e10vq
Table of Contents

(FORM 10-Q)
(USBANCORP LOGO)


Table of Contents

 
 
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 June 30, 2007
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 Number)
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 July 31, 2007
1,726,437,268 shares
 
 


 

Table of Contents and Form 10-Q Cross Reference Index
       
   
   
 
a)  Overview
  3
    4
    7
    25
    25
   
 
a)  Overview
  8
    8
    14
    14
    14
    18
    18
    18
  19
  26
   
  38
  38
  38
  38
5)  Signature
  39
6)  Exhibits
  40
 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. 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 U.S. Bancorp. Forward-looking statements involve inherent risks and uncertainties, and important factors could cause actual results to differ materially from those anticipated, including 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, effects of critical accounting policies and judgments, and management’s ability to effectively manage credit risk, market risk, operational risk, legal risk, and regulatory and compliance risk. 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, 2006, 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 U.S. Bancorp undertakes no obligation to update them in light of new information or future events.
U.S. Bancorp 1


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Table 1 Selected Financial Data
                                                   
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
        Percent       Percent
(Dollars and Shares in Millions, Except Per Share Data)   2007   2006   Change   2007   2006   Change
 
Condensed Income Statement
                                               
Net interest income (taxable-equivalent basis) (a)
    $1,650       $1,697       (2.8 )%     $3,316       $3,422       (3.1 )%
Noninterest income
    1,852       1,752       5.7       3,547       3,366       5.4  
Securities gains (losses), net
    3       3             4       3       33.3  
                     
 
Total net revenue
    3,505       3,452       1.5       6,867       6,791       1.1  
Noninterest expense
    1,640       1,530       7.2       3,185       3,030       5.1  
Provision for credit losses
    191       125       52.8       368       240       53.3  
                     
 
Income before taxes
    1,674       1,797       (6.8 )     3,314       3,521       (5.9 )
Taxable-equivalent adjustment
    18       11       63.6       35       21       66.7  
Applicable income taxes
    500       585       (14.5 )     993       1,146       (13.4 )
                     
 
Net income
    $1,156       $1,201       (3.7 )     $2,286       $2,354       (2.9 )
                     
 
Net income applicable to common equity
    $1,141       $1,184       (3.6 )     $2,256       $2,337       (3.5 )
                     
Per Common Share
                                               
Earnings per share
    $.66       $.66       %     $1.29       $1.30       (.8 )%
Diluted earnings per share
    .65       .66       (1.5 )     1.27       1.29       (1.6 )
Dividends declared per share
    .40       .33       21.2       .80       .66       21.2  
Book value per share
    11.19       10.89       2.8                          
Market value per share
    32.95       30.88       6.7                          
Average common shares outstanding
    1,736       1,781       (2.5 )     1,744       1,791       (2.6 )
Average diluted common shares outstanding
    1,760       1,805       (2.5 )     1,770       1,816       (2.5 )
Financial Ratios
                                               
Return on average assets
    2.09 %     2.27 %             2.09 %     2.25 %        
Return on average common equity
    23.0       24.3               22.7       23.8          
Net interest margin (taxable-equivalent basis) (a)
    3.44       3.68               3.47       3.74          
Efficiency ratio (b)
    46.8       44.4               46.4       44.6          
Average Balances
                                               
Loans
    $145,653     $ 139,370       4.5 %   $ 145,176     $ 138,579       4.8 %
Loans held for sale
    4,334       3,555       21.9       4,090       3,412       19.9  
Investment securities
    40,704       40,087       1.5       40,791       39,885       2.3  
Earning assets
    192,301       184,890       4.0       191,721       184,000       4.2  
Assets
    222,022       212,407       4.5       220,774       211,222       4.5  
Noninterest-bearing deposits
    27,977       28,949       (3.4 )     27,828       28,893       (3.7 )
Deposits
    118,975       121,233       (1.9 )     119,847       120,701       (.7 )
Short-term borrowings
    29,524       22,246       32.7       28,114       23,295       20.7  
Long-term debt
    44,655       41,225       8.3       43,804       39,735       10.2  
Shareholders’ equity
    20,895       20,556       1.6       21,052       20,353       3.4  
                     
   
June  30,
2007
  December 31,
2006
                               
                             
Period End Balances
                                               
Loans
    $145,708     $ 143,597       1.5 %                        
Allowance for credit losses
    2,260       2,256       .2                          
Investment securities
    39,514       40,117       (1.5 )                        
Assets
    222,530       219,232       1.5                          
Deposits
    119,702       124,882       (4.1 )                        
Long-term debt
    45,946       37,602       22.2                          
Shareholders’ equity
    20,330       21,197       (4.1 )                        
Regulatory capital ratios
                                               
 
Tier 1 capital
    8.5 %     8.8 %                                
 
Total risk-based capital
    13.0       12.6                                  
 
Leverage
    7.9       8.2                                  
 
Tangible common equity
    5.2       5.5                                  
 
(a) Presented on a fully taxable-equivalent basis utilizing a tax rate of 35 percent.
(b) Computed as noninterest expense divided by the sum of net interest income on a taxable-equivalent basis and noninterest income excluding securities gains (losses), net.
2 U.S. Bancorp


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Management’s Discussion and Analysis
OVERVIEW
Earnings Summary U.S. Bancorp and its subsidiaries (the “Company”) reported net income of $1,156 million for the second quarter of 2007 or $.65 per diluted share, compared with $1,201 million, or $.66 per diluted share for the second quarter of 2006. Return on average assets and return on average common equity were 2.09 percent and 23.0 percent, respectively, for the second quarter of 2007, compared with returns of 2.27 percent and 24.3 percent, respectively, for the second quarter of 2006. The Company’s results for the second quarter of 2007 declined from the same period of 2006, as strong fee-based revenue growth was more than offset by a $35 million gain in the second quarter of 2006 from the initial public offering of a cardholder association, as well as an expected increase in credit costs due to the prior year favorable impact on charge-offs as a result of changes in bankruptcy laws, and lower net interest income.
     Total net revenue, on a taxable-equivalent basis, for the second quarter of 2007, was $53 million (1.5 percent) higher than the second quarter of 2006, primarily reflecting a 5.7 percent increase in noninterest income, partially offset by a 2.8 percent decline in net interest income from a year ago. Noninterest income growth was driven primarily by organic business growth, offset somewhat by the impact in the second quarter of 2006 of a $35 million gain from the initial public offering of a cardholder association.
     Total noninterest expense in the second quarter of 2007 was $110 million (7.2 percent) higher than in the second quarter of 2006, principally due to investments in business initiatives, higher operating and business integration costs associated with recent acquisitions, costs related to tax-advantaged investments and an increase in merchant airline processing primarily due to sales volumes and recent business expansion with a major airline. Growth in expenses from a year ago was partially offset by a debt prepayment charge recorded in the second quarter of 2006.
     The provision for credit losses for the second quarter of 2007 increased $66 million (52.8 percent), compared with the second quarter of 2006. The increase in the provision for credit losses from a year ago reflected expected losses from strong growth in credit card accounts. Also, the provision for credit losses in the second quarter of 2006 partially reflected the favorable residual impact on net charge-offs, principally for credit cards and other retail charge-offs, due to changes in bankruptcy laws in late 2005. Net charge-offs in the second quarter of 2007 were $191 million, compared with $125 million in the second quarter of 2006. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.
     The Company reported net income of $2,286 million for the first six months of 2007 or $1.27 per diluted share, compared with $2,354 million, or $1.29 per diluted share for the first six months of 2006. Return on average assets and return on average common equity were 2.09 percent and 22.7 percent, respectively, for the first six months of 2007, compared with returns of 2.25 percent and 23.8 percent, respectively, for the first six months of 2006. The Company’s results for the first six months of 2007 declined from the same period of 2006, as growth in fee-based revenue was more than offset by lower net interest income, increased credit costs reflecting the prior year favorable impact on charge-offs as a result of changes in bankruptcy laws, and operating costs of acquired businesses and other business initiatives.
     Total net revenue, on a taxable-equivalent basis, for the first six months of 2007, was $76 million (1.1 percent) higher than the first six months of 2006, primarily reflecting a 5.4 percent increase in noninterest income, partially offset by a 3.1 percent decline in net interest income from a year ago. Noninterest income growth was driven by organic business growth and expansion in payment processing and trust businesses. Fee-based revenue growth was partially offset by the net favorable impact in the first six months of 2006 of $52 million from several previously reported items, including a $44 million trading gain related to certain derivatives, a $35 million gain from the initial public offering of a cardholder association and a $10 million gain related to a favorable settlement in the merchant processing business, offset by a $37 million reduction in mortgage banking revenue due principally to the adoption of fair value accounting standards for mortgage servicing rights (“MSRs”).
     Total noninterest expense in the first six months of 2007 was $155 million (5.1 percent) higher than in the first six months of 2006, principally due to investments in business initiatives, higher operating and business integration costs associated with recent acquisitions,
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costs related to tax-advantaged investments and an increase in merchant airline processing primarily due to sales volumes and recent business expansion with a major airline. Growth in expenses from a year ago was partially offset by an $11 million debt prepayment charge recorded in the first six months of 2006.
     The provision for credit losses for the first six months of 2007 increased $128 million (53.3 percent), compared with the same period of 2006. The increase in the provision for credit losses from a year ago reflected expected losses from strong growth in credit card accounts. Also, the provision for credit losses in the first six months of 2006 partially reflected the favorable residual impact on net charge-offs of changes in bankruptcy laws in late 2005. Net charge-offs in the first six months of 2007 were $368 million, compared with $240 million in the first six months of 2006. 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 $1,650 million in the second quarter of 2007, compared with $1,697 million in the second quarter of 2006. Net interest income, on a taxable-equivalent basis, was $3,316 million in the first six months of 2007, compared with $3,422 million in the first six months of 2006. Average earning assets increased $7.4 billion (4.0 percent) and $7.7 billion (4.2 percent) in the second quarter and first six months of 2007, respectively, compared with the same periods of 2006. The increases were primarily driven by growth in total average loans of $6.3 billion (4.5 percent) and $6.6 billion (4.8 percent) in the second quarter and first six months of 2007, respectively, compared with the same periods of 2006. The positive impact on net interest income from the growth in earning assets was more than offset by a lower net interest margin. The net interest margin in the second quarter and first six months of 2007 was 3.44 percent and 3.47 percent, respectively, compared with 3.68 percent and 3.74 percent, respectively, for the same periods of 2006, reflecting the competitive environment and the impact of the flat yield curve during the past several quarters. Compared with the same periods of 2006, credit spreads tightened by approximately 9 basis points in the second quarter and 10 basis points in the first six months of 2007 across most lending products due to competitive loan pricing. In addition, funding costs were higher as rates on interest-bearing deposits increased and the funding mix continued to shift toward higher cost deposits and other sources. An increase in loan fees partially offset these factors.
            The Company anticipates the net interest margin to remain relatively stable throughout the remainder of the year. 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 second quarter and first six months of 2007 were $6.3 billion (4.5 percent) and $6.6 billion (4.8 percent) higher, respectively, than the same periods of 2006, reflecting growth in retail loans, commercial loans and residential mortgages, partially offset by a decline in total commercial real estate loans. Average credit card balances for the second quarter and first six months of 2007 increased $1.8 billion (23.9 percent) and $1.6 billion (22.6 percent), respectively, compared with the same periods of 2006, as a result of growth in branch originated, co-branded and financial institution partner portfolios.
     Average investment securities in the second quarter and first six months of 2007 were $.6 billion (1.5 percent) and $.9 billion (2.3 percent) higher, respectively, than the same periods of 2006, driven primarily by an increase in the municipal securities portfolio, partially offset by a reduction in mortgage-backed assets.
     Average noninterest-bearing deposits for the second quarter and first six months of 2007 decreased $1.0 billion (3.4 percent) and $1.1 billion (3.7 percent), respectively, compared with the same periods of 2006, reflecting a decline in business demand deposits within most lines of business as customers reduced excess liquidity to fund business growth and reinvested excess funds in interest-bearing deposit and sweep products. The decline in business demand account balances was partially offset by higher corporate trust deposits, driven by acquisitions and business growth.
     Average total savings deposits remained relatively flat in the second quarter and first six months of 2007, compared with the same periods of 2006, as increases in interest checking balances were offset by declines in money market and savings balances, primarily within Consumer Banking. Interest checking balances for the second quarter and first six months of 2007 increased $2.5 billion (10.8 percent) and $2.2 billion (9.6 percent), respectively, compared with the same periods of 2006, due to higher broker-dealer, government and institutional trust balances. Average money market and savings balances for the second quarter and first six months of 2007 decreased $2.7 billion (8.1 percent) and $2.3 billion (7.0 percent), respectively, compared with the same periods of 2006, as a result of the Company’s deposit pricing decisions
4 U.S. Bancorp


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for money market products in relation to other fixed-rate deposit products. A portion of branch-based money market savings accounts migrated to fixed-rate time certificates, as customers took advantage of higher interest rates for these products.
     Average time certificates of deposit less than $100,000 were higher in the second quarter and first six months of 2007 by $1.0 billion (7.5 percent) and $1.1 billion (8.4 percent), respectively, compared with the same periods of 2006. The year-over-year growth in time certificates less than $100,000 was primarily due to consumer-based time deposits, reflecting customer migration to higher rate deposit products. Average time deposits greater than $100,000 decreased $2.2 billion (9.7 percent) and $.9 billion (3.9 percent) in the second quarter and first six months of 2007, respectively, compared with the same periods of 2006. Time deposits greater than $100,000 are largely viewed as purchased funds and are managed at levels deemed appropriate, given alternative funding sources.
Provision for Credit Losses The provision for credit losses for the second quarter and first six months of 2007 increased $66 million (52.8 percent) and $128 million (53.3 percent), respectively, compared with the same periods of 2006. The increases in the provision for credit losses in the second quarter and first six months of 2007 from the same periods a year ago reflected expected losses from strong growth in credit card accounts. Also, the provision for credit losses in the second quarter and first six months of 2006 partially reflected the favorable residual impact on net charge-offs of changes in bankruptcy laws in late 2005. Net charge-offs were $191 million in the second quarter and $368 million in the first six months of 2007, compared with $125 million in the second quarter and $240 million in the first six months of 2006. 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.
Noninterest Income Noninterest income in the second quarter and first six months of 2007 was $1,855 million and $3,551 million, respectively, compared with $1,755 million and $3,369 million in the same periods of 2006. The $100 million (5.7 percent) increase during the second quarter and $182 million (5.4 percent) increase during the first six months of 2007, compared with the same periods in 2006, were driven by organic growth offset somewhat by a $35 million gain on the initial public offering of a cardholder association recorded in the second quarter of 2006. In addition, certain revenue categories were impacted by accounting items in the first six months of 2006.
     The growth in credit and debit card revenue was primarily driven by an increase in customer accounts and higher customer transaction volumes from a year ago. The corporate payment products revenue growth reflected organic growth in sales volumes and card usage, and an acquired business. Merchant processing services revenue growth reflected an increase in customers and sales volumes and business expansion. Trust and investment management fees increased year-over-year due to core account growth and favorable market conditions. Deposit service charges grew year-over-year primarily due to increased transaction-related fees and continued growth in net new checking accounts. Treasury management fees increased over the
Table 2 Noninterest Income
                                                   
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
            Percent       Percent
(Dollars in Millions)   2007   2006   Change   2007   2006   Change
 
Credit and debit card revenue
    $228       $202       12.9 %     $433       $384       12.8 %
Corporate payment products revenue
    157       139       12.9       302       266       13.5  
ATM processing services
    62       61       1.6       121       120       .8  
Merchant processing services
    285       253       12.6       535       466       14.8  
Trust and investment management fees
    342       314       8.9       664       611       8.7  
Deposit service charges
    272       264       3.0       515       496       3.8  
Treasury management fees
    126       116       8.6       237       223       6.3  
Commercial products revenue
    105       107       (1.9 )     205       211       (2.8 )
Mortgage banking revenue
    68       75       (9.3 )     135       99       36.4  
Investment products fees and commissions
    38       42       (9.5 )     72       80       (10.0 )
Securities gains (losses), net
    3       3             4       3       33.3  
Other
    169       179       (5.6 )     328       410       (20.0 )
     
 
Total noninterest income
    $1,855       $1,755       5.7 %     $3,551       $3,369       5.4 %
 
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prior year due to higher transaction volumes and customer growth.
     Favorable changes in fee-based revenue were partially offset by a decline in other income. The reduction in other income in the second quarter of 2007, compared with the second quarter of 2006, reflected the $35 million gain recognized in the second quarter of 2006 related to the initial public offering of a cardholder association, partially offset by an increase in revenue from incremental investment in a bank-owned life insurance program and higher revenue from equity investments. In addition, the reduction in other income in the first six months of 2007, compared with the first six months of 2006, resulted from a $44 million trading gain recognized in the first quarter of 2006 related to terminating certain interest rate swaps previously designated as cash flow hedges that did not qualify as hedges in accordance with Statement of Financial Accounting Standards 133, “Accounting for Derivative Instruments and Hedging Activities”, as well as a $10 million favorable settlement within the merchant processing business recorded in the prior year. Mortgage banking revenue declined in the second quarter of 2007, compared with the same period of the prior year, as growth in both production gains and servicing income was more than offset by an adverse change in the valuation of MSRs and corresponding MSR economic hedges due to changes in interest rates late in the second quarter of 2007. Mortgage banking revenue increased in the first six months of 2007 due to changes in accounting for MSRs and mortgage banking revenue that resulted in a $37 million reduction in revenue in the first quarter of 2006.
Noninterest Expense Noninterest expense was $1,640 million in the second quarter and $3,185 million in the first six months of 2007, reflecting increases of $110 million (7.2 percent) and $155 million (5.1 percent), respectively, from the same periods of 2006. Compensation expense increased due to ongoing bank operations and acquired businesses. Net occupancy and equipment expense increased primarily due to acquisitions and branch-based business initiatives. Professional services expense increased due to revenue enhancing business initiatives and higher legal costs associated with litigation and the establishment of a bank charter in Ireland to support pan-European payment processing. Marketing and business development expense increased year-over-year due to the timing of customer promotions, solicitations and advertising activities. Postage, printing and supplies expense increased due to changes in postal rates and increases in customer-related operations. Other intangibles expense increased from the same periods of 2006 due to recent acquisitions in Consumer Banking, Wealth Management and Payment Services. Other expense increased over the prior year due to an increase in the Company’s merchant airline processing, driven by volumes and the impact of the recent signing of a contract with a major airline. Changes in other expense also reflected an increase in the costs related to tax-advantaged investments, integration expenses related to recent acquisitions and higher credit-related costs for other real estate owned and loan collection activities. These expense increases were partially offset by an $11 million debt prepayment charge recorded in the second quarter of 2006.
Income Tax Expense The provision for income taxes was $500 million (an effective rate of 30.2 percent) for the second quarter and $993 million (an effective rate of 30.3 percent) for the first six months of 2007,
Table 3 Noninterest Expense
                                                   
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
        Percent       Percent
(Dollars in Millions)   2007   2006   Change   2007   2006   Change
 
Compensation
    $659       $627       5.1 %     $1,294       $1,260       2.7 %
Employee benefits
    123       123             256       256        
Net occupancy and equipment
    171       161       6.2       336       326       3.1  
Professional services
    59       41       43.9       106       76       39.5  
Marketing and business development
    64       58       10.3       112       98       14.3  
Technology and communications
    126       127       (.8 )     251       244       2.9  
Postage, printing and supplies
    71       66       7.6       140       132       6.1  
Other intangibles
    95       89       6.7       189       174       8.6  
Debt prepayment
          11       *             11       *  
Other
    272       227       19.8       501       453       10.6  
     
 
Total noninterest expense
    $1,640       $1,530       7.2 %     $3,185       $3,030       5.1 %
     
Efficiency ratio (a)
    46.8 %     44.4 %             46.4 %     44.6 %        
 
* Not meaningful
(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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compared with $585 million (an effective rate of 32.8 percent) and $1,146 million (an effective rate of 32.7 percent) for the same periods of 2006. For further information on income taxes, refer to Note 7 of the Notes to Consolidated Financial Statements.
BALANCE SHEET ANALYSIS
Loans The Company’s total loan portfolio was $145.7 billion at June 30, 2007, compared with $143.6 billion at December 31, 2006, an increase of $2.1 billion (1.5 percent). The increase was driven by growth in retail loans, residential mortgages and commercial loans, partially offset by a decrease in commercial real estate loans. The $.3 billion (.6 percent) increase in commercial loans was primarily driven by seasonal increases in corporate payment card balances.
     Commercial real estate loans decreased slightly to $28.4 billion at June 30, 2007, compared with $28.6 billion at December 31, 2006. The decline in commercial real estate balances reflected current unfavorable real estate market conditions in certain industry sectors and the excess liquidity in the capital markets.
     Residential mortgages held in the loan portfolio increased $.7 billion (3.3 percent) at June 30, 2007, compared with December 31, 2006, reflecting an increase in consumer finance originations.
     Total retail loans outstanding, which include credit card, retail leasing, home equity and second mortgages and other retail loans, increased $1.4 billion (2.9 percent) at June 30, 2007, compared with December 31, 2006. The increase was primarily driven by growth in credit card, installment and home equity loans, partially offset by decreases in retail leasing and student loan balances.
     At June 30, 2007, the residential and home equity and second mortgage portfolios included approximately $3.2 billion and $.9 billion, respectively, of loans to customers that may be defined as sub-prime borrowers. Together, these balances represented 2.8 percent of the Company’s total loans outstanding at June 30, 2007.
Loans Held for Sale At June 30, 2007, loans held for sale, consisting of residential mortgages, student loans and other selective loans to be sold in the secondary market, were $4.6 billion, compared with $3.3 billion at December 31, 2006. The increase in loans held for sale was principally due to seasonal loan originations and the timing of sales during the first six months of 2007.
Investment Securities Investment securities, both available-for-sale and held-to-maturity, totaled $39.5 billion at June 30, 2007, compared with $40.1 billion at December 31, 2006, reflecting purchases of $3.0 billion of securities, which were more than offset by sales, maturities, prepayments and a $.7 billion increase in the unrealized loss on the available-for-sale portfolio. As of June 30, 2007, and December 31, 2006, approximately 37 percent of the investment securities portfolio represented adjustable-rate financial instruments. Adjustable-rate financial instruments include variable-rate collateralized mortgage obligations, mortgage-backed securities, agency securities, adjustable-rate money market accounts and asset-backed securities.
Deposits Total deposits were $119.7 billion at June 30, 2007, compared with $124.9 billion at December 31, 2006, a decrease of $5.2 billion (4.1 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 an increase in interest checking accounts. The $2.6 billion (8.0 percent) decrease in noninterest-bearing deposits was primarily due to a decline of business demand deposits. The
Table 4 Available-for-Sale Investment Securities
                                                                   
    June 30, 2007   December 31, 2006
     
        Weighted-       Weighted-    
        Average   Weighted-       Average   Weighted-
    Amortized   Fair   Maturity in   Average   Amortized   Fair   Maturity in   Average
(Dollars in Millions)   Cost   Value   Years   Yield (c)   Cost   Value   Years   Yield (c)
 
U.S. Treasury and agencies
    $474       $469       9.9       5.93 %     $472       $467       10.1       5.94 %
Mortgage-backed securities (a)
    32,597       31,439       7.5       5.12       34,465       33,787       5.6       5.10  
Asset-backed securities (a)
    6       6       .1       5.65       7       7       .1       5.32  
Obligations of state and political subdivisions (b)
    5,798       5,695       12.0       6.69       4,463       4,539       9.7       6.68  
Other debt securities
    1,546       1,510       28.1       6.20       994       993       23.8       6.08  
Other investments
    306       314             6.73       229       237             6.26  
     
 
Total available-for-sale investment securities
    $40,727       $39,433       9.0       5.41 %     $40,630       $40,030       6.6       5.32 %
 
(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) Average yields are presented on a fully-taxable equivalent basis under a tax rate of 35 percent. Yields are computed based on historical cost balances. Average yield and maturity calculations exclude equity securities that have no stated yield or maturity.
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$1.7 billion (6.3 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. Time deposits greater than $100,000 decreased $2.5 billion (11.1 percent) at June 30, 2007, compared with December 31, 2006. Time deposits greater than $100,000 are largely viewed as purchased funds and are managed to levels deemed appropriate given alternative funding sources. Interest checking account balances increased $.9 billion (3.6 percent) due to higher trust and custody balances and a migration from noninterest-bearing accounts within government banking.
Borrowings The Company utilizes both short-term and long-term borrowings to fund growth of assets in excess of deposit growth. Short-term borrowings, which include federal funds purchased, commercial paper, securities sold under agreements to repurchase and other short-term borrowings, were $27.2 billion at June 30, 2007, compared with $26.9 billion at December 31, 2006. Short-term funding is managed within approved liquidity policies. Long-term debt was $45.9 billion at June 30, 2007, compared with $37.6 billion at December 31, 2006, reflecting the issuances of $3.0 billion of convertible senior debentures, $1.3 billion of subordinated notes, $1.3 billion of bank notes and $.5 billion of junior subordinated debentures, and the net addition of $4.4 billion of Federal Home Loan Bank (“FHLB”) advances, partially offset by $1.7 billion of bank note maturities. The $8.3 billion (22.2 percent) increase in long-term debt reflected wholesale funding associated with the Company’s asset growth and asset/liability management activities. 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 value, operational, interest rate, market and liquidity risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Residual value risk is the potential reduction in the end-of-term value of leased assets or the residual cash flows related to asset securitization and other off-balance sheet structures. Operational risk includes 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, which can affect the repricing of assets and liabilities differently, as well as their market value. Market risk arises from fluctuations in interest rates, foreign exchange rates, and equity prices that may result in changes in the values of financial instruments, such as trading and available-for-sale securities that are accounted for on a mark-to-market basis. Liquidity risk is the possible inability to fund obligations to depositors, investors or borrowers. In addition, corporate strategic decisions, as well as the risks described above, could give rise to reputation risk. Reputation risk is the risk that negative publicity or press, whether true or not, could result in costly litigation or cause a decline in the Company’s stock value, customer base or revenue.
Credit Risk 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. 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. 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, 2006, 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 Company measures delinquencies, both including and excluding nonperforming loans, to enable comparability with other companies. Accruing loans 90 days or more past due totaled $376 million at June 30, 2007, compared with $349 million at December 31, 2006. 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 accruing loans 90 days or more past due to total loans was ..26 percent at June 30, 2007, compared with ..24 percent at December 31, 2006.
     The Company’s retail lending business utilizes several distinct business processes and channels to originate retail credit, including traditional branch lending, indirect lending, portfolio acquisitions and a
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Table 5 Delinquent Loan Ratios as a Percent of Ending Loan Balances
                       
    June 30,   December 31,
90 days or more past due excluding nonperforming loans   2007   2006
 
Commercial
               
 
Commercial
    .08 %     .06 %
 
Lease financing
    .02        
     
   
Total commercial
    .07       .05  
Commercial real estate
               
 
Commercial mortgages
          .01  
 
Construction and development
          .01  
     
   
Total commercial real estate
          .01  
Residential mortgages
    .50       .45  
Retail
               
 
Credit card
    1.63       1.75  
 
Retail leasing
    .05       .03  
 
Other retail
    .23       .23  
     
   
Total retail
    .48       .48  
     
     
Total loans
    .26 %     .24 %
 
                   
    June 30,   December 31,
90 days or more past due including nonperforming loans   2007   2006
 
Commercial
    .44 %     .57 %
Commercial real estate
    .69       .53  
Residential mortgages (a)
    .69       .62  
Retail
    .55       .58  
     
 
Total loans
    .57 %     .57 %
 
(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 2.90 percent at June 30, 2007, and 3.11 percent at December 31, 2006.

consumer finance division. Generally, loans managed by the Company’s consumer finance division exhibit higher credit risk characteristics, but are priced commensurate with the differing risk profile. To monitor credit risk associated with retail loans, the Company monitors delinquency ratios in the various stages of collection, including nonperforming status.
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The following table provides summary delinquency information for residential mortgages and retail loans:
                                       
        As a Percent of Ending
    Amount   Loan Balances
     
    June 30,   December 31,   June 30,   December 31,
(Dollars in Millions)   2007   2006   2007   2006
 
Residential mortgages
                               
   
30-89 days
    $171       $154       .78 %     .72 %
   
90 days or more
    111       95       .50       .45  
   
Nonperforming
    41       36       .19       .17  
     
     
Total
    $323       $285       1.47 %     1.34 %
 
Retail
                               
 
Credit card
                               
   
30-89 days
    $199       $204       2.12 %     2.35 %
   
90 days or more
    154       152       1.63       1.75  
   
Nonperforming
    20       31       .21       .36  
     
     
Total
    $373       $387       3.96 %     4.46 %
 
Retail leasing
                               
   
30-89 days
    $27       $34       .41 %     .49 %
   
90 days or more
    3       2       .05       .03  
   
Nonperforming
                       
     
     
Total
    $30       $36       .46 %     .52 %
 
Home equity and second mortgages
                               
   
30-89 days
    $61       $79       .38 %     .51 %
   
90 days or more
    28       28       .18       .18  
   
Nonperforming
    15       14       .09       .09  
     
     
Total
    $104       $121       .65 %     .78 %
 
Other retail
                               
   
30-89 days
    $133       $131       .79 %     .80 %
   
90 days or more
    47       44       .28       .27  
   
Nonperforming
    4       3       .02       .02  
     
     
Total
    $184       $178       1.09 %     1.09 %
 
Within these product categories, the following table provides information on delinquent and nonperforming loans as a percent of ending loan balances, by channel:
                                       
    Consumer Finance   Other Retail
     
    June 30,   December 31,   June 30,   December 31,
    2007   2006   2007   2006
 
Residential mortgages
                               
   
30-89 days
    .88 %     .83 %     .71 %     .66 %
   
90 days or more
    .68       .64       .38       .32  
   
Nonperforming
    .27       .19       .13       .16  
     
     
Total
    1.83 %     1.66 %     1.22 %     1.14 %
 
Retail
                               
 
Credit card
                               
   
30-89 days
    %     %     2.12 %     2.35 %
   
90 days or more
                1.63       1.75  
   
Nonperforming
                .21       .36  
     
     
Total
    %     %     3.96 %     4.46 %
 
Retail leasing
                               
   
30-89 days
    %     %     .41 %     .49 %
   
90 days or more
                .05       .03  
   
Nonperforming
                       
     
     
Total
    %     %     .46 %     .52 %
 
Home equity and second mortgages
                               
   
30-89 days
    1.64 %     1.64 %     .22 %     .35 %
   
90 days or more
    .98       .79       .07       .10  
   
Nonperforming
    .11       .11       .09       .09  
     
     
Total
    2.73 %     2.54 %     .38 %     .54 %
 
Other retail
                               
   
30-89 days
    4.33 %     4.30 %     .70 %     .71 %
   
90 days or more
    .96       .76       .26       .26  
   
Nonperforming
                .02       .02  
     
     
Total
    5.29 %     5.06 %     .98 %     .99 %
 
Within the consumer finance division at June 30, 2007, approximately $130 million and $54 million of these delinquent and nonperforming residential mortgages and other retail loans, respectively, were to customers that may be defined as sub-prime borrowers, compared with
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Table 6 Nonperforming Assets (a)
                       
    June 30,   December 31,
(Dollars in Millions)   2007   2006
 
Commercial
               
 
Commercial
  $ 128     $ 196  
 
Lease financing
    44       40  
     
   
Total commercial
    172       236  
Commercial real estate
               
 
Commercial mortgages
    90       112  
 
Construction and development
    107       38  
     
   
Total commercial real estate
    197       150  
Residential mortgages
    41       36  
Retail
               
 
Credit card
    20       31  
 
Retail leasing
           
 
Other retail
    19       17  
     
   
Total retail
    39       48  
     
     
Total nonperforming loans
    449       470  
Other real estate (b)
    103       95  
Other assets
    13       22  
     
     
Total nonperforming assets
  $ 565     $ 587  
     
Accruing loans 90 days or more past due
  $ 376     $ 349  
Nonperforming loans to total loans
    .31 %     .33 %
Nonperforming assets to total loans plus other real estate (b)
    .39 %     .41 %
 
Changes in Nonperforming Assets
                                 
    Commercial and   Retail and    
    Commercial   Residential    
(Dollars in Millions)   Real Estate   Mortgages (d)   Total
 
Balance December 31, 2006
    $406       $181       $587  
 
Additions to nonperforming assets
                       
   
New nonaccrual loans and foreclosed properties
    222       24       246  
   
Advances on loans
    6             6  
     
     
Total additions
    228       24       252  
 
Reductions in nonperforming assets
                       
   
Paydowns, payoffs
    (78 )     (12 )     (90 )
   
Net sales
    (63 )           (63 )
   
Return to performing status
    (20 )     (1 )     (21 )
   
Charge-offs (c)
    (94 )     (6 )     (100 )
     
     
Total reductions
    (255 )     (19 )     (274 )
     
       
Net additions to (reductions in) nonperforming assets
    (27 )     5       (22 )
     
Balance June 30, 2007
    $379       $186       $565  
 
(a) Throughout this document, nonperforming assets and related ratios do not include accruing loans 90 days or more past due.
(b) Excludes $85 million and $83 million of foreclosed GNMA loans which continue to accrue interest at June 30, 2007, and December 31, 2006, respectively.
(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.

$105 million and $50 million, respectively, at December 31, 2006.
Nonperforming Assets The level of nonperforming assets represents another indicator of the potential for future credit losses. At June 30, 2007, total nonperforming assets were $565 million, compared with $587 million at December 31, 2006. The ratio of total nonperforming assets to total loans and other real estate decreased to .39 percent at June 30, 2007, compared with .41 percent at December 31, 2006.
     Included in nonperforming loans were restructured loans of $34 million at June 30, 2007, compared with $38 million at December 31, 2006. At June 30, 2007, the Company had $2 million of commitments to lend additional funds under restructured loans, compared with no commitments at December 31, 2006.
     Other real estate included in nonperforming assets was $103 million at June 30, 2007, compared with $95 million at December 31, 2006, and was primarily related to properties that the Company has taken ownership of that once secured residential mortgages and home equity and second mortgage loan balances.
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The following table provides an analysis of other real estate as a percent of their related loan balances, including further detail for residential mortgages and home equity and second mortgage loan balances by geographical location:
                                     
        As a Percent of Ending
    Amount   Loan Balances
     
    June 30,   December 31,   June 30,   December 31,
(Dollars in Millions)   2007   2006   2007   2006
 
Residential mortgages and home equity and second mortgages
                               
 
Michigan
    $20       $17       3.53 %     2.90 %
 
Ohio
    11       12       .44       .48  
 
Minnesota
    11       11       .21       .21  
 
Colorado
    7       7       .25       .28  
 
Missouri
    6       6       .23       .25  
 
All other states
    46       38       .19       .16  
     
   
Total residential mortgages and home equity and second mortgages
    101       91       .27       .25  
Commercial real estate and construction
    2       4       .01       .01  
     
              Total
    $103       $95       .07 %     .07 %
 
     Within other real estate in the table above, approximately $53 million at June 30, 2007, and $41 million at December 31, 2006, were from portfolios that may be defined as sub-prime.
     Based on existing economic and market conditions, the Company expects nonperforming assets to increase modestly over the next several quarters.
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.
The following table provides a summary of restructured loans that continue to accrue interest:
                                   
        As a Percent of Ending
    Amount   Loan Balances
     
    June 30,   December 31,   June 30,   December 31,
(Dollars in Millions)   2007   2006   2007   2006
 
Commercial
    $12       $18       .03 %     .04 %
Commercial real estate
          1              
Residential mortgages
    87       80       .40       .38  
Credit card
    291       267       3.09       3.08  
Other retail
    45       39       .11       .10  
     
 
Total
    $435       $405       .30 %     .28 %
 
Analysis of Loan Net Charge-Offs Total loan net charge-offs were $191 million and $368 million during the second quarter and first six months of 2007, respectively, compared with net charge-offs of $125 million and $240 million, respectively, for the same periods of 2006. The ratio of total loan net charge-offs to average loans outstanding on an annualized basis in the second quarter and first six months of 2007 was .53 percent and ..51 percent, respectively, compared with .36 percent and .35 percent, respectively, for the same periods of 2006. The expected year-over-year increases in total net charge-offs were due primarily to an anticipated increase in consumer charge-offs, specifically related to strong credit card growth, lower credit card charge-offs in prior periods related to the impact of changes in bankruptcy legislation that went into effect in late 2005 and the impact of implementing minimum balance payment programs for consumer loans.
     Commercial and commercial real estate loan net charge-offs for the second quarter of 2007 were $38 million (.20 percent of average loans outstanding on an annualized basis), compared with $20 million (.11 percent of average loans outstanding on an annualized basis) for the second quarter of 2006. Commercial and commercial real estate loan net charge-offs for the first six months of 2007 were $74 million (.20 percent of average loans outstanding on an annualized basis), compared with $34 million (.09 percent of average loans outstanding on an annualized basis) for the first six months of 2006. The Company expects commercial and commercial real estate net charge-offs to continue to increase somewhat over the next several quarters, due to higher gross charge-offs and lower loan recoveries.
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Table 7 Net Charge-offs as a Percent of Average Loans Outstanding
                                       
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
    2007   2006   2007   2006
 
Commercial
                               
 
Commercial
    .20 %     .13 %     .26 %     .09 %
 
Lease financing
    .57       .54       .40       .55  
     
   
Total commercial
    .25       .18       .27       .15  
Commercial real estate
                               
 
Commercial mortgages
    .14       (.02 )     .08       .01  
 
Construction and development
    .09       .05       .05       .02  
     
   
Total commercial real estate
    .13             .07       .01  
Residential mortgages
    .28       .21       .25       .17  
Retail
                               
 
Credit card
    3.56       2.72       3.52       2.67  
 
Retail leasing
    .24       .11       .21       .17  
 
Home equity and second mortgages
    .41       .35       .41       .34  
 
Other retail
    .89       .77       .89       .82  
     
   
Total retail
    1.15       .84       1.13       .85  
     
     
Total loans
    .53 %     .36 %     .51 %     .35 %
 
     Retail loan net charge-offs for the second quarter of 2007 were $138 million (1.15 percent of average loans outstanding on an annualized basis), compared with $94 million (.84 percent of average loans outstanding on an annualized basis) for the second quarter of 2006. Retail loan net charge-offs for the first six months of 2007 were $267 million (1.13 percent of average loans outstanding on an annualized basis), compared with $188 million (.85 percent of average loans outstanding on an annualized basis) for the first six months of 2006. The increase in retail loan net charge-offs reflected the impact of bankruptcy legislation changes that occurred in late 2005 and the implementation of the minimum balance payment requirements for credit cards. The Company anticipates slightly higher delinquencies in the retail portfolios and that net charge-offs will continue to increase modestly during the remainder of 2007.
The following table provides an analysis of net charge-offs as a percent of average loans outstanding managed by the consumer finance division, compared with other retail related loans:
                                                                 
    Three Months Ended June 30   Six Months Ended June 30
     
        Percent of       Percent of
    Average Loans   Average Loans   Average Loans   Average Loans
     
(Dollars in Millions)   2007   2006   2007   2006   2007   2006   2007   2006
 
Consumer Finance (a)
                                                               
  Residential mortgages
    $8,969       $7,295       .58 %     .49 %     $8,731       $7,055       .55 %     .46 %
  Home equity and second mortgages
    1,836       1,984       2.40       1.62       1,853       2,021       2.29       1.50  
  Other retail
    412       402       1.95       3.99       406       403       2.48       4.50  
Other Retail
                                                               
  Residential mortgages
    $12,862       $13,573       .06 %     .06 %     $12,969       $13,872       .05 %     .03 %
  Home equity and second mortgages
    13,899       13,051       .14       .15       13,793       12,964       .16       .16  
  Other retail
    16,193       14,725       .87       .68       16,116       14,634       .85       .72  
Total Company
                                                               
  Residential mortgages
    $21,831       $20,868       .28 %     .21 %     $21,700       $20,927       .25 %     .17 %
  Home equity and second mortgages
    15,735       15,035       .41       .35       15,646       14,985       .41       .34  
  Other retail
    16,605       15,127       .89       .77       16,522       15,037       .89       .82  
 
(a) Consumer finance category included credit originated and managed by US Bank Consumer Finance as well as home equity and second mortgages with a loan-to-value greater than 100 percent that were originated in the branches.
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Within the consumer finance division, the Company originates loans to customers that may be defined as sub-prime borrowers. The following table provides further information on net charge-offs as a percent of average loans outstanding for this division:
                                                                   
    Three Months Ended June 30   Six Months Ended June 30
     
        Percent of       Percent of
    Average Loans   Average Loans   Average Loans   Average Loans
     
(Dollars in Millions)   2007   2006   2007   2006   2007   2006   2007   2006
 
Residential mortgages
                                                               
  Sub-prime borrowers
    $3,134       $2,558       1.15 %     .94 %     $3,070       $2,404       1.12 %     .84 %
  Other borrowers
    5,835       4,737       .27       .25       5,661       4,651       .25       .26  
     
 
Total
    $8,969       $7,295       .58 %     .49 %     $8,731       $7,055       .55 %     .46 %
Home equity and second mortgages
                                                               
  Sub-prime borrowers
    $911       $827       3.08 %     1.94 %     $911       $813       2.88 %     1.74 %
  Other borrowers
    925       1,157       1.73       1.39       942       1,208       1.71       1.34  
     
 
Total
    $1,836       $1,984       2.40 %     1.62 %     $1,853       $2,021       2.29 %     1.50 %
 
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. Several factors were taken into consideration in evaluating the allowance for credit losses at June 30, 2007, 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, 2006. Management also considered the uncertainty related to certain industry sectors, and the extent of credit exposure to specific borrowers within the portfolio. In addition, concentration risks associated with commercial real estate and the mix of loans, including credit cards, loans originated through the consumer finance division and residential mortgage balances, and their relative credit risks were evaluated. Finally, the Company considered current economic conditions that might impact the portfolio.
     At June 30, 2007, the allowance for credit losses was $2,260 million (1.55 percent of loans), compared with an allowance of $2,256 million (1.57 percent of loans) at December 31, 2006. The ratio of the allowance for credit losses to nonperforming loans was 503 percent at June 30, 2007, compared with 480 percent at December 31, 2006. The ratio of the allowance for credit losses to annualized loan net charge-offs was 295 percent at June 30, 2007, compared with 415 percent at December 31, 2006.
Residual Value Risk Management The Company manages its risk to changes in the residual value of leased assets through disciplined residual valuation setting at the inception of a lease, diversification of its leased assets, regular residual asset valuation reviews and monitoring of residual value gains or losses upon the disposition of assets. As of June 30, 2007, no significant change in the amount of residuals or concentration of the portfolios has occurred since December 31, 2006. Refer to “Management’s Discussion and Analysis — Residual Value Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, for further discussion on residual value 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 operating risks on a regular basis. Business lines have direct and primary responsibility and accountability for identifying, controlling, and monitoring operational risks embedded in their business activities. 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, 2006, for further discussion on operational risk management.
Interest Rate Risk Management In the banking industry, changes in interest rates are a significant risk that can impact earnings, market valuations and safety and soundness of an entity. To minimize the volatility of net interest income and the market value of assets and liabilities, the Company manages its exposure to changes in interest rates through asset and liability management activities within guidelines established by its Asset Liability Policy Committee (“ALPC”) and approved by the Board of Directors. ALPC has the responsibility for approving and ensuring compliance with ALPC management policies, including interest rate
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Table 8 Summary of Allowance for Credit Losses
                                         
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
(Dollars in Millions)   2007   2006   2007   2006
 
Balance at beginning of period
    $2,260       $2,251       $2,256       $2,251  
Charge-offs
                               
 
Commercial
                               
   
Commercial
    34       24       79       52  
   
Lease financing
    15       13       29       25  
     
     
Total commercial
    49       37       108       77  
 
Commercial real estate
                               
   
Commercial mortgages
    8       3       10       6  
   
Construction and development
    2       1       2       1  
     
     
Total commercial real estate
    10       4       12       7  
 
Residential mortgages
    16       11       28       19  
 
Retail
                               
   
Credit card
    98       59       187       113  
   
Retail leasing
    6       6       11       13  
   
Home equity and second mortgages
    18       16       36       32  
   
Other retail
    55       43       107       90  
     
     
Total retail
    177       124       341       248  
     
       
Total charge-offs
    252       176       489       351  
Recoveries
                               
 
Commercial
                               
   
Commercial
    13       11       26       34  
   
Lease financing
    7       6       18       11  
     
     
Total commercial
    20       17       44       45  
 
Commercial real estate
                               
   
Commercial mortgages
    1       4       2       5  
   
Construction and development
                       
     
     
Total commercial real estate
    1       4       2       5  
 
Residential mortgages
    1             1       1  
 
Retail
                               
   
Credit card
    17       9       32       17  
   
Retail leasing
    2       4       4       7  
   
Home equity and second mortgages
    2       3       4       7  
   
Other retail
    18       14       34       29  
     
     
Total retail
    39       30       74       60  
     
       
Total recoveries
    61       51       121       111  
Net Charge-offs
                               
 
Commercial
                               
   
Commercial
    21       13       53       18  
   
Lease financing
    8       7       11       14  
     
     
Total commercial
    29       20       64       32  
 
Commercial real estate
                               
   
Commercial mortgages
    7       (1 )     8       1  
   
Construction and development
    2       1       2       1  
     
     
Total commercial real estate
    9             10       2  
 
Residential mortgages
    15       11       27       18  
 
Retail
                               
   
Credit card
    81       50       155       96  
   
Retail leasing
    4       2       7       6  
   
Home equity and second mortgages
    16       13       32       25  
   
Other retail
    37       29       73       61  
     
     
Total retail
    138       94       267       188  
     
       
Total net charge-offs
    191       125       368       240  
     
Provision for credit losses
    191       125       368       240  
Acquisitions and other changes
                4        
     
Balance at end of period
    $2,260       $2,251       $2,260       $2,251  
     
Components
                               
 
Allowance for loan losses
    $2,028       $2,039                  
 
Liability for unfunded credit commitments
    232       212                  
                 
   
Total allowance for credit losses
    $2,260       $2,251                  
                 
Allowance for credit losses as a percentage of
                               
 
Period-end loans
    1.55 %     1.61 %                
 
Nonperforming loans
    503       500                  
 
Nonperforming assets
    400       409                  
 
Annualized net charge-offs
    295       449                  
 
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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 Through this simulation, management estimates the impact on net interest income of gradual upward or downward changes of market interest rates over a one-year period, the effect of immediate and sustained parallel shifts in the yield curve and the effect of immediate and sustained flattening or steepening of the yield curve. The table below summarizes the interest rate risk of net interest income based on forecasts over the succeeding 12 months. At June 30, 2007, the Company’s overall interest rate risk position was liability sensitive to changes in interest rates. ALPC policy guidelines limit the estimated change in net interest income to 4.0 percent of forecasted net interest income over the succeeding 12 months. At June 30, 2007, and December 31, 2006, the Company was within its policy guidelines. 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, 2006, for further discussion on net interest income simulation analysis.
Market Value of Equity Modeling The Company also manages interest rate sensitivity by utilizing market value of equity modeling, which 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 June 30, 2007. The up 200 basis point scenario resulted in a 9.2 percent decrease in the market value of equity at June 30, 2007, compared with a 6.7 percent decrease at December 31, 2006. The down 200 basis point scenario resulted in a ..6 percent decrease in the market value of equity at June 30, 2007, compared with a 1.8 percent decrease at December 31, 2006. At June 30, 2007, and December 31, 2006, 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. At June 30, 2007, the duration of assets, liabilities and equity was 2.0 years, 1.8 years and 2.7 years, respectively, compared with 1.8 years, 1.9 years and 1.6 years, respectively, at December 31, 2006. The duration of equity measures shows that sensitivity of the market value of equity of the Company was liability sensitive to changes in interest rates. 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, 2006, for further discussion on market value of equity modeling.
Use of Derivatives to Manage Interest Rate and Other Risks In the ordinary course of business, the Company enters into derivative transactions to manage its interest rate, prepayment, credit, price and foreign currency risks (“asset and liability management positions”) and to accommodate the business requirements of its customers (“customer-related positions”). Refer to “Management’s Discussion and Analysis — Use of Derivatives to Manage Interest Rate and Other Risks” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, for further discussion on the use of derivatives to manage interest rate and other risks.
Sensitivity of Net Interest Income:
                                                                 
    June 30, 2007   December 31, 2006
     
    Down 50   Up 50   Down 200   Up 200   Down 50   Up 50   Down 200   Up 200
    Immediate   Immediate   Gradual   Gradual   Immediate   Immediate   Gradual   Gradual
 
Net interest income
    1.50%       (1.82)%       2.66%       (3.46)%       .42%       (1.43)%       .92%       (2.95)%  
 
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Table 9 Derivative Positions
                                                       
    June 30, 2007   December 31, 2006
     
        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
    $3,380       $(137 )     42.79       $5,345       $27       22.97  
   
Pay fixed/receive floating swaps
    16,387       92       2.25       12,329             2.33  
   
Futures and forwards
                                               
     
Buy
    5,318       (22 )     .11       4,008             .22  
     
Sell
    6,814       42       .13       2,816       3       .09  
   
Options
                                               
     
Written
    8,103       (4 )     .13       7,544       (1 )     .13  
 
Foreign exchange contracts
                                               
   
Cross-currency swaps
    1,777       40       9.30       386       14       8.61  
   
Forwards
    115       (2 )     .04       318       1       .02  
 
Equity contracts
    85       (2 )     2.67       86       4       2.95  
 
Credit default swaps
    66       (1 )     4.08       25       (1 )     4.72  
 
Customer-related Positions
                                               
 
 
Interest rate contracts
                                               
   
Receive fixed/pay floating swaps
    $11,376       $(160 )     5.34       $10,371       $(42 )     5.42  
   
Pay fixed/receive floating swaps
    11,370       219       5.34       10,341       98       5.42  
   
Options
                                               
     
Purchased
    1,743       10       1.96       1,899       5       1.92  
     
Written
    1,736       (9 )     1.96       1,899       (3 )     1.92  
 
Risk participation agreements (a)
                                               
   
Purchased
    201             7.65       206             6.62  
   
Written
    532             5.93       356             6.05  
 
Foreign exchange rate contracts
                                               
   
Forwards and swaps
                                               
   
Buy
    2,321       71       .40       2,092       52       .46  
   
Sell
    2,430       (64 )     .37       2,033       (43 )     .47  
 
Options
                                               
   
Purchased
    328       (3 )     .63       408       (3 )     .44  
   
Written
    328       3       .62       408       3       .44  
 
(a) At June 30, 2007, the credit equivalent amount was $2 million and $68 million, compared with $2 million and $50 million at December 31, 2006, for purchased and written risk participation agreements, respectively.
     By their nature, derivative instruments are subject to market risk. The Company does not utilize derivative instruments for speculative purposes. Of the Company’s $42.0 billion of total notional amount of asset and liability management positions at June 30, 2007, $26.8 billion was designated as either cash flow or fair value hedges or net investment hedges of foreign operations. The cash flow hedge derivative positions are interest rate swaps that hedge the forecasted cash flows from the underlying variable-rate debt. The fair value hedges are primarily interest rate swaps that hedge the change in fair value related to interest rate changes of underlying fixed-rate debt and subordinated obligations.
     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. In connection with its mortgage banking operations, the Company held $2.5 billion of forward commitments to sell mortgage loans and $2.4 billion of unfunded mortgage loan commitments at June 30, 2007, that were derivatives in accordance with the provisions of the Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedge Activities.” The unfunded mortgage loan commitments are reported at fair value as options in Table 9. The Company also utilizes U.S. Treasury futures, options on U.S. Treasury futures contracts and forward commitments to buy residential mortgage loans to economically hedge the change in fair value of its residential MSRs.
     At June 30, 2007, the Company had less than $1 million in accumulated other comprehensive income related to realized and unrealized losses on derivatives classified as cash flow hedges. Unrealized gains and
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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 2007 and the next 12 months is a loss of $12 million and $16 million, respectively.
     The change in the fair value of all other asset and liability management positions attributed to hedge ineffectiveness recorded in noninterest income was not material for the second quarter and first six months of 2007. Gains or losses on customer-related positions were not material for the second quarter and first six months of 2007.
     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 fluctuations in foreign currency exchange rates. The net amount of gains or losses included in the cumulative translation adjustment for the second quarter and first six months of 2007 was not material.
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. These trading activities principally support the risk management processes of the Company’s customers including their management of foreign currency and interest rate risks. The Company also manages market risk of non-trading business activities including its MSRs and loans held-for-sale. 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.
     The Company’s market valuation risk for trading and non-trading positions, as estimated by the VaR analysis, was $1 million and $13 million, respectively, at June 30, 2007, compared with $1 million and $30 million, respectively, at December 31, 2006. At June 30, 2007, the Company’s VaR limit was $45 million. 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, 2006, 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 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, 2006, for further discussion on liquidity risk management.
     At June 30, 2007, parent company long-term debt outstanding was $14.5 billion, compared with $11.4 billion at December 31, 2006. The $3.1 billion increase was primarily due to the issuances of $3.0 billion of convertible senior debentures and $.5 billion of junior subordinated debentures during the first six months of 2007. As of June 30, 2007, there was $1.3 billion of parent company debt scheduled to mature during the remainder of 2007.
     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 June 30, 2007.
Capital Management The Company is committed to managing capital for maximum shareholder benefit and maintaining strong protection for depositors and creditors. In the first six months of 2007, the Company returned 139 percent of earnings to its common shareholders through a combination of dividends and net share repurchases. The Company also manages its capital to exceed regulatory capital requirements for well-capitalized bank holding companies. Table 10 provides a summary of capital ratios as of June 30, 2007, and December 31, 2006. All regulatory ratios continue to be in excess of regulatory “well-capitalized” requirements. Total shareholders’ equity was $20.3 billion at June 30, 2007, compared with $21.2 billion at December 31, 2006. The decrease was the result of share repurchases and dividends, partially offset by corporate earnings.
     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.
18 U.S. Bancorp


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Table 10 Capital Ratios
                   
    June 30,   December 31,
(Dollars in Millions)   2007   2006
 
Tier 1 capital
    $16,876       $17,036  
 
As a percent of risk-weighted assets
    8.5 %     8.8 %
 
As a percent of adjusted quarterly average assets (leverage ratio)
    7.9 %     8.2 %
Total risk-based capital
    $25,709       $24,495  
 
As a percent of risk-weighted assets
    13.0 %     12.6 %
Tangible common equity
    $11,194       $11,703  
 
As a percent of tangible assets
    5.2 %     5.5 %
 

The following table provides a detailed analysis of all shares repurchased under this authorization during the second quarter of 2007:
                         
            Maximum
    Total Number       Number of
    of Shares       Shares that May
    Purchased as   Average   Yet Be Purchased
    Part of the   Price Paid   Under the
Time Period   Program   per Share   Program
 
April
    5,052,241     $34.61       82,529,448  
May
    5,462,142       34.50       77,067,306  
June
    7,167,833       33.82       69,899,473  
     
 Total
    17,682,216       $34.26       69,899,473  
 
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, 2006, 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 2007, certain organization and methodology changes were made and, accordingly, 2006 results were restated and presented on a comparable basis.
Wholesale Banking offers lending, equipment finance and small-ticket leasing, depository, treasury management, capital markets, foreign exchange, international trade services and other financial services to middle market, large corporate, commercial real estate and public sector clients. Wholesale Banking contributed $278 million of the Company’s net income in the second quarter and $553 million in the first six months of 2007, or decreases of $27 million (8.9 percent) and $59 million (9.6 percent), respectively, compared with the same periods of 2006. The decreases were primarily driven by lower total net revenue, higher total noninterest expense and an increase in the provision for credit losses.
     Total net revenue decreased $19 million (2.7 percent) in the second quarter and $45 million (3.2 percent) in the first six months of 2007, compared with the same periods of 2006. Net interest income, on a taxable-equivalent basis, decreased $32 million (6.6 percent) in the second quarter and $58 million (6.0 percent) in the first six months of 2007, compared with the same periods of 2006. The decreases were driven by tighter credit spreads and a decline in average noninterest-bearing deposit balances as customers utilized their liquidity to fund business growth and to generate higher returns by investing excess funds in interest-bearing deposit and sweep products. The decreases were partially offset by growth in average loan balances and the margin benefit of deposits. The increase in average loans was driven by commercial loan growth during 2006 and the first six months of 2007. Noninterest income increased $13 million (5.8 percent) in the second quarter and $13 million (2.9 percent) in the first six months of 2007, compared with the same periods of 2006, as an increase in treasury management revenue was offset by lower capital markets revenue.
     Total noninterest expense increased $11 million (4.8 percent) in the second quarter and $13 million (2.8 percent) in the first six months of 2007, compared with the same periods of 2006, primarily as a result of increases in personnel expenses related to investments in select business units. The provision for credit losses increased $12 million in the second quarter and $33 million in the first six months of 2007, compared with the same periods of 2006. The unfavorable
U.S. Bancorp 19


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Table 11 Line of Business Financial Performance
                                                     
    Wholesale   Consumer
    Banking   Banking
     
            Percent       Percent
Three Months Ended June 30 (Dollars in Millions)   2007   2006   Change   2007   2006   Change
 
Condensed Income Statement
                                               
Net interest income (taxable-equivalent basis)
    $453       $485       (6.6 )%     $968       $967       .1 %
Noninterest income
    238       223       6.7       472       466       1.3  
Securities gains (losses), net
          2       *                    
                     
 
Total net revenue
    691       710       (2.7 )     1,440       1,433       .5  
Noninterest expense
    238       227       4.8       633       599       5.7  
Other intangibles
    4       4             13       12       8.3  
                     
 
Total noninterest expense
    242       231       4.8       646       611       5.7  
                     
   
Income before provision and income taxes
    449       479       (6.3 )     794       822       (3.4 )
Provision for credit losses
    12             *       77       55       40.0  
                     
Income before income taxes
    437       479       (8.8 )     717       767       (6.5 )
Income taxes and taxable-equivalent adjustment
    159       174       (8.6 )     261       279       (6.5 )
                     
Net income
    $278       $305       (8.9 )     $456       $488       (6.6 )
                     
Average Balance Sheet Data
                                               
Commercial
    $34,410       $33,266       3.4 %     $6,492       $6,386       1.7 %
Commercial real estate
    16,687       17,344       (3.8 )     11,079       10,686       3.7  
Residential mortgages
    70       54       29.6       21,300       20,363       4.6  
Retail
    66       38       73.7       35,514       33,618       5.6  
                     
 
Total loans
    51,233       50,702       1.0       74,385       71,053       4.7  
Goodwill
    1,329       1,329             2,218       2,108       5.2  
Other intangible assets
    40       55       (27.3 )     1,682       1,453       15.8  
Assets
    56,869       56,494       .7       85,170       80,777       5.4  
Noninterest-bearing deposits
    11,112       12,127       (8.4 )     12,175       12,672       (3.9 )
Interest checking
    4,819       3,175       51.8       17,988       17,768       1.2  
Savings products
    5,054       5,572       (9.3 )     19,671       21,365       (7.9 )
Time deposits
    9,392       13,254       (29.1 )     20,094       18,483       8.7  
                     
 
Total deposits
    30,377       34,128       (11.0 )     69,928       70,288       (.5 )
Shareholders’ equity
    5,720       5,729       (.2 )     6,353       6,393       (.6 )
 
                                                     
    Wholesale   Consumer
    Banking   Banking
     
        Percent       Percent
Six Months Ended June 30 (Dollars in Millions)   2007   2006   Change   2007   2006   Change
 
Condensed Income Statement
                                               
Net interest income (taxable-equivalent basis)
    $906       $964       (6.0 )%     $1,930       $1,914       .8 %
Noninterest income
    463       448       3.3       902       849       6.2  
Securities gains (losses), net
          2       *                    
                     
 
Total net revenue
    1,369       1,414       (3.2 )     2,832       2,763       2.5  
Noninterest expense
    465       452       2.9       1,258       1,204       4.5  
Other intangibles
    8       8             27       25       8.0  
                     
 
Total noninterest expense
    473       460       2.8       1,285       1,229       4.6  
                     
   
Income before provision and income taxes
    896       954       (6.1 )     1,547       1,534       .8  
Provision for credit losses
    26       (7 )     *       146       117       24.8  
                     
Income before income taxes
    870       961       (9.5 )     1,401       1,417       (1.1 )
Income taxes and taxable-equivalent adjustment
    317       349       (9.2 )     510       516       (1.2 )
                     
Net income
    $553       $612       (9.6 )     $891       $901       (1.1 )
                     
Average Balance Sheet Data
                                               
Commercial
    $34,546       $32,840       5.2 %     $6,439       $6,351       1.4 %
Commercial real estate
    16,759       17,309       (3.2 )     11,074       10,639       4.1  
Residential mortgages
    65       56       16.1       21,171       20,418       3.7  
Retail
    66       40       65.0       35,413       33,528       5.6  
                     
 
Total loans
    51,436       50,245       2.4       74,097       70,936       4.5  
Goodwill
    1,329       1,329             2,212       2,106       5.0  
Other intangible assets
    42       57       (26.3 )     1,640       1,393       17.7  
Assets
    56,803       55,837       1.7       84,571       80,408       5.2  
Noninterest-bearing deposits
    10,963       12,063       (9.1 )     12,145       12,673       (4.2 )
Interest checking
    4,662       3,149       48.0       17,896       17,702       1.1  
Savings products
    5,391       5,431       (.7 )     19,736       21,848       (9.7 )
Time deposits
    10,567       12,750       (17.1 )     19,997       18,252       9.6  
                     
 
Total deposits
    31,583       33,393       (5.4 )     69,774       70,475       (1.0 )
Shareholders’ equity
    5,756       5,653       1.8       6,391       6,323       1.1  
 
* Not meaningful
20 U.S. Bancorp


Table of Contents

                                                                                                 
Wealth   Payment   Treasury and   Consolidated    
Management   Services   Corporate Support   Company    
 
    Percent       Percent       Percent       Percent    
2007   2006   Change   2007   2006   Change   2007   2006   Change   2007   2006   Change    
 
 
  $120       $128       (6.3 )%     $166       $156       6.4 %     $(57 )     $(39 )     (46.2 )%     $1,650       $1,697       (2.8 )%    
  403       369       9.2       733       654       12.1       6       40       (85.0 )     1,852       1,752       5.7      
   —                                     3       1       *       3       3            
                                         
  523       497       5.2       899       810       11.0       (48 )     2       *       3,505       3,452       1.5      
  234       238       (1.7 )     336       297       13.1       104       80       30.0       1,545       1,441       7.2      
  23       22       4.5       55       51       7.8                         95       89       6.7      
                                         
  257       260       (1.2 )     391       348       12.4       104       80       30.0       1,640       1,530       7.2      
                                         
  266       237       12.2       508       462       10.0       (152 )     (78 )     (94.9 )     1,865       1,922       (3.0 )    
   —       2       *       101       65       55.4       1       3       (66.7 )     191       125       52.8      
                                         
  266       235       13.2       407       397       2.5       (153 )     (81 )     (88.9 )     1,674       1,797       (6.8 )    
  97       86       12.8       148       144       2.8       (147 )     (87 )     (69.0 )     518       596       (13.1 )    
                                         
  $169       $149       13.4       $259       $253       2.4       $(6 )     $6       *       $1,156       $1,201       (3.7 )    
                                         
 
  $1,991       $1,539       29.4 %     $4,160       $3,759       10.7 %     $144       $120       20.0 %     $47,197       $45,070       4.7 %    
  672       702       (4.3 )                       65       63       3.2       28,503       28,795       (1.0 )    
  457       447       2.2                         4       4             21,831       20,868       4.6      
  2,335       2,425       (3.7 )     10,167       8,512       19.4       40       44       (9.1 )     48,122       44,637       7.8      
                                         
  5,455       5,113       6.7       14,327       12,271       16.8       253       231       9.5       145,653       139,370       4.5      
  1,553       1,378       12.7       2,489       2,463       1.1             1       *       7,589       7,279       4.3      
  425       473       (10.1 )     1,122       1,165       (3.7 )                       3,269       3,146       3.9      
  8,027       7,533       6.6       19,805       17,295       14.5       52,151       50,308       3.7       222,022       212,407       4.5      
  4,270       3,682       16.0       367       298       23.2       53       170       (68.8 )     27,977       28,949       (3.4 )    
  3,047       2,387       27.6                         4       3       33.3       25,858       23,333       10.8      
  5,251       5,702       (7.9 )     21       19       10.5       49       43       14.0       30,046       32,701       (8.1 )    
  3,703       2,859       29.5       3       3             1,902       1,651       15.2       35,094       36,250       (3.2 )    
                                         
  16,271       14,630       11.2       391       320       22.2       2,008       1,867       7.6       118,975       121,233       (1.9 )    
  2,475       2,339       5.8       4,842       4,744       2.1       1,505       1,351       11.4       20,895       20,556       1.6      
 
                                                                                                 
Wealth   Payment   Treasury and   Consolidated    
Management   Services   Corporate Support   Company    
 
    Percent       Percent       Percent       Percent    
2007   2006   Change   2007   2006   Change   2007   2006   Change   2007   2006   Change    
 
 
  $241       $253       (4.7 )%     $335       $319       5.0 %     $(96 )     $(28 )     * %     $3,316       $3,422       (3.1 )%    
  777       719       8.1       1,391       1,244       11.8       14       106       (86.8 )     3,547       3,366       5.4      
   —                                     4       1       *       4       3       33.3      
                                         
  1,018       972       4.7       1,726       1,563       10.4       (78 )     79       *       6,867       6,791       1.1      
  466       475       (1.9 )     656       591       11.0       151       134       12.7       2,996       2,856       4.9      
  46       44       4.5       108       97       11.3                         189       174       8.6      
                                         
  512       519       (1.3 )     764       688       11.0       151       134       12.7       3,185       3,030       5.1      
                                         
  506       453       11.7       962       875       9.9       (229 )     (55 )     *       3,682       3,761       (2.1 )    
   —       2       *       194       125       55.2       2       3       (33.3 )     368       240       53.3      
                                         
  506       451       12.2       768       750       2.4       (231 )     (58 )     *       3,314       3,521       (5.9 )    
  184       165       11.5       279       272       2.6       (262 )     (135 )     (94.1 )     1,028       1,167       (11.9 )    
                                         
  $322       $286       12.6       $489       $478       2.3       $31       $77       (59.7 )     $2,286       $2,354       (2.9 )    
                                         
 
  $1,979       $1,528       29.5 %     $3,998       $3,647       9.6 %     $141       $135       4.4 %     $47,103       $44,501       5.8 %    
  675       694       (2.7 )                       65       64       1.6       28,573       28,706       (.5 )    
  460       449       2.4                         4       4             21,700       20,927       3.7      
  2,340       2,415       (3.1 )     9,941       8,417       18.1       40       45       (11.1 )     47,800       44,445       7.5      
                                         
  5,454       5,086       7.2       13,939       12,064       15.5       250       248       .8       145,176       138,579       4.8      
  1,551       1,376       12.7       2,473       2,376       4.1       14       1       *       7,579       7,188       5.4      
  437       484       (9.7 )     1,105       1,110       (.5 )     21             *       3,245       3,044       6.6      
  8,023       7,512       6.8       19,301       16,884       14.3       52,076       50,581       3.0       220,774       211,222       4.5      
  4,262       3,662       16.4       410       296       38.5       48       199       (75.9 )     27,828       28,893       (3.7 )    
  2,908       2,384       22.0                         4       3       33.3       25,470       23,238       9.6      
  5,370       5,552       (3.3 )     21       19       10.5       58       33       75.8       30,576       32,883       (7.0 )    
  3,784       2,449       54.5       3       3             1,622       2,233       (27.4 )     35,973       35,687       .8      
                                         
  16,324       14,047       16.2       434       318       36.5       1,732       2,468       (29.8 )     119,847       120,701       (.7 )    
  2,486       2,342       6.1       4,793       4,555       5.2       1,626       1,480       9.9       21,052       20,353       3.4      
 
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changes were primarily due to an increase in gross charge-offs. Credit quality continued to be strong within this business segment. Nonperforming assets were $230 million at June 30, 2007, $226 million at March 31, 2007, and $218 million at June 30, 2006. Nonperforming assets as a percentage of period-end loans were .46 percent at June 30, 2007, .44 percent at March 31, 2007, and .43 percent at June 30, 2006. 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 banking, student banking and 24-hour banking. Consumer Banking contributed $456 million of the Company’s net income in the second quarter and $891 million in the first six months of 2007, or decreases of $32 million (6.6 percent) and $10 million (1.1 percent), respectively, compared with the same periods of 2006. The retail banking division contributed $428 million of the total contribution in the second quarter and $838 million in the first six months of 2007, or decreases of 5.9 percent and 3.0 percent, respectively, compared with the same periods in the prior year.
     Total net revenue increased $7 million (.5 percent) in the second quarter and $69 million (2.5 percent) in the first six months of 2007, compared with the same periods of 2006. Net interest income, on a taxable-equivalent basis, increased $1 million (.1 percent) in the second quarter and $16 million (.8 percent) in the first six months of 2007, compared with the same periods of 2006. The year-over-year increases in net interest income were due to growth in average loans, higher loan fees and the funding benefit of deposits. Partially offsetting these increases were reduced spreads on commercial and retail loans due to competitive pricing within the Company’s markets. The increases in average loan balances reflected growth in all loan categories, with the largest increase in retail loans. The growth in retail loans was principally driven by an increase in installment and home equity loans, partially offset by a reduction in retail leasing balances due to customer demand for installment loan products and pricing competition. The year-over-year decreases in average deposits reflected a reduction in savings and noninterest-bearing deposit products, partially offset by growth in time deposits and interest checking. Average time deposit balances grew $1.6 billion (8.7 percent) in the second quarter and $1.7 billion (9.6 percent) in the first six months of 2007, compared with the same periods of 2006, as a portion of noninterest-bearing and money market balances migrated to fixed-rate time deposit products. Average savings balances declined $1.7 billion (7.9 percent), in the second quarter and $2.1 billion (9.7 percent) in the first six months of 2007, compared with the same periods of 2006, primarily related to a decrease in money market account balances. Fee-based noninterest income increased $6 million (1.3 percent) in the second quarter and $53 million (6.2 percent) in the first six months of 2007, compared with the same periods of 2006. The increase in fee-based revenue in the second quarter of 2007, compared to the same period of 2006 was driven primarily by an increase in deposit service charges. The increase in fee-based revenue in the first six months of 2007, compared to the same period of 2006, was driven by an increase in mortgage banking revenue, principally related to the adoption of fair value accounting for MSRs, as well as an increase in deposit service charges. These increases were partially offset by lower revenue related to student loan sales.
     Total noninterest expense increased $35 million (5.7 percent) in the second quarter and $56 million (4.6 percent) in the first six months of 2007, compared with the same periods of 2006. The increases were primarily attributable to increases in compensation and employee benefit expenses which reflected the net addition, including the impact of recent acquisitions, of 25 in-store and 40 traditional branches at June 30, 2007, compared with June 30, 2006.
     The provision for credit losses increased $22 million (40.0 percent) in the second quarter and $29 million (24.8 percent) in the first six months of 2007, compared with the same periods of 2006. The increases were attributable to higher net charge-offs. As a percentage of average loans outstanding on an annualized basis, net charge-offs increased to ..42 percent in the second quarter of 2007, compared with ..31 percent in the second quarter of 2006. Commercial and commercial real estate loan net charge-offs increased $4 million (40.0 percent) in the second quarter of 2007, compared with the second quarter of 2006. Retail loan and residential mortgage net charge-offs increased $18 million (40.0 percent) in the second quarter of 2007, compared with the second quarter of 2006, reflecting higher levels of bankruptcy-related losses. Nonperforming assets were $300 million at June 30, 2007, $312 million at March 31, 2007, and $275 million at June 30, 2006. Nonperforming assets as a percentage of period-end loans were .42 percent at
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June 30, 2007, .44 percent at March 31, 2007, and ..40 percent at June 30, 2006. Refer to the “Corporate Risk Profile” section for further information on factors impacting the credit quality of the loan portfolios.
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 & Insurance, FAF Advisors, Institutional Trust & Custody and Fund Services. Wealth Management contributed $169 million of the Company’s net income in the second quarter and $322 million in the first six months of 2007, or increases of $20 million (13.4 percent) and $36 million (12.6 percent), respectively, compared with the same periods of 2006. The growth was primarily attributable to core account fee growth and improved equity market conditions relative to a year ago.
     Total net revenue increased $26 million (5.2 percent) in the second quarter and $46 million (4.7 percent) in the first six months of 2007, compared with the same periods of 2006. Net interest income, on a taxable-equivalent basis, decreased $8 million (6.3 percent) in the second quarter and $12 million (4.7 percent) in the first six months of 2007, compared with the same periods of 2006. The decreases in net interest income were due to the unfavorable impacts from deposit pricing and tightening credit spreads, partially offset by earnings from deposit growth. The increases in total deposits were attributable to growth in noninterest-bearing deposits, interest checking and time deposits, principally due to acquired businesses. Noninterest income increased $34 million (9.2 percent) in the second quarter and $58 million (8.1 percent) in the first six months of 2007, compared with the same periods of 2006, primarily driven by core account fee growth and favorable equity market conditions.
     Total noninterest expense decreased $3 million (1.2 percent) in the second quarter and $7 million (1.3 percent) in the first six months of 2007, compared with the same periods of 2006. The decreases were primarily due to the completion of certain acquisition integration activities.
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 $259 million of the Company’s net income in the second quarter and $489 million in the first six months of 2007, or increases of $6 million (2.4 percent) and $11 million (2.3 percent), respectively, compared with the same periods of 2006. The increases were due to growth in total net revenue driven by loan growth and higher transaction volumes, partially offset by an increase in total noninterest expense and a higher provision for credit losses.
     Total net revenue increased $89 million (11.0 percent) in the second quarter and $163 million (10.4 percent) in the first six months of 2007, compared with the same periods of 2006. Net interest income, on a taxable-equivalent basis, increased $10 million (6.4 percent) in the second quarter and $16 million (5.0 percent) in the first six months of 2007, compared with the same periods of 2006. The increases were primarily due to growth in higher yielding retail credit card loan balances, partially offset by declining spreads on retail credit cards. Noninterest income increased $79 million (12.1 percent) in the second quarter and $147 million (11.8 percent) in the first six months of 2007, compared with the same periods of 2006. The increases in fee-based revenue were driven by higher transaction volumes, rate changes, and business expansion initiatives. The increase in noninterest income for the first six months of 2007, compared with the same period of the prior year, was partially offset by a merchant processing settlement recorded in the first quarter of 2006.
     Total noninterest expense increased $43 million (12.4 percent) in the second quarter and $76 million (11.0 percent) in the first six months of 2007, compared with the same periods of 2006. The increases were primarily attributable to the acquisition of merchant acquiring and corporate payments businesses, and growth in personnel expense, marketing, and consulting expense related to other new business initiatives.
     The provision for credit losses increased $36 million (55.4 percent) in the second quarter and $69 million (55.2 percent) in the first six months 2007, compared with the same periods of 2006, due to higher net charge-offs, reflecting portfolio growth, the impact of implementing minimum balance repayment requirements for credit cards and other consumer lines and a higher level of losses due to changes in bankruptcy legislation that went into effect in late 2005. As a percentage of average loans outstanding on an annualized basis, net charge-offs were 2.83 percent in the second quarter of 2007, compared with 2.12 percent in the second quarter of 2006.
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 average balances and the residual aggregate of those expenses associated with corporate activities that are
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managed on a consolidated basis. Treasury and Corporate Support recorded a net loss of $6 million in the second quarter and net income of $31 million in the first six months of 2007, compared with net income of $6 million and $77 million in the same periods of 2006, respectively.
     Total net revenue decreased $50 million in the second quarter and $157 million in the first six months of 2007, compared with the same periods of 2006. The year-over-year decreases in total net revenue were due to unfavorable variances in both net interest income and noninterest income. The declines in net interest income reflected the impact of a flatter yield curve and the impact of issuing higher cost wholesale funding to support earning asset growth. Noninterest income decreased $32 million (78.0 percent) in the second quarter and $89 million (83.2 percent) in the first six months of 2007, compared with the same periods of 2006. The decreases were primarily due to a gain recognized in second quarter of 2006 related to the initial public offering of a cardholder association. In addition, the decrease for the first six months of 2007, compared with the same period of the prior year, was due to trading gains realized in the first quarter of 2006 related to terminating certain interest rate derivatives.
     Total noninterest expense increased $24 million (30.0 percent) in the second quarter and $17 million (12.7 percent) in the first six months of 2007, compared with the same periods of 2006. The increases were driven by increases in compensation and benefits primarily in the technology development areas, higher costs related to tax-advantaged investments, and higher expenses associated with systems conversions for recent acquisitions.
     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 30.2 percent in the second quarter and 30.3 percent in the first six months of 2007, compared with 32.8 percent and 32.7 percent in the same periods of 2006, respectively. The decreases in the effective tax rate primarily reflected higher tax exempt income from municipal securities, incremental tax credits generated from investments in affordable housing and similar tax-advantaged projects, and expansion of a bank-owned life insurance program.
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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, 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”)). 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
                       
    June 30,   December 31,
(Dollars in Millions)   2007   2006
 
    (Unaudited)    
Assets
               
Cash and due from banks
    $6,534       $8,639  
Investment securities
               
 
Held-to-maturity (fair value $83 and $92, respectively)
    81       87  
 
Available-for-sale
    39,433       40,030  
Loans held for sale
    4,552       3,256  
Loans
               
 
Commercial
    46,459       46,190  
 
Commercial real estate
    28,421       28,645  
 
Residential mortgages
    21,992       21,285  
 
Retail
    48,836       47,477  
     
   
Total loans
    145,708       143,597  
     
Less allowance for loan losses
    (2,028 )     (2,022 )
     
     
Net loans
    143,680       141,575  
Premises and equipment
    1,798       1,835  
Goodwill
    7,593       7,538  
Other intangible assets
    3,352       3,227  
Other assets
    15,507       13,045  
     
   
Total assets
    $222,530       $219,232  
     
Liabilities and Shareholders’ Equity
               
Deposits
               
 
Noninterest-bearing
    $29,545       $32,128  
 
Interest-bearing
    70,216       70,330  
 
Time deposits greater than $100,000
    19,941       22,424  
     
   
Total deposits
    119,702       124,882  
Short-term borrowings
    27,160       26,933  
Long-term debt
    45,946       37,602  
Other liabilities
    9,392       8,618  
     
   
Total liabilities
    202,200       198,035  
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: 40,000 shares
    1,000       1,000  
 
Common stock, par value $0.01 a share — authorized: 4,000,000,000 shares;
issued: 6/30/07 and 12/31/06 — 1,972,643,007 shares
    20       20  
 
Capital surplus
    5,748       5,762  
 
Retained earnings
    22,110       21,242  
 
Less cost of common stock in treasury: 6/30/07 — 244,766,681 shares; 12/31/06 — 207,928,756 shares
    (7,476 )     (6,091 )
 
Other comprehensive income
    (1,072 )     (736 )
     
   
Total shareholders’ equity
    20,330       21,197  
     
   
Total liabilities and shareholders’ equity
    $222,530       $219,232  
 
See Notes to Consolidated Financial Statements.
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U.S. Bancorp
Consolidated Statement of Income
                                   
    Three Months Ended   Six Months Ended
    June 30,   June 30,
(Dollars and Shares in Millions, Except Per Share Data)    
(Unaudited)   2007   2006   2007   2006
 
Interest Income
                               
Loans
    $2,616       $2,425       $5,194       $4,732  
Loans held for sale
    70       57       129       108  
Investment securities
    516       500       1,032       990  
Other interest income
    34       36       68       79  
     
 
Total interest income
    3,236       3,018       6,423       5,909  
Interest Expense
                               
Deposits
    663       578       1,338       1,081  
Short-term borrowings
    379       270       707       540  
Long-term debt
    562       484       1,097       887  
     
 
Total interest expense
    1,604       1,332       3,142       2,508  
     
Net interest income
    1,632       1,686       3,281       3,401  
Provision for credit losses
    191       125       368       240  
     
Net interest income after provision for credit losses
    1,441       1,561       2,913       3,161  
Noninterest Income
                               
Credit and debit card revenue
    228       202       433       384  
Corporate payment products revenue
    157       139       302       266  
ATM processing services
    62       61       121       120  
Merchant processing services
    285       253       535       466  
Trust and investment management fees
    342       314       664       611  
Deposit service charges
    272       264       515       496  
Treasury management fees
    126       116       237       223  
Commercial products revenue
    105       107       205       211  
Mortgage banking revenue
    68       75       135       99  
Investment products fees and commissions
    38       42       72       80  
Securities gains (losses), net
    3       3       4       3  
Other
    169       179       328       410  
     
 
Total noninterest income
    1,855       1,755       3,551       3,369  
Noninterest Expense
                               
Compensation
    659       627       1,294       1,260  
Employee benefits
    123       123       256       256  
Net occupancy and equipment
    171       161       336       326  
Professional services
    59       41       106       76  
Marketing and business development
    64       58       112       98  
Technology and communications
    126       127       251       244  
Postage, printing and supplies
    71       66       140       132  
Other intangibles
    95       89       189       174  
Debt prepayment
          11             11  
Other
    272       227       501       453  
     
 
Total noninterest expense
    1,640       1,530       3,185       3,030  
     
Income before income taxes
    1,656       1,786       3,279       3,500  
Applicable income taxes
    500       585       993       1,146  
     
Net income
    $1,156       $1,201       $2,286       $2,354  
     
Net income applicable to common equity
    $1,141       $1,184       $2,256       $2,337  
     
Earnings per common share
    $.66       $.66       $1.29       $1.30  
Diluted earnings per common share
    $.65       $.66       $1.27       $1.29  
Dividends declared per common share
    $.40       $.33       $.80       $.66  
Average common shares outstanding
    1,736       1,781       1,744       1,791  
Average diluted common shares outstanding
    1,760       1,805       1,770       1,816  
 
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, 2005
    1,815       $—       $20       $5,907       $19,001       $(4,413 )     $(429 )     $20,086  
Change in accounting principle
                                    4                       4  
Net income
                                    2,354                       2,354  
Unrealized loss on securities available for sale
                                                    (1,105 )     (1,105 )
Unrealized gain on derivatives
                                                    153       153  
Foreign currency translation
                                                    4       4  
Realized loss on derivatives
                                                    (199 )     (199 )
Reclassification for realized losses
                                                    6       6  
Income taxes
                                                    433       433  
                                                 
          Total comprehensive income
                                                            1,646  
Cash dividends declared
                                                               
 
Preferred
                                    (17 )                     (17 )
 
Common
                                    (1,178 )                     (1,178 )
Issuance of common and treasury stock
    18                       (79 )             533               454  
Purchase of treasury stock
    (50 )                                     (1,538 )             (1,538 )
Stock option and restricted stock grants
                            12                               12  
Shares reserved to meet deferred compensation obligations
                            1               (3 )             (2 )
Issuance of preferred stock
            1,000               (52 )                             948  
     
Balance June 30, 2006
    1,783       $1,000       $20       $5,789       $20,164       $(5,421 )     $(1,137 )     $20,415  
 
Balance December 31, 2006
    1,765       $1,000       $20       $5,762       $21,242       $(6,091 )     $(736 )     $21,197  
Net income
                                    2,286                       2,286  
Unrealized loss on securities available for sale
                                                    (701 )     (701 )
Unrealized gain on derivatives
                                                    94       94  
Foreign currency translation
                                                    19       19  
Reclassification for realized losses
                                                    46       46  
Change in retirement obligation
                                                    1       1  
Income taxes
                                                    205       205  
                                                 
   
Total comprehensive income
                                                            1,950  
Cash dividends declared
                                                               
 
Preferred
                                    (30 )                     (30 )
 
Common
                                    (1,388 )                     (1,388 )
Issuance of common and treasury stock
    15                       (23 )             453               430  
Purchase of treasury stock
    (52 )                                     (1,836 )             (1,836 )
Stock option and restricted stock grants
                            9                               9  
Shares reserved to meet deferred compensation obligations
                                            (2 )             (2 )
     
Balance June 30, 2007
    1,728       $1,000       $20       $5,748       $22,110       $(7,476 )     $(1,072 )     $20,330  
 
See Notes to Consolidated Financial Statements.
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U.S. Bancorp
Consolidated Statement of Cash Flows
                   
    Six Months Ended
    June 30,
(Dollars in Millions)    
(Unaudited)   2007   2006
 
Operating Activities
               
 
Net cash provided by operating activities
    $975       $2,124  
Investing Activities
               
Proceeds from sales of available-for-sale investment securities
    788       859  
Proceeds from maturities of investment securities
    2,204       2,573  
Purchases of investment securities
    (3,117 )     (3,649 )
Net increase in loans outstanding
    (1,187 )     (2,760 )
Proceeds from sales of loans
    340       369  
Purchases of loans
    (1,073 )     (1,563 )
Acquisitions, net of cash acquired
    (73 )     (446 )
Other, net
    (1,215 )     (290 )
     
 
Net cash used in investing activities
    (3,333 )     (4,907 )
Financing Activities
               
Net decrease in deposits
    (5,488 )     (1,990 )
Net increase in short-term borrowings
    220       370  
Proceeds from issuance of long-term debt
    12,634       7,538  
Principal payments or redemption of long-term debt
    (4,242 )     (2,384 )
Proceeds from issuance of preferred stock
          948  
Proceeds from issuance of common stock
    305       383  
Repurchase of common stock
    (1,781 )     (1,528 )
Cash dividends paid on preferred stock
    (30 )      
Cash dividends paid on common stock
    (1,403 )     (1,188 )
     
 
Net cash provided by financing activities
    215       2,149  
     
 
Change in cash and cash equivalents
    (2,143 )     (634 )
Cash and cash equivalents at beginning of period
    8,805       8,202  
     
 
Cash and cash equivalents at end of period
    $6,662       $7,568  
 
See Notes to Consolidated Financial Statements.
U.S. Bancorp 29


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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, 2006. 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
Fair Value Option for Financial Assets and Financial Liabilities In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 159 (“SFAS 159”), “The Fair Value Option for Financial Assets and Financial Liabilities”, effective for the Company beginning on January 1, 2008. This Statement provides entities with an option to report selected financial assets and liabilities at fair value, with the objective to reduce both the complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. The Company is currently assessing the impact of this guidance on its 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. 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. 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 recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on disclosure and other matters. The adoption of FIN 48 did not have a material impact on the Company’s financial statements.
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Note 3 Loans
The composition of the loan portfolio was as follows:
                                       
    June 30, 2007   December 31, 2006
     
        Percent       Percent
(Dollars in Millions)   Amount   of Total   Amount   of Total
 
Commercial
                               
 
Commercial
    $40,746       28.0 %     $40,640       28.3 %
 
Lease financing
    5,713       3.9       5,550       3.9  
     
   
Total commercial
    46,459       31.9       46,190       32.2  
Commercial real estate
                               
 
Commercial mortgages
    19,455       13.3       19,711       13.7  
 
Construction and development
    8,966       6.2       8,934       6.2  
     
   
Total commercial real estate
    28,421       19.5       28,645       19.9  
Residential mortgages
                               
 
Residential mortgages
    16,116       11.1       15,316       10.7  
 
Home equity loans, first liens
    5,876       4.0       5,969       4.1  
     
   
Total residential mortgages
    21,992       15.1       21,285       14.8  
Retail
                               
 
Credit card
    9,429       6.5       8,670       6.0  
 
Retail leasing
    6,572       4.5       6,960       4.9  
 
Home equity and second mortgages
    15,907       10.9       15,523       10.8  
 
Other retail
                               
   
Revolving credit
    2,579       1.8       2,563       1.8  
   
Installment
    5,022       3.4       4,478       3.1  
   
Automobile
    8,901       6.1       8,693       6.1  
   
Student
    426       .3       590       .4  
     
     
Total other retail
    16,928       11.6       16,324       11.4  
     
   
Total retail
    48,836       33.5       47,477       33.1  
     
     
Total loans
    $145,708       100.0 %     $143,597       100.0 %
 
Loans are presented net of unearned interest and deferred fees and costs, which amounted to $1.3 billion at June 30, 2007, and December 31, 2006.
U.S. Bancorp 31


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Note 4 Mortgage Servicing Rights
The Company’s portfolio of residential mortgages serviced for others was $89.7 billion and $82.9 billion at June 30, 2007, and December 31, 2006, respectively. The Company records mortgage servicing rights (“MSRs”) initially at fair value and at each subsequent reporting date, and records changes in fair value in noninterest income in the period in which they occur. In conjunction with its MSRs, the Company may utilize derivatives, including futures and option contracts to manage the volatility of changes in the fair value of MSRs. The net impact of assumption changes on the fair value of MSRs, excluding decay, and the related derivatives included in mortgage banking revenue was a net loss of $6 million and a net gain of $10 million for the three months ended June 30, 2007, and 2006, respectively, and a net loss of $5 million and $9 million for the six months ended June 30, 2007 and 2006, respectively. Loan servicing fees, not including valuation changes, included in mortgage banking revenue were $87 million and $80 million for the three months ended June 30, 2007, and 2006, respectively, and $173 million and $156 million for the six months ended June 30, 2007, and 2006, respectively.
Changes in fair value of capitalized MSRs are summarized as follows:
                                     
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
(Dollars in Millions)   2007   2006   2007   2006
 
Balance at beginning of period
    $1,447       $1,228       $1,427       $1,123  
 
Rights purchased
    3       1       6       47  
 
Rights capitalized
    104       99       186       170  
 
Changes in fair value of MSRs
                               
   
Due to change in valuation assumptions (a)
    147       38       124       71  
   
Other changes in fair value (b)
    (52 )     (43 )     (94 )     (88 )
     
Balance at end of period
    $1,649       $1,323       $1,649       $1,323  
 
(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 (decay).
     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 valuation of MSRs include higher than expected prepayment rates and/or delayed receipt of cash flows. The estimated sensitivity to changes in interest rates of the fair value of the MSRs portfolio and the related derivative instruments at June 30, 2007, was as follows:
                                 
    Down Scenario   Up Scenario
     
(Dollars in Millions)   50 bps   25 bps   25 bps   50 bps
 
Net fair value
    $(49 )     $(17 )     $(9 )     $(47 )
 
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Note 5 Earnings Per Common Share
The components of earnings per common share were:
                                 
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
(Dollars and Shares in Millions, Except Per Share Data)   2007   2006   2007   2006
 
Net income
    $1,156       $1,201       $2,286       $2,354  
Preferred dividends
    (15 )     (17 )     (30 )     (17 )
     
Net income applicable to common equity
    $1,141       $1,184       $2,256       $2,337  
     
Average common shares outstanding
    1,736       1,781       1,744       1,791  
Net effect of the exercise and assumed purchase of stock awards and
conversion of outstanding convertible notes
    24       24       26       25  
     
Average diluted common shares outstanding
    1,760       1,805       1,770       1,816  
     
Earnings per common share
    $.66       $.66       $1.29       $1.30  
Diluted earnings per common share
    $.65       $.66       $1.27       $1.29  
 
Options to purchase 13 million and 4 million common shares for the three months ended June 30, 2007 and 2006, respectively, and 12 million and 4 million common shares for the six months ended June 30, 2007 and 2006, respectively, were outstanding but not included in the computation of diluted earnings per common share because they were antidilutive.
Note 6 Employee Benefits
The components of net periodic benefit cost (income) for the Company’s retirement plans were:
                                                                   
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
        Postretirement       Postretirement
    Pension Plans   Medical Plan   Pension Plans   Medical Plan
     
(Dollars in Millions)   2007   2006   2007   2006   2007   2006   2007   2006
 
Service cost
    $17       $18       $2       $1       $35       $36       $3       $2  
Interest cost
    32       29       3       4       63       59       7       7  
Expected return on plan assets
    (49 )     (47 )     (1 )           (99 )     (95 )     (3 )      
Prior service (credit) cost and transition (asset) obligation amortization
    (2 )     (1 )                 (3 )     (3 )            
Actuarial (gain) loss amortization
    15       22                   31       45              
     
 
Net periodic benefit cost (income)
    $13       $21       $4       $5       $27       $42       $7       $9  
 
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Note 7 Income Taxes
The components of income tax expense were:
                                   
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
(Dollars in Millions)   2007   2006   2007   2006
 
Federal
                               
Current
    $488       $631       $937       $1,212  
Deferred
    (46 )     (154 )     (68 )     (236 )
     
 
Federal income tax
    442       477       869       976  
State
                               
Current
    62       120       131       188  
Deferred
    (4 )     (12 )     (7 )     (18 )
     
 
State income tax
    58       108       124       170  
     
 
Total income tax provision
    $500       $585       $993       $1,146  
 
A reconciliation of expected income tax expense at the federal statutory rate of 35 percent to the Company’s applicable income tax expense follows:
                                   
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
(Dollars in Millions)   2007   2006   2007   2006
 
Tax at statutory rate (35 percent)
    $579       $625       $1,147       $1,225  
State income tax, at statutory rates, net of federal tax benefit
    38       70       81       110  
Tax effect of
                               
 
Tax credits
    (71 )     (61 )     (140 )     (119 )
 
Tax-exempt income
    (31 )     (23 )     (58 )     (43 )
 
Other items
    (15 )     (26 )     (37 )     (27 )
     
Applicable income taxes
    $500       $585       $993       $1,146  
 
Effective January 1, 2007, the Company adopted the provisions of FIN 48. The adoption of FIN 48 did not result in a cumulative-effect accounting adjustment for the Company. The Company elected to classify interest and penalties related to unrecognized tax positions as components of income tax expense. At January 1, 2007, the Company’s total amount of unrecognized tax positions were $364 million, of which $237 million related to unrecognized tax positions that if recognized, would affect the effective tax rate. In addition, the amount accrued for the payment of interest on unrecognized tax positions was $22 million.
     The Company’s income tax returns are subject to review and examination by federal, state, local and foreign government authorities. On an ongoing basis, numerous federal, state, local and foreign examinations are in progress and cover multiple tax years. As of June 30, 2007, the federal taxing authority has completed its examination of the Company through the fiscal year ended December 31, 2004. The years open to examination by foreign, state and local government authorities vary by jurisdiction.
     The Company’s net deferred tax liability was $1,218 million at June 30, 2007, and $1,483 million at December 31, 2006.
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Note 8 Guarantees and Contingent Liabilities
The following table is a summary of the guarantees and contingent liabilities of the Company at June 30, 2007:
                 
        Maximum
        Potential
    Carrying   Future
(Dollars in Millions)   Amount   Payments
 
Standby letters of credit
    $71       $11,934  
Third-party borrowing arrangements
    3       386  
Securities lending indemnifications
          18,239  
Asset sales (a)
    7       512  
Merchant processing
    50       78,358  
Other guarantees
    34       1,674  
Other contingent liabilities
          1,981  
 
(a) The maximum potential future payments does not include loan sales where the Company provides standard representations and warranties to the buyer against losses related to loan underwriting documentation. For these types of loan sales, the maximum potential future payments are not readily determinable because the Company’s obligation under these agreements depends upon the occurrence of future events.
     The Company, through its subsidiaries, provides merchant processing services. Under the rules of credit card associations, a merchant processor retains a contingent liability for credit card transactions processed. This contingent liability arises in the event of a billing dispute between the merchant and a cardholder that is ultimately resolved in the cardholder’s favor. In this situation, the transaction is “charged-back” to the merchant and the disputed amount is credited or otherwise refunded to the cardholder. If the Company is unable to collect this amount from the merchant, it bears the loss for the amount of the refund paid to the cardholder.
     The Company currently processes card transactions in the United States, Canada and Europe for airlines, cruise lines and large tour operators. In the event of liquidation of these merchants, the Company could become financially liable for refunding tickets purchased through the credit card associations under the charge-back provisions. Charge-back risk related to these merchants is evaluated in a manner similar to credit risk assessments and, as such, merchant processing contracts contain various provisions to protect the Company in the event of default. At June 30, 2007, the value of airline, cruise line and large tour operator tickets purchased to be delivered at a future date was $5.1 billion, with airline tickets representing 92 percent of that amount. The Company held collateral of $1.1 billion in escrow deposits, letters of credit and indemnities from financial institutions, and liens on various assets.
     The Company is subject to various other litigation, investigations and legal and administrative cases and proceedings that arise in the ordinary course of its businesses. Due to their complex nature, it may be years before some matters are resolved. While it is impossible to ascertain the ultimate resolution or range of financial liability with respect to these contingent matters, the Company believes that the aggregate amount of such liabilities will not have a material adverse effect on the financial condition, results of operations or cash flows of the Company.
     For additional information on the nature of the Company’s guarantees and contingent liabilities, please refer to Note 21 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.
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U.S. Bancorp
Consolidated Daily Average Balance Sheet and Related Yields and Rates (a)
                                                                   
    For the Three Months Ended June 30,        
    2007   2006        
 
            Yields       Yields   % Change    
(Dollars in Millions)   Average       and   Average       and   Average    
(Unaudited)   Balances   Interest   Rates   Balances   Interest   Rates   Balances    
 
Assets
                                                           
Investment securities
    $40,704       $548       5.39 %     $40,087       $513       5.12 %     1.5 %    
Loans held for sale
    4,334       70       6.43       3,555       57       6.34       21.9      
Loans (b)
                                                           
 
Commercial
    47,197       781       6.64       45,070       734       6.53       4.7      
 
Commercial real estate
    28,503       524       7.37       28,795       528       7.36       (1.0 )    
 
Residential mortgages
    21,831       331       6.06       20,868       302       5.80       4.6      
 
Retail
    48,122       988       8.23       44,637       867       7.79       7.8      
                               
   
Total loans
    145,653       2,624       7.22       139,370       2,431       7.00       4.5      
Other earning assets
    1,610       34       8.36       1,878       36       7.60       (14.3 )    
                               
   
Total earning assets
    192,301       3,276       6.83       184,890       3,037       6.58       4.0      
Allowance for loan losses
    (2,039 )                     (2,051 )                     .6      
Unrealized gain (loss) on available-for-sale securities
    (771 )                     (1,431 )                     (46.1 )    
Other assets
    32,531                       30,999                       4.9      
                                               
   
Total assets
    $222,022                       $212,407                       4.5      
                                               
Liabilities and Shareholders’ Equity
                                                           
Noninterest-bearing deposits
    $27,977                       $28,949                       (3.4 )    
Interest-bearing deposits
                                                           
 
Interest checking
    25,858       84       1.32       23,333       50       .87       10.8      
 
Money market savings
    24,603       159       2.59       26,981       138       2.05       (8.8 )    
 
Savings accounts
    5,443       5       .38       5,720       5       .33       (4.8 )    
 
Time certificates of deposit less than $100,000
    14,716       162       4.40       13,689       126       3.68       7.5      
 
Time deposits greater than $100,000
    20,378       253       4.98       22,561       259       4.61       (9.7 )    
                               
   
Total interest-bearing deposits
    90,998       663       2.92       92,284       578       2.51       (1.4 )    
Short-term borrowings
    29,524       401       5.44       22,246       278       5.01       32.7      
Long-term debt
    44,655       562       5.05       41,225       484       4.71       8.3      
                               
   
Total interest-bearing liabilities
    165,177       1,626       3.95       155,755       1,340       3.45       6.0      
Other liabilities
    7,973                       7,147                       11.6      
Shareholders’ equity
                                                           
 
Preferred equity
    1,000                       1,000                            
 
Common equity
    19,895                       19,556                       1.7      
                                               
   
Total shareholders’ equity
    20,895                       20,556                       1.6      
                                               
     
Total liabilities and shareholders’ equity
    $222,022                       $212,407                       4.5  %    
                                         
Net interest income
            $1,650                       $1,697                      
                                               
Gross interest margin
                    2.88 %                     3.13 %            
                                               
Gross interest margin without taxable-equivalent increments
                    2.84                       3.11              
                                               
Percent of Earning Assets
                                                           
Interest income
                    6.83 %                     6.58 %            
Interest expense
                    3.39                       2.90              
                                               
Net interest margin
                    3.44 %                     3.68 %            
                                               
Net interest margin without taxable-equivalent increments
                    3.40 %                     3.66 %            
           
(a) Interest and rates are presented on a fully taxable-equivalent basis utilizing a tax rate of 35 percent.
(b) Interest income and rates on loans include loan fees. Nonaccrual loans are included in average loan balances.
36 U.S. Bancorp


Table of Contents

U.S. Bancorp
Consolidated Daily Average Balance Sheet and Related Yields and Rates (a)
                                                                   
    For the Six Months Ended June 30,        
    2007   2006        
 
            Yields       Yields   % Change    
(Dollars in Millions)   Average       and   Average       and   Average    
(Unaudited)   Balances   Interest   Rates   Balances   Interest   Rates   Balances    
 
Assets
                                                           
Investment securities
    $40,791       $1,094       5.36 %     $39,885       $1,009       5.06 %     2.3 %    
Loans held for sale
    4,090       129       6.33       3,412       108       6.28       19.9      
Loans (b)
                                                           
 
Commercial
    47,103       1,555       6.65       44,501       1,424       6.44       5.8      
 
Commercial real estate
    28,573       1,044       7.37       28,706       1,025       7.20       (.5 )    
 
Residential mortgages
    21,700       654       6.04       20,927       596       5.71       3.7      
 
Retail
    47,800       1,955       8.25       44,445       1,699       7.71       7.5      
                               
   
Total loans
    145,176       5,208       7.23       138,579       4,744       6.90       4.8      
Other earning assets
    1,664       68       8.18       2,124       79       7.46       (21.7 )    
                               
   
Total earning assets
    191,721       6,499       6.82       184,000       5,940       6.49       4.2      
Allowance for loan losses
    (2,038 )                     (2,055 )                     .8      
Unrealized gain (loss) on available-for-sale securities
    (695 )                     (1,117 )                     37.8      
Other assets
    31,786                       30,394                       4.6      
                                               
   
Total assets
    $220,774                       $211,222                       4.5      
                                               
Liabilities and Shareholders’ Equity
                                                           
Noninterest-bearing deposits
    $27,828                       $28,893                       (3.7 )    
Interest-bearing deposits
                                                           
 
Interest checking
    25,470       160       1.27       23,238       95       .82       9.6      
 
Money market savings
    25,154       322       2.58       27,178       254       1.88       (7.4 )    
 
Savings accounts
    5,422       10       .38       5,705       9       .31       (5.0 )    
 
Time certificates of deposit less than $100,000
    14,745       320       4.37       13,598       240       3.55       8.4      
 
Time deposits greater than $100,000
    21,228       526       4.99       22,089       483       4.41       (3.9 )    
                               
   
Total interest-bearing deposits
    92,019       1,338       2.93       91,808       1,081       2.37       .2      
Short-term borrowings
    28,114       748       5.37       23,295       550       4.77       20.7      
Long-term debt
    43,804       1,097       5.04       39,735       88