UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2010

 

OR

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from (not applicable)

 

Commission file number 1-6880

 

U.S. BANCORP

(Exact name of registrant as specified in its charter)

 

 

800 Nicollet Mall

Minneapolis, Minnesota 55402

(Address of principal executive offices, including zip code)

 

651-466-3000

(Registrant’s telephone number, including area code)

 

(not applicable)

(Former name, former address and former fiscal year, if changed since last report)

 

 

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.

 

YES þ  NO o

 

     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

YES þ  NO o

 

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

YES o  NO þ

 

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

 

Table of Contents and Form 10-Q Cross Reference Index

 

 

 

“Safe Harbor” Statement under the Private Securities Litigation Reform Act of 1995.

This quarterly report on Form 10-Q contains forward-looking statements about U.S. Bancorp. Statements that are not historical or current facts, including statements about beliefs and expectations, are forward-looking statements and are based on the information available to, and assumptions and estimates made by, management as of the date made. These forward-looking statements cover, among other things, anticipated future revenue and expenses and the future plans and prospects of U.S. Bancorp. Forward-looking statements involve inherent risks and uncertainties, and important factors could cause actual results to differ materially from those anticipated. Global and domestic economies could fail to recover from the recent economic downturn or could experience another severe contraction, which could adversely affect U.S. Bancorp’s revenues and the values of its assets and liabilities. Global financial markets could experience a recurrence of significant turbulence, which could reduce the availability of funding to certain financial institutions and lead to a tightening of credit, a reduction of business activity, and increased market volatility. Stress in the commercial real estate markets, as well as a delay or failure of recovery in the residential real estate markets, could cause additional credit losses and deterioration in asset values. In addition, U.S. Bancorp’s business and financial performance is likely to be impacted by effects of recently enacted and future legislation and regulation. U.S. Bancorp’s results could also be adversely affected by continued deterioration in general business and economic conditions; changes in interest rates; deterioration in the credit quality of its loan portfolios or in the value of the collateral securing those loans; deterioration in the value of securities held in its investment securities portfolio; legal and regulatory developments; increased competition from both banks and non-banks; changes in customer behavior and preferences; effects of mergers and acquisitions and related integration; effects of critical accounting policies and judgments; and management’s ability to effectively manage credit risk, residual value risk, market risk, operational risk, interest rate risk and liquidity risk.

 

For discussion of these and other risks that may cause actual results to differ from expectations, refer to U.S. Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2009, on file with the Securities and Exchange Commission, including the sections entitled “Risk Factors” and “Corporate Risk Profile” contained in Exhibit 13, and all subsequent filings with the Securities and Exchange Commission under Sections 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934. Forward-looking statements speak only as of the date they are made, and U.S. Bancorp undertakes no obligation to update them in light of new information or future events.

 

 

 

Table 1    Selected Financial Data

 

 

Management’s Discussion and Analysis

 

 

Earnings Summary U.S. Bancorp and its subsidiaries (the “Company”) reported net income attributable to U.S. Bancorp of $766 million for the second quarter of 2010 or $.45 per diluted common share, compared with $471 million, or $.12 per diluted common share for the second quarter of 2009. Return on average assets and return on average common equity were 1.09 percent and 13.4 percent, respectively, for the second quarter of 2010, compared with .71 percent and 4.2 percent, respectively, for the second quarter of 2009. Diluted earnings per common share for the second quarter of 2010 included a non-recurring $.05 benefit related to an exchange of newly issued perpetual preferred stock for outstanding income trust securities (“ITS exchange”), net of related debt extinguishment costs. Also impacting the second quarter of 2010 were $25 million of provision for credit losses in excess of net charge-offs, net securities losses of $21 million and a $28 million gain related to the Company’s investment in Visa Inc. The second quarter of 2009 included $466 million of provision for credit losses in excess of net charge-offs, net securities losses of $19 million, a $123 million accrual for a Federal Deposit Insurance Corporation (“FDIC”) special assessment and a reduction to earnings per share from recognition of $154 million of unaccreted preferred stock discount as a result of the redemption of preferred stock previously issued to the U.S. Department of the Treasury.

Total net revenue, on a taxable-equivalent basis, for the second quarter of 2010 was $360 million (8.7 percent) higher than the second quarter of 2009, reflecting a 14.5 percent increase in net interest income and a 2.7 percent increase in total noninterest income. The increase in net interest income over a year ago was largely the result of continued growth in lower cost core deposit funding and an increase in average earning assets, primarily related to acquisitions. Noninterest income increased over a year ago as a result of higher payments-related and commercial products revenue and other income.

Total noninterest expense in the second quarter of 2010 was $248 million (11.6 percent) higher than the second quarter of 2009, primarily due to the impact of acquisitions, higher compensation and employee benefits expense and costs related to investments in affordable housing and other tax-advantaged projects, partially offset by lower FDIC deposit insurance expense due to the FDIC special assessment in the second quarter of the prior year.

The provision for credit losses for the second quarter of 2010 was $1.1 billion, or $256 million (18.4 percent) lower than the second quarter of 2009. The provision for credit losses exceeded net charge-offs by $25 million in the second quarter of 2010, compared with $466 million in the second quarter of 2009. Net charge-offs in the second quarter of 2010 were $1.1 billion, compared with net charge-offs of $929 million in the second quarter of 2009. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.

The Company reported net income attributable to U.S. Bancorp of $1.4 billion for the first six months of 2010 or $.79 per diluted common share, compared with $1.0 billion, or $.36 per diluted common share for the first six months of 2009. Return on average assets and return on average common equity were 1.03 percent and 12.0 percent, respectively, for the first six months of 2010, compared with .76 percent and 6.4 percent, respectively, for the first six months of 2009. The Company’s results for the first six months of 2010 reflected $200 million of provision for credit losses in excess of net charge-offs, $55 million of net securities losses and a $28 million gain related to the Company’s investment in Visa Inc. The first six months of 2009 included $996 million of provision for credit losses in excess of net charge-offs, $217 million of net securities losses, the $123 million FDIC special assessment, the $154 million preferred stock discount recognition and a $92 million gain from a corporate real estate transaction.

Total net revenue, on a taxable-equivalent basis, for the first six months of 2010 was $798 million (9.9 percent) higher than the first six months of 2009, reflecting a 14.6 percent increase in net interest income and a 4.8 percent increase in total noninterest income. The increase in net interest income over a year ago was largely the result of continued growth in lower cost core deposit funding and an increase in average earning assets. Noninterest income increased over a year ago, principally due to higher payments-related and commercial products revenue and a decrease in net securities losses, partially offset by lower mortgage banking revenue and other service charges.

 

 

Total noninterest expense in the first six months of 2010 was $513 million (12.8 percent) higher than the first six months of 2009, primarily due to the impact of acquisitions, higher compensation and employee benefits expense and costs related to investments in affordable housing and other tax-advantaged projects, partially offset by lower FDIC deposit insurance expense due to the special assessment in the second quarter of 2009.

The provision for credit losses for the first six months of 2010 was $2.4 billion, or $264 million (9.7 percent) lower than the first six months of 2009. The provision for credit losses exceeded net charge-offs by $200 million in the first six months of 2010, compared with $996 million in the first six months of 2009. Net charge-offs in the first six months of 2010 were $2.2 billion, compared with net charge-offs of $1.7 billion in the first six months of 2009. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.

 

STATEMENT OF INCOME ANALYSIS

 

Net Interest Income Net interest income, on a taxable-equivalent basis, was $2.4 billion in the second quarter of 2010, compared with $2.1 billion in the second quarter of 2009. Net interest income, on a taxable-equivalent basis, was $4.8 billion in the first six months of 2010, compared with $4.2 billion in the first six months of 2009. The increases were primarily the result of continued growth in lower cost core deposit funding, increases in average earning assets and a higher net interest margin. Average deposits increased $20.1 billion (12.3 percent) in the second quarter and $21.0 billion (13.0 percent) in the first six months of 2010, compared with the same periods of 2009. Average earning assets were $13.2 billion (5.6 percent) higher in the second quarter and $13.3 billion (5.7 percent) higher in the first six months of 2010, compared with the same periods of 2009, driven by increases in average loans and investment securities. The net interest margin in the second quarter and first six months of 2010 was 3.90 percent, compared with 3.60 percent in the second quarter of 2009 and 3.59 percent in the first six months of 2009. The increases in net interest margin were principally due to the impact of favorable funding rates as a result of the increase in deposits and improved credit spreads. Refer to the “Consolidated Daily Average Balance Sheet and Related Yields and Rates” tables for further information on net interest income.

Total average loans for the second quarter and first six months of 2010 were $7.3 billion (4.0 percent) and $7.2 billion (3.9 percent) higher, respectively, than the same periods of 2009, driven by growth in residential mortgages, retail loans, commercial real estate loans and acquired loans covered by loss sharing agreements with the FDIC, partially offset by a decline in commercial loans which was principally the result of lower utilization by customers of available commitments. Residential mortgage growth reflected an increase in activity throughout most of 2009 as a result of market interest rate declines, including an increase in government agency-guaranteed mortgages. Average retail loans increased year-over-year, driven by increases in credit card, home equity and other retail (primarily auto) loans. Average credit card balances for the second quarter and first six months of 2010 were $2.0 billion (14.0 percent) and $2.4 billion (17.1 percent) higher, respectively, than the same periods of 2009, reflecting growth in existing portfolios and portfolio purchases of $1.6 billion during 2009 and $.5 billion in the second quarter of 2010. Growth in average commercial real estate balances reflected the impact of new business activity, partially offset by customer debt deleveraging. Assets acquired in FDIC-assisted transactions that are covered by loss sharing agreements with the FDIC (“covered assets” or “covered loans”) relate to the fourth quarter 2008 acquisitions of the banking operations of Downey Savings and Loan Association, F.A. and PFF Bank and Trust (“Downey” and “PFF”, respectively) and the fourth quarter 2009 acquisition of the banking operations of First Bank of Oak Park Corporation (“FBOP”). Average covered loans were $20.5 billion and $20.9 billion in the second quarter and first six months of 2010, respectively, compared with $10.7 billion and $11.0 billion in the same periods of 2009, respectively.

Average investment securities in the second quarter and first six months of 2010 were $5.0 billion (11.7 percent) and $4.4 billion (10.5 percent) higher, respectively, than the same periods of 2009, primarily due to purchases of U.S. government agency-related securities and the consolidation of $.6 billion of held-to-maturity securities held in a variable interest entity (“VIE”) due to the adoption of new authoritative accounting guidance effective January 1, 2010. As a result, the composition of the Company’s investment portfolio shifted to a larger concentration in agency mortgage-backed securities, compared with a year ago.

Average total deposits for the second quarter and first six months of 2010 were $20.1 billion (12.3 percent) and $21.0 billion (13.0 percent) higher, respectively, than the same periods of 2009. Excluding deposits from acquisitions, second quarter 2010 average total deposits increased $6.7 billion (4.1 percent) over the second quarter of 2009. Average noninterest-bearing

 

 

 

Table 2    Noninterest Income

 

deposits for the second quarter and first six months of 2010 were $2.5 billion (6.8 percent) and $2.3 billion (6.1 percent) higher, respectively, than the same periods of 2009, primarily due to growth in corporate and institutional trust balances, higher Consumer and Wholesale Banking business line balances and the impact of acquisitions. Average total savings deposits were $22.9 billion (29.7 percent) higher in the second quarter and $25.7 billion (34.9 percent) higher in the first six months of 2010, compared with the same periods of 2009, the result of growth in Consumer Banking, broker-dealer, institutional and corporate trust balances, and the impact of acquisitions. Average time certificates of deposit less than $100,000 were lower in the second quarter and first six months of 2010 by $988 million (5.5 percent) and $396 million (2.2 percent), respectively, compared with the same periods in 2009, as decreases in Consumer Banking balances, reflecting the Company’s funding and pricing decisions, were partially offset by acquisition-related growth. Average time deposits greater than $100,000 were $4.3 billion (13.9 percent) and $6.5 billion (19.5 percent) lower in the second quarter and first six months of 2010, respectively, compared with the same periods of 2009, reflecting a decrease in overall wholesale funding requirements, partially offset by the impact of acquisitions.

 

Provision for Credit Losses The provision for credit losses for the second quarter and first six months of 2010 decreased $256 million (18.4 percent) and $264 million (9.7 percent), respectively, from the same periods of 2009. Net charge-offs increased $185 million (19.9 percent) and $532 million (31.0 percent) in the second quarter and first six months of 2010, respectively, compared with the same periods of 2009, as borrowers impacted by weak economic conditions and real estate markets defaulted on loans. Overall, however, the loan portfolio experienced decreases in delinquencies in all major loan categories in the second quarter of 2010, compared to the first quarter of 2010. The Company recorded provision for credit losses in excess of net charge-offs of $25 million in the second quarter and $200 million in the first six months of 2010, compared with $466 million in the second quarter and $996 million in the first six months of 2009. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.

 

Noninterest Income Noninterest income in the second quarter and first six months of 2010 was $2.1 billion and $4.0 billion, respectively, compared with $2.1 billion and $3.8 billion in the same periods of 2009. The $55 million (2.7 percent) increase during the second quarter and $185 million (4.8 percent) increase during the first six months of 2010, compared with the same periods of 2009, were due to higher payments-related income, due to increased volumes, and increases in commercial products revenue attributable to higher standby letters of credit fees, commercial loan fees and syndication revenue. In addition, noninterest income for the first six months of 2010 also increased over the same period of the prior year due to a favorable variance in net securities losses of $162 million. Trust and investment management fees declined as low interest rates negatively impacted money market investment fees and lower money market fund balances led to a decline in account-level fees. Deposit service charges decreased as a result of Company-initiated revisions to overdraft fee policies and lower overdraft incidences. Mortgage banking revenue declined principally due to lower loan

 

 

 

Table 3    Noninterest Expense

 

production, partially offset by higher servicing income and favorable net changes in the valuation of mortgage servicing rights (“MSRs”) and related economic hedging activities. Other income increased in the second quarter and first six months of 2010, compared with the same periods of 2009, primarily due to the $28 million gain related to the Company’s investment in Visa Inc., lower retail lease residual valuation losses and improved equity investment income over the prior year. The increases in other income for the first six months of 2010, compared with the first six months of 2009, were partially offset by the $92 million gain on a corporate real estate transaction that occurred in the first quarter of 2009.

 

Noninterest Expense Noninterest expense was $2.4 billion in the second quarter and $4.5 billion in the first six months of 2010, compared with $2.1 billion in the second quarter and $4.0 billion in the first six months of 2009, or increases of $248 million (11.6 percent) and $513 million (12.8 percent), respectively. The increases in noninterest expense from a year ago were principally due to acquisitions, increased compensation and employee benefits expense, and higher costs related to investments in affordable housing and other tax-advantaged projects. Compensation and employee benefits expense increased reflecting acquisitions, ending a five percent cost reduction program that was in effect during the second quarter of 2009, higher incentives costs related to improved financial results, merit increases, and increased pension costs associated with previous declines in the value of pension assets. Net occupancy and equipment expense and professional services expense increased principally due to acquisitions and other business initiatives. Technology and communications expense increased as a result of payments-related initiatives and acquisitions. Other expense decreased in the second quarter and increased in the first six months of 2010, compared with the same periods of 2009, reflecting the net effect of the $123 million FDIC special assessment recorded in the second quarter of 2009, offset by higher costs related to investments in affordable housing and other tax-advantaged projects which benefit the Company’s income tax expense, higher merchant processing expense, increased other real estate owned (“OREO”) costs and debt extinguishment expense associated with the ITS exchange.

 

Income Tax Expense The provision for income taxes was $199 million (an effective rate of 20.9 percent) for the second quarter and $360 million (an effective rate of 20.3 percent) for the first six months of 2010, compared with $100 million (an effective rate of 17.1 percent) and $201 million (an effective rate of 16.3 percent) for the same periods of 2009. The increases in the effective tax rate for the second quarter and first six months of 2010, compared with the same periods of the prior year, primarily reflected the marginal impact of higher pre-tax earnings year-over-year. For further information on income taxes, refer to Note 10 of the Notes to Consolidated Financial Statements.

 

Loans The Company’s total loan portfolio was $191.6 billion at June 30, 2010, compared with $194.8 billion at December 31, 2009, a decrease of $3.2 billion (1.6 percent). The decrease was driven primarily by lower commercial and covered loans, partially offset by higher residential mortgages. The $2.0 billion (4.2 percent) decrease in commercial loans was primarily driven by lower capital spending and uncertain economic conditions decreasing utilization of existing commitments by business customers. The decrease was also due to the consolidation of a VIE and

 

 

the elimination of a related loan balance, the result of the adoption of new authoritative accounting guidance effective January 1, 2010.

Commercial real estate loans decreased $149 million (.4 percent) at June 30, 2010, compared with December 31, 2009, reflecting customer debt deleveraging, partially offset by the impact of new business activity.

Residential mortgages held in the loan portfolio increased $1.2 billion (4.6 percent) at June 30, 2010, compared with December 31, 2009. Most loans retained in the portfolio are to customers with prime or near-prime credit characteristics at the date of origination.

Total retail loans outstanding, which include credit card, retail leasing, home equity and second mortgages and other retail loans, decreased $316 million (.5 percent) at June 30, 2010, compared with December 31, 2009. The decrease was primarily driven by lower student loans and retail leasing balances, partially offset by higher installment loans.

 

Loans Held for Sale Loans held for sale, consisting primarily of residential mortgages, were $4.9 billion at June 30, 2010, compared with $4.8 billion at December 31, 2009, as residential mortgage production volume was similar in the second quarter of 2010 to the fourth quarter of 2009.

 

Investment Securities Investment securities totaled $48.4 billion at June 30, 2010, compared with $44.8 billion at December 31, 2009. The $3.6 billion (8.0 percent) increase reflected $2.1 billion of net investment purchases, the consolidation of $.6 billion of held-to-maturity securities held in a VIE due to the adoption of new authoritative accounting guidance effective January 1, 2010, and a $.9 billion favorable change in net unrealized gains (losses) on available-for-sale securities.

The Company conducts a regular assessment of its investment portfolio to determine whether any securities are other-than-temporarily impaired. At June 30, 2010, the Company’s net unrealized gain on available-for-sale securities was $226 million, compared with a net unrealized loss of $635 million at December 31, 2009. The favorable change in net unrealized gains (losses) was primarily due to increases in the fair value of agency mortgage-backed securities. Unrealized losses on securities in an unrealized loss position totaled $948 million at June 30, 2010, compared with $1.3 billion at December 31, 2009. When assessing unrealized losses for other-than-temporary impairment, the Company considers the nature of the investment, the financial condition of the issuer, the extent and duration of unrealized loss, expected cash flows of underlying collateral or assets and market conditions. At June 30, 2010, the Company had no plans to sell securities with unrealized losses and believes it is more likely than not it would not be required to sell such securities before recovery of their amortized cost.

There is limited market activity for structured investment related and non-agency mortgage-backed securities held by the Company. As a result, the Company estimates the fair value of these securities using estimates of expected cash flows, discount rates and management’s assessment of various other market factors, which are judgmental in nature. The Company recorded $21 million and $67 million of impairment charges in earnings during the second quarter and first six months of 2010, respectively, predominately on non-agency mortgage-backed and structured investment related securities. These impairment charges were due to changes in expected cash flows resulting from increases in defaults in the underlying mortgage pools and regulatory actions in the first quarter of 2010 related to an insurer of some of the securities. Further adverse changes in market conditions may result in additional impairment charges in future periods. Refer to Notes 3 and 12 in the Notes to Consolidated Financial Statements for further information on investment securities.

 

Deposits Total deposits were $183.1 billion at June 30, 2010, compared with $183.2 billion at December 31, 2009, the result of increases in savings accounts and noninterest-bearing deposit balances, offset by decreases in time certificates of deposit, money market savings and interest checking balances. Savings account balances increased $4.1 billion (24.2 percent) primarily due to continued strong participation in a savings product offered by Consumer Banking beginning in 2008. Noninterest-bearing deposits increased $3.5 billion (9.1 percent) primarily due to increases in corporate and commercial banking, and corporate trust balances. Money market savings balances decreased $2.8 billion (7.0 percent), reflecting the Company’s deposit pricing decisions in relation to other funding sources. Interest checking balances decreased $861 million (2.2 percent) due to lower Consumer Banking balances. Time certificates of deposit less than $100,000 decreased $2.5 billion (13.2 percent), and time deposits greater than $100,000 decreased $1.5 billion (5.0 percent), reflecting the Company’s funding and pricing decisions. Time deposits greater than $100,000 are managed as an alternative to other funding sources, such as wholesale borrowing, based largely on relative pricing.

 

 

 

Table 4    Investment Securities

 

 

 

 

Borrowings The Company utilizes both short-term and long-term borrowings to fund growth of assets in excess of deposit growth. Short-term borrowings, which include federal funds purchased, commercial paper, repurchase agreements, borrowings secured by high-grade assets and other short-term borrowings, were $33.8 billion at June 30, 2010, compared with $31.3 billion at December 31, 2009. The $2.5 billion (7.9 percent) increase in short-term borrowings reflected wholesale funding associated with the Company’s asset growth and asset/liability management activities.

Long-term debt was $29.1 billion at June 30, 2010, compared with $32.6 billion at December 31, 2009, reflecting a $2.6 billion net decrease in Federal Home Loan Bank advances, $4.0 billion of medium-term note maturities and repayments and the extinguishment of $.6 billion of junior subordinated debentures in connection with the ITS exchange, partially offset by $2.3 billion of medium-term note and subordinated debt issuances and the consolidation of $1.7 billion of long-term debt related to certain VIEs at June 30, 2010. Refer to the “Liquidity Risk Management” section for discussion of liquidity management of the Company.

 

CORPORATE RISK PROFILE

Overview Managing risks is an essential part of successfully operating a financial services company. The most prominent risk exposures are credit, residual value, operational, interest rate, market and liquidity risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan, investment or derivative contract when it is due. Residual value risk is the potential reduction in the end-of-term value of leased assets. Operational risk includes risks related to fraud, legal and compliance risk, processing errors, technology, breaches of internal controls and business continuation and disaster recovery risk. Interest rate risk is the potential reduction of net interest income as a result of changes in interest rates, which can affect the re-pricing of assets and liabilities differently. Market risk arises from fluctuations in interest rates, foreign exchange rates, and security prices that may result in changes in the values of financial instruments, such as trading and available-for-sale securities and derivatives that are accounted for on a mark-to-market basis. Liquidity risk is the possible inability to fund obligations to depositors, investors or borrowers. In addition, corporate strategic decisions, as well as the risks described above, could give rise to reputation risk. Reputation risk is the risk that negative publicity or press, whether true or not, could result in costly litigation or cause a decline in the Company’s stock value, customer base, funding sources or revenue.

Credit Risk Management The Company’s strategy for credit risk management includes well-defined, centralized credit policies, uniform underwriting criteria, and ongoing risk monitoring and review processes for all commercial and consumer credit exposures. 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. Refer to “Management’s Discussion and Analysis — Credit Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, for a more detailed discussion on credit risk management processes.

The Company manages its credit risk, in part, through diversification of its loan portfolio and limit setting by product type criteria and concentrations. As part of its normal business activities, the Company offers a broad array of commercial and retail lending products. The Company’s retail lending business utilizes several distinct business processes and channels to originate retail credit, including traditional branch lending, indirect lending, portfolio acquisitions and a consumer finance division. Generally, loans managed by the Company’s consumer finance division exhibit higher credit risk characteristics, but are priced commensurate with the differing risk profile. With respect to residential mortgages originated through these channels, the Company may either retain the loans on its balance sheet or sell its interest in the balances into the secondary market while retaining the servicing rights and customer relationships. For residential mortgages that are retained in the Company’s portfolio and for home equity and second mortgages, credit risk is also diversified by geography and managed by adherence to loan-to-value and borrower credit criteria during the underwriting process.

 

 

 

 

The following tables provide summary information of the loan-to-values of residential mortgages and home equity and second mortgages by distribution channel and type at June 30, 2010 (excluding covered loans):

 

 

 

Within the consumer finance division, at June 30, 2010, approximately $2.3 billion of residential mortgages were to customers that may be defined as sub-prime borrowers based on credit scores from independent credit rating agencies at loan origination, compared with $2.5 billion at December 31, 2009.

 

The following table provides further information on the loan-to-values of residential mortgages specifically for the consumer finance division at June 30, 2010:

 

In addition to residential mortgages, at June 30, 2010, the consumer finance division had $.6 billion of home equity and second mortgage loans to customers that may be defined as sub-prime borrowers, unchanged from December 31, 2009.

 

The following table provides further information on the loan-to-values of home equity and second mortgages specifically for the consumer finance division at June 30, 2010:

 

The total amount of residential mortgage, home equity and second mortgage loans, other than covered loans, to customers that may be defined as sub-prime borrowers represented only 1.0 percent of total assets at June 30, 2010, compared with 1.1 percent at December 31, 2009. Covered loans include $1.8 billion in loans with negative-amortization payment options at June 30, 2010, compared with $2.2 billion at December 31, 2009. Other than covered loans, the Company does not have any residential mortgages with payment schedules that would cause balances to increase over time.

 

 

Table 5    Delinquent Loan Ratios as a Percent of Ending Loan Balances