US Bank 2007 Annual Report Download - page 64

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 and commercial real estate loans is sensitive to
the assigned credit risk ratings and inherent loss rates at
December 31, 2007. In the event that 10 percent of loans
within these portfolios experienced downgrades of two risk
categories, the allowance for commercial and commercial
real estate would increase by approximately $168 million
at December 31, 2007. In the event that inherent loss or
estimated loss rates for these portfolios increased by
10 percent, the allowance determined for commercial and
commercial real estate would increase by approximately
$95 million at December 31, 2007. The Company’s
determination of the allowance for residential and retail
loans is sensitive to changes in estimated loss rates. In the
event that estimated loss rates increased by 10 percent, the
allowance for residential mortgages and retail loans would
increase by approximately $82 million at December 31,
2007. 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.
Estimations of Fair Value 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 in
accordance with applicable accounting principles generally
accepted in the United States. These include all of the
Company’s trading securities, available-for-sale securities,
derivatives and MSRs. The estimation of fair value also
affects 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, including goodwill and
other intangible assets, impaired loans, other real estate
owned and other repossessed assets, that are recorded at
either fair value or fair value less costs-to-sell when
acquired, and are periodically evaluated for impairment
using fair value estimates.
Fair value is generally defined as the amount 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.
Trading and available-for-sale securities are generally
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
interests held in entities collateralized by mortgage and/or
debt obligations as part of a structured investment. For more
information on investment securities, refer to Note 4 of the
Notes to Consolidated Financial Statements.
As few derivative contracts are listed on an exchange,
the majority of the Company’s derivative positions are
valued using valuation techniques that use readily observable
market parameters. Certain derivatives, however, must be
valued using techniques that include unobservable
parameters. For these instruments, the significant
assumptions must be estimated and therefore, are subject to
judgment. These instruments are normally traded less
actively. An example includes certain long-dated interest rate
swaps. Table 18 provides a summary of the Company’s
derivative positions.
Mortgage Servicing Rights Mortgage servicing rights are
capitalized as separate assets when loans are sold and
servicing is retained or may be purchased from others. MSRs
are initially recorded at fair value and at each subsequent
reporting date. Because MSRs do not trade in an active
62 U.S. BANCORP