UNITED STATES
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
For the quarterly period ended September 30, 2002
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
For the transition period from (not applicable)
Commission file number 1-6880
U.S. BANCORP
800 Nicollet Mall
612-973-1111
225 South Sixth Street
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months, and (2) has been subject to such filing requirements for the past 90 days.
YES X NO
Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date.
TABLE OF CONTENTS
Table of Contents and Form 10-Q Cross Reference Index
Forward-Looking Statements
Financial Summary" -->
Management’s Discussion and Analysis" -->
OVERVIEW
Earnings SummaryU.S. Bancorp (the “Company”) reported net income of $860.3 million for the third quarter of 2002, or $.45 per diluted share, compared with $38.7 million, or $.02 per diluted share, for the third quarter of 2001. Return on average assets and return on average equity were 1.97 percent and 19.8 percent, respectively, for the third quarter of 2002, compared with ..09 percent and .9 percent, respectively, for the third quarter of 2001. Net income includes after-tax merger and restructuring-related items of $45.9 million ($70.4 million on a pre-tax basis) for the third quarter of 2002, compared with $111.0 million ($163.1 million on a pre-tax basis) for the third quarter of 2001. For the third quarter of 2002, total merger and restructuring-related items on a pre-tax basis included $58.2 million of net expenses associated with the merger of Firstar Corporation (“Firstar”) and the former U.S. Bancorp (“USBM”) and $12.2 million associated with the acquisition of NOVA Corporation (“NOVA”) and other smaller acquisitions. For the third quarter of 2001, merger and restructuring-related items, on a pre-tax basis, included $125.6 million of noninterest expenses and $14.3 million of provision for credit losses associated with the merger of Firstar and USBM. The third quarter of 2001 merger and restructuring-related items also included $17.6 million of expense for restructuring operations of U.S. Bancorp Piper Jaffray and $5.6 million related to the acquisition of NOVA and other acquisitions.
Selected Financial Data — Supplemental Information
Acquisition and Divestiture ActivityU.S. Bancorp and its subsidiaries compose the organization created by the acquisition by Firstar of USBM. The merger was completed on February 27, 2001, and was accounted for as a pooling-of-interests. Accordingly, all financial information has been restated to include the historical information of both companies. Each share of Firstar stock was exchanged for one share of the Company’s common stock while each share of USBM stock was exchanged for 1.265 shares of the Company’s common stock. The Company retained the U.S. Bancorp name.
STATEMENT OF INCOME ANALYSIS
Net Interest IncomeThe third quarter of 2002 net interest income, on a taxable-equivalent basis, of $1,741.1 million, compared with $1,609.7 million for the third quarter of 2001, represented a $131.4 million (8.2 percent) increase from a year ago. Year-to-date net interest income on a taxable-equivalent basis was $5,101.3 million, compared with $4,748.8 million for the first nine months of 2001. The third quarter and year-to-date average earning assets increased $4.5 billion (3.1 percent) and $3.0 billion (2.1 percent), respectively, over the comparable periods of 2001, primarily driven by increases in the investment portfolio and retail loan growth, partially offset by transfers of high credit quality, low margin commercial loans to Stellar Funding Group, Inc. (the “loan conduit”) and a decline in commercial and commercial real estate loans partially due to current economic conditions. The net interest margin for the third quarter of 2002 was 4.61 percent, compared with 4.40 percent for the third quarter of 2001, while the year-to-date net interest margin increased from 4.37 percent in 2001 to 4.60 percent in 2002. The improvement in the net interest margin reflected the funding benefits of the declining interest rate environment in late 2001, a more favorable funding mix and improving spreads due to product repricing dynamics, a shift in mix toward retail loans and loan conduit transfers, partially offset by lower yields on the investment portfolio.
Provision for Credit LossesThe provision for credit losses was $330.0 million for the third quarter of 2002, compared with $1,289.3 million for the third quarter of 2001. The provision for credit losses for the third quarter of 2001 included an incremental provision of $1,025 million and a merger-related provision of $14.3 million related to restructuring a co-branding relationship of USBM. The incremental provision for credit losses was taken after extensive reviews of the Company’s commercial portfolio in light of the dramatic world events that occurred in the third quarter of 2001, declining economic conditions, and company-specific trends. This action reflected management’s expectations at the time of a prolonged economic slowdown and recovery. The restructuring charge of
Noninterest IncomeNoninterest income during the third quarter of 2002 was $1,558.3 million, an increase of $239.9 million (18.2 percent) from the third quarter of 2001. For the nine months ended September 30, 2002, noninterest income was $4,322.5 million, compared with $4,066.9 million in 2001. During the first nine months of 2001, noninterest income included $62.2 million of merger and restructuring-related gains in connection with the sale of 14 branches representing $771 million in deposits. Also included in noninterest income during the third quarter and first nine months of 2002 were net securities gains of $119.0 million and $193.7, respectively, compared with net securities gains of $59.8 million and $307.1 million for the third quarter and first nine months of 2001, respectively. For the first nine months of 2002, noninterest income, excluding merger and restructuring-related gains, was $4,322.5 million, an increase of $317.8 million (7.9 percent) from the first nine months of 2001.
Noninterest ExpenseThird quarter of 2002 noninterest expense was $1,640.3 million, an increase of $72.8 million (4.6 percent) from the third quarter of 2001. During the third quarter of 2002, noninterest expense included $70.4 million of merger and restructuring-related charges, compared with $148.8 million for the third quarter of 2001. Year-to-date noninterest expense was $4,597.5 million, a decrease of $363.2 million (7.3 percent) from the first nine months of 2001. Year-to-date noninterest expense included $216.2 million of merger and restructuring-related charges, compared with $805.8 million for the same period of 2001.
Pension PlansBecause of the long-term nature of pension plans, the accounting for pensions is complex and can be impacted by several factors including accounting methods, investment and funding policies and the plan’s actuarial assumptions. The Company’s pension accounting policy complies with Statement of Financial Accounting Standards No. 87 “Employer’s Accounting for Pension Plans” (“SFAS 87”) and reflects the long-term nature of benefit obligations and the investment horizon of plan assets. The Company has 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, investment policies considering its long-term investment time horizon and asset allocation strategies, funding policies and significant plan assumptions. Although plan assumptions are established annually, the Company may update its analysis on an interim basis in order to be
Regardless of the extent of the Company’s analysis of alternative asset allocation strategies, economic scenarios and possible outcomes, plan assumptions developed are subject to imprecision and changes in economic factors. To illustrate, for the period from 1994 to 2001, the actual return on plan assets was 11.3 percent compared with an assumed LTROR of approximately 11.1 percent and an expected compound rate of return of 9.9 percent. As a result of the modeling imprecision and uncertainty, the Company considers a range of potential expected rates of return, economic conditions for several scenarios, historical performance relative to assumed rates of return and asset allocation and LTROR information for a peer group in establishing its assumptions. The Company has considered these factors, but has not established a final LTROR for 2003 and does not anticipate making a decision until additional market data is available, most likely sometime in the second quarter of 2003. The Company plans to use the 9.9 percent LTROR established in the recent re-measurement to initially estimate its periodic pension expense for 2003.
Because of the complexity of forecasting pension plan activities, the accounting methods utilized for pensions, management’s ability to respond to factors impacting the plans and the hypothetical nature of this information, actual changes in periodic pension costs could be significantly different than the information provided in the sensitivity analysis.
Merger and Restructuring-Related ItemsEarnings in the third quarter of 2002 included pre-tax merger and restructuring-related items of $70.4 million ($45.9 million after-tax), compared with $163.1 million ($111.0 million after taxes) in the same quarter a year ago. Total merger and restructuring-related items for the third quarter of 2002 included $58.2 million of net
Income Tax ExpenseThe provision for income taxes was $459.5 million (an effective rate of 34.8 percent) for the third quarter of 2002 and $1,322.3 million (an effective rate of 34.8 percent) for the first nine months of 2002, compared with $21.9 million (an effective rate of 36.1 percent) and $534.9 million (an effective rate of 34.6 percent), respectively, for the same periods of 2001. On an operating basis (excluding the impact of merger and restructuring-related items and the cumulative effect of change in accounting principles), the provision for income taxes was $484.0 million (an effective rate of 34.8 percent) for the third quarter of 2002 and $1,397.5 million (an effective rate of 34.8 percent) for the first nine months of 2002, compared with $74.0 million (an effective rate of 33.1 percent) and $906.2 million (an effective rate of 33.9 percent), respectively, for the same periods of 2001.
BALANCE SHEET ANALYSIS
Loans The Company’s total loan portfolio was $115.9 billion at September 30, 2002, compared with $114.4 billion at December 31, 2001, an increase of $1.5 billion (1.3 percent). The change in total loans was driven by strong retail loan growth, partially offset by a decline in commercial loans due in part to current economic conditions. During the third quarter of 2002, reclassifications between loan categories occurred in connection with conforming loan classifications at the time of system conversions. Prior quarters were not restated, as it was impractical to determine the extent of reclassification for all periods presented. Commercial loans, including lease financing, totaled $43.8 billion at September 30, 2002, compared with $46.3 billion at December 31, 2001, a decrease of $2.5 billion (5.4 percent). The decline was driven by softness in loan demand, workout activities, and reclassifications to other loan categories. Included in the change for commercial loans was a reclassification of approximately $1.2 billion from commercial loans predominately to the commercial real estate and residential mortgages loan categories. The Company’s portfolio of commercial real estate loans, which includes commercial mortgages and construction loans, was $26.3 billion at September 30, 2002, compared with $25.4 billion at December 31, 2001, an increase of $.9 billion (3.7 percent). Included in the change in commercial real estate loans was a net reclassification of approximately $.5 billion to the commercial real estate loan category predominately from the commercial loan category. Residential mortgages held in the loan portfolio were $8.4 billion at September 30, 2002, compared with $7.8 billion at December 31, 2001, an increase of $.6 billion (7.8 percent). The change in residential mortgages was driven by the Leader acquisition, an increase in refinancing given the current rate environment and a reclassification of approximately $.7 billion to the residential mortgages category predominately from the commercial loan category, partially offset by residential loan sales during the first nine months of 2002. Total retail loans outstanding, which include credit card, retail leasing, home equity and second mortgages and other retail loans, were $37.4 billion at September 30, 2002, compared with $34.9 billion at December 31, 2001. The increase of $2.5 billion (7.1 percent) was driven by an increase in home equity lines during the recent declining rate environment and an increase in the retail leasing portfolio. This growth was partially offset by a decline in credit card activity due to seasonality.
Loans Held for SaleAt September 30, 2002, loans held for sale, consisting primarily of residential mortgages to be sold in the secondary markets, were $2.6 billion, compared with $2.8 billion at December 31, 2001. The $245 million (8.7 percent) decrease primarily reflected improvement in inventory turn related to residential mortgage loans, partially offset by strong mortgage loan origination volume in connection with refinancing activity during the third quarter of 2002 given declining interest rates for residential mortgage loans.
Investment SecuritiesAt September 30, 2002, investment securities, both available-for-sale and held-to-maturity, totaled $28.5 billion, compared with $26.6 billion at December 31, 2001. The $1.9 billion (7.1 percent) increase reflected the reinvestment of proceeds from loan sales and declines in commercial and commercial real estate loan balances. During the third quarter and first nine months of 2002, the Company sold $4.6 billion and $10.7 billion, respectively, of fixed-rate securities. A portion of the fixed-rate securities sold was replaced with floating-rate securities in conjunction with the Company’s interest rate risk management strategies. At September 30, 2002, approximately 27.0 percent of the investment securities portfolio represented adjustable rate financial instruments compared with 15.6 percent as of December 31, 2001.
Deposits Total deposits were $107.4 billion at September 30, 2002, compared with $105.2 billion at December 31, 2001, an increase of $2.2 billion (2.1 percent). The increase in total deposits was the result of continued desire by customers to maintain liquidity, specific deposit gathering initiatives and funding decisions during the third quarter of 2002. Noninterest-bearing deposits were $32.2 billion at September 30, 2002, compared with $31.2 billion at December 31, 2001, an increase of $1.0 billion (3.1 percent). Interest-bearing deposits totaled $75.2 billion at September 30, 2002, compared with $74.0 billion at December 31, 2001, an increase of $1.2 billion (1.7 percent). The increase in interest-bearing deposits was driven by increases in time deposits greater than $100,000 (35.5 percent), savings accounts (5.7 percent), interest checking (2.7 percent) and money market accounts (1.7 percent), partially offset by a decline in the higher cost time certificates of deposits less than $100,000 (14.0 percent). The decline in time certificates of deposits less than $100,000 reflected a shift in product mix toward savings products and funding decisions toward more favorably priced wholesale funding sources given the current interest rate environment.
BorrowingsShort-term borrowings, which include federal funds purchased, securities sold under agreements to repurchase and other short-term borrowings, were $7.5 billion at September 30, 2002, compared with $14.7 billion at December 31, 2001. The decrease of $7.2 billion (48.9 percent) in short-term borrowings reflected the impact of funding earning assets through growth in deposits and a shift toward longer-term funding sources. Long-term debt was $31.7 billion at September 30, 2002, compared with $25.7 billion at December 31, 2001. The $6.0 billion (23.2 percent) increase in long-term debt included the issuance of $1.0 billion of fixed-rate subordinated notes in February 2002, the issuance of $6.5 billion of medium-term notes and bank notes and the issuance of $3.1 billion of long-term Federal Home Loan Bank advances during the first nine months of 2002. The issuance of long-term debt was partially offset by repayments and maturities of $5.2 billion during the first nine months of 2002 including the repurchase on August 6, 2002, of approximately $1.1 billion accreted value of the Company’s convertible senior notes (the “CZARS”) due to mature in 2021. Refer to Note 10 of the Notes to Consolidated Financial Statements for additional information regarding long-term debt.
CORPORATE RISK PROFILE
Overview Managing risks is an essential part of successfully operating a financial services company. The most prominent risk exposures are credit, interest rate, market and liquidity. The Company also has exposure related to changes in residual valuations and ongoing operational activities. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. 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 account 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 and borrowers. 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 and breaches of internal controls.
Credit Risk ManagementThe Company’s strategy for credit risk management includes stringent, centralized
Analysis of Net Loan Charge-offsTotal net loan charge-offs were $329.0 million and $994.5 million during the third quarter and the first nine months of 2002, respectively, compared with net charge-offs of $563.3 million and $1,280.7 million, respectively, for the same periods of 2001. Included in the third quarter of 2001 net charge-offs were $313.2 million of commercial charge-offs related to specific events or credit initiatives taken by management. Additionally, year-to-date net charge-offs for 2001 included $160.0 million of charge-offs taken in the first quarter of 2001 related to the Company’s accelerated loan workout strategy and $90.0 million of write-offs to conform risk management practices, align charge-off policies and expedite the transition out of a specific segment of the health care portfolio not meeting the risk profile of the Company. The level of net charge-offs during the third quarter and the first nine months of 2002 reflected the impact of current economic conditions and continued weakness in the communications, transportation and manufacturing sectors, as well as the impact of the economy on highly leveraged enterprise value financings. Assuming no further deterioration in the economy, net charge-offs are expected to remain at current levels until the economy gains strength.
Analysis of Nonperforming AssetsNonperforming assets include nonaccrual loans, restructured loans, other real estate and other nonperforming assets owned by the Company. Interest payments are typically applied against the principal balance and not recorded as income. At September 30, 2002, nonperforming assets totaled $1,344.4 million, compared with $1,120.0 million at December 31, 2001. The ratio of nonperforming assets to loans and other real estate has
Delinquent Loan Ratios (c)
Analysis and Determination of the Allowance for Credit Losses The allowance for credit losses provides coverage for probable losses inherent in the Company’s loan portfolio. Management evaluates the allowance each quarter to determine that it is adequate to cover inherent losses. The evaluation of each element and the overall allowance is based on a continuing assessment of problem loans and related off-balance sheet items, recent loss experience and other factors, including regulatory guidance and economic conditions.
Interest Rate Risk ManagementThe Company manages its exposure to adverse changes in interest rates through asset and liability management activities within guidelines established by its Asset/ Liability Policy Committee (“ALPC”). The Company limits the exposure of interest rate sensitive revenues, which includes both net interest income and selected other income, associated with interest rate movements through asset/ liability management strategies. ALPC uses simulation modeling and market value of equity as the primary methods for measuring and managing consolidated interest rate risk.
Interest Sensitive Revenue SimulationThe Company performs simulation analysis to estimate the impact of changes in interest rates on net interest income and interest sensitive revenue. The model, which is updated monthly, incorporates substantially all of the Company’s assets and liabilities, off-balance sheet instruments and selected fee based revenues, together with forecasted changes in the balance sheet and assumptions that reflect the current interest rate environment. ALPC also calculates the sensitivity of the simulation results to changes in key assumptions, such as the Prime/ LIBOR spread and core deposit repricing. The results from the simulation are reviewed by ALPC monthly and are used to guide ALPC’s hedging strategies. ALPC guidelines, approved by the Company’s Board of Directors, limit the estimated change in interest rate sensitive income to 5.0 percent of forecasted rate sensitive revenue given a 300 basis point change in interest rates occurring over a 12-month time period. Based on interest rate sensitivity analysis, the interest rate risk position of the Company was relatively neutral as of September 30, 2002. The impact of an immediate upward movement in rates of 50 basis points was expected to increase net interest income by less than $15.0 million over a 12-month period. An immediate downward movement in rates of 50 basis points was expected to reduce net interest income by less than $15.0 million over a 12-month period. These estimates were based on the Company’s balance sheet at September 30, 2002, and reflect expectations regarding future changes in the balance sheet. At September 30, 2002, the Company was well within policy guidelines.
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. The amount of market value risk is subject to a limit, approved by the Company’s Board of Directors, of a 15 percent change for an immediate 200 basis point rate shock. Given the low level of rates, currently the down 200 basis point scenario cannot be computed. ALPC reviews other down-rate scenarios, including a down 100 basis points scenario, to evaluate the impact of falling rates.
Use of Derivatives to Manage Interest Rate Risk In the ordinary course of business, the Company enters into derivative transactions to manage interest rate risk and to accommodate the business requirements of its customers. 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. In connection with its mortgage banking operations, the Company enters into forward commitments to sell mortgage loans related to fixed-rate mortgage loans held for sale and fixed-rate mortgage loan commitments.
Market Risk ManagementMarket risk is subject to regular monitoring by management. The Company uses a value-at-risk (“VaR”) model to measure and manage market risk in its trading activities. The VaR model uses an estimate of volatility appropriate to each instrument and a ninety-ninth percentile adverse move in the underlying markets. The Company establishes market risk limits, subject to approval by the Company’s Board of Directors. The Company’s VaR limit was $40 million at September 30, 2002. The market valuation risk inherent in its customer-based derivative trading, mortgage banking pipeline, broker-dealer activities (including equities, fixed-income, and high-yield securities) and foreign exchange, as estimated by the VaR analysis, was $10.4 million at September 30, 2002.
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 a long-term and short-term perspective, 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.
Residual Risk ManagementThe Company manages its risk to changes in the value of lease residual assets through disciplined residual setting and valuation at the inception of a lease, diversification of its leased assets, a focus on longer term vehicle leases, effective end-of-term marketing of off-lease vehicles, regular asset valuation reviews and monitoring of residual value gains or losses upon the disposition of assets. To reduce the financial impact of potential changes in vehicle residuals, the Company maintains residual value risk insurance. The catastrophic insurance maintained by the Company provides for the potential recovery of losses on individual vehicle sales in an amount equal to the difference between a) 105 percent or 110 percent of the average wholesale auction price for the vehicle at the time of sale and b) the vehicle residual value specified by the Automotive Lease Guide (an authoritative industry source) at the inception of the lease. The potential recovery is calculated for each individual vehicle sold in a particular policy year and is reduced by any gains realized on vehicles sold during the same period. The Company will receive claim proceeds if, in the aggregate, there is a net loss for such period. Also, equipment lease originations are subject to the same stringent underwriting standards referred to in the segment captioned “Credit Risk Management.”
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 systems, and breaches of the internal control system and compliance requirements. 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.
Capital ManagementThe Company is committed to managing capital for maximum shareholder benefit and maintaining strong protection for depositors and creditors. Total shareholders’ equity was $17.5 billion at September 30, 2002, compared with $16.5 billion at December 31, 2001. The increase was the result of increased corporate earnings, including merger and restructuring-related items and cumulative effect of change in accounting principles, offset by dividends, share buybacks and acquisitions.
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, Capital Markets 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. Business line results are derived from the Company’s business unit profitability reporting systems.
assets relative to the total Company. Certain lines of business, such as trust, asset management and capital markets, have no significant balance sheet components. For these business units, capital is allocated taking into consideration fiduciary and operational risk, capital levels of independent organizations operating similar businesses and regulatory requirements. Merger and restructuring-related items and cumulative effect of change in accounting principles are not recorded within the lines of business.
Wholesale BankingWholesale Banking offers lending, depository, treasury management and other financial services to middle market, large corporate and public sector clients. Wholesale Banking contributed $308.3 million of the Company’s net operating earnings in the third quarter of 2002 and $1,074.8 million in the first nine months of 2002. The significant increase in operating earnings for the third quarter and first nine months of 2002, compared with the same periods of 2001 was primarily driven by the incremental provision taken during the third quarter of 2001.
Consumer BankingConsumer Banking delivers 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, consumer lending, mortgage banking, workplace banking, student banking, 24-hour banking and investment product and insurance sales. Consumer Banking contributed $369.2 million of the Company’s net operating earnings for the third quarter of 2002 and $1,089.1 million for the first nine months of 2002, a 29.5 percent and 6.7 percent increase, respectively, over the same periods of 2001.
Private Client, Trust and Asset ManagementPrivate Client, Trust and Asset Management provides mutual fund processing services, trust, private banking and financial advisory services through four businesses, including: the Private Client Group, Corporate Trust, Institutional Trust and Custody, and Mutual Fund Services, LLC. The business segment also offers investment management services to several client segments, including mutual funds, institutional customers, and private asset management. Private Client, Trust and Asset Management contributed $107.6 million of the Company’s net operating earnings for the third quarter of 2002 and $338.0 million in the first nine months of 2002, an increase of 4.4 percent and 3.2 percent, respectively, from the same periods in 2001.
Payment ServicesPayment Services includes consumer and business credit cards, corporate and purchasing card services, consumer lines of credit, ATM processing, merchant processing and debit cards. Payment Services contributed $198.7 million of the Company’s net operating earnings for the third quarter of 2002 and $502.9 million for the first nine months of 2002, a 44.1 percent and 30.9 percent increase, respectively, over the third quarter and the first nine months of 2001. The business unit’s financial results were, in part, driven by the impact of the NOVA acquisition completed during the third quarter of 2001.
Capital MarketsCapital Markets engages in equity and fixed income trading activities, offers investment banking and underwriting services for corporate and public sector customers and provides financial advisory services and securities, mutual funds, annuities and insurance products to consumers and regionally based businesses through a network of brokerage offices. Capital Markets contributed $7.4 million of the Company’s net operating earnings for the third quarter of 2002 and $24.5 million for the first nine months of 2002, a 2.6 percent and 11.6 percent decline, respectively, from the third quarter and the first nine months of 2001. The unfavorable variance in net operating income from the third quarter and the first nine months of 2001 was due to a decline in fees related to trading, investment product fees and commissions, investment banking fees and mark-to-market valuation adjustments reflecting the recent adverse capital markets conditions. Capital markets activities continued to experience weak sales volumes and lower levels of investment banking and merger and acquisition transactions. Management anticipates continued softness in sales activities and related revenue growth throughout the next several quarters. In response to the adverse market conditions, the Company restructured the division beginning in the third quarter of 2001 to improve the operating model and rationalize the distribution network.
Treasury and Corporate SupportTreasury and Corporate Support includes 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 change in residual allocations associated with the provision for loan losses. It also includes business activities managed on a corporate basis, including enterprise-wide operations and administrative support functions. Treasury and Corporate Support recorded net operating losses of $85.0 million in the third quarter of 2002 and $411.7 million for the first nine months of 2002, a 68.9 percent and 10.7 percent improvement, respectively, from the comparable periods of 2001.
ACCOUNTING CHANGES
Accounting for Business Combinations and Goodwill and Other Intangible AssetsIn June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141 (“SFAS 141”), “Business Combinations” and Statement of Financial Accounting Standards No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets.” SFAS 141 mandates that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, and establishes specific criteria for the recognition of intangible assets separately from goodwill. SFAS 142 addresses the accounting for goodwill and intangible assets subsequent to their acquisition. The Company adopted SFAS 142 on January 1, 2002. The most significant changes made by SFAS 142 are that goodwill and indefinite lived intangible assets are no longer amortized and will be tested for impairment at least annually. Impairment charges from the initial impairment test were recognized as a “cumulative effect of change in accounting principles” in the income statement. 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.
Acquisitions of Certain Financial InstitutionsIn October 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 147 (“SFAS 147”), “Acquisitions of Certain Financial Institutions,” an amendment of Statement of Financial Accounting Standards No. 72, No. 144 and Financial Accounting Standards Board Interpretation No. 9. In accordance with SFAS 147, the acquisition of all or a part of a financial institution that meets the definition of a business combination will be accounted for by the purchase method in accordance with SFAS 141. In addition, SFAS 147 provides that long-term customer-relationship intangible assets, except for servicing assets, recognized in the acquisition of a financial institution, should be evaluated for impairment by the provisions of Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The effective date of SFAS 147 is for acquisitions on or after October 1, 2002, and adoption is not expected to have a material impact on the Company.
CRITICAL ACCOUNTING POLICIES
The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The Company’s significant accounting policies are described in detail in the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001. 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 and are integral to the understanding of reported results. 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 they require management to make estimates that are difficult, subjective, or complex. Management has discussed the development and the selection of critical accounting estimates with the Company’s Audit Committee.
Allowance for Credit LossesThe allowance for credit losses provides coverage for probable losses inherent in the Company’s loan portfolio. Management evaluates the adequacy of the allowance for credit losses each quarter based on changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, regulatory guidance and macroeconomic factors. This
Asset Impairment The Company is required to determine some assets based on a concept of fair value and complete periodic asset impairment evaluations. The initial valuation and subsequent impairment tests may require the use of significant management estimates.
Mortgage Servicing RightsMortgage servicing rights (“MSRs”) associated with loans originated and sold, where servicing is retained, are capitalized and included in other intangible assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the present value of the future servicing fees arising from the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. For purposes of measuring impairment, the servicing rights are stratified based on the underlying loan type and note rate and compared to a valuation prepared based on a discounted cash flow methodology, utilizing current prepayment speeds and discount rates. Impairment is recognized through a valuation allowance for each impaired stratum and recorded as amortization of intangible assets. Refer to Note 8 of the Notes to Consolidated Financial Statements for additional information regarding mortgage servicing rights.
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 SFAS 141. Goodwill is no longer amortized but is subject, at a minimum, to annual tests for impairment. 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. The initial goodwill and other intangibles recorded and subsequent impairment analysis requires management to make subjective judgements concerning estimates of how the acquired asset will perform in the future using a discounted cash flow analysis. Events and factors that may significantly affect the estimates include, among others, customer attrition, changes in revenue growth trends, specific industry or market sector conditions and changes in cost structures.
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 Rule 15d-14(c) under the Securities Exchange Act of 1934) as of a date within 90 days prior to the filing date of this report. Based upon this evaluation, the principal executive officer and principal financial officer concluded that, as of such date, the Company’s disclosure controls and procedures were effective in making them aware on a timely basis of the material information relating to the Company required to be included in the Company’s periodic filings with the Securities and Exchange Commission.
See Notes to Consolidated Financial Statements.
Notes to Consolidated Financial Statements" -->
The accompanying consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and footnotes necessary for a complete presentation of financial position, results of operations and cash flow activity required in accordance with accounting principles generally accepted in the United States. In the opinion of management of U.S. Bancorp (the “Company”), all adjustments (consisting only of normal recurring adjustments) necessary for a fair statement of results for the interim periods have been made, and the Company believes such presentation is adequate to make the information presented not misleading. For further information, refer to the consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001. Certain amounts in prior periods have been reclassified to conform to the current presentation.
Acquisitions of Certain Financial InstitutionsIn October 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 147 (“SFAS 147”), “Acquisitions of Certain Financial Institutions,” an amendment of Statement of Financial Accounting Standards No. 72, No. 144 and Financial Accounting Standards Board Interpretation No. 9. In accordance with SFAS 147, the acquisition of all or a part of a financial institution that meets the definition of a business combination will be accounted for by the purchase method in accordance with SFAS 141. In addition, SFAS 147 provides that long-term customer-relationship intangible assets, except for servicing assets, recognized in the acquisition of a financial institution, should be evaluated for impairment by the provisions of Statement of Financial Accounting Standards No. 144, “Accounting
On February 27, 2001, Firstar Corporation (“Firstar”) and the former U.S. Bancorp (“USBM”) merged in a pooling-of-interests transaction and accordingly all financial information has been restated to include the historical information of both companies. Each share of Firstar stock was exchanged for one share of the Company’s common stock while each share of USBM stock was exchanged for 1.265 shares of the Company’s common stock. The Company retained the U.S. Bancorp name.
The following table summarizes acquisitions by the Company completed since January 1, 2001, treating Firstar as the original acquiring company:
On August 13, 2002, the Company announced a definitive agreement to acquire the corporate trust business of State Street Bank and Trust Company in a cash transaction valued at $725 million. This business is a leading provider of corporate trust and agency services to a variety of municipalities, corporations, government agencies and other financial institutions serving approximately 20,000 client issuances representing over $689 billion of assets under administration. After the acquisition, the Company will be among the nation’s leading providers of a full range of corporate trust products and services. The transaction is subject to certain regulatory approvals and is expected to close in the fourth quarter of 2002.
The Company recorded pre-tax merger and restructuring-related items of $216.2 million in the first nine months of 2002. In 2002, merger-related items were primarily incurred in connection with the merger of Firstar and USBM, the NOVA acquisition and the Company’s various other acquisitions. Refer to Note 3 of the Notes to Consolidated Financial Statements for additional information regarding business combinations.
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 following table presents a summary of activity with respect to the merger and restructuring-related accruals:
The adequacy of the accrued liabilities is reviewed regularly taking into consideration actual and projected payments. Adjustments are made to increase or decrease these accruals as needed. Reversals of expenses can reflect a lower utilization of benefits by affected staff, changes in initial assumptions as a result of subsequent mergers and alterations of business plans.
The following table presents a summary of activity with respect to the merger of Firstar and USBM:
The components of the merger and restructuring-related accruals for all acquisitions were as follows:
The merger and restructuring-related accrual by significant acquisition or business restructuring was as follows:
In connection with the merger of Firstar and USBM, management estimates the Company will incur pre-tax merger-related charges of approximately $88.0 million for the remainder of 2002. These are currently estimated to include $44.6 million in occupancy and equipment charges (elimination of duplicate facilities and write-offs of equipment), $38.8 million for conversions of systems and consolidation of operations and $4.6 million in severance and employee-related costs.
The amortized cost and fair value of held-to-maturity and available-for-sale securities consisted of the following:
The following table represents realized gains and losses from available-for-sale securities:
The composition of the loan portfolio was as follows:
During the third quarter of 2002, reclassifications between loan categories occurred in connection with conforming loan classifications at the time of system conversions. Prior quarters were not restated, as it was impractical to determine the extent of reclassification for all periods presented. Reclassifications included approximately $1.2 billion from the commercial loans category to the commercial real estate loan category ($.5 billion) and the residential mortgages category ($.7 billion). Loans are presented net of unearned interest which amounted to $1.6 billion at September 30, 2002, and December 31, 2001.
The Company adopted SFAS 142 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 amortization expense (net of tax) and asset impairments related to goodwill are as follows:
Management anticipates that applying the provisions of SFAS 141 to recent acquisitions and the provisions of SFAS 142 to purchase acquisitions completed prior to July 1, 2001, will increase after-tax income for the year ending December 31, 2002, by approximately $200 million, or $.10 per diluted share.
The following table reflects the changes in the carrying value of goodwill for the nine months ended September 30, 2002:
Goodwill acquired in the first nine months of 2002 included $25 million in Wholesale Banking from an earn-out payment related to the acquisition of Oliver-Allen Corporation, Inc. in April of 2000 and $15 million in Consumer Banking related to the purchase of Leader in April of 2002.
Amortizable intangible assets consisted of the following:
Below is the estimated amortization expense for the years ended:
Changes in capitalized mortgage servicing rights are summarized as follows:
The Company serviced $39.4 billion and $22.0 billion of mortgage loans for other investors as of September 30, 2002, and December 31, 2001, respectively.
The composition of deposits was as follows:
Long-term debt (debt with original maturities of more than one year) consisted of the following:
In February 2002, the Company’s subsidiary U.S. Bank National Association issued $1.0 billion of fixed-rate subordinated notes due February 4, 2014. The interest rate is 6.30% per annum. Also during the first nine months of 2002, the Company issued $6.5 billion of medium-term notes and bank notes, $3.1 billion of long-term Federal Home Loan Bank advances and had debt repayments and maturities of $5.2 billion.
The following table is a summary of the Trust Preferred Securities at September 30, 2002:
At December 31, 2000, the Company had the authority to issue 2 billion shares of common stock and 10 million shares of preferred stock. In connection with the merger of Firstar and USBM, on February 27, 2001, the number of authorized common shares for the Company was increased to 4 billion. Additionally, on February 27, 2001, in connection with the merger of Firstar and USBM, the par value of the Company’s common stock was reduced from $1.25 per share to $.01 per share. The Company had 1,914.7 million and 1,951.7 million shares of common stock outstanding at September 30, 2002, and December 31, 2001, respectively.
The components of earnings per share were:
For the three months ended September 30, 2002 and 2001, options to purchase 128 million and 82 million shares, respectively, and 119 million and 110 million shares for the nine months ended 2002 and 2001, respectively, were outstanding but not included in the computation of diluted earnings per share because they were antidilutive.
The components of income tax expense were:
The reconciliation between income tax expense and the amount computed by applying the statutory federal income tax rate was as follows:
The Company’s net deferred tax liability was $1,222.1 million at September 30, 2002, and $573.2 million at December 31, 2001.
Consolidated Statement of Cash FlowsListed below are supplemental disclosures to the Consolidated Statement of Cash Flows:
Money Market Investmentsare included with cash and due from banks as part of cash and cash equivalents. Money market investments consisted of the following:
Transfers and Servicing of Financial AssetsThe Company transferred $45.4 billion and $50.4 billion of high credit quality, low margin commercial loans to the conduit, Stellar Funding Group, Inc., in the first nine months of 2002 and 2001, respectively. The amount of these transfers are reported on a gross basis representing new participations and the renewal of participations. The amount of loan transfers net of repayments was approximately $(2.1) billion and $4.7 billion in the first nine months of 2002 and 2001, respectively.
Along with many other investment banking firms, the Company’s brokerage and investment banking subsidiary, U.S. Bancorp Piper Jaffray, has received subpoenas and requests for information from governmental and self-regulatory agencies in connection with the industry-wide investigations of research analyst independence and related issues. The Company is cooperating fully with these investigations. While the Company cannot determine the extent of any adverse judgements, penalties or fines, if any, that could result from the resolution of these matters, management does not believe that the financial impact of any resolution will be material.
Interest and rates are presented on a fully taxable-equivalent basis under a tax rate of 35 percent.
Part II -- Other Information" -->
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(b) Reports on Form 8-K
SIGNATURE
CERTIFICATION PURSUANT TO
I, Jerry A. Grundhofer, Chief Executive Officer of U.S. Bancorp, a Delaware corporation, certify that:
Dated: November 14, 2002
I, David M. Moffett, Chief Financial Officer of U.S. Bancorp, a Delaware corporation, certify that:
EXHIBIT 12
Computation of Ratio of Earnings to Fixed Charges
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U.S. Bancorp, including each of our subsidiaries, is an Equal Opportunity Employer and a Drug-Free Workplace.
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