US Bank 2011 Annual Report Download - page 37

repayment source, borrower’s debt capacity and financial
flexibility, loan covenants, and nature and value of pledged
collateral, if any. These risk characteristics, among others, are
considered in determining estimates about the likelihood of
default by the borrowers and the severity of loss in the event
of default. The Company considers these risk characteristics in
assigning internal risk ratings to, or forecasting losses on,
these loans which are the significant factors in determining the
allowance for credit losses for loans in the commercial lending
segment.
The consumer lending segment represents loans and
leases made to consumer customers including residential
mortgages, credit card loans, and other retail loans such as
revolving consumer lines, auto loans and leases, student loans,
and home equity loans and lines. Home equity and second
mortgage loans are junior lien closed-end accounts fully
disbursed at origination. These loans typically are fixed rate
loans, secured by residential real estate, with a 10 or 15 year
fixed payment amortization schedule. Home equity lines are
revolving accounts giving the borrower the ability to draw
and repay balances repeatedly, up to a maximum
commitment, and are secured by residential real estate. These
include accounts in either a first or junior lien position.
Typical terms on home equity lines are variable rates
benchmarked to the prime rate, with a 15 year draw period
during which a minimum payment is equivalent to the
monthly interest, followed by a 10 year amortization period.
At December 31, 2011, substantially all of the Company’s
home equity lines were in the draw period. Key risk
characteristics relevant to consumer lending segment loans
primarily relate to the borrowers’ capacity and willingness to
repay and include unemployment rates and other economic
factors, customer payment history and in some cases, updated
loan-to-value information on collateral-dependent loans.
These risk characteristics, among others, are reflected in
forecasts of delinquency levels, bankruptcies and losses which
are the primary factors in determining the allowance for credit
losses for the consumer lending segment.
The covered loan segment represents loans acquired in
FDIC-assisted transactions that are covered by loss sharing
agreements with the FDIC that greatly reduce the risk of
future credit losses to the Company. Key risk characteristics
for covered segment loans are consistent with the segment
they would otherwise be included in had the loss share
coverage not been in place but consider the indemnification
provided by the FDIC.
The Company further disaggregates its loan portfolio
segments into various classes based on their underlying risk
characteristics. The two classes within the commercial lending
segment are commercial loans and commercial real estate
loans. The three classes within the consumer lending segment
are residential mortgages, credit card loans and other retail
loans. The covered loan segment consists of only one class.
Because business processes and credit risks associated
with unfunded credit commitments are essentially the same as
for loans, the Company utilizes similar processes to estimate
its liability for unfunded credit commitments. The Company
also engages in non-lending activities that may give rise to
credit risk, including derivative transactions for balance sheet
hedging purposes, foreign exchange transactions, deposit
overdrafts and interest rate swap contracts for customers, and
settlement risk, including Automated Clearing House
transactions and the processing of credit card transactions for
merchants. These activities are subject to credit review,
analysis and approval processes.
Economic and Other Factors 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, such as changes in unemployment rates, gross
domestic product and consumer bankruptcy filings.
Beginning in late 2007, financial markets suffered
significant disruptions, leading to and exacerbated by
declining real estate values and subsequent economic
challenges, both domestically and globally. Median home
prices, which peaked in 2006, declined across most domestic
markets, which had a significant adverse impact on the
collectability of residential mortgage loans. Residential
mortgage delinquencies increased throughout 2008 and 2009.
High unemployment levels throughout 2009, 2010 and 2011
further increased losses in prime-based residential portfolios
and credit cards.
Economic conditions began to stabilize in late 2009 and
continued to improve throughout 2010 and 2011, though
unemployment and under-employment continued to be
elevated, consumer confidence and spending remained lower
and stress continued in the residential mortgage portfolio due
to a decline in home values. Credit costs peaked for the
Company in late 2009 and have trended downward
thereafter. The provision for credit losses was lower than net
charge-offs by $500 million in 2011, and exceeded net charge-
offs by $175 million in 2010 and $1.7 billion in 2009. The
$2.0 billion (46.2 percent) decrease in the provision for credit
losses in 2011, compared with 2010, reflected improving
credit trends and the underlying risk profile of the loan
portfolio as economic conditions continued to further
stabilize.
Credit Diversification The Company manages its credit risk,
in part, through diversification of its loan portfolio and limit
setting by product type criteria and concentrations. As part of
its normal business activities, the Company offers a broad
array of traditional commercial lending products and
U.S. BANCORP 35