US Bank 2006 Annual Report Download - page 60

cycle is highly subjective. As discussed in the ‘‘Analysis and
CRITICAL ACCOUNTING POLICIES
Determination of Allowance for Credit Losses’’ section,
The accounting and reporting policies of the Company management considers the effect of imprecision and many
comply with accounting principles generally accepted in the other factors in determining the allowance for credit losses
United States and conform to general practices within the by establishing an ‘‘allowance available for other factors’’
banking industry. The preparation of financial statements in that is not specifically allocated to a category of loans. If
conformity with generally accepted accounting principles not considered, inherent losses in the portfolio related to
requires management to make estimates and assumptions. imprecision and other subjective factors could have a
The financial position and results of operations can be dramatic adverse impact on the liquidity and financial
affected by these estimates and assumptions, which are viability of a bank.
integral to understanding the Company’s financial Given the many subjective factors affecting the credit
statements. Critical accounting policies are those policies portfolio, changes in the allowance for credit losses may not
that management believes are the most important to the directly coincide with changes in the risk ratings of the
portrayal of the Company’s financial condition and results, credit portfolio reflected in the risk rating process. This is in
and require management to make estimates that are part due to the timing of the risk rating process in relation
difficult, subjective or complex. Most accounting policies to changes in the business cycle, the exposure and mix of
are not considered by management to be critical accounting loans within risk rating categories, levels of nonperforming
policies. Several factors are considered in determining loans and the timing of charge-offs and recoveries. For
whether or not a policy is critical in the preparation of example, the amount of loans within specific risk ratings
financial statements. These factors include, among other may change, providing a leading indicator of improving
things, whether the estimates are significant to the financial credit quality, while nonperforming loans and net charge-
statements, the nature of the estimates, the ability to readily offs continue at elevated levels. Also, inherent loss ratios,
validate the estimates with other information including determined through migration analysis and historical loss
third-parties or available prices, and sensitivity of the performance over the estimated business cycle of a loan,
estimates to changes in economic conditions and whether may not change to the same degree as net charge-offs.
alternative accounting methods may be utilized under Because risk ratings and inherent loss ratios primarily drive
generally accepted accounting principles. Management has the allowance specifically allocated to commercial loans, the
discussed the development and the selection of critical amount of the allowance for commercial and commercial
accounting policies with the Company’s Audit Committee. real estate loans might decline; however, the degree of
Significant accounting policies are discussed in Note 1 change differs somewhat from the level of changes in
of the Notes to Consolidated Financial Statements. Those nonperforming loans and net charge-offs. Also, management
policies considered to be critical accounting policies are would maintain an adequate allowance for credit losses by
described below. increasing the allowance for other factors during periods of
Allowance for Credit Losses The allowance for credit losses economic uncertainty or changes in the business cycle.
is established to provide for probable losses inherent in the Some factors considered in determining the adequacy of
Company’s credit portfolio. The methods utilized to the allowance for credit losses are quantifiable while other
estimate the allowance for credit losses, key assumptions factors require qualitative judgment. Management conducts
and quantitative and qualitative information considered by analysis with respect to the accuracy of risk ratings and the
management in determining the adequacy of the allowance volatility of inherent losses, and utilizes this analysis along
for credit losses are discussed in the ‘‘Credit Risk with qualitative factors including uncertainty in the
Management’’ section. economy from changes in unemployment rates, the level of
Management’s evaluation of the adequacy of the bankruptcies, concentration risks, including risks associated
allowance for credit losses is often the most critical of with the airline industry sector and highly leveraged
accounting estimates for a banking institution. It is an enterprise-value credits, in determining the overall level of
inherently subjective process impacted by many factors as the allowance for credit losses. The Company’s
discussed throughout the Management’s Discussion and determination of the allowance for commercial and
Analysis section of the Annual Report. Although risk commercial real estate loans is sensitive to the assigned
management practices, methodologies and other tools are credit risk ratings and inherent loss rates at December 31,
utilized to determine each element of the allowance, degrees 2006. In the event that 10 percent of loans within these
of imprecision exist in these measurement tools due in part portfolios experienced downgrades of two risk categories,
to subjective judgments involved and an inherent lagging of the allowance for commercial and commercial real estate
credit quality measurements relative to the stage of the would increase by approximately $234 million at
business cycle. Even determining the stage of the business December 31, 2006. In the event that inherent loss or
58 U.S. BANCORP