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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

þ  

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

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2016

OR

 

¨  

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   41-0255900

(State or other jurisdiction of

incorporation or organization)

 

(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 ¨

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

YES þ    NO ¨

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

 

Large accelerated filer þ    Accelerated filer ¨

Non-accelerated filer ¨

(Do not check if a smaller reporting company)

   Smaller reporting company ¨

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

YES ¨    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   Outstanding as of October 31, 2016
Common Stock, $0.01 Par Value   1,699,676,375 shares

 

 

 


Table of Contents

Table of Contents and Form 10-Q Cross Reference Index

 

Part I — Financial Information

    

1) Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 2)

       3   

a) Overview

       3   

b) Statement of Income Analysis

       4   

c) Balance Sheet Analysis

       6   

d) Non-GAAP Financial Measures

       33   

e) Critical Accounting Policies

       35   

f) Controls and Procedures (Item 4)

       35   

2) Quantitative and Qualitative Disclosures About Market Risk/Corporate Risk Profile (Item 3)

       9   

a) Overview

       9   

b) Credit Risk Management

       10   

c) Residual Value Risk Management

       23   

d) Operational Risk Management

       23   

e) Compliance Risk Management

       23   

f) Interest Rate Risk Management

       23   

g) Market Risk Management

       24   

h) Liquidity Risk Management

       25   

i) Capital Management

       27   

3) Line of Business Financial Review

       28   

4) Financial Statements (Item 1)

       36   

Part II — Other Information

    

1) Legal Proceedings (Item 1)

       81   

2) Risk Factors (Item 1A)

       81   

3) Unregistered Sales of Equity Securities and Use of Proceeds (Item 2)

       81   

4) Exhibits (Item 6)

       81   

5) Signature

       82   

6) Exhibits

       83   

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

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

For discussion of these and other risks that may cause actual results to differ from expectations, refer to U.S. Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2015, on file with the Securities and Exchange Commission, including the sections entitled “Risk Factors” and “Corporate Risk Profile” contained in Exhibit 13, and all subsequent filings with the Securities and Exchange Commission under Sections 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934, including the “Risk Factors” section of U.S. Bancorp’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016. However, factors other than these also could adversely affect U.S. Bancorp’s results, and the reader should not consider these factors to be a complete set of all potential risks or uncertainties. Forward-looking statements speak only as of the date hereof, and U.S. Bancorp 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
September 30,
           Nine Months Ended
September 30,
 
(Dollars and Shares in Millions, Except Per Share Data)   2016     2015     Percent
Change
           2016     2015     Percent
Change
 

Condensed Income Statement

               

Net interest income

  $ 2,893      $ 2,768        4.5       $ 8,573      $ 8,182        4.8

Taxable-equivalent adjustment (a)

    50        53        (5.7         154        161        (4.3

Net interest income (taxable-equivalent basis) (d)

    2,943        2,821        4.3            8,727        8,343        4.6   

Noninterest income

    2,435        2,327        4.6            7,130        6,753        5.6   

Securities gains (losses), net

    10        (1     *            16        (1     *   

Total net revenue

    5,388        5,147        4.7            15,873        15,095        5.2   

Noninterest expense

    2,931        2,775        5.6            8,672        8,122        6.8   

Provision for credit losses

    325        282        15.2            982        827        18.7   

Income before taxes

    2,132        2,090        2.0            6,219        6,146        1.2   

Income taxes and taxable-equivalent adjustment

    616        587        4.9            1,766        1,702        3.8   

Net income

    1,516        1,503        .9            4,453        4,444        .2   

Net (income) loss attributable to noncontrolling interests

    (14     (14                (43     (41     (4.9

Net income attributable to U.S. Bancorp

  $ 1,502      $ 1,489        .9          $ 4,410      $ 4,403        .2   

Net income applicable to U.S. Bancorp common shareholders

  $ 1,434      $ 1,422        .8          $ 4,198      $ 4,204        (.1

Per Common Share

               

Earnings per share

  $ .84      $ .81        3.7       $ 2.44      $ 2.38        2.5

Diluted earnings per share

    .84        .81        3.7            2.43        2.36        3.0   

Dividends declared per share

    .280        .255        9.8            .790        .755        4.6   

Book value per share

    24.78        22.99        7.8             

Market value per share

    42.89        41.01        4.6             

Average common shares outstanding

    1,710        1,758        (2.7         1,724        1,770        (2.6

Average diluted common shares outstanding

    1,716        1,766        (2.8         1,730        1,778        (2.7

Financial Ratios

               

Return on average assets

    1.36     1.44           1.37     1.45  

Return on average common equity

    13.5        14.1              13.4        14.1     

Net interest margin (taxable-equivalent basis) (a)

    2.98        3.04              3.02        3.05     

Efficiency ratio (b)

    54.5        53.9              54.7        53.8     

Net charge-offs as a percent of average loans outstanding

    .46        .46              .48        .47     

Average Balances

               

Loans

  $ 269,637      $ 250,536        7.6       $ 266,179      $ 248,358        7.2

Loans held for sale

    4,691        6,835        (31.4         3,888        6,370        (39.0

Investment securities (c)

    108,109        103,943        4.0            107,095        102,361        4.6   

Earning assets

    393,783        369,265        6.6            385,816        365,543        5.5   

Assets

    437,863        410,439        6.7            429,421        406,757        5.6   

Noninterest-bearing deposits

    82,021        80,940        1.3            79,928        77,623        3.0   

Deposits

    318,548        289,692        10.0            307,312        284,673        8.0   

Short-term borrowings

    15,929        27,525        (42.1         21,457        28,252        (24.1

Long-term debt

    37,875        33,202        14.1            36,392        34,015        7.0   

Total U.S. Bancorp shareholders’ equity

    47,791        44,867        6.5            47,240        44,489        6.2   
 
    September 30,
2016
    December 31,
2015
                               

Period End Balances

               

Loans

  $ 271,289      $ 260,849        4.0          

Investment securities

    110,028        105,587        4.2             

Assets

    454,134        421,853        7.7             

Deposits

    334,595        300,400        11.4             

Long-term debt

    37,978        32,078        18.4             

Total U.S. Bancorp shareholders’ equity

    47,759        46,131        3.5             

Asset Quality

               

Nonperforming assets

  $ 1,664      $ 1,523        9.3          

Allowance for credit losses

    4,338        4,306        .7             

Allowance for credit losses as a percentage of period-end loans

    1.60     1.65            

Capital Ratios

               

Basel III transitional standardized approach:

               

Common equity tier 1 capital

    9.5     9.6            

Tier 1 capital

    11.1        11.3               

Total risk-based capital

    13.3        13.3               

Leverage

    9.2        9.5               

Common equity tier 1 capital to risk-weighted assets for the Basel III transitional advanced approaches

    12.4        12.5               

Common equity tier 1 capital to risk-weighted assets estimated for the Basel III
fully implemented standardized approach (d)

    9.3        9.1               

Common equity tier 1 capital to risk-weighted assets estimated for the Basel III
fully implemented advanced approaches (d)

    12.1        11.9               

Tangible common equity to tangible assets (d)

    7.5        7.6               

Tangible common equity to risk-weighted assets (d)

    9.3        9.2                                           

 

  * Not meaningful
(a) Utilizes a tax rate of 35 percent for those assets and liabilities whose income or expense is not included for federal income tax purposes.
(b) Computed as noninterest expense divided by the sum of net interest income on a taxable-equivalent basis and noninterest income excluding net securities gains (losses).
(c) Excludes unrealized gains and losses on available-for-sale investment securities and any premiums or discounts recorded related to the transfer of investment securities at fair value from available-for-sale to held-to-maturity.
(d) See Non-GAAP Financial Measures beginning on page 33.

 

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 attributable to U.S. Bancorp of $1.5 billion for the third quarter of 2016, or $0.84 per diluted common share, compared with $1.5 billion, or $0.81 per diluted common share, for the third quarter of 2015. Return on average assets and return on average common equity were 1.36 percent and 13.5 percent, respectively, for the third quarter of 2016, compared with 1.44 percent and 14.1 percent, respectively, for the third quarter of 2015.

Total net revenue for the third quarter of 2016 was $241 million (4.7 percent) higher than the third quarter of 2015, reflecting a 4.5 percent increase in net interest income (4.3 percent increase on a taxable-equivalent basis) and a 5.1 percent increase in noninterest income. The increase in net interest income from the third quarter of 2015 was mainly a result of loan growth. The noninterest income increase was primarily driven by higher mortgage banking revenue, trust and investment management fees, and credit and debit card revenue.

Noninterest expense in the third quarter of 2016 was $156 million (5.6 percent) higher than the third quarter of 2015, the result of increased compensation expense due to merit increases and higher variable compensation expense along with hiring to support business growth and compliance programs, increased technology and communications expense reflecting capital investments, and higher other noninterest expense, which includes a special Federal Deposit Insurance Corporation (“FDIC”) surcharge that began in the third quarter of 2016.

The provision for credit losses for the third quarter of 2016 of $325 million was $43 million (15.2 percent) higher than the third quarter of 2015. Net charge-offs in the third quarter of 2016 were $315 million, compared with $292 million in the third quarter of 2015. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and other factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.

Net income attributable to U.S. Bancorp for the first nine months of 2016 was $4.4 billion, or $2.43 per diluted common share, compared with $4.4 billion, or $2.36 per diluted common share, for the first nine months of 2015. Return on average assets and return on average common equity were 1.37 percent and 13.4 percent, respectively, for the first nine months of 2016, compared with 1.45 percent and 14.1 percent, respectively, for the first nine months of 2015. The results for the first nine months of 2016 included $180 million of equity investment income, primarily the result of the Company’s membership in Visa Europe Limited (“Visa Europe”) which was sold to Visa, Inc. in the second quarter of 2016, along with a $110 million increase in reserves related to legal and regulatory matters and a $40 million charitable contribution, also recorded in the second quarter of 2016.

Total net revenue for the first nine months of 2016 was $778 million (5.2 percent) higher than the first nine months of 2015, reflecting a 4.8 percent increase in net interest income (4.6 percent increase on a taxable-equivalent basis) and a 5.8 percent increase in noninterest income. The increase in net interest income from a year ago was mainly the result of loan growth. The increase in noninterest income was primarily driven by the impact of the Visa Europe sale, along with growth in credit and debit card revenue, trust and investment management fees, mortgage banking revenue and merchant processing services revenue.

Noninterest expense in the first nine months of 2016 was $550 million (6.8 percent) higher than the first nine months of 2015, the result of increased compensation expense due to merit increases and higher variable compensation expense along with hiring to support business growth and compliance programs, higher marketing expense as a result of a charitable contribution and brand advertising, increased technology and communications expense reflecting capital investments, and higher other noninterest expense, which includes the special FDIC surcharge and the second quarter 2016 increase in reserves related to legal and regulatory matters.

The provision for credit losses for the first nine months of 2016 of $982 million was $155 million (18.7 percent) higher than the first nine months of 2015. Net charge-offs in the first nine months of 2016 were $947 million, compared with $867 million in the first nine months of 2015. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and other factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.

 

U.S. Bancorp   3


Table of Contents

STATEMENT OF INCOME ANALYSIS

Net Interest Income Net interest income, on a taxable-equivalent basis, was $2.9 billion in the third quarter and $8.7 billion in the first nine months of 2016, representing increases of $122 million (4.3 percent) and $384 million (4.6 percent), respectively, over the same periods of 2015. The increases were driven by loan growth and higher interest rates, partially offset by the loan portfolio mix and lower yields in the investment portfolio. Average earning assets were $24.5 billion (6.6 percent) higher in the third quarter and $20.3 billion (5.5 percent) higher in the first nine months of 2016, compared with the same periods of 2015, driven by increases in loans and in investment securities. The net interest margin, on a taxable-equivalent basis, in the third quarter and first nine months of 2016 was 2.98 percent and 3.02 percent, respectively, compared with 3.04 percent and 3.05 percent in the third quarter and first nine months of 2015, respectively. The decreases in the net interest margin from the same periods of the prior year were principally due to increased funding costs, higher average cash balances, securities purchases at lower average rates and lower reinvestment rates on maturing securities, partially offset by higher rates on new loans. Refer to the “Consolidated Daily Average Balance Sheet and Related Yields and Rates” tables for further information on net interest income.

Average investment securities in the third quarter and first nine months of 2016 were $4.2 billion (4.0 percent) and $4.7 billion (4.6 percent) higher, respectively, than the same periods of 2015, primarily due to purchases of U.S. Treasury and U.S. government agency-backed securities, net of prepayments and maturities, to support regulatory liquidity coverage ratio requirements.

Average total loans in the third quarter and first nine months of 2016 were $19.1 billion (7.6 percent) and $17.8 billion (7.2 percent) higher, respectively, than the same periods of 2015, due to growth in commercial loans, residential mortgages, other retail loans, credit card loans and commercial real estate loans. The increases were driven by higher demand for loans from new and existing customers. In addition, at the end of the fourth quarter of 2015, the Company acquired a credit card portfolio which increased average credit card loans by approximately $1.6 billion and $1.5 billion for the third quarter and first nine months of 2016, respectively. These increases were partially offset by a decline in loans acquired in FDIC assisted transactions that are covered by loss sharing agreements with the FDIC (“covered” loans), a run-off portfolio.

Average total deposits for the third quarter and first nine months of 2016 were $28.9 billion (10.0 percent) and $22.6 billion (8.0 percent) higher, respectively, than the same periods of 2015. Average noninterest-bearing deposits for the third quarter and first nine months of 2016 increased $1.1 billion (1.3 percent) and $2.3 billion (3.0 percent), respectively, over the same periods of the prior year, mainly in Consumer and Small Business Banking, partially offset by declines in balances in Wealth Management and Securities Services. In addition, the increase in average noninterest-bearing deposits for the first nine months of 2016, compared with the same period of the prior year, was due to higher Wholesale Banking and Commercial Real Estate balances. Average total savings deposits for the third quarter and first nine months of 2016 were $29.4 billion (16.8 percent) and $23.4 billion (13.7 percent) higher, respectively, over the same periods of the prior year, the result of growth across all business lines. Average time deposits for the third quarter and first nine months of 2016 were $1.6 billion (4.7 percent) and $3.1 billion (8.4 percent) lower, respectively, compared with the same periods of 2015. The decreases were primarily due to lower Consumer and Small Business Banking balances driven by maturities, as well as declines related to those deposits managed as an alternative to other funding sources such as wholesale borrowing, based largely on relative pricing and liquidity characteristics.

Provision for Credit Losses The provision for credit losses for the third quarter and first nine months of 2016 increased $43 million (15.2 percent) and $155 million (18.7 percent), respectively, compared with the same periods of 2015. The provision for credit losses was higher than net charge-offs by $10 million and $35 million in the third quarter and first nine months of 2016, respectively. This compares with the provision for credit losses being lower than net charge-offs by $10 million and $40 million in the third quarter and first nine months of 2015, respectively. The increase in the allowance for credit losses during the third quarter of 2016 was driven by loan portfolio growth, partially offset by improvements in residential mortgage and home equity loans and lines. The increase in the allowance for credit losses during the first nine months of 2016 reflected loan portfolio growth and an increase in energy portfolio credit reserves, partially offset by improvements in residential mortgage and home equity loans and lines. Net charge-offs increased $23 million (7.9 percent) and $80 million (9.2 percent) in the third quarter and first nine months of 2016, respectively, compared with the same periods of the prior year, primarily due to higher commercial loan net charge-offs and lower commercial

 

4   U.S. Bancorp


Table of Contents
 Table 2  Noninterest Income

 

   

Three Months Ended

September 30,

           

Nine Months Ended

September 30,

 
(Dollars in Millions)   2016     2015     Percent
Change
            2016     2015     Percent
Change
 

Credit and debit card revenue

  $ 299      $ 269        11.2        $ 861      $ 776        11.0

Corporate payment products revenue

    190        190                    541        538        .6   

Merchant processing services

    412        400        3.0             1,188        1,154        2.9   

ATM processing services

    87        81        7.4             251        239        5.0   

Trust and investment management fees

    362        329        10.0             1,059        985        7.5   

Deposit service charges

    192        185        3.8             539        520        3.7   

Treasury management fees

    147        143        2.8             436        422        3.3   

Commercial products revenue

    219        231        (5.2          654        645        1.4   

Mortgage banking revenue

    314        224        40.2             739        695        6.3   

Investment products fees

    41        46        (10.9          120        141        (14.9

Securities gains (losses), net

    10        (1     *             16        (1     *   

Other

    172        229        (24.9              742        638        16.3   

Total noninterest income

  $ 2,445      $ 2,326        5.1            $ 7,146      $ 6,752        5.8

 

* Not meaningful.

 

real estate loan recoveries, partially offset by lower charge-offs related to residential mortgages and home equity loans. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and other factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.

Noninterest Income Noninterest income was $2.4 billion in the third quarter and $7.1 billion in the first nine months of 2016, representing increases of $119 million (5.1 percent) and $394 million (5.8 percent), respectively, compared with the same periods of 2015. The increases from a year ago were primarily due to higher mortgage banking revenue, trust and investment management fees, credit and debit card revenue and merchant processing services revenue. Mortgage banking revenue increased, driven by higher origination and sales volume in part due to refinancing activities in the marketplace. Trust and investment management fees increased, reflecting lower money market fee waivers, along with account growth, an increase in assets under management and improved market conditions. Credit and debit card revenue increased, reflecting higher transaction volumes including acquired portfolios. Merchant processing services revenue increased 3.0 percent in the third quarter and 2.9 percent in the first nine months of 2016, compared with the same periods of 2015, as a result of an increase in product fees and higher volumes. Adjusted for the impact of foreign currency rate changes, the increases would have been approximately 5.3 percent and 4.9 percent, respectively. Commercial products revenue decreased in the third quarter of 2016, compared with the third quarter of 2015, primarily driven by a large syndication transaction in the prior year. Other revenue was lower in the third quarter of 2016, compared with the third quarter of 2015, primarily due to lower equity investment income, partially offset by a third quarter 2015 student loan market valuation adjustment. Other revenue was higher in the first nine months of 2016, compared with the same period of the prior year, reflecting the second quarter 2016 Visa Europe sale and the impact of the 2015 student loan market valuation adjustment, partially offset by lower equity investment income.

Noninterest Expense Noninterest expense was $2.9 billion in the third quarter and $8.7 billion in the first nine months of 2016, representing increases of $156 million (5.6 percent) and $550 million (6.8 percent), respectively, compared with the same periods of 2015. The increases from a year ago were primarily due to higher compensation expense, technology and communications expense, professional services expense and other noninterest expense, partially offset by lower employee benefits expense. Compensation expense increased principally due to the impact of hiring decisions to support business growth and compliance programs, merit increases, and higher variable compensation. Technology and communications expense increased primarily due to capital investments and costs related to acquired card portfolios, while professional services expense increased due to compliance-related matters. The increases in other noninterest expense reflect the impact of the FDIC surcharge, which began in the third quarter of 2016. In addition, the increase in other noninterest expense for the first nine months of 2016, over the same period of the prior year, includes the second quarter 2016 change related to legal and regulatory matters. Further, marketing and business development expense for the first nine months of 2016 increased over the same period of the prior year, as a result of brand advertising and the second quarter 2016 charitable contribution.

 

U.S. Bancorp    5


Table of Contents
 Table 3  Noninterest Expense

 

    Three Months Ended
September 30,
          

Nine Months Ended

September 30,

 
(Dollars in Millions)   2016     2015     Percent
Change
           2016     2015     Percent
Change
 

Compensation

  $ 1,329      $ 1,225        8.5       $ 3,855      $ 3,600        7.1

Employee benefits

    280        285        (1.8         858        895        (4.1

Net occupancy and equipment

    250        251        (.4         741        745        (.5

Professional services

    127        115        10.4            346        298        16.1   

Marketing and business development

    102        99        3.0            328        265        23.8   

Technology and communications

    243        222        9.5            717        657        9.1   

Postage, printing and supplies

    80        77        3.9            236        223        5.8   

Other intangibles

    45        42        7.1            134        128        4.7   

Other

    475        459        3.5                1,457        1,311        11.1   

Total noninterest expense

  $ 2,931      $ 2,775        5.6           $ 8,672      $ 8,122        6.8

Efficiency ratio (a)

    54.5     53.9                     54.7     53.8        

 

(a) Computed as noninterest expense divided by the sum of net interest income on a taxable-equivalent basis and noninterest income excluding net securities gains (losses).

 

Offsetting the increases were lower employee benefits expense mainly due to lower pension costs.

Income Tax Expense The provision for income taxes was $566 million (an effective rate of 27.2 percent) for the third quarter and $1.6 billion (an effective rate of 26.6 percent) for the first nine months of 2016, compared with $534 million (an effective rate of 26.2 percent) and $1.5 billion (an effective rate of 25.7 percent) for the same periods of 2015. For further information on income taxes, refer to Note 11 of the Notes to Consolidated Financial Statements.

BALANCE SHEET ANALYSIS

Loans The Company’s loan portfolio was $271.3 billion at September 30, 2016, compared with $260.8 billion at December 31, 2015, an increase of $10.5 billion (4.0 percent). The increase was driven primarily by higher commercial loans, residential mortgages, commercial real estate loans and other retail loans, partially offset by lower credit card loans and covered loans.

Commercial loans and commercial real estate loans increased $4.8 billion (5.4 percent) and $1.3 billion (3.2 percent), respectively, at September 30, 2016, compared with December 31, 2015, reflecting higher demand from new and existing customers.

Residential mortgages held in the loan portfolio increased $2.7 billion (5.1 percent), reflecting 2016 origination activity, including strong refinancing activities due to lower longer-term interest rates during the third quarter of 2016. Residential mortgages originated and placed in the Company’s loan portfolio include well-secured jumbo mortgages and branch-originated first lien home equity loans to borrowers with high credit quality.

Other retail loans increased $2.5 billion (4.8 percent) at September 30, 2016, compared with December 31, 2015, driven by higher auto, installment and retail leasing balances, partially offset by decreases in student loan and revolving credit balances.

Credit card loans decreased $306 million (1.5 percent) at September 30, 2016, compared with December 31, 2015, primarily the result of customers paying down balances.

The Company generally retains portfolio loans through maturity; however, the Company’s intent may change over time based upon various factors such as ongoing asset/liability management activities, assessment of product profitability, credit risk, liquidity needs, and capital implications. If the Company’s intent or ability to hold an existing portfolio loan changes, it is transferred to loans held for sale.

Loans Held for Sale Loans held for sale, consisting primarily of residential mortgages to be sold in the secondary market, were $5.6 billion at September 30, 2016, compared with $3.2 billion at December 31, 2015. The increase in loans held for sale was principally due to a higher level of mortgage loan closings, driven by strong refinancing activities, in the third quarter of 2016. Almost all of the residential mortgage loans the Company originates or purchases for sale follow guidelines that allow the loans to be sold into existing, highly liquid secondary markets; in particular in government agency transactions and to government-sponsored enterprises (“GSEs”).

Investment Securities Investment securities totaled $110.0 billion at September 30, 2016, compared with $105.6 billion at December 31, 2015. The $4.4 billion (4.2 percent) increase reflected $3.8 billion of net

 

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 Table 4  Investment Securities

 

    Available-for-Sale             Held-to-Maturity  

At September 30, 2016

(Dollars in Millions)

  Amortized
Cost
     Fair Value      Weighted-
Average
Maturity in
Years
     Weighted-
Average
Yield (e)
            Amortized
Cost
     Fair Value      Weighted-
Average
Maturity in
Years
     Weighted-
Average
Yield (e)
 

U.S. Treasury and Agencies

                          

Maturing in one year or less

  $ 2,729       $ 2,731         .5         .88        $ 424       $ 426         .7         .97

Maturing after one year through five years

    7,529         7,575         2.9         1.08             734         750         2.8         1.76   

Maturing after five years through ten years

    4,195         4,322         6.2         1.89             3,609         3,686         6.7         1.81   

Maturing after ten years

    1         2         10.9         4.15                                           

Total

  $ 14,454       $ 14,630         3.4         1.28            $ 4,767       $ 4,862         5.6         1.73

Mortgage-Backed Securities (a)

                          

Maturing in one year or less

  $ 697       $ 703         .6         2.39        $ 479       $ 481         .6         2.30

Maturing after one year through five years

    41,085         41,592         3.9         1.84             35,952         36,368         3.5         1.94   

Maturing after five years through ten years

    3,489         3,522         6.3         1.97             1,595         1,607         5.8         1.55   

Maturing after ten years

    97         97         12.5         1.74                 37         37         12.2         1.42   

Total

  $ 45,368       $ 45,914         4.1         1.85            $ 38,063       $ 38,493         3.6         1.92

Asset-Backed Securities (a)

                          

Maturing in one year or less

  $ 11       $ 13         .4         6.96        $       $         .1         1.17

Maturing after one year through five years

    294         298         4.0         3.19             4         7         2.7         1.25   

Maturing after five years through ten years

    222         226         5.6         2.78             4         4         5.9         1.20   

Maturing after ten years

                                                    5         17.6         1.29   

Total

  $ 527       $ 537         4.6         3.10            $ 8       $ 16         4.2         1.23

Obligations of State and Political
Subdivisions (b) (c)

                          

Maturing in one year or less

  $ 2,175       $ 2,206         .4         7.10        $       $         .4         7.58

Maturing after one year through five years

    674         713         2.4         6.40             1         1         2.7         8.15   

Maturing after five years through ten years

    1,743         1,810         8.2         5.17             7         7         9.1         2.60   

Maturing after ten years

    640         647         19.5         5.11                                 10.2         8.07   

Total

  $ 5,232       $ 5,376         5.6         6.12            $ 8       $ 8         8.6         3.18

Other Debt Securities

                          

Maturing in one year or less

  $       $                        $ 6       $ 6         .4         2.00

Maturing after one year through five years

                                        21         21         3.7         1.55   

Maturing after five years through ten years

                                                                  

Maturing after ten years

    628         579         15.8         2.62                                           

Total

  $ 628       $ 579         15.8         2.62            $ 27       $ 27         3.0         1.65

Other Investments

  $ 67       $ 119         5.2         5.89            $       $                

Total investment securities (d)

  $ 66,276       $ 67,155         4.2         2.09            $ 42,873       $ 43,406         3.8         1.90

 

(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) Maturity calculations for obligations of state and political subdivisions are based on the first optional call date for securities with a fair value above par and contractual maturity for securities with a fair value equal to or below par.
(d) The weighted-average maturity of the available-for-sale investment securities was 4.7 years at December 31, 2015, with a corresponding weighted-average yield of 2.21 percent. The weighted-average maturity of the held-to-maturity investment securities was 4.2 years at December 31, 2015, with a corresponding weighted-average yield of 1.92 percent.
(e) Weighted-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 investment securities are computed based on amortized cost balances, excluding any premiums or discounts recorded related to the transfer of investment securities at fair value from available-for-sale to held-to-maturity. Weighted-average yield and maturity calculations exclude equity securities that have no stated yield or maturity.

 

    September 30, 2016             December 31, 2015  
(Dollars in Millions)   Amortized
Cost
     Percent
of Total
            Amortized
Cost
     Percent
of Total
 

U.S. Treasury and agencies

  $ 19,221         17.6        $ 7,536         7.2

Mortgage-backed securities

    83,431         76.4             91,265         86.6   

Asset-backed securities

    535         .5             558         .5   

Obligations of state and political subdivisions

    5,240         4.8             5,157         4.9   

Other debt securities and investments

    722         .7                 891         .8   

Total investment securities

  $ 109,149         100.0            $ 105,407         100.0

 

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investment purchases and a $699 million favorable change in net unrealized gains (losses) on available-for-sale investment securities.

The Company’s available-for-sale securities are carried at fair value with changes in fair value reflected in other comprehensive income (loss) unless a security is deemed to be other-than-temporarily impaired. At September 30, 2016, the Company’s net unrealized gains on available-for-sale securities were $879 million, compared with $180 million at December 31, 2015. The favorable change in net unrealized gains (losses) was primarily due to increases in the fair value of agency mortgage-backed securities as a result of changes in interest rates. Gross unrealized losses on available-for-sale securities totaled $130 million at September 30, 2016, compared with $480 million at December 31, 2015. At September 30, 2016, the Company had no plans to sell securities with unrealized losses, and believes it is more likely than not that it would not be required to sell such securities before recovery of their amortized cost.

In December 2013, U.S. banking regulators approved final rules that prohibit banks from holding certain types of investments, such as investments in hedge and certain private equity funds. The Company does not anticipate the implementation of these final rules will require any significant liquidation of securities held or impairment charges. Refer to Notes 3 and 14 in the Notes to Consolidated Financial Statements for further information on investment securities.

Deposits Total deposits were $334.6 billion at September 30, 2016, compared with $300.4 billion at December 31, 2015, the result of increases in total savings deposits and noninterest-bearing deposits, partially offset by a decrease in time deposits. Money market deposit balances increased $20.9 billion (24.2 percent) at September 30, 2016, compared with December 31, 2015, primarily due to higher Wholesale Banking and Commercial Real Estate and Wealth Management and Securities Services balances. Interest checking balances increased $6.9 billion (11.6 percent) primarily due to higher Wholesale Banking and Commercial Real Estate, corporate trust, and Consumer and Small Business Banking balances. Savings account balances increased $2.4 billion (6.3 percent), primarily due to higher Consumer and Small Business Banking balances. Noninterest-bearing deposits increased $5.3 billion (6.4 percent) at September 30, 2016, compared with December 31, 2015, primarily due to higher corporate trust, Consumer and Small Business Banking and Wholesale Banking and Commercial Real Estate balances. Time deposits decreased $1.3 billion (3.9 percent) at September 30, 2016, compared with December 31, 2015, primarily related to a decrease in Consumer and Small Business Banking balances due to maturities and those deposits managed as an alternative to other funding sources such as wholesale borrowing, based largely on relative pricing and liquidity characteristics.

Borrowings The Company utilizes both short-term and long-term borrowings as part of its asset/liability management and funding strategies. Short-term borrowings, which include federal funds purchased, commercial paper, repurchase agreements, borrowings secured by high-grade assets and other short-term borrowings, were $15.7 billion at September 30, 2016, compared with $27.9 billion at December 31, 2015. The $12.2 billion (43.7 percent) decrease in short-term borrowings was primarily driven by lower commercial paper balances. Long-term debt was $38.0 billion at September 30, 2016, compared with $32.1 billion at December 31, 2015. The $5.9 billion (18.4 percent) increase was primarily due to the issuances of $4.5 billion of bank notes, $2.6 billion of medium-term notes and $1.0 billion of subordinated notes, and an $842 million increase in Federal Home Loan Bank (“FHLB”) advances, partially offset by $3.1 billion of bank note and subordinated note repayments and maturities. Refer to the “Liquidity Risk Management” section for discussion of liquidity management of the Company.

 

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CORPORATE RISK PROFILE

Overview Managing risks is an essential part of successfully operating a financial services company. The Company’s Board of Directors has approved a risk management framework which establishes governance and risk management requirements for all risk-taking activities. This framework includes Company and business line risk appetite statements which set boundaries for the types and amount of risk that may be undertaken in pursuing business objectives and initiatives. The Board of Directors, primarily through its Risk Management Committee, oversees performance relative to the risk management framework, risk appetite statements, and other policy requirements.

The Executive Risk Committee (“ERC”), which is chaired by the Chief Risk Officer and includes the Chief Executive Officer and other members of the executive management team, oversees execution against the risk management framework and risk appetite statements. The ERC focuses on current and emerging risks, including strategic and reputational risks, by directing timely and comprehensive actions. Senior operating committees have also been established, each responsible for overseeing a specified category of risk.

The Company’s most prominent risk exposures are credit, interest rate, market, liquidity, operational, compliance, strategic, and reputational. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan, investment or derivative contract when it is due. Interest rate risk is the potential reduction of net interest income or market valuations as a result of changes in interest rates. Market risk arises from fluctuations in interest rates, foreign exchange rates, and security prices that may result in changes in the values of financial instruments, such as trading and available-for-sale securities, mortgage loans held for sale (“MLHFS”), mortgage servicing rights (“MSRs”) and derivatives that are accounted for on a fair value basis. Liquidity risk is the possible inability to fund obligations or new business at a reasonable cost and in a timely manner. Operational risk is the risk of loss resulting from inadequate or failed internal processes, people, or systems, or from external events, including the risk of loss resulting from breaches in data security. Operational risk can also include failures by third parties with which the Company does business. Compliance risk is the risk of loss arising from violations of, or nonconformance with, laws, rules, regulations, prescribed practices, internal policies, and procedures, or ethical standards, potentially exposing the Company to fines, civil money penalties, payment of damages, and the voiding of contracts. Compliance risk also arises in situations where the laws or rules governing certain Company products or activities of the Company’s customers may be ambiguous or untested. Strategic risk is the risk to earnings or capital arising from adverse business decisions or improper implementation of those decisions. Reputational risk is the risk to current or anticipated earnings, capital, or franchise or enterprise value arising from negative public opinion. This risk may impair the Company’s competitiveness by affecting its ability to establish new relationships, offer new services or continue serving existing relationships. In addition to the risks identified above, other risk factors exist that may impact the Company. Refer to “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, and in the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, for a detailed discussion of these factors.

The Company’s Board and management-level governance committees are supported by a “three lines of defense” model for establishing effective checks and balances. The first line of defense, the business lines, manages risks in conformity with established limits and policy requirements. In turn, business leaders and their risk officers establish programs to ensure conformity with these limits and policy requirements. The second line of defense, which includes the Chief Risk Officer’s organization as well as policy and oversight activities of corporate support functions, translates risk appetite and strategy into actionable risk limits and policies. The second line of defense monitors first line of defense conformity with limits and policies, and provides reporting and escalation of emerging risks and other concerns to senior management and the Risk Management Committee of the Board of Directors. The third line of defense, internal audit, is responsible for providing the Audit Committee of the Board of Directors and senior management with independent assessment and assurance regarding the effectiveness of the Company’s governance, risk management, and control processes.

Management provides various risk reports to the Risk Management Committee of the Board of Directors. The Risk Management Committee discusses with management the Company’s risk management performance, and provides a summary of key risks to the entire Board of Directors, covering the status of existing matters, areas of potential future concern, and specific information on certain types of loss events. The Risk Management Committee considers quarterly reports by management assessing the Company’s performance relative to the risk appetite statements and the associated risk limits, including:

 

Qualitative considerations, such as the macroeconomic environment, regulatory and compliance changes,

 

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litigation developments, and technology and cybersecurity;

  Capital ratios and projections, including regulatory measures and stressed scenarios;
  Credit measures, including adversely rated and nonperforming loans, leveraged transactions, credit concentrations and lending limits;
  Interest rate and market risk, including market value and net income simulation, and trading-related Value at Risk;
  Liquidity risk, including funding projections under various stressed scenarios;
  Operational and compliance risk, including losses stemming from events such as fraud, processing errors, control breaches, breaches in data security, or adverse business decisions, as well as reporting on technology performance, and various legal and regulatory compliance measures; and
  Reputational and strategic risk considerations, impacts and responses.

Credit Risk Management The Company’s strategy for credit risk management includes well-defined, centralized credit policies, uniform underwriting criteria, and ongoing risk monitoring and review processes for all commercial and consumer credit exposures. In evaluating its credit risk, the Company considers changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), collateral values, trends in loan performance and macroeconomic factors, such as changes in unemployment rates, gross domestic product and consumer bankruptcy filings. The Risk Management Committee oversees the Company’s credit risk management process.

In addition, credit quality ratings, as defined by the Company, are an important part of the Company’s overall credit risk management and evaluation of its allowance for credit losses. Loans with a pass rating represent those loans not classified on the Company’s rating scale for problem credits, as minimal risk has been identified. Loans with a special mention or classified rating, including loans that are 90 days or more past due and still accruing, nonaccrual loans, those loans considered troubled debt restructurings (“TDRs”), and loans in a junior lien position that are current but are behind a modified or delinquent loan in a first lien position, encompass all loans held by the Company that it considers to have a potential or well-defined weakness that may put full collection of contractual cash flows at risk. The Company’s internal credit quality ratings for consumer loans are primarily based on delinquency and nonperforming status, except for a limited population of larger loans within those portfolios that are individually evaluated. For this limited population, the determination of the internal credit quality rating may also consider collateral value and customer cash flows. The Company obtains recent collateral value estimates for the majority of its residential mortgage and home equity and second mortgage portfolios, which allows the Company to compute estimated loan-to-value (“LTV”) ratios reflecting current market conditions. These individual refreshed LTV ratios are considered in the determination of the appropriate allowance for credit losses. However, the underwriting criteria the Company employs consider the relevant income and credit characteristics of the borrower, such that the collateral is not the primary source of repayment. Refer to Note 4 in the Notes to Consolidated Financial Statements for further discussion of the Company’s loan portfolios, including internal credit quality ratings. In addition, refer to “Management’s Discussion and Analysis — Credit Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, for a more detailed discussion on credit risk management processes.

The Company manages its credit risk, in part, through diversification of its loan portfolio and limit setting by product type criteria and concentrations. As part of its normal business activities, the Company offers a broad array of lending products. The Company categorizes its loan portfolio into three segments, which is the level at which it develops and documents a systematic methodology to determine the allowance for credit losses. The Company’s three loan portfolio segments are commercial lending, consumer lending and covered loans.

The commercial lending segment includes loans and leases made to small business, middle market, large corporate, commercial real estate, financial institution, non-profit and public sector customers. Key risk characteristics relevant to commercial lending segment loans include the industry and geography of the borrower’s business, purpose of the loan, repayment source, borrower’s debt capacity and financial flexibility, loan covenants, and nature of pledged collateral, if any. These risk characteristics, among others, are considered in determining estimates about the likelihood of default by the borrowers and the severity of loss in the event of default. The Company considers these risk characteristics in assigning internal risk ratings to, or forecasting losses on, these loans which are the significant factors in determining the allowance for credit losses for loans in the commercial lending segment.

Included within the commercial lending segment are energy loans, which represented 1.0 percent of the Company’s total loans outstanding at September 30,

 

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2016. Low energy prices during 2016 have increased criticized commitments and nonperforming loans at September 30, 2016, compared with December 31, 2015.

The following table provides a summary of the Company’s energy loans:

 

(Dollars in Millions)  

September 30,

2016

   

December 31,

2015

 

Loans outstanding

  $ 2,732      $ 3,183   

Total commitments outstanding

    11,085        12,118   

Total criticized commitments outstanding

    3,231        1,886   

Nonperforming assets

    259        19   

Allowance for credit losses as a percentage of loans outstanding

    8.9     5.4

The consumer lending segment represents loans and leases made to consumer customers, including residential mortgages, credit card loans, and other retail loans such as revolving consumer lines, auto loans and leases, home equity loans and lines, and student loans, a run-off portfolio. Home equity or second mortgage loans are junior lien closed-end accounts fully disbursed at origination. These loans typically are fixed rate loans, secured by residential real estate, with a 10- or 15-year fixed payment amortization schedule. Home equity lines are revolving accounts giving the borrower the ability to draw and repay balances repeatedly, up to a maximum commitment, and are secured by residential real estate. These include accounts in either a first or junior lien position. Typical terms on home equity lines in the portfolio are variable rates benchmarked to the prime rate, with a 10- or 15-year draw period during which a minimum payment is equivalent to the monthly interest, followed by a 20- or 10-year amortization period, respectively. At September 30, 2016, substantially all of the Company’s home equity lines were in the draw period. Approximately $1.0 billion, or 7 percent, of the outstanding home equity line balances at September 30, 2016, will enter the amortization period within the next 36 months. Key risk characteristics relevant to consumer lending segment loans primarily relate to the borrowers’ capacity and willingness to repay and include unemployment rates and other economic factors, customer payment history and in some cases, updated LTV information on real estate based loans. These risk characteristics, among others, are reflected in forecasts of delinquency levels, bankruptcies and losses which are the primary factors in determining the allowance for credit losses for the consumer lending segment.

The covered loan segment represents loans acquired in FDIC-assisted transactions that are covered by loss sharing agreements with the FDIC that greatly reduce the risk of future credit losses to the Company. Key risk characteristics for covered segment loans are consistent with the segment they would otherwise be included in had the loss share coverage not been in place, but consider the indemnification provided by the FDIC.

The Company further disaggregates its loan portfolio segments into various classes based on their underlying risk characteristics. The two classes within the commercial lending segment are commercial loans and commercial real estate loans. The three classes within the consumer lending segment are residential mortgages, credit card loans and other retail loans. The covered loan segment consists of only one class.

The Company’s consumer lending segment utilizes several distinct business processes and channels to originate consumer credit, including traditional branch lending, on-line banking, indirect lending, portfolio acquisitions, correspondent banks and loan brokers. Each distinct underwriting and origination activity manages unique credit risk characteristics and prices its loan production commensurate with the differing risk profiles.

Residential mortgages are originated through the Company’s branches, loan production offices, on-line services and a wholesale network of originators. The Company may retain residential mortgage loans it originates on its balance sheet or sell the loans into the secondary market while retaining the servicing rights and customer relationships. Utilizing the secondary markets enables the Company to effectively reduce its credit and other asset/liability risks. For residential mortgages that are retained in the Company’s portfolio and for home equity and second mortgages, credit risk is also diversified by geography and managed by adherence to LTV and borrower credit criteria during the underwriting process.

The Company estimates updated LTV information on its outstanding residential mortgages quarterly, based on a method that combines automated valuation model updates and relevant home price indices. LTV is the ratio of the loan’s outstanding principal balance to the current estimate of property value. For home equity and second mortgages, combined loan-to-value (“CLTV”) is the combination of the first mortgage original principal balance and the second lien outstanding principal balance, relative to the current estimate of property value. Certain loans do not have a LTV or CLTV, primarily due to lack of availability of relevant automated valuation model and/or home price indices values, or lack of necessary valuation data on acquired loans.

 

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The following tables provide summary information for the LTVs of residential mortgages and home equity and second mortgages by borrower type at September 30, 2016:

 

Residential mortgages

(Dollars in Millions)

  Interest
Only
    Amortizing     Total     Percent
of Total
 

Prime Borrowers

       

Less than or equal to 80%

  $ 1,717      $ 44,775      $ 46,492        91.4

Over 80% through 90%

    25        3,057        3,082        6.1   

Over 90% through 100%

    16        620        636        1.2   

Over 100%

    13        599        612        1.2   

No LTV available

    2        66        68        .1   

Total

  $ 1,773      $ 49,117      $ 50,890        100.0

Sub-Prime Borrowers

       

Less than or equal to 80%

  $      $ 615      $ 615        63.5

Over 80% through 90%

           151        151        15.6   

Over 90% through 100%

           97        97        10.0   

Over 100%

           106        106        10.9   

No LTV available

                           

Total

  $      $ 969      $ 969        100.0

Other Borrowers

       

Less than or equal to 80%

  $ 1      $ 358      $ 359        69.6

Over 80% through 90%

           53        53        10.2   

Over 90% through 100%

           37        37        7.2   

Over 100%

           67        67        13.0   

No LTV available

                           

Total

  $ 1      $ 515      $ 516        100.0

Loans Purchased From GNMA Mortgage Pools (a)

  $      $ 3,854      $ 3,854        100.0

Total

       

Less than or equal to 80%

  $ 1,718      $ 45,748      $ 47,466        84.4

Over 80% through 90%

    25        3,261        3,286        5.8   

Over 90% through 100%

    16        754        770        1.4   

Over 100%

    13        772        785        1.4   

No LTV available

    2        66        68        .1   

Loans purchased from GNMA mortgage pools (a)

           3,854        3,854        6.9   

Total

  $ 1,774      $ 54,455      $ 56,229        100.0

 

(a) Represents loans purchased from Government National Mortgage Association (“GNMA”) mortgage pools whose payments are primarily insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs.

 

Home equity and second mortgages

(Dollars in Millions)

  Lines     Loans     Total     Percent
of Total
 

Prime Borrowers

       

Less than or equal to 80%

  $ 11,533      $ 536      $ 12,069        75.6

Over 80% through 90%

    2,223        589        2,812        17.6   

Over 90% through 100%

    488        114        602        3.8   

Over 100%

    385        24        409        2.5   

No LTV/CLTV available

    60        18        78        .5   

Total

  $ 14,689      $ 1,281      $ 15,970        100.0

Sub-Prime Borrowers

       

Less than or equal to 80%

  $ 39      $ 17      $ 56        33.5

Over 80% through 90%

    8        21        29        17.4   

Over 90% through 100%

    7        47        54        32.3   

Over 100%

    11        16        27        16.2   

No LTV/CLTV available

           1        1        .6   

Total

  $ 65      $ 102      $ 167        100.0

Other Borrowers

       

Less than or equal to 80%

  $ 217      $ 6      $ 223        67.6

Over 80% through 90%

    18        7        25        7.6   

Over 90% through 100%

    6        1        7        2.1   

Over 100%

    5               5        1.5   

No LTV/CLTV available

    70               70        21.2   

Total

  $ 316      $ 14      $ 330        100.0

Total

       

Less than or equal to 80%

  $ 11,789      $ 559      $ 12,348        75.0

Over 80% through 90%

    2,249        617        2,866        17.4   

Over 90% through 100%

    501        162        663        4.0   

Over 100%

    401        40        441        2.7   

No LTV/CLTV available

    130        19        149        .9   

Total

  $ 15,070      $ 1,397      $ 16,467        100.0

         The total amount of consumer lending segment residential mortgage, home equity and second mortgage loans to customers that may be defined as sub-prime borrowers represented only 0.3 percent of total assets at September 30, 2016 and December 31, 2015. The Company considers sub-prime loans to be those made to borrowers with a risk of default significantly higher than those approved for prime lending programs, as reflected in credit scores obtained from independent agencies at loan origination, in addition to other credit underwriting criteria. Sub-prime portfolios include only loans originated according to the Company’s underwriting programs specifically designed to serve customers with weakened credit histories. The sub-prime designation indicators have been and will continue to be subject to re-evaluation over time as borrower characteristics, payment performance and economic conditions change. The sub-prime loans originated during periods from June 2009 and after are with borrowers who met the Company’s program guidelines and have a credit score that generally is at or below a threshold of 620 to 650 depending on the program. Sub-prime loans originated during periods prior to June 2009 were based upon program level guidelines without regard to credit score.

Home equity and second mortgages were $16.5 billion at September 30, 2016, compared with $16.4 billion at December 31, 2015, and included $5.0 billion of home equity lines in a first lien position and $11.5 billion of home equity and second mortgage loans and lines in a junior lien position. Loans and lines in a junior lien position at September 30, 2016, included approximately $4.7 billion of loans and lines for which the Company also serviced the related first lien loan, and approximately $6.8 billion where the Company did not service the related first lien loan. The Company was able to determine the status of the related first liens using information the Company has as the servicer of the first lien or information reported on customer credit bureau files. The Company also evaluates other indicators of credit risk for these junior lien loans and lines including delinquency, estimated average CLTV ratios and updated weighted-average credit scores in making its assessment of credit risk, related loss estimates and determining the allowance for credit losses.

 

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

 

90 days or more past due excluding nonperforming loans   September 30,
2016
    December 31,
2015
 

Commercial

   

Commercial

    .06     .06

Lease financing

             

Total commercial

    .05        .05   

Commercial Real Estate

   

Commercial mortgages

             

Construction and development

    .05        .13   

Total commercial real estate

    .02        .03   

Residential Mortgages (a)

    .28        .33   

Credit Card

    1.11        1.09   

Other Retail

   

Retail leasing

           .02   

Home equity and second mortgages

    .24        .25   

Other

    .11        .11   

Total other retail (b)

    .14        .15   

Total loans, excluding covered loans

    .19        .21   

Covered Loans

    5.72        6.31   

Total loans

    .28     .32
90 days or more past due including nonperforming loans   September 30,
2016
    December 31,
2015
 

Commercial

    .61     .25

Commercial real estate

    .26        .33   

Residential mortgages (a)

    1.37        1.66   

Credit card

    1.13        1.13   

Other retail (b)

    .42        .46   

Total loans, excluding covered loans

    .72        .67   

Covered loans

    5.89        6.48   

Total loans

    .79     .78

 

(a) Delinquent loan ratios exclude $2.4 billion at September 30, 2016, and $2.9 billion at December 31, 2015, of loans purchased from GNMA mortgage pools whose repayments are primarily insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs. Including these loans, the ratio of residential mortgages 90 days or more past due including all nonperforming loans was 5.70 percent at September 30, 2016, and 7.15 percent at December 31, 2015.
(b) Delinquent loan ratios exclude student loans that are guaranteed by the federal government. Including these loans, the ratio of total other retail loans 90 days or more past due including all nonperforming loans was .60 percent at September 30, 2016, and .75 percent at December 31, 2015.

 

The following table provides a summary of delinquency statistics and other credit quality indicators for the Company’s junior lien positions at September 30, 2016:

 

    Junior Liens Behind        
(Dollars in Millions)  

Company Owned
or Serviced

First Lien

    Third Party
First Lien
    Total  

Total

  $ 4,695      $ 6,818      $ 11,513   

Percent 30-89 days past due

    .29     .47     .40

Percent 90 days or more past due

    .10     .10     .10

Weighted-average CLTV

    73     69     71

Weighted-average credit score

    775        769        771   

See the “Analysis and Determination of the Allowance for Credit Losses” section for additional information on how the Company determines the allowance for credit losses for loans in a junior lien position.

Loan Delinquencies Trends in delinquency ratios are an indicator, among other considerations, of credit risk within the Company’s loan portfolios. 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 $748 million ($518 million excluding covered loans) at September 30, 2016, compared with $831 million ($541 million excluding covered loans) at December 31, 2015. These balances exclude loans purchased from Government National Mortgage Association (“GNMA”) mortgage pools whose repayments are primarily insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs, as well as student loans guaranteed by the federal government. Accruing loans 90 days or more past due are not included in nonperforming assets and continue to accrue interest because they are adequately secured by collateral, are in the process of collection and are reasonably expected to result in repayment or restoration to current status, or are managed in homogeneous portfolios with specified charge-off timeframes adhering to regulatory guidelines. The ratio of accruing loans 90 days or more past due to total loans was 0.28 percent (0.19 percent excluding covered loans) at September 30, 2016, compared with 0.32 percent (0.21 percent excluding covered loans) at December 31, 2015.

 

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The following table provides summary delinquency information for residential mortgages, credit card and other retail loans included in the consumer lending segment:

 

    Amount             

As a Percent of Ending

Loan Balances

 
(Dollars in Millions)   September 30,
2016
     December 31,
2015
             September 30,
2016
    December 31,
2015
 

Residential Mortgages (a)

              

30-89 days

  $ 146       $ 170              .26     .32

90 days or more

    159         176              .28        .33   

Nonperforming

    614         712                  1.09        1.33   

Total

  $ 919       $ 1,058              1.63     1.98

Credit Card

              

30-89 days

  $ 264       $ 243              1.27     1.15

90 days or more

    229         228              1.11        1.09   

Nonperforming

    4         9                  .02        .04   

Total

  $ 497       $ 480              2.40     2.28

Other Retail

              

Retail Leasing

              

30-89 days

  $ 13       $ 11              .21     .21

90 days or more

            1                     .02   

Nonperforming

    3         3                  .05        .06   

Total

  $ 16       $ 15              .26     .29

Home Equity and Second Mortgages

              

30-89 days

  $ 67       $ 59              .41     .36

90 days or more

    40         41              .24        .25   

Nonperforming

    124         136                  .75        .83   

Total

  $ 231       $ 236              1.40     1.44

Other (b)

              

30-89 days

  $ 174       $ 154              .56     .52

90 days or more

    34         33              .11        .11   

Nonperforming

    26         23                  .08        .08   

Total

  $ 234       $ 210                  .75     .71

 

(a) Excludes $307 million of loans 30-89 days past due and $2.4 billion of loans 90 days or more past due at September 30, 2016, purchased from GNMA mortgage pools that continue to accrue interest, compared with $320 million and $2.9 billion at December 31, 2015, respectively.
(b) Includes revolving credit, installment, automobile and student loans.

 

The following tables provide further information on residential mortgages and home equity and second mortgages as a percent of ending loan balances by borrower type:

 

Residential mortgages (a)   September 30,
2016
    December 31,
2015
 

Prime Borrowers

   

30-89 days

    .22     .25

90 days or more

    .24        .30   

Nonperforming

    .89        1.12   

Total

    1.35     1.67

Sub-Prime Borrowers

   

30-89 days

    2.89     3.92

90 days or more

    2.89        2.52   

Nonperforming

    14.45        15.30   

Total

    20.23     21.74

Other Borrowers

   

30-89 days

    1.36     1.60

90 days or more

    1.36        1.12   

Nonperforming

    4.26        4.00   

Total

    6.98     6.72

 

(a) Excludes delinquent and nonperforming information on loans purchased from GNMA mortgage pools as their repayments are primarily insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs.

 

Home equity and second mortgages   September 30,
2016
    December 31,
2015
 

Prime Borrowers

   

30-89 days

    .36     .31

90 days or more

    .22        .23   

Nonperforming

    .66        .74   

Total

    1.24     1.28

Sub-Prime Borrowers

   

30-89 days

    2.39     2.56

90 days or more

    1.20        1.03   

Nonperforming

    5.39        4.62   

Total

    8.98     8.21

Other Borrowers

   

30-89 days

    1.82     1.23

90 days or more

    .91        .74   

Nonperforming

    2.72        2.45   

Total

    5.45     4.42

The following table provides summary delinquency information for covered loans:

 

    Amount           

As a Percent of Ending

Loan Balances

 
(Dollars in Millions)   September 30,
2016
    December 31,
2015
           September 30,
2016
    December 31,
2015
 

30-89 days

  $ 55      $ 62            1.37     1.35

90 days or more

    230        290            5.72        6.31   

Nonperforming

    7        8                .17        .17   

Total

  $ 292      $ 360                7.26     7.83

 

 

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Restructured Loans In certain circumstances, the Company may modify the terms of a loan to maximize the collection of amounts due when a borrower is experiencing financial difficulties or is expected to experience difficulties in the near-term. In most cases the modification is either a concessionary reduction in interest rate, extension of the maturity date or reduction in the principal balance that would otherwise not be considered.

Troubled Debt Restructurings Concessionary modifications are classified as TDRs unless the modification results in only an insignificant delay in the payments to be received. TDRs accrue interest if the borrower complies with the revised terms and conditions and has demonstrated repayment performance at a level commensurate with the modified terms over several payment cycles, which is generally six months or greater. At September 30, 2016, performing TDRs were $4.0 billion, compared with $4.7 billion at December 31, 2015. Loans classified as TDRs are considered impaired loans for reporting and measurement purposes.

The Company continues to work with customers to modify loans for borrowers who are experiencing financial difficulties, including those acquired through FDIC-assisted acquisitions. Many of the Company’s TDRs are determined on a case-by-case basis in connection with ongoing loan collection processes. The modifications vary within each of the Company’s loan classes. Commercial lending segment TDRs generally include extensions of the maturity date and may be accompanied by an increase or decrease to the interest rate. The Company may also work with the borrower to make other changes to the loan to mitigate losses, such as obtaining additional collateral and/or guarantees to support the loan.

The Company has also implemented certain residential mortgage loan restructuring programs that may result in TDRs. The Company participates in the U.S. Department of the Treasury Home Affordable Modification Program (“HAMP”). HAMP gives qualifying homeowners an opportunity to permanently modify their loan and achieve more affordable monthly payments, with the U.S. Department of the Treasury compensating the Company for a portion of the reduction in monthly amounts due from borrowers participating in this program. The Company also modifies residential mortgage loans under Federal Housing Administration, Department of Veterans Affairs, and its own internal programs. Under these programs, the Company provides concessions to qualifying borrowers experiencing financial difficulties. The concessions may include adjustments to interest rates, conversion of adjustable rates to fixed rates, extensions of maturity dates or deferrals of payments, capitalization of accrued interest and/or outstanding advances, or in limited situations, partial forgiveness of loan principal. In most instances, participation in residential mortgage loan restructuring programs requires the customer to complete a short-term trial period. A permanent loan modification is contingent on the customer successfully completing the trial period arrangement and the loan documents are not modified until that time. The Company reports loans in a trial period arrangement as TDRs and continues to report them as TDRs after the trial period.

Credit card and other retail loan TDRs are generally part of distinct restructuring programs providing customers modification solutions over a specified time period, generally up to 60 months.

In accordance with regulatory guidance, the Company considers secured consumer loans that have had debt discharged through bankruptcy where the borrower has not reaffirmed the debt to be TDRs. If the loan amount exceeds the collateral value, the loan is charged down to collateral value and the remaining amount is reported as nonperforming.

Modifications to loans in the covered segment are similar in nature to that described above for non-covered loans, and the evaluation and determination of TDR status is similar, except that acquired loans restructured after acquisition are not considered TDRs for purposes of the Company’s accounting and disclosure if the loans evidenced credit deterioration as of the acquisition date and are accounted for in pools. Losses associated with modifications on covered loans, including the economic impact of interest rate reductions, are generally eligible for reimbursement under the loss sharing agreements.

 

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The following table provides a summary of TDRs by loan class, including the delinquency status for TDRs that continue to accrue interest and TDRs included in nonperforming assets:

 

           As a Percent of Performing TDRs              

At September 30, 2016

(Dollars in Millions)

  Performing
TDRs
     30-89 Days
Past Due
    90 Days or More
Past Due
    Nonperforming
TDRs
    Total
TDRs
 

Commercial

  $ 308         2.0     1.5   $ 349 (a)    $ 657   

Commercial real estate

    274         1.1        .1        25 (b)      299   

Residential mortgages

    1,749         3.1        4.1        426        2,175 (d) 

Credit card

    213         10.8        6.5        4 (c)      217   

Other retail

    128         4.3        3.2        50 (c)      178 (e) 

TDRs, excluding GNMA and covered loans

    2,672         3.4        3.6        854        3,526   

Loans purchased from GNMA mortgage pools (g)

    1,344                              1,344 (f) 

Covered loans

    31         1.4        12.6        6        37   

Total

  $ 4,047         2.3     2.4   $ 860      $ 4,907   

 

(a) Primarily represents loans less than six months from the modification date that have not met the performance period required to return to accrual status (generally six months) and small business credit cards with a modified rate equal to 0 percent.
(b) Primarily represents loans less than six months from the modification date that have not met the performance period required to return to accrual status (generally six months).
(c) Primarily represents loans with a modified rate equal to 0 percent.
(d) Includes $282 million of residential mortgage loans to borrowers that have had debt discharged through bankruptcy and $81 million in trial period arrangements or previously placed in trial period arrangements but not successfully completed.
(e) Includes $91 million of other retail loans to borrowers that have had debt discharged through bankruptcy and $7 million in trial period arrangements or previously placed in trial period arrangements but not successfully completed.
(f) Includes $366 million of Federal Housing Administration and Department of Veterans Affairs residential mortgage loans to borrowers that have had debt discharged through bankruptcy and $284 million in trial period arrangements or previously placed in trial period arrangements but not successfully completed.
(g) Approximately 5.6 percent and 61.8 percent of the total TDR loans purchased from GNMA mortgage pools are 30-89 days past due and 90 days or more past due, respectively, but are not classified as delinquent as their repayments are insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs.

 

Short-term Modifications The Company makes short-term modifications that it does not consider to be TDRs, in limited circumstances, to assist borrowers experiencing temporary hardships. Consumer lending programs include payment reductions, deferrals of up to three past due payments, and the ability to return to current status if the borrower makes required payments. The Company may also make short-term modifications to commercial lending loans, with the most common modification being an extension of the maturity date of three months or less. Such extensions generally are used when the maturity date is imminent and the borrower is experiencing some level of financial stress, but the Company believes the borrower will pay all contractual amounts owed. Short-term modified loans were not material at September 30, 2016.

 

16    U.S. Bancorp


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 Table 6  Nonperforming Assets (a)

 

(Dollars in Millions)   September 30,
2016
    December 31,
2015
 

Commercial

   

Commercial

  $ 477      $ 160   

Lease financing

    40        14   

Total commercial

    517        174   

Commercial Real Estate

   

Commercial mortgages

    98        92   

Construction and development

    7        35   

Total commercial real estate

    105        127   

Residential Mortgages (b)

    614        712   

Credit Card

    4        9   

Other Retail

   

Retail leasing

    3        3   

Home equity and second mortgages

    124        136   

Other

    26        23   

Total other retail

    153        162   

Total nonperforming loans, excluding covered loans

    1,393        1,184   

Covered Loans

    7        8   

Total nonperforming loans

    1,400        1,192   

Other Real Estate (c)(d)

    213        280   

Covered Other Real Estate (d)

    28        32   

Other Assets

    23        19   

Total nonperforming assets

  $ 1,664      $ 1,523   

Total nonperforming assets, excluding covered assets

  $ 1,629      $ 1,483   

Excluding covered assets

   

Accruing loans 90 days or more past due (b)

  $ 518      $ 541   

Nonperforming loans to total loans

    .52     .46

Nonperforming assets to total loans plus other real estate (c)

    .61     .58

Including covered assets

   

Accruing loans 90 days or more past due (b)

  $ 748      $ 831   

Nonperforming loans to total loans

    .52     .46

Nonperforming assets to total loans plus other real estate (c)

    .61     .58

Changes in Nonperforming Assets

 

(Dollars in Millions)    Commercial and
Commercial
Real Estate
    Residential
Mortgages,
Credit Card and
Other Retail
    Covered
Assets
    Total  

Balance December 31, 2015

   $ 336      $ 1,147      $ 40      $ 1,523   

Additions to nonperforming assets

        

New nonaccrual loans and foreclosed properties

     895        320        15        1,230   

Advances on loans

     57                      57   

Total additions

     952        320        15        1,287   

Reductions in nonperforming assets

        

Paydowns, payoffs

     (221     (205     (1     (427

Net sales

     (159     (125     (18     (302

Return to performing status

     (27     (93            (120

Charge-offs (e)

     (239     (57     (1     (297

Total reductions

     (646     (480     (20     (1,146

Net additions to (reductions in) nonperforming assets

     306        (160     (5     141   

Balance September 30, 2016

   $ 642      $ 987      $ 35      $ 1,664   

 

(a) Throughout this document, nonperforming assets and related ratios do not include accruing loans 90 days or more past due.
(b) Excludes $2.4 billion and $2.9 billion at September 30, 2016, and December 31, 2015, respectively, of loans purchased from GNMA mortgage pools that are 90 days or more past due that continue to accrue interest, as their repayments are primarily insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs.
(c) Foreclosed GNMA loans of $397 million and $535 million at September 30, 2016, and December 31, 2015, respectively, continue to accrue interest and are recorded as other assets and excluded from nonperforming assets because they are insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs.
(d) Includes equity investments in entities whose principal assets are other real estate owned.
(e) Charge-offs exclude actions for certain card products and loan sales that were not classified as nonperforming at the time the charge-off occurred.

 

U.S. Bancorp    17


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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 and not accruing interest, restructured loans that have not met the performance period required to return to accrual status, other real estate owned (“OREO”) and other nonperforming assets owned by the Company. Nonperforming assets are generally either originated by the Company or acquired under FDIC loss sharing agreements that substantially reduce the risk of credit losses to the Company. Interest payments collected from assets on nonaccrual status are generally applied against the principal balance and not recorded as income. However, interest income may be recognized for interest payments if the remaining carrying amount of the loan is believed to be collectible.

At September 30, 2016, total nonperforming assets were $1.7 billion, compared with $1.5 billion at December 31, 2015. The $141 million (9.3 percent) increase in nonperforming assets was primarily driven by a $240 million increase in nonperforming commercial loans within the energy portfolio, partially offset by improvements in the Company’s residential and commercial real estate portfolios. Excluding energy loans, nonperforming assets decreased 6.5 percent at September 30, 2016, compared with December 31, 2015. Nonperforming covered assets were $35 million at September 30, 2016, compared with $40 million at December 31, 2015. The ratio of total nonperforming assets to total loans and other real estate was 0.61 percent at September 30, 2016, compared with 0.58 percent at December 31, 2015.

OREO, excluding covered assets, was $213 million at September 30, 2016, compared with $280 million at December 31, 2015, and was related to foreclosed properties that previously secured loan balances. These balances exclude foreclosed GNMA loans whose repayments are primarily insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs.

The following table provides an analysis of OREO, excluding covered assets, as a percent of their related loan balances, including geographical location detail for residential (residential mortgage, home equity and second mortgage) and commercial (commercial and commercial real estate) loan balances:

 

    Amount           

As a Percent of Ending

Loan Balances

 
(Dollars in Millions)   September 30,
2016
    December 31,
2015
           September 30,
2016
    December 31,
2015
 

Residential

           

Illinois

  $ 16      $ 18            .37     .42

Minnesota

    15        23            .24        .37   

Wisconsin

    13        11            .58        .49   

Florida

    12        17            .81        1.12   

Ohio

    11        17            .37        .56   

All other states

    134        164                .24        .31   

Total residential

    201        250            .28        .36   

Commercial

           

California

    4        11            .02        .05   

Tennessee

    1        1            .04        .04   

Iowa

    1        1            .03        .04   

Ohio

    1        1            .02        .02   

New Jersey

    1        1            .04        .04   

All other states

    4        15                       .02   

Total  commercial

    12        30                .01        .02   

Total

  $ 213      $ 280                .08     .11

Analysis of Loan Net Charge-Offs Total loan net charge-offs were $315 million for the third quarter and $947 million for the first nine months of 2016, compared with $292 million and $867 million for the same periods of 2015. The ratio of total loan net charge-offs to average loans outstanding on an annualized basis for the third quarter and first nine months of 2016 was 0.46 percent and 0.48 percent, respectively, compared with 0.46 percent and 0.47 percent for the same periods of 2015. The year-over-year increases in total net charge-offs reflected higher commercial loan net charge-offs and lower commercial real estate recoveries, partially offset by lower charge-offs related to residential mortgages and home equity loans.

Commercial and commercial real estate loan net charge-offs for the third quarter of 2016 were $88 million (0.26 percent of average loans outstanding on an annualized basis), compared with $60 million (0.19 percent of average loans outstanding on an annualized basis) for the third quarter of 2015. Commercial and commercial real estate loan net charge-offs for the first nine months of 2016 were $245 million (0.24 percent of average loans outstanding on an annualized basis), compared with $128 million (0.14 percent of average loans outstanding on an annualized basis) for the first nine months of 2015. The year-over-year increases include higher energy net charge-offs and lower commercial real estate recoveries in the current year.

 

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 Table 7  Net Charge-offs as a Percent of Average Loans Outstanding

 

    Three Months Ended
September 30,
            Nine Months Ended
September 30,
 
     2016     2015             2016     2015  

Commercial

            

Commercial

    .38     .34          .37     .25

Lease financing

    .23        .23                 .33        .23   

Total commercial

    .37        .33             .36        .25   

Commercial Real Estate

            

Commercial mortgages

    .06                           .01   

Construction and development

    (.14     (.43              (.04     (.42

Total commercial real estate

    .01        (.10          (.01     (.09

Residential Mortgages

    .08        .19             .12        .24   

Credit Card

    3.11        3.38             3.25        3.64   

Other Retail

            

Retail leasing

    .07        .14             .10        .09   

Home equity and second mortgages

    .02        .17             .02        .27   

Other

    .68        .65                 .68        .62   

Total other retail

    .41        .44                 .41        .44   

Total loans, excluding covered loans

    .47        .47             .48        .48   

Covered Loans

                                    

Total loans

    .46     .46              .48     .47

 

 

Residential mortgage loan net charge-offs for the third quarter of 2016 were $12 million (0.08 percent of average loans outstanding on an annualized basis), compared with $25 million (0.19 percent of average loans outstanding on an annualized basis) for the third quarter of 2015. Residential mortgage loan net charge-offs for the first nine months of 2016 were $48 million (0.12 percent of average loans outstanding on an annualized basis), compared with $93 million (0.24 percent of average loans outstanding on an annualized basis) for the first nine months of 2015. Credit card loan net charge-offs for the third quarter of 2016 were $161 million (3.11 percent of average loans outstanding on an annualized basis), compared with $153 million (3.38 percent of average loans outstanding on an annualized basis) for the third quarter of 2015. Credit card loan net charge-offs for the first nine months of 2016 were $495 million (3.25 percent of average loans outstanding on an annualized basis), compared with $485 million (3.64 percent of average loans outstanding on an annualized basis) for the first nine months of 2015. Other retail loan net charge-offs for the third quarter of 2016 were $54 million (0.41 percent of average loans outstanding on an annualized basis), compared with $54 million (0.44 percent of average loans outstanding on an annualized basis) for the third quarter of 2015. Other retail loan net charge-offs for the first nine months of 2016 were $159 million (0.41 percent of average loans outstanding on an annualized basis), compared with $161 million (0.44 percent of average loans outstanding on an annualized basis) for the first nine months of 2015. The decreases in total residential mortgage, credit card and other retail loan net charge-offs as a percentage of average loans outstanding on an annualized basis reflected the continued improvement in economic conditions.

 

The following table provides an analysis of net charge-offs as a percent of average loans outstanding for residential mortgages and home equity and second mortgages by borrower type:

 

    Three Months Ended September 30,             Nine Months Ended September 30,  
    Average Loans      Percent of
Average Loans
            Average Loans      Percent of
Average Loans
 
(Dollars in Millions)   2016      2015      2016     2015             2016      2015      2016     2015  

Residential Mortgages

                        

Prime borrowers

  $ 50,623       $ 45,108         .07     .13        $ 49,254       $ 44,501         .09     .17

Sub-prime borrowers

    980         1,124         .81        2.82             1,013         1,164         1.19        2.99   

Other borrowers

    528         689         .75        1.15             566         739         .71        1.09   

Loans purchased from GNMA mortgage pools (a)

    4,153         4,910                                4,501         5,054         .06        .08   

Total

  $ 56,284       $ 51,831         .08     .19        $ 55,334       $ 51,458         .12     .24

Home Equity and Second Mortgages

                        

Prime borrowers

  $ 15,958       $ 15,428         .02     .13        $ 15,864       $ 15,286         .01     .22

Sub-prime borrowers

    170         207                1.92             179         219         (.74     2.44   

Other borrowers

    342         448                .89                 368         475         .73        .84   

Total

  $ 16,470       $ 16,083         .02     .17            $ 16,411       $ 15,980         .02     .27

 

(a) Represents loans purchased from GNMA mortgage pools whose payments are primarily insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs.

 

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Analysis and Determination of the Allowance for Credit Losses The allowance for credit losses is established for probable and estimable losses incurred in the Company’s loan and lease portfolio, including unfunded credit commitments, and includes certain amounts that do not represent loss exposure to the Company because those losses are recoverable under loss sharing agreements with the FDIC. The allowance for credit losses is increased through provisions charged to operating earnings and reduced by net charge-offs. Management evaluates the allowance each quarter to ensure it appropriately reserves for incurred losses.

The allowance recorded for loans in the commercial lending segment is based on reviews of individual credit relationships and considers the migration analysis of commercial lending segment loans and actual loss experience. In the migration analysis applied to risk rated loan portfolios, the Company currently examines up to a 15-year period of historical loss experience. For each loan type, this historical loss experience is adjusted as necessary to consider any relevant changes in portfolio composition, lending policies, underwriting standards, risk management practices or economic conditions. The results of the analysis are evaluated quarterly to confirm an appropriate historical timeframe is selected for each commercial loan type. The allowance recorded for impaired loans greater than $5 million in the commercial lending segment is based on an individual loan analysis utilizing expected cash flows discounted using the original effective interest rate, the observable market price of the loan, or the fair value of the collateral, less selling costs, for collateral-dependent loans, rather than the migration analysis. The allowance recorded for all other commercial lending segment loans is determined on a homogenous pool basis and includes consideration of product mix, risk characteristics of the portfolio, bankruptcy experience, and historical losses, adjusted for current trends.

The allowance recorded for TDR loans and purchased impaired loans in the consumer lending segment is determined on a homogenous pool basis utilizing expected cash flows discounted using the original effective interest rate of the pool, or the prior quarter effective rate, respectively. The allowance for collateral-dependent loans in the consumer lending segment is determined based on the fair value of the collateral less costs to sell. The allowance recorded for all other consumer lending segment loans is determined on a homogenous pool basis and includes consideration of product mix, risk characteristics of the portfolio, bankruptcy experience, delinquency status, refreshed LTV ratios when possible, portfolio growth and historical losses, adjusted for current trends. Credit card and other retail loans 90 days or more past due are generally not placed on nonaccrual status because of the relatively short period of time to charge-off and, therefore, are excluded from nonperforming loans and measures that include nonperforming loans as part of the calculation.

When evaluating the appropriateness of the allowance for credit losses for any loans and lines in a junior lien position, the Company considers the delinquency and modification status of the first lien. At September 30, 2016, the Company serviced the first lien on 41 percent of the home equity loans and lines in a junior lien position. The Company also considers information received from its primary regulator on the status of the first liens that are serviced by other large servicers in the industry and the status of first lien mortgage accounts reported on customer credit bureau files. Regardless of whether or not the Company services the first lien, an assessment is made of economic conditions, problem loans, recent loss experience and other factors in determining the allowance for credit losses. Based on the available information, the Company estimated $330 million or 2.0 percent of its total home equity portfolio at September 30, 2016, represented non-delinquent junior liens where the first lien was delinquent or modified.

The Company uses historical loss experience on the loans and lines in a junior lien position where the first lien is serviced by the Company, or can be identified in credit bureau data, to establish loss estimates for junior lien loans and lines the Company services that are current, but the first lien is delinquent or modified. Historically, the number of junior lien defaults has been a small percentage of the total portfolio (approximately 1.1 percent annually), while the long-term average loss rate on loans that default has been approximately 90 percent. In addition, the Company obtains updated credit scores on its home equity portfolio each quarter, and in some cases more frequently, and uses this information to qualitatively supplement its loss estimation methods. Credit score distributions for the portfolio are monitored monthly and any changes in the distribution are one of the factors considered in assessing the Company’s loss estimates. In its evaluation of the allowance for credit losses, the Company also considers the increased risk of loss associated with home equity lines that are contractually scheduled to convert from a revolving status to a fully amortizing payment and with residential lines and loans that have a balloon payoff provision.

The allowance for the covered loan segment is evaluated each quarter in a manner similar to that described for non-covered loans, and represents any decreases in expected cash flows on those loans after the

 

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acquisition date. The provision for credit losses for covered loans considers the indemnification provided by the FDIC.

In addition, the evaluation of the appropriate allowance for credit losses for purchased non-impaired loans acquired after January 1, 2009, in the various loan segments considers credit discounts recorded as a part of the initial determination of the fair value of the loans. For these loans, no allowance for credit losses is recorded at the purchase date. Credit discounts representing the principal losses expected over the life of the loans are a component of the initial fair value. Subsequent to the purchase date, the methods utilized to estimate the required allowance for credit losses for these loans is similar to originated loans; however, the Company records a provision for credit losses only when the required allowance, net of any expected reimbursement under any loss sharing agreements with the FDIC, exceeds any remaining credit discounts.

The evaluation of the appropriate allowance for credit losses for purchased impaired loans in the various loan segments considers the expected cash flows to be collected from the borrower. These loans are initially recorded at fair value and, therefore, no allowance for credit losses is recorded at the purchase date.

Subsequent to the purchase date, the expected cash flows of purchased loans are subject to evaluation. Decreases in expected cash flows are recognized by recording an allowance for credit losses with the related provision for credit losses reduced for the amount reimbursable by the FDIC, where applicable. If the expected cash flows on the purchased loans increase such that a previously recorded impairment allowance can be reversed, the Company records a reduction in the allowance with a related reduction in losses reimbursable by the FDIC, where applicable. Increases in expected cash flows of purchased loans, when there are no reversals of previous impairment allowances, are recognized over the remaining life of the loans and resulting decreases in expected cash flows of the FDIC indemnification assets are amortized over the shorter of the remaining contractual term of the indemnification agreements or the remaining life of the loans.

The Company’s methodology for determining the appropriate allowance for credit losses for all the loan segments also considers the imprecision inherent in the methodologies used. As a result, in addition to the amounts determined under the methodologies described above, management also considers the potential impact of other qualitative factors which include, but are not limited to, economic factors; geographic and other concentration risks; delinquency and nonaccrual trends; current business conditions; changes in lending policy, underwriting standards, internal review and other relevant business practices; and the regulatory environment. The consideration of these items results in adjustments to allowance amounts included in the Company’s allowance for credit losses for each of the above loan segments.

Refer to “Management’s Discussion and Analysis —Analysis of the Allowance for Credit Losses” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, for further discussion on the analysis and determination of the allowance for credit losses.

At September 30, 2016, the allowance for credit losses was $4.3 billion (1.60 percent of period-end loans), compared with an allowance of $4.3 billion (1.65 percent of period-end loans) at December 31, 2015. The ratio of the allowance for credit losses to nonperforming loans was 310 percent at September 30, 2016, compared with 361 percent at December 31, 2015. The ratio of the allowance for credit losses to annualized loan net charge-offs was 346 percent at September 30, 2016, compared with 367 percent of full year 2015 net charge-offs at December 31, 2015.

 

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 Table 8  Summary of Allowance for Credit Losses

 

    Three Months Ended
September 30,
            Nine Months Ended
September 30,
 
(Dollars in Millions)           2016             2015             2016     2015  

Balance at beginning of period

  $ 4,329      $ 4,326           $ 4,306      $ 4,375   

Charge-Offs

            

Commercial

            

Commercial

    98        85             301        212   

Lease financing

    6        6                 21        18   

Total commercial

    104        91             322        230   

Commercial real estate

            

Commercial mortgages

    7        2             10        15   

Construction and development

    2                        9        1   

Total commercial real estate

    9        2             19        16   

Residential mortgages

    19        31             67        113   

Credit card

    182        171             559        543   

Other retail

            

Retail leasing

    2        3             7        6   

Home equity and second mortgages

    12        16             31        57   

Other

    70        58                 205        170   

Total other retail

    84        77             243        233   

Covered loans (a)

                                    

Total charge-offs

    398        372             1,210        1,135   

Recoveries

            

Commercial

            

Commercial

    14        17             65        65   

Lease financing

    3        3                 8        9   

Total commercial

    17        20             73        74   

Commercial real estate

            

Commercial mortgages

    2        2             11        12   

Construction and development

    6        11                 12        32   

Total commercial real estate

    8        13             23        44   

Residential mortgages

    7        6             19        20   

Credit card

    21        18             64        58   

Other retail

            

Retail leasing

    1        1             3        2   

Home equity and second mortgages

    11        9             29        25   

Other

    18        13                 52        45   

Total other retail

    30        23             84        72   

Covered loans (a)

                                    

Total recoveries

    83        80             263        268   

Net Charge-Offs

            

Commercial

            

Commercial

    84        68             236        147   

Lease financing

    3        3                 13        9   

Total commercial

    87        71             249        156   

Commercial real estate

            

Commercial mortgages

    5                    (1     3   

Construction and development

    (4     (11              (3     (31

Total commercial real estate

    1        (11          (4     (28

Residential mortgages

    12        25             48        93   

Credit card

    161        153             495        485   

Other retail

            

Retail leasing

    1        2             4        4   

Home equity and second mortgages

    1        7             2        32   

Other

    52        45                 153        125   

Total other retail

    54        54             159        161   

Covered loans (a)

                                    

Total net charge-offs

    315        292             947        867   

Provision for credit losses

    325        282             982        827   

Other changes (b)

    (1     (10              (3     (29

Balance at end of period (c)

  $ 4,338      $ 4,306               $ 4,338      $ 4,306   

Components

            

Allowance for loan losses

  $ 3,797      $ 3,965            

Liability for unfunded credit commitments

    541        341                

Total allowance for credit losses

  $ 4,338      $ 4,306                

Allowance for Credit Losses as a Percentage of

            

Period-end loans, excluding covered loans

    1.61     1.71         

Nonperforming loans, excluding covered loans

    309        347            

Nonperforming and accruing loans 90 days or more past due, excluding covered loans

    225        245            

Nonperforming assets, excluding covered assets

    264        280            

Annualized net charge-offs, excluding covered loans

    343        368            

Period-end loans

    1.60     1.69         

Nonperforming loans

    310        347            

Nonperforming and accruing loans 90 days or more past due

    202        208            

Nonperforming assets

    261        275            

Annualized net charge-offs

    346        372                            

 

(a) Relates to covered loan charge-offs and recoveries not reimbursable by the FDIC.
(b) Includes net changes in credit losses to be reimbursed by the FDIC and reductions in the allowance for covered loans where the reversal of a previously recorded allowance was offset by an associated decrease in the indemnification asset, and the impact of any loan sales.
(c) At September 30, 2016 and 2015, $1.5 billion and $1.6 billion, respectively, of the total allowance for credit losses related to incurred losses on credit card and other retail loans.

 

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Residual Value 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 September 30, 2016, no significant change in the amount of residual values or concentration of the portfolios had occurred since December 31, 2015. Refer to “Management’s Discussion and Analysis — Residual Value Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December  31, 2015, for further discussion on residual value risk management.

Operational Risk Management Operational risk is inherent in all business activities, and the management of this risk is important to the achievement of the Company’s objectives. Business lines have direct and primary responsibility and accountability for identifying, controlling, and monitoring operational risks embedded in their business activities. The Company maintains a system of controls with the objective of providing proper transaction authorization and execution, proper system operations, proper oversight of third parties with whom they do business, safeguarding of assets from misuse or theft, and ensuring the reliability and security of financial and other data. 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, 2015, for further discussion on operational risk management.

Compliance Risk Management The Company may suffer legal or regulatory sanctions, material financial loss, or damage to reputation through failure to comply with laws, regulations, rules, standards of good practice, and codes of conduct, including those related to compliance with Bank Secrecy Act/anti-money laundering requirements, sanctions compliance requirements as administered by the Office of Foreign Assets Control, consumer protection and other requirements. The Company has controls and processes in place for the assessment, identification, monitoring, management and reporting of compliance risks and issues. Refer to “Management’s Discussion and Analysis — Compliance Risk Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, for further discussion on compliance risk management.

Interest Rate Risk Management In the banking industry, changes in interest rates are a significant risk that can impact earnings, market valuations and the safety and soundness of an entity. To manage the impact on 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 Committee (“ALCO”) and approved by the Board of Directors. The ALCO has the responsibility for approving and ensuring compliance with the ALCO 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 Management estimates the impact on net interest income of changes in market interest rates under a number of scenarios, including gradual shifts, immediate and sustained parallel shifts, and flattening or steepening of the yield curve. Table 9 summarizes the projected impact to net interest income over the next 12 months of various potential interest rate changes. The ALCO policy limits the estimated change in net interest income in a gradual 200 basis point (“bps”) rate change scenario to a 4.0 percent decline of forecasted net interest income over the next 12 months. At September 30, 2016, and December 31, 2015, the Company was within policy. 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, 2015, for further discussion on net interest income simulation analysis.

Market Value of Equity Modeling The Company also manages interest rate sensitivity by utilizing market value of equity modeling, which 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. Management measures the impact of changes in market interest rates under a number of scenarios, including immediate and sustained

 

 Table 9  Sensitivity of Net Interest Income

 

    September 30, 2016             December 31, 2015  
     Down 50 bps
Immediate
     Up 50 bps
Immediate
    Down 200 bps
Gradual
     Up 200 bps
Gradual
            Down 50 bps
Immediate
     Up 50 bps
Immediate
    Down 200 bps
Gradual
     Up 200 bps
Gradual
 

Net interest income

    *         1.75     *         2.20              *         1.78     *         2.69

 

* Given the current level of interest rates, downward rate scenario is not computed.

 

 

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parallel shifts, and flattening or steepening of the yield curve. The ALCO policy limits the change in market value of equity in a 200 bps parallel rate shock to a 15.0 percent decline. A 200 bps increase would have resulted in a 1.9 percent decrease in the market value of equity at September 30, 2016, compared with a 5.8 percent decrease at December 31, 2015. A 200 bps decrease, where possible given current rates, would have resulted in a 14.0 percent decrease in the market value of equity at September 30, 2016, compared with a 7.0 percent decrease at December 31, 2015. The change in the market value of equity sensitivity to an immediate 200 bps decrease in the yield curve at September 30, 2016, as compared with December 31, 2015, was primarily due to assuming deposit rates do not decrease below zero, combined with lower rates on the long end of the yield curve. 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, 2015, for further discussion on market value of equity modeling.

Use of Derivatives to Manage Interest Rate and Other Risks To manage the sensitivity of earnings and capital to interest rate, prepayment, credit, price and foreign currency fluctuations (asset and liability management positions), the Company enters into derivative transactions. The Company uses derivatives for asset and liability management purposes primarily in the following ways:

  To convert fixed-rate debt from fixed-rate payments to floating-rate payments;
  To convert the cash flows associated with floating-rate debt from floating-rate payments to fixed-rate payments;
  To mitigate changes in value of the Company’s mortgage origination pipeline, funded MLHFS and MSRs;
  To mitigate remeasurement volatility of foreign currency denominated balances; and
  To mitigate the volatility of the Company’s investment in foreign businesses driven by fluctuations in foreign currency exchange rates.

The Company may enter into derivative contracts that are either exchange-traded, centrally cleared through clearinghouses or over-the-counter. In addition, the Company enters into interest rate and foreign exchange derivative contracts to support the business requirements of its customers (customer-related positions). The Company minimizes the market and liquidity risks of customer-related positions by either entering into similar offsetting positions with broker-dealers, or on a portfolio basis by entering into other derivative or non-derivative financial instruments that partially or fully offset the exposure from these customer-related positions. The Company does not utilize derivatives for speculative purposes.

The Company does not designate all of the derivatives that it enters into for risk management purposes as accounting hedges because of the inefficiency of applying the accounting requirements and may instead elect fair value accounting for the related hedged items. In particular, the Company enters into interest rate swaps, forward commitments to buy to-be-announced securities (“TBAs”), U.S. Treasury and Eurodollar futures and options on U.S. Treasury futures to mitigate fluctuations in the value of its MSRs, but does not designate those derivatives as accounting hedges.

Additionally, the Company uses forward commitments to sell TBAs and other commitments to sell residential mortgage loans at specified prices to economically hedge the interest rate risk in its residential mortgage loan production activities. At September 30, 2016, the Company had $9.1 billion of forward commitments to sell, hedging $4.0 billion of MLHFS and $6.0 billion of unfunded mortgage loan commitments. The forward commitments to sell and the unfunded mortgage loan commitments on loans intended to be sold are considered derivatives under the accounting guidance related to accounting for derivative instruments and hedging activities. The Company has elected the fair value option for the MLHFS.

Derivatives are subject to credit risk associated with counterparties to the contracts. Credit risk associated with derivatives is measured by the Company based on the probability of counterparty default. The Company manages the credit risk of its derivative positions by diversifying its positions among various counterparties, by entering into master netting arrangements, and, where possible, by requiring collateral arrangements. The Company may also transfer counterparty credit risk related to interest rate swaps to third parties through the use of risk participation agreements. In addition, certain interest rate swaps and forwards and credit contracts are required to be centrally cleared through clearinghouses to further mitigate counterparty credit risk.

For additional information on derivatives and hedging activities, refer to Notes 12 and 13 in the Notes to Consolidated Financial Statements.

Market Risk Management In addition to interest rate risk, the Company is exposed to other forms of market risk, principally related to trading activities which support customers’ strategies to manage their own foreign currency, interest rate risk and funding activities. For purposes of its internal capital adequacy assessment

 

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process, the Company considers risk arising from its trading activities employing methodologies consistent with the requirements of regulatory rules for market risk. The Company’s Market Risk Committee (“MRC”), within the framework of the ALCO, oversees market risk management. The MRC monitors and reviews the Company’s trading positions and establishes policies for market risk management, including exposure limits for each portfolio. The Company uses a Value at Risk (“VaR”) approach to measure general market risk. Theoretically, VaR represents the statistical risk of loss the Company has to adverse market movements over a one-day time horizon. The Company uses the Historical Simulation method to calculate VaR for its trading businesses measured at the ninety-ninth percentile using a one-year look-back period for distributions derived from past market data. The market factors used in the calculations include those pertinent to market risks inherent in the underlying trading portfolios, principally those that affect its corporate bond trading business, foreign currency transaction business, client derivatives business, loan trading business and municipal securities business. On average, the Company expects the one-day VaR to be exceeded by actual losses two to three times per year for its trading businesses. The Company monitors the effectiveness of its risk programs by back-testing the performance of its VaR models, regularly updating the historical data used by the VaR models and stress testing. If the Company were to experience market losses in excess of the estimated VaR more often than expected, the VaR models and associated assumptions would be analyzed and adjusted.

The average, high, low and period-end one-day VaR amounts for the Company’s trading positions were as follows:

 

Nine Months Ended September 30,

(Dollars in Millions)

  2016      2015  

Average

  $ 1       $ 1   

High

    1         2   

Low

    1         1   

Period-end

    1         1   

The Company did not experience any actual trading losses for its combined trading businesses that exceeded VaR during the nine months ended September 30, 2016 and 2015. The Company stress tests its market risk measurements to provide management with perspectives on market events that may not be captured by its VaR models, including worst case historical market movement combinations that have not necessarily occurred on the same date.

The Company calculates Stressed VaR using the same underlying methodology and model as VaR, except that a historical continuous one-year look-back period is utilized that reflects a period of significant financial stress appropriate to the Company’s trading portfolio. The period selected by the Company includes the significant market volatility of the last four months of 2008.

The average, high, low and period-end one-day Stressed VaR amounts for the Company’s trading positions were as follows:

 

Nine Months Ended September 30,

(Dollars in Millions)

  2016      2015  

Average

  $ 4       $ 4   

High

    7         8   

Low

    2         2   

Period-end

    5         3   

Valuations of positions in the client derivatives and foreign currency transaction businesses are based on discounted cash flow or other valuation techniques using market-based assumptions. These valuations are compared to third party quotes or other market prices to determine if there are significant variances. Significant variances are approved by the Company’s market risk management department. Valuation of positions in the corporate bond trading, loan trading and municipal securities businesses are based on trader marks. These trader marks are evaluated against third party prices, with significant variances approved by the Company’s market risk management department.

The Company also measures the market risk of its hedging activities related to residential MLHFS and MSRs using the Historical Simulation method. The VaRs are measured at the ninety-ninth percentile and employ factors pertinent to the market risks inherent in the valuation of the assets and hedges. The Company monitors the effectiveness of the models through back-testing, updating the data and regular validations. A three-year look-back period is used to obtain past market data for the models.

The average, high and low VaR amounts for the residential MLHFS and related hedges and the MSRs and related hedges were as follows:

 

Nine Months Ended September 30,

(Dollars in Millions)

  2016      2015  

Residential Mortgage Loans Held For Sale and Related Hedges

    

Average

  $       $ 1   

High

    2         2   

Low

              

Mortgage Servicing Rights and Related Hedges

    

Average

  $ 8       $ 6   

High

    11         8   

Low

    4         4   

Liquidity Risk Management The Company’s liquidity risk management process is designed to identify, measure, and manage the Company’s funding and liquidity risk to meet its daily funding needs and to address expected and

 

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unexpected changes in its funding requirements. The Company engages in various activities to manage its liquidity risk. These activities include diversifying its funding sources, stress testing, and holding readily-marketable assets which can be used as a source of liquidity if needed. In addition, the Company’s profitable operations, sound credit quality and strong capital position have enabled it to develop a large and reliable base of core deposit funding within its market areas and in domestic and global capital markets.

The Company’s Board of Directors approves the Company’s liquidity policy. The Risk Management Committee of the Company’s Board of Directors oversees the Company’s liquidity risk management process and approves the contingency funding plan. The ALCO reviews the Company’s liquidity policy and guidelines, and regularly assesses the Company’s ability to meet funding requirements arising from adverse company-specific or market events.

The Company regularly projects its funding needs under various stress scenarios and maintains a contingency funding plan consistent with the Company’s access to diversified sources of contingent funding. The Company maintains a substantial level of total available liquidity in the form of on-balance sheet and off-balance sheet funding sources. These include cash at the Federal Reserve Bank, unencumbered liquid assets, and capacity to borrow at the FHLB and the Federal Reserve Bank’s Discount Window. At September 30, 2016, the fair value of unencumbered available-for-sale and held-to-maturity investment securities totaled $99.7 billion, compared with $92.4 billion at December 31, 2015. Refer to Table 4 and “Balance Sheet Analysis” for further information on investment securities maturities and trends. Asset liquidity is further enhanced by the Company’s ability to pledge loans to access secured borrowing facilities through the FHLB and Federal Reserve Bank. At September 30, 2016, the Company could have borrowed an additional $85.3 billion at the FHLB and Federal Reserve Bank based on collateral available for additional borrowings.

The Company’s diversified deposit base provides a sizeable source of relatively stable and low-cost funding, while reducing the Company’s reliance on the wholesale markets. Total deposits were $334.6 billion at September 30, 2016, compared with $300.4 billion at December 31, 2015. Refer to “Balance Sheet Analysis” for further information on the Company’s deposits.

Additional funding is provided by long-term debt and short-term borrowings. Long-term debt was $38.0 billion at September 30, 2016, and is an important funding source because of its multi-year borrowing structure. Short-term borrowings were $15.7 billion at September 30, 2016, and supplement the Company’s other funding sources. Refer to “Balance Sheet Analysis” for further information on the Company’s long-term debt and short-term borrowings.

In addition to assessing liquidity risk on a consolidated basis, the Company monitors the parent company’s liquidity. The Company maintains sufficient funding to meet expected parent company obligations, without access to the wholesale funding markets or dividends from subsidiaries, for 12 months when forecasted payments of common stock dividends are included and 24 months assuming dividends were reduced to zero. The parent company currently has available funds considerably greater than the amounts required to satisfy these conditions.

At September 30, 2016, parent company long-term debt outstanding was $14.4 billion, compared with $11.5 billion at December 31, 2015. The $2.9 billion (25.5 percent) increase was primarily due to the issuances of $2.6 billion of medium-term notes and $1.0 billion of subordinated notes, partially offset by $500 million of subordinated note maturities. As of September 30, 2016, there was $1.3 billion of parent company debt scheduled to mature in the remainder of 2016.

Effective January 1, 2015, the Company became subject to a regulatory Liquidity Coverage Ratio (“LCR”) requirement. Certain transition provisions apply until full implementation by January 1, 2017. The LCR rule requires banks to maintain an adequate level of unencumbered high quality liquid assets to meet estimated liquidity needs over a 30-day stressed period. At September 30, 2016, the Company was compliant with the fully implemented LCR requirement based on its interpretation of the final U.S. LCR rule.

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, 2015, for further discussion on liquidity risk management.

European Exposures Certain European countries have experienced slower than historical economic growth conditions over the past several years. The Company provides merchant processing and corporate trust services in Europe either directly or through banking affiliations in Europe. Operating cash for these businesses is deposited on a short-term basis typically with certain European central banks. For deposits placed at other European banks, exposure is mitigated by the Company placing deposits at multiple banks and managing the amounts on deposit at any bank based on institution-specific deposit limits. At September 30, 2016, the

 

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Company had an aggregate amount on deposit with European banks of approximately $5.8 billion, predominately with the Central Bank of Ireland and Bank of England.

In addition, the Company provides financing to domestic multinational corporations that generate revenue from customers in European countries, transacts with various European banks as counterparties to certain derivative-related activities, and through a subsidiary manages money market funds that hold certain investments in European sovereign debt. Any further deterioration in economic conditions in Europe is unlikely to have a significant effect on the Company related to these activities. However, the effects on the Company which could result from the United Kingdom’s potential formal withdrawal from the European Union (“Brexit”) remain uncertain. Refer to “Risk Factors” in the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, for further information regarding potential impacts to the Company’s businesses, results of operations, financial condition, liquidity and capital resulting from Brexit.

Off-Balance Sheet Arrangements Off-balance sheet arrangements include any contractual arrangements 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. 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. Refer to Note 15 of the Notes to Consolidated Financial Statements for further information on these arrangements. The Company has not utilized private label asset securitizations as a source of funding. Off-balance sheet arrangements also include any obligation related to a variable interest held in an unconsolidated entity that provides financing, liquidity, credit enhancement or market risk support. Refer to Note 5 of the Notes to Consolidated Financial Statements for further information related to the Company’s interests in variable interest entities.

The FDIC has adopted a final rule that establishes a temporary premium surcharge applicable to the Company. The surcharge began in the third quarter of 2016 which impacts the Company’s expenses by approximately $23 million per quarter through 2018.

Capital Management The Company is committed to managing capital to maintain strong protection for depositors and creditors and for maximum shareholder benefit. The Company also manages its capital to exceed regulatory capital requirements for banking organizations. Beginning January 1, 2014, the regulatory capital requirements effective for the Company follow Basel III, subject to certain transition provisions from Basel I over the following four years to full implementation by January 1, 2018. Basel III includes two comprehensive methodologies for calculating risk-weighted assets: a general standardized approach and more risk-sensitive advanced approaches, with the Company’s capital adequacy being evaluated against the methodology that is most restrictive. Table 10 provides a summary of statutory regulatory capital ratios in effect for the Company at September 30, 2016 and December 31, 2015. All regulatory ratios exceeded regulatory “well-capitalized” requirements.

Effective January 1, 2018, the Company will be subject to a regulatory Supplementary Leverage Ratio (“SLR”) requirement for banks calculating capital adequacy using advanced approaches under Basel III. The SLR is defined as tier 1 capital divided by total leverage exposures, which includes both on- and off-balance sheet exposures. At September 30, 2016, the Company’s SLR exceeds the applicable minimum SLR requirement.

Total U.S. Bancorp shareholders’ equity was $47.8 billion at September 30, 2016, compared with $46.1 billion at December 31, 2015. The increase was primarily the result of corporate earnings and changes in unrealized gains and losses on available-for-sale investment securities included in other comprehensive income (loss), partially offset by dividends and common share repurchases.

The Company believes certain capital ratios in addition to statutory regulatory capital ratios are useful in evaluating its capital adequacy. The Company’s tangible common equity, as a percent of tangible assets and as a percent of risk-weighted assets calculated under the transitional standardized approach, was 7.5 percent and 9.3 percent, respectively, at September 30, 2016, compared with 7.6 percent and 9.2 percent, respectively, at December 31, 2015. The Company’s common equity tier 1 capital to risk-weighted assets ratio using the Basel III standardized approach as if fully implemented was 9.3 percent at September 30, 2016, compared with 9.1 percent at December 31, 2015. The Company’s common equity tier 1 capital to risk-weighted assets ratio using the Basel III advanced approaches as if fully implemented was 12.1 percent at September 30, 2016, compared with 11.9 percent at December 31, 2015. Refer to “Non-GAAP Financial Measures” for further information regarding the calculation of these ratios.

 

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 Table 10  Regulatory Capital Ratios

 

(Dollars in Millions)   September 30,
2016
    December 31,
2015
 

Basel III transitional standardized approach:

   

Common equity tier 1 capital

  $ 33,827      $ 32,612   

Tier 1 capital

    39,531        38,431   

Total risk-based capital

    47,452        45,313   

Risk-weighted assets

    356,733        341,360   

Common equity tier 1 capital as a percent of risk-weighted assets

    9.5     9.6

Tier 1 capital as a percent of risk-weighted assets

    11.1        11.3   

Total risk-based capital as a percent of risk-weighted assets

    13.3        13.3   

Tier 1 capital as a percent of adjusted quarterly average assets (leverage ratio)

    9.2        9.5   

Basel III transitional advanced approaches:

   

Common equity tier 1 capital

  $ 33,827      $ 32,612   

Tier 1 capital

    39,531        38,431   

Total risk-based capital

    44,368        42,262   

Risk-weighted assets

    272,832        261,668   

Common equity tier 1 capital as a percent of risk-weighted assets

    12.4     12.5

Tier 1 capital as a percent of risk-weighted assets

    14.5        14.7   

Total risk-based capital as a percent of risk-weighted assets

    16.3        16.2   

 

On June 29, 2016, the Company announced its Board of Directors had approved an authorization to repurchase up to $2.6 billion of its common stock, from July 1, 2016 through June 30, 2017.

The following table provides a detailed analysis of all shares purchased by the Company or any affiliated purchaser during the third quarter of 2016:

 

Period

(Dollars in Millions,

Except Per Share
Data)

  Total Number
of Shares
Purchased
    Average
Price Paid
Per Share
    Total Number of
Shares Purchased
as Part of Publicly
Announced
Program (a)
    Approximate Dollar
Value of Shares
that May Yet Be
Purchased Under
the Program
 

July

    7,900,309  (b)    $ 42.01        7,800,309      $ 2,272   

August

    4,564,954         42.98        4,564,954        2,076   

September

    3,080,931  (c)      43.22        3,030,931        1,945   

Total

    15,546,194  (d)    $ 42.53        15,396,194      $ 1,945   

 

(a) All shares were purchased under the stock repurchase program announced on June 29, 2016.
(b) Includes 100,000 shares of common stock purchased, at an average price per share of $40.94, in open-market transactions by U.S. Bank National Association, the Company’s banking subsidiary, in its capacity as trustee of the Company’s Employee Retirement Savings Plan.
(c) Includes 50,000 shares of common stock purchased, at an average price per share of $43.20, in open-market transactions by U.S. Bank National Association in its capacity as trustee of the Company’s Employee Retirement Savings Plan.
(d) Includes 150,000 shares of common stock purchased, at an average price per share of $41.69, in open-market transactions by U.S. Bank National Association in its capacity as trustee of the Company’s Employee Retirement Savings Plan.

On September 19, 2016, the Company announced its Board of Directors had approved a 9.8 percent increase in the Company’s dividend rate per common share from $0.255 per quarter to $0.28 per quarter.

Refer to “Management’s Discussion and Analysis —Capital Management” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, for further discussion on capital management.

LINE OF BUSINESS FINANCIAL REVIEW

The Company’s major lines of business are Wholesale Banking and Commercial Real Estate, Consumer and Small Business Banking, Wealth Management and Securities Services, Payment Services, and Treasury and Corporate Support. These operating segments are components of the Company about which financial information is prepared and is evaluated regularly by management 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. The allowance for credit losses and related provision expense are allocated to the lines of business based on the related loan balances managed. 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, 2015, 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 2016, certain organization and methodology changes were made and, accordingly, 2015 results were restated and presented on a comparable basis.

Wholesale Banking and Commercial Real Estate Wholesale Banking and Commercial Real Estate offers lending, equipment finance and small-ticket leasing, depository services, treasury management, capital markets services, international trade services and other financial services to middle market, large corporate, commercial real estate, financial institution, non-profit and public sector clients. Wholesale Banking and Commercial Real Estate contributed $230 million of the

 

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Company’s net income in the third quarter and $587 million in the first nine months of 2016, or an increase of $25 million (12.2 percent) and a decrease of $78 million (11.7 percent), respectively, compared with the same periods of 2015. The increase in the third quarter of 2016 over the same period of the prior year was primarily due to an increase in net revenue, partially offset by an increase in noninterest expense. The decrease in the first nine months of 2016 from the same period of the prior year was primarily due to increases in the provision for credit losses and noninterest expense, partially offset by an increase in net revenue.

Net revenue increased $51 million (7.0 percent) in the third quarter and $149 million (6.9 percent) in the first nine months of 2016, compared with the same periods of 2015. Net interest income, on a taxable-equivalent basis, increased $56 million (11.0 percent) in the third quarter and $143 million (9.6 percent) in the first nine months of 2016, compared with the same periods of 2015. The increases were primarily due to higher average loan and deposit balances, partially offset by lower rates on loans. Noninterest income decreased $5 million (2.2 percent) in the third quarter of 2016, compared with the third quarter of 2015, reflecting a large syndication transaction in the prior year and higher loan-related charges, partially offset by higher foreign currency customer activity and capital markets volume. Noninterest income increased $6 million (0.9 percent) in the first nine months of 2016, compared with the same period of 2015, driven by higher capital markets volume and foreign currency customer activity, partially offset by higher loan-related charges.

Noninterest expense increased $19 million (5.8 percent) in the third quarter and $61 million (6.2 percent) in the first nine months of 2016, compared with the same periods of 2015, primarily due to increases in variable costs allocated to manage the business, including the impact of the FDIC surcharge. The provision for credit losses decreased $7 million (8.8 percent) in the third quarter of 2016, compared with the third quarter of 2015, primarily due to a favorable change in the reserve allocation, partially offset by an increase in net charge-offs. The provision for credit losses increased $212 million in the first nine months of 2016, compared with the same period of 2015, primarily due to an increase in commercial loan net charge-offs and lower commercial real estate recoveries, along with an unfavorable change in the reserve allocation driven by loan growth and an increase in energy portfolio credit reserves.

Consumer and Small Business Banking Consumer and Small Business Banking delivers products and services through banking offices, telephone servicing and sales, on-line services, direct mail, ATM processing and mobile devices, such as mobile phones and tablet computers. It encompasses community banking, metropolitan banking and indirect lending, as well as mortgage banking. Consumer and Small Business Banking contributed $373 million of the Company’s net income in the third quarter and $1.1 billion in the first nine months of 2016, or increases of $61 million (19.6 percent) and $100 million (10.3 percent), respectively, compared with the same periods of 2015. The increase in the third quarter of 2016 over the same period of the prior year was primarily due to higher net revenue, partially offset by higher noninterest expense and an increase in the provision for credit losses. The increase in the first nine months of 2016 over the same period of the prior year was primarily due to higher net revenue and a decrease in the provision for credit losses, partially offset by higher noninterest expense.

Net revenue increased $136 million (7.6 percent) in the third quarter and $145 million (2.7 percent) in the first nine months of 2016, compared with the same periods of 2015. Net interest income, on a taxable-equivalent basis, increased $53 million (4.6 percent) in the third quarter and $122 million (3.6 percent) in the first nine months of 2016, compared with the same periods of 2015. The increases were primarily due to higher average loan and deposit balances, partially offset by lower loan rates. Noninterest income increased $83 million (13.2 percent) in the third quarter and $23 million (1.2 percent) in the first nine months of 2016, compared with the same periods of 2015, driven by higher mortgage banking revenue, reflecting the impact of higher origination and sales revenue in part due to refinancing activities in the marketplace.

Noninterest expense increased $26 million (2.1 percent) in the third quarter and $82 million (2.2 percent) in the first nine months of 2016, compared with the same periods of 2015, primarily due to higher net shared services expense and higher compensation expense, reflecting the impact of merit increases and increased staffing, partially offset by the impact of a prior year legal matter. In addition, the increase in the first nine months of 2016 included higher professional services expense, principally due to compliance-related matters. The provision for credit losses increased $14 million (45.2 percent) in the third quarter of 2016, compared with the third quarter of 2015, primarily due to an unfavorable change in the reserve allocation, partially offset by lower net charge-offs. The provision for credit losses decreased $96 million (81.4 percent) in the first nine months of 2016, compared with the same period of 2015, primarily due to a favorable change in the reserve allocation driven by improvements in the mortgage portfolio and lower net charge-offs.

 

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 Table 11  Line of Business Financial Performance

 

   

Wholesale Banking and

Commercial Real Estate

          

Consumer and Small

Business Banking

        

Three Months Ended September 30,

(Dollars in Millions)

  2016     2015     Percent
Change
           2016      2015     Percent
Change
        

Condensed Income Statement

                    

Net interest income (taxable-equivalent basis)

  $ 563      $ 507        11.0       $ 1,203       $ 1,150        4.6    

Noninterest income

    220        225        (2.2         712         629        13.2       

Securities gains (losses), net

                                                  

Total net revenue

    783        732        7.0            1,915         1,779        7.6       

Noninterest expense

    348        329        5.8            1,275         1,247        2.2       

Other intangibles

    1        1                   8         10        (20.0    

Total noninterest expense

    349        330        5.8            1,283         1,257        2.1       

Income before provision and income taxes

    434        402        8.0            632         522        21.1       

Provision for credit losses

    73        80        (8.8         45         31        45.2       

Income before income taxes

    361        322        12.1            587         491        19.6       

Income taxes and taxable-equivalent adjustment

    131        117        12.0            214         179        19.6       

Net income

    230        205        12.2            373         312        19.6       

Net (income) loss attributable to noncontrolling interests

                                                  

Net income attributable to U.S. Bancorp

  $ 230      $ 205        12.2          $ 373       $ 312        19.6       

Average Balance Sheet

                    

Commercial

  $ 70,813      $ 64,984        9.0       $ 10,546       $ 10,004        5.4    

Commercial real estate

    21,476        20,587        4.3            18,300         17,857        2.5       

Residential mortgages

    8        8                   53,933         49,924        8.0       

Credit card

                                                  

Other retail

    2        2                   50,785         46,717        8.7       

Total loans, excluding covered loans

    92,299        85,581        7.8            133,564         124,502        7.3       

Covered loans

                             4,107         4,839        (15.1    

Total loans

    92,299        85,581        7.8            137,671         129,341        6.4       

Goodwill

    1,647        1,647                   3,681         3,681              

Other intangible assets

    16        20        (20.0         2,270         2,661        (14.7    

Assets

    100,871        93,681        7.7            153,496         147,273        4.2       

Noninterest-bearing deposits

    36,624        36,929        (.8         28,380         26,514        7.0       

Interest checking

    9,628        7,528        27.9            43,827         40,005        9.6       

Savings products

    44,288        28,855        53.5            57,777         54,161        6.7       

Time deposits

    13,490        13,827        (2.4         14,280         15,439        (7.5    

Total deposits

    104,030        87,139        19.4            144,264         136,119        6.0       

Total U.S. Bancorp shareholders’ equity

    8,997        8,497        5.9                11,312         10,629        6.4           

 

   

Wholesale Banking and

Commercial Real Estate

          

Consumer and Small

Business Banking

        

Nine Months Ended September 30,

(Dollars in Millions)

  2016     2015     Percent
Change
           2016      2015     Percent
Change
        

Condensed Income Statement

                    

Net interest income (taxable-equivalent basis)

  $ 1,638      $ 1,495        9.6       $ 3,532       $ 3,410        3.6    

Noninterest income

    676        670        .9            1,900         1,877        1.2       

Securities gains (losses), net

                                                  

Total net revenue

    2,314        2,165        6.9            5,432         5,287        2.7       

Noninterest expense

    1,047        986        6.2            3,704         3,616        2.4       

Other intangibles

    3        3                   24         30        (20.0    

Total noninterest expense

    1,050        989        6.2            3,728         3,646        2.2       

Income before provision and income taxes

    1,264        1,176        7.5            1,704         1,641        3.8       

Provision for credit losses

    342        130        *            22         118        (81.4    

Income before income taxes

    922        1,046        (11.9         1,682         1,523        10.4       

Income taxes and taxable-equivalent adjustment

    335        381        (12.1         613         554        10.6       

Net income

    587        665        (11.7         1,069         969        10.3       

Net (income) loss attributable to noncontrolling interests

                                                  

Net income attributable to U.S. Bancorp

  $ 587      $ 665        (11.7       $ 1,069       $ 969        10.3       

Average Balance Sheet

                    

Commercial

  $ 70,412      $ 63,828        10.3       $ 10,367       $ 9,839        5.4    

Commercial real estate

    21,099        20,519        2.8            18,143         17,902        1.3       

Residential mortgages

    7        8        (12.5         53,127         49,678        6.9       

Credit card

                                                  

Other retail

    2        3        (33.3         49,738         46,301        7.4       

Total loans, excluding covered loans

    91,520        84,358        8.5            131,375         123,720        6.2       

Covered loans

                             4,289         5,006        (14.3    

Total loans

    91,520        84,358        8.5            135,664         128,726        5.4       

Goodwill

    1,647        1,647                   3,681         3,681              

Other intangible assets

    17        21        (19.0         2,393         2,573        (7.0    

Assets

    99,937        92,805        7.7            150,704         146,200        3.1       

Noninterest-bearing deposits

    36,498        35,742        2.1            27,111         25,539        6.2       

Interest checking

    8,202        7,563        8.4            43,175         39,672        8.8       

Savings products

    40,028        27,194        47.2            57,057         53,381        6.9       

Time deposits

    13,000        15,467        (16.0         14,392         16,130        (10.8    

Total deposits

    97,728        85,966        13.7            141,735         134,722        5.2       

Total U.S. Bancorp shareholders’ equity

    8,927        8,261        8.1                11,138         10,944        1.8           

 

* Not meaningful

 

30    U.S. Bancorp


Table of Contents

 

       

Wealth Management and

Securities Services

    

Payment

Services

           

Treasury and

Corporate Support

           

Consolidated

Company

 
        2016     2015      Percent
Change
            2016             2015     Percent
Change
            2016     2015     Percent
Change
            2016     2015     Percent
Change
 
                                           
   $ 135      $ 90         50.0        $ 538         $ 484        11.2        $ 504      $ 590        (14.6 )%         $ 2,943      $ 2,821        4.3
     403        368         9.5             912           874        4.3             188        231        (18.6          2,435        2,327        4.6   
                                                                         10        (1     *             10        (1     *   
     538        458         17.5             1,450           1,358        6.8             702        820        (14.4          5,388        5,147        4.7   
     383        355         7.9             679           635        6.9             201        167        20.4             2,886        2,733        5.6   
           6        7         (14.3          30                 24        25.0                                       45        42        7.1   
           389        362         7.5             709                 659        7.6             201        167        20.4             2,931        2,775        5.6   
     149        96         55.2             741           699        6.0             501        653        (23.3          2,457        2,372        3.6   
           (1     1         *             208                 180        15.6                    (10     *             325        282        15.2   
     150        95         57.9             533           519        2.7             501        663        (24.4          2,132        2,090        2.0   
           55        35         57.1             194                 189        2.6             22        67        (67.2          616        587        4.9   
     95        60         58.3             339           330        2.7             479        596        (19.6          1,516        1,503        .9   
                                      (8              (8                 (6     (6                 (14     (14       
         $ 95      $ 60         58.3           $ 331               $ 322        2.8           $ 473      $ 590        (19.8        $ 1,502      $ 1,489        .9   
                                           
   $ 2,892      $ 2,212         30.7        $ 7,766         $ 7,239        7.3        $ 352      $ 265        32.8        $ 92,369      $ 84,704        9.0
     513        570         (10.0                                       3,085        3,302        (6.6          43,374        42,316        2.5   
     2,343        1,887         24.2                                                 12        *            56,284        51,831        8.6   
                                20,628           17,944        15.0                                       20,628        17,944        15.0   
           1,549        1,544         .3             515                 586        (12.1                                    52,851        48,849        8.2   
     7,297        6,213         17.4             28,909           25,769        12.2             3,437        3,579        (4.0          265,506        245,644        8.1   
                  1         *                                                24        52        (53.8          4,131        4,892        (15.6
     7,297        6,214         17.4             28,909           25,769        12.2   <