities, which are insurance “wrapped” by AAA/Aaa-rated monoline insurance companies and (ii) government agency mortgage-backed securities and collateralized mortgage obligations. The conduit had commercial paper liabilities of $5.7 billion at December 31, 2004 and $7.3 billion at December 31, 2003. The Company benefits by transferring the investment securities into a conduit that provides diversification of funding sources in a capital-efficient manner and the generation of income.
The Company provides a liquidity facility to the conduit. Utilization of the liquidity facility would be triggered if the conduit is unable to, or does not, issue commercial paper to fund its assets. A liability for the estimate of the potential risk of loss the Company has as the liquidity facility provider is recorded on the balance sheet in other liabilities. The liability is adjusted downward over time as the underlying assets pay down with the offset recognized as other noninterest income. The liability for the liquidity facility was $32.4 million at December 31, 2004 and $47.3 million at December 31, 2003. In addition, the Company recorded at fair value its retained residual interest in the investment securities conduit of $56.8 million at December 31, 2004 and $89.5 million at December 31, 2003. The Company recorded $24.9 million from the conduit during 2004 and $30.5 million during 2003, for revenues related to the conduit including fees for servicing, management, administration and accretion income from retained interests.
The Company also has an asset-backed securitization to fund an unsecured small business credit product. The unsecured small business credit securitization trust held assets of $375.3 million at December 31, 2004, of which the Company retained $85.0 million of subordinated securities and a residual interest-only strip of $36.1 million. This compared with $497.5 million in assets at December 31, 2003, of which the Company retained $112.4 million of subordinated securities and a residual interest-only strip of $34.4 million. The qualifying special purpose entity issued asset-backed variable funding notes in various tranches. The Company provides credit enhancement in the form of subordinated securities and reserve accounts. The Company’s risk, primarily from losses in the underlying assets, was considered in determining the fair value of the Company’s retained interests in this securitization. The Company recognized income from subordinated securities, an interest-only strip and servicing fees from this securitization of $33.2 million during 2004 and $29.8 million during 2003. The unsecured small business credit securitization held average assets of $438.9 million in 2004, and $571.4 million in 2003.
During 2003, the Company undertook several actions with respect to off-balance sheet structures. In January 2003, the Company exercised a cleanup call option on an indirect automobile loan securitization, with the remaining assets from the securitization recorded on the Company’s balance sheet at fair value. The indirect automobile securitization held $156.1 million in assets at December 31, 2002.
Sensitivity AnalysisAt December 31, 2004, key economic assumptions and the sensitivity of the current fair value of residual cash flows to immediate 10 percent and 20 percent adverse changes in those assumptions were as follows:
These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10 percent variation in assumptions generally cannot be extrapolated because the relationship of the change in the assumptions to the change in fair value may not be linear. Also, in this table the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumptions; in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities.
Cash Flow InformationThe table below summarizes certain cash flows received from and paid to conduit or structured entities for the asset sales described above:
Other InformationQuantitative information related to managed assets and loan sales was as follows:
Premises and equipment at December 31 consisted of the following:
The Company’s portfolio of residential mortgages serviced for others was $63.2 billion, $53.9 billion and $43.1 billion at December 31, 2004, 2003 and 2002 respectively.
Changes in net carrying value of capitalized mortgage servicing rights are summarized as follows:
The key economic assumptions used to estimate the value of the mortgage servicing rights portfolio were as follows:
The estimated sensitivity of the fair value of the mortgage servicing rights portfolio to changes in interest rates at December 31, 2004, was as follows:
The fair value of mortgage servicing rights and its sensitivity to changes in interest rates is influenced by the mix of the servicing portfolio and characteristics of each segment of the portfolio. In the current interest rate environment, mortgage loans originated as part of government agency and state loan programs tend to experience slower prepayment speeds and better cash flows than conventional mortgage loans. The Company’s servicing portfolio consists of the distinct portfolios of Mortgage Revenue Bond Programs (“MRBP”), government-related mortgages and conventional mortgages. The MRBP division specializes in servicing loans made under state and local housing authority programs. These programs provide mortgages to low and moderate income borrowers and are generally under government insured programs with down payment or closing cost assistance. The conventional and government servicing portfolios are predominantly comprised of fixed-rate agency loans (FNMA, FHLMC, GNMA, FHLB and various housing agencies) with limited adjustable-rate or jumbo mortgage loans.
A summary of the Company’s mortgage servicing rights and related characteristics by portfolio as of December 31, 2004, was as follows:
The Company adopted Statement of Financial Accounting Standards No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets” on January 1, 2002. The most significant changes made by SFAS 142 are that goodwill and other indefinite lived intangible assets are no longer amortized and will be tested for impairment at least annually. The amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the amortization provisions of SFAS 142 were effective upon adoption of SFAS 142.
Net income and earnings per share adjusted for the exclusion of asset impairments related to goodwill are as follows:
The following table reflects the changes in the carrying value of goodwill for the years ended December 31, 2003 and 2004:
Intangible assets consisted of the following:
Aggregate amortization expense consisted of the following:
Below is the estimated amortization expense for the next five years:
The following table is a summary of short-term borrowings for the last three years:
Long-term debt (debt with original maturities of more than one year) at December 31 consisted of the following:
Maturities of long-term debt outstanding at December 31, 2004, were:
The Company sponsors and wholly owns 100% of the common equity of eight trusts that were formed for the purpose of issuing Company-obligated mandatorily redeemable preferred securities (“Trust Preferred Securities”) to third-party investors and investing the proceeds from the sale of the Trust Preferred Securities solely in junior subordinated debt securities of the Company (the “Debentures”). The Debentures held by the trusts, which total $2.6 billion, are the sole assets of each trust. The Company’s obligations under the Debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the Trusts. The guarantee covers the distributions and payments on liquidation or redemption of the Trust Preferred Securities, but only to the extent of funds held by the Trusts. The Company used the proceeds from the sales of the Debentures for general corporate purposes.
The following table is a summary of the Debentures included in long-term debt as of December 31, 2004:
At December 31, 2004 and 2003, the Company had authority to issue 4 billion shares of common stock and 10 million shares of preferred stock. The Company had 1,857.6 million and 1,922.9 million shares of common stock outstanding at December 31, 2004 and 2003, respectively. At December 31, 2004, the Company had 170.5 million shares of common stock reserved for future issuances, primarily under stock option plans.
The following table summarizes the Company’s common stock repurchased in each of the last three years:
Regulatory CapitalThe measures used to assess capital include the capital ratios established by bank regulatory agencies, including the specific ratios for the “well capitalized” designation. For a description of the regulatory capital requirements and the actual ratios as of December 31, 2004 and 2003, for the Company and its bank subsidiaries, see Table 20 included in Management’s Discussion and Analysis, which is incorporated by reference into these Notes to Consolidated Financial Statements.
The components of earnings per share were:
For the years ended December 31, 2004, 2003 and 2002, options to purchase 36 million, 79 million and 140 million shares, respectively, were outstanding but not included in the computation of diluted earnings per share because they were antidilutive.
Employee Investment PlanThe Company has a defined contribution retirement savings plan which allows qualified employees, at their option, to make contributions up to 50 percent of pre-tax base salary through salary deductions under Section 401(k) of the Internal Revenue Code. Employee contributions are invested, at the employees’ direction, among a variety of investment alternatives. Employee contributions are 100 percent matched by the Company, up to the first four percent of an employee’s compensation. The Company’s matching contribution vests immediately; however, a participant must be employed on December 31st to receive that year’s matching contribution. Although the matching contribution is initially invested in the Company’s common stock, an employee can reinvest the matching contributions among various investment alternatives. Total expense was $49.1 million, $48.5 million and $50.5 million in 2004, 2003 and 2002, respectively.
Pension PlansPension benefits are provided to substantially all employees based on years of service and employees’ compensation while employed with the Company. Employees are fully vested after five years of service. Under the plan’s benefit structure, a participant’s future retirement benefits are based on a participant’s highest five-year average annual compensation during his or her last 10 years before retirement or termination from the Company. Plan assets primarily consist of various equity mutual funds and other miscellaneous assets.
Funding PracticesThe Company’s funding policy is to contribute amounts to its plans sufficient to meet the minimum funding requirements of the Employee Retirement Income Security Act of 1974, plus such additional amounts as the Company determines to be appropriate. In 2003, the Company made a contribution of $310.8 million to the qualified pension plan in accordance with this policy. No contributions were made in 2004. In 2005, the Company anticipates no minimum funding requirement and therefore does not expect to make any contributions to the plan. Contributions made to the plan were invested in accordance with established investment policies and asset allocation strategies.
Investment Policies and Asset AllocationIn establishing its investment policies and asset allocation strategies, the Company considers expected returns and the volatility associated with different strategies. The independent consultant performs modeling that projects numerous outcomes using a broad range of possible scenarios, including a mix of possible rates of inflation and economic growth. Some of the scenarios included are: low inflation and high growth (ideal growth), low inflation and low growth (recession), high inflation and low growth (stagflation) and high inflation and high growth (inflationary growth). Starting with current economic information, the model bases its projections on past relationships between inflation, fixed income rates and equity returns when these types of economic conditions have existed over the previous 30 years, both in the U.S. and in foreign countries.
The following unaudited table provides a summary of asset allocations adopted by the Company compared with a typical asset allocation alternative:
Post-Retirement Medical PlansIn addition to providing pension benefits, the Company provides health care and death benefits to certain retired employees through several retiree medical programs. The Company adopted one retiree medical program for all future retirees on January 1, 2002. For certain eligible employees, the provisions of the USBM retiree medical plan and the Mercantile retiree medical plan remained in place until December 31, 2002. Generally, all employees may become eligible for retiree health care benefits by meeting defined age and service requirements. The Company may also subsidize the cost of coverage for employees meeting certain age and service requirements. The medical plan contains other cost-sharing features such as deductibles and coinsurance. The estimated cost of these retiree benefit payments is accrued during the employees’ active service.
The Company uses a measurement date of September 30 for its retirement plans. The following table summarizes benefit obligation and plan asset activity for the retirement plans:
The following table sets forth the components of net periodic benefit cost (income) for the retirement plans:
The following table sets forth the weighted-average plan assumptions and other data:
The following table provides information for pension plans with benefit obligations in excess of plan assets:
The following benefit payments (net of participant contributions) are expected to be paid from the retirement plans:
As part of its employee and director compensation programs, the Company may grant certain stock awards under the provisions of the existing stock compensation plans, including plans assumed in acquisitions. The plans provide for grants of options to purchase shares of common stock at a fixed price generally equal to the fair value of the underlying stock at the date of grant. Option grants are generally exercisable up to ten years from the date of grant. In addition, the plans provide for grants of shares of common stock or stock units that are subject to restriction on transfer. Most stock awards vest over three to five years and are subject to forfeiture if certain vesting requirements are not met.
The following is a summary of stock options outstanding and exercised under various stock options plans of the Company:
Additional information regarding stock options outstanding as of December 31, 2004, is as follows:
Stock-based compensation was $175.6 million in 2004, compared with $158.1 million and $185.0 million in 2003 and 2002, respectively. At the time employee stock options expire, are exercised or cancelled, the Company determines the tax benefit associated with the stock award and under certain circumstances may be required to recognize an adjustment to tax expense. On an after-tax basis, stock-based compensation was $138.5 million in 2004, compared with $123.4 million and $113.3 million in 2003 and 2002, respectively.
The following table provides a summary of the valuation assumptions utilized by the Company to determine the estimated value of stock option grants:
The components of income tax expense were:
A reconciliation of expected income tax expense at the federal statutory rate of 35% to the Company’s applicable income tax expense follows:
The tax effects of fair value adjustments on securities available-for-sale, derivative instruments in cash flow hedges and certain tax benefits related to stock options are recorded directly to shareholders’ equity as part of other comprehensive income.
The significant components of the Company’s net deferred tax liability as of December 31 were:
The Company has established a valuation allowance to offset deferred tax assets related to state net operating loss carryforwards which are expected to expire unused. The Company has approximately $134 million of net operating loss carryforwards which expire at various times through 2009.
In the ordinary course of business, the Company enters into derivative transactions to manage its interest rate, prepayment and foreign currency risks and to accommodate the business requirements of its customers. The Company does not enter into derivative transactions for speculative purposes. Refer to Note 1 “Significant Accounting Policies” in the Notes to Consolidated Financial Statements for a discussion of the Company’s accounting policies for derivative instruments. For information related to derivative positions held for asset and liability management purposes and customer-related derivative positions, see Table 17 “Derivative Positions,” included in Management’s Discussion and Analysis, which is incorporated by reference in these Notes to Consolidated Financial Statements.
ASSET AND LIABILITY MANAGEMENT POSITIONS
Cash Flow Hedges The Company has $24.3 billion of designated cash flow hedges at December 31, 2004. These derivatives are interest rate swaps that are hedges of the forecasted cash flows from the underlying variable-rate LIBOR loans and floating-rate debt. All cash flow hedges are highly effective for the year ended December 31, 2004, and the change in fair value attributed to hedge ineffectiveness was not material.
Fair Value HedgesThe Company has $7.8 billion of designated fair value hedges at December 31, 2004. These derivatives are primarily interest rate contracts that hedge the change in fair value related to interest rate changes of underlying fixed-rate debt and trust preferred securities. In addition, 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.
Net Investment HedgesIn 2004, the Company entered into derivatives to protect its net investment in certain foreign operations. The Company uses forward commitments to sell specified amounts of certain foreign currencies to hedge its capital volatility risk associated with fluctuations in foreign currency exchange rates. The net amount of gains or losses included in the cumulative translation adjustment for 2004 was not significant.
Other Asset and Liability Management Derivative Positions The Company has derivative positions that are used for interest rate risk and other risk management purposes but are not designated as cash flow hedges or fair value hedges in accordance with the provisions of Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities.” At December 31, 2004, the Company had $1.1 billion of forward commitments to sell residential mortgage loans to hedge the Company’s interest rate risk related to $1.0 billion of unfunded residential loan commitments. Gains and losses on mortgage banking derivatives and the unfunded loan commitments are included in mortgage banking revenue on the Consolidated Statement of Income.
CUSTOMER-RELATED POSITIONS
The Company acts as a seller and buyer of interest rate contracts and foreign exchange rate contracts on behalf of customers. At December 31, 2004, the Company had $20.0 billion of aggregate customer derivative positions, including $15.8 billion of interest rate swaps, caps, and floors and $4.2 billion of foreign exchange rate contracts. The Company minimizes its market and liquidity risks by taking similar offsetting positions. Gains or losses on customer-related transactions were not significant for the year ended December 31, 2004.
Due to the nature of its business and its customers’ needs, the Company offers a large number of financial instruments, most of which are not actively traded. When market quotes are unavailable, valuation techniques including discounted cash flow calculations and pricing models or services are used. The Company also uses various aggregation methods and assumptions, such as the discount rate and cash flow timing and amounts. As a result, the fair value estimates can neither be substantiated by independent market comparisons, nor realized by the immediate sale or settlement of the financial instrument. Also, the estimates reflect a point in time and could change significantly based on changes in economic factors, such as interest rates. Furthermore, the disclosure of certain financial and nonfinancial assets and liabilities are not required. Finally, the fair value disclosure is not intended to estimate a market value of the Company as a whole. A summary of the Company’s valuation techniques and assumptions follows.
Cash and Cash EquivalentsThe carrying value of cash, amounts due from banks, federal funds sold and securities purchased under resale agreements was assumed to approximate fair value.
SecuritiesInvestment securities were valued using available market quotes. In some instances, for securities that are not widely traded, market quotes for comparable securities were used.
Loans The loan portfolio includes adjustable and fixed-rate loans, the fair value of which was estimated using discounted cash flow analyses and other valuation techniques. To calculate discounted cash flows, the loans were aggregated into pools of similar types and expected repayment terms. The expected cash flows of loans considered historical prepayment experiences and estimated credit losses for nonperforming loans and were discounted using current rates offered to borrowers of similar credit characteristics. The fair value of floating-rate loans are assumed to be equal to their carrying value.
Deposit LiabilitiesThe fair value of demand deposits, savings accounts and certain money market deposits is equal to the amount payable on demand at year-end. The fair value of fixed-rate certificates of deposit was estimated
Short-term BorrowingsFederal funds purchased, securities sold under agreements to repurchase, commercial paper and other short-term funds borrowed are at floating rates or have short-term maturities. Their carrying value is assumed to approximate their fair value.
Long-term Debt The estimated fair value of medium-term notes, bank notes, Federal Home Loan Bank advances, capital lease obligations and mortgage note obligations was determined using a discounted cash flow analysis based on current market rates of similar maturity debt securities to discount cash flows. Other long-term debt instruments were valued using available market quotes.
Interest Rate Swaps, Equity Contracts, Basis Swaps and Options The interest rate options and swap cash flows were estimated using a third-party pricing model and discounted based on appropriate LIBOR, eurodollar futures, swap, treasury note yield curves and equity market prices.
Loan Commitments, Letters of Credit and Guarantees The fair value of commitments, letters of credit and guarantees represents the estimated costs to terminate or otherwise settle the obligations with a third-party. Residential mortgage commitments are actively traded and the fair value is estimated using available market quotes. Other loan commitments, letters of credit and guarantees are not actively traded. Substantially all loan commitments have floating rates and do not expose the Company to interest rate risk assuming no premium or discount was ascribed to loan commitments because funding could occur at market rates. The Company estimates the fair value of loan commitments, letters of credit and guarantees based on the related amount of unamortized deferred commitment fees adjusted for the probable losses for these arrangements.
The estimated fair values of the Company’s financial instruments at December 31 are shown in the table below.
COMMITMENTS TO EXTEND CREDIT
Commitments to extend credit are legally binding and generally have fixed expiration dates or other termination clauses. The contractual amount represents the Company’s exposure to credit loss, in the event of default by the borrower. The Company manages this credit risk by using the same credit policies it applies to loans. Collateral is obtained to secure commitments based on management’s credit assessment of the borrower. The collateral may include marketable securities, receivables, inventory, equipment and real estate. Since the Company expects many of the commitments to expire without being drawn, total commitment amounts do not necessarily represent the Company’s future liquidity requirements. In addition, the commitments include consumer credit lines that are cancelable upon notification to the consumer.
LETTERS OF CREDIT
Standby letters of credit are commitments the Company issues to guarantee the performance of a customer to a third-party. The guarantees frequently support public and private borrowing arrangements, including commercial paper issuances, bond financings and other similar transactions. The Company issues commercial letters of credit on behalf of customers to ensure payment or collection in connection with trade transactions. In the event of a customer’s nonperformance, the Company’s credit loss exposure is the same as in any extension of credit, up to the letter’s contractual amount. Management assesses the borrower’s credit to determine the necessary collateral, which may include marketable securities, receivables, inventory, equipment and real estate. Since the conditions requiring the Company to fund letters of credit may not occur, the Company expects its liquidity requirements to be less than the total outstanding commitments. The maximum potential future payments guaranteed by the Company under standby letter of credit arrangements at December 31, 2004, were approximately $10.6 billion with a weighted-average term of approximately 22 months. The estimated fair value of standby letters of credit was approximately $75.5 million at December 31, 2004.
LEASE COMMITMENTS
Rental expense for operating leases amounted to $184.6 million in 2004, $205.0 million in 2003 and $201.5 million in 2002. Future minimum payments, net of sublease rentals, under capitalized leases and noncancelable operating leases with initial or remaining terms of one year or more, consisted of the following at December 31, 2004:
GUARANTEES
Guarantees are contingent commitments issued by the Company to customers or other third-parties. The Company’s guarantees primarily include parent guarantees related to subsidiaries’ third-party borrowing arrangements; third-party performance guarantees inherent in the Company’s business operations such as indemnified securities lending programs and merchant charge-back guarantees; indemnification or buy-back provisions related to certain asset sales; and contingent consideration arrangements related to acquisitions. For certain guarantees, the Company has recorded a liability related to the potential obligation, or has access to collateral to support the guarantee or through the exercise of other recourse provisions can offset some or all of the maximum potential future payments made under these guarantees.
Third-Party Borrowing ArrangementsThe Company provides guarantees to third-parties as a part of certain
Commitments from Securities LendingThe Company participates in securities lending activities by acting as the customer’s agent involving the lending of securities. The Company indemnifies customers for the difference between the market value of the securities lent and the market value of the collateral received. Cash collateralizes these transactions. The maximum potential future payments guaranteed by the Company under these arrangements were approximately $11.4 billion at December 31, 2004, and represented the market value of the securities lent to third-parties. At December 31, 2004, the Company held assets with a market value of $11.7 billion as collateral for these arrangements.
Asset Sales The Company has provided guarantees to certain third-parties in connection with the sale of certain assets, primarily loan portfolios and low-income housing tax credits. These guarantees are generally in the form of asset buy-back or make-whole provisions that are triggered upon a credit event or a change in the tax-qualifying status of the related projects, as applicable, and remain in effect until the loans are collected or final tax credits are realized, respectively. The maximum potential future payments guaranteed by the Company under these arrangements were approximately $487.5 million at December 31, 2004, and represented the total proceeds received from the buyer in these transactions where the buy-back or make-whole provisions have not yet expired. Recourse available to the Company includes guarantees from the Small Business Administration (for SBA loans sold), recourse against the correspondent that originated the loan or to the private mortgage issuer, the right to collect payments from the debtors, and/or the right to liquidate the underlying collateral, if any, and retain the proceeds. Based on its established loan-to-value guidelines, the Company believes the recourse available is sufficient to recover future payments, if any, under the loan buy-back guarantees.
Merchant ProcessingThe Company, through its subsidiaries NOVA Information Systems, Inc. and NOVA European Holdings Company, provides merchant processing services. Under the rules of credit card associations, a merchant processor retains a contingent liability for credit card transactions processed. This contingent liability arises in the event of a billing dispute between the merchant and a cardholder that is ultimately resolved in the cardholder’s favor. In this situation, the transaction is “charged back” to the merchant and the disputed amount is credited or otherwise refunded to the cardholder. If the Company is unable to collect this amount from the merchant, it bears the loss for the amount of the refund paid to the cardholder.
Other Guarantees The Company provides liquidity and credit enhancement facilities to a Company-sponsored conduit, as more fully described in the Note 10. Although management believes a draw against these facilities is remote, the maximum potential future payments guaranteed by the Company under these arrangements were approximately $5.7 billion at December 31, 2004. The recorded fair value of the Company’s liability for the credit enhancement recourse obligation and liquidity facility was $32.4 million at December 31, 2004, and was included in other liabilities.
OTHER CONTINGENT LIABILITIES
In connection with the spin-off of Piper Jaffray Companies, the Company has agreed to indemnify Piper Jaffray Companies against losses that may result from third-party claims relating to certain specified matters. The Company’s indemnification obligation related to these specified matters is capped at $17.5 million and can be terminated by the Company if there is a change in control event for Piper Jaffray Companies. Through December 31, 2004, the Company has paid approximately $3.3 million to Piper Jaffray Companies under this agreement.
Condensed Balance Sheet
Condensed Statement of Income
Transfer of funds (dividends, loans or advances) from bank subsidiaries to the Company is restricted. Federal law prohibits loans unless they are secured and generally limits any loan to the Company or individual affiliate to 10 percent of each bank’s unimpaired capital and surplus. In aggregate, loans to the Company and all affiliates cannot exceed 20 percent of each bank’s unimpaired capital and surplus.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON THE CONSOLIDATED FINANCIAL STATEMENTS" -->
The Board of Directors and Shareholders of U.S. Bancorp:
We have audited the accompanying consolidated balance sheets of U.S. Bancorp as of December 31, 2004 and 2003, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the two years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of U.S. Bancorp at December 31, 2004 and 2003, and the consolidated results of its operations and cash flows for each of the two years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of U.S. Bancorp’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 18, 2005 expressed an unqualified opinion thereon.
Minneapolis, Minnesota
To the Shareholders and Board of Directors of U.S. Bancorp:
In our opinion, the accompanying consolidated statements of income, shareholders’ equity and cash flows of U.S. Bancorp and its subsidiaries present fairly, in all material respects, the results of their operations and their cash flows for the year ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
As discussed in Note 13 of the Notes to Consolidated Financial Statements, in 2002 the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.”
REPORT OF MANAGEMENT" -->
Responsibility for the financial statements and other information presented throughout the Annual Report on Form 10-K rests with the management of U.S. Bancorp. The Company believes that the consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States and present the substance of transactions based on the circumstances and management’s best estimates and judgment.
In meeting its responsibilities for the reliability of the financial statements, management is responsible for establishing and maintaining an adequate system of internal control over financial reporting as defined by Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s system of internal controls is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of publicly filed financial statements in accordance with accounting principles generally accepted in the United States.
To test compliance, the Company carries out an extensive audit program. This program includes a review for compliance with written policies and procedures and a comprehensive review of the adequacy and effectiveness of the internal control system. Although control procedures are designed and tested, it must be recognized that there are limits inherent in all systems of internal control and, therefore, errors and irregularities may nevertheless occur. Also, estimates and judgments are required to assess and balance the relative cost and expected benefits of the controls. Projection of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Board of Directors of the Company has an Audit Committee composed of directors who are independent of U.S. Bancorp. The committee meets periodically with management, the internal auditors and the independent accountants to consider audit results and to discuss internal accounting control, auditing and financial reporting matters.
Management assessed the effectiveness of the Company’s internal controls over financial reporting as of December 31, 2004. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in its Internal Control-Integrated Framework. Based on our assessment and those criteria, management believes that the Company designed and maintained effective internal control over financial reporting as of December 31, 2004.
The Company’s independent accountants, Ernst & Young LLP, have been engaged to render an independent professional opinion on the financial statements and issue an attestation report on management’s assessment of the Company’s system of internal control over financial reporting. Their opinion on the financial statements appearing on page 105 and their attestation on the system of internal controls over financial reporting appearing on page 107 are based on procedures conducted in accordance with auditing standards of the Public Company Accounting Oversight Board (United States).
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING" -->
We have audited management’s assessment, included in the accompanying Report of Management, that U.S. Bancorp maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). U.S. Bancorp’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that U.S. Bancorp maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, U.S. Bancorp maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of U.S. Bancorp as of December 31, 2004 and 2003, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the two years in the period ended December 31, 2004 and our report dated February 18, 2005 expressed an unqualified opinion thereon.
Stock Price Range and Dividends
The common stock of U.S. Bancorp is traded on the New York Stock Exchange, under the ticker symbol “USB.”
Reconciliation of Quarterly Consolidated Financial Data
ANNUAL REPORT ON FORM 10-K" -->
Securities and Exchange Commission Washington, D.C. 20549
Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2004
Commission File Number 1-6880
U.S. BancorpIncorporated in the State of Delaware IRS Employer Identification #41-0255900 Address: 800 Nicollet Mall Minneapolis, Minnesota 55402-7014 Telephone: (651) 466-3000
Securities registered pursuant to Section 12(b) of the Act (and listed on the New York Stock Exchange): Common Stock, par value $.01.
General Business Description U.S. Bancorp is a multi-state financial holding company headquartered in Minneapolis, Minnesota. U.S. Bancorp was incorporated in Delaware in 1929 and operates as a financial holding company and a bank holding company under the Bank Holding Company Act of 1956. U.S. Bancorp provides a full range of financial services, including lending and depository services, cash management, foreign exchange and trust and investment management services. It also engages in credit card services, merchant and automated teller machine (“ATM”) processing, mortgage banking, insurance, brokerage, leasing and investment banking.
Competition The commercial banking business is highly competitive. Subsidiary banks compete with other commercial banks and with other financial institutions, including savings and loan associations, mutual savings banks, finance companies, mortgage banking companies, credit unions and investment companies. In recent years, competition has increased from institutions not subject to the same regulatory restrictions as domestic banks and bank holding companies.
Government PoliciesThe operations of the Company’s various operating units are affected by state and federal legislative changes and by policies of various regulatory authorities, including those of the numerous states in which they operate, the United States and foreign governments. These policies include, for example, statutory maximum legal lending rates, domestic monetary policies of the Board of Governors of the Federal Reserve System, United States fiscal policy, international currency regulations and monetary policies, U.S. Patriot Act and capital adequacy and liquidity constraints imposed by bank regulatory agencies.
Supervision and RegulationAs a registered bank holding company and financial holding company under the Bank Holding Company Act, U.S. Bancorp is subject to the supervision of, and regulation by, the Board of Governors of the Federal Reserve System.
PropertiesU.S. Bancorp and its significant subsidiaries occupy headquarter offices under a long-term lease in Minneapolis, Minnesota. The Company also leases eight freestanding operations centers in St. Paul, Portland, Milwaukee and Denver. The Company owns six principal operations centers in Cincinnati, St. Louis, Fargo, Milwaukee and St. Paul. At December 31, 2004, the Company’s subsidiaries owned and operated a total of 1,484 facilities and leased an additional 1,462 facilities, all of which are well maintained. The Company believes its current facilities are adequate to meet its needs. Additional information with respect to premises and equipment is presented in Notes 11 and 24 of the Notes to Consolidated Financial Statements.
Equity Compensation Plan InformationThe following table summarizes information regarding equity compensation plans in effect as of December 31, 2004.
The U.S. Bancorp Deferred Compensation Plan allows non-employee directors and members of our senior management, including all of our executive officers, to defer all or part of their compensation until retirement or earlier termination of employment. The deferred compensation is deemed to be invested in one of several investment alternatives at the option of the participant, including shares of U.S. Bancorp common stock. Deferred compensation deemed to be invested in U.S. Bancorp stock may be received at the time of distribution at the election of the participant, in the form of shares of U.S. Bancorp common stock. The 3,585,410 shares included in the table assumes that participants in the plan whose deferred compensation had been deemed to be invested in U.S. Bancorp common stock had elected to receive all of that deferred compensation in shares of U.S. Bancorp common stock on December 31, 2004.
Website Access to SEC ReportsU.S. Bancorp’s internet website can be found at usbank.com. U.S. Bancorp makes available free of charge on its website its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13 or 15(d) of the Exchange Act, as well as all other reports filed by U.S. Bancorp with the SEC, as soon as reasonably practicable after electronically filed with, or furnished to, the SEC.
Certifications We have filed as exhibits to this annual report on Form 10-K the Chief Executive Officer and Chief Financial Officer certifications required by Section 302 of the Sarbanes-Oxley Act. We have also submitted the required annual Chief Executive Officer certification to the New York Stock Exchange.
Governance DocumentsOur Corporate Governance Guidelines, Code of Ethics and Business Conduct and Board of Directors committee charters are available free of charge on our web site at usbank.com, by clicking on “About U.S. Bancorp,” then “Corporate Governance.” Shareholders may request a free printed copy of any of these documents from our investor relations department by contacting them at investorrelations@usbank.com or calling (866) 775-9668.
Exhibits
Schedules to the consolidated financial statements required by Regulation S-X are omitted since the required information is included in the footnotes or is not applicable.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on February 28, 2005, on its behalf by the undersigned, thereunto duly authorized.
U.S. Bancorp
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on February 28, 2005, by the following persons on behalf of the registrant and in the capacities indicated.
Jerry A. Grundhofer
David M. Moffett
Terrance R. Dolan
Linda L. Ahlers
Victoria Buyniski Gluckman
Arthur D. Collins, Jr.
Peter H. Coors
Joel W. Johnson
Jerry W. Levin
David B. O’Maley
O’dell M. Owens, M.D., M.P.H.
Thomas E. Petry
Richard G. Reiten
Craig D. Schnuck
Warren R. Staley
Patrick T. Stokes
John J. Stollenwerk
EXHIBIT 31.1
CERTIFICATION PURSUANT TO
I, Jerry A. Grundhofer, Chief Executive Officer of U.S. Bancorp, a Delaware corporation, certify that:
Dated: February 28, 2005
EXHIBIT 31.2
I, David M. Moffett, Chief Financial Officer of U.S. Bancorp, a Delaware corporation, certify that:
EXHIBIT 32
EXECUTIVE OFFICERS" -->
Jennie P. Carlson
Andrew Cecere
William L. Chenevich
Richard K. Davis
Michael J. Doyle
Joseph E. Hasten
Richard J. Hidy
Pamela A. Joseph
Lee R. Mitau
Jerry A. Grundhofer1,6
Linda L. Ahlers1,2,3
Victoria Buyniski Gluckman4,6
Arthur D. Collins, Jr.1,5,6
Peter H. Coors2,4
Joel W. Johnson4,5
Jerry W. Levin5,6
David B. O’Maley1,2,5
O’dell M. Owens, M.D., M.P.H.4,6
Thomas E. Petry1,2,5
Richard G. Reiten1,3,6
Craig D. Schnuck3,4
Warren R. Staley1,3,6
Patrick T. Stokes1,2,5
John J. Stollenwerk2,3
Executive Offices
Common Stock Transfer Agent and Registrar
Mellon Investor ServicesP.O. Box 3315South Hackensack, NJ 07606-1915Phone: 888-778-1311 or 201-329-8660Internet: melloninvestor.com
For Registered or Certified Mail:Mellon Investor Services85 Challenger RoadRidgefield Park, NJ 07660-2104
Telephone representatives are available weekdays from 8:00 a.m. to 6:00 p.m. Central Time, and automated support is available 24 hours a day, 7 days a week. Specific information about your account is available on Mellon’s internet site by clicking on For Investors and then the Investor ServiceDirect® link.
Independent Auditor
Common Stock Listing and Trading
Dividends and Reinvestment Plan
Investor Relations Contacts
Financial Information
Website. For information about U.S. Bancorp, including news, financial results, annual reports and other documents filed with the Securities and Exchange Commission, access our home page on the internet at usbank.com, click on About U.S. Bancorp, then Investor/Shareholder Information.
Mail. At your request, we will mail to you our quarterly earnings, news releases, quarterly financial data reported on Form 10-Q and additional copies of our annual reports. Please contact:
U.S. Bancorp Investor Relations800 Nicollet MallMinneapolis, MN 55402investorrelations@usbank.comPhone: 612-303-0799 or 866-775-9668
Media RequestsSteven W. DaleSenior Vice President, Media Relationssteve.dale@usbank.comPhone: 612-303-0784
Privacy
Code of Ethics
Diversity
Equal Employment Opportunity/Affirmative Action
U.S. Bancorp, including each of our subsidiaries, is an Equal Opportunity Employer committed to creating a diverse workforce.
U.S. Bancorp 800 Nicollet Mall Minneapolis, MN 55402 usbank.com