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, 2011

 

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. Continued 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 negatively 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, 2010, 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 $1.3 billion for the third quarter of 2011, or $.64 per diluted common share, compared with $908 million, or $.45 per diluted common share for the third quarter of 2010. Return on average assets and return on average common equity were 1.57 percent and 16.1 percent, respectively, for the third quarter of 2011, compared with 1.26 percent and 12.8 percent, respectively, for the third quarter of 2010. The provision for credit losses for the third quarter of 2011 was $150 million lower than net charge-offs. The provision for credit losses equaled net charge-offs in the third quarter of 2010.

Total net revenue, on a taxable-equivalent basis, for the third quarter of 2011 was $208 million (4.5 percent) higher than the third quarter of 2010, reflecting a 5.9 percent increase in net interest income and a 2.9 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 and continued growth in lower cost core deposit funding. Noninterest income increased over a year ago, primarily due to higher payments-related revenue, deposit service charges and commercial products revenue, partially offset by lower mortgage banking revenue.

Total noninterest expense in the third quarter of 2011 was $91 million (3.8 percent) higher than the third quarter of 2010, primarily due to higher total compensation and employee benefits expense, including higher pension costs, higher professional services expense and other business initiatives.

The provision for credit losses for the third quarter of 2011 was $519 million, or $476 million (47.8 percent) lower than the third quarter of 2010. Net charge-offs in the third quarter of 2011 were $669 million, compared with $995 million in the third quarter of 2010. 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 $3.5 billion for the first nine months of 2011, or $1.77 per diluted common share, compared with $2.3 billion, or $1.24 per diluted common share for the first nine months of 2010. Return on average assets and return on average common equity were 1.50 percent and 15.5 percent, respectively, for the first nine months of 2011, compared with 1.11 percent and 12.3 percent, respectively, for the first nine months of 2010. The Company’s results for the first nine months of 2011 included a $46 million gain related to the acquisition of First Community Bank of New Mexico (“FCB”) in a transaction with the Federal Deposit Insurance Corporation (“FDIC”) during the first quarter of 2011. Results for the first nine months of 2011 also included net securities losses of $22 million and a provision for credit losses lower than net charge-offs by $375 million. 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 perpetual preferred stock for outstanding income trust securities. The first nine months of 2010 also included $200 million of provision for credit losses in excess of net charge-offs and $64 million of net securities losses.

Total net revenue, on a taxable-equivalent basis, for the first nine months of 2011 was $577 million (4.3 percent) higher than the first nine months of 2010, reflecting a 5.3 percent increase in net interest income and a 3.1 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 and continued growth in lower cost core deposit funding. Noninterest income increased over a year ago, primarily due to higher payments-related revenue, commercial products revenue and other income, as well as lower net securities losses, partially offset by lower mortgage banking revenue.

Total noninterest expense in the first nine months of 2011 was $317 million (4.6 percent) higher than the first nine months of 2010, primarily due to higher total compensation and employee benefits expense, including higher pension costs, higher professional services expense and other business initiatives.

The provision for credit losses for the first nine months of 2011 was $1.8 billion, or $1.6 billion (46.4 percent) lower than the first nine months of 2010. Net charge-offs in the first nine months of 2011 were $2.2 billion, compared with $3.2 billion in the first nine months of 2010. 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.

 

 

STATEMENT OF INCOME ANALYSIS

 

Net Interest Income Net interest income, on a taxable-equivalent basis, was $2.6 billion in the third quarter of 2011, compared with $2.5 billion in the third quarter of 2010. Net interest income, on a taxable-equivalent basis, was $7.7 billion in the first nine months of 2011, compared with $7.3 billion in the first nine months of 2010. The increases were primarily the result of growth in average earning assets and lower cost core deposit funding. Average earning assets increased $34.4 billion (13.6 percent) in the third quarter and $29.9 billion (12.0 percent) in the first nine months of 2011, compared with the same periods of 2010, driven by increases in investment securities, loans and other earning assets, which included cash balances held at the Federal Reserve. The net interest margin in the third quarter and first nine months of 2011 was 3.65 percent and 3.67 percent, respectively, compared with 3.91 percent and 3.90 percent in the third quarter and first nine months of 2010, respectively. The decreases in the net interest margin reflected higher balances in lower yielding investment securities and growth in cash balances held at the Federal Reserve. 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 2011 were $9.6 billion (5.0 percent) and $7.3 billion (3.8 percent) higher, respectively, than the same periods of 2010, driven by growth in residential mortgages, commercial loans, commercial real estate loans and other retail loans, partially offset by decreases in credit card balances and loans covered by loss sharing agreements with the FDIC (“covered” loans). The increases were driven by demand for loans and lines by new and existing credit-worthy borrowers and the impact of the FCB acquisition. Average covered loans decreased for the third quarter and first nine months of 2011, by $3.5 billion (18.2 percent) and $3.7 billion (18.1 percent), respectively, compared with the same periods of 2010.

Average investment securities in the third quarter and first nine months of 2011 were $18.4 billion (38.4 percent) and $14.8 billion (31.5 percent) higher, respectively, than the same periods of 2010, primarily due to purchases of U.S. Treasury and government agency-related securities, as the Company increased its on-balance sheet liquidity in response to anticipated regulatory requirements.

Average total deposits for the third quarter and first nine months of 2011 were $32.7 billion (17.9 percent) and $26.9 billion (14.7 percent) higher, respectively, than the same periods of 2010. Excluding deposits from acquisitions, third quarter 2011 average total deposits increased $24.2 billion (13.2 percent) over the third quarter of 2010. Average noninterest-bearing deposits for the third quarter and first nine months of 2011 were $18.9 billion (47.5 percent) and $11.3 billion (28.9 percent) higher, respectively, than the same periods of 2010, with growth in Wholesale Banking and Commercial Real Estate, Wealth Management and Securities Services, and Consumer and Small Business Banking balances. Average total savings deposits for the third quarter and first nine months of 2011 were $13.4 billion (13.5 percent) and $14.4 billion (14.5 percent) higher, respectively, than the same periods of 2010, primarily due to growth in corporate and institutional trust balances, including the impact of the December 30, 2010 acquisition of the securitization trust administration business of Bank of America, N.A. (“securitization trust administration acquisition”), as well as increases in Consumer and Small Business Banking balances, partially offset by lower broker-dealer balances. Average time certificates of deposit less than $100,000 were lower in the third quarter and first nine months of 2011 by $773 million (4.8 percent) and $1.8 billion (10.6 percent), respectively, compared with the same periods of 2010, as a result of expected decreases in acquired certificates of deposit and decreases in Consumer and Small Business Banking balances. Average time deposits greater than $100,000 were $1.2 billion (4.4 percent) and $3.0 billion (11.0 percent) higher in the third quarter and first nine months of 2011, respectively, compared with the same periods of 2010, principally due to higher balances in Wholesale Banking and Commercial Real Estate and institutional and corporate trust, including the impact of the securitization trust administration and FCB acquisitions.

 

Provision for Credit Losses The provision for credit losses for the third quarter and first nine months of 2011 decreased $476 million (47.8 percent) and $1.6 billion (46.4 percent), respectively, from the same periods of 2010. Net charge-offs decreased $326 million (32.8 percent) and $1.0 billion (31.5 percent) in the third quarter and first nine months of 2011, respectively, compared with the same periods of 2010, principally due to improvement in the commercial, commercial real estate, credit card and other retail loan portfolios. The provision for credit losses was lower than net charge-offs by $150 million in the third quarter and $375 million in the first nine months of 2011, equaled net charge-offs in the third quarter of 2010, and exceeded net charge-offs by $200 million in the first nine months of 2010. 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.

 

 

Table 2    Noninterest Income

 

 

Noninterest Income Noninterest income in the third quarter and first nine months of 2011 was $2.2 billion and $6.3 billion, respectively, compared with $2.1 billion and $6.1 billion in the same periods of 2010, or increases of $61 million (2.9 percent) and $191 million (3.1 percent), respectively. Payments-related revenues and ATM processing services income were higher largely due to increased transaction volumes. Commercial products revenue increased due to higher commercial leasing revenue, syndication fees and other commercial loan fees. Investment products fees and commissions also increased due to business initiatives. Deposit service charges increased in the third quarter of 2011, compared with the third quarter of 2010, primarily due to new account growth, higher transaction volumes and recent product redesign initiatives, partially offset by 2010 legislative and pricing changes. Deposit service charges were lower in the first nine months of 2011, compared with the same period of the prior year, due to the 2010 legislative and pricing changes, partially offset by account growth. Other income increased in the third quarter and first nine months of 2011, compared with the same periods of the prior year, primarily due to higher retail lease residual revenue and customer-related derivative revenue. In addition, other income for the first nine months of 2011 also increased over the same period of the prior year due to a gain recognized on the FCB acquisition in the first quarter of 2011. Trust and investment management fees decreased as a result of the sale of the Company’s long-term asset management business in the fourth quarter of 2010 and increased money market investment fee waivers, partially offset by the positive impact of the securitization trust administration acquisition and improved market conditions. In addition, mortgage banking revenue decreased due to lower origination and sales revenue.

The Company anticipates the implementation of recently passed legislation, under the Durbin Amendment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, will reduce future noninterest income by approximately $300 million on an annualized basis beginning in the fourth quarter of 2011, based on anticipated transaction volume excluding any mitigating actions the Company may take.

 

Noninterest Expense Noninterest expense was $2.5 billion in the third quarter and $7.2 billion in the first nine months of 2011, compared with $2.4 billion in the third quarter and $6.9 billion in the first nine months of 2010, or increases of $91 million (3.8 percent) and $317 million (4.6 percent), respectively. The increase in noninterest expense from a year ago was principally due to increased total compensation, employee benefits, net occupancy and equipment expense, and professional services expense, partially offset by decreases in other intangibles expense and other expense. Total compensation increased primarily due to an increase in staffing related to branch expansion and other business initiatives, and merit increases. Employee benefits expense increased due to higher pension costs and the impact of additional staff. Net occupancy and equipment expense increased principally due to business expansion and technology initiatives. Professional services expense increased due to mortgage servicing-related and other projects across multiple business lines. These increases were partially offset by decreases in other intangibles expense due to the reduction or completion of the amortization of certain intangibles. Other expense was also lower due to lower costs related to other real estate owned, insurance and litigation matters.

 

 

 

Table 3    Noninterest Expense

 

 

Income Tax Expense The provision for income taxes was $490 million (an effective rate of 28.1 percent) for the third quarter and $1.3 billion (an effective rate of 27.5 percent) for the first nine months of 2011, compared with $260 million (an effective rate of 22.5 percent) and $620 million (an effective rate of 21.2 percent) for the same periods of 2010. The increases in the effective tax rates for the third quarter and first nine months of 2011, compared with the same periods of the prior year, principally reflected the marginal impact of higher pretax earnings year-over-year. For further information on income taxes, refer to Note 11 of the Notes to Consolidated Financial Statements.

 

 

Loans The Company’s total loan portfolio was $204.8 billion at September 30, 2011, compared with $197.1 billion at December 31, 2010, an increase of $7.7 billion (3.9 percent). The increase was driven by increases in most major loan categories, partially offset by lower credit card and covered loans. The $5.4 billion (11.2 percent) increase in commercial loans was primarily driven by higher loan demand from new and existing customers, and the $908 million (2.6 percent) increase in commercial real estate loans was primarily due to the FCB acquisition.

Residential mortgages held in the loan portfolio increased $4.4 billion (14.3 percent) at September 30, 2011, compared with December 31, 2010, as a result of mortgage originations exceeding prepayments and paydowns in the portfolio. Most loans retained in the portfolio are to customers with prime or near-prime credit characteristics at the date of origination.

Total credit card loans decreased $471 million (2.8 percent) at September 30, 2011, compared with December 31, 2010. Other retail loans, which include retail leasing, home equity and other consumer loans, were essentially unchanged at September 30, 2011, compared with December 31, 2010.

 

Loans Held for Sale Loans held for sale, consisting primarily of residential mortgages to be sold in the secondary market, were $5.4 billion at September 30, 2011, compared with $8.4 billion at December 31, 2010. The decrease in loans held for sale was principally due to a high level of mortgage loan origination and refinancing activity in the second half of 2010.

Most of the Company’s residential mortgage loans are originated to guidelines that allow the loans to be sold into existing, highly liquid secondary markets; in particular in government agency transactions and to government sponsored enterprises (“GSEs”). The Company also originates residential mortgages that follow its own investment guidelines with the intent to hold such loans in the loan portfolio, primarily well secured jumbo mortgages to borrowers with high credit quality, as well as near-prime non-conforming mortgages. The Company generally retains portfolio loans through maturity; however, the Company’s intent may change over time based upon various factors such as ongoing asset/liability management activities, assessment of product profitability, credit risk, liquidity needs, and capital implications. If the Company’s intent or ability to hold an existing portfolio loan changes, it is transferred to loans held for sale.

 

Investment Securities Investment securities totaled $68.4 billion at September 30, 2011, compared with $53.0 billion at December 31, 2010. The $15.4 billion (29.1 percent) increase primarily reflected $14.1 billion of net investment purchases, primarily in the held-to-maturity investment portfolio, as well as a $1.0 billion favorable change in unrealized gains (losses) on available-for-sale investment securities. Held-to-maturity securities were $16.3 billion at September 30, 2011, compared with $1.5 billion at December 31, 2010, primarily reflecting increases in U.S. Treasury and agency mortgage-backed securities, as the Company increased its on-balance sheet liquidity in response to anticipated regulatory requirements.

 

 

MDA Tables Throw Away Note and Keep Tables

Table 4    Investment Securities

 

 

The Company conducts a regular assessment of its investment portfolio to determine whether any securities are other-than-temporarily impaired. At September 30, 2011, the Company’s net unrealized gain on available-for-sale securities was $617 million, compared with a net unrealized loss of $346 million at December 31, 2010. The favorable change in net unrealized gains (losses) was primarily due to increases in the fair value of state and

 

 

political securities and agency mortgage-backed securities. Unrealized losses on available-for-sale securities in an unrealized loss position totaled $646 million at September 30, 2011, compared with $1.2 billion at December 31, 2010. 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 assets and market conditions. At September 30, 2011, the Company had no plans to sell securities with unrealized losses and believes it is more likely than not that it would not be required to sell such securities before recovery of their amortized cost.

There is limited market activity for 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 $9 million and $24 million of impairment charges in earnings during the third quarter and first nine months of 2011, respectively, predominately on non-agency mortgage-backed securities. These impairment charges were due to changes in expected cash flows primarily resulting from increases in defaults in the underlying mortgage pools. Further adverse changes in market conditions may result in additional impairment charges in future periods. Refer to Notes 4 and 13 in the Notes to Consolidated Financial Statements for further information on investment securities.

 

Deposits Total deposits were $222.6 billion at September 30, 2011, compared with $204.3 billion at December 31, 2010, the result of increases in noninterest-bearing and savings account deposits, partially offset by decreases in money market and time deposits greater than $100,000. Noninterest-bearing deposits increased $18.9 billion (41.7 percent), primarily due to increases in Wholesale Banking and Commercial Real Estate, and corporate trust balances. Savings account balances increased $3.0 billion (12.5 percent), primarily due to continued strong participation in a savings product offered by Consumer and Small Business Banking. Money market balances decreased $2.0 billion (4.3 percent) primarily due to lower Consumer and Small Business Banking, and broker-dealer balances, partially offset by higher corporate trust balances. Time deposits greater than $100,000, which are managed as an alternative to other funding sources such as wholesale borrowing, based largely on relative pricing, decreased $1.5 billion (5.0 percent) at September 30, 2011, compared with December 31, 2010. Interest checking balances decreased $160 million (.4 percent) primarily due to lower institutional trust balances, partially offset by higher Consumer and Small Business Banking, and corporate trust balances.

 

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 $32.0 billion at September 30, 2011, compared with $32.6 billion at December 31, 2010. The $528 million (1.6 percent) decrease in short-term borrowings was primarily due to lower repurchase agreements, partially offset by higher commercial paper and other borrowed funds balances. Long-term debt was $30.6 billion at September 30, 2011, compared with $31.5 billion at December 31, 2010. The $913 million (2.9 percent) decrease was primarily due to $1.7 billion of medium-term note and subordinated debt repayments and maturities, $.8 billion of extinguishments of junior subordinated debentures, and a $.6 billion decrease in Federal Home Loan Bank advances, partially offset by $1.0 billion of medium-term note issuances and a $1.0 billion increase in long-term debt related to certain consolidated variable interest entities. 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, 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, mortgage servicing rights (“MSRs”) and derivatives that are accounted for on a fair value 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. In addition, credit quality ratings as defined by the Company, are an important part of the Company’s overall credit risk management and evaluation of its allowance for credit losses. Loans with a pass rating represent those not classified on the Company’s rating scale for problem credits, as minimal risk has been identified. Loans with a special mention or classified rating, including all of the Company’s loans that are 90 days or more past due and still accruing, nonaccrual loans, and those considered troubled debt restructurings (“TDRs”), encompass all loans held by the Company that it considers to have a potential or well-defined weakness that may put full collection of contractual cash flows at risk. Refer to Note 5 in the Notes to Consolidated Financial Statements for further discussion of the Company’s loan portfolios including internal credit quality ratings. In addition, 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, 2010, 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 lending products. 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 these loans which is the primary factor 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 cards, 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 with a 10 or 15 year fixed payment amortization schedule. Home equity lines are revolving accounts originated 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 September 30, 2011, 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, and customer payment history. 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.

The Company’s consumer lending segment utilizes several distinct business processes and channels to originate consumer 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, 2011:

 

 

Within the consumer finance division, at September 30, 2011, approximately $1.9 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 $2.1 billion at December 31, 2010.

 

The following table provides further information on the loan-to-values of residential mortgages specifically for the consumer finance division at September 30, 2011:

 

In addition to residential mortgages, at September 30, 2011, the consumer finance division had $.5 billion of home equity and second mortgage loans to customers that may be defined as sub-prime borrowers, unchanged from December 31, 2010.

 

 

 

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