U.S. Bancorp - 10-Q quarterly report FY

(Exact name of registrant as specified in its charter)

(Address of principal executive offices, including zip code)

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year,

if changed since last report)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

     This Form 10-Q 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 Securities and Exchange Commission: (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.

     Total net revenue, on a taxable-equivalent basis for the second quarter of 2005 was $281 million (9.3 percent) higher than the second quarter of 2004, primarily reflecting 8.9 percent growth in fee-based revenue across the majority of categories, expansion in payment processing businesses and a $173 million favorable variance in securities gains (losses), partially offset by a 1.0 percent reduction in net interest income.

     Total noninterest expense in the second quarter of 2005 was $362 million (29.4 percent) higher than the second quarter of 2004, primarily reflecting the $224 million unfavorable change in the valuation of MSRs and the $54 million charge related to the Company’s recent tender offer for certain subordinated and trust preferred debt securities. In addition, expenses reflected incremental costs related to expanding the payment processing businesses, investments in in-store branches, marketing initiatives and higher pension costs from a year ago. The efficiency ratio (the ratio of noninterest expense to taxable-equivalent net revenue excluding net securities gains or losses) was 48.3 percent for the second quarter of 2005, compared with 38.6 percent for the second quarter of 2004.

     The provision for credit losses for the second quarter of 2005 was $144 million, a decrease of $60 million (29.4 percent) from the second quarter of 2004. The decrease in the provision for credit losses year-over-year reflected a decrease in total net charge-offs. Net charge-offs in the second quarter of 2005 were $144 million, compared with $204 million in the second quarter of 2004. The decline in losses from a year ago was primarily the result of declining levels of nonperforming loans, continuing collection efforts and improving economic conditions. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.

     The Company reported net income of $2,192 million for the first six months of 2005, compared with $2,045 million for the first six months of 2004. Net income of $1.17 per diluted share in the first six months of 2005 was higher than the same period of 2004 by $.11 (10.4 percent). Return on average assets and return on average equity were 2.22 percent and 22.3 percent, respectively, for the first six months of 2005, compared with returns of 2.16 percent and 21.3 percent, respectively, for the first six months of 2004. The Company’s results for the first six months of 2005 improved over the same period of 2004, as net income rose by $147 million (7.2 percent), primarily due to growth in fee-based products and services and reduced credit costs. During the first six months of 2005, the Company recognized nominal reparation of its MSR asset, compared with the recognition of a $62 million reparation in the first six months of 2004. The Company had net securities losses of $58 million during the first six months of 2005, compared with net securities losses of $172 million in the same period of 2004.

     Total net revenue, on a taxable-equivalent basis for the first six months of 2005 was $317 million (5.2 percent) higher than the first six months of 2004, primarily reflecting 9.1 percent growth in fee-based revenue across the majority of fee categories, expansion in payment processing businesses and a $114 million

favorable variance in securities gains (losses), partially offset by a 1.3 percent reduction in net interest income.

     Total noninterest expense in the first six months of 2005 was $238 million (8.9 percent) higher than the first six months of 2004. Expenses reflected incremental costs related to expanding the payment processing businesses, investments in in-store branches, marketing initiatives, higher pension costs from a year ago and the $61 million unfavorable change in the valuation of MSRs. The efficiency ratio (the ratio of noninterest expense to taxable-equivalent net revenue excluding net securities gains or losses) was 45.1 percent for the first six months of 2005, compared with 42.7 percent for the first six months of 2004.

     The provision for credit losses for the first six months of 2005 was $316 million, a decrease of $123 million (28.0 percent) from the same period of 2004. The decrease in the provision for credit losses year-over-year reflected a decrease in total net charge-offs. Net charge-offs for the first six months of 2005 were $316 million, compared with $438 million for the first six months of 2004. The decline in losses from a year ago was primarily the result of declining levels of nonperforming loans, continuing collection efforts and improving economic conditions. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.

     Average loans for the second quarter and first six months of 2005 were higher by $10.1 billion (8.3 percent) and $9.5 billion (7.9 percent), respectively, compared with the same periods of 2004, driven by growth in average retail loans, total commercial loans and residential mortgages. Total commercial real estate loans for the second quarter and first six months of 2005 also increased slightly, relative to the comparable periods of 2004.

     Average investment securities in the second quarter and first six months of 2005 were $148 million (.3 percent) and $1.0 billion (2.4 percent) lower, respectively, than in the same periods of 2004. The decline principally reflected the net impact of repositioning the investment portfolio during 2004 as part of asset/liability risk management decisions to acquire variable-rate and shorter-term fixed-rate securities to reduce the effective duration of the portfolio and minimize the Company’s liability sensitive position. During the second quarter and first six months of 2005, the Company retained its mix of approximately 39 percent variable-rate securities. Refer to the “Interest Rate Risk Management” section for further information on the sensitivity of net interest income to changes in interest rates.

     Average noninterest-bearing deposits for the second quarter and first six months of 2005 were lower by $1.5 billion (4.8 percent) and $1.0 billion (3.5 percent), respectively, compared with the same periods of 2004. The year-over-year change in the average balances of

noninterest-bearing deposits was impacted by product changes in the Consumer Banking business line. In late 2004, the Company migrated approximately $1.3 billion of noninterest-bearing deposit balances to interest checking accounts as an enhancement to its Silver Elite Checking product. Average branch-based noninterest-bearing deposits in the second quarter and first six months of 2005, excluding the migration of certain high-value customers to Silver Elite Checking, were higher by approximately $200 million (1.7 percent) and $300 million (2.9 percent), respectively, over the same periods of 2004. Average noninterest-bearing deposits in other areas, including commercial banking and private client, trust and asset management, also increased year-over-year. These favorable variances were offset, however, by expected declines in average noninterest-bearing deposits in corporate banking as customers utilized their excess liquidity.

     Average total savings products declined year-over-year by $2.4 billion (4.0 percent) in the second quarter and $2.2 billon (3.5 percent) in the first six months of 2005, compared with the same periods of 2004, principally due to a reduction in average money market account balances, partially offset by higher interest checking accounts balances. Average branch-based interest checking deposits increased by $2.5 billion (16.5 percent) in the second quarter and $2.5 billion (17.3 percent) in the first six months of 2005, compared with the same periods of 2004, in part, due to the change in the Silver Elite Checking product, as well as new account growth. Average branch-based interest checking deposits, excluding Silver Elite Checking, were higher by approximately $1.2 billion (8.0 percent) in the second quarter and $1.3 billion (8.6 percent) in the first six months of 2005, compared with the same periods of 2004. Average money market account balances declined year-over-year as a result of the Company’s deposit pricing decisions. The largest declines were in the branches, national corporate banking, and government banking. A portion of the money market balances have migrated to time deposits greater than $100,000 as rates increased on the time deposit products.

     Average time deposits greater than $100,000 grew $7.9 billion (62.7 percent) and $7.2 billion (58.3 percent) in the second quarter and first six months of 2005, respectively, compared with the same periods of 2004, most notably in corporate banking, as customers migrated balances to higher rate deposits.

to decreases in other loan expense, insurance, lower merchant charge-back risk, and other operating losses.

     Residential mortgages increased $2.6 billion (16.9 percent) at June 30, 2005, compared with December 31, 2004. The increase was primarily the result of asset/liability risk management decisions to retain a greater portion of the Company’s adjustable-rate loan production and an increase in consumer finance originations.

     Total retail loans outstanding, which include credit card, retail leasing, home equity and second mortgages and other retail loans, grew $1.4 billion (3.2 percent) at June 30, 2005, compared with December 31, 2004. The growth was primarily due to an increase in installment, retail leasing and home equity.

     The decrease in interest-bearing deposits of $1.6 billion (1.7 percent) at June 30, 2005, compared with December 31, 2004, was primarily due to decreases in interest checking and money market savings account balances. The $1.1 billion (4.8 percent) decrease in interest checking and $1.7 billion (5.6 percent) decrease in money market savings account balances reflects the Company’s deposit pricing

decisions in selected markets, given excess liquidity throughout 2004 and a migration of some customer balances to time deposits greater than $100,000 as rates increased on time deposit products. Time deposits greater than $100,000 increased $.7 billion (3.8 percent) and time certificates of deposit less than $100,000 increased $.4 billion (3.3 percent) at June 30, 2005, compared with December 31, 2004. Time deposits greater than $100,000 are largely viewed as purchased funds and are managed to levels deemed appropriate given alternative funding sources.

     In evaluating its credit risk, the Company considers changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, the level of allowance coverage relative to similar banking institutions and macroeconomic factors. Economic conditions during the second quarter and the first six months of 2005 have improved from the same periods of 2004, as reflected in improved unemployment rates, favorable trends related to corporate profits and consumer spending for retail goods and services. Current economic conditions are relatively unchanged from December 31, 2004, with somewhat higher energy costs and some increasing inflationary trends. The Federal Reserve Bank continued its measured approach to increasing short-term interest rates in an effort to prevent an acceleration of inflation and maintain the current rate of economic growth.

     Refer to “Management’s Discussion and Analysis — Credit Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 for further discussion on credit risk management.

     The Company had restructured loans of $46 million at June 30, 2005, compared with $68 million at December 31, 2004. Commitments to lend additional funds under restructured loans were $8 million as of June 30, 2005, compared with $12 million as of December 31, 2004. Restructured loans performing under the restructured terms beyond a specific timeframe are reported as accruing. Of the Company’s total restructured loans at June 30, 2005, $6 million were reported as accruing.

     Accruing loans 90 days or more past due totaled $258 million at June 30, 2005, compared with $294 million at December 31, 2004. These loans were not included in nonperforming assets and continue to accrue interest because they are adequately secured by collateral, and/or are in the process of collection and are reasonably expected to result in repayment or restoration to current status. The ratio of delinquent loans to total loans was ..19 percent at June 30, 2005, compared with ..23 percent at December 31, 2004.

     To monitor credit risk associated with retail loans, the Company monitors delinquency ratios in the various stages of collection including nonperforming status.

The following table provides summary delinquency information for residential mortgages and retail loans:

     In general, delinquency ratios for retail loans continued to improve relative to December 31, 2004, reflecting current economic conditions.

     Commercial and commercial real estate loan net charge-offs for the second quarter of 2005 were $13 million (.07 percent of average loans outstanding), compared with $57 million (.35 percent of average loans outstanding) in the second quarter of 2004. Commercial and commercial real estate loan net charge-offs for the first six months of 2005 were $46 million (.13 percent of average loans outstanding), compared with $141 million (.43 percent of average loans outstanding) in the first six months of 2004. The year-over-year improvement was broad-based across most industries within the commercial loan portfolio.

     Retail loan net charge-offs for the second quarter of 2005 were $123 million (1.12 percent of average loans outstanding), compared with $140 million (1.38 percent of average loans outstanding) for the second quarter of 2004. Retail loan net charge-offs for the first six months of 2005 were $253 million (1.17 percent of average loans outstanding), compared with $283 million (1.42 percent of average loans outstanding) for the first six months of 2004. Lower levels of retail loan net charge-offs principally reflected the Company’s ongoing improvement in collection efforts, underwriting and risk management.

     The Company’s retail lending business utilizes several distinct business processes and channels to originate retail credit including traditional branch credit, indirect lending and a consumer finance division. Each distinct underwriting and origination activity manages unique credit risk characteristics and prices its loan production commensurate with the differing risk profiles. Within Consumer Banking, U.S. Bank Consumer Finance (“USBCF”) participates in all facets of the Company’s consumer lending activities. USBCF specializes in serving channel-specific and alternative lending markets in residential mortgages, home equity and installment loan financing. USBCF manages loans originated through a broker network, correspondent relationships and U.S. Bank branch offices. Generally, loans managed by the Company’s consumer finance division exhibit higher credit risk characteristics, but are priced commensurate with the differing risk profile.

The following table provides an analysis of net charge-offs as a percentage of average loans outstanding managed by the consumer finance division, compared with traditional branch-related loans:

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 the allowance for credit losses.

     Several factors were taken into consideration in evaluating the allowance for credit losses at June 30, 2005, including the risk profile of the portfolios and loan net charge-offs during the period, the level of nonperforming assets, the accruing loans 90 days or more past due, and delinquency ratios in most loan categories compared with December 31, 2004. Management also considered the uncertainty related to certain industry sectors, including the airline industry, and the extent of credit exposure to highly leveraged enterprise-value borrowers within the portfolio. In addition, concentration risks associated with commercial real estate and the mix of loans, including credit cards, loans originated through the consumer finance division and residential mortgages balances, and their relative credit risk were evaluated compared with other banks. Finally, the Company considered current economic conditions that might impact the portfolio.

Sensitivity of Net Interest Income and Rate Sensitive Income:

     The table above summarizes the interest rate risk of net interest income and rate sensitive income based on forecasts over the succeeding 12 months. At June 30, 2005, the Company’s overall interest rate risk position was liability sensitive to changes in interest rates. The Company manages the overall interest rate risk profile within policy limits. At June 30, 2005, and December 31, 2004, the Company was within its policy guidelines.

     The Company also uses duration of equity as a measure of interest rate risk. The duration of equity is a measure of the net market value sensitivity of the assets, liabilities and derivative positions of the Company. The duration of assets was 1.51 years at June 30, 2005, compared with 1.63 years at December 31, 2004. The duration of liabilities was 1.79 years at June 30, 2005, compared with 1.89 years at December 31, 2004. At June 30, 2005, the duration of equity was (.15) years, compared with ..12 years at December 31, 2004. The duration of equity measure shows that sensitivity of the market value of equity of the Company was liability sensitive to changes in interest rates. Refer to “Management’s Discussion and Analysis — Market Value of Equity Modeling” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, for further discussion on market value of equity modeling.

     By their nature, derivative instruments are subject to market risk. The Company does not utilize derivative instruments for speculative purposes. Of the Company’s $41 billion of total notional amount of asset and liability management derivative positions at June 30, 2005, $37 billion was designated as either fair value or cash flow hedges. The cash flow hedge positions are interest rate swaps that hedge the forecasted cash flows from the underlying variable-rate LIBOR loans and floating-rate debt. The fair value hedges are primarily interest rate contracts that hedge the change in fair value related to interest rate changes of underlying fixed-rate debt and subordinated obligations.

     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. Related to its mortgage banking operations, the Company held $2.0 billion of forward commitments to sell mortgage loans and $2.0 billion of unfunded mortgage loan commitments that were derivatives in accordance with the provisions of the Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedge Activities.” The unfunded mortgage loan commitments are reported at fair value as options in Table 9.