e10vq
Table of Contents

(FORM 10-Q)
(USBANCORP LOGO)


Table of Contents

 
 
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, 2006
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)
     
Delaware
(State or other jurisdiction of
incorporation or organization)
  41-0255900
(I.R.S. Employer
Identification No.)
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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o
     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.
     
Class
Common Stock, $.01 Par Value
  Outstanding as of July 31, 2006
1,777,189,374 shares
 
 


 

Table of Contents and Form 10-Q Cross Reference Index
       
Part I — Financial Information
   
   
 
a)  Overview
  3
    4
    7
    26
    26
2) Quantitative and Qualitative Disclosures About Market Risk/ Corporate Risk Profile (Item 3)
   
 
a)  Overview
  9
    9
    16
    16
    16
    19
    19
    20
  20
  28
   
  44
  44
  44
  44
5)  Signature
  45
6) Exhibits
  46
 Computation of Ratio of Earnings to Fixed Charges
 Certification of Chief Executive Officer to Rule 13a-14(a)
 Certification of Chief Financial Officer to Rule 13a-14(a)
 Certification of CEO and CFO pursuant to 18 U.S.C. Section 1350
“Safe Harbor” Statement under the Private Securities Litigation Reform Act of 1995.
     This 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. These statements often include the words “may,” “could,” “would,” “should,” “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions. These forward-looking statements cover, among other things, anticipated future revenue and expenses and the future plans and prospects of the Company. Forward-looking statements involve inherent risks and uncertainties, and important factors could cause actual results to differ materially from those anticipated, including changes in general business and economic conditions, changes in interest rates, 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, and effects of critical accounting policies and judgments. For discussion of these and other risks that may cause actual results to differ from expectations, refer to our Annual Report on Form 10-K for the year ended December 31, 2005, on file with the Securities and Exchange Commission, including the sections entitled “Risk Factors” and “Corporate Risk Profile.” Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to update them in light of new information or future events.
U.S. Bancorp 1


Table of Contents

Table 1 Selected Financial Data
                                                   
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
            Percent       Percent
(Dollars and Shares in Millions, Except Per Share Data)   2006   2005   Change   2006   2005   Change
 
Condensed Income Statement
                                               
Net interest income (taxable-equivalent basis) (a)
    $1,697       $1,761       (3.6 )%     $3,422       $3,512       (2.6 )%
Noninterest income
    1,752       1,540       13.8       3,366       2,981       12.9  
Securities gains (losses), net
    3       1       *       3       (58 )     *  
                     
 
Total net revenue
    3,452       3,302       4.5       6,791       6,435       5.5  
Noninterest expense
    1,530       1,595       (4.1 )     3,030       2,926       3.6  
Provision for credit losses
    125       144       (13.2 )     240       316       (24.1 )
                     
Income before taxes
    1,797       1,563       15.0       3,521       3,193       10.3  
Taxable-equivalent adjustment
    11       7       57.1       21       14       50.0  
Applicable income taxes
    585       435       34.5       1,146       987       16.1  
                     
Net income
    $1,201       $1,121       7.1       $2,354       $2,192       7.4  
                     
Net income applicable to common equity
    $1,184       $1,121       5.6       $2,337       $2,192       6.6  
                     
Per Common Share
                                               
Earnings per share
    $.66       $.61       8.2 %     $1.30       $1.19       9.2 %
Diluted earnings per share
    .66       .60       10.0       1.29       1.17       10.3  
Dividends declared per share
    .33       .30       10.0       .66       .60       10.0  
Book value per share
    10.89       10.88       .1                          
Market value per share
    30.88       29.20       5.8                          
Average common shares outstanding
    1,781       1,833       (2.8 )     1,791       1,842       (2.8 )
Average diluted common shares outstanding
    1,805       1,857       (2.8 )     1,816       1,869       (2.8 )
Financial Ratios
                                               
Return on average assets
    2.27 %     2.23 %             2.25 %     2.22 %        
Return on average common equity
    24.3       22.7               23.8       22.3          
Net interest margin (taxable-equivalent basis)
    3.68       3.99               3.74       4.03          
Efficiency ratio (b)
    44.4       48.3               44.6       45.1          
Average Balances
                                               
Loans
    $140,863       $131,275       7.3 %     $140,125       $129,474       8.2 %
Loans held for sale
    2,062       1,697       21.5       1,866       1,564       19.3  
Investment securities
    40,087       42,341       (5.3 )     39,885       42,576       (6.3 )
Earning assets
    184,890       176,730       4.6       184,000       175,022       5.1  
Assets
    212,407       201,818       5.2       211,222       199,390       5.9  
Noninterest-bearing deposits
    28,949       29,148       (.7 )     28,893       28,784       .4  
Deposits
    121,233       121,232             120,701       120,332       .3  
Short-term borrowings
    22,246       17,013       30.8       23,295       16,313       42.8  
Long-term debt
    41,225       36,973       11.5       39,735       36,211       9.7  
Shareholders’ equity
    20,556       19,820       3.7       20,353       19,812       2.7  
                     
   
June  30,
2006
 
December  31,
2005
                               
                             
Period End Balances
                                               
Loans
    $141,382       $137,806       2.6 %                        
Allowance for credit losses
    2,251       2,251                                
Investment securities
    38,462       39,768       (3.3 )                        
Assets
    213,405       209,465       1.9                          
Deposits
    122,719       124,709       (1.6 )                        
Long-term debt
    41,952       37,069       13.2                          
Shareholders’ equity
    20,415       20,086       1.6                          
Regulatory capital ratios
                                               
 
Tier 1 capital
    8.9 %     8.2 %                                
 
Total risk-based capital
    13.1       12.5                                  
 
Leverage
    8.2       7.6                                  
 
Tangible common equity
    5.6       5.9                                  
 
* Not meaningful.
(a) Interest and rates are presented on a fully taxable-equivalent basis utilizing a tax rate of 35 percent.
(b) Computed as noninterest expense divided by the sum of net interest income on a taxable-equivalent basis and noninterest income excluding securities gains (losses), net.
2 U.S. Bancorp


Table of Contents

Management’s Discussion and Analysis
OVERVIEW
Earnings Summary U.S. Bancorp and its subsidiaries (the “Company”) reported net income of $1,201 million for the second quarter of 2006, compared with $1,121 million for the second quarter of 2005. Net income of $.66 per diluted common share in the second quarter of 2006 was higher than the same period of 2005 by $.06 (10.0 percent). Return on average assets and return on average common equity were 2.27 percent and 24.3 percent, respectively, for the second quarter of 2006, compared with returns of 2.23 percent and 22.7 percent, respectively, for the second quarter of 2005. The Company’s results for the second quarter of 2006 improved over the same period of 2005, as net income increased by $80 million (7.1 percent), primarily due to strong growth in a majority of fee-based products.
     Total net revenue, on a taxable-equivalent basis, for the second quarter of 2006, was $150 million (4.5 percent) higher than the second quarter of 2005, primarily reflecting a 13.9 percent increase in noninterest income, partially offset by a 3.6 percent decline in net interest income reflecting the impact of rising interest rates during the past several quarters. Noninterest income growth was driven by organic business growth and recent expansion in trust and payment processing businesses. Noninterest income also included a gain related to the initial public offering of a cardholder association. These favorable changes in noninterest income were partially offset by lower mortgage banking revenue due to the impact of adopting the fair value method of accounting under Statement of Financial Accounting Standards No. 156 “Accounting for Servicing of Financial Assets” (“SFAS 156”) in the first quarter of 2006. Mortgage banking revenue in the second quarter of 2006 included the effect of principal repayments on the valuation of servicing rights that were previously recognized as part of intangible expense.
     Total noninterest expense in the second quarter of 2006 was $65 million (4.1 percent) lower than the second quarter of 2005, primarily reflecting lower intangible expense due to the adoption of SFAS 156 and lower debt prepayment expense. This was partially offset by incremental operating and business integration costs principally associated with recent acquisitions, increased pension costs and higher expenses related to investments in tax-advantaged projects from a year ago. The efficiency ratio (the ratio of noninterest expense to taxable-equivalent net revenue excluding net securities gains or losses) was 44.4 percent for the second quarter of 2006, compared with 48.3 percent for the second quarter of 2005.
     The provision for credit losses for the second quarter of 2006 decreased $19 million (13.2 percent), compared with the second quarter of 2005. The decrease in the provision for credit losses year-over-year primarily reflected strong credit quality and the near-term favorable impact of changes in bankruptcy law in the fourth quarter of 2005. Net charge-offs in the second quarter of 2006 were $125 million, compared with $144 million in the second quarter of 2005. The decline in credit losses from a year ago was principally due to the impact of changes in bankruptcy legislation that went into effect during the fourth quarter of 2005. 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 of $2,354 million for the first six months of 2006, compared with $2,192 million for the first six months of 2005. Net income of $1.29 per diluted common share in the first six months of 2006 was higher than the same period of 2005 by $.12 (10.3 percent). Return on average assets and return on average common equity were 2.25 percent and 23.8 percent, respectively, for the first six months of 2006, compared with returns of 2.22 percent and 22.3 percent, respectively, for the first six months of 2005. The Company’s results for the first six months of 2006 improved over the same period of 2005, as net income rose by $162 million (7.4 percent), primarily due to strong revenue growth in fee-based products.
     Total net revenue, on a taxable-equivalent basis, for the first six months of 2006, was $356 million (5.5 percent) higher than the first six months of 2005, primarily reflecting a 15.3 percent increase in noninterest income, partially offset by a 2.6 percent decline in net interest income, reflecting the impact of rising interest rates during the past several quarters. Noninterest income growth was driven by organic business growth, recent expansion in trust and payment processing businesses, trading income related to certain derivatives, a favorable settlement during the first quarter of 2006 and the gain from the initial public offering of a cardholder association during the second quarter of 2006. These favorable changes in noninterest
U.S. Bancorp 3


Table of Contents

income categories were partially offset by lower mortgage banking revenue due to the impact of adopting SFAS 156 in the first quarter of 2006. In addition, there was a $61 million favorable variance in net securities gains (losses) in the first six months of 2006 as compared with the same period of 2005.
     Total noninterest expense in the first six months of 2006 was $104 million (3.6 percent) higher than the first six months of 2005, primarily reflecting incremental operating and business integration costs principally associated with recent acquisitions, increased pension costs and higher expenses related to investments in tax-advantaged projects from a year ago. This was partially offset by lower intangible expense due to the adoption of SFAS 156 and lower debt prepayment expense. The efficiency ratio was 44.6 percent for the first six months of 2006, compared with 45.1 percent for the first six months of 2005.
     The provision for credit losses for the first six months of 2006 decreased $76 million (24.1 percent), compared with the first six months of 2005. The decrease in the provision for credit losses year-over-year primarily reflected strong credit quality and the near-term favorable impact of changes in bankruptcy law in the fourth quarter of 2005. Net charge-offs in the first six months of 2006 were $240 million, compared with $316 million in the first six months of 2005. The decline in losses from a year ago was principally due to the impact of changes in bankruptcy legislation that went into effect during the fourth quarter of 2005. 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 $1,697 million in the second quarter of 2006, compared with $1,761 million in the second quarter of 2005. Net interest income, on a taxable-equivalent basis, was $3,422 million in the first six months of 2006, compared with $3,512 million in the first six months of 2005. Average earning assets increased $8.2 billion (4.6 percent) and $9.0 billion (5.1 percent) in the second quarter and first six months of 2006, respectively, compared with the same periods of 2005. The increases were primarily driven by growth in residential mortgages, commercial loans, retail loans and commercial real estate loans, partially offset by a decrease in investment securities. The positive impact to net interest income from the growth in earning assets was more than offset by a lower net interest margin. The net interest margin for the second quarter and first six months of 2006 was 3.68 percent and 3.74 percent, respectively, compared with 3.99 percent and 4.03 percent, respectively, for the same periods of 2005. The year-over-year decline in the net interest margin for the second quarter and first six months of 2006 reflected the competitive lending environment during 2005 and the first half of 2006, asset/liability management decisions and the impact of changes in the yield curve from a year ago. Compared with the same periods of 2005, credit spreads have tightened by approximately 23 basis points in the second quarter and 21 basis points in the first six months of 2006 across most lending products due to competitive pricing and a change in mix due to growth in lower-spread, fixed-rate credit products. The net interest margin also declined due to funding incremental asset growth with higher cost wholesale funding, share repurchases and asset/liability decisions designed to reduce the Company’s interest rate sensitivity position. An increase in the margin benefit of net free funds and loan fees partially offset these factors. Refer to the “Consolidated Daily Average Balance Sheet and Related Yields and Rates” table for further information on net interest income.
     Average loans for the second quarter and first six months of 2006 were higher by $9.6 billion (7.3 percent) and $10.7 billion (8.2 percent), respectively, compared with the same periods of 2005, reflecting growth in the majority of loan categories. During the first quarter of 2006, the Company began selling an increased proportion of its residential mortgage loan production and anticipates that residential mortgage loan balances will remain essentially flat in future periods.
     Average investment securities in the second quarter and first six months of 2006 were $2.3 billion (5.3 percent) and $2.7 billion (6.3 percent) lower, respectively, than the same periods of 2005. The change in the balance of the investment securities portfolio from a year ago principally reflected asset/liability management decisions to reduce the focus on residential mortgage assets given the changing interest rate environment and mix of loan growth. Additionally, the Company reclassified approximately $460 million of principal-only securities to its trading account effective January 1, 2006, in connection with the adoption of SFAS 156. During the second quarter and first six months of 2006, the Company maintained a mix of approximately 40 percent variable-rate securities. Refer to the “Interest Rate Risk Management” section for further information on the sensitivity of net interest income to changes in interest rates.
4 U.S. Bancorp


Table of Contents

     Average noninterest-bearing deposits for the second quarter and first six months of 2006 remained relatively flat compared with the same periods of the prior year. The average balances for the second quarter and first six months of 2006 decreased $199 million (.7 percent) and increased $109 million (.4 percent), respectively, compared with the same periods of 2005, despite a reduction of excess liquidity in the markets.
     Average total savings products declined year-over-year by $2.4 billion (4.2 percent) in the second quarter and $2.8 billion (4.8 percent) in the first six months of 2006, compared with the same periods of 2005, due to reductions in average money market savings and other savings account balances. Average money market savings balances declined year-over-year primarily due to a decline in balances within the branches. This decrease was partially offset by increases in broker dealer and corporate trust balances. The overall decrease in average money market savings balances year-over-year was primarily the result of the Company’s deposit pricing decisions for money market products in relation to fixed-rate deposit products offered. As a result, a portion of branch-based money market savings accounts have migrated to fixed-rate time certificates, while larger customer money market savings accounts have migrated to time deposits greater than $100,000 as rates increased on the time deposit products.
     Average time certificates of deposit less than $100,000 were higher by $537 million (4.1 percent) and $532 million (4.1 percent) in the second quarter and first six months of 2006, respectively, compared with the same periods of 2005. Average time deposits greater than $100,000 grew $2.1 billion (10.3 percent) and $2.5 billion (12.9 percent) in the second quarter and first six months of 2006, respectively, compared with the same periods of 2005. This growth was broad-based across most areas of the Company including: corporate, commercial, branch banking, private client and corporate trust, as customers migrated balances to higher rate deposits.
Provision for Credit Losses The provision for credit losses for the second quarter and first six months of 2006 decreased $19 million (13.2 percent) and $76 million (24.1 percent), respectively, compared with the same periods of 2005. The decrease in the provision for credit losses year-over-year primarily reflected stronger credit quality and the near-term favorable impact of changes in bankruptcy law in the fourth quarter of 2005. Net charge-offs in the second quarter and first six months of 2006 were $125 million and $240 million, respectively, compared with $144 million and $316 million in the second quarter and first six months of 2005, respectively. The decline in losses from a year ago was principally due to the impact of changes in bankruptcy legislation that went into effect during the fourth quarter of 2005. 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 2006 was $1,755 million and $3,369 million, respectively, compared with $1,541 million and $2,923 million in the same periods of 2005. The $214 million (13.9 percent) increase during the second quarter and $446 million (15.3 percent) increase during the first six months of 2006, compared with the same periods in
Table 2 Noninterest Income
                                                   
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
            Percent       Percent
(Dollars in Millions)   2006   2005   Change   2006   2005   Change
 
Credit and debit card revenue
    $202       $177       14.1 %     $384       $331       16.0 %
Corporate payment products revenue
    139       120       15.8       266       227       17.2  
ATM processing services
    61       57       7.0       120       104       15.4  
Merchant processing services
    253       198       27.8       466       376       23.9  
Trust and investment management fees
    314       253       24.1       611       500       22.2  
Deposit service charges
    264       234       12.8       496       444       11.7  
Treasury management fees
    116       117       (.9 )     223       224       (.4 )
Commercial products revenue
    107       100       7.0       211       196       7.7  
Mortgage banking revenue
    75       110       (31.8 )     99       212       (53.3 )
Investment products fees and commissions
    42       39       7.7       80       78       2.6  
Securities gains (losses), net
    3       1       *       3       (58 )     *  
Other
    179       135       32.6       410       289       41.9  
     
 
Total noninterest income
  $ 1,755     $ 1,541       13.9 %   $ 3,369     $ 2,923       15.3 %
 
* Not meaningful
U.S. Bancorp 5


Table of Contents

2005, were driven by favorable variances in the majority of fee income categories and a $35 million gain from the initial public offering of a cardholder association included in other income. The increase in noninterest income for the first six months of 2006 also reflected the impact of additional trading income related to certain derivatives recorded in the current year and a favorable variance in securities gains (losses) of $61 million related to net securities losses recorded in the prior year. This strong growth in revenue was partially offset by the accounting impact of SFAS 156 on mortgage banking revenue.
     The growth in credit and debit card revenue was primarily driven by higher customer transaction volumes. The corporate payment products revenue growth reflected organic growth in sales volumes and card usage. ATM processing services revenue for the first six months of 2006 was higher due to the acquisition of an ATM business in May of 2005. Merchant processing services revenue growth reflects an increase in sales volume driven by acquisitions, higher same store sales and equipment fees. Trust and investment management fees increased in the second quarter and first six months year-over-year, primarily due to improved equity market conditions, incremental account growth and customer balances and the acquisition of the corporate and institutional trust business of a large national bank. Deposit service charges grew year-over-year due to increased transaction-related fees and growth in net checking accounts. Other income for the second quarter and first six months of 2006 was higher than the same periods of 2005 due to a $35 million gain from the initial public offering of a cardholder association. In addition, other income for the first six months of 2006 was higher due to a $44 million gain on certain interest rate swaps, end-of-term lease residual value improvement, higher student loan sales gains and the receipt of a favorable settlement within the merchant processing business. These favorable changes in fee-based revenue were partially offset by the decline in mortgage banking revenue, principally driven by the adoption of the fair value method of accounting for mortgage servicing rights (“MSR”) under SFAS 156.
Noninterest Expense Noninterest expense was $1,530 million and $3,030 million, respectively, in the second quarter and first six months of 2006, a decrease of $65 million (4.1 percent) and an increase of $104 million (3.6 percent), respectively, from the same periods of 2005. The decrease in expense in the second quarter of 2006, compared with the second quarter of 2005, reflected the impact of adopting SFAS 156 on other intangible expense and lower debt prepayment expense. The increase in expense in the first six months of 2006, compared with the same period of the prior year, reflected the impact of business acquisitions and related integration costs, partially offset by lower other intangible and debt prepayment expense. Compensation expense was higher year-over-year in the second quarter and first six months of 2006, primarily due to business expansion, including the Company’s payment processing businesses, the acquisition of a large national bank’s corporate and institutional trust business and other growth initiatives. Employee benefits increased year-over-year primarily as a result of higher pension costs. Net occupancy and equipment expense increased in the first six months of 2006 from the same period of 2005 primarily due to business expansion. Technology and communications expense rose due to increased software expense and higher outside data processing expense principally associated with expanding a prepaid gift card program and the acquisition of a large national
Table 3 Noninterest Expense
                                                   
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
            Percent       Percent
(Dollars in Millions)   2006   2005   Change   2006   2005   Change
 
Compensation
    $627       $612       2.5 %     $1,260       $1,179       6.9 %
Employee benefits
    123       108       13.9       256       224       14.3  
Net occupancy and equipment
    161       159       1.3       326       313       4.2  
Professional services
    41       39       5.1       76       75       1.3  
Marketing and business development
    58       67       (13.4 )     98       110       (10.9)  
Technology and communications
    127       113       12.4       244       219       11.4  
Postage, printing and supplies
    66       63       4.8       132       126       4.8  
Other intangibles
    89       181       (50.8 )     174       252       (31.0)  
Debt prepayment
    11       54       (79.6 )     11       54       (79.6)  
Other
    227       199       14.1       453       374       21.1  
     
 
Total noninterest expense
    $1,530       $1,595       (4.1 )%     $3,030       $2,926       3.6 %
     
Efficiency ratio (a)
    44.4 %     48.3 %             44.6 %     45.1 %        
 
(a) Computed as noninterest expense divided by the sum of net interest income on a taxable-equivalent basis and noninterest income excluding securities gains (losses), net.
6 U.S. Bancorp


Table of Contents

bank’s corporate and institutional trust business. Other expense increased in the second quarter and first six months of 2006 from the same periods of 2005, primarily due to the increased investments in tax-advantaged projects relative to a year ago and business integration costs. These expense increases were offset by a year-over-year decline in other intangibles expense, reflecting the elimination of MSR amortization and impairment due to the adoption of SFAS 156, and lower debt prepayment expense.
Income Tax Expense The provision for income taxes was $585 million (an effective rate of 32.8 percent) for the second quarter and $1,146 million (an effective rate of 32.7 percent) for the first six months of 2006, compared with $435 million (an effective rate of 28.0 percent) and $987 million (an effective rate of 31.0 percent) for the same periods of 2005. The second quarter of 2005 included a $94 million reduction in income tax expense related to the resolution of federal income tax examinations covering substantially all of the Company’s legal entities for the years 2000 through 2002. For further information on income taxes, refer to Note 9 of the Notes to Consolidated Financial Statements.
BALANCE SHEET ANALYSIS
Loans The Company’s total loan portfolio was $141.4 billion at June 30, 2006, compared with $137.8 billion at December 31, 2005, an increase of $3.6 billion (2.6 percent). The increase in total loans was driven primarily by growth in commercial loans, residential mortgages and retail loans. The $2.4 billion (5.7 percent) increase in commercial loans was primarily driven by new customer relationships, utilization under lines of credit, growth in commercial leasing and corporate payment card balances.
     Commercial real estate loans were $28.6 billion at June 30, 2006, an increase of $.1 billion (.3 percent) compared with December 31, 2005. The increase was driven by growth in construction loans, partially offset by a decrease in commercial mortgage balances.
     Residential mortgages held in the loan portfolio were $21.1 billion at June 30, 2006, an increase of $.3 billion (1.6 percent) compared with December 31, 2005. The growth was the result of an increase in consumer finance originations, partially offset by the Company selling an increased proportion of its residential mortgage loan production in 2006.
     Total retail loans outstanding, which include credit card, retail leasing, home equity and second mortgages and other retail loans, increased $.7 billion (1.6 percent) at June 30, 2006, compared with December 31, 2005. The increase was primarily driven by growth in installment, credit card and home equity loans, partially offset by decreases in retail leasing, home equity lines and student loan balances.
Investment Securities Investment securities, both available-for-sale and held-to-maturity, totaled $38.5 billion at June 30, 2006, compared with $39.8 billion at December 31, 2005, reflecting purchases of $3.7 billion of securities, which were more than offset by maturities and prepayments and the reclassification of $.5 billion of principal-only securities to the trading account effective January 1, 2006, in connection with the adoption of SFAS 156. As of June 30, 2006, approximately 40 percent of the investment securities portfolio represented adjustable-rate financial instruments, compared with 41 percent at December 31, 2005. Adjustable-rate financial instruments include variable-rate collateralized mortgage obligations, mortgage-backed securities, agency securities, adjustable-rate money market accounts and asset-backed securities.
U.S. Bancorp 7


Table of Contents

Table 4 Investment Securities
                                                                     
    Available-for-Sale   Held-to-Maturity
     
        Weighted-       Weighted-    
        Average   Weighted-       Average   Weighted-
    Amortized   Fair   Maturity in   Average   Amortized   Fair   Maturity in   Average
June 30, 2006 (Dollars in Millions)   Cost   Value   Years   Yield (d)   Cost   Value   Years   Yield (d)
 
U.S. Treasury and agencies
                                                               
 
Maturing in one year or less
    $119       $119       .3       4.70 %     $—       $—             %
 
Maturing after one year through five years
    37       37       2.4       6.39                          
 
Maturing after five years through ten years
    14       14       6.9       7.10                          
 
Maturing after ten years
    338       324       14.1       5.97                          
     
   
Total
    $508       $494       9.8       5.73 %     $—       $—             %
     
Mortgage-backed securities (a)
                                                               
 
Maturing in one year or less
    $140       $138       .6       5.18 %     $—       $—             %
 
Maturing after one year through five years
    17,298       16,463       3.8       4.53       8       8       3.1       5.75  
 
Maturing after five years through ten years
    12,622       11,847       7.5       5.08                          
 
Maturing after ten years
    5,793       5,715       15.1       6.36                          
     
   
Total
    $35,853       $34,163       7.0       5.02 %     $8       $8       3.1       5.75 %
     
Asset-backed securities (a)
                                                               
 
Maturing in one year or less
    $8       $8       .3       5.33 %     $—       $—             %
 
Maturing after one year through five years
                                               
 
Maturing after five years through ten years
                                               
 
Maturing after ten years
                                               
     
   
Total
    $8       $8       .3       5.33 %     $—       $—             %
     
Obligations of state and political subdivisions (b)
                                                               
 
Maturing in one year or less
    $52       $52       .4       7.00 %     $2       $2       .5       6.04 %
 
Maturing after one year through five years
    40       41       2.3       7.01       20       21       3.2       6.31  
 
Maturing after five years through ten years
    1,967       1,925       9.2       6.83       14       15       7.9       7.22  
 
Maturing after ten years
    742       720       14.3       6.44       37       38       15.8       6.54  
     
   
Total
    $2,801       $2,738       10.3       6.73 %     $73       $76       10.4       6.59 %
     
Other debt securities
                                                               
 
Maturing in one year or less
    $256       $256       .1       4.57 %     $5       $5       .4       6.44 %
 
Maturing after one year through five years
    9       9       1.5       4.52       11       11       3.0       5.44  
 
Maturing after five years through ten years
    15       15       10.0       6.25       1       1       5.8       5.15  
 
Maturing after ten years
    627       625       21.2       6.06                          
     
   
Total
    $907       $905       14.8       5.63 %     $17       $17       2.3       5.74 %
     
Other investments
    $54       $56             %     $—       $—             %
     
Total investment securities (c)
    $40,131       $38,364       7.4       5.17 %     $98       $101       8.4       6.37 %
 
(a) Information related to asset and mortgage-backed securities included above is presented based upon weighted-average maturities anticipating future prepayments.
(b) Information related to obligations of state and political subdivisions is presented based upon yield to first optional call date if the security is purchased at a premium, yield to maturity if purchased at par or a discount.
(c) The weighted-average maturity of the available for sale investment securities was 6.1 years at December 31, 2005, with a corresponding weighted-average yield of 4.89 percent. The weighted-average maturity of the held-to-maturity investment securities was 7.2 years at December 31, 2005, with a corresponding weighted-average yield of 6.44 percent.
(d) Average yields are presented on a fully-taxable equivalent basis under a tax rate of 35 percent. Yields on available-for-sale and held-to-maturity securities are computed based on historical cost balances. Average yield and maturity calculations exclude equity securities that have no stated yield or maturity.
                                   
    June 30, 2006   December 31, 2005
     
    Amortized   Percent   Amortized   Percent
(Dollars in Millions)   Cost   of Total   Cost   of Total
 
U.S. Treasury and agencies
    $508       1.3 %     $496       1.2 %
Mortgage-backed securities
    35,861       89.1       38,169       94.4  
Asset-backed securities
    8             12       .1  
Obligations of state and political subdivisions
    2,874       7.1       724       1.8  
Other debt securities and investments
    978       2.5       1,029       2.5  
     
 
Total investment securities
    $40,229       100.0 %     $40,430       100.0 %
 
8 U.S. Bancorp


Table of Contents

Deposits Total deposits were $122.7 billion at June 30, 2006, compared with $124.7 billion at December 31, 2005, a decrease of $2.0 billion (1.6 percent). The decrease in total deposits was primarily the result of decreases in noninterest-bearing deposits and money market savings accounts, partially offset by increases in interest checking, time certificates of deposits less than $100,000 and time deposits greater than $100,000. The $1.5 billion (4.6 percent) decrease in noninterest-bearing deposits reflected lower balances in most business lines, partially offset by an increase in corporate trust balances due to seasonality. The $1.3 billion (4.7 percent) decrease in money market savings account balances reflected the Company’s deposit pricing decisions for money market products in relation to other fixed-rate deposit products offered. A portion of branch-based money market savings accounts have migrated to fixed-rate time certificates, while larger customer money market savings accounts have migrated to time deposits greater than $100,000 as rates increased on the time deposit products. Time deposits greater than $100,000 increased $.2 billion (1.0 percent) and time certificates of deposit less than $100,000 increased $.3 billion (2.1 percent) at June 30, 2006, compared with December 31, 2005. Interest checking accounts increased $.2 billion (1.0 percent) due to an increase in trust and custody balances, partially offset by decreases in consumer and private banking balances.
Borrowings The Company utilizes both short-term and long-term borrowings to fund growth of earning assets in excess of deposit growth. Short-term borrowings, which include federal funds purchased, commercial paper, securities sold under agreements to repurchase and other short-term borrowings, were $20.6 billion at June 30, 2006, compared with $20.2 billion at December 31, 2005. Short-term funding is managed within approved liquidity policies. The increase of $.4 billion in short-term borrowings reflected wholesale funding associated with the Company’s earning asset growth and asset/liability management activities. Long-term debt was $42.0 billion at June 30, 2006, compared with $37.1 billion at December 31, 2005, reflecting the issuances of $2.0 billion of bank notes, $1.5 billion of medium-term notes and $1.8 billion of junior subordinated debentures and the addition of $2.2 billion of Federal Home Loan Bank (“FHLB”) advances, partially offset by $1.6 billion of medium-term note maturities and $.7 billion of junior subordinated debentures repayments. 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, 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 or investment when it is due. Residual risk is the potential reduction in the end-of-term value of leased assets or the residual cash flows related to asset securitization and other off-balance sheet structures. 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. Rate movements can affect the repricing of assets and liabilities differently, as well as their market value. Market risk arises from fluctuations in interest rates, foreign exchange rates, and equity prices that may result in changes in the values of financial instruments, such as trading and available-for-sale securities 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 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. The strategy also emphasizes diversification on a geographic, industry and customer level, regular credit examinations and management reviews of loans experiencing deterioration of credit quality. The credit risk management strategy also includes a credit risk assessment process, independent of business line managers, that performs assessments of compliance with commercial and consumer credit policies, risk ratings, and other critical credit information. The Company strives to identify potential problem loans early, take any necessary charge-offs promptly and maintain adequate reserve levels for probable loan losses inherent in the portfolio.
     In evaluating its credit risk, the Company considers changes, if any, in underwriting activities, the loan portfolio composition (including product mix and
U.S. Bancorp 9


Table of Contents

Table 5 Delinquent Loan Ratios as a Percent of Ending Loan Balances
                       
    June 30,   December 31,
90 days or more past due excluding nonperforming loans   2006   2005
 
Commercial
               
 
Commercial
    .06 %     .06 %
 
Lease financing
           
     
   
Total commercial
    .05       .05  
Commercial real estate
               
 
Commercial mortgages
           
 
Construction and development
    .01        
     
   
Total commercial real estate
           
Residential mortgages
    .30       .32  
Retail
               
 
Credit card
    1.56       1.26  
 
Retail leasing
    .03       .04  
 
Other retail
    .18       .22  
     
   
Total retail
    .38       .36  
     
     
Total loans
    .19 %     .18 %
 
                   
    June 30,   December 31,
90 days or more past due including nonperforming loans   2006   2005
 
Commercial
    .58 %     .69 %
Commercial real estate
    .40       .55  
Residential mortgages (a)
    .49       .55  
Retail
    .50       .50  
     
 
Total loans
    .51 %     .58 %
 
(a) Delinquent loan ratios exclude advances made pursuant to servicing agreements to Government National Mortgage Association (“GNMA”) mortgage pools whose repayments are insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs. Including the guaranteed amounts, the ratio of residential mortgages 90 days or more past due was 3.06 percent at June 30, 2006, and 4.35 percent at December 31, 2005.
geographic, industry or customer-specific concentrations), trends in loan performance, the level of allowance coverage relative to similar banking institutions and macroeconomic factors. Economic conditions during the second quarter and first six months of 2006 have improved from the same periods of 2005, as reflected in strong expansion of the gross domestic product index, lower unemployment rates, favorable trends related to corporate profits and consumer spending for retail goods and services. Current economic conditions are relatively unchanged from December 31, 2005. The Federal Reserve Bank continued increasing short-term interest rates in an effort to prevent an acceleration of inflation and maintain the current rate of economic growth.
     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, 2005, for a more detailed discussion on credit risk management processes.
Loan Delinquencies Trends in delinquency ratios represent an indicator, among other considerations, of credit risk within the Company’s loan portfolios. The entire balance of the account is considered delinquent if the minimum payment contractually required to be made is not received by the specified date on the billing statement. The Company measures delinquencies, both including and excluding nonperforming loans, to enable comparability with other companies. Accruing loans 90 days or more past due totaled $264 million at June 30, 2006, compared with $253 million at December 31, 2005. These loans are not included in nonperforming assets and continue to accrue interest because they are adequately secured by collateral, and/or are in the process of collection and are reasonably expected to result in repayment or restoration to current status. The ratio of delinquent loans to total loans was .19 percent at June 30, 2006, and .18 percent at December 31, 2005.
     To monitor credit risk associated with retail loans, the Company monitors delinquency ratios in the various stages of collection including nonperforming status.
10 U.S. Bancorp


Table of Contents

The following table provides summary delinquency information for residential mortgages and retail loans:
                                     
        As a Percent of Ending
    Amount   Loan Balances
     
    June 30,   December 31,   June 30,   December 31,
(Dollars in Millions)   2006   2005   2006   2005
 
Residential mortgages
                               
     30-89 days
    $105       $112       .50 %     .55 %
     90 days or more
    64       67       .30       .32  
     Nonperforming
      39       48       .19       .23  
     
 
Total
    $208       $227       .99 %     1.10 %
 
Retail
                               
     Credit card
                               
     30-89 days
    $153       $147       2.06 %     2.06 %
     90 days or more
    116       90       1.56       1.26  
     Nonperforming
    41       49       .55       .69  
     
 
Total
    $310       $286       4.17 %     4.01 %
Retail leasing
                               
     30-89 days
    $26       $43       .36 %     .59 %
     90 days or more
    2       3       .03       .04  
     Nonperforming
                       
     
 
Total
    $28       $46       .39 %     .63 %
Other retail
                               
     30-89 days
    $162       $206       .51 %     .66 %
     90 days or more
    58       70       .18       .22  
     Nonperforming
    16       17       .05       .06  
     
 
Total
    $236       $293       .74 %     .94 %
 
Nonperforming Assets The level of nonperforming assets represents another indicator of the potential for future credit losses. Nonperforming assets include nonaccrual loans, restructured loans not performing in accordance with modified terms, other real estate and other nonperforming assets owned by the Company. Interest payments collected from assets on nonaccrual status are typically applied against the principal balance and not recorded as income. At June 30, 2006, total nonperforming assets were $550 million, compared with $644 million at December 31, 2005. The ratio of total nonperforming assets to total loans and other real estate decreased to ..39 percent at June 30, 2006, compared with ..47 percent at December 31, 2005.
     Included in nonperforming loans were restructured loans of $50 million at June 30, 2006, compared with $75 million at December 31, 2005. At June 30, 2006, the Company had no commitments to lend additional funds under restructured loans, compared to commitments of $9 million at December 31, 2005.
U.S. Bancorp 11


Table of Contents

Table 6 Nonperforming Assets (a)
                       
    June 30,   December 31,
(Dollars in Millions)   2006   2005
 
Commercial
               
 
Commercial
    $203       $231  
 
Lease financing
    38       42  
     
   
Total commercial
    241       273  
Commercial real estate
               
 
Commercial mortgages
    88       134  
 
Construction and development
    25       23  
     
   
Total commercial real estate
    113       157  
Residential mortgages
    39       48  
Retail
               
 
Credit card
    41       49  
 
Retail leasing
           
 
Other retail
    16       17  
     
   
Total retail
    57       66  
     
     
Total nonperforming loans
    450       544  
Other real estate (b)
    77       71  
Other assets
    23       29  
     
     
Total nonperforming assets
    $550       $644  
     
Accruing loans 90 days or more past due
    $264       $253  
Nonperforming loans to total loans
    .32 %     .39 %
Nonperforming assets to total loans plus other real estate (b)
    .39 %     .47 %
 
Changes in Nonperforming Assets
                                 
    Commercial and   Retail and    
    Commercial   Residential    
(Dollars in Millions)   Real Estate   Mortgages (d)   Total
 
Balance December 31, 2005
    $457       $187       $644  
 
Additions to nonperforming assets
                       
   
New nonaccrual loans and foreclosed properties
    139       34       173  
   
Advances on loans
    18             18  
     
     
Total additions
    157       34       191  
 
Reductions in nonperforming assets
                       
   
Paydowns, payoffs
    (125 )     (36 )     (161 )
   
Net sales
    (21 )           (21 )
   
Return to performing status
    (30 )     (4 )     (34 )
   
Charge-offs (c)
    (61 )     (8 )     (69 )
     
     
Total reductions
    (237 )     (48 )     (285 )
     
       
Net additions to (reductions in) nonperforming assets
    (80 )     (14 )     (94 )
     
Balance June 30, 2006
    $377       $173       $550  
 
(a) Throughout this document, nonperforming assets and related ratios do not include accruing loans 90 days or more past due.
(b) Excludes $87 million of foreclosed GNMA loans which continue to accrue interest.
(c) Charge-offs exclude actions for certain card products and loan sales that were not classified as nonperforming at the time the charge-off occurred.
(d) Residential mortgage information excludes changes related to residential mortgages serviced by others.
Restructured Loans Accruing Interest On a case-by-case basis, management determines whether an account that experiences financial difficulties should be modified as to its interest rate or repayment terms to maximize the Company’s collection of its balance.
     Loans restructured at a rate equal to or greater than that of a new loan with comparable risk at the time the contract is modified are excluded from restructured loans once repayment performance, in accordance with the modified agreement, has been demonstrated over several payment cycles. Loans that have interest rates reduced below comparable market rates remain classified as restructured loans; however, interest income is accrued at the reduced rate as long as the customer complies with the revised terms and conditions.
12 U.S. Bancorp


Table of Contents

The following table provides a summary of restructured loans that continue to accrue interest:
                                 
        As a Percent of Ending
    Amount   Loan Balances
     
    June 30,   December 31,   June 30,   December 31,
(Dollars in Millions)   2006   2005   2006   2005
 
Commercial
    $ 16       $ 5       .04 %     .01 %
Commercial real estate
    1       1              
Residential mortgages
    65       59       .31       .28  
Credit card
    252       218       3.39       3.05  
Other retail
    36       32       .09       .08  
     
              Total
    $370       $315       .26 %     .23 %
 
     Restructured loans that continue to accrue interest were higher at June 30, 2006, compared with December 31, 2005, reflecting the impact of the Company implementing higher minimum balance payment requirements for credit card customers in response to industry guidance issued by the banking regulatory agencies.
Analysis of Loan Net Charge-Offs Total loan net charge-offs were $125 million and $240 million during the second quarter and first six months of 2006, respectively, compared with net charge-offs of $144 million and $316 million, respectively, for the same periods of 2005. The ratio of total loan net charge-offs to average loans in the second quarter and first six months of 2006 was .36 percent and ..35 percent, respectively, compared with .44 percent and .49 percent, respectively, for the same periods of 2005.
     Commercial and commercial real estate loan net charge-offs for the second quarter of 2006 were $20 million (.11 percent of average loans outstanding), compared with $13 million (.07 percent of average loans outstanding) in the second quarter of 2005. The increase in net charge-offs reflected lower gross charge-offs, more than offset by a lower level of recoveries as compared with the same quarter of the prior year. Commercial and commercial real estate loan net charge-offs for the first six months of 2006 were $34 million (.09 percent of average loans outstanding), compared with $46 million (.13 percent of average loans outstanding) in the first six months of 2005.
     Retail loan net charge-offs for the second quarter of 2006 were $94 million (.82 percent of average loans outstanding), compared with $123 million (1.12 percent of average loans outstanding) for the second quarter of 2005. Retail loan net charge-offs for the first six months of 2006 were $188 million (.82 percent of average loans outstanding), compared with $253 million (1.17 percent of average loans outstanding) for the first six months of 2005. The decrease in retail loan net charge-offs reflected the impact of the bankruptcy legislation change that occurred in the fourth quarter of 2005. The Company anticipates that bankruptcy charge-offs will return to more normalized levels in future quarters.
     The Company’s retail lending business utilizes several distinct business processes and channels to originate retail credit including traditional branch lending, indirect lending and a consumer finance division. Each distinct underwriting and origination activity manages unique credit risk characteristics and prices its loan production commensurate with the differing risk profiles. Within Consumer Banking, U.S. Bank Consumer Finance (“USBCF”) participates in
Table 7 Net Charge-offs as a Percent of Average Loans Outstanding
                                       
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
    2006   2005   2006   2005
 
Commercial
                               
 
Commercial
    .13 %     .10 %     .09 %     .13 %
 
Lease financing
    .54       .49       .55       .78  
     
   
Total commercial
    .18       .14       .15       .20  
Commercial real estate
                               
 
Commercial mortgages
    (.02 )     .02       .01       .05  
 
Construction and development
    .05       (.16 )     .02       (.03 )
     
   
Total commercial real estate
          (.03 )     .01       .03  
Residential mortgages
    .21       .19       .17       .21  
Retail
                               
 
Credit card
    2.72       3.93       2.67       4.02  
 
Retail leasing
    .11       .27       .17       .36  
 
Home equity and second mortgages
    .35       .43       .34       .45  
 
Other retail
    .70       1.01       .74       1.05  
     
   
Total retail
    .82       1.12       .82       1.17  
     
     
Total loans
    .36 %     .44 %     .35 %     .49 %
 
U.S. Bancorp 13


Table of Contents

substantially all facets of the Company’s consumer lending activities. USBCF specializes in serving channel-specific and alternative lending markets in residential mortgages, home equity and installment loan financing. USBCF manages loans originated through a broker network, correspondent relationships and U.S. Bank branch offices. Generally, loans managed by the Company’s consumer finance division exhibit higher credit risk characteristics, but are priced commensurate with the differing risk profile.
The following table provides an analysis of net charge-offs as a percent of average loans outstanding managed by the consumer finance division, compared with traditional branch related loans:
                                                                 
    Three Months Ended June 30   Six Months Ended June 30
     
    Average Loan   Percent of   Average Loan   Percent of
    Amount   Average Loans   Amount   Average Loans
     
(Dollars in Millions)   2006   2005   2006   2005   2006   2005   2006   2005
 
Consumer Finance (a)
                                                               
  Residential mortgages
    $7,295       $5,788       .49 %     .49 %     $7,055       $5,455       .46 %     .52 %
  Home equity and second mortgages
    1,984       2,548       1.62       1.57       2,021       2,603       1.50       1.63  
  Other retail
    402       387       3.99       4.15       403       385       4.50       4.71  
Traditional Branch
                                                               
  Residential mortgages
    $13,573       $11,410       .06 %     .04 %     $13,872       $11,062       .03 %     .05 %
  Home equity and second mortgages
    13,051       12,455       .15       .19       12,964       12,321       .16       .20  
  Other retail
    16,218       14,747       .62       .92       16,180       14,616       .65       .95  
Total Company
                                                               
  Residential mortgages
    $20,868       $17,198       .21 %     .19 %     $20,927       $16,517       .17 %     .21 %
  Home equity and second mortgages
    15,035       15,003       .35       .43       14,985       14,924       .34       .45  
  Other retail
    16,620       15,134       .70       1.01       16,583       15,001       .74       1.05  
 
(a) Consumer finance category included credit originated and managed by USBCF, as well as home equity and second mortgages with a loan-to-value greater than 100 percent that were originated in the branches.
Analysis and Determination of the Allowance for Credit Losses The allowance for loan losses provides coverage for probable and estimable losses inherent in the Company’s loan and lease portfolio. Management evaluates the allowance each quarter to determine that it is adequate to cover these inherent losses. The evaluation of each element and the overall allowance is based on a continuing assessment of problem loans, recent loss experience and other factors, including regulatory guidance and economic conditions. Because business processes and credit risks associated with unfunded credit commitments are essentially the same as for loans, the Company utilizes similar processes to estimate its liability for unfunded credit commitments, which is included in other liabilities in the Consolidated Balance Sheet. Both the allowance for loan losses and the liability for unfunded credit commitments are included in the Company’s analysis of the allowance for credit losses.
     At June 30, 2006, the allowance for credit losses was $2,251 million (1.59 percent of loans), compared with an allowance of $2,251 million (1.63 percent of loans) at December 31, 2005. The ratio of the allowance for credit losses to nonperforming loans was 500 percent at June 30, 2006, compared with 414 percent at December 31, 2005. The ratio of the allowance for credit losses to annualized loan net charge-offs was 449 percent at June 30, 2006, compared with 329 percent at December 31, 2005.
14 U.S. Bancorp


Table of Contents

Table 8 Summary of Allowance for Credit Losses
                                         
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
(Dollars in Millions)   2006   2005   2006   2005
 
Balance at beginning of period
    $2,251       $2,269       $2,251       $2,269  
Charge-offs
                               
 
Commercial
                               
   
Commercial
    24       42       52       74  
   
Lease financing
    13       15       25       38  
     
     
Total commercial
    37       57       77       112  
 
Commercial real estate
                               
   
Commercial mortgages
    3       4       6       10  
   
Construction and development
    1       1       1       3  
     
     
Total commercial real estate
    4       5       7       13  
 
Residential mortgages
    11       8       19       18  
 
Retail
                               
   
Credit card
    59       73       113       146  
   
Retail leasing
    6       8       13       19  
   
Home equity and second mortgages
    16       19       32       40  
   
Other retail
    43       52       90       105  
     
     
Total retail
    124       152       248       310  
     
       
Total charge-offs
    176       222       351       453  
Recoveries
                               
 
Commercial
                               
   
Commercial
    11       33       34       51  
   
Lease financing
    6       9       11       19  
     
     
Total commercial
    17       42       45       70  
 
Commercial real estate
                               
   
Commercial mortgages
    4       3       5       5  
   
Construction and development
          4             4  
     
     
Total commercial real estate
    4       7       5       9  
 
Residential mortgages
                1       1  
 
Retail
                               
   
Credit card
    9       9       17       17  
   
Retail leasing
    4       3       7       6  
   
Home equity and second mortgages
    3       3       7       7  
   
Other retail
    14       14       29       27  
     
     
Total retail
    30       29       60       57  
     
       
Total recoveries
    51       78       111       137  
Net Charge-offs
                               
 
Commercial
                               
   
Commercial
    13       9       18       23  
   
Lease financing
    7       6       14       19  
     
     
Total commercial
    20       15       32       42  
 
Commercial real estate
                               
   
Commercial mortgages
    (1 )     1       1       5  
   
Construction and development
    1       (3 )     1       (1 )
     
     
Total commercial real estate
          (2 )     2       4  
 
Residential mortgages
    11       8       18       17  
 
Retail
                               
   
Credit card
    50       64       96       129  
   
Retail leasing
    2       5       6       13  
   
Home equity and second mortgages
    13       16       25       33  
   
Other retail
    29       38       61       78  
     
     
Total retail
    94       123       188       253  
     
       
Total net charge-offs
    125       144       240       316  
     
Provision for credit losses
    125       144       240       316  
     
Balance at end of period
    $2,251       $2,269       $2,251       $2,269  
     
Components
                               
 
Allowance for loan losses
    $2,039       $2,082                  
 
Liability for unfunded credit commitments
    212       187                  
                 
   
Total allowance for credit losses
    $2,251       $2,269                  
                 
Allowance for credit losses as a percentage of
                               
 
Period-end loans
    1.59 %     1.70 %                
 
Nonperforming loans
    500       441                  
 
Nonperforming assets
    409       372                  
 
Annualized net charge-offs
    449       393                  
 
U.S. Bancorp 15


Table of Contents

     Several factors were taken into consideration in evaluating the allowance for credit losses at June 30, 2006, including the risk profile of the portfolios and loan net charge-offs during the period, the level of nonperforming assets, accruing loans 90 days or more past due, delinquency ratios and changes in restructured loan balances compared with December 31, 2005. Management also considered the uncertainty related to certain industry sectors, including the airline industry, and the extent of credit exposure to other borrowers within the portfolio. In addition, concentration risks associated with commercial real estate and the mix of loans, including credit cards, loans originated through the consumer finance division and residential mortgages, and their relative credit risk were evaluated. Finally, the Company considered current economic conditions that might impact the portfolio.
Residual Risk Management The Company manages its risk to changes in the residual value of leased assets through disciplined residual valuation setting at the inception of a lease, diversification of its leased assets, regular residual asset valuation reviews and monitoring of residual value gains or losses upon the disposition of assets. As of June 30, 2006, no significant change in the amount of residuals or concentration of the portfolios has occurred since December 31, 2005. Refer to “Management’s Discussion and Analysis — Residual Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on residual risk management.
Operational Risk Management The Company manages operational risk through a risk management framework and its internal control processes. Within this framework, the Corporate Risk Committee (“Risk Committee”) provides oversight and assesses the most significant operational risks facing the Company within its business lines. Under the guidance of the Risk Committee, enterprise risk management personnel establish policies and interact with business lines to monitor significant operational risks on a regular basis. Business lines have direct and primary responsibility and accountability for identifying, controlling, and monitoring operational risks embedded in their business activities. Refer to “Management’s Discussion and Analysis — Operational Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on operational risk management.
Interest Rate Risk Management In the banking industry, changes in interest rates is a significant risk that can impact earnings, market valuations and safety and soundness of the entity. To minimize the volatility of net interest income and the market value of assets and liabilities, the Company manages its exposure to changes in interest rates through asset and liability management activities within guidelines established by its Asset Liability Policy Committee (“ALPC”) and approved by the Board of Directors. ALPC has the responsibility for approving and ensuring compliance with ALPC management policies, including interest rate risk exposure. The Company uses Net Interest Income Simulation Analysis and Market Value of Equity Modeling for measuring and analyzing consolidated interest rate risk.
Net Interest Income Simulation Analysis One of the primary tools used to measure interest rate risk and the effect of interest rate changes on net interest income is simulation analysis. Through this simulation, management estimates the impact on net interest income of a 200 basis point upward or downward gradual change of market interest rates over a one-year period. This represents a change, effective in the first quarter of 2006, from a previous policy of estimating the effect of a 300 basis point upward or downward gradual change on net interest income. The simulation also estimates the effect of immediate and sustained parallel shifts in the yield curve of 50 basis points as well as the effect of immediate and sustained flattening or steepening of the yield curve.
     Refer to “Management’s Discussion and Analysis — Net Interest Income Simulation Analysis” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on net interest income simulation analysis.
16 U.S. Bancorp


Table of Contents

Sensitivity of Net Interest Income:
                                                                 
    June 30, 2006   December 31, 2005
     
    Down 50   Up 50   Down 200   Up 200   Down 50   Up 50   Down 200   Up 200
    Immediate   Immediate   Gradual   Gradual   Immediate   Immediate   Gradual*   Gradual*
 
Net interest income
    1.17%       (1.39)%       2.55%       (2.94)%       .66%       (.73)%       1.19%       (2.60)%  
 
* As of January 31, 2006, due to the change to a 200 basis point gradual change policy during the first quarter of 2006.
     The table above summarizes the interest rate risk of net interest income based on forecasts over the succeeding 12 months. At June 30, 2006, the Company’s overall interest rate risk position was liability sensitive to changes in interest rates. The Company manages the overall interest rate risk profile within policy limits. ALPC policy guidelines limit the estimated change in net interest income to 3.0 percent of forecasted net interest income over the succeeding 12 months. At June 30, 2006, and December 31, 2005, the Company was within its policy guidelines.
Market Value of Equity Modeling The Company also utilizes the market value of equity as a measurement tool in managing interest rate sensitivity. The market value of equity measures the degree to which the market values of the Company’s assets and liabilities and off-balance sheet instruments will change given a change in interest rates. ALPC guidelines limit the change in market value of equity in a 200 basis point parallel rate shock to 15 percent of the market value of equity assuming interest rates at June 30, 2006. The up 200 basis point scenario resulted in a 6.2 percent decrease in the market value of equity at June 30, 2006, compared with a 6.8 percent decrease at December 31, 2005. The down 200 basis point scenario resulted in a 1.1 percent decrease in the market value of equity at June 30, 2006, compared with a 4.1 percent decrease at December 31, 2005. At June 30, 2006, and December 31, 2005, the Company was within its policy guidelines.
     The Company also uses duration of equity as a measure of interest rate risk. The duration of equity is a measure of the net market value sensitivity of the assets, liabilities and derivative positions of the Company. The duration of assets was 1.9 years at June 30, 2006, compared with 1.6 years at December 31, 2005. The duration of liabilities was 1.8 years at June 30, 2006, compared with 1.6 years at December 31, 2005. At June 30, 2006, the duration of equity was 1.9 years, compared with 1.8 years at December 31, 2005. The increased duration of equity measure shows that sensitivity of the market value of equity of the Company was liability sensitive to changes in interest rates. Refer to “Management’s Discussion and Analysis — Market Value of Equity Modeling” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on market value of equity modeling.
Use of Derivatives to Manage Interest Rate Risk In the ordinary course of business, the Company enters into derivative transactions to manage its interest rate, prepayment and foreign currency risks (“asset and liability management positions”) and to accommodate the business requirements of its customers (“customer-related positions”). Refer to “Management’s Discussion and Analysis — Use of Derivatives to Manage Interest Rate Risk” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on the use of derivatives to manage interest rate risk.
     By their nature, derivative instruments are subject to market risk. The Company does not utilize derivative instruments for speculative purposes. Of the Company’s $24.4 billion of total notional amount of asset and liability management derivative positions at June 30, 2006, $19.2 billion was designated as either fair value or cash flow hedges or net investment hedges of foreign operations. The cash flow hedge derivative positions are interest rate swaps that hedge the forecasted cash flows from the underlying variable-rate LIBOR loans and floating-rate debt. The fair value hedges are primarily interest rate swaps that hedge the change in fair value related to interest rate changes of underlying fixed-rate debt and subordinated obligations.
     In addition, the Company uses forward commitments to sell residential mortgage loans to hedge its interest rate risk related to residential mortgage loans held for sale. Related to its mortgage banking operations, the Company held $2.3 billion of forward commitments to sell mortgage loans and $1.7 billion of unfunded mortgage loan commitments that were derivatives in accordance with the provisions of the Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedge Activities.” The unfunded mortgage loan commitments are reported at fair value as options in Table 9. Beginning in March 2006, the Company entered into U.S. Treasury futures and options on U.S. Treasury futures contracts to hedge the change in fair value related to the election of fair value measurement for its residential MSRs.
U.S. Bancorp 17


Table of Contents

Table 9 Derivative Positions
                                                       
    June 30, 2006   December 31, 2005
     
        Weighted-       Weighted-
        Average       Average
            Remaining       Remaining
    Notional   Fair   Maturity   Notional   Fair   Maturity
(Dollars in Millions)   Amount   Value   In Years   Amount   Value   In Years
 
 
Asset and Liability Management Positions
                                               
 
 
Interest rate contracts
                                               
   
Receive fixed/pay floating swaps
    $5,810       $(106 )     17.73       $16,370       $(82 )     7.79  
   
Pay fixed/receive floating swaps
    8,398       123       2.00       9,163       139       1.33  
   
Futures and forwards
                                               
     
Buy
    53             .11       104             .07  
     
Sell
    5,625       (2 )     .14       2,669       (15 )     .09  
   
Options
                                               
     
Written
    4,046       (4 )     .12       1,086       3       .08  
 
Foreign exchange contracts
                                               
   
Cross-currency swaps
    403       19       9.12       387       11       9.61  
   
Forwards
    10             .08       404       7       .05  
 
Equity contracts
    46       1       2.79       42       3       3.29  
 
Customer-related Positions
                                               
 
 
Interest rate contracts
                                               
   
Receive fixed/pay floating swaps
    $10,218       $(264 )     5.33       $9,753       $(69 )     5.25  
   
Pay fixed/receive floating swaps
    10,189       318       5.42       9,707       121       5.25  
   
Options
                                               
     
Purchased
    1,611       14       2.25       1,453       6       2.26  
     
Written
    1,597       (13 )     2.25       1,453       (5 )     2.26  
 
Risk participation agreements (a)
                                               
   
Purchased
    147             7.49       143             8.02  
   
Written
    224             5.89       169             4.64  
 
Foreign exchange rate contracts
                                               
   
Forwards and swaps
                                               
     
Buy
    2,265       67       .39       2,042       77       .43  
     
Sell
    2,212       (59 )     .41       2,018       (73 )     .46  
   
Options
                                               
     
Purchased
    134       (1 )     .46       56       1       .24  
     
Written
    134       1       .46       56       (1 )     .24  
 
(a) At June 30, 2006, the credit equivalent amount was $1 million and $32 million, compared with $1 million and $18 million at December 31, 2005, for purchased and written risk participation agreements, respectively.
     At June 30, 2006, the Company had $36 million in accumulated other comprehensive income related to realized and unrealized losses on derivatives classified as cash flow hedges. Unrealized gains and losses are reflected in earnings when the related cash flows or hedged transactions occur and offset the related performance of the hedged items. The estimated amount to be reclassified from accumulated other comprehensive income into earnings during the remainder of 2006 and the next 12 months is a gain of $21 million and $39 million, respectively.
     Gains or losses on customer-related derivative positions were not material for the second quarter and first six months of 2006. The change in fair value of forward commitments attributed to hedge ineffectiveness recorded in noninterest income was not significant for the second quarter of 2006 and was a decrease of $1 million for the first six months of 2006. The change in the fair value of all other asset and liability management derivative positions attributed to hedge ineffectiveness recorded in noninterest income was not material for the second quarter and first six months of 2006.
     The Company enters into derivatives to protect its net investment in certain foreign operations. The Company uses forward commitments to sell specified amounts of certain foreign currencies to hedge its capital volatility risk associated with fluctuations in foreign currency exchange rates. The net amount of gains or losses included in the cumulative translation
18 U.S. Bancorp


Table of Contents

adjustment for the second quarter and first six months of 2006 was not material.
Market Risk Management In addition to interest rate risk, the Company is exposed to other forms of market risk as a consequence of conducting normal trading activities. Business activities that contribute to market risk include primarily residential mortgage related risks, but also other things, such as proprietary trading and foreign exchange positions. Value at Risk (“VaR”) is a key measure of market risk for the Company. Theoretically, VaR represents the maximum amount that the Company has placed at risk of loss, with a ninety-ninth percentile degree of confidence, to adverse market movements in the course of its risk taking activities. Due to the election of fair value measurement of its residential MSRs and related hedging strategy in the first quarter of 2006, the Company increased its VaR limit to $40 million at March 31, 2006, compared with $20 million at December 31, 2005. The Company’s market valuation risk, as estimated by the VaR analysis, was $16 million at June 30, 2006, compared with $1 million at December 31, 2005. Refer to “Management’s Discussion and Analysis — Market Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on market risk management.
Liquidity Risk Management ALPC establishes policies, as well as analyzes and manages liquidity, to ensure that adequate funds are available to meet normal operating requirements in addition to unexpected customer demands for funds, such as high levels of deposit withdrawals or loan demand, in a timely and cost-effective manner. Liquidity management is viewed from long-term and short-term perspectives, as well as from an asset and liability perspective. Management monitors liquidity through a regular review of maturity profiles, funding sources, and loan and deposit forecasts to minimize funding risk. Refer to “Management’s Discussion and Analysis — Liquidity Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on liquidity risk management.
     At June 30, 2006, parent company long-term debt outstanding was $12.6 billion, compared with $10.9 billion at December 31, 2005. The $1.7 billion increase was primarily due to the issuances of $1.8 billion of junior subordinated debentures and $1.5 billion of medium-term notes, offset by long-term debt maturities and repayments during the first six months of 2006. As of June 30, 2006, there is no parent company debt scheduled to mature in the remainder of 2006.
     Federal banking laws regulate the amount of dividends that may be paid by banking subsidiaries without prior approval. The amount of dividends available to the parent company from its banking subsidiaries after meeting the regulatory capital requirements for well-capitalized banks was approximately $1.1 billion at June 30, 2006.
Off-Balance Sheet Arrangements Off-balance sheet arrangements include any contractual arrangement to which an unconsolidated entity is a party, under which the Company has an obligation to provide credit or liquidity enhancements or market risk support. Off-balance sheet arrangements include certain defined guarantees, asset securitization trusts and conduits. Off-balance sheet arrangements also include any obligation under a variable interest held by an unconsolidated entity that provides financing, liquidity, credit enhancement or market risk support.
     In the ordinary course of business, the Company enters into an array of commitments to extend credit, letters of credit and various forms of guarantees that may be considered off-balance sheet arrangements. The extent of these arrangements is provided in Note 10 of the Notes to Consolidated Financial Statements.
     Asset securitizations and conduits represent a source of funding for the Company through off-balance sheet structures. The Company sponsors an off-balance sheet conduit to which it transferred high-grade investment securities, funded by the issuance of commercial paper. The conduit held assets and related commercial paper liabilities of $3.0 billion at June 30, 2006, and $3.8 billion at December 31, 2005. The Company provides a liquidity facility to the conduit. A liability for the estimate of the potential risk of loss for the Company as the liquidity facility provider is recorded on the balance sheet in other liabilities and was $15 million at June 30, 2006, and $20 million at December 31, 2005. In addition, the Company recorded at fair value its retained residual interest in the investment securities conduit of $21 million at June 30, 2006, and $28 million at December 31, 2005.
     The Company does not rely significantly on off-balance sheet arrangements for liquidity or capital resources. Refer to “Management’s Discussion and Analysis — Off-Balance Sheet Arrangements” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on off-balance sheet arrangements.
U.S. Bancorp 19


Table of Contents

Table 10 Capital Ratios
                   
    June 30,   December 31,
(Dollars in Millions)   2006   2005
 
Tier 1 capital
    $16,841       $15,145  
 
As a percent of risk-weighted assets
    8.9 %     8.2 %
 
As a percent of adjusted quarterly average assets (leverage ratio)
    8.2 %     7.6 %
Total risk-based capital
    $24,893       $23,056  
 
As a percent of risk-weighted assets
    13.1 %     12.5 %
Tangible common equity
    $11,535       $11,873  
 
As a percent of tangible assets
    5.6 %     5.9 %
 
Capital Management The Company is committed to managing capital for maximum shareholder benefit and maintaining strong protection for depositors and creditors. The Company has targeted returning 80 percent of earnings to its common shareholders through a combination of dividends and share repurchases. In the first six months of 2006, the Company returned 116 percent of earnings. The Company continually assesses its business risks and capital position. The Company also manages its capital to exceed regulatory capital requirements for well-capitalized bank holding companies. To achieve these capital goals, the Company employs a variety of capital management tools including dividends, common share repurchases, and the issuance of subordinated debt and other capital instruments. Total shareholders’ equity was $20.4 billion at June 30, 2006, compared with $20.1 billion at December 31, 2005. The increase was the result of corporate earnings and the issuance of $1.0 billion of non-cumulative, perpetual preferred stock on March 27, 2006, partially offset by share repurchases and dividends.
     Table 10 provides a summary of capital ratios as of June 30, 2006, and December 31, 2005. Tier 1 capital at June 30, 2006, was positively affected by the $1.0 billion issuance of preferred stock and the $1.8 billion issuance of junior subordinated debentures during the first six months of 2006. All regulatory ratios continue to be in excess of regulatory “well-capitalized” requirements.
     On December 21, 2004, the Board of Directors approved and announced an authorization to repurchase 150 million shares of common stock during the next 24 months.
     The following table provides a detailed analysis of all shares repurchased under this program during the second quarter of 2006:
                         
            Maximum Number of
    Total Number of   Average   Shares that May Yet
    Shares Purchased as   Price Paid   Be Purchased
Period   Part of the Program   per Share   Under the Program
 
April
    6,588,329       $30.64       35,948,635  
May
    2,284,831       31.17       33,663,804  
June
    811,039       30.89       32,852,765  
     
 Total
    9,684,199       $30.78       32,852,765  
 
     On August 3, 2006, the Company announced that the Board of Directors approved an authorization to repurchase 150 million shares of common stock through December 2008. This new authorization replaces the December 21, 2004, share repurchase program.
LINE OF BUSINESS FINANCIAL REVIEW
     Within the Company, financial performance is measured by major lines of business, which include Wholesale Banking, Consumer Banking, Wealth Management, Payment Services, and Treasury and Corporate Support. These operating segments are components of the Company about which financial information is available and is evaluated regularly in deciding how to allocate resources and assess performance.
Basis for Financial Presentation Business line results are derived from the Company’s business unit profitability reporting systems by specifically attributing managed balance sheet assets, deposits and other liabilities and their related income or expense. Refer to “Management’s Discussion and Analysis — Line of Business Financial Review” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion on the business lines’ basis for financial presentation.
     Designations, assignments and allocations change from time to time as management systems are enhanced, methods of evaluating performance or product lines change or business segments are realigned to better respond to the Company’s diverse customer base. During 2006, certain organization and methodology changes were made and, accordingly, 2005 results were restated and presented on a comparable basis, including a change in the allocation of risk adjusted capital to the business lines. Business lines are allocated risk adjusted capital based upon economic capital requirements, regulatory capital requirements, goodwill and intangibles. The allocations to the business lines are equal to the capital that is held by the Company. The capital allocations include credit and operational capital allocations which are performed using a Basel II
20 U.S. Bancorp


Table of Contents

approach with adjustments for regulatory Tier I leverage requirements.
Wholesale Banking offers lending, depository, treasury management and other financial services to middle market, large corporate, commercial real estate, equipment finance, small-ticket leasing and public sector clients, along with lending guaranteed by the Small Business Administration. Wholesale Banking contributed $298 million of the Company’s net income in the second quarter and $598 million in the first six months of 2006, or increases of $6 million and $27 million, respectively, compared with the same periods of 2005. The increases were primarily driven by growth in total net revenue.
     Total net revenue increased $21 million (3.1 percent) in the second quarter and $46 million (3.4 percent) in the first six months of 2006, compared with the same periods of 2005. Net interest income, on a taxable-equivalent basis, increased $15 million in the second quarter and $39 million in the first six months of 2006, compared with the same periods of 2005. The increases in net interest income were driven by growth in average loan balances and wider spreads on total deposits due to the funding benefit associated with the impact of rising interest rates, partially offset by reduced loan spreads due to competitive pricing. The increase in average loans was driven by stronger commercial loan and commercial real estate loan demand in 2005 and the first six months of 2006. Total deposits increased year-over-year driven by growth in fixed-rate time deposits, partially offset by a decrease in interest checking deposits.
     The $6 million (2.7 percent) and $7 million (1.6 percent) increases in noninterest income in the second quarter and first six months of 2006, respectively, compared with the same periods of 2005, were due to higher commercial products revenue and equipment leasing revenue, partially offset by lower other commercial loan fees and treasury management-related fees. Treasury management-related fees were lower due to higher earnings credits on customers’ compensating balances, partially offset by growth in treasury management-related services activity.
     Noninterest expense was relatively flat in the second quarter of 2006, compared with the second quarter of 2005. Noninterest expense increased $8 million (1.7 percent) in the first six months of 2006, compared with the same period of 2005. The increase was primarily driven by higher personnel-related costs and net shared services expense.
     The provision for credit losses increased $12 million in the second quarter and decreased $5 million in the first six months of 2006, compared with the same periods of 2005. The increase in the provision for credit losses in the second quarter of 2006 was due to lower net recoveries compared to the second quarter of 2005. Nonperforming assets within Wholesale Banking were $218 million at June 30, 2006, $260 million at March 31, 2006, and $298 million at June 30, 2005. Nonperforming assets as a percentage of period-end loans were .43 percent at June 30, 2006, ..52 percent at March 31, 2006, and .63 percent at June 30, 2005. Refer to the “Corporate Risk Profile” section for further information on factors impacting the credit quality of the loan portfolios.
Consumer Banking delivers products and services through banking offices, telephone servicing and sales, on-line services, direct mail and ATMs. It encompasses community banking, metropolitan banking, in-store banking, small business banking, consumer lending, mortgage banking, consumer finance, workplace banking, student banking and 24-hour banking. Consumer Banking contributed $488 million of the Company’s net income in the second quarter and $899 million in the first six months of 2006, or increases of $59 million and $83, respectively, compared with the same periods of 2005. While the retail banking business grew net income 13.9 percent in the second quarter and 11.2 percent in the first six months of 2006, the contribution of the mortgage banking business increased 12.5 percent and decreased 3.4 percent, respectively, compared with the same periods of 2005.
     Total net revenue increased $22 million (1.6 percent) in the second quarter and $31 million (1.1 percent) in the first six months of 2006, compared with the same periods of 2005. Net interest income, on a taxable-equivalent basis, increased $19 million in the second quarter and $56 million in the first six months of 2006, compared with the same periods of 2005. The year-over-year increases in net interest income were due to strong growth in average loans and the funding benefit of total deposits due to rising interest rates. Partially offsetting these increases were reduced spreads on commercial and retail loans due to competitive pricing. The increases in average loan balances reflected growth in retail loans, residential mortgages, commercial loans and commercial real estate loans. The growth in retail loans was principally driven by an increase in installment loans which increased 15.8 percent in the second quarter and 15.5 percent in the first six months of 2006 over the same periods of 2005. Residential mortgages, which include traditional residential mortgages, grew 21.6 percent in the second
U.S. Bancorp 21


Table of Contents

quarter and 27.1 percent in the first six months of 2006, compared with the same periods of a year ago, reflecting the Company’s retention of adjustable-rate residential mortgages during 2005. Average balances of residential mortgages are expected to remain essentially flat in future periods due to the Company’s decision in the first quarter of 2006 to package and sell the majority of its residential mortgage loan production in the secondary markets. The year-over-year decreases in average deposits were primarily due to a reduction in saving products, offset by growth in interest checking and time deposits. The year-over-year increases in interest checking balances reflected strong branch-based new account deposit growth. On a combined basis, the Consumer Banking line of business generated growth of $90 million (.3 percent) in average checking account balances in the second quarter of 2006, compared with the second quarter of 2005, driven by 5.7 percent growth in net new checking accounts. Offsetting this growth was a decline in average savings balances of $3.2 billion (13.0 percent) from second quarter of 2005, principally related to money market accounts. Average time deposit balances grew $1.6 billion in the second quarter and $1.7 billion in the first six months of 2006, compared with the same periods of 2005, as a portion of money market balances migrated to fixed-rate time deposit products.
     Fee-based noninterest income increased $3 million in the second quarter and decreased $25 million in the first six months of 2006, compared with the same periods of 2005. The year-over-year decline in fee-based revenue was driven by a reduction in mortgage banking revenue, partially offset by increases in deposit service charges, retail leasing revenue, and other revenue. The increase in other revenue reflected higher gains from the sales of student loans. The reduction in mortgage banking revenue reflected the adoption of fair value accounting for MSRs as of January 1, 2006.
     Noninterest expense decreased $61 million (9.1 percent) in the second quarter and $78 million (5.9 percent) in the first six months of 2006, compared with the same periods of 2005. The decreases were primarily attributable to the elimination of MSR amortization under SFAS 156 which resulted in a reduction of other intangible expense. Partially offsetting this decrease were increases in compensation and employee benefit expenses. The increases in compensation and employee benefit expenses reflect the impact of the net addition of 38 in-store and 13 traditional branches at June 30, 2006, compared with June 30, 2005.
     The provision for credit losses decreased $9 million and $20 million in the second quarter and first six months of 2006, respectively, compared with the same periods of 2005. The improvements were attributable to lower net charge-offs. As a percentage of average loans outstanding, net charge-offs declined to .30 percent in the second quarter of 2006, compared with .38 percent in the second quarter of 2005. The decline in net charge-offs included both the commercial and retail loan portfolios. Commercial and commercial real estate loan net charge-offs declined $3 million in the second quarter of 2006, compared with the second quarter of 2005. Retail loan and residential mortgage net charge-offs declined by $6 million in the second quarter of 2006, compared with the second quarter of 2005. Nonperforming assets within Consumer Banking were $275 million at June 30, 2006, $291 million at March 31, 2006, and $304 million at June 30, 2005. Nonperforming assets as a percentage of period-end loans were .39 percent at June 30, 2006, ..42 percent at March 31, 2006, and .49 percent at June 30, 2005. Refer to the “Corporate Risk Profile” section for further information on factors impacting the credit quality of the loan portfolios.
Wealth Management provides trust, private banking, financial advisory, investment management, insurance, custody and mutual fund servicing through six businesses: Private Client Group, Corporate Trust, U.S. Bancorp Investments and Insurance, FAF Advisors, Institutional Trust and Custody and Fund Services. Wealth Management contributed $148 million of the Company’s net income in the second quarter and $282 million in the first six months of 2006, or increases of $32 million and $55 million, respectively, compared with the same periods of 2005. The growth was primarily attributable to higher total net revenue, partially offset by an increase in noninterest expense.
     Total net revenue increased $88 million (21.6 percent) in the second quarter and $170 million (21.2 percent) in the first six months of 2006, compared with the same periods of 2005. Net interest income, on a taxable-equivalent basis, increased $21 million in the second quarter and $47 million in the first six months of 2006, compared with the same periods of 2005. The increases in net interest income were due to growth in total average deposits and the favorable impact of rising interest rates on the funding benefit of customer deposits, partially offset by a decline in loan spreads. The increase in total deposits was attributable to growth in noninterest-bearing deposits and time deposits principally in Corporate Trust. Noninterest income increased $67 million in the second quarter and $123 million in the first six months of 2006, compared with the same periods of 2005, primarily driven by the acquisition of the corporate and institutional trust
22 U.S. Bancorp


Table of Contents

business of a large national bank, growth in core revenue, and favorable equity market valuations.
     Noninterest expense increased $39 million (17.5 percent) in the second quarter and $84 million (19.0 percent) in the first six months of 2006, compared with the same periods of 2005. The increases in noninterest expense were primarily attributable to the acquisition of a large national bank’s corporate and institutional trust business.
Payment Services includes consumer and business credit cards, stored-value cards, debit cards, corporate and purchasing card services, consumer lines of credit, ATM processing and merchant processing. Payment Services contributed $251 million of the Company’s net income in the second quarter and $474 in the first six months of 2006, or increases of $68 million and $123 million, respectively, compared with the same periods of 2005. The increases were due to growth in total net revenue driven by higher transaction volumes and a lower provision for credit losses, partially offset by increases in total noninterest expense.
     Total net revenue increased $128 million (18.8 percent) in the second quarter and $251 million (19.1 percent) in the first six months of 2006, compared with the same periods of 2005. Net interest income increased $21 million in the second quarter and $38 million in the first six months of 2006, compared with the same periods of 2005. The increases were primarily due to increases in retail credit card balances and customer late fees, partially offset by an increase in nonearning assets resulting in higher funding expense. Noninterest income increased $107 million in the second quarter and $213 million in the first six months of 2006, compared with the same periods of 2005. The increases in fee-based revenue were driven by strong growth in credit card and debit card revenue, corporate payment products revenue, ATM processing services revenue and merchant processing revenue. Credit and debit card revenue increased due to higher customer transaction volume. Corporate payment products revenue reflected organic growth in sales volumes and card usage. ATM processing services revenue increased primarily due to the acquisition of an ATM business in May of 2005. Merchant processing revenue also grew from a year ago due to an increase in sales volume driven by acquisitions, higher same store sales and equipment fees. Noninterest income for the first six months of 2006 also included the impact of a $10 million settlement in the first quarter.
     Noninterest expense increased $48 million (15.8 percent) in the second quarter and $113 million (19.5 percent) in the first six months of 2006, compared with the same periods of 2005. The increases in noninterest expense were primarily attributable to the acquisition of merchant acquiring businesses, higher compensation and employee benefit costs for processing associated with increased credit and debit card transaction volumes, higher corporate payment products and merchant processing sales volumes, and higher ATM processing services volumes.
     The provision for credit losses decreased $27 million (29.3 percent) in the second quarter and $56 million (30.9 percent) in the first six months of 2006, compared with the same periods of 2005, due to lower net charge-offs. As a percentage of average loans outstanding, net charge-offs were 2.16 percent in the second quarter of 2006, compared with 3.26 percent in the second quarter of 2005. The favorable change in credit losses reflected the near-term impact of changes in bankruptcy legislation in the fourth quarter of 2005.
Treasury and Corporate Support includes the Company’s investment portfolios, funding, capital management and asset securitization activities, interest rate risk management, the net effect of transfer pricing related to average balances and the residual aggregate of those expenses associated with corporate activities that are managed on a consolidated basis. In addition, prior to the adoption of SFAS 156, changes in MSR valuations due to interest rate changes were managed at a corporate level and, as such, reported within this business unit. Treasury and Corporate Support recorded net income of $16 million in the second quarter and $101 million in the first six months of 2006, or decreases of $85 million and $126 million, respectively, compared with the same periods of 2005.
     Total net revenue decreased $109 million (92.4 percent) in the second quarter and $142 million (61.2 percent) in the first six months of 2006, compared with the same periods of 2005. The year-over-year decreases in total net revenue were primarily due to unfavorable variances in net interest income, partially offset by higher noninterest income. The decrease in net interest income reflected the impact of a flatter yield curve and asset/liability management decisions during the past year, including reducing the investment securities portfolio, changes in interest rate derivative positions and the issuance of higher cost wholesale funding. Noninterest income increased $31 million in the second quarter and $128 million in the first six months of 2006, compared with the same periods of 2005. The increase in noninterest income in the second quarter and first six months of 2006 was driven by a gain from an initial public offering of a cardholder association. The increase during the first six months of 2006 was also due to a gain on derivatives that did not qualify as hedges, realized in the first quarter of 2006, and securities losses incurred in the first six months of 2005.
U.S. Bancorp 23


Table of Contents

Table 11 Line of Business Financial Performance
                                                     
    Wholesale   Consumer
    Banking   Banking
     
            Percent       Percent
Three Months Ended June 30 (Dollars in Millions)   2006   2005   Change   2006   2005   Change
 
Condensed Income Statement
                                               
Net interest income (taxable-equivalent basis)
    $478       $463       3.2 %     $968       $949       2.0 %
Noninterest income
    224       220       1.8       465       462       .6  
Securities gains (losses), net
    2             *                    
                     
 
Total net revenue
    704       683       3.1       1,433       1,411       1.6  
Noninterest expense
    230       231       (.4 )     600       609       (1.5 )
Other intangibles
    4       4             12       64       (81.3 )
                     
 
Total noninterest expense
    234       235       (.4 )     612       673       (9.1 )
                     
   
Income before provision and income taxes
    470       448       4.9       821       738       11.2  
Provision for credit losses
    1       (11 )     *       54       63       (14.3 )
                     
Income before income taxes
    469       459       2.2       767       675       13.6  
Income taxes and taxable-equivalent adjustment
    171       167       2.4       279       246       13.4  
                     
Net income
    $298       $292       2.1       $488       $429       13.8  
                     
Average Balance Sheet Data
                                               
Commercial
    $33,292       $31,187       6.7 %     $6,380       $6,143       3.9 %
Commercial real estate
    17,346       16,630       4.3       10,699       10,226       4.6  
Residential mortgages
    59       57       3.5       20,365       16,742       21.6  
Retail
    40       28       42.9       35,112       33,710       4.2  
                     
 
Total loans
    50,737       47,902       5.9       72,556       66,821       8.6  
Goodwill
    1,329       1,329             2,108       2,108        
Other intangible assets
    55       73       (24.7 )     1,453       1,168       24.4  
Assets
    56,934       53,886       5.7       80,774       74,795       8.0  
Noninterest-bearing deposits
    12,107       12,303       (1.6 )     12,720       13,035       (2.4 )
Interest checking
    3,164       3,189       (.8 )     17,789       17,384       2.3  
Savings products
    5,569       5,469       1.8       21,393       24,581       (13.0 )
Time deposits
    13,020       12,267       6.1       18,669       17,034       9.6  
                     
 
Total deposits
    33,860       33,228       1.9       70,571       72,034       (2.0 )
Shareholders’ equity
    5,554       5,308       4.6       6,436       6,457       (.3 )
 
                                                     
    Wholesale   Consumer
    Banking   Banking
     
        Percent       Percent
Six Months Ended June 30 (Dollars in Millions)   2006   2005   Change   2006   2005   Change
 
Condensed Income Statement
                                               
Net interest income (taxable-equivalent basis)
    $950       $911       4.3 %     $1,918       $1,862       3.0 %
Noninterest income
    449       448       .2       848       873       (2.9 )
Securities gains (losses), net
    2       (4 )     *                    
                     
 
Total net revenue
    1,401       1,355       3.4       2,766       2,735       1.1  
Noninterest expense
    459       451       1.8       1,211       1,188       1.9  
Other intangibles
    8       8             25       126       (80.2 )
                     
 
Total noninterest expense
    467       459       1.7       1,236       1,314       (5.9 )
                     
   
Income before provision and income taxes
    934       896       4.2       1,530       1,421       7.7  
Provision for credit losses
    (7 )     (2 )     *       117       137       (14.6 )
                     
Income before income taxes
    941       898       4.8       1,413       1,284       10.0  
Income taxes and taxable-equivalent adjustment
    343       327       4.9       514       468       9.8  
                     
Net income
    $598       $571       4.7       $899       $816       10.2  
                     
Average Balance Sheet Data
                                               
Commercial
    $32,866       $30,709       7.0 %     $6,345       $6,010       5.6 %
Commercial real estate
    17,312       16,615       4.2       10,650       10,194       4.5  
Residential mortgages
    61       60       1.7       20,420       16,069       27.1  
Retail
    42       38       10.5       35,075       33,425       4.9  
                     
 
Total loans
    50,281       47,422       6.0       72,490       65,698       10.3  
Goodwill
    1,329       1,329             2,107       2,109       (.1 )
Other intangible assets
    57       76       (25.0 )     1,392       1,141       22.0  
Assets
    56,287       53,248       5.7       80,405       73,251       9.8  
Noninterest-bearing deposits
    12,049       12,125       (.6 )     12,747       12,937       (1.5 )
Interest checking
    3,139       3,397       (7.6 )     17,722       17,198       3.0  
Savings products
    5,427       5,351       1.4       21,877       25,027       (12.6 )
Time deposits
    12,536       11,660       7.5       18,422       16,760       9.9  
                     
 
Total deposits
    33,151       32,533       1.9       70,768       71,922       (1.6 )
Shareholders’ equity
    5,474       5,296       3.4       6,424       6,445       (.3 )
 
* Not meaningful
24 U.S. Bancorp


Table of Contents

                                                                                                 
Wealth   Payment   Treasury and   Consolidated    
Management   Services   Corporate Support   Company    
 
    Percent       Percent       Percent       Percent    
2006   2005   Change   2006   2005   Change   2006   2005   Change   2006   2005   Change    
             
  $127       $106       19.8 %     $156       $135       15.6 %     $(32 )     $108       * %     $1,697       $1,761       (3.6 )%    
  369       302       22.2       654       547       19.6       40       9       *       1,752       1,540       13.8      
   —                                     1       1             3       1       *      
                                         
  496       408       21.6       810       682       18.8       9       118       (92.4 )     3,452       3,302       4.5      
  240       208       15.4       300       260       15.4       71       106       (33.0 )     1,441       1,414       1.9      
  22       15       46.7       51       43       18.6             55       *       89       181       (50.8 )    
                                         
  262       223       17.5       351       303       15.8       71       161       (55.9 )     1,530       1,595       (4.1 )    
                                         
  234       185       26.5       459       379       21.1       (62 )     (43 )     (44.2 )     1,922       1,707       12.6      
  2       2             65       92       (29.3 )     3       (2 )     *       125       144       (13.2 )    
                                         
  232       183       26.8       394       287       37.3       (65 )     (41 )     (58.5 )     1,797       1,563       15.0      
  84       67       25.4       143       104       37.5       (81 )     (142 )     43.0       596       442       34.8      
                                         
  $148       $116       27.6       $251       $183       37.2       $16       $101       (84.2 )     $1,201       $1,121       7.1      
                                         
       
  $1,520       $1,582       (3.9 )%     $3,758       $3,433       9.5 %     $120       $172       (30.2 )%     $45,070       $42,517       6.0 %    
  689       639       7.8                         61       87       (29.9 )     28,795       27,582       4.4      
  440       393       12.0                         4       6       (33.3 )     20,868       17,198       21.3      
  2,422       2,313       4.7       8,512       7,878       8.0       44       49       (10.2 )     46,130       43,978       4.9      
                                         
  5,071       4,927       2.9       12,270       11,311       8.5       229       314       (27.1 )     140,863       131,275       7.3      
  1,378       874       57.7       2,463       2,030       21.3       1             *       7,279       6,341       14.8      
  473       316       49.7       1,165       972       19.9             3       *       3,146       2,532       24.2      
  7,487       6,647       12.6       17,294       15,163       14.1       49,918       51,327       (2.7 )     212,407       201,818       5.2      
  3,668       3,616       1.4       297       134       *       157       60       *       28,949       29,148       (.7 )    
  2,379       2,445       (2.7 )                       1       6       (83.3 )     23,333       23,024       1.3      
  5,677       5,368       5.8       19       15       26.7       43       16       *       32,701       35,449       (7.8 )    
  2,900       1,102       *       3       1       *       1,658       3,207       (48.3 )     36,250       33,611       7.9      
                                         
  14,624       12,531       16.7       319       150       *       1,859       3,289       (43.5 )     121,233       121,232            
  2,349       1,663       41.3       4,747       4,011       18.3       1,470       2,381       (38.3 )     20,556       19,820       3.7      
             
                                                                                                 
Wealth   Payment   Treasury and   Consolidated    
Management   Services   Corporate Support   Company    
 
    Percent       Percent       Percent       Percent    
2006   2005   Change   2006   2005   Change   2006   2005   Change   2006   2005   Change    
             
  $252       $205       22.9 %     $319       $281       13.5 %     $(17 )     $253       * %     $3,422       $3,512       (2.6 )%    
  719       596       20.6       1,244       1,031       20.7       106       33       *       3,366       2,981       12.9      
   —                                     1       (54 )     *       3       (58 )     *      
                                         
  971       801       21.2       1,563       1,312       19.1       90       232       (61.2 )     6,791       6,435       5.5      
  482       411       17.3       596       496       20.2       108       128       (15.6 )     2,856       2,674       6.8      
  44       31       41.9       97       84       15.5             3       *       174       252       (31.0 )    
                                         
  526       442       19.0       693       580       19.5       108       131       (17.6 )     3,030       2,926       3.6      
                                         
  445       359       24.0       870       732       18.9       (18 )     101       *       3,761       3,509       7.2      
  2       2             125       181       (30.9 )     3       (2 )     *       240       316       (24.1 )    
                                         
  443       357       24.1       745       551       35.2       (21 )     103       *       3,521       3,193       10.3      
  161       130       23.8       271       200       35.5       (122 )     (124 )     1.6       1,167       1,001       16.6      
                                         
  $282       $227       24.2       $474       $351       35.0       $101       $227       (55.5 )     $2,354       $2,192       7.4      
                                         
       
  $1,508       $1,568       (3.8 )%     $3,647       $3,315       10.0 %     $135       $159       (15.1 )%     $44,501       $41,761       6.6 %    
  681       642       6.1                         63       92       (31.5 )     28,706       27,543       4.2      
  442       380       16.3                         4       8       (50.0 )     20,927       16,517       26.7      
  2,412       2,295       5.1       8,417       7,846       7.3       45       49       (8.2 )     45,991       43,653       5.4      
                                         
  5,043       4,885       3.2       12,064       11,161       8.1       247       308       (19.8 )     140,125       129,474       8.2      
  1,376       874       57.4       2,375       1,986       19.6       1       (1 )     *       7,188       6,297       14.1      
  484       323       49.8       1,111       940       18.2             8       *       3,044       2,488       22.3      
  7,466       6,638       12.5       16,882       14,818       13.9       50,182       51,435       (2.4 )     211,222       199,390       5.9      
  3,649       3,527       3.5       295       137       *       153       58       *       28,893       28,784       .4      
  2,376       2,482       (4.3 )                       1       8       (87.5 )     23,238       23,085       .7      
  5,527       5,430       1.8       19       15       26.7       33       15       *       32,883       35,838       (8.2 )    
  2,487       1,035       *       3             *       2,239       3,170       (29.4 )     35,687       32,625       9.4      
                                         
  14,039       12,474       12.5       317       152       *       2,426       3,251       (25.4 )     120,701       120,332       .3      
  2,351       1,671       40.7       4,557       3,941       15.6       1,547       2,459       (37.1 )     20,353       19,812       2.7      
             
U.S. Bancorp 25


Table of Contents

     Noninterest expense decreased $90 million in the second quarter and $23 million in the first six months of 2006, compared with the same periods of 2005. The decreases in noninterest expense were driven by lower debt prepayment expense and the elimination of MSR impairment or reparation due to the adoption of SFAS 156 in the first quarter of 2006.
     The provision for credit losses for this business unit represents the residual aggregate of the net credit losses allocated to the reportable business units and the Company’s recorded provision determined in accordance with accounting principles generally accepted in the United States. Refer to the “Corporate Risk Profile” section for further information on the provision for credit losses, nonperforming assets and factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.
     Income taxes are assessed to each line of business at a managerial tax rate of 36.4 percent with the residual tax expense or benefit to arrive at the consolidated effective tax rate included in Treasury and Corporate Support. The consolidated effective tax rate of the Company was 32.8 percent and 32.7 percent in the second quarter and first six months of 2006, respectively, compared with 28.0 percent and 31.0 percent in the same periods of 2005, respectively. The second quarter of 2005 included a $94 million reduction in income tax expense related to the resolution of federal income tax examinations covering substantially all of the Company’s legal entities for the years 2000 through 2002.
CRITICAL ACCOUNTING POLICIES
     The accounting and reporting policies of the Company comply with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions, which are integral to understanding the Company’s financial statements. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and require management to make estimates that are difficult, subjective or complex. Most accounting policies are not considered by management to be critical accounting policies. Those policies considered to be critical accounting policies relate to the allowance for credit losses, MSRs, goodwill and other intangibles and income taxes. Management has discussed the development and the selection of critical accounting policies with the Company’s Audit Committee. These accounting policies are discussed in detail in “Management’s Discussion and Analysis — Critical Accounting Policies” and the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. Refer to Note 2 of the Notes to Consolidated Financial Statements for discussion of the change in accounting for MSRs implemented in the first quarter of 2006.
CONTROLS AND PROCEDURES
     Under the supervision and with the participation of the Company’s management, including its principal executive officer and principal financial officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based upon this evaluation, the principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective.
     During the most recently completed fiscal quarter, there was no change made in the Company’s internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
26 U.S. Bancorp


Table of Contents

(This page intentionally left blank)
U.S. Bancorp 27


Table of Contents

U.S. Bancorp
Consolidated Balance Sheet
                       
    June 30,   December 31,
(Dollars in Millions)   2006   2005
 
    (Unaudited)    
Assets
               
Cash and due from banks
    $7,234       $8,004  
Investment securities
               
 
Held-to-maturity (fair value $101 and $113, respectively)
    98       109  
 
Available-for-sale
    38,364       39,659  
Loans held for sale
    2,589       1,686  
Loans
               
 
Commercial
    45,369       42,942  
 
Commercial real estate
    28,562       28,463  
 
Residential mortgages
    21,063       20,730  
 
Retail
    46,388       45,671  
     
   
Total loans
    141,382       137,806  
     
Less allowance for loan losses
    (2,039 )     (2,041 )
     
     
Net loans
    139,343       135,765  
Premises and equipment
    1,817       1,841  
Goodwill
    7,283       7,005  
Other intangible assets
    3,158       2,874  
Other assets
    13,519       12,522  
     
   
Total assets
    $213,405       $209,465  
     
Liabilities and Shareholders’ Equity
               
Deposits
               
 
Noninterest-bearing
    $30,730       $32,214  
 
Interest-bearing
    69,302       70,024  
 
Time deposits greater than $100,000
    22,687       22,471  
     
   
Total deposits
    122,719       124,709  
Short-term borrowings
    20,570       20,200  
Long-term debt
    41,952       37,069  
Other liabilities
    7,749       7,401  
     
   
Total liabilities
    192,990       189,379  
Shareholders’ equity
               
 
Preferred stock, par value $1.00 a share (liquidation preference of $25,000 per share) authorized: 50,000,000 shares;
issued and outstanding: 6/30/06 — 40,000 shares
    1,000        
 
Common stock, par value $0.01 a share — authorized: 4,000,000,000 shares;
issued: 6/30/06 and 12/31/05 — 1,972,643,007 shares
    20       20  
 
Capital surplus
    5,789       5,907  
 
Retained earnings
    20,164       19,001  
 
Less cost of common stock in treasury: 6/30/06 — 189,672,491 shares; 12/31/05 — 157,689,004 shares
    (5,421 )     (4,413 )
 
Other comprehensive income
    (1,137 )     (429 )
     
   
Total shareholders’ equity
    20,415       20,086  
     
   
Total liabilities and shareholders’ equity
    $213,405       $209,465  
 
See Notes to Consolidated Financial Statements.
28 U.S. Bancorp


Table of Contents

U.S. Bancorp
Consolidated Statement of Income
                                 
    Three Months Ended   Six Months Ended
    June 30,   June 30,
(Dollars and Shares in Millions, Except Per Share Data)    
(Unaudited)   2006   2005   2006   2005
 
Interest Income
                               
Loans
    $2,449       $2,027       $4,781       $3,938  
Loans held for sale
    33       24       59       45  
Investment securities
    500       486       990       962  
Other interest income
    36       28       79       55  
     
        Total interest income
    3,018       2,565       5,909       5,000  
Interest Expense
                               
Deposits
    578       361       1,081       669  
Short-term borrowings
    270       143       540       255  
Long-term debt
    484       307       887       578  
     
        Total interest expense
    1,332       811       2,508       1,502  
     
Net interest income
    1,686       1,754       3,401       3,498  
Provision for credit losses
    125       144       240       316  
     
Net interest income after provision for credit losses
    1,561       1,610       3,161       3,182  
Noninterest Income
                               
Credit and debit card revenue
    202       177       384       331  
Corporate payment products revenue
    139       120       266       227  
ATM processing services
    61       57       120       104  
Merchant processing services
    253       198       466       376  
Trust and investment management fees
    314       253       611       500  
Deposit service charges
    264       234       496       444  
Treasury management fees
    116       117       223       224  
Commercial products revenue
    107       100       211       196  
Mortgage banking revenue
    75       110       99       212  
Investment products fees and commissions
    42       39       80       78  
Securities gains (losses), net
    3       1       3       (58 )
Other
    179       135       410       289  
     
        Total noninterest income
    1,755       1,541       3,369       2,923  
Noninterest Expense
                               
Compensation
    627       612       1,260       1,179  
Employee benefits
    123       108       256       224  
Net occupancy and equipment
    161       159       326       313  
Professional services
    41       39       76       75  
Marketing and business development
    58       67       98       110  
Technology and communications
    127       113       244       219  
Postage, printing and supplies
    66       63       132       126  
Other intangibles
    89       181       174       252  
Debt prepayment
    11       54       11       54  
Other
    227       199       453       374  
     
        Total noninterest expense
    1,530       1,595       3,030       2,926  
     
Income before income taxes
    1,786       1,556       3,500       3,179  
Applicable income taxes
    585       435       1,146       987  
     
Net income
    $1,201       $1,121       $2,354       $2,192  
     
Net income applicable to common equity
    $1,184       $1,121       $2,337       $2,192  
     
Earnings per common share
    $.66       $.61       $1.30       $1.19  
Diluted earnings per common share
    $.66       $.60       $1.29       $1.17  
Dividends declared per common share
    $.33       $.30       $.66       $.60  
Average common shares outstanding
    1,781       1,833       1,791       1,842  
Average diluted common shares outstanding
    1,805       1,857       1,816       1,869  
 
See Notes to Consolidated Financial Statements.
U.S. Bancorp 29


Table of Contents

U.S. Bancorp
Consolidated Statement of Shareholders’ Equity
                                                                   
                            Other   Total
(Dollars and Shares in Millions)   Common Shares   Preferred   Common   Capital   Retained   Treasury   Comprehensive   Shareholders’
(Unaudited)   Outstanding   Stock   Stock   Surplus   Earnings   Stock   Income   Equity
 
Balance December 31, 2004
    1,858       $—       $20       $5,902       $16,758       $(3,125 )     $(16 )     $19,539  
Net income
                                    2,192                       2,192  
Unrealized gain on securities available for sale
                                                    246       246  
Unrealized loss on derivatives
                                                    (56 )     (56 )
Foreign currency translation adjustment
                                                    3       3  
Realized loss on derivatives
                                                    (90 )     (90 )
Reclassification adjustment for losses
realized in net income
                                                    104       104  
Income taxes
                                                    (78 )     (78 )
                                                 
          Total comprehensive income
                                                            2,321  
Cash dividends declared on common stock
                                    (1,101 )                     (1,101 )
Issuance of common and treasury stock
    9                       (51 )             236               185  
Purchase of treasury stock
    (38 )                                     (1,092 )             (1,092 )
Stock option and restricted stock grants
                            51                               51  
Shares reserved to meet deferred compensation obligations
                            1               (3 )             (2 )
     
Balance June 30, 2005
    1,829       $—       $20       $5,903       $17,849       $(3,984 )     $113       $19,901  
 
Balance December 31, 2005
    1,815       $—       $20       $5,907       $19,001       $(4,413 )     $(429 )     $20,086  
Change in accounting principle
                                    4                       4  
Net income
                                    2,354                       2,354  
Unrealized loss on securities available for sale
                                                    (1,105 )     (1,105 )
Unrealized gain on derivatives
                                                    153       153  
Foreign currency translation adjustment
                                                    4       4  
Realized loss on derivatives
                                                    (199 )     (199 )
Reclassification adjustment for losses
realized in net income
                                                    6       6  
Income taxes
                                                    433       433  
                                                 
          Total comprehensive income
                                                            1,646  
Cash dividends declared:
                                                               
 
Preferred
                                    (17 )                     (17 )
 
Common
                                    (1,178 )                     (1,178 )
Issuance of common and treasury stock
    18                       (79 )             533               454  
Purchase of treasury stock
    (50 )                                     (1,538 )             (1,538 )
Stock option and restricted stock grants
                            12                               12  
Shares reserved to meet deferred compensation obligations
                            1               (3 )             (2 )
Issuance of preferred stock
            1,000               (52 )                             948  
     
Balance June 30, 2006
    1,783       $1,000       $20       $5,789       $20,164       $(5,421 )     $(1,137 )     $20,415  
 
See Notes to Consolidated Financial Statements.
30 U.S. Bancorp


Table of Contents

U.S. Bancorp
Consolidated Statement of Cash Flows
                   
    Six Months Ended
    June 30,
(Dollars in Millions)    
(Unaudited)   2006   2005
 
Operating Activities
               
 
Net cash provided by operating activities
    $1,861       $1,813  
Investing Activities
               
Proceeds from sales of available-for-sale investment securities
    859       2,992  
Proceeds from maturities of investment securities
    2,573       5,011  
Purchases of investment securities
    (3,649 )     (7,637 )
Net (increase) decrease in loans outstanding
    (3,217 )     (6,182 )
Proceeds from sales of loans
    1,089       849  
Purchases of loans
    (1,563 )     (1,814 )
Other, net
    (736 )     (1,394 )
     
 
Net cash used in investing activities
    (4,644 )     (8,175 )
Financing Activities
               
Net increase (decrease) in deposits
    (1,990 )     1,082  
Net increase (decrease) in short-term borrowings
    370       7,350  
Principal payments or redemption of long-term debt
    (2,384 )     (6,472 )
Proceeds from issuance of long-term debt
    7,538       6,558  
Proceeds from issuance of preferred stock
    948        
Proceeds from issuance of common stock
    383       153  
Repurchase of common stock
    (1,528 )     (1,149 )
Cash dividends paid on common stock
    (1,188 )     (1,111 )
     
 
Net cash provided by financing activities
    2,149       6,411  
     
 
Change in cash and cash equivalents
    (634 )     49  
Cash and cash equivalents at beginning of period
    8,202       6,537  
     
 
Cash and cash equivalents at end of period
    $7,568       $6,586  
 
See Notes to Consolidated Financial Statements.
U.S. Bancorp 31


Table of Contents

Notes to Consolidated Financial Statements
(Unaudited)
Note 1 Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and notes necessary for a complete presentation of financial position, results of operations and cash flow activity required in accordance with accounting principles generally accepted in the United States. In the opinion of management of U.S. Bancorp (the “Company”), all adjustments (consisting only of normal recurring adjustments) necessary for a fair statement of results for the interim periods have been made. For further information, refer to the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. Certain amounts in prior periods have been reclassified to conform to the current presentation.
     Accounting policies for the lines of business are generally the same as those used in preparation of the consolidated financial statements with respect to activities specifically attributable to each business line. However, the preparation of business line results requires management to establish methodologies to allocate funding costs and benefits, expenses and other financial elements to each line of business. Table 11 “Line of Business Financial Performance” provides details of segment results. This information is incorporated by reference into these Notes to Consolidated Financial Statements.
Note 2 Accounting Changes
Accounting for Servicing of Financial Assets In March 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 156, “Accounting for Servicing of Financial Assets” (“SFAS 156”), that amends accounting and reporting standards for servicing assets and liabilities under Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. Specifically, SFAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. For subsequent measurement purposes, SFAS 156 permits an entity to choose to measure servicing assets and liabilities either based on fair value or lower of cost or market (“LOCOM”). The Company elected to adopt SFAS 156 effective January 1, 2006, utilizing the fair value measurement option for residential mortgage servicing rights (“MSRs”) and continuing the LOCOM method for all other servicing assets and liabilities. Adopting the fair value measurement method resulted in the Company recording a cumulative-effect accounting adjustment to increase beginning retained earnings by $4 million (net of tax). Approximately $3 million represented the difference between the fair value and the carrying amount of the Company’s MSRs as of January 1, 2006, and the additional $1 million represented the reclassification of unrealized gains in accumulated other comprehensive income at adoption, for certain available-for-sale securities reclassified to trading securities upon the adoption of the provisions of this statement. Additional information regarding MSRs is disclosed in Note 5 in the Notes to Consolidated Financial Statements.
Other-Than-Temporary Impairment In November 2005, the FASB issued FASB Staff Position FAS 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP 115-1”), effective for the Company beginning on January 1, 2006. FSP 115-1 provides clarification on when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. FSP 115-1 also requires certain disclosures for unrealized losses that have not been recognized as other-than-temporary impairments. The adoption of FSP 115-1 did not have a material impact on the Company’s financial statements.
Stock-Based Compensation In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004) (“SFAS 123R”), “Share-Based Payment”, a revision of Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation.” SFAS 123R requires companies to measure the cost of employee services in exchange for an award of equity instruments based on the grant-date fair value of the award. This statement eliminates the use of the alternative intrinsic value method of accounting that was allowed when SFAS 123 was originally issued. The provisions of this statement were effective for the Company beginning on January 1, 2006. The Company adopted SFAS 123R using the modified retrospective method. Because the Company retroactively adopted the fair value method in 2003, the impact of expensing stock-based awards was
32 U.S. Bancorp


Table of Contents

already recorded in the Company’s financial results. In conjunction with the adoption of SFAS 123R, the Company recognized $13 million of incremental stock-based compensation expense due to certain provisions that require immediate recognition of the value of stock awards to employees that meet retirement status, despite their continued active employment. Upon adoption, the Company also changed its method of expensing all new awards from an accelerated to a straight-line attribution method. This methodology change for expensing stock awards is expected to reduce expenses in 2006 by approximately $33 million ($20 million after tax).
Accounting for Uncertainty in Income Taxes In June 2006, the FASB issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes,” effective for the Company beginning on January 1, 2007. FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company is currently assessing the impact of this guidance on its financial statements.
Note 3 Investment Securities
The detail of the amortized cost, gross unrealized holding gains and losses, and fair value of held-to-maturity and available-for-sale securities was as follows:
                                                                     
    June 30, 2006   December 31, 2005
     
    Amortized   Unrealized   Unrealized   Fair   Amortized   Unrealized   Unrealized   Fair
(Dollars in Millions)   Cost   Gains   Losses   Value   Cost   Gains   Losses   Value
 
Held-to-maturity (a)
                                                               
 
Mortgage-backed securities
    $8       $—       $—       $8       $8       $—       $—       $8  
 
Obligations of state and political subdivisions
    73       4       (1 )     76       84       5       (1 )     88  
 
Other debt securities
    17                   17       17                   17  
     
 
     Total held-to-maturity securities
    $98       $4       $(1 )     $101       $109       $5       $(1 )     $113  
 
Available-for-sale (b)
                                                               
 
U.S. Treasury and agencies
    $508       $1       $(15 )     $494       $496       $2       $(9 )     $489  
 
Mortgage-backed securities
  35,853       48       (1,738 )     34,163       38,161       86       (733 )     37,514  
 
Asset-backed securities
    8                   8       12                   12  
 
Obligations of state and political subdivisions
    2,801       1       (64 )     2,738       640       3       (6 )     637  
 
Other securities and investments
    961       5       (5 )     961       1,012       2       (7 )     1,007  
     
 
       Total available-for-sale securities
    $40,131       $55       $(1,822 )     $38,364       $40,321       $93       $(755 )     $39,659  
 
(a) Held-to-maturity securities are carried at historical cost adjusted for amortization of premiums and accretion of discounts.
(b) Available-for-sale securities are carried at fair value with unrealized net gains or losses reported within other comprehensive income in shareholders’ equity.
     The weighted-average maturity of the available-for-sale investment securities was 7.4 years at June 30, 2006, compared with 6.1 years at December 31, 2005. The corresponding weighted-average yields were 5.17 percent and 4.89 percent, respectively. The weighted-average maturity of the held-to-maturity investment securities was 8.4 years at June 30, 2006, compared with 7.2 years at December 31, 2005. The corresponding weighted-average yields were 6.37 percent and 6.44 percent, respectively.
     Securities carried at $33.9 billion at June 30, 2006, and $36.9 billion at December 31, 2005, were pledged to secure public, private and trust deposits, repurchase agreements and for other purposes required by law. Securities sold under agreements to repurchase, where the buyer/lender has the right to sell or pledge the securities, were collateralized by securities with an amortized cost of $6.7 billion at June 30, 2006, and $10.9 billion at December 31, 2005, respectively.
The following table provides information as to the amount of interest income from taxable and non-taxable investment securities:
                                   
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
(Dollars in Millions)   2006   2005   2006   2005
 
Taxable
    $475       $482       $951       $955  
Non-taxable
    25       4       39       7  
     
       Total interest income from investment securities
    $500       $486       $990       $962  
 
U.S. Bancorp 33


Table of Contents

The following table provides information as to the amount of gross gains and losses realized through the sales of available-for-sale investment securities:
                                 
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
(Dollars in Millions)   2006   2005   2006   2005
 
Realized gains
    $4       $1       $4       $12  
Realized losses
    (1 )           (1 )     (70 )
     
Net realized gains (losses)
    $3       $1       $3       $(58 )
     
Income tax (benefit) on realized gains (losses)
    $1       $—       $1       $(22 )
 
     For amortized cost, fair value and yield by maturity date of held-to-maturity and available-for-sale securities outstanding at June 30, 2006, refer to Table 4 included in Management’s Discussion and Analysis which is incorporated by reference into these Notes to Consolidated Financial Statements.
     The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired which have been in a continuous unrealized loss position at June 30, 2006:
                                                     
    Less Than 12 Months   12 Months or Greater   Total
     
    Fair   Unrealized   Fair   Unrealized   Fair   Unrealized
(Dollars in Millions)   Value   Losses   Value   Losses   Value   Losses
 
Held-to-maturity
                                               
 
Mortgage-backed securities
    $—       $—       $—       $—       $—       $—  
 
Obligations of state and political subdivisions
    16       (1 )     2             18       (1 )
 
Other debt securities
                                   
     
 
Total
    $16       $(1 )     $2       $—       $18       $(1 )
 
Available-for-sale
                                               
 
U.S. Treasury and agencies
    $447       $(15 )     $5       $—       $452       $(15 )
 
Mortgage-backed securities
    15,938       (768 )     15,149       (970 )     31,087       (1,738 )
 
Asset-backed securities
    8                         8        
 
Obligations of state and political subdivisions
    2,615       (63 )     28       (1 )     2,643       (64 )
 
Other securities and investments
    86             312       (5 )     398       (5 )
     
 
Total
    $19,094       $(846 )     $15,494       $(976 )     $34,588       $(1,822 )
 
     The Company’s rationale, by investment category, for determining if investments with unrealized losses that are not deemed to be other-than-temporarily impaired at June 30, 2006, was as follows:
Held-to-Maturity
Obligations of state and political subdivisions During the second quarter of 2006, the Company recorded an impairment of $1 million on a municipal security with a balance of $2 million as it was determined that the revenues supporting the security may not be sufficient to make all contractual principal and interest payments. The remaining unrealized losses were caused by increases in interest rates. The issuers of these securities do not have the contractual ability to pay off these securities at less than par. The Company has the ability and intent to hold these investments until maturity which is consistent with their designation as held-to-maturity. Consequently, the Company does not consider these investments to be other-than-temporarily impaired as of June 30, 2006.
Available-for-Sale
U.S. Treasury and agencies The unrealized losses on these securities were caused solely by rising interest rates since credit quality is not an issue for these types of securities. None of these securities can be paid off for less than par at maturity or any earlier call date. Because the Company has the ability and intent to hold these securities until a recovery to adjusted book value, they are not considered to be other-than-temporarily impaired as of June 30, 2006.
Mortgage-backed securities Substantially all of these securities were issued by GNMA, FNMA and FHLMC, and the remainder were privately issued with high investment grade credit ratings. The unrealized losses for these securities were caused by rising interest rates over the past few years. Given the high credit quality of these investments, the Company fully expects to receive all contractual cash flows. Because the Company has the ability and intent to hold
34 U.S. Bancorp


Table of Contents

these securities until a recovery to adjusted book value, they are not considered to be other-than-temporarily impaired as of June 30, 2006.
Obligations of state and political subdivisions The unrealized losses were caused by rising interest rates. These municipal securities are investment grade credit quality with substantially all rated AAA. None of these securities can be paid off for less than par at maturity or any earlier call date. Because the Company has the ability and intent to hold these securities until a recovery to adjusted book value, they are not considered to be other-than-temporarily impaired as of June 30, 2006.
Other securities and investments The securities in this category consist primarily of debt issued by major U.S. banks. The losses are a result of a modest widening of credit spreads since the initial purchase dates. Given the high credit quality of these issuers, the Company expects to receive all contractual cash flows. None of these securities can be paid off for less than par at maturity or any earlier call date. Because the Company has the ability and intent to hold these securities until a recovery to adjusted book value, they are not considered to be other-than-temporarily impaired as of June 30, 2006.
Note 4 Loans
The composition of the loan portfolio was as follows:
                                       
    June 30, 2006   December 31, 2005
     
        Percent       Percent
(Dollars in Millions)   Amount   of Total   Amount   of Total
 
Commercial
                               
 
Commercial
    $40,055       28.3 %     $37,844       27.5 %
 
Lease financing
    5,314       3.8       5,098       3.7  
     
   
Total commercial
    45,369       32.1       42,942       31.2  
Commercial real estate
                               
 
Commercial mortgages
    19,966       14.1       20,272       14.7  
 
Construction and development
    8,596       6.1       8,191       6.0  
     
   
Total commercial real estate
    28,562       20.2       28,463       20.7  
Residential mortgages
                               
 
Residential mortgages
    14,902       10.5       14,538       10.5  
 
Home equity loans, first liens
    6,161       4.4       6,192       4.5  
     
   
Total residential mortgages
    21,063       14.9       20,730       15.0  
Retail
                               
 
Credit card
    7,432       5.3       7,137       5.2  
 
Retail leasing
    7,092       5.0       7,338       5.3  
 
Home equity and second mortgages
    15,124       10.7       14,979       10.9  
 
Other retail
                               
   
Revolving credit
    2,505       1.8       2,504       1.8  
   
Installment
    4,090       2.9       3,582       2.6  
   
Automobile
    8,257       5.8       8,112       5.9  
   
Student
    1,888       1.3       2,019       1.4  
     
     
Total other retail
    16,740       11.8       16,217       11.7  
     
   
Total retail
    46,388       32.8       45,671       33.1  
     
     
Total loans
    $141,382       100.0 %     $137,806       100.0 %
 
Loans are presented net of unearned interest and deferred fees and costs, which amounted to $1.3 billion at June 30, 2006, and December 31, 2005.
U.S. Bancorp 35


Table of Contents

Note 5 Mortgage Servicing Rights
The Company’s portfolio of residential mortgages serviced for others was $76.4 billion and $69.0 billion at June 30, 2006, and December 31, 2005, respectively. Effective January 1, 2006, the Company early adopted SFAS 156 and elected the fair value measurement method for MSRs. The fair value measurement method requires MSRs to be recorded initially at fair value, if practicable, and at each subsequent reporting date. In accordance with SFAS 156 the changes in fair value are to be recorded in earnings in the period in which they occur. Prior to the adoption of SFAS 156, the initial carrying value of MSRs was amortized in proportion to, and over the period of, estimated net servicing revenue and recorded in noninterest expense as amortization of intangible assets.
     Beginning in March 2006, the Company began entering into U.S. Treasury futures and options on U.S. Treasury futures contracts to offset the change in fair value of the MSRs. Changes in fair value related to the MSRs and the futures and options contracts, as well as, servicing and other related fees are recorded in mortgage banking revenue. The Company recorded $80 million and $156 million of servicing and other related fees revenue in the second quarter and first six months of 2006, respectively. Changes in fair value of capitalized MSRs are summarized as follows:
                     
    Three Months Ended   Six Months Ended
(Dollars in Millions)   June 30, 2006   June 30, 2006
 
Balance at beginning of period
    $1,228       $1,123  
 
Rights purchased
    1       47  
 
Rights capitalized
    99       170  
 
Changes in fair value of MSRs:
               
   
Due to change in valuation assumptions (a)
    38       71  
   
Other changes in fair value (b)
    (43 )     (88 )
     
Balance at end of period
    $1,323       $1,323  
 
(a) Principally reflects changes in discount rates and prepayment speed assumptions, primarily arising from interest rate changes.
(b) Primarily represents changes due to collection/realization of expected cash flows over time.
     The Company determines fair value by estimating the present value of the asset’s future cash flows utilizing market-based prepayment rates, discount rates, and other assumptions validated through comparison to trade information, industry surveys, and independent third party appraisals. Risks inherent in the MSRs valuation include higher than expected prepayment rates and/or delayed receipt of cash flows. In March 2006, the Company implemented a program utilizing futures and options contracts to mitigate the valuation risk. The estimated sensitivity to changes in interest rates of the fair value of the MSRs portfolio and the related derivative instruments at June 30, 2006, was as follows:
                                 
    Down Scenario   Up Scenario
     
(Dollars in Millions)   50 bps   25 bps   25 bps   50 bps
 
Net fair value
    $(22 )     $(6 )     $(2 )     $(15 )
 
     The fair value of MSRs and its sensitivity to changes in interest rates is influenced by the mix of the servicing portfolio and characteristics of each segment of the portfolio. The Company’s servicing portfolio consists of the distinct portfolios of Mortgage Revenue Bond Programs (“MRBP”), government-insured mortgages and conventional mortgages. The MRBP division specializes in servicing loans made under state and local housing authority programs. These programs provide mortgages to low-income and moderate-income borrowers and are generally government-insured programs with a favorable rate subsidy, down payment and/or closing cost assistance. Mortgage loans originated as part of government agency and state loan programs tend to experience slower prepayment speeds and better cash flows than conventional mortgage loans. The servicing portfolios are predominantly comprised of fixed-rate agency loans (FNMA, FHLMC, GNMA, FHLB and various housing agencies) with limited adjustable-rate or jumbo mortgage loans.
36 U.S. Bancorp


Table of Contents

A summary of the Company’s MSRs and related characteristics by portfolio as of June 30, 2006, was as follows:
                                 
(Dollars in Millions)   MRBP   Government   Conventional   Total
 
Servicing portfolio
    $7,034       $8,603       $60,738       $76,375  
Fair market value
    $138       $163       $1,022       $1,323  
Value (bps)*
    196       189       168       173  
Weighted-average servicing fees (bps)
    41       44       35       37  
Multiple (value/servicing fees)
    4.78       4.30       4.80       4.68  
Weighted-average note rate
    5.94 %     6.07 %     5.77 %     5.82 %
Age (in years)
    3.6       2.9       2.3       2.5  
Expected life (in years)
    7.8       7.3       7.9       7.8  
Discount rate
    11.5 %     11.3 %     10.6 %     10.8 %
 
* Value is calculated as fair market value divided by the servicing portfolio.
Note 6 Earnings Per Common Share
The components of earnings per common share were:
                                 
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
(Dollars and Shares in Millions, Except Per Share Data)   2006   2005   2006   2005
 
Net income
    $1,201       $1,121       $2,354       $2,192  
Preferred dividends
    (17 )           (17 )      
     
Net income applicable to common equity
    $1,184       $1,121       $2,337       $2,192  
Average common shares outstanding
    1,781       1,833       1,791       1,842  
Net effect of the assumed purchase of stock based on the treasury stock method for options and
stock plans
    24       24       25       27  
     
Average diluted common shares outstanding
    1,805       1,857       1,816       1,869  
     
Earnings per common share
    $.66       $.61       $1.30       $1.19  
Diluted earnings per common share
    $.66       $.60       $1.29       $1.17  
 
Options to purchase 4 million and 38 million common shares for the three months ended June 30, 2006 and 2005, respectively, and 4 million and 17 million common shares for the six months ended June 30, 2006 and 2005, respectively, were outstanding but not included in the computation of diluted earnings per common share because they were antidilutive.
Note 7 Employee Benefits
The components of net periodic benefit cost (income) for the Company’s retirement plans were:
                                                                   
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
        Post Retirement       Post Retirement
    Pension Plans   Medical Plans   Pension Plans   Medical Plans
     
(Dollars in Millions)   2006   2005   2006   2005   2006   2005   2006   2005
 
Components of net periodic benefit cost (income)
                                                               
 
Service cost
    $18       $16       $1       $1       $36       $32       $2       $2  
 
Interest cost
    29       28       4       4       59       56       7       8  
 
Expected return on plan assets
    (47 )     (48 )           (1 )     (95 )     (97 )           (1 )
 
Net amortization and deferral
    (1 )     (1 )                 (3 )     (3 )            
 
Recognized actuarial loss
    22       14             1       45       29             1  
     
Net periodic benefit cost (income)
    $21       $9       $5       $5       $42       $17       $9       $10  
 
U.S. Bancorp 37


Table of Contents

Note 8 Stock-based Compensation
As part of its employee and director compensation programs, the Company may grant certain stock awards under the provisions of the existing stock compensation plans, including plans assumed in acquisitions. The plans provide for grants of options to purchase shares of common stock at a fixed price equal to the fair value of the underlying stock at the date of grant. Option grants are generally exercisable up to ten years from the date of grant. In addition, the plans provide for grants of shares of common stock or stock units that are subject to restriction on transfer prior to vesting. Most stock awards vest over three to five years and are subject to forfeiture if certain vesting requirements are not met. At June 30, 2006, there were 13 million shares (subject to adjustment for forfeitures) available for grant under various plans.
The following is a summary of stock options outstanding and exercised under various stock options plans of the Company:
                                                                   
    2006   2005
     
        Weighted-       Weighted-    
        Weighted-   Average   Aggregate       Weighted-   Average   Aggregate
        Average   Remaining   Intrinsic       Average   Remaining   Intrinsic
    Stock   Exercise   Contractual   Value   Stock   Exercise   Contractual   Value
Three Months Ended June 30,   Options/Shares   Price   Term   (in millions)   Options/Shares   Price   Term   (in millions)
 
Stock option plans
                                                               
Number outstanding at beginning of period
    128,459,228       $25.08                       140,842,422       $24.03                  
 
Granted
    678,767       31.16                       909,032       29.13                  
 
Exercised
    (9,440,942 )     22.52                       (3,131,672 )     20.70                  
 
Cancelled (a)
    (982,713 )     27.52                       (639,170 )     24.44                  
     
Number outstanding at end of period (b)
    118,714,340       $25.30       5.2       $663       137,980,612       $24.14       5.5       $930  
Exercisable at end of period
    88,362,876       $24.32       4.0       $580       100,363,009       $23.74       4.6       $717  
 
                                                                   
    2006   2005
     
        Weighted-       Weighted-    
        Weighted-   Average   Aggregate       Weighted-   Average   Aggregate
        Average   Remaining   Intrinsic       Average   Remaining   Intrinsic
    Stock   Exercise   Contractual   Value   Stock   Exercise   Contractual   Value
Six Months Ended June 30,   Options/Shares   Price   Term   (in millions)   Options/Shares   Price   Term   (in millions)
 
Stock option plans
                                                               
Number outstanding at beginning of period
    125,983,461       $24.38                       134,727,285       $23.41                  
 
Granted
    12,000,109       30.05                       12,191,833       30.15                  
 
Exercised
    (17,801,534 )     21.82                       (7,397,036 )     20.72                  
 
Cancelled (a)
    (1,467,696 )     27.41                       (1,541,470 )     24.46                  
     
Number outstanding at end of period (b)
    118,714,340       $25.30       5.2       $663       137,980,612       $24.14       5.5       $930  
Exercisable at end of period
    88,362,876       $24.32       4.0       $580       100,363,009       $23.74       4.6       $717  
 
(a) Options cancelled includes both non-vested (i.e., forfeitures) and vested options.
(b) Outstanding options include stock-based awards that may be forfeited in future periods, however the impact of the estimated forfeitures is reflected in compensation expense.
     The weighted-average grant-date fair value of options granted was $6.00 and $6.35 for the three months ended June 30, 2006 and 2005, respectively, and was $6.32 and $6.68 for the six months ended June 30, 2006 and 2005, respectively. The total intrinsic value of options exercised was $82 million and $27 million for the three months ended June 30, 2006 and 2005, respectively, and was $162 million and $68 million for the six months ended June 30, 2006 and 2005, respectively. The total fair value of option shares vested was $9 million and $8 million for the three months ended June 30, 2006 and 2005, respectively, and was $49 million and $53 million for the six months ended June 30, 2006 and 2005, respectively.
     Cash received from option exercises under all share-based payment arrangements was $212 million and $65 million for the three months ended June 30, 2006 and 2005, respectively, and was $388 million and $153 million for the six months ended June 30, 2006 and 2005, respectively. The tax benefit realized for the tax deductions from option exercises of the share-based payment arrangements totaled $31 million and $10 million for the three months ended June 30, 2006 and 2005, respectively, and totaled $61 million and $25 million for the six
38 U.S. Bancorp


Table of Contents

months ended June 30, 2006 and 2005, respectively. To satisfy share option exercises, the Company predominantly uses treasury stock.
The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model, requiring the use of subjective assumptions. The following table includes the assumptions utilized by the Company:
                                 
    Three Months Ended   Six Months Ended
    June 30,   June 30,
     
    2006   2005   2006   2005
 
Risk-free interest rate
    4.3 %     3.6 %     4.3 %     3.6 %
Dividend yield
    4.0 %     3.5 %     4.0 %     3.5 %
Stock volatility factor
    .28       .29       .28       .29  
Expected life of options (in years)
    5.4       5.4       5.4       5.4  
 
     Expected stock volatility is based on several factors including the historical volatility of the Company’s stock, implied volatility determined from traded options and other factors. The Company uses historical data to estimate option exercises and employee terminations to estimate the expected life of options. The risk-free interest rate for the expected life of the options is based on the U.S. Treasury yield curve in effect on the date of grant. The expected dividend yield is based on the Company’s expected dividend yield over the life of the options.
Additional information regarding stock options outstanding as of June 30, 2006, is as follows:
                                         
    Options Outstanding   Exercisable Options
     
        Weighted-    
        Average   Weighted-       Weighted-
        Remaining   Average       Average
        Contractual   Exercise       Exercise
Range of Exercise Prices   Shares   Life (Years)   Price   Shares   Price
 
$5.05 - $10.00
    31,469       .7       $8.05       31,469       $8.05  
$10.01 - $15.00
    739,936       2.3       12.14       739,936       12.14  
$15.01 - $20.00
    16,047,010       4.7       18.80       15,745,797       18.79  
$20.01 - $25.00
    44,171,250       4.7       22.35       38,473,296       22.47  
$25.01 - $30.00
    42,701,863       5.4       29.02       26,756,634       28.71  
$30.01 - $35.00
    14,746,285       6.6       30.93       6,339,217       31.74  
$35.01 - $36.95
    276,527       .9       35.89       276,527       35.89  
     
      118,714,340       5.2       $25.30       88,362,876       $24.32  
 
A summary of the status of the Company’s restricted shares of stock is presented below:
                                                                   
    Three Months Ended June 30,   Six Months Ended June 30,
     
    2006   2005   2006   2005
     
        Weighted-       Weighted-       Weighted-       Weighted-
        Average       Average       Average       Average
        Grant-       Grant-       Grant-       Grant-
        Date       Date       Date       Date
    Shares   Fair Value   Shares   Fair Value   Shares   Fair Value   Shares   Fair Value
 
Nonvested shares
                                                               
Number outstanding at beginning of period
    3,037,250       $27.26       2,817,001       $26.45       2,644,171       $26.73       2,265,625       $25.06  
 
Granted
    138,758       31.04       82,276       29.14       990,250       30.13       990,618       30.04  
 
Cancelled/vested
    (57,189 )     26.33       (50,540 )     26.62       (480,581 )     28.89       (385,956 )     26.78  
 
Forfeited
    (100,505 )     29.19       (22,321 )     29.27       (135,526 )     29.25       (43,871 )     29.04  
     
Number outstanding at end of period
    3,018,314       $27.39