US Bank 2012 Annual Report Download - page 41

second mortgage portfolios, which allows the Company to
compute estimated loan-to-value (“LTV”) ratios reflecting
current market conditions. These individual refreshed LTV
ratios are considered in the determination of the appropriate
allowance for credit losses. The decline in housing prices over
the past several years has deteriorated the collateral support of
the residential mortgage, home equity and second mortgage
portfolios. However, the underwriting criteria the Company
employs consider the relevant income and credit characteristics
of the borrower, such that the collateral is not the primary
source of repayment. The Company strives to identify potential
problem loans early, record any necessary charge-offs
promptly and maintain appropriate allowance levels for
probable incurred loan losses. Refer to Notes 1 and 5 in the
Notes to Consolidated Financial Statements for further
information of the Company’s loan portfolios including
internal credit quality ratings.
The Company categorizes its loan portfolio into three
segments, which is the level at which it develops and
documents a systematic methodology to determine the
allowance for credit losses. The Company’s three loan
portfolio segments are commercial lending, consumer lending
and covered loans. The commercial lending segment includes
loans and leases made to small business, middle market, large
corporate, commercial real estate, financial institution, and
public sector customers. Key risk characteristics relevant to
commercial lending segment loans include the industry and
geography of the borrower’s business, purpose of the loan,
repayment source, borrower’s debt capacity and financial
flexibility, loan covenants, and nature 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 or 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, 2012, 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
LTV information on real estate based 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,
investments in securities and other financial assets, 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
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