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(U.S. BANCORP cover)

FIVE STAR SERVICE IN ACTION 2004 ANNUAL REPORT AND FORM 10-K


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U.S. Bank lapel pin signifying This year, we
At U.S. Bancorp, we value and recognize the expertise and energy of our employees, especially their commitment to providing outstanding customer service and contributing to the corporation’s financial results. Each employee wears a our customer service guarantee. will acknowledge employees’ milestone service anniversaries with special gemstone lapel pins for service at five, 10, 15, 20 and 25 years.

(U.S. BANCORP AT A GLANCE)

(U.S. BANCORP LOGO)

     
At year-end 2004
   
U.S. BANCORP AT A GLANCE
Ranking
  6th largest financial holding company
 
Asset size
  $195 billion
 
Deposits
  $121 billion
 
Total loans
  $126 billion
 
Earnings per share (diluted)
  $2.18
 
Return on average assets
  2.17%
 
Return on average equity
  21.4%
 
Tangible common equity
  6.4%
 
Efficiency ratio
  45.3%
 
Customers
  13.1 million
 
Primary banking region
  24 states
 
Bank branches
  2,370
 
ATMs
  4,620
 
NYSE symbol
  USB
 

 


(CONTENTS)

         
    2  
    3  
    4  

             
FEATURES
           
 
           
(FIVE STAR SERVICE IN ACTION)
  Five Star Service
in Action

U.S. Bancorp employees deliver on our promise to provide the outstanding service our customers expect and deserve.
    6  
 
           
(ADVANTAGEOUS BUSINESS MIX)
  Advantageous
Business Mix

We help our customers achieve their financial goals by offering an extensive scope of strategic services through specialized lines of business.
    10  
 
           
(INITIATIVES FOR SUCCESS)
  Initiatives for Success
We are increasing our ability to provide the highest quality service and the most innova- tive products through new investments and initiatives for future growth and service.
    14  
     
FINANCIALS
   
 
   
  18
  64
  68
  105
  108
  110
  111
  114
  121
  124
  125
  inside back cover
 Information Re: 2005 Compensation
 Statement Re: 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 18 U.S.C. Section 1350

“Safe Harbor” Statement under the Private Securities Litigation Reform Act of 1995:
Statements in this report regarding U.S. Bancorp’s business which are not historical facts are “forward-looking statements” that involve risks and uncertainties. For a discussion of such risks and uncertainties, which could cause actual results to differ from those contained in the forward-looking statements, see the “Forward-Looking Statements” disclosure on page 17 of this report.



CORPORATE PROFILE

U.S. Bancorp, headquartered in Minneapolis, is the 6th largest financial holding company in the United States, with total assets exceeding $195 billion at year-end 2004. U.S. Bancorp, the parent company of U.S. Bank, serves 13.1 million customers and operates 2,370 branch offices in 24 states. U.S. Bancorp customers also access their accounts through 4,620 U.S. Bank ATMs, U.S. Bank Internet Banking and telephone banking. A network of specialized U.S. Bancorp offices across the nation, inside and outside our 24-state footprint, provides a comprehensive

 

line of banking, brokerage, insurance, investment, mortgage, trust and payment services products to consumers, businesses, governments and institutions.

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



U.S. BANCORP     1

 


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SELECTED FINANCIAL HIGHLIGHTS

(SELECTED FINAN. HGHLTS)

     
(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.

2     U.S. BANCORP

 


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FINANCIAL SUMMARY

                                         
Year Ended December 31                           2004     2003  
(Dollars and Shares in Millions, Except Per Share Data)   2004     2003     2002     v 2003     v 2002  
 
Total net revenue (taxable-equivalent basis)
  $ 12,659.1     $ 12,530.5     $ 12,057.9       1.0 %     3.9 %
Noninterest expense
    5,784.5       5,596.9       5,740.5       3.4       (2.5 )
Provision for credit losses
    669.6       1,254.0       1,349.0                  
Income taxes and taxable-equivalent adjustments
    2,038.2       1,969.5       1,740.4                  
 
   
Income from continuing operations
    4,166.8       3,710.1       3,228.0       12.3       14.9  
Discontinued operations (after-tax)
          22.5       (22.7 )                
Cumulative effect of accounting change (after-tax)
                (37.2 )                
 
   
Net income
  $ 4,166.8     $ 3,732.6     $ 3,168.1       11.6       17.8  
 
   
 
Per Common Share
                                       
Earnings per share from continuing operations
  $ 2.21     $ 1.93     $ 1.68       14.5 %     14.9 %
Diluted earnings per share from continuing operations
    2.18       1.92       1.68       13.5       14.3  
Earnings per share
    2.21       1.94       1.65       13.9       17.6  
Diluted earnings per share
    2.18       1.93       1.65       13.0       17.0  
Dividends declared per share
    1.020       .855       .780       19.3       9.6  
Book value per share
    10.52       10.01       9.62       5.1       4.1  
Market value per share
    31.32       29.78       21.22       5.2       40.3  
Average common shares outstanding
    1,887.1       1,923.7       1,916.0       (1.9 )     .4  
Average diluted common shares outstanding
    1,912.9       1,936.2       1,924.8       (1.2 )     .6  
 
Financial Ratios
                                       
Return on average assets
    2.17 %     1.99 %     1.84 %                
Return on average equity
    21.4       19.2       18.3                  
Net interest margin (taxable-equivalent basis)
    4.25       4.49       4.65                  
Efficiency ratio
    45.3       45.6       48.8                  
 
Average Balances
                                       
Loans
  $ 122,141     $ 118,362     $ 114,453       3.2 %     3.4 %
Investment securities
    43,009       37,248       28,829       15.5       29.2  
Earning assets
    168,123       160,808       147,410       4.5       9.1  
Assets
    191,593       187,630       171,948       2.1       9.1  
Deposits
    116,222       116,553       105,124       (.3 )     10.9  
Shareholders’ equity
    19,459       19,393       17,273       .3       12.3  
 
Period End Balances
                                       
Loans
  $ 126,315     $ 118,235     $ 116,251       6.8 %     1.7 %
Allowance for credit losses
    2,269       2,369       2,422       (4.2 )     (2.2 )
Investment securities
    41,481       43,334       28,488       (4.3 )     52.1  
Assets
    195,104       189,471       180,027       3.0       5.2  
Deposits
    120,741       119,052       115,534       1.4       3.0  
Shareholders’ equity
    19,539       19,242       18,436       1.5       4.4  
Regulatory capital ratios
                                       
Tangible common equity
    6.4 %     6.5 %     5.7 %                
Tier 1 capital
    8.6       9.1       8.0                  
Total risk-based capital
    13.1       13.6       12.4                  
Leverage
    7.9       8.0       7.7                  
 

U.S. BANCORP     3

 


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(LETTER TO SHAREHOLDER)

LETTER TO SHAREHOLDERS 2004 was a year that it all came together for U.S. Bancorp. Service quality levels have never been higher. Financial results are strong and lead the industry in key measurements. All lines of business are contributing to revenue and growth.

Fellow Shareholders:

I am pleased to tell you that in 2004, U.S. Bancorp achieved its goals for the year and delivered on its promises to you.

STRONG FINANCIAL RESULTS WITH A
FOCUS ON REVENUE GROWTH

We reported record net income of $4.2 billion, a 13 percent increase in diluted earnings per share, and industry-leading returns on assets and equity of 2.17 percent and 21.4 percent, respectively. Credit quality trends continued to improve as credit losses decreased significantly from a year ago. And reflecting our priority to grow revenue, we achieved solid fee income growth.

During the coming year, we will act to sustain those successes. Revenue growth is our primary focus, particularly net interest income from improved commercial lending results. Our consumer lending business continues to grow, and we have made a number of changes surrounding our commercial banking and small business banking lines of business to increase commercial loan growth. We saw middle market commercial loan balances move upward in fourth quarter 2004.

We are very disciplined in our acquisitions, focusing only on those which will enhance revenue growth, create operating scale, build a more profitable business line or strengthen a critical competitive advantage. This strategy has proved very successful, most notably in our payments business, which reported 10.6 percent net revenue growth in 2004.

Our capital position remains strong, and we repurchased 93.8 million shares during 2004.

INVESTING FOR GROWTH AND SERVICE

We are investing more in our core businesses to drive revenue growth. Our investments and expertise in new technology have delivered a new generation of electronic options for customers—check imaging, processing, payments, account management, collections and other service delivery systems. Of particular note is the expansion of our merchant processing capabilities in Europe; there are further details of that expansion on page 16 of this report. And, we continue to invest in our branch office network in higher-growth markets. There are further details of our in-store and traditional branch expansion program on page 13 of this report.

We continue to support our pledge of guaranteed high levels of customer service. Investments in delivery and operational systems allowed us to unify systems, simplify procedures, streamline processes and increase the ease of numerous customer transactions and communications. These investments improved customer service and increased customer satisfaction and loyalty, contributing significantly to our ability to attract and retain customers. We have also improved hiring and training practices, and service quality is an integral part of our employees’ performance evaluation and incentive programs.

RATING AGENCIES VIEW
U.S. BANK FAVORABLY

We are pleased that on January 18, 2005, Moody’s rating agency upgraded U.S. Bank’s ratings. Long-term senior debt at the holding company, U.S. Bancorp, was upgraded to Aa2 from Aa3 while long-term senior ratings of its subsidiary bank, U.S. Bank National Association, were upgraded to Aa1 from Aa2. The main driver behind the


4     U.S. BANCORP

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upgrade was Moody’s view that the corporation’s business model will generate strong profitability, and the consistency of that profitability performance is supported by improving risk management and maintenance of very good liquidity.

We were also pleased that on September 27, 2004, Fitch’s rating agency upgraded U.S. Bank’s ratings. Long- and short-term senior debt at the holding company, U.S. Bancorp, were upgraded to AA- and F1+, respectively, from A+ and F1, respectively. The long-term ratings of its subsidiary bank, U.S. Bank National Association, were upgraded to AA from AA-. The main driver behind the upgrade was Fitch’s view of the corporation’s solid net interest margin, diverse sources of non-interest income, disciplined expense management and improved asset quality.

The debt ratings established for U.S. Bank by Moody’s, Standard and Poor’s, and Fitch reflect the ratings agencies’ recognition of the strong, consistent financial performance of the company and the quality of the balance sheet.

U.S. BANCORP IS A CORPORATION
BUILT ON INTEGRITY

We recognize that our financial results are only as good as the respect and confidence of the public and our reputation in the industry and in the marketplace. We operate with the highest levels of honesty and integrity, and we have the controls and monitors in place to ensure that is always true. Our Corporate Governance Guidelines, our Privacy Pledge, and our Code of Ethics and Business Conduct can all be found on our internet website at usbank.com. I urge you to visit the site.

CREATING SHAREHOLDER VALUE
IS OUR PRIORITY

We delivered on our commitment to return at least 80 percent of earnings to shareholders, returning virtually all excess capital to shareholders, 109 percent of earnings in 2004, in the form of dividends and share repurchases. We reaffirmed that commitment with our December 2004 announcement of a 25 percent dividend increase and the authorization of a new 150-million share repurchase program.

This corporation has paid a cash dividend for 142 consecutive years, and we have increased the dividend for 33 consecutive years. That long-time record of dividend increases earned U.S. Bancorp the designation of one of the S&P’s 58 “Dividend Aristocrats.” Only nine other issues have paid a dividend longer than U.S. Bancorp, which first paid a dividend in 1863.

We manage this corporation to increase the value of your investment in U.S. Bancorp. It’s the reason we come to work each day.

Sincerely,

(JERRY A. GRUNDHOFER SIGNATURE)

Jerry A. Grundhofer
Chairman and Chief Executive Officer
U.S. Bancorp
February 28, 2005



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FIVE STAR SERVICE IN ACTION THE VALUES OF FIVE STAR SERVICE Take Ownership Make it Personal Add Value to Every Interaction Make Customer Courtesy Common Share Knowledge SHE TAKES OWNERSHIP. May Li, Manager Factoria Office, Bellevue, WA When Terrie Nixdorff needed help obtaining a debit card after experiencing an unsettling fraud situation, May Li stepped right in. With unyielding determination and extensive follow-through, May Li ensured that Terrie's situation was completely resolved. 6 U.S. BANCORP


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Teshan Lewis, Account Coordinator Corporate Payment Systems, Minneapolis, MN Teshan Lewis went above and beyond to secure a Government Purchase Card for a staff member of the United States Air Force who was preparing for a short-notice deployment to Iraq. Teshan's personal commitment and persistence ensured the staff member received the card in time to carry out his mission. Teshan is pictured with Lt. Col. Todd Pospisil and Government Purchase Card Program Managers Laura Ball and Marie D'Angelo. HE MAKES IT PERSONAL.


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SHE ADDS VALUE. Pam Paley, Relationship Manager The Private Client Group, Cincinnati, OH Pam Paley partners with Frederic H. Mayerson, Chairman and Managing General Partner of The Walnut Group, a diversified private equity investment company. Pam adds value to every interaction by consistently finding the right specialized, competitive products and services designed to meet the needs of The Walnut Group's principals. Ann Vazquez, Manager Broker Dealer Division, St. Louis, MO Since 1989, Ann Vazquez has provided unparalleled expertise and professional, courteous service to Rodger Riney, Founder, President and CEO of Scottrade. Recently, Ann was instrumental in finding a creative credit facility solution. Coupled with her consistently personalized attention, Ann makes sure that what matters most to Scottrade matters most to U.S. Bank. SHE MAKES CUSTOMER COURTESY COMMON.


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Andrew Eberhardy, Project Manager Elan Financial Services, Milwaukee, WI Andrew Eberhardy's skilled support made all the difference to Oregon-based Umpqua Bank during a recent credit card portfolio conversion. Drawing on his vast knowledge of conversion processes, Andrew offered Umpqua flexible, efficient and reliable options to guarantee their satisfaction. Andrew is pictured with Susie McEuin and Laura Schaeffer of Umpqua. HE SHARES HIS KNOWLEDGE.


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(ADVANTAGEOUS BUSINESS MIX)

(PHOTO)

ADVANTAGEOUS BUSINESS MIX
13.1 million customers rely on U.S. Bancorp as their financial partner. From a simple personal checking account to sophisticated corporate transactions, U.S. Bancorp has the products and services, the talent, the technologies and the expertise to help our customers achieve their goals.

WHOLESALE
     BANKING

With relationship managers who understand the companies, the markets and the industries of our commercial, corporate and correspondent customers, no bank brings more to the table than U.S. Bank.

Whether it’s finding the right financing and capital for growth and expansion, accelerating receivables, expediting transactions, managing employee benefits programs or structuring transactions to finance foreign trade, U.S. Bank has the business solutions that build businesses and futures.

After several years of lackluster demand, in 2004 we saw an increase, albeit modest, in commercial and corporate lending, particularly in the areas of commercial and industrial lending and commercial real estate. Economic trends across most markets are positive overall and we expect to see continued improvement in 2005. Interest rates, while rising, are affordable, and companies appear more ready than at any time in the past several years to invest in their businesses.

Significant changes within our organization position us well to be more visible and active in every market, with more streamlined procedures and more competitive pricing. These changes augment the high level of customer service and industry expertise already provided to our customers.

KEY BUSINESS UNITS

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


10      U.S. BANCORP


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PAYMENT
     SERVICES

U.S. Bancorp is a recognized leader in the rapidly growing payments business, with customers ranging from individual credit and debit cardholders and ATM users to local and global merchants, fleet enterprises and multinational corporations with complex payment and payment processing needs.

KEY BUSINESS UNITS

 
Corporate Payment Systems
Merchant Payment Services
NOVA Information Systems, Inc.
Retail Payment Solutions (card services)
Transaction Services


We provide innovative card-based programs, internet-based reporting tools, fully integrated payment solutions and electronic payments settlement answers across the country and around the world.

Payment Services is a higher growth, higher return line of business for U.S. Bancorp. We will continue to invest in the technology, acquisitions, product development and sales promotion needed to support its continued growth.

There is strong momentum in merchant processing, especially related to our new NOVA processing capabilities in Europe. Both our retail payments and corporate payments businesses are focusing on the expansion of existing relationships with current

customers. Additionally, corporate payment products and merchant processing can provide valuable benefits to middle market and small business companies, and we are increasing penetration of those customer segments for payments and processing services.

We are also investing in the hardware and technology to expand and enhance our network of U.S. Bank ATMs. Our newest generation of ATMs are among the most highly functional in the industry, with vivid, striking graphics and transaction screens and customization capabilities so that customers’ transactions are faster, easier and individualized.



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THE PRIVATE CLIENT GROUP,
                    TRUST & ASSET MANAGEMENT

U.S. Bancorp understands what it takes to build, manage and preserve our clients’ wealth. From sensitive and personalized family financial management and estate planning to sophisticated corporate trust transactions to expert advice on investments, we prepare clients for today’s realities and tomorrow’s goals.

KEY BUSINESS UNITS

 
The Private Client Group
Corporate Trust Services
Institutional Trust & Custody
U.S. Bancorp Asset Management, Inc.
U.S. Bancorp Fund Services, LLC


The Private Client Group works with affluent individuals and families, professional service corporations and non-profit organizations as a bank within a bank, providing tailored programs to meet specialized needs. Recognizing that many more U.S. Bank customers could benefit from the financial planning, investment management, personal trust and private banking expertise of The Private Client Group, this group is building stronger bank-wide partnerships with other U.S. Bank lines of business to identify Private Client Group referral opportunities.

Built on our strong technology platform and superior management, Corporate Trust Services is leveraging its distribution and scale following our two most recent acquisitions. We reported to you last year about our acquisition of the State Street corporate trust business, and in June 2004 we completed the acquisition of National City’s corporate trust division, a transaction that brought

the bank $34 billion in assets under administration and 3,800 corporate clients throughout the Midwest. It is our sixth corporate trust acquisition since 1999, reflecting our approach of acquisitions to grow revenue and businesses capable of competing with anyone.

U.S. Bancorp Asset Management, Inc., a subsidiary of U.S. Bank National Association, serves as the investment advisor to the First American Funds. It provides investment management services to individuals and institutions including corporations, foundations, pension funds, public funds, and retirement plans. The firm has offices in 24 states. Asset Management distribution is expanding through increased penetration of the Institutional Market and third-party distribution. In 2004, U.S. Bancorp Asset Management launched two new mutual funds—the First American Inflation Protected Securities Fund and the First American U.S. Treasury Money Market Fund. A retirement (R) share class was also added to a number of funds in the fund family.



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CONSUMER
          BANKING

Our customers want convenience, accessibility, quality products and outstanding service. Our distribution channels—full-service banking offices, ATMs, telephone banking, and internet banking—deliver the deposit, credit, mortgage, investment and insurance products that support the goals and visions of personal and small business customers.

Business momentum in Consumer Banking is strong, and we continue to invest in technologies and initiatives that enhance distribution and deliver on customer expectations.

Customer satisfaction remains our top priority, and new Consumer Banking product initiatives are positively impacting customer satisfaction. Enhancements to internet banking on usbank.com, again ranked number one by Speer and Associates, provide even greater flexibility, customization and functionality.

Significant investment in innovative image technology enables U.S. Bank Internet Banking customers to instantly view more than 3.5 million check and deposit slip images per month on their computer screens. A wide range of operational procedures have also been simplified and streamlined.

(PAGE 13 RIGHT PHOTO)

KEY BUSINESS UNITS

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

We continue to expand our unique Checking That Pays® rewards program, which gives customers who use their U.S. Bank Visa® Check Card the choice of four different reward options. In 2004, U.S. Bank rewarded customers more than $26 million in annual cash rebates, five times the $5 million rewarded in 2000.



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OUR IN-STORE BANKING
NETWORK CONTINUES TO GROW
Our in-store branch network—the third largest in the industry—delivers all the access of traditional branches to our customers inside grocery and convenience stores. Building on the tremendous success of this lower cost distribution channel, last year U.S. Bank began a major expansion of in-store branches in fast-growing markets such as Arizona, California, Nevada and Utah. These new branches continue to exceed expectations for profitability.
In 2003, we opened six new Nashville Publix and 32 new Safeway, Vons, Smith’s, Pak N Save and Pavilion branches, plus additional branches with other valued partners. We continued to grow in 2004, opening 112 new in-store branches. By the end of 2005, U.S. Bank will have opened 185 new in-store branches as part of the newest expansion initiative, for a total overall of 478 in-store branches in 19 states.

(INITIATIVES FOR SUCCESS)

INITIATIVES FOR SUCCESS
INVESTING
IN OUR COMPANY FOR GROWTH AND SERVICE Increasing our ability to provide better customer service, offer new customer options, and develop and deliver new products keeps us ahead of the curve and ahead of the competition.

(PHOTO)

MARKET PENETRATION

In Consumer Banking, we have improved our automated capability to identify product recommendation and customer service opportunities at the individual customer level so we can provide more personalized service and recommend the most appropriate products.

In Corporate Payment Systems, we are dedicating resources to build middle market relationships. We have redesigned and simplified processes, applications and contracts and have been pursuing new client categories among companies with annual sales between $20 and $500 million. Our new One Card for the middle market combines the best features from our corporate and purchasing cards into one easy-to-manage program.

NOVA’s new Electronic Check Service processing streamlines check acceptance and mitigates risk for our customers so they can accept checks as safely and easily as card payment alternatives.

Gift card industry sales reached $45 billion in 2003 and are forecast to double by 2007. NOVA’s growing gift card program meets the needs of merchants in a cost-effective manner, and NOVA gift cards are processed using the same point-of-sale systems used for credit and debit card processing, further controlling costs.



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The Private Client Group has several initiatives in progress which leverage the franchise to develop new client relationships. Our focus is on building stronger internal partnerships with other U.S. Bancorp lines of business. We recognize that many customers already doing business with U.S. Bank could benefit from the comprehensive and specialized expertise of our Financial Planning, Private Banking, Personal Trust, Investment and Insurance experts in The Private Client Group.

Retail Payment Solutions has increased penetration of personal and small business checking account customers with U.S. Bank-branded credit and debit cards by investing in sales and training opportunities with our expanded branch network.

PRODUCT DEVELOPMENT
Treasury Management will launch SinglePointSM, a unified customer workstation in 2005, providing a single point of access for our core U.S. Bank Treasury Management

services. SinglePointSM allows business customers to access information and reports, initiate and manage ACH transactions and wires, view check and deposit images and manage check fraud programs at one source.

We have upgraded and image-enabled key lockbox sites for both wholesale and retail payment processing, and introduced a suite of check conversion products and services including On-Site Electronic Deposit and Electronic Cash Letter.

Institutional Trust has launched Health Savings Accounts (HSA) to client companies. HSAs are tax-exempt trust or custodial accounts to be used exclusively for future medical expenses. Similar to IRAs, they are special tax-sheltered savings accounts for medical bills for those employees who qualify.

Our new generation of ATMs integrates customization and information delivery with ATM transactions. Customers will have access to personalized messages, customized “fast cash” preferences, and more. These ATMs provide a faster, easier to use, and more personal experience.


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We are leveraging our expertise in Commercial Real Estate financing and capitalizing on an improving economy by opening new Commercial Real Estate offices in Phoenix, Dallas and Washington, D.C. Offering our clients greater investment choice, The Private Client Group launched Mutual Fund Open Architecture in 2004, allowing clients to access investments that complement our proprietary funds. We will continue to strategically expand Open Architecture. Retail Payment Solutions successfully entered the affinity debit and credit card market in June 2004. With a potential partner base of 7,000 or more across the country, growth prospects are excellent. U.S. Bancorp’s Elan Financial Services division now offers prepaid card processing for its financial institution clients, providing the ability for these clients to offer payroll cards and to offer or purchase gifts cards. MARKET DEVELOPMENT Our Asset Management business is performance driven, and on this foundation, we have created investment products attractive not only to our own investors, but also products that will be competitive and attractive in third party retail and institutional distribution. We will expand into these new distribution channels in 2005. U.S. Bancorp Fund Services (USBFS), long a recognized administrator for U.S.-based mutual funds, is gaining name recognition and reputation as a third party outsourcing administrator in the alternative investment industry as well. USBFS has made investments in the specialized technology and accounting systems to support servicing both the simple and complex investments held by hedge funds. NOVA continues its merchant processing expansion in Europe through its EuroConex business, headquartered in Ireland. Growing through acquisitions and alliances, EuroConex now supports more than 100,000 merchants across eight European countries. As a specialized business with notable competitive advantages, and one that benefits from economies of scale, we see considerable potential for further European expansion. NOVA also launched a Canadian merchant processing product in October 2004. We anticipate that many current U.S. customers will consolidate their U.S. and Canadian merchant processing with NOVA and that Canadian merchants will switch from fragmented processing systems to NOVA as a single source of top-rated processing and customer service.


 


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(FINANCIAL REVIEW 2004)

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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MANAGEMENT’S DISCUSSION AND ANALYSIS

OVERVIEW

In 2004, U.S. Bancorp and its subsidiaries (the “Company”) continued to demonstrate its financial strength and shareholder focus. We began the year with several specific financial objectives. The first goal was a focus on organic revenue growth. While growth in net interest income has been challenging for the banking industry due to rising interest rates and sluggish commercial loan growth, the Company experienced strong growth in its fee-based revenues, particularly in payment processing services. The Company generated fee-based revenue growth of 11.0 percent in 2004. By year-end, commercial loan balances also displayed encouraging trends as the Company experienced its first year-over-year growth in quarterly average balances since mid-2001. Retail loans continued to display strong growth in 2004. In 2005, the Company will continue to focus on revenue growth driven by disciplined strategic business initiatives, customer service and an emphasis on payment processing, retail banking and commercial lending. The second goal was to continue improving the credit quality of our loan portfolios. During the year nonperforming assets declined 34.8 percent from a year ago and total net charge-offs decreased to .63 percent of average loans outstanding in 2004, compared with 1.06 percent in 2003. By year end 2004, the credit risk profile of the Company had improved to pre-2001 levels. In 2005, the Company will continue to focus on credit quality and minimizing volatility of credit-related losses. Finally, effectively managing costs is always a goal for the Company. During 2004, our efficiency ratio (the ratio of noninterest expense to taxable-equivalent net revenue excluding net securities gains or losses) improved to 45.3 percent, compared with 45.6 percent in 2003, and continues to be a leader in the banking industry. The Company’s results for 2004 reflect the achievement of these operating objectives and help to position the Company to achieve its long-term goal of 10 percent or greater growth in earnings per diluted share.

     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 continued to be strong at 6.4 percent of tangible common assets at December 31, 2004, compared with 6.5 percent at December 31, 2003. Credit ratings for the Company were upgraded by Fitch Ratings in September 2004 and Moody’s Investors Service in January 2005. 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 capital through earnings.
     In concert with achieving our stated financial objectives, the Company exceeded its objective to return at least 80 percent of earnings to shareholders in the form of dividends and share repurchases by returning 109 percent of 2004 earnings to shareholders. In December 2004, we announced an expanded share repurchase program and further increased our cash dividend resulting in a 25.0 percent increase from the dividend rate in the fourth quarter of 2003. We continue to affirm our goal of returning at least 80 percent of earnings to shareholders.

Earnings Summary The Company reported net income of $4.2 billion in 2004, or $2.18 per diluted share, compared with $3.7 billion, or $1.93 per diluted share, in 2003. The 13.0 percent increase in earnings per diluted share principally reflected growth in fee-based revenues and lower credit costs. Return on average assets and return on average equity were 2.17 percent and 21.4 percent, respectively, in 2004, compared with returns of 1.99 percent and 19.2 percent, respectively, in 2003. Net income in 2003 included after-tax income from discontinued operations of $22.5 million, or $.01 per diluted share.

     In 2004, the Company had income from continuing operations, net of tax, of $4.2 billion, or $2.18 per diluted share, compared with $3.7 billion, or $1.92 per diluted share, in 2003. The Company’s results from continuing operations in 2004 reflected slightly lower net interest income, strong fee-based revenue growth and lower credit costs. During 2004, certain elements of the Company’s operating results included the impact of management actions or specific events. In 2004, the Company undertook several asset/liability management actions in response to changing interest rates, including sales of investment securities and the prepayment of certain long-term debt. These actions enabled the Company to maintain an interest rate risk position that is relatively neutral to rising interest rates; however, the Company incurred $104.9 million of net securities losses in 2004, a net reduction of $349.7 million from 2003, and debt prepayment costs of $154.8 million in 2004. Also resulting from changes in interest rates, the Company incurred a $56.8 million impairment of its portfolio of mortgage servicing rights (“MSR”), a favorable reduction in other intangibles expenses of $151.9 million relative to 2003. Included in the provision for credit losses in 2004 was a reduction in the allowance for credit losses of $98.5 million, reflecting continued improvement in credit quality and economic conditions. In addition, the Company’s effective income tax rate declined to
 
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32.5 percent in 2004, from 34.4 percent in 2003, principally due to changes in estimated tax liabilities related to the resolution of certain federal and state tax examinations. Year-over-year results were also impacted by a reduction in merger and restructuring-related charges of $46.2 million, reflecting the completion of all significant business integration activities in 2003.
     Total net revenue, on a taxable-equivalent basis, was $12.7 billion in 2004, compared with $12.5 billion in 2003, a year-over-year increase of $128.6 million (1.0 percent). The increase in net revenue was comprised of a 3.9 percent increase in noninterest income and a 1.1 percent decline in net interest income. The 3.9 percent net increase in noninterest income was driven by strong growth in fee-
 
 Table 1   Selected Financial Data
                                           
Year Ended December 31
(Dollars and Shares in Millions, Except Per Share Data) 2004 2003 2002 2001 2000

Condensed Income Statement
                                       
Net interest income (taxable-equivalent basis) (a)
  $ 7,139.9     $ 7,217.5     $ 6,847.2     $ 6,405.2     $ 6,072.4  
Noninterest income
    5,624.1       5,068.2       4,910.8       4,340.3       3,958.9  
Securities gains (losses), net
    (104.9 )     244.8       299.9       329.1       8.1  
   
 
Total net revenue
    12,659.1       12,530.5       12,057.9       11,074.6       10,039.4  
Noninterest expense
    5,784.5       5,596.9       5,740.5       6,149.0       4,982.9  
Provision for credit losses
    669.6       1,254.0       1,349.0       2,528.8       828.0  
   
 
Income from continuing operations before taxes
    6,205.0       5,679.6       4,968.4       2,396.8       4,228.5  
Taxable-equivalent adjustment
    28.6       28.2       32.9       54.5       82.0  
Applicable income taxes
    2,009.6       1,941.3       1,707.5       818.3       1,422.0  
   
 
Income from continuing operations
    4,166.8       3,710.1       3,228.0       1,524.0       2,724.5  
Discontinued operations (after-tax)
          22.5       (22.7 )     (45.2 )     27.6  
Cumulative effect of accounting change (after-tax)
                (37.2 )            
   
 
Net income
  $ 4,166.8     $ 3,732.6     $ 3,168.1     $ 1,478.8     $ 2,752.1  
   
Per Common Share
                                       
Earnings per share from continuing operations
  $ 2.21     $ 1.93     $ 1.68     $ .79     $ 1.43  
Diluted earnings per share from continuing operations
    2.18       1.92       1.68       .79       1.42  
Earnings per share
    2.21       1.94       1.65       .77       1.44  
Diluted earnings per share
    2.18       1.93       1.65       .76       1.43  
Dividends declared per share (b)
    1.020       .855       .780       .750       .650  
Book value per share
    10.52       10.01       9.62       8.58       8.06  
Market value per share
    31.32       29.78       21.22       20.93       23.25  
Average common shares outstanding
    1,887.1       1,923.7       1,916.0       1,927.9       1,906.0  
Average diluted common shares outstanding
    1,912.9       1,936.2       1,924.8       1,940.3       1,918.5  
 
Financial Ratios
                                       
Return on average assets
    2.17 %     1.99 %     1.84 %     .89 %     1.74 %
Return on average equity
    21.4       19.2       18.3       9.0       19.0  
Net interest margin (taxable-equivalent basis)
    4.25       4.49       4.65       4.46       4.38  
Efficiency ratio (c)
    45.3       45.6       48.8       57.2       49.7  
 
Average Balances
                                       
Loans
  $ 122,141     $ 118,362     $ 114,453     $ 118,177     $ 118,317  
Loans held for sale
    1,608       3,616       2,644       1,911       1,303  
Investment securities
    43,009       37,248       28,829       21,916       17,311  
Earning assets
    168,123       160,808       147,410       143,501       138,636  
Assets
    191,593       187,630       171,948       165,944       158,481  
Noninterest-bearing deposits
    29,816       31,715       28,715       25,109       23,820  
Deposits
    116,222       116,553       105,124       104,956       103,426  
Short-term borrowings
    14,534       10,503       10,116       11,679       11,008  
Long-term debt
    35,115       33,663       32,172       26,088       23,316  
Shareholders’ equity
    19,459       19,393       17,273       16,426       14,499  
 
Period End Balances
                                       
Loans
  $ 126,315     $ 118,235     $ 116,251     $ 114,405     $ 122,365  
Allowance for credit losses
    2,269       2,369       2,422       2,457       1,787  
Investment securities
    41,481       43,334       28,488       26,608       17,642  
Assets
    195,104       189,471       180,027       171,390       164,921  
Deposits
    120,741       119,052       115,534       105,219       109,535  
Long-term debt
    34,739       33,816       31,582       28,542       23,276  
Shareholders’ equity
    19,539       19,242       18,436       16,745       15,333  
Regulatory capital ratios
                                       
 
Tangible common equity
    6.4 %     6.5 %     5.7 %     5.9 %     6.4 %
 
Tier 1 capital
    8.6       9.1       8.0       7.8       7.3  
 
Total risk-based capital
    13.1       13.6       12.4       11.9       10.7  
 
Leverage
    7.9       8.0       7.7       7.9       7.5  

(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/ former U.S. Bancorp of Minneapolis 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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based products and services (11.0 percent), particularly in payment processing revenue, offset by a $349.7 million reduction in gains (losses) on sales of securities. The 1.1 percent decline in net interest income reflected modest growth in average earning assets, offset by lower net interest margins. Also contributing to the year-over-year decline in net interest income was a reduction in loan fees, the result of fewer loan prepayments during a rising rate environment. In 2004, average earning assets increased $7.3 billion (4.5 percent), compared with 2003, primarily due to growth in residential mortgages, retail loans and investment securities, partially offset by a decline in commercial loans and loans held for sale related to mortgage banking activities. The net interest margin in 2004 was 4.25 percent, compared with 4.49 percent in 2003. The decline in net interest margin primarily reflected the competitive credit pricing environment, a preference to acquire adjustable-rate securities for asset/liability management purposes, lower prepayment fees, a modest increase in the percent of total earning assets funded by wholesale sources of funding and higher rates paid on wholesale funding due to the impact of rising rates. In addition, the net interest margin declined year-over-year as a result of consolidating high credit quality, low margin loans from Stellar, a commercial loan conduit, onto the Company’s balance sheet beginning in the third quarter of 2003.
     Total noninterest expense was $5.8 billion in 2004, compared with $5.6 billion in 2003. The increase in total noninterest expense of $187.6 million (3.4 percent), primarily reflected a $154.8 million charge related to the prepayment of a portion of the Company’s long-term debt. The expense growth also reflected increases in compensation, employee benefits, professional services, marketing and business development, technology and communications and other operating expense, as well as expenses related to the expansion of the merchant acquiring business in Europe. These unfavorable variances were partially offset by a favorable change in impairment charges related to the MSR portfolio of $151.9 million and a $46.2 million reduction in merger and restructuring-related charges. Refer to “Acquisition and Divestiture Activity” for further information on the timing of acquisitions. The efficiency ratio (the ratio of noninterest expense to taxable-equivalent net revenue excluding net securities gains or losses) was 45.3 percent in 2004, compared with 45.6 percent in 2003.
     The provision for credit losses was $669.6 million for 2004, compared with $1,254.0 million for 2003, a decrease of $584.4 million (46.6 percent). The decrease in the provision for credit losses reflected improving credit quality and economic conditions relative to 2003. Net charge-offs during 2004 were $767.1 million, compared with net charge-offs of $1,251.7 million during 2003, a reduction of $484.6 million. The decline in net charge-offs was primarily the result of declining levels of stressed and nonperforming loans, continuing collection efforts and improving economic conditions. In response to improving credit conditions, the Company made a decision in 2004 to reduce the allowance for credit losses. 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 continues 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. In connection with the spin-off of Piper Jaffray, historical financial results related to Piper Jaffray have been segregated and accounted for in the Company’s financial statements as discontinued operations.

     On June 29, 2004, the Company purchased the remaining 50 percent ownership interest in EuroConex Technologies Ltd (“EuroConex”) from the Bank of Ireland. In addition, during the second and fourth quarters of 2004, the Company completed three separate transactions to acquire merchant processing businesses in Poland, the United Kingdom and Norway. In connection with these transactions, EuroConex and its affiliates provide debit and credit card processing services to merchants, directly and through alliances with banking partners in these European markets. These transactions represented total assets acquired of $377 million and total liabilities assumed of $115 million at the closing date. Included in total assets were contract and other intangibles with a fair value of $163 million and goodwill of $105 million. The goodwill reflected the strategic value of these businesses to the Company’s European merchant processing business and anticipated economies of scale that will result from these transactions.
     On December 31, 2002, the Company acquired the corporate trust business of State Street Bank and Trust Company (“State Street Corporate Trust”) in a cash
 
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transaction valued at $720 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. The transaction represented total assets acquired of $677 million and total liabilities assumed of $39 million. Included in total assets were contract and other intangibles with a fair value of $218 million and goodwill of $520 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.
     On November 1, 2002, the Company acquired 57 branches and a related operations facility in northern California from Bay View Bank (“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 The Leader Mortgage Company, LLC (“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.
     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 $7.1 billion in 2004, compared with $7.2 billion in 2003 and $6.8 billion in 2002. The decline in net interest income in 2004 reflected modest growth in average earning assets, more than offset by lower net interest margins. Also contributing to the year-over-year decline in net interest income was a $37.6 million reduction in loan fees, the result of fewer loan prepayments in a rising rate environment. Average earning assets were $168.1 billion for 2004, compared with $160.8 billion and $147.4 billion for 2003 and 2002, respectively. The $7.3 billion (4.5 percent) increase in average earning assets for 2004, compared with 2003, was primarily driven by increases in residential mortgages, retail loans and investment securities, partially offset by a decline in commercial loans and loans held for sale related to mortgage banking activities. The decline in average commercial loans from a year ago reflected soft loan demand in 2003 and through the third quarter of 2004. The Company began to experience growth in commercial

 
 Table 2   Analysis of Net Interest Income
                                           
2004 2003
(Dollars in Millions) 2004 2003 2002 v 2003 v 2002

Components of net interest income
                                       
 
Income on earning assets (taxable-equivalent basis) (a)
  $ 9,215.1     $ 9,286.2     $ 9,526.8     $ (71.1 )   $ (240.6 )
 
Expense on interest-bearing liabilities
    2,075.2       2,068.7       2,679.6       6.5       (610.9 )
   
Net interest income (taxable-equivalent basis)
  $ 7,139.9     $ 7,217.5     $ 6,847.2     $ (77.6 )   $ 370.3  
   
Net interest income, as reported
  $ 7,111.3     $ 7,189.3     $ 6,814.3     $ (78.0 )   $ 375.0  
   
Average yields and rates paid
                                       
 
Earning assets yield (taxable-equivalent basis)
    5.48 %     5.77 %     6.46 %     (.29 )%     (.69 )%
 
Rate paid on interest-bearing liabilities
    1.53       1.60       2.26       (.07 )     (.66 )
   
Gross interest margin (taxable-equivalent basis)
    3.95 %     4.17 %     4.20 %     (.22 )%     (.03 )%
   
Net interest margin (taxable-equivalent basis)
    4.25 %     4.49 %     4.65 %     (.24 )%     (.16 )%
   
Average balances
                                       
 
Investment securities
  $ 43,009     $ 37,248     $ 28,829     $ 5,761     $ 8,419  
 
Loans
    122,141       118,362       114,453       3,779       3,909  
 
Earning assets
    168,123       160,808       147,410       7,315       13,398  
 
Interest-bearing liabilities
    136,055       129,004       118,697       7,051       10,307  
 
Net free funds (b)
    32,068       31,804       28,713       264       3,091  

(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 loan losses, unrealized gain (loss) on available-for-sale securities, non-earning assets, other noninterest-bearing liabilities and equity.
 
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loans in late 2004 as economic conditions continued to improve. The net interest margin in 2004 was 4.25 percent, compared with 4.49 percent and 4.65 percent in 2003 and 2002, respectively. The 24 basis point decline in 2004 net interest margin, compared with 2003, primarily reflected the competitive credit pricing environment, a preference to acquire adjustable-rate securities which have lower yields and a decline in prepayment fees. The net interest margin was also impacted by a modest increase in the percent of total earning assets funded by wholesale sources of funding and higher rates paid on wholesale funding due to the impact of rising rates. The shift towards wholesale funding reflects, in part, slower growth in deposits as growth in mortgage banking escrows and government-related deposits declined. It also reflects asset/liability decisions to issue longer-term fixed-rate borrowings given the rising rate environment. In addition, the net interest margin declined year-over-year as a result of consolidating high credit quality, low margin loans from the Stellar commercial loan conduit onto the Company’s balance sheet beginning in the third quarter of 2003.
     Total average loans of $122.1 billion in 2004 were $3.8 billion (3.2 percent) higher, compared with 2003, reflecting growth in average residential mortgages, average retail loans and average commercial real estate loans of $2.6 billion (22.5 percent), $3.0 billion (7.9 percent) and $.1 billion (.5 percent), respectively. Growth in these categories was offset somewhat by an overall decline in average commercial loans of $2.0 billion (4.8 percent). Although the consolidation of loans from the Stellar commercial loan conduit had a positive impact on average loan balances year-over-year, excess liquidity and improving cash flows among corporate borrowers led to the overall decrease in total commercial loans. The Company began to experience growth in average commercial loans in the fourth quarter of 2004.
     Average investment securities were $5.8 billion (15.5 percent) higher in 2004, compared with 2003, reflecting the reinvestment of proceeds from declining average commercial loan balances and loans held for sale. The Company utilizes the investment portfolio as part of its overall asset/liability management practices to minimize structural interest rate and market valuation risks associated with changes in interest rates. During 2004, the Company received proceeds from prepayments and maturities of investment securities of $12.3 billion. Also, the Company made a decision to sell $8.2 billion of fixed-rate securities, classified as available-for-sale, as part of interest rate risk management actions given changes in rates during the year, recognizing a $104.9 million loss on the sale of securities.
 
 Table 3   Net Interest Income — Changes Due to Rate and Volume (a)
                                                     
2004 v 2003 2003 v 2002

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

Increase (decrease) in
                                               
Interest income
                                               
 
Investment securities
  $ 254.3     $ (115.5 )   $ 138.8     $ 428.4     $ (235.2 )   $ 193.2  
 
Loans held for sale
    (112.2 )     1.5       (110.7 )     62.7       (31.1 )     31.6  
 
Commercial loans
    (110.8 )     8.3       (102.5 )     (149.0 )     (157.8 )     (306.8 )
 
Commercial real estate
    7.3       (48.6 )     (41.3 )     90.2       (141.9 )     (51.7 )
 
Residential mortgage
    160.2       (61.5 )     98.7       232.5       (114.4 )     118.1  
 
Retail loans
    210.4       (264.5 )     (54.1 )     134.9       (363.9 )     (229.0 )
   
   
Total loans
    267.1       (366.3 )     (99.2 )     308.6       (778.0 )     (469.4 )
 
Other earning assets
    (13.7 )     13.7             6.4       (2.4 )     4.0  
   
   
Total
    395.5       (466.6 )     (71.1 )     806.1       (1,046.7 )     (240.6 )
Interest expense
                                               
 
Interest checking
    8.0       (21.5 )     (13.5 )     22.6       (40.6 )     (18.0 )
 
Money market accounts
    5.3       (87.8 )     (82.5 )     87.7       (82.8 )     4.9  
 
Savings accounts
    1.0       (6.8 )     (5.8 )     3.5       (7.4 )     (3.9 )
 
Time certificates of deposit less than $100,000
    (70.4 )     (39.2 )     (109.6 )     (146.3 )     (146.2 )     (292.5 )
 
Time deposits greater than $100,000
    24.6       (5.5 )     19.1       26.3       (105.5 )     (79.2 )
   
   
Total interest-bearing deposits
    (31.5 )     (160.8 )     (192.3 )     (6.2 )     (382.5 )     (388.7 )
 
Short-term borrowings
    64.1       31.8       95.9       8.5       (64.6 )     (56.1 )
 
Long-term debt
    34.7       68.2       102.9       45.0       (211.1 )     (166.1 )
   
   
Total
    67.3       (60.8 )     6.5       47.3       (658.2 )     (610.9 )
   
 
Increase (decrease) in net interest income
  $ 328.2     $ (405.8 )   $ (77.6 )   $ 758.8     $ (388.5 )   $ 370.3  

(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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Given the soft commercial loan demand in early 2004, the Company acquired $19.6 billion of investment securities, representing principally adjustable and shorter-term fixed-rate mortgage-backed securities, giving consideration to the Company’s overall asset/liability position. Refer to the “Interest Rate Risk Management” section for further information on the sensitivity of net interest income to changes in interest rates.
     Average noninterest-bearing deposits of $29.8 billion in 2004 were lower by $1.9 billion (6.0 percent), compared with 2003. While average branch-based noninterest-bearing deposits increased by 2.7 percent from a year ago, mortgage-related escrow balances and business-related noninterest-bearing deposits, including corporate banking, mortgage banking and government deposits, declined. Average interest-bearing deposits of $86.4 billion in 2004 were higher by $1.6 billion (1.8 percent), compared with 2003. The year-over-year increase in average interest-bearing deposits included increases in average savings products deposits of $2.6 billion (4.6 percent) and time deposits greater than $100,000 of $1.4 billion (11.0 percent), partially offset by a decrease in time certificates of deposit less than $100,000 of $2.4 billion (15.6 percent). The decrease in time certificates of deposit less than $100,000 was primarily due to pricing decisions by management in connection with the Company’s overall funding and risk management activities.
     Average net free funds increased $.3 billion from a year ago, including a decrease in average noninterest-bearing deposits, other liabilities and other assets of $1.9 billion (6.0 percent), $1.3 billion (16.7 percent) and $3.1 billion (10.5 percent), respectively, in 2004, compared with 2003. The decrease in other assets and liabilities principally reflects the impact of the spin-off of Piper Jaffray Companies.
     The increase in net interest income in 2003, compared with 2002, 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 various 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 for 2002. 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 16 basis point decline in 2003 net interest margin, compared with 2002, primarily reflected 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, a commercial loan conduit, onto the Company’s balance sheet in the third quarter of 2003. The $3.9 billion (3.4 percent) increase in total average loans for 2003, compared with 2002, reflected 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, offset somewhat by an overall decline in average commercial loans of $2.5 billion (5.7 percent). 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. 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. Average net free funds increased $3.1 billion from the prior year, 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.

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 $669.6 million in 2004, compared with $1,254.0 million and $1,349.0 million in 2003 and 2002, respectively.

     The decline in the provision for credit losses of $584.4 million in 2004 reflected continuing improvement in the credit quality of the loan portfolio and changing economic conditions. The changes in credit quality continued to be broad-based across most industries resulting in improving credit risk ratings, a decline in nonperforming assets and lower total net charge-offs. While general economic conditions improved somewhat in 2003, commercial loan demand continued to be soft in most markets within the banking footprint during much of 2004. In the fourth quarter of 2004, the Company began to experience growth in commercial loans, indicating that
 
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economic conditions within the Company’s markets were expanding. In response to improving credit performance and economic conditions, the Company made a decision to reduce the allowance for credit losses.
     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 continued to improve across most retail loan portfolios, reflecting improving economic conditions and the Company’s ongoing collection efforts and risk management activities. These were also the principal factors resulting in lower levels of retail net charge-offs during 2003.
     Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and other factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.

Noninterest Income Noninterest income in 2004 was $5.5 billion, compared with $5.3 billion in 2003 and $5.2 billion in 2002. The increase in noninterest income of $206.2 million (3.9 percent) in 2004, compared with 2003, was driven by strong organic growth in most fee-based products and services categories (11.0 percent), particularly in payment processing revenue. Partially offsetting the increase in fee-based revenue growth in 2004 was a year-over-year reduction in net securities gains (losses) of $349.7 million.

 
     Credit and debit card revenue, corporate payment products revenue and ATM processing services revenue were higher in 2004, compared with 2003, by $88.6 million (15.8 percent), $45.5 million (12.6 percent) and $9.4 million (5.7 percent), respectively. Although credit and debit card revenue increased year-over-year, the 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, which lowered interchange rates on signature debit transactions beginning in August 2003. The year-over-year impact of VISA’s settlement on debit card revenue for 2004 was approximately $32.8 million. This change in the interchange rate, in addition to higher customer loyalty rewards expenses, however, were more than offset by growth in transaction volumes and other rate changes. The corporate payment products revenue growth reflected growth in sales, card usage and rate changes. The favorable variance in ATM processing services revenue was also due to increases in transaction volumes and sales. Merchant processing services revenue was higher in 2004 by $113.2 million (20.2 percent), compared with 2003, reflecting an increase in same store sales volume, new business and the recent expansion of the Company’s merchant acquiring business in Europe. These recent European acquisitions accounted for approximately $58.6 million of the total increase. Deposit service charges increased in 2004 by $90.6 million (12.7 percent), primarily due to account growth, revenue enhancement initiatives and transaction-related fees. Trust and investment management fees increased by $27.3 million (2.9 percent), compared with 2003, as gains from equity market valuations were partially offset by lower fees, partially due to a change in mix of fund balances and customers’ migration from money market mutual funds to interest-bearing deposits with marginally better pricing. Treasury management fees were relatively flat from a year ago. Increased fees driven by a change in the Federal government’s payment methodology for treasury management services to fees for services rather than maintaining compensating balances in the third quarter of 2003 were offset by higher interest earnings credit on customers’ compensating balances and the impact of an
 
 Table 4   Noninterest Income
                                           
2004 2003
(Dollars in Millions) 2004 2003 2002 v 2003 v 2002

Credit and debit card revenue
  $ 649.3     $ 560.7     $ 517.0       15.8 %     8.5 %
Corporate payment products revenue
    406.8       361.3       325.7       12.6       10.9  
ATM processing services
    175.3       165.9       160.6       5.7       3.3  
Merchant processing services
    674.6       561.4       567.3       20.2       (1.0 )
Trust and investment management fees
    981.2       953.9       892.1       2.9       6.9  
Deposit service charges
    806.4       715.8       690.3       12.7       3.7  
Treasury management fees
    466.7       466.3       416.9       .1       11.8  
Commercial products revenue
    432.2       400.5       479.2       7.9       (16.4 )
Mortgage banking revenue
    397.3       367.1       330.2       8.2       11.2  
Investment products fees and commissions
    156.0       144.9       132.7       7.7       9.2  
Securities gains (losses), net
    (104.9 )     244.8       299.9       *       (18.4 )
Other
    478.3       370.4       398.8       29.1       (7.1 )
   
 
Total noninterest income
  $ 5,519.2     $ 5,313.0     $ 5,210.7       3.9 %     2.0 %

* Not meaningful
 
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industry-wide shift of payments from paper-based to electronic and card-based transactions. During 2004, commercial products revenue increased $31.7 million (7.9 percent), primarily due to syndication fees and commercial leasing revenue. An increase in loan servicing revenues from a year ago contributed to an increase of $30.2 million (8.2 percent) in mortgage banking revenue during 2004. The growth in mortgage servicing revenues was offset somewhat by lower gains from the sale of mortgage loan production. Investment products fees and commissions revenue increased in 2004 by $11.1 million (7.7 percent), compared with 2003, primarily due to higher sales activity in the Consumer Banking business line. The increase in sales activities reflected improving equity market conditions in late 2003 and 2004. Other noninterest income increased by $107.9 million (29.1 percent) from 2003, principally due to improving retail lease residual values resulting in lower end-of-term residual losses, a residual value insurance recovery of $17.2 million during the third quarter of 2004 and improving equity investment valuations.
     In 2003, noninterest income increased $102.3 million (2.0 percent), compared with 2002, 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. 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. Credit and debit card revenue growth in 2003 was somewhat muted ($19.4 million) 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 beginning in August 2003. 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. 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 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.

Noninterest Expense Noninterest expense in 2004 was $5.8 billion, compared with $5.6 billion and $5.7 billion in 2003 and 2002, respectively. The increase of $187.6 million (3.4 percent) in 2004, compared with 2003, principally reflected a $154.8 million charge related to the prepayment of a portion of the Company’s long-term debt, costs related to business initiatives and incremental expenses of $62.8 million due to the expansion of EuroConex. These increases were offset somewhat by a net reduction in MSR impairments of $151.9 million and lower merger and restructuring-related charges. In 2003, noninterest expense included $46.2 million of merger and restructuring-related costs related to acquisitions completed in prior years. Compensation expense increased in 2004, compared with 2003, due to increases in salaries and stock-based compensation. The increase in salaries reflected business

 
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expansion of in-store branches, the expansion of the Company’s merchant acquiring business in Europe and other initiatives. Stock-based compensation was higher due to lower employee stock-award forfeitures relative to prior years. Employee benefits increased primarily as a result of higher payroll taxes and pension expense; pension and retirement expense increased $34.6 million in 2004, principally reflecting recognition of actuarial losses resulting from lower expected returns in prior years. Marketing and business development increased $13.2 million in 2004, compared with 2003, related to corporate brand advertising and an increase in product marketing campaigns. Technology and communications expense was higher year-over-year by $12.2 million in 2004, compared with 2003, reflecting technology investments that increased software amortization and the write-off of capitalized software being replaced. Included in 2004 results were charges of $154.8 million related to the prepayment of a portion of the Company’s long-term debt. Other expense increased $54.1 million in 2004, compared with 2003. The increase was related to higher fraud and operating losses, insurance costs, operating costs associated with affordable housing investments and merchant processing costs for payment services products, the result of the EuroConex expansion and increases in transaction volume year-over-year.
     The decrease in noninterest expense in 2003, compared with 2002, 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 expense of $39.9 million and expenses related to 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 in 2002 associated with the merger of Firstar and the former U.S. Bancorp of Minneapolis (“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. Acquisitions in 2002, including Leader, Bay View and State Street Corporate Trust, accounted for an increase of $124.9 million in noninterest expense from 2002 to 2003.

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 19 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
 
 Table 5   Noninterest Expense
                                           
2004 2003
(Dollars in Millions) 2004 2003 2002 v 2003 v 2002

Compensation
  $ 2,252.2     $ 2,176.8     $ 2,167.5       3.5 %     .4 %
Employee benefits
    389.4       328.4       317.5       18.6       3.4  
Net occupancy and equipment
    630.8       643.7       658.7       (2.0 )     (2.3 )
Professional services
    148.9       143.4       129.7       3.8       10.6  
Marketing and business development
    193.5       180.3       171.4       7.3       5.2  
Technology and communications
    429.6       417.4       392.1       2.9       6.5  
Postage, printing and supplies
    248.4       245.6       243.2       1.1       1.0  
Other intangibles
    550.1       682.4       553.0       (19.4 )     23.4  
Merger and restructuring-related charges
          46.2       321.2       *       (85.6 )
Debt prepayment
    154.8             (.2 )     *       *  
Other
    786.8       732.7       786.4       7.4       (6.8 )
   
 
Total noninterest expense
  $ 5,784.5     $ 5,596.9     $ 5,740.5       3.4 %     (2.5 )%
   
Efficiency ratio (a)
    45.3 %     45.6 %     48.8 %                

(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.
 * Not meaningful
 
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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, 2004, the accumulated unrecognized loss approximated $139 million and will ratably impact the actuarially derived market-related value of plan assets through 2009. The impact to pension expense of the unrecognized asset gains or losses will incrementally increase (decrease) pension costs in each year from 2005 to 2009, by approximately $28.9 million, $39.4 million, $6.3 million, $(11.4) million and $(4.1) million, respectively. 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 2004, the Company recognized a pension cost of $9.0 million compared with pension credits of $23.9 million in 2003 and $63.8 million in 2002. The $32.9 million increase in pension costs in 2004 was driven by a recognition of deferred actuarial (gains) losses and the impact of a lower discount rate, partially offset by the benefit of higher investment income related to the pension contributions made in 2003. In 2003, pension costs increased by $39.9 million, compared with 2002, 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 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 employment demographics, such as retirement age.
     In 2005, the Company anticipates that pension costs will increase by approximately $23.5 million. The increase will be driven by the lower discount rate and amortization of unrecognized actuarial losses from prior years.

Note 19 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)
  $ (43.8 )   $ (21.9 )   $     $ 21.9     $ 43.7  
Percent of 2004 net income
    (.65 )%     (.33 )%     %     .33 %     .65 %

                                         
Base
Discount rate 4.0% 5.0% 6.0% 7.0% 8.0%

Incremental benefit (cost)
  $ (57.0 )   $ (30.9 )   $     $ 35.4     $ 73.5  
Percent of 2004 net income
    (.85 )%     (.46 )%     %     .53 %     1.09 %

     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.

Income Tax Expense The provision for income taxes was $2,009.6 million (an effective rate of 32.5 percent) in 2004, compared with $1,941.3 million (an effective rate of 34.4 percent) in 2003 and $1,707.5 million (an effective rate of 34.6 percent) in 2002. The improvement in the effective tax rate in 2004, compared with 2003, was primarily due to changes in estimated tax liabilities of $90.0 million related to the resolution of federal tax examinations covering substantially all of the Company’s legal entities for the years 1995 through 1999 and $16.3 million related to the resolution of a state tax examination for tax years through 2000. The improvement in the effective tax rate in 2003, compared with 2002, was primarily driven by 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.

     For further information on income taxes, refer to Note 21 of the Notes to Consolidated Financial Statements.
 
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BALANCE SHEET ANALYSIS

Average earning assets were $168.1 billion in 2004, compared with $160.8 billion in 2003. The increase in average earning assets of $7.3 billion (4.5 percent) was primarily driven by growth in residential mortgages, retail loans and investment securities, partially offset by a decline in commercial loans and loans held for sale related to mortgage banking activities. The increase in average earning assets was principally funded by increases of $1.6 billion in interest-bearing deposits and $5.5 billion in wholesale funding.

     For average balance information, refer to Consolidated Daily Average Balance Sheet and Related Yields and Rates on pages 112 and 113.

Loans The Company’s total loan portfolio was $126.3 billion at December 31, 2004, an increase of $8.1 billion (6.8 percent) from December 31, 2003. The increase in total loans was driven by strong growth in retail loans (10.7 percent) and residential mortgages (14.2 percent) and to a lesser extent by commercial loans (4.3 percent) and commercial real estate loans (1.3 percent). The increase in retail loans was across most loan categories while the increase in residential mortgages was primarily the result of asset/liability management decisions to retain a greater portion of the Company’s adjustable-rate loan production. Table 6 provides a summary of the loan distribution by product type. Table 8 provides a summary of selected loan maturity distribution by loan category. Average total loans increased $3.8 billion (3.2 percent) in 2004, compared with 2003. Growth in average retail loans and residential mortgages, compared to 2003, was partially offset by a decline in average commercial loans.

 
 Table 6   Loan Portfolio Distribution
                                                                                       
2004 2003 2002 2001 2000

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
  $ 35,210       27.9 %   $ 33,536       28.4 %   $ 36,584       31.5 %   $ 40,472       35.4 %   $ 47,041       38.5 %
 
Lease financing
    4,963       3.9       4,990       4.2       5,360       4.6       5,858       5.1       5,776       4.7  
   
   
Total commercial
    40,173       31.8       38,526       32.6       41,944       36.1       46,330       40.5       52,817       43.2  
 
Commercial real estate
                                                                               
 
Commercial mortgages
    20,315       16.1       20,624       17.4       20,325       17.5       18,765       16.4       19,466       15.9  
 
Construction and development
    7,270       5.7       6,618       5.6       6,542       5.6       6,608       5.8       6,977       5.7  
   
   
Total commercial real estate
    27,585       21.8       27,242       23.0       26,867       23.1       25,373       22.2       26,443       21.6  
 
Residential mortgages
                                                                               
 
Residential mortgages
    9,722       7.7       7,332       6.2       6,446       5.6       5,746       5.0       *       *  
 
Home equity loans, first liens
    5,645       4.5       6,125       5.2       3,300       2.8       2,083       1.8       *       *  
   
   
Total residential mortgages
    15,367       12.2       13,457       11.4       9,746       8.4       7,829       6.8       9,397       7.7  
 
Retail
                                                                               
 
Credit card
    6,603       5.2       5,933       5.0       5,665       4.9       5,889       5.1       6,012       4.9  
 
Retail leasing
    7,166       5.7       6,029       5.1       5,680       4.9       4,906       4.3       4,153       3.4  
 
Home equity and second mortgages
    14,851       11.8       13,210       11.2       13,572       11.6       12,235       10.7       11,956       9.7  
 
Other retail
                                                                               
   
Revolving credit
    2,541       2.0       2,540       2.1       2,650       2.3       2,673       2.3       2,750       2.2  
   
Installment
    2,767       2.2       2,380       2.0       2,258       1.9       2,292       2.0       2,186       1.8  
   
Automobile
    7,419       5.9       7,165       6.1       6,343       5.5       5,660       5.0       5,609       4.6  
   
Student
    1,843       1.4       1,753       1.5       1,526       1.3       1,218       1.1       1,042       .9  
   
     
Total other retail
    14,570       11.5       13,838       11.7       12,777       11.0       11,843       10.4       11,587       9.5  
   
   
Total retail
    43,190       34.2       39,010       33.0       37,694       32.4       34,873       30.5       33,708       27.5  
   
     
Total loans
  $ 126,315       100.0 %   $ 118,235       100.0 %   $ 116,251       100.0 %   $ 114,405       100.0 %   $ 122,365       100.0 %

Information not available
 
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Commercial Commercial loans, including lease financing, totaled $40.2 billion at December 31, 2004, compared with $38.5 billion at December 31, 2003, an increase of

$1.6 billion (4.3 percent). The increase in commercial loans was driven by new customer relationships, increases in
corporate card balances and to a lesser extent, increased utilization under lines of credit by commercial customers. The growth of corporate and industrial and corporate card loan categories was tempered somewhat by lower mortgage loans held for sale from a year ago due to declining mortgage banking volume. Although general economic conditions experienced some improvement in 2003, commercial loan demand continued to be soft in the Company’s markets throughout the first half of 2004. As a result, average commercial loans in 2004 decreased by $2.0 billion (4.8 percent) from 2003, despite the positive impact on average balances from the consolidation of loans from the Stellar commercial loan conduit in the third
 
 Table 7   Commercial Loans by Industry Group and Geography
                                   
December 31, 2004 December 31, 2003

Industry Group (Dollars in Millions) Loans Percent Loans Percent

Consumer products and services
  $ 8,073       20.1 %   $ 6,858       17.8 %
Financial services
    4,784       11.9       4,469       11.6  
Commercial services and supplies
    3,870       9.6       3,785       9.8  
Capital goods
    3,825       9.5       4,598       11.9  
Agriculture
    2,601       6.5       2,907       7.6  
Property management and development
    2,334       5.8       1,653       4.3  
Paper and forestry products, mining and basic materials
    1,905       4.7       1,415       3.7  
Consumer staples
    1,887       4.7       1,817       4.7  
Health care
    1,826       4.6       1,532       4.0  
Private investors
    1,630       4.1       1,629       4.2  
Transportation
    1,592       4.0       1,758       4.6  
Energy
    730       1.8       708       1.8  
Information technology
    644       1.6       729       1.9  
Other
    4,472       11.1       4,668       12.1  
   
 
Total
  $ 40,173       100.0 %   $ 38,526       100.0 %

Geography
                               

California
  $ 3,786       9.4 %   $ 4,091       10.6 %
Colorado
    2,064       5.1       1,820       4.7  
Illinois
    2,549       6.3       2,121       5.5  
Minnesota
    6,649       16.6       6,527       16.9  
Missouri
    2,525       6.3       2,742       7.1  
Ohio
    2,528       6.3       2,361       6.1  
Oregon
    1,441       3.6       1,500       3.9  
Washington
    2,695       6.7       2,767       7.2  
Wisconsin
    2,604       6.5       2,874       7.5  
Iowa, Kansas, Nebraska, North Dakota, South Dakota
    3,455       8.6       3,760       9.8  
Arkansas, Indiana, Kentucky, Tennessee
    1,747       4.3       1,549       4.0  
Idaho, Montana, Wyoming
    830       2.1       744       1.9  
Arizona, Nevada, Utah
    926       2.3       829       2.2  
   
 
Total banking region
    33,799       84.1       33,685       87.4  
Outside the Company’s banking region
    6,374       15.9       4,841       12.6  
   
 
Total
  $ 40,173       100.0 %   $ 38,526       100.0 %

 
 Table 8   Selected Loan Maturity Distribution
                                   
Over One
One Year Through Over Five
December 31, 2004 (Dollars in Millions) or Less Five Years Years Total

Commercial
  $ 19,283     $ 18,141     $ 2,749     $ 40,173  
Commercial real estate
    7,378       14,280       5,927       27,585  
Residential mortgages
    974       2,698       11,695       15,367  
Retail
    13,312       19,619       10,259       43,190  
   
 
Total loans
  $ 40,947     $ 54,738     $ 30,630     $ 126,315  
Total of loans due after one year with
                               
 
Predetermined interest rates
                          $ 40,042  
 
Floating interest rates
                          $ 45,326  

 
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quarter of 2003. Commercial loans began to display encouraging trends in the Company’s markets during the fourth quarter of 2004 with quarterly average commercial loan balances increasing for the first time since the second quarter of 2001.
     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 $27.6 billion at December 31, 2004, compared with $27.2 billion at December 31, 2003, a modest increase of $343 million (1.3 percent). Specifically, construction and development loans increased by $652 million (9.9 percent) as developers continued to take advantage of relatively low interest rates. Commercial mortgages outstanding decreased modestly by $309 million (1.5 percent) as growth in Small Business Administration (“SBA”) real estate mortgages was more than offset by reductions in traditional commercial real estate mortgages. Average commercial real estate loans increased by $125 million (.5 percent) in 2004, compared with 2003, primarily driven by growth in SBA commercial real estate mortgage loans. 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 $638 million of construction loans were permanently financed and reclassified to the commercial mortgage loan category in 2004. At year-end 2004, $202 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 $7.9 billion at December 31, 2004, compared with $7.3 billion at December 31, 2003. 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 $1.1 billion at December 31, 2004.

Residential Mortgages Residential mortgages held in the loan portfolio were $15.4 billion at December 31, 2004, an increase of $1.9 billion (14.2 percent) from December 31,

 
 Table 9   Commercial Real Estate by Property Type and Geography
                                   
  December 31, 2004  December 31, 2003

Property Type (Dollars in Millions) Loans Percent Loans Percent

Business owner occupied
  $ 8,551       31.0 %   $ 8,037       29.5 %
Multi-family
    3,903       14.1       3,868       14.2  
Commercial property
                               
 
Industrial
    1,103       4.0       1,280       4.7  
 
Office
    2,676       9.7       3,078       11.3  
 
Retail
    3,586       13.0       3,487       12.8  
 
Other
    2,359       8.6       2,452       9.0  
Homebuilders
    2,952       10.7       2,098       7.7  
Hotel/motel
    1,848       6.7       2,234       8.2  
Health care facilities
    607       2.2       708       2.6  
   
 
Total
  $ 27,585       100.0 %   $ 27,242       100.0 %

Geography
                               

California
  $ 5,252       19.0 %   $ 4,380       16.1 %
Colorado
    1,181       4.3       1,139       4.2  
Illinois
    996       3.6       1,095       4.0  
Minnesota
    1,721       6.2       1,536       5.6  
Missouri
    1,525       5.5       1,741       6.4  
Ohio
    1,975       7.2       2,193       8.0  
Oregon
    1,730       6.3       1,771       6.5  
Washington
    2,855       10.3       2,956       10.9  
Wisconsin
    1,768       6.4       1,921       7.1  
Iowa, Kansas, Nebraska, North Dakota, South Dakota
    2,003       7.3       2,138       7.8  
Arkansas, Indiana, Kentucky, Tennessee
    1,710       6.2       1,817       6.7  
Idaho, Montana, Wyoming
    880       3.2       874       3.2  
Arizona, Nevada, Utah
    1,948       7.1       1,722       6.3  
   
 
Total banking region
    25,544       92.6       25,283       92.8  
Outside the Company’s banking region
    2,041       7.4       1,959       7.2  
   
 
Total
  $ 27,585       100.0 %   $ 27,242       100.0 %

 
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2003. The increase in residential mortgages was primarily the result of asset/liability risk management decisions to retain a greater portion of the Company’s adjustable-rate loan production. This growth was partially offset by approximately $.5 billion in residential loan sales during 2004 primarily representing fixed-rate mortgage loans. Average residential mortgages increased $2.6 billion (22.5 percent) to $14.3 billion in 2004, primarily due to retaining adjustable-rate residential mortgages throughout 2004 and growth in first-lien home equity loans of 20.0 percent.

Retail Total retail loans outstanding, which include credit card, retail leasing, home equity and second mortgages and other retail loans, were $43.2 billion at December 31, 2004, compared with $39.0 billion at December 31, 2003. The increase of $4.2 billion (10.7 percent) was driven by an increase in home equity lines of credit, credit cards, retail leasing, automobile loans and installment loans, which increased $2,275 million, $670 million, $1,137 million, $254 million and $387 million, respectively, during 2004. The increases in these loan categories were offset somewhat by a reduction in home equity loans of $634 million during the year. Average retail loans increased $3.0 billion (7.9 percent) to $41.2 billion in 2004, reflecting growth in home equity lines, retail leasing, installment loans and credit card. Of the total retail loans and residential mortgages outstanding, approximately 87.4 percent are to customers located in the Company’s primary banking regions.

Loans Held for Sale At December 31, 2004, loans held for sale, consisting of residential mortgages to be sold in the secondary market, were $1.4 billion. This asset category was essentially unchanged relative to loans held for sale at December 31, 2003, despite $4.4 billion of mortgage loan production during the fourth quarter of 2004, compared with $3.9 billion in fourth quarter 2003. Average loans held for sale declined to $1.6 billion in 2004, compared with $3.6 billion in 2003, due to the impact of rising interest rates on mortgage loan production.

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. While it is the Company’s intent to hold its investment securities indefinitely, the Company may take actions in response to structural changes in interest rate risks and to meet liquidity requirements.

     At December 31, 2004, investment securities, both available-for-sale and held-to-maturity, totaled $41.5 billion, compared with $43.3 billion at December 31, 2003. The $1.9 billion (4.3 percent) year-over-year decrease primarily reflected the sale of $8.2 billion of fixed-rate investment securities, along with maturities and prepayments of $12.3 billion, partially offset by purchases of $19.6 billion of securities. Investment securities purchases were principally adjustable and shorter-term fixed-rate mortgage-backed securities, giving consideration to the Company’s overall asset/liability position, actual and projected changes in the mix and characteristics of the balance sheet and in interest rates. At December 31, 2004, approximately 38.9 percent of the investment securities portfolio represented adjustable-rate financial instruments, compared with 22.2 percent as of December 31, 2003. Adjustable-rate financial instruments include variable-rate collateralized mortgage obligations, mortgage-backed securities, agency securities, adjustable-rate money market accounts and asset-backed securities. Average investment securities were $43.0 billion in 2004, compared with $37.2 billion in 2003. The increase principally reflects the timing of securities transactions in early 2004 as proceeds from loan repayments and deposit growth were reinvested in this asset category.
     The weighted-average yield of the available-for-sale portfolio was 4.43 percent at December 31, 2004, compared with 4.27 percent at December 31, 2003. The average maturity of the available-for-sale portfolio declined to 4.5 years at December 31, 2004, down from 5.1 years at December 31, 2003. The relative mix of the type of investment securities maintained in the portfolio is provided in Table 10. At December 31, 2004, the available-for-sale portfolio included a $271 million net unrealized loss, compared with a net unrealized loss of $259 million at December 31, 2003.

Deposits Total deposits were $120.7 billion at December 31, 2004, an increase of $1.7 billion (1.4 percent) from December 31, 2003. The increase in total deposits was primarily the result of an increase in time deposits greater than $100,000, partially offset by decreases in noninterest-bearing deposits, savings deposits and time certificates of deposit less than $100,000. Average total deposits were $116.2 billion in 2004, declining $331 million from $116.6 billion in 2003. The decline in average total deposits was primarily due to lower average noninterest-bearing deposits and time certificates of deposit less than $100,000. The reductions in these categories were offset somewhat by growth in average savings deposits and time deposits greater than $100,000.

     Noninterest-bearing deposits were $30.8 billion at December 31, 2004, compared with $32.5 billion at December 31, 2003, a decrease of $1.7 billion (5.3 percent). The decrease in noninterest-bearing deposits was primarily attributable to declining deposits related to corporate business deposits, mortgage banking businesses and
 
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government banking deposits in the Wholesale Banking business line relative to a year ago. The decline also included certain product changes to migrate high-value customers with balances of $1.3 billion to the Company’s Silver Elite interest checking product to further enhance
customer retention. Corporate business deposits are declining as business customers utilize their deposit liquidity to fund business growth. Mortgage banking activities continue to decline directly related to the upward movement in interest rates since mid-2003. Government banking deposits have also declined. Average noninterest-bearing deposits were $29.8 billion in 2004, a decrease of $1.9 billion (6.0 percent), compared with 2003. While average branch-based noninterest-bearing deposits increased 2.7 percent from a year ago, business-related noninterest-bearing deposits, including government, corporate banking and mortgage banking deposits, and mortgage-related escrow balances declined.
     Interest-bearing savings deposits totaled $59.4 billion at December 31, 2004, a decrease of $1.7 billion (2.7 percent)
 
 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, 2004 (Dollars in Millions) Cost Value Years Yield (d) Cost Value Years Yield (d)

U.S. Treasury and agencies
                                                               
 
Maturing in one year or less (a)
  $ 601     $ 593       .19       3.24 %   $     $             %
 
Maturing after one year through five years
    56       58       3.09       4.98                          
 
Maturing after five years through ten years
    27       28       7.52       4.47                          
 
Maturing after ten years (a)
                                               
   
   
Total
  $ 684     $ 679       .72       3.43 %   $     $             %
   
Mortgage-backed securities (b)
                                                               
 
Maturing in one year or less
  $ 1,716     $ 1,721       .57       4.01 %   $     $             %
 
Maturing after one year through five years
    24,849       24,724       3.25       4.34       11       11       3.07       5.30  
 
Maturing after five years through ten years
    12,742       12,588       6.51       4.70                          
 
Maturing after ten years
    502       504       14.06       3.85                          
   
   
Total
  $ 39,809     $ 39,537       4.31       4.43 %   $ 11     $ 11       3.07       5.30 %
   
Asset-backed securities (b)
                                                               
 
Maturing in one year or less
  $ 39     $ 39       .65       5.61 %   $     $             %
 
Maturing after one year through five years
    25       25       2.36       5.26                          
 
Maturing after five years through ten years
                                               
 
Maturing after ten years
                                               
   
   
Total
  $ 64     $ 64       1.31       5.47 %   $     $             %
   
Obligations of state and political subdivisions
                                                               
 
Maturing in one year or less
  $ 101     $ 102       .39       7.38 %   $ 10     $ 10       .25       6.44 %
 
Maturing after one year through five years
    97       101       2.49       7.24       35       37       2.66       6.55  
 
Maturing after five years through ten years
    6       7       6.38       7.82       19       20       6.90       6.57  
 
Maturing after ten years
    1       1       16.77       5.33       34       36       13.66       6.68  
   
   
Total
  $ 205     $ 211       1.65       7.32 %   $ 98     $ 103       7.09       6.59 %
   
Other debt securities
                                                               
 
Maturing in one year or less
  $ 8     $ 8       1.11       3.10 %   $     $             %
 
Maturing after one year through five years
    86       86       2.35       11.00       18       18       3.23       5.20  
 
Maturing after five years through ten years
                                               
 
Maturing after ten years
    499       490       22.35       2.98                          
   
   
Total
  $ 593     $ 584       19.16       4.15 %   $ 18     $ 18       3.23       5.20 %
   
Other investments
  $ 270     $ 279             %   $     $             %
   
Total investment securities (c)
  $ 41,625     $ 41,354       4.45       4.43 %   $ 127     $ 132       6.19       6.28 %

(a) In January 2005, approximately $450 million of floating-rate agency notes with an original maturity of June 2023 were called by the issuer. These notes are classified in the table as maturing in one year or less.
(b) Information related to asset and mortgage-backed securities included above is presented based upon weighted-average maturities anticipating future prepayments.
(c) The weighted-average maturity of the available-for-sale investment securities was 5.12 years at December 31, 2003 with a corresponding weighted-average yield of 4.27%. The weighted- average maturity of the held-to-maturity investment securities was 6.16 years at December 31, 2003 with a corresponding weighted-average yield of 6.05%.
(d) 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.
                                   
2004 2003

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

U.S. Treasury and agencies
  $ 684       1.6 %   $ 1,634       3.7 %
Mortgage-backed securities
    39,820       95.4       40,243       92.3  
Asset-backed securities
    64       .2       250       .6  
Obligations of state and political subdivisions
    303       .7       473       1.1  
Other securities and investments
    881       2.1       993       2.3  
   
 
Total investment securities
  $ 41,752       100.0 %   $ 43,593       100.0 %

 
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from December 31, 2003. The decrease in interest-bearing savings deposits was primarily due to decreases in money market accounts of $3.5 billion (10.4 percent), partially offset by an increase of $1.8 billion (8.3 percent) in interest checking. The increase in interest checking reflects the migration of noninterest-bearing deposits to the Silver Elite interest checking product. The decrease in money market savings account balances, in part, reflects pricing decisions by the Company given the profitability of certain business accounts and modest commercial loan growth and business customer decisions to utilize deposit liquidity during 2004. A portion of money market balances migrated to time deposits greater than $100,000 as interest rates increased for these products. Average interest-bearing savings deposits were $59.7 billion in 2004, an increase of $2.6 billion (4.6 percent), compared with 2003. The increase in average interest-bearing savings deposits from 2003 to 2004 was primarily driven by increases in interest checking of $1.8 billion (9.6 percent), along with increases in money market accounts of $.5 billion (1.7 percent) and savings accounts of $.3 billion (4.5 percent).
     Interest-bearing time deposits were $30.6 billion at December 31, 2004, compared with $25.5 billion at December 31, 2003, an increase of $5.1 billion (19.9 percent). The increase in interest-bearing time deposits was driven by an increase of $6.2 billion (52.5 percent) in time deposits greater than $100,000, partially offset by a decrease in the higher cost time certificates of deposits less than $100,000 of $1.1 billion (8.4 percent). Changes in these deposit categories were principally due to pricing decisions based on the relative cost of funding. Time certificates of deposit less than $100,000 were essentially unchanged in the fourth quarter and represent a source of fixed-rate funding in a rising rate environment. Average time deposits greater than $100,000 increased $1.4 billion (11.0 percent) and average time certificates of deposit less than $100,000 declined $2.4 billion (15.6 percent) during 2004. Time deposits greater than $100,000 are largely viewed as purchased funds and are managed to levels deemed appropriate given alternative funding sources.

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 $13.1 billion at December 31, 2004, compared with $10.9 billion at December 31, 2003. Short-term funding is managed to levels deemed appropriate given alternative funding sources. The increase of $2.2 billion in short-term borrowings reflected wholesale funding associated with the Company’s earning asset growth.

     Long-term debt was $34.7 billion at December 31, 2004, compared with $33.8 billion at December 31, 2003, an increase of $.9 billion. The increase in long-term debt
 
 Table 11   Deposits

The composition of deposits was as follows:

                                                                                     
2004 2003 2002 2001 2000

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
  $ 30,756       25.5 %   $ 32,470       27.3 %   $ 35,106       30.4 %   $ 31,212       29.7 %   $ 26,633       24.3 %
Interest-bearing deposits
                                                                               
 
Interest checking
    23,186       19.2       21,404       18.0       17,467       15.1       15,251       14.5       13,982       12.8  
 
Money market accounts
    30,478       25.2       34,025       28.6       27,753       24.0       24,835       23.6       23,899       21.8  
 
Savings accounts
    5,728       4.8       5,630       4.7       5,021       4.4       4,637       4.4       4,516       4.1  
   
   
Total of savings deposits
    59,392       49.2       61,059       51.3       50,241       43.5       44,723       42.5       42,397       38.7  
Time certificates of deposit less than $100,000
    12,544       10.4       13,690       11.5       17,973       15.5       20,724       19.7       25,780       23.5  
Time deposits greater than $100,000
                                                                               
 
Domestic
    11,956       9.9       5,902       4.9       9,427       8.2       7,286       6.9       11,221       10.3  
 
Foreign
    6,093       5.0       5,931       5.0       2,787       2.4       1,274       1.2       3,504       3.2  
   
   
Total interest-bearing deposits
    89,985       74.5       86,582       72.7       80,428       69.6       74,007       70.3       82,902       75.7  
   
 
Total deposits
  $ 120,741       100.0 %   $ 119,052       100.0 %   $ 115,534       100.0 %   $ 105,219       100.0 %   $ 109,535       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, 2004 (Dollars in Millions) Deposit Less Than $100,000 Greater Than $100,000 Total

Three months or less
  $ 2,324     $ 14,097     $ 16,421  
Three months through six months
    1,961       1,325       3,286  
Six months through one year
    2,536       940       3,476  
2006
    2,998       825       3,823  
2007
    1,579       445       2,024  
2008
    614       188       802  
2009
    521       220       741  
Thereafter
    11       9       20  
   
 
Total
  $ 12,544     $ 18,049     $ 30,593  

 
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was primarily driven by the issuance of $12.2 billion of bank notes and $1.0 billion of subordinated notes, partially offset by maturities of $8.0 billion and prepayments of $4.7 billion of Federal Home Loan Bank (“FHLB”) advances. The prepayments of FHLB advances during the first and fourth quarters of 2004 and the issuance of predominantly fixed-rate funding were principally done in connection with asset/liability management activities. Refer to Note 15 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 credit risk management strategy also includes a credit risk assessment process, independent of business line managers, that performs assessments of compliance with commercial and consumer credit policies, risk ratings, and other critical credit information. The Company strives to identify potential problem loans early, take any necessary charge-offs promptly and maintain adequate reserve levels for probable loan losses inherent in the portfolio. 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 to an independent credit administration function 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 specific allowance for commercial 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 credit risks of consumer, small business and small-ticket leasing customers 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 specific allowance for credit losses for these products. Because business processes and credit risks associated with unfunded credit commitments are essentially the same as for loans, the Company utilizes similar processes to estimate its liability for unfunded credit commitments. The Company also engages in non-lending activities that may give rise to credit risk, including interest rate swap and option contracts for balance sheet hedging purposes, foreign exchange transactions, deposit overdrafts and interest rate swap contracts for customers, and 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.

 
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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 relative to similar banking institutions and macroeconomic factors. Beginning in 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 in 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. Also, unemployment rates stabilized and began to decline in late 2003. However, the banking industry continued 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, lagged behind the growth in the broader economy especially in some markets served by the Company.
     During 2004, unemployment rates and bankruptcy levels continued to improve. The trends related to consumer spending for retail goods and services continued to expand throughout the year. While corporate profits continued to be strong, the index of corporate profits retreated somewhat in the second quarter of 2004. As a result, equity markets stalled in the second and third quarters of 2004 due to uncertainty related to corporate profits and world events. Within the Company’s customer base, commercial loan demand continued to be somewhat soft through mid-2004. In the fourth quarter of 2004, most economic indicators again began to expand and commercial loan balances for the Company displayed year-over-year quarterly growth for the first time since mid-2001.

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 2004.

     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, 2004 and 2003. The commercial loan portfolio is diversified among various industries with somewhat higher concentrations in consumer products and services, financial services, commercial services and supplies, capital goods (including manufacturing and commercial construction-related businesses) and agricultural industries. Additionally, the commercial portfolio is diversified across the Company’s geographical markets with 84.1 percent of total commercial loans within the 24-state banking region. Credit relationships outside of the Company’s banking region are specifically targeted industries 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 transportation and manufacturing have experienced economic stress since 2001. Additionally, highly leveraged enterprise-value financings have under-performed
 
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due to changes in cash flows during softer economic conditions. At December 31, 2004, the transportation sector represented 4.0 percent of the total commercial loan portfolio. Since 2001, the sector has been impacted by 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 2004, the Company’s transportation portfolio consisted of airline and airfreight businesses (28.2 percent of the sector), trucking businesses (46.4 percent of the sector) and the remainder in the railroad and shipping businesses (25.4 percent of the sector). Capital goods represented 9.5 percent of the total commercial portfolio at December 31, 2004. Included in this sector were approximately 21.5 percent of loans related to building products while engineering and construction equipment and machinery businesses were 34.8 percent and 30.2 percent, respectively. During 2004, economic conditions improved and production levels increased resulting in an improvement in the credit quality of the manufacturing 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; however, these credits continued to perform well as of December 31, 2004.
     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 and will have higher inherent loss rates than other commercial loans. The Company actively monitors the credit quality of these customers and develops action plans accordingly. Such leveraged enterprise-value financings approximated $1.7 billion in loans outstanding at December 31, 2004, compared with approximately $1.8 billion outstanding at December 31, 2003. The Company’s portfolio of highly leveraged enterprise-value 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 and national investment-based real estate. At December 31, 2004, the Company had commercial real estate loans of $27.6 billion, or 21.8 percent of total loans, compared with $27.2 billion at December 31, 2003. Within commercial real estate loans, different property types have varying degrees of credit risk. Table 9 provides a summary of the significant property types and geographic locations of commercial real estate loans outstanding at December 31, 2004 and 2003. At December 31, 2004, approximately 31.0 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. While investment-based commercial real estate continues to perform with relatively strong occupancy levels and cash flows, these categories of loans can be adversely impacted during a rising rate environment. Included in commercial real estate at year end 2004 was approximately $.4 billion in land held for development and $1.4 billion of loans related to residential and commercial acquisition and development properties. These loans are subject to quarterly monitoring for changes in local market conditions due to a higher credit risk profile. Acquisition and development loans continued to perform well with strong market conditions; however, these loans can be adversely impacted by a slow down in the housing market and softening of demand. The commercial real estate portfolio is diversified across the Company’s geographical markets with 92.6 percent of total commercial real estate loans outstanding at December 31, 2004, within the 24-state banking region.

Analysis of Nonperforming Assets The level of 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, 2004, total nonperforming assets were $748.4 million, compared with $1,148.1 million at year-end 2003 and $1,373.5 million at year-end 2002. The ratio of total nonperforming assets to total loans and other real estate decreased to .59 percent at December 31, 2004, compared with .97 percent and 1.18 percent at the end of 2003 and 2002, respectively.

     The $399.7 million decrease in total nonperforming assets in 2004 reflected a decrease of $374.3 million in nonperforming commercial and commercial real estate loans
 
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and a $8.0 million decrease in nonperforming retail loans, partially offset by an increase of $2.8 million in nonperforming residential mortgages. The decrease in nonperforming assets in 2004 was broad-based across most industry sectors within the commercial loan portfolio including capital goods, consumer-related sectors, manufacturing and certain segments of transportation. While airline travel has increased from a year ago, the industry continues to be economically stressed and has had difficulty improving cash flows from operations. Certain health care facilities providers continue to experience operational stress leading to some deterioration in credit quality within that sector. While nonperforming assets are expected to continue to decline slightly during the next few quarters, the ongoing level of nonperforming assets is not expected to decline much further after mid-2005.
     The $225.4 million decrease in total nonperforming assets in 2003, as compared with 2002, 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 also broad-based across most industry sectors within the commercial loan portfolio including capital goods, consumer-related sectors, manufacturing, telecommunications, and certain segments of transportation.
 
 Table 12   Nonperforming Assets (a)
                                               
At December 31, (Dollars in Millions) 2004 2003 2002 2001 2000

 
Commercial
                                       
 
Commercial
  $ 289.5     $ 623.5     $ 760.4     $ 526.6     $ 470.4  
 
Lease financing
    90.6       113.3       166.7       180.8       70.5  
   
   
Total commercial
    380.1       736.8       927.1       707.4       540.9  
 
Commercial real estate
                                       
 
Commercial mortgages
    174.6       177.6       174.6       131.3       105.5  
 
Construction and development
    25.3       39.9       57.5       35.9       38.2  
   
   
Total commercial real estate
    199.9       217.5       232.1       167.2       143.7  
Residential mortgages
    43.3       40.5       52.0       79.1       56.9  
 
Retail
                                       
 
Credit card
                            8.8  
 
Retail leasing
          .4       1.0       6.5        
 
Other retail
    17.2       24.8       25.1       41.1       15.0  
   
   
Total retail
    17.2       25.2       26.1       47.6       23.8  
   
     
Total nonperforming loans
    640.5       1,020.0       1,237.3       1,001.3       765.3  
Other real estate
    72.2       72.6       59.5       43.8       61.1  
Other assets
    35.7       55.5       76.7       74.9       40.6  
   
     
Total nonperforming assets
  $ 748.4     $ 1,148.1     $ 1,373.5     $ 1,120.0     $ 867.0  
   
Restructured loans accruing interest (b)
  $ 10.2     $ 18.0     $ 1.4     $     $  
Accruing loans 90 days or more past due
  $ 294.0     $ 329.4     $ 426.4     $ 462.9     $ 385.2  
Nonperforming loans to total loans
    .51 %     .86 %     1.06 %     .88 %     .63 %
Nonperforming assets to total loans plus other real estate
    .59 %     .97 %     1.18 %     .98 %     .71 %
Net interest lost on nonperforming loans
  $ 42.1     $ 67.4     $ 65.4     $ 63.0     $ 50.8  

Changes in Nonperforming Assets

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

Balance December 31, 2003
  $ 1,013.3     $ 134.8     $ 1,148.1  
 
Additions to nonperforming assets
                       
   
New nonaccrual loans and foreclosed properties
    650.7       41.5       692.2  
   
Advances on loans
    39.0             39.0  
   
     
Total additions
    689.7       41.5       731.2  
 
Reductions in nonperforming assets
                       
   
Paydowns, payoffs
    (498.3 )     (24.1 )     (522.4 )
   
Net sales
    (132.0 )           (132.0 )
   
Return to performing status
    (106.1 )     (15.3 )     (121.4 )
   
Charge-offs (c)
    (347.3 )     (7.8 )     (355.1 )
   
     
Total reductions
    (1,083.7 )     (47.2 )     (1,130.9 )
   
       
Net reductions in nonperforming assets
    (394.0 )     (5.7 )     (399.7 )
   
Balance December 31, 2004
  $ 619.3     $ 129.1     $ 748.4  

(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) Charge-offs exclude actions for certain card products and loan sales that were not classified as nonperforming at the time the charge-off occurred.
(d) Residential mortgage information excludes changes related to residential mortgages serviced by others.
 
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 Table 13   Delinquent Loan Ratios as a Percent of Ending Loan Balances
                                               
At December 31,
90 days or more past due excluding nonperforming loans 2004 2003 2002 2001 2000

Commercial
                                       
 
Commercial
    .05 %     .06 %     .14 %     .14 %     .11 %
 
Lease financing
    .02       .04       .10       .45       .02  
   
   
Total commercial
    .05       .06       .14       .18       .10  
Commercial real estate
                                       
 
Commercial mortgages
          .02       .03       .03       .07  
 
Construction and development
          .03       .07       .02       .03  
   
   
Total commercial real estate
          .02       .04       .02       .06  
Residential mortgages
    .46       .61       .90       .78       .62  
Retail
                                       
 
Credit card
    1.74       1.68       2.09       2.18       1.70  
 
Retail leasing
    .08       .14       .19       .11       .20  
 
Other retail
    .29       .41       .54       .74       .62  
   
   
Total retail
    .47       .56       .72       .90       .76  
   
     
Total loans
    .23 %     .28 %     .37 %     .40 %     .31 %

 
                                           
At December 31,
90 days or more past due including nonperforming loans 2004 2003 2002 2001 2000

Commercial
    .99 %     1.97 %     2.35 %     1.71 %     1.13 %
Commercial real estate
    .73       .82       .90       .68       .60  
Residential mortgages (a)
    .74       .91       1.44       1.79       1.23  
Retail
    .51       .62       .79       1.03       .83  
   
 
Total loans
    .74 %     1.14 %     1.43 %     1.28 %     .94 %

(a) Delinquent loan ratios exclude advances made pursuant to servicing agreements to Government National Mortgage Association (“GNMA”) mortgage pools whose repayments are insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs. Including the guaranteed amounts, the ratio of residential mortgages 90 days or more past due was 5.19 percent and 6.07 percent at December 31, 2004 and 2003, respectively. Information prior to 2003 is not available.
 
     The Company had $68.2 million and $58.5 million of restructured loans as of December 31, 2004 and 2003, respectively. Commitments to lend additional funds under restructured loans were $11.9 million and $8.2 million as of December 31, 2004 and 2003, 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, 2004, $10.2 million were reported as accruing.
     Accruing loans 90 days or more past due totaled $294.0 million at December 31, 2004, compared with $329.4 million at December 31, 2003, and $426.4 million at December 31, 2002. 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 ..23 percent at December 31, 2004, compared with ..28 percent at December 31, 2003. Improving economic conditions and the Company’s continued focus on improving the credit process were the primary factors for the favorable change from a year ago. Given the relative level of loans 90 days or more past due, the Company does not anticipate significant reductions in future periods.
     To monitor credit risk associated with retail loans, the Company monitors delinquency ratios in the various stages of collection including nonperforming status.
 
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     The following table provides summary delinquency information for residential mortgages and retail loans:
                                       
As a Percent
of Ending Loan
Amount Balances
December 31
(Dollars in Millions) 2004 2003 2004 2003

Residential Mortgages
                               
   
30-89 days
  $ 108.3     $ 102.9       .70 %     .76 %
   
90 days or more
    70.2       82.5       .46       .61  
   
Nonperforming
    43.3       40.5       .28       .30  
   
   
Total
    $ 221.8     $ 225.9       1.44 %     1.68 %

Retail
                               
 
Credit Card
                               
   
30-89 days
  $ 142.4     $ 150.9       2.16 %     2.54 %
   
90 days or more
    114.8       99.5       1.74       1.68  
   
Nonperforming
                       
   
     
Total
  $ 257.2     $ 250.4       3.90 %     4.22 %
 
Retail Leasing
                               
   
30-89 days
  $ 59.4     $ 78.8       .83 %     1.31 %
   
90 days or more
    5.6       8.2       .08       .14  
   
Nonperforming
          .4             .01  
   
     
Total
  $ 65.0     $ 87.4       .91 %     1.45 %
 
Other Retail
                               
   
30-89 days
  $ 223.6     $ 311.9       .76 %     1.15 %
   
90 days or more
    84.3       110.2       .29       .41  
   
Nonperforming
    17.2       24.8       .05       .09  
   
     
Total
  $ 325.1     $ 446.9       1.10 %     1.65 %

     The decline in residential mortgage delinquencies from December 31, 2003, to December 31, 2004, 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, risk management actions taken by the Company and the effect of portfolio growth on delinquency ratios reported on a concurrent basis.

Analysis of Loan Net Charge-Offs Total loan net charge-offs decreased $484.6 million to $767.1 million in 2004, compared with $1,251.7 million in 2003 and $1,373.0 million in 2002. The ratio of total loan net charge-offs to average loans was .63 percent in 2004, compared with 1.06 percent in 2003 and 1.20 percent in 2002. The overall level of net charge-offs in 2004 reflected the Company’s ongoing efforts to reduce the overall risk profile of the organization, improved economic conditions, higher commercial loan recoveries, refinancing by higher risk customers with other companies and higher asset valuations. Net charge-offs are expected to increase modestly as the level of commercial loan recoveries declines to more normalized levels in 2005. The improvement in net charge-offs in 2003, compared with 2002, was due to credit risk management initiatives taken by the Company that 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 and consumer loan delinquencies.

     Commercial and commercial real estate loan net charge-offs for 2004 were $195.7 million (.29 percent of average loans outstanding), compared with $608.7 million
 
 Table 14   Net Charge-offs as a Percent of Average Loans Outstanding
                                               
Year Ended December 31 2004 2003 2002 2001 2000

Commercial
                                       
 
Commercial
    .29 %     1.34 %     1.29 %     1.62 %     .56 %
 
Lease financing
    1.42       1.65       2.67       1.95       .46  
   
   
Total commercial
    .43       1.38       1.46       1.66       .55  
Commercial real estate
                                       
 
Commercial mortgages
    .09       .14       .17       .21       .03  
 
Construction and development
    .13       .16       .11       .17       .11  
   
   
Total commercial real estate
    .10       .14       .15       .20       .05  
Residential mortgages
    .20       .23       .23       .15       .11  
Retail
                                       
 
Credit card
    4.14       4.61       4.98       4.80       4.18  
 
Retail leasing
    .59       .86       .72       .65       .41  
 
Home equity and second mortgages
    .54       .70       .74       .85       *  
 
Other retail
    1.22       1.60       2.10       2.16       1.32  
   
   
Total retail
    1.32       1.61       1.85       1.94       1.69  
   
     
Total loans (a)
    .63 %     1.06 %     1.20 %     1.31 %     .70 %

(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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(.89 percent of average loans outstanding) in 2003 and $679.9 million (.98 percent of average loans outstanding) in 2002. The improvement from 2003 was broad-based and extended across most industries within the commercial loan portfolio and reflected higher levels of commercial loan recoveries principally within the Wholesale Banking line of business. These higher levels of recoveries are not expected to continue throughout 2005. The decrease in commercial and commercial real estate loan net charge-offs in 2003, when compared with 2002, was experienced within most industries in 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.
     Retail loan net charge-offs in 2004 were $542.7 million (1.32 percent of average loans outstanding), compared with $616.1 million (1.61 percent of average loans outstanding) in 2003 and $674.0 million (1.85 percent of average loans outstanding) in 2002. Lower levels of retail loan net charge-offs in 2004, compared with 2003, principally reflected changes by the Company in underwriting, ongoing collection efforts and other risk management activities. The decline also reflected lower delinquency ratios from a year ago as the economy continued to improve. 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 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. USBCF specializes in serving channel-specific and alternative lending markets in residential mortgages, home equity and installment loan financing. USBCF manages loans originated through a broker network, correspondent relationships and U.S. Bank branch offices. Generally, loans managed by the Company’s consumer finance division exhibit higher credit risk characteristics, but are priced commensurate with the differing risk profile.
     The following table provides an analysis of net charge-offs as a 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) 2004 2003 2004 2003

Consumer finance (a)
                               
 
Residential mortgages
  $ 4,531     $ 3,499       .44 %     .44 %
 
Home equity and second mortgages
    2,412       2,350       2.07       2.38  
 
Other retail
    414       360       5.04       4.76  
Traditional branch
                               
 
Residential mortgages
  $ 9,791     $ 8,197       .09 %     .14 %
 
Home equity and second mortgages
    11,628       10,889       .22       .34  
 
Other retail
    14,007       13,270       1.10       1.52  
Total Company
                               
 
Residential mortgages
  $ 14,322     $ 11,696       .20 %     .23 %
 
Home equity and second mortgages
    14,040       13,239       .54       .70  
 
Other retail
    14,421       13,630       1.22       1.60  

(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 loan losses provides coverage for probable and estimable losses inherent in the Company’s loan and lease portfolio. Management evaluates the allowance each quarter to determine that it is adequate to cover these inherent losses. The evaluation of each element and the overall allowance is based on a continuing assessment of problem loans, recent loss experience and other factors, including regulatory guidance and economic conditions. Because business processes and credit risks associated with unfunded credit commitments are essentially the same as for loans, the Company utilizes similar processes to estimate its liability for unfunded credit commitments, which is included in other liabilities in the Consolidated Balance Sheet. Both the allowance for loan losses and the liability for unfunded credit commitments are included in the Company’s analysis of credit losses.

 
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 Table 15   Summary of Allowance for Credit Losses
                                                 
(Dollars in Millions) 2004 2003 2002 2001 2000

Balance at beginning of year
  $ 2,368.6     $ 2,422.0     $ 2,457.3     $ 1,786.9     $ 1,710.3  
Charge-offs
                                       
 
Commercial
                                       
   
Commercial
    243.5       555.6       559.2       779.0       319.8  
   
Lease financing
    110.6       139.3       188.8       144.4       27.9  
   
     
Total commercial
    354.1       694.9       748.0       923.4       347.7  
 
Commercial real estate
                                       
   
Commercial mortgages
    29.1       43.9       40.9       49.5       15.8  
   
Construction and development
    12.5       13.0       8.8       12.6       10.3  
   
     
Total commercial real estate
    41.6       56.9       49.7       62.1       26.1  
 
Residential mortgages
    32.5       30.3       23.1       15.8       13.7  
 
Retail
                                       
   
Credit card
    281.5       282.1       304.9       294.1       235.8  
   
Retail leasing
    49.0       57.0       45.2       34.2       14.8  
   
Home equity and second mortgages
    89.6       105.0       107.9       112.7       *  
   
Other retail
    225.2       267.9       311.9       329.1       379.5  
   
     
Total retail
    645.3       712.0       769.9       770.1       630.1  
   
       
Total charge-offs
    1,073.5       1,494.1       1,590.7       1,771.4       1,017.6  
Recoveries
                                       
 
Commercial
                                       
   
Commercial
    143.9       70.0       67.4       60.6       64.0  
   
Lease financing
    41.5       55.3       39.9       30.4       7.2  
   
     
Total commercial
    185.4       125.3       107.3       91.0       71.2  
 
Commercial real estate
                                       
   
Commercial mortgages
    11.1       15.8       9.1       9.1       10.8  
   
Construction and development
    3.5       2.0       1.4       .8       2.6  
   
     
Total commercial real estate
    14.6       17.8       10.5       9.9       13.4  
 
Residential mortgages
    3.8       3.4       4.0       3.2       1.3  
 
Retail
                                       
   
Credit card
    29.6       27.3       24.6       23.4       27.5  
   
Retail leasing
    9.6       7.0       6.3       4.5       2.0  
   
Home equity and second mortgages
    13.8       12.1       10.6       12.9       *  
   
Other retail
    49.6       49.5       54.4       80.0       76.8  
   
     
Total retail
    102.6       95.9       95.9       120.8       106.3  
   
       
Total recoveries
    306.4       242.4       217.7       224.9       192.2  
Net Charge-offs
                                       
 
Commercial
                                       
   
Commercial
    99.6       485.6       491.8       718.4       255.8  
   
Lease financing
    69.1       84.0       148.9       114.0       20.7  
   
     
Total commercial
    168.7       569.6       640.7       832.4       276.5  
 
Commercial real estate
                                       
   
Commercial mortgages
    18.0       28.1       31.8       40.4       5.0  
   
Construction and development
    9.0       11.0       7.4       11.8       7.7  
   
     
Total commercial real estate
    27.0       39.1       39.2       52.2       12.7  
 
Residential mortgages
    28.7       26.9       19.1       12.6       12.4  
 
Retail
                                       
   
Credit card
    251.9       254.8       280.3       270.7       208.3  
   
Retail leasing
    39.4       50.0       38.9       29.7       12.8  
   
Home equity and second mortgages
    75.8       92.9       97.3       99.8       *  
   
Other retail
    175.6       218.4       257.5       249.1       302.7  
   
     
Total retail
    542.7       616.1       674.0       649.3       523.8  
   
       
Total net charge-offs
    767.1       1,251.7       1,373.0       1,546.5       825.4  
   
Provision for credit losses
    669.6       1,254.0       1,349.0       2,528.8       828.0  
Losses from loan sales/transfers (a)
                      (329.3 )      
Acquisitions and other changes
    (1.8 )     (55.7 )     (11.3 )     17.4       74.0  
   
Balance at end of year
  $ 2,269.3     $ 2,368.6     $ 2,422.0     $ 2,457.3     $ 1,786.9  
   
Components
                                       
 
Allowance for loan losses
  $ 2,080.4     $ 2,183.6                          
 
Liability for unfunded credit commitments (b)
    188.9       185.0                          
   
                 
     
Total allowance for credit losses
  $ 2,269.3     $ 2,368.6                          
   
                 
Allowance for credit losses as a percentage of
                                       
 
Period-end loans
    1.80 %     2.00 %     2.08 %     2.15 %     1.46 %
 
Nonperforming loans
    354       232       196       245       233  
 
Nonperforming assets
    303       206       176       219       206  
 
Net charge-offs (a)
    296       189       176       159       216  

(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.
(b) During 2004, the Company reclassified the portion of its allowance for credit losses related to commercial off-balance sheet loan commitments and letters of credit to a separate liability account included in other liabilities in the Consolidated Balance Sheet. Amounts for 2003 have been restated.
 * Information not available
 
U.S. BANCORP  41


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 Table 16   Elements of the Allowance for Credit Losses
                                                                                     
Allowance Amount Allowance as a Percent of Loans

December 31 (Dollars in Millions) 2004 2003 2002 2001 2000 2004 2003 2002 2001 2000

Commercial
                                                                               
 
Commercial
  $ 663.6     $ 696.1     $ 776.4     $ 1,068.1     $ 418.8       1.88 %     2.08 %     2.12 %     2.64 %     .89 %
 
Lease financing
    105.8       90.4       107.6       107.5       17.7       2.13       1.81       2.01       1.84       .31  
   
   
Total commercial
    769.4       786.5       884.0       1,175.6       436.5       1.92       2.04       2.11       2.54       .83  
Commercial real estate
                                                                               
 
Commercial mortgages
    131.1       169.7       152.9       176.6       42.7       .65       .82       .75       .94       .22  
 
Construction and development
    40.2       58.8       53.5       76.4       17.7       .55       .89       .82       1.16       .25  
   
   
Total commercial real estate
    171.3       228.5       206.4       253.0       60.4       .62       .84       .77       1.00       .23  
Residential mortgages
    33.1       33.3       34.2       21.9       11.6       .22       .25       .35       .28       .12  
Retail
                                                                               
 
Credit card
    283.2       267.9       272.4       295.2       265.6       4.29       4.52       4.81       5.01       4.42  
 
Retail leasing
    43.8       47.1       44.0       38.7       27.2       .61       .78       .77       .79       .65  
 
Home equity and second mortgages
    87.9       100.5       114.7       88.6       107.7       .59       .76       .85       .72       .90  
 
Other retail
    195.4       234.8       268.6       282.8       250.3       1.34       1.70       2.10       2.39       2.16  
   
   
Total retail
    610.3       650.3       699.7       705.3       650.8       1.41       1.67       1.86       2.02       1.93  
   
   
Total allocated allowance
    1,584.1       1,698.6       1,824.3       2,155.8       1,159.3       1.25       1.43       1.57       1.89       .95  
   
Available for other factors
    685.2       670.0       597.7       301.5       627.6       .54       .57       .51       .26       .51  
   
Total allowance
  $ 2,269.3     $ 2,368.6     $ 2,422.0     $ 2,457.3     $ 1,786.9       1.80 %     2.00 %     2.08 %     2.15 %     1.46 %

     At December 31, 2004, the allowance for credit losses was $2,269.3 million (1.80 percent of loans). This compares with an allowance of $2,368.6 million (2.00 percent of loans) at December 31, 2003, and $2,422.0 million (2.08 percent of loans) at December 31, 2002. The ratio of the allowance for credit losses to nonperforming loans was 354 percent at year-end 2004, compared with 232 percent at year-end 2003 and 196 percent at year-end 2002. The ratio of the allowance for credit losses to loan net charge-offs was 296 percent at year-end 2004, compared with 189 percent at year-end 2003 and 176 percent at year-end 2002. Management determined that the allowance for credit losses was adequate at December 31, 2004.

     Several factors were taken into consideration in evaluating the allowance for credit losses in 2004, including the improving credit risk profile of the portfolios and declining net charge-offs during the period, the lower level of nonperforming assets and relative size of accruing loans 90 days or more past due and improving delinquency ratios in most loan categories compared with December 31, 2003. Management also considered the uncertainty related to certain industry sectors, including the transportation sector, the extent of credit exposure to highly leveraged enterprise-value borrowers within the portfolio. In addition, concentration risks associated with commercial real estate and the mix of loans, including credit cards, loans originated through the consumer finance division and lower residential mortgages balances, and their relative credit risk was evaluated compared with other banks. Finally, the Company considered the improving economic trends, including improving corporate earnings, changes in 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. On an ongoing basis, management evaluates its methods for determining the allowance for each element of the portfolio and makes enhancements considered appropriate. Table 16 shows the amount of the allowance for credit losses by portfolio 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 these elements of the allowance for credit losses. An allowance for credit losses is established for pools of commercial and commercial real estate loans and unfunded commitments based on the risk ratings assigned. 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 the exposure for credits with similar risk characteristics. During 2004, the Company enhanced the process of determining specific allowances for commercial and commercial real estate credit facilities by further segmenting these portfolios based upon risk characteristics and historical performance. Additionally, the Company reassessed the historical timeframe considered in developing inherent loss ratios to more effectively consider the implications of the last business cycle. These enhancements had the effect of increasing inherent loss ratios for higher risk leveraged financings and transportation leases while
 
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reducing inherent loss rates for commercial real estate and traditional corporate lending. On a composite basis, inherent loss rates for commercial credit facilities increased slightly for most risk rating categories relative to a year ago. In addition to its risk rating process, 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 $940.7 million at December 31, 2004, compared with $1,015.0 million and $1,090.4 million at December 31, 2003 and 2002, respectively. The decline in the allowance for commercial and commercial real estate loans of $74.3 million reflected a $143.1 million reduction due to improvements in the risk classifications, offset somewhat by the impact of growth in the portfolios and a $68.8 million increase related to changes in loss severity rates. The increase in loss severity rates is driven by enhancements to the Company’s migration analysis offset somewhat by recent loss experience.
     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 $33.1 million at December 31, 2004, compared with $33.3 million and $34.2 million at December 31, 2003 and 2002, 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 inherent losses due to growth in the first lien home equity portfolio during 2004. The allowance established for retail loans was $610.3 million at December 31, 2004, compared with $650.3 million and $699.7 million at December 31, 2003 and 2002, respectively. The decline in the allowance for the retail portfolio in 2004 reflected improved credit quality favorably impacting inherent loss ratios and declining delinquency trends, partially offset by the impact of portfolio growth.
     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 these subjective factors, the process utilized to determine each element of the allowance for credit losses by specific loan category has some imprecision. As such, the Company estimates a range of inherent losses in the portfolio 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 statistical analysis attempts to measure the extent of imprecision by determining the volatility of losses over time across loan categories. Also, management judgmentally considers loan concentrations, risks associated with specific industries, the stage of the business cycle, economic conditions and other qualitative factors. Based on this process, the amount of the allowance available for other factors was $685.2 million at December 31, 2004 compared with $670.0 million at December 31, 2003 and $597.7 million at December 31, 2002. At December 31, 2004, approximately $500 million was related to estimated imprecision as described above. Of this amount, commercial and commercial real estate represented approximately 72 percent while residential and retail loans represented approximately 28 percent. The remaining allowance available for other factors of $185 million was related to concentration risk, including risks associated with the sluggish airline industry, relative size of the consumer finance and commercial real estate portfolios and highly leveraged enterprise-value credits and other qualitative factors. 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 or the credit portfolio.
     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 estimated amounts. Refer to Note 1 of the Notes to Consolidated Financial Statements for accounting policies related to the allowance for credit losses.

Residual Risk Management The Company manages its risk to changes in the residual value of leased assets through disciplined residual valuation setting at the inception of a

 
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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 under this insurance program if, in the aggregate, there is a net loss for such period. In addition, the Company obtains separate residual value insurance for all vehicles at lease inception where end of lease term settlement is based solely on the residual value of the individual leased vehicles. Under this program, the potential recovery is computed for each individual vehicle sold and does not allow the insurance carrier to offset individual determined losses with gains from other leases. This individual vehicle coverage is included in the calculation of minimum lease payments when making the capital lease assessment. 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 $4.0 billion of retail leasing residuals at December 31, 2004, compared with $3.3 billion at December 31, 2003. The Company monitors concentrations of leases by manufacturer and vehicle “make and model.” At year-end 2004, no vehicle-type concentration exceeded five 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, 2004, the weighted-average origination term of the portfolio was 52 months. During the period from 1998 through 2002, the used vehicle market experienced pricing stress that adversely impacted lease residual valuations. Several factors contributed to this competitive 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 created a cyclical oversupply of certain off-lease vehicles causing significant declines in used vehicle prices during that period. Since late 2002, residual values for used cars have improved. Economic pressures during 2001 and 2002 moderated new car sales volumes to some degree. As a result, production levels declined from record levels in 2000, reducing the supply of newer model years. Another factor that has affected 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 residual values has benefited from certified car programs that receive premium pricing from dealers at auction. In addition, competition within the new car market continues to cause manufacturers to offer a record number of different makes and models in an attempt to target smaller segments of the consumer market. Also, consumers are purchasing vehicles with more content as former optional equipment becomes standard on more vehicles. These trends tend to favorably impact vehicle prices. Within the new car market, higher levels of incentive spending continue to exist. While this supports higher sales volumes, certain vehicle models will continue to see some downward pressure on the initial residual values of new leases, reducing the risk of end-of-term residual valuation losses as lessees purchase off-lease vehicles. Within vehicle categories, residual values for automobiles have performed better than trucks, experiencing an increase in average wholesale prices of 5.2% during 2004, while trucks have seen a decline of 1.6%. The decline in truck values is attributed to a market decline in demand for full size sport utility vehicles. These models have experienced price declines due to increased competition in the segment as well as the impact of higher gas prices on consumer buying patterns. These factors, along with the mix of the Company’s lease residual portfolio have reduced the exposure to retail lease residual impairments relative to a year ago.
     At December 31, 2004, the commercial leasing portfolio had $769 million of residuals, compared with $816 million at December 31, 2003. At year-end 2004, lease residuals related to trucks and other transportation equipment were 29.8 percent of the total residual portfolio. Railcars represented 16.5 percent of the aggregate portfolio, while aircraft and business and office equipment were 16.3 percent and 12.7 percent, respectively. No other significant concentrations of more than 10 percent existed at December 31, 2004. In 2004, reduced airline travel and
 
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higher fuel costs continued to adversely impact 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 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. Within this framework, the Corporate Risk Committee (“Risk Committee”) provides oversight and assesses the most significant operational risks facing the Company within its business lines. Under the guidance of the Risk Committee, enterprise risk management personnel establish policies and interact with business lines to monitor significant operating risks on a regular basis. Business lines have direct and primary responsibility and accountability for identifying, controlling, and monitoring operational risks embedded in their business activities. 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 for, among other things, 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 24 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

 
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Sensitivity of Net Interest Income and Rate Sensitive Income

                                                                 
December 31, 2004 December 31, 2003

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
    (.49 )%     .04 %     *%       (.19 )%     1.30 %     .19 %     *%       (.02 )%
Rate sensitive income
    (.40 )%     (.13 )%     *%       (.69 )%     .74 %     .01 %     *%       (.54 )%

Given the current level of interest rates, a downward 300 basis point scenario can not be computed.
 
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 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 above summarizes the interest rate risk of net interest income and rate sensitive income based on forecasts over the succeeding 12 months. At December 31, 2004, the Company’s overall interest rate risk position was substantively neutral to changes in interest rates. Rate sensitive income includes net interest income as well as other income items that are sensitive to interest rates, including asset management fees, mortgage banking and the impact from compensating deposit balances. 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 manages the overall interest rate risk profile within policy limits. At December 31, 2004 and 2003, 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, 2004. The up 200 basis point scenario resulted in a 2.7 percent decrease in the market value of equity at December 31, 2004, compared with a 3.1 percent decrease at December 31, 2003. The down 200 basis point scenario resulted in a 4.2 percent decrease in the market value of equity at December 31, 2004. Given the low level of interest rates, the down 200 basis point scenario was not computed for December 31, 2003. ALPC reviews other down rate scenarios to evaluate the impact of falling interest rates. The down 100 basis point scenario resulted in a ..7 percent decrease at December 31, 2004, and a 1.3 percent increase at December 31, 2003. At December 31, 2004 and 2003, 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 ALPC monthly and is used to guide hedging strategies. The results of the valuation analysis as of December 31, 2004, were well within policy guidelines. The Company also uses duration of equity as a measure of interest rate risk. The duration of equity is a measure of the net market value sensitivity of the assets, liabilities and derivative positions of the Company. The duration of assets was 1.68 years at December 31, 2004, compared with 1.91 years at December 31, 2003. The duration of liabilities was 2.02 years at December 31, 2004, compared with 2.18 years at December 31, 2003. After giving effect to the Company’s derivative positions, the estimated duration of equity was .12 years at December 31, 2004, compared with 1.35 years at December 31, 2003. The duration of equity measure shows that sensitivity of the market value of equity of the Company was relatively neutral to changes in interest rates.

Use of Derivatives to Manage Interest Rate Risk In the ordinary course of business, the Company enters into derivative transactions to manage its interest rate, prepayment and foreign currency risks (“asset and liability management positions”) and to accommodate the business requirements of its customers (“customer-related positions”). 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

 
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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 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
 
 Table 17   Derivative Positions

Asset and Liability Management Positions

                                                                               
Weighted-
Maturing Average

Remaining
December 31, 2004 Fair Maturity
(Dollars in Millions) 2005 2006 2007 2008 2009 Thereafter Total Value In Years

Interest rate contracts
                                                                       
 
Receive fixed/pay floating swaps
                                                                       
   
Notional amount
  $ 2,750     $ 2,750     $ 3,520     $ 5,000     $ 1,750     $ 4,300     $ 20,070     $ 379       5.25  
   
Weighted-average
                                                                       
     
Receive rate
    3.75 %     3.67 %     3.76 %     3.78 %     4.62 %     6.29 %     4.37 %                
     
Pay rate
    2.28       2.36       2.39       2.31       2.39       2.74       2.42                  
 
Pay fixed/receive floating swaps
                                                                       
   
Notional amount
  $ 5,425     $ 2,950     $ 2,400     $     $     $     $ 10,775     $ 56       1.42  
   
Weighted-average
                                                                       
     
Receive rate
    2.38 %     2.24 %     2.47 %     %     %     %     2.36 %                
     
Pay rate
    2.21       2.64       3.36                         2.58                  
 
Futures and forwards
  $ 2,262     $     $     $     $     $     $ 2,262     $ (4 )     .12  
 
Options
                                                                       
   
Written
    1,039       20                               1,059     $ 1       .15  
Foreign exchange forward contracts
  $ 314     $     $     $     $     $     $ 314     $ (12 )     .04  
Equity contracts
  $     $     $     $     $ 53     $     $ 53     $ 4       4.29  

Customer-related Positions

                                                                             
Weighted-
Maturing Average

Remaining
December 31, 2004 Fair Maturity
(Dollars in Millions) 2005 2006 2007 2008 2009 Thereafter Total Value In Years

Interest rate contracts
                                                                       
 
Receive fixed/pay floating swaps
                                                                       
   
Notional amount
  $ 671     $ 1,069     $ 1,018     $ 1,171     $ 613     $ 2,166     $ 6,708     $ 76       4.67  
 
Pay fixed/receive floating swaps
                                                                       
   
Notional amount
    671       1,067       1,006       1,159       613       2,166       6,682       (40 )     4.67  
 
Options
                                                                       
   
Purchased
    91       242       362       157       72       175       1,099       7       3.00  
   
Written
    91       242       362       157       72       175       1,099       (7 )     3.00  
 
Risk participation agreements
                                                                       
   
Purchased
    27       5       32       9       21       43       137             7.13  
   
Written
    16       22             25       17       4       84             2.93  
Foreign exchange rate contracts
                                                                       
 
Swaps and forwards
                                                                       
   
Buy
  $ 1,957     $ 47     $ 34     $ 7     $ 2     $     $ 2,047     $ 80       .31  
   
Sell
    1,917       54       35       8       1             2,015       (76 )     .33  
 
Options
                                                                       
   
Purchased
    77                                     77       1       .59  
   
Written
    77                                     77       (1 )     .59  

 
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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 $34.5 billion of total notional amount of asset and liability management derivative positions at December 31, 2004, $32.1 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-