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 September 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 $908 million for the third quarter of 2010 or $.45 per diluted common share, compared with $603 million, or $.30 per diluted common share for the third quarter of 2009. Return on average assets and return on average common equity were 1.26 percent and 12.8 percent, respectively, for the third quarter of 2010, compared with .90 percent and 10.0 percent, respectively, for the third quarter of 2009. Significant items in the third quarter of 2009 that impact the comparison of results included provision for credit losses in excess of net charge-offs of $415 million, net securities losses of $76 million, and a $39 million gain related to the Company’s investment in Visa Inc.

Total net revenue, on a taxable-equivalent basis, for the third quarter of 2010 was $337 million (7.9 percent) higher than the third quarter of 2009, reflecting a 14.8 percent increase in net interest income and a .8 percent increase in total noninterest income. The increase in net interest income over a year ago was largely the result of an increase in average earning assets, primarily related to acquisitions, and continued growth in lower cost core deposit funding. Noninterest income increased over a year ago as a result of higher payments-related revenue, commercial products revenue and mortgage banking revenue.

Total noninterest expense in the third quarter of 2010 was $332 million (16.2 percent) higher than the third quarter of 2009, primarily due to the impact of acquisitions and higher total compensation and employee benefits expense.

The provision for credit losses for the third quarter of 2010 was $995 million, or $461 million (31.7 percent) lower than the third quarter of 2009. The provision for credit losses equaled net charge-offs in the third quarter of 2010, and exceeded net charge-offs by $415 million in the third quarter of 2009. Net charge-offs in the third quarter of 2010 were $995 million, compared with net charge-offs of $1,041 million in the third quarter of 2009. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and other 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 $2.3 billion for the first nine months of 2010 or $1.24 per diluted common share, compared with $1.6 billion, or $.66 per diluted common share for the first nine months of 2009. Return on average assets and return on average common equity were 1.11 percent and 12.3 percent, respectively, for the first nine months of 2010, compared with .81 percent and 7.7 percent, respectively, for the first nine months of 2009. Diluted earnings per common share for the first nine months of 2010 included a non-recurring $.05 benefit in the second quarter 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 first nine months of 2010 were $200 million of provision for credit losses in excess of net charge-offs, net securities losses of $64 million and a $28 million gain related to the Company’s investment in Visa Inc. The first nine months of 2009 included $1.4 billion of provision for credit losses in excess of net charge-offs, net securities losses of $293 million, a $123 million Federal Deposit Insurance Corporation (“FDIC”) special assessment, a $92 million gain from a corporate real estate transaction, a $39 million gain related to the Company’s investment in Visa Inc. 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 first nine months of 2010 was $1.1 billion (9.2 percent) higher than the first nine months of 2009, reflecting a 14.7 percent increase in net interest income and a 3.4 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, deposit service charges and trust and investment management fees.

Total noninterest expense in the first nine months of 2010 was $845 million (14.0 percent) higher than the first nine months of 2009, primarily due to the impact of acquisitions, higher total 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 nine months of 2010 was $3.4 billion, or $725 million (17.4 percent) lower than the first nine months of 2009. The provision for credit losses exceeded net charge-offs by $200 million in the first nine months of 2010, compared with $1.4 billion in the first nine months of 2009. Net charge-offs in the first nine months of 2010 were $3.2 billion, compared with net charge-offs of $2.8 billion in the first nine 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.

 

Net Interest Income Net interest income, on a taxable-equivalent basis, was $2.5 billion in the third quarter of 2010, compared with $2.2 billion in the third quarter of 2009. Net interest income, on a taxable-equivalent basis, was $7.3 billion in the first nine months of 2010, compared with $6.4 billion in the first nine 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 $16.3 billion (9.8 percent) in the third quarter and $19.4 billion (11.9 percent) in the first nine months of 2010, compared with the same periods of 2009. Average earning assets were $17.8 billion (7.6 percent) higher in the third quarter and $14.8 billion (6.3 percent) higher in the first nine 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 third quarter and first nine months of 2010 was 3.91 percent and 3.90 percent, respectively, compared with 3.67 percent in the third quarter of 2009 and 3.62 percent in the first nine 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 third quarter and first nine months of 2010 were $10.6 billion (5.8 percent) and $8.4 billion (4.5 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 increased origination and refinancing activity as a result of market interest rate declines. Average retail loans increased year-over-year, driven by increases in credit card and installment (primarily auto) loans. Average credit card balances for the third quarter and first nine months of 2010 were $1.1 billion (7.3 percent) and $2.0 billion (13.6 percent) higher, respectively, than the same periods of 2009, reflecting growth in existing portfolios and portfolio purchases during 2009 and 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 $19.3 billion and $20.4 billion in the third quarter and first nine months of 2010, respectively, compared with $10.3 billion and $10.8 billion in the same periods of 2009.

Average investment securities in the third quarter and first nine months of 2010 were $5.3 billion (12.5 percent) and $4.7 billion (11.2 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.

Average total deposits for the third quarter and first nine months of 2010 were $16.3 billion (9.8 percent) and $19.4 billion (11.9 percent) higher, respectively, than the same periods of 2009. Excluding deposits from acquisitions, third quarter 2010 average total deposits increased $4.5 billion (2.7 percent) over the third quarter of 2009. Average noninterest-bearing deposits for the third quarter and first nine months of 2010 were $2.8 billion (7.4 percent) and $2.4 billion (6.6 percent) higher, respectively, than the same periods of 2009, primarily due to growth in Consumer and Wholesale Banking business line balances and the impact of acquisitions. Average total savings deposits were $13.9 billion (16.3 percent) higher in the third quarter and $21.7 billion (28.0 percent) higher in the first nine

 

 

 

Table 2    Noninterest Income

 

months of 2010, compared with the same periods of 2009, primarily the result of growth in Consumer Banking, institutional and corporate trust balances, and the impact of acquisitions. Average time certificates of deposit less than $100,000 were lower in the third quarter and first nine months of 2010 by $961 million (5.7 percent) and $586 million (3.3 percent), respectively, compared with the same periods in 2009, as decreases in Consumer Banking balances were partially offset by acquisition-related growth. Average time deposits greater than $100,000 were $617 million (2.3 percent) higher and $4.1 billion (13.2 percent) lower in the third quarter and first nine months of 2010, respectively, compared with the same periods of 2009, reflecting the net impact of acquisitions, offset by a decrease in required overall wholesale funding.

 

Provision for Credit Losses The provision for credit losses for the third quarter and first nine months of 2010 decreased $461 million (31.7 percent) and $725 million (17.4 percent), respectively, from the same periods of 2009. Net charge-offs decreased $46 million (4.4 percent) in the third quarter of 2010, compared with the third quarter of 2009, principally due to improvement in the commercial and commercial real estate portfolios. Net charge-offs increased $486 million (17.6 percent) in the first nine months of 2010, compared with the same period of 2009, as borrowers impacted by weak economic conditions and real estate markets defaulted on loans. Delinquencies decreased in most major loan categories in the third quarter of 2010, compared to the second quarter of 2010. The provision for credit losses equaled net charge-offs in the third quarter of 2010, but exceeded net charge-offs by $415 million in the third quarter of 2009. The provision for credit losses exceeded net charge-offs by $200 million in the first nine months of 2010, compared with $1.4 billion in the first nine months of 2009. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and other 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 third quarter and first nine months of 2010 was $2.1 billion and $6.1 billion, respectively, compared with $2.1 billion and $5.9 billion in the same periods of 2009. The $17 million (.8 percent) increase during the third quarter and $202 million (3.4 percent) increase during the first nine months of 2010, compared with the same periods of 2009, were due to higher payments-related revenues, principally due to increased transaction volumes, increases in commercial products revenue attributable to higher standby letters of credit fees, commercial loan fees and syndication revenue, and decreases in net securities losses, primarily due to lower impairments in the current year. Mortgage banking revenue increased for the third quarter of 2010 compared to the third quarter of 2009 due to higher production and servicing revenue, partially offset by an unfavorable net change in the valuation of mortgage servicing rights (“MSRs”) and related economic hedging activities. Mortgage banking revenue declined in the first nine months of 2010, compared with the same period in 2009, principally due to lower loan production, partially offset by higher servicing income and a favorable net change in the valuation of MSRs and related economic hedging activities. Deposit service charges decreased in the third quarter and first nine months of 2010, compared with the same periods of the prior year, as a result of Company-initiated and regulatory revisions to overdraft fee policies and lower overdraft incidences. Trust and investment management fees declined in the

 

 

 

Table 3    Noninterest Expense

 

third quarter and first nine months of 2010, compared with the same periods of 2009, as low interest rates negatively impacted money market investment fees and lower money market fund balances led to a decline in account-level fees. Other income decreased in the third quarter of 2010, compared with the third quarter of 2009, primarily due to the third quarter 2009 gain related to the Company’s investment in Visa Inc. and lower customer derivative revenue, partially offset by improved retail lease end-of-term results and higher income from equity investments. The increase in other income for the first nine months of 2010, compared with the first nine months of 2009, reflected improved retail lease end-of-term results and higher income from equity investments, partially offset by the $92 million gain on a corporate real estate transaction that occurred in the first quarter of 2009 and lower customer derivative revenue.

 

Noninterest Expense Noninterest expense was $2.4 billion in the third quarter and $6.9 billion in the first nine months of 2010, compared with $2.1 billion in the third quarter and $6.1 billion in the first nine months of 2009, or increases of $332 million (16.2 percent) and $845 million (14.0 percent), respectively. The increases in noninterest expense from a year ago were principally due to acquisitions, increased total compensation and employee benefits expense and higher costs related to investments in affordable housing and other tax-advantaged projects. Total compensation and employee benefits expense increased, reflecting acquisitions, a five percent cost reduction program that was in effect during the second and third quarters 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 business initiatives and volume increases across various business lines. Other expense increased in the third quarter and first nine months of 2010, compared with the same periods of 2009, reflecting higher costs related to investments in affordable housing and other tax-advantaged projects, which benefit the Company’s income tax expense, and higher other real estate owned (“OREO”) costs, partially offset by the $123 million FDIC special assessment recorded in the second quarter of 2009. Marketing and business development expense decreased in the third quarter and first nine months of 2010, compared with the same periods of the prior year, largely due to payments-related initiatives during 2009, partially offset by increased contributions to the Company’s charitable foundation in the third quarter of 2010.

 

Income Tax Expense The provision for income taxes was $260 million (an effective rate of 22.5 percent) for the third quarter and $620 million (an effective rate of 21.2 percent) for the first nine months of 2010, compared with $86 million (an effective rate of 12.4 percent) and $287 million (an effective rate of 14.9 percent) for the same periods of 2009. The increases in the effective tax rate for the third quarter and first nine 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 $194.6 billion at September 30, 2010, compared with $194.8 billion at December 31, 2009, a decrease of $138 million (.1 percent). The decrease was driven primarily by lower commercial and covered loans, partially offset by higher residential mortgages and retail loans. The $1.2 billion (2.4 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 elimination of a related loan balance as a result of adopting new authoritative accounting guidance effective January 1, 2010.

Commercial real estate loans increased $225 million (.7 percent) at September 30, 2010, compared with December 31, 2009, reflecting the impact of new business activity, partially offset by customer debt deleveraging.

Residential mortgages held in the loan portfolio increased $2.5 billion (9.7 percent) at September 30, 2010, compared with December 31, 2009, reflecting an increase in mortgage banking origination and refinancing activity as a result of current market interest rate declines. 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, increased $1.1 billion (1.7 percent) at September 30, 2010, compared with December 31, 2009. The increase was primarily driven by higher installment (primarily auto) and federally-guaranteed student loans, partially offset by lower credit card, home equity and retail leasing balances.

 

Loans Held for Sale Loans held for sale, consisting primarily of residential mortgages, were $8.4 billion at September 30, 2010, compared with $4.8 billion at December 31, 2009. The increase in loans held for sale was principally due to an increase in mortgage loan origination and refinancing activity as a result of a decline in market interest rates.

 

Investment Securities Investment securities totaled $49.0 billion at September 30, 2010, compared with $44.8 billion at December 31, 2009. The $4.2 billion (9.4 percent) increase reflected $2.3 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 $1.3 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 September 30, 2010, the Company’s net unrealized gain on available-for-sale securities was $633 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 and certain non-agency mortgage-backed and state and political securities. Unrealized losses on available-for-sale securities in an unrealized loss position totaled $689 million at September 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 September 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 $18 million and $85 million of impairment charges in earnings during the third quarter and first nine 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.

 

 

 

Table 4    Investment Securities

 

 

 

 

 

 

Deposits Total deposits were $187.4 billion at September 30, 2010, compared with $183.2 billion at December 31, 2009, the result of increases in savings, interest checking and noninterest-bearing deposit balances, partially offset by decreases in time deposits. Savings account balances increased $5.8 billion (34.3 percent), primarily due to continued strong participation in a savings product offered by Consumer Banking. Noninterest-bearing deposits increased $2.6 billion (6.7 percent), primarily due to increases in Wholesale and Consumer Banking balances. Interest checking balances increased $1.5 billion (3.8 percent), primarily due to higher broker dealer balances. Time certificates of deposit less than $100,000 decreased $3.5 billion (18.2 percent), as a result of decreases in Consumer Banking and expected decreases in acquired certificates of deposit. Time deposits greater than $100,000 decreased $2.1 billion (7.1 percent). Time deposits greater than $100,000 are managed as an alternative to other funding sources, such as wholesale borrowing, based largely on relative pricing.

 

Borrowings The Company utilizes both short-term and long-term borrowings as part of its asset/liability management and funding strategies. Short-term borrowings, which include federal funds purchased, commercial paper, repurchase agreements, borrowings secured by high-grade assets and other short-term borrowings, were $34.3 billion at September 30, 2010, compared with $31.3 billion at December 31, 2009. The $3.0 billion (9.7 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 $30.4 billion at September 30, 2010, compared with $32.6 billion at December 31, 2009, reflecting a $2.6 billion net decrease in Federal Home Loan Bank advances, $5.3 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 $4.3 billion of medium-term note and subordinated debt issuances and the consolidation of $2.1 billion of long-term debt related to certain VIEs at September 30, 2010. Refer to the “Liquidity Risk Management” section for discussion of liquidity management of the Company.

 

 

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, processing errors, technology, breaches of internal controls and business continuation and disaster recovery. 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 September 30, 2010 (excluding covered loans):

 

 

 

Within the consumer finance division, at September 30, 2010, approximately $2.2 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 September 30, 2010:

 

 

In addition to residential mortgages, at September 30, 2010, the consumer finance division had $.5 billion of home equity and second mortgage loans to customers that may be defined as sub-prime borrowers, compared with $.6 billion at 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 September 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 September 30, 2010, compared with 1.1 percent at December 31, 2009. Covered loans include $1.7 billion in loans with negative-amortization payment options at September 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