US Bank 2011 Annual Report Download - page 66

elevated levels. Also, inherent loss ratios, determined through
migration analysis and historical loss performance over the
estimated business cycle of a loan, may not change to the
same degree as net charge-offs. Because risk ratings and
inherent loss ratios primarily drive the allowance specifically
allocated to commercial lending segment loans, the amount of
the allowance might decline; however, the degree of change
differs somewhat from the level of changes in nonperforming
loans and net charge-offs. Also, management would maintain
an appropriate allowance for credit losses by increasing the
allowance during periods of economic uncertainty or changes
in the business cycle.
Some factors considered in determining the appropriate
allowance for credit losses are quantifiable while other factors
require qualitative judgment. Management conducts an
analysis with respect to the accuracy of risk ratings and the
volatility of inherent losses, and utilizes this analysis along
with qualitative factors, including uncertainty in the economy
from changes in unemployment rates, the level of
bankruptcies and concentration risks, including risks
associated with the weakened housing market and highly
leveraged enterprise-value credits, in determining the overall
level of the allowance for credit losses. The Company’s
determination of the allowance for commercial lending
segment loans is sensitive to the assigned credit risk ratings
and inherent loss rates at December 31, 2011. In the event
that 10 percent of period ending loan balances (including
unfunded commitments) within each risk category of this
segment of the loan portfolio experienced downgrades of two
risk categories, the allowance for credit losses would increase
by approximately $277 million at December 31, 2011. The
Company believes the allowance for credit losses
appropriately considers the imprecision in estimating credit
losses based on credit risk ratings and inherent loss rates but
actual losses may differ from those estimates. In the event that
inherent loss or estimated loss rates for commercial lending
segment loans increased by 10 percent, the allowance for
credit losses would increase by approximately $171 million at
December 31, 2011. The Company’s determination of the
allowance for consumer lending segment loans is sensitive to
changes in estimated loss rates. In the event that estimated loss
rates for this segment of the loan portfolio increased by
10 percent, the allowance for credit losses would increase by
approximately $169 million at December 31, 2011. Because
several quantitative and qualitative factors are considered in
determining the allowance for credit losses, these sensitivity
analyses do not necessarily reflect the nature and extent of
future changes in the allowance for credit losses. They are
intended to provide insights into the impact of adverse
changes in risk rating and inherent losses and do not imply
any expectation of future deterioration in the risk rating or
loss rates. Given current processes employed by the Company,
management believes the risk ratings and inherent loss rates
currently assigned are appropriate. It is possible that others,
given the same information, may at any point in time reach
different reasonable conclusions that could be significant to
the Company’s financial statements. Refer to the “Analysis
and Determination of the Allowance for Credit Losses”
section for further information.
Fair Value Estimates A portion of the Company’s assets and
liabilities are carried at fair value on the Consolidated Balance
Sheet, with changes in fair value recorded either through
earnings or other comprehensive income (loss) in accordance
with applicable accounting principles generally accepted in the
United States. These include all of the Company’s
available-for-sale securities, derivatives and other trading
instruments, MSRs and certain mortgage loans held for sale.
The estimation of fair value also affects other loans held for
sale, which are recorded at the lower-of-cost-or-fair value.
The determination of fair value is important for certain other
assets that are periodically evaluated for impairment using fair
value estimates, including goodwill and other intangible
assets, assets acquired in business combinations, impaired
loans, OREO and other repossessed assets.
Fair value is generally defined as the exit price at which
an asset or liability could be exchanged in a current
transaction between willing, unrelated parties, other than in a
forced or liquidation sale. Fair value is based on quoted
market prices in an active market, or if market prices are not
available, is estimated using models employing techniques
such as matrix pricing or discounting expected cash flows.
The significant assumptions used in the models, which include
assumptions for interest rates, discount rates, prepayments
and credit losses, are independently verified against observable
market data where possible. Where observable market data is
not available, the estimate of fair value becomes more
subjective and involves a high degree of judgment. In this
circumstance, fair value is estimated based on management’s
judgment regarding the value that market participants would
assign to the asset or liability. This valuation process takes
into consideration factors such as market illiquidity.
Imprecision in estimating these factors can impact the amount
recorded on the balance sheet for a particular asset or liability
with related impacts to earnings or other comprehensive
income (loss).
When available, trading and available-for-sale securities
are valued based on quoted market prices. However, certain
securities are traded less actively and therefore, may not be
able to be valued based on quoted market prices. The
determination of fair value may require benchmarking to
similar instruments or performing a discounted cash flow
analysis using estimates of future cash flows and prepayment,
interest and default rates. An example is non-agency
residential mortgage-backed securities. For more information
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