US Bank 2012 Annual Report Download - page 71

estimates and assumptions. The Company’s financial position
and results of operations can be affected by these estimates
and assumptions, which are integral to understanding the
Company’s financial statements. Critical accounting policies
are those policies management believes are the most important
to the portrayal of the Company’s financial condition and
results, and require management to make estimates that are
difficult, subjective or complex. Most accounting policies are
not considered by management to be critical accounting
policies. Several factors are considered in determining whether
or not a policy is critical in the preparation of financial
statements. These factors include, among other things,
whether the estimates are significant to the financial
statements, the nature of the estimates, the ability to readily
validate the estimates with other information (including third-
parties sources or available prices), and sensitivity of the
estimates to changes in economic conditions and whether
alternative accounting methods may be utilized under GAAP.
Management has discussed the development and the selection
of critical accounting policies with the Company’s Audit
Committee.
Significant accounting policies are discussed in Note 1 of
the Notes to Consolidated Financial Statements. Those
policies considered to be critical accounting policies are
described below.
Allowance for Credit Losses The allowance for credit losses is
established to provide for probable losses incurred in the
Company’s credit portfolio. The methods utilized to estimate
the allowance for credit losses, key assumptions and
quantitative and qualitative information considered by
management in determining the appropriate allowance for
credit losses are discussed in the “Credit Risk Management”
section.
Management’s evaluation of the appropriate allowance
for credit losses is often the most critical of all the accounting
estimates for a banking institution. It is an inherently
subjective process impacted by many factors as discussed
throughout the Management’s Discussion and Analysis section
of the Annual Report. Although risk management practices,
methodologies and other tools are utilized to determine each
element of the allowance, degrees of imprecision exist in these
measurement tools due in part to subjective judgments
involved and an inherent lagging of credit quality
measurements relative to the stage of the business cycle. Even
determining the stage of the business cycle is highly subjective.
As discussed in the “Analysis and Determination of Allowance
for Credit Losses” section, management considers the effect of
imprecision and many other factors in determining the
allowance for credit losses. If not considered, incurred losses in
the portfolio related to imprecision and other subjective factors
could have a dramatic adverse impact on the liquidity and
financial viability of a bank.
Given the many subjective factors affecting the credit
portfolio, changes in the allowance for credit losses may not
directly coincide with changes in the risk ratings of the credit
portfolio reflected in the risk rating process. This is in part
due to the timing of the risk rating process in relation to
changes in the business cycle, the exposure and mix of loans
within risk rating categories, levels of nonperforming loans
and the timing of charge-offs and recoveries. For example, the
amount of loans within specific risk ratings may change,
providing a leading indicator of improving credit quality,
while nonperforming loans and net charge-offs continue at
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, 2012. 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 $232 million at December 31, 2012. 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 $143 million at
December 31, 2012. 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
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