US Bank 2008 Annual Report Download - page 65

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 and
commercial real estate loans is sensitive to the assigned
credit risk ratings and inherent loss rates at December 31,
2008. 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 $206 million at
December 31, 2008. 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
$126 million at December 31, 2008. 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 $176 million at December 31,
2008. 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 trading securities, available-for-sale securities,
derivatives, MSRs and certain MLHFS. 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 and securities, other real estate owned 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
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 5 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.
Refer to Note 21 of the Notes to Consolidated
Financial Statements for additional information regarding
estimations of fair value.
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