USB

U.S. Bancorp 10-Q Summary: Period Ended June 30, 2007

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2007, and the first six months of 2007 for U.S. Bancorp, a Delaware corporation headquartered in Minneapolis, Minnesota. The Company operates as a large accelerated filer and is a major financial services provider offering wholesale banking, consumer banking, wealth management, and payment services.

Key Financial Metrics

Material Changes vs. Prior Period

• Net Income Decline: Net income decreased 3.7% in Q2 and 2.9% YTD compared to the prior year. This was driven by a 52.8% increase in the provision for credit losses and a decline in net interest income, which offset growth in noninterest income.
• Credit Costs: The provision for credit losses rose significantly ($66 million in Q2) due to strong growth in credit card accounts and the expiration of favorable impacts from 2005 bankruptcy law changes. Net charge-offs increased to $191 million in Q2 from $125 million in Q2 2006.
• Net Interest Margin Compression: The net interest margin declined to 3.44% in Q2 from 3.68% a year ago. This was caused by a competitive environment, a flat yield curve, and higher funding costs as rates on interest-bearing deposits increased.
• Expense Growth: Noninterest expenses increased 7.2% in Q2, primarily due to investments in business initiatives, integration costs from recent acquisitions, and higher merchant airline processing costs.
• Balance Sheet: Total assets grew 4.5% to $222.5 billion. Loans increased 4.5% to $145.7 billion, while total deposits decreased 4.1% to $119.7 billion. Long-term debt increased 22.2% to $45.9 billion to support asset growth.

Guidance, Outlook, and Risks

• Outlook: Management anticipates the net interest margin to remain relatively stable for the remainder of the year. Nonperforming assets are expected to increase modestly over the next several quarters.
• Credit Risk: The Company expects commercial and commercial real estate net charge-offs to continue to increase somewhat. Retail loan net charge-offs are also expected to increase modestly due to bankruptcy legislation impacts and minimum balance payment requirements.
• Interest Rate Risk: The Company's interest rate risk position is liability sensitive. Under a 200 basis point parallel rate shock, the market value of equity would decrease by 9.2% (up scenario) or 0.6% (down scenario), remaining within policy guidelines.
• Capital Management: The Company returned 139% of earnings to shareholders in the first six months of 2007 via dividends and share repurchases. Regulatory capital ratios remain well above "well-capitalized" requirements (Tier 1 capital at 8.5%).
• Forward-Looking Statements: Results may differ materially due to changes in economic conditions, interest rates, legal developments, and the ability to manage credit and market risks.

Investor Verification Checklist

• Credit Quality Trends: Verify the trajectory of net charge-offs in the credit card and consumer finance portfolios, specifically regarding the impact of bankruptcy law changes.
• Net Interest Margin Sustainability: Assess the ability to maintain margins given the flat yield curve and rising cost of funds.
• Sub-prime Exposure: Review the specific exposure to sub-prime borrowers ($3.2 billion in residential and $0.9 billion in home equity loans) and associated delinquency rates.
• Expense Control: Monitor the efficiency ratio and the impact of integration costs from recent acquisitions on future profitability.
• Liquidity and Funding: Evaluate the reliance on wholesale funding (long-term debt increased significantly) versus core deposits, which declined.