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(U.S. BANCORP)

(U.S. BANCORP LOGO) (DYNAMIC STARS DIE FPO)

(U.S. BANCORP)

 


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c o r p o r a t e
p r o f i l e

U.S. Bancorp, headquartered in Minneapolis, is the 8th largest financial services holding company in the United States with total assets exceeding $189 billion at year-end 2003.

Through U.S. Bank® and other subsidiaries, U.S. Bancorp serves 11.6 million customers, primarily through 2,243 full-service branch offices in 24 states. Customers also access their accounts and conduct all or part of their banking transactions through 4,425 U.S. Bank ATMs, U.S. Bank Internet Banking and telephone banking. In addition, a network of specialized U.S. Bancorp offices and representatives across the nation serves customers inside and outside our 24-state footprint through comprehensive product sets that meet the financial needs of customers beyond basic core banking. Backed by expertise and advanced technology, these sophisticated U.S. Bancorp products and services include large corporate services, payment services, private banking, personal and institutional trust services, corporate trust services, specialized large-scale government banking services, mortgage, commercial credit vehicles, and financial and asset management services.

Major lines of business provided by U.S. Bancorp through U.S. Bank and other subsidiaries include Consumer Banking; Payment Services; Private Client, Trust & Asset Management; and Wholesale Banking. U.S. Bank is home of the exclusive U.S. Bank Five Star Service Guarantee.

(DYNAMIC STARS DIE FPO)

     
U.S. BANCORP AT A GLANCE
Ranking
  8th largest bank in the U.S.

 
Asset size
  $189 billion

 
Deposits
  $119 billion

 
Loans
  $118 billion

 
Earnings per share (diluted)
  $1.93

 
Return on average assets
  1.99%

 
Return on average equity
  19.2%

 
Tangible common equity
  6.5%

 
Efficiency ratio
  45.6%

 
Customers
  11.6 million

 
Primary banking region
  24 states

 
Bank branches
  2,243

 
ATMs
  4,425

 
NYSE
  USB
 
   
At year-end 2003
   


 


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f i n a n c i a l   s e c t i o n
   
 
   
Management’s Discussion and Analysis
  pg. 18
 
   
Consolidated Financial Statements
  pg. 62
 
   
Notes to Consolidated Financial Statements
  pg. 66
 
   
Reports of Independent Auditors and Accountants
  pg. 105
 
   
Five-Year Consolidated Financial Statements
  pg. 106
 
   
Quarterly Consolidated Financial Data
  pg. 108
 
   
Supplemental Financial Data
  pg. 109
 
   
Annual Report on Form 10-K
  pg. 112
 
   
CEO and CFO Certifications
  pg. 119
 
   
Executive Officers
  pg. 122
 
   
Directors
  pg. 123
 
   
Corporate Information inside
  back cover               
 Amendments to Non-Qualified Exec. Retirement Plan
 Executive Employees Deferred Compensation Plan
 Form of Change in Control Agreement
 Computation of Ratio of Earnings to Fixed Charges
 Subsidiaries of the Registrant
 Consent of Ernst & Young LLP
 Consent of PricewaterhouseCoopers LLP
 Certification of CEO Pursuant to Rule 13a-14(a)
 Certification of CFO Pursuant to Rule 13a-14(a)
 Certification of CEO and CFO Pursuant to Sec. 906

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g r a p h s  o f  s e l e c t e d
f i n a n c i a l
 h i g h l i g h t s

(BAR CHARTS)

  * Information was not available to compute pre-merger proforma percentage.
  (a)   Dividends per share have not been restated for the 2001 Firstar/USBM merger.
  (b)   Computed as noninterest expense divided by the sum of net interest income on a taxable-equivalent basis and noninterest income excluding securities gains (losses), net.

 


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     f i n a n c i a l  s u m m a r y

                                         
Year Ended December 31                           2003   2002
(Dollars and Shares in Millions, Except Per Share Data)   2003   2002   2001   v 2002   v 2001

 
Total net revenue (taxable-equivalent basis)
  $ 12,530.5     $ 12,057.9     $ 11,074.6       3.9 %     8.9 %
Noninterest expense
    5,596.9       5,740.5       6,149.0       (2.5 )     (6.6 )
Provision for credit losses
    1,254.0       1,349.0       2,528.8                  
Income taxes and taxable-equivalent adjustments
    1,969.5       1,740.4       872.8                  
   
 
               
Income from continuing operations
  $ 3,710.1     $ 3,228.0     $ 1,524.0       14.9       111.8  
Discontinued operations (after-tax)
    22.5       (22.7 )     (45.2 )                
Cumulative effect of accounting change (after-tax)
          (37.2 )                      
   
 
               
Net income
  $ 3,732.6     $ 3,168.1     $ 1,478.8       17.8       114.2  
   
 
               
Per Common Share
                                       
Earnings per share from continuing operations
  $ 1.93     $ 1.68     $ .79       14.9 %     112.7 %
Diluted earnings per share from continuing operations
    1.92       1.68       .79       14.3       112.7  
Earnings per share
    1.94       1.65       .77       17.6       114.3  
Diluted earnings per share
    1.93       1.65       .76       17.0       117.1  
Dividends declared per share
    .855       .780       .750       9.6       4.0  
Book value per share
    10.01       9.62       8.58       4.1       12.1  
Market value per share
    29.78       21.22       20.93       40.3       1.4  
Average shares outstanding
    1,923.7       1,916.0       1,927.9       .4       (.6 )
Average diluted shares outstanding
    1,936.2       1,924.8       1,940.3       .6       (.8 )
Financial Ratios
                                       
Return on average assets
    1.99 %     1.84 %     .89 %                
Return on average equity
    19.2       18.3       9.0                  
Net interest margin (taxable-equivalent basis)
    4.49       4.65       4.46                  
Efficiency ratio
    45.6       48.8       57.2                  
Average Balances
                                       
Loans
  $ 118,362     $ 114,453     $ 118,177       3.4 %     (3.2 )%
Investment securities
    37,248       28,829       21,916       29.2       31.5  
Earning assets
    160,808       147,410       143,501       9.1       2.7  
Assets
    187,630       171,948       165,944       9.1       3.6  
Deposits
    116,553       105,124       104,956       10.9       .2  
Total shareholders’ equity
    19,393       17,273       16,426       12.3       5.2  
Period End Balances
                                       
Loans
  $ 118,235     $ 116,251     $ 114,405       1.7 %     1.6 %
Allowance for credit losses
    2,369       2,422       2,457       (2.2 )     (1.4 )
Investment securities
    43,334       28,488       26,608       52.1       7.1  
Assets
    189,286       180,027       171,390       5.1       5.0  
Deposits
    119,052       115,534       105,219       3.0       9.8  
Total shareholders’ equity
    19,242       18,436       16,745       4.4       10.1  
Regulatory capital ratios
                                       
Tangible common equity
    6.5 %     5.7 %     5.9 %                
Tier 1 capital
    9.1       8.0       7.8                  
Total risk-based capital
    13.6       12.4       11.9                  
Leverage
    8.0       7.7       7.9                  


Forward-Looking Statements This Annual Report and Form 10-K contains forward-looking statements. Statements that are not historical or current facts, including statements about beliefs and expectations, are forward-looking statements. These statements often include the words “may,” “could,” “would,” “should,” “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions. These forward-looking statements cover, among other things, anticipated future revenue and expenses and the future 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, including the following, in addition to those contained in U.S. Bancorp’s reports on file with the SEC: (i) general economic or industry conditions could be less favorable than expected, resulting in a deterioration in credit quality, a change in the allowance for credit losses, or a reduced demand for credit or fee-based products and services; (ii) changes in the domestic interest rate environment could reduce net interest income and could increase credit losses; (iii) inflation, changes in securities market conditions and monetary fluctuations could adversely affect the value or credit quality of our assets, or the availability and terms of funding necessary to meet our liquidity needs; (iv) changes in the extensive laws, regulations and policies governing financial services companies could alter our business environment or affect operations; (v) the potential need to adapt to industry changes in information technology systems, on which we are highly dependent, could present operational issues or require significant capital spending; (vi) competitive pressures could intensify and affect our profitability, including as a result of continued industry consolidation, the increased availability of financial services from non-banks, technological developments or bank regulatory reform; (vii) changes in consumer spending and savings habits could adversely affect our results of operations; (viii) changes in the financial performance and condition of our borrowers could negatively affect repayment of such borrowers’ loans; (ix) acquisitions may not produce revenue enhancements or cost savings at levels or within time frames originally anticipated, or may result in unforeseen integration difficulties; (x) capital investments in our businesses may not produce expected growth in earnings anticipated at the time of the expenditure; and (xi) acts or threats of terrorism, and/or political and military actions taken by the U.S. or other governments in response to acts or threats of terrorism or otherwise could adversely affect general economic or industry conditions. Forward-looking statements speak only as of the date they are made, and U.S. Bancorp undertakes no obligation to update them in light of new information or future events.

 


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“We are pleased to tell you that in 2003, we reported record earnings and also achieved the financial results to which we had committed.”

f e l l o w
s h a r e h o l d e r s :

Strong financial results. U.S. Bancorp delivered strong financial results in 2003, the culmination of five years of transformation and integration, during which we forged a company uniquely positioned to generate consistent earnings and revenue growth.

    Earnings per share increased 17.6% over 2002
    Record net income increased 17.8% over 2002
    Industry-leading Return on Assets of 1.99%
    Industry-leading Return on Equity of 19.2%
    Industry-leading Tangible Common Equity of 6.5%
    Positive debt rating changes by the rating agencies

Growing U.S. Bancorp. With virtually all integration and merger-related activities behind us, we are now focused solely on growing U.S. Bancorp by leveraging the breadth and depth of the powerful franchise we have built. Our five-year transformation allowed us to gain access to high-growth markets, to solidify strong regional positions and to build a national platform. During our integration process, we accelerated our cost control leadership. We are now extending that cost and execution leadership, as well as making significant strategic investments in our highest-potential businesses, and reaffirming our focus on delivering high-quality service.

Achieving our goals to build a stronger corporation. I am pleased to tell you that U.S. Bancorp accomplished the performance, credit quality and other goals we had previously committed to achieving. We met financial objectives — in particular, revenue growth, expense management, net interest margin and earnings per share.

In addition, and perhaps most importantly, we continue to show improvement in overall credit quality, a direct result of all we have done in the past two years to reduce this corporation’s risk profile. We also completed the spin-off of Piper Jaffray, further reducing risk and volatility in our business. Finally, we began a major expansion of our distribution channels in fast-growing markets within our franchise through the previously announced in-store branch partnerships with Safeway/Vons, Smith’s and Publix.

140 years of creating value for shareholders. We have targeted returning 80 percent of our earnings to shareholders through a combination of dividends and share repurchases.

The 17 percent common stock dividend increase approved by our Board of Directors and announced in December 2003 is a continuation of a long history of paying significant dividends, as well as a reflection of the Board’s confidence in this corporation’s future success.

U.S. Bancorp, through its predecessor companies, has increased its dividend in each of the past 32 years and has paid a dividend for 140 consecutive years.

In addition to the common stock dividend discussed above, as part of the December 2003 spin-off of Piper Jaffray, U.S. Bancorp distributed common shares of the new Piper Jaffray Companies in the form of a special dividend to eligible U.S. Bancorp shareholders.

Also in December 2003, our Board of Directors approved authorization to repurchase 150 million shares of outstanding U.S. Bancorp common stock during the next two years.

These specific steps were undertaken to increase the value of your shares; in addition, we manage this corporation with the long-term value of your investment as our paramount objective. It’s the reason we come to work each day.

Sincerely,

(-s- Jerry A. Grundhofer)

Jerry A. Grundhofer
Chairman, President and Chief Executive Officer
U.S. Bancorp
February 27, 2004




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c o r p o r a t e
g o v e r n a n c e

Good corporate governance promotes ethical business practices, demands meticulous accounting policies and procedures and includes a structure with effective checks and balances. Corporate governance is vital to the continued success of U.S. Bancorp and the entire financial services industry. Our ethical standards have rewarded us with an enviable reputation in today’s marketplace — a marketplace where trust is hard to earn. Our shareholders, customers, communities and employees demand — and deserve — to do business with companies they can trust. U.S. Bancorp operates with uncompromising honesty and integrity. Our Board of Directors has had a Corporate Governance Committee for many years. We have implemented Corporate Governance Guidelines in response to today’s heightened concern. Our Corporate Governance Guidelines are available for you to view on our Internet web site at usbank.com. Following are some of the important elements of our Corporate Governance practices.

Independent oversight. Each of our Audit Committee, Compensation Committee and Governance Committee is composed entirely of independent outside directors. In fact, following our annual meeting, our Chairman, President and Chief Executive Officer will be the only member of our Board of Directors who is not independent. In addition, our Board of Directors and the committees of the Board meet in “executive session” without management in attendance at every meeting. The presiding director at every executive session of the Board is an independent director. The Board and each committee also have express authority to engage outside advisors to provide additional independent expertise for their deliberations.

Board of Directors’ focus on U.S. Bancorp. To ensure that our directors are able to focus effectively on our business, we limit the number of other public company boards a director may serve on to three. The Chairman, President and Chief Executive Officer of U.S. Bancorp serves on only two other public company boards. Audit Committee members may serve on no more than three other public company audit committees, and the chairman of the Audit Committee serves on no other audit committees.

Board of Directors’ knowledge and expertise. All of our directors are skilled business leaders. Directors are encouraged to attend continuing director education seminars in order to keep a sharp focus on current good governance practices. In addition, the Board and each committee may use outside advisors to add expertise on specific issues. Our directors have full and

unrestricted access to our management and employees. Additionally, key members of management attend Board meetings from time to time to present information about the results, plans and operations of their business segments. The Board and each committee perform annual self-evaluations in order to assess their performance and to ensure that the Board and committee structure is providing effective oversight of corporate management. You may review the charters of each of our Board committees on our Internet web site at usbank.com.

Management’s ownership commitment. We understand clearly that U.S. Bancorp shareholders are the primary beneficiaries of management’s actions. All U.S. Bancorp executive officers and directors own shares of company stock, and in order to tightly align management’s interests with those of our shareholders, we have established stock ownership guidelines for our executive officers.

Disclosure controls. We have established rigorous procedures to ensure that we provide complete and accurate disclosure in our publicly filed documents. We have also established a telephone hotline for employees to anonymously submit any concern they may have regarding corporate controls or ethical breaches. Management investigates all complaints and directs to our Audit Committee any issues relating to concerns about our financial statements or public disclosures.

U.S. Bancorp Code of Ethics and Business Conduct. Each year, we reiterate the vital importance of our Code of Ethics and Business Conduct. The Code applies to directors, officers and all employees, who must certify annually their compliance with the standards of the Code. The content of the Code is based not solely on what we have the right to do, but, even more importantly, on what is the right thing to do. Our standards are higher than any legal minimum because our business is built on trust. You may review our Code of Ethics and Business Conduct on our Internet web site at usbank.com.

Communications with our Board of Directors. Shareholders can communicate with our Board of Directors by sending a letter addressed to the Board of Directors, the independent outside directors or specified individual directors, to:

The Office of the Corporate Secretary
U.S. Bancorp
800 Nicollet Mall
Minneapolis, MN 55402



















(STATUE OF LIBERTY)



 


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s e r v i c e
e x c e l l e n c e

Great service is more than our goal; it’s the way we do business. Every U.S. Bancorp employee in every U.S. Bancorp line of business is committed to providing responsive, prompt and helpful service - every transaction, every relationship, every day. And our exclusive Five Star Service Guarantee backs up our promise to deliver the outstanding service our customers expect and deserve.

Five Star Service Guarantee ensures highest level of service. Exceptional service is the single most important thing U.S. Bank offers our customers. We make a promise to deliver the highest level of customer service and we boldly back up this pledge with the U.S. Bank Five Star Service Guarantee, which ensures the core service standards most important to our customers — such as availability, accuracy, timeliness and responsiveness — are met and exceeded. Every U.S. Bank customer is covered by one or more guarantees. If we fall short in keeping our service guarantees, and our customer tells us they did not get the service they expected and deserved, we pay the customer for the inconvenience.

Taking ownership of our business one employee at a time. Each line of business has developed and adapted its own Five Star Service Guarantee, defining the quality standards that are expected and demanded of every employee — standards that are based on meeting the diverse financial needs of all our customers. U.S. Bank has created an environment in which employees understand how their individual service and sales performance contributes to revenue growth and

(PICTURE)

 


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shareholder value. It is an environment where employees take ownership of their business, where they are held accountable for the company’s success and where they are compensated for measurable performance results.

Service is foundation of success. U.S. Bank employees are recognized and rewarded for their outstanding service. Our Pay for Performance compensation program rewards employees financially and personally for their achievements in meeting service and sales goals and for their contributions to company earnings. Customized line of business incentive programs drive employees to generate revenue while fulfilling customers’ needs. Each quarter, 20 selected employees who exemplify our high service standards are inducted into the prestigious Circle of Service Excellence.

The Service Advantage puts customers at center of everything we do. To deepen our commitment to superior service, in 2003, we launched The Service Advantage, an innovative internal initiative designed to increase customer access and convenience; simplify customer issue solutions; make quality service central to hiring, orientation and training; and improve the common customer experience. Our Service Council is the driving force behind The Service Advantage; it is comprised of senior managers from every line of business who identify areas of improvement, analyze customer satisfaction measurements and implement resolutions that create greater customer satisfaction and loyalty. We are enhancing existing and creating new internal service techniques and processes, as well, so that our frontline employees have the tools and support they need to better meet customer expectations. By the end of first quarter 2004, every U.S. Bank employee will have received personalized training on the core principles of The Service Advantage.













Cacique® is the #1 selling brand of Hispanic-style cheeses and creams in the world. For over three decades, the family owned and operated company has produced authentic cheeses, creams and chorizos, growing from a small, abandoned facility to one of the world’s most sophisticated cheese manufacturing facilities. Cacique is committed to quality, heritage and tradition, sharing this legacy with the community through a long history of philanthropy, including Fighting Diabetes Together, a recent collaboration with City of Hope®. U.S. Bank Commercial Banking partners with Cacique to provide flexible, competitive products to meet the financial needs of this unique company.



(GILBERT DE CARDENAS COMMENT)

 


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U.S. Bancorp meets the diverse financial needs of our customers by providing innovative, creative answers through specialized lines of business. Across 24 states and beyond, our experienced bankers share ideas, best practices, capabilities and cross-sell opportunities, supported by advanced technology and operating systems. The results are competitive benefits for our customers and competitive advantages for U.S. Bancorp.



l i n e s  o f
b u s i n e s s

KEY BUSINESS UNITS

    Commercial Banking
    Commercial Real Estate
    Corporate Banking
    Correspondent Banking
    Dealer Commercial Services
    Equipment Leasing
    Foreign Exchange
    Government Banking
    International Banking
    Specialized Industries
    Treasury Management

Wholesale Banking offers strategic lending, depository, treasury management and other financial services to middle market, large corporate, financial institution and public sector customers. Experienced, accessible relationship managers serve as our customers’ link to all the products, credit, support and resources that the extensive scope of U.S. Bancorp provides.

S U C C E S S E S

  Launched U.S. Bank Returned Check Management, providing customers the capability to consolidate all returned items to one location, convert them to electronic items and monitor collection on a state-of-the-art web-based reporting system.
  Introduced Global Trade Works, an industry-leading web-based Trade Finance Product Suite; delivers increased customer productivity by providing secure online access to real-time data and extensive reporting capabilities, and allows customers to initiate letters of credit via the Internet.
  Introduced enhancements to U.S. Bank ONLINE BANKER services, a web-based cash management solution; provides a single point of access to information reporting, plus the initiation of wire transfers, ACH, book transfers, stop payments and data export functions.
  Expanded U.S. Bank FIRSTLook Now, a new wholesale lockbox image service that offers same-day, online customer access to wholesale lockbox checks and invoices, plus added CD-ROM archive capabilities.
  Developed a new remittance processing system for government banking customers that integrates payment and remittance information received over the Internet via a newest generation image-based lockbox system; speeds processing, provides more valuable incoming payment information, enhances service quality and is scalable and upgradable as customer needs change.

(KIM HERMAN QUOTE) The Washington State Housing Finance Commission seeks partnerships that create greater access to housing and community services throughout the state of Washington. U.S. Bank Corporate Trust Services provides the continuous, personalized service and customized administration capabilities that are vital to the success and growth of the Housing Finance Commission.

 


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KEY BUSINESS UNITS

    Corporate Payment Systems
    Travel and entertainment, purchasing, fleet, freight payment systems and business-to-business payment

    NOVA Information Systems, Inc.
    Merchant processing with top 3 market share

    Retail Payment Solutions
    Relationship-based retail payment solutions; includes credit, debit and stored value cards through U.S. Bank, Elan financial institutions and co-brand partners

    Transaction Services
    ATM Banking
    Elan Financial Services, a single source provider of transaction processing for financial institutions nationwide

Our unique Payment Services business specializes in credit and debit cards, commercial card services, business-to-business payment and ATM and merchant processing. Customized products delivered through leading-edge technology channels equip consumers, small businesses, merchants of every size, government entities, large corporations, financial institutions and co-brand partners with the most advanced payment services tools available.

S U C C E S S E S

  Released AccountCommander, Voyager Fleet Systems’ newest online account maintenance tool, to customers nationwide, marking the first phase of Voyager’s FleetCommander Online, a web-based fuel management program designed to provide complete, convenient online account access.
  Introduced eQuest,™ an Internet-based application that allows financial institution customers to analyze and report on daily ATM and debit transaction activity; eQuest generates a suite of informational reports with customized selection criteria.
  Expanded the Fastbank® ATM network through Elan Financial Services to become the 12th largest ATM network in the nation.
  Launched Electronic Check Service and Electronic Gift Card programs through NOVA Information Systems; these value-added products enhance the payment services offerings for bank partners, and improve cash flow and point-of-sale operations for merchant customers.
  Entered the health care payment segment through the MedAssist Advantage Plan (MAP), offering a new solution for patient financing.


KEY BUSINESS UNITS

    Corporate Trust Services
    Escrow
    Public Finance/Structured Finance/Corporate Finance
    Document Custody

    Institutional Trust & Custody
    Retirement Plans
    Institutional Custody
    Master Trust

    Private Client Group
    Private Banking
    Personal Trust
    Investment Management
    Financial and Estate Planning

    U.S. Bancorp Asset Management, Inc.
    First American Funds™
    Private Asset Management
    Institutional Advisory
    Securities Lending

    U.S. Bancorp Fund Services, LLC
    Mutual Fund Administration and Compliance
    Transfer Agent
    Mutual Fund Accounting
    Fund Distribution
    Partnership Administration
    Offshore Trust Administration

Private Client, Trust & Asset Management meets diverse wealth management needs through best-in-class personal trust, corporate trust, institutional trust and custody, private banking, financial advisory, investment management and mutual fund and alternative investment product services. Expert advisers and relationship managers offering sophisticated knowledge and personalized service give U.S. Bank a competitive advantage.

S U C C E S S E S

  Launched a number of new products to meet individual and institutional investors’ needs, including the First American Stable Asset Advisor Fund - designed for investors who seek preservation of principal and competitive returns; new institutional-class money market shares; and a unique alliance with Coast Asset Management to provide qualified investors with absolute-return hedge-fund-of-fund products.
  Expanded U.S. Bancorp Fund Services, LLC service offerings to include private investment products, such as investment partnerships and separately managed accounts.
  Unveiled the U.S. Bank Trust Investor Reporting web site usbank.com/abs, providing investors in public and private corporate trust transactions the ability to assign entitlements for access to private deals; offers a customized portfolio, improved factor and payment searching and a simplified navigational flow for excellent customer usability.
  Expanded TrustNow Essentials, a new comprehensive online reporting system allowing Corporate Trust Services, Institutional Trust & Custody and Private Client Group customers to view, print and download trust statements and reports via the Internet 24 hours a day, seven days a week.
  Successfully completed purchase of State Street Corporate Trust and resulting systems conversions, seamlessly integrating approximately 20,000 new client issuances, 365,000 bondholders and $689 billion in assets to the U.S. Bank Corporate Trust Services platform.


 


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Our industry-leading Consumer Banking delivers a full range of products and services to the broad consumer market and small businesses through full-service banking offices, ATMs, telephone customer service and telesales, online banking and direct mail. A disciplined sales culture, optimal distribution channel convenience and a mandate for quality service are the hallmarks of Consumer Banking.

S U C C E S S E S

  Enhanced our unique Checking That Pays® program, giving customers who use their U.S. Bank Visa® Check Card the choice of four different reward options. In August 2003, rewarded more than one million Checking That Pays customers with an annual cash rebate. Expanded Checking That Pays to business check card customers, too.
  Introduced free U.S. Bank Internet Bill Pay, eliminating the monthly fee and making online bill payment even easier for consumer checking account customers.
  Enhanced usbank.com with a host of new features, including free online account statements through U.S. Bank Internet Banking, instant application decisions for U.S. Bank Cash Rewards Cards and U.S. Bank Student Checking Account, direct enrollment in the online security program Verified by Visa®, and Spanish-language additions to usbank.com/espanol.
  Introduced U.S. Bank Home Mortgage Payment Buster, a new mortgage loan program that reduces monthly payments and eliminates the need to purchase mortgage insurance.
  Partnered with the United States Hispanic Chamber of Commerce to create ¡Capital!, a first-of-its-kind, strategic loan program designed to meet small business lending needs in high-growth Hispanic markets nationwide.
  Reached the $1 billion milestone in outstanding recreation finance loans just two years after inception of our Recreation Finance Division; announced the creation of the U.S. Bank manufactured housing finance business, modeled after our successful recreation finance strategies and partnerships.
  Expanded Student Banking Campus Card relationships with Bellarmine University, Creighton University, Gonzaga University, John Carroll University, Minnesota State University Moorhead and San Diego State University; multi-purpose campus ID card provides students with official campus identification and ATM access, plus convenient access to laundry facilities, vending machines, health services, computer labs and more.

KEY BUSINESS UNITS

    24-Hour Banking and Financial Sales
    Business Equipment Finance Group
    Community Banking
    Consumer Lending
    Group Sales and Student Banking
    Home Mortgage
    In-store and Corporate On-site Banking
    Investments and Insurance
    Metropolitan Branch Banking
    SBA Division
    Small Business Banking

(LADY)



(PEOPLE)

 


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STRENGTH IN NUMBERS

 


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U.S. Bancorp strategically invests in the distribution channels, lines of business and markets with high potential for growth. These investments take full advantage of the existing resources, capabilities and national platforms we have built, enhancing our core geography and increasing customer convenience with moderate expenditure and low risk to the company.

           i n v e s t i n g  i n
 d i s t r i b u t i o n  a n d  s c a l e

Distribution channels deliver anytime access. Our distribution channels — including 2,243 branch banking offices in 24 states, 4,425 U.S. Bank ATMs, 24-hour call center service, U.S. Bank Internet Banking and specialized trust, brokerage and home mortgage offices — form the foundation of our powerful presence in many of the country’s high-growth, diversified markets. Our growing branch network operates in three strategically segmented formats. Community Banking delivers our full range of products and services in smaller, non-urban communities through the local office. Metropolitan Banking serves branch customers in larger and urban locations as a separate line of business through partnerships with all businesses of the bank. Our highly successful In-store Banking operates branches inside grocery stores, colleges and universities, workplaces, retirement centers and other high-traffic locations.

(BRANCH BANKING)

 


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Expanding in-store banking office distribution. In 2003, we began a major expansion of our in-store network — the third largest in the country — by partnering with supermarket retailers Safeway Inc., Publix and Smith’s Food & Drug Stores. Beginning with six new Nashville Publix branches in 2003, by the end of 2004, U.S. Bank will have opened 15 new Smith’s in-store branches in Utah, and by the end of 2005 we will have opened a total of 163 new full-service in-store locations in Safeway and Vons stores throughout California, Arizona and Nevada.

Strategic investments solidify our position in high-growth markets and businesses. In 2003, U.S. Bank completed system conversions resulting from the 2002 purchase and deposit assumption of 57 Bay View Bank branches in California. This transaction strengthened the U.S. Bank geographic footprint in California, adding to existing U.S. Bank branches to create an integrated network offering complete coverage of the fast-growing Greater Bay area- San Francisco, San Jose, Alameda County, Contra Costa County, Santa Rosa, Vallejo-Fairfield-Sonoma and Santa Cruz.

In 2003, U.S. Bank also completed system conversions resulting from the purchase of State Street Corporate Trust in 2002. This transaction strongly complemented our existing corporate trust business, making U.S. Bank the leading corporate trust provider in New England in addition to our current lead status in the Northwest, West and Central regions of the country.

(UNITED STATES)

With over thirty-five years of experience, Millennium Development Corp. has invested in and developed a wide variety of real estate projects ranging from agricultural land to office buildings to shopping centers. As an equity participant in each project, Millennium Development Corp. is committed to preserving capital and producing an attractive return on investment. For more than 10 years, U.S. Bank Small Business Banking has provided the cash flow management, credit and financing resources that support Millennium Development’s business vision.

(SANDY SCHWARTZ QUOTE)

 


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a t t r a c t i v e
b u s i n e s s
 m i x


The sports, educational and cultural programs of the Mathews-Dickey Boys’ & Girls’ Club in St. Louis instill “The Three R’s: Respect, Restraint & Responsibility” within more than 40,000 deserving young men and women each year. In 1982, President Ronald Reagan recognized the Club’s neighbor-helping neighbor concept by declaring it a model for the country. Numerous other government, media, sports and civic luminaries have applauded the 44-year-old organization’s impact in keeping more than one million youth on the fields, in the classroom and off the streets. We’ve enjoyed a successful relationship with Mathews-Dickey, a long-time client of the U.S. Bank Private Client Group. We are proud to manage the Endowment Fund for Mathews- Dickey to support its youth-enrichment programs for years to come.

U.S. Bancorp serves multiple customer segments in our 24-state footprint through a broad, attractive business mix with scale, resulting in competitive advantages, operating economies, reduced risk, diversified revenue streams and a wide range of ways to satisfy every customer.

U.S. Bancorp has a very attractive growth franchise. Our core regional businesses operate in our 24-state footprint and benefit from the geographic density of our banking locations and franchise support in terms of cross-sell, crossservicing and back-office support. Our top-performing regional businesses, combined with our specialized national-scale businesses, create a diversified and advantaged revenue mix of both spread and fee income from discrete sources. With challenge, opportunity, risk and reward spread across all geographic markets and a wide range of customer and business segments, we are positioned to capitalize on a recovering economy, while tolerating individual market or industry weaknesses.



(MARTIN L. MATHEWS QUOTE)

 


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(BUSINESS MIX)




Improving business unit trends. We see strong business momentum in Consumer Banking; we opened nearly a quarter of a million more checking accounts than were closed in 2003. A checking account is our retail customers’ primary link to U.S. Bank and is the basis for our 11.7 percent compound annual growth rate in branch-generated average low-cost core deposits. More importantly, checking is the starting point for expanded consumer relationships, reflected in a 12 percent compound annual growth rate in branch-generated average retail loans. Small business loans and branch-based investment product fee income also showed double-digit growth rates.

Our investment in distribution in high-growth markets continues, most particularly our current in-store branch expansion and our extension of mortgage banking origination capabilities in western markets.

In our Wholesale Banking business, the timing of commercial loan growth is still uncertain; however, we expect credit improvement trends to continue, a key driver of future growth. Along with loan generation, our relationship managers are putting renewed focus on providing appropriate supplementary services and deposit products to our commercial customers.

Improving equity markets are driving growth in our Private Client, Trust & Asset Management business units, as are outstanding service and our exceptional personal attention to each customer. Deposits, total loans and noninterest income are on upward trends. We strive to increase the level and breadth of services we provide to corporate executives, business owners, legal and healthcare professionals, professional athletes and non-profit organizations with their specialized and complex financial needs. Private Client Group earns an increasing share of wallet through expert investment management, financial planning, personal trust and private banking services. Institutional investment needs are met with high-performing securities lending, equity, fixed income and cash products.

Revenue by
Business Segment

15.1% Metropolitan Banking
11.9% Community Banking
10.3% Retail Payment Solutions
  6.7% Corporate Banking
  6.2% NOVA Information Systems
  5.5% Middle Market Banking
  4.9% Mortgage Banking
  4.3% Consumer Lending
  3.9% Private Client Group
  3.4% Commercial Real Estate
  2.5% Corporate Trust
  2.0% Government Banking
  1.9% Asset Management
  1.9% Corporate Payment Systems
  1.1% Institutional Trust
    .7% Fund Services

Diversified
Regional Businesses

Consumer Banking

Community Banking
In-store Banking
Insurance
Investments
Metropolitan Banking
Small Business Banking

Institutional Trust

Middle Market Banking

Private Client Group



(PICTURE)

 


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With top-ranked payment services, expertise in highly specialized businesses, advanced technological capabilities and financial products and services not limited by location, U.S. Bancorp has built a national standing in a number of high-growth businesses.



               h i g h — v a l u e  n a t i o n a l
b u s i n e s s e s



Lockheed Martin Corporation, the world’s premier advanced technology systems integrator, has partnered with U.S. Bank Corporate Payment Systems for ten years, adopting a full range of Corporate Payment Systems services, including corporate travel card and purchasing card programs. As a result of U.S. Bank Corporate Payment Systems’ flexibility and client-focus, Lockheed Martin recently extended its purchasing card commitment with a new five-year contract

Connie Mearkle (left), Assistant Treasurer,
and Molly Chung (right), Director,
Global Treasury Operations
Lockheed Martin Corporation
Bethesda, MD

Payment Services is a high-value, growth business without boundaries. U.S. Bank has developed innovative payment services to meet the rapidly expanding needs of consumers, businesses, financial institutions, government entities and millions of merchants throughout the world. This line of business has unlimited potential, and we utilize our expertise, technology and reputation for service to seize a growing share of business within this burgeoning arena.

We are the Number 3 merchant processor (NOVA), the Number 1 Visa commercial card issuer, the Number 2 small business card issuer, the Number 7 Visa and MasterCard® consumer card issuer, the Number 2 bank-owned ATM network, the Number 2 universal fleet card (Voyager) and the Number 2 freight payment provider (PowerTrack®).

Through NOVA Information Systems, recognized for superlative customer service and technical proficiency, our Merchant Processing business ranks third in the nation and serves more than 600,000 merchant locations in the United States and in Europe. We continue to expand this business through penetration of the U.S. Bank customer base of merchants and through ongoing activities, backed by the full resources of U.S. Bancorp, to gain additional merchant customers.



(QUOTE)

 


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Our Retail Payment Solutions business is unique among large issuers in that we build this business in large part on relationship-based efforts among our retail and small business customers, among our growing network of correspondent financial institutions and with a star-studded roster of co-brand partners. There is enormous potential in the further penetration of our existing customer base and in our ability to stay at the leading edge of new product introductions.

Corporate Payment Systems is at the forefront of payment providers, using leading technology and expertise to automate the entire payment continuum for commercial buyers and sellers. Card solutions like One Card, Corporate Card, Purchasing Card and Fleet Card provide flexible solutions for classic payables, while PowerTrack adds increased control and sophisticated pre-payment audits for complex business-to-business procurement processes.

With a compelling investment in the industry’s best technology, our Transaction Services is the hub of electronic payments transactions for all U.S. Bancorp ATMs, as well as ATMs, credit and debit cards, merchant processing, and the electronic funds transfer network gateway for other financial institutions, through Elan Financial Services. With expertise, technology, economy of scale and existing potential still within our markets, this is a full-service, start-to-finish business with growth expectation.

Diverse U.S. Bancorp national businesses serve customers coast to coast. U.S. Bank is a leading financial resource for local and state government, political sub-divisions and the federal government through our Government Banking business. We are one of the largest tax payment processors for the U.S. Government, and we provide a wide range of financial services for the Department of Defense, as well as web and lockbox collection services for the U.S. Department of Homeland Security. Mortgage Banking originates loans in all 50 states. We are targeting becoming a Top 10 mortgage provider through expanded sales efforts nationally and also the extension of our Mortgage Banking as a primary line of business into our western markets.

With expertise to support the nation’s largest corporations, specialized industries and our middle market customers, Corporate Banking provides services to meet the most complex transactional, credit, financial management, international financing and exchange, and risk mitigation needs. We are also a national leader in treasury management services. Our relationship-based model succeeds on the experience of our managers, the economies of scope and scale derived from our size and geography and our commitment to cost management. As the leading provider of municipal trust services and a top provider of corporate, escrow and structured finance services, Corporate Trust Services brings an unrelenting commitment to exceeding expectations by providing the right solutions at the right time for customers nationwide.

U.S. Bancorp Asset Management leverages the multiple distribution channels and broad geographic range of U.S. Bank to deliver the First American family of mutual funds, which encompasses a full range of equity and fixed income investment strategies. We are a performance-driven culture of expanding non-proprietary distribution, and we continue to promote U.S. Bancorp Asset Management to prospective customers nationwide.

National
Businesses

Asset Management
Commercial Real Estate
Consumer Lending
Corporate Banking
Corporate Payment Systems
Corporate Trust
Elan Financial Services
Equipment Financing
Fund Services
Government Banking
Institutional Custody
Mortgage Banking
NOVA Information Systems
Retail Payment Solutions
Transaction Services

(COMPUTER)



 


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                c o m m u n i t y
p a r t n e r s h i p s

(BOY SWINGING)

(GLOBE)

Our commitment to helping build strong communities begins with local market leadership and dedicated community involvement. U.S. Bancorp and our employees are committed to giving and volunteerism in the markets we serve. We make this investment proudly, promoting powerful partnerships and fostering economic development in communities, small and large, across the country.

Creating stronger communities for a stronger company. U.S. Bancorp is not just part of the community — we’re a partner in all the communities we serve across the country. Working with people, businesses and non-profit organizations in these local markets, we assist with economic, educational and cultural development. As an active partner, U.S. Bancorp provides superior, competitive products and services to every customer we serve, while offering customized financial solutions to customers and businesses who need assistance overcoming challenging financial situations. By helping to create strong, vibrant communities, U.S. Bancorp is building a healthy marketplace for our company - one community at a time.

Sponsorships support quality of life. The enduring vitality of a community is ultimately in the hands of its artists, athletes, performers, scholars, musicians and the institutions that train, educate, nurture and promote them. We extend sponsorship support to a variety of music, arts, sports and education programs, in addition to many other civic and cultural activities. From county fairs to the performing arts to professional, minor league, collegiate and high school sports, U.S. Bancorp supports a diverse range of opportunities and interests of our customers.



 


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Empowering local leaders. To meet the unique needs of the communities we serve, local leaders are empowered with the autonomy to customize all the resources of U.S. Bancorp for their individual markets. Coupled with the valuable insight of local market leaders, local boards provide further knowledge, expertise and insight into each community’s businesses, industries and important causes. Together, this leadership team is equipped with the first-hand knowledge needed to make strategic pricing and business development decisions that strengthen both U.S. Bancorp and the community.

Investing in our employees. The U.S. Bancorp Development Network promotes the personal and professional development of our employees by enhancing leadership, management and communication skills; organizing networking opportunities; providing community involvement opportunities; and encouraging and capitalizing on the diversity of our employees. The Development Network is composed of 42 geographically based chapters, which share these objectives and fulfill the program’s mission by organizing professional and community service activities, such as financial and leadership seminars for employees, mentoring opportunities, charitable fundraising drives and more.










U.S. Bank gives “Back 2 Schools in Minnesota.” U.S. Bank is investing nearly $500,000 in programs that support Minnesota teachers, high schools and students during the 2003-2004 school year. Designed to enrich student learning, recognize outstanding high school students and assist school athletic programs, Back 2 Schools is part of the ongoing investment U.S. Bank makes in Minnesota schools. Cynthia Welsh, teacher at Cloquet High School, has developed an interactive science discovery class using the funds she received from a U.S. Bank Back 2 Schools grant. Cynthia and her students collaborate with the Fond du Lac Band of Lake Superior Chippewa and other local scientists conducting environmental research that benefits the entire community.



(CYNTHIA WELSH QUOTE)

(SCHOOL)

 


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Management’s Discussion and Analysis

OVERVIEW

In 2003, U.S. Bancorp and its subsidiaries (the “Company”) achieved each of the goals outlined for the year despite challenging economic conditions in early 2003. We began the year with several specific financial objectives. The first goal was to focus on organic revenue growth. In 2003, the Company’s revenue growth of 3.9 percent included 3.7 percent growth in revenue from baseline business products and services. The second goal was to continue improving our operating leverage. During 2003, our efficiency ratio improved to 45.6 percent compared with 48.8 percent in 2002. Third, the Company was determined to continue improving its credit quality and reduce the overall risk profile of the organization. Nonperforming assets have declined 16.4 percent from a year ago and total net charge-offs decreased to 1.06 percent of average loans outstanding in 2003 compared with 1.20 percent in 2002. Finally, despite the challenges of 2003, the Company always desires to grow revenues faster than expenses. The Company’s results for 2003 reflect the achievement of this objective.

     The Company’s strong performance is also reflected in our capital levels and the improving outlook by our credit rating agencies relative to a year ago. Equity capital of the Company has increased to 6.5 percent of tangible common equity at December 31, 2003 from 5.7 percent at December 31, 2002. Credit ratings assigned by various credit rating agencies reflect the favorable rating agency views of the direction of the Company’s credit quality, risk management, liquidity and capital management practices and our ability to generate earnings. Each of these factors is considered important by management and discussed further throughout this document.
     In concert with achieving our stated financial objectives, the Company took key steps to strategically change the risk profile of the organization and enhance shareholder value. The Company’s financial statements reflect decisions by the Company to spin off Piper Jaffray Companies (“Piper Jaffray”) and to adopt the fair value method of accounting for stock-based compensation. Additionally, in December 2003 we announced an expanded share repurchase program and further increased our cash dividend resulting in a 23.1 percent increase from the dividend rate in the fourth quarter of 2002. The tax-free distribution of Piper Jaffray strategically changed the risk profile of the Company by reducing the earnings volatility and business risks associated with investment banking and resulted in the distribution to our shareholders of an independent company with approximately $880 million of market value shortly after the distribution.
     In connection with the Piper Jaffray spin-off and the change in our method of accounting for stock-based compensation, the financial statements of the Company have been restated for all prior periods. As such, historical financial results related to Piper Jaffray have been segregated and accounted for in the Company’s financial statements as discontinued operations.

Earnings Summary The Company reported net income of $3.7 billion in 2003, or $1.93 per diluted share, compared with $3.2 billion, or $1.65 per diluted share, in 2002. Return on average assets and return on average equity were 1.99 percent and 19.2 percent, respectively, in 2003, compared with returns of 1.84 percent and 18.3 percent, respectively, in 2002. Net income in 2003 included after-tax income from discontinued operations of $22.5 million, or $.01 per diluted share, compared with an after-tax loss of $22.7 million, or $.01 per diluted share, in 2002. Included in net income for 2002 was an after-tax goodwill impairment charge of $37.2 million, or $.02 per diluted share, primarily related to the purchase of a transportation leasing company in 1998 by the equipment leasing business. This charge was taken at the time of adopting new accounting standards related to goodwill and other intangible assets and was recognized as a “cumulative effect of accounting change” in the income statement. Refer to Note 2 of the Notes to Consolidated Financial Statements for further discussion of the impact of changes in accounting principles.

     In 2003, the Company had income from continuing operations, net of tax, of $3.7 billion, or $1.92 per diluted share, compared with $3.2 billion, or $1.68 per diluted share, in 2002. The 14.9 percent increase in income from continuing operations was primarily due to growth in net revenue, lower expenses and decreased credit costs. Net income from continuing operations included after-tax merger and restructuring-related items of $30.4 million ($46.2 million on a pre-tax basis), compared with after-tax merger and restructuring-related items of $209.3 million ($321.2 million on a pre-tax basis) in 2002. The $275.0 million decline in pre-tax merger and restructuring-related charges was primarily due to the completion of integration activities associated with the merger of Firstar Corporation and the former U.S. Bancorp of Minneapolis (“USBM”) at the end of 2002. Partially offsetting this favorable item in 2003 was a year-over-year decrease of $55.1 million in net securities gains realized in 2002, and a year-over-year increase in the level of mortgage servicing rights (“MSRs”) impairment of $22.6 million, driven by
 
18 U.S. Bancorp


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changes in interest rates and related prepayments. Refer to “Merger and Restructuring-Related Items” for further discussion on merger and restructuring-related items and the related earnings impact.

     Total net revenue, on a taxable-equivalent basis, was $12.5 billion in 2003, compared with $12.1 billion in 2002, a year-over-year increase of $472.6 million (3.9 percent). This growth was primarily due to organic growth of 3.7 percent and the benefit of acquisitions, offset somewhat by lower gains from asset sales. Revenue growth was comprised of a 5.4 percent increase in net interest income and a 2.0 percent net increase in noninterest income. The
 
 Table 1   Selected Financial Data
                                           
Year Ended December 31
(Dollars and Shares in Millions, Except Per Share Data) 2003 2002 2001 2000 1999

Condensed Income Statement
                                       
Net interest income (taxable-equivalent basis) (a)
  $ 7,217.5     $ 6,847.2     $ 6,405.2     $ 6,072.4     $ 5,875.7  
Noninterest income
    5,068.2       4,910.8       4,340.3       3,958.9       3,501.9  
Securities gains, net
    244.8       299.9       329.1       8.1       13.2  
   
 
Total net revenue
    12,530.5       12,057.9       11,074.6       10,039.4       9,390.8  
Noninterest expense
    5,596.9       5,740.5       6,149.0       4,982.9       5,131.8  
Provision for credit losses
    1,254.0       1,349.0       2,528.8       828.0       646.0  
   
 
Income from continuing operations before taxes
    5,679.6       4,968.4       2,396.8       4,228.5       3,613.0  
Taxable-equivalent adjustment
    28.2       32.9       54.5       82.0       94.2  
Applicable income taxes
    1,941.3       1,707.5       818.3       1,422.0       1,296.3  
   
 
Income from continuing operations
    3,710.1       3,228.0       1,524.0       2,724.5       2,222.5  
Discontinued operations (after-tax)
    22.5       (22.7 )     (45.2 )     27.6       17.9  
Cumulative effect of accounting change (after-tax)
          (37.2 )                  
   
 
Net income
  $ 3,732.6     $ 3,168.1     $ 1,478.8     $ 2,752.1     $ 2,240.4  
   
Per Common Share
                                       
Earnings per share from continuing operations
  $ 1.93     $ 1.68     $ .79     $ 1.43     $ 1.16  
Diluted earnings per share from continuing operations
    1.92       1.68       .79       1.42       1.15  
Earnings per share
    1.94       1.65       .77       1.44       1.17  
Diluted earnings per share
    1.93       1.65       .76       1.43       1.16  
Dividends declared per share (b)
    .855       .780       .750       .650       .460  
Book value per share
    10.01       9.62       8.58       8.06       7.29  
Market value per share
    29.78       21.22       20.93       23.25       21.13  
Average shares outstanding
    1,923.7       1,916.0       1,927.9       1,906.0       1,907.8  
Average diluted shares outstanding
    1,936.2       1,924.8       1,940.3       1,918.5       1,930.0  
 
Financial Ratios
                                       
Return on average assets
    1.99 %     1.84 %     .89 %     1.74 %     1.49 %
Return on average equity
    19.2       18.3       9.0       19.0       16.9  
Net interest margin (taxable-equivalent basis)
    4.49       4.65       4.46       4.38       4.43  
Efficiency ratio (c)
    45.6       48.8       57.2       49.7       54.7  
 
Average Balances
                                       
Loans
  $ 118,362     $ 114,453     $ 118,177     $ 118,317     $ 109,638  
Loans held for sale
    3,616       2,644       1,911       1,303       1,450  
Investment securities
    37,248       28,829       21,916       17,311       19,271  
Earning assets
    160,808       147,410       143,501       138,636       132,685  
Assets
    187,630       171,948       165,944       158,481       150,167  
Noninterest-bearing deposits
    31,715       28,715       25,109       23,820       23,556  
Deposits
    116,553       105,124       104,956       103,426       99,920  
Short-term borrowings
    10,503       10,116       11,679       11,008       10,883  
Long-term debt
    30,965       29,268       24,133       21,916       19,873  
Total shareholders’ equity
    19,393       17,273       16,426       14,499       13,273  
 
Period End Balances
                                       
Loans
  $ 118,235     $ 116,251     $ 114,405     $ 122,365     $ 113,229  
Allowance for credit losses
    2,369       2,422       2,457       1,787       1,710  
Investment securities
    43,334       28,488       26,608       17,642       17,449  
Assets
    189,286       180,027       171,390       164,921       154,318  
Deposits
    119,052       115,534       105,219       109,535       103,417  
Long-term debt
    31,215       28,588       25,716       21,876       21,027  
Total shareholders’ equity
    19,242       18,436       16,745       15,333       14,051  
Regulatory capital ratios
                                       
 
Tangible common equity
    6.5 %     5.7 %     5.9 %     6.4 %     * %
 
Tier 1 capital
    9.1       8.0       7.8       7.3       7.4  
 
Total risk-based capital
    13.6       12.4       11.9       10.7       11.1  
 
Leverage
    8.0       7.7       7.9       7.5       7.6  

 * Information was not available to compute pre-merger proforma percentage.
(a)  Interest and rates are presented on a fully taxable-equivalent basis utilizing a tax rate of 35 percent.
(b)  Dividends per share have not been restated for the 2001 Firstar/ USBM merger.
(c)  Computed as noninterest expense divided by the sum of net interest income on a taxable-equivalent basis and noninterest income excluding securities gains (losses), net.
 
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5.4 percent increase in net interest income resulted from an increase of $13.4 billion (9.1 percent) in average earning assets, primarily driven by increases in investment securities, residential mortgages, retail loans and loans held for sale, partially offset by an overall decline in commercial loans. The impact of the increase in average earning assets was offset in part by a lower net interest margin given the current interest rate environment. The net interest margin in 2003 was 4.49 percent, compared with 4.65 percent in 2002. The decline reflected the change in asset mix among loan products, reinvestment of loan proceeds into lower-yielding investment securities and a reduction in the marginal benefit of net free funds due to lower average interest rates. The 2.0 percent net increase in noninterest income was driven by increases in payment services revenue, trust and investment management fees, deposit service charges, treasury management fees, mortgage banking activity, strong investment product sales and the impact of acquisitions. Somewhat offsetting the growth in these fee-based revenues was a year-over-year decline in net securities gains of $55.1 million. Additionally, other revenues for 2002 included $67.4 million of gains related to the sales of two co-branded credit card portfolios. Approximately $194.6 million of the increase in net revenue in 2003, compared with 2002, was due to acquisitions, including The Leader Mortgage Company, LLC (“Leader”), the 57 branches of Bay View Bank (“Bay View”) in northern California and the corporate trust business of State Street Bank and Trust Company (“State Street Corporate Trust”).
     Total noninterest expense was $5.6 billion in 2003, compared with $5.7 billion in 2002. The decrease in total noninterest expense of $143.6 million (2.5 percent) primarily reflected a year-over-year reduction in merger and restructuring-related charges of $275.0 million and cost savings related to integration efforts. Partially offsetting this decrease in expense during 2003 was a year-over-year increase of $22.6 million in MSR impairments coupled with the net impact of acquisitions, which accounted for approximately $124.9 million of the expense growth in 2003. Refer to “Acquisition and Divestiture Activity” and “Merger and Restructuring-related Items” for further information on the timing of acquisitions and discussion of merger and restructuring-related items. The efficiency ratio (the ratio of noninterest expense to taxable-equivalent net revenue excluding net securities gains or losses) was 45.6 percent in 2003, compared with 48.8 percent in 2002. The favorable change in the efficiency ratio reflects the continuing improvement in the Company’s operating leverage resulting from integrated operating systems across all of our markets and business lines. In 2003, all business and system integration activities were completed including systems for our merchant processing business, Nova Information Systems, Inc., and the recent acquisitions of the corporate trust business of State Street Bank and Trust Company and the 57 branches of Bay View Bank. The Company anticipates no merger and restructuring-related charges in 2004 relating to completed acquisitions.
     The provision for credit losses was $1,254.0 million for 2003, compared with $1,349.0 million for 2002, a decrease of $95.0 million (7.0 percent). Net charge-offs during 2003 were $1,251.7 million, compared with net charge-offs of $1,373.0 million during 2002. The decline in net charge-offs reflects an improving economy and the Company’s ongoing efforts to reduce the overall credit risk profile of the organization over the past three years. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.

Acquisition and Divestiture Activity On December 31, 2003, the Company announced that it had completed the tax-free distribution of Piper Jaffray Companies representing substantially all of the Company’s capital markets business line. The Company distributed to our shareholders one share of Piper Jaffray common stock for every 100 shares of U.S. Bancorp common stock, by means of a special dividend of $685 million. This distribution did not include brokerage, financial advisory or asset management services offered to customers through other business units. The Company will continue to provide asset management services to its customers through the Private Client, Trust and Asset Management business segment and access to investment products and services through its extensive network of licensed financial advisors within the retail brokerage platform of the Consumer Banking business segment.

     The following acquisition transactions were accounted for as purchases from the date of completion. On December 31, 2002, the Company acquired the corporate trust business of State Street Corporate Trust in a cash transaction valued at $725 million. State Street Corporate Trust was a leading provider, particularly in the Northeast, of corporate trust and agency services to a variety of municipalities, corporations, government agencies and other financial institutions serving approximately 20,000 client issuances representing over $689 billion of assets under administration. With this acquisition, the Company is among the nation’s leading providers of a full range of corporate trust products and services. The transaction represented total assets acquired of $682 million and total liabilities of $39 million at the closing date. Included in total assets were contract and other intangibles with a fair value of $218 million and the excess of purchase price over the fair value of identifiable net assets (“goodwill”) of
 
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$449 million. The goodwill reflected the strategic value of the combined organization’s leadership position in the corporate trust business and processing economies of scale resulting from the transaction. As part of the purchase price, $75 million was placed in escrow for up to eighteen months with payment contingent on the successful transition of business relationships.
     On November 1, 2002, the Company acquired 57 branches and a related operations facility in northern California from Bay View, a wholly-owned subsidiary of Bay View Capital Corporation, in a cash transaction. The transaction represented total assets acquired of $853 million and total liabilities assumed (primarily retail and small business deposits) of $3.3 billion. Included in total assets were approximately $336 million of select loans primarily with depository relationships, core deposit intangibles of $56 million and goodwill of $427 million. The goodwill reflected the strategic value of expanding the Company’s market within the San Francisco Bay area.
     On April 1, 2002, the Company acquired Cleveland-based Leader, a wholly-owned subsidiary of First Defiance Financial Corp., in a cash transaction. The transaction represented total assets acquired of $531 million and total liabilities assumed of $446 million. Included in total assets were mortgage servicing rights and other intangibles of $173 million and goodwill of $18 million. Leader specializes in acquiring servicing of loans originated for state and local housing authorities.
     The following acquisitions were completed during the year 2001. On September 7, 2001, the Company acquired Pacific Century Bank (“Pacific Century”), which had 20 branches located in southern California and total assets of $570 million. On July 24, 2001, the Company acquired NOVA Corporation (“NOVA”), a merchant processor, which had total assets of $2.9 billion.
     Refer to Notes 3, 4 and 5 of the Notes to Consolidated Financial Statements for additional information regarding discontinued operations, business combinations and merger and restructuring-related items.

STATEMENT OF INCOME ANALYSIS

Net Interest Income Net interest income, on a taxable-equivalent basis, was $7.2 billion in 2003, compared with $6.8 billion in 2002 and $6.4 billion in 2001. The increase in net interest income in 2003 was driven by an increase in average earning assets, growth in average net free funds and favorable changes in the Company’s average funding mix. Also contributing to the year-over-year increase in net interest income were recent acquisitions, including Leader, State Street Corporate Trust and Bay View, which accounted for approximately $71.9 million of the increase during 2003. Average earning assets were $160.8 billion for 2003, compared with $147.4 billion and $143.5 billion for 2002 and 2001, respectively. The $13.4 billion (9.1 percent) increase in average earning assets for 2003, compared with 2002, was primarily driven by increases in investment securities, loans held for sale, residential mortgages and retail loans, partially offset by a decline in commercial loans. The net interest margin in 2003 was 4.49 percent, compared with 4.65 percent and 4.46 percent in 2002 and 2001, respectively. The 16 basis point decline in 2003 net interest margin, compared with 2002, primarily reflected

 
 Table 2   Analysis of Net Interest Income
                                           
2003 2002
(Dollars in Millions) 2003 2002 2001 v 2002 v 2001

Components of net interest income
                                       
 
Income on earning assets (taxable-equivalent basis) (a)
  $ 9,286.2     $ 9,526.8     $ 11,000.9     $ (240.6 )   $ (1,474.1 )
 
Expense on interest-bearing liabilities
    2,068.7       2,679.6       4,595.7       (610.9 )     (1,916.1 )
   
Net interest income (taxable-equivalent basis)
  $ 7,217.5     $ 6,847.2     $ 6,405.2     $ 370.3     $ 442.0  
   
Net interest income, as reported
  $ 7,189.3     $ 6,814.3     $ 6,350.7     $ 375.0     $ 463.6  
   
Average yields and rates paid
                                       
 
Earning assets yield (taxable-equivalent basis)
    5.77 %     6.46 %     7.67 %     (.69 )%     (1.21 )%
 
Rate paid on interest-bearing liabilities
    1.60       2.26       3.91       (.66 )     (1.65 )
   
Gross interest margin (taxable-equivalent basis)
    4.17 %     4.20 %     3.76 %     (.03 )%     .44%  
   
Net interest margin (taxable-equivalent basis)
    4.49 %     4.65 %     4.46 %     (.16 )%     .19%  
   
Average balances
                                       
 
Investment securities
  $ 37,248     $ 28,829     $ 21,916     $ 8,419     $ 6,913  
 
Loans
    118,362       114,453       118,177       3,909       (3,724 )
 
Earning assets
    160,808       147,410       143,501       13,398       3,909  
 
Interest-bearing liabilities
    129,004       118,697       117,614       10,307       1,083  
 
Net free funds (b)
    31,804       28,713       25,887       3,091       2,826  

(a) Interest and rates are presented on a fully taxable-equivalent basis utilizing a tax rate of 35 percent.
(b) Represents noninterest-bearing deposits, allowance for credit losses, unrealized gain (loss) on available-for-sale securities, non-earning assets, other noninterest-bearing liabilities and equity.
 
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growth in lower-yielding investment securities as a percent of total earning assets, changes in loan mix and a decline in the margin benefit from net free funds due to lower average interest rates. In addition, the net interest margin declined year-over-year as a result of consolidating high credit quality, low margin loans from Stellar Funding Group, Inc., a commercial loan conduit, onto the Company’s balance sheet in mid-2003.
     Total average loans of $118.4 billion in 2003 were $3.9 billion (3.4 percent) higher, compared with 2002, reflecting growth in average residential mortgages, retail loans and commercial real estate loans of $3.3 billion (39.0 percent), $1.7 billion (4.6 percent) and $1.4 billion (5.5 percent), respectively. Growth in these categories was offset somewhat by an overall decline in average commercial loans of $2.5 billion (5.7 percent). The decline in commercial loans was primarily driven by softness in commercial loan demand, modestly offset by the consolidation of loans from Stellar Funding Group, Inc. in mid-2003. Despite recent economic growth, the Company anticipates that commercial loan demand will continue to be soft in early 2004 while business customers utilize liquidity in deposit accounts to fund business activities.
     Average investment securities were $8.4 billion (29.2 percent) higher in 2003, compared with 2002, reflecting the reinvestment of proceeds from loan sales, declining commercial loan balances and deposits assumed in connection with the Bay View transaction. During 2003, the Company sold $15.3 billion of fixed-rate securities classified as available-for-sale as part of the Company’s interest rate risk management practices. During early 2003, sales of fixed-rate securities offset much of the economic impact of changes in MSR valuations. During the course of 2003, the Company began repositioning the investment portfolio by reinvesting proceeds from the sale of fixed-rate securities into floating-rate instruments.
     Average interest-bearing deposits of $84.8 billion in 2003 were higher by $8.4 billion (11.0 percent), compared with 2002. Approximately $3.0 billion of the year-over-year increase in average interest-bearing deposits was due to acquisitions, while the remaining growth was driven by increases in savings balances. The increase in savings balances reflected product initiatives, increasing government banking deposits and customer decisions to maintain liquidity. The Company anticipates that the growth in
 
 Table 3   Net Interest Income — Changes Due to Rate and Volume (a)
                                                       
2003 v 2002 2002 v 2001

(Dollars in Millions) Volume Yield/Rate Total Volume Yield/Rate Total

Increase (decrease) in
                                               
 
Interest income
                                               
   
Investment securities
  $ 428.4     $ (235.2 )   $ 193.2     $ 403.7     $ (235.2 )   $ 168.5  
   
Loans held for sale
    62.7       (31.1 )     31.6       56.4       (32.7 )     23.7  
   
Commercial loans
    (149.0 )     (157.8 )     (306.8 )     (451.0 )     (536.1 )     (987.1 )
   
Commercial real estate
    90.2       (141.9 )     (51.7 )     (27.5 )     (338.9 )     (366.4 )
   
Residential mortgages
    232.5       (114.4 )     118.1       (12.6 )     (50.3 )     (62.9 )
   
Retail loans
    134.9       (363.9 )     (229.0 )     288.2       (543.6 )     (255.4 )
   
     
Total loans
    308.6       (778.0 )     (469.4 )     (202.9 )     (1,468.9 )     (1,671.8 )
   
Other earning assets
    6.4       (2.4 )     4.0       (.8 )     6.3       5.5  
   
     
Total
    806.1       (1,046.7 )     (240.6 )     256.4       (1,730.5 )     (1,474.1 )
 
Interest expense
                                               
   
Interest checking
    22.6       (40.6 )     (18.0 )     24.4       (125.7 )     (101.3 )
   
Money market accounts
    87.7       (82.8 )     4.9       8.7       (406.9 )     (398.2 )
   
Savings accounts
    3.5       (7.4 )     (3.9 )     3.3       (20.7 )     (17.4 )
   
Time certificates of deposit less than $100,000
    (146.3 )     (146.2 )     (292.5 )     (215.2 )     (282.8 )     (498.0 )
   
Time deposits greater than $100,000
    26.3       (105.5 )     (79.2 )     (83.1 )     (244.8 )     (327.9 )
   
     
Total interest-bearing deposits
    (6.2 )     (382.5 )     (388.7 )     (261.9 )     (1,080.9 )     (1,342.8 )
   
Short-term borrowings
    8.5       (64.6 )     (56.1 )     (63.6 )     (189.1 )     (252.7 )
   
Long-term debt
    48.4       (181.0 )     (132.6 )     247.5       (576.9 )     (329.4 )
   
Company-obligated mandatorily redeemable preferred securities
    (9.7 )     (23.8 )     (33.5 )     62.1       (53.3 )     8.8  
   
     
Total
    41.0       (651.9 )     (610.9 )     (15.9 )     (1,900.2 )     (1,916.1 )
   
   
Increase (decrease) in net interest income
  $ 765.1     $ (394.8 )   $ 370.3     $ 272.3     $ 169.7     $ 442.0  

(a) This table shows the components of the change in net interest income by volume and rate on a taxable-equivalent basis utilizing a tax rate of 35 percent. This table does not take into account the level of noninterest-bearing funding, nor does it fully reflect changes in the mix of assets and liabilities. The change in interest not solely due to changes in volume or rates has been allocated on a pro-rata basis to volume and yield/rate.
 
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interest-bearing deposits will moderate in 2004 as the economy continues to expand.
     Average net free funds increased $3.1 billion from a year ago, including an increase in average noninterest-bearing deposits of $3.0 billion (10.4 percent) in 2003, compared with 2002. The increase in noninterest-bearing deposits was primarily due to mortgage banking activities during early 2003 and higher liquidity among corporate customers maintained in demand deposit balances year-over-year.
     The increase in net interest income in 2002, compared with 2001, was related to an improvement in the net interest margin as well as growth in earning assets. The 19 basis point improvement in the 2002 net interest margin, compared with 2001, reflected the funding benefits of the declining interest rate environment, a more favorable funding mix and improving spreads due to product repricing dynamics, growth in net free funds and a shift in mix toward retail loans, partially offset by lower yields on the investment portfolio. The $3.9 billion (2.7 percent) increase in average earning assets for 2002, compared with 2001, was primarily driven by increases in the investment portfolio and retail loan growth, partially offset by a decline in commercial and commercial real estate loans. The $3.7 billion decrease in total average loans for 2002, compared with 2001, reflected strong growth in average retail loans of $3.1 billion which was more than offset by an overall decline in average commercial and commercial real estate loans of $6.6 billion. Average investment securities were $6.9 billion (31.5 percent) higher in 2002, compared with 2001, reflecting reinvestment of proceeds from loan sales, declines in commercial and commercial real estate loan balances and growth in deposits. Average interest-bearing deposits of $76.4 billion in 2002 were lower by $3.4 billion, compared with 2001. Growth in average savings products (5.4 percent) for 2002 was more than offset by reductions in the average balances of higher cost time certificates of deposit (17.3 percent) and time certificates of deposit greater than $100,000 (13.2 percent). The decline in time certificates and time deposits greater than $100,000 reflected funding decisions toward more favorably priced wholesale funding sources given the rate environment and customers’ desire to maintain liquidity. The increase in average net free funds was driven by an increase in average noninterest-bearing deposits of $3.6 billion (14.4 percent) in 2002, compared with 2001.

Provision for Credit Losses The provision for credit losses is recorded to bring the allowance for credit losses to a level deemed appropriate by management based on factors discussed in the “Analysis and Determination of Allowance for Credit Losses” section. The provision for credit losses was $1,254.0 million in 2003, compared with $1,349.0 million and $2,528.8 million in 2002 and 2001, respectively.

     The decline in the provision for credit losses of $95.0 million in 2003 primarily reflected an improving credit risk profile resulting in lower nonperforming loans and commercial and retail loan losses. The decline in nonperforming loans and commercial loan net charge-offs was broad-based across most industries within the commercial loan portfolio. Retail loan delinquency ratios have also continued to improve across most retail loan portfolios reflecting improving economic conditions and the Company’s ongoing collection efforts and risk management activities. These are also the principal factors resulting in lower levels of retail net charge-offs during the year.
     The decline in the provision for credit losses of $1,179.8 million in 2002 was primarily related to specific credit actions taken in 2001. Included in the provision for credit losses in 2001 was a $1,025 million incremental provision recognized in the third quarter of 2001 and a $160 million charge during the first quarter of 2001 in connection with an accelerated loan workout strategy. The third quarter of 2001 provision for credit losses was significantly above the level anticipated earlier in that quarter and was taken after extensive review of the Company’s commercial loan portfolio in light of the events of September 11, 2001, declining economic conditions, and company-specific trends. The action reflected the Company’s expectations, at that time, of a prolonged economic slowdown and recovery. In addition to these actions, the provision for credit losses in 2001 included a merger and restructuring-related provision of $382.2 million. The merger and restructuring-related provision consisted of a $201.3 million provision for losses related to the disposition of an unsecured small business product; a $90.0 million charge to align risk management practices, align charge-off policies and expedite the transition out of a specific segment of the health care industry not meeting the lower risk appetite of the combined company; a $76.6 million provision for losses related to the sales of high loan-to-value home equity loans and the indirect automobile loan portfolio of USBM; and a $14.3 million charge related to the restructuring of a co-branding credit card relationship. Refer to Note 5 of the Notes to Consolidated Financial Statements for further information on merger and restructuring-related items.
     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.
 
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Noninterest Income Noninterest income in 2003 was $5.3 billion, compared with $5.2 billion in 2002 and $4.7 billion in 2001. The increase in noninterest income of $102.3 million (2.0 percent) in 2003, compared with 2002, was driven by strong growth in payment services revenue, trust and investment management fees, deposit service charges, treasury management fees, mortgage banking revenue and investment products fees and commissions attributable to both organic growth and acquisitions. Partially offsetting the increase in noninterest income in 2003 was a year-over-year decrease in net securities gains of $55.1 million. Noninterest income in 2002 also included $67.4 million of gains recognized in connection with the sale of two co-branded credit card portfolios. The favorable impact on noninterest income from acquisitions, which included Leader, Bay View and State Street Corporate Trust, was approximately $122.7 million during 2003.

     Credit and debit card revenue, corporate payment products revenue and ATM processing services revenue were higher in 2003, compared with 2002, by $43.7 million (8.5 percent), $35.6 million (10.9 percent) and $5.3 million (3.3 percent), respectively. Although credit and debit card revenue increased year-over-year, revenue growth was somewhat muted due to the impact of the settlement of the antitrust litigation brought against VISA USA and Mastercard by Wal-Mart Stores, Inc., Sears Roebuck & Co. and other retailers. This settlement lowered interchange rates that can be received by members of the associations on signature debit transactions beginning in August 2003. In 2003, the impact of the VISA settlement was to lower debit card revenue by $19.4 million relative to 2002. In 2004, the incremental impact will be to lower debit card revenue by approximately $15.0 million. This change in the interchange rate in the third quarter of 2003, in addition to higher customer loyalty rewards expenses, however, were more than offset by increases in transaction volumes and other pricing enhancements. Corporate payment products revenue and ATM processing services revenue were higher in 2003, primarily reflecting growth in sales and card usage during the year. Merchant processing services revenue was lower in 2003 by $5.9 million (1.0 percent), compared with 2002, primarily due to lower processing spreads resulting from pricing changes that occurred in late 2002 and changes in the mix of merchants. Merchant acquiring sales volumes increased by 7.1 percent relative to the fourth quarter of 2002. The Company’s mix of merchants toward smaller retailers and specialty shops often results in a lag in the growth of sales volumes relative to improvements experienced at larger retailers in late 2003. Assuming economic conditions continue to improve, management anticipates stronger merchant processing revenue growth in 2004. The favorable variance in trust and investment management fees in 2003 of $61.8 million (6.9 percent), compared with 2002, was driven by the acquisition of State Street Corporate Trust, which contributed $83.7 million in fees during 2003. Treasury management fees grew by $49.4 million (11.8 percent) in 2003, compared with 2002, with the majority of the increase occurring within the Wholesale Banking line of business. The increase in treasury management fees during 2003 was driven by growth in product sales, pricing enhancements and the relatively low earnings credit rates to customers. The growth was also driven by a change in the Federal government’s payment methodology for treasury management services from compensating balances, reflected in net interest income, to fees during the third quarter of 2003. During 2003, commercial products revenue declined $78.7 million (16.4 percent), principally reflecting lower commercial loan conduit servicing fees resulting, in part, from consolidating the Stellar commercial loan conduit. Mortgage banking revenue had a year-over-year increase of $36.9 million (11.2 percent) during 2003, principally due to higher
 
 Table 4   Noninterest Income
                                           
2003 2002
(Dollars in Millions) 2003 2002 2001 v 2002 v 2001

Credit and debit card revenue
  $ 560.7     $ 517.0     $ 465.9       8.5 %     11.0 %
Corporate payment products revenue
    361.3       325.7       297.7       10.9       9.4  
ATM processing services
    165.9       160.6       153.0       3.3       5.0  
Merchant processing services
    561.4       567.3       308.9       (1.0 )     83.7  
Trust and investment management fees
    953.9       892.1       887.8       6.9       .5  
Deposit service charges
    715.8       690.3       644.9       3.7       7.0  
Treasury management fees
    466.3       416.9       347.3       11.8       20.0  
Commercial products revenue
    400.5       479.2       437.4       (16.4 )     9.6  
Mortgage banking revenue
    367.1       330.2       234.0       11.2       41.1  
Investment products fees and commissions
    144.9       132.7       130.8       9.2       1.5  
Securities gains, net
    244.8       299.9       329.1       (18.4 )     (8.9 )
Merger and restructuring-related gains
                62.2             *  
Other
    370.4       398.8       370.4       (7.1 )     7.7  
   
 
Total noninterest income
  $ 5,313.0     $ 5,210.7     $ 4,669.4       2.0 %     11.6 %

* Not meaningful

 
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mortgage originations, servicing and secondary market sales and the acquisition of Leader, which contributed $16.5 million of the favorable variance in 2003. Investment products fees and commissions revenue increased in 2003 by $12.2 million (9.2 percent), compared with 2002, primarily due to increased retail brokerage activity given more favorable equity capital market conditions relative to 2002. Deposit service charges increased in 2003 by $25.5 million (3.7 percent), compared with 2002, primarily due to net new growth in checking accounts and fee enhancements principally within the Consumer Banking line of business. Other noninterest income decreased by $28.4 million (7.1 percent) from 2002, which included $67.4 million of gains on the sales of two co-branded credit card portfolios.
     In 2002, noninterest income increased $541.3 million (11.6 percent), compared with 2001. Increases resulting from acquisitions, including NOVA, Pacific Century, Leader and Bay View, accounted for approximately $301.3 million of the increase in noninterest income in 2002. Partially offsetting this favorable variance in 2002 was $62.2 million of merger and restructuring-related gains in connection with the sale of 14 branches representing $771 million in deposits recognized in 2001. Refer to Note 5 of the Notes to Consolidated Financial Statements for further information on merger and restructuring-related items. Credit and debit card revenue, corporate payment products revenue and ATM processing services revenue were higher in 2002, compared with 2001, by $51.1 million (11.0 percent), $28.0 million (9.4 percent) and $7.6 million (5.0 percent), respectively, primarily reflecting growth in sales and card usage. Merchant processing services revenue grew by $258.4 million (83.7 percent), primarily due to the acquisition of NOVA in July 2001. Deposit service charges increased in 2002 by $45.4 million (7.0 percent), primarily due to fee enhancements and new account growth. Cash management fees and commercial products revenue grew by $69.6 million (20.0 percent) and $41.8 million (9.6 percent), respectively, primarily driven by changes in the earnings credit rates for business deposits, growth in commercial business activities, fees related to loan conduit activities and product enhancements. Commercial product revenue growth was offset somewhat by lease residual impairments in 2002. In addition to the impact of the acquisition of Leader, the $96.2 million (41.1 percent) increase in mortgage banking revenue was also due to higher levels of mortgage originations and sales and loan servicing revenue in 2002, compared with 2001. Investment products fees and commissions revenues slightly increased in 2002, by $1.9 million (1.5 percent), compared with 2001. Included in noninterest income were net securities gains (losses) of $299.9 million in 2002, compared with $329.1 million in 2001, representing a decline of $29.2 million (8.9 percent). Other fee income was higher in 2002, compared with 2001, by $28.4 million (7.7 percent). The change was primarily due to $67.4 million in gains from credit card portfolio sales in 2002 and a reduction in retail leasing residual and other asset impairments from 2001, offset somewhat by lower official check revenue which is sensitive to changes in interest rates.

Noninterest Expense Noninterest expense in 2003 was $5.6 billion, compared with $5.7 billion and $6.1 billion in 2002 and 2001, respectively. The Company’s efficiency ratio improved to 45.6 percent in 2003, compared with 48.8 percent in 2002 and 57.2 percent in 2001. The improved operating leverage resulting from the decrease in noninterest expense in 2003 of $143.6 million (2.5 percent) was primarily the result of business initiatives, cost savings from integration activities and lower merger and restructuring-related charges, partially offset by an increase in MSR impairments, incremental pension and retirement

 
 Table 5   Noninterest Expense
                                           
2003 2002
(Dollars in Millions) 2003 2002 2001 v 2002 v 2001

Compensation
  $ 2,176.8     $ 2,167.5     $ 2,036.6       .4 %     6.4 %
Employee benefits
    328.4       317.5       285.5       3.4       11.2  
Net occupancy and equipment
    643.7       658.7       666.6       (2.3 )     (1.2 )
Professional services
    143.4       129.7       116.4       10.6       11.4  
Marketing and business development
    180.3       171.4       178.0       5.2       (3.7 )
Technology and communications
    417.4       392.1       353.9       6.5       10.8  
Postage, printing and supplies
    245.6       243.2       241.9       1.0       .5  
Goodwill
                236.7             *  
Other intangibles
    682.4       553.0       278.4       23.4       98.6  
Merger and restructuring-related charges
    46.2       321.2       1,044.8       (85.6 )     (69.3 )
Other
    732.7       786.2       710.2       (6.8 )     10.7  
   
 
Total noninterest expense
  $ 5,596.9     $ 5,740.5     $ 6,149.0       (2.5 )%     (6.6 )%
   
Efficiency ratio (a)
    45.6 %     48.8 %     57.2 %                

 * Not meaningful
(a) Computed as noninterest expense divided by the sum of net interest income on a taxable-equivalent basis and noninterest income excluding securities gains (losses), net.
 
U.S. Bancorp  25


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expense of $39.9 million and expenses related to recent acquisitions. Noninterest expense related to merger and restructuring-related charges declined by $275.0 million (85.6 percent) in 2003, compared with 2002. The decline in merger and restructuring-related charges was primarily due to the completion of integration activities associated with the merger of Firstar and USBM. During 2003, noninterest expense included an MSR impairment of $208.7 million, a net increase of $22.6 million, compared with 2002. The year-over-year changes in the valuation of MSRs were caused by fluctuations in mortgage interest rates and related prepayment speeds due to refinancing activities. Refer to Note 11 of the Notes to Consolidated Financial Statements for the sensitivity of the fair value of mortgage servicing rights to future changes in interest rates. Recent acquisitions, including Leader, Bay View and State Street Corporate Trust, accounted for a year-over-year increase of $124.9 million in noninterest expense.
     The decline in noninterest expense of $408.5 million (6.6 percent) in 2002, compared with 2001, was primarily the result of a reduction in merger and restructuring-related costs of $723.6 million, the elimination of $236.7 million of goodwill amortization in connection with new accounting principles adopted in 2002 and a reduction in asset write-downs of $52.6 million related to commercial leasing partnerships and tractor/ trailer property repossessed in 2001. Offsetting these favorable trends were higher costs associated with acquisitions, an increase in MSR impairments and post-integration realignment costs. Acquisitions, including NOVA, Pacific Century, Leader and Bay View, accounted for an increase of approximately $317.4 million in noninterest expense during 2002, comprised primarily of increased intangible amortization and personnel expenses. Included in noninterest expense in 2002 was $186.1 million in MSR impairments, compared with $60.8 million in 2001, an increase of $125.3 million. The increase in MSR impairments was related to increasing mortgage prepayments driven by declining interest rates. Another significant item impacting noninterest expense in 2002 was $46.4 million of personnel and related costs for post-integration rationalization of technology, operations and certain support functions.

Pension Plans Because of the long-term nature of pension plans, the administration and accounting for pensions is complex and can be impacted by several factors, including investment and funding policies, accounting methods and the plan’s actuarial assumptions. The Company and its Compensation Committee have an established process for evaluating the plans, their performance and significant plan assumptions, including the assumed discount rate and the long-term rate of return (“LTROR”). At least annually, an independent consultant is engaged to assist U.S. Bancorp’s Compensation Committee in evaluating plan objectives, funding policies and investment policies considering its long-term investment time horizon and asset allocation strategies. Note 18 of the Notes to Consolidated Financial Statements provides further information on funding practices, investment policies and asset allocation strategies.

     Periodic pension expense (or credits) includes service costs, interest costs based on the assumed discount rate, the expected return on plan assets based on an actuarially derived market-related value and amortization of actuarial gains and losses. The Company’s pension accounting policy follows guidance outlined in Statement of Financial Accounting Standards No. 87, “Employer’s Accounting for Pension Plans” (“SFAS 87”), and reflects the long-term nature of benefit obligations and the investment horizon of plan assets. This accounting guidance has the effect of reducing earnings volatility related to short-term changes in interest rates and market valuations. Actuarial gains and losses include the impact of plan amendments and various unrecognized gains and losses which are deferred and amortized over the future service periods of active employees. The market-related value utilized to determine the expected return on plan assets is based on fair value adjusted for the difference between expected returns and actual performance of plan assets. The unrealized difference between actual experience and expected returns is included in the market-related value ratably over a five-year period. At September 30, 2003, the accumulated unrecognized loss approximated $369 million and will ratably impact the actuarially derived market-related value of plan assets through 2008. The impact to pension expense of the unrecognized asset gains or losses will incrementally increase (decrease) pension costs in each year from 2004 to 2008, by approximately $26.5 million, $33.0 million, $43.3 million, $10.3 million and $(7.2) million, respectively, during that timeframe. This assumes that the performance of plan assets equals the assumed LTROR. Actual results will vary depending on the performance of plan assets and changes to assumptions required in the future. Refer to Note 1 of the Notes to Consolidated Financial Statements for further discussion of the Company’s accounting policies for pension plans.
     In 2003, the Company recognized a pension credit of $23.9 million compared with pension credits of $63.8 million in 2002 and $75.3 million in 2001. The $39.9 million increase in pension costs in 2003 was driven by a $46.4 million reduction in the expected return on assets and a lower discount rate utilized to determine the projected benefit obligation given the declining rate environment. Also, contributing to the increase in pension costs was a one-time curtailment gain in 2002 of $9.0 million related to a nonqualified pension plan compared with a settlement loss of $3.5 million related to
 
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nonqualified pension payments in 2003. Somewhat offsetting the increase in pension costs was an expected benefit of approximately $19.0 million associated with lower interest costs related to cash balance accounts and actual changes in employee demographics, such as retirement age. In 2002, pension costs increased by approximately $11.5 million due to a $32.5 million reduction of expected return on plan assets, utilizing a lower discount rate to determine the projected benefit obligation given the declining rate environment and the impact of changes in employee demographics. Partially offsetting this increase was a one-time curtailment gain of $9.0 million related to freezing certain benefits of a nonqualified pension plan and a reduction in service costs of $11.9 million related to changes in the pension plans at the time of the plan mergers.
     In 2004, the Company anticipates that pension costs will increase by approximately $14.1 million. The increase will be driven by a reduction in the discount rate and amortization of the unrecognized losses offset by the expected benefit of investment returns from the pension contributions made in 2003.

Note 18 of the Notes to Consolidated Financial Statements provides a summary of the significant pension plan assumptions. Because of the subjective nature of plan assumptions, a sensitivity analysis to hypothetical changes in the LTROR and the discount rate is provided below:

                                         
Base
LTROR 6.9% 7.9% 8.9% 9.9% 10.9%

Incremental benefit (cost)
  $ (45.8 )   $ (22.9 )   $     $ 22.9     $ 45.8  
Percent of 2003 net income
    (.76 )%     (.38 )%     %     .38 %     .76 %

                                         
Base
Discount rate 4.2% 5.2% 6.2% 7.2% 8.2%

Incremental benefit (cost)
  $ (51.6 )   $ (27.9 )   $     $ 31.6     $ 52.2  
Percent of 2003 net income
    (.86 )%     (.46 )%     %     .52 %     .87 %

     Due to the complexity of forecasting pension plan activities, the accounting method utilized for pension plans, management’s ability to respond to factors impacting the plans and the hypothetical nature of this information, the actual changes in periodic pension costs could be significantly different than the information provided in the sensitivity analysis.

Merger and Restructuring-Related Items The Company incurred merger and restructuring-related items in each of the last three years in conjunction with its acquisitions. Merger and restructuring-related items included in pre-tax earnings were $46.2 million ($30.4 million after-tax) in 2003, compared with $321.2 million ($209.3 million after-tax) and $1,364.8 million ($904.5 million after-tax) for 2002 and 2001, respectively.

     In 2003, the Company incurred pre-tax merger and restructuring-related charges of approximately $33.5 million in connection with the integration of merchant processing platforms and business processes of U.S. Bank National Association and NOVA. In addition, the Company incurred pre-tax merger and restructuring-related expenses in 2003 of $12.7 million primarily for systems conversion costs associated with the Bay View and State Street Corporate Trust transactions. The integration of these acquisitions was completed at the end of 2003, and the Company does not anticipate any merger or restructuring-related expenses in 2004 relating to completed acquisitions.
     At December 31, 2002, the integration of Firstar and USBM was completed. Total merger and restructuring-related items associated with the Firstar/ USBM merger were approximately $1.6 billion. Merger and restructuring-related items in 2002 included $269.0 million of net expense associated with the Firstar/ USBM merger and $52.2 million associated with NOVA and other smaller acquisitions. Merger and restructuring-related items in 2002 associated with the Firstar/ USBM merger were primarily related to systems conversions and integration, asset write-downs and lease terminations recognized at the completion of conversions. Offsetting a portion of these costs in 2002 was an asset gain related to the sale of a non-strategic investment in a sub-prime lending business and a mark-to-market recovery associated with the liquidation of U.S. Bancorp Libra’s investment portfolio. The Company exited this business in 2001 and the liquidation efforts were substantially completed in the second quarter of 2002.
     Merger and restructuring-related items in 2001 included $382.2 million in provision for credit losses, a $62.2 million gain on the required sale of branches and $1,044.8 million of noninterest expense. Total merger and restructuring-related items in 2001 consisted of $1,327.1 million related to the Firstar/ USBM merger and $37.7 million related to NOVA and other smaller acquisitions. With respect to the Firstar/ USBM merger, the $1,327.1 million of merger and restructuring-related items included $238.6 million for severance and employee-related
 
U.S. Bancorp  27


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costs and $477.6 million of charges to exit business lines and products, sell credit portfolios or otherwise realign business practices in the new Company. The Company also incurred $190.5 million related to the accelerated vesting of certain stock options and restricted stock, $207.1 million of systems conversion and business integration costs, $48.7 million for lease cancellation and other building-related costs, $226.8 million for transaction costs, funding a charitable foundation to reaffirm a commitment to its markets and other costs, and a $62.2 million gain related to the required sale of branches.
     Refer to Notes 3 and 5 of the Notes to Consolidated Financial Statements for further information on these acquired businesses and merger and restructuring-related items.

Income Tax Expense The provision for income taxes was $1,941.3 million (an effective rate of 34.4 percent) in 2003, compared with $1,707.5 million (an effective rate of 34.6 percent) in 2002 and $818.3 million (an effective rate of 34.9 percent) in 2001. The improvement in the effective tax rate in 2003, compared with 2002, primarily reflected a change in unitary state tax apportionment factors driven by a shift in business mix as a result of the impact of acquisitions, market demographics, the mix of product revenue and an increase in federal and state tax credits. The improvement in the effective tax rate in 2002, compared with 2001, was primarily driven by a change in unitary state tax apportionment factors, a decrease in non-deductible merger and restructuring-related charges and the change in accounting for goodwill.

     The Company’s net deferred tax liability was $1,556.4 million at December 31, 2003, compared with $1,329.4 million for the year ended 2002. The change in 2003 primarily relates to leasing activities and a decrease in the net unrealized appreciation on available-for-sale securities and financial instruments. For further information on income taxes, refer to Note 20 of the Notes to Consolidated Financial Statements.

BALANCE SHEET ANALYSIS

Average earning assets were $160.8 billion in 2003, compared with $147.4 billion in 2002. The increase in average earning assets of $13.4 billion (9.1 percent) was primarily driven by growth in investment securities,

 
 Table 6   Loan Portfolio Distribution
                                                                                       
2003 2002 2001 2000 1999

Percent Percent Percent Percent Percent
At December 31 (Dollars in Millions) Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total

Commercial
                                                                               
 
Commercial
  $ 33,536       28.4 %   $ 36,584       31.5 %   $ 40,472       35.4 %   $ 47,041       38.5 %   $ 42,021       37.1 %
 
Lease financing
    4,990       4.2       5,360       4.6       5,858       5.1       5,776       4.7       3,835       3.4  
   
   
Total commercial
    38,526       32.6       41,944       36.1       46,330       40.5       52,817       43.2       45,856       40.5  
 
Commercial real estate
                                                                               
 
Commercial mortgages
    20,624       17.4       20,325       17.5       18,765       16.4       19,466       15.9       18,636       16.5  
 
Construction and development
    6,618       5.6       6,542       5.6       6,608       5.8       6,977       5.7       6,506       5.7  
   
   
Total commercial real estate
    27,242       23.0       26,867       23.1       25,373       22.2       26,443       21.6       25,142       22.2  
 
Residential mortgages
                                                                               
 
Residential mortgages
    7,332       6.2       6,446       5.6       5,746       5.0       *       *       *       *  
 
Home equity loans, first liens
    6,125       5.2       3,300       2.8       2,083       1.8       *       *       *       *  
   
   
Total residential mortgages
    13,457       11.4       9,746       8.4       7,829       6.8       9,397       7.7       12,760       11.3  
 
Retail
                                                                               
 
Credit card
    5,933       5.0       5,665       4.9       5,889       5.1       6,012       4.9       5,004       4.4  
 
Retail leasing
    6,029       5.1       5,680       4.9       4,906       4.3       4,153       3.4       2,123       1.9  
 
Home equity and second mortgages (a)
    13,210       11.2       13,572       11.6       12,235       10.7       11,956       9.7       *       *  
 
Other retail
                                                                               
   
Revolving credit
    2,540       2.1       2,650       2.3       2,673       2.3       2,750       2.2       *       *  
   
Installment
    2,380       2.0       2,258       1.9       2,292       2.0       2,186       1.8       *       *  
   
Automobile
    7,165       6.1       6,343       5.5       5,660       5.0       5,609       4.6       *       *  
   
Student
    1,753       1.5       1,526       1.3       1,218       1.1       1,042       .9       *       *  
   
     
Total other retail (a)
    13,838       11.7       12,777       11.0       11,843       10.4       11,587       9.5       22,344       19.7  
   
   
Total retail
    39,010       33.0       37,694       32.4       34,873       30.5       33,708       27.5       29,471       26.0  
   
     
Total loans
  $ 118,235       100.0 %   $ 116,251       100.0 %   $ 114,405       100.0 %   $ 122,365       100.0 %   $ 113,229       100.0 %

(a)  Home equity and second mortgages are included in the total other retail category in 1999.
 * Information not available
 
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residential mortgages, loans held for sale and retail loans, partially offset by a decline in commercial loans. The increase in average earning assets was funded with an increase in average interest-bearing liabilities of $10.3 billion, consisting principally of higher savings products balances and more favorably priced longer-term wholesale funding, and an increase in net free funds, including an increase in average noninterest-bearing deposits of $3.0 billion.
     For average balance information, refer to Consolidated Daily Average Balance Sheet and Related Yields and Rates on pages 110 and 111.

Loans The Company’s total loan portfolio was $118.2 billion at December 31, 2003, an increase of $2.0 billion (1.7 percent) from December 31, 2002. The increase in total loans was driven by growth in residential mortgages and retail loans, partially offset by a decline in commercial loans due to soft commercial loan demand. The increase in residential mortgages reflects the Company’s decision to retain adjustable-rate mortgage production in connection with asset/liability management activities and strong growth in first lien home equity loans within the branch network and consumer finance. Table 6 provides a summary of the loan distribution by product type. Average total loans increased $3.9 billion (3.4 percent) in 2003, compared with 2002. The increase in total average loans in 2003, compared with 2002, was driven by similar factors discussed above including the growth of residential mortgages, retail loans and commercial real estate loans, partially offset by the decline in commercial loans.

Commercial Commercial loans, including lease financing, totaled $38.5 billion at December 31, 2003, compared with $41.9 billion at December 31, 2002, a decrease of $3.4 billion (8.1 percent). Although the consolidation of loans from the Stellar commercial loan conduit in mid-2003 had a positive impact on commercial loan balances year-over-year, current credit markets and soft economic conditions during early 2003 led to the decline in total commercial loans. Although economic growth occurred in the second half of 2003, commercial loan demand

 
 Table 7   Commercial Loans by Industry Group and Geography
                                   
December 31, 2003 December 31, 2002

Industry Group (Dollars in Millions) Loans Percent Loans Percent

Consumer products and services
  $ 6,858       17.8 %   $ 7,206       17.2 %
Capital goods
    4,598       11.9       5,486       13.1  
Financial services
    4,469       11.6       5,769       13.7  
Commercial services and supplies
    3,785       9.8       3,853       9.2  
Agriculture
    2,907       7.6       3,153       7.5  
Consumer staples
    1,817       4.7       1,924       4.6  
Transportation
    1,758       4.6       2,231       5.3  
Property management and development
    1,653       4.3       1,266       3.0  
Private investors
    1,629       4.2       1,759       4.2  
Health care
    1,532       4.0       1,475       3.5  
Paper and forestry products, mining and basic materials
    1,415       3.7       1,664       4.0  
Information technology
    729       1.9       797       1.9  
Energy
    708       1.8       575       1.4  
Other
    4,668       12.1       4,786       11.4  
   
 
Total
  $ 38,526       100.0 %   $ 41,944       100.0 %

Geography
                               

California
  $ 4,091       10.6 %   $ 4,127       9.8 %
Colorado
    1,820       4.7       1,796       4.3  
Illinois
    2,121       5.5       2,214       5.3  
Minnesota
    6,527       16.9       6,605       15.7  
Missouri
    2,742       7.1       2,895       6.9  
Ohio
    2,361       6.1       2,455       5.9  
Oregon
    1,500       3.9       1,604       3.8  
Washington
    2,767       7.2       3,129       7.5  
Wisconsin
    2,874       7.5       3,052       7.3  
Iowa, Kansas, Nebraska, North Dakota, South Dakota
    3,760       9.8       4,421       10.5  
Arkansas, Indiana, Kentucky, Tennessee
    1,549       4.0       1,865       4.4  
Idaho, Montana, Wyoming
    744       1.9       996       2.4  
Arizona, Nevada, Utah
    829       2.2       986       2.4  
   
 
Total banking region
    33,685       87.4       36,145       86.2  
Outside the Company’s banking region
    4,841       12.6       5,799       13.8  
   
 
Total
  $ 38,526       100.0 %   $ 41,944       100.0 %

 
U.S. Bancorp  29


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continued to be soft through year-end given the liquidity of commercial customers. Average commercial loans in 2003 decreased by $2.5 billion (5.7 percent). The decline in average commercial loans for 2003 was primarily due to the run-off of corporate loans and continued softness in loan demand, partially offset by the consolidation of loans from the Stellar commercial loan conduit in mid-2003. Despite recent economic growth, the Company anticipates soft commercial loan demand will continue in early 2004 while business customers utilize liquidity to fund business activities.
     Table 7 provides a summary of commercial loans by industry and geographical locations.

Commercial Real Estate The Company’s portfolio of commercial real estate loans, which includes commercial mortgages and construction loans, was $27.2 billion at December 31, 2003, compared with $26.9 billion at December 31, 2002, a slight increase of $375 million (1.4 percent). Specifically, commercial mortgages outstanding and real estate construction and development loans increased modestly by $299 million (1.5 percent) and $76 million (1.2 percent), respectively, as business owners and real estate investors continued to take advantage of the current interest rate environment. Average commercial real estate loans increased by $1.4 billion (5.5 percent) in 2003, compared with 2002, primarily driven by increased commercial mortgage activity. Table 9 provides a summary of commercial real estate by property type and geographical locations.

     The Company maintains the real estate construction designation until the completion of the construction phase and, if retained, the loan is reclassified to the commercial mortgage category. Approximately $1.4 billion of construction loans were permanently financed and transferred to the commercial mortgage loan category in 2003. At year-end 2003, $205 million of tax-exempt industrial development loans were secured by real estate. The Company’s commercial real estate mortgages and construction loans had unfunded commitments of $7.3 billion at December 31, 2003, compared with $7.9 billion at December 31, 2002. The Company also finances the operations of real estate developers and other entities with operations related to real estate. These loans are not secured directly by real estate and are subject to terms and conditions similar to commercial loans. These loans were included in the commercial loan category and totaled $364 million at December 31, 2003.

Residential Mortgages Residential mortgages held in the loan portfolio were $13.5 billion at December 31, 2003, an increase of $3.7 billion (38.1 percent) from December 31, 2002. The increase in residential mortgages was primarily the result of an increase in consumer finance originations and branch originated home equity loans with first liens driven by refinancing activities in 2003. The increase in residential mortgages also reflects the Company’s asset/liability management decisions to retain adjustable-rate mortgage loan production. This growth was partially offset by approximately $1.0 billion in residential loan sales during 2003 primarily representing fixed-rate mortgage loans. Average residential mortgages increased $3.3 billion (39.0 percent) to $11.7 billion in 2003, primarily due to the increases in first lien home equity loans and adjustable-rate mortgages.

Retail Total retail loans outstanding, which include credit card, retail leasing, home equity and second mortgages and other retail loans, were $39.0 billion at December 31, 2003, compared with $37.7 billion at December 31, 2002. The increase of $1.3 billion (3.5 percent) was driven by an increase in automobile loans, retail leasing, credit card lending and student loans, which increased $822 million, $349 million, $268 million and $227 million, respectively, during 2003. This growth was partially offset by declines in home equity and second mortgage loans as consumers refinanced with first lien home equity products classified as residential mortgages. Average retail loans increased $1.7 billion (4.6 percent) to $38.2 billion in 2003, reflecting growth in retail leasing, installment loans and home equity lines. Growth in these retail products was offset somewhat by a 1.9 percent decline in average credit card balances primarily due to portfolio sales in late 2002 and lower

 
 Table 8   Selected Loan Maturity Distribution
                                   
Over One
One Year Through Over Five
December 31, 2003 (Dollars in Millions) or Less Five Years Years Total

Commercial
  $ 19,028     $ 17,008     $ 2,490     $ 38,526  
Commercial real estate
    7,162       13,699       6,381       27,242  
Residential mortgages
    914       2,382       10,161       13,457  
Retail
    11,977       17,373       9,660       39,010  
   
 
Total loans
  $ 39,081     $ 50,462     $ 28,692     $ 118,235  
Total of loans due after one year with
                               
 
Predetermined interest rates
                          $ 40,339  
 
Floating interest rates
                          $ 38,815  

 
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second mortgage home equity loans. Of the total retail loans and residential mortgages outstanding, approximately 88.5 percent are to customers located in the Company’s primary banking regions.

Loans Held for Sale At December 31, 2003, loans held for sale, consisting of residential mortgages to be sold in the secondary markets, were $1.4 billion. The $2.7 billion (65.5 percent) decrease from December 31, 2002, despite strong mortgage banking activities in early 2003, was the result of a 56.3 percent decline in mortgage production volumes during the fourth quarter of 2003 relative to the same period of 2002.

Investment Securities The Company uses its investment securities portfolio for several purposes. It serves as a vehicle to manage interest rate and prepayment risk, generates interest and dividend income from the investment of excess funds depending on loan demand, provides liquidity and is used as collateral for public deposits and wholesale funding sources.

     At December 31, 2003, investment securities, both available-for-sale and held-to-maturity, totaled $43.3 billion, compared with $28.5 billion at December 31, 2002. The $14.8 billion (52.1 percent) year-over-year increase reflected the reinvestment of proceeds from loan sales and declining commercial loan balances due to the continued softness in commercial loan demand and the investment of cash inflows related to deposit growth. During 2003, the Company sold $15.3 billion of fixed-rate securities as part of an economic hedge of the MSR portfolio. In the first and second quarters of 2003, securities gains were taken to offset impairment recognized in the MSR portfolio. When MSR reparation occurred in the third quarter of 2003, the Company began repositioning the investment securities portfolio by selling fixed-rate securities with lower yields at a loss, with the proceeds being reinvested at higher yields. At December 31, 2003, approximately 19.5 percent of the investment securities portfolio represented adjustable-rate financial instruments, compared with 18.6 percent as of December 31, 2002.
     The weighted-average yield of the available-for-sale portfolio was 4.27 percent at December 31, 2003, compared with 4.97 percent at December 31, 2002. The average maturity of the available-for-sale portfolio rose to
 
 Table 9   Commercial Real Estate by Property Type and Geography
                                   
  December 31, 2003  December 31, 2002

Property Type (Dollars in Millions) Loans Percent Loans Percent

Business owner occupied
  $ 8,037       29.5 %   $ 6,513       24.2 %
Multi-family
    3,868       14.2       3,258       12.1  
Commercial property
                               
 
Industrial
    1,280       4.7       1,227       4.6  
 
Office
    3,078       11.3       3,564       13.3  
 
Retail
    3,487       12.8       3,832       14.3  
 
Other
    2,452       9.0       1,447       5.4  
Homebuilders
    2,098       7.7       2,142       8.0  
Hotel/motel
    2,234       8.2       2,585       9.6  
Health care facilities
    708       2.6       1,290       4.8  
Other (a)
                1,009       3.7  
   
 
Total
  $ 27,242       100.0 %   $ 26,867       100.0 %

Geography
                               

California
  $ 4,380       16.1 %   $ 4,277       15.9 %
Colorado
    1,139       4.2       1,190       4.4  
Illinois
    1,095       4.0       1,140       4.2  
Minnesota
    1,536       5.6       1,508       5.6  
Missouri
    1,741       6.4       2,297       8.6  
Ohio
    2,193       8.0       2,264       8.4  
Oregon
    1,771       6.5       1,614       6.0  
Washington
    2,956       10.9       3,242       12.1  
Wisconsin
    1,921       7.1       2,040       7.6  
Iowa, Kansas, Nebraska, North Dakota, South Dakota
    2,138       7.8       1,895       7.1  
Arkansas, Indiana, Kentucky, Tennessee
    1,817       6.7       1,679       6.2  
Idaho, Montana, Wyoming
    874       3.2       682       2.5  
Arizona, Nevada, Utah
    1,722       6.3       1,439       5.4  
   
 
Total banking region
    25,283       92.8       25,267       94.0  
Outside the Company’s banking region
    1,959       7.2       1,600       6.0  
   
 
Total
  $ 27,242       100.0 %   $ 26,867       100.0 %

(a)  In 2003, enhancements in loan system reporting enabled the Company to reclassify loans classified as “other” in 2002 to the applicable category.
 
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5.1 years at December 31, 2003, up from 2.8 years at December 31, 2002. The relative mix of the type of investment securities maintained in the portfolio is provided in Table 10. At December 31, 2003, the available-for-sale portfolio included a $259 million net unrealized loss, compared with a net unrealized gain of $714 million at December 31, 2002. The change from 2002 reflected rising interest rates in the later half of 2003 and the longer duration of the portfolio relative to a year ago.

Deposits Total deposits were $119.1 billion at December 31, 2003, an increase of $3.5 billion (3.0 percent) from December 31, 2002. The increase in total

 
 Table 10   Investment Securities
                                                                     
Available-for-Sale Held-to-Maturity

Weighted Weighted
Average Weighted Average Weighted
Amortized Fair Maturity in Average Amortized Fair Maturity in Average
December 31, 2003 (Dollars in Millions) Cost Value Years Yield Cost Value Years Yield

U.S. Treasury and agencies
                                                               
 
Maturing in one year or less
  $ 57     $ 57       .57       2.88 %   $     $             %
 
Maturing after one year through five years
    190       199       2.66       4.33                          
 
Maturing after five years through ten years
    237       225       9.08       3.93                          
 
Maturing after ten years
    1,150       1,094       19.50       2.38                          
   
   
Total
  $ 1,634     $ 1,575       15.37       2.85 %   $     $             %
   
Mortgage-backed securities
                                                               
 
Maturing in one year or less
  $ 2,355     $ 2,358       .63       3.15 %   $     $             %
 
Maturing after one year through five years
    22,516       22,542       3.66       4.30       14       14       3.08       5.38  
 
Maturing after five years through ten years
    15,016       14,785       6.50       4.50                          
 
Maturing after ten years
    342       340       13.26       2.66                          
   
   
Total
  $ 40,229     $ 40,025       4.62       4.30 %   $ 14     $ 14       3.08       5.38 %
   
Asset-backed securities
                                                               
 
Maturing in one year or less
  $ 100     $ 101       .70       4.74 %   $     $             %
 
Maturing after one year through five years
    130       130       2.54       5.89                          
 
Maturing after five years through ten years
    20       21       5.08       5.55                          
 
Maturing after ten years
                                               
   
   
Total
  $ 250     $ 252       2.00       5.40 %   $     $             %
   
Obligations of states and political subdivisions
                                                               
 
Maturing in one year or less
  $ 70     $ 71       .40       7.32 %   $ 33     $ 33       .35       3.93 %
 
Maturing after one year through five years
    171       178       2.71       7.34       39       42       2.93       6.54  
 
Maturing after five years through ten years
    79       84       6.88       7.43       26       28       6.84       6.92  
 
Maturing after ten years
    15       15       14.60       8.32       40       44       14.66       6.97  
   
   
Total
  $ 335     $ 348       3.74       7.40 %   $ 138     $ 147       6.47       6.12 %
   
Other debt securities
                                                               
 
Maturing in one year or less
  $ 3     $ 3       .42       3.35 %   $     $             %
 
Maturing after one year through five years
    128       128       2.51       10.42                          
 
Maturing after five years through ten years
    8       8       6.09       3.21                          
 
Maturing after ten years
    260       246       23.45       1.84                          
   
   
Total
  $ 399     $ 385       16.21       4.64 %   $     $             %
   
Other investments
  $ 594     $ 597             %   $     $             %
   
Total investment securities
  $ 43,441     $ 43,182       5.12       4.27 %   $ 152     $ 161       6.16       6.05 %

Note:  Information related to asset and mortgage-backed securities included above is presented based upon weighted average maturities anticipating future prepayments. Average yields are presented on a fully-taxable equivalent basis. Yields on available-for-sale and held-to-maturity securities are computed based on historical cost balances. Average yield and maturity calculations exclude equity securities that have no stated yield or maturity.
                                   
2003 2002

Amortized Percent Amortized Percent
At December 31 (Dollars in Millions) Cost of Total Cost of Total

U.S. Treasury and agencies
  $ 1,634       3.7 %   $ 421       1.5 %
Mortgage-backed securities
    40,243       92.3       24,987       90.0  
Asset-backed securities
    250       .6       646       2.3  
Obligations of states and political subdivisions
    473       1.1       771       2.8  
Other securities and investments
    993       2.3       949       3.4  
   
 
Total investment securities
  $ 43,593       100.0 %   $ 27,774       100.0 %

 
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deposits was primarily the result of increases in all savings deposit products, partially offset by declines in noninterest-bearing deposits, time certificates of deposit less than $100,000 and time deposits greater than $100,000.
     Noninterest-bearing deposits were $32.5 billion at December 31, 2003, compared with $35.1 billion at December 31, 2002, a decrease of $2.6 billion (7.5 percent). The decrease in noninterest-bearing deposits was primarily attributable to a decline in deposits related to mortgage banking businesses and lower government banking deposits relative to a year ago. Mortgage banking declined substantially in the third quarter directly related to the upward movement in interest rates experienced since late June, 2003. Government banking deposits declined primarily due to a decision by the federal government to pay fees for cash management services rather than maintain compensating balances. Average noninterest-bearing deposits were $31.7 billion in 2003, an increase of $3.0 billion (10.4 percent), compared with 2002. The increase in average noninterest-bearing deposits was primarily the result of higher demand deposits of mortgage and government banking customers during the first half of 2003, customer decisions to maintain excess liquidity in demand deposit balances, and acquisitions.
     Interest-bearing savings deposits totaled $61.1 billion at December 31, 2003, an increase of $10.8 billion (21.5 percent) from December 31, 2002. Average interest-bearing savings deposits were $57.0 billion in 2003, an increase of $11.2 billion (24.5 percent), compared with 2002. The increase in interest-bearing savings deposits from December 31, 2002, to December 31, 2003, was primarily driven by increases in money market accounts of $6.3 billion (22.6 percent), along with increases in interest checking of $3.9 billion (22.5 percent) and savings accounts of $.6 billion (12.1 percent). The favorable change in money market accounts was the result of product pricing initiatives on high-impact money market products, the continued desire by customers to maintain liquidity, specific deposit gathering initiatives and the State Street Corporate Trust acquisition, which contributed approximately $.6 billion of the increase during 2003.
     Interest-bearing time deposits were $25.5 billion at December 31, 2003, compared with $30.2 billion at December 31, 2002, a decrease of $4.7 billion (15.5 percent). The decrease in interest-bearing time deposits was driven by a decrease in the higher cost time certificates of deposits less than $100,000 of $4.3 billion (23.8 percent) and a decrease of $381 million (3.1 percent) in time deposits greater than $100,000. Average time deposits greater than $100,000 increased $1.0 billion (8.7 percent) and average time certificates of deposit less than $100,000 declined $3.8 billion (19.7 percent) during 2003. Time certificates of deposits are largely viewed as purchased funds and are managed to levels deemed appropriate given alternative funding sources. The decline in time certificates of deposits less than $100,000 from a year
 
 Table 11   Deposits

The composition of deposits was as follows:

                                                                                     
2003 2002 2001 2000 1999

Percent Percent Percent Percent Percent
December 31 (Dollars in Millions) Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total

Noninterest-bearing deposits
  $ 32,470       27.3 %   $ 35,106       30.4 %   $ 31,212       29.7 %   $ 26,633       24.3 %   $ 26,350       25.5 %
Interest-bearing deposits
                                                                               
 
Interest checking
    21,404       18.0       17,467       15.1       15,251       14.5       13,982       12.8       13,141       12.7  
 
Money market accounts
    34,025       28.6       27,753       24.0       24,835       23.6       23,899       21.8       22,751       22.0  
 
Savings accounts
    5,630       4.7       5,021       4.4       4,637       4.4       4,516       4.1       5,445       5.3  
   
   
Total of savings deposits
    61,059       51.3       50,241       43.5       44,723       42.5       42,397       38.7       41,337       40.0  
Time certificates of deposit less than $100,000
    13,690       11.5       17,973       15.5       20,724       19.7       25,780       23.5       25,394       24.5  
Time deposits greater than $100,000
                                                                               
 
Domestic
    5,902       4.9       9,427       8.2       7,286       6.9       11,221       10.3       9,348       9.0  
 
Foreign
    5,931       5.0       2,787       2.4       1,274       1.2       3,504       3.2       988       1.0  
   
   
Total interest-bearing deposits
    86,582       72.7       80,428       69.6       74,007       70.3       82,902       75.7       77,067       74.5  
   
 
Total deposits
  $ 119,052       100.0 %   $ 115,534       100.0 %   $ 105,219       100.0 %   $ 109,535       100.0 %   $ 103,417       100.0 %

The maturity of time certificates of deposit less than $100,000 and time deposits greater than $100,000 was as follows:

                           
Time Certificates of Time Deposits
December 31, 2003 (Dollars in Millions) Deposit Less Than $100,000 Greater Than $100,000 Total

Three months or less
  $ 2,747     $ 8,610     $ 11,357  
Three months through six months
    2,237       831       3,068  
Six months through one year
    2,778       745       3,523  
One year through three years
    4,179       1,128       5,307  
Three years through five years
    1,733       508       2,241  
Thereafter
    16       11       27  
   
 
Total
  $ 13,690     $ 11,833     $ 25,523  

 
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ago, and on average during 2003, reflected a shift in product mix toward savings products and funding decisions toward more favorably priced wholesale funding sources. The increase in average time deposits greater than $100,000 was primarily due to a shift in short-term funding mix to cover balance sheet growth, net of deposit growth.

Borrowings The Company utilizes both short-term and long-term borrowings to fund growth of earning assets in excess of deposit growth. Short-term borrowings, which include federal funds purchased, securities sold under agreements to repurchase and other short-term borrowings, were $10.9 billion at December 31, 2003, up $3.1 billion (39.0 percent) from $7.8 billion at year-end 2002. Short-term funding is managed to levels deemed appropriate given alternative funding sources. The increase in short-term borrowings reflected the impact of funding growth in earning assets, partially offset by the growth in deposits.

     Long-term debt was $31.2 billion at December 31, 2003, up from $28.6 billion at December 31, 2002. The $2.6 billion (9.2 percent) increase in long-term debt was driven by the issuance of $11.5 billion of medium- and long-term notes and bank notes during 2003. The issuance of long-term debt was partially offset by maturities of $8.6 billion during 2003. Refer to Note 14 of the Notes to Consolidated Financial Statements for additional information regarding long-term debt and the “Liquidity Risk Management” section for discussion of liquidity management of the Company.

CORPORATE RISK PROFILE

Overview Managing risks is an essential part of successfully operating a financial services company. The most prominent risk exposures are credit, residual, operational, interest rate, market and liquidity risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Residual risk is the potential reduction in the end-of-term value of leased assets or the residual cash flows related to asset securitization and other off-balance sheet structures. Operational risk includes risks related to fraud, legal and compliance risk, processing errors, technology, breaches of internal controls and business continuation and disaster recovery risk. Interest rate risk is the potential reduction of net interest income as a result of changes in interest rates. Rate movements can affect the repricing of assets and liabilities differently, as well as their market value. Market risk arises from fluctuations in interest rates, foreign exchange rates, and equity prices that may result in changes in the values of financial instruments, such as trading and available-for-sale securities that are accounted for on a mark-to-market basis. Liquidity risk is the possible inability to fund obligations to depositors, investors or borrowers. In addition, corporate strategic decisions, as well as the risks described above, could give rise to reputation risk. Reputation risk is the risk that negative publicity or press, whether true or not, could result in costly litigation or cause a decline in the Company’s stock value, customer base or revenue.

Credit Risk Management The Company’s strategy for credit risk management includes well-defined, centralized credit policies, uniform underwriting criteria, and ongoing risk monitoring and review processes for all commercial and consumer credit exposures. The strategy also emphasizes diversification on a geographic, industry and customer level, regular credit examinations and management reviews of loans experiencing deterioration of credit quality. The Company strives to identify potential problem loans early, take any necessary charge-offs promptly and maintain adequate reserve levels for probable loan losses inherent in the portfolio. Commercial banking operations rely on a strong credit culture that combines prudent credit policies and individual lender accountability. Lenders are assigned lending grades based on their level of experience and customer service requirements. Lending grades represent the level of approval authority for the amount of credit exposure and level of risk. Credit officers reporting independently to Credit Administration have higher levels of lending grades and support the business units in their credit decision process. Loan decisions are documented as to the borrower’s business, purpose of the loan, evaluation of the repayment source and the associated risks, evaluation of collateral, covenants and monitoring requirements, and risk rating rationale. The Company utilizes a credit risk rating system to measure the credit quality of individual commercial loan transactions. The Company uses the risk rating system for regulatory reporting, determining the frequency of review of the credit exposures, and evaluation and determination of the adequacy of the allowance for credit losses. The Company regularly forecasts potential changes in risk ratings, nonperforming status and potential for loss and the estimated impact on the allowance for credit losses. In the Company’s retail banking operations, standard credit scoring systems are used to assess consumer credit risks and to price consumer products accordingly. The Company conducts the underwriting and collections of its retail products in loan underwriting and servicing centers specializing in certain retail products. Forecasts of delinquency levels, bankruptcies and losses in conjunction with projection of estimated losses by delinquency categories and vintage information are regularly prepared and are used to evaluate underwriting and collection and determine the adequacy of the allowance for credit losses for these products. The Company also engages in non-lending activities that may give rise to credit risk, including interest rate swap contracts for balance sheet hedging

 
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purposes, foreign exchange transactions and interest rate swap contracts for customers, settlement risk, including Automated Clearing House transactions, and the processing of credit card transactions for merchants. These activities are also subject to credit review, analysis and approval processes.

Economic Overview In evaluating its credit risk, the Company considers changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, the level of allowance coverage and macroeconomic factors. Since late 2000, the domestic economy experienced slower growth. During 2001, corporate earnings weakened and credit quality indicators among certain industry sectors deteriorated. The stagnant economic growth was evidenced by the Federal Reserve Board’s (“FRB”) actions to stimulate economic growth through a series of interest rate reductions from mid-2001 through late 2002. In addition, events of September 11, 2001, had a profound impact on credit quality due to changes in consumer confidence and related spending, governmental priorities and business activities. In response to declining economic conditions, company-specific portfolio trends, and the Firstar/ USBM merger, the Company initiated several actions during 2001 including aligning the risk management practices and charge-off policies of the companies and restructuring and disposing of certain portfolios that did not align with the credit risk profile of the combined company. The Company also implemented accelerated loan workout strategies for certain commercial credits and increased the provision for credit losses above anticipated levels by approximately $1,025 million in the third quarter of 2001.

     By the end of 2002, economic conditions had stabilized somewhat, although the banking sector continued to experience elevated levels of nonperforming assets and net charge-offs, especially with respect to certain industry segments. Unemployment rates had increased slightly and consumer spending and confidence levels had declined during that year. Economic conditions began to improve in early to mid-2003 as evidenced by stronger earnings across many corporate sectors, higher equity valuations, stronger retail sales and consumer spending, and improving economic indicators. While the economy has begun to strengthen relative to a year ago, the banking industry continues to have elevated levels of nonperforming assets and net charge-offs compared with the late 1990’s. Conditions within certain industries, including manufacturing and airline transportation sectors, continue to lag behind the growth in the broader economy. In addition, certain segments within the agricultural industry have experienced deterioration since late 2002.

Credit Diversification The Company manages its credit risk, in part, through diversification of its loan portfolio. As part of its normal business activities, it offers a broad array of traditional commercial lending products and specialized products such as asset-based lending, commercial lease financing, agricultural credit, warehouse mortgage lending, commercial real estate, health care and correspondent banking. The Company also offers an array of retail lending products including credit cards, retail leases, home equity, revolving credit, lending to students and other consumer loans. These retail credit products are primarily offered through the branch office network, specialized trust, home mortgage and loan production offices, indirect distribution channels, such as automobile dealers and a consumer finance division. The Company monitors and manages the portfolio diversification by industry, customer and geography. Table 6 provides information with respect to the overall product diversification and changes in the mix during 2003.

     The commercial portfolio reflects the Company’s focus on serving small business customers, middle market and larger corporate businesses throughout its 24-state banking region and large national customers within certain niche industry groups. Table 7 provides a summary of the significant industry groups and geographic locations of commercial loans outstanding at December 31, 2003 and 2002. The commercial loan portfolio is diversified among various industries with somewhat higher concentrations in consumer products and services, capital goods (including manufacturing and commercial construction-related businesses), financial services, commercial services and supplies, and agricultural industries. Additionally, the commercial portfolio is diversified across the Company’s geographical markets with 87.4 percent of total commercial loans within the 24-state banking region. Credit relationships outside of the Company’s banking region are typically niche businesses including the mortgage banking and the leasing businesses. Loans to mortgage banking customers are primarily warehouse lines which are collateralized with the underlying mortgages. The Company regularly monitors its mortgage collateral position to manage its risk exposure.
     Certain industry segments within the commercial loan portfolio, including telecommunications, transportation and manufacturing experienced economic stress since 2001. Additionally, highly leveraged enterprise-value financings have under-performed. Over the past several years, the telecommunications sector has been adversely impacted by excess capacity. As a result of credit workout initiatives, the Company’s outstandings to this industry declined in 2003 to only .7 percent of the commercial loan portfolio at December 31, 2003. At December 31, 2003, the transportation sector represented 4.6 percent of the total
 
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commercial loan portfolio. Since 2001, the sector has been impacted by reduced airline travel, slower economic activity and changes in fuel prices. In general, the credit risk profile of the trucking, railroad and shipping segments have improved from a year ago; however, the airline segment continues to be sluggish. At year-end 2003, the Company’s transportation portfolio consisted of airline and airfreight businesses (30.0 percent of the sector), trucking businesses (48.4 percent of the sector) and the remainder in the railroad and shipping businesses (21.6 percent of the sector). Capital goods represented 11.9 percent of the total commercial portfolio at December 31, 2003. Included in this sector were approximately 34.0 percent of loans related to building products while engineering and construction equipment and machinery businesses were 32.5 percent and 21.3 percent, respectively. During 2003, economic conditions improved and production levels increased resulting in an improvement in the credit quality of the capital goods sectors from a year ago. With respect to certain construction and building-related businesses, the recent changes in the interest rate environment may somewhat hamper their future profitability. During 2003, segments of the agricultural industry experienced deterioration in credit quality due to depressed livestock prices and excess production within the food processing businesses. At December 31, 2003, approximately 7.6 percent of the commercial loan portfolio was concentrated in the agricultural sector. Within the agricultural sector, 37.9 percent of loans were to livestock producers, 30.9 percent to crop producers, 20.4 percent to food processors and 10.8 percent to wholesalers of agricultural products. Wholesalers have been less affected by commodity prices.
     Within its commercial lending business, the Company also provides financing to enable customers to grow their businesses through acquisitions of existing businesses, buyouts or other recapitalizations. During a business cycle with slower economic growth, businesses with leveraged capital structures may experience insufficient cash flows to service their debt. The Company manages leveraged enterprise-value financings by maintaining well-defined underwriting standards, portfolio diversification and actively managing the customer relationship. Regardless of these actions, leveraged enterprise-value financings often exhibit stress during a recession or period of slow economic growth. Given this risk profile, the Company continued to significantly de-emphasize and reduce the size of this portfolio during the past year. The Company actively monitors the credit quality of these customers and develops action plans accordingly. Such leveraged enterprise-value financings approximated $1.8 billion in loans outstanding at December 31, 2003, compared with approximately $2.9 billion outstanding at December 31, 2002. The decline was primarily due to the Company’s decision to reduce its exposure to these types of lending arrangements through repayments, refinancing activities and loan sales. The sector has also been reduced by charge-offs taken during the year. The Company’s portfolio of leveraged financings is included in Table 7 and is diversified among industry groups similar to the total commercial loan portfolio, except for higher concentrations in telecommunications and cable.
     The commercial real estate portfolio reflects the Company’s focus on serving business owners within its footprint as well as regional investment-based real estate. Table 9 provides a summary of the significant property types and geographic locations of commercial real estate loans outstanding at December 31, 2003 and 2002. At December 31, 2003, approximately 29.5 percent of the commercial real estate loan portfolio represented business owner-occupied properties that tend to exhibit credit risk characteristics similar to the middle market commercial loan portfolio. Generally, the investment-based real estate mortgages are diversified among various property types with somewhat higher concentrations in multi-family, office and retail properties. Additionally, the commercial real estate portfolio is diversified across the Company’s geographical markets with 92.8 percent of total commercial real estate loans outstanding at December 31, 2003, within the 24-state banking region.

Analysis of Nonperforming Assets Nonperforming assets represents a key indicator, among other considerations, of the potential for future credit losses. Nonperforming assets include nonaccrual loans, restructured loans not performing in accordance with modified terms and other real estate and other nonperforming assets owned by the Company. Interest payments collected from assets on nonaccrual status are typically applied against the principal balance and not recorded as income. At December 31, 2003, total nonperforming assets were $1,148.1 million, compared with $1,373.5 million at year-end 2002 and $1,120.0 million at year-end 2001. The ratio of total nonperforming assets to total loans and other real estate decreased to .97 percent at December 31, 2003, compared with 1.18 percent and .98 percent at the end of 2002 and 2001, respectively.

     The $225.4 million decrease in total nonperforming assets in 2003 reflected a decrease of $204.9 million in nonperforming commercial and commercial real estate loans, a decrease of $11.5 million in nonperforming residential mortgages and a $.9 million decrease in nonperforming retail loans. The decrease in nonperforming assets in 2003 was broad-based across most industry sectors within the commercial loan portfolio including capital goods, consumer-related sectors, manufacturing, telecommunications, and certain segments of transportation. While airline travel has increased from a year ago, the
 
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industry continues to be economically stressed and has had difficulty improving cash flows from operations. Also, certain industries continue to experience financial stress. Certain segments of livestock producers and food processors within the agricultural sector continue to suffer from lower prices. Certain health care facilities providers continue to experience operational stress leading to some deterioration in credit quality within that sector. Also, given the recent slowdown in refinancing activities and housing starts, the mortgage banking and real estate development sectors may experience increased credit risk. While nonperforming assets declined during 2003, the amount of nonperforming assets is still at elevated levels relative to the 1990’s reflecting the general impact of economic conditions during the past two years. Given the Company’s ongoing efforts to reduce the overall risk profile of the organization and the anticipation that the economy will continue to improve, nonperforming assets are expected to trend lower in 2004.
     The $253.5 million increase in total nonperforming assets in 2002 reflected an increase of $284.6 million in nonperforming commercial and commercial real estate loans, and a $17.5 million increase in other nonperforming assets, partially offset by a decrease of $27.1 million in nonperforming residential mortgages and a $21.5 million decrease in nonperforming retail loans. The increase in
 
 Table 12   Nonperforming Assets (a)
                                               
At December 31, (Dollars in Millions) 2003 2002 2001 2000 1999

 
Commercial
                                       
 
Commercial
  $ 623.5     $ 760.4     $ 526.6     $ 470.4     $ 219.0  
 
Lease financing
    113.3       166.7       180.8       70.5       31.5  
   
   
Total commercial
    736.8       927.1       707.4       540.9       250.5  
 
Commercial real estate
                                       
 
Commercial mortgages
    177.6       174.6       131.3       105.5       138.2  
 
Construction and development
    39.9       57.5       35.9       38.2       31.6  
   
   
Total commercial real estate
    217.5       232.1       167.2       143.7       169.8  
Residential mortgages
    40.5       52.0       79.1       56.9       72.8  
 
Retail
                                       
 
Credit card
                      8.8       5.0  
 
Retail leasing
    .4       1.0       6.5             .4  
 
Other retail
    24.8       25.1       41.1       15.0       21.1  
   
   
Total retail
    25.2       26.1       47.6       23.8       26.5  
   
     
Total nonperforming loans
    1,020.0       1,237.3       1,001.3       765.3       519.6  
 
Other real estate
    72.6       59.5       43.8       61.1       40.0  
 
Other assets
    55.5       76.7       74.9       40.6       28.9  
   
     
Total nonperforming assets
  $ 1,148.1     $ 1,373.5     $ 1,120.0     $ 867.0     $ 588.5  
   
Restructured loans accruing interest (b)
  $ 18.0     $ 1.4     $     $     $  
Accruing loans 90 days or more past due (c)
  $ 329.4     $ 426.4     $ 462.9     $ 385.2     $ 248.6  
Nonperforming loans to total loans
    .86 %     1.06 %     .88 %     .63 %     .46 %
Nonperforming assets to total loans plus other real estate
    .97 %     1.18 %     .98 %     .71 %     .52 %
Net interest lost on nonperforming loans
  $ 67.4     $ 65.4     $ 63.0     $ 50.8     $ 29.5  

Changes in Nonperforming Assets

                                 
Commercial and Retail and
(Dollars in Millions) Commercial Real Estate Residential Mortgages(e) Total

Balance December 31, 2002
  $ 1,295.4     $ 78.1     $ 1,373.5  
 
Additions to nonperforming assets
                       
   
New nonaccrual loans and foreclosed properties
    1,303.5       41.4       1,344.9  
   
Advances on loans
    58.9             58.9  
   
     
Total additions
    1,362.4       41.4       1,403.8  
 
Reductions in nonperforming assets
                       
   
Paydowns, payoffs
    (501.1 )     (36.0 )     (537.1 )
   
Net sales
    (288.8 )           (288.8 )
   
Return to performing status
    (118.7 )     (9.1 )     (127.8 )
   
Charge-offs (d)
    (666.8 )     (8.7 )     (675.5 )
   
     
Total reductions
    (1,575.4 )     (53.8 )     (1,629.2 )
       
Net additions (reductions) to nonperforming assets
    (213.0 )     (12.4 )     (225.4 )
   
Balance December 31, 2003
  $ 1,082.4     $ 65.7     $ 1,148.1  

(a) Throughout this document, nonperforming assets and related ratios do not include accruing loans 90 days or more past due.
(b) Nonaccrual restructured loans are included in the respective nonperforming loan categories and excluded from restructured loans accruing interest.
(c) These loans are not included in nonperforming assets and continue to accrue interest because they are adequately secured by collateral and/or are in the process of collection and are reasonably expected to result in repayment or restoration to current status.
(d) Charge-offs exclude actions for certain card products and loan sales that were not classified as nonperforming at the time the charge-off occurred.
(e) Residential mortgage information excludes changes related to residential mortgages serviced by others.
 
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nonperforming commercial and commercial real estate assets was principally due to the Company’s exposure to certain communications, cable, manufacturing and highly leveraged enterprise-value financings. Nonperforming loans in the capital goods sector also increased in 2002.
     The Company had $58.5 million and $50.0 million of restructured loans as of December 31, 2003 and 2002, respectively. Commitments to lend additional funds under restructured loans were $8.2 million and $1.7 million as of December 31, 2003 and 2002, respectively. Restructured loans performing under the restructured terms beyond a specific timeframe are reported as accruing. Of the Company’s total restructured loans at December 31, 2003, $18.0 million were reported as accruing.
     Accruing loans 90 days or more past due totaled $329.4 million at December 31, 2003, compared with $426.4 million at December 31, 2002, and $462.9 million at December 31, 2001. These loans were not included in nonperforming assets and continue to accrue interest because they are adequately secured by collateral, and/or are in the process of collection and are reasonably expected to result in repayment or restoration to current status. The ratio of delinquent loans to total loans declined to .28 percent at December 31, 2003, compared with .37 percent at December 31, 2002. Improving economic conditions and the Company’s continued focus on credit process are the primary factors for the favorable change from a year ago.
     To monitor credit risk associated with retail loans, the Company monitors delinquency ratios in the various stages of collection including nonperforming status. The following table provides summary delinquency information for residential mortgages and retail loans:
                                       
As a Percent
Amount of Loans
December 31
(Dollars in Millions) 2003 2002 2003 2002

Residential Mortgages
                               
   
30-89 days
  $ 102.9     $ 137.5       .76 %     1.41 %
   
90 days or more
    82.5       87.9       .61       .90  
   
Nonperforming
    40.5       52.0       .30       .53  
   
     
Total
  $ 225.9     $ 277.4       1.68 %     2.85 %

Retail Loans
                               
 
Credit Card
                               
   
30-89 days
  $ 150.9     $ 145.7       2.54 %     2.57 %
   
90 days or more
    99.5       118.3       1.68       2.09  
   
Nonperforming
                       
   
     
Total
  $ 250.4     $ 264.0       4.22 %     4.66 %
 
Retail Leasing
                               
   
30-89 days
  $ 78.8     $ 89.7       1.31 %     1.58 %
   
90 days or more
    8.2       10.7       .14       .19  
   
Nonperforming
    .4       1.0       .01       .02  
   
     
Total
  $ 87.4     $ 101.4       1.45 %     1.78 %
 
Other Retail
                               
   
30-89 days
  $ 311.9     $ 395.3       1.15 %     1.50 %
   
90 days or more
    110.2       141.2       .41       .54  
   
Nonperforming
    24.8       25.1       .09       .10  
   
     
Total
  $ 446.9     $ 561.6       1.65 %     2.13 %

 
 Table 13   Delinquent Loan Ratios as a Percent of Ending Loan Balances
                                               
At December 31,
90 days or more past due excluding nonperforming loans 2003 2002 2001 2000 1999

Commercial
                                       
 
Commercial
    .06 %     .14 %     .14 %     .11 %     .05 %
 
Lease financing
    .04       .10       .45       .02        
   
   
Total commercial
    .06       .14       .18       .10       .05  
Commercial real estate
                                       
 
Commercial mortgages
    .02       .03       .03       .07       .08  
 
Construction and development
    .03       .07       .02       .03       .05  
   
   
Total commercial real estate
    .02       .04       .02       .06       .07  
Residential mortgages
    .61       .90       .78       .62       .42  
Retail
                                       
 
Credit card
    1.68       2.09       2.18       1.70       1.23  
 
Retail leasing
    .14       .19       .11       .20       .12  
 
Other retail
    .41       .54       .74       .62       .41  
   
   
Total retail
    .56       .72       .90       .76       .53  
   
     
Total loans
    .28 %     .37 %     .40 %     .31 %     .22 %

                                           
At December 31,
90 days or more past due including nonperforming loans 2003 2002 2001 2000 1999

Commercial
    1.97 %     2.35 %     1.71 %     1.13 %     .59 %
Commercial real estate
    .82       .90       .68       .60       .74  
Residential mortgages
    .91       1.44       1.79       1.23       .99  
Retail
    .62       .79       1.03       .83       .62  
   
 
Total loans
    1.14 %     1.43 %     1.28 %     .94 %     .68 %

 
 
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     The decline in residential mortgage delinquencies from December 31, 2002, to December 31, 2003, reflected the general improvement in economic conditions, collection efforts and the effect of portfolio growth on delinquency ratios reported on a concurrent basis. The decline in retail loan delinquencies from a year ago, reflected improving economic conditions as well as ongoing collection efforts and risk management actions taken by the Company over the past three years.

Analysis of Loan Net Charge-Offs Total loan net charge-offs decreased $121.3 million to $1,251.7 million in 2003, compared with $1,373.0 million in 2002 and $1,546.5 million in 2001. The ratio of total loan net charge-offs to average loans was 1.06 percent in 2003, compared with 1.20 percent in 2002 and 1.31 percent in 2001. The improvement in net charge-offs in 2003 was due to credit risk management initiatives taken by the Company during the past two years that have improved the credit risk profile of the loan portfolio. These initiatives along with better economic conditions resulted in improving credit risk classifications and lower levels of nonperforming assets. The level of loan net charge-offs during 2002 reflected the impact of soft economic conditions at that time and weakness in the communications, transportation and manufacturing sectors, as well as the impact of the economy on highly leveraged enterprise-value financings. The decline during 2002 reflected net charge-offs taken in 2001 related to several credit initiatives taken by management in that year. Due to the Company’s ongoing workout, collection and risk management efforts and expected improvement in the economy, net charge-offs are anticipated to trend lower in 2004.

     Commercial and commercial real estate loan net charge-offs for 2003 were $608.7 million (.89 percent of average loans outstanding), compared with $679.9 million (.98 percent of average loans outstanding) in 2002 and $884.6 million (1.16 percent of average loans outstanding) in 2001. While commercial and commercial real estate loan net charge-offs for 2003 continue at elevated levels compared with the late 1990’s, improvement from 2002 was broad-based and extended across most industries within the commercial portfolio. In addition, net charge-offs related to the equipment-leasing portfolio declined to 1.65 percent of average leases outstanding from 2.67 percent in 2002. In 2002, higher levels of net charge-offs related to the leasing portfolio included airline and other transportation related losses. The decrease in commercial and commercial real estate loan net charge-offs in 2002, when compared with 2001, was driven by credit actions taken in 2001. Commercial and commercial real estate loan net charge-offs in 2001 included approximately $312.2 million related to several factors including: a large cattle fraud, collateral deterioration specific to transportation equipment caused by the impact of higher fuel prices and the weak economy, deterioration in the manufacturing, communications and technology sectors and specific management decisions to accelerate its workout strategy for certain borrowers. Also included in 2001 commercial and commercial real estate loan net charge-offs were $95 million in merger and restructuring-related
 
 Table 14   Net Charge-offs as a Percent of Average Loans Outstanding
                                               
Year Ended December 31 2003 2002 2001 2000 1999

Commercial
                                       
 
Commercial
    1.34 %     1.29 %     1.62 %     .56 %     .41 %
 
Lease financing
    1.65       2.67       1.95       .46       .24  
   
   
Total commercial
    1.38       1.46       1.66       .55       .40  
Commercial real estate
                                       
 
Commercial mortgages
    .14       .17       .21       .03       .02  
 
Construction and development
    .16       .11       .17       .11       .03  
   
   
Total commercial real estate
    .14       .15       .20       .05       .02  
 
Residential mortgages
    .23       .23       .15       .11       .11  
Retail
                                       
 
Credit card
    4.61       4.98       4.80       4.18       4.00  
 
Retail leasing
    .86       .72       .65       .41       .28  
 
Home equity and second mortgages
    .70       .74       .85       *       *  
 
Other retail
    1.60       2.10       2.16       1.32       1.26  
   
   
Total retail
    1.61       1.85       1.94       1.69       1.63  
   
     
Total loans (a)
    1.06 %     1.20 %     1.31 %     .70 %     .61 %

(a) In accordance with guidance provided in the Interagency Guidance on Certain Loans Held for Sale, loans held with the intent to sell are transferred to the Loans Held for Sale category based on the lower of cost or fair value. At the time of transfer, the portion of the mark-to-market losses representing probable credit losses determined in accordance with policies and methods utilized to determine the allowance for credit losses is included in net charge-offs. The remaining portion of the losses was reported separately as a reduction of the allowance for credit losses under “Losses from loan sales/transfers.” Had the entire amount of the loss been reported as charge-offs, total net charge-offs would have been $1,875.8 million (1.59 percent of average loans) for the year ended December 31, 2001.
 * Information not available
 
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charge-offs to align risk management practices and net charge-offs of $160 million associated with an accelerated loan workout strategy in the first quarter of 2001.
     Retail loan net charge-offs in 2003 were $616.1 million (1.61 percent of average loans outstanding), compared with $674.0 million (1.85 percent of average loans outstanding) in 2002 and $649.3 million (1.94 percent of average loans outstanding) in 2001. Lower levels of retail loan net charge-offs in 2003, compared with 2002, were primarily due to the implementation of uniform underwriting standards and processes across the entire Company, improvement in ongoing collection efforts and changes in other risk management practices. The favorable change in credit card losses also reflected the impact of two portfolio sales in late 2002. The improvement in the retail loan net charge-offs in 2002, compared with 2001, principally reflected changes in the mix of the retail loan portfolio to auto loans and leases and home equity products, and improvement in ongoing collection efforts as a result of the successful completion of the integration efforts.
     The Company’s retail lending business utilizes several distinct business processes and channels to originate retail credit including traditional branch credit, indirect lending and a consumer finance division. Each distinct underwriting and origination activity manages unique credit risk characteristics and prices its loan production commensurate with the differing risk profiles. Within Consumer Banking, U.S. Bank Consumer Finance (“USBCF”), participates in all facets of the Company’s consumer lending activities. The consumer finance division specializes in serving channel-specific and alternative lending markets in residential mortgages, home equity and installment loan financing. The consumer finance division manages loans originated through a broker network, correspondent relationships and U.S. Bank branch offices. Generally, loans managed by the Company’s consumer finance division exhibit higher credit risk characteristics, but are priced commensurate with the differing risk profile.
     The following table provides an analysis of net charge-offs as a percentage of average loans outstanding managed by the consumer finance division, compared with traditional branch-related loans:
                                   
Average Loan Percent of
Amount Average Loans
Year Ended December 31

(Dollars in Millions) 2003 2002 2003 2002

Consumer finance (a)
                               
 
Residential mortgages
  $ 3,499     $ 2,447       .44 %     .57 %
 
Home equity and second mortgages
    2,350       2,570       2.38       1.95  
 
Other retail
    360       237       4.76       3.90  
Traditional branch
                               
 
Residential mortgages
  $ 8,197     $ 5,965       .14 %     .09 %
 
Home equity and second mortgages
    10,889       10,662       .34       .44  
 
Other retail
    13,270       12,010       1.52       2.07  
Total Company
                               
 
Residential mortgages
  $ 11,696     $ 8,412       .23 %     .23 %
 
Home equity and second mortgages
    13,239       13,232       .70       .74  
 
Other retail
    13,630       12,247       1.60       2.10  

(a) Consumer finance category included credit originated and managed by USBCF, as well as home equity loans and second mortgages with a loan-to-value greater than 100 percent that were originated in the branches.

Analysis and Determination of the Allowance for Credit Losses The allowance for credit losses provides coverage for probable and estimable losses inherent in the Company’s loan and lease portfolio. Management evaluates the allowance each quarter to determine that it is adequate to cover inherent losses. The evaluation of each element and the overall allowance is based on a continuing assessment of problem loans and related off-balance sheet items, recent loss experience and other factors, including regulatory guidance and economic conditions.

     At December 31, 2003, the allowance for credit losses was $2,368.6 million (2.00 percent of loans). This compares with an allowance of $2,422.0 million (2.08 percent of loans) at December 31, 2002, and $2,457.3 million (2.15 percent of loans) at December 31, 2001. The ratio of the allowance for credit losses to nonperforming loans was 232 percent at year-end 2003, compared with 196 percent at year-end 2002 and 245 percent at year-end 2001. The ratio of the allowance for credit losses to loan net charge-offs was 189 percent at year-end 2003, compared with 176 percent at year-end 2002 and 159 percent at year-end 2001. Management determined that the allowance for credit losses was adequate at December 31, 2003.
     Several factors were taken into consideration in evaluating the 2003 allowance for credit losses, including improvements in the risk profile of the portfolios and loan net charge-offs during the period, the lower level of nonperforming assets, the decline in accruing loans 90 days or more past due and the improvement in all delinquency categories from December 31, 2002. Management also
 
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considered the uncertainty related to certain industry sectors, including the airline transportation sector, the extent of credit exposure to highly leveraged enterprise-value arrangements within the portfolio and the fact that nonperforming assets remain at elevated levels despite recent improvements. Finally, the Company considered improving but somewhat mixed economic trends including improving corporate earnings, lagging unemployment rates, the level of bankruptcies and general economic indicators.
     Management determines the allowance that is required for specific loan categories based on relative risk characteristics of the loan portfolio. Table 15 shows the amount of the allowance for credit losses by loan category. The allowance recorded for commercial and commercial real estate loans is based on a regular review of individual credit relationships. The Company’s risk rating process is an integral component of the methodology utilized in determining the allowance for credit losses. An analysis of the migration of commercial and commercial real estate loans and actual loss experience throughout the business cycle is also conducted quarterly to assess reserves established for credits with similar risk characteristics. An allowance is established for pools of commercial and commercial real estate loans based on the risk ratings assigned. The amount is supported by the results of the migration analysis that considers historical loss experience by risk rating, as well as current and historical economic conditions and industry risk factors. The Company separately analyzes the carrying value of impaired loans to determine whether the carrying value is less than or equal to the appraised collateral value or the present value of expected cash flows. Based on this analysis, an allowance for credit losses may be specifically established for impaired loans. The allowance established for commercial and commercial real estate loan portfolios, including impaired commercial and commercial real estate loans, was $1,015.0 million at December 31, 2003, compared with $1,090.4 million and $1,428.6 million at December 31, 2002 and 2001, respectively. The decline in the allowance for commercial and commercial real estate loans of $75.4 million reflected improvement in the risk classifications of commercial and commercial real estate portfolios, partially offset by higher loss severity rates from the Company’s historical migration analysis.
     The allowance recorded for the residential mortgages and retail loan portfolios is based on an analysis of product mix, credit scoring and risk composition of the portfolio, loss and bankruptcy experiences, economic conditions and historical and expected delinquency and charge-off statistics for each homogenous group of loans. Based on this information and analysis, an allowance was established approximating a rolling twelve-month estimate of net charge-offs. The allowance established for residential mortgages was $33.3 million at December 31, 2003,
 
 Table 15   Elements of the Allowance for Credit Losses (a)
                                                                                       
Allowance Amount Allowance as a Percent of Loans

December 31 (Dollars in Millions) 2003 2002 2001 2000 1999 2003 2002 2001 2000 1999

Commercial
                                                                               
 
Commercial
  $ 696.1     $ 776.4     $ 1,068.1     $ 418.8     $ 408.3       2.08 %     2.12 %     2.64 %     .89 %     .97 %
 
Lease financing
    90.4       107.6       107.5       17.7       20.2       1.81       2.01       1.84       .31       .53  
   
   
Total commercial
    786.5       884.0       1,175.6       436.5       428.5       2.04       2.11       2.54       .83       .93  
Commercial real estate
                                                                               
 
Commercial mortgages
    169.7       152.9       176.6       42.7       110.4       .82       .75       .94       .22       .59  
 
Construction and development
    58.8       53.5       76.4       17.7       22.5       .89       .82       1.16       .25       .35  
   
   
Total commercial real estate
    228.5       206.4       253.0       60.4       132.9       .84       .77       1.00       .23       .53  
Residential mortgages
    33.3       34.2       21.9       11.6       18.6       .25       .35       .28       .12       .15  
Retail
                                                                               
 
Credit card
    267.9       272.4       295.2       265.6       320.8       4.52       4.81       5.01       4.42       6.41  
 
Retail leasing
    47.1       44.0       38.7       27.2       18.6       .78       .77       .79       .65       .88  
 
Home equity and second mortgages
    100.5       114.7       88.6       107.7       *       .76       .85       .72       .90       *  
 
Other retail
    234.8       268.6       282.8       250.3       389.2       1.70       2.10       2.39       2.16       1.74  
   
     
Total retail
    650.3       699.7       705.3       650.8       728.6       1.67       1.86       2.02       1.93       2.47  
   
     
Total allocated allowance
    1,698.6       1,824.3       2,155.8       1,159.3       1,308.6       1.43       1.57       1.89       .95       1.16  
     
Available for other factors
    670.0       597.7       301.5       627.6       401.7       .57       .51       .26       .51       .35  
   
Total allowance
  $ 2,368.6     $ 2,422.0     $ 2,457.3     $ 1,786.9     $ 1,710.3       2.00 %     2.08 %     2.15 %     1.46 %     1.51 %

(a)  During 2001, the Company changed its methodology for determining the specific allowance for elements of the loan portfolio. Table 15 has been restated for 2000. Due to the Company’s inability to gather historical loss data on a combined basis for 1999, the methodologies and amounts assigned to each element of the loan portfolio for that year has not been conformed. Utilizing the prior methods, the total assigned to the allocated allowance for 2000 was $1,397.3 million and the allowance available for other factors portion was $389.6 million.
 * Information not available
 
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compared with $34.2 million and $21.9 million at December 31, 2002 and 2001, respectively. The slight decrease in the allowance for the residential mortgage portfolio year-over-year was primarily due to lower expected loss severity resulting from the more uniform underwriting processes and standards associated with the portfolio, partially offset by losses due to incremental growth in the first lien home equity portfolio during 2003. The allowance established for retail loans was $650.3 million at December 31, 2003, compared with $699.7 million and $705.3 million at December 31, 2002 and 2001, respectively. The decline in the allowance for the retail portfolio in 2003 reflected improved credit quality and delinquency trends, partially offset by the impact of portfolio growth and unemployment rates that continue to lag other economic indicators.
     Regardless of the extent of the Company’s analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolios. This is due to several factors, including inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions, the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses from larger non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogeneous groups of loans, loan portfolio concentrations, and other subjective considerations are among other factors. Because of the imprecision surrounding these factors, the Company estimates a range of inherent losses based on statistical analyses and management judgment, and maintains an “allowance available for other factors” that is not allocated to a specific loan category. The amount of the allowance available for other factors was $670.0 million at December 31, 2003, compared with $597.7 million at December 31, 2002, and $301.5 million at December 31, 2001.
     Given the many subjective factors affecting the credit portfolio, changes in the allowance for other factors may not directly coincide with changes in the risk ratings of the credit portfolio reflected in the risk rating process. This is, in part, due to a lagging effect between changes in the business cycle, the exposure and mix of loans within risk rating categories, levels of nonperforming loans, and the timing of charge-offs and recoveries. In 2001, management conducted extensive reviews of its portfolios and enhanced its commercial migration methods to better differentiate and weight loss severity ratios by risk rating category to reflect the adverse impact of loss experienced in 2001. The $326.1 million decrease in the allowance for other factors in 2001 reflected the impact of that change in loss severity ratios, which led the Company to increase the allowance established for commercial loans. In 2002, the Company reduced the level of higher risk commercial credits and net charge-off ratios improved by 20 basis points from 2001. As a result, loss severity rates determined through historical migration analysis had improved somewhat relative to 2001. This led the Company to reduce the level of the allowance specifically allocated to commercial loans; however, nonperforming assets continued to remain at elevated levels, economic growth continued to be soft and the ability to further reduce higher risk credits had diminished as refinancing opportunities had tightened. As such, volatility of loss rates remained higher relative to prior periods and management increased the level of the allowance for other factors. At December 31, 2003, quantifiable factors supporting the level of the allowance for other factors included $23.3 million related to imprecision in risk ratings, $184.6 million for volatility of commercial loss rates and $199.1 million for volatility of retail loss forecasts. The remaining allowance for other factors of $263.0 million was related to uncertainty in the economy from lagging unemployment rates, concentration risk, including risks associated with the sluggish airline industry and highly leveraged enterprise-value credits, and other qualitative factors.
     Although the Company determines the amount of each element of the allowance separately and this process is an important credit management tool, the entire allowance for credit losses is available for the entire loan portfolio. The actual amount of losses incurred can vary significantly from the recorded amounts. The Company’s methodology included several factors intended to minimize the differences in recorded and actual losses. These factors allowed the Company to adjust its estimate of losses based on the most recent information available. Refer to Note 1 of the Notes to Consolidated Financial Statements for accounting policies related to the allowance for credit losses.
 
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 Table 16   Summary of Allowance for Credit Losses
                                                 
(Dollars in Millions) 2003 2002 2001 2000 1999

Balance at beginning of year
  $ 2,422.0     $ 2,457.3     $ 1,786.9     $ 1,710.3     $ 1,705.7  
 
Charge-offs
                                       
 
Commercial
                                       
   
Commercial
    555.6       559.2       779.0       319.8       250.1  
   
Lease financing
    139.3       188.8       144.4       27.9       12.4  
   
     
Total commercial
    694.9       748.0       923.4       347.7       262.5  
 
Commercial real estate
                                       
   
Commercial mortgages
    43.9       40.9       49.5       15.8       19.1  
   
Construction and development
    13.0       8.8       12.6       10.3       2.6  
   
     
Total commercial real estate
    56.9       49.7       62.1       26.1       21.7  
 
Residential mortgages
    30.3       23.1       15.8       13.7       16.2  
 
Retail
                                       
   
Credit card
    282.1       304.9       294.1       235.8       220.2  
   
Retail leasing
    57.0       45.2       34.2       14.8       6.2  
   
Home equity and second mortgages
    105.0       107.9       112.7       *       *  
   
Other retail
    267.9       311.9       329.1       379.5       376.0  
   
     
Total retail
    712.0       769.9       770.1       630.1       602.4  
   
       
Total charge-offs
    1,494.1       1,590.7       1,771.4       1,017.6       902.8  
 
Recoveries
                                       
 
Commercial
                                       
   
Commercial
    70.0       67.4       60.6       64.0       84.8  
   
Lease financing
    55.3       39.9       30.4       7.2       4.0  
   
     
Total commercial
    125.3       107.3       91.0       71.2       88.8  
 
Commercial real estate
                                       
   
Commercial mortgages
    15.8       9.1       9.1       10.8       15.1  
   
Construction and development
    2.0       1.4       .8       2.6       1.0  
   
     
Total commercial real estate
    17.8       10.5       9.9       13.4       16.1  
 
Residential mortgages
    3.4       4.0       3.2       1.3       1.4  
 
Retail
                                       
   
Credit card
    27.3       24.6       23.4       27.5       34.6  
   
Retail leasing
    7.0       6.3       4.5       2.0       1.1  
   
Home equity and second mortgages
    12.1       10.6       12.9       *       *  
   
Other retail
    49.5       54.4       80.0       76.8       88.2  
   
     
Total retail
    95.9       95.9       120.8       106.3       123.9  
   
       
Total recoveries
    242.4       217.7       224.9       192.2       230.2  
 
Net Charge-offs
                                       
 
Commercial
                                       
   
Commercial
    485.6       491.8       718.4       255.8       165.3  
   
Lease financing
    84.0       148.9       114.0       20.7       8.4  
   
     
Total commercial
    569.6       640.7       832.4       276.5       173.7  
 
Commercial real estate
                                       
   
Commercial mortgages
    28.1       31.8       40.4       5.0       4.0  
   
Construction and development
    11.0       7.4       11.8       7.7       1.6  
   
     
Total commercial real estate
    39.1       39.2       52.2       12.7       5.6  
 
Residential mortgages
    26.9       19.1       12.6       12.4       14.8  
 
Retail
                                       
   
Credit card
    254.8       280.3       270.7       208.3       185.6  
   
Retail leasing
    50.0       38.9       29.7       12.8       5.1  
   
Home equity and second mortgages
    92.9       97.3       99.8       *       *  
   
Other retail
    218.4       257.5       249.1       302.7       287.8  
   
     
Total retail
    616.1       674.0       649.3       523.8       478.5  
   
       
Total net charge-offs
    1,251.7       1,373.0       1,546.5       825.4       672.6  
   
Provision for credit losses
    1,254.0       1,349.0       2,528.8       828.0       646.0  
Losses from loan sales/transfers (a)
                (329.3 )            
Acquisitions and other changes
    (55.7 )     (11.3 )     17.4       74.0       31.2  
   
Balance at end of year
  $ 2,368.6     $ 2,422.0     $ 2,457.3     $ 1,786.9     $ 1,710.3  
   
Allowance as a percent of
                                       
 
Period-end loans
    2.00 %     2.08 %     2.15 %     1.46 %     1.51 %
 
Nonperforming loans
    232       196       245       233       329  
 
Nonperforming assets
    206       176       219       206       291  
 
Net charge-offs (a)
    189       176       159       216       254  

(a) In accordance with guidance provided in the Interagency Guidance on Certain Loans Held for Sale, loans held with the intent to sell are transferred to the Loans Held for Sale category based on the lower of cost or fair value. At the time of the transfer, the portion of the mark-to-market losses representing probable credit losses determined in accordance with policies and methods utilized to determine the allowance for credit losses is included in net charge-offs. The remaining portion of the losses was reported separately as a reduction of the allowance for credit losses under “Losses from loan sales/ transfers.” Had the entire amount of the loss been reported as charge-offs, total net charge-offs would have been $1,875.8 million for the year ended 2001. Additionally, the allowance as a percent of net charge-offs would have been 131 percent for the year ended December 31, 2001.
 * Information not available
 
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Residual Risk Management The Company manages its risk to changes in the value of lease residual assets through disciplined residual valuation setting at the inception of a lease, diversification of its leased assets, regular asset valuation reviews and monitoring of residual value gains or losses upon the disposition of assets. Commercial lease originations are subject to the same well-defined underwriting standards referred to in the “Credit Risk Management” section which includes an evaluation of the residual risk. Retail lease residual risk is mitigated further by originating longer-term vehicle leases and effective end-of-term marketing of off-lease vehicles. Also, to reduce the financial risk of potential changes in vehicle residual values, the Company maintains residual value insurance. The catastrophic insurance maintained by the Company provides for the potential recovery of losses on individual vehicle sales in an amount equal to the difference between: (a) 105 percent or 110 percent of the average wholesale auction price for the vehicle at the time of sale and (b) the vehicle residual value specified by the Automotive Lease Guide (an authoritative industry source) at the inception of the lease. The potential recovery is calculated for each individual vehicle sold in a particular policy year and is reduced by any gains realized on vehicles sold during the same period. The Company will receive claim proceeds if, in the aggregate, there is a net loss for such period. To reduce the risk associated with collecting insurance claims, the Company monitors the financial viability of the insurance carrier based on insurance industry ratings and available financial information.

     Included in the retail leasing portfolio was approximately $3.3 billion of retail leasing residuals at December 31, 2003, compared with $3.2 billion at December 31, 2002. The Company monitors concentrations of leases by manufacturer and vehicle “make and model.” At year-end 2003, no vehicle-type concentration exceeded six percent of the aggregate portfolio. Because retail residual valuations tend to be less volatile for longer-term leases, relative to the estimated residual at inception of the lease, the Company actively manages lease origination production to achieve a longer-term portfolio. At December 31, 2003, the weighted-average origination term of the portfolio was 53 months. Since 1998, the used vehicle market has experienced pricing stress. Several factors have contributed to this business cycle. Aggressive leasing programs by automobile manufacturers and competitors within the banking industry included a marketing focus on monthly lease payments, enhanced residuals at lease inception, shorter-term leases and low mileage leases. These practices have created a cyclical oversupply of certain off-lease vehicles causing significant declines in used vehicle prices. Automobile manufacturers and others have retreated somewhat from these marketing programs or exited the leasing business. However, zero percent financing offered with rebates continued to exert pressure on used car pricing. Another factor impacting the used vehicle market has been the deflation in new vehicle prices. This trend has been driven by surplus automobile manufacturing capacity and related production and highly competitive sales programs. Economic factors are expected to moderate new car production. Production levels have continued to decline from record levels in 2000. Also, many Internet marketers failed or transformed into distribution channels of dealers rather than direct competitors. These trends are expected to abate the deflationary pricing pressures of the past few years. Another factor that has slowed the decline in residual values is the growth of “certified” used car programs. Certified cars are low mileage, newer model vehicles that have been inspected, reconditioned, and usually have a warranty program. The Company’s exposure to declining valuation should benefit from certified car programs that receive premium pricing from dealers at auction. Given the current economic environment, it is difficult to assess the timing and degree of changes in residual values that may impact financial results over the next several quarters.
     At December 31, 2003, the commercial leasing portfolio had $816 million of residuals, compared with $896 million at December 31, 2002. At year-end 2003, lease residuals related to trucks and other transportation equipment were 32 percent of the total residual portfolio. Railcars represented 16 percent of the aggregate portfolio, while aircraft and business and office equipment were 15 percent and 11 percent, respectively. No other significant concentrations of more than 10 percent existed at December 31, 2003. In 2003, reduced airline travel and higher fuel costs adversely impacted aircraft and transportation equipment lease residual values.

Operational Risk Management Operational risk represents the risk of loss resulting from the Company’s operations, including, but not limited to, the risk of fraud by employees or persons outside the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements and business continuation and disaster recovery. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity.

     The Company operates in many different businesses in diverse markets and relies on the ability of its employees and systems to process a high number of transactions. Operational risk is inherent in all business activities, and the management of this risk is important to the achievement of
 
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the Company’s objectives. In the event of a breakdown in the internal control system, improper operation of systems or improper employees’ actions, the Company could suffer financial loss, face regulatory action and suffer damage to its reputation.
     The Company manages operational risk through a risk management framework and its internal control processes. The framework involves the business lines, corporate risk management personnel and executive management. Under this framework, business lines have direct and primary responsibility and accountability for identifying, controlling, and monitoring operational risk. Clear structures and processes with defined responsibilities are in place. Business managers maintain a system of controls with the objective of providing proper transaction authorization and execution, proper system operations, safeguarding of assets from misuse or theft, and ensuring the reliability of financial and other data. Business managers ensure that the controls are appropriate and are implemented as designed.
     Each business line within the Company has designated risk managers. These risk managers are responsible, among other things, for coordinating the completion of ongoing risk assessments and ensuring that operational risk management is integrated into business decision-making activities. Business continuation and disaster recovery planning is also critical to effectively manage operational risks. Each business unit of the Company is required to develop, maintain and test these plans at least annually to ensure that recovery activities, if needed, can support mission critical functions including technology, networks and data centers supporting customer applications and business operations. The Company’s internal audit function validates the system of internal controls through risk-based, regular and ongoing audit procedures and reports on the effectiveness of internal controls to executive management and the Audit Committee of the Board of Directors.
     Customer-related business conditions may also increase operational risk or the level of operational losses in certain transaction processing business units, including merchant processing activities. Ongoing risk monitoring of customer activities and their financial condition and operational processes serve to mitigate customer-related operational risk. Refer to Note 23 of the Notes to Consolidated Financial Statements for further discussion on merchant processing.
     While the Company believes that it has designed effective methods to minimize operational risks, there is no absolute assurance that business disruption or operational losses would not occur in the event of a disaster. On an ongoing basis, management makes process changes and investments to enhance its systems of internal controls and business continuity and disaster recovery plans.

Interest Rate Risk Management In the banking industry, a significant risk exists related to changes in interest rates. To minimize the volatility of net interest income and of the market value of assets and liabilities, the Company manages its exposure to changes in interest rates through asset and liability management activities within guidelines established by its Asset Liability Policy Committee (“ALPC”) and approved by the Board of Directors. ALPC has the responsibility for approving and ensuring compliance with ALPC management policies, including interest rate risk exposure. The Company uses Net Interest Income Simulation Analysis and Market Value of Equity Modeling for measuring and analyzing consolidated interest rate risk.

Net Interest Income Simulation Analysis One of the primary tools used to measure interest rate risk and the effect of interest rate changes on rate sensitive income and net interest income is simulation analysis. The monthly analysis incorporates substantially all of the Company’s assets and liabilities and off-balance sheet instruments, together with forecasted changes in the balance sheet and assumptions that reflect the current interest rate environment. Through these simulations, management estimates the impact on interest rate sensitive income of a 300 basis point upward or downward gradual change of market interest rates over a one-year period. The simulations also estimate the effect of immediate and sustained parallel shifts in the yield curve of 50 basis points as well as the effect of immediate and sustained flattening or steepening of the yield curve. These simulations include assumptions about how the balance sheet is likely to be affected by changes in loan and deposit growth. Assumptions are made to project interest rates for new loans and deposits based on historical analysis, management’s outlook and repricing strategies. These assumptions are validated on a periodic basis. A sensitivity analysis is provided for key variables of the simulation. The results are reviewed by ALPC monthly and are used to

Sensitivity of Net Interest Income and Rate Sensitive Income:

                                                                 
December 31, 2003 December 31, 2002

Down 50 Up 50 Down 300 Up 300 Down 50 Up 50 Down 300 Up 300
Immediate Immediate Gradual Gradual Immediate Immediate Gradual Gradual

Net interest income
    1.30 %     .19%       * %     (.02 )%     .08 %     (.34 )%     * %     (1.91 )%
Rate sensitive income
    .74 %     .01%       * %     (.54 )%     .20 %     (.55 )%     * %     (2.57 )%

Given the current level of interest rates, a downward 300 basis point scenario can not be computed.
 
U.S. Bancorp  45


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guide hedging strategies. ALPC policy guidelines limit the estimated change in interest rate sensitive income to 5.0 percent of forecasted interest rate sensitive income over the succeeding 12 months.
     The table on page 45 summarizes the interest rate risk of net interest income and rate sensitive income based on forecasts over the succeeding 12 months. At December 31, 2003, the Company’s overall interest rate risk position was substantively neutral to changes in interest rates. The Company manages its interest rate risk position by holding assets on the balance sheet with desired interest rate risk characteristics, implementing certain pricing strategies for loans and deposits and through the selection of derivatives and various funding and investment portfolio strategies. The Company plans to continue to manage the overall interest rate risk profile within policy limits and towards a neutral position. At December 31, 2003 and 2002, the Company was within its policy guidelines.

Market Value of Equity Modeling The Company also utilizes the market value of equity as a measurement tool in managing interest rate sensitivity. The market value of equity measures the degree to which the market values of the Company’s assets and liabilities and off-balance sheet instruments will change given a change in interest rates. ALPC guidelines limit the change in market value of equity in a 200 basis point parallel rate shock to 15 percent of the market value of equity assuming interest rates at December 31, 2003. Given the low level of current interest rates, the down 200 basis point scenario cannot be computed. The up 200 basis point scenario resulted in a 3.1 percent decrease in the market value of equity at December 31, 2003, compared with a 2.5 percent decrease at December 31, 2002. ALPC reviews other down rate scenarios to evaluate the impact of falling interest rates. The down 100 basis point scenario resulted in a 1.3 percent increase at December 31, 2003, and a 1.0 percent decrease at December 31, 2002. At December 31, 2003 and 2002, the Company was within its policy guidelines.

     The valuation analysis is dependent upon certain key assumptions about the nature of indeterminate maturity of assets and liabilities. Management estimates the average life and rate characteristics of asset and liability accounts based upon historical analysis and management’s expectation of rate behavior. These assumptions are validated on a periodic basis. A sensitivity analysis of key variables of the valuation analysis is provided to the ALPC monthly and is used to guide hedging strategies. The results of the valuation analysis as of December 31, 2003, were well within policy guidelines.

Use of Derivatives to Manage Interest Rate Risk In the ordinary course of business, the Company enters into derivative transactions to manage its interest rate and prepayment risk (“asset and liability management positions”) and to accommodate the business requirements of its customers (“customer-related positions”). To manage its interest rate risk, the Company may enter into interest rate swap agreements and interest rate options such as caps and floors. Interest rate swaps involve the exchange of fixed-rate and variable-rate payments without the exchange of the underlying notional amount on which the interest payments are calculated. Interest rate caps protect against rising interest rates while interest rate floors protect against declining interest rates. In connection with its mortgage banking operations, the Company enters into forward commitments to sell mortgage loans related to fixed-rate mortgage loans held for sale and fixed-rate mortgage loan commitments. The Company also acts as a seller and buyer of interest rate contracts and foreign exchange rate contracts on behalf of customers. The Company minimizes its market and liquidity risks by taking similar offsetting positions.

     All interest rate derivatives that qualify for hedge accounting are recorded at fair value as other assets or liabilities on the balance sheet and are designated as either “fair value” or “cash flow” hedges. The Company performs an assessment, both at inception and quarterly thereafter, when required, to determine whether these derivatives are highly effective in offsetting changes in the value of the hedged items. Hedge ineffectiveness for both cash flow and fair value hedges is immediately recorded in noninterest income. Changes in the fair value of derivatives designated as fair value hedges, and changes in the fair value of the hedged items, are recorded in earnings. Changes in the fair value of derivatives designated as cash flow hedges are recorded in other comprehensive income until income from the cash flows of the hedged items is realized. Customer-related interest rate swaps, foreign exchange rate contracts, and all other derivative contracts that do not qualify for hedge accounting are recorded at fair value and resulting gains or losses are recorded in trading account gains or losses or mortgage banking revenue.
     By their nature, derivative instruments are subject to market risk. The Company does not utilize derivative instruments for speculative purposes. Of the Company’s $31.8 billion of total notional amount of asset and liability management derivative positions at December 31, 2003, $29.8 billion was designated as either fair value or cash flow hedges. The cash flow hedge positions are interest rate swaps that hedge the forecasted cash flows from the underlying variable-rate LIBOR loans and floating-rate debt. The fair value hedges are primarily interest rate contracts that hedge the change in fair value related to interest rate changes of underlying fixed-rate debt, trust preferred securities and deposit obligations. In addition, the Company uses forward commitments to sell residential mortgage loans
 
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to hedge its interest rate risk related to residential mortgage loans held for sale. The Company commits to sell the loans at specified prices in a future period, typically within 90 days. The Company is exposed to interest rate risk during the period between issuing a loan commitment and the sale of the loan into the secondary market. Related to its mortgage banking operations, the Company held $1.0 billion of forward commitments to sell mortgage loans and $1.0 billion of unfunded mortgage loan commitments that were derivatives in accordance with the provisions of the Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedge Activities.” The unfunded mortgage loan commitments are reported at fair value as options in Table 17.
     Derivative instruments are also subject to credit risk associated with counterparties to the derivative contracts. Credit risk associated with derivatives is measured based on the replacement cost should the counterparties with contracts in a gain position to the Company fail to perform under the terms of the contract. The Company manages this risk through diversification of its derivative positions among various counterparties, requiring collateral agreements with credit-rating thresholds, entering into master netting agreements in certain cases and entering into interest rate swap risk participation agreements. These agreements are credit derivatives that transfer the credit risk related to interest rate swaps from the Company to an unaffiliated third-party. The Company also provides credit protection to
 
 Table 17   Derivative Positions

Asset and Liability Management Positions

                                                                               
Weighted-
Maturing Average

Remaining
December 31, 2003 Fair Maturity
(Dollars in Millions) 2004 2005 2006 2007 2008 Thereafter Total Value In Years

Interest rate contracts
                                                                       
 
Receive fixed/pay floating swaps
                                                                       
   
Notional amount
  $ 13,073     $     $ 500     $ 1,720     $ 3,750     $ 4,150     $ 23,193     $ 691       4.17  
   
Weighted-average
                                                                       
     
Receive rate
    4.22 %           2.37 %     3.96 %     3.90 %     6.60 %     4.54 %                
     
Pay rate
    1.19             1.17       1.20       1.16       1.67       1.27                  
 
Pay fixed/receive floating swaps
                                                                       
   
Notional amount
  $ 2,700     $ 2,390     $ 250     $     $     $     $ 5,340     $ (60 )     1.25  
   
Weighted-average
                                                                       
     
Receive rate
    1.13 %     1.17 %     1.19 %                       1.15 %                
     
Pay rate
    3.15       2.56       2.73                         2.86                  
 
Futures and forwards
  $ 2,229     $     $     $     $     $     $ 2,229     $       .16  
 
Options
                                                                       
   
Written
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