e10vq
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2006
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from (not applicable)
Commission File Number 1-6880
U.S. BANCORP
(Exact name of registrant as specified in its charter)
     
Delaware
(State or other jurisdiction of
incorporation or organization)
  41-0255900
(I.R.S. Employer
Identification No.)
800 Nicollet Mall
Minneapolis, Minnesota 55402
(Address of principal executive offices, including zip code)
651-466-3000
(Registrant’s telephone number, including area code)
(not applicable)
(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.
YES þ     NO o
     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES o     NO þ
     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
     
Class
Common Stock, $.01 Par Value
  Outstanding as of October 31, 2006
1,757,859,766 shares
 
 


 

Table of Contents and Form 10-Q Cross Reference Index
       
Part I — Financial Information
   
   
    3
    4
    7
    26
    26
   
    9
    10
    16
    16
    16
    19
    19
    20
  21
  28
Part II — Other Information
   
  46
  46
  46
4)  Signature
  47
5)  Exhibits
  48
 Computation of Ratio of Earnings to Fixed Charges
 Section 302 Certification of Chief Executive Officer
 Section 302 Certification of Chief Financial Officer
 Section 906 Certification of Chief Executive Officer and Chief Financial Officer
“Safe Harbor” Statement under the Private Securities Litigation Reform Act of 1995.
     This Form 10-Q contains forward-looking statements about U.S. Bancorp. 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 plans and prospects of the Company. Forward-looking statements involve inherent risks and uncertainties, and important factors could cause actual results to differ materially from those anticipated, including changes in general business and economic conditions, changes in interest rates, legal and regulatory developments, increased competition from both banks and non-banks, changes in customer behavior and preferences, effects of mergers and acquisitions and related integration, and effects of critical accounting policies and judgments. For discussion of these and other risks that may cause actual results to differ from expectations, refer to our Annual Report on Form 10-K for the year ended December 31, 2005, on file with the Securities and Exchange Commission, including the sections entitled “Risk Factors” and “Corporate Risk Profile.” Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to update them in light of new information or future events.
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Table 1 Selected Financial Data
                                                     
    Three Months Ended     Nine Months Ended
    September 30,     September 30,
       
            Percent         Percent
(Dollars and Shares in Millions, Except Per Share Data)   2006   2005   Change     2006   2005   Change
       
Condensed Income Statement
                                                 
Net interest income (taxable-equivalent basis)(a)
  $1,673     $1,791       (6.6 )%     $5,095     $5,303       (3.9 )%
Noninterest income
    1,748       1,575       11.0         5,114       4,556       12.2  
Securities gains (losses), net
          1       *         3       (57 )     *  
                       
 
Total net revenue
    3,421       3,367       1.6         10,212       9,802       4.2  
Noninterest expense
    1,538       1,473       4.4         4,568       4,399       3.8  
Provision for credit losses
    135       145       (6.9 )       375       461       (18.7 )
                       
Income before taxes
    1,748       1,749       (.1 )       5,269       4,942       6.6  
Taxable-equivalent adjustment
    13       9       44.4         34       23       47.8  
Applicable income taxes
    532       586       (9.2 )       1,678       1,573       6.7  
                       
Net income
  $1,203     $1,154       4.2       $3,557     $3,346       6.3  
                       
Net income applicable to common equity
  $1,187     $1,154       2.9       $3,524     $3,346       5.3  
                       
Per Common Share
                                                 
Earnings per share
  $.67     $.63       6.3 %     $1.98     $1.82       8.8 %
Diluted earnings per share
    .66       .62       6.5         1.95       1.80       8.3  
Dividends declared per share
    .33       .30       10.0         .99       .90       10.0  
Book value per share
    11.30       10.93       3.4                            
Market value per share
    33.22       28.08       18.3                            
Average common shares outstanding
    1,771       1,823       (2.9 )       1,784       1,836       (2.8 )
Average diluted common shares outstanding
    1,796       1,849       (2.9 )       1,809       1,862       (2.8 )
Financial Ratios
                                                 
Return on average assets
    2.23 %     2.23 %               2.24 %     2.22 %        
Return on average common equity
    23.6       22.8                 23.7       22.5          
Net interest margin (taxable-equivalent basis)(a)
    3.56       3.95                 3.68       4.00          
Efficiency ratio(b)
    45.0       43.8                 44.7       44.6          
Average Balances
                                                 
Loans
  $142,894     $135,283       5.6 %     $141,059     $131,432       7.3 %
Loans held for sale
    2,448       2,038       20.1         2,062       1,723       19.7  
Investment securities
    39,806       41,782       (4.7 )       39,858       42,308       (5.8 )
Earning assets
    187,190       180,452       3.7         185,075       176,851       4.7  
Assets
    214,089       205,667       4.1         212,188       201,505       5.3  
Noninterest-bearing deposits
    28,220       29,434       (4.1 )       28,666       29,003       (1.2 )
Deposits
    119,975       120,984       (.8 )       120,456       120,552       (.1 )
Short-term borrowings
    23,601       22,248       6.1         23,398       18,313       27.8  
Long-term debt
    41,892       35,633       17.6         40,462       36,016       12.3  
Shareholders’ equity
    20,917       20,106       4.0         20,543       19,911       3.2  
                       
   
September  30,
2006
 
December  31,
2005
                                 
                               
Period End Balances
                                                 
Loans
  $144,408     $137,806       4.8 %                          
Allowance for credit losses
    2,256       2,251       .2                            
Investment securities
    39,520       39,768       (.6 )                          
Assets
    216,855       209,465       3.5                            
Deposits
    120,961       124,709       (3.0 )                          
Long-term debt
    41,230       37,069       11.2                            
Shareholders’ equity
    20,926       20,086       4.2                            
Regulatory capital ratios
                                                 
 
Tier 1 capital
    8.8 %     8.2 %                                  
 
Total risk-based capital
    13.0       12.5                                    
 
Leverage
    8.3       7.6                                    
 
Tangible common equity
    5.4       5.9                                    
       
 * Not meaningful.
(a) Presented on a fully taxable-equivalent basis utilizing a tax rate of 35 percent.
(b) Computed as noninterest expense divided by the sum of net interest income on a taxable-equivalent basis and noninterest income excluding securities gains (losses), net.
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Management’s Discussion and Analysis
OVERVIEW
Earnings Summary U.S. Bancorp and its subsidiaries (the “Company”) reported net income of $1,203 million for the third quarter of 2006, compared with $1,154 million for the third quarter of 2005. Net income of $.66 per diluted common share in the third quarter of 2006 was higher than the same period of 2005 by $.04 (6.5 percent). Return on average assets and return on average common equity were 2.23 percent and 23.6 percent, respectively, for the third quarter of 2006, compared with returns of 2.23 percent and 22.8 percent, respectively, for the third quarter of 2005. The Company’s results for the third quarter of 2006 improved over the same period of 2005, as net income increased by $49 million (4.2 percent), primarily due to strong growth in fee-based revenues and the benefit of a lower effective tax rate from a year ago. This was offset somewhat by lower net interest income and the additional operating costs of acquired businesses.
     Total net revenue, on a taxable-equivalent basis, for the third quarter of 2006, was $54 million (1.6 percent) higher than the third quarter of 2005, primarily reflecting a 10.9 percent increase in noninterest income, partially offset by a 6.6 percent decline in net interest income. Noninterest income growth was driven by organic business growth and expansion in trust and payment processing businesses. Noninterest income also included a gain related to the sale of equity interests in a card association. These favorable changes in noninterest income were partially offset by lower mortgage banking revenue due to the impact of adopting the fair value method of accounting under Statement of Financial Accounting Standards No. 156 “Accounting for Servicing of Financial Assets” (“SFAS 156”) in the first quarter of 2006.
     Total noninterest expense in the third quarter of 2006 was $65 million (4.4 percent) higher than the third quarter of 2005, primarily reflecting incremental operating and business integration costs associated with recent acquisitions, increased pension costs and higher operating costs related to investments in tax-advantaged projects from a year ago. This was partially offset by lower intangible expense due to the adoption of SFAS 156. The efficiency ratio (the ratio of noninterest expense to taxable-equivalent net revenue excluding net securities gains or losses) was 45.0 percent for the third quarter of 2006, compared with 43.8 percent for the third quarter of 2005.
     The provision for credit losses for the third quarter of 2006 decreased $10 million (6.9 percent), compared with the third quarter of 2005. The decrease in the provision for credit losses year-over-year primarily reflected strong credit quality and the near-term favorable impact of changes in bankruptcy law in the fourth quarter of 2005. Net charge-offs in the third quarter of 2006 were $135 million, compared with $156 million in the third quarter of 2005. The decline in credit losses from a year ago was principally due to the impact of changes in bankruptcy legislation that went into effect during the fourth quarter of 2005. 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 $3,557 million for the first nine months of 2006, compared with $3,346 million for the first nine months of 2005. Net income of $1.95 per diluted common share in the first nine months of 2006 was higher than the same period of 2005 by $.15 (8.3 percent). Return on average assets and return on average common equity were 2.24 percent and 23.7 percent, respectively, for the first nine months of 2006, compared with returns of 2.22 percent and 22.5 percent, respectively, for the first nine months of 2005. The Company’s results for the first nine months of 2006 improved over the same period of 2005, as net income rose by $211 million (6.3 percent), primarily due to strong growth in fee-based revenues and lower credit-related costs. This was offset somewhat by lower net interest income and incremental operating and integration costs of acquired businesses.
     Total net revenue, on a taxable-equivalent basis, for the first nine months of 2006, was $410 million (4.2 percent) higher than the first nine months of 2005, primarily reflecting a 13.7 percent increase in noninterest income, partially offset by a 3.9 percent decline in net interest income. Noninterest income growth was driven by organic business growth, expansion in trust and payment processing businesses, higher trading income, and equity gains from the initial public offering and subsequent sale of the equity interest of a card association during the second and third quarters of 2006, respectively. These favorable changes in noninterest income categories were partially offset by
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lower mortgage banking revenue due to the impact of adopting SFAS 156, effective in the first quarter of 2006. In addition, there was a $60 million favorable change in net securities gains (losses) as compared with the first nine months of 2005.
     Total noninterest expense in the first nine months of 2006 was $169 million (3.8 percent) higher than the first nine months of 2005, primarily reflecting incremental operating and business integration costs associated with recent acquisitions, increased pension costs and higher operating costs related to certain investments. This was partially offset by lower intangible expense due to the adoption of SFAS 156 and lower debt prepayment expense. The efficiency ratio was 44.7 percent for the first nine months of 2006, compared with 44.6 percent for the first nine months of 2005.
     The provision for credit losses for the first nine months of 2006 decreased $86 million (18.7 percent), compared with the first nine months of 2005. The decrease in the provision for credit losses year-over-year primarily reflected strong credit quality and lower net charge-offs relative to 2005. Net charge-offs in the first nine months of 2006 were $375 million, compared with $472 million in the first nine months of 2005. The decline in losses from a year ago was principally due to the impact of changes in bankruptcy legislation that went into effect during the fourth quarter of 2005 offset somewhat by lower commercial loan recoveries relative to the first nine months of 2005. 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.
STATEMENT OF INCOME ANALYSIS
Net Interest Income Net interest income, on a taxable-equivalent basis, was $1,673 million in the third quarter of 2006, compared with $1,791 million in the third quarter of 2005. Net interest income, on a taxable-equivalent basis, was $5,095 million in the first nine months of 2006, compared with $5,303 million in the first nine months of 2005. Average earning assets increased $6.7 billion (3.7 percent) and $8.2 billion (4.7 percent) in the third quarter and first nine months of 2006, respectively, compared with the same periods of 2005. The increases in average earning assets were primarily driven by growth in total average loans, partially offset by a decrease in investment securities. The positive impact to net interest income from the growth in earning assets was more than offset by a lower net interest margin. The net interest margin for the third quarter and first nine months of 2006 was 3.56 percent and 3.68 percent, respectively, compared with 3.95 percent and 4.00 percent, respectively, for the same periods of 2005. The year-over-year decline in the net interest margin for the third quarter and first nine months of 2006 reflected the competitive lending environment, asset/liability management decisions and the impact of changes in the yield curve from a year ago. Compared with the same periods of 2005, credit spreads have tightened by approximately 24 basis points in the third quarter and 22 basis points in the first nine months of 2006 across most lending products due to competitive pricing and a change in mix reflecting growth in lower-spread, fixed-rate credit products and noninterest-bearing corporate card balances. The net interest margin also declined due to funding incremental asset growth with higher cost wholesale funding, share repurchases and asset/liability decisions designed to reduce the Company’s interest rate sensitivity position. An increase in the margin benefit of net free funds and loan fees partially offset these factors. Beginning in the third quarter of 2006, the Federal Reserve Bank paused from its policies of increasing interest rates and tightening the money supply. If the Federal Reserve Bank leaves rates unchanged over the next several quarters, the Company expects net interest margin to stabilize as asset repricing occurs and funding costs moderate. Refer to the “Consolidated Daily Average Balance Sheet and Related Yields and Rates” table for further information on net interest income.
     Average loans for the third quarter and first nine months of 2006 were higher by $7.6 billion (5.6 percent) and $9.6 billion (7.3 percent), respectively, compared with the same periods of 2005, reflecting growth in the majority of loan categories. During the first quarter of 2006, the Company began selling an increased proportion of its residential mortgage loan production and anticipates that residential mortgage loan balances will remain essentially flat in future periods.
     Average investment securities in the third quarter and first nine months of 2006 were $2.0 billion (4.7 percent) and $2.5 billion (5.8 percent) lower, respectively, than the same periods of 2005. The change in the balance of the investment securities portfolio from a year ago principally reflected prepayments and maturities of securities and a reduced focus on residential mortgage assets given the changing interest rate environment and mix of loan growth. Additionally, the Company reclassified approximately $460 million of principal-only securities to its trading account effective January 1, 2006, in connection with the adoption of SFAS 156. Refer to the “Interest Rate Risk
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Management” section for further information on the sensitivity of net interest income to changes in interest rates.
     Average noninterest-bearing deposits for the third quarter and first nine months of 2006 decreased $1.2 billion (4.1 percent) and $337 million (1.2 percent), respectively, compared with the same periods of 2005, reflecting a decline in business demand deposits as these customers reduce excess liquidity to fund business growth. The change also reflects a migration of customers to interest-bearing products given rising interest rates.
     Average total savings products declined year-over-year by $1.7 billion (3.0 percent) in the third quarter and $2.4 billion (4.2 percent) in the first nine months of 2006, compared with the same periods of 2005, due to reductions in average money market savings and other savings accounts, partially offset by an increase in interest checking balances. Average money market savings balances declined year-over-year primarily due to a decline in balances within the branches. This decrease was partially offset by increases in broker dealer and corporate trust balances. The overall decrease in average money market savings balances year-over-year was primarily the result of the Company’s deposit pricing decisions for money market products in relation to fixed-rate deposit products offered. A portion of branch-based money market savings accounts have migrated to fixed-rate time certificates to take advantage of higher interest rates for these products.
     Average time certificates of deposit less than $100,000 were higher by $604 million (4.6 percent) and $556 million (4.2 percent) in the third quarter and first nine months of 2006, respectively, compared with the same periods of 2005. Average time deposits greater than $100,000 grew $1.3 billion (6.2 percent) and $2.1 billion (10.5 percent) in the third quarter and first nine months of 2006, respectively, compared with the same periods of 2005. This growth was broad-based across most areas of the Company including: branch banking, commercial banking, private client and corporate trust, as customers migrated balances to higher rate deposits.
Provision for Credit Losses The provision for credit losses for the third quarter and first nine months of 2006 decreased $10 million (6.9 percent) and $86 million (18.7 percent), respectively, compared with the same periods of 2005. The decrease in the provision for credit losses year-over-year primarily reflected stronger credit quality and the near-term favorable impact of changes in bankruptcy law in the fourth quarter of 2005. Net charge-offs in the third quarter and first nine months of 2006 were $135 million and $375 million, respectively, compared with $156 million and $472 million in the third quarter and first nine months of 2005, respectively. The decline in losses from a year ago was principally due to the impact of changes in bankruptcy legislation that went into effect during the fourth quarter of 2005. 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.
Table 2 Noninterest Income
                                                     
    Three Months Ended     Nine Months Ended
    September 30,     September 30,
       
            Percent         Percent
(Dollars in Millions)   2006   2005   Change     2006   2005   Change
       
Credit and debit card revenue
  $206     $185       11.4 %     $590     $516       14.3 %
Corporate payment products revenue
    150       135       11.1         416       362       14.9  
ATM processing services
    63       64       (1.6 )       183       168       8.9  
Merchant processing services
    253       200       26.5         719       576       24.8  
Trust and investment management fees
    305       251       21.5         916       751       22.0  
Deposit service charges
    268       246       8.9         764       690       10.7  
Treasury management fees
    111       109       1.8         334       333       .3  
Commercial products revenue
    100       103       (2.9 )       311       299       4.0  
Mortgage banking revenue
    68       111       (38.7 )       167       323       (48.3 )
Investment products fees and commissions
    34       37       (8.1 )       114       115       (.9 )
Securities gains (losses), net
          1       *         3       (57 )     *  
Other
    190       134       41.8         600       423       41.8  
           
 
Total noninterest income
  $1,748     $1,576       10.9 %     $5,117     $4,499       13.7 %
       
* Not meaningful.
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Noninterest Income Noninterest income in the third quarter and first nine months of 2006 was $1,748 million and $5,117 million, respectively, compared with $1,576 million and $4,499 million in the same periods of 2005. The $172 million (10.9 percent) increase during the third quarter and $618 million (13.7 percent) increase during the first nine months of 2006, compared with the same periods in 2005, were driven by favorable variances in the majority of fee income categories and a gain on the sale of equity interests in a card association included in other income. The increase in noninterest income for the first nine months of 2006 also reflected the impact of higher trading income related to certain derivatives and a gain from the initial public offering of a card association recorded in the current year, and a favorable variance in securities gains (losses) of $60 million related to net securities losses recorded in the prior year. This strong growth in fee-based revenue was partially offset by the accounting impact of SFAS 156 on mortgage banking revenue.
     The growth in credit and debit card revenue was primarily driven by higher customer transaction volumes. The corporate payment products revenue growth reflected organic growth in sales volumes and card usage and acquired business expansion. ATM processing services revenue for the first nine months of 2006 was higher due to the acquisition of an ATM business in May of 2005. Merchant processing services revenue growth reflected an increase in sales volume driven by acquisitions, higher same store sales, rates and equipment fees. Trust and investment management fees increased in the third quarter and first nine months year-over-year, primarily due to the acquisition of the corporate and institutional trust business of a large national bank, account growth and favorable equity market conditions. Deposit service charges grew year-over-year due to increased transaction-related fees and the impact of net new checking accounts. Other income for the third quarter and first nine months of 2006 was higher than the same periods of 2005 due to a $32 million gain on the sale of equity interests in a card association and an increase in other equity investment revenue. In addition, other income for the first nine months of 2006 was higher due to a $44 million gain on certain interest rate swaps, a $35 million gain from the initial public offering of a card association, end-of-term lease residual value improvement, higher student loan sales gains and the receipt of a favorable settlement within the merchant processing business. These favorable changes in fee-based revenue were partially offset by the decline in mortgage banking revenue, principally driven by the adoption of the fair value method of accounting for mortgage servicing rights (“MSRs”) under SFAS 156.
Noninterest Expense Noninterest expense was $1,538 million and $4,568 million, respectively, in the third quarter and first nine months of 2006, an increase of $65 million (4.4 percent) and $169 million (3.8 percent), respectively, from the same periods of 2005. Compensation expense was higher year-over-year in the third quarter and first nine months of 2006, primarily due to the corporate and institutional trust and payments processing acquisitions and other growth initiatives. Employee benefits increased year-over-year primarily as a result of higher pension costs. Net occupancy and equipment expense increased from the same periods of 2005 primarily due to business expansion. Professional services expense was higher year-over-year primarily due to business development initiatives, regulatory and legal costs. Technology and communications expense rose due to higher outside data
Table 3 Noninterest Expense
                                                     
    Three Months Ended     Nine Months Ended
    September 30,     September 30,
       
        Percent         Percent
(Dollars in Millions)   2006   2005   Change     2006   2005   Change
       
Compensation
  $632     $603       4.8 %     $1,892     $1,782       6.2 %
Employee benefits
    123       106       16.0         379       330       14.8  
Net occupancy and equipment
    168       162       3.7         494       475       4.0  
Professional services
    54       44       22.7         130       119       9.2  
Marketing and business development
    58       61       (4.9 )       156       171       (8.8 )
Technology and communications
    128       118       8.5         372       337       10.4  
Postage, printing and supplies
    66       64       3.1         198       190       4.2  
Other intangibles
    89       125       (28.8 )       263       377       (30.2 )
Debt prepayment
                        11       54       (79.6 )
Other
    220       190       15.8         673       564       19.3  
           
 
Total noninterest expense
  $1,538     $1,473       4.4 %     $4,568     $4,399       3.8 %
           
Efficiency ratio (a)
    45.0 %     43.8 %               44.7 %     44.6 %        
       
(a) Computed as noninterest expense divided by the sum of net interest income on a taxable-equivalent basis and noninterest income excluding securities gains (losses), net.
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processing expense principally associated with expanding a prepaid gift card program and the corporate and institutional trust acquisition. Other expense increased in the third quarter and first nine months of 2006 from the same periods of 2005, primarily due to the increased investments in tax-advantaged projects relative to a year ago. Offsetting these expense increases was a year-over-year decline in other intangibles expense, reflecting the elimination of MSR amortization and impairment due to the adoption of SFAS 156. Debt prepayment expense was also lower in the first nine months of 2006, compared with the same period of 2005.
Income Tax Expense The provision for income taxes was $532 million (an effective rate of 30.7 percent) for the third quarter and $1,678 million (an effective rate of 32.1 percent) for the first nine months of 2006, compared with $586 million (an effective rate of 33.7 percent) and $1,573 million (an effective rate of 32.0 percent) for the same periods of 2005. The effective rate for the third quarter of 2006 reflected an expected increase in income tax credits from tax-advantaged investments through the remainder of the year. For further information on income taxes, refer to Note 9 of the Notes to Consolidated Financial Statements.
BALANCE SHEET ANALYSIS
Loans The Company’s total loan portfolio was $144.4 billion at September 30, 2006, compared with $137.8 billion at December 31, 2005, an increase of $6.6 billion (4.8 percent). The increase in total loans was driven by growth in commercial loans, retail loans, commercial real estate loans and residential mortgages. The $3.7 billion (8.5 percent) increase in commercial loans was primarily driven by new customer relationships and growth in corporate payment card and commercial leasing balances.
     Commercial real estate loans were $29.0 billion at September 30, 2006, an increase of $.5 billion (1.8 percent) compared with December 31, 2005. The increase was driven by growth in construction loans, partially offset by a decrease in commercial mortgage balances.
     Residential mortgages held in the loan portfolio were $21.2 billion at September 30, 2006, an increase of $.5 billion (2.3 percent) compared with December 31, 2005. The growth was the result of an increase in consumer finance originations, partially offset by the Company selling an increased proportion of its residential mortgage loan production in 2006.
     Total retail loans outstanding, which include credit card, retail leasing, home equity and second mortgages and other retail loans, were $47.6 billion at September 30, 2006, an increase of $2.0 billion (4.3 percent) compared with December 31, 2005. The increase was primarily driven by growth in installment, credit card and home equity and second mortgage loans, partially offset by decreases in retail leasing balances.
Investment Securities Investment securities, both available-for-sale and held-to-maturity, totaled $39.5 billion at September 30, 2006, compared with $39.8 billion at December 31, 2005, reflecting purchases of $5.6 billion of securities, which were more than offset by maturities and prepayments and the reclassification of $.5 billion of principal-only securities to the trading account effective January 1, 2006, in connection with the adoption of SFAS 156. As of September 30, 2006, approximately 39 percent of the investment securities portfolio represented adjustable-rate financial instruments, compared with 41 percent at December 31, 2005. Adjustable-rate financial instruments include variable-rate collateralized mortgage obligations, mortgage-backed securities, agency securities, adjustable-rate money market accounts, asset-backed securities and floating-rate preferred stock.
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Table 4 Investment Securities
                                                                       
    Available-for-Sale     Held-to-Maturity
       
        Weighted-         Weighted-    
        Average   Weighted-         Average   Weighted-
    Amortized   Fair   Maturity in   Average     Amortized   Fair   Maturity in   Average
September 30, 2006 (Dollars in Millions)   Cost   Value   Years   Yield (d)     Cost   Value   Years   Yield (d)
       
U.S. Treasury and agencies
                                                                 
 
Maturing in one year or less
  $71     $72       .5       5.27 %     $—     $—             %
 
Maturing after one year through five years
    29       29       2.5       7.14                            
 
Maturing after five years through ten years
    24       24       6.8       6.91                            
 
Maturing after ten years
    331       324       13.9       5.98                            
           
   
Total
  $455     $449       10.7       5.99 %     $—     $—             %
           
Mortgage-backed securities (a)
                                                                 
 
Maturing in one year or less
  $346     $345       .9       5.33 %     $—     $—             %
 
Maturing after one year through five years
    17,496       17,038       3.5       4.58         7       7       3.1       5.75  
 
Maturing after five years through ten years
    12,623       12,289       7.0       5.22                            
 
Maturing after ten years
    4,513       4,535       13.1       6.46                            
           
   
Total
  $34,978     $34,207       6.0       5.06 %     $7     $7       3.1       5.75 %
           
Asset-backed securities (a)
                                                                 
 
Maturing in one year or less
  $7     $7       .2       5.32 %     $—     $—             %
 
Maturing after one year through five years
                                                 
 
Maturing after five years through ten years
                                                 
 
Maturing after ten years
                                                 
           
   
Total
  $7     $7       .2       5.32 %     $—     $—             %
           
Obligations of state and political subdivisions (b)
                                                                 
 
Maturing in one year or less
  $53     $53       .3       6.94 %     $3     $3       .4       6.94 %
 
Maturing after one year through five years
    42       43       2.2       6.83         20       21       3.0       6.24  
 
Maturing after five years through ten years
    3,276       3,332       8.9       6.76         14       16       7.9       7.18  
 
Maturing after ten years
    324       330       11.1       6.74         34       37       15.4       6.54  
           
   
Total
  $3,695     $3,758       8.9       6.76 %     $71     $77       9.8       6.59 %
           
Other debt securities
                                                                 
 
Maturing in one year or less
  $210     $210       .2       4.46 %     $2     $2       .8       6.94 %
 
Maturing after one year through five years
    1       1       3.8       10.31         10       10       2.9       5.75  
 
Maturing after five years through ten years
    15       15       9.8       6.19         1       1       5.5       6.09  
 
Maturing after ten years
    627       626       20.9       6.35                            
           
   
Total
  $853     $852       15.6       5.89 %     $13     $13       2.8       5.96 %
           
Other investments
  $151     $156             5.20 %     $—     $—             %
           
Total investment securities (c)
  $40,139     $39,429       6.5       5.25 %     $91     $97       8.2       6.44 %
       
(a) Information related to asset and mortgage-backed securities included above is presented based upon weighted-average maturities anticipating future prepayments.
(b) Information related to obligations of state and political subdivisions is presented based upon yield to first optional call date if the security is purchased at a premium, yield to maturity if purchased at par or a discount.
(c) The weighted-average maturity of the available-for-sale investment securities was 6.1 years at December 31, 2005, with a corresponding weighted-average yield of 4.89 percent. The weighted-average maturity of the held-to-maturity investment securities was 7.2 years at December 31, 2005, with a corresponding weighted-average yield of 6.44 percent.
(d) Average yields are presented on a fully-taxable equivalent basis under a tax rate of 35 percent. Yields on available-for-sale and held-to-maturity securities are computed based on historical cost balances. Average yield and maturity calculations exclude equity securities that have no stated yield or maturity.
                                     
                     September 30, 2006                   December 31, 2005
       
    Amortized   Percent     Amortized   Percent
(Dollars in Millions)   Cost   of Total     Cost   of Total
       
U.S. Treasury and agencies
  $455       1.1 %     $496       1.2 %
Mortgage-backed securities
    34,985       87.0         38,169       94.4  
Asset-backed securities
    7               12       .1  
Obligations of state and political subdivisions
    3,766       9.4         724       1.8  
Other debt securities and investments
    1,017       2.5         1,029       2.5  
           
 
Total investment securities
  $40,230       100.0 %     $40,430       100.0 %
       
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Deposits Total deposits were $121.0 billion at September 30, 2006, compared with $124.7 billion at December 31, 2005, a decrease of $3.7 billion (3.0 percent). The decrease in total deposits was primarily the result of decreases in noninterest-bearing deposits, money market savings accounts and time deposits greater than $100,000, partially offset by increases in interest checking and time certificates of deposits less than $100,000. The $1.7 billion (5.2 percent) decrease in noninterest-bearing deposits primarily reflected a decline in business demand deposits as these customers reduce excess liquidity to fund business growth. The change also reflected a migration of customers to interest-bearing products given rising interest rates. The $2.5 billion (8.8 percent) decrease in money market savings account balances reflected the Company’s deposit pricing decisions for money market products in relation to other fixed-rate deposit products offered. A portion of branch-based money market savings accounts have migrated to fixed-rate time certificates to take advantage of higher interest rates for these products. Time deposits greater than $100,000 decreased $1.2 billion (5.2 percent) at September 30, 2006, compared with December 31, 2005, due to a decrease in corporate banking balances, partially offset by increases in consumer and private banking balances due to customer migration of deposit balances. Time deposits greater than $100,000 are largely viewed as purchased funds and are managed at levels deemed appropriate given alternative lending sources. Time certificates of deposit less than $100,000 increased $.6 billion (4.2 percent) at September 30, 2006, compared with December 31, 2005. Interest checking accounts increased $1.1 billion (4.6 percent) due to an increase in trust and custody and government balances, partially offset by decreases in consumer and private banking balances.
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, commercial paper, securities sold under agreements to repurchase and other short-term borrowings, were $24.8 billion at September 30, 2006, compared with $20.2 billion at December 31, 2005. Short-term funding is managed within approved liquidity policies. The increase of $4.6 billion in short-term borrowings reflected wholesale funding associated with the Company’s earning asset growth and asset/liability management activities. Long-term debt was $41.2 billion at September 30, 2006, compared with $37.1 billion at December 31, 2005, reflecting the issuances of $8.0 billion of medium-term and bank notes, $2.5 billion of junior subordinated debentures and the addition of $2.8 billion of Federal Home Loan Bank advances, partially offset by $8.2 billion of medium-term and bank note maturities and repayments, and $.7 billion of junior subordinated debentures repayments. Refer to the “Liquidity Risk Management” section for discussion of liquidity management of the Company.
CORPORATE RISK PROFILE
Overview Managing risks is an essential part of successfully operating a financial services company. The most prominent risk exposures are credit, residual, 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.
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Table 5 Delinquent Loan Ratios as a Percent of Ending Loan Balances
                       
    September 30,   December 31,
90 days or more past due excluding nonperforming loans   2006   2005
 
Commercial
               
 
Commercial
    .07 %     .06 %
 
Lease financing
           
     
   
Total commercial
    .06       .05  
Commercial real estate
               
 
Commercial mortgages
    .01        
 
Construction and development
    .01        
     
   
Total commercial real estate
    .01        
Residential mortgages
    .36       .32  
Retail
               
 
Credit card
    1.59       1.26  
 
Retail leasing
    .03       .04  
 
Other retail
    .19       .22  
     
   
Total retail
    .40       .36  
     
     
Total loans
    .20 %     .18 %
 
                   
    September 30,   December 31,
90 days or more past due including nonperforming loans   2006   2005
 
Commercial
    .55 %     .69 %
Commercial real estate
    .54       .55  
Residential mortgages (a)
    .53       .55  
Retail
    .51       .50  
     
 
        Total loans
    .53 %     .58 %
 
(a) Delinquent loan ratios exclude advances made pursuant to servicing agreements to Government National Mortgage Association (“GNMA”) mortgage pools whose repayments are insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs. Including the guaranteed amounts, the ratio of residential mortgages 90 days or more past due was 2.78 percent at September 30, 2006, and 4.35 percent at December 31, 2005.
Credit Risk Management The Company’s strategy for credit risk management includes well-defined, centralized credit policies, uniform underwriting criteria, and ongoing risk monitoring and review processes for all commercial and consumer credit exposures. The strategy also emphasizes diversification on a geographic, industry and customer level, regular credit examinations and management reviews of loans 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.
     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 third quarter and first nine months of 2006 have improved from the same periods of 2005, as reflected in strong expansion of the gross domestic product index, lower 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, 2005. Through the second quarter of 2006, the Federal Reserve Bank continued increasing short-term interest rates in an effort to prevent an acceleration of inflation and maintain the current rate of economic growth. Beginning in the third quarter of 2006, the Federal Reserve Bank paused from its policies of increasing interest rates and tightening the money supply.
     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, 2005, for a more detailed discussion on credit risk management processes.
Loan Delinquencies Trends in delinquency ratios represent an indicator, among other considerations, of credit risk within the Company’s loan portfolios. The entire balance of the account is considered delinquent if the minimum payment contractually required to be made is not received by the specified date on the billing statement. The Company measures delinquencies, both
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including and excluding nonperforming loans, to enable comparability with other companies. Accruing loans 90 days or more past due increased $42 million to $295 million at September 30, 2006, compared with $253 million at December 31, 2005, due to the seasoning of the residential mortgage portfolio originated by the consumer finance division and the continued return to normalized delinquency levels after the bankruptcy legislation change that occurred in the fourth quarter of 2005. These loans are 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 .20 percent at September 30, 2006, compared with .18 percent at December 31, 2005.
     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:
                                         
          As a Percent of Ending
    Amount     Loan Balances
       
    September 30,   December 31,     September 30,   December 31,
(Dollars in Millions)   2006   2005     2006   2005
       
Residential mortgages
                                 
   
30-89 days
    $129       $112         .61 %     .55 %
   
90 days or more
    76       67         .36       .32  
   
Nonperforming
    36       48         .17       .23  
           
     
Total
    $241       $227         1.14 %     1.10 %
       
Retail
                                 
 
Credit card
                                 
   
30-89 days
    $168       $147         2.14 %     2.06 %
   
90 days or more
    125       90         1.59       1.26  
   
Nonperforming
    37       49         .47       .69  
           
     
Total
    $330       $286         4.20 %     4.01 %
 
Retail leasing
                                 
   
30-89 days
    $30       $43         .42 %     .59 %
   
90 days or more
    2       3         .03       .04  
   
Nonperforming
                         
           
     
Total
    $32       $46         .45 %     .63 %
 
Other retail
                                 
   
30-89 days
    $187       $206         .57 %     .66 %
   
90 days or more
    62       70         .19       .22  
   
Nonperforming
    16       17         .05       .06  
           
     
Total
    $265       $293         .81 %     .94 %
       
Nonperforming Assets The level of nonperforming assets represents another indicator of the potential for future credit losses. Nonperforming assets include nonaccrual loans, restructured loans not performing in accordance with modified terms, other real estate and other nonperforming assets owned by the Company. Interest payments collected from assets on nonaccrual status are typically applied against the principal balance and not recorded as income. At September 30, 2006, total nonperforming assets were $575 million, compared with $644 million at December 31, 2005. The ratio of total nonperforming assets to total loans and other real estate decreased to .40 percent at September 30, 2006, compared with .47 percent at December 31, 2005.
     Included in nonperforming loans were restructured loans of $43 million at September 30, 2006, compared with $75 million at December 31, 2005. At September 30, 2006, the Company had no commitments to lend additional funds under restructured loans, compared to commitments of $9 million at December 31, 2005.
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Table 6 Nonperforming Assets (a)
                       
    September 30,   December 31,
(Dollars in Millions)   2006   2005
 
Commercial
               
 
Commercial
  $192     $231  
 
Lease financing
    39       42  
     
   
Total commercial
    231       273  
Commercial real estate
               
 
Commercial mortgages
    114       134  
 
Construction and development
    40       23  
     
   
Total commercial real estate
    154       157  
Residential mortgages
    36       48  
Retail
               
 
Credit card
    37       49  
 
Retail leasing
           
 
Other retail
    16       17  
     
   
Total retail
    53       66  
     
     
Total nonperforming loans
    474       544  
Other real estate (b)
    79       71  
Other assets
    22       29  
     
     
Total nonperforming assets
  $575     $644  
     
Accruing loans 90 days or more past due
  $295     $253  
Nonperforming loans to total loans
    .33 %     .39 %
Nonperforming assets to total loans plus other real estate (b)
    .40 %     .47 %
 
Changes in Nonperforming Assets
                                 
    Commercial and   Retail and    
    Commercial   Residential    
(Dollars in Millions)   Real Estate   Mortgages (d)   Total
 
Balance December 31, 2005
  $457     $187       $644  
 
Additions to nonperforming assets
                       
   
New nonaccrual loans and foreclosed properties
    334       41       375  
   
Advances on loans
    30             30  
     
     
Total additions
    364       41       405  
 
Reductions in nonperforming assets
                       
   
Paydowns, payoffs
    (210 )     (41 )     (251 )
   
Net sales
    (21 )           (21 )
   
Return to performing status
    (92 )     (6 )     (98 )
   
Charge-offs (c)
    (93 )     (11 )     (104 )
     
     
Total reductions
    (416 )     (58 )     (474 )
     
       
Net additions to (reductions in) nonperforming assets
    (52 )     (17 )     (69 )
     
Balance September 30, 2006
  $405     $170       $575  
 
(a) Throughout this document, nonperforming assets and related ratios do not include accruing loans 90 days or more past due.
(b) Excludes $85 million of foreclosed GNMA loans which continue to accrue interest.
(c) Charge-offs exclude actions for certain card products and loan sales that were not classified as nonperforming at the time the charge-off occurred.
(d) Residential mortgage information excludes changes related to residential mortgages serviced by others.
Restructured Loans Accruing Interest On a case-by-case basis, management determines whether an account that experiences financial difficulties should be modified as to its interest rate or repayment terms to maximize the Company’s collection of its balance.
     Loans restructured at a rate equal to or greater than that of a new loan with comparable risk at the time the contract is modified are excluded from restructured loans once repayment performance, in accordance with the modified agreement, has been demonstrated over several payment cycles. Loans that have interest rates reduced below comparable market rates remain classified as restructured loans; however, interest income is accrued at the reduced rate as long as the customer complies with the revised terms and conditions.
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The following table provides a summary of restructured loans that continue to accrue interest:
                                     
          As a Percent of Ending
    Amount     Loan Balances
       
    September 30,   December 31,     September 30,   December 31,
(Dollars in Millions)   2006   2005     2006   2005
       
Commercial
    $19       $5         .04 %     .01 %
Commercial real estate
    1       1                
Residential mortgages
    76       59         .36       .28  
Credit card
    236       218         3.00       3.05  
Other retail
    37       32         .09       .08  
           
 
Total
    $369       $315         .26 %     .23 %
       
     Restructured loans that continue to accrue interest were higher at September 30, 2006, compared with December 31, 2005, reflecting the impact of the Company implementing higher minimum balance payment requirements for credit card customers in response to industry guidance issued by the banking regulatory agencies.
Analysis of Loan Net Charge-Offs Total loan net charge-offs were $135 million and $375 million during the third quarter and first nine months of 2006, respectively, compared with net charge-offs of $156 million and $472 million, respectively, for the same periods of 2005. The ratio of total loan net charge-offs to average loans in the third quarter and first nine months of 2006 was .37 percent and ..36 percent, respectively, compared with .46 percent and .48 percent, respectively, for the same periods of 2005.
     Commercial and commercial real estate loan net charge-offs for the third quarter of 2006 were $21 million (.11 percent of average loans outstanding), compared with $23 million (.13 percent of average loans outstanding) for the third quarter of 2005. Commercial and commercial real estate loan net charge-offs for the first nine months of 2006 were $55 million (.10 percent of average loans outstanding), compared with $69 million (.13 percent of average loans outstanding) for the first nine months of 2005. The decrease in net charge-offs reflected lower gross charge-offs, partially offset by a lower level of recoveries as compared with the same periods of the prior year. The Company expects commercial net charge-offs to increase somewhat over the next several quarters due to an increase in gross chargeoffs from cyclical lows and declining commercial loan recoveries.
     Retail loan net charge-offs for the third quarter of 2006 were $103 million (.87 percent of average loans outstanding), compared with $124 million (1.09 percent of average loans outstanding) for the third quarter of 2005. Retail loan net charge-offs for the first nine months of 2006 were $291 million (.84 percent of average loans outstanding), compared with $377 million (1.14 percent of average loans outstanding) for the first nine months of 2005. The decrease in retail loan net charge-offs reflected the impact of the bankruptcy legislation change that occurred in the fourth quarter of 2005 and improved retail portfolio performance. The Company anticipates that bankruptcy charge-offs will return to more normalized levels during the next several quarters.
     The Company’s retail lending business utilizes several distinct business processes and channels to
Table 7 Net Charge-offs as a Percent of Average Loans Outstanding
                                         
    Three Months Ended     Nine Months Ended
    September 30,     September 30,
       
    2006   2005     2006   2005
       
Commercial
                                 
 
Commercial
    .18 %     .07 %       .12 %     .11 %
 
Lease financing
    .23       1.29         .44       .95  
           
   
Total commercial
    .18       .21         .16       .21  
Commercial real estate
                                 
 
Commercial mortgages
          .04         .01       .05  
 
Construction and development
          (.10 )       .02       (.05 )
           
   
Total commercial real estate
                  .01       .02  
Residential mortgages
    .21       .19         .18       .20  
Retail
                                 
 
Credit card
    2.85       3.74         2.74       3.92  
 
Retail leasing
    .22       .27         .19       .33  
 
Home equity and second mortgages
    .31       .37         .33       .42  
 
Other retail
    .72       1.04         .74       1.05  
           
   
Total retail
    .87       1.09         .84       1.14  
           
     
Total loans
    .37 %     .46 %       .36 %     .48 %
       
U.S. Bancorp 13


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originate retail credit including traditional branch lending, 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 substantially all facets of the Company’s consumer lending activities. USBCF specializes in serving channel-specific and alternative lending markets in residential mortgages, home equity and installment loan financing. USBCF manages loans originated through a broker network, correspondent relationships and U.S. Bank branch offices. Generally, loans managed by the Company’s consumer finance division exhibit higher credit risk characteristics, but are priced commensurate with the differing risk profile. The following table provides an analysis of net charge-offs as a percent of average loans outstanding managed by the consumer finance division, compared with traditional branch related loans:
                                                                     
    Three Months Ended September 30,     Nine Months Ended September 30,
       
    Average Loan   Percent of     Average Loan   Percent of
    Amount   Average Loans     Amount   Average Loans
       
(Dollars in Millions) 2006   2005   2006   2005     2006   2005   2006   2005
       
Consumer Finance (a)
                                                                 
 
Residential mortgages
    $7,627       $6,292       .52 %     .50 %     $7,245     $5,734       .48 %     .51 %
 
Home equity and second mortgages
    1,939       2,363       1.43       1.68         1,993       2,523       1.48       1.64  
 
Other retail
    397       400       5.00       4.96         401       390       4.67       4.80  
Traditional Branch
                                                                 
 
Residential mortgages
    $13,491       $12,449       .03 %     .03 %     $13,747     $11,532       .03 %     .05 %
 
Home equity and second mortgages
    13,227       12,621       .15       .13         13,054       12,421       .15       .17  
 
Other retail
    16,575       15,563       .62       .94         16,313       14,935       .64       .95  
Total Company
                                                                 
 
Residential mortgages
    $21,118       $18,741       .21 %     .19 %     $20,992     $17,266       .18 %     .20 %
 
Home equity and second mortgages
    15,166       14,984       .31       .37         15,047       14,944       .33       .42  
 
Other retail
    16,972       15,963       .72       1.04         16,714       15,325       .74       1.05  
       
(a) Consumer finance category included credit originated and managed by USBCF, as well as home equity and second mortgages with a loan-to-value greater than 100 percent that were originated in the branches.
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.
     At September 30, 2006, the allowance for credit losses was $2,256 million (1.56 percent of loans), compared with an allowance of $2,251 million (1.63 percent of loans) at December 31, 2005. The ratio of the allowance for credit losses to nonperforming loans was 476 percent at September 30, 2006, compared with 414 percent at December 31, 2005. The ratio of the allowance for credit losses to annualized loan net charge-offs was 421 percent at September 30, 2006, compared with 329 percent at December 31, 2005.
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Table 8 Summary of Allowance for Credit Losses
                                           
    Three Months Ended     Nine Months Ended
    September 30,     September 30,
       
(Dollars in Millions)   2006   2005     2006   2005
       
Balance at beginning of period
  $2,251     $2,269       $2,251     $2,269  
Charge-offs
                                 
 
Commercial
                                 
   
Commercial
    34       37         86       111  
   
Lease financing
    12       24         37       62  
           
     
Total commercial
    46       61         123       173  
 
Commercial real estate
                                 
   
Commercial mortgages
    1       5         7       15  
   
Construction and development
                  1       3  
           
     
Total commercial real estate
    1       5         8       18  
 
Residential mortgages
    12       10         31       28  
 
Retail
                                 
   
Credit card
    65       71         178       217  
   
Retail leasing
    6       8         19       27  
   
Home equity and second mortgages
    14       19         46       59  
   
Other retail
    51       55         141       160  
           
     
Total retail
    136       153         384       463  
           
       
Total charge-offs
    195       229         546       682  
Recoveries
                                 
 
Commercial
                                 
   
Commercial
    16       30         50       81  
   
Lease financing
    9       8         20       27  
           
     
Total commercial
    25       38         70       108  
 
Commercial real estate
                                 
   
Commercial mortgages
    1       3         6       8  
   
Construction and development
          2               6  
           
     
Total commercial real estate
    1       5         6       14  
 
Residential mortgages
    1       1         2       2  
 
Retail
                                 
   
Credit card
    9       8         26       25  
   
Retail leasing
    2       3         9       9  
   
Home equity and second mortgages
    2       5         9       12  
   
Other retail
    20       13         49       40  
           
     
Total retail
    33       29         93       86  
           
       
Total recoveries
    60       73         171       210  
Net Charge-offs
                                 
 
Commercial
                                 
   
Commercial
    18       7         36       30  
   
Lease financing
    3       16         17       35  
           
     
Total commercial
    21       23         53       65  
 
Commercial real estate
                                 
   
Commercial mortgages
          2         1       7  
   
Construction and development
          (2 )       1       (3 )
           
     
Total commercial real estate
                  2       4  
 
Residential mortgages
    11       9         29       26  
 
Retail
                                 
   
Credit card
    56       63         152       192  
   
Retail leasing
    4       5         10       18  
   
Home equity and second mortgages
    12       14         37       47  
   
Other retail
    31       42         92       120  
           
     
Total retail
    103       124         291       377  
           
       
Total net charge-offs
    135       156         375       472  
           
Provision for credit losses
    135       145         375       461  
Acquisitions and other changes
    5               5        
           
Balance at end of period
  $2,256     $2,258       $2,256     $2,258  
           
Components
                                 
 
Allowance for loan losses
  $2,034     $2,055                    
 
Liability for unfunded credit commitments
    222       203                    
                   
   
Total allowance for credit losses
  $2,256     $2,258                    
                   
Allowance for credit losses as a percentage of
                                 
 
Period-end loans
    1.56 %     1.65 %                  
 
Nonperforming loans
    476       413                    
 
Nonperforming assets
    392       351                    
 
Annualized net charge-offs
    421       365                    
       
    
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    Several factors were taken into consideration in evaluating the allowance for credit losses at September 30, 2006, including the risk profile of the portfolios and loan net charge-offs during the period, the level of nonperforming assets, accruing loans 90 days or more past due, delinquency ratios and changes in restructured loan balances compared with December 31, 2005. Management also considered the uncertainty related to certain industry sectors, including the airline industry, and the extent of credit exposure to other 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, and their relative credit risk were evaluated. Finally, the Company considered current economic conditions that might impact the portfolio.
Residual Risk Management The Company manages its risk to changes in the residual value of leased assets through disciplined residual valuation setting at the inception of a lease, diversification of its leased assets, regular residual asset valuation reviews and monitoring of residual value gains or losses upon the disposition of assets. As of September 30, 2006, no significant change in the amount of residuals or concentration of the portfolios has occurred since December 31, 2005. Refer to “Management’s Discussion and Analysis — Residual Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on residual risk management.
Operational Risk Management The Company manages operational risk through a risk management framework and its internal control processes. Within this framework, the Corporate Risk Committee (“Risk Committee”) provides oversight and assesses the most significant operational risks facing the Company within its business lines. Under the guidance of the Risk Committee, enterprise risk management personnel establish policies and interact with business lines to monitor significant operational risks on a regular basis. Business lines have direct and primary responsibility and accountability for identifying, controlling, and monitoring operational risks embedded in their business activities. Refer to “Management’s Discussion and Analysis — Operational Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on operational risk management.
Interest Rate Risk Management In the banking industry, changes in interest rates is a significant risk that can impact earnings, market valuations and safety and soundness of the entity. To minimize the volatility of net interest income and the market value of assets and liabilities, the Company manages its exposure to changes in interest rates through asset and liability management activities within guidelines established by its Asset Liability Policy Committee (“ALPC”) and approved by the Board of Directors. ALPC has the responsibility for approving and ensuring compliance with ALPC management policies, including interest rate risk exposure. The Company uses Net Interest Income Simulation Analysis and Market Value of Equity Modeling for measuring and analyzing consolidated interest rate risk.
Net Interest Income Simulation Analysis One of the primary tools used to measure interest rate risk and the effect of interest rate changes on net interest income is simulation analysis. Through this simulation, management estimates the impact on net interest income of a 200 basis point upward or downward gradual change of market interest rates over a one-year period. This represents a change, effective in the first quarter of 2006, from a previous policy of estimating the effect of a 300 basis point upward or downward gradual change on net interest income. The simulation also estimates the effect of immediate and sustained parallel shifts in the yield curve of 50 basis points as well as the effect of immediate and sustained flattening or steepening of the yield curve.
     Refer to “Management’s Discussion and Analysis — Net Interest Income Simulation Analysis” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on net interest income simulation analysis.
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Sensitivity of Net Interest Income:
                                                                   
    September 30, 2006     December 31, 2005
       
    Down 50   Up 50   Down 200   Up 200     Down 50   Up 50   Down 200   Up 200
    Immediate   Immediate   Gradual   Gradual     Immediate   Immediate   Gradual*   Gradual*
     
Net interest income
    1.14%       (1.10)%       2.35%       (2.85)%         .66%       (.73)%       1.19%       (2.60)%  
       
* As of January 31, 2006, due to the change to a 200 basis point gradual change policy during the first quarter of 2006.
     The table above summarizes the interest rate risk of net interest income based on forecasts over the succeeding 12 months. At September 30, 2006, 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. ALPC policy guidelines limit the estimated change in net interest income to 3.0 percent of forecasted net interest income over the succeeding 12 months. At September 30, 2006, and December 31, 2005, the Company was within its policy guidelines.
Market Value of Equity Modeling The Company also utilizes the market value of equity as a measurement tool in managing interest rate sensitivity. The market value of equity measures the degree to which the market values of the Company’s assets and liabilities and off-balance sheet instruments will change given a change in interest rates. ALPC 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 September 30, 2006. The up 200 basis point scenario resulted in a 5.4 percent decrease in the market value of equity at September 30, 2006, compared with a 6.8 percent decrease at December 31, 2005. The down 200 basis point scenario resulted in a 4.2 percent decrease in the market value of equity at September 30, 2006, compared with a 4.1 percent decrease at December 31, 2005. At September 30, 2006, and December 31, 2005, 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 1.8 years at September 30, 2006, compared with 1.6 years at December 31, 2005. The duration of liabilities was 2.0 years at September 30, 2006, compared with 1.6 years at December 31, 2005. At September 30, 2006, the duration of equity was ..9 years, compared with 1.8 years at December 31, 2005. 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, 2005, for further discussion on market value of equity modeling.
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, credit and foreign currency risks (“asset and liability management positions”) and to accommodate the business requirements of its customers (“customer-related positions”). Refer to “Management’s Discussion and Analysis — Use of Derivatives to Manage Interest Rate Risk” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on the use of derivatives to manage interest rate risk.
     By their nature, derivative instruments are subject to market risk. The Company does not utilize derivative instruments for speculative purposes. Of the Company’s $32.6 billion of total notional amount of asset and liability management derivative positions at September 30, 2006, $23.5 billion was designated as either fair value or cash flow hedges or net investment hedges of foreign operations. The cash flow hedge derivative positions are interest rate swaps that hedge the forecasted cash flows from the underlying variable-rate LIBOR loans and floating-rate debt. The fair value hedges are primarily interest rate swaps that hedge the change in fair value related to interest rate changes of underlying fixed-rate debt and subordinated obligations.
     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 $2.3 billion of forward commitments to sell mortgage loans and $1.6 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. Beginning in March 2006, the Company entered into U.S. Treasury futures and options on U.S. Treasury futures contracts to hedge the change in fair value related to the election of fair value measurement for its residential MSRs.
U.S. Bancorp 17


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     At September 30, 2006, the Company had $95 million in accumulated other comprehensive income related to realized and unrealized losses on derivatives classified as cash flow hedges. Unrealized gains and losses are reflected in earnings when the related cash flows or hedged transactions occur and offset the related performance of the hedged items. The estimated amount to be reclassified from accumulated other comprehensive income into earnings during the remainder of 2006 and the next 12 months is a loss of $7 million and $32 million, respectively.
     Gains or losses on customer-related derivative positions were not material for the third quarter and first nine months of 2006. The change in fair value of forward commitments attributed to hedge ineffectiveness recorded in noninterest income was a decrease of $2 million and $3 million for the third quarter and first nine months of 2006, respectively. The change in the fair value of all other asset and liability management derivative positions attributed to hedge ineffectiveness recorded in noninterest income was not material for the third quarter and first nine months of 2006.
     The Company enters 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 the third quarter and first nine months of 2006 was not material.
Table 9 Derivative Positions
                                                         
    September 30, 2006     December 31, 2005
       
        Weighted-         Weighted-
        Average         Average
        Remaining         Remaining
    Notional   Fair   Maturity     Notional   Fair   Maturity
(Dollars in Millions)   Amount   Value   In Years     Amount   Value   In Years
     
   
Asset and Liability Management Positions                                                  
   
 
Interest rate contracts
                                                 
   
Receive fixed/pay floating swaps
  $6,610     $13       22.36       $16,370     $(82 )     7.79  
   
Pay fixed/receive floating swaps
    11,998       4       2.42         9,163       139       1.33  
   
Futures and forwards
                                                 
     
Buy
    3             .11         104             .07  
     
Sell
    6,469       (49 )     .15         2,669       (15 )     .09  
   
Options
                                                 
     
Written
    7,007       7       .12         1,086       3       .08  
 
Foreign exchange contracts
                                                 
   
Cross-currency swaps
    403       27       8.87         387       11       9.61  
   
Forwards
    16             .07         404       7       .05  
 
Equity contracts
    74       4       3.38         42       3       3.29  
 
Credit default swaps
    25             4.98                      
   
Customer-related Positions                                                  
   
 
Interest rate contracts
                                                 
   
Receive fixed/pay floating swaps
  $10,499     $(47 )     5.33       $9,753     $(69 )     5.25  
   
Pay fixed/receive floating swaps
    10,468       104       5.42         9,707       121       5.25  
   
Options
                                                 
     
Purchased
    1,877       4       2.00         1,453       6       2.26  
     
Written
    1,865       (3 )     2.00         1,453       (5 )     2.26  
 
Risk participation agreements (a)
                                                 
   
Purchased
    177             7.05         143             8.02  
   
Written
    320       (1 )     6.26         169             4.64  
 
Foreign exchange rate contracts
                                                 
   
Forwards and swaps
                                                 
     
Buy
    1,954       47       .40         2,042       77       .43  
     
Sell
    1,918       (39 )     .41         2,018       (73 )     .46  
   
Options
                                                 
     
Purchased
    104       (1 )     .40         56       1       .24  
     
Written
    104       1       .40         56       (1 )     .24  
       
(a) At September 30, 2006, the credit equivalent amount was $2 million and $45 million, compared with $1 million and $18 million at December 31, 2005, for purchased and written risk participation agreements, respectively.
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Market Risk Management In 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 primarily residential mortgage related risks, but also other items, such as 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. Due to the election of fair value measurement of its residential MSRs and related hedging strategy in the first quarter of 2006, the Company increased its VaR limit to $40 million at March 31, 2006, compared with $20 million at December 31, 2005. The Company’s market valuation risk, as estimated by the VaR analysis, was $25 million at September 30, 2006, compared with $1 million at December 31, 2005. Refer to “Management’s Discussion and Analysis — Market Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on market risk management.
Liquidity Risk Management ALPC 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. 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. Refer to “Management’s Discussion and Analysis — Liquidity Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on liquidity risk management.
     The Company’s ability to raise negotiated funding at competitive prices is influenced by rating agencies’ views of the Company’s credit quality, liquidity, capital and earnings. On October 26, 2006, Dominion Bond Rating Service upgraded the Company’s senior and unsecured subordinated debt ratings to AA and AA(low), respectively, from AA(low) and A(high), respectively. On November 1, 2006, Standard & Poor’s Ratings Services changed its credit ratings outlook for the Company to “Positive”. At November 1, 2006, the credit ratings outlook for the Company was considered “Positive” by Fitch and “Stable” by Moody’s Investors Service and Dominion Bond Ratings Service.
     At September 30, 2006, parent company long-term debt outstanding was $13.9 billion, compared with $10.9 billion at December 31, 2005. The $3.0 billion increase was primarily due to the issuances of $2.5 billion of junior subordinated debentures and $4.0 billion of medium-term notes, offset by long-term debt maturities and repayments during the first nine months of 2006. As of September 30, 2006, there was no parent company debt scheduled to mature in the remainder of 2006.
     Federal banking laws regulate the amount of dividends that may be paid by banking subsidiaries without prior approval. The amount of dividends available to the parent company from its banking subsidiaries after meeting the regulatory capital requirements for well-capitalized banks was approximately $1.2 billion at September 30, 2006.
Off-Balance Sheet Arrangements Off-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.
     In the ordinary course of business, the Company enters into various forms of guarantees that may be considered off-balance sheet arrangements. The extent of these arrangements is provided in Note 10 of the Notes to Consolidated Financial Statements.
     Asset securitizations and conduits represent a source of funding for the Company through off-balance sheet structures. The Company sponsors an off-balance sheet conduit to which it transferred high-grade investment securities, funded by the issuance of commercial paper. The conduit held assets and related commercial paper liabilities of $2.7 billion at September 30, 2006, and $3.8 billion at December 31, 2005. The Company provides a liquidity facility to the conduit. A liability for the estimate of the potential risk of loss for the Company as the liquidity facility provider is recorded on the balance sheet in other liabilities and was $13 million at September 30, 2006, and $20 million at December 31, 2005. In addition, the Company recorded at fair value its retained residual interest in the investment securities conduit of $19 million at September 30, 2006, and $28 million at December 31, 2005.
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Table 10 Capital Ratios
                   
    September 30,   December 31,
(Dollars in Millions)   2006   2005
 
Tier 1 capital
  $17,042     $15,145  
 
As a percent of risk-weighted assets
    8.8 %     8.2 %
 
As a percent of adjusted quarterly average assets (leverage ratio)
    8.3 %     7.6 %
Total risk-based capital
  $25,011     $23,056  
 
As a percent of risk-weighted assets
    13.0 %     12.5 %
Tangible common equity
  $11,286     $11,873  
 
As a percent of tangible assets
    5.4 %     5.9 %
 
     The Company does not rely significantly on off-balance sheet arrangements for liquidity or capital resources. Refer to “Management’s Discussion and Analysis — Off-Balance Sheet Arrangements” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on off-balance sheet arrangements.
Capital Management The 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 its common shareholders through a combination of dividends and share repurchases. In the first nine months of 2006, the Company returned 120 percent of earnings. 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 $20.9 billion at September 30, 2006, compared with $20.1 billion at December 31, 2005. The increase was the result of corporate earnings and the issuance of $1.0 billion of non-cumulative, perpetual preferred stock on March 27, 2006, partially offset by share repurchases and dividends.
     Table 10 provides a summary of capital ratios as of September 30, 2006, and December 31, 2005. Tier 1 capital at September 30, 2006, was positively affected by the $1.0 billion issuance of preferred stock and the $2.5 billion issuance of junior subordinated debentures during the first nine months of 2006. All regulatory ratios continue to be in excess of regulatory “well-capitalized” requirements.
     On December 21, 2004, the Board of Directors approved and announced an authorization to repurchase 150 million shares of common stock during the next 24 months. During 2006, the Company repurchased 62 million shares under this authorization.
     On August 3, 2006, the Company announced that the Board of Directors approved an authorization to repurchase 150 million shares of common stock through December 31, 2008. This new authorization replaced the December 21, 2004, share repurchase program. The Company purchased 18 million shares under this authorization during the third quarter of 2006.
The following table provides a detailed analysis of all shares repurchased during the third quarter of 2006:
                           
    Total Number of       Maximum Number
    Shares Purchased as       of Shares that May
    Part of Publicly   Average   Yet Be Purchased
    Announced   Price Paid   Under the
Time Period   Programs   per Share   Programs
 
July 1 – July 31 (a)
    8,755,561     $31.80       24,097,204  
August 1 – August 31 (b)
    14,905,110       32.20       137,494,890  
September 1 – September 30 (c)
    5,773,647       33.01       131,721,243  
     
 
Total
    29,434,318     $32.24       131,721,243  
 
(a) All shares purchased during July of 2006 were purchased under the publicly announced December 21, 2004, authorization.
(b) During August of 2006, 2.4 million shares were purchased under the publicly announced December 21, 2004, authorization and 12.5 million shares were purchased under the publicly announced August 3, 2006, authorization.
(c) All shares purchased during September of 2006 were purchased under the publicly announced August 3, 2006, authorization.
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LINE OF BUSINESS FINANCIAL REVIEW
     Within the Company, financial performance is measured by major lines of business, which include Wholesale Banking, Consumer Banking, Wealth 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 Presentation Business 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. Refer to “Management’s Discussion and Analysis — Line of Business Financial Review” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on the business lines’ basis for financial presentation.
     Designations, assignments and allocations change from time to time as management systems are enhanced, methods of evaluating performance or product lines change or business segments are realigned to better respond to the Company’s diverse customer base. During 2006, certain organization and methodology changes were made and, accordingly, 2005 results were restated and presented on a comparable basis, including a change in the allocation of risk adjusted capital to the business lines. Business lines are allocated risk adjusted capital based upon economic capital requirements, regulatory capital requirements, goodwill and intangibles. The allocations to the business lines are equal to the capital that is held by the Company. The capital allocations include credit and operational capital allocations which are performed using a Basel II approach with adjustments for regulatory Tier I leverage requirements.
Wholesale Banking offers lending, depository, treasury management and other financial services to middle market, large corporate, commercial real estate, equipment finance, small-ticket leasing and public sector clients, along with lending guaranteed by the Small Business Administration. Wholesale Banking contributed $298 million of the Company’s net income in the third quarter and $907 million in the first nine months of 2006, or increases of $11 million and $41 million, respectively, compared with the same periods of 2005. The increases were primarily driven by growth in total net revenue.
     Total net revenue increased $15 million (2.2 percent) in the third quarter and $60 million (2.9 percent) in the first nine months of 2006, compared with the same periods of 2005. Net interest income, on a taxable-equivalent basis, increased $2 million in the third quarter and $40 million in the first nine months of 2006, compared with the same periods of 2005. The increases in net interest income were driven by growth in average loan balances and a wider spread on total deposits due to their funding benefit during a rising interest rate environment, partially offset by reduced loan spreads due to competitive pricing. The increase in average loans was due to stronger commercial loan and commercial real estate loan demand in the first nine months of 2006.
     Noninterest income increased $13 million (6.3 percent) and $20 million (3.1 percent) in the third quarter and first nine months of 2006, respectively, compared with the same periods of 2005. The third quarter 2006 increase from a year ago was due to higher revenue from equity investments. The increase during the first nine months of 2006 was related to higher commercial products revenue including improvement in equipment leasing, partially offset by lower other commercial loan fees and letter of credit fees.
     Noninterest expense was flat in the third quarter of 2006, compared with the third quarter of 2005. Noninterest expense increased $2 million (.3 percent) in the first nine months of 2006, compared with the same period of 2005. The increase was primarily driven by higher personnel-related costs.
     The provision for credit losses decreased $2 million in the third quarter and $7 million in the first nine months of 2006, compared with the same periods of 2005. The decrease in the provision for credit losses in the third quarter of 2006, was due to lower net charge-offs compared with the third quarter of 2005 caused by lower levels of nonperforming assets during this growth stage of the business cycle and strong credit underwriting. Nonperforming assets within Wholesale Banking were $213 million at September 30, 2006, $218 million at June 30, 2006, and $304 million at September 30, 2005. Nonperforming assets as a percentage of period-end loans were .42 percent at September 30, 2006, .43 percent at June 30, 2006, and ..62 percent at September 30, 2005. Refer to the “Corporate Risk Profile” section for further information on factors impacting the credit quality of the loan portfolios.
Consumer Banking delivers products and services through banking offices, telephone servicing and sales, on-line services, direct mail and ATMs. It encompasses community banking, metropolitan banking, in-store banking, small business banking, consumer lending, mortgage banking, consumer finance, workplace
U.S. Bancorp 21


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Table 11 Line of Business Financial Performance
                                                     
    Wholesale     Consumer
    Banking     Banking
           
            Percent         Percent
Three Months Ended September 30 (Dollars in Millions)   2006   2005   Change     2006   2005   Change
       
Condensed Income Statement
                                                 
Net interest income (taxable-equivalent basis)
  $478     $476       .4 %     $986     $965       2.2 %
Noninterest income
    219       206       6.3         458       488       (6.1 )
Securities gains (losses), net
                                     
                       
 
Total net revenue
    697       682       2.2         1,444       1,453       (.6 )
Noninterest expense
    224       224               623       622       .2  
Other intangibles
    4       4               12       63       (81.0 )
                       
 
Total noninterest expense
    228       228               635       685       (7.3 )
                       
Income before provision and income taxes
    469       454       3.3         809       768       5.3  
Provision for credit losses
    1       3       (66.7 )       59       65       (9.2 )
                       
Income before income taxes
    468       451       3.8         750       703       6.7  
Income taxes and taxable-equivalent adjustment
    170       164       3.7         273       256       6.6  
                       
Net income
  $298     $287       3.8       $477     $447       6.7  
                       
   
Average Balance Sheet Data
                                                 
Commercial
  $33,764     $31,643       6.7 %     $6,447     $6,283       2.6 %
Commercial real estate
    17,139       17,091       .3         10,805       10,385       4.0  
Residential mortgages
    61       68       (10.3 )       20,592       18,263       12.8  
Retail
    44       31       41.9         35,586       34,710       2.5  
                       
 
Total loans
    51,008       48,833       4.5         73,430       69,641       5.4  
Goodwill
    1,329       1,329               2,131       2,108       1.1  
Other intangible assets
    51       69       (26.1 )       1,490       1,193       24.9  
Assets
    56,359       53,809       4.7         82,164       78,059       5.3  
Noninterest-bearing deposits
    11,264       12,201       (7.7 )       12,663       13,319       (4.9 )
Interest checking
    3,737       2,847       31.3         17,437       17,333       .6  
Savings products
    5,481       5,181       5.8         20,591       23,809       (13.5 )
Time deposits
    12,022       14,080       (14.6 )       18,831       17,326       8.7  
                       
 
Total deposits
    32,504       34,309       (5.3 )       69,522       71,787       (3.2 )
Shareholders’ equity
    5,800       5,503       5.4         6,622       6,627       (.1 )
       
                                                     
    Wholesale     Consumer
    Banking     Banking
           
        Percent         Percent
Nine Months Ended September 30 (Dollars in Millions)   2006   2005   Change     2006   2005   Change
       
Condensed Income Statement
                                                 
Net interest income (taxable-equivalent basis)
  $1,440     $1,400       2.9 %     $2,903     $2,824       2.8 %
Noninterest income
    668       654       2.1         1,306       1,361       (4.0 )
Securities gains (losses), net
    2       (4 )     *                      
                       
 
Total net revenue
    2,110       2,050       2.9         4,209       4,185       .6  
Noninterest expense
    678       676       .3         1,827       1,809       1.0  
Other intangibles
    12       12               37       189       (80.4 )
                       
 
Total noninterest expense
    690       688       .3         1,864       1,998       (6.7 )
                       
Income before provision and income taxes
    1,420       1,362       4.3         2,345       2,187       7.2  
Provision for credit losses
    (6 )     1       *         176       202       (12.9 )
                       
Income before income taxes
    1,426       1,361       4.8         2,169       1,985       9.3  
Income taxes and taxable-equivalent adjustment
    519       495       4.8         790       723       9.3  
                       
Net income
  $907     $866       4.7       $1,379     $1,262       9.3  
                       
   
Average Balance Sheet Data
                                                 
Commercial
  $33,164     $31,020       6.9 %     $6,381     $6,104       4.5 %
Commercial real estate
    17,262       16,779       2.9         10,691       10,252       4.3  
Residential mortgages
    61       62       (1.6 )       20,478       16,808       21.8  
Retail
    43       36       19.4         35,247       33,859       4.1  
                       
 
Total loans
    50,530       47,897       5.5         72,797       67,023       8.6  
Goodwill
    1,329       1,329               2,115       2,109       .3  
Other intangible assets
    55       73       (24.7 )       1,425       1,159       23.0  
Assets
    56,032       53,068       5.6         81,003       74,868       8.2  
Noninterest-bearing deposits
    11,784       12,144       (3.0 )       12,686       13,067       (2.9 )
Interest checking
    3,346       3,216       4.0         17,614       17,236       2.2  
Savings products
    5,449       5,308       2.7         21,425       24,587       (12.9 )
Time deposits
    12,470       12,575       (.8 )       18,471       16,865       9.5  
                       
 
Total deposits
    33,049       33,243       (.6 )       70,196       71,755       (2.2 )
Shareholders’ equity
    5,689       5,424       4.9         6,509       6,486       .4  
       
* Not meaningful
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Wealth     Payment         Treasury and     Consolidated    
Management     Services         Corporate Support     Company    
       
    Percent         Percent         Percent         Percent    
2006   2005   Change     2006   2005   Change     2006   2005   Change     2006   2005   Change    
                   
       
$127     $111       14.4 %     $164     $154       6.5 %     $(82 )   $85       * %     $1,673     $1,791       (6.6 )%    
  354       301       17.6         672       579       16.1         45       1       *         1,748       1,575       11.0      
                                                1       *               1       *      
                                               
  481       412       16.7         836       733       14.1         (37 )     87       *         3,421       3,367       1.6      
  230       205       12.2         313       274       14.2         59       23       *         1,449       1,348       7.5      
  20       15       33.3         53       45       17.8               (2 )     *         89       125       (28.8 )    
                                               
  250       220       13.6         366       319       14.7         59       21       *         1,538       1,473       4.4      
                                               
  231       192       20.3         470       414       13.5         (96 )     66       *         1,883       1,894       (.6 )    
                      74       88       (15.9 )       1       (11 )     *         135       145       (6.9 )    
                                               
  231       192       20.3         396       326       21.5         (97 )     77       *         1,748       1,749       (.1 )    
  84       70       20.0         144       119       21.0         (126 )     (14 )     *         545       595       (8.4 )    
                                               
$147     $122       20.5       $252     $207       21.7       $29     $91       (68.1 )     $1,203     $1,154       4.2      
                                               
       
$1,847     $1,588       16.3 %     $3,880     $3,570       8.7 %     $130     $167       (22.2 )%     $46,068     $43,251       6.5 %    
  695       631       10.1                             62       86       (27.9 )       28,701       28,193       1.8      
  460       405       13.6                             5       5               21,118       18,741       12.7      
  2,408       2,315       4.0         8,927       7,993       11.7         42       49       (14.3 )       47,007       45,098       4.2      
                                               
  5,410       4,939       9.5         12,807       11,563       10.8         239       307       (22.1 )       142,894       135,283       5.6      
  1,379       874       57.8         2,477       2,061       20.2         1             *         7,317       6,372       14.8      
  452       301       50.2         1,157       1,002       15.5               2       *         3,150       2,567       22.7      
  7,808       6,640       17.6         17,850       15,475       15.3         49,908       51,684       (3.4 )       214,089       205,667       4.1      
  4,020       3,735       7.6         334       163       *         (61 )     16       *         28,220       29,434       (4.1 )    
  2,418       2,325       4.0                             3       3               23,595       22,508       4.8      
  5,595       5,491       1.9         20       17       17.6         27       19       42.1         31,714       34,517       (8.1 )    
  3,249       1,656       96.2         3       7       (57.1 )       2,341       1,456       60.8         36,446       34,525       5.6      
                                               
  15,282       13,207       15.7         357       187       90.9         2,310       1,494       54.6         119,975       120,984       (.8 )    
  2,337       1,654       41.3         4,782       4,063       17.7         1,376       2,259       (39.1 )       20,917       20,106       4.0      
                   
                                                                                                       
Wealth     Payment         Treasury and     Consolidated    
Management     Services         Corporate Support     Company    
       
    Percent         Percent         Percent         Percent    
2006   2005   Change     2006   2005   Change     2006   2005   Change     2006   2005   Change    
                   
       
$379     $316       19.9 %     $483     $435       11.0 %     $(110 )   $328       * %     $5,095     $5,303       (3.9 )%    
  1,073       897       19.6         1,916       1,610       19.0         151       34       *         5,114       4,556       12.2      
                                          1       (53 )     *         3       (57 )     *      
                                               
  1,452       1,213       19.7         2,399       2,045       17.3         42       309       (86.4 )       10,212       9,802       4.2      
  705       616       14.4         908       768       18.2         187       153       22.2         4,305       4,022       7.0      
  64       46       39.1         150       129       16.3               1       *         263       377       (30.2 )    
                                               
  769       662       16.2         1,058       897       17.9         187       154       21.4         4,568       4,399       3.8      
                                               
  683       551       24.0         1,341       1,148       16.8         (145 )     155       *         5,644       5,403       4.5      
  2       2               199       269       (26.0 )       4       (13 )     *         375       461       (18.7 )    
                                               
  681       549       24.0         1,142       879       29.9         (149 )     168       *         5,269       4,942       6.6      
  248       200       24.0         416       320       30.0         (261 )     (142 )     (83.8 )       1,712       1,596       7.3      
                                               
$433     $349       24.1       $726     $559       29.9       $112     $310       (63.9 )     $3,557     $3,346       6.3      
                                               
       
$1,624     $1,576       3.0 %     $3,726     $3,401       9.6 %     $134     $162       (17.3 )%     $45,029     $42,263       6.5 %    
  688       641       7.3                             63       90       (30.0 )       28,704       27,762       3.4      
  449       389       15.4                             4       7       (42.9 )       20,992       17,266       21.6      
  2,411       2,302       4.7         8,589       7,895       8.8         44       49       (10.2 )       46,334       44,141       5.0      
                                               
  5,172       4,908       5.4         12,315       11,296       9.0         245       308       (20.5 )       141,059       131,432       7.3      
  1,377       874       57.6         2,410       2,010       19.9         1             *         7,232       6,322       14.4      
  474       316       50.0         1,125       960       17.2               6       *         3,079       2,514       22.5      
  7,589       6,642       14.3         17,210       15,038       14.4         50,354       51,889       (3.0 )       212,188       201,505       5.3      
  3,778       3,601       4.9         308       146       *         110       45       *         28,666       29,003       (1.2 )    
  2,395       2,432       (1.5 )                           3       7       (57.1 )       23,358       22,891       2.0      
  5,565       5,466       1.8         19       15       26.7         31       17       82.4         32,489       35,393       (8.2 )    
  2,730       1,234       *         3       3               2,269       2,588       (12.3 )       35,943       33,265       8.1      
                                               
  14,468       12,733       13.6         330       164       *         2,413       2,657       (9.2 )       120,456       120,552       (.1 )    
  2,337       1,666       40.3         4,620       3,971       16.3         1,388       2,364       (41.3 )       20,543       19,911       3.2      
                   
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banking, student banking and 24-hour banking. Consumer Banking contributed $477 million of the Company’s net income in the third quarter and $1,379 million in the first nine months of 2006, or increases of $30 million and $117 million, respectively, compared with the same periods of 2005. While the retail banking business grew net income 7.5 percent in the third quarter and 10.4 percent in the first nine months of 2006, the contribution of the mortgage banking business decreased 2.9 percent and 4.3 percent, respectively, compared with the same periods of 2005.
     Total net revenue decreased $9 million (.6 percent) in the third quarter and increased $24 million (.6 percent) in the first nine months of 2006, compared with the same periods of 2005. Net interest income, on a taxable-equivalent basis, increased $21 million in the third quarter and $79 million in the first nine months of 2006, compared with the same periods of 2005. The year-over-year increases in net interest income were due to strong growth in average loans and the funding benefit of total deposits due to rising interest rates. Partially offsetting these increases were reduced spreads on commercial and retail loans due to competitive pricing. The increases in average loan balances reflected growth in residential mortgages, retail loans, commercial loans and commercial real estate loans. Residential mortgages, which include traditional residential mortgages, grew 12.8 percent in the third quarter and 21.8 percent in the first nine months of 2006, compared with the same periods of a year ago. Residential mortgage balances increased throughout 2005, reflecting the Company’s retention of adjustable-rate residential mortgages. However, during the first nine months of 2006, residential mortgage balances have increased only slightly and are expected to remain essentially flat in future periods due to the Company’s decision in the first quarter of 2006 to package and sell the majority of its residential mortgage loan production in the secondary markets. The growth in retail loans was principally driven by an increase in installment loans which increased 10.1 percent in the third quarter and 13.6 percent in the first nine months of 2006, over the same periods of 2005. The year-over-year decreases in average deposits were primarily due to a reduction in savings and noninterest-bearing deposit products, offset by growth in interest checking and time deposits. Average time deposit balances grew $1.5 billion in the third quarter and $1.6 billion in the first nine months of 2006, compared with the same periods of 2005, as a portion of noninterest-bearing and money market balances migrated to fixed-rate time deposit products. Average savings balances declined $3.2 billion (13.5 percent) and $3.2 billion (12.9 percent) in the third quarter and first nine months of 2006, respectively, compared with the same periods of 2005, principally related to money market accounts.
     Fee-based noninterest income decreased $30 million in the third quarter and $55 million in the first nine months of 2006, compared with the same periods of 2005. The year-over-year decline in fee-based revenue was driven by a reduction in mortgage banking revenue, partially offset by an increase in deposit service charges due to increased transaction-related fees and net new checking accounts. The reduction in mortgage banking revenue principally reflected the adoption of fair value accounting for MSRs as of January 1, 2006.
     Noninterest expense decreased $50 million (7.3 percent) in the third quarter and $134 million (6.7 percent) in the first nine months of 2006, compared with the same periods of 2005. The decreases were primarily attributable to the elimination of MSR amortization under SFAS 156 which resulted in a reduction of other intangible expense. Partially offsetting this decrease were increases in compensation and employee benefit expenses. The increases in compensation and employee benefit expenses reflected the impact of the net addition of 33 in-store and 33 traditional branches at September 30, 2006, compared with September 30, 2005.
     The provision for credit losses decreased $6 million and $26 million in the third quarter and first nine months of 2006, respectively, compared with the same periods of 2005. The improvements were attributable to lower net charge-offs. As a percentage of average loans outstanding, net charge-offs declined to .32 percent in the third quarter of 2006, compared with .37 percent in the third quarter of 2005. The decline in net charge-offs included both the commercial and retail loan portfolios. Commercial and commercial real estate loan net charge-offs declined $2 million in the third quarter of 2006, compared with the third quarter of 2005. Retail loan and residential mortgage net charge-offs declined by $4 million in the third quarter of 2006, compared with the third quarter of 2005, primarily due to lower bankruptcy losses and slightly higher retail recoveries. Nonperforming assets within Consumer Banking were $305 million at September 30, 2006, $275 million at June 30, 2006, and $302 million at September 30, 2005. Nonperforming assets as a percentage of period-end loans were ..43 percent at September 30, 2006, .39 percent at June 30, 2006, and .45 percent at September 30, 2005. Refer to the “Corporate Risk Profile” section for further information on factors impacting the credit quality of the loan portfolios.
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Wealth Management provides trust, private banking, financial advisory, investment management, retail brokerage services, insurance, custody and mutual fund servicing through six businesses: Private Client Group, Corporate Trust, U.S. Bancorp Investments and Insurance, FAF Advisors, Institutional Trust and Custody and Fund Services. Wealth Management contributed $147 million of the Company’s net income in the third quarter and $433 million in the first nine months of 2006, or increases of $25 million and $84 million, respectively, compared with the same periods of 2005. The growth was primarily attributable to higher total net revenue, partially offset by an increase in noninterest expense.
     Total net revenue increased $69 million (16.7 percent) in the third quarter and $239 million (19.7 percent) in the first nine months of 2006, compared with the same periods of 2005. Net interest income, on a taxable-equivalent basis, increased $16 million in the third quarter and $63 million in the first nine months of 2006, compared with the same periods of 2005. The increases in net interest income were due to growth in total average deposits and the favorable impact of rising interest rates on the funding benefit of customer deposits, partially offset by a decline in loan spreads. The increase in total deposits was attributable to growth in noninterest-bearing deposits and time deposits principally in Corporate Trust. Noninterest income increased $53 million in the third quarter and $176 million in the first nine months of 2006, compared with the same periods of 2005, driven by account growth, favorable equity market conditions and the acquisition of a corporate and institutional trust business in late 2005.
     Noninterest expense increased $30 million (13.6 percent) in the third quarter and $107 million (16.2 percent) in the first nine months of 2006, compared with the same periods of 2005. The increases in noninterest expense were primarily attributable to the acquisition of the corporate and institutional trust business.
Payment Services includes consumer and business credit cards, stored-value cards, debit cards, corporate and purchasing card services, consumer lines of credit, ATM processing and merchant processing. Payment Services contributed $252 million of the Company’s net income in the third quarter and $726 million in the first nine months of 2006, or increases of $45 million and $167 million, respectively, compared with the same periods of 2005. The increases were due to growth in total net revenue driven by higher transaction volumes and a lower provision for credit losses, partially offset by increases in total noninterest expense.
     Total net revenue increased $103 million (14.1 percent) in the third quarter and $354 million (17.3 percent) in the first nine months of 2006, compared with the same periods of 2005. Net interest income increased $10 million in the third quarter and $48 million in the first nine months of 2006, compared with the same periods of 2005. The increases were primarily due to growth in higher yielding retail loan balances, partially offset by an increase in non-earning assets resulting in higher funding expense. Noninterest income increased $93 million in the third quarter and $306 million in the first nine months of 2006, compared with the same periods of 2005. The increases in fee-based revenue were driven by strong growth in credit and debit card revenue, corporate payment products revenue and merchant processing revenue. Credit and debit card revenue increased due to higher customer transaction volume. Corporate payment products revenue reflected organic growth in sales volumes and card usage as well as the acquisition of a freight payments company in July of 2006. Merchant processing revenue also grew from a year ago due to an increase in sales volume driven by acquisitions, higher same store sales and equipment fees. Noninterest income for the first nine months of 2006 also included the impact of a $10 million settlement in the first quarter.
     Noninterest expense increased $47 million (14.7 percent) in the third quarter and $161 million (17.9 percent) in the first nine months of 2006, compared with the same periods of 2005. The increases in noninterest expense were primarily attributable to the acquisition of merchant acquiring and corporate payments businesses, higher compensation and employee benefit costs for processing associated with increased credit and debit card transaction volumes, higher corporate payment products and merchant processing sales volumes, and higher ATM processing services volumes.
     The provision for credit losses decreased $14 million (15.9 percent) in the third quarter and $70 million (26.0 percent) in the first nine months of 2006, compared with the same periods of 2005, due to lower net charge-offs. As a percentage of average loans outstanding, net charge-offs were 2.29 percent in the third quarter of 2006, compared with 3.02 percent in the third quarter of 2005. The favorable change in credit losses reflected the near-term impact of changes in bankruptcy legislation in the fourth quarter of 2005.
Treasury 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
U.S. Bancorp 25


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average balances and the residual aggregate of those expenses associated with corporate activities that are managed on a consolidated basis. In addition, prior to the adoption of SFAS 156, changes in MSR valuations due to interest rate changes were managed at a corporate level and, as such, reported within this business unit. Treasury and Corporate Support recorded net income of $29 million in the third quarter and $112 million in the first nine months of 2006, or decreases of $62 million and $198 million, respectively, compared with the same periods of 2005.
     Total net revenue decreased $124 million in the third quarter and $267 million in the first nine months of 2006, compared with the same periods of 2005. The year-over-year decreases in total net revenue were primarily due to unfavorable variances in net interest income, partially offset by higher noninterest income. The decrease in net interest income reflected the impact of a flatter yield curve and asset/liability management decisions, including reducing the investment securities portfolio, changes in interest rate derivative positions and the issuance of wholesale funding. Noninterest income increased $43 million in the third quarter and $171 million in the first nine months of 2006, compared with the same periods of 2005. The increase in noninterest income in the third quarter and first nine months of 2006 was driven by a gain on the sale of equity interests in a card association. The increase during the first nine months of 2006 was also due to trading income from derivatives, a gain from the initial public offering of a card association realized in the second quarter of 2006 and securities losses incurred in the first nine months of 2005.
     Noninterest expense increased $38 million in the third quarter and $33 million in the first nine months of 2006, compared with the same periods of 2005. The increases in noninterest expense were driven by higher business integration costs related to recent acquisitions and amortization of community development investments.
     The provision for credit losses for this business unit represents the residual aggregate of the net credit losses allocated to the reportable business units and the Company’s recorded provision determined in accordance with accounting principles generally accepted in the United States. Refer to the “Corporate Risk Profile” section for further information on the provision for credit losses, nonperforming assets and factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.
     Income taxes are assessed to each line of business at a managerial tax rate of 36.4 percent with the residual tax expense or benefit to arrive at the consolidated effective tax rate included in Treasury and Corporate Support. The consolidated effective tax rate of the Company was 30.7 percent and 32.1 percent in the third quarter and first nine months of 2006, respectively, compared with 33.7 percent and 32.0 percent in the same periods of 2005, respectively. The effective rate for the third quarter of 2006 reflected an expected increase in income tax credits from tax-advantaged investments through the remainder of the year.
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. Those policies considered to be critical accounting policies relate to the allowance for credit losses, MSRs, goodwill and other intangibles and income taxes. Management has discussed the development and the selection of critical accounting policies with the Company’s Audit Committee. These accounting policies are discussed in detail in “Management’s Discussion and Analysis — Critical Accounting Policies” and the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. Refer to Note 2 of the Notes to Consolidated Financial Statements for discussion of the change in accounting for MSRs implemented in the first quarter of 2006.
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”)).
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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.
     During the most recently completed fiscal quarter, there was no change made in the Company’s internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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U.S. Bancorp
Consolidated Balance Sheet
                       
    September 30,   December 31,
(Dollars in Millions)   2006   2005
 
    (Unaudited)    
Assets
               
Cash and due from banks
  $6,355     $8,004  
Investment securities
               
 
Held-to-maturity (fair value $97 and $113, respectively)
    91       109  
 
Available-for-sale
    39,429       39,659  
Loans held for sale
    2,649       1,686  
Loans
               
 
Commercial
    46,594       42,942  
 
Commercial real estate
    28,973       28,463  
 
Residential mortgages
    21,215       20,730  
 
Retail
    47,626       45,671  
     
   
Total loans
    144,408       137,806  
     
Less allowance for loan losses
    (2,034 )     (2,041 )
     
     
Net loans
    142,374       135,765  
Premises and equipment
    1,835       1,841  
Goodwill
    7,444       7,005  
Other intangible assets
    3,171       2,874  
Other assets
    13,507       12,522  
     
   
Total assets
  $216,855     $209,465  
     
Liabilities and Shareholders’ Equity
               
Deposits
               
 
Noninterest-bearing
  $30,554     $32,214  
 
Interest-bearing
    69,095       70,024  
 
Time deposits greater than $100,000
    21,312       22,471  
     
   
Total deposits
    120,961       124,709  
Short-term borrowings
    24,783       20,200  
Long-term debt
    41,230       37,069  
Other liabilities
    8,955       7,401  
     
   
Total liabilities
    195,929       189,379  
Shareholders’ equity
               
 
Preferred stock, par value $1.00 a share (liquidation preference of $25,000 per share) authorized: 50,000,000 shares; issued and outstanding: 9/30/06 — 40,000 shares
    1,000        
 
Common stock, par value $0.01 a share — authorized: 4,000,000,000 shares; issued: 9/30/06 and 12/31/05 — 1,972,643,007 shares
    20       20  
 
Capital surplus
    5,770       5,907  
 
Retained earnings
    20,770       19,001  
 
Less cost of common stock in treasury: 9/30/06 — 209,488,841 shares; 12/31/05 — 157,689,004 shares
    (6,093 )     (4,413 )
 
Other comprehensive income
    (541 )     (429 )
     
   
Total shareholders’ equity
    20,926       20,086  
     
   
Total liabilities and shareholders’ equity
  $216,855     $209,465  
 
See Notes to Consolidated Financial Statements.
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U.S. Bancorp
Consolidated Statement of Income
                                     
    Three Months Ended     Nine Months Ended
    September 30,     September 30,
(Dollars and Shares in Millions, Except Per Share Data)      
(Unaudited)   2006   2005     2006   2005
       
Interest Income
                                 
Loans
  $2,569     $2,167       $7,350     $6,105  
Loans held for sale
    40       30         99       75  
Investment securities
    500       492         1,490       1,454  
Other interest income
    40       29         119       84  
           
 
Total interest income
    3,149       2,718         9,058       7,718  
Interest Expense
                                 
Deposits
    640       414         1,721       1,083  
Short-term borrowings
    321       205         861       460  
Long-term debt
    528       317         1,415       895  
           
 
Total interest expense
    1,489       936         3,997       2,438  
           
Net interest income
    1,660       1,782         5,061       5,280  
Provision for credit losses
    135       145         375       461  
           
Net interest income after provision for credit losses
    1,525       1,637         4,686       4,819  
Noninterest Income
                                 
Credit and debit card revenue
    206       185         590       516  
Corporate payment products revenue
    150       135         416       362  
ATM processing services
    63       64         183       168  
Merchant processing services
    253       200         719       576  
Trust and investment management fees
    305       251         916       751  
Deposit service charges
    268       246         764       690  
Treasury management fees
    111       109         334       333  
Commercial products revenue
    100       103         311       299  
Mortgage banking revenue
    68       111         167       323  
Investment products fees and commissions
    34       37         114       115  
Securities gains (losses), net
          1         3       (57 )
Other
    190       134         600       423  
           
 
Total noninterest income
    1,748       1,576         5,117       4,499  
Noninterest Expense
                                 
Compensation
    632       603         1,892       1,782  
Employee benefits
    123       106         379       330  
Net occupancy and equipment
    168       162         494       475  
Professional services
    54       44         130       119  
Marketing and business development
    58       61         156       171  
Technology and communications
    128       118         372       337  
Postage, printing and supplies
    66       64         198       190  
Other intangibles
    89       125         263       377  
Debt prepayment
                  11       54  
Other
    220       190         673       564  
           
 
Total noninterest expense
    1,538       1,473         4,568       4,399  
           
Income before income taxes
    1,735       1,740         5,235       4,919  
Applicable income taxes
    532       586         1,678       1,573  
           
Net income
  $1,203     $1,154       $3,557     $3,346  
           
Net income applicable to common equity
  $1,187     $1,154       $3,524     $3,346  
           
Earnings per common share
  $.67     $.63       $1.98     $1.82  
Diluted earnings per common share
  $.66     $.62       $1.95     $1.80  
Dividends declared per common share
  $.33     $.30       $.99     $.90  
Average common shares outstanding
    1,771       1,823         1,784       1,836  
Average diluted common shares outstanding
    1,796       1,849         1,809       1,862  
       
See Notes to Consolidated Financial Statements.
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U.S. Bancorp
Consolidated Statement of Shareholders’ Equity
                                                                     
                            Other   Total
(Dollars and Shares in Millions)   Common Shares   Preferred   Common   Capital   Retained   Treasury   Comprehensive   Shareholders’
(Unaudited)   Outstanding   Stock   Stock   Surplus   Earnings   Stock   Income   Equity
 
Balance December 31, 2004
    1,858     $—     $20     $5,902     $16,758     $(3,125 )   $(16 )   $19,539  
Net income
                                    3,346                       3,346  
Unrealized loss on securities available for sale
                                                    (211 )     (211 )
Unrealized loss on derivatives
                                                    (30 )     (30 )
Foreign currency translation adjustment
                                                    8       8  
Realized loss on derivatives
                                                    (197 )     (197 )
Reclassification adjustment for losses realized in net income
                                                    120       120  
Income taxes
                                                    118       118  
                                                 
   
Total comprehensive income
                                                            3,154  
Cash dividends declared on common stock
                                    (1,647 )                     (1,647 )
Issuance of common and treasury stock
    13                       (62 )             360               298  
Purchase of treasury stock
    (53 )                                     (1,549 )             (1,549 )
Stock option and restricted stock grants
                            72                               72  
Shares reserved to meet deferred compensation obligations
                            1               (4 )             (3 )
     
Balance September 30, 2005
    1,818     $—     $20     $5,913     $18,457     $(4,318 )   $(208 )   $19,864  
 
Balance December 31, 2005
    1,815     $—     $20     $5,907     $19,001     $(4,413 )   $(429 )   $20,086  
Change in accounting principle
                                    4                       4  
Net income
                                    3,557                       3,557  
Unrealized loss on securities available for sale
                                                    (52 )     (52 )
Unrealized gain on derivatives
                                                    39       39  
Foreign currency translation adjustment
                                                    5       5  
Realized loss on derivatives
                                                    (199 )     (199 )
Reclassification adjustment for losses realized in net income
                                                    28       28  
Income taxes
                                                    67       67  
                                                 
   
Total comprehensive income
                                                            3,445  
Cash dividends declared:
                                                               
 
Preferred
                                    (33 )                     (33 )
 
Common
                                    (1,759 )                     (1,759 )
Issuance of common and treasury stock
    28                       (95 )             812               717  
Purchase of treasury stock
    (80 )                                     (2,488 )             (2,488 )
Stock option and restricted stock grants
                            9                               9  
Shares reserved to meet deferred compensation obligations
                            1               (4 )             (3 )
Issuance of preferred stock
            1,000               (52 )                             948  
     
Balance September 30, 2006
    1,763     $1,000     $20     $5,770     $20,770     $(6,093 )   $(541 )   $20,926  
 
See Notes to Consolidated Financial Statements.
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U.S. Bancorp
Consolidated Statement of Cash Flows
                   
            Nine Months Ended
            September 30,
     
(Dollars in Millions)        
(Unaudited)   2006   2005
 
Operating Activities
               
 
Net cash provided by operating activities
    $4,512       $2,899  
Investing Activities
               
Proceeds from sales of available-for-sale investment securities
    1,132       3,065  
Proceeds from maturities of investment securities
    3,174       8,072  
Purchases of investment securities
    (5,094 )     (10,430 )
Net (increase) decrease in loans outstanding
    (5,455 )     (8,940 )
Proceeds from sales of loans
    1,394       1,150  
Purchases of loans
    (2,171 )     (2,581 )
Acquisitions, net of cash acquired
    (587 )     (279 )
Other, net
    (305 )     (1,216 )
     
 
Net cash used in investing activities
    (7,912 )     (11,159 )
Financing Activities
               
Net increase (decrease) in deposits
    (4,313 )     54  
Net increase (decrease) in short-term borrowings
    4,462       9,977  
Principal payments or redemption of long-term debt
    (9,103 )     (9,248 )
Proceeds from issuance of long-term debt
    13,379       11,002  
Proceeds from issuance of preferred stock
    948        
Proceeds from issuance of common stock
    613       246  
Repurchase of common stock
    (2,480 )     (1,605 )
Cash dividends paid on preferred stock
    (17 )      
Cash dividends paid on common stock
    (1,777 )     (1,660 )
     
 
Net cash provided by financing activities
    1,712       8,766  
     
 
Change in cash and cash equivalents
    (1,688 )     506  
Cash and cash equivalents at beginning of period
    8,202       6,537  
     
 
Cash and cash equivalents at end of period
    $6,514       $7,043  
 
See Notes to Consolidated Financial Statements.
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Notes to Consolidated Financial Statements
(Unaudited)
Note 1 Basis of Presentation
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 notes 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. For further information, refer to the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. Certain amounts in prior periods have been reclassified to conform to the current presentation.
     Accounting policies for the lines of business are generally 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. Table 11 “Line of Business Financial Performance” provides details of segment results. This information is incorporated by reference into these Notes to Consolidated Financial Statements.
Note 2 Accounting Changes
Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 158 (“SFAS 158”), “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R)”, effective for the Company for the year ending December 31, 2006. This statement requires the recognition of the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability on the balance sheet, and recognition of changes in that funded status in the year in which the changes occur through other comprehensive income. The adoption of SFAS 158 is not expected to have a material impact on the Company’s financial statements.
Fair Value Measurements In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (“SFAS 157”), “Fair Value Measurements”, effective for the Company beginning on January 1, 2008, with earlier adoption permitted. This Statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This statement establishes a fair value hierarchy that distinguishes between valuations obtained from sources independent of the entity and those from the entity’s own unobservable inputs that are not corroborated by observable market data. SFAS 157 expands disclosures about the use of fair value to measure assets and liabilities in interim and annual periods subsequent to initial recognition. The disclosures focus on the inputs used to measure fair value and for recurring fair value measurements using significant unobservable inputs, the effect of the measurements on earnings or changes in net assets for the period. This statement encourages an entity to combine the fair value information disclosed under this statement with the fair value information disclosed under other accounting pronouncements, including SFAS 107, “Disclosures about Fair Value of Financial Instruments”, where practicable. The Company is currently assessing the impact of this guidance on its financial statements.
Accounting for Uncertainty in Income Taxes In June 2006, the FASB issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes,” effective for the Company beginning on January 1, 2007. FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company is currently assessing the impact of this guidance on its financial statements.
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Accounting for Servicing of Financial Assets In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156, “Accounting for Servicing of Financial Assets” (“SFAS 156”), that amends accounting and reporting standards for servicing assets and liabilities under Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. Specifically, SFAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. For subsequent measurement purposes, SFAS 156 permits an entity to choose to measure servicing assets and liabilities either based on fair value or lower of cost or market (“LOCOM”). The Company elected to adopt SFAS 156 effective January 1, 2006, utilizing the fair value measurement option for residential mortgage servicing rights (“MSRs”) and continuing the LOCOM method for all other servicing assets and liabilities. Adopting the fair value measurement method resulted in the Company recording a cumulative-effect accounting adjustment to increase beginning retained earnings by $4 million (net of tax). Approximately $3 million represented the difference between the fair value and the carrying amount of the Company’s MSRs as of January 1, 2006, and the additional $1 million represented the reclassification of unrealized gains in accumulated other comprehensive income at adoption, for certain available-for-sale securities reclassified to trading securities upon the adoption of the provisions of this statement. Additional information regarding MSRs is disclosed in Note 5 in the Notes to Consolidated Financial Statements.
Other-Than-Temporary Impairment In November 2005, the FASB issued FASB Staff Position FAS 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP 115-1”), effective for the Company beginning on January 1, 2006. FSP 115-1 provides clarification on when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. FSP 115-1 also requires certain disclosures for unrealized losses that have not been recognized as other-than-temporary impairments. The adoption of FSP 115-1 did not have a material impact on the Company’s financial statements.
Stock-Based Compensation In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004) (“SFAS 123R”), “Share-Based Payment”, a revision of Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation.” SFAS 123R requires companies to measure the cost of employee services in exchange for an award of equity instruments based on the grant-date fair value of the award. This statement eliminates the use of the alternative intrinsic value method of accounting that was allowed when SFAS 123 was originally issued. The provisions of this statement were effective for the Company beginning on January 1, 2006. The Company adopted SFAS 123R using the modified retrospective method. Because the Company retroactively adopted the fair value method in 2003, the impact of expensing stock-based awards was already recorded in the Company’s financial results. In conjunction with the adoption of SFAS 123R, the Company recognized $13 million of incremental stock-based compensation expense due to certain provisions that require immediate recognition of the value of stock awards to employees that meet retirement status, despite their continued active employment. Upon adoption, the Company also changed its method of expensing all new awards from an accelerated to a straight-line attribution method. This methodology change for expensing stock awards is expected to reduce expenses in 2006 by approximately $33 million ($20 million after tax).
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Note 3 Investment Securities
The detail of the amortized cost, gross unrealized holding gains and losses, and fair value of held-to-maturity and available-for-sale securities was as follows:
                                                                       
    September 30, 2006     December 31, 2005
       
    Amortized   Unrealized   Unrealized   Fair     Amortized   Unrealized   Unrealized   Fair
(Dollars in Millions)   Cost   Gains   Losses   Value     Cost   Gains   Losses   Value
       
Held-to-maturity (a)
                                                                 
 
Mortgage-backed securities
  $7     $—     $—     $7       $8     $—     $—     $8  
 
Obligations of state and political subdivisions
    71       6             77         84       5       (1 )     88  
 
Other debt securities
    13                   13         17                   17  
           
   
Total held-to-maturity securities
  $91     $6     $—     $97       $109     $5     $(1 )   $113  
       
Available-for-sale (b)
                                                                 
 
U.S. Treasury and agencies
  $455     $1     $(7 )   $449       $496     $2     $(9 )   $489  
 
Mortgage-backed securities
    34,978       84       (855 )     34,207         38,161       86       (733 )     37,514  
 
Asset-backed securities
    7                   7         12                   12  
 
Obligations of state and political subdivisions
    3,695       63             3,758         640       3       (6 )     637  
 
Other securities and investments
    1,004       9       (5 )     1,008         1,012       2       (7 )     1,007  
           
   
Total available-for-sale securities
  $40,139     $157     $(867 )   $39,429       $40,321     $93     $(755 )   $39,659  
       
(a) Held-to-maturity securities are carried at historical cost adjusted for amortization of premiums and accretion of discounts.
(b) Available-for-sale securities are carried at fair value with unrealized net gains or losses reported within other comprehensive income in shareholders’ equity.
    The weighted-average maturity of the available-for-sale investment securities was 6.5 years at September 30, 2006, compared with 6.1 years at December 31, 2005. The corresponding weighted-average yields were 5.25 percent and 4.89 percent, respectively. The weighted-average maturity of the held-to-maturity investment securities was 8.2 years at September 30, 2006, compared with 7.2 years at December 31, 2005. The corresponding weighted-average yields were 6.44 percent at September 30, 2006, and December 31, 2005.
    Securities carried at $37.8 billion at September 30, 2006, and $36.9 billion at December 31, 2005, were pledged to secure public, private and trust deposits, repurchase agreements and for other purposes required by law. Securities sold under agreements to repurchase where the buyer/lender has the right to sell or pledge the securities, were collateralized by securities with an amortized cost of $9.7 billion at September 30, 2006, and $10.9 billion at December 31, 2005, respectively.
The following table provides information as to the amount of interest income from taxable and non-taxable investment securities:
                                     
                Three Months Ended     Nine Months Ended
                September 30,     September 30,
       
(Dollars in Millions)   2006   2005     2006   2005
       
Taxable
  $465     $488       $1,416     $1,443  
Non-taxable
    35       4         74       11  
           
 
Total interest income from investment securities
  $500     $492       $1,490     $1,454  
       
The following table provides information as to the amount of gross gains and losses realized through the sales of available-for-sale investment securities:
                                     
              Three Months Ended     Nine Months Ended
              September 30,     September 30,
       
(Dollars in Millions)   2006   2005     2006   2005
       
Realized gains
  $—     $1       $4     $13  
Realized losses
                  (1 )     (70 )
           
 
Net realized gains (losses)
  $—     $1       $3     $(57 )
           
Income tax (benefit) on realized gains (losses)
  $—     $—       $1     $(22 )
       
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    For amortized cost, fair value and yield by maturity date of held-to-maturity and available-for-sale securities outstanding at September 30, 2006, refer to Table 4 included in Management’s Discussion and Analysis which is incorporated by reference into these Notes to Consolidated Financial Statements.
The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired which have been in a continuous unrealized loss position at September 30, 2006:
                                                         
              Less Than 12 Months               12 Months or Greater     Total
         
    Fair   Unrealized     Fair   Unrealized     Fair   Unrealized
(Dollars in Millions)   Value   Losses     Value   Losses     Value   Losses
             
Held-to-maturity
                                                   
 
Obligations of state and political subdivisions
  $10     $—       $3     $—       $13     $—  
                 
   
Total
  $10     $—       $3     $—       $13     $—  
             
Available-for-sale
                                                   
 
U.S. Treasury and agencies
  $—     $—       $332     $(7 )     $332     $(7 )
 
Mortgage-backed securities
    5,726       (92 )       23,806       (763 )       29,532       (855 )
 
Asset-backed securities
                  7               7        
 
Obligations of state and political subdivisions
    44               35               79        
 
Other securities and investments
    70               330       (5 )       400       (5 )
                 
   
Total
  $5,840     $(92 )     $24,510     $(775 )     $30,350     $(867 )
             
    The Company’s rationale, by investment category, for determining if investments with unrealized losses that are not deemed to be other-than-temporarily impaired at September 30, 2006, was as follows:
Held-to-Maturity
Obligations of state and political subdivisions During the second quarter of 2006, the Company recorded an impairment of $1 million on a municipal security with a balance of $2 million as it was determined that the revenues supporting the security may not be sufficient to make all contractual principal and interest payments. The remaining unrealized losses were caused by increases in interest rates. The issuers of these securities do not have the contractual ability to pay off these securities at less than par. The Company has the ability and intent to hold these investments until maturity which is consistent with their designation as held to maturity. Consequently, the Company does not consider these investments to be other-than-temporarily impaired as of September 30, 2006.
Available-for-Sale
U.S. Treasury and agencies The unrealized losses on these securities were caused solely by rising interest rates since credit quality is not an issue for these types of securities. None of these securities can be paid off for less than par at maturity or any earlier call date. Because the Company has the ability and intent to hold these securities until a recovery to adjusted book value, they are not considered to be other-than-temporarily impaired as of September 30, 2006.
Mortgage-backed securities Substantially all of these securities were issued by GNMA, FNMA and FHLMC and the remainder were privately issued with high investment grade credit ratings. The unrealized losses for these securities were caused by rising interest rates over the past few years. Given the high credit quality of the investments, the Company fully expects to receive all contractual cash flows. Because the Company has the ability and intent to hold these securities until a recovery to adjusted book value, they are not considered to be other-than-temporarily impaired as of September 30, 2006.
Obligations of state and political subdivisions The unrealized losses were caused by rising interest rates. These municipal securities are investment grade credit quality with substantially all rated AAA. None of these securities can be paid off for less than par at maturity or any earlier call date. Because the Company has the ability and intent to hold these securities until a recovery to adjusted book value, they are not considered to be other-than-temporarily impaired as of September 30, 2006.
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Other securities and investments The securities in this category consist primarily of debt issued by major U.S. banks. The losses are a result of a modest widening of credit spreads since the initial purchase dates. Given the high credit quality of these issuers, the Company expects to receive all contractual cash flows. None of these securities can be paid off for less than par at maturity or any earlier call date. Because the Company has the ability and intent to hold these securities until a recovery to adjusted book value, they are not considered to be other-than-temporarily impaired as of September 30, 2006.
Note 4 Loans
The composition of the loan portfolio was as follows:
                                         
    September 30, 2006     December 31, 2005
       
        Percent         Percent
(Dollars in Millions)   Amount   of Total     Amount   of Total
   
Commercial
                                 
 
Commercial
  $41,237       28.5 %     $37,844       27.5 %
 
Lease financing
    5,357       3.7         5,098       3.7  
           
   
Total commercial
    46,594       32.2         42,942       31.2  
Commercial real estate
                                 
 
Commercial mortgages
    20,029       13.9         20,272       14.7  
 
Construction and development
    8,944       6.2         8,191       6.0  
           
   
Total commercial real estate
    28,973       20.1         28,463       20.7  
Residential mortgages
                                 
 
Residential mortgages
    15,142       10.5         14,538       10.5  
 
Home equity loans, first liens
    6,073       4.2         6,192       4.5  
           
   
Total residential mortgages
    21,215       14.7         20,730       15.0  
Retail
                                 
 
Credit card
    7,864       5.4         7,137       5.2  
 
Retail leasing
    7,068       4.9         7,338       5.3  
 
Home equity and second mortgages
    15,258       10.6         14,979       10.9  
 
Other retail
                                 
   
Revolving credit
    2,601       1.8         2,504       1.8  
   
Installment
    4,369       3.0         3,582       2.6  
   
Automobile
    8,431       5.9         8,112       5.9  
   
Student
    2,035       1.4         2,019       1.4  
           
     
Total other retail
    17,436       12.1         16,217       11.7  
           
   
Total retail
    47,626       33.0         45,671       33.1  
           
     
Total loans
  $144,408       100.0 %     $137,806       100.0 %
       
Loans are presented net of unearned interest and deferred fees and costs, which amounted to $1.3 billion at September 30, 2006, and December 31, 2005.
Note 5 Mortgage Servicing Rights
The Company’s portfolio of residential mortgages serviced for others was $79.2 billion and $69.0 billion at September 30, 2006, and December 31, 2005, respectively. Effective January 1, 2006, the Company early adopted SFAS 156 and elected the fair value measurement method for MSRs. Under this method, the Company records MSRs initially at fair value and at each subsequent reporting date. The Company records changes in fair value in noninterest income in the period in which they occur. Prior to the adoption of SFAS 156, the initial carrying value of MSRs was amortized and recorded in noninterest expense as amortization of intangible assets.
    In March 2006, the Company began hedging the change in fair value of the MSRs using U.S. Treasury futures and options on U.S. Treasury futures contracts. Fair value changes related to the MSRs and the futures and options contracts, as well as servicing and other related fees, are recorded in mortgage banking revenue. The net impact of fair value changes related to MSRs and the futures and options contracts included in mortgage banking revenue was a net gain of $7 million and net loss of $3 million for the third quarter and first nine months of 2006, respectively.
36 U.S. Bancorp


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Servicing and other related fees revenue recorded in the third quarter and first nine months of 2006, was $79 million and $235 million, respectively.
Changes in fair value of capitalized MSRs are summarized as follows:
                       
    Three Months Ended     Nine Months Ended
(Dollars in Millions)   September 30, 2006     September 30, 2006
  
Balance at beginning of period
  $1,323       $1,123  
 
Rights purchased
    3         50  
 
Rights capitalized
    108         278  
 
Changes in fair value of MSRs:
                 
   
Due to change in valuation assumptions (a)
    (68 )       3  
   
Other changes in fair value (b)
    (42 )       (130 )
               
Balance at end of period
  $1,324       $1,324  
         
(a) Principally reflects changes in discount rates and prepayment speed assumptions, primarily arising from interest rate changes.
(b) Primarily represents changes due to collection/realization of expected cash flows over time.
     The Company determines fair value by estimating the present value of the asset’s future cash flows utilizing market-based prepayment rates, discount rates, and other assumptions validated through comparison to trade information, industry surveys, and independent third party appraisals. Risks inherent in the MSRs valuation include higher than expected prepayment rates and/or delayed receipt of cash flows. In March 2006, the Company implemented a program utilizing futures and options contracts to mitigate the valuation risk. The estimated sensitivity to changes in interest rates of the fair value of the MSRs portfolio and the related derivative instruments at September 30, 2006, was as follows:
                                   
              Down Scenario               Up Scenario
       
(Dollars in Millions)   50 bps   25 bps     25 bps   50 bps
   
Net fair value
  $(31 )   $(7 )     $(16 )   $(56 )
       
     The fair value of MSRs 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. The Company’s servicing portfolio consists of the distinct portfolios of Mortgage Revenue Bond Programs (“MRBP”), government-insured 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-income and moderate-income borrowers and are generally government-insured programs with a favorable rate subsidy, down payment and/or closing cost assistance. 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 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 MSRs and related characteristics by portfolio as of September 30, 2006, was as follows:
                                 
(Dollars in Millions)   MRBP   Government   Conventional   Total
 
Servicing portfolio
  $7,519     $8,614     $63,100     $79,233  
Fair market value
  $149     $156     $1,019     $1,324  
Value (bps) *
    198       181       161       167  
Weighted-average servicing fees (bps)
    41       43       36       37  
Multiple (value/servicing fees)
    4.83       4.21       4.47       4.51  
Weighted-average note rate
    5.90 %     6.11 %     5.81 %     5.85 %
Age (in years)
    3.4       3.0       2.3       2.5  
Expected life (in years)
    7.8       6.6       6.8       6.9  
Discount rate
    11.4 %     11.3 %     10.6 %     10.8 %
 
* Value is calculated as fair market value divided by the servicing portfolio.
U.S. Bancorp 37


Table of Contents

Note 6 Earnings Per Common Share
The components of earnings per common share were:
                                   
              Three Months Ended               Nine Months Ended
              September 30,               September 30,
       
(Dollars and Shares in Millions, Except Per Share Data)   2006   2005     2006   2005
   
Net income
  $1,203     $1,154       $3,557     $3,346  
Preferred dividends
    16               33        
           
Net income applicable to common equity
  $1,187     $1,154       $3,524     $3,346  
Average common shares outstanding
    1,771       1,823         1,784       1,836  
Net effect of the assumed purchase of stock based on the treasury stock method for options and stock plans
    25       26         25       26  
           
Average diluted common shares outstanding
    1,796       1,849         1,809       1,862  
           
Earnings per common share
  $.67     $.63       $1.98     $1.82  
Diluted earnings per common share
  $.66     $.62       $1.95     $1.80  
       
Options to purchase 3 million and 15 million common shares for the three months ended September 30, 2006 and 2005, respectively, and 4 million and 16 million common shares for the nine months ended September 30, 2006 and 2005, respectively, were outstanding but not included in the computation of diluted earnings per common share because they were antidilutive.
Note 7 Employee Benefits
The components of net periodic benefit cost (income) for the Company’s retirement plans were: