U.S. Bancorp Annual Report 2003

Plain-text annual report

2 0 0 3 A N N U A L R E P O R T A N D F O R M 10 - K c o r p o r a t e p r o f i l e U.S. Bancorp, headquartered in Minneapolis, is the 8th largest financial services holding company in the United States with total assets exceeding 189 billion at year-end 2003. Through U.S. Bank® and other subsidiaries, U.S. Bancorp serves 11.6 million customers, primarily through 2,243 full-service branch offices in 24 states. Customers also access their accounts and conduct all or part of their banking transactions through 4,425 U.S. Bank ATMs, U.S. Bank Internet Banking and telephone banking. In addition, a network of specialized U.S. Bancorp offices and representatives across the nation serves customers inside and outside our 24-state footprint through comprehensive product sets that meet the financial needs of customers beyond basic core banking. Backed by expertise and advanced technology, these sophisticated U.S. Bancorp products and services include large corporate services, payment services, private banking, personal and institutional trust services, corporate trust services, specialized large-scale government banking services, mortgage, commercial credit vehicles, and financial and asset management services. Major lines of business provided by U.S. Bancorp through U.S. Bank and other subsidiaries include Consumer Banking Payment Services Private Client, Trust & Asset Management and Wholesale Banking. U.S. Bank is home of the exclusive U.S. Bank Five Star Service uarantee. S A CORP AT A LA CE Ranking Asset size Deposits Loans 8th largest bank in the U.S. 189 billion 119 billion 118 billion Earnings per share diluted 1.93 Return on average assets Return on average equity Tangible common equity Efficiency ratio Customers 1.99 19.2 6.5 45.6 11.6 million Primary banking region 24 states Bank branches ATMs NYSE At year-end 2003 2,243 4,425 USB 2 3 4 5 6 8 10 12 14 16 Graphs of Selected Financial Highlights pg. 2 3 3 0 0 2 2 0 0 t a b l e o f c o n t e n t s Financial Summary pg. 3 Letter to Shareholders pg. 4 Corporate Governance pg. 5 Service Excellence pg. 6 Lines of Business pg. 8 Investing in Distribution and Scale pg. 10 Attractive Business Mix pg. 12 High-Value National Businesses pg. 14 Community Partnerships pg. 16 f i n a n c i a l s e c t i o n Management’s Discussion and Analysis pg. 18 Consolidated Financial Statements pg. 62 Notes to Consolidated Financial Statements pg. 66 Reports of Independent Auditors and Accountants pg. 105 Five-Year Consolidated Financial Statements pg. 106 Quarterly Consolidated Financial Data pg. 108 Supplemental Financial Data pg. 109 Annual Report on Form 10-K pg. 112 CEO and CFO Certifications pg. 119 Executive Officers pg. 122 Directors pg. 123 Corporate Information inside back cover g r a p h s o f s e l e c t e d f i n a n c i a l h i g h l i g h t s Net Income (Dollars in Millions) 03 3,732.6 02 3,168.1 01 1,478.8 00 99 2,752.1 2,240.4 Diluted Earnings Per Common Share (In Dollars) 03 1.93 Dividends Declared Per Common Share (a) (In Dollars) .855 03 02 01 00 99 1.65 .76 1.43 1.16 02 01 00 99 .780 .750 .650 .460 Return on Average Assets (In Percents) 03 1.99 Return on Average Equity (In Percents) 03 02 01 00 99 .89 1.84 1.74 1.49 02 01 00 99 19.2 18.3 9.0 19.0 16.9 Dividend Payout Ratio (In Percents) 03 44.1 02 01 00 99 47.3 45.1 39.3 97.4 Net Interest Margin (Taxable-Equivalent Basis) (In Percents) 03 4.49 Efficiency Ratio (b) (In Percents) 03 45.6 Tangible Common Equity to Assets (In Percents) 03 6.5 02 01 00 99 4.65 4.46 4.38 4.43 02 01 00 99 48.8 57.2 49.7 54.7 02 01 00 99 * Average Assets (Dollars In Millions) 03 187,630 Average Shareholders’ Equity (Dollars In Millions) 03 19,393 Average Equity to Average Assets (In Percents) 03 02 01 00 99 171,948 165,944 158,481 150,167 02 01 00 99 17,273 16,426 14,499 13,273 02 01 00 99 *Information was not available to compute pre-merger proforma percentage. (a) Dividends per share have not been restated for the 2001 Firstar/USBM merger. (b) Computed as noninterest expense divided by the sum of net interest income on a taxable-equivalent basis and noninterest income excluding securities gains (losses), net. 5.7 5.9 6.4 10.3 10.0 9.9 9.1 8.8 f i n a n c i a l s u m m a r y Year Ended December 31 (Dollars and Shares in Millions, Except Per Share Data) 2003 2002 2001 Total net revenue (taxable-equivalent basis) Noninterest expense Provision for credit losses Income taxes and taxable-equivalent adjustments Income from continuing operations Discontinued operations (after-tax) Cumulative effect of accounting change (after-tax) Net income Per Common Share Earnings per share from continuing operations Diluted earnings per share from continuing operations Earnings per share Diluted earnings per share Dividends declared per share Book value per share Market value per share Average shares outstanding Average diluted shares outstanding Financial Ratios Return on average assets Return on average equity Net interest margin (taxable-equivalent basis) Efficiency ratio Average Balances Loans Investment securities Earning assets Assets Deposits Total shareholders’ equity Period End Balances Loans Allowance for credit losses Investment securities Assets Deposits Total shareholders’ equity Regulatory capital ratios Tangible common equity Tier 1 capital Total risk-based capital Leverage $12,530.5 5,596.9 1,254.0 1,969.5 $ 3,710.1 22.5 – $ 3,732.6 $ 1.93 1.92 1.94 1.93 .855 10.01 29.78 1,923.7 1,936.2 $12,057.9 5,740.5 1,349.0 1,740.4 $ 3,228.0 (22.7) (37.2) $ 3,168.1 $ 1.68 1.68 1.65 1.65 .780 9.62 21.22 1,916.0 1,924.8 $11,074.6 6,149.0 2,528.8 872.8 $ 1,524.0 (45.2) – $ 1,478.8 $ .79 .79 .77 .76 .750 8.58 20.93 1,927.9 1,940.3 % 1.99 19.2 4.49 45.6 % 1.84 18.3 4.65 48.8 % .89 9.0 4.46 57.2 $ 118,362 37,248 160,808 187,630 116,553 19,393 $ 118,235 2,369 43,334 189,286 119,052 19,242 $ 114,453 28,829 147,410 171,948 105,124 17,273 $ 116,251 2,422 28,488 180,027 115,534 18,436 $ 118,177 21,916 143,501 165,944 104,956 16,426 $ 114,405 2,457 26,608 171,390 105,219 16,745 % 6.5 9.1 13.6 8.0 % 5.7 8.0 12.4 7.7 % 5.9 7.8 11.9 7.9 2003 v 2002 3.9% (2.5) 2002 v 2001 8.9% (6.6) 14.9 111.8 17.8 114.2 14.9% 14.3 17.6 17.0 9.6 4.1 40.3 .4 .6 3.4% 29.2 9.1 9.1 10.9 12.3 1.7% (2.2) 52.1 5.1 3.0 4.4 112.7% 112.7 114.3 117.1 4.0 12.1 1.4 (.6) (.8) (3.2)% 31.5 2.7 3.6 .2 5.2 1.6% (1.4) 7.1 5.0 9.8 10.1 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. R E C O R D E A R N I N G S , A N D I N D U S T R Y - L E A D I N G C A P I T A L G E N E R A T I O N R E F L E C T T H E P O W E R O F O U R F R A N C H I S E I N D U S T R Y - L E A D I N G P E R F O R M A N C E “We are pleased to tell you that in 2003, we reported record earnings and also achieved the financial results to which we had committed.” f e l l o w s h a r e h o l d e r s : Strong financial results. U.S. Bancorp delivered strong financial results in 2003, the culmination of five years of transformation and integration, during which we forged a company uniquely positioned to generate consistent earnings and revenue growth. (cid:157) Earnings per share increased 17.6% over 2002 (cid:127) Record net income increased 17.8% over 2002 (cid:127) Industry-leading Return on Assets of 1.99% (cid:127) Industry-leading Return on Equity of 19.2% (cid:127) Industry-leading Tangible Common Equity of 6.5% (cid:127) Positive debt rating changes by the rating agencies Growing U.S. Bancorp. With virtually all integration and merger-related activities behind us, we are now focused solely on growing U.S. Bancorp by leveraging the breadth and depth of the powerful franchise we have built. Our five-year transformation allowed us to gain access to high-growth markets, to solidify strong regional positions and to build a national platform. During our integration process, we accelerated our cost control leadership. We are now extending that cost and execution leadership, as well as making significant strategic investments in our highest-potential businesses, and reaffirming our focus on delivering high-quality service. Achieving our goals to build a stronger corporation. I am pleased to tell you that U.S. Bancorp accomplished the performance, credit quality and other goals we had previously committed to achieving. We met financial objectives — in particular, revenue growth, expense management, net interest margin and earnings per share. In addition, and perhaps most importantly, we continue to show improvement in overall credit quality, a direct result of all we have done in the past two years to reduce this corporation’s risk profile. We also completed the spin-off of Piper Jaffray, further reducing risk and volatility in our business. Finally, we began a major expansion of our distribution channels in fast-growing markets within our franchise through the previously announced in-store branch partnerships with Safeway/Vons, Smith’s and Publix. 140 years of creating value for shareholders. We have targeted returning 80 percent of our earnings to shareholders through a combination of dividends and share repurchases. The 17 percent common stock dividend increase approved by our Board of Directors and announced in December 2003 is a continuation of a long history of paying significant dividends, as well as a reflection of the Board’s confidence in this corporation’s future success. U.S. Bancorp, through its predecessor companies, has increased its dividend in each of the past 32 years and has paid a dividend for 140 consecutive years. In addition to the common stock dividend discussed above, as part of the December 2003 spin-off of Piper Jaffray, U.S. Bancorp distributed common shares of the new Piper Jaffray Companies in the form of a special dividend to eligible U.S. Bancorp shareholders. Also in December 2003, our Board of Directors approved authorization to repurchase 150 million shares of outstanding U.S. Bancorp common stock during the next two years. These specific steps were undertaken to increase the value of your shares; in addition, we manage this corporation with the long-term value of your investment as our paramount objective. It’s the reason we come to work each day. Sincerely, Jerry A. Grundhofer Chairman, President and Chief Executive Officer U.S. Bancorp February 27, 2004 c o r p o r a t e g o v e r n a n c e Good corporate governance promotes ethical business practices, demands meticulous accounting policies and procedures and includes a structure with effective checks and balances. Corporate governance is vital to the continued success of U.S. Bancorp and the entire financial services industry. Our ethical standards have rewarded us with an enviable reputation in today’s marketplace — a marketplace where trust is hard to earn. Our shareholders, customers, communities and employees demand — and deserve — to do business with companies they can trust. U.S. Bancorp operates with uncompromising honesty and integrity. Our Board of Directors has had a Corporate Governance Committee for many years. We have implemented Corporate Governance Guidelines in response to today’s heightened concern. Our Corporate Governance Guidelines are available for you to view on our Internet web site at usbank.com. Following are some of the important elements of our Corporate Governance practices. Independent oversight. Each of our Audit Committee, Compensation Committee and Governance Committee is composed entirely of independent outside directors. In fact, following our annual meeting, our Chairman, President and Chief Executive Officer will be the only member of our Board of Directors who is not independent. In addition, our Board of Directors and the committees of the Board meet in “executive session” without management in attendance at every meeting. The presiding director at every executive session of the Board is an independent director. The Board and each committee also have express authority to engage outside advisors to provide additional independent expertise for their deliberations. Board of Directors’ focus on U.S. Bancorp. To ensure that our directors are able to focus effectively on our business, we limit the number of other public company boards a director may serve on to three. The Chairman, President and Chief Executive Officer of U.S. Bancorp serves on only two other public company boards. Audit Committee members may serve on no more than three other public company audit committees, and the chairman of the Audit Committee serves on no other audit committees. Board of Directors’ knowledge and expertise. All of our directors are skilled business leaders. Directors are encouraged to attend continuing director education seminars in order to keep a sharp focus on current good governance practices. In addition, the Board and each committee may use outside advisors to add expertise on specific issues. Our directors have full and unrestricted access to our management and employees. Additionally, key members of management attend Board meetings from time to time to present information about the results, plans and operations of their business segments. The Board and each committee perform annual self-evaluations in order to assess their performance and to ensure that the Board and committee structure is providing effective oversight of corporate management. You may review the charters of each of our Board committees on our Internet web site at usbank.com. Management’s ownership commitment. We understand clearly that U.S. Bancorp shareholders are the primary beneficiaries of management’s actions. All U.S. Bancorp executive officers and directors own shares of company stock, and in order to tightly align management’s interests with those of our shareholders, we have established stock ownership guidelines for our executive officers. Disclosure controls. We have established rigorous procedures to ensure that we provide complete and accurate disclosure in our publicly filed documents. We have also established a telephone hotline for employees to anonymously submit any concern they may have regarding corporate controls or ethical breaches. Management investigates all complaints and directs to our Audit Committee any issues relating to concerns about our financial statements or public disclosures. U.S. Bancorp Code of Ethics and Business Conduct. Each year, we reiterate the vital importance of our Code of Ethics and Business Conduct. The Code applies to directors, officers and all employees, who must certify annually their compliance with the standards of the Code. The content of the Code is based not solely on what we have the right to do, but, even more importantly, on what is the right thing to do. Our standards are higher than any legal minimum because our business is built on trust. You may review our Code of Ethics and Business Conduct on our Internet web site at usbank.com. Communications with our Board of Directors. Shareholders can communicate with our Board of Directors by sending a letter addressed to the Board of Directors, the independent outside directors or specified individual directors, to: The Office of the Corporate Secretary U.S. Bancorp 800 Nicollet Mall Minneapolis, MN 55402 s e r v i c e e x c e l l e n c e Great service is more than our goal; it’s the way we do business. Every U.S. Bancorp employee in every U.S. Bancorp line of business is committed to providing responsive, prompt and helpful service — every transaction, every relationship, every day. And our exclusive Five Star Service Guarantee backs up our promise to deliver the outstanding service our customers expect and deserve. Five Star Service Guarantee ensures highest level of service. Exceptional service is the single most important thing U.S. Bank offers our customers. We make a promise to deliver the highest level of customer service and we boldly back up this pledge with the U.S. Bank Five Star Service Guarantee, which ensures the core service standards most important to our customers — such as availability, accuracy, timeliness and responsiveness — are met and exceeded. Every U.S. Bank customer is covered by one or more guarantees. If we fall short in keeping our service guarantees, and our customer tells us they did not get the service they expected and deserved, we pay the customer for the inconvenience. Taking ownership of our business one employee at a time. Each line of business has developed and adapted its own Five Star Service Guarantee, defining the quality standards that are expected and demanded of every employee — standards that are based on meeting the diverse financial needs of all our customers. U.S. Bank has created an environment in which employees understand how their individual service and sales performance contributes to revenue growth and W E A R E F O C U S E D O N D E L I V E R I N G T H E H I G H E S T - Q U A L I T Y S E R V I C E shareholder value. It is an environment where employees take ownership of their business, where they are held accountable for the company’s success and where they are compensated for measurable performance results. Service is foundation of success. U.S. Bank employees are recognized and rewarded for their outstanding service. Our Pay for Performance compensation program rewards employees financially and personally for their achievements in meeting service and sales goals and for their contributions to company earnings. Customized line of business incentive programs drive employees to generate revenue while fulfilling customers’ needs. Each quarter, 20 selected employees who exemplify our high service standards are inducted into the prestigious Circle of Service Excellence. The Service Advantage puts customers at center of everything we do. To deepen our commitment to superior service, in 2003, we launched The Service Advantage, an innovative internal initiative designed to increase customer access and convenience; simplify customer issue solutions; make quality service central to hiring, orientation and training; and improve the common customer experience. Our Service Council is the driving force behind The Service Advantage; it is comprised of senior managers from every line of business who identify areas of improvement, analyze customer satisfaction measurements and implement resolutions that create greater customer satisfaction and loyalty. We are enhancing existing and creating new internal service techniques and processes, as well, so that our frontline employees have the tools and support they need to better meet customer expectations. By the end of first quarter 2004, every U.S. Bank employee will have received personalized training on the core principles of The Service Advantage. Cacique® is the #1 selling brand of Hispanic-style cheeses and creams in the world. For over three decades, the family owned and operated company has produced authentic cheeses, creams and chorizos, growing from a small, abandoned facility to one of the world’s most sophisticated cheese manufacturing facilities. Cacique is committed to quality, heritage and tradition, sharing this legacy with the community through a long history of philanthropy, including Fighting Diabetes Together, a recent collaboration with City of Hope®. U.S. Bank Commercial Banking partners with Cacique to provide flexible, competitive products to meet the financial needs of this unique company. U.S. Bank’s to quality service clear commitment is as strong as our own and is extremely important to our company. Gilbert de Cardenas President Cacique, Inc. Los Angeles, CA U.S. Bancorp meets the diverse financial needs of our customers by providing innovative, creative answers through specialized lines of business. Across 24 states and beyond, our experienced bankers share ideas, best practices, capabilities and cross-sell opportunities, supported by advanced technology and operating systems. The results are competitive benefits for our customers and competitive advantages for U.S. Bancorp. l i n e s o f b u s i n e s s K E Y B U S I N E S S U N I T S (cid:157)(cid:127) Commercial Banking (cid:127) Commercial Real Estate (cid:127) Corporate Banking (cid:127) Correspondent Banking (cid:127) Dealer Commercial Services (cid:127) Equipment Leasing (cid:127) Foreign Exchange (cid:127) Government Banking (cid:127) Government Banking (cid:127) International Banking (cid:127) Specialized Industries (cid:127) Treasury Management Wholesale Banking offers strategic lending, depository, treasury management and other financial services to middle market, large corporate, financial institution and public sector customers. Experienced, accessible relationship managers serve as our customers’ link to all the products, credit, support and resources that the extensive scope of U.S. Bancorp provides. S U C C E S S E S (cid:157) Launched U.S. Bank Returned Check Management, providing customers the capability to consolidate all returned items to one location, convert them to electronic items and monitor collection on a state-of-the-art web-based reporting system. (cid:127) Introduced Global Trade Works, an industry-leading web-based Trade Finance Product Suite; delivers increased customer productivity by providing secure online access to real-time data and extensive reporting capabilities, and allows customers to initiate letters of credit via the Internet. (cid:127) Introduced enhancements to U.S. Bank ONLINE BANKER services, a web-based cash management solution; provides a single point of access to information reporting, plus the initiation of wire transfers, ACH, book transfers, stop payments and data export functions. (cid:127) Expanded U.S. Bank FIRSTLook Now, a new wholesale lockbox image service that offers same-day, online customer access to wholesale lockbox checks and invoices, plus added CD-ROM archive capabilities. (cid:127) Developed a new remittance processing system for government banking customers that integrates payment and remittance information received over the Internet via a newest generation image-based lockbox system; speeds processing, provides more valuable incoming payment information, enhances service quality and is scalable and upgradable as customer needs change. Corporate Trust Services, we are that our efforts Working with U.S. Bank confident to provide housing for the people of Washington constant receive the personal attention needed to succeed. Kim Herman Executive Director Washington State Housing Finance Commission Seattle, WA The Washington State Housing Finance Commission seeks partnerships that create greater access to housing and community services throughout the state of Washington. U.S. Bank Corporate Trust Services provides the continuous, personalized service and customized administration capabilities that are vital to the success and growth of the Housing Finance Commission. D I V E R S I F I E D L I N E S O F B U S I N E S S F O C U S O N C U S T O M E R S , D E L I V E R T O P - Q U A L I T Y P R O D U C T S A N D S E R V I C E S Our unique Payment Services business specializes in credit and debit cards, commercial card services, business-to-business payment and ATM and merchant processing. Customized products delivered through leading-edge technology channels equip consumers, small businesses, merchants of every size, government entities, large corporations, financial institutions and co-brand partners with the most advanced payment services tools available. Our industry-leading Consumer Banking delivers a full range of products and services to the broad consumer market and small businesses through full-service banking offices, ATMs, telephone customer service and telesales, online banking and direct mail. A disciplined sales culture, optimal distribution channel convenience and a mandate for quality service are the hallmarks of Consumer Banking. S U C C E S S E S (cid:157) Enhanced our unique Checking That Pays® program, giving customers who use their U.S. Bank Visa® Check Card the choice of four different reward options. In August 2003, rewarded more than one million Checking That Pays customers with an annual cash rebate. Expanded Checking That Pays to business check card customers, too. (cid:127) Introduced free U.S. Bank Internet Bill Pay, eliminating the monthly fee and making online bill payment even easier for consumer checking account customers. (cid:127) Enhanced usbank.com with a host of new features, including free online account statements through U.S. Bank Internet Banking, instant application decisions for U.S. Bank Cash Rewards Cards and U.S. Bank Student Checking Account, direct enrollment in the online security program Verified by Visa®, and Spanish-language additions to usbank.com/espanol. (cid:127) Introduced U.S. Bank Home Mortgage Payment Buster, a new mortgage loan program that reduces monthly payments and eliminates the need to purchase mortgage insurance. (cid:127) Partnered with the United States Hispanic Chamber of Commerce to create ¡Capital!, a first-of-its-kind, strategic loan program designed to meet small business lending needs in high-growth Hispanic markets nationwide. (cid:127) Reached the $1 billion milestone in outstanding recreation finance loans just two years after inception of our Recreation Finance Division; announced the creation of the U.S. Bank manufactured housing finance business, modeled after our successful recreation finance strategies and partnerships. (cid:127) Expanded Student Banking Campus Card relationships with Bellarmine University, Creighton University, Gonzaga University, John Carroll University, Minnesota State University Moorhead and San Diego State University; multi-purpose campus ID card provides students with official campus identification and ATM access, plus convenient access to laundry facilities, vending machines, health services, computer labs and more. S U C C E S S E S (cid:127) Released AccountCommander, Voyager Fleet Systems’ newest online account maintenance tool, to customers nationwide, marking the first phase of Voyager’s FleetCommander Online, a web-based fuel management program designed to provide complete, convenient online account access. (cid:127) Introduced eQuest,™ an Internet-based application that allows financial institution customers to analyze and report on daily ATM and debit transaction activity; eQuest generates a suite of informational reports with customized selection criteria. (cid:127) Expanded the Fastbank® ATM network through Elan Financial Services to become the 12th largest ATM network in the nation. (cid:127) Launched Electronic Check Service and Electronic Gift Card programs through NOVA Information Systems; these value-added products enhance the payment services offerings for bank partners, and improve cash flow and point-of-sale operations for merchant customers. (cid:127) Entered the health care payment segment through the MedAssist Advantage Plan (MAP), offering a new solution for patient financing. Private Client, Trust & Asset Management meets diverse wealth management needs through best-in-class personal trust, corporate trust, institutional trust and custody, private banking, financial advisory, investment management and mutual fund and alternative investment product services. Expert advisors and relationship managers offering sophisticated knowledge and personalized service give U.S. Bank a competitive advantage. S U C C E S S E S (cid:127) Launched a number of new products to meet individual and institutional investors’ needs, including the First American Stable Asset Advisor Fund – designed for investors who seek preservation of principal and competitive returns; new institutional-class money market shares; and a unique alliance with Coast Asset Management to provide qualified investors with absolute-return hedge-fund-of-fund products. (cid:127) Expanded U.S. Bancorp Fund Services, LLC service offerings to include private investment products, such as investment partnerships and separately managed accounts. (cid:127) Unveiled the U.S. Bank Trust Investor Reporting web site usbank.com/abs, providing investors in public and private corporate trust transactions the ability to assign entitlements for access to private deals; offers a customized portfolio, improved factor and payment searching and a simplified navigational flow for excellent customer usability. (cid:127) Expanded TrustNow Essentials, a new comprehensive online reporting system allowing Corporate Trust Services, Institutional Trust & Custody and Private Client Group customers to view, print and download trust statements and reports via the Internet 24 hours a day, seven days a week. (cid:127) Successfully completed purchase of State Street Corporate Trust and resulting systems conversions, seamlessly integrating approximately 20,000 new client issuances, 365,000 bondholders and $689 billion in assets to the U.S. Bank Corporate Trust Services platform. K E Y B U S I N E S S U N I T S (cid:127) Corporate Payment Systems - Travel and entertainment, purchasing, fleet, freight payment systems and business-to-business payment (cid:127) NOVA Information Systems, Inc. - Merchant processing with top 3 market share (cid:127) Retail Payment Solutions - Relationship-based retail payment solutions; includes credit, debit and stored value cards through U.S. Bank, Elan financial institutions and co-brand partners (cid:127) Transaction Services - ATM Banking - Elan Financial Services, a single source provider of transaction processing for financial institutions nationwide K E Y B U S I N E S S U N I T S (cid:127) Corporate Trust Services - Escrow - Public Finance/Structured Finance/Corporate Finance - Document Custody (cid:127) Institutional Trust & Custody - Retirement Plans - Institutional Custody - Master Trust (cid:127) Private Client Group - Private Banking - Personal Trust - Investment Management - Financial and Estate Planning (cid:127) U.S. Bancorp Asset Management, Inc. - First American Funds™ - Private Asset Management - Institutional Advisory - Securities Lending (cid:127) U.S. Bancorp Fund Services, LLC - Mutual Fund Administration and Compliance - Transfer Agent - Mutual Fund Accounting - Fund Distribution - Partnership Administration - Offshore Trust Administration K E Y B U S I N E S S U N I T S (cid:157) 24-Hour Banking and Financial Sales (cid:127) Business Equipment Finance Group (cid:127) Community Banking (cid:127) Consumer Lending (cid:127) Group Sales and Student Banking (cid:127) Home Mortgage (cid:127) (cid:127) In-store and Corporate On-site Banking Investments and Insurance (cid:127) Metropolitan Branch Banking (cid:127) SBA Division (cid:127) Small Business Banking s t r e n g t h i n n u m b e r s (cid:157) Leading depository bank for federal, state and municipal governments (cid:127) Leading correspondent banking depository for community banks (cid:127) Top 2 agricultural lender (cid:127) Top 6 bank-owned equipment leasing company (cid:127) Top 7 treasury management provider (cid:127) Top 2 Small Business Administration (SBA) bank lender by loan dollar volume (cid:127) Top 3 small business lender (cid:127) Top 4 Small Business Internet Banking site as rated by Speer and Associates (cid:127) Top 3 merchant payment processor (cid:127) #1 commercial card issuer (cid:127) Top 2 corporate card provider (cid:127) Top 2 fleet card provider (cid:127) Top 2 freight payment provider (cid:127) Top 2 bank-owned ATM network (cid:127) Top 12 ATM network through Fastbank, owned by Elan Financial Services (cid:127) Top 5 check processor (cid:127) Top 7 U.S. credit and debit card issuer in total sales volume (cid:127) Top 8 worldwide credit and debit card issuer in total sales volume (cid:127) Processor of ATM/debit/credit transactions for more than 21% of all banks in the U.S. (cid:127) #1 municipal finance trustee (cid:127) Top 5 in corporate, asset-backed and mortgage-backed bond issues (cid:127) Top 5 bank-affiliated U.S. mutual fund family through First American Funds (cid:127) Top 5 full-service, third-party provider of mutual fund services (cid:127) Top 6 bank provider of recordkeeping by assets (cid:127) Top 11 domestic bank securities custodian (cid:127) Private Client Group has $68.2 billion in assets under administration (cid:127) U.S. Bancorp Asset Management has more than $127.7 billion in assets under management*; ranks as the 37th largest asset manager domiciled in the U.S. (cid:127) First American Funds family includes open-end funds with assets of more than $57.6 billion* (cid:127) A number of First American Funds products have received notable recognition from both third-party rating and ranking agencies (cid:127) #1 Retail Internet Banking site as rated by Speer and Associates (cid:127) #1 retail auto lessor (cid:127) Top 3 in-store branch network (cid:127) Top 4 branch network (cid:127) Top 6 bank dealer indirect consumer loan provider (cid:127) Top 7 in ATM volume (cid:127) Top 9 ATM processor (cid:127) Processor of 7% of all ATM/debit point of sale transactions in the U.S. (cid:127) Top 9 student loan provider (cid:127) Top 20 U.S. home mortgage lender (cid:127) U.S. Bank Consumer Finance has more than $6 billion in loan receivables *Assets are as of December 31, 2003, and reflect U.S. Bancorp Asset Management, Inc., and its affiliated private asset management group within U.S. Bank National Association. Investment products, including shares of mutual funds, are not obligations of, or guaranteed by, any bank, including U.S. Bank or any U.S. Bancorp affiliate, nor are they insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other agency. An investment in such products involves investment risk, including possible loss of principal. U.S. Bancorp Asset Management, Inc., serves as the investment advisor to First American Funds. First American Funds are distributed by Quasar Distributors, LLC, an affiliate of the investment advisor. W E A R E N O W F O C U S E D S O L E L Y O N G R O W I N G U . S . B A N C O R P B Y L E V E R A G I N G T H E B R E A D T H A N D D E P T H O F T H E P O W E R F U L F R A N C H I S E W E H A V E B U I L T U.S. Bancorp strategically invests in the distribution channels, lines of business and markets with high potential for growth. These investments take full advantage of the existing resources, capabilities and national platforms we have built, enhancing our core geography and increasing customer convenience with moderate expenditure and low risk to the company. i n v e s t i n g i n d i s t r i b u t i o n a n d s c a l e Distribution channels deliver anytime access. Our distribution channels — including 2,243 branch banking offices in 24 states, 4,425 U.S. Bank ATMs, 24-hour call center service, U.S. Bank Internet Banking and specialized trust, brokerage and home mortgage offices — form the foundation of our powerful presence in many of the country’s high-growth, diversified markets. Our growing branch network operates in three strategically segmented formats. Community Banking delivers our full range of products and services in smaller, non-urban communities through the local office. Metropolitan Banking serves branch customers in larger and urban locations as a separate line of business through partnerships with all businesses of the bank. Our highly successful In-store Banking operates branches inside grocery stores, colleges and universities, workplaces, retirement centers and other high-traffic locations. Branch Banking and Specialized Services/Offices Metropolitan Branch Banking & Community Banking CANADA Commercial Banking Consumer Banking Corporate Banking Payment Services Private Client, Trust & Asset Management U.S. Bancorp Operations and Support Centers Expanding in-store banking office distribution. In 2003, we began a major expansion of our in-store network — the third largest in the country — by partnering with supermarket retailers Safeway Inc., Publix and Smith’s Food & Drug Stores. Beginning with six new Reno Salt Lake City Sacramento San Francisco Los Angeles Las Vegas Nashville Publix branches in 2003, by the end of 2004, U.S. Bank San Diego Phoenix Nashville will have opened 15 new Smith’s in-store branches in Utah, and by the end of 2005 we will have opened a total of 163 new full-service in-store locations in Safeway and Vons stores throughout California, Arizona and Nevada. Strategic investments solidify our position in high-growth markets and businesses. In 2003, U.S. Bank completed system conversions resulting from the 2002 purchase and deposit assumption of 57 Bay View Bank branches in California. This transaction strengthened the U.S. Bank geographic footprint in California, adding to existing U.S. Bank branches to create an integrated network offering complete coverage of the fast-growing Greater Bay area— San Francisco, San Jose, Alameda County, Contra Costa County, Santa Rosa, Vallejo-Fairfield-Sonoma and Santa Cruz. In 2003, U.S. Bank also completed system conversions resulting from the purchase of State Street Corporate Trust in 2002. This transaction strongly complemented our existing corporate trust business, making U.S. Bank the leading corporate trust provider in New England in addition to our current lead status in the Northwest, West and Central regions of the country. With over thirty-five years of experience, Millennium Development Corp. has invested in and developed a wide variety of real estate projects ranging from agricultural land to office buildings to shopping centers. As an equity participant in each project, Millennium Development Corp. is committed to preserving capital and producing an attractive return on investment. For more than 10 years, U.S. Bank Small Business Banking has provided the cash flow management, credit and financing resources that support Millennium Development’s business vision. The business services offered by U.S. Bank allow us the diversification to satisfy each project’s requirements. we need Internet business banking provides us with additional convenient options, too. Sandy Schwartz General Manager Millennium Development Corp. Scottsdale, AZ a t t r a c t i v e b u s i n e s s m i x U.S. Bancorp serves multiple customer segments in our 24-state footprint through a broad, attractive business mix with scale, resulting in competitive advantages, operating economies, reduced risk, diversified revenue streams and a wide range of ways to satisfy every customer. U.S. Bancorp has a very attractive growth franchise. Our core regional businesses operate in our 24-state footprint and benefit from the geographic density of our banking locations and franchise support in terms of cross-sell, cross- servicing and back-office support. Our top-performing regional businesses, combined with our specialized national-scale businesses, create a diversified and advantaged revenue mix of both spread and fee income from discrete sources. With challenge, opportunity, risk and reward spread across all geographic markets and a wide range of customer and business segments, we are positioned to capitalize on a recovering economy, while tolerating individual market or industry weaknesses. The sports, educational and cultural programs of the Mathews-Dickey Boys’ & Girls’ Club in St. Louis instill “The Three R’s: Respect, Restraint & Responsibility” within more than 40,000 deserving young men and women each year. In 1982, President Ronald Reagan recognized the Club’s neighbor-helping- neighbor concept by declaring it a model for the country. Numerous other government, media, sports and civic luminaries have applauded the 44-year-old organization’s impact in keeping more than one million youth on the fields, in the classroom and off the streets. We’ve enjoyed a successful relationship with Mathews-Dickey, a long-time client of the U.S. Bank Private Client Group. We are proud to manage the Endowment Fund for Mathews- Dickey to support its youth-enrichment programs for years to come. U.S. Bank’s Private Client Group is sor a trusted advi to our organization. Their expert endowment management skills and understanding of our invaluable asset investment objectives are an to our ongoing programs. Martin L. Mathews President, CEO & Co-Founder Mathews-Dickey Boys’ & Girls’ Club St. Louis, MO Revenue by Business Segment 15.1% Metropolitan Banking 11.9% Community Banking 10.3% Retail Payment Solutions 6.7% Corporate Banking 6.2% NOVA Information Systems 5.5% Middle Market Banking 4.9% Mortgage Banking 4.3% Consumer Lending 3.9% Private Client Group 3.4% Commercial Real Estate 2.5% Corporate Trust 2.0% Government Banking 1.9% Asset Management 1.9% Corporate Payment Systems 1.1% Institutional Trust .7% Fund Services Diversified Regional Businesses Consumer Banking Community Banking In-store Banking Insurance Investments Metropolitan Banking Small Business Banking Institutional Trust Middle Market Banking Private Client Group O U R E X T E N S I V E B U S I N E S S M I X G E N E R A T E S A S O U N D C O M B I N A T I O N O F I N T E R E S T A N D N O N I N T E R E S T I N C O M E S T R E A M S Improving business unit trends. We see strong business momentum in Consumer Banking; we opened nearly a quarter of a million more checking accounts than were closed in 2003. A checking account is our retail customers’ primary link to U.S. Bank and is the basis for our 11.7 percent compound annual growth rate in branch-generated average low-cost core deposits. More importantly, checking is the starting point for expanded consumer relationships, reflected in a 12 percent compound annual growth rate in branch-generated average retail loans. Small business loans and branch-based investment product fee income also showed double-digit growth rates. Our investment in distribution in high-growth markets continues, most particularly our current in-store branch expansion and our extension of mortgage banking origination capabilities in western markets. In our Wholesale Banking business, the timing of commercial loan growth is still uncertain; however, we expect credit improvement trends to continue, a key driver of future growth. Along with loan generation, our relationship managers are putting renewed focus on providing appropriate supplementary services and deposit products to our commercial customers. Improving equity markets are driving growth in our Private Client, Trust & Asset Management business units, as are outstanding service and our exceptional personal attention to each customer. Deposits, total loans and noninterest income are on upward trends. We strive to increase the level and breadth of services we provide to corporate executives, business owners, legal and healthcare professionals, professional athletes and non-profit organizations with their specialized and complex financial needs. Private Client Group earns an increasing share of wallet through expert investment management, financial planning, personal trust and private banking services. Institutional investment needs are met with high-performing securities lending, equity, fixed income and cash products. T H E R E A C H O F O U R F R A N C H I S E E X T E N D S F A R B E Y O N D O U R 2 4 - S T A T E B R A N C H B A N K I N G A N D P R I M A R Y F O O T P R I N T With top-ranked payment services, expertise in highly specialized businesses, advanced technological capabilities and financial products and services not limited by location, U.S. Bancorp has built a national standing in a number of high-growth businesses. h i g h - v a l u e n a t i o n a l b u s i n e s s e s Lockheed Martin Corporation, the world’s premier advanced technology systems integrator, has partnered with U.S. Bank Corporate Payment Systems for ten years, adopting a full range of Corporate Payment Systems services, including corporate travel card and purchasing card programs. As a result of U.S. Bank Corporate Payment Systems’ flexibility and client-focus, Lockheed Martin recently extended its purchasing card commitment with a new five-year contract. Connie Mearkle (left), Assistant Treasurer, and Molly Chung (right), Director, Global Treasury Operations Lockheed Martin Corporation Bethesda, MD Payment Services is a high-value, growth business without boundaries. U.S. Bank has developed innovative payment services to meet the rapidly expanding needs of consumers, businesses, financial institutions, government entities and millions of merchants throughout the world. This line of business has unlimited potential, and we utilize our expertise, technology and reputation for service to seize a growing share of business within this burgeoning arena. We are the Number 3 merchant processor (NOVA), the Number 1 Visa commercial card issuer, the Number 2 small business card issuer, the Number 7 Visa and MasterCard® consumer card issuer, the Number 2 bank-owned ATM network, the Number 2 universal fleet card (Voyager) and the Number 2 freight payment provider (PowerTrack®). Through NOVA Information Systems, recognized for superlative customer service and technical proficiency, our Merchant Processing business ranks third in the nation and serves more than 600,000 merchant locations in the United States and in Europe. We continue to expand this business through penetration of the U.S. Bank customer base of merchants and through ongoing activities, backed by the full resources of U.S. Bancorp, to gain additional merchant customers. U.S. Bank Corporate Payment Systems is a Lockheed Martin Corporation, providing strategic customized resource for technology solutions. National Businesses Asset Management Commercial Real Estate Consumer Lending Corporate Banking Corporate Payment Systems Corporate Trust Elan Financial Services Equipment Financing Fund Services Government Banking Institutional Custody Mortgage Banking NOVA Information Systems Retail Payment Solutions Transaction Services Our Retail Payment Solutions business is unique among large card issuers in that we build this business in large part on relationship-based efforts among our retail and small business customers, among our growing network of correspondent financial institutions and with a star-studded roster of co-brand partners. There is enormous potential in the further penetration of our existing customer base and in our ability to stay at the leading edge of new product introductions. Corporate Payment Systems is at the forefront of payment providers, using leading technology and expertise to automate the entire payment continuum for commercial buyers and sellers. Card solutions like One Card, Corporate Card, Purchasing Card and Fleet Card provide flexible solutions for classic payables, while PowerTrack adds increased control and sophisticated pre-payment audits for complex business-to-business procurement processes. With a compelling investment in the industry’s best technology, our Transaction Services is the hub of electronic payments transactions for all U.S. Bancorp ATMs, as well as ATMs, credit and debit cards, merchant processing, and the electronic funds transfer network gateway for other financial institutions, through Elan Financial Services. With expertise, technology, economy of scale and existing potential still within our markets, this is a full-service, start-to-finish business with growth expectation. Diverse U.S. Bancorp national businesses serve customers coast to coast. U.S. Bank is a leading financial resource for local and state government, political sub-divisions and the federal government through our Government Banking business. We are one of the largest tax payment processors for the U.S. Government, and we provide a wide range of financial services for the Department of Defense, as well as web and lockbox collection services for the U.S. Department of Homeland Security. Mortgage Banking originates loans in all 50 states. We are targeting becoming a Top 10 mortgage provider through expanded sales efforts nationally and also the extension of our Mortgage Banking as a primary line of business into our western markets. With expertise to support the nation’s largest corporations, specialized industries and our middle market customers, Corporate Banking provides services to meet the most complex transactional, credit, financial management, international financing and exchange, and risk mitigation needs. We are also a national leader in treasury management services. Our relationship-based model succeeds on the experience of our managers, the economies of scope and scale derived from our size and geography and our commitment to cost management. As the leading provider of municipal trust services and a top provider of corporate, escrow and structured finance services, Corporate Trust Services brings an unrelenting commitment to exceeding expectations by providing the right solutions at the right time for customers nationwide. U.S. Bancorp Asset Management leverages the multiple distribution channels and broad geographic range of U.S. Bank to deliver the First American family of mutual funds, which encompasses a full range of equity and fixed income investment strategies. We are a performance-driven culture of expanding non-proprietary distribution, and we continue to promote U.S. Bancorp Asset Management to prospective customers nationwide. U . S . B A N C O R P H E L P S B U I L D S T R O N G , V I B R A N T C O M M U N I T I E S T H R O U G H C H A R I T A B L E C O N T R I B U T I O N S , S P O N S O R S H I P S A N D V O L U N T E E R I S M c o m m u n i t y p a r t n e r s h i p s Through the U.S. Bancorp Foundation, we provide cash contributions to non-profit organizations for affordable housing, economic opportunities, education and artistic and cultural Our commitment to helping build strong communities begins with local market leadership and dedicated community involvement. U.S. Bancorp and our employees are committed to giving and volunteerism in the markets we serve. We make this investment proudly, promoting powerful partnerships and fostering economic development in communities, small and large, across the country. enrichment. Total charitable Creating stronger communities for a stronger company. contributions from the U.S. Bancorp is not just part of the community — we’re a partner in all the U.S. Bancorp Foundation communities we serve across the country. Working with people, businesses and topped $20 million in 2003. non-profit organizations in these local markets, we assist with economic, educational and cultural development. As an active partner, U.S. Bancorp provides superior, competitive products and services to every customer we serve, while offering customized financial solutions to customers and businesses who need assistance overcoming challenging financial situations. By helping to create strong, vibrant communities, U.S. Bancorp is building a healthy marketplace for our company — one community at a time. Sponsorships support quality of life. The enduring vitality of a community is ultimately in the hands of its artists, athletes, performers, scholars, musicians and the institutions that train, educate, nurture and promote them. We extend sponsorship support to a variety of music, arts, sports and education programs, in addition to many other civic and cultural activities. From county fairs to the performing arts to professional, minor league, collegiate and high school sports, U.S. Bancorp supports a diverse range of opportunities and interests of our customers. U.S. BANCORP FOUNDATION 2003 CHARITABLE CONTRIBUTIONS BY PROGRAM AREA 32% Human Services and United Way 28% Economic Opportunity 17% Arts & Culture 16% Education 7% Matching Gifts Empowering local leaders. To meet the unique needs of the communities we serve, local leaders are empowered with the autonomy to customize all the resources of U.S. Bancorp for their individual markets. Coupled with the valuable insight of local market leaders, local boards provide further knowledge, expertise and insight into each community’s businesses, industries and important causes. Together, this leadership team is equipped with the first-hand knowledge needed to make strategic pricing and business development decisions that strengthen both U.S. Bancorp and the community. Investing in our employees. The U.S. Bancorp Development Network promotes the personal and professional development of our employees by enhancing leadership, management and communication skills; organizing networking opportunities; providing community involvement opportunities; and encouraging and capitalizing on the diversity of our employees. The Development Network is composed of 42 geographically based chapters, which share these objectives and fulfill the program’s mission by organizing professional and community service activities, such as financial and leadership seminars for employees, mentoring opportunities, charitable fundraising drives and more. U.S. Bank gives “Back 2 Schools in Minnesota.” U.S. Bank is investing nearly $500,000 in programs that support Minnesota teachers, high schools and students during the 2003- 2004 school year. Designed to enrich student learning, recognize outstanding high school students and assist school athletic programs, Back 2 Schools is part of the ongoing investment U.S. Bank makes in Minnesota schools. Cynthia Welsh, teacher at Cloquet High School, has developed an interactive science discovery class With the help of the U.S. Bank Teacher’s Edition gra to my students were given the tools understand the courage and the means to science, to use excel. Cynthia Welsh Teacher Cloquet High School Cloquet, MN U . S . B A N K B A C K 2 S C H O O L S Management’s Discussion and Analysis OVERVIEW In 2003, U.S. Bancorp and its subsidiaries (the ‘‘Company’’) achieved each of the goals outlined for the year despite challenging economic conditions in early 2003. We began the year with several speciﬁc ﬁnancial objectives. The ﬁrst goal was to focus on organic revenue growth. In 2003, the Company’s revenue growth of 3.9 percent included 3.7 percent growth in revenue from baseline business products and services. The second goal was to continue improving our operating leverage. During 2003, our efﬁciency ratio improved to 45.6 percent compared with 48.8 percent in 2002. Third, the Company was determined to continue improving its credit quality and reduce the overall risk proﬁle of the organization. Nonperforming assets have declined 16.4 percent from a year ago and total net charge-offs decreased to 1.06 percent of average loans outstanding in 2003 compared with 1.20 percent in 2002. Finally, despite the challenges of 2003, the Company always desires to grow revenues faster than expenses. The Company’s results for 2003 reﬂect the achievement of this objective. The Company’s strong performance is also reﬂected in our capital levels and the improving outlook by our credit rating agencies relative to a year ago. Equity capital of the Company has increased to 6.5 percent of tangible common equity at December 31, 2003 from 5.7 percent at December 31, 2002. Credit ratings assigned by various credit rating agencies reﬂect the favorable rating agency views of the direction of the Company’s credit quality, risk management, liquidity and capital management practices and our ability to generate earnings. Each of these factors is considered important by management and discussed further throughout this document. In concert with achieving our stated ﬁnancial objectives, the Company took key steps to strategically change the risk proﬁle of the organization and enhance shareholder value. The Company’s ﬁnancial statements reﬂect decisions by the Company to spin off Piper Jaffray Companies (‘‘Piper Jaffray’’) and to adopt the fair value method of accounting for stock-based compensation. Additionally, in December 2003 we announced an expanded share repurchase program and further increased our cash dividend resulting in a 23.1 percent increase from the dividend rate in the fourth quarter of 2002. The tax- free distribution of Piper Jaffray strategically changed the risk proﬁle of the Company by reducing the earnings volatility and business risks associated with investment banking and resulted in the distribution to our shareholders of an independent company with approximately $880 million of market value shortly after the distribution. 18 U.S. Bancorp In connection with the Piper Jaffray spin-off and the change in our method of accounting for stock-based compensation, the ﬁnancial statements of the Company have been restated for all prior periods. As such, historical ﬁnancial results related to Piper Jaffray have been segregated and accounted for in the Company’s ﬁnancial statements as discontinued operations. Earnings Summary The Company reported net income of $3.7 billion in 2003, or $1.93 per diluted share, compared with $3.2 billion, or $1.65 per diluted share, in 2002. Return on average assets and return on average equity were 1.99 percent and 19.2 percent, respectively, in 2003, compared with returns of 1.84 percent and 18.3 percent, respectively, in 2002. Net income in 2003 included after-tax income from discontinued operations of $22.5 million, or $.01 per diluted share, compared with an after-tax loss of $22.7 million, or $.01 per diluted share, in 2002. Included in net income for 2002 was an after-tax goodwill impairment charge of $37.2 million, or $.02 per diluted share, primarily related to the purchase of a transportation leasing company in 1998 by the equipment leasing business. This charge was taken at the time of adopting new accounting standards related to goodwill and other intangible assets and was recognized as a ‘‘cumulative effect of accounting change’’ in the income statement. Refer to Note 2 of the Notes to Consolidated Financial Statements for further discussion of the impact of changes in accounting principles. In 2003, the Company had income from continuing operations, net of tax, of $3.7 billion, or $1.92 per diluted share, compared with $3.2 billion, or $1.68 per diluted share, in 2002. The 14.9 percent increase in income from continuing operations was primarily due to growth in net revenue, lower expenses and decreased credit costs. Net income from continuing operations included after-tax merger and restructuring-related items of $30.4 million ($46.2 million on a pre-tax basis), compared with after-tax merger and restructuring-related items of $209.3 million ($321.2 million on a pre-tax basis) in 2002. The $275.0 million decline in pre-tax merger and restructuring- related charges was primarily due to the completion of integration activities associated with the merger of Firstar Corporation and the former U.S. Bancorp of Minneapolis (‘‘USBM’’) at the end of 2002. Partially offsetting this favorable item in 2003 was a year-over-year decrease of $55.1 million in net securities gains realized in 2002, and a year-over-year increase in the level of mortgage servicing rights (‘‘MSRs’’) impairment of $22.6 million, driven by changes in interest rates and related prepayments. Refer to ‘‘Merger and Restructuring-Related Items’’ for further discussion on merger and restructuring-related items and the related earnings impact. Total net revenue, on a taxable-equivalent basis, was $12.5 billion in 2003, compared with $12.1 billion in 2002, a year-over-year increase of $472.6 million (3.9 percent). This growth was primarily due to organic growth of 3.7 percent and the beneﬁt of acquisitions, offset somewhat by lower gains from asset sales. Revenue growth was comprised of a 5.4 percent increase in net interest income and a 2.0 percent net increase in noninterest income. The Table 1 Selected Financial Data Year Ended December 31 (Dollars and Shares in Millions, Except Per Share Data) Condensed Income Statement Net interest income (taxable-equivalent basis) (a) ************* Noninterest income *************************************** Securities gains, net ************************************** Total net revenue ************************************** Noninterest expense ************************************** Provision for credit losses********************************** Income from continuing operations before taxes *********** Taxable-equivalent adjustment ****************************** Applicable income taxes *********************************** Income from continuing operations ********************** Discontinued operations (after-tax) ************************** Cumulative effect of accounting change (after-tax) ************ Net income ******************************************* Per Common Share Earnings per share from continuing operations *************** Diluted earnings per share from continuing operations ******** Earnings per share**************************************** Diluted earnings per share ********************************* Dividends declared per share (b) *************************** Book value per share ************************************* Market value per share ************************************ Average shares outstanding ******************************** Average diluted shares outstanding ************************* Financial Ratios Return on average assets ********************************* Return on average equity ********************************** Net interest margin (taxable-equivalent basis) **************** Efﬁciency ratio (c) ***************************************** Average Balances Loans *************************************************** Loans held for sale *************************************** Investment securities ************************************** Earning assets ******************************************* Assets *************************************************** Noninterest-bearing deposits ******************************* Deposits ************************************************* Short-term borrowings ************************************* Long-term debt ******************************************* Total shareholders’ equity ********************************** Period End Balances Loans *************************************************** Allowance for credit losses ********************************* Investment securities ************************************** Assets *************************************************** Deposits ************************************************* Long-term debt ******************************************* Total shareholders’ equity ********************************** Regulatory capital ratios Tangible common equity ******************************** Tier 1 capital ****************************************** Total risk-based capital ********************************* Leverage ********************************************* 2003 2002 2001 2000 1999 $ 7,217.5 5,068.2 244.8 12,530.5 5,596.9 1,254.0 5,679.6 28.2 1,941.3 3,710.1 22.5 — $ 6,847.2 4,910.8 299.9 12,057.9 5,740.5 1,349.0 4,968.4 32.9 1,707.5 3,228.0 (22.7) (37.2) $ 6,405.2 4,340.3 329.1 11,074.6 6,149.0 2,528.8 2,396.8 54.5 818.3 1,524.0 (45.2) — $ 6,072.4 3,958.9 8.1 10,039.4 4,982.9 828.0 4,228.5 82.0 1,422.0 2,724.5 27.6 — $ 5,875.7 3,501.9 13.2 9,390.8 5,131.8 646.0 3,613.0 94.2 1,296.3 2,222.5 17.9 — $ 3,732.6 $ 3,168.1 $ 1,478.8 $ 2,752.1 $ 2,240.4 $ 1.93 1.92 1.94 1.93 .855 10.01 29.78 1,923.7 1,936.2 $ 1.68 1.68 1.65 1.65 .780 9.62 21.22 1,916.0 1,924.8 $ .79 .79 .77 .76 .750 8.58 20.93 1,927.9 1,940.3 $ 1.43 1.42 1.44 1.43 .650 8.06 23.25 1,906.0 1,918.5 $ 1.16 1.15 1.17 1.16 .460 7.29 21.13 1,907.8 1,930.0 1.99% 19.2 4.49 45.6 1.84% 18.3 4.65 48.8 .89% 9.0 4.46 57.2 1.74% 19.0 4.38 49.7 1.49% 16.9 4.43 54.7 $118,362 3,616 37,248 160,808 187,630 31,715 116,553 10,503 30,965 19,393 $118,235 2,369 43,334 189,286 119,052 31,215 19,242 $114,453 2,644 28,829 147,410 171,948 28,715 105,124 10,116 29,268 17,273 $116,251 2,422 28,488 180,027 115,534 28,588 18,436 $118,177 1,911 21,916 143,501 165,944 25,109 104,956 11,679 24,133 16,426 $114,405 2,457 26,608 171,390 105,219 25,716 16,745 $118,317 1,303 17,311 138,636 158,481 23,820 103,426 11,008 21,916 14,499 $122,365 1,787 17,642 164,921 109,535 21,876 15,333 $109,638 1,450 19,271 132,685 150,167 23,556 99,920 10,883 19,873 13,273 $113,229 1,710 17,449 154,318 103,417 21,027 14,051 6.5% 9.1 13.6 8.0 5.7% 8.0 12.4 7.7 5.9% 7.8 11.9 7.9 6.4% 7.3 10.7 7.5 *% 7.4 11.1 7.6 Information was not available to compute pre-merger proforma percentage. * (a) Interest and rates are presented on a fully taxable-equivalent basis utilizing a tax rate of 35 percent. (b) Dividends per share have not been restated for the 2001 Firstar/USBM merger. (c) Computed as noninterest expense divided by the sum of net interest income on a taxable-equivalent basis and noninterest income excluding securities gains (losses), net. U.S. Bancorp 19 5.4 percent increase in net interest income resulted from an increase of $13.4 billion (9.1 percent) in average earning assets, primarily driven by increases in investment securities, residential mortgages, retail loans and loans held for sale, partially offset by an overall decline in commercial loans. The impact of the increase in average earning assets was offset in part by a lower net interest margin given the current interest rate environment. The net interest margin in 2003 was 4.49 percent, compared with 4.65 percent in 2002. The decline reﬂected the change in asset mix among loan products, reinvestment of loan proceeds into lower- yielding investment securities and a reduction in the marginal beneﬁt of net free funds due to lower average interest rates. The 2.0 percent net increase in noninterest income was driven by increases in payment services revenue, trust and investment management fees, deposit service charges, treasury management fees, mortgage banking activity, strong investment product sales and the impact of acquisitions. Somewhat offsetting the growth in these fee- based revenues was a year-over-year decline in net securities gains of $55.1 million. Additionally, other revenues for 2002 included $67.4 million of gains related to the sales of two co-branded credit card portfolios. Approximately $194.6 million of the increase in net revenue in 2003, compared with 2002, was due to acquisitions, including The Leader Mortgage Company, LLC (‘‘Leader’’), the 57 branches of Bay View Bank (‘‘Bay View’’) in northern California and the corporate trust business of State Street Bank and Trust Company (‘‘State Street Corporate Trust’’). Total noninterest expense was $5.6 billion in 2003, compared with $5.7 billion in 2002. The decrease in total noninterest expense of $143.6 million (2.5 percent) primarily reﬂected a year-over-year reduction in merger and restructuring-related charges of $275.0 million and cost savings related to integration efforts. Partially offsetting this decrease in expense during 2003 was a year-over-year increase of $22.6 million in MSR impairments coupled with the net impact of acquisitions, which accounted for approximately $124.9 million of the expense growth in 2003. Refer to ‘‘Acquisition and Divestiture Activity’’ and ‘‘Merger and Restructuring-related Items’’ for further information on the timing of acquisitions and discussion of merger and restructuring-related items. The efﬁciency ratio (the ratio of noninterest expense to taxable-equivalent net revenue excluding net securities gains or losses) was 45.6 percent in 2003, compared with 48.8 percent in 2002. The favorable change in the efﬁciency ratio reﬂects the continuing improvement in the Company’s operating leverage resulting from integrated operating systems across all of our markets and business lines. In 2003, all business and system integration activities were completed including systems for our merchant processing business, Nova Information Systems, Inc., and the recent acquisitions of the corporate trust business of State Street Bank and Trust Company and the 57 branches of Bay View Bank. The Company anticipates no merger and restructuring-related charges in 2004 relating to completed acquisitions. The provision for credit losses was $1,254.0 million for 2003, compared with $1,349.0 million for 2002, a decrease of $95.0 million (7.0 percent). Net charge-offs during 2003 were $1,251.7 million, compared with net charge-offs of $1,373.0 million during 2002. The decline in net charge- offs reﬂects an improving economy and the Company’s ongoing efforts to reduce the overall credit risk proﬁle of the organization over the past three years. Refer to ‘‘Corporate Risk Proﬁle’’ for further information on the provision for credit losses, net charge-offs, nonperforming assets and factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses. Acquisition and Divestiture Activity On December 31, 2003, the Company announced that it had completed the tax-free distribution of Piper Jaffray Companies representing substantially all of the Company’s capital markets business line. The Company distributed to our shareholders one share of Piper Jaffray common stock for every 100 shares of U.S. Bancorp common stock, by means of a special dividend of $685 million. This distribution did not include brokerage, ﬁnancial advisory or asset management services offered to customers through other business units. The Company will continue to provide asset management services to its customers through the Private Client, Trust and Asset Management business segment and access to investment products and services through its extensive network of licensed ﬁnancial advisors within the retail brokerage platform of the Consumer Banking business segment. The following acquisition transactions were accounted for as purchases from the date of completion. On December 31, 2002, the Company acquired the corporate trust business of State Street Corporate Trust in a cash transaction valued at $725 million. State Street Corporate Trust was a leading provider, particularly in the Northeast, of corporate trust and agency services to a variety of municipalities, corporations, government agencies and other ﬁnancial institutions serving approximately 20,000 client issuances representing over $689 billion of assets under administration. With this acquisition, the Company is among the nation’s leading providers of a full range of corporate trust products and services. The transaction represented total assets acquired of $682 million and total liabilities of $39 million at the closing date. Included in total assets were contract and other intangibles with a fair value of $218 million and the excess of purchase price over the fair value of identiﬁable net assets (‘‘goodwill’’) of 20 U.S. Bancorp $449 million. The goodwill reﬂected the strategic value of the combined organization’s leadership position in the corporate trust business and processing economies of scale resulting from the transaction. As part of the purchase price, $75 million was placed in escrow for up to eighteen months with payment contingent on the successful transition of business relationships. On November 1, 2002, the Company acquired 57 branches and a related operations facility in northern California from Bay View, a wholly-owned subsidiary of Bay View Capital Corporation, in a cash transaction. The transaction represented total assets acquired of $853 million and total liabilities assumed (primarily retail and small business deposits) of $3.3 billion. Included in total assets were approximately $336 million of select loans primarily with depository relationships, core deposit intangibles of $56 million and goodwill of $427 million. The goodwill reﬂected the strategic value of expanding the Company’s market within the San Francisco Bay area. On April 1, 2002, the Company acquired Cleveland- based Leader, a wholly-owned subsidiary of First Deﬁance Financial Corp., in a cash transaction. The transaction represented total assets acquired of $531 million and total liabilities assumed of $446 million. Included in total assets were mortgage servicing rights and other intangibles of $173 million and goodwill of $18 million. Leader specializes in acquiring servicing of loans originated for state and local housing authorities. The following acquisitions were completed during the year 2001. On September 7, 2001, the Company acquired Paciﬁc Century Bank (‘‘Paciﬁc Century’’), which had 20 Table 2 Analysis of Net Interest Income branches located in southern California and total assets of $570 million. On July 24, 2001, the Company acquired NOVA Corporation (‘‘NOVA’’), a merchant processor, which had total assets of $2.9 billion. Refer to Notes 3, 4 and 5 of the Notes to Consolidated Financial Statements for additional information regarding discontinued operations, business combinations and merger and restructuring-related items. STATEMENT OF INCOME ANALYSIS Net Interest Income Net interest income, on a taxable- equivalent basis, was $7.2 billion in 2003, compared with $6.8 billion in 2002 and $6.4 billion in 2001. The increase in net interest income in 2003 was driven by an increase in average earning assets, growth in average net free funds and favorable changes in the Company’s average funding mix. Also contributing to the year-over-year increase in net interest income were recent acquisitions, including Leader, State Street Corporate Trust and Bay View, which accounted for approximately $71.9 million of the increase during 2003. Average earning assets were $160.8 billion for 2003, compared with $147.4 billion and $143.5 billion for 2002 and 2001, respectively. The $13.4 billion (9.1 percent) increase in average earning assets for 2003, compared with 2002, was primarily driven by increases in investment securities, loans held for sale, residential mortgages and retail loans, partially offset by a decline in commercial loans. The net interest margin in 2003 was 4.49 percent, compared with 4.65 percent and 4.46 percent in 2002 and 2001, respectively. The 16 basis point decline in 2003 net interest margin, compared with 2002, primarily reﬂected (Dollars in Millions) 2003 2002 2001 Components of net interest income Income on earning assets (taxable-equivalent basis) (a) Expense on interest-bearing liabilities ***************** $ 9,286.2 2,068.7 $ 9,526.8 2,679.6 $11,000.9 4,595.7 Net interest income (taxable-equivalent basis)************* $ 7,217.5 $ 6,847.2 $ 6,405.2 Net interest income, as reported ************************ $ 7,189.3 $ 6,814.3 $ 6,350.7 2003 v 2002 2002 v 2001 $ (240.6) (610.9) $ 370.3 $ 375.0 $(1,474.1) (1,916.1) $ $ 442.0 463.6 Average yields and rates paid Earning assets yield (taxable-equivalent basis)********* Rate paid on interest-bearing liabilities **************** Gross interest margin (taxable-equivalent basis)*********** Net interest margin (taxable-equivalent basis) ************* Average balances 5.77% 1.60 4.17% 4.49% 6.46% 2.26 4.20% 4.65% 7.67% 3.91 3.76% 4.46% (.69)% (.66) (.03)% (.16)% (1.21)% (1.65) .44% .19% Investment securities******************************** Loans ********************************************* Earning assets ************************************* Interest-bearing liabilities **************************** Net free funds (b) ********************************** $ 37,248 118,362 160,808 129,004 31,804 $ 28,829 114,453 147,410 118,697 28,713 $ 21,916 118,177 143,501 117,614 25,887 $ 8,419 3,909 13,398 10,307 3,091 $ 6,913 (3,724) 3,909 1,083 2,826 (a) Interest and rates are presented on a fully taxable-equivalent basis utilizing a tax rate of 35 percent. (b) Represents noninterest-bearing deposits, allowance for credit losses, unrealized gain (loss) on available-for-sale securities, non-earning assets, other noninterest-bearing liabilities and equity. U.S. Bancorp 21 growth in lower-yielding investment securities as a percent of total earning assets, changes in loan mix and a decline in the margin beneﬁt from net free funds due to lower average interest rates. In addition, the net interest margin declined year-over-year as a result of consolidating high credit quality, low margin loans from Stellar Funding Group, Inc., a commercial loan conduit, onto the Company’s balance sheet in mid-2003. Total average loans of $118.4 billion in 2003 were $3.9 billion (3.4 percent) higher, compared with 2002, reﬂecting growth in average residential mortgages, retail loans and commercial real estate loans of $3.3 billion (39.0 percent), $1.7 billion (4.6 percent) and $1.4 billion (5.5 percent), respectively. Growth in these categories was offset somewhat by an overall decline in average commercial loans of $2.5 billion (5.7 percent). The decline in commercial loans was primarily driven by softness in commercial loan demand, modestly offset by the consolidation of loans from Stellar Funding Group, Inc. in mid-2003. Despite recent economic growth, the Company anticipates that commercial loan demand will continue to be soft in early 2004 while business customers utilize liquidity in deposit accounts to fund business activities. Average investment securities were $8.4 billion (29.2 percent) higher in 2003, compared with 2002, reﬂecting the reinvestment of proceeds from loan sales, declining commercial loan balances and deposits assumed in connection with the Bay View transaction. During 2003, the Company sold $15.3 billion of ﬁxed-rate securities classiﬁed as available-for-sale as part of the Company’s interest rate risk management practices. During early 2003, sales of ﬁxed-rate securities offset much of the economic impact of changes in MSR valuations. During the course of 2003, the Company began repositioning the investment portfolio by reinvesting proceeds from the sale of ﬁxed-rate securities into ﬂoating-rate instruments. Average interest-bearing deposits of $84.8 billion in 2003 were higher by $8.4 billion (11.0 percent), compared with 2002. Approximately $3.0 billion of the year-over-year increase in average interest-bearing deposits was due to acquisitions, while the remaining growth was driven by increases in savings balances. The increase in savings balances reﬂected product initiatives, increasing government banking deposits and customer decisions to maintain liquidity. The Company anticipates that the growth in Table 3 Net Interest Income — Changes Due to Rate and Volume (a) (Dollars in Millions) Increase (decrease) in Interest income Investment securities***************** Loans held for sale ****************** Commercial loans ******************* Commercial real estate*************** Residential mortgages *************** Retail loans ************************* Total loans*********************** Other earning assets***************** Total **************************** Interest expense Interest checking ******************** Money market accounts ************** Savings accounts ******************** Time certiﬁcates of deposit less than $100,000 ************************ Time deposits greater than $100,000 ** Total interest-bearing deposits ***** Short-term borrowings**************** Long-term debt ********************** Company-obligated mandatorily redeemable preferred securities **** Total **************************** Increase (decrease) in net interest income *************************** 2003 v 2002 2002 v 2001 Volume Yield/Rate Total Volume Yield/Rate Total $ 428.4 62.7 (149.0) 90.2 232.5 134.9 308.6 6.4 806.1 22.6 87.7 3.5 (146.3) 26.3 (6.2) 8.5 48.4 (9.7) 41.0 $ (235.2) (31.1) (157.8) (141.9) (114.4) (363.9) (778.0) (2.4) (1,046.7) (40.6) (82.8) (7.4) (146.2) (105.5) (382.5) (64.6) (181.0) (23.8) (651.9) $ 193.2 31.6 (306.8) (51.7) 118.1 (229.0) (469.4) 4.0 (240.6) (18.0) 4.9 (3.9) (292.5) (79.2) (388.7) (56.1) (132.6) (33.5) (610.9) $ 403.7 56.4 (451.0) (27.5) (12.6) 288.2 (202.9) (.8) 256.4 24.4 8.7 3.3 (215.2) (83.1) (261.9) (63.6) 247.5 62.1 (15.9) $ (235.2) (32.7) (536.1) (338.9) (50.3) (543.6) (1,468.9) 6.3 $ 168.5 23.7 (987.1) (366.4) (62.9) (255.4) (1,671.8) 5.5 (1,730.5) (1,474.1) (125.7) (406.9) (20.7) (282.8) (244.8) (1,080.9) (189.1) (576.9) (101.3) (398.2) (17.4) (498.0) (327.9) (1,342.8) (252.7) (329.4) (53.3) 8.8 (1,900.2) (1,916.1) $ 765.1 $ (394.8) $ 370.3 $ 272.3 $ 169.7 $ 442.0 (a) This table shows the components of the change in net interest income by volume and rate on a taxable-equivalent basis utilizing a tax rate of 35 percent. This table does not take into account the level of noninterest-bearing funding, nor does it fully reﬂect changes in the mix of assets and liabilities. The change in interest not solely due to changes in volume or rates has been allocated on a pro-rata basis to volume and yield/rate. 22 U.S. Bancorp interest-bearing deposits will moderate in 2004 as the economy continues to expand. Average net free funds increased $3.1 billion from a year ago, including an increase in average noninterest- bearing deposits of $3.0 billion (10.4 percent) in 2003, compared with 2002. The increase in noninterest-bearing deposits was primarily due to mortgage banking activities during early 2003 and higher liquidity among corporate customers maintained in demand deposit balances year- over-year. The increase in net interest income in 2002, compared with 2001, was related to an improvement in the net interest margin as well as growth in earning assets. The 19 basis point improvement in the 2002 net interest margin, compared with 2001, reﬂected the funding beneﬁts of the declining interest rate environment, a more favorable funding mix and improving spreads due to product repricing dynamics, growth in net free funds and a shift in mix toward retail loans, partially offset by lower yields on the investment portfolio. The $3.9 billion (2.7 percent) increase in average earning assets for 2002, compared with 2001, was primarily driven by increases in the investment portfolio and retail loan growth, partially offset by a decline in commercial and commercial real estate loans. The $3.7 billion decrease in total average loans for 2002, compared with 2001, reﬂected strong growth in average retail loans of $3.1 billion which was more than offset by an overall decline in average commercial and commercial real estate loans of $6.6 billion. Average investment securities were $6.9 billion (31.5 percent) higher in 2002, compared with 2001, reﬂecting reinvestment of proceeds from loan sales, declines in commercial and commercial real estate loan balances and growth in deposits. Average interest-bearing deposits of $76.4 billion in 2002 were lower by $3.4 billion, compared with 2001. Growth in average savings products (5.4 percent) for 2002 was more than offset by reductions in the average balances of higher cost time certiﬁcates of deposit (17.3 percent) and time certiﬁcates of deposit greater than $100,000 (13.2 percent). The decline in time certiﬁcates and time deposits greater than $100,000 reﬂected funding decisions toward more favorably priced wholesale funding sources given the rate environment and customers’ desire to maintain liquidity. The increase in average net free funds was driven by an increase in average noninterest-bearing deposits of $3.6 billion (14.4 percent) in 2002, compared with 2001. Provision for Credit Losses The provision for credit losses is recorded to bring the allowance for credit losses to a level deemed appropriate by management based on factors discussed in the ‘‘Analysis and Determination of Allowance for Credit Losses’’ section. The provision for credit losses was $1,254.0 million in 2003, compared with $1,349.0 million and $2,528.8 million in 2002 and 2001, respectively. The decline in the provision for credit losses of $95.0 million in 2003 primarily reﬂected an improving credit risk proﬁle resulting in lower nonperforming loans and commercial and retail loan losses. The decline in nonperforming loans and commercial loan net charge-offs was broad-based across most industries within the commercial loan portfolio. Retail loan delinquency ratios have also continued to improve across most retail loan portfolios reﬂecting improving economic conditions and the Company’s ongoing collection efforts and risk management activities. These are also the principal factors resulting in lower levels of retail net charge-offs during the year. The decline in the provision for credit losses of $1,179.8 million in 2002 was primarily related to speciﬁc credit actions taken in 2001. Included in the provision for credit losses in 2001 was a $1,025 million incremental provision recognized in the third quarter of 2001 and a $160 million charge during the ﬁrst quarter of 2001 in connection with an accelerated loan workout strategy. The third quarter of 2001 provision for credit losses was signiﬁcantly above the level anticipated earlier in that quarter and was taken after extensive review of the Company’s commercial loan portfolio in light of the events of September 11, 2001, declining economic conditions, and company-speciﬁc trends. The action reﬂected the Company’s expectations, at that time, of a prolonged economic slowdown and recovery. In addition to these actions, the provision for credit losses in 2001 included a merger and restructuring-related provision of $382.2 million. The merger and restructuring-related provision consisted of a $201.3 million provision for losses related to the disposition of an unsecured small business product; a $90.0 million charge to align risk management practices, align charge-off policies and expedite the transition out of a speciﬁc segment of the health care industry not meeting the lower risk appetite of the combined company; a $76.6 million provision for losses related to the sales of high loan-to-value home equity loans and the indirect automobile loan portfolio of USBM; and a $14.3 million charge related to the restructuring of a co-branding credit card relationship. Refer to Note 5 of the Notes to Consolidated Financial Statements for further information on merger and restructuring-related items. Refer to ‘‘Corporate Risk Proﬁle’’ for further information on the provision for credit losses, net charge- offs, nonperforming assets and other factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses. U.S. Bancorp 23 Noninterest Income Noninterest income in 2003 was $5.3 billion, compared with $5.2 billion in 2002 and $4.7 billion in 2001. The increase in noninterest income of $102.3 million (2.0 percent) in 2003, compared with 2002, was driven by strong growth in payment services revenue, trust and investment management fees, deposit service charges, treasury management fees, mortgage banking revenue and investment products fees and commissions attributable to both organic growth and acquisitions. Partially offsetting the increase in noninterest income in 2003 was a year-over-year decrease in net securities gains of $55.1 million. Noninterest income in 2002 also included $67.4 million of gains recognized in connection with the sale of two co-branded credit card portfolios. The favorable impact on noninterest income from acquisitions, which included Leader, Bay View and State Street Corporate Trust, was approximately $122.7 million during 2003. Credit and debit card revenue, corporate payment products revenue and ATM processing services revenue were higher in 2003, compared with 2002, by $43.7 million (8.5 percent), $35.6 million (10.9 percent) and $5.3 million (3.3 percent), respectively. Although credit and debit card revenue increased year-over-year, revenue growth was somewhat muted due to the impact of the settlement of the antitrust litigation brought against VISA USA and Mastercard by Wal-Mart Stores, Inc., Sears Roebuck & Co. and other retailers. This settlement lowered interchange rates that can be received by members of the associations on signature debit transactions beginning in August 2003. In 2003, the impact of the VISA settlement was to lower debit card revenue by $19.4 million relative to 2002. In 2004, the incremental impact will be to lower debit card revenue by approximately $15.0 million. This change in the interchange rate in the third quarter of 2003, in addition to higher customer loyalty rewards expenses, however, were more than offset by increases in transaction volumes and Table 4 Noninterest Income other pricing enhancements. Corporate payment products revenue and ATM processing services revenue were higher in 2003, primarily reﬂecting growth in sales and card usage during the year. Merchant processing services revenue was lower in 2003 by $5.9 million (1.0 percent), compared with 2002, primarily due to lower processing spreads resulting from pricing changes that occurred in late 2002 and changes in the mix of merchants. Merchant acquiring sales volumes increased by 7.1 percent relative to the fourth quarter of 2002. The Company’s mix of merchants toward smaller retailers and specialty shops often results in a lag in the growth of sales volumes relative to improvements experienced at larger retailers in late 2003. Assuming economic conditions continue to improve, management anticipates stronger merchant processing revenue growth in 2004. The favorable variance in trust and investment management fees in 2003 of $61.8 million (6.9 percent), compared with 2002, was driven by the acquisition of State Street Corporate Trust, which contributed $83.7 million in fees during 2003. Treasury management fees grew by $49.4 million (11.8 percent) in 2003, compared with 2002, with the majority of the increase occurring within the Wholesale Banking line of business. The increase in treasury management fees during 2003 was driven by growth in product sales, pricing enhancements and the relatively low earnings credit rates to customers. The growth was also driven by a change in the Federal government’s payment methodology for treasury management services from compensating balances, reﬂected in net interest income, to fees during the third quarter of 2003. During 2003, commercial products revenue declined $78.7 million (16.4 percent), principally reﬂecting lower commercial loan conduit servicing fees resulting, in part, from consolidating the Stellar commercial loan conduit. Mortgage banking revenue had a year-over-year increase of $36.9 million (11.2 percent) during 2003, principally due to higher (Dollars in Millions) 2003 2002 2001 Credit and debit card revenue *************************** Corporate payment products revenue ********************* ATM processing services******************************** Merchant processing services *************************** Trust and investment management fees******************* Deposit service charges ******************************** Treasury management fees****************************** Commercial products revenue *************************** Mortgage banking revenue ****************************** Investment products fees and commissions *************** Securities gains, net ************************************ Merger and restructuring-related gains******************** Other ************************************************* Total noninterest income ***************************** $ 560.7 361.3 165.9 561.4 953.9 715.8 466.3 400.5 367.1 144.9 244.8 — 370.4 $5,313.0 $ 517.0 325.7 160.6 567.3 892.1 690.3 416.9 479.2 330.2 132.7 299.9 — 398.8 $5,210.7 $ 465.9 297.7 153.0 308.9 887.8 644.9 347.3 437.4 234.0 130.8 329.1 62.2 370.4 $4,669.4 2003 v 2002 8.5% 10.9 3.3 (1.0) 6.9 3.7 11.8 (16.4) 11.2 9.2 (18.4) — (7.1) 2.0% 2002 v 2001 11.0% 9.4 5.0 83.7 .5 7.0 20.0 9.6 41.1 1.5 (8.9) * 7.7 11.6% * Not meaningful 24 U.S. Bancorp mortgage originations, servicing and secondary market sales and the acquisition of Leader, which contributed $16.5 million of the favorable variance in 2003. Investment products fees and commissions revenue increased in 2003 by $12.2 million (9.2 percent), compared with 2002, primarily due to increased retail brokerage activity given more favorable equity capital market conditions relative to 2002. Deposit service charges increased in 2003 by $25.5 million (3.7 percent), compared with 2002, primarily due to net new growth in checking accounts and fee enhancements principally within the Consumer Banking line of business. Other noninterest income decreased by $28.4 million (7.1 percent) from 2002, which included $67.4 million of gains on the sales of two co-branded credit card portfolios. In 2002, noninterest income increased $541.3 million (11.6 percent), compared with 2001. Increases resulting from acquisitions, including NOVA, Paciﬁc Century, Leader and Bay View, accounted for approximately $301.3 million of the increase in noninterest income in 2002. Partially offsetting this favorable variance in 2002 was $62.2 million of merger and restructuring-related gains in connection with the sale of 14 branches representing $771 million in deposits recognized in 2001. Refer to Note 5 of the Notes to Consolidated Financial Statements for further information on merger and restructuring-related items. Credit and debit card revenue, corporate payment products revenue and ATM processing services revenue were higher in 2002, compared with 2001, by $51.1 million (11.0 percent), $28.0 million (9.4 percent) and $7.6 million (5.0 percent), respectively, primarily reﬂecting growth in sales and card usage. Merchant processing services revenue grew by $258.4 million (83.7 percent), primarily due to the acquisition of NOVA in July 2001. Deposit service charges increased in 2002 by $45.4 million (7.0 percent), primarily due to fee enhancements and new account growth. Cash Table 5 Noninterest Expense management fees and commercial products revenue grew by $69.6 million (20.0 percent) and $41.8 million (9.6 percent), respectively, primarily driven by changes in the earnings credit rates for business deposits, growth in commercial business activities, fees related to loan conduit activities and product enhancements. Commercial product revenue growth was offset somewhat by lease residual impairments in 2002. In addition to the impact of the acquisition of Leader, the $96.2 million (41.1 percent) increase in mortgage banking revenue was also due to higher levels of mortgage originations and sales and loan servicing revenue in 2002, compared with 2001. Investment products fees and commissions revenues slightly increased in 2002, by $1.9 million (1.5 percent), compared with 2001. Included in noninterest income were net securities gains (losses) of $299.9 million in 2002, compared with $329.1 million in 2001, representing a decline of $29.2 million (8.9 percent). Other fee income was higher in 2002, compared with 2001, by $28.4 million (7.7 percent). The change was primarily due to $67.4 million in gains from credit card portfolio sales in 2002 and a reduction in retail leasing residual and other asset impairments from 2001, offset somewhat by lower ofﬁcial check revenue which is sensitive to changes in interest rates. Noninterest Expense Noninterest expense in 2003 was $5.6 billion, compared with $5.7 billion and $6.1 billion in 2002 and 2001, respectively. The Company’s efﬁciency ratio improved to 45.6 percent in 2003, compared with 48.8 percent in 2002 and 57.2 percent in 2001. The improved operating leverage resulting from the decrease in noninterest expense in 2003 of $143.6 million (2.5 percent) was primarily the result of business initiatives, cost savings from integration activities and lower merger and restructuring-related charges, partially offset by an increase in MSR impairments, incremental pension and retirement (Dollars in Millions) 2003 2002 2001 Compensation ***************************************** Employee beneﬁts************************************** Net occupancy and equipment*************************** Professional services *********************************** Marketing and business development ********************* Technology and communications ************************* Postage, printing and supplies *************************** Goodwill ********************************************** Other intangibles *************************************** Merger and restructuring-related charges ***************** Other ************************************************* Total noninterest expense **************************** $2,176.8 328.4 643.7 143.4 180.3 417.4 245.6 — 682.4 46.2 732.7 $5,596.9 $2,167.5 317.5 658.7 129.7 171.4 392.1 243.2 — 553.0 321.2 786.2 $5,740.5 $2,036.6 285.5 666.6 116.4 178.0 353.9 241.9 236.7 278.4 1,044.8 710.2 $6,149.0 Efﬁciency ratio (a) ************************************** 45.6% 48.8% 57.2% 2003 v 2002 2002 v 2001 .4% 6.4% 3.4 (2.3) 10.6 5.2 6.5 1.0 — 23.4 (85.6) (6.8) 11.2 (1.2) 11.4 (3.7) 10.8 .5 * 98.6 (69.3) 10.7 (2.5)% (6.6)% * Not meaningful (a) Computed as noninterest expense divided by the sum of net interest income on a taxable-equivalent basis and noninterest income excluding securities gains (losses), net. U.S. Bancorp 25 expense of $39.9 million and expenses related to recent acquisitions. Noninterest expense related to merger and restructuring-related charges declined by $275.0 million (85.6 percent) in 2003, compared with 2002. The decline in merger and restructuring-related charges was primarily due to the completion of integration activities associated with the merger of Firstar and USBM. During 2003, noninterest expense included an MSR impairment of $208.7 million, a net increase of $22.6 million, compared with 2002. The year-over-year changes in the valuation of MSRs were caused by ﬂuctuations in mortgage interest rates and related prepayment speeds due to reﬁnancing activities. Refer to Note 11 of the Notes to Consolidated Financial Statements for the sensitivity of the fair value of mortgage servicing rights to future changes in interest rates. Recent acquisitions, including Leader, Bay View and State Street Corporate Trust, accounted for a year-over-year increase of $124.9 million in noninterest expense. The decline in noninterest expense of $408.5 million (6.6 percent) in 2002, compared with 2001, was primarily the result of a reduction in merger and restructuring-related costs of $723.6 million, the elimination of $236.7 million of goodwill amortization in connection with new accounting principles adopted in 2002 and a reduction in asset write- downs of $52.6 million related to commercial leasing partnerships and tractor/trailer property repossessed in 2001. Offsetting these favorable trends were higher costs associated with acquisitions, an increase in MSR impairments and post-integration realignment costs. Acquisitions, including NOVA, Paciﬁc Century, Leader and Bay View, accounted for an increase of approximately $317.4 million in noninterest expense during 2002, comprised primarily of increased intangible amortization and personnel expenses. Included in noninterest expense in 2002 was $186.1 million in MSR impairments, compared with $60.8 million in 2001, an increase of $125.3 million. The increase in MSR impairments was related to increasing mortgage prepayments driven by declining interest rates. Another signiﬁcant item impacting noninterest expense in 2002 was $46.4 million of personnel and related costs for post-integration rationalization of technology, operations and certain support functions. Pension Plans Because of the long-term nature of pension plans, the administration and accounting for pensions is complex and can be impacted by several factors, including investment and funding policies, accounting methods and the plan’s actuarial assumptions. The Company and its Compensation Committee have an established process for evaluating the plans, their performance and signiﬁcant plan assumptions, including the assumed discount rate and the long-term rate of return (‘‘LTROR’’). At least annually, an independent consultant is engaged to assist U.S. Bancorp’s Compensation Committee in evaluating plan objectives, funding policies and investment policies considering its long-term investment time horizon and asset allocation strategies. Note 18 of the Notes to Consolidated Financial Statements provides further information on funding practices, investment policies and asset allocation strategies. Periodic pension expense (or credits) includes service costs, interest costs based on the assumed discount rate, the expected return on plan assets based on an actuarially derived market-related value and amortization of actuarial gains and losses. The Company’s pension accounting policy follows guidance outlined in Statement of Financial Accounting Standards No. 87, ‘‘Employer’s Accounting for Pension Plans’’ (‘‘SFAS 87’’), and reﬂects the long-term nature of beneﬁt obligations and the investment horizon of plan assets. This accounting guidance has the effect of reducing earnings volatility related to short-term changes in interest rates and market valuations. Actuarial gains and losses include the impact of plan amendments and various unrecognized gains and losses which are deferred and amortized over the future service periods of active employees. The market-related value utilized to determine the expected return on plan assets is based on fair value adjusted for the difference between expected returns and actual performance of plan assets. The unrealized difference between actual experience and expected returns is included in the market-related value ratably over a ﬁve-year period. At September 30, 2003, the accumulated unrecognized loss approximated $369 million and will ratably impact the actuarially derived market-related value of plan assets through 2008. The impact to pension expense of the unrecognized asset gains or losses will incrementally increase (decrease) pension costs in each year from 2004 to 2008, by approximately $26.5 million, $33.0 million, $43.3 million, $10.3 million and $(7.2) million, respectively, during that timeframe. This assumes that the performance of plan assets equals the assumed LTROR. Actual results will vary depending on the performance of plan assets and changes to assumptions required in the future. Refer to Note 1 of the Notes to Consolidated Financial Statements for further discussion of the Company’s accounting policies for pension plans. In 2003, the Company recognized a pension credit of $23.9 million compared with pension credits of $63.8 million in 2002 and $75.3 million in 2001. The $39.9 million increase in pension costs in 2003 was driven by a $46.4 million reduction in the expected return on assets and a lower discount rate utilized to determine the projected beneﬁt obligation given the declining rate environment. Also, contributing to the increase in pension costs was a one-time curtailment gain in 2002 of $9.0 million related to a nonqualiﬁed pension plan compared with a settlement loss of $3.5 million related to 26 U.S. Bancorp nonqualiﬁed pension payments in 2003. Somewhat offsetting the increase in pension costs was an expected beneﬁt of approximately $19.0 million associated with lower interest costs related to cash balance accounts and actual changes in employee demographics, such as retirement age. In 2002, pension costs increased by approximately $11.5 million due to a $32.5 million reduction of expected return on plan assets, utilizing a lower discount rate to determine the projected beneﬁt obligation given the declining rate environment and the impact of changes in employee demographics. Partially offsetting this increase was a one-time curtailment gain of $9.0 million related to freezing certain beneﬁts of a nonqualiﬁed pension plan and a reduction in service costs of $11.9 million related to changes in the pension plans at the time of the plan mergers. In 2004, the Company anticipates that pension costs will increase by approximately $14.1 million. The increase will be driven by a reduction in the discount rate and amortization of the unrecognized losses offset by the expected beneﬁt of investment returns from the pension contributions made in 2003. Note 18 of the Notes to Consolidated Financial Statements provides a summary of the signiﬁcant pension plan assumptions. Because of the subjective nature of plan assumptions, a sensitivity analysis to hypothetical changes in the LTROR and the discount rate is provided below: LTROR Incremental beneﬁt (cost) ***************************************************** Percent of 2003 net income*************************************************** Discount rate Incremental beneﬁt (cost) ***************************************************** Percent of 2003 net income*************************************************** 6.9% 7.9% $(45.8) $(22.9) Base 8.9% $ — 9.9% $22.9 10.9% $45.8 (.76)% (.38)% —% .38% .76% 4.2% 5.2% $(51.6) $(27.9) Base 6.2% $ — 7.2% $31.6 8.2% $52.2 (.86)% (.46)% —% .52% .87% Due to the complexity of forecasting pension plan activities, the accounting method utilized for pension plans, management’s ability to respond to factors impacting the plans and the hypothetical nature of this information, the actual changes in periodic pension costs could be signiﬁcantly different than the information provided in the sensitivity analysis. Merger and Restructuring-Related Items The Company incurred merger and restructuring-related items in each of the last three years in conjunction with its acquisitions. Merger and restructuring-related items included in pre-tax earnings were $46.2 million ($30.4 million after-tax) in 2003, compared with $321.2 million ($209.3 million after- tax) and $1,364.8 million ($904.5 million after-tax) for 2002 and 2001, respectively. In 2003, the Company incurred pre-tax merger and restructuring-related charges of approximately $33.5 million in connection with the integration of merchant processing platforms and business processes of U.S. Bank National Association and NOVA. In addition, the Company incurred pre-tax merger and restructuring-related expenses in 2003 of $12.7 million primarily for systems conversion costs associated with the Bay View and State Street Corporate Trust transactions. The integration of these acquisitions was completed at the end of 2003, and the Company does not anticipate any merger or restructuring-related expenses in 2004 relating to completed acquisitions. At December 31, 2002, the integration of Firstar and USBM was completed. Total merger and restructuring- related items associated with the Firstar/USBM merger were approximately $1.6 billion. Merger and restructuring-related items in 2002 included $269.0 million of net expense associated with the Firstar/USBM merger and $52.2 million associated with NOVA and other smaller acquisitions. Merger and restructuring-related items in 2002 associated with the Firstar/USBM merger were primarily related to systems conversions and integration, asset write-downs and lease terminations recognized at the completion of conversions. Offsetting a portion of these costs in 2002 was an asset gain related to the sale of a non-strategic investment in a sub-prime lending business and a mark-to- market recovery associated with the liquidation of U.S. Bancorp Libra’s investment portfolio. The Company exited this business in 2001 and the liquidation efforts were substantially completed in the second quarter of 2002. Merger and restructuring-related items in 2001 included $382.2 million in provision for credit losses, a $62.2 million gain on the required sale of branches and $1,044.8 million of noninterest expense. Total merger and restructuring-related items in 2001 consisted of $1,327.1 million related to the Firstar/USBM merger and $37.7 million related to NOVA and other smaller acquisitions. With respect to the Firstar/USBM merger, the $1,327.1 million of merger and restructuring-related items included $238.6 million for severance and employee-related U.S. Bancorp 27 costs and $477.6 million of charges to exit business lines and products, sell credit portfolios or otherwise realign business practices in the new Company. The Company also incurred $190.5 million related to the accelerated vesting of certain stock options and restricted stock, $207.1 million of systems conversion and business integration costs, $48.7 million for lease cancellation and other building- related costs, $226.8 million for transaction costs, funding a charitable foundation to reafﬁrm a commitment to its markets and other costs, and a $62.2 million gain related to the required sale of branches. Refer to Notes 3 and 5 of the Notes to Consolidated Financial Statements for further information on these acquired businesses and merger and restructuring-related items. Income Tax Expense The provision for income taxes was $1,941.3 million (an effective rate of 34.4 percent) in 2003, compared with $1,707.5 million (an effective rate of 34.6 percent) in 2002 and $818.3 million (an effective rate of 34.9 percent) in 2001. The improvement in the effective tax rate in 2003, compared with 2002, primarily reﬂected a change in unitary state tax apportionment factors driven by Table 6 Loan Portfolio Distribution a shift in business mix as a result of the impact of acquisitions, market demographics, the mix of product revenue and an increase in federal and state tax credits. The improvement in the effective tax rate in 2002, compared with 2001, was primarily driven by a change in unitary state tax apportionment factors, a decrease in non- deductible merger and restructuring-related charges and the change in accounting for goodwill. The Company’s net deferred tax liability was $1,556.4 million at December 31, 2003, compared with $1,329.4 million for the year ended 2002. The change in 2003 primarily relates to leasing activities and a decrease in the net unrealized appreciation on available-for-sale securities and ﬁnancial instruments. For further information on income taxes, refer to Note 20 of the Notes to Consolidated Financial Statements. BALANCE SHEET ANALYSIS Average earning assets were $160.8 billion in 2003, compared with $147.4 billion in 2002. The increase in average earning assets of $13.4 billion (9.1 percent) was primarily driven by growth in investment securities, At December 31 (Dollars in Millions) Amount Percent of Total Amount Percent of Total Amount Percent of Total Amount Percent of Total Amount Percent of Total 2003 2002 2001 2000 1999 Commercial Commercial ********************** $ 33,536 Lease ﬁnancing ****************** 4,990 28.4% $ 36,584 5,360 4.2 31.5% $ 40,472 5,858 4.6 35.4% $ 47,041 5,776 5.1 38.5% $ 42,021 3,835 4.7 37.1% 3.4 Total commercial ************** 38,526 32.6 41,944 36.1 46,330 40.5 52,817 43.2 45,856 40.5 Commercial real estate Commercial mortgages************ Construction and development ***** 20,624 6,618 Total commercial real estate **** 27,242 Residential mortgages Residential mortgages ************ Home equity loans, ﬁrst liens ****** 7,332 6,125 17.4 5.6 23.0 6.2 5.2 Total residential mortgages ***** 13,457 11.4 Retail Credit card*********************** Retail leasing ******************** Home equity and second mortgages (a)***************** Other retail 5,933 6,029 5.0 5.1 20,325 6,542 26,867 17.5 5.6 23.1 18,765 6,608 25,373 16.4 5.8 22.2 19,466 6,977 26,443 6,446 3,300 9,746 5,665 5,680 5.6 2.8 8.4 4.9 4.9 5,746 2,083 7,829 5,889 4,906 5.0 1.8 6.8 5.1 4.3 15.9 5.7 21.6 * * 18,636 6,506 25,142 * * 16.5 5.7 22.2 * * * * 9,397 7.7 12,760 11.3 6,012 4,153 4.9 3.4 5,004 2,123 4.4 1.9 13,210 11.2 13,572 11.6 12,235 10.7 11,956 9.7 Revolving credit *************** Installment******************** Automobile ******************* Student ********************** 2,540 2,380 7,165 1,753 Total other retail (a)********* 13,838 Total retail ******************** 39,010 2.1 2.0 6.1 1.5 11.7 33.0 2,650 2,258 6,343 1,526 12,777 37,694 2.3 1.9 5.5 1.3 11.0 32.4 2,673 2,292 5,660 1,218 11,843 34,873 2.3 2.0 5.0 1.1 10.4 30.5 2,750 2,186 5,609 1,042 11,587 2.2 1.8 4.6 .9 9.5 33,708 27.5 29,471 * * * * * 22,344 * * * * * 19.7 26.0 Total loans **************** $118,235 100.0% $116,251 100.0% $114,405 100.0% $122,365 100.0% $113,229 100.0% (a) Home equity and second mortgages are included in the total other retail category in 1999. * Information not available 28 U.S. Bancorp residential mortgages, loans held for sale and retail loans, partially offset by a decline in commercial loans. The increase in average earning assets was funded with an increase in average interest-bearing liabilities of $10.3 billion, consisting principally of higher savings products balances and more favorably priced longer-term wholesale funding, and an increase in net free funds, including an increase in average noninterest-bearing deposits of $3.0 billion. For average balance information, refer to Consolidated Daily Average Balance Sheet and Related Yields and Rates on pages 110 and 111. Loans The Company’s total loan portfolio was $118.2 billion at December 31, 2003, an increase of $2.0 billion (1.7 percent) from December 31, 2002. The increase in total loans was driven by growth in residential mortgages and retail loans, partially offset by a decline in commercial loans due to soft commercial loan demand. The increase in residential mortgages reﬂects the Company’s decision to retain adjustable-rate mortgage production in connection with asset/liability management activities and strong growth in ﬁrst lien home equity loans within the branch network and consumer ﬁnance. Table 6 provides a summary of the loan distribution by product type. Average total loans increased $3.9 billion (3.4 percent) in 2003, compared with 2002. The increase in total average loans in 2003, compared with 2002, was driven by similar factors discussed above including the growth of residential mortgages, retail loans and commercial real estate loans, partially offset by the decline in commercial loans. Commercial Commercial loans, including lease ﬁnancing, totaled $38.5 billion at December 31, 2003, compared with $41.9 billion at December 31, 2002, a decrease of $3.4 billion (8.1 percent). Although the consolidation of loans from the Stellar commercial loan conduit in mid-2003 had a positive impact on commercial loan balances year- over-year, current credit markets and soft economic conditions during early 2003 led to the decline in total commercial loans. Although economic growth occurred in the second half of 2003, commercial loan demand Table 7 Commercial Loans by Industry Group and Geography December 31, 2003 December 31, 2002 Industry Group (Dollars in Millions) Consumer products and services ************************************* Capital goods ****************************************************** Financial services*************************************************** Commercial services and supplies ************************************ Agriculture ********************************************************* Consumer staples ************************************************** Transportation ****************************************************** Property management and development******************************* Private investors **************************************************** Health care ******************************************************** Paper and forestry products, mining and basic materials **************** Information technology ********************************************** Energy ************************************************************ Other************************************************************** Total *********************************************************** Geography California ********************************************************** Colorado*********************************************************** Illinois ************************************************************* Minnesota ********************************************************* Missouri *********************************************************** Ohio ************************************************************** Oregon ************************************************************ Washington ******************************************************** Wisconsin********************************************************** Iowa, Kansas, Nebraska, North Dakota, South Dakota ****************** Arkansas, Indiana, Kentucky, Tennessee ****************************** Idaho, Montana, Wyoming ******************************************* Arizona, Nevada, Utah ********************************************** Total banking region ********************************************* Outside the Company’s banking region******************************** Loans $ 6,858 4,598 4,469 3,785 2,907 1,817 1,758 1,653 1,629 1,532 1,415 729 708 4,668 $38,526 $ 4,091 1,820 2,121 6,527 2,742 2,361 1,500 2,767 2,874 3,760 1,549 744 829 33,685 4,841 Percent 17.8% 11.9 11.6 9.8 7.6 4.7 4.6 4.3 4.2 4.0 3.7 1.9 1.8 12.1 Loans $ 7,206 5,486 5,769 3,853 3,153 1,924 2,231 1,266 1,759 1,475 1,664 797 575 4,786 Percent 17.2% 13.1 13.7 9.2 7.5 4.6 5.3 3.0 4.2 3.5 4.0 1.9 1.4 11.4 100.0% $41,944 100.0% 10.6% 4.7 5.5 16.9 7.1 6.1 3.9 7.2 7.5 9.8 4.0 1.9 2.2 87.4 12.6 $ 4,127 1,796 2,214 6,605 2,895 2,455 1,604 3,129 3,052 4,421 1,865 996 986 36,145 5,799 9.8% 4.3 5.3 15.7 6.9 5.9 3.8 7.5 7.3 10.5 4.4 2.4 2.4 86.2 13.8 Total *********************************************************** $38,526 100.0% $41,944 100.0% U.S. Bancorp 29 continued to be soft through year-end given the liquidity of commercial customers. Average commercial loans in 2003 decreased by $2.5 billion (5.7 percent). The decline in average commercial loans for 2003 was primarily due to the run-off of corporate loans and continued softness in loan demand, partially offset by the consolidation of loans from the Stellar commercial loan conduit in mid-2003. Despite recent economic growth, the Company anticipates soft commercial loan demand will continue in early 2004 while business customers utilize liquidity to fund business activities. Table 7 provides a summary of commercial loans by industry and geographical locations. Commercial Real Estate The Company’s portfolio of commercial real estate loans, which includes commercial mortgages and construction loans, was $27.2 billion at December 31, 2003, compared with $26.9 billion at December 31, 2002, a slight increase of $375 million (1.4 percent). Speciﬁcally, commercial mortgages outstanding and real estate construction and development loans increased modestly by $299 million (1.5 percent) and $76 million (1.2 percent), respectively, as business owners and real estate investors continued to take advantage of the current interest rate environment. Average commercial real estate loans increased by $1.4 billion (5.5 percent) in 2003, compared with 2002, primarily driven by increased commercial mortgage activity. Table 9 provides a summary of commercial real estate by property type and geographical locations. The Company maintains the real estate construction designation until the completion of the construction phase and, if retained, the loan is reclassiﬁed to the commercial mortgage category. Approximately $1.4 billion of construction loans were permanently ﬁnanced and transferred to the commercial mortgage loan category in 2003. At year-end 2003, $205 million of tax-exempt industrial development loans were secured by real estate. The Company’s commercial real estate mortgages and construction loans had unfunded commitments of $7.3 billion at December 31, 2003, compared with Table 8 Selected Loan Maturity Distribution $7.9 billion at December 31, 2002. The Company also ﬁnances the operations of real estate developers and other entities with operations related to real estate. These loans are not secured directly by real estate and are subject to terms and conditions similar to commercial loans. These loans were included in the commercial loan category and totaled $364 million at December 31, 2003. Residential Mortgages Residential mortgages held in the loan portfolio were $13.5 billion at December 31, 2003, an increase of $3.7 billion (38.1 percent) from December 31, 2002. The increase in residential mortgages was primarily the result of an increase in consumer finance originations and branch originated home equity loans with first liens driven by refinancing activities in 2003. The increase in residential mortgages also reflects the Company’s asset/liability management decisions to retain adjustable-rate mortgage loan production. This growth was partially offset by approximately $1.0 billion in residential loan sales during 2003 primarily representing fixed-rate mortgage loans. Average residential mortgages increased $3.3 billion (39.0 percent) to $11.7 billion in 2003, primarily due to the increases in first lien home equity loans and adjustable-rate mortgages. Retail Total retail loans outstanding, which include credit card, retail leasing, home equity and second mortgages and other retail loans, were $39.0 billion at December 31, 2003, compared with $37.7 billion at December 31, 2002. The increase of $1.3 billion (3.5 percent) was driven by an increase in automobile loans, retail leasing, credit card lending and student loans, which increased $822 million, $349 million, $268 million and $227 million, respectively, during 2003. This growth was partially offset by declines in home equity and second mortgage loans as consumers reﬁnanced with ﬁrst lien home equity products classiﬁed as residential mortgages. Average retail loans increased $1.7 billion (4.6 percent) to $38.2 billion in 2003, reﬂecting growth in retail leasing, installment loans and home equity lines. Growth in these retail products was offset somewhat by a 1.9 percent decline in average credit card balances primarily due to portfolio sales in late 2002 and lower December 31, 2003 (Dollars in Millions) Commercial *********************************************************** Commercial real estate************************************************* Residential mortgages ************************************************* Retail **************************************************************** Total loans********************************************************* Total of loans due after one year with Predetermined interest rates ***************************************** Floating interest rates *********************************************** One Year or Less $19,028 7,162 914 11,977 $39,081 Over One Through Five Years $17,008 13,699 2,382 17,373 $50,462 Over Five Years $ 2,490 6,381 10,161 9,660 $28,692 Total $ 38,526 27,242 13,457 39,010 $118,235 $ 40,339 $ 38,815 30 U.S. Bancorp Table 9 Commercial Real Estate by Property Type and Geography December 31, 2003 December 31, 2002 Property Type (Dollars in Millions) Business owner occupied ******************************************** Multi-family********************************************************* Commercial property Industrial ******************************************************* Ofﬁce ********************************************************** Retail ********************************************************** Other ********************************************************** Homebuilders ****************************************************** Hotel/motel********************************************************* Health care facilities************************************************* Other (a)*********************************************************** Loans $ 8,037 3,868 1,280 3,078 3,487 2,452 2,098 2,234 708 — Percent 29.5% 14.2 Loans $ 6,513 3,258 Percent 24.2% 12.1 4.7 11.3 12.8 9.0 7.7 8.2 2.6 — 1,227 3,564 3,832 1,447 2,142 2,585 1,290 1,009 4.6 13.3 14.3 5.4 8.0 9.6 4.8 3.7 Total *********************************************************** $27,242 100.0% $26,867 100.0% Geography California ********************************************************** Colorado*********************************************************** Illinois ************************************************************* Minnesota ********************************************************* Missouri *********************************************************** Ohio ************************************************************** Oregon ************************************************************ Washington ******************************************************** Wisconsin********************************************************** Iowa, Kansas, Nebraska, North Dakota, South Dakota ****************** Arkansas, Indiana, Kentucky, Tennessee ****************************** Idaho, Montana, Wyoming ******************************************* Arizona, Nevada, Utah ********************************************** Total banking region ********************************************* Outside the Company’s banking region******************************** $ 4,380 1,139 1,095 1,536 1,741 2,193 1,771 2,956 1,921 2,138 1,817 874 1,722 25,283 1,959 16.1% 4.2 4.0 5.6 6.4 8.0 6.5 10.9 7.1 7.8 6.7 3.2 6.3 92.8 7.2 $ 4,277 1,190 1,140 1,508 2,297 2,264 1,614 3,242 2,040 1,895 1,679 682 1,439 25,267 1,600 15.9% 4.4 4.2 5.6 8.6 8.4 6.0 12.1 7.6 7.1 6.2 2.5 5.4 94.0 6.0 Total *********************************************************** $27,242 100.0% $26,867 100.0% (a) In 2003, enhancements in loan system reporting enabled the Company to reclassify loans classiﬁed as ‘‘other’’ in 2002 to the applicable category. second mortgage home equity loans. Of the total retail loans and residential mortgages outstanding, approximately 88.5 percent are to customers located in the Company’s primary banking regions. Loans Held for Sale At December 31, 2003, loans held for sale, consisting of residential mortgages to be sold in the secondary markets, were $1.4 billion. The $2.7 billion (65.5 percent) decrease from December 31, 2002, despite strong mortgage banking activities in early 2003, was the result of a 56.3 percent decline in mortgage production volumes during the fourth quarter of 2003 relative to the same period of 2002. Investment Securities The Company uses its investment securities portfolio for several purposes. It serves as a vehicle to manage interest rate and prepayment risk, generates interest and dividend income from the investment of excess funds depending on loan demand, provides liquidity and is used as collateral for public deposits and wholesale funding sources. At December 31, 2003, investment securities, both available-for-sale and held-to-maturity, totaled $43.3 billion, compared with $28.5 billion at December 31, 2002. The $14.8 billion (52.1 percent) year-over-year increase reﬂected the reinvestment of proceeds from loan sales and declining commercial loan balances due to the continued softness in commercial loan demand and the investment of cash inﬂows related to deposit growth. During 2003, the Company sold $15.3 billion of ﬁxed-rate securities as part of an economic hedge of the MSR portfolio. In the ﬁrst and second quarters of 2003, securities gains were taken to offset impairment recognized in the MSR portfolio. When MSR reparation occurred in the third quarter of 2003, the Company began repositioning the investment securities portfolio by selling ﬁxed-rate securities with lower yields at a loss, with the proceeds being reinvested at higher yields. At December 31, 2003, approximately 19.5 percent of the investment securities portfolio represented adjustable-rate ﬁnancial instruments, compared with 18.6 percent as of December 31, 2002. The weighted-average yield of the available-for-sale portfolio was 4.27 percent at December 31, 2003, compared with 4.97 percent at December 31, 2002. The average maturity of the available-for-sale portfolio rose to U.S. Bancorp 31 5.1 years at December 31, 2003, up from 2.8 years at December 31, 2002. The relative mix of the type of investment securities maintained in the portfolio is provided in Table 10. At December 31, 2003, the available-for-sale portfolio included a $259 million net unrealized loss, compared with a net unrealized gain of $714 million at December 31, 2002. The change from 2002 reﬂected rising interest rates in the later half of 2003 and the longer duration of the portfolio relative to a year ago. Deposits Total deposits were $119.1 billion at December 31, 2003, an increase of $3.5 billion (3.0 percent) from December 31, 2002. The increase in total Table 10 Investment Securities December 31, 2003 (Dollars in Millions) Available-for-Sale Held-to-Maturity Amortized Cost Fair Value Weighted Average Maturity in Years Weighted Average Yield Amortized Cost Fair Value Weighted Average Maturity in Years Weighted Average Yield U.S. Treasury and agencies Maturing in one year or less ********** Maturing after one year through ﬁve years************************ Maturing after ﬁve years through ten years ************************ Maturing after ten years ************** Total************************* Mortgage-backed securities Maturing in one year or less ********** Maturing after one year through ﬁve years************************ Maturing after ﬁve years through ten years ************************ Maturing after ten years ************** Total************************* Asset-backed securities Maturing in one year or less ********** Maturing after one year through ﬁve years************************ Maturing after ﬁve years through ten years ************************ Maturing after ten years ************** Total************************* Obligations of states and political subdivisions Maturing in one year or less ********** Maturing after one year through ﬁve years************************ Maturing after ﬁve years through ten years ************************ Maturing after ten years ************** Total************************* Other debt securities Maturing in one year or less ********** Maturing after one year through ﬁve years************************ Maturing after ﬁve years through ten years ************************ Maturing after ten years ************** Total************************* Other investments ****************** Total investment securities *************** $ 57 $ 57 190 237 1,150 199 225 1,094 $ 1,634 $ 1,575 $ 2,355 $ 2,358 22,516 22,542 15,016 342 14,785 340 $40,229 $40,025 $ 100 $ 101 130 20 — 130 21 — $ 250 $ 252 $ 70 $ 71 171 79 15 335 3 128 8 260 399 594 $ $ $ $ 178 84 15 348 3 128 8 246 385 597 $ $ $ $ $43,441 $43,182 .57 2.66 9.08 19.50 15.37 .63 3.66 6.50 13.26 4.62 .70 2.54 5.08 — 2.00 .40 2.71 6.88 14.60 3.74 .42 2.51 6.09 23.45 16.21 — 5.12 2.88% $ — $ — 4.33 3.93 2.38 — — — — — — 2.85% $ — $ — 3.15% $ — $ — 4.30 4.50 2.66 14 — — 14 — — 4.30% $ 14 $ 14 4.74% $ — $ — 5.89 5.55 — — — — — — — 5.40% $ — $ — 7.32% $ 33 $ 33 7.34 7.43 8.32 39 26 40 42 28 44 7.40% $138 $147 3.35% 10.42 3.21 1.84 4.64% —% 4.27% $ — $ — — — — $ — $ — $152 — — — $ — $ — $161 — — — — — — 3.08 — — 3.08 — — — — — .35 2.93 6.84 14.66 6.47 — — — — — — —% — — — —% —% 5.38 — — 5.38% —% — — — —% 3.93% 6.54 6.92 6.97 6.12% —% — — — —% —% 6.16 6.05% Note: Information related to asset and mortgage-backed securities included above is presented based upon weighted average maturities anticipating future prepayments. Average yields are presented on a fully-taxable equivalent basis. Yields on available-for-sale and held-to-maturity securities are computed based on historical cost balances. Average yield and maturity calculations exclude equity securities that have no stated yield or maturity. At December 31 (Dollars in Millions) 2003 2002 Amortized Cost Percent of Total Amortized Cost Percent of Total U.S. Treasury and agencies ********************************************************************* $ 1,634 Mortgage-backed securities ********************************************************************* 40,243 Asset-backed securities************************************************************************* 250 Obligations of states and political subdivisions **************************************************** 473 Other securities and investments **************************************************************** 993 3.7% 92.3 .6 1.1 2.3 Total investment securities******************************************************************* $43,593 100.0% $ 421 24,987 646 771 949 $27,774 1.5% 90.0 2.3 2.8 3.4 100.0% 32 U.S. Bancorp deposits was primarily the result of increases in all savings deposit products, partially offset by declines in noninterest- bearing deposits, time certiﬁcates of deposit less than $100,000 and time deposits greater than $100,000. Noninterest-bearing deposits were $32.5 billion at December 31, 2003, compared with $35.1 billion at December 31, 2002, a decrease of $2.6 billion (7.5 percent). The decrease in noninterest-bearing deposits was primarily attributable to a decline in deposits related to mortgage banking businesses and lower government banking deposits relative to a year ago. Mortgage banking declined substantially in the third quarter directly related to the upward movement in interest rates experienced since late June, 2003. Government banking deposits declined primarily due to a decision by the federal government to pay fees for cash management services rather than maintain compensating balances. Average noninterest-bearing deposits were $31.7 billion in 2003, an increase of $3.0 billion (10.4 percent), compared with 2002. The increase in average noninterest-bearing deposits was primarily the result of higher demand deposits of mortgage and government banking customers during the ﬁrst half of 2003, customer decisions to maintain excess liquidity in demand deposit balances, and acquisitions. Interest-bearing savings deposits totaled $61.1 billion at December 31, 2003, an increase of $10.8 billion (21.5 percent) from December 31, 2002. Average interest- bearing savings deposits were $57.0 billion in 2003, an Table 11 Deposits The composition of deposits was as follows: increase of $11.2 billion (24.5 percent), compared with 2002. The increase in interest-bearing savings deposits from December 31, 2002, to December 31, 2003, was primarily driven by increases in money market accounts of $6.3 billion (22.6 percent), along with increases in interest checking of $3.9 billion (22.5 percent) and savings accounts of $.6 billion (12.1 percent). The favorable change in money market accounts was the result of product pricing initiatives on high-impact money market products, the continued desire by customers to maintain liquidity, speciﬁc deposit gathering initiatives and the State Street Corporate Trust acquisition, which contributed approximately $.6 billion of the increase during 2003. Interest-bearing time deposits were $25.5 billion at December 31, 2003, compared with $30.2 billion at December 31, 2002, a decrease of $4.7 billion (15.5 percent). The decrease in interest-bearing time deposits was driven by a decrease in the higher cost time certiﬁcates of deposits less than $100,000 of $4.3 billion (23.8 percent) and a decrease of $381 million (3.1 percent) in time deposits greater than $100,000. Average time deposits greater than $100,000 increased $1.0 billion (8.7 percent) and average time certiﬁcates of deposit less than $100,000 declined $3.8 billion (19.7 percent) during 2003. Time certiﬁcates of deposits are largely viewed as purchased funds and are managed to levels deemed appropriate given alternative funding sources. The decline in time certiﬁcates of deposits less than $100,000 from a year December 31 (Dollars in Millions) 2003 2002 2001 2000 1999 Amount Percent of Total Amount Percent of Total Amount Percent of Total Amount Percent of Total Amount Percent of Total Noninterest-bearing deposits ***************** $ 32,470 Interest-bearing deposits 27.3% $ 35,106 30.4% $ 31,212 29.7% $ 26,633 24.3% $ 26,350 25.5% Interest checking ************************ Money market accounts****************** Savings accounts *********************** Total of savings deposits************** Time certificates of deposit less than $100,000*** Time deposits greater than $100,000 Domestic ******************************* Foreign ******************************** 21,404 34,025 5,630 61,059 13,690 5,902 5,931 18.0 28.6 4.7 51.3 11.5 4.9 5.0 17,467 27,753 5,021 50,241 17,973 9,427 2,787 15.1 24.0 4.4 43.5 15.5 8.2 2.4 15,251 24,835 4,637 44,723 20,724 7,286 1,274 14.5 23.6 4.4 42.5 19.7 6.9 1.2 Total interest-bearing deposits ********* 86,582 72.7 80,428 69.6 74,007 70.3 13,982 23,899 4,516 42,397 25,780 11,221 3,504 82,902 12.8 21.8 4.1 38.7 23.5 10.3 3.2 75.7 13,141 22,751 5,445 41,337 25,394 9,348 988 12.7 22.0 5.3 40.0 24.5 9.0 1.0 77,067 74.5 Total deposits *************************** $119,052 100.0% $115,534 100.0% $105,219 100.0% $109,535 100.0% $103,417 100.0% The maturity of time certiﬁcates of deposit less than $100,000 and time deposits greater than $100,000 was as follows: December 31, 2003 (Dollars in Millions) Three months or less ******************************************** Three months through six months ********************************* Six months through one year************************************** One year through three years ************************************* Three years through ﬁve years ************************************ Thereafter ****************************************************** Total ******************************************************** Time Certiﬁcates of Deposit Less Than $100,000 Time Deposits Greater Than $100,000 $ 2,747 2,237 2,778 4,179 1,733 16 $13,690 $ 8,610 831 745 1,128 508 11 $11,833 Total $11,357 3,068 3,523 5,307 2,241 27 $25,523 U.S. Bancorp 33 ago, and on average during 2003, reﬂected a shift in product mix toward savings products and funding decisions toward more favorably priced wholesale funding sources. The increase in average time deposits greater than $100,000 was primarily due to a shift in short-term funding mix to cover balance sheet growth, net of deposit growth. Borrowings The Company utilizes both short-term and long-term borrowings to fund growth of earning assets in excess of deposit growth. Short-term borrowings, which include federal funds purchased, securities sold under agreements to repurchase and other short-term borrowings, were $10.9 billion at December 31, 2003, up $3.1 billion (39.0 percent) from $7.8 billion at year-end 2002. Short- term funding is managed to levels deemed appropriate given alternative funding sources. The increase in short-term borrowings reﬂected the impact of funding growth in earning assets, partially offset by the growth in deposits. Long-term debt was $31.2 billion at December 31, 2003, up from $28.6 billion at December 31, 2002. The $2.6 billion (9.2 percent) increase in long-term debt was driven by the issuance of $11.5 billion of medium- and long-term notes and bank notes during 2003. The issuance of long-term debt was partially offset by maturities of $8.6 billion during 2003. Refer to Note 14 of the Notes to Consolidated Financial Statements for additional information regarding long-term debt and the ‘‘Liquidity Risk Management’’ section for discussion of liquidity management of the Company. CORPORATE RISK PROFILE Overview Managing risks is an essential part of successfully operating a ﬁnancial services company. The most prominent risk exposures are credit, residual, operational, interest rate, market and liquidity risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Residual risk is the potential reduction in the end-of-term value of leased assets or the residual cash ﬂows related to asset securitization and other off-balance sheet structures. Operational risk includes risks related to fraud, legal and compliance risk, processing errors, technology, breaches of internal controls and business continuation and disaster recovery risk. Interest rate risk is the potential reduction of net interest income as a result of changes in interest rates. Rate movements can affect the repricing of assets and liabilities differently, as well as their market value. Market risk arises from ﬂuctuations in interest rates, foreign exchange rates, and equity prices that may result in changes in the values of ﬁnancial instruments, such as trading and available-for-sale securities that are accounted for on a mark-to-market basis. Liquidity risk is the possible inability to fund obligations to depositors, investors or borrowers. In addition, corporate strategic decisions, as well as the risks described above, could give rise to reputation risk. Reputation risk is the risk that negative publicity or press, whether true or not, could result in costly litigation or cause a decline in the Company’s stock value, customer base or revenue. Credit Risk Management The Company’s strategy for credit risk management includes well-deﬁned, centralized credit policies, uniform underwriting criteria, and ongoing risk monitoring and review processes for all commercial and consumer credit exposures. The strategy also emphasizes diversiﬁcation on a geographic, industry and customer level, regular credit examinations and management reviews of loans experiencing deterioration of credit quality. The Company strives to identify potential problem loans early, take any necessary charge-offs promptly and maintain adequate reserve levels for probable loan losses inherent in the portfolio. Commercial banking operations rely on a strong credit culture that combines prudent credit policies and individual lender accountability. Lenders are assigned lending grades based on their level of experience and customer service requirements. Lending grades represent the level of approval authority for the amount of credit exposure and level of risk. Credit ofﬁcers reporting independently to Credit Administration have higher levels of lending grades and support the business units in their credit decision process. Loan decisions are documented as to the borrower’s business, purpose of the loan, evaluation of the repayment source and the associated risks, evaluation of collateral, covenants and monitoring requirements, and risk rating rationale. The Company utilizes a credit risk rating system to measure the credit quality of individual commercial loan transactions. The Company uses the risk rating system for regulatory reporting, determining the frequency of review of the credit exposures, and evaluation and determination of the adequacy of the allowance for credit losses. The Company regularly forecasts potential changes in risk ratings, nonperforming status and potential for loss and the estimated impact on the allowance for credit losses. In the Company’s retail banking operations, standard credit scoring systems are used to assess consumer credit risks and to price consumer products accordingly. The Company conducts the underwriting and collections of its retail products in loan underwriting and servicing centers specializing in certain retail products. Forecasts of delinquency levels, bankruptcies and losses in conjunction with projection of estimated losses by delinquency categories and vintage information are regularly prepared and are used to evaluate underwriting and collection and determine the adequacy of the allowance for credit losses for these products. The Company also engages in non- lending activities that may give rise to credit risk, including interest rate swap contracts for balance sheet hedging 34 U.S. Bancorp purposes, foreign exchange transactions and interest rate swap contracts for customers, settlement risk, including Automated Clearing House transactions, and the processing of credit card transactions for merchants. These activities are also subject to credit review, analysis and approval processes. Economic Overview In evaluating its credit risk, the Company considers changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-speciﬁc concentrations), trends in loan performance, the level of allowance coverage and macroeconomic factors. Since late 2000, the domestic economy experienced slower growth. During 2001, corporate earnings weakened and credit quality indicators among certain industry sectors deteriorated. The stagnant economic growth was evidenced by the Federal Reserve Board’s (‘‘FRB’’) actions to stimulate economic growth through a series of interest rate reductions from mid-2001 through late 2002. In addition, events of September 11, 2001, had a profound impact on credit quality due to changes in consumer conﬁdence and related spending, governmental priorities and business activities. In response to declining economic conditions, company-speciﬁc portfolio trends, and the Firstar/USBM merger, the Company initiated several actions during 2001 including aligning the risk management practices and charge-off policies of the companies and restructuring and disposing of certain portfolios that did not align with the credit risk proﬁle of the combined company. The Company also implemented accelerated loan workout strategies for certain commercial credits and increased the provision for credit losses above anticipated levels by approximately $1,025 million in the third quarter of 2001. By the end of 2002, economic conditions had stabilized somewhat, although the banking sector continued to experience elevated levels of nonperforming assets and net charge-offs, especially with respect to certain industry segments. Unemployment rates had increased slightly and consumer spending and conﬁdence levels had declined during that year. Economic conditions began to improve in early to mid-2003 as evidenced by stronger earnings across many corporate sectors, higher equity valuations, stronger retail sales and consumer spending, and improving economic indicators. While the economy has begun to strengthen relative to a year ago, the banking industry continues to have elevated levels of nonperforming assets and net charge-offs compared with the late 1990’s. Conditions within certain industries, including manufacturing and airline transportation sectors, continue to lag behind the growth in the broader economy. In addition, certain segments within the agricultural industry have experienced deterioration since late 2002. Credit Diversiﬁcation The Company manages its credit risk, in part, through diversiﬁcation of its loan portfolio. As part of its normal business activities, it offers a broad array of traditional commercial lending products and specialized products such as asset-based lending, commercial lease ﬁnancing, agricultural credit, warehouse mortgage lending, commercial real estate, health care and correspondent banking. The Company also offers an array of retail lending products including credit cards, retail leases, home equity, revolving credit, lending to students and other consumer loans. These retail credit products are primarily offered through the branch ofﬁce network, specialized trust, home mortgage and loan production ofﬁces, indirect distribution channels, such as automobile dealers and a consumer ﬁnance division. The Company monitors and manages the portfolio diversiﬁcation by industry, customer and geography. Table 6 provides information with respect to the overall product diversiﬁcation and changes in the mix during 2003. The commercial portfolio reﬂects the Company’s focus on serving small business customers, middle market and larger corporate businesses throughout its 24-state banking region and large national customers within certain niche industry groups. Table 7 provides a summary of the signiﬁcant industry groups and geographic locations of commercial loans outstanding at December 31, 2003 and 2002. The commercial loan portfolio is diversiﬁed among various industries with somewhat higher concentrations in consumer products and services, capital goods (including manufacturing and commercial construction-related businesses), ﬁnancial services, commercial services and supplies, and agricultural industries. Additionally, the commercial portfolio is diversiﬁed across the Company’s geographical markets with 87.4 percent of total commercial loans within the 24-state banking region. Credit relationships outside of the Company’s banking region are typically niche businesses including the mortgage banking and the leasing businesses. Loans to mortgage banking customers are primarily warehouse lines which are collateralized with the underlying mortgages. The Company regularly monitors its mortgage collateral position to manage its risk exposure. Certain industry segments within the commercial loan portfolio, including telecommunications, transportation and manufacturing experienced economic stress since 2001. Additionally, highly leveraged enterprise-value ﬁnancings have under-performed. Over the past several years, the telecommunications sector has been adversely impacted by excess capacity. As a result of credit workout initiatives, the Company’s outstandings to this industry declined in 2003 to only .7 percent of the commercial loan portfolio at December 31, 2003. At December 31, 2003, the transportation sector represented 4.6 percent of the total U.S. Bancorp 35 commercial loan portfolio. Since 2001, the sector has been impacted by reduced airline travel, slower economic activity and changes in fuel prices. In general, the credit risk proﬁle of the trucking, railroad and shipping segments have improved from a year ago; however, the airline segment continues to be sluggish. At year-end 2003, the Company’s transportation portfolio consisted of airline and airfreight businesses (30.0 percent of the sector), trucking businesses (48.4 percent of the sector) and the remainder in the railroad and shipping businesses (21.6 percent of the sector). Capital goods represented 11.9 percent of the total commercial portfolio at December 31, 2003. Included in this sector were approximately 34.0 percent of loans related to building products while engineering and construction equipment and machinery businesses were 32.5 percent and 21.3 percent, respectively. During 2003, economic conditions improved and production levels increased resulting in an improvement in the credit quality of the capital goods sectors from a year ago. With respect to certain construction and building-related businesses, the recent changes in the interest rate environment may somewhat hamper their future proﬁtability. During 2003, segments of the agricultural industry experienced deterioration in credit quality due to depressed livestock prices and excess production within the food processing businesses. At December 31, 2003, approximately 7.6 percent of the commercial loan portfolio was concentrated in the agricultural sector. Within the agricultural sector, 37.9 percent of loans were to livestock producers, 30.9 percent to crop producers, 20.4 percent to food processors and 10.8 percent to wholesalers of agricultural products. Wholesalers have been less affected by commodity prices. Within its commercial lending business, the Company also provides ﬁnancing to enable customers to grow their businesses through acquisitions of existing businesses, buyouts or other recapitalizations. During a business cycle with slower economic growth, businesses with leveraged capital structures may experience insufﬁcient cash ﬂows to service their debt. The Company manages leveraged enterprise-value ﬁnancings by maintaining well-deﬁned underwriting standards, portfolio diversiﬁcation and actively managing the customer relationship. Regardless of these actions, leveraged enterprise-value ﬁnancings often exhibit stress during a recession or period of slow economic growth. Given this risk proﬁle, the Company continued to signiﬁcantly de-emphasize and reduce the size of this portfolio during the past year. The Company actively monitors the credit quality of these customers and develops action plans accordingly. Such leveraged enterprise-value ﬁnancings approximated $1.8 billion in loans outstanding at December 31, 2003, compared with approximately $2.9 billion outstanding at December 31, 2002. The decline was primarily due to the Company’s decision to reduce its exposure to these types of lending arrangements through repayments, reﬁnancing activities and loan sales. The sector has also been reduced by charge-offs taken during the year. The Company’s portfolio of leveraged ﬁnancings is included in Table 7 and is diversiﬁed among industry groups similar to the total commercial loan portfolio, except for higher concentrations in telecommunications and cable. The commercial real estate portfolio reﬂects the Company’s focus on serving business owners within its footprint as well as regional investment-based real estate. Table 9 provides a summary of the signiﬁcant property types and geographic locations of commercial real estate loans outstanding at December 31, 2003 and 2002. At December 31, 2003, approximately 29.5 percent of the commercial real estate loan portfolio represented business owner-occupied properties that tend to exhibit credit risk characteristics similar to the middle market commercial loan portfolio. Generally, the investment-based real estate mortgages are diversiﬁed among various property types with somewhat higher concentrations in multi-family, ofﬁce and retail properties. Additionally, the commercial real estate portfolio is diversiﬁed across the Company’s geographical markets with 92.8 percent of total commercial real estate loans outstanding at December 31, 2003, within the 24-state banking region. Analysis of Nonperforming Assets Nonperforming assets represents a key indicator, among other considerations, of the potential for future credit losses. Nonperforming assets include nonaccrual loans, restructured loans not performing in accordance with modiﬁed terms and other real estate and other nonperforming assets owned by the Company. Interest payments collected from assets on nonaccrual status are typically applied against the principal balance and not recorded as income. At December 31, 2003, total nonperforming assets were $1,148.1 million, compared with $1,373.5 million at year-end 2002 and $1,120.0 million at year-end 2001. The ratio of total nonperforming assets to total loans and other real estate decreased to .97 percent at December 31, 2003, compared with 1.18 percent and .98 percent at the end of 2002 and 2001, respectively. The $225.4 million decrease in total nonperforming assets in 2003 reﬂected a decrease of $204.9 million in nonperforming commercial and commercial real estate loans, a decrease of $11.5 million in nonperforming residential mortgages and a $.9 million decrease in nonperforming retail loans. The decrease in nonperforming assets in 2003 was broad-based across most industry sectors within the commercial loan portfolio including capital goods, consumer-related sectors, manufacturing, telecommunications, and certain segments of transportation. While airline travel has increased from a year ago, the 36 U.S. Bancorp industry continues to be economically stressed and has had difﬁculty improving cash ﬂows from operations. Also, certain industries continue to experience ﬁnancial stress. Certain segments of livestock producers and food processors within the agricultural sector continue to suffer from lower prices. Certain health care facilities providers continue to experience operational stress leading to some deterioration in credit quality within that sector. Also, given the recent slowdown in reﬁnancing activities and housing starts, the mortgage banking and real estate development sectors may experience increased credit risk. While nonperforming assets declined during 2003, the amount of nonperforming assets is still at elevated levels relative to the 1990’s reﬂecting the Table 12 Nonperforming Assets (a) general impact of economic conditions during the past two years. Given the Company’s ongoing efforts to reduce the overall risk proﬁle of the organization and the anticipation that the economy will continue to improve, nonperforming assets are expected to trend lower in 2004. The $253.5 million increase in total nonperforming assets in 2002 reﬂected an increase of $284.6 million in nonperforming commercial and commercial real estate loans, and a $17.5 million increase in other nonperforming assets, partially offset by a decrease of $27.1 million in nonperforming residential mortgages and a $21.5 million decrease in nonperforming retail loans. The increase in At December 31, (Dollars in Millions) 2003 2002 2001 2000 1999 Commercial Commercial ***************************** Lease ﬁnancing ************************* Total commercial ********************* Commercial real estate Commercial mortgages******************* Construction and development ************ Total commercial real estate *********** Residential mortgages******************* Retail Credit card****************************** Retail leasing *************************** Other retail ***************************** Total retail *************************** Total nonperforming loans ********** Other real estate ************************ Other assets ***************************** Total nonperforming assets ********* Restructured loans accruing interest (b) ******* Accruing loans 90 days or more past due (c) *** Nonperforming loans to total loans************ Nonperforming assets to total loans plus other real estate ******************************* Net interest lost on nonperforming loans ****** Changes in Nonperforming Assets (Dollars in Millions) $ 623.5 113.3 736.8 $ 760.4 166.7 927.1 $ 526.6 180.8 707.4 177.6 39.9 217.5 40.5 — .4 24.8 25.2 174.6 57.5 232.1 52.0 — 1.0 25.1 26.1 131.3 35.9 167.2 79.1 — 6.5 41.1 47.6 1,020.0 1,237.3 1,001.3 72.6 55.5 $1,148.1 $ 18.0 $ 329.4 .86% .97% $ 67.4 $ 59.5 76.7 $1,373.5 $ 1.4 $ 426.4 1.06% 1.18% 65.4 43.8 74.9 $1,120.0 $ — $ 462.9 .88% .98% $ 63.0 $470.4 70.5 540.9 105.5 38.2 143.7 56.9 8.8 — 15.0 23.8 765.3 61.1 40.6 $867.0 $ — $385.2 .63% .71% $ 50.8 $219.0 31.5 250.5 138.2 31.6 169.8 72.8 5.0 .4 21.1 26.5 519.6 40.0 28.9 $588.5 $ — $248.6 .46% .52% $ 29.5 Commercial and Commercial Real Estate Retail and Residential Mortgages(e) Total Balance December 31, 2002 ****************************** Additions to nonperforming assets New nonaccrual loans and foreclosed properties *********** Advances on loans ************************************* Total additions ************************************** Reductions in nonperforming assets Paydowns, payoffs************************************** Net sales ********************************************** Return to performing status****************************** Charge-offs (d) ***************************************** Total reductions ************************************* Net additions (reductions) to nonperforming assets ** $ 1,295.4 1,303.5 58.9 1,362.4 (501.1) (288.8) (118.7) (666.8) (1,575.4) (213.0) $ 78.1 $ 1,373.5 41.4 — 41.4 (36.0) — (9.1) (8.7) (53.8) (12.4) 1,344.9 58.9 1,403.8 (537.1) (288.8) (127.8) (675.5) (1,629.2) (225.4) Balance December 31, 2003 ****************************** $ 1,082.4 $ 65.7 $ 1,148.1 (a) Throughout this document, nonperforming assets and related ratios do not include accruing loans 90 days or more past due. (b) Nonaccrual restructured loans are included in the respective nonperforming loan categories and excluded from restructured loans accruing interest. (c) These loans are not included in nonperforming assets and continue to accrue interest because they are adequately secured by collateral and/or are in the process of collection and are reasonably expected to result in repayment or restoration to current status. (d) Charge-offs exclude actions for certain card products and loan sales that were not classiﬁed as nonperforming at the time the charge-off occurred. (e) Residential mortgage information excludes changes related to residential mortgages serviced by others. U.S. Bancorp 37 Table 13 Delinquent Loan Ratios as a Percent of Ending Loan Balances At December 31, 90 days or more past due excluding nonperforming loans Commercial Commercial ****************************** Lease ﬁnancing*************************** Total commercial************************ Commercial real estate Commercial mortgages******************* Construction and development ************ Total commercial real estate *********** Residential mortgages******************* Retail Credit card****************************** Retail leasing *************************** Other retail ***************************** Total retail *************************** Total loans *********************** 2003 2002 2001 2000 1999 .06% .04 .14% .10 .14% .45 .11% .02 .05% — .06 .02 .03 .02 .61 1.68 .14 .41 .56 .14 .03 .07 .04 .90 2.09 .19 .54 .72 .18 .03 .02 .02 .78 2.18 .11 .74 .90 .10 .07 .03 .06 .62 1.70 .20 .62 .76 .05 .08 .05 .07 .42 1.23 .12 .41 .53 .28% .37% .40% .31% .22% At December 31, 90 days or more past due including nonperforming loans Commercial ********************************* Commercial real estate *********************** Residential mortgages ************************ Retail *************************************** Total loans ******************************* 2003 1.97% .82 .91 .62 1.14% nonperforming commercial and commercial real estate assets was principally due to the Company’s exposure to certain communications, cable, manufacturing and highly leveraged enterprise-value ﬁnancings. Nonperforming loans in the capital goods sector also increased in 2002. The Company had $58.5 million and $50.0 million of restructured loans as of December 31, 2003 and 2002, respectively. Commitments to lend additional funds under restructured loans were $8.2 million and $1.7 million as of December 31, 2003 and 2002, respectively. Restructured loans performing under the restructured terms beyond a speciﬁc timeframe are reported as accruing. Of the Company’s total restructured loans at December 31, 2003, $18.0 million were reported as accruing. Accruing loans 90 days or more past due totaled $329.4 million at December 31, 2003, compared with $426.4 million at December 31, 2002, and $462.9 million at December 31, 2001. These loans were not included in nonperforming assets and continue to accrue interest because they are adequately secured by collateral, and/or are in the process of collection and are reasonably expected to result in repayment or restoration to current status. The ratio of delinquent loans to total loans declined to .28 percent at December 31, 2003, compared with .37 percent at December 31, 2002. Improving economic conditions and the Company’s continued focus on credit process are the primary factors for the favorable change from a year ago. 2002 2.35% .90 1.44 .79 1.43% 2001 1.71% .68 1.79 1.03 1.28% 2000 1.13% .60 1.23 .83 .94% 1999 .59% .74 .99 .62 .68% To monitor credit risk associated with retail loans, the Company monitors delinquency ratios in the various stages of collection including nonperforming status. The following table provides summary delinquency information for residential mortgages and retail loans: December 31 (Dollars in Millions) Residential Mortgages Amount As a Percent of Loans 2003 2002 2003 2002 30-89 days ********* 90 days or more **** Nonperforming ***** $102.9 82.5 40.5 $137.5 87.9 52.0 .76% .61 .30 1.41% .90 .53 Total ********** $225.9 $277.4 1.68% 2.85% Retail Loans Credit Card 30-89 days ********* 90 days or more **** Nonperforming ***** $150.9 99.5 — $145.7 118.3 — 2.54% 1.68 — 2.57% 2.09 — Total ********** $250.4 $264.0 4.22% 4.66% Retail Leasing 30-89 days ********* 90 days or more **** Nonperforming ***** $ 78.8 8.2 .4 $ 89.7 10.7 1.0 1.31% .14 .01 1.58% .19 .02 Total ********** $ 87.4 $101.4 1.45% 1.78% Other Retail 30-89 days ********* 90 days or more **** Nonperforming ***** $311.9 110.2 24.8 $395.3 141.2 25.1 1.15% .41 .09 1.50% .54 .10 Total ********** $446.9 $561.6 1.65% 2.13% 38 U.S. Bancorp The decline in residential mortgage delinquencies from December 31, 2002, to December 31, 2003, reﬂected the general improvement in economic conditions, collection efforts and the effect of portfolio growth on delinquency ratios reported on a concurrent basis. The decline in retail loan delinquencies from a year ago, reﬂected improving economic conditions as well as ongoing collection efforts and risk management actions taken by the Company over the past three years. Analysis of Loan Net Charge-Offs Total loan net charge-offs decreased $121.3 million to $1,251.7 million in 2003, compared with $1,373.0 million in 2002 and $1,546.5 million in 2001. The ratio of total loan net charge-offs to average loans was 1.06 percent in 2003, compared with 1.20 percent in 2002 and 1.31 percent in 2001. The improvement in net charge-offs in 2003 was due to credit risk management initiatives taken by the Company during the past two years that have improved the credit risk proﬁle of the loan portfolio. These initiatives along with better economic conditions resulted in improving credit risk classiﬁcations and lower levels of nonperforming assets. The level of loan net charge-offs during 2002 reﬂected the impact of soft economic conditions at that time and weakness in the communications, transportation and manufacturing sectors, as well as the impact of the economy on highly leveraged enterprise-value ﬁnancings. The decline during 2002 reﬂected net charge-offs taken in 2001 related to several credit initiatives taken by management in that year. Due to the Company’s ongoing workout, collection and risk management efforts and expected improvement in the economy, net charge-offs are anticipated to trend lower in 2004. Commercial and commercial real estate loan net charge-offs for 2003 were $608.7 million (.89 percent of average loans outstanding), compared with $679.9 million (.98 percent of average loans outstanding) in 2002 and $884.6 million (1.16 percent of average loans outstanding) in 2001. While commercial and commercial real estate loan net charge-offs for 2003 continue at elevated levels compared with the late 1990’s, improvement from 2002 was broad-based and extended across most industries within the commercial portfolio. In addition, net charge-offs related to the equipment-leasing portfolio declined to 1.65 percent of average leases outstanding from 2.67 percent in 2002. In 2002, higher levels of net charge- offs related to the leasing portfolio included airline and other transportation related losses. The decrease in commercial and commercial real estate loan net charge-offs in 2002, when compared with 2001, was driven by credit actions taken in 2001. Commercial and commercial real estate loan net charge-offs in 2001 included approximately $312.2 million related to several factors including: a large cattle fraud, collateral deterioration speciﬁc to transportation equipment caused by the impact of higher fuel prices and the weak economy, deterioration in the manufacturing, communications and technology sectors and speciﬁc management decisions to accelerate its workout strategy for certain borrowers. Also included in 2001 commercial and commercial real estate loan net charge-offs were $95 million in merger and restructuring-related Table 14 Net Charge-offs as a Percent of Average Loans Outstanding Year Ended December 31 Commercial Commercial ******************************************** Lease ﬁnancing***************************************** Total commercial ************************************ Commercial real estate Commercial mortgages ********************************** Construction and development *************************** Total commercial real estate ************************** Residential mortgages ********************************** Retail Credit card ********************************************* Retail leasing******************************************* Home equity and second mortgages ********************** Other retail ********************************************* Total retail ****************************************** 2003 2002 2001 2000 1999 1.34% 1.65 1.38 .14 .16 .14 .23 4.61 .86 .70 1.60 1.61 1.29% 2.67 1.46 .17 .11 .15 .23 4.98 .72 .74 2.10 1.85 1.62% 1.95 1.66 .21 .17 .20 .15 4.80 .65 .85 2.16 1.94 .56% .46 .41% .24 .55 .03 .11 .05 .11 4.18 .41 * 1.32 1.69 .40 .02 .03 .02 .11 4.00 .28 * 1.26 1.63 Total loans (a)************************************ 1.06% 1.20% 1.31% .70% .61% (a) * In accordance with guidance provided in the Interagency Guidance on Certain Loans Held for Sale, loans held with the intent to sell are transferred to the Loans Held for Sale category based on the lower of cost or fair value. At the time of transfer, the portion of the mark-to-market losses representing probable credit losses determined in accordance with policies and methods utilized to determine the allowance for credit losses is included in net charge-offs. The remaining portion of the losses was reported separately as a reduction of the allowance for credit losses under ‘‘Losses from loan sales/transfers.’’ Had the entire amount of the loss been reported as charge-offs, total net charge-offs would have been $1,875.8 million (1.59 percent of average loans) for the year ended December 31, 2001. Information not available U.S. Bancorp 39 charge-offs to align risk management practices and net charge-offs of $160 million associated with an accelerated loan workout strategy in the ﬁrst quarter of 2001. Retail loan net charge-offs in 2003 were $616.1 million (1.61 percent of average loans outstanding), compared with $674.0 million (1.85 percent of average loans outstanding) in 2002 and $649.3 million (1.94 percent of average loans outstanding) in 2001. Lower levels of retail loan net charge- offs in 2003, compared with 2002, were primarily due to the implementation of uniform underwriting standards and processes across the entire Company, improvement in ongoing collection efforts and changes in other risk management practices. The favorable change in credit card losses also reﬂected the impact of two portfolio sales in late 2002. The improvement in the retail loan net charge-offs in 2002, compared with 2001, principally reﬂected changes in the mix of the retail loan portfolio to auto loans and leases and home equity products, and improvement in ongoing collection efforts as a result of the successful completion of the integration efforts. The Company’s retail lending business utilizes several distinct business processes and channels to originate retail credit including traditional branch credit, indirect lending and a consumer ﬁnance division. Each distinct underwriting and origination activity manages unique credit risk characteristics and prices its loan production commensurate with the differing risk proﬁles. Within Consumer Banking, U.S. Bank Consumer Finance (‘‘USBCF’’), participates in all facets of the Company’s consumer lending activities. The consumer ﬁnance division specializes in serving channel- speciﬁc and alternative lending markets in residential mortgages, home equity and installment loan ﬁnancing. The consumer ﬁnance division manages loans originated through a broker network, correspondent relationships and U.S. Bank branch ofﬁces. Generally, loans managed by the Company’s consumer ﬁnance division exhibit higher credit risk characteristics, but are priced commensurate with the differing risk proﬁle. The following table provides an analysis of net charge- offs as a percentage of average loans outstanding managed by the consumer ﬁnance division, compared with traditional branch-related loans: Year Ended December 31 (Dollars in Millions) Consumer ﬁnance (a) Residential mortgages **** Home equity and second mortgages ************ Other retail ************** Traditional branch Residential mortgages **** Home equity and second mortgages ************ Other retail ************** Total Company Residential mortgages **** Home equity and second mortgages ************ Other retail ************** Average Loan Amount Percent of Average Loans 2003 2002 2003 2002 $ 3,499 $ 2,447 .44% .57% 2,350 360 2,570 237 2.38 4.76 1.95 3.90 $ 8,197 $ 5,965 .14% .09% 10,889 13,270 10,662 12,010 .34 1.52 .44 2.07 $11,696 $ 8,412 .23% .23% 13,239 13,630 13,232 12,247 .70 1.60 .74 2.10 (a) Consumer ﬁnance category included credit originated and managed by USBCF, as well as home equity loans and second mortgages with a loan-to-value greater than 100 percent that were originated in the branches. Analysis and Determination of the Allowance for Credit Losses The allowance for credit losses provides coverage for probable and estimable losses inherent in the Company’s loan and lease portfolio. Management evaluates the allowance each quarter to determine that it is adequate to cover inherent losses. The evaluation of each element and the overall allowance is based on a continuing assessment of problem loans and related off-balance sheet items, recent loss experience and other factors, including regulatory guidance and economic conditions. At December 31, 2003, the allowance for credit losses was $2,368.6 million (2.00 percent of loans). This compares with an allowance of $2,422.0 million (2.08 percent of loans) at December 31, 2002, and $2,457.3 million (2.15 percent of loans) at December 31, 2001. The ratio of the allowance for credit losses to nonperforming loans was 232 percent at year-end 2003, compared with 196 percent at year-end 2002 and 245 percent at year-end 2001. The ratio of the allowance for credit losses to loan net charge- offs was 189 percent at year-end 2003, compared with 176 percent at year-end 2002 and 159 percent at year-end 2001. Management determined that the allowance for credit losses was adequate at December 31, 2003. Several factors were taken into consideration in evaluating the 2003 allowance for credit losses, including improvements in the risk proﬁle of the portfolios and loan net charge-offs during the period, the lower level of nonperforming assets, the decline in accruing loans 90 days or more past due and the improvement in all delinquency categories from December 31, 2002. Management also 40 U.S. Bancorp considered the uncertainty related to certain industry sectors, including the airline transportation sector, the extent of credit exposure to highly leveraged enterprise- value arrangements within the portfolio and the fact that nonperforming assets remain at elevated levels despite recent improvements. Finally, the Company considered improving but somewhat mixed economic trends including improving corporate earnings, lagging unemployment rates, the level of bankruptcies and general economic indicators. Management determines the allowance that is required for speciﬁc loan categories based on relative risk characteristics of the loan portfolio. Table 15 shows the amount of the allowance for credit losses by loan category. The allowance recorded for commercial and commercial real estate loans is based on a regular review of individual credit relationships. The Company’s risk rating process is an integral component of the methodology utilized in determining the allowance for credit losses. An analysis of the migration of commercial and commercial real estate loans and actual loss experience throughout the business cycle is also conducted quarterly to assess reserves established for credits with similar risk characteristics. An allowance is established for pools of commercial and commercial real estate loans based on the risk ratings assigned. The amount is supported by the results of the migration analysis that considers historical loss experience by risk rating, as well as current and historical economic conditions and industry risk factors. The Company separately analyzes the carrying value of impaired loans to determine whether the carrying value is less than or equal to the appraised collateral value or the present value of expected cash ﬂows. Based on this analysis, an allowance for credit losses may be speciﬁcally established for impaired loans. The allowance established for commercial and commercial real estate loan portfolios, including impaired commercial and commercial real estate loans, was $1,015.0 million at December 31, 2003, compared with $1,090.4 million and $1,428.6 million at December 31, 2002 and 2001, respectively. The decline in the allowance for commercial and commercial real estate loans of $75.4 million reﬂected improvement in the risk classiﬁcations of commercial and commercial real estate portfolios, partially offset by higher loss severity rates from the Company’s historical migration analysis. The allowance recorded for the residential mortgages and retail loan portfolios is based on an analysis of product mix, credit scoring and risk composition of the portfolio, loss and bankruptcy experiences, economic conditions and historical and expected delinquency and charge-off statistics for each homogenous group of loans. Based on this information and analysis, an allowance was established approximating a rolling twelve-month estimate of net charge-offs. The allowance established for residential mortgages was $33.3 million at December 31, 2003, Table 15 Elements of the Allowance for Credit Losses (a) December 31 (Dollars in Millions) 2003 2002 2001 2000 1999 2003 2002 2001 2000 1999 Allowance Amount Allowance as a Percent of Loans Commercial Commercial****************************** $ 696.1 Lease ﬁnancing ************************** 90.4 $ 776.4 107.6 $1,068.1 107.5 $ 418.8 17.7 $ 408.3 20.2 2.08% 2.12% 2.64% .89% .97% 1.84 1.81 2.01 .53 .31 Total commercial ********************** 786.5 884.0 1,175.6 436.5 428.5 2.04 2.11 2.54 .83 .93 Commercial real estate Commercial mortgages ******************* Construction and development ************* Total commercial real estate ************ Residential mortgages ******************* Retail Credit card ****************************** Retail leasing **************************** Home equity and second mortgages******** Other retail ****************************** Total retail ************************* 169.7 58.8 228.5 33.3 267.9 47.1 100.5 234.8 650.3 152.9 53.5 206.4 34.2 272.4 44.0 114.7 268.6 699.7 176.6 76.4 253.0 21.9 295.2 38.7 88.6 282.8 705.3 42.7 17.7 60.4 11.6 265.6 27.2 107.7 250.3 650.8 110.4 22.5 132.9 18.6 320.8 18.6 * 389.2 .82 .89 .84 .25 4.52 .78 .76 1.70 .75 .82 .77 .35 4.81 .77 .85 2.10 .94 1.16 1.00 .28 5.01 .79 .72 2.39 .22 .25 .23 .12 4.42 .65 .90 2.16 .59 .35 .53 .15 6.41 .88 * 1.74 728.6 1.67 1.86 2.02 1.93 2.47 Total allocated allowance************ Available for other factors *********** 1,698.6 670.0 1,824.3 597.7 2,155.8 301.5 1,159.3 627.6 1,308.6 401.7 1.43 .57 1.57 .51 1.89 .26 .95 .51 1.16 .35 Total allowance ****************************** $2,368.6 $2,422.0 $2,457.3 $1,786.9 $1,710.3 2.00% 2.08% 2.15% 1.46% 1.51% (a) During 2001, the Company changed its methodology for determining the speciﬁc allowance for elements of the loan portfolio. Table 15 has been restated for 2000. Due to the Company’s inability to gather historical loss data on a combined basis for 1999, the methodologies and amounts assigned to each element of the loan portfolio for that year has not been conformed. Utilizing the prior methods, the total assigned to the allocated allowance for 2000 was $1,397.3 million and the allowance available for other factors portion was $389.6 million. Information not available * U.S. Bancorp 41 compared with $34.2 million and $21.9 million at December 31, 2002 and 2001, respectively. The slight decrease in the allowance for the residential mortgage portfolio year-over-year was primarily due to lower expected loss severity resulting from the more uniform underwriting processes and standards associated with the portfolio, partially offset by losses due to incremental growth in the ﬁrst lien home equity portfolio during 2003. The allowance established for retail loans was $650.3 million at December 31, 2003, compared with $699.7 million and $705.3 million at December 31, 2002 and 2001, respectively. The decline in the allowance for the retail portfolio in 2003 reﬂected improved credit quality and delinquency trends, partially offset by the impact of portfolio growth and unemployment rates that continue to lag other economic indicators. Regardless of the extent of the Company’s analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolios. This is due to several factors, including inherent delays in obtaining information regarding a customer’s ﬁnancial condition or changes in their unique business conditions, the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-speciﬁc conditions affecting the identiﬁcation and estimation of losses from larger non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogeneous groups of loans, loan portfolio concentrations, and other subjective considerations are among other factors. Because of the imprecision surrounding these factors, the Company estimates a range of inherent losses based on statistical analyses and management judgment, and maintains an ‘‘allowance available for other factors’’ that is not allocated to a speciﬁc loan category. The amount of the allowance available for other factors was $670.0 million at December 31, 2003, compared with $597.7 million at December 31, 2002, and $301.5 million at December 31, 2001. Given the many subjective factors affecting the credit portfolio, changes in the allowance for other factors may not directly coincide with changes in the risk ratings of the credit portfolio reﬂected in the risk rating process. This is, in part, due to a lagging effect between changes in the business cycle, the exposure and mix of loans within risk rating categories, levels of nonperforming loans, and the timing of charge-offs and recoveries. In 2001, management conducted extensive reviews of its portfolios and enhanced its commercial migration methods to better differentiate and weight loss severity ratios by risk rating category to reﬂect the adverse impact of loss experienced in 2001. The $326.1 million decrease in the allowance for other factors in 2001 reﬂected the impact of that change in loss severity ratios, which led the Company to increase the allowance established for commercial loans. In 2002, the Company reduced the level of higher risk commercial credits and net charge-off ratios improved by 20 basis points from 2001. As a result, loss severity rates determined through historical migration analysis had improved somewhat relative to 2001. This led the Company to reduce the level of the allowance speciﬁcally allocated to commercial loans; however, nonperforming assets continued to remain at elevated levels, economic growth continued to be soft and the ability to further reduce higher risk credits had diminished as reﬁnancing opportunities had tightened. As such, volatility of loss rates remained higher relative to prior periods and management increased the level of the allowance for other factors. At December 31, 2003, quantiﬁable factors supporting the level of the allowance for other factors included $23.3 million related to imprecision in risk ratings, $184.6 million for volatility of commercial loss rates and $199.1 million for volatility of retail loss forecasts. The remaining allowance for other factors of $263.0 million was related to uncertainty in the economy from lagging unemployment rates, concentration risk, including risks associated with the sluggish airline industry and highly leveraged enterprise-value credits, and other qualitative factors. Although the Company determines the amount of each element of the allowance separately and this process is an important credit management tool, the entire allowance for credit losses is available for the entire loan portfolio. The actual amount of losses incurred can vary signiﬁcantly from the recorded amounts. The Company’s methodology included several factors intended to minimize the differences in recorded and actual losses. These factors allowed the Company to adjust its estimate of losses based on the most recent information available. Refer to Note 1 of the Notes to Consolidated Financial Statements for accounting policies related to the allowance for credit losses. 42 U.S. Bancorp Table 16 Summary of Allowance for Credit Losses (Dollars in Millions) Balance at beginning of year **************************** 2003 2002 2001 2000 1999 $2,422.0 $2,457.3 $1,786.9 $1,710.3 $1,705.7 Charge-offs Commercial Commercial ************************************* Lease ﬁnancing********************************** Total commercial ***************************** Commercial real estate Commercial mortgages *************************** Construction and development ******************** Total commercial real estate ******************* Residential mortgages ******************************* Retail Credit card ************************************** Retail leasing************************************ Home equity and second mortgages *************** Other retail************************************** Total retail *********************************** Total charge-offs ************************** Recoveries Commercial Commercial ************************************* Lease ﬁnancing********************************** Total commercial ***************************** Commercial real estate Commercial mortgages *************************** Construction and development ******************** Total commercial real estate ******************* Residential mortgages ******************************* Retail Credit card ************************************** Retail leasing************************************ Home equity and second mortgages *************** Other retail************************************** Total retail *********************************** Total recoveries *************************** Net Charge-offs Commercial Commercial ************************************* Lease ﬁnancing********************************** Total commercial ***************************** Commercial real estate Commercial mortgages *************************** Construction and development ******************** Total commercial real estate ******************* Residential mortgages ******************************* Retail Credit card ************************************** Retail leasing************************************ Home equity and second mortgages *************** Other retail************************************** Total retail *********************************** Total net charge-offs *********************** Provision for credit losses ******************************* Losses from loan sales/transfers (a) ********************** Acquisitions and other changes ************************** Balance at end of year********************************** 555.6 139.3 694.9 43.9 13.0 56.9 30.3 282.1 57.0 105.0 267.9 712.0 559.2 188.8 748.0 40.9 8.8 49.7 23.1 304.9 45.2 107.9 311.9 769.9 779.0 144.4 923.4 49.5 12.6 62.1 15.8 294.1 34.2 112.7 329.1 770.1 319.8 27.9 347.7 15.8 10.3 26.1 13.7 235.8 14.8 * 379.5 630.1 1,494.1 1,590.7 1,771.4 1,017.6 70.0 55.3 125.3 15.8 2.0 17.8 3.4 27.3 7.0 12.1 49.5 95.9 67.4 39.9 107.3 9.1 1.4 10.5 4.0 24.6 6.3 10.6 54.4 95.9 242.4 217.7 485.6 84.0 569.6 28.1 11.0 39.1 26.9 254.8 50.0 92.9 218.4 616.1 491.8 148.9 640.7 31.8 7.4 39.2 19.1 280.3 38.9 97.3 257.5 674.0 60.6 30.4 91.0 9.1 .8 9.9 3.2 23.4 4.5 12.9 80.0 120.8 224.9 718.4 114.0 832.4 40.4 11.8 52.2 12.6 270.7 29.7 99.8 249.1 649.3 1,251.7 1,254.0 — (55.7) 1,373.0 1,349.0 — (11.3) 1,546.5 2,528.8 (329.3) 17.4 64.0 7.2 71.2 10.8 2.6 13.4 1.3 27.5 2.0 * 76.8 106.3 192.2 255.8 20.7 276.5 5.0 7.7 12.7 12.4 208.3 12.8 * 302.7 523.8 825.4 828.0 — 74.0 250.1 12.4 262.5 19.1 2.6 21.7 16.2 220.2 6.2 * 376.0 602.4 902.8 84.8 4.0 88.8 15.1 1.0 16.1 1.4 34.6 1.1 * 88.2 123.9 230.2 165.3 8.4 173.7 4.0 1.6 5.6 14.8 185.6 5.1 * 287.8 478.5 672.6 646.0 — 31.2 $2,368.6 $2,422.0 $2,457.3 $1,786.9 $1,710.3 Allowance as a percent of Period-end loans ************************************ Nonperforming loans ******************************** Nonperforming assets ******************************* Net charge-offs (a) ********************************** 2.00% 232 206 189 2.08% 196 176 176 2.15% 245 219 159 1.46% 233 206 216 1.51% 329 291 254 (a) * In accordance with guidance provided in the Interagency Guidance on Certain Loans Held for Sale, loans held with the intent to sell are transferred to the Loans Held for Sale category based on the lower of cost or fair value. At the time of the transfer, the portion of the mark-to-market losses representing probable credit losses determined in accordance with policies and methods utilized to determine the allowance for credit losses is included in net charge-offs. The remaining portion of the losses was reported separately as a reduction of the allowance for credit losses under ‘‘Losses from loan sales/transfers.’’ Had the entire amount of the loss been reported as charge-offs, total net charge-offs would have been $1,875.8 million for the year ended 2001. Additionally, the allowance as a percent of net charge-offs would have been 131 percent for the year ended December 31, 2001. Information not available U.S. Bancorp 43 Residual Risk Management The Company manages its risk to changes in the value of lease residual assets through disciplined residual valuation setting at the inception of a lease, diversiﬁcation of its leased assets, regular asset valuation reviews and monitoring of residual value gains or losses upon the disposition of assets. Commercial lease originations are subject to the same well-deﬁned underwriting standards referred to in the ‘‘Credit Risk Management’’ section which includes an evaluation of the residual risk. Retail lease residual risk is mitigated further by originating longer-term vehicle leases and effective end- of-term marketing of off-lease vehicles. Also, to reduce the ﬁnancial risk of potential changes in vehicle residual values, the Company maintains residual value insurance. The catastrophic insurance maintained by the Company provides for the potential recovery of losses on individual vehicle sales in an amount equal to the difference between: (a) 105 percent or 110 percent of the average wholesale auction price for the vehicle at the time of sale and (b) the vehicle residual value speciﬁed by the Automotive Lease Guide (an authoritative industry source) at the inception of the lease. The potential recovery is calculated for each individual vehicle sold in a particular policy year and is reduced by any gains realized on vehicles sold during the same period. The Company will receive claim proceeds if, in the aggregate, there is a net loss for such period. To reduce the risk associated with collecting insurance claims, the Company monitors the ﬁnancial viability of the insurance carrier based on insurance industry ratings and available ﬁnancial information. Included in the retail leasing portfolio was approximately $3.3 billion of retail leasing residuals at December 31, 2003, compared with $3.2 billion at December 31, 2002. The Company monitors concentrations of leases by manufacturer and vehicle ‘‘make and model.’’ At year-end 2003, no vehicle-type concentration exceeded six percent of the aggregate portfolio. Because retail residual valuations tend to be less volatile for longer-term leases, relative to the estimated residual at inception of the lease, the Company actively manages lease origination production to achieve a longer-term portfolio. At December 31, 2003, the weighted-average origination term of the portfolio was 53 months. Since 1998, the used vehicle market has experienced pricing stress. Several factors have contributed to this business cycle. Aggressive leasing programs by automobile manufacturers and competitors within the banking industry included a marketing focus on monthly lease payments, enhanced residuals at lease inception, shorter-term leases and low mileage leases. These practices have created a cyclical oversupply of certain off-lease vehicles causing signiﬁcant declines in used vehicle prices. Automobile manufacturers and others have retreated somewhat from these marketing programs or exited the leasing business. However, zero percent ﬁnancing offered with rebates continued to exert pressure on used car pricing. Another factor impacting the used vehicle market has been the deﬂation in new vehicle prices. This trend has been driven by surplus automobile manufacturing capacity and related production and highly competitive sales programs. Economic factors are expected to moderate new car production. Production levels have continued to decline from record levels in 2000. Also, many Internet marketers failed or transformed into distribution channels of dealers rather than direct competitors. These trends are expected to abate the deﬂationary pricing pressures of the past few years. Another factor that has slowed the decline in residual values is the growth of ‘‘certiﬁed’’ used car programs. Certiﬁed cars are low mileage, newer model vehicles that have been inspected, reconditioned, and usually have a warranty program. The Company’s exposure to declining valuation should beneﬁt from certiﬁed car programs that receive premium pricing from dealers at auction. Given the current economic environment, it is difﬁcult to assess the timing and degree of changes in residual values that may impact ﬁnancial results over the next several quarters. At December 31, 2003, the commercial leasing portfolio had $816 million of residuals, compared with $896 million at December 31, 2002. At year-end 2003, lease residuals related to trucks and other transportation equipment were 32 percent of the total residual portfolio. Railcars represented 16 percent of the aggregate portfolio, while aircraft and business and ofﬁce equipment were 15 percent and 11 percent, respectively. No other signiﬁcant concentrations of more than 10 percent existed at December 31, 2003. In 2003, reduced airline travel and higher fuel costs adversely impacted aircraft and transportation equipment lease residual values. Operational Risk Management Operational risk represents the risk of loss resulting from the Company’s operations, including, but not limited to, the risk of fraud by employees or persons outside the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements and business continuation and disaster recovery. This risk of loss also includes the potential legal actions that could arise as a result of an operational deﬁciency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. The Company operates in many different businesses in diverse markets and relies on the ability of its employees and systems to process a high number of transactions. Operational risk is inherent in all business activities, and the management of this risk is important to the achievement of 44 U.S. Bancorp the Company’s objectives. In the event of a breakdown in the internal control system, improper operation of systems or improper employees’ actions, the Company could suffer ﬁnancial loss, face regulatory action and suffer damage to its reputation. The Company manages operational risk through a risk management framework and its internal control processes. The framework involves the business lines, corporate risk management personnel and executive management. Under this framework, business lines have direct and primary responsibility and accountability for identifying, controlling, and monitoring operational risk. Clear structures and processes with deﬁned responsibilities are in place. Business managers maintain a system of controls with the objective of providing proper transaction authorization and execution, proper system operations, safeguarding of assets from misuse or theft, and ensuring the reliability of ﬁnancial and other data. Business managers ensure that the controls are appropriate and are implemented as designed. Each business line within the Company has designated risk managers. These risk managers are responsible, among other things, for coordinating the completion of ongoing risk assessments and ensuring that operational risk management is integrated into business decision-making activities. Business continuation and disaster recovery planning is also critical to effectively manage operational risks. Each business unit of the Company is required to develop, maintain and test these plans at least annually to ensure that recovery activities, if needed, can support mission critical functions including technology, networks and data centers supporting customer applications and business operations. The Company’s internal audit function validates the system of internal controls through risk-based, regular and ongoing audit procedures and reports on the effectiveness of internal controls to executive management and the Audit Committee of the Board of Directors. Customer-related business conditions may also increase operational risk or the level of operational losses in certain transaction processing business units, including merchant processing activities. Ongoing risk monitoring of customer activities and their ﬁnancial condition and operational processes serve to mitigate customer-related operational risk. Refer to Note 23 of the Notes to Consolidated Financial Statements for further discussion on merchant processing. While the Company believes that it has designed effective methods to minimize operational risks, there is no absolute assurance that business disruption or operational losses would not occur in the event of a disaster. On an ongoing basis, management makes process changes and investments to enhance its systems of internal controls and business continuity and disaster recovery plans. Interest Rate Risk Management In the banking industry, a signiﬁcant risk exists related to changes in interest rates. To minimize the volatility of net interest income and of the market value of assets and liabilities, the Company manages its exposure to changes in interest rates through asset and liability management activities within guidelines established by its Asset Liability Policy Committee (‘‘ALPC’’) and approved by the Board of Directors. ALPC has the responsibility for approving and ensuring compliance with ALPC management policies, including interest rate risk exposure. The Company uses Net Interest Income Simulation Analysis and Market Value of Equity Modeling for measuring and analyzing consolidated interest rate risk. Net Interest Income Simulation Analysis One of the primary tools used to measure interest rate risk and the effect of interest rate changes on rate sensitive income and net interest income is simulation analysis. The monthly analysis incorporates substantially all of the Company’s assets and liabilities and off-balance sheet instruments, together with forecasted changes in the balance sheet and assumptions that reﬂect the current interest rate environment. Through these simulations, management estimates the impact on interest rate sensitive income of a 300 basis point upward or downward gradual change of market interest rates over a one-year period. The simulations also estimate the effect of immediate and sustained parallel shifts in the yield curve of 50 basis points as well as the effect of immediate and sustained ﬂattening or steepening of the yield curve. These simulations include assumptions about how the balance sheet is likely to be affected by changes in loan and deposit growth. Assumptions are made to project interest rates for new loans and deposits based on historical analysis, management’s outlook and repricing strategies. These assumptions are validated on a periodic basis. A sensitivity analysis is provided for key variables of the simulation. The results are reviewed by ALPC monthly and are used to Sensitivity of Net Interest Income and Rate Sensitive Income: December 31, 2003 December 31, 2002 Down 50 Immediate Up 50 Immediate Down 300 Gradual Up 300 Gradual Down 50 Immediate Up 50 Immediate Down 300 Gradual Up 300 Gradual Net interest income ************** Rate sensitive income ************ 1.30% .74% .19% .01% *% *% (.02)% (.54)% .08% .20% (.34)% (.55)% *% *% (1.91)% (2.57)% * Given the current level of interest rates, a downward 300 basis point scenario can not be computed. U.S. Bancorp 45 guide hedging strategies. ALPC policy guidelines limit the estimated change in interest rate sensitive income to 5.0 percent of forecasted interest rate sensitive income over the succeeding 12 months. The table on page 45 summarizes the interest rate risk of net interest income and rate sensitive income based on forecasts over the succeeding 12 months. At December 31, 2003, the Company’s overall interest rate risk position was substantively neutral to changes in interest rates. The Company manages its interest rate risk position by holding assets on the balance sheet with desired interest rate risk characteristics, implementing certain pricing strategies for loans and deposits and through the selection of derivatives and various funding and investment portfolio strategies. The Company plans to continue to manage the overall interest rate risk proﬁle within policy limits and towards a neutral position. At December 31, 2003 and 2002, the Company was within its policy guidelines. Market Value of Equity Modeling The Company also utilizes the market value of equity as a measurement tool in managing interest rate sensitivity. The market value of equity measures the degree to which the market values of the Company’s assets and liabilities and off-balance sheet instruments will change given a change in interest rates. ALPC guidelines limit the change in market value of equity in a 200 basis point parallel rate shock to 15 percent of the market value of equity assuming interest rates at December 31, 2003. Given the low level of current interest rates, the down 200 basis point scenario cannot be computed. The up 200 basis point scenario resulted in a 3.1 percent decrease in the market value of equity at December 31, 2003, compared with a 2.5 percent decrease at December 31, 2002. ALPC reviews other down rate scenarios to evaluate the impact of falling interest rates. The down 100 basis point scenario resulted in a 1.3 percent increase at December 31, 2003, and a 1.0 percent decrease at December 31, 2002. At December 31, 2003 and 2002, the Company was within its policy guidelines. The valuation analysis is dependent upon certain key assumptions about the nature of indeterminate maturity of assets and liabilities. Management estimates the average life and rate characteristics of asset and liability accounts based upon historical analysis and management’s expectation of rate behavior. These assumptions are validated on a periodic basis. A sensitivity analysis of key variables of the valuation analysis is provided to the ALPC monthly and is used to guide hedging strategies. The results of the valuation analysis as of December 31, 2003, were well within policy guidelines. Use of Derivatives to Manage Interest Rate Risk In the ordinary course of business, the Company enters into derivative transactions to manage its interest rate and prepayment risk (‘‘asset and liability management positions’’) and to accommodate the business requirements of its customers (‘‘customer-related positions’’). To manage its interest rate risk, the Company may enter into interest rate swap agreements and interest rate options such as caps and ﬂoors. Interest rate swaps involve the exchange of ﬁxed-rate and variable-rate payments without the exchange of the underlying notional amount on which the interest payments are calculated. Interest rate caps protect against rising interest rates while interest rate ﬂoors protect against declining interest rates. In connection with its mortgage banking operations, the Company enters into forward commitments to sell mortgage loans related to ﬁxed-rate mortgage loans held for sale and ﬁxed-rate mortgage loan commitments. The Company also acts as a seller and buyer of interest rate contracts and foreign exchange rate contracts on behalf of customers. The Company minimizes its market and liquidity risks by taking similar offsetting positions. All interest rate derivatives that qualify for hedge accounting are recorded at fair value as other assets or liabilities on the balance sheet and are designated as either ‘‘fair value’’ or ‘‘cash ﬂow’’ hedges. The Company performs an assessment, both at inception and quarterly thereafter, when required, to determine whether these derivatives are highly effective in offsetting changes in the value of the hedged items. Hedge ineffectiveness for both cash ﬂow and fair value hedges is immediately recorded in noninterest income. Changes in the fair value of derivatives designated as fair value hedges, and changes in the fair value of the hedged items, are recorded in earnings. Changes in the fair value of derivatives designated as cash ﬂow hedges are recorded in other comprehensive income until income from the cash ﬂows of the hedged items is realized. Customer- related interest rate swaps, foreign exchange rate contracts, and all other derivative contracts that do not qualify for hedge accounting are recorded at fair value and resulting gains or losses are recorded in trading account gains or losses or mortgage banking revenue. By their nature, derivative instruments are subject to market risk. The Company does not utilize derivative instruments for speculative purposes. Of the Company’s $31.8 billion of total notional amount of asset and liability management derivative positions at December 31, 2003, $29.8 billion was designated as either fair value or cash ﬂow hedges. The cash ﬂow hedge positions are interest rate swaps that hedge the forecasted cash ﬂows from the underlying variable-rate LIBOR loans and ﬂoating-rate debt. The fair value hedges are primarily interest rate contracts that hedge the change in fair value related to interest rate changes of underlying ﬁxed-rate debt, trust preferred securities and deposit obligations. In addition, the Company uses forward commitments to sell residential mortgage loans 46 U.S. Bancorp to hedge its interest rate risk related to residential mortgage loans held for sale. The Company commits to sell the loans at speciﬁed prices in a future period, typically within 90 days. The Company is exposed to interest rate risk during the period between issuing a loan commitment and the sale of the loan into the secondary market. Related to its mortgage banking operations, the Company held $1.0 billion of forward commitments to sell mortgage loans and $1.0 billion of unfunded mortgage loan commitments that were derivatives in accordance with the provisions of the Statement of Financial Accounting Standards No. 133, ‘‘Accounting for Derivative Instruments and Hedge Activities.’’ The unfunded mortgage loan commitments are reported at fair value as options in Table 17. Derivative instruments are also subject to credit risk associated with counterparties to the derivative contracts. Credit risk associated with derivatives is measured based on the replacement cost should the counterparties with contracts in a gain position to the Company fail to perform under the terms of the contract. The Company manages this risk through diversiﬁcation of its derivative positions among various counterparties, requiring collateral agreements with credit-rating thresholds, entering into master netting agreements in certain cases and entering into interest rate swap risk participation agreements. These agreements are credit derivatives that transfer the credit risk related to interest rate swaps from the Company to an unafﬁliated third-party. The Company also provides credit protection to Table 17 Derivative Positions Asset and Liability Management Positions December 31, 2003 (Dollars in Millions) Interest rate contracts Receive ﬁxed/pay ﬂoating swaps Notional amount********************* Weighted-average Receive rate ********************* Pay rate************************* Pay ﬁxed/receive ﬂoating swaps Notional amount********************* Weighted-average Receive rate ********************* Pay rate************************* Futures and forwards ******************* Options Maturing 2004 2005 2006 2007 2008 Thereafter Total Weighted- Average Remaining Maturity In Years Fair Value $13,073 $ — $ 500 $1,720 $3,750 $4,150 $23,193 $ 691 4.17 4.22% 1.19 — — 2.37% 1.17 3.96% 1.20 3.90% 1.16 6.60% 1.67 4.54% 1.27 $ 2,700 $2,390 $ 250 $ — $ — $ — $ 5,340 $ (60) 1.25 1.13% 3.15 $ 2,229 1.17% 2.56 — — $ — $ — $ — $ — 1.19% 2.73 — — — — 1.15% 2.86 $ — $ 2,229 $ — .16 Written ***************************** Equity contracts ************************ 995 $ — $ — 3 20 — — — 1,015 1 $ — $ — $ — $ — $ 3 $ — .21 1.92 Customer-related Positions December 31, 2003 (Dollars in Millions) Interest rate contracts Receive ﬁxed/pay ﬂoating swaps Notional amount********************* Pay ﬁxed/receive ﬂoating swaps Notional amount********************* Basis swaps *************************** Options Purchased************************** Written ***************************** Risk participation agreements Purchased************************** Written ***************************** Maturing 2004 2005 2006 2007 2008 Thereafter Total Weighted- Average Remaining Maturity in Years Fair Value $ 615 $ 871 $1,195 $ 628 $1,083 $1,434 $ 5,826 $ 155 4.50 615 1 30 30 15 — 871 — 1,195 — 628 — 1,083 — 1,434 — 5,826 1 (124) — 40 40 62 17 42 42 1 22 62 62 3 — 161 161 11 25 42 42 35 — 377 377 127 64 9 (9) — — Foreign exchange rate contracts Swaps and forwards Buy ******************************** Sell ******************************** $ 1,868 1,902 $ 104 106 Options $ — $ — $ — — — — $ — $ 1,972 2,008 — $ 95 (93) Purchased************************** Written ***************************** 20 20 — — — — — — — — — — 20 20 — — 4.50 .67 3.75 3.75 7.08 3.14 .55 .55 .29 .29 U.S. Bancorp 47 third-parties with risk participation agreements, for a fee, as part of a loan syndication transaction. analysis, was $1.5 million at December 31, 2003, and $8.8 million at December 31, 2002. At December 31, 2003, the Company had $174.9 million in accumulated other comprehensive income related to unrealized gains on derivatives classiﬁed as cash ﬂow hedges. The unrealized gains will be reﬂected in earnings when the related cash ﬂows or hedged transactions occur and will offset the related performance of the hedged items. The estimated amount of gain to be reclassiﬁed from accumulated other comprehensive income into earnings during the next 12 months is $53.1 million. Gains or losses on customer-related derivative positions were not material in 2003. The change in fair value of forward commitments attributed to hedge ineffectiveness recorded in noninterest income was a decrease of $6.8 million in 2003. The change in the fair value of all other asset and liability management derivative positions attributed to hedge ineffectiveness was not material in 2003. Table 17 summarizes information on the Company’s derivative positions at December 31, 2003. Refer to Notes 1 and 21 of the Notes to Consolidated Financial Statements for signiﬁcant accounting policies and additional information regarding the Company’s use of derivatives. Market Risk Management In addition to interest rate risk, the Company is exposed to other forms of market risk as a consequence of conducting normal trading activities. Business activities that contribute to market risk include, among other things, proprietary trading and foreign exchange positions. Value at Risk (‘‘VaR’’) is a key measure of market risk for the Company. Theoretically, VaR represents the maximum amount that the Company has placed at risk of loss, with a ninety-ninth percentile degree of conﬁdence, to adverse market movements in the course of its risk taking activities. VaR modeling of trading activities is subject to certain limitations. Additionally, it should be recognized that there are assumptions and estimates associated with VaR modeling and actual results could differ from those assumptions and estimates. The Company mitigates these uncertainties through regular monitoring of trading activities by management and other risk management practices, including stop-loss and position limits related to its trading activities. Stress-test models are used to provide management with perspectives on market events that VaR models do not capture. The Company establishes market risk limits, subject to approval by the Company’s Board of Directors. The Company’s VaR limit was $40 million at December 31, 2003 and 2002. The market valuation risk inherent in its customer-based derivative trading, mortgage banking pipeline and foreign exchange, as estimated by the VaR Liquidity Risk Management ALPC establishes policies, as well as analyzes and manages liquidity, to ensure that adequate funds are available to meet normal operating requirements in addition to unexpected customer demands for funds, such as high levels of deposit withdrawals or loan demand, in a timely and cost-effective manner. The most important factor in the preservation of liquidity is maintaining public conﬁdence that facilitates the retention and growth of a large, stable supply of core deposits and wholesale funds. Ultimately, public conﬁdence is generated through proﬁtable operations, sound credit quality and a strong capital position. The Company’s performance in these areas has enabled it to develop a large and reliable base of core funding within its market areas and in domestic and global capital markets. Liquidity management is viewed from long-term and short-term perspectives, as well as from an asset and liability perspective. Management monitors liquidity through a regular review of maturity proﬁles, funding sources, and loan and deposit forecasts to minimize funding risk. The Company maintains strategic liquidity and contingency plans that are subject to the availability of asset liquidity in the balance sheet. Monthly, ALPC reviews the Company’s ability to meet funding requirements due to adverse business events. These funding needs are then matched with speciﬁc asset-based sources to ensure sufﬁcient funds are available. Also, strategic liquidity policies require diversiﬁcation of wholesale funding sources to avoid concentrations in any one market source. Subsidiary banks are members of various Federal Home Loan Banks (‘‘FHLB’’) that provide a source of funding through FHLB advances. The Company maintains a Grand Cayman branch for issuing eurodollar time deposits. The Company also establishes relationships with dealers to issue national market retail and institutional savings certiﬁcates and short- and medium-term bank notes. Also, the Company’s subsidiary banks have signiﬁcant correspondent banking networks and corporate accounts. Accordingly, it has access to national fed funds, funding through repurchase agreements and sources of more stable, regionally based certiﬁcates of deposit. The Company’s ability to raise negotiated funding at competitive prices is inﬂuenced by rating agencies’ views of the Company’s credit quality, liquidity, capital and earnings. The debt ratings noted in Table 18 reﬂect the rating agencies’ recognition of the strong, consistent ﬁnancial performance of the Company and the quality of the balance sheet. At December 31, 2003, the credit ratings outlook for the Company was considered ‘‘Positive’’ by 48 U.S. Bancorp Table 18 Debt Ratings At December 31, 2003 U.S. Bancorp Moody’s Standard & Poors Short-term borrowings *************************************************************** Senior debt and medium-term notes ************************************************** Subordinated debt******************************************************************* Preferred stock ********************************************************************* Commercial paper******************************************************************* Aa3 A1 A2 P–1 A+ A A– A–1 U.S. Bank National Association Short-term time deposits ************************************************************* Long-term time deposits ************************************************************* Bank notes ************************************************************************* Subordinated debt******************************************************************* P–1 Aa2 Aa2/P–1 Aa3 A–1+ AA– AA–/A–1+ A+ Fitch F1 A+ A A F1 F1+ AA– A+/F1+ A both Moody’s Investors Services and Fitch and ‘‘Stable’’ by Standard & Poors. The parent company’s routine funding requirements consist primarily of operating expenses, dividends to shareholders, debt service, repurchases of common stock and funds used for acquisitions. The parent company obtains funding to meet its obligations from dividends collected from its subsidiaries and the issuance of debt securities. On April 1, 2003, USB Capital II, a subsidiary of U.S. Bancorp, redeemed 100 percent, or $350 million, of its 7.20 percent Trust Preferred Securities. At December 31, 2003, parent company long-term debt outstanding was $5.2 billion, compared with $5.7 billion at December 31, 2002. The change in long-term debt during 2003 was driven by medium-term note maturities of $1.3 billion and $.3 billion of parent company subordinated debt maturities, partially offset by the issuance of $1.2 billion of ﬁxed-rate medium-term notes. Total parent company debt scheduled to mature in 2004 is $888 million. These debt obligations may be met through medium-term note issuances and dividends from subsidiaries, as well as from parent company cash and cash equivalents. Federal banking laws regulate the amount of dividends that may be paid by banking subsidiaries without prior approval. The amount of dividends available to the parent company from its banking subsidiaries was approximately $828.5 million at December 31, 2003. For further information, see Note 24 of the Notes to Consolidated Financial Statements. Table 19 Contractual Obligations Refer to Table 19 for further information on signiﬁcant contractual obligations at December 31, 2003. Off-Balance Sheet Arrangements Off-balance sheet arrangements include any contractual arrangement to which an unconsolidated entity is a party, under which the Company has an obligation to provide credit or liquidity enhancements or market risk support. Off-balance sheet arrangements include certain deﬁned guarantees, asset securitization trusts and conduits. Off-balance sheet arrangements also include any obligation under a variable interest held by an unconsolidated entity that provides ﬁnancing, liquidity or credit enhancement or market risk support to the Company. In the ordinary course of business, the Company enters into an array of commitments to extend credit, letters of credit, lease commitments and various forms of guarantees that may be considered off-balance sheet arrangements. The nature and extent of these arrangements is provided in Note 23 of the Notes to Consolidated Financial Statements. Asset securitization and conduits represent a source of funding for the Company through off-balance sheet structures. Credit, liquidity, operational and legal structural risks exist due to the nature and complexity of asset securitizations and other off-balance sheet structures. ALPC regularly monitors the performance of each off-balance sheet structure in an effort to minimize these risks and ensure compliance with the requirements of the structures. (Dollars in Millions) Contractual Obligations Long-term debt (a)************ Trust preferred securities (a) *** Capital leases **************** Operating leases ************* Purchase obligations ********** Beneﬁt obligations (b) ********* One Year or Less $9,989 — 9 182 166 47 Payments Due By Period Over One Through Three Years Over Three Through Five Years $10,932 — 15 308 227 101 $5,876 — 13 242 36 109 Over Five Years $4,418 2,601 38 516 4 308 Total $31,215 2,601 75 1,248 433 565 (a) In the banking industry, interest-bearing obligations are principally utilized to fund interest-bearing assets. As such, interest charges on related contractual obligations were excluded from reported amounts as the potential cash outﬂows would have corresponding cash inﬂows from interest-bearing assets. (b) Amounts only include obligations related to the unfunded non-qualiﬁed pension plan and post-retirement medical plans. U.S. Bancorp 49 The Company utilizes its credit risk management systems to evaluate the credit quality of underlying assets and regularly forecasts cash ﬂows to evaluate any potential impairment of retained interests. Also, regulatory guidelines require consideration of asset securitizations in the determination of risk-based capital ratios. The Company does not rely signiﬁcantly on off-balance sheet arrangements for liquidity or capital resources. The Company sponsors an off-balance sheet conduit to which it transferred high-grade investment securities, funded by the issuance of commercial paper. The conduit held assets of $7.3 billion at December 31, 2003, and $9.5 billion at December 31, 2002. These investment securities include primarily (i) private label asset-backed securities, which are insurance ‘‘wrapped’’ by AAA/Aaa-rated monoline insurance companies and (ii) government agency mortgage-backed securities and collateralized mortgage obligations. The conduit had commercial paper liabilities of $7.3 billion at December 31, 2003, and $9.5 billion at December 31, 2002. The Company provides a liquidity facility to the conduit. Utilization of the liquidity facility would be triggered by the conduit’s inability to issue commercial paper to fund its assets. The recorded fair value of the Company’s liability for the liquidity facility included in other liabilities was $47.3 million at December 31, 2003, and $37.7 million at December 31, 2002. Changes in fair value of these liabilities are recorded in the income statement as other noninterest income or expense. In addition, the Company recorded at fair value its retained residual interest in the investment securities conduit of $89.5 million at December 31, 2003, and $93.4 million at December 31, 2002. The Company also has an asset-backed securitization to fund an unsecured small business credit product. The unsecured small business credit securitization trust held assets of $497.5 million at December 31, 2003, of which the Company retained $112.4 million of subordinated securities, transferor’s interests of $12.4 million and a residual interest-only strip of $34.4 million. This compared with $652.4 million in assets at December 31, 2002, of which the Company retained $150.1 million of subordinated securities, transferor’s interests of $16.3 million and a residual interest-only strip of $53.3 million. The securitization trust issued asset-backed variable funding notes in various tranches. The Company provides credit enhancement in the form of subordinated securities and reserve accounts. The Company’s risk, primarily from losses in the underlying assets, was considered in determining the fair value of the Company’s retained interests in this securitization. The Company recognized income from subordinated securities, an interest- only strip and servicing fees from this securitization of $29.8 million during 2003 and $52.8 million during 2002. The unsecured small business credit securitization held average assets of $571.4 million in 2003 and $700.6 million in 2002. During 2003, the Company undertook several actions with respect to off-balance sheet structures. In January of 2003, the Company exercised a cleanup call option on an indirect automobile loan securitization, with the remaining assets from the securitization recorded on the Company’s balance sheet at fair value. The indirect automobile securitization held $156.1 million in assets at December 31, 2002. In June 2003, the Company terminated its involvement with an operating lease arrangement involving third-party lessors that acquired certain business assets, including real estate, through leveraged ﬁnancing structures commonly referred to as ‘‘synthetic leases.’’ All assets previously leased through the synthetic lease structures were acquired and recorded by the Company at fair value. The termination of the synthetic lease structures did not have a material impact on the Company’s ﬁnancial statements. During the third quarter of 2003, the Company elected not to reissue more than 90 percent of the commercial paper funding of Stellar Funding Group, Inc., the commercial loan conduit. This action caused the conduit to lose its status as a ‘‘qualifying special purpose entity’’ as deﬁned below. As a result, the Company recorded all of Stellar’s assets and liabilities at fair value and the results of operations in the consolidated ﬁnancial statements of the Company. Given the ﬂoating rate nature and high credit quality of the assets within the conduit, the impact to the Company’s ﬁnancial statements was not signiﬁcant. In the third quarter of 2003, average commercial loan balances increased by approximately $2 billion and the resulting increase in net interest income was offset by a similar decline in conduit fee income within commercial products revenue. Prior to December 31, 2003, the remaining commercial paper borrowings held by third-party investors matured and the conduit was legally dissolved. In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46 (‘‘FIN 46’’), ‘‘Consolidation of Variable Interest Entities’’ (‘‘VIEs’’), an interpretation of Accounting Research Bulletin No. 51, ‘‘Consolidated Financial Statements,’’ to improve ﬁnancial reporting of special purpose and other entities. The interpretation requires the consolidation of entities in which an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other ﬁnancial interests in the entity. Prior to the issuance of FIN 46, consolidation generally occurred when an enterprise controlled another entity through voting interests. Certain VIEs that are qualifying special purpose entities (‘‘QSPEs’’) subject to the reporting requirements of 50 U.S. Bancorp Statement of Financial Accounting Standards No. 140 (‘‘SFAS 140’’), ‘‘Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,’’ will not be required to be consolidated under the provisions of FIN 46. The consolidation provisions of FIN 46 apply to VIEs created or entered into after January 31, 2003. For VIEs created before February 1, 2003, the effective date of applying the provisions of FIN 46 for entities that have interests in structures that are special purpose entities was for periods ending after December 15, 2003, and for all other types of entities was deferred to periods ending after March 15, 2004. Because the Company’s investment securities conduit and the asset-backed securitization are QSPEs, which are exempt from consolidation under the provisions of FIN 46, the consolidation of the conduit or securitizations in its ﬁnancial statements is not required at this time. Capital Management The Company is committed to managing capital for maximum shareholder beneﬁt and maintaining strong protection for depositors and creditors. The Company continually assesses its business risks and capital position. The Company also manages its capital to exceed regulatory capital requirements for well-capitalized bank holding companies. To achieve these capital goals, the Company employs a variety of capital management tools including dividends, common share repurchases, and the issuance of subordinated debt and other capital instruments. Total shareholders’ equity was $19.2 billion at Table 20 Regulatory Capital Ratios At December 31 (Dollars in millions) December 31, 2003, compared with $18.4 billion at December 31, 2002. The increase was the result of corporate earnings, offset primarily by the payment of dividends, including the special dividend of $685 million related to the spin-off of Piper Jaffray, and the repurchase of common stock. On December 16, 2003, the Company increased its dividend rate per common share by 17.1 percent, from $.205 per quarter to $.24 per quarter. On March 12, 2003, the Company increased its dividend rate per common share by 5.1 percent, from $.195 per quarter to $.205 per quarter. On March 12, 2002, the Company increased its dividend rate per common share by 4.0 percent, from $.1875 per quarter to $.195 per quarter. On December 18, 2001, the Board of Directors approved an authorization to repurchase 100 million shares of common stock through 2003. In 2002, the Company purchased 5.2 million shares of common stock under the December 2001 plan. In 2003, the Company repurchased 7.0 million shares of common stock under the plan, which expired in December of 2003. On December 16, 2003, the Board of Directors approved an authorization to repurchase 150 million shares of common stock over the following 24 months. During 2003, the Company purchased 8.0 million shares under the December 2003 plan. There are approximately 142.0 million shares remaining to be purchased under this authorization. The average price paid for the 15.0 million shares repurchased during 2003 was U.S. Bancorp Tangible common equity ********************************************************************************* As a percent of tangible assets *********************************************************************** Tier 1 capital ******************************************************************************************* As a percent of risk-weighted assets******************************************************************* As a percent of adjusted quarterly average assets (leverage ratio) **************************************** Total risk-based capital ********************************************************************************** As a percent of risk-weighted assets******************************************************************* Bank Subsidiaries (a) U.S. Bank National Association Tier 1 capital************************************************************************************* Total risk-based capital**************************************************************************** Leverage **************************************************************************************** U.S. Bank National Association ND Tier 1 capital************************************************************************************* Total risk-based capital**************************************************************************** Leverage **************************************************************************************** Bank Regulatory Capital Requirements Tier 1 capital************************************************************************************* Total risk-based capital**************************************************************************** Leverage **************************************************************************************** 2003 2002 $11,858 $ 9,824 6.5% 5.7% $14,623 $12,941 9.1% 8.0% 8.0% 7.7% $21,710 $20,088 13.6% 12.4% 6.6% 10.8 6.3 13.1% 18.0 11.0 6.7% 10.8 6.7 13.4% 18.9 12.1 Minimum Well- Capitalized 4.0% 8.0 4.0 6.0% 10.0 5.0 (a) These balances and ratios were prepared in accordance with regulatory accounting principles as disclosed in the subsidiaries’ regulatory reports. 2002 ratios for the bank subsidiaries were not restated for the adoption of SFAS 123. U.S. Bancorp 51 $27.84 per share. For a complete analysis of activities impacting shareholders’ equity and capital management programs, refer to Note 16 of the Notes to Consolidated Financial Statements. Banking regulators deﬁne minimum capital requirements for banks and ﬁnancial services holding companies. These requirements are expressed in the form of a minimum Tier 1 capital ratio, total risk-based capital ratio, and Tier 1 leverage ratio. The minimum required level for these ratios is 4.0 percent, 8.0 percent, and 4.0 percent, respectively. The Company targets its regulatory capital levels, at both the bank and bank holding company level, to exceed the ‘‘well-capitalized’’ threshold for these ratios of 6.0 percent, 10.0 percent, and 5.0 percent, respectively. As of December 31, 2003, the Company’s Tier 1 capital, total risk-based capital, and Tier 1 leverage ratio were 9.1 percent, 13.6 percent, and 8.0 percent, respectively. These ratios compare to 8.0 percent, 12.4 percent, and 7.7 percent, respectively, as of December 31, 2002. All regulatory ratios, at both the bank and bank holding company level, continue to be in excess of stated ‘‘well- capitalized’’ requirements. Currently, mandatorily redeemable preferred securities issued through subsidiary grantor trusts (‘‘Trust Preferred Securities’’) qualify as Tier 1 capital of the Company for regulatory purposes. Prior to the adoption of FIN 46, the Company consolidated the grantor trusts, and the balance sheet included the mandatorily redeemable preferred securities of the grantor trusts. The Company has determined that the provisions of FIN 46 may require de-consolidation of the subsidiary grantor trusts and the junior subordinated debentures of the Company owned by the grantor trusts would be included in the consolidated ﬁnancial statements of the Company as long-term debt. The banking regulatory agencies have issued guidance that would continue the current capital treatment for Trust Preferred Securities until further notice. As of December 31, 2003, management does not believe the adoption of FIN 46, including the de-consolidation of Trust Preferred Securities, if required, will have a material impact on the Company’s results from operations, its ﬁnancial condition or regulatory capital ratios. The Company uses tangible common equity expressed as a percent of tangible common assets as an additional measure of its capital. At December 31, 2003, the Company’s tangible common equity ratio was 6.5 percent, compared with 5.7 percent at year-end 2002. Table 20 provides a summary of capital ratios as of December 31, 2003 and 2002, including Tier 1 and total risk-based capital ratios, as deﬁned by the regulatory agencies. FOURTH QUARTER SUMMARY The Company reported net income of $977.0 million for the fourth quarter of 2003, or $.50 per diluted share, compared with $819.7 million, or $.43 per diluted share, for the fourth quarter of 2002. Return on average assets and return on average equity were 2.05 percent and 19.4 percent, respectively, for the fourth quarter of 2003, compared with returns of 1.83 percent and 17.8 percent, respectively, for the fourth quarter of 2002. The Company’s results for the fourth quarter of 2003 improved over the fourth quarter of 2002, primarily due to growth in net interest income and fee-based products and services, as well as controlled operating expense and lower credit costs. Net income from continuing operations was $970.3 million, or $.50 per diluted share, compared with $858.6 million, or $.45 per diluted share for the fourth quarter of 2002, representing an 11.1 percent annual growth rate. Net income for the fourth quarter of 2003 also included after- tax merger and restructuring-related items of $5.0 million ($7.6 million on a pre-tax basis), compared with after-tax merger and restructuring-related items of $69.9 million ($107.3 million on a pre-tax basis) for the fourth quarter of 2002. The $99.7 million decline in pre-tax merger and restructuring-related charges was primarily due to the completion of integration activities associated with the merger of Firstar and USBM at the end of 2002. Total net revenue, on a taxable-equivalent basis, was $3,113.3 million for the fourth quarter of 2003, compared with $3,151.0 million for the fourth quarter of 2002, a decrease of $37.7 million (1.2 percent) from a year ago. This decline primarily reﬂected the net reduction in securities gains (losses) of $106.3 million. Otherwise, favorable growth occurred in net interest income, payment services revenue, trust and investment management fees, treasury management fees, mortgage banking revenue and acquisitions, including Bay View and State Street Corporate Trust, which contributed approximately $33.0 million of the increase in net revenue year-over-year. Fourth quarter net interest income, on a taxable- equivalent basis was $1,816.7 million, compared with $1,765.3 million in the fourth quarter of 2002. The $51.4 million (2.9 percent) increase in net interest income was driven by an increase of $12.6 billion (8.3 percent) in average earning assets, primarily due to increases in investment securities, residential mortgages and retail loans, partially offset by a decline in commercial loans and loans held for sale related to mortgage banking activities. The net interest margin for the fourth quarter of 2003 was 4.42 percent, compared with 4.65 percent in the fourth quarter of 2002. The year-over-year decline in net interest margin primarily reﬂected growth in lower-yielding investment securities as a percent of total earning assets, 52 U.S. Bancorp a change 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 the Stellar commercial loan conduit onto the Company’s balance sheet during the third quarter of 2003. Fourth quarter 2003 noninterest income declined 6.4 percent from the same period of a year ago. The decline is primarily due to a net reduction in securities gains (losses) of $106.3 million year-over-year. In addition, included in fourth quarter of 2002 was a $46.5 million gain on the sale of an out-of-market credit card portfolio. Credit and debit card revenue and corporate payment products revenue were higher in the fourth quarter of 2003 than the fourth quarter of 2002 by $9.7 million (6.8 percent) and $8.3 million (10.3 percent), respectively. Although credit and debit card revenue grew 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 the interchange rate on signature debit transactions beginning August 2003. The year-over-year impact of the VISA settlement on credit and debit card revenue for the quarter was a decline of Table 21 Fourth Quarter Summary approximately $12.6 million. This change in the interchange rate, in addition to higher customer loyalty rewards expenses, however, was more than offset by the impact of increases in transaction volumes and other rate adjustments. The corporate payment products revenue growth reﬂected growth in sales and card usage. Merchant processing services revenue was higher in the fourth quarter of 2003 than the same quarter of 2002 by $4.0 million (2.8 percent), due to an increase in transaction volume, which was partially offset by lower processing spreads resulting from revenue-sharing associated with speciﬁc banking alliances and changes in the mix of merchants. The favorable variance in trust and investment management fees of $33.0 million (15.4 percent) in the fourth quarter of 2003 over the same period of 2002 was principally driven by the acquisition of State Street Corporate Trust, which contributed approximately $21.1 million in fees during the fourth quarter of 2003. In addition, trust and investment management fees beneﬁted from higher equity market valuations and account growth year-over-year. Treasury management fees grew by $13.7 million (13.4 percent) in the fourth quarter of 2003 over the same period of 2002. The increase in treasury management fees year-over-year was driven, in part, by a change during the third quarter of (In Millions, Except Per Share Data) Condensed Income Statement Net interest income (taxable-equivalent basis) (a) ********************************************************** Noninterest income ************************************************************************************* Securities gains (losses), net **************************************************************************** Total net revenue *********************************************************************************** Noninterest expense************************************************************************************ Provision for credit losses ******************************************************************************* Income from continuing operations before taxes ******************************************************** Taxable-equivalent adjustment *************************************************************************** Applicable income taxes ******************************************************************************** Income from continuing operations ******************************************************************** Discontinued operations (after-tax) *********************************************************************** Three Months Ended December 31, 2003 2002 $1,816.7 1,296.7 (.1) 3,113.3 1,342.4 286.0 1,484.9 7.2 507.4 970.3 6.7 $1,765.3 1,279.5 106.2 3,151.0 1,486.6 349.0 1,315.4 7.7 449.1 858.6 (38.9) Net income***************************************************************************************** $ 977.0 $ 819.7 Per Common Share Earnings per share ************************************************************************************* Diluted earnings per share ****************************************************************************** Dividends declared per share**************************************************************************** Average shares outstanding ***************************************************************************** Average diluted shares outstanding ********************************************************************** Financial Ratios Return on average assets ******************************************************************************* Return on average equity ******************************************************************************* Net interest margin (taxable-equivalent basis) ************************************************************* Efﬁciency ratio (b) ************************************************************************************** $ .51 .50 .240 1,927.3 1,950.8 2.05% 19.4 4.42 43.1 $ .43 .43 .195 1,916.2 1,923.6 1.83% 17.8 4.65 48.8 Interest and rates are presented on a fully taxable-equivalent basis utilizing a tax rate of 35 percent. (a) (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. U.S. Bancorp 53 2003 in the Federal government’s payment methodology for treasury management services from compensating balances, reﬂected in net interest income, to fees. Mortgage banking revenue increased by $3.5 million (4.0 percent) over the same period of 2002 due to higher loan servicing revenue, which was slightly offset by a decline in origination and sales revenue. Offsetting these favorable variances were declines in other income and commercial products revenue year-over-year. Other income declined primarily due to the sale of the credit card portfolio in the fourth quarter of 2002. Commercial products revenue declined by $9.8 million (9.0 percent) year-over-year, principally reﬂecting lower commercial loan conduit servicing fees, which resulted, in part, from unwinding the Stellar commercial loan conduit. Total noninterest expense was $1,342.4 million in the fourth quarter of 2003, compared with $1,486.6 million in the fourth quarter of 2002. The decrease in noninterest expense of $144.2 million (9.7 percent) was primarily due to a $99.7 million reduction in merger and restructuring-related charges, the favorable change in MSR impairments of $54.1 million and cost savings from merger and restructuring-related activities. These positive variances were partially offset by the impact of recent acquisitions, including the branches of Bay View and State Street Corporate Trust. The acquisitions contributed approximately $16.0 million of expense growth to the quarter. The provision for credit losses was $286.0 million for the fourth quarter of 2003 and $349.0 million for the fourth quarter of 2002, a decrease of $63.0 million (18.1 percent). Net charge-offs in the fourth quarter of 2003 were $285.1 million, compared with net charge-offs of $378.5 million during the fourth quarter of 2002. The decline from a year ago primarily reﬂected lower retail and commercial losses, the result of collection efforts and an improving credit risk proﬁle. LINE OF BUSINESS FINANCIAL REVIEW Within the Company, ﬁnancial performance is measured by major lines of business, which include Wholesale Banking, Consumer Banking, Private Client, Trust and Asset Management, Payment Services, and Treasury and Corporate Support. These operating segments are components of the Company about which ﬁnancial information is available and is evaluated regularly in deciding how to allocate resources and assess performance. Basis for Financial Presentation Business line results are derived from the Company’s business unit proﬁtability reporting systems by speciﬁcally attributing managed balance sheet assets, deposits and other liabilities and their related income or expense. Funds transfer-pricing methodologies are utilized to allocate a cost of funds used or credit for funds provided to all business line assets and liabilities using a matched funding concept. Also, the business unit is allocated the taxable-equivalent beneﬁt of tax-exempt products. Noninterest income and expenses directly managed by each business line, including fees, service charges, salaries and beneﬁts, and other direct costs are accounted for within each segment’s ﬁnancial results in a manner similar to the consolidated ﬁnancial statements. Occupancy costs are allocated based on utilization of facilities by the lines of business. Noninterest expenses incurred by centrally managed operations or business lines that directly support another business line’s operations are not charged to the applicable business line. Goodwill and other intangible assets are assigned to the lines of business based on the mix of business of the acquired entity. The provision for credit losses within the Wholesale Banking, Consumer Banking, Private Client, Trust and Asset Management and Payment Services lines of business is based on net charge-offs while Treasury and Corporate Support reﬂects the residual component of the Company’s total consolidated provision for credit losses determined in accordance with accounting principles generally accepted in the United States. Income taxes are assessed to each line of business at a standard tax rate with the residual tax expense or beneﬁt to arrive at the consolidated effective tax rate included in Treasury and Corporate Support. Merger and restructuring-related charges and cumulative effects of changes in accounting principles are not identiﬁed by or allocated to lines of business. Within the Company, capital levels are evaluated and managed centrally; however, capital is allocated to the operating segments to support evaluation of business performance. Capital allocations to the business lines are based on the amount of goodwill and other intangibles, the extent of off-balance sheet managed assets and lending commitments and the ratio of on-balance sheet assets relative to the total Company. Certain lines of business, such as trust, asset management and capital markets, have no signiﬁcant balance sheet components. For these business units, capital is allocated taking into consideration ﬁduciary and operational risk, capital levels of independent organizations operating similar businesses, and regulatory requirements. Designations, assignments and allocations may change from time to time as management systems are enhanced, methods of evaluating performance or product lines change or business segments are realigned to better respond to our diverse customer base. During 2003, certain organization and methodology changes were made and, accordingly, 2002 results were restated and presented on a comparable basis. Due to organizational and methodology changes, the Company’s basis of ﬁnancial presentation differed in 2001. The presentation of comparative business line results for 2001 is not practical and has not been provided. 54 U.S. Bancorp Wholesale Banking offers lending, depository, treasury management and other financial services to middle market, large corporate and public sector clients. Wholesale Banking contributed $1,195.3 million of the Company’s operating earnings in 2003 and $1,115.7 million in 2002. The increase in operating earnings in 2003 was driven by slightly higher net revenue and reductions in noninterest expense and provision for credit losses, compared with 2002. Total net revenue increased $48.9 million (1.9 percent) in 2003, compared with 2002. Net interest income, on a taxable-equivalent basis, increased 1.5 percent, compared with 2002, as average deposits increased $7.7 billion (36.5 percent) in 2003, compared with 2002. The impact of increasing average deposits on net interest income was offset somewhat by the adverse impact of declining interest rates on the funding beneﬁts of customer deposits in addition to the declines in average loans and loan spreads. Loan spreads declined from a year ago due, in part, to the consolidation of high credit quality, low margin commercial loans from the loan conduit onto the balance sheet. The decline in average loans in 2003 was driven in part by soft customer loan demand given the current economic environment, in addition to the Company’s decisions in 2001 to tighten credit availability to certain types of lending products, industries and customers and reductions due to asset workout strategies. Noninterest income increased 2.9 percent in 2003 to $753.0 million, compared to 2002 noninterest income of $731.8 million. The increase in noninterest income in 2003 was due to growth in treasury management-related fees, international banking, syndication and customer derivative fees, and equipment leasing revenue, partially offset by reductions in fee income related to lower commercial loan volumes and the consolidation of the commercial loan conduit, compared with 2002. The increase in cash management-related fees was driven by growth in product sales, pricing enhancements and lower 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. Noninterest expense was $350.6 million in 2003, compared with $383.5 million in 2002. The $32.9 million decrease (8.6 percent) was primarily due to cost savings initiatives that reduced personnel-related costs, legal expenses and professional costs. Loan workout expenses also declined in 2003 as the credit quality of the loan portfolio has improved. In addition, noninterest expense for the business segment in 2003 included $12.6 million of equipment ﬁnancing related residual value and inventory write-downs. The provision for credit losses was $401.1 million and $444.5 million in 2003 and 2002, respectively, a decline of $43.4 million (9.8 percent). The favorable change in the provision for credit losses for Wholesale Banking business is due to improving net charge-offs which declined to .89 percent of average loans in 2003 from .96 percent of average loans in 2002. The reduction in net charge-offs was attributable to improvements in credit quality driven by initiatives taken by the Company during the past three years including asset workout strategies and reductions in commitments to certain industries and customers. Nonperforming assets within Wholesale Banking were $744.2 million at December 31, 2003, compared with $983.9 million at December 31, 2002. While nonperforming asset levels continue to be elevated relative to the 1990’s, significant improvement in credit quality has been achieved with reductions being broad-based across most industry sectors. The Company expects further improvements in nonperforming asset levels through 2004. Refer to the ‘‘Corporate Risk Profile’’ section for further information on factors impacting the credit quality of the loan portfolios. Consumer Banking delivers products and services to the broad consumer market and small businesses through banking offices, telemarketing, on-line services, direct mail and automated teller machines (‘‘ATMs’’). It encompasses community banking, metropolitan banking, small business banking, including lending guaranteed by the Small Business Administration, small-ticket leasing, consumer lending, mortgage banking, workplace banking, student banking, 24-hour banking and investment product and insurance sales. Consumer Banking contributed $1,688.4 million of the Company’s operating earnings for 2003 and $1,521.0 million for 2002, an 11.0 percent increase over 2002. The increase in operating earnings in 2003 was driven by higher net revenue and reductions in provision for credit losses, offset by increases in noninterest expense, compared with 2002. Total net revenue increased $358.4 million (7.3 percent) in 2003, compared with 2002. Net interest income, on a taxable-equivalent basis, increased $230.4 million (6.8 percent). Fee-based revenue increased $42.4 million (3.0 percent) and securities gains (losses) increased $85.6 million. The year-over-year increase in net interest income was due to growth in average loan balances and residential mortgages held for sale, improved spreads on retail and commercial loans, lower funding costs on non- earning asset balances, growth in interest-bearing and noninterest-bearing deposit balances and acquisitions. Partially offsetting these increases was the impact of declining interest rates on the funding benefit of consumer deposits. The increase in average loan balances of 10.1 percent reflected retail loan growth of 6.9 percent and growth in residential mortgages of 40.6 percent in 2003, compared with 2002. Residential mortgages include first-lien home equity loans, which accounted for 26.7 percent of the growth U.S. Bancorp 55 in residential mortgages. Commercial and commercial real estate loan balances increased 1.3 percent during the same period. The year-over-year increase in average deposits included growth in noninterest-bearing, interest checking, savings and money market account balances, partially offset by a reduction in balances associated with time deposits. The decline in lower margin time deposits primarily reflected a shift in product mix towards savings products. Noninterest income excluding securities gains was $1,460.1 million in 2003, $42.4 million (3.0 percent) higher compared with 2002. This growth was driven by mortgage banking revenue, deposit service charges, investment products fees and commissions and acquisitions, partially offset by higher end-of-term lease residual losses. The year- over-year growth in mortgage banking revenue was partially attributable to the acquisition of Leader in the second quarter of 2002, which contributed $63.7 million in 2003, compared with $47.2 million in 2002. Securities gains were $193.4 million in 2003, a net increase of $85.6 million from a year ago. The Company utilizes its investment portfolio as an economic hedge to the valuation risk of the portfolio of mortgage servicing rights caused by declining interest rates and related increases in mortgage prepayments due to mortgage reﬁnancing activity. Noninterest expense was $2,198.2 million in 2003, compared with $2,074.7 million for 2002, an increase of $123.5 million (6.0 percent). The year-over-year increase in noninterest expense was attributable to an increase in MSR amortization and impairment of $85.3 million, higher loan origination and repossession costs and incremental operating costs of $56.4 million related to the Bay View Bank and Leader acquisitions. Table 22 Line of Business Financial Performance Year Ended December 31 (Dollars in Millions) Wholesale Banking Consumer Banking 2003 Percent 2002 Change 2003 Percent 2002 Change Condensed Income Statement Net interest income (taxable-equivalent basis) ************************************ $1,877.9 $1,850.2 Noninterest income************************************************************ 731.8 Securities gains, net *********************************************************** — 753.0 — 1.5% $3,634.7 $3,404.3 1,417.7 1,460.1 2.9 107.8 193.4 — Total net revenue ********************************************************** Noninterest expense*********************************************************** Other intangibles ************************************************************** 2,630.9 331.1 19.5 2,582.0 362.9 20.6 Total noninterest expense *************************************************** 350.6 383.5 Operating income (loss) ************************************************* Provision for credit losses ****************************************************** Operating earnings (loss), before income taxes *********************************** Income taxes and taxable-equivalent adjustment ********************************** 2,280.3 401.1 1,879.2 683.9 2,198.5 444.5 1,754.0 638.3 Operating earnings (loss) ****************************************************** $1,195.3 $1,115.7 1.9 (8.8) (5.3) (8.6) 3.7 (9.8) 7.1 7.1 7.1 Merger and restructuring-related items (after-tax) ********************************* Discontinued operations (after-tax) ********************************************** Cumulative effect of accounting change (after-tax) ******************************** Net income ******************************************************************* 6.8% 3.0 79.4 7.3 1.7 27.7 5,288.2 1,765.4 432.8 4,929.8 1,735.7 339.0 2,198.2 2,074.7 6.0 3,090.0 435.8 2,654.2 965.8 2,855.1 463.8 2,391.3 870.3 8.2 (6.0) 11.0 11.0 $1,688.4 $1,521.0 11.0 Average Balance Sheet Data Commercial ****************************************************************** $ 28,337 $ 30,015 Commercial real estate ******************************************************** 15,908 Residential mortgages ********************************************************* 160 Retail ************************************************************************ 130 16,414 119 57 (5.6)% $ 8,100 $ 8,795 9,010 9,936 3.2 8,013 11,265 (25.6) 26,960 28,832 (56.2) (7.9)% 10.3 40.6 6.9 Total loans **************************************************************** Goodwill ********************************************************************* Other intangible assets ******************************************************** Assets *********************************************************************** Noninterest-bearing deposits *************************************************** Savings products************************************************************** Time deposits **************************************************************** Total deposits ************************************************************* Shareholders’ equity*********************************************************** 44,927 1,227 107 51,775 14,738 10,227 3,901 28,866 5,058 46,213 1,226 127 52,572 12,993 5,556 2,592 21,141 5,049 (2.8) .1 (15.7) (1.5) 13.4 84.1 50.5 36.5 .2 58,133 2,242 928 67,831 13,748 40,769 18,587 73,104 6,022 52,778 1,892 946 61,403 12,939 35,803 22,632 71,374 5,128 10.1 18.5 (1.9) 10.5 6.3 13.9 (17.9) 2.4 17.4 * Not meaningful 56 U.S. Bancorp The provision for credit losses decreased $28.0 million in 2003, compared with 2002. The improvement in the provision for credit losses in 2003 was primarily attributable to lower net charge-offs. As a percentage of average loans, net charge-offs declined to .75 percent in 2003, compared with .88 percent in 2002. The declines in net charge-offs included the commercial, commercial real estate and retail loan portfolios. The improvement in commercial and commercial real estate loan net charge-offs within Consumer Banking of $20.6 million was broad- based across most industry and geographical regions. Retail loan net charge-offs declined by $16.5 million primarily resulting from ongoing collection efforts and risk management. Nonperforming assets within Consumer Banking were $367.1 million at December 31, 2003, compared with $345.4 million at December 31, 2002. Refer to the ‘‘Corporate Risk Proﬁle’’ section for further information on factors impacting the credit quality of the loan portfolios. Private Client, Trust and Asset Management provides trust, private banking, ﬁnancial advisory, investment management and mutual fund and alternative investment product services through ﬁve businesses: Private Client Group, Corporate Trust, Asset Management, Institutional Trust and Custody and Fund Services, LLC. Private Client, Trust and Asset Management contributed $506.5 million of the Company’s operating earnings in 2003, and increase of 10.9 percent compared with 2002. Total net revenue was $1,352.0 million in 2003, an increase of 10.4 percent, compared with 2002. Net interest income, on a taxable-equivalent basis, increased $60.6 million (18.8 percent) in 2003, compared with 2002. The increase in net interest income in 2003 was due to growth in total deposits of 34.5 percent attributable to Private Client, Trust and Asset Management Payment Services Treasury and Corporate Support Consolidated Company 2003 2002 Percent Change 2003 2002 Percent Change 2003 2002 Percent Change 2003 2002 Percent Change 18.8% $ 624.4 1,692.3 — 7.4 — 2,316.7 593.9 158.1 $ 675.6 1,676.8 — 2,352.4 627.3 161.1 (7.6)% $ 696.9 194.4 51.4 .9 — 942.7 1,694.6 5.8 $ 594.1 183.0 192.1 969.2 1,675.9 1.2 17.3% $ 7,217.5 5,068.2 244.8 6.2 (73.2) 12,530.5 4,868.3 682.4 $ 6,847.2 4,910.8 299.9 12,057.9 4,866.3 553.0 $ 383.6 968.4 — 1,352.0 483.3 66.2 549.5 802.5 6.2 796.3 289.8 $ 323.0 901.5 — 1,224.5 464.5 31.1 495.6 728.9 11.0 717.9 261.2 $ 506.5 $ 456.7 10.4 4.0 * 10.9 10.1 (43.6) 10.9 10.9 10.9 (1.5) (5.3) (1.9) (4.6) — (9.6) 4.0 4.0 4.0 752.0 788.4 1,564.7 412.7 1,152.0 419.2 1,564.0 456.4 1,107.6 403.0 $ 732.8 $ 704.6 (2.7) 1.1 * 1.4 (7.0) 93.3 (11.0) (16.5) 1,700.4 1,677.1 (757.7) (1.8) (755.9) (373.4) (707.9) (26.7) (681.2) (320.5) 5,550.7 5,419.3 6,979.8 1,254.0 5,725.8 1,985.3 6,638.6 1,349.0 5,289.6 1,852.3 $ (382.5) $ (360.7) (6.0) 3,740.5 3,437.3 (30.4) (209.3) 22.5 — (22.7) (37.2) $ 3,732.6 $ 3,168.1 $ 1,784 594 299 2,159 $ 1,819 591 231 2,056 (1.9)% $ 2,887 — — 7,103 .5 29.4 5.0 $ 2,803 — — 7,304 $ 3.0% $ — — (2.8) 218 198 13 47 4,836 740 399 6,624 3,031 6,019 474 9,524 2,169 4,697 290 227 5,771 2,333 4,301 448 7,082 1,405 3.0 * 75.8 14.8 29.9 39.9 5.8 34.5 54.4 9,990 1,814 675 13,564 278 10 — 288 3,010 10,107 1,814 769 13,350 258 7 — 265 3,059 (1.2) — (12.2) 1.6 7.8 42.9 — 8.7 (1.6) 476 305 20 47,836 (80) 1 4,850 4,771 3,134 385 214 8 51 658 306 11 38,852 192 129 4,941 5,262 2,632 (43.4)% $ 41,326 27,142 11,696 38,198 (7.5) 62.5 (7.8) $ 43,817 25,723 8,412 36,501 (27.7) (.3) 81.8 23.1 * (99.2) (1.8) (9.3) 19.1 118,362 6,328 2,129 187,630 31,715 57,026 27,812 116,553 19,393 114,453 5,528 2,080 171,948 28,715 45,796 30,613 105,124 17,273 5.4% 3.2 (18.4) 3.9 — 23.4 2.4 5.1 (7.0) 8.2 7.2 8.8 (5.7)% 5.5 39.0 4.6 3.4 14.5 2.4 9.1 10.4 24.5 (9.1) 10.9 12.3 U.S. Bancorp 57 growth in noninterest-bearing deposits, savings products, time deposits and the State Street Corporate Trust acquisition, partially offset by the impact of declining interest rates on the funding beneﬁt of deposits. The acquisition of the corporate trust business from State Street represented approximately $31.4 million of the 2003 increase in net interest income. Noninterest income increased $66.9 million (7.4 percent) in 2003, compared with 2002. The acquisition of the State Street Corporate Trust business was the primary factor for this increase, partially offset by a year-over-year decrease in the value of assets under management due to adverse capital market conditions in early 2003. During the second half of 2003, equity capital market conditions improved signiﬁcantly, and the line of business experienced an increase in assets under management and related fees. Noninterest expense increased $53.9 million (10.9 percent) in 2003, compared with 2002, primarily attributable to the State Street Corporate Trust acquisition ($68.5 million), offset by cost savings from business integration and other cost control initiatives. The provision for credit losses decreased $4.8 million (43.6 percent) in 2003, compared with 2002. The year- over-year decrease in the provision for credit losses was primarily due to lower retail loan net charge-offs. Payment Services includes consumer and business credit cards, corporate and purchasing card services, consumer lines of credit, ATM processing, merchant processing and debit cards. Payment Services contributed $732.8 million of the Company’s operating earnings in 2003, a 4.0 percent increase over 2002. Total net revenue was $2,316.7 million in 2003, a 1.5 percent decrease, compared with 2002. Net interest income decreased 7.6 percent in 2003, compared with 2002, primarily due to a reduction in customer late fees and lost interest revenue from the sale of two credit card portfolios. During late 2002, the Company sold two co-branded credit card portfolios, reducing year-over-year net interest income for this business line by approximately $29.3 million in 2003. Noninterest income increased .9 percent in 2003, compared with 2002. The increase in fee-based revenue in 2003 was driven by strong growth in credit card and debit card revenue and corporate payment product revenues, which was partially offset by a reduction in merchant processing and other revenue. The growth in credit and debit card revenue was muted somewhat by the $19.4 million impact of the debit card antitrust settlement by VISA USA and Mastercard which lowered interchange rates on signature debit transactions. Merchant processing revenue declined due to lower processing spreads resulting from changes in revenue-sharing associated with speciﬁc banking alliances and a change in the mix of merchants, which offset the favorable impact of increased transaction processing volumes. Other revenue in 2002 included $67.4 million related to the credit card portfolio sales. Noninterest expense was $752.0 million in 2003, a decrease of $36.4 million (4.6 percent), compared with 2002. The decrease in noninterest expense was primarily attributable to lower fraud losses and third-party merchant processing costs partially offset by increased marketing costs. Personnel cost increases attributable to higher processing volumes were more than offset by business line cost savings. The provision for credit losses was $412.7 million in 2003, a decrease of $43.7 million (9.6 percent), compared with 2002 due to lower net charge-offs of the business line. As a percentage of average loans, net charge-offs were 4.13 percent in 2003, compared with 4.52 percent of average loans in 2002. The favorable change in credit losses was due to improvements in ongoing collection efforts, risk management and the sale of two co-branded credit card portfolios during late 2002. Treasury and Corporate Support includes the Company’s investment portfolios, funding, capital management and asset securitization activities, interest rate risk management, the net effect of transfer pricing related to average balances and business activities managed on a corporate basis, including enterprise-wide operations and administrative support functions. Treasury and Corporate Support recorded operating losses of $382.5 million in 2003, an increase of 6.0 percent, compared with 2002. Total net revenue was $942.7 million in 2003, compared with total net revenue of $969.2 million in 2002. The year-over-year decline of $26.5 million (2.7 percent) in total net revenue in 2003 was attributable to a reduction in securities gains of $140.7 million partially offset by increases in net interest income of $102.8 million (17.3 percent) and noninterest income of $11.4 million (6.2 percent). The increase in net interest income was primarily attributable to the increase in average investment securities of $8.4 billion. Investment securities increased in 2003 compared with 2002, reﬂecting the reinvestment of proceeds from loan sales, declines in commercial loan balances and additional deposits assumed from acquisitions. Noninterest expense was $1,700.4 million in 2003, compared with $1,677.1 million in 2002. The $23.3 million increase (1.4 percent) year-over-year was primarily the result of higher costs associated with employee pension beneﬁts, corporate insurance, postage, telecommunications and charitable contributions. The provision for credit losses for this business unit represents the residual aggregate of the net credit losses allocated to the reportable business units and the Company’s recorded provision determined in accordance with accounting principles generally accepted in the United 58 U.S. Bancorp States. The provision for credit losses was a net recovery of $1.8 million in 2003, compared with a net recovery of $26.7 million in 2002. Refer to the ‘‘Corporate Risk Proﬁle’’ section for further information on the provision for credit losses, nonperforming assets and factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses. ACCOUNTING CHANGES Note 2 of the Notes to Consolidated Financial Statements discusses accounting standards recently issued or proposed but not yet required to be adopted and the expected impact of the changes in accounting standards. To the extent the adoption of new accounting standards affects the Company’s ﬁnancial condition, results of operations or liquidity, the impacts are discussed in the applicable section(s) of the Management’s Discussion and Analysis and the Notes to Consolidated Financial Statements. On January 8, 2004, the Company elected to adopt the ‘‘fair value’’ method of accounting for stock-based compensation. The Company implemented this accounting change utilizing the ‘‘retroactive restatement method,’’ requiring all prior periods to be restated to recognize compensation expense for the estimated fair value of all employee stock awards including stock options granted, modiﬁed or settled in ﬁscal years beginning after December 15, 1994. CRITICAL ACCOUNTING POLICIES The accounting and reporting policies of the Company comply with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The preparation of ﬁnancial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The ﬁnancial position and results of operations can be affected by these estimates and assumptions, which are integral to understanding the Company’s ﬁnancial statements. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s ﬁnancial condition and results, and require management to make estimates that are difﬁcult, subjective or complex. Most accounting policies are not considered by management to be critical accounting policies. Several factors are considered in determining whether or not a policy is critical in the preparation of ﬁnancial statements. These factors include, among other things, whether the estimates are signiﬁcant to the ﬁnancial statements, the nature of the estimates, the ability to readily validate the estimates with other information including third-parties or available prices, and sensitivity of the estimates to changes in economic conditions and whether alternative accounting methods may be utilized under generally accepted accounting principles. Management has discussed the development and the selection of critical accounting policies with the Company’s Audit Committee. Signiﬁcant accounting policies are discussed in Note 1 of the Notes to Consolidated Financial Statements. Those policies considered to be critical accounting policies are described below. Allowance for Credit Losses The allowance for credit losses is established to provide for probable losses inherent in the Company’s credit portfolio. The methods utilized to estimate the allowance for credit losses, key assumptions and quantitative and qualitative information considered by management in determining the adequacy of the allowance for credit losses are discussed in the ‘‘Credit Risk Management’’ section. Management’s evaluation of the adequacy of the allowance for credit losses is often the most critical of accounting estimates for a banking institution. It is a highly subjective process impacted by many factors as discussed throughout the Management’s Discussion and Analysis section of the Annual Report. Although risk management practices, methodologies and other tools are utilized to determine each element of the allowance, degrees of imprecision exist in these measurement tools due in part to subjective judgments involved and an inherent lagging of credit quality measurements relative to the stage of the business cycle. Even determining the stage of the business cycle is highly subjective. As discussed in the ‘‘Analysis and Determination of Allowance for Credit Losses’’ section, management considers the effect of imprecision and many other factors in determining the allowance for credit losses by establishing an ‘‘allowance for other factors’’ that is not speciﬁcally allocated to a category of loans. If not considered, inherent losses in the portfolio related to imprecision and other subjective factors could have a dramatic adverse impact on the liquidity and ﬁnancial viability of a bank. Given the many subjective factors affecting the credit portfolio, changes in the allowance for other factors may not directly coincide with changes in the risk ratings of the credit portfolio reﬂected in the risk rating process. This is in part due to the timing of the risk rating process in relation to changes in the business cycle, the exposure and mix of loans within risk rating categories, levels of nonperforming loans and the timing of charge-offs and recoveries. For example, the amount of loans within speciﬁc risk ratings may change, providing a leading indicator of improving credit quality, while nonperforming loans and net charge- offs continue at elevated levels. Because the allowance speciﬁcally allocated to commercial loans is primarily driven by risk ratings and loss ratios determined through migration U.S. Bancorp 59 analysis and historical performance, the amount of the allowance for commercial and commercial real estate loans might decline. However, it is likely that management would maintain an adequate allowance for credit losses by increasing the allowance for other factors at a stage in the business cycle that is uncertain and when nonperforming asset levels remain elevated. Sensitivity analysis to the many factors impacting the allowance for credit losses is difﬁcult. Some factors are quantiﬁable while other factors require qualitative judgment. Management conducts analysis with respect to the accuracy of risk ratings and the volatility of inherent loss rates applied to risk categories and utilizes the results of this analysis to determine retail loss projections. This analysis is then considered in determining the level of the allowance for credit losses. Refer to the ‘‘Analysis and Determination of the Allowance for Credit Losses’’ section for further information. Asset Impairment In the ordinary course of business, the Company evaluates the carrying value of its assets for potential impairment. Generally, potential impairment is determined based on a comparison of fair value to the carrying value. The determination of fair value can be highly subjective, especially for assets that are not actively traded or when market-based prices are not available. The Company estimates fair value based on the present value of estimated future cash ﬂows. The initial valuation and subsequent impairment tests may require the use of signiﬁcant management estimates. Additionally, determining the amount, if any, of an impairment may require an assessment of whether or not a decline in an asset’s estimated fair value below the recorded value is temporary in nature. While impairment assessments impact most asset categories, the following areas are considered to be critical accounting matters in relation to the ﬁnancial statements. Mortgage Servicing Rights MSRs are capitalized as separate assets when loans are sold and servicing is retained. The total cost of loans sold is allocated between the loans sold and the servicing assets retained based on their relative fair values. MSRs that are purchased from others are initially recorded at cost. The carrying value of the MSRs is amortized in proportion to and over the period of estimated net servicing revenue and recorded in noninterest expense as amortization of intangible assets. The carrying value of these assets is periodically reviewed for impairment using a lower of carrying value or fair value methodology. For purposes of measuring impairment, the servicing rights are stratiﬁed based on the underlying loan type and note rate and the carrying value for each stratum is compared to fair value based on a discounted cash ﬂow analysis, utilizing current prepayment speeds and discount rates. Events that may signiﬁcantly affect the estimates used are changes in interest rates and the related impact on mortgage loan prepayment speeds and the payment performance of the underlying loans. If the carrying value is greater than fair value, impairment is recognized through a valuation allowance for each impaired stratum and recorded as amortization of intangible assets. The changes in the fair value of MSRs at December 31, 2003, to immediate 25 and 50 basis point adverse changes in interest rates would be approximately $78 million and $127 million, respectively. An upward movement in interest rates at December 31, 2003, of 25 and 50 basis points would increase the value of the MSRs by approximately $75 million and $133 million, respectively. Refer to Note 11 of the Notes to Consolidated Financial Statements for additional information regarding MSRs. Goodwill and Other Intangibles The Company records all assets and liabilities acquired in purchase acquisitions, including goodwill and other intangibles, at fair value as required by Statement of Financial Accounting Standards No. 141, ‘‘Goodwill and Other Intangible Assets.’’ Goodwill and indeﬁnite-lived assets are no longer amortized but are subject, at a minimum, to annual tests for impairment. Under certain situations, interim impairment tests may be required if events occur or circumstances change that would more likely than not reduce the fair value of a reporting segment below its carrying amount. Other intangible assets are amortized over their estimated useful lives using straight-line and accelerated methods and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount. The initial recognition of goodwill and other intangible assets and subsequent impairment analysis require management to make subjective judgments concerning estimates of how the acquired assets will perform in the future using valuation methods including discounted cash ﬂow analysis. Additionally, estimated cash ﬂows may extend beyond ten years and, by their nature, are difﬁcult to determine over an extended timeframe. Events and factors that may signiﬁcantly affect the estimates include, among others, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures and technology, changes in discount rates and speciﬁc industry and market conditions. In determining the reasonableness of cash ﬂow estimates, the Company reviews historical performance of the underlying assets or similar assets in an effort to assess and validate assumptions utilized in its estimates. In assessing the fair value of reporting units, the Company may consider the stage of the current business cycle and potential changes in market conditions in estimating the timing and extent of future cash ﬂows. Also, management often utilizes other information to validate the 60 U.S. Bancorp reasonableness of its valuations including public market comparables, multiples of recent mergers and acquisitions of similar businesses. Valuation multiples may be based on revenue, price-to-earnings and tangible capital ratios of comparable public companies and business segments. These multiples may be adjusted to consider competitive differences including size, operating leverage and other factors. The carrying amount of a reporting unit is determined based on the capital required to support the reporting unit’s activities including its tangible and intangible assets. The determination of a reporting unit’s capital allocation requires management judgment and considers many factors including the regulatory capital regulations and capital characteristics of comparable public companies in relevant industry sectors. In certain circumstances, management will engage a third-party to independently validate its assessment of the fair value of its business segments. The Company’s annual assessment of potential goodwill impairment was completed during the second quarter of 2003. Based on the results of this assessment, no goodwill impairment was recognized. DISCLOSURE CONTROLS AND PROCEDURES Under the supervision and with the participation of the Company’s management, including its principal executive ofﬁcer and principal ﬁnancial ofﬁcer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as deﬁned in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the ‘‘Exchange Act’’)). Based upon this evaluation, the principal executive ofﬁcer and principal ﬁnancial ofﬁcer have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in reports that it ﬁles or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods speciﬁed in Securities and Exchange Commission rules and forms. During the most recently completed ﬁscal quarter, there was no change made in the Company’s internal controls over ﬁnancial reporting (as deﬁned in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over ﬁnancial reporting. U.S. Bancorp 61 U.S. Bancorp Consolidated Balance Sheet At December 31 (Dollars in Millions) Assets Cash and due from banks ****************************************************************************** Investment securities Held-to-maturity (fair value $161 and $240, respectively) ************************************************ Available-for-sale *********************************************************************************** Loans held for sale ************************************************************************************ Loans Commercial**************************************************************************************** Commercial real estate****************************************************************************** Residential mortgages ****************************************************************************** Retail ********************************************************************************************* Total loans ************************************************************************************* Less allowance for credit losses *************************************************************** Net loans *********************************************************************************** Premises and equipment ******************************************************************************* Customers’ liability on acceptances ********************************************************************** Goodwill ********************************************************************************************** Other intangible assets ********************************************************************************* Other assets ****************************************************************************************** 2003 2002 $ 8,630 $ 10,758 152 43,182 1,433 38,526 27,242 13,457 39,010 118,235 (2,369) 115,866 1,957 121 6,025 2,124 9,796 233 28,255 4,159 41,944 26,867 9,746 37,694 116,251 (2,422) 113,829 1,697 140 6,325 2,321 12,310 Total assets ************************************************************************************ $189,286 $180,027 Liabilities and Shareholders’ Equity Deposits Noninterest-bearing ********************************************************************************* Interest-bearing ************************************************************************************ Time deposits greater than $100,000 ***************************************************************** Total deposits *********************************************************************************** Short-term borrowings********************************************************************************** Long-term debt **************************************************************************************** Company-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely the junior subordinated debentures of the parent company ******************************************************* Acceptances outstanding ******************************************************************************* Other liabilities **************************************************************************************** $ 32,470 74,749 11,833 119,052 10,850 31,215 2,601 121 6,205 $ 35,106 68,214 12,214 115,534 7,806 28,588 2,994 140 6,529 Total liabilities *********************************************************************************** 170,044 161,591 Shareholders’ equity Common stock, par value $0.01 a share — authorized: 4,000,000,000 shares issued: 2003 — 1,972,643,007 shares; 2002 — 1,972,643,060 shares ********************************* Capital surplus ************************************************************************************* Retained earnings ********************************************************************************** Less cost of common stock in treasury: 2003 — 49,722,856 shares; 2002 — 55,686,500 shares************* Other comprehensive income ************************************************************************ Total shareholders’ equity ************************************************************************ 20 5,851 14,508 (1,205) 68 19,242 20 5,799 13,105 (1,272) 784 18,436 Total liabilities and shareholders’ equity ************************************************************ $189,286 $180,027 See Notes to Consolidated Financial Statements. 62 U.S. Bancorp U.S. Bancorp Consolidated Statement of Income Year Ended December 31 (Dollars and Shares in Millions, Except Per Share Data) 2003 2002 2001 Interest Income Loans********************************************************************************* Loans held for sale ********************************************************************* Investment securities Taxable **************************************************************************** Non-taxable ************************************************************************ Other interest income ******************************************************************* Total interest income ************************************************************* Interest Expense Deposits ****************************************************************************** Short-term borrowings ****************************************************************** Long-term debt ************************************************************************ Company-obligated mandatorily redeemable preferred securities***************************** Total interest expense ************************************************************ Net interest income********************************************************************* Provision for credit losses *************************************************************** Net interest income after provision for credit losses **************************************** Noninterest Income Credit and debit card revenue *********************************************************** Corporate payment products revenue ***************************************************** ATM processing services**************************************************************** Merchant processing services *********************************************************** Trust and investment management fees*************************************************** Deposit service charges **************************************************************** Treasury management fees************************************************************** Commercial products revenue *********************************************************** Mortgage banking revenue ************************************************************** Investment products fees and commissions *********************************************** Securities gains, net ******************************************************************** Merger and restructuring-related gains**************************************************** Other ********************************************************************************* Total noninterest income ********************************************************** Noninterest Expense Compensation ************************************************************************* Employee beneﬁts********************************************************************** Net occupancy and equipment*********************************************************** Professional services ******************************************************************* Marketing and business development ***************************************************** Technology and communications ********************************************************* Postage, printing and supplies *********************************************************** Goodwill ****************************************************************************** Other intangibles *********************************************************************** Merger and restructuring-related charges ************************************************* Other ********************************************************************************* Total noninterest expense ********************************************************* Income from continuing operations before income taxes ************************************ Applicable income taxes **************************************************************** Income from continuing operations ******************************************************* Income (loss) from discontinued operations (after-tax) *********************************** Cumulative effect of accounting change (after-tax) ************************************** Net income **************************************************************************** Earnings Per Share Income from continuing operations **************************************************** Discontinued operations ************************************************************* Cumulative effect of accounting change *********************************************** Net income************************************************************************* Diluted Earnings Per Share Income from continuing operations **************************************************** Discontinued operations ************************************************************* Cumulative effect of accounting change *********************************************** Net income************************************************************************* Dividends declared per share************************************************************ Average common shares **************************************************************** Average diluted common shares ********************************************************* See Notes to Consolidated Financial Statements. $7,272.0 202.2 $7,743.0 170.6 1,654.6 29.4 99.8 9,258.0 1,096.6 166.8 702.2 103.1 2,068.7 7,189.3 1,254.0 5,935.3 560.7 361.3 165.9 561.4 953.9 715.8 466.3 400.5 367.1 144.9 244.8 — 370.4 1,438.2 46.1 96.0 9,493.9 1,485.3 222.9 834.8 136.6 2,679.6 6,814.3 1,349.0 5,465.3 517.0 325.7 160.6 567.3 892.1 690.3 416.9 479.2 330.2 132.7 299.9 — 398.8 $9,413.7 146.9 1,206.1 89.5 90.2 10,946.4 2,828.1 475.6 1,164.2 127.8 4,595.7 6,350.7 2,528.8 3,821.9 465.9 297.7 153.0 308.9 887.8 644.9 347.3 437.4 234.0 130.8 329.1 62.2 370.4 5,313.0 5,210.7 4,669.4 2,176.8 328.4 643.7 143.4 180.3 417.4 245.6 — 682.4 46.2 732.7 5,596.9 5,651.4 1,941.3 3,710.1 22.5 — 2,167.5 317.5 658.7 129.7 171.4 392.1 243.2 — 553.0 321.2 786.2 5,740.5 4,935.5 1,707.5 3,228.0 (22.7) (37.2) 2,036.6 285.5 666.6 116.4 178.0 353.9 241.9 236.7 278.4 1,044.8 710.2 6,149.0 2,342.3 818.3 1,524.0 (45.2) — $3,732.6 $3,168.1 $1,478.8 $ $ $ $ $ 1.93 .01 — 1.94 1.92 .01 — 1.93 .855 $ $ $ $ $ 1.68 (.01) (.02) 1.65 1.68 (.01) (.02) 1.65 .780 $ $ $ $ $ .79 (.02) — .77 .79 (.03) — .76 .750 1,923.7 1,936.2 1,916.0 1,924.8 1,927.9 1,940.3 U.S. Bancorp 63 U.S. Bancorp Consolidated Statement of Shareholders’ Equity Common Shares Outstanding Common Stock Capital Surplus Retained Earnings Other Treasury Comprehensive Income Stock Total Shareholders’ Equity 1,902,083,434 $19 $4,275 430 $11,658 (265) 1,479 $ (880) $ 96 (Dollars in Millions) Balance December 31, 2000 ************ Cumulative impact of retroactive restatement*** Net income ******************************** Unrealized gain on securities available for sale *** Unrealized gain on derivatives**************** Foreign currency translation adjustment ******* Realized gain on derivatives ***************** Reclassiﬁcation adjustment for gains realized in net income ******************************* Income taxes ******************************* Total comprehensive income *********** Cash dividends declared on common stock **** Issuance of common stock and treasury shares ** Purchase of treasury stock******************* Retirement of treasury stock ***************** Stock option grants and restricted stock amortization ****************************** Shares reserved to meet deferred 194 106 (4) 42 (333) (6) 49 (468) 824 (3) $15,168 165 1,479 194 106 (4) 42 (333) (6) 1,478 (1,447) 1,434 (468) — 415 — 69,502,689 (19,743,672) 1 1,384 (1,447) (824) 415 3 compensation obligations ****************** (132,939) Balance December 31, 2001 ************ 1,951,709,512 $20 $5,683 $11,425 $ (478) $ 95 $16,745 Net income ******************************** Unrealized gain on securities available for sale *** Unrealized gain on derivatives**************** Foreign currency translation adjustment ******* Realized gain on derivatives ***************** Reclassiﬁcation adjustment for gains realized in net income ******************************* Income taxes ******************************* Total comprehensive income *********** Cash dividends declared on common stock **** Issuance of common stock and treasury shares ** Purchase of treasury stock******************* Stock option grants and restricted stock amortization ****************************** Shares reserved to meet deferred 10,589,034 (45,256,736) compensation obligations ****************** (85,250) 3,168 (1,488) (75) 188 3 249 (1,040) (3) 1,048 324 7 64 (332) (422) 3,168 1,048 324 7 64 (332) (422) 3,857 (1,488) 174 (1,040) 188 — Balance December 31, 2002 ************ 1,916,956,560 $20 $5,799 $13,105 $(1,272) $ 784 $18,436 Net income ******************************** Unrealized loss on securities available for sale *** Unrealized loss on derivatives **************** Foreign currency translation adjustment ******* Realized gain on derivatives ***************** Reclassiﬁcation adjustment for gains realized in net income ******************************* Income taxes ******************************* Total comprehensive income *********** Cash dividends declared on common stock **** Special dividend-Piper Jaffray spin-off ********* Issuance of common stock and treasury shares ** Purchase of treasury stock******************* Stock option grants and restricted stock amortization ****************************** Shares reserved to meet deferred 21,709,297 (14,971,000) compensation obligations ****************** (774,706) 3,733 (1,645) (685) (51) 111 (8) 502 (417) (18) (716) (373) 23 199 (288) 439 3,733 (716) (373) 23 199 (288) 439 3,017 (1,645) (685) 451 (417) 111 (26) Balance December 31, 2003 ************ 1,922,920,151 $20 $5,851 $14,508 $(1,205) $ 68 $19,242 See Notes to Consolidated Financial Statements. 64 U.S. Bancorp U.S. Bancorp Consolidated Statement of Cash Flows Year Ended December 31 (Dollars in Millions) 2003 2002 2001 Operating Activities Net income ************************************************************************** Adjustments to reconcile net income to net cash provided by operating activities Provision for credit losses ********************************************************** Depreciation and amortization of premises and equipment ***************************** Amortization of goodwill and other intangibles **************************************** Provision for deferred income taxes ************************************************* (Gain) loss on sales of securities and other assets, net******************************** Mortgage loans originated for sale in the secondary market, net of repayments ********** Proceeds from sales of mortgage loans********************************************** Stock-based compensation ********************************************************* Other, net ************************************************************************ $ 3,732.6 $ 3,168.1 $ 1,478.8 1,254.0 275.2 682.4 272.7 (300.4) (27,665.8) 30,228.4 123.4 79.7 1,349.0 285.3 553.0 291.7 (411.1) (22,567.9) 20,756.6 113.3 248.3 2,528.8 284.0 515.1 (296.1) (428.7) (15,500.2) 13,483.0 227.7 (110.5) Net cash provided by (used in) operating activities ********************************* 8,682.2 3,786.3 2,181.9 Investing Activities Proceeds from sales of investment securities ******************************************** Proceeds from maturities of investment securities **************************************** Purchases of investment securities ***************************************************** Net (increase) decrease in loans outstanding ******************************************** Proceeds from sales of loans ********************************************************** Purchases of loans ******************************************************************* Proceeds from sales of premises and equipment***************************************** Purchases of premises and equipment************************************************** Acquisitions, net of cash acquired ****************************************************** Divestitures ************************************************************************** Other, net *************************************************************************** 17,383.3 18,139.9 (51,127.3) (4,193.3) 2,203.7 (944.3) 39.7 (670.1) — (381.8) 124.7 14,386.9 11,246.5 (26,469.8) (4,111.3) 2,219.1 (240.2) 211.8 (429.8) 1,368.8 — (126.1) 19,240.2 4,572.2 (32,278.6) 2,532.3 3,729.1 (87.5) 166.3 (299.2) (741.4) (340.0) (143.9) Net cash provided by (used in) investing activities ********************************* (19,425.5) (1,944.1) (3,650.5) Financing Activities Net increase (decrease) in deposits **************************************************** Net increase (decrease) in short-term borrowings **************************************** Principal payments on long-term debt*************************************************** Proceeds from issuance of long-term debt ********************************************** Proceeds from issuance of Company-obligated mandatorily redeemable preferred securities ** Redemption of Company-obligated mandatorily redeemable preferred securities ************* Proceeds from issuance of common stock*********************************************** Repurchase of common stock ********************************************************* Cash dividends paid ****************************************************************** Net cash provided by (used in) ﬁnancing activities ********************************* Change in cash and cash equivalents ******************************************** Cash and cash equivalents at beginning of year ***************************************** 3,449.0 3,869.5 (8,617.9) 11,467.5 — (350.0) 398.4 (326.3) (1,556.8) 8,333.4 (2,409.9) 11,192.1 7,002.3 (7,307.0) (8,367.5) 10,650.9 — — 147.0 (1,040.4) (1,480.7) (395.4) 1,446.8 9,745.3 (4,258.1) 5,244.3 (10,539.6) 11,702.3 1,500.0 — 136.4 (467.9) (1,235.1) 2,082.3 613.7 9,131.6 Cash and cash equivalents at end of year **************************************** $ 8,782.2 $ 11,192.1 $ 9,745.3 See Notes to Consolidated Financial Statements. U.S. Bancorp 65 Notes to Consolidated Financial Statements Note 1 Signiﬁcant Accounting Policies U.S. Bancorp and its subsidiaries (the ‘‘Company’’) is a multi-state ﬁnancial services holding company headquartered in Minneapolis, Minnesota. The Company provides a full range of ﬁnancial services including lending and depository services through banking ofﬁces principally in 24 states. The Company also engages in credit card, merchant, and ATM processing, mortgage banking, insurance, trust and investment management, brokerage, and leasing activities principally in domestic markets. Basis of Presentation The consolidated ﬁnancial statements include the accounts of the Company and its subsidiaries. The consolidation eliminates all signiﬁcant intercompany accounts and transactions. Certain items in prior periods have been reclassiﬁed to conform to the current presentation. The consolidated ﬁnancial statements have been retroactively restated due to the adoption of the fair value method of accounting for stock-based compensation as described in Note 2 and to report the results of Piper Jaffray Companies as discontinued operations as described in Note 4 of the Notes to Consolidated Financial Statements. Uses of Estimates The preparation of ﬁnancial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the ﬁnancial statements and accompanying notes. Actual experience could differ from those estimates. Payment Services includes consumer and business credit cards, corporate and purchasing card services, ATM processing, merchant processing and debit cards. Customized products and services, coupled with cutting- edge technology are provided to consumer and business customers, government clients, correspondent ﬁnancial institutions, merchants and co-brand partners. Treasury and Corporate Support includes the Company’s investment portfolios, funding, capital management and asset securitization activities, interest rate risk management, the net effect of transfer pricing related to average balances, and the change in residual allocations associated with the provision for loan losses. It also includes business activities managed on a corporate basis, including income and expense of enterprise-wide operations and administrative support functions. Segment Results Accounting policies for the lines of business are the same as those used in preparation of the consolidated ﬁnancial statements with respect to activities speciﬁcally attributable to each business line. However, the preparation of business line results requires management to establish methodologies to allocate funding costs and beneﬁts, expenses and other ﬁnancial elements to each line of business. For details of these methodologies and segment results, see ‘‘Basis for Financial Presentation’’ and Table 22 ‘‘Line of Business Financial Performance’’ included in Management’s Discussion and Analysis which is incorporated by reference into these Notes to Consolidated Financial Statements. BUSINESS SEGMENTS SECURITIES Within the Company, ﬁnancial performance is measured by major lines of business based on the products and services provided to customers through its distribution channels. The Company has ﬁve reportable operating segments: Wholesale Banking offers lending, depository, treasury management and other ﬁnancial services to middle market, large corporate and public sector clients. Consumer Banking delivers products and services to the broad consumer market and small businesses through banking ofﬁces, telemarketing, on-line services, direct mail and automated teller machines (‘‘ATMs’’). Private Client, Trust and Asset Management provides trust, private banking, ﬁnancial advisory, investment management and mutual fund processing services to afﬂuent individuals, businesses, institutions and mutual funds. Realized gains or losses on securities are determined on a trade date basis based on the speciﬁc carrying value of the investments being sold. Trading Securities Debt and equity securities held for resale are classiﬁed as trading securities and reported at fair value. Realized gains or losses are reported in noninterest income. Available-for-sale Securities These securities are not trading securities but may be sold before maturity in response to changes in the Company’s interest rate risk proﬁle, funding needs or demand for collateralized deposits by public entities. Available-for-sale securities are carried at fair value with unrealized net gains or losses reported within other comprehensive income in shareholders’ equity. When sold, the amortized cost of the speciﬁc securities is used to compute the gain or loss. Declines in fair value that 66 U.S. Bancorp are deemed other than temporary, if any, are reported in noninterest income. are disclosed as off-balance sheet ﬁnancial instruments in Note 23 in the Notes to Consolidated Financial Statements. Held-to-maturity Securities Debt securities for which the Company has the positive intent and ability to hold to maturity are reported at historical cost adjusted for amortization of premiums and accretion of discounts. Declines in fair value that are deemed other than temporary, if any, are reported in noninterest income. Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to Repurchase Securities purchased under agreements to resell and securities sold under agreements to repurchase are generally accounted for as collateralized ﬁnancing transactions and are recorded at the amounts at which the securities were acquired or sold, plus accrued interest. Securities pledged as collateral under these ﬁnancing arrangements cannot be sold or repledged by the secured party. The fair value of collateral received is continually monitored and additional collateral obtained or requested to be returned to the Company as deemed appropriate. EQUITY INVESTMENTS IN OPERATING ENTITIES Equity investments in public entities in which ownership is less than 20 percent are accounted for as available-for-sale securities and carried at fair value. Similar investments in private entities are accounted for using the cost method. Investments in entities where ownership interest is between 20 percent and 50 percent are accounted for using the equity method with the exception of limited partnerships and limited liability companies where an ownership interest of greater than 5 percent requires the use of the equity method. If the Company has a voting interest greater than 50 percent, the consolidation method is used. All equity investments are evaluated for impairment at least annually and more frequently if certain criteria are met. LOANS Loans are reported net of unearned income. Interest income is accrued on the unpaid principal balances as earned. Loan and commitment fees and certain direct loan origination costs are deferred and recognized over the life of the loan and/or commitment period as yield adjustments. Commitments to Extend Credit Unfunded residential mortgage loan commitments entered into in connection with mortgage banking activities are considered derivatives and recorded on the balance sheet at fair value with changes in fair value recorded in income. All other unfunded loan commitments are generally related to providing credit facilities to customers of the bank and are not actively traded ﬁnancial instruments. These unfunded commitments Allowance for Credit Losses Management determines the adequacy of the allowance based on evaluations of the loan portfolio, recent loss experience, and other pertinent factors, including economic conditions. This evaluation is inherently subjective as it requires estimates, including amounts of future cash collections expected on nonaccrual loans, which may be susceptible to signiﬁcant change. The allowance for credit losses relating to impaired loans is based on the loan’s observable market price, the collateral for certain collateral-dependent loans, or the discounted cash ﬂows using the loan’s effective interest rate. The Company determines the amount of the allowance required for certain sectors based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on quarterly reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for homogeneous consumer loans is based on an analysis of product mix, risk characteristics of the portfolio, bankruptcy experiences, and historical losses, adjusted for current trends, for each homogenous category or group of loans. The allowance is increased through provisions charged to operating earnings and reduced by net charge-offs. The Company also assesses the credit risk associated with off-balance sheet loan commitments and letters of credit and determines the appropriate amount of credit loss liability that should be recorded. The liability for off- balance sheet credit exposure related to loan commitments is included in the allowance for loan losses. Nonaccrual Loans Generally commercial loans (including impaired loans) are placed on nonaccrual status when the collection of interest or principal has become 90 days past due or is otherwise considered doubtful. When a loan is placed on nonaccrual status, unpaid interest is reversed. Future interest payments are generally applied against principal. Revolving consumer lines and credit cards are charged off by 180 days past due and closed-end consumer loans other than loans secured by 1-4 family properties are charged off at 120 days past due and are, therefore, generally not placed on nonaccrual status. Impaired Loans A loan is considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due (both interest and principal) according to the contractual terms of the loan agreement. Restructured Loans In cases where a borrower experiences ﬁnancial difﬁculties and the Company makes certain concessionary modiﬁcations to contractual terms, the loan is U.S. Bancorp 67 classiﬁed as a restructured loan. Loans restructured at a rate equal to or greater than that of a new loan with comparable risk at the time the contract is modiﬁed may be excluded from restructured loans in the calendar years subsequent to the restructuring if they are in compliance with the modiﬁed terms. Generally, a nonaccrual loan that is restructured remains on nonaccrual for a period of six months to demonstrate that the borrower can meet the restructured terms. However, performance prior to the restructuring, or signiﬁcant events that coincide with the restructuring, are considered in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of restructuring or after a shorter performance period. If the borrower’s ability to meet the revised payment schedule is not reasonably assured, the loan remains classiﬁed as a nonaccrual loan. Leases The Company engages in both direct and leveraged lease ﬁnancing. The net investment in direct ﬁnancing leases is the sum of all minimum lease payments and estimated residual values, less unearned income. Unearned income is added to interest income over the terms of the leases to produce a level yield. The investment in leveraged leases is the sum of all lease payments (less nonrecourse debt payments) plus estimated residual values, less unearned income. Income from leveraged leases is recognized over the term of the leases based on the unrecovered equity investment. Residual values on leased assets are reviewed regularly for other than temporary impairment. Residual valuations for retail automobile leases are based on independent assessments of expected used car sales prices at the end-of- term. Impairment tests are conducted based on these valuations considering the probability of the lessee returning the asset to the Company, re-marketing efforts, insurance coverage and ancillary fees and costs. Valuations for commercial leases are based upon external or internal management appraisals. When there is other than temporary impairment in the estimated fair value of the Company’s interest in the residual value of a leased asset, the carrying value is reduced to the estimated fair value with the writedown recognized in the current period in commercial products revenue or other noninterest income. Loans Held for Sale Loans held for sale (‘‘LHFS’’) represent mortgage loan originations intended to be sold in the secondary market and other loans that management has an active plan to sell. LHFS are carried at the lower of cost or market value as determined on an aggregate basis by type of loan. In the event management decides to sell loans receivable, the loans are transferred at the lower of cost or fair value. The Interagency Guidance on Certain Loans Held for Sale, dated March 26, 2001, requires loans transferred to LHFS to be marked-to-market (‘‘MTM’’) at the time of transfer. MTM losses related to the sale/transfer of non-homogeneous loans that are predominantly credit- related are reﬂected in charge-offs. With respect to homogeneous loans, the amount of ‘‘probable’’ credit loss determined in accordance with Statement of Financial Accounting Standards No. 5 (‘‘SFAS 5’’), ‘‘Accounting for Contingencies,’’ methodologies utilized to determine the speciﬁc allowance allocation for the portfolio is also included in charge-offs. Any incremental loss determined in accordance with MTM accounting, that includes consideration of other factors such as estimates of future losses, is reported separately from charge-offs as a reduction to the allowance for credit losses. Subsequent decreases in fair value are recognized in noninterest income. Other Real Estate Other real estate (‘‘ORE’’), which is included in other assets, is property acquired through foreclosure or other proceedings. ORE is carried at fair value, less estimated selling costs. The property is evaluated regularly and any decreases in the carrying amount are included in noninterest expense. DERIVATIVE FINANCIAL INSTRUMENTS In the ordinary course of business, the Company enters into derivative transactions to manage its interest rate and prepayment risk and to accommodate the business requirements of its customers. All derivative instruments are recorded as either assets or liabilities at fair value. Subsequent changes in a derivative’s fair value are recognized currently in earnings unless speciﬁc hedge accounting criteria are met. All derivative instruments that qualify for hedge accounting are recorded at fair value and classiﬁed either as a hedge of the fair value of a recognized asset or liability (‘‘fair value’’ hedge) or as a hedge of the variability of cash ﬂows to be received or paid related to a recognized asset or liability or a forecasted transaction (‘‘cash ﬂow’’ hedge). Changes in the fair value of a derivative that is highly effective and designated as a fair value hedge and the offsetting changes in the fair value of the hedged item are recorded in income. Changes in the fair value of a derivative that is highly effective and designated as a cash ﬂow hedge are recognized in other comprehensive income until income from the cash ﬂows of the hedged item is recognized. The Company performs an assessment, both at the inception of the hedge and on a quarterly basis thereafter, when required, to determine whether these derivatives are highly effective in offsetting changes in the value of the hedged items. Any change in fair value resulting from hedge ineffectiveness is immediately recorded in noninterest income. 68 U.S. Bancorp If a derivative designated as a hedge is terminated or ceases to be highly effective, the gain or loss is amortized to earnings over the remaining life of the hedged asset or liability (fair value hedge) or over the same period(s) that the forecasted hedged transactions impact earnings (cash ﬂow hedge). If the hedged item is disposed of, or the forecasted transaction is no longer probable, the derivative is recorded at fair value with any resulting gain or loss included in the gain or loss from the disposition of the hedged item or, in the case of a forecasted transaction that is no longer probable, included in earnings immediately. OTHER SIGNIFICANT POLICIES Intangible Assets The price paid over the net fair value of the acquired businesses (‘‘goodwill’’) is not amortized. Other intangible assets are amortized over their estimated useful lives, using straight-line and accelerated methods. The recoverability of goodwill and other intangible assets is evaluated annually, at a minimum, or on an interim basis if events or circumstances indicate a possible inability to realize the carrying amount. The evaluation includes assessing the estimated fair value of the intangible asset based on market prices for similar assets, where available, and the present value of the estimated future cash ﬂows associated with the intangible asset. Income Taxes Deferred taxes are recorded to reﬂect the tax consequences on future years of differences between the tax bases of assets and liabilities and the ﬁnancial reporting amounts at each year-end. Mortgage Servicing Rights Mortgage servicing rights (‘‘MSRs’’) are capitalized as separate intangible assets when loans are sold and servicing is retained. The total cost of loans sold is allocated between the loans sold and the servicing assets retained based on their relative fair values. MSRs that are purchased from others are initially recorded at cost. The carrying value of the MSRs is amortized in proportion to, and over the period of, estimated net servicing revenue and recorded in noninterest expense as amortization of intangible assets. The carrying value of these assets is periodically reviewed for impairment using a lower of carrying value or fair value methodology. For purposes of measuring impairment, the servicing rights are stratiﬁed based on the underlying loan type and note rate and the carrying value of each stratum is compared to fair value based on a discounted cash ﬂow analysis, utilizing current prepayment speeds and discount rates. Events that may signiﬁcantly affect the estimates used are changes in interest rates and the related impact on mortgage loan prepayment speed and the payment performance of the underlying loans. If the carrying value is greater than fair value, impairment is recognized through a valuation allowance for each impaired stratum and recorded as amortization of intangible assets. The valuation allowance is adjusted each subsequent period to reﬂect any increase or decrease in the indicated impairment. The Company reviews mortgage servicing rights for other-than-temporary impairment each quarter and recognizes a direct write-down when the recoverability of a recorded valuation allowance is determined to be remote. In determining whether other- than-temporary impairment has taken place, the Company considers both historical and projected trends in pay off activity and the potential for impairment recovery. Unlike a valuation allowance, a direct write-down permanently reduces the carrying value of the mortgage servicing rights, precluding subsequent reversals. Pensions For purposes of its retirement plans, the Company utilizes a measurement date of September 30. At the measurement date, plan assets are determined based on fair value, generally representing observable market prices. The actuarial cost method used to compute the pension liabilities and related expense is the projected unit credit method. In essence, the projected beneﬁt obligation is determined based on the present value of projected beneﬁt distributions at an assumed discount rate. The discount rate utilized is based on match-funding maturities and interest payments of high quality corporate bonds available in the market place to projected cash ﬂows as of the measurement date for future beneﬁt payments. 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. Pension accounting reﬂects the long-term nature of beneﬁt obligations and the investment horizon of plan assets and can have 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. Premises and Equipment Premises and equipment are stated at cost less accumulated depreciation and depreciated primarily on a straight-line basis over the estimated life of the assets. Estimated useful lives range up to 40 years for newly constructed buildings and from 3 to 20 years for furniture and equipment. Capitalized leases, less accumulated amortization, are included in premises and equipment. The lease obligations U.S. Bancorp 69 are included in long-term debt. Capitalized leases are amortized on a straight-line basis over the lease term and the amortization is included in depreciation expense. Statement of Cash Flows For purposes of reporting cash ﬂows, cash and cash equivalents include cash and money market investments, deﬁned as interest-bearing amounts due from banks, federal funds sold and securities purchased under agreements to resell. Stock-Based Compensation The Company grants stock awards including restricted stock and options to purchase common stock of the Company. Stock option grants are for a ﬁxed number of shares to employees and directors with an exercise price equal to the fair value of the shares at the date of grant. The Company recognizes stock-based compensation in its results of operations utilizing the fair value method under Statement of Financial Accounting Standard No. 123, ‘‘Accounting for Stock-Based Compensation’’ (‘‘SFAS 123’’). Stock-based compensation is recognized using an accelerated method of amortization for awards with graded vesting features and on a straight-line basis for awards with cliff vesting. The amortization of stock-based compensation reﬂects estimated forfeitures adjusted for actual forfeiture experience. As compensation expense is recognized, a deferred tax is recorded that represents an estimate of the future tax deduction from exercise or release of restrictions. At the time stock options are exercised, cancelled or expire, the Company may be required to recognize an adjustment to tax expense. Per Share Calculations Earnings per share is calculated by dividing net income by the weighted average number of common shares outstanding during the year. Diluted earnings per share is calculated by adjusting income and outstanding shares, assuming conversion of all potentially dilutive securities, using the treasury stock method. All per share amounts have been restated for stock splits. Note 2 Accounting Changes Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity In May 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 150 (‘‘SFAS 150’’), ‘‘Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,’’ which establishes standards for how an issuer classiﬁes and measures certain ﬁnancial instruments with characteristics of both liabilities and equity. The Company adopted SFAS 150 for ﬁnancial instruments entered into or modiﬁed after May 31, 2003, and adopted for all other ﬁnancial instruments as of July 1, 2003. The adoption of SFAS 150 did not have a material impact on the Company’s ﬁnancial instruments. Derivative Instruments and Hedging Activities In April 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 149 (‘‘SFAS 149’’), ‘‘Amendment of Statement 133 on Derivative Instruments and Hedging Activities,’’ which amends and clariﬁes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under Statement of Financial Accounting Standards No. 133 (‘‘SFAS 133’’), ‘‘Accounting for Derivative Instruments and Hedging Activities.’’ In particular, SFAS 149 clariﬁes under what circumstances a contract with an initial net investment meets the characteristic of a derivative and clariﬁes when a derivative contains a ﬁnancing component. SFAS 149 is generally effective for contracts entered into or modiﬁed after June 30, 2003. The adoption of SFAS 149 did not have a material impact on the Company’s ﬁnancial statements. Consolidation of Variable Interest Entities In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46 (revised December 2003) (‘‘FIN 46’’), ‘‘Consolidation of Variable Interest Entities’’ (‘‘VIEs’’), an interpretation of Accounting Research Bulletin No. 51, ‘‘Consolidated Financial Statements,’’ to improve ﬁnancial reporting of special purpose and other entities. The interpretation requires the consolidation of entities in which an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other ﬁnancial interests in the entity. Prior to the issuance of FIN 46, consolidation generally occurred when an enterprise controlled another entity through voting interests. Certain VIEs that are qualifying special purpose entities (‘‘QSPEs’’) subject to the reporting requirements of Statement of Financial Accounting Standards No. 140 (‘‘SFAS 140’’), ‘‘Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,’’ are not required to be consolidated under the provisions of FIN 46. The consolidation provisions of FIN 46 apply to VIEs created or entered into after January 31, 2003. For VIEs created before February 1, 2003, the provisions of FIN 46 were effective for entities commonly referred to as special purpose entities (‘‘SPEs’’) for periods ending after December 15, 2003, and for all other types of entities was deferred to periods ending after March 15, 2004. The Company has relationships with several SPEs. Because the Company’s investment securities conduit and the asset-backed securitizations are QSPEs, which are exempt from consolidation under the provisions of FIN 46, the Company does not believe that FIN 46 requires the consolidation of the conduit or securitizations in its ﬁnancial statements. During the third quarter of 2003, the 70 U.S. Bancorp Company elected not to reissue more than 90 percent of the commercial paper funding of Stellar Funding Group, Inc., the commercial loan conduit. This action caused the conduit to lose its status as a qualifying special purpose entity. As a result, the Company recorded all of Stellar’s assets and liabilities at fair value and the results of operations in the consolidated ﬁnancial statements of the Company. Given the ﬂoating rate nature and high credit quality of the assets within the conduit, the net impact to the Company’s ﬁnancial statements was not signiﬁcant. Prior to December 31, 2003, the remaining commercial paper borrowings held by third-party investors matured and the conduit was legally dissolved. With respect to other interests in entities subject to FIN 46, including low-income housing investments, the adoption of FIN 46 did not have a material impact on the Company’s ﬁnancial statements. The Company has determined that the provisions of FIN 46 may require de- consolidation of the subsidiary grantor trusts, which issue mandatorily redeemable preferred securities (‘‘Trust Preferred Securities’’). Currently, the Company consolidates the grantor trusts and the balance sheet includes the mandatorily redeemable preferred securities of the grantor trusts. In the ﬁrst quarter of 2004, the grantor trusts may be de-consolidated and the junior subordinated debentures of the Company owned by the grantor trusts would be recorded. The Trust Preferred Securities currently qualify as Tier 1 capital of the Company for regulatory capital purposes. The banking regulatory agencies have issued guidance that would continue the current regulatory capital treatment for Trust Preferred Securities until further notice. Stock-Based Compensation In December 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 148 (‘‘SFAS 148’’), ‘‘Accounting for Stock-Based Compensation — Transition and Disclosure,’’ an amendment of SFAS 123. SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In previous years, the Company accounted for stock-based employee compensation under the intrinsic based method and provided disclosure of the impact of the fair value based method on reported income. For its 2003 ﬁnancial statements, the Company elected to adopt the fair value method using the retroactive restatement approach. All prior periods presented have been restated to reﬂect the compensation cost that would have been recognized had the recognition provisions of SFAS 123 been applied to all awards granted to employees after January 1, 1995 that remained unvested at the beginning of the ﬁrst period presented. Guarantees In November 2002, the Financial Accounting Standards Board issued Interpretation No. 45 (‘‘FIN 45’’), ‘‘Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,’’ to clarify accounting and disclosure requirements relating to a guarantor’s issuance of certain types of guarantees. FIN 45 requires entities to disclose additional information about certain guarantees, or group of similar guarantees, even if the likelihood of the guarantor’s having to make any payments under the guarantee is remote. The disclosure provisions are effective for interim and annual ﬁnancial statements for the ﬁrst reporting period ending after December 15, 2002. For certain guarantees, the interpretation also requires that guarantors recognize a liability equal to the fair value of the guarantee upon its issuance. The Company adopted the initial recognition and measurement provision effective January 1, 2003, which did not have a material impact on the Company’s ﬁnancial statements. Business Combinations and Goodwill and Other Intangible Assets In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141 (‘‘SFAS 141’’), ‘‘Business Combinations,’’ and Statement of Financial Accounting Standards No. 142 (‘‘SFAS 142’’), ‘‘Goodwill and Other Intangible Assets.’’ SFAS 141 mandates that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, and established speciﬁc criteria for the recognition of intangible assets separately from goodwill. SFAS 142 addresses the accounting for goodwill and intangible assets subsequent to their acquisition. The Company adopted SFAS 142 on January 1, 2002. The most signiﬁcant changes made by SFAS 142 are that goodwill and indeﬁnite lived intangible assets are no longer amortized and are to be tested for impairment at least annually. The amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the amortization provisions of SFAS 142 were effective upon adoption of SFAS 142. Applying the provisions of SFAS 141 to recent acquisitions and the provisions of SFAS 142 to purchase acquisitions completed prior to July 1, 2001, increased after-tax income for the year ended December 31, 2002, by $205.6 million, or $.11 per diluted share. During the ﬁrst quarter of 2002, the Company completed its initial impairment test as required by SFAS 142. As a result of this initial impairment test, the Company recognized an after-tax goodwill impairment charge of $37.2 million as a ‘‘cumulative effect of accounting change’’ in the income statement in the ﬁrst quarter of 2002. The impairment was primarily related to the purchase of a transportation leasing U.S. Bancorp 71 company in 1998 by the equipment leasing business. Banking regulations exclude 100 percent of goodwill from the determination of capital adequacy; therefore, the impact of this impairment on the Company’s capital adequacy was not signiﬁcant. Note 3 Business Combinations On July 24, 2001, the Company acquired NOVA Corporation (‘‘NOVA’’), a merchant processor, in a stock and cash transaction valued at approximately $2.1 billion. The transaction represented total assets acquired of $2.9 billion and total liabilities assumed of $773 million. Included in total assets were merchant contracts and other intangibles of $650 million and the excess of purchase price over the fair value of identiﬁable net assets (‘‘goodwill’’) of $1.6 billion. The goodwill reﬂected NOVA’s leadership position in the merchant processing market and its ability to provide a technologically superior product that is enhanced by a high level of customer service. The Company believes that these factors, among others, will allow NOVA to generate sufﬁcient positive cash ﬂows from new business in future periods to support the goodwill recorded in connection with the acquisition. 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 transaction valued at $725 million. State Street Corporate Trust was a leading provider, particularly in the Northeast, of corporate trust and agency services to a variety of municipalities, corporations, government agencies and other ﬁnancial institutions serving approximately 20,000 client issuances representing over $689 billion of assets under administration. With this acquisition, the Company is among the nation’s leading providers of a full range of corporate trust products and services. The transaction represented total assets acquired of $682 million and total liabilities assumed of $39 million at the closing date. Included in total assets were contract and other intangibles with a fair value of $218 million and goodwill of $449 million. The goodwill reﬂected the strategic value of the combined organization’s leadership position in the corporate trust business and processing economies of scale resulting from the transaction. As part of the purchase price, $75 million was placed in escrow for up to eighteen months with payment contingent on the successful transition of business relationships. In addition to these mergers and business acquisitions, the Company completed other strategic acquisitions to enhance its presence in certain markets and businesses. The following table summarizes acquisitions by the Company completed since January 1, 2001, treating Firstar Corporation as the original acquiring company: (Dollars and Shares in Millions) Date Assets (a) Deposits Corporate Trust business of State Street Bank and Trust Company ***** Bay View Bank branches ************* The Leader Mortgage Company, LLC ** Paciﬁc Century Bank ***************** NOVA Corporation ******************* U.S. Bancorp************************ December 2002 November 2002 April 2002 September 2001 July 2001 February 2001 $ 13 362 517 570 949 86,602 $ — 3,305 — 712 — 51,335 (a) Assets acquired do not include purchase accounting adjustments. Goodwill and Other Intangibles $ 667 483 191 134 2,231 — Cash Paid / (Received) Shares Issued Accounting Method $ 643 (2,494) 85 (43) 842 — — — — — 57.0 952.4 Purchase Purchase Purchase Purchase Purchase Pooling 72 U.S. Bancorp Note 4 Discontinued Operations On February 19, 2003, the Company announced that its Board of Directors approved a plan to effect a distribution of its capital markets business unit, including the investment banking and brokerage activities primarily conducted by its wholly-owned subsidiary, Piper Jaffray Companies. On December 31, 2003, the Company completed the distribution of all the outstanding shares of common stock of Piper Jaffray Companies to its shareholders. This non- cash distribution was tax-free to the Company, its shareholders and Piper Jaffray Companies. In connection with the December 31, 2003 distribution, the results of Piper Jaffray Companies are reported in the Company’s Consolidated Statement of Income separately as discontinued operations. The following table represents the condensed results of operations for discontinued operations: Year Ended December 31 (Dollars in Millions) Revenue ******************************************************************************** Noninterest expense ********************************************************************* Income (loss) from discontinued operations ************************************************* Costs of disposal (a) ********************************************************************* Income taxes (beneﬁt) ******************************************************************** 2003 $783.4 716.5 66.9 27.6 16.8 2002 $729.0 760.3 (31.3) — (8.6) 2001 $800.8 870.3 (69.5) — (24.3) Discontinued operations, net of tax ****************************************************** $ 22.5 $ (22.7) $ (45.2) (a) The $27.6 million of disposal costs related to discontinued operations primarily represents legal, investment banking and other costs directly related to the distribution. The distribution was treated as a dividend to shareholders for accounting purposes and, as such, reduced the Company’s retained earnings by $685 million. At December 31, 2003, the Consolidated Balance Sheet reﬂects the non-cash dividend and corresponding reduction in assets and liabilities at that date. In accordance with accounting principles generally accepted in the United States, the Consolidated Balance Sheet for 2002 has not been restated. A summary of the assets and liabilities of the discontinued operations is as follows: December 31 (Dollars in Millions) 2003 2002 Assets Cash and cash equivalents ******************************************************************************* Trading securities **************************************************************************************** Loans ************************************************************************************************** Goodwill ************************************************************************************************ Other assets (a) ***************************************************************************************** Total assets ******************************************************************************************* Liabilities Deposits ************************************************************************************************ Short-term borrowings ************************************************************************************ Long-term debt ****************************************************************************************** Other liabilities (b) *************************************************************************************** $ 382 656 — 306 1,025 $2,369 $ 6 905 180 593 Total liabilities ***************************************************************************************** $1,684 $ 271 463 2 306 954 $1,996 $ 7 707 215 458 $1,387 (a) (b) Includes customer margin account receivables, due from brokers/dealers and other assets. Includes accrued expenses, due to brokers/dealers and other liabilities. Following the distribution, the Company’s wholly-owned subsidiary, USB Holdings, Inc. holds a $180 million subordinated debt facility with Piper Jaffray & Co., a broker-dealer subsidiary of Piper Jaffray Companies. In addition, the Company provides an indemniﬁcation in an amount up to $17.5 million with respect to certain speciﬁed liabilities primarily resulting from third-party claims relating to research analyst independence and from certain regulatory investigations, as deﬁned in the separation and distribution agreement entered into with Piper Jaffray Companies at the time of the distribution. Note 5 Merger and Restructuring-Related Items The Company recorded pre-tax merger and restructuring- related items of $46.2 million, $321.2 million, and $1,364.8 million, in 2003, 2002, and 2001, respectively. In 2003, merger-related items were primarily incurred in connection with the NOVA acquisition and the Company’s various other acquisitions including BayView and State Street Corporate Trust. In 2002 and 2001, merger-related items included costs associated with the Firstar/USBM merger, NOVA and other smaller acquisitions noted below and in Note 3 — Business Combinations. U.S. Bancorp 73 The components of the merger and restructuring-related items are shown below: (Dollars in Millions) USBM NOVA Other (a) Total 2003 Severance and employee-related ******************************** Systems conversions and integration***************************** Asset write-downs and lease terminations ************************ Other merger-related items ************************************* Total 2003 **************************************************** Noninterest expense ******************************************* Balance sheet recognition ************************************** Merger-related items — 2003 ******************************** 2002 Severance and employee-related ******************************** Systems conversions and integration***************************** Asset write-downs and lease terminations ************************ Balance sheet restructurings ************************************ Other merger-related items ************************************* Total 2002 **************************************************** Noninterest expense ******************************************* Balance sheet recognition ************************************** Merger-related items — 2002 ******************************** 2001 Severance and employee-related ******************************** Stock-based compensation ************************************* Systems conversions and integration***************************** Asset write-downs and lease terminations ************************ Charitable contributions **************************************** Balance sheet restructurings ************************************ Branch sale gain ********************************************** Branch consolidations ****************************************** Other merger-related items ************************************* $ $ $ $ $ — — — — — — — — 4.1 194.9 104.0 (38.8) 4.8 $ 269.0 $ 269.0 — $ 269.0 $ 238.6 190.5 207.1 130.4 76.0 457.6 (62.2) 20.0 69.1 Total 2001 **************************************************** $1,327.1 Provision for credit losses ************************************** Noninterest income ******************************************** Noninterest expense ******************************************* Merger-related items **************************************** Balance sheet recognition ************************************** Merger-related items — 2001 ******************************** $ 382.2 (62.2) 1,007.1 $1,327.1 — $1,327.1 $ .8 25.9 6.8 — $33.5 $33.5 — $33.5 $ (3.8) 29.4 14.2 — (1.1) $38.7 $34.9 3.8 $38.7 $23.3 — 1.6 34.7 — — — — 24.2 $83.8 $ — — 1.6 $ 1.6 82.2 $83.8 $ — 6.9 3.0 1.4 $11.3 $12.7 (1.4) $11.3 $ 9.1 17.3 6.0 — 3.5 $35.9 $17.3 18.6 $35.9 $17.8 — 15.2 5.7 — — — — 4.8 $43.5 $ — — 36.1 $36.1 7.4 $43.5 $ $ $ $ $ .8 32.8 9.8 1.4 44.8 46.2 (1.4) 44.8 9.4 241.6 124.2 (38.8) 7.2 $ 343.6 $ 321.2 22.4 $ 343.6 $ 279.7 190.5 223.9 170.8 76.0 457.6 (62.2) 20.0 98.1 $1,454.4 $ 382.2 (62.2) 1,044.8 $1,364.8 89.6 $1,454.4 (a) In 2003 and 2002, ‘‘Other’’ primarily included merger and restructuring-related items pertaining to the Bay View acquisition, State Street Corporate Trust and the Lyon Financial acquisition. In 2001, ‘‘Other’’ primarily included the 1999 merger of Firstar and Mercantile Bancorporation, Inc. and the 1998 acquisition of the former Firstar Corporation by Star Banc. Star Banc was renamed Firstar Corporation. The Company determines merger and restructuring- related items and related accruals based on its integration strategy and formulated plans. These plans are established as of the acquisition date and are regularly evaluated during the integration process. Severance and employee-related charges include the cost of severance, other beneﬁts and outplacement costs associated with the termination of employees primarily in branch ofﬁces and centralized corporate support and data processing functions. The severance amounts are determined based on the Company’s existing severance pay programs and are paid out over a beneﬁt period of up to two years from the time of termination. The total number of employees included in severance amounts were approximately 2,860 for USBM, and 400 for NOVA. In 2002, the Company recognized additional severance costs of $13.1 million in connection with the USBM merger offset by net curtailment and settlement gains of $9.0 million related to changes in certain non-qualiﬁed pension plans. Changes in severance costs for USBM and NOVA primarily reﬂected a change in estimate in the liability given the mix of employees terminated. Severance and employee-related costs for identiﬁed groups of acquired employees are included in the determination of goodwill at closing. Severance and employee-related costs are recorded as incurred for groups of employees not speciﬁcally identiﬁed 74 U.S. Bancorp at the time of closing or acquired in business combinations accounted for as ‘‘poolings.’’ In 2001, the company also recognized $190.5 million of stock-based compensation expense as a result of the accelerated vesting of certain stock options and restricted stock due to the change of control triggered by the USBM merger. Systems conversions and integration costs are recorded as incurred and are associated with the preparation and mailing of numerous customer communications for the acquisitions and conversion of customer accounts, printing and distribution of training materials and policy and procedure manuals, outside consulting fees, and other expenses related to systems conversions and the integration of acquired branches and operations. Asset write-downs and lease terminations represent lease termination costs and impairment of assets for redundant ofﬁce space, branches that will be vacated and equipment disposed of as part of the integration plan. These costs are recognized in the accounting period that contract terminations occur or the asset becomes impaired and is abandoned. In 2002, this category included $38.2 million of signage write-offs, $26.9 million of software and equipment write-offs, $32.0 million of lease and contract cancellations and $6.9 million of leasehold and other related items associated with the Firstar/USBM merger. In 2001, asset write-downs and lease terminations included $45.7 million of lease and contract cancellation costs, $36.2 million of software and equipment write-offs and $48.5 million of other assets deemed to be worthless due to integration decisions in connection with the merger. In connection with certain mergers, the Company has made charitable contributions to reafﬁrm a commitment to its markets or as part of speciﬁc conditions necessary to achieve regulatory approval. These contributions were funded up front and represent costs that would not have been incurred had the merger not occurred. Charitable contributions are charged to merger and restructuring expenses or considered in determining the acquisition cost at the applicable closing date. Balance sheet restructurings primarily represent gains or losses incurred by the Company related to the disposal of certain businesses, products, or customer and business relationships that no longer align with the long-term strategy of the Company. It may also include charges to realign risk management practices related to certain credit portfolios. During 2002, the Company recognized asset gains related to the sale of a non-strategic investment in a sub-prime lending business of $28.7 million and a mark-to- market recovery of $10.1 million associated with the liquidation of U.S. Bancorp Libra’s investment portfolio. During 2001, balance sheet restructuring costs incurred in connection with the Firstar/USBM merger of $457.6 million were comprised of a $201.3 million provision associated with the Company’s integration of certain small business products and management’s decision to discontinue an unsecured small business product of USBM; $90.0 million of charge-offs to align risk management practices, align charge-off policies and to expedite the Company’s transition out of a speciﬁc segment of the healthcare industry; and $76.6 million of losses related to the sales of two higher credit risk retail loan portfolios of USBM. Also, the amount included $89.7 million related to the Company’s decision to discontinue a high-yield investment banking business, to restructure a co-branding credit card relationship of USBM, and for the planned disposition of certain equity investments that no longer aligned with the long-term strategy of the Company. The alignment of risk management practices included a write-down of several large commercial loans originally held separately by both Firstar and USBM, primarily to allow the Company to exit or reduce these credits to conform with the credit risk exposure policy of the combined entity. Other merger-related items in 2002 of $7.2 million primarily represented changes to conform accounting policies implemented at the time of systems conversions related to the Firstar/USBM merger and other acquired entities. In 2001, other merger-related charges of $98.1 million primarily included $69.1 million and $24.2 million of investment banking fees, legal fees and stock registration fees associated with the Firstar/USBM merger and the acquisition of NOVA, respectively and $4.8 million of other costs. U.S. Bancorp 75 The following table presents a summary of activity with respect to the merger and restructuring-related accruals: (Dollars in Millions) Balance at December 31, 2000 ****************************************** Provision charged to operating expense ******************************* Additions related to purchase acquisitions ***************************** Cash outlays ******************************************************* Noncash write-downs and other ************************************** Balance at December 31, 2001 ****************************************** Provision charged to operating expense ******************************* Additions related to purchase acquisitions ***************************** Cash outlays ******************************************************* Noncash write-downs and others ************************************* Balance at December 31, 2002 ****************************************** Provision charged to operating expense ******************************* Additions (adjustments) related to purchase acquisitions***************** Cash outlays ******************************************************* Noncash write-downs and others ************************************* USBM $ — 1,327.1 — (532.2) (670.6) 124.3 269.0 — (325.8) (48.9) 18.6 — — (16.2) — NOVA $ — 1.6 82.2 (32.4) (3.0) 48.4 34.9 3.8 (36.2) (35.8) 15.1 33.5 — (29.1) (1.4) Other (a) Total $ 46.6 36.1 7.4 (66.3) (11.0) 12.8 17.3 18.6 (24.6) (5.7) 18.4 12.7 (1.4) (14.1) (11.5) $ 46.6 1,364.8 89.6 (630.9) (684.6) 185.5 321.2 22.4 (386.6) (90.4) 52.1 46.2 (1.4) (59.4) (12.9) Balance at December 31, 2003 ****************************************** $ 2.4 $ 18.1 $ 4.1 $ 24.6 (a) In 2003 and 2002, ‘‘Other’’ primarily included merger and restructuring-related items pertaining to the Bay View acquisition, State Street Corporate Trust and the Lyon Financial acquisition. In 2001, ‘‘Other’’ primarily included the 1999 merger of Firstar and Mercantile Bancorporation, Inc. and the 1998 acquisition of the former Firstar Corporation by Star Banc. Star Banc was renamed Firstar Corporation. The adequacy of the accrued liabilities is reviewed regularly taking into consideration actual and projected payments. Adjustments are made to increase or decrease these accruals as needed. Reversals of expenses can reﬂect a lower utilization of beneﬁts by affected staff, changes in initial assumptions as a result of subsequent mergers and alterations of business plans. The components of the merger and restructuring-related accruals for all acquisitions were as follows: (Dollars in Millions) Severance**************************************************************************************** Other employee-related costs*********************************************************************** Lease termination and facility costs ***************************************************************** Contracts and system write-offs********************************************************************* Other ******************************************************************************************** Total****************************************************************************************** December 31, 2003 December 31, 2002 $ 3.4 1.1 14.4 2.4 3.3 $24.6 $30.2 3.1 17.2 .5 1.1 $52.1 The merger and restructuring-related accruals by signiﬁcant acquisition or business restructuring was as follows: (Dollars in Millions) NOVA******************************************************************************************** State Street Corporate Trust ************************************************************************ USBM ******************************************************************************************* Bay View ***************************************************************************************** Other acquisitions ********************************************************************************* Total****************************************************************************************** December 31, 2003 December 31, 2002 $18.1 4.1 2.4 — — $24.6 $15.1 7.8 18.6 5.8 4.8 $52.1 At December 31, 2002, the integration of Firstar and USBM was completed, and no additional merger and restructuring related charges occurred in 2003. The only activity in the USBM accrual during 2003 was related to severance costs that continue to be paid through the period provided for in the Company’s severance plans. In 2003, the integration of merchant processing platforms and business processes of U.S. Bank National Association and NOVA, as well as systems conversions for the acquisitions of the State Street Corporate Trust business and Bay View were completed. The Company does not anticipate any merger or restructuring-related expenses in 2004 related to completed acquisitions. 76 U.S. Bancorp Note 6 Restrictions on Cash and Due from Banks Bank subsidiaries are required to maintain minimum average reserve balances with the Federal Reserve Bank. The amount of those reserve balances was approximately $243 million at December 31, 2003. Note 7 Investment Securities The detail of the amortized cost, gross unrealized holding gains and losses, and fair value of held-to-maturity and available- for-sale securities at December 31 was as follows: 2003 Gross Unrealized Holding Gains Gross Unrealized Holding Losses Amortized Cost 2002 Gross Unrealized Holding Gains Gross Unrealized Holding Losses Fair Value Fair Value Amortized Cost $ 14 $ — $ — $ 14 $ 20 $ — $ — $ 20 (Dollars in Millions) Held-to-maturity (a) Mortgage-backed securities ********** Obligations of state and political subdivisions ********************* 138 11 (2) 147 213 Total held-to-maturity securities ******* $ 152 $ 11 $ (2) $ 161 $ 233 Available-for-sale (b) U.S. Treasury and agencies ********** Mortgage-backed securities ********** Asset-backed securities ************** Obligations of state and political subdivisions ********************* Other securities and investments****** $ 1,634 40,229 250 335 993 $ 10 203 5 13 9 $ (69) (407) (3) $ 1,575 40,025 252 $ 421 24,967 646 — (20) 348 982 558 949 14 $ 14 $ 15 699 28 22 2 (7) 220 $ (7) $ 240 $ — $ — (4) (1) (47) 436 25,666 670 579 904 Total available-for-sale securities ****** $43,441 $240 $(499) $43,182 $27,541 $766 $(52) $28,255 (a) Held-to-maturity securities are carried at historical cost adjusted for amortization of premiums and accretion of discounts. (b) Available-for-sale securities are carried at fair value with unrealized net gains or losses reported within other comprehensive income in shareholders’ equity. The fair value of available-for-sale investments shown above includes investments totaling $266.1 million with unrealized losses of $19.8 million which have been in an unrealized loss position for greater than 12 months. The investments primarily represent 43 trust preferred securities from 13 bank issuers. All principal and interest payments are expected to be collected given the high credit quality of the bank holding company issuers and the Company’s ability and intent to hold the investments until such time as the value recovers or maturity. All other available-for-sale investments with unrealized losses have an aggregate fair value of $27.3 billion and have been in an unrealized loss position for less than 12 months and primarily represent ﬁxed-rate investments with temporary impairment resulting from increases in interest rates since the purchase of the investments. The Company has the ability to hold these investments until such time as the value recovers or maturity. Securities carried at $31.0 billion at December 31, 2003, and $20.2 billion at December 31, 2002, were pledged to secure public, private and trust deposits and for other purposes required by law. Securities sold under agreements to repurchase were collateralized by securities and securities purchased under agreements to resell with an amortized cost of $3.6 billion and $2.9 billion at December 31, 2003, and 2002, respectively. The following table provides information as to the amount of gross gains and losses realized through the sales of available- for-sale investment securities. (Dollars in Millions) Realized gains ************************************************************************** Realized losses ************************************************************************* Net realized gains (losses) ************************************************************ Income tax (beneﬁt) on realized gains (losses) ********************************************* 2003 $ 363.9 (119.1) $ 244.8 $ 93.0 2002 $316.5 (16.6) $299.9 $114.0 2001 $333.0 (3.9) $329.1 $115.2 For amortized cost, fair value and yield by maturity date of held-to-maturity and available-for-sale securities outstanding as of December 31, 2003, see Table 10 included in Management’s Discussion and Analysis which is incorporated by reference into these Notes to Consolidated Financial Statements. U.S. Bancorp 77 Note 8 Loans and Allowance for Credit Losses The composition of the loan portfolio at December 31 was as follows: (Dollars in millions) Commercial 2003 2002 Commercial**************************************************************************************** Lease ﬁnancing ************************************************************************************ $ 33,536 4,990 $ 36,584 5,360 Total commercial ******************************************************************************** 38,526 41,944 Commercial real estate Commercial mortgages ***************************************************************************** Construction and development *********************************************************************** Total commercial real estate ********************************************************************** Residential mortgages ***************************************************************************** Retail Credit card **************************************************************************************** Retail leasing ************************************************************************************** Home equity and second mortgage******************************************************************* Other retail Revolving credit ********************************************************************************* Installment ************************************************************************************* Automobile ************************************************************************************* Student **************************************************************************************** Total other retail ***************************************************************************** Total retail ************************************************************************************** 20,624 6,618 27,242 13,457 5,933 6,029 13,210 2,540 2,380 7,165 1,753 13,838 39,010 20,325 6,542 26,867 9,746 5,665 5,680 13,572 2,650 2,258 6,343 1,526 12,777 37,694 Total loans ********************************************************************************** $118,235 $116,251 Loans are presented net of unearned interest and deferred fees and costs, which amounted to $1.5 billion and $1.8 billion at December 31, 2003 and 2002, respectively. The Company had loans of $28.7 billion at December 31, 2003, and $26.1 billion at December 31, 2002, pledged at the Federal Home Loan Bank. Loans of $12.1 billion at December 31, 2003, and $12.7 billion at December 31, 2002, were pledged at the Federal Reserve Bank. The Company primarily lends to borrowers in the 24 states in which it has banking ofﬁces. Collateral for commercial loans may include marketable securities, accounts receivable, inventory and equipment. For details of the Company’s commercial portfolio by industry group and geography as of December 31, 2003 and 2002, see Table 7 included in Management’s Discussion and Analysis which is incorporated by reference into these Notes to Consolidated Financial Statements. For detail of the Company’s commercial real estate portfolio by property type and geography as of December 31, 2003 and 2002, see Table 9 included in Management’s Discussion and Analysis which is incorporated by reference into these Notes to Consolidated Financial Statements. Such loans are collateralized by the related property. Nonperforming assets include nonaccrual loans, restructured loans not performing in accordance with modiﬁed terms, other real estate and other nonperforming assets owned by the Company. For details of the Company’s nonperforming assets as of December 31, 2003, 2002 and 2001, see Table 12 included in Management’s Discussion and Analysis which is incorporated by reference into these Notes to Consolidated Financial Statements. The following table lists information related to nonperforming loans as of December 31: (Dollars in Millions) 2003 2002 Loans on nonaccrual status ***************************************************************************** Restructured loans ************************************************************************************* Total nonperforming loans ******************************************************************************* Interest income that would have been recognized at original contractual terms ******************************** Amount recognized as interest income******************************************************************** Forgone revenue *************************************************************************************** $ 979.5 40.5 $1,020.0 $ $ 94.1 26.7 67.4 $1,188.7 48.6 $1,237.3 $ 102.1 36.7 $ 65.4 78 U.S. Bancorp Activity in the allowance for credit losses was as follows: (Dollars in Millions) Balance at beginning of year ************************************************************ Add 2003 2002 2001 $2,422.0 $2,457.3 $1,786.9 Provision charged to operating expense (a) ******************************************** 1,254.0 1,349.0 2,528.8 Deduct Loans charged off******************************************************************* Less recoveries of loans charged off ************************************************** Net loans charged off *************************************************************** Losses from loan sales/transfers ********************************************************* Acquisitions and other changes ********************************************************** 1,494.1 242.4 1,251.7 — (55.7) 1,590.7 217.7 1,373.0 — (11.3) 1,771.4 224.9 1,546.5 (329.3) 17.4 Balance at end of year****************************************************************** $2,368.6 $2,422.0 $2,457.3 (a) In 2001, $382.2 million of the provision for credit losses was incurred in connection with the Firstar/USBM merger. A portion of the allowance for credit losses is allocated to loans deemed impaired. All impaired loans are included in non-performing assets. A summary of these loans and their related allowance for loan losses is as follows: (Dollars in Millions) Impaired loans Valuation allowance required********* No valuation allowance required****** Total impaired loans ******************* Average balance of impaired loans during the year *************************** Interest income recognized on impaired loans during the year *************** 2003 2002 2001 Recorded Investment Valuation Allowance Recorded Investment Valuation Allowance Recorded Investment Valuation Allowance $841 — $841 $970 — $108 — $108 $157 — $157 $992 — $992 $839 — $694 — $694 $780 — $125 — $125 Commitments to lend additional funds to customers whose loans were classiﬁed as nonaccrual or restructured at December 31, 2003, totaled $107.9 million. During 2003 there were $18.0 million of loans that were restructured at market interest rates and returned to an accruing status. The allowance for credit losses includes credit loss liability related to off-balance sheet loan commitments. At December 31, 2003, the allowance for credit losses includes an estimated $133.6 million credit loss liability related to the Company’s $58.3 billion of commercial off-balance sheet loan commitments and letters of credit. Note 9 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities FINANCIAL ASSET SALES When the Company sells ﬁnancial assets, it may retain interest-only strips, servicing rights, residual rights to a cash reserve account, and/or other retained interests in the sold ﬁnancial assets. The gain or loss on sale depends in part on the previous carrying amount of the ﬁnancial assets involved in the transfer and is allocated between the assets sold and the retained interests based on their relative fair values at the date of transfer. Quoted market prices are used to determine retained interest fair values when readily available. Since quotes are generally not available for retained interests, the Company estimates fair value based on the present value of future expected cash ﬂows using management’s best estimates of the key assumptions including credit losses, prepayment speeds, forward yield curves, and discount rates commensurate with the risks involved. Retained interests and liabilities are recorded at fair value using a discounted cash ﬂow methodology at inception and are evaluated at least quarterly thereafter. Conduits and Securitization The Company sponsors an off- balance sheet conduit to which it transferred high-grade investment securities, funded by the issuance of commercial paper. The conduit, a qualifying special purpose entity, held assets of $7.3 billion at December 31, 2003, and $9.5 billion in assets at December 31, 2002. These investment securities include primarily (i) private label asset-backed securities, which are insurance ‘‘wrapped’’ by AAA/Aaa-rated monoline insurance companies and (ii) government agency mortgage- backed securities and collateralized mortgage obligations. The conduit had commercial paper liabilities of $7.3 billion at December 31, 2003, and $9.5 billion at December 31, 2002. The Company benefits by transferring the investment securities into a conduit that provides diversification of funding sources in a capital-efficient manner and the generation of income. U.S. Bancorp 79 The Company provides a liquidity facility to the conduit. Utilization of the liquidity facility would be triggered by the conduit’s inability to issue commercial paper to fund its assets. The recorded fair value of the Company’s liability for the liquidity facility included in other liabilities was $47.3 million at December 31, 2003, and $37.7 million at December 31, 2002. Changes in fair value of these liabilities are recorded in the income statement as other noninterest income or expense. In addition, the Company recorded at fair value its retained residual interest in the investment securities conduit of $89.5 million at December 31, 2003, and $93.4 million at December 31, 2002. The Company recorded $30.5 million from the conduit during 2003 and $63.0 million during 2002 in other noninterest income, for revenues related to the conduit including fees for servicing, management, administration and accretion income from retained interests. The Company also has an asset-backed securitization to fund an unsecured small business credit product. The unsecured small business credit securitization trust held assets of $497.5 million at December 31, 2003, of which the Company retained $112.4 million of subordinated securities, transferor’s interest of $12.4 million and a residual interest-only strip of $34.4 million. This compared with $652.4 million in assets at December 31, 2002, of which the Company retained $150.1 million of subordinated securities, transferor’s interest of $16.3 million and a residual interest-only strip of $53.3 million. The qualifying special purpose entity issued asset-backed variable funding notes in various tranches. The Company provides credit enhancement in the form of subordinated securities and reserve accounts. The Company’s risk, primarily from losses in the underlying assets, was considered in determining the fair value of the Company’s retained interests in this securitization. The Company recognized income from subordinated securities, an interest- only strip and servicing fees from this securitization of $29.8 million during 2003 and $52.8 million during 2002. The unsecured small business credit securitization held average assets of $571.4 million in 2003, and $700.6 million in 2002. During 2003, the Company undertook several actions with respect to off-balance sheet structures. In January 2003, the Company exercised a cleanup call option on an indirect automobile loan securitization, with the remaining assets from the securitization recorded on the Company’s balance sheet at fair value. The indirect automobile securitization held $156.1 million in assets at December 31, 2002. During the third quarter of 2003, the Company elected not to reissue more than 90 percent of the commercial paper funding of Stellar Funding Group, Inc., the commercial loan conduit. This action caused the conduit to lose its status as a qualifying special purpose entity. As a result, the Company recorded all of Stellar’s assets and liabilities at fair value and the results of operations in the consolidated ﬁnancial statements of the Company. Given the ﬂoating rate nature and high credit quality of the assets within the conduit, the impact to the Company’s ﬁnancial statements was not signiﬁcant. In the third quarter of 2003, average commercial loan balances increased by approximately $2 billion and the resulting increase in net interest income was offset by a similar decline in conduit fee income within commercial products revenue. Prior to December 31, 2003, the remaining commercial paper borrowings held by third-party investors matured and the conduit was legally dissolved. Sensitivity Analysis At December 31, 2003, key economic assumptions and the sensitivity of the current fair value of residual cash ﬂows to immediate 10 percent and 20 percent adverse changes in those assumptions were as follows: December 31, 2003 (Dollars in Millions) Current Economic Assumptions Sensitivity Analysis Carrying value (fair value) of retained interests **************************************************** Weighted average life (in years) ***************************************************************** Expected remaining life (a) ******************************************************************** Impact of 10% adverse change ****************************************************************** Impact of 20% adverse change ****************************************************************** Expected credit losses (annual) (b) ************************************************************ Impact of 10% adverse change ****************************************************************** Impact of 20% adverse change ****************************************************************** Residual cash ﬂow discount rate ************************************************************** Impact of 10% adverse change ****************************************************************** Impact of 20% adverse change ****************************************************************** Interest rate on variable rate loans and bonds (c)(d)****************************************** Impact of 10% adverse change ****************************************************************** Impact of 20% adverse change ****************************************************************** Unsecured Small Business Receivables $146.8 .9 2.5 years $ (2.6) (5.6) 9.5%-11.4% $ (3.0) (13.6) 11.0% (.5) (2.2) Prime $ — (1.4) $ Investment Securities $ 89.5 2.6 4.9 years $ (8.9) (16.3) NA $ — — 3.6% $ (1.0) (1.2) LIBOR $ — — (a) For the small business receivables a monthly principal payment rate assumption is used to value the residual interests. (b) Credit losses are zero for the investment securities conduit as the investments are all AAA/Aaa rated or insured investments. (c) For the small business receivables interest income is based on Prime + contractual spread. (d) The investment securities conduit is mostly match funded. Therefore, interest rate movements create no material impact to the value of the residual interest. 80 U.S. Bancorp These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10 percent variation in assumptions generally cannot be extrapolated because the relationship of the change in the assumptions to the change in fair value may not be linear. Also, in this table the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumptions; in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities. Cash Flow Information The table below summarizes certain cash ﬂows received from and paid to conduits or structured entities for the asset sales described above: Year Ended December 31 (Dollars in Millions) 2003 Commercial Loans Indirect Automobile Loans Unsecured Small Business Receivables (a) Investment Securities Proceeds from New sales and securitizations ******************************************* Collections used by trust to purchase new receivables in revolving securitizations ***************************************************** Servicing and other fees received and cash ﬂows on retained interests ******** Net cash ﬂow from loan conduit consolidation ******************************* 2002 Proceeds from New sales and securitizations ******************************************* Collections used by trust to purchase new receivables in revolving securitizations ***************************************************** Servicing and other fees received and cash ﬂows on retained interests ******** $ — $ — $ — $ — — 23.9 (1,884.0) — 24.3 — 420.6 85.3 — — 51.8 — $ — $ — $ — $1,677.5 — 83.0 — 4.0 610.3 115.0 — 71.8 (a) The small business credit securitizations are revolving transactions where proceeds are reinvested until their legal terminations. Other Information Quantitative information related to managed assets and loan securitizations was as follows: At December 31 Year Ended December 31 Total Principal Balance Principal Amount 90 Days or More Past Due (a) Average Balance Net Credit Losses 2003 2002 2003 2002 2003 2002 2003 2002 $ 34,427 4,990 $ 41,861 5,360 39,417 47,221 $ 651 115 766 $ 819 172 991 $ 39,093 5,088 $ 45,192 5,573 44,181 50,765 $ 535 84 619 $ 543 149 692 20,624 6,618 27,242 13,457 5,933 6,029 27,048 39,010 20,325 6,542 26,867 9,746 5,665 5,680 26,505 37,850 181 42 223 123 100 8 135 243 181 62 243 140 118 12 167 297 20,166 6,976 27,142 11,696 5,525 5,804 26,876 38,205 19,212 6,511 25,723 8,412 5,633 5,389 25,756 36,778 28 11 39 27 255 50 311 616 32 7 39 19 280 39 360 679 $119,126 $121,684 $1,355 $1,671 $121,224 $121,678 $1,301 $1,429 50,679 37,999 — — 45,633 38,689 — — $169,805 $159,683 $1,355 $1,671 $166,857 $160,367 $1,301 $1,429 8,236 14,944 $161,569 $144,739 11,247 17,085 $155,610 $143,282 $ — $ 4,151 156 — 490 406 636 485 9,511 7,345 $ 8,236 $ 14,944 $ — — — 6 — $ 6 $ — 1 — 6 — $ 7 $ 1,834 7 450 571 8,385 $ 5,715 277 532 701 9,860 $ 11,247 $ 17,085 $ — — — 49 — $ 49 $ — 5 — 51 — $ 56 (Dollars in Millions) Commercial Commercial ******************** Lease ﬁnancing **************** Total commercial ************ Commercial real estate Commercial mortgages********** Construction and development *** Total commercial real estate ** Residential mortgages ********* Retail Credit card********************* Retail leasing ****************** Other retail ******************** Total retail ****************** Total managed loans ***** Investment securities ********** Total managed assets *********** Less Assets sold or securitized ******* Total assets held ********* Managed or securitized assets Commercial loans ************** Indirect automobile loans (b) ***** Guaranteed SBA loans (c)******* Small business credit lines (c) *** Investment securities************ Total securitized assets ****** (a) Includes nonaccrual (b) Reported in ‘‘other retail’’ loans. (c) Reported in ‘‘commercial’’ loans. U.S. Bancorp 81 Note 10 Premises and Equipment Premises and equipment at December 31 consisted of the following: (Dollars in Millions) Land******************************************************************************************************* Buildings and improvements********************************************************************************** Furniture, ﬁxtures and equipment ***************************************************************************** Capitalized building and equipment leases ********************************************************************* Construction in progress ************************************************************************************* Less accumulated depreciation and amortization *************************************************************** 2003 $ 311 2,226 2,092 175 7 4,811 2,854 Total**************************************************************************************************** $1,957 2002 $ 275 1,844 2,152 173 4 4,448 2,751 $1,697 Note 11 Mortgage Servicing Rights The Company’s portfolio of residential mortgages serviced for others was $53.9 billion, $43.1 billion and $22.0 billion at December 31, 2003, 2002, and 2001 respectively. The net carrying value of capitalized mortgage servicing rights was as follows: December 31 (Dollars in Millions) Initial carrying value, net of amortization ********************************************************** Impairment valuation allowance****************************************************************** Net carrying value ************************************************************************** Changes in capitalized mortgage servicing rights are summarized as follows: Year Ended December 31 (Dollars in Millions) Balance at beginning of year************************************************************** Rights purchased********************************************************************* Rights capitalized********************************************************************* Amortization ************************************************************************* Rights sold ************************************************************************** Impairment ************************************************************************** Balance at end of year ******************************************************************* 2003 $ 830 (160) $ 670 2003 $ 642 55 338 (156) — (209) $ 670 2002 $ 849 (207) $ 642 2002 $ 360 229 357 (94) (24) (186) $ 642 The key economic assumptions used to estimate the value of the mortgage servicing rights portfolio were as follows: December 31 (Dollars in Millions) Fair value ************************************************************************************* Expected weighted-average life (in years) ********************************************************* Discount rate ********************************************************************************** 2003 $670 5.2 9.9% 2002 $655 4.8 9.8% The estimated sensitivity of the fair value of the mortgage servicing rights portfolio to changes in interest rates at December 31, 2003, was as follows: (Dollars in Millions) Down Scenario Up Scenario 50 bps 25 bps 25 bps 50 bps Fair value************************************************************************************ $(127) $(78) $75 $133 The Company utilizes the investment securities portfolio as an economic hedge against possible adverse interest rate changes. The Company also, from time to time, purchases principal-only securities that act as a partial economic hedge. The Company is able to recognize reparations from increases in fair value of servicing rights when impairment reserves are released. The fair value of mortgage servicing rights and its sensitivity to changes in interest rates is inﬂuenced by the mix of the servicing portfolio and characteristics of each segment of the portfolio. In the current interest rate environment, mortgage loans originated as part of government agency and state loan programs tend to experience slower prepayment speeds and better cash ﬂows than conventional mortgage loans. The Company’s servicing portfolio consists of the distinct portfolios of The Leader Mortgage Company, LLC (a wholly-owned subsidiary) and U.S. Bank Home Mortgage. 82 U.S. Bancorp A summary of the Company’s mortgage servicing rights and related characteristics by portfolio as of December 31, 2003, is as follows: (Dollars in Millions) Servicing portfolio ******************************************************************* Fair market value ******************************************************************* Value (bps) ************************************************************************* Weighted-average servicing fees (bps) ************************************************ Multiple (value/servicing fees) ******************************************************** Weighted-average note rate ********************************************************** Age (in years) ********************************************************************** Expected life (in years) ************************************************************** Discount rate *********************************************************************** Leader Mortgage $8,018 $ 119 148 44 3.36 6.49% 3.3 5.4 10.1% U.S. Bank Home Mortgage Conventional Government Total $36,306 412 $ 113 34 3.32 5.82% 1.3 5.1 9.5% $9,597 $ 139 145 45 3.22 6.39% 2.0 5.1 11.1% $53,921 670 $ 124 37 3.35 6.02% 1.8 5.2 9.9% The Leader Mortgage Company, LLC specializes in servicing loans made under state and local housing authority programs. These programs provide mortgages to low and moderate income borrowers and are generally under government insured programs with down payment or closing cost assistance. As a result of the slower prepayment characteristics of the state and local loan programs, the Leader portfolio has a longer expected life relative to other servicing portfolios. The U.S. Bank Home Mortgage servicing portfolio is predominantly comprised of ﬁxed-rate agency loans (FNMA, FHLMC, GNMA, FHLB and various housing agencies) with limited adjustable-rate or jumbo mortgage loans. Note 12 Intangible Assets The Company adopted SFAS 142 on January 1, 2002. The most signiﬁcant changes made by SFAS 142 are that goodwill and other indeﬁnite lived intangible assets are no longer amortized and will be tested for impairment at least annually. The amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the amortization provisions of SFAS 142 were effective upon adoption of SFAS 142. Prior to the adoption of SFAS 142, the Company evaluated goodwill for impairment under a projected undiscounted cash ﬂow model. As a result of the initial impairment test from the adoption of SFAS 142, the Company recognized an impairment loss of $58.8 million resulting in an after-tax loss of $37.2 million in the ﬁrst quarter of 2002. The impairment was primarily related to the purchase of a transportation leasing company in 1998 by the equipment leasing business. This charge was recognized as a ‘‘cumulative effect of accounting change’’ in the income statement. The fair value of that reporting unit was estimated using the present value of future expected cash ﬂows. Net income and earnings per share adjusted for the exclusion of amortization expense (net of tax) and asset impairments related to goodwill are as follows: Year Ended December 31 (Dollars in Millions, Except Per Share Data) 2003 2002 2001 Reported net income ******************************************************************* Goodwill amortization, net of tax ****************************************************** Asset impairments, net of tax ******************************************************** Adjusted net income ************************************************************* Earnings per share Reported net income **************************************************************** Goodwill amortization, net of tax ****************************************************** Asset impairments, net of tax ******************************************************** Adjusted net income ************************************************************* Diluted earnings per share Reported net income **************************************************************** Goodwill amortization, net of tax ****************************************************** Asset impairments, net of tax ******************************************************** $3,732.6 — — $3,732.6 $ $ $ 1.94 — — 1.94 1.93 — — $3,168.1 — 37.2 $3,205.3 $ $ $ 1.65 — .02 1.67 1.65 — .02 Adjusted net income ************************************************************* $ 1.93 $ 1.67 $1,478.8 236.7 — $1,715.5 $ $ $ $ .77 .12 — .89 .76 .12 — .88 U.S. Bancorp 83 The following table reﬂects the changes in the carrying value of goodwill for the years ended December 31, 2002 and 2003: (Dollars in Millions) Balance at December 31, 2001 ******** Goodwill acquired******************* Disposal *************************** Balance at December 31, 2002 ******** Goodwill acquired******************* Disposal *************************** Balance at December 31, 2003 ******** Wholesale Banking Consumer Banking Private Client, Trust and Asset Management $1,244 45 (59) $1,230 — (5) $1,225 $1,810 431 — $2,241 1 — $2,242 $289 447 — $736 6 — $742 Payment Services $1,810 2 — $1,812 4 — $1,816 $ 306 — — $ 306 — (306) $ — Capital Markets (a) Consolidated Company (a) In 2003, the Company completed a tax-free distribution of Piper Jaffray Companies. The reduction represents goodwill associated with Piper Jaffray Companies. Intangible assets consisted of the following: December 31 (Dollars in Millions) Goodwill ****************************************************** Merchant processing contracts ********************************** Core deposit beneﬁts******************************************* Mortgage servicing rights *************************************** Trust relationships********************************************** Other identiﬁed intangibles ************************************** Total ****************************************************** Estimated Life (a) Amortization Method (b) — 8 years 10 years/6 years 5 years 15 years/10 years 8 years/9 years — AC SL/AC AC SL/AC SL/AC Balance 2003 $6,025 552 417 670 311 174 $8,149 $5,459 925 (59) $6,325 11 (311) $6,025 2002 $6,325 596 505 642 371 207 $8,646 (a) Estimated life represents the amortization period for assets subject to the straight line method and the weighted average amortization period for intangibles subject to accelerated methods. If more than one amortization method is used for a category, the estimated life for each method is calculated and reported separately. (b) Amortization methods: SL = straight line method AC = accelerated methods generally based on cash ﬂows Aggregate amortization and impairment expense consisted of the following: Year Ended December 31 (Dollars in Millions) Goodwill (a) ***************************************************************************** Merchant processing contracts ************************************************************ Core deposit beneﬁts********************************************************************* Mortgage servicing rights ***************************************************************** Trust relationships************************************************************************ Other identiﬁed intangibles **************************************************************** Total ******************************************************************************** 2003 $ — 132.4 88.2 365.1 53.3 43.4 $682.4 2002 $ — 135.1 80.9 280.1 19.3 37.6 $553.0 2001 $236.7 15.3 80.9 106.1 19.3 56.8 $515.1 (a) The Company adopted SFAS 142 on January 1, 2002, resulting in the elimination of amortization of goodwill and other indeﬁnite lived intangible assets. Below is the estimated amortization expense for the next ﬁve years: (Dollars in Millions) 2004*********************************************************************************************************************** 2005*********************************************************************************************************************** 2006*********************************************************************************************************************** 2007*********************************************************************************************************************** 2008*********************************************************************************************************************** $477.5 370.2 306.9 261.3 209.6 84 U.S. Bancorp Note 13 Short-Term Borrowings The following table is a summary of short-term borrowings for the last three years: (Dollars in Millions) At year-end Federal funds purchased ***************************** Securities sold under agreements to repurchase ******** Commercial paper *********************************** Treasury, tax and loan notes ************************** Other short-term borrowings ************************** Total ******************************************** Average for the year Federal funds purchased ***************************** Securities sold under agreements to repurchase ******** Commercial paper *********************************** Treasury, tax and loan notes ************************** Other short-term borrowings ************************** Total ******************************************** Maximum month-end balance Federal funds purchased ***************************** Securities sold under agreements to repurchase ******** Commercial paper *********************************** Treasury, tax and loan notes ************************** Other short-term borrowings ************************** 2003 2002 2001 Amount Rate Amount Rate Amount Rate $ 5,098 3,586 699 809 658 $10,850 $ 4,966 3,374 681 634 848 $10,503 $ 6,658 4,173 952 4,223 2,676 .91% .71 .88 .69 .65 $ 3,025 2,950 380 102 1,349 .98% .97 1.20 .91 1.26 $ 1,146 3,001 452 4,038 6,033 .81% $ 7,806 1.03% $14,670 2.36% .79 1.06 .95 1.13 $ 4,145 2,308 391 707 2,565 2.94% 1.14 1.74 1.50 2.23 $ 4,997 2,421 390 1,321 2,550 1.59% $10,116 2.20% $11,679 $ 7,009 2,950 452 4,164 6,172 $ 7,829 3,001 590 6,618 7,149 1.08% 1.10 1.85 1.27 2.54 1.75% 5.02% 2.89 3.85 3.53 3.65 4.07% U.S. Bancorp 85 Note 14 Long-Term Debt Long-term debt (debt with original maturities of more than one year) at December 31 consisted of the following: (Dollars in Millions) U.S. Bancorp (Parent Company) Fixed-rate subordinated notes 2003 2002 7.00% due 2003************************************************************************************* 6.625% due 2003************************************************************************************ 7.25% due 2003************************************************************************************* 8.00% due 2004************************************************************************************* 7.625% due 2005************************************************************************************ 6.75% due 2005************************************************************************************* 6.875% due 2007************************************************************************************ 7.30% due 2007************************************************************************************* 7.50% due 2026************************************************************************************* Senior contingent convertible debt 1.50% due 2021 ******************************************************** Medium-term notes ************************************************************************************* Capitalized lease obligations, mortgage indebtedness and other ********************************************* Subtotal ***************************************************************************************** Subsidiaries Fixed-rate subordinated notes 6.00% due 2003************************************************************************************* 6.375% due 2004************************************************************************************ 6.375% due 2004************************************************************************************ 7.55% due 2004************************************************************************************* 8.35% due 2004************************************************************************************* 7.30% due 2005************************************************************************************* 6.875% due 2006************************************************************************************ 6.625% due 2006************************************************************************************ 6.50% due 2008************************************************************************************* 6.30% due 2008************************************************************************************* 5.70% due 2008************************************************************************************* 7.125% due 2009************************************************************************************ 7.80% due 2010************************************************************************************* 6.375% due 2011************************************************************************************ 6.30% due 2014************************************************************************************* 4.80% due 2015************************************************************************************* Federal Home Loan Bank advances ********************************************************************** Bank notes********************************************************************************************* Euro medium-term notes due 2004 *********************************************************************** Capitalized lease obligations, mortgage indebtedness and other ********************************************* Subtotal ***************************************************************************************** $ — — — 73 120 191 220 200 200 — 4,025 171 5,200 — 75 150 100 100 100 70 100 300 300 400 500 300 1,500 1,000 500 8,595 10,870 400 655 26,015 Total ******************************************************************************************** $31,215 $ 150 100 32 73 120 191 220 200 200 57 4,127 225 5,695 79 75 150 100 100 100 70 100 300 300 400 500 300 1,500 1,000 — 9,255 7,302 400 862 22,893 $28,588 In April 2003, the Company’s subsidiary U.S. Bank Federal Home Loan Bank (‘‘FHLB’’) advances National Association issued $500 million of ﬁxed-rate subordinated notes due April 15, 2015. The interest rate is 4.80 percent per annum. Medium-term notes (‘‘MTNs’’) outstanding at December 31, 2003, mature from May 2004 through March 2008. The MTNs bear ﬁxed or ﬂoating interest rates ranging from 1.28 percent to 7.05 percent. The weighted- average interest rate of MTNs at December 31, 2003, was 3.87 percent. outstanding at December 31, 2003, mature from February 2004 through October 2026. The advances bear ﬁxed or ﬂoating interest rates ranging from .50 percent to 8.25 percent. The Company has an arrangement with the FHLB whereby based on collateral available (residential and commercial mortgages), the Company could have borrowed an additional $7.0 billion at December 31, 2003. The weighted-average interest rate of FHLB advances at December 31, 2003, was 2.25 percent. 86 U.S. Bancorp Bank notes outstanding at December 31, 2003, mature from January 2004 through November 2006. The Bank notes bear ﬁxed or ﬂoating interest rates ranging from 1.05 percent to 5.63 percent. The weighted-average interest rate of Bank notes at December 31, 2003, was 1.36 percent. Euro medium-term notes outstanding at December 31, 2003, bear ﬂoating rate interest at three-month LIBOR plus .15 percent. The interest rate at December 31, 2003, was 1.30 percent. Maturities of long-term debt outstanding at December 31, 2003, are as follows: (Dollars in Millions) Consolidated 2004*************************** 2005*************************** 2006*************************** 2007*************************** 2008*************************** Thereafter ********************** Total *************************** $ 9,989 9,074 1,858 1,574 4,302 4,418 $31,215 Parent Company $ 888 1,346 658 1,557 503 248 $5,200 Note 15 Company-obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts Holding Solely the Junior Subordinated Debentures of the Parent Company The Company has issued $2.6 billion of company-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely the junior subordinated debentures of the parent company (‘‘Trust Preferred Securities’’) through eight separate issuances by eight wholly-owned subsidiary grantor trusts (‘‘Trusts’’). The Trust Preferred Securities accrue and pay distributions periodically at speciﬁed rates as provided in the indentures. The Trusts used the net proceeds from the offerings to purchase a like amount of junior subordinated deferrable interest debentures (the ‘‘Debentures’’) of the Company. The Debentures are the sole assets of the Trusts and are eliminated, along with the related income statement effects, in the consolidated ﬁnancial statements. The Trust Preferred Securities are mandatorily redeemable upon the maturity of the Debentures, or upon earlier redemption as provided in the indentures. The Company has the right to redeem retail Debentures in whole or in part, as well as on or after speciﬁc dates, at a redemption price speciﬁed in the indentures plus any accrued but unpaid interest to the redemption date. The Company has the right to redeem institutional Debentures in whole, (but not in part), on or after speciﬁc dates, at a redemption price speciﬁed in the indentures plus any accrued but unpaid interest to the redemption date. The Trust Preferred Securities are redeemable in whole or in part in 2006 and 2007 in the amounts of $2.3 billion and $300 million, respectively. The Company’s obligations under the Debentures and The Trust Preferred Securities qualify as Tier I capital related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the Trusts. The guarantee covers the distributions and payments on liquidation or redemption of the Trust Preferred Securities, but only to the extent of funds held by the Trusts. of the Company for regulatory capital purposes. The Company used the proceeds from the sales of the Debentures for general corporate purposes. U.S. Bancorp 87 The following table is a summary of the Trust Preferred Securities as of December 31, 2003: Issuance Trust (Dollars in Millions) Retail Trust Preferred Securities Debentures Amount Amount (a) Issuance Date Rate Type (b) Rate Maturity Date Redemption Date (c) USB Capital V ***************** December 2001 USB Capital IV ***************** November 2001 USB Capital III ***************** May 2001 Institutional Star Capital I******************* June 1997 Mercantile Capital Trust I ******** February 1997 USB Capital I ****************** December 1996 Firstar Capital Trust I************ December 1996 FBS Capital I ****************** November 1996 $300 500 700 150 150 300 150 300 $309 515 722 155 155 309 155 309 Fixed Fixed Fixed Variable Variable Fixed Fixed Fixed 7.25% December 2031 December 7, 2006 November 2031 November 1, 2006 7.35 May 4, 2006 7.75 May 2031 June 2027 1.94(d) 2.01(e) February 2027 8.27 8.32 8.09 June 15, 2007 February 1, 2007 December 2026 December 15, 2006 December 2026 December 15, 2006 November 2026 November 15, 2006 (a) Company-obligated Mandatorily Redeemable Securities of Subsidiary Trusts which are designated in hedging relationships at December 31, 2003, are recorded on the balance sheet at fair value. Carrying value includes a fair value adjustment of $56 million related to hedges on certain retail and institutional obligated trust securities, as well as unamortized issuance costs of $(5) million. (b) The variable-rate Trust Preferred Securities reprice quarterly. (c) Earliest date of redemption. (d) Three-month LIBOR +76.5 basis points (e) Three-month LIBOR +85.0 basis points On April 1, 2003, USB Capital II, a subsidiary Refer to Note 2 with respect to the potential impact of company of U.S. Bancorp, redeemed 100 percent, or $350 million of its 7.20 percent Trust Preferred Securities. On May 2, 2003, USB Capital II was legally dissolved. Note 16 Shareholders’ Equity At December 31, 2003 and 2002, the Company had authority to issue 4 billion shares of common stock and 10 million shares of preferred stock. The Company had 1,922.9 million and 1,917.0 million shares of common stock outstanding at December 31, 2003 and 2002, respectively. At December 31, 2003, the Company had 208.0 million shares of common stock reserved for future issuances, primarily under stock option plans. The Company has a preferred share purchase rights plan intended to preserve the long-term value of the Company by discouraging a hostile takeover of the Company. Under the plan, each share of common stock carries a right to purchase one one-thousandth of a share of preferred stock. The rights become exercisable in certain limited circumstances involving a potential business combination transaction or an acquisition of shares of the Company and are exercisable at a price of $100 per right, subject to adjustment. Following certain other events, each right entitles its holder to purchase for $100 an amount of common stock of the Company, or, in certain circumstances, securities of the acquirer, having a then- current market value of twice the exercise price of the right. The dilutive effect of the rights on the acquiring company is intended to encourage it to negotiate with the Company’s Board of Directors prior to attempting a takeover. If the Board of Directors believes a proposed acquisition is in the best interests of the Company and its shareholders, the the adoption of FIN 46 relative to Trust Preferred Securities. Board may amend the plan or redeem the rights for a nominal amount in order to permit the acquisition to be completed without interference from the plan. Until a right is exercised, the holder of a right has no rights as a shareholder of the Company. The rights expire on February 27, 2011. On July 17, 2001, the Company’s Board of Directors authorized the repurchase of up to 56.4 million shares of the Company’s common stock to replace shares issued in connection with the acquisition of NOVA. During the ﬁrst quarter of 2002, the Company effectively completed the July 17, 2001 authorization. On December 18, 2001, the Board of Directors approved an authorization to repurchase an additional 100 million shares of outstanding common stock throughout 2003. On December 16, 2003, the Board of Directors approved an authorization to repurchase an additional 150 million shares of outstanding common stock during the following 24 months. This repurchase program replaced the Company’s December 18, 2001 program. The following table summarizes the Company’s common stock repurchased in each of the last three years: (Dollars and Shares in Millions) 2003 ******************************* 2002 ******************************* 2001 ******************************* Shares 15.0 45.3 19.7 Value $ 417 1,040 468 88 U.S. Bancorp Shareholders’ equity is affected by transactions and valuations of asset and liability positions that require adjustments to Other Comprehensive Income. The reconciliation of the transactions affecting Other Comprehensive Income included in shareholders’ equity for the years ended December 31, is as follows: (Dollars in Millions) Transactions Pre-tax Tax-effect Net-of-tax Balance Net-of-tax 2003 Unrealized loss on securities available-for-sale*********************************** Unrealized loss on derivatives ************************************************* Realized gain on derivatives *************************************************** Reclassiﬁcation adjustment for gains realized in net income ***************************************************** Foreign currency translation adjustment ***************************************** $ (716) (373) 199 (288) 23 Total ********************************************************************* $(1,155) 2002 Unrealized gain on securities available-for-sale ********************************** Unrealized gain on derivatives ************************************************* Realized gain on derivatives *************************************************** Reclassiﬁcation adjustment for gains realized in net income ***************************************************** Foreign currency translation adjustment ***************************************** $ 1,048 324 64 (332) 7 Total ********************************************************************* $ 1,111 2001 Unrealized gain on securities available-for-sale ********************************** Unrealized gain on derivatives ************************************************* Realized gain on derivatives *************************************************** Reclassiﬁcation adjustment for gains realized in net income ***************************************************** Foreign currency translation adjustment ***************************************** $ 194 106 42 (333) (4) $ 272 142 (76) 110 (9) $ 439 $(398) (123) (24) 126 (3) $(422) $ (78) (40) (16) 127 1 $(444) (231) 123 (178) 14 $(123) 35 140 — 16 $(716) $ 68 $ 650 201 40 (206) 4 $ 473 266 43 — 2 $ 689 $ 784 $ 116 66 26 (206) (3) $ 9 65 24 — (3) Total ********************************************************************* $ 5 $ (6) $ (1) $ 95 Note 17 Earnings Per Share The components of earnings per share were: (Dollars and Shares in Millions, Except Per Share Data) Income from continuing operations ******************************************************* Income (loss) from discontinued operations (after-tax) *********************************** Cumulative effect of accounting change (after-tax) ************************************** Net income ********************************************************************* 2003 2002 2001 $3,710.1 22.5 — $3,732.6 $3,228.0 (22.7) (37.2) $1,524.0 (45.2) — $3,168.1 $1,478.8 Weighted-average common shares outstanding ******************************************** Net effect of the assumed purchase of stock based on the treasury stock method for options and stock plans ********************************************************************** Weighted-average diluted common shares outstanding ************************************* 1,923.7 1,916.0 1,927.9 12.5 1,936.2 8.8 1,924.8 12.4 1,940.3 Earnings per share Income from continuing operations **************************************************** Discontinued operations ********************************************************** Cumulative effect of accounting change ******************************************** Net income ****************************************************************** Diluted earnings per share Income from continuing operations **************************************************** Discontinued operations ********************************************************** Cumulative effect of accounting change ******************************************** $ $ $ 1.93 .01 — 1.94 1.92 .01 — $ $ $ 1.68 (.01) (.02) 1.65 1.68 (.01) (.02) $ $ $ .79 (.02) — .77 .79 (.03) — Net income ****************************************************************** $ 1.93 $ 1.65 $ .76 For the years ended December 31, 2003, 2002 and 2001, options to purchase 79 million, 140 million and 125 million shares, respectively, were outstanding but not included in the computation of diluted earnings per share because they were antidilutive. U.S. Bancorp 89 Note 18 Employee Beneﬁts Employee Investment Plan The Company has deﬁned contribution retirement savings plans which allow qualiﬁed employees, at their option, to make contributions up to certain percentages of pre-tax base salary through salary deductions under Section 401(k) of the Internal Revenue Code. Employee contributions are invested, at the employees’ direction, among a variety of investment alternatives. Employee contributions are 100 percent matched by the Company, up to the ﬁrst four percent of an employee’s compensation. The Company’s matching contribution vests immediately; however, a participant must be employed on December 31st to receive that year’s matching contribution. Although the matching contribution is initially invested in the Company’s common stock, an employee can reinvest the matching contributions among various investment alternatives. Total expense was $48.5 million, $50.5 million and $43.7 million in 2003, 2002 and 2001, respectively. Pension Plans Pension beneﬁts are provided to substantially all employees based on years of service and employees’ compensation while employed with the Company. Employees are fully vested after ﬁve years of service. Prior to their acquisition dates, employees of certain acquired companies were covered by separate, noncontributory pension plans that provided beneﬁts based on years of service and compensation. Generally, the Company merges plans of acquired companies into its existing pension plans when it becomes practicable. As of January 1, 2002, the Company’s two existing pension plans were merged under a new ﬁnal average-pay beneﬁt structure. During 2001, the Company had maintained two different qualiﬁed pension plans, with three different pension beneﬁt structures: the former USBM’s cash balance pension beneﬁt structure, a ﬁnal average pay beneﬁt structure for the former Firstar organization, and a cash balance pension beneﬁt structure related to the Mercantile acquisition. The beneﬁt structure of the new combined plan did not become effective for the Mercantile acquisition until January 1, 2003. Under the new plan’s beneﬁt structure, a participant’s future retirement beneﬁts are based on a participant’s highest ﬁve year average annual compensation during his or her last 10 years before retirement or termination from the Company. Generally, under the two previous cash balance pension beneﬁt structures, the participant’s earned retirement beneﬁts based on their average compensation over their career. Retirement beneﬁts under the former Firstar beneﬁt structure were earned based on ﬁnal average pay and years of service, similar to the new plan. Plan assets primarily consist of various equity mutual funds and other miscellaneous assets. During 2001, the Company also maintained several unfunded, non-qualiﬁed, supplemental executive retirement programs that provided additional deﬁned pension beneﬁts for senior managers and executive employees. As of September 30, 2001, a supplemental executive retirement plan of USBM was frozen for substantially all participants but with service credit running through December 31, 2001. Effective January 1, 2002, substantially all of these programs were merged into one non-qualiﬁed retirement plan. Because all the non-qualiﬁed plans were unfunded, the aggregate accumulated beneﬁt obligations exceeded the assets. The assumptions used in computing the present value of the accumulated beneﬁt obligation, the projected beneﬁt obligation and net pension expense are substantially consistent with those assumptions used for the funded qualiﬁed plans. The Company recognized a settlement loss of $3.5 million on this plan in 2003, related to the level of payouts made from the plan. In 2002, the Company recognized combined curtailment and settlement gains of $11.7 million related to changes in the non-qualiﬁed pension plans in connection with the mergers of the prior plans. In general, the Company’s pension plan objectives include maintaining a funded status sufﬁcient to meet participant beneﬁt obligations over time while reducing long-term funding requirements and pension costs. The Company has an established process for evaluating all 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 plan investment policies considering its long-term investment time horizon and asset allocation strategies. The process also evaluates signiﬁcant plan assumptions. Although plan assumptions are established annually, the Company may update its analysis on an interim basis in order to be responsive to signiﬁcant events that occur during the year, such as plan mergers and amendments. Funding Practices The Company’s funding policy is to contribute amounts to its plans sufﬁcient to meet the minimum funding requirements of the Employee Retirement Income Security Act of 1974, plus such additional amounts as the Company determines to be appropriate. During 2003 and 2002, the Company made contributions of $310.8 million and $150.0 million, respectively, to the qualiﬁed pension plan in accordance with this policy. In 2004, the Company anticipates no minimum funding requirement and therefore does not expect to make any contributions to the plan. Contributions made to the plan were invested in accordance with established investment policies and asset allocation strategies. 90 U.S. Bancorp Investment Policies and Asset Allocation In establishing its investment policies and asset allocation strategies, the Company considers expected returns and the volatility associated with different strategies. The independent consultant performs modeling that projects numerous outcomes using a broad range of possible scenarios, including a mix of possible rates of inﬂation and economic growth. Some of the scenarios included are: low inﬂation and high growth (ideal growth), low inﬂation and low growth (recession), high inﬂation and low growth (stagﬂation) and high inﬂation and high growth (inﬂationary growth). Starting with current economic information, the model bases its projections on past relationships between inﬂation, ﬁxed income rates and equity returns when these types of economic conditions have existed over the previous 30 years, both in the U.S. and in foreign countries. Based on an analysis of historical performance by asset class, over any 20-year period since the mid-1940’s, investments in equities have outperformed other investment classes but are subject to higher volatility. While an asset allocation including bonds and other assets generally has lower volatility and may provide protection in a declining interest rate environment, it limits the pension plan’s long- term up-side potential. Given the pension plan’s investment horizon and the ﬁnancial viability of the Company to meet its funding objectives, the Committee has determined that an asset allocation strategy investing in 100% equities diversiﬁed among various domestic equity categories and international equities is appropriate. The following unaudited table provides a summary of asset allocations adopted by the Company compared with a typical asset allocation alternative: Asset Class Domestic Equities Large Cap ******************* Mid Cap ********************* Small Cap ******************* International Equities ******** Fixed Income ***************** Other ************************* Total mix or weighted rates ** LTROR assumed ************* Standard deviation************ Sharpe ratio (c) ************** Typical Asset Mix 30% 15 15 10 30 — 100% 7.8% 13.9% .399 Asset Allocation December 2003 December 2002 2003 Expected Returns Actual Target (a) Actual Target Compound Average Standard Deviation 42% 15 19 21 — 3 55% 19 6 20 — — 33% 18 27 18 — 4 100% 100% 100% 8.9% (b) 18.0% .389 36% 18 26 20 — — 100% 9.9% 18.8% .382 8.3% 8.6 8.8 8.5 9.7% 10.6 11.3 10.6 18.0% 21.1 24.0 21.9 8.7 10.2 18.0 (a) The target asset allocation was modiﬁed in December 2003, effective January 1, 2004, to reduce the potential volatility of the portfolio without signiﬁcantly reducing the expected returns. The change in the allocation is not expected to be completed until the second quarter of 2004 and variations from the target allocation are a result of the recent change. (b) The LTROR assumed for the target asset allocation strategy of 8.9 percent is based on a range of estimates evaluated by the Company including the compound expected return of 8.7 percent and the average expected return of 10.2 percent. (c) The Sharpe ratio is a direct measure of reward-to-risk. The Sharpe ratio for these asset allocation strategies is considered to be within acceptable parameters. In accordance with its existing practices, the independent pension consultant utilized by the Company updated the analysis of expected rates of return and evaluated peer group data, market conditions and other factors relevant to determining the LTROR assumptions for pension costs for 2003 and 2004. The analysis performed late in 2002 indicated that there had been a continued deterioration in market performance of equities and as a result of that independent analysis, the Company made a decision to reduce the LTROR assumption from 9.9 percent used in the second half of 2002, to 8.9 percent for 2003. The analysis performed late in 2003 indicated a stabilization of market performance with the potential for better performance in 2004. As a result, the Company expects to continue to use an LTROR of 8.9 percent in 2004. Regardless of the extent of the Company’s analysis of alternative asset allocation strategies, economic scenarios and possible outcomes, plan assumptions developed for the LTROR are subject to imprecision and changes in economic factors. As a result of the modeling imprecision and uncertainty, the Company considers a range of potential expected rates of return, economic conditions for several scenarios, historical performance relative to assumed rates of return and asset allocation and LTROR information for a peer group in establishing its assumptions. U.S. Bancorp 91 Post-Retirement Medical Plans In addition to providing pension beneﬁts, the Company provides health care and death beneﬁts to certain retired employees through several retiree medical programs. As a result of the Firstar/USBM merger, there were three major retiree medical programs in place during 2001 with various terms and subsidy schedules. Effective January 1, 2002, the Company adopted one retiree medical program for all future retirees. For certain eligible employees, the provisions of the USBM retiree medical plan and the Mercantile retiree medical plan remained in place until December 31, 2002. Generally, all employees may become eligible for retiree health care beneﬁts by meeting deﬁned age and service requirements. The Company may also subsidize the cost of coverage for employees meeting certain age and service requirements. The medical plan contains other cost-sharing features such as deductibles and coinsurance. The estimated cost of these retiree beneﬁt payments is accrued during the employees’ active service. The following table summarizes beneﬁt obligation and plan asset activity for the retirement plans: (Dollars in Millions) Projected beneﬁt obligation Beneﬁt obligation at beginning of measurement period **************** Service cost ****************************************************** Interest cost ****************************************************** Plan participants’ contributions************************************** Actuarial loss ***************************************************** Beneﬁt payments************************************************** Curtailments ****************************************************** Settlements******************************************************* Beneﬁt obligation transferred to Piper Jaffray Companies ************** Termination beneﬁts *********************************************** Beneﬁt obligation at end of measurement period (a) (b) *************** Fair value of plan assets Fair value at beginning of measurement period *********************** Actual return on plan assets**************************************** Employer contributions ********************************************* Plan participants’ contributions************************************** Settlements******************************************************* Beneﬁt payments************************************************** Fair value at end of measurement period (c) ************************* Funded status Funded status at end of measurement period ************************ Unrecognized transition (asset) obligation **************************** Unrecognized prior service cost************************************* Unrecognized net (gain) loss *************************************** Fourth quarter contribution ***************************************** Net amount recognized ******************************************** Components of statement of ﬁnancial position Prepaid beneﬁt cost *********************************************** Accrued beneﬁt liability ******************************************** Net amount recognized ******************************************** Pension Plans Post-Retirement Medical Plans 2003 2002 2003 2002 $1,671.1 56.5 107.7 — 161.7 (140.8) — (23.8) (31.3) — $1,801.1 $1,442.7 351.7 346.0 — (23.8) (140.8) $1,975.8 $ 174.7 — (51.1) 854.7 4.8 $ 983.1 $1,123.8 (140.7) $ 983.1 $1,656.4 49.9 115.1 — — (147.3) (.7) (5.0) — 2.7 $ 282.5 3.4 18.5 14.9 38.9 (36.5) — — (1.4) — $1,671.1 $ 320.3 $1,611.1 (193.2) 172.1 — — (147.3) $ 30.2 .4 29.9 14.9 — (36.5) $1,442.7 $ 38.9 $ (228.4) (.1) (59.0) 867.8 4.3 $ 584.6 $ 763.9 (179.3) $ 584.6 $(281.4) 6.6 (7.2) 80.0 5.4 $(196.6) $ — (196.6) $(196.6) $ 265.1 3.3 19.1 10.4 18.1 (33.5) — — — — $ 282.5 $ 35.4 .7 17.2 10.4 — (33.5) $ 30.2 $(252.3) 7.4 (8.6) 41.0 13.7 $(198.8) $ — (198.8) $(198.8) (a) At December 31, 2003 and 2002, the accumulated beneﬁt obligation for all qualiﬁed pension plans was $1.6 billion and $1.4 billion, respectively. (b) U.S. Bancorp retained the qualiﬁed pension plan obligation for the inactive participants, relating to employees of Piper Jaffray Companies. Therefore, all liabilities and plan assets related to inactive participants in the qualiﬁed pension plan associated with the Piper Jaffray Companies are included in the pension plans beneﬁt obligation. (c) At December 31, 2003 and 2002, the Company’s qualiﬁed pension plans held 799,803 shares of U.S. Bancorp common stock, with a fair value of $23.8 million and $17.0 million, respectively. Dividends paid on the shares of U.S. Bancorp common stock held by the qualiﬁed pension plans totaled $.6 million for each of the years ended December 31, 2003 and 2002. 92 U.S. Bancorp The following table sets forth the components of net periodic beneﬁt cost (income) for the retirement plans: (Dollars in Millions) 2003 2002 2001 2003 2002 2001 Pension Plans Post-Retirement Medical Plans Components of net periodic beneﬁt cost (income) Service cost***************************************** Interest cost ***************************************** Expected return on plan assets************************ Net amortization and deferral************************** Recognized actuarial (gain) loss *********************** Net periodic beneﬁt cost (income)************************* Curtailment and settlement (gain) loss ***************** Cost of special or contractual termination $ 56.5 107.7 (184.4) (6.7) (.5) (27.4) 3.5 $ 49.9 115.1 (214.1) (6.5) .8 (54.8) (11.7) $ 50.5 118.7 (232.6) (10.7) (1.2) (75.3) — beneﬁts recognized ******************************* — 2.7 — $ 3.4 18.5 (1.2) (.2) .5 21.0 — — $ 3.3 19.1 (1.6) (.1) — 20.7 — — $ 2.1 17.9 (1.0) .2 (.1) 19.1 — — Net periodic beneﬁt cost (income) after curtailment and settlement (gain) loss, and cost of special or contractual termination beneﬁts recognized************************ $ (23.9) $ (63.8) $ (75.3) $21.0 $20.7 $19.1 The following table sets forth the weighted-average plan assumptions and other data: (Dollars in Millions) Pension plan actuarial computations Company 2003 2002 USBM 2001 Firstar 2001 Expected long-term return on plan assets (a) (b) ************************************ Discount rate in determining beneﬁt obligations (c) ********************************** Rate of increase in future compensation ******************************************* Post-retirement medical plan actuarial computations Expected long-term return on plan assets ****************************************** Discount rate in determining beneﬁt obligations ************************************* Health care cost trend rate (d) Prior to age 65 *************************************************************** After age 65 ***************************************************************** Effect of one percent increase in health care cost trend rate Service and interest costs ******************************************************** Accumulated post-retirement beneﬁt obligation ************************************** Effect of one percent decrease in health care cost trend rate Service and interest costs ******************************************************** Accumulated post-retirement beneﬁt obligation ************************************** 8.9% 6.2 3.5 3.5% 6.2 11.0% 13.0 $ 1.4 22.5 $ (1.3) (20.0) 10.9% 6.8 3.5 5.0% 6.8 12.0% 14.0 $ 1.3 19.7 $ (1.2) (17.5) 11.0% 7.5 3.5 5.0% 7.5 10.5% 13.0 $ 1.2 13.1 $ (1.0) (13.6) 12.2% 7.5 3.5 *% 7.5 10.5% 13.0 $ .4 6.0 $ (.4) (5.7) (a) (b) In connection with the Firstar/USBM merger, the asset management practices and investment strategies of the plan were conformed. At December 31, 2001, the investment asset allocation was weighted toward equities and diversiﬁed by industry and companies with varying market capitalization levels. In light of the market performance and the results of the independent analysis, the Company made a decision to re-measure its pension plans effective in the third quarter of 2002 based on the current information at that time with respect to asset values, a reduction in the LTROR, discount rates, census data and other relevant factors. As a result of the remeasurement, the LTROR was reduced to 9.9% for the last half of 2002. (c) The discount rate at the measurement date approximated the Moody’s Aa corporate bond rating for projected beneﬁt distributions with a duration of 12.2 and 11.6 years for 2003 and 2002, respectively. (d) The pre-65 and post-65 rates are assumed to decrease gradually to 5.5% and 6.0% respectively by 2011 and remain at these levels thereafter. The following table provides information for pension plans with beneﬁt obligations in excess of plan assets: (Dollars in Millions) Beneﬁt obligation****************************************************************************************** Accumulated beneﬁt obligation****************************************************************************** Fair value of plan assets *********************************************************************************** 2003 2002 $188.7 179.6 — $218.6 210.6 — U.S. Bancorp 93 Note 19 Stock-based Compensation As part of its employee and director compensation programs, the Company may grant certain stock awards under the provisions of the existing stock compensation plans, including plans assumed in acquisitions. The plans provide for grants of options to purchase shares of common stock at a ﬁxed price generally equal to the fair value of the underlying stock at the date of grant. Option grants are generally exercisable up to ten years from the date of grant. In addition, the plans provide for grants of shares of common stock or stock units that are subject to restriction on transfer. Most stock awards vest over three to ﬁve years and are subject to forfeiture if certain vesting requirements are not met. Stock incentive plans of acquired companies are generally terminated at the merger closing dates. Option holders under such plans receive the Company’s common stock, or options to buy the Company’s stock, based on the conversion terms of the various merger agreements. The historical stock award information presented below reﬂects awards originally granted under acquired companies’ plans. At December 31, 2003, there were 41.8 million shares (subject to adjustment for forfeitures) available for grant under our current stock incentive plan. The following is a summary of shares issuable under stock options outstanding and exercised under various stock option plans of the Company: Year Ended December 31 Stock option plans Number outstanding at beginning of year ********************** Granted ********************* Assumed/converted (a) ******** Exercised ******************** Cancelled******************** Number outstanding at end of year ** Exercisable at end of year ******** Restricted share plans Number outstanding at beginning of year ********************** Granted ********************* Assumed/converted *********** Cancelled/vested ************* Number outstanding at end of year ** Weighted-average fair value of shares granted *************** 2003 2002 2001 Stock Options Weighted-Average Exercise Price Stock Options Weighted-Average Exercise Price Stock Options Weighted-Average Exercise Price 206,252,590 1,872,653 1,116,884 (22,484,069) (21,235,704) 165,522,354 116,427,321 2,280,057 58,481 — (1,034,432) 1,304,106 $22.77 23.00 — 18.27 25.13 $22.93 $23.60 201,610,265 29,742,189 — (9,594,213) (15,505,651) 206,252,590 123,195,273 2,177,588 806,355 — (703,886) 2,280,057 $22.58 21.81 — 13.26 24.18 $22.77 $23.63 153,396,226 65,144,310 8,669,285 (12,775,067) (12,824,489) 201,610,265 117,534,343 6,377,137 1,021,887 298,988 (5,520,424) 2,177,588 $22.80 21.25 16.40 13.44 23.29 $22.58 $22.36 $ 6.82 $ 7.03 $ 6.76 (a) The number of shares subject to then-outstanding stock options have been multiplied by, and the exercise prices have been divided by, a factor of 1.0068 in order to maintain the economic value of the options following the spin off of Piper Jaffray Companies. Additional information regarding stock options outstanding as of December 31, 2003, is as follows: Range of Exercise Prices $.83 — $10.00 ************************************** $10.01 — $15.00************************************ $15.01 — $20.00************************************ $20.01 — $25.00************************************ $25.01 — $30.00************************************ $30.01 — $35.00************************************ $35.01 — $36.95************************************ 94 U.S. Bancorp Options Outstanding Exercisable Options Weighted- Average Remaining Contractual Life (Years) 1.4 3.8 7.1 7.1 5.0 3.4 3.0 6.3 Shares 2,893,745 4,120,299 34,269,234 78,525,163 40,092,423 5,138,138 483,352 165,522,354 Weighted- Average Exercise Price $ 5.90 11.72 18.79 22.43 28.43 32.65 35.81 Shares 2,890,211 3,561,885 20,441,742 45,944,620 37,967,373 5,138,138 483,352 $22.93 116,427,321 Weighted- Average Exercise Price $ 5.90 11.55 18.58 22.70 28.49 32.65 35.81 $23.60 Stock-based compensation expense was $158.1 million in 2003, compared with $185.0 million and $168.7 million in 2002 and 2001, respectively. In 2001, the Company also recognized $190.5 million of stock-based compensation expense as part of its merger and restructuring-related charges as a result of accelerated vesting of certain stock options and restricted stock due to change-in-control provisions triggered by the Firstar/USBM merger. At the time employee stock options expire or are exercised or cancelled, the Company determines the tax beneﬁt associated with the stock award and under certain circumstances may be required to recognize an adjustment to tax expense. On an after-tax basis, the ﬁnancial impact of stock-based compensation expense was $123.4 million in 2003, compared with $113.3 million and $106.9 million in 2002 and 2001, respectively. Stock-based compensation expense is based on the fair value of the award at the date of grant or modiﬁcation. The fair value of options was estimated using the Black-Scholes option-pricing model requiring the use of subjective valuation assumptions. Because employee stock options have characteristics that differ from those of traded options, including vesting provisions and trading limitations that impact their liquidity, the determined value used to measure compensation expense may vary from their actual fair value. The following table provides a summary of the valuation assumptions utilized by the Company to determine the estimated value of stock option grants: Weighted-average assumptions in stock option valuation Risk-free interest rates *********************************************************************************** Dividend yields ****************************************************************************************** Stock volatility factor ************************************************************************************* Expected life of options (in years) ************************************************************************* 2003 2002 2001 2.8% 3.0% .40 5.3 3.3% 3.0% .41 6.0 4.6% 3.0% .42 4.5 Note 20 Income Taxes The components of income tax expense were: (Dollars in Millions) 2003 2002 2001 Federal Current ******************************************************************************* Deferred ****************************************************************************** Federal income tax ****************************************************************** State Current ******************************************************************************* Deferred ****************************************************************************** State income tax ******************************************************************** $1,528.8 222.9 1,751.7 139.8 49.8 189.6 $1,268.9 256.9 1,525.8 146.9 34.8 181.7 $ 982.2 (275.9) 706.3 132.2 (20.2) 112.0 Total income tax provision************************************************************ $1,941.3 $1,707.5 $ 818.3 A reconciliation of expected income tax expense at the federal statutory rate of 35% to the Company’s applicable income tax expense follows: (Dollars in Millions) Tax at statutory rate (35%) ************************************************************** State income tax, at statutory rates, net of federal tax beneﬁt ******************************* Tax effect of Tax-exempt interest, net ************************************************************* Amortization of nondeductible goodwill ************************************************ Tax credits ************************************************************************* Nondeductible merger charges ******************************************************* Other items ************************************************************************ 2003 2002 $1,978.0 123.2 $1,727.4 116.5 (21.7) — (109.6) — (28.6) (24.9) — (85.5) 5.0 (31.0) 2001 $ 819.8 68.9 (37.4) 83.0 (69.4) 52.5 (99.1) Applicable income taxes **************************************************************** $1,941.3 $1,707.5 $ 818.3 The tax effects of fair value adjustments on securities available-for-sale, derivative instruments in cash ﬂow hedges and certain tax beneﬁts related to stock options are recorded directly to shareholders’ equity as part of other comprehensive income. In preparing its tax returns, the Company is required to interpret complex tax laws and regulations and utilize income and cost allocation methods to determine its taxable income. On an ongoing basis, the Company is subject to examinations by federal and state taxing authorities that U.S. Bancorp 95 may give rise to differing interpretations of these complex laws, regulations and methods. Due to the nature of the examination process, it generally takes years before these examinations are completed and matters are resolved. At December 31, 2003, the Company is in various stages of the examination process for federal tax return matters of U.S. Bancorp for periods dating back to 1995 and other predecessor entities dating back to 1997. In addition, examinations by various state taxing authorities date back to 1997. At year-end, the Company believes the aggregate amount of any additional tax liabilities that may result from these examinations, if any, will not have a material adverse effect on the ﬁnancial condition, results of operations or cash ﬂows of the Company. Deferred income tax assets and liabilities reﬂect the tax effect of temporary differences between the carrying amounts of assets and liabilities for ﬁnancial reporting purposes and the amounts used for the same items for income tax reporting purposes. The components of the Company’s net deferred tax liability as of December 31 were: (Dollars in Millions) 2003 2002 Deferred tax assets Allowance for credit losses ***************************************************************************** Stock compensation *********************************************************************************** Federal AMT credits and capital losses ****************************************************************** Pension and postretirement beneﬁts ********************************************************************* Deferred fees ***************************************************************************************** State and federal operating loss carryforwards ************************************************************ Real estate and other asset basis differences************************************************************* Other deferred tax assets, net ************************************************************************** $ 977.6 318.2 59.1 58.8 29.9 21.2 7.0 209.2 $ 961.0 334.7 48.6 62.8 (70.6) 34.9 39.1 487.4 Gross deferred tax assets *************************************************************************** 1,681.0 1,897.9 Deferred tax liabilities Leasing activities ************************************************************************************** Accrued severance, pension and retirement beneﬁts******************************************************* Accelerated depreciation ******************************************************************************* Securities available-for-sale and ﬁnancial instruments ****************************************************** Other investment basis differences ********************************************************************** Other deferred tax liabilities, net ************************************************************************* Gross deferred tax liabilities ************************************************************************* Valuation allowance ************************************************************************************ (2,509.6) (297.5) (142.3) (31.2) (19.5) (236.3) (3,236.4) (1.0) (2,292.2) (65.0) (104.4) (478.8) (37.2) (248.7) (3,226.3) (1.0) Net deferred tax liability *************************************************************************** $(1,556.4) $(1,329.4) The Company has established a valuation allowance to offset deferred tax assets related to state net operating loss carryforwards which are expected to expire unused. The Company has approximately $252 million of state net operating loss carryforwards, which expire at various times through 2022. Certain events covered by Internal Revenue Code section 593(e), which was not repealed, will trigger a recapture of base year reserves of acquired thrift institutions. The base year reserves of acquired thrift Note 21 Derivative Instruments institutions would be recaptured if an entity ceases to qualify as a bank for federal income tax purposes. The base year reserves of thrift institutions also remain subject to income tax penalty provisions that, in general, require recapture upon certain stock redemptions of, and excess distributions to, stockholders. At December 31, 2003, retained earnings included approximately $101.8 million of base year reserves for which no deferred federal income tax liability has been recognized. In the ordinary course of business, the Company enters into derivative transactions to manage its interest rate and prepayment risk and to accommodate the business requirements of its customers. The Company does not enter into derivative transactions for speculative purposes. Refer to Note 1 ‘‘Signiﬁcant Accounting Policies’’ in the Notes to Consolidated Financial Statements for a discussion of the Company’s accounting policies for derivative instruments. For information related to derivative positions held for asset and liability management purposes and customer-related derivative positions, see Table 17 ‘‘Derivative Positions,’’ included in Management’s Discussion and Analysis, which is incorporated by reference into these Notes to Consolidated Financial Statements. ASSET AND LIABILITY MANAGEMENT POSITIONS Cash Flow Hedges The Company had $21.2 billion of designated cash ﬂow hedges at December 31, 2003. These 96 U.S. Bancorp derivatives are interest rate swaps that are hedges of the forecasted cash ﬂows from the underlying variable-rate LIBOR loans and ﬂoating-rate debt. All cash ﬂow hedges are highly effective for the year ended December 31, 2003, and the change in fair value attributed to hedge ineffectiveness was not material. At December 31, 2003 and 2002, accumulated other comprehensive income included a deferred after-tax net gain of $174.9 million and $309.9 million, respectively, related to derivatives used to hedge cash ﬂows. The unrealized gain will be reﬂected in earnings when the related cash ﬂows or hedged transactions occur and will offset the related performance of the hedged items. The occurrence of these related cash ﬂows and hedged transactions remains probable. The estimated amount of after-tax gain to be reclassiﬁed from accumulated other comprehensive income into earnings during 2004 is $53.1 million, which includes gains related to hedges that were terminated early when the forecasted transactions are still probable. Fair Value Hedges The Company has $8.6 billion of designated fair value hedges at December 31, 2003. These derivatives are primarily interest rate contracts that hedge the change in fair value related to interest rate changes of underlying ﬁxed-rate debt, trust preferred securities, and deposit obligations. In addition, the Company uses forward commitments to sell residential mortgage loans to hedge its interest rate risk related to residential mortgage loans held for sale. The Company commits to sell the loans at speciﬁed prices in a future period, typically within 90 days. The Company is exposed to interest rate risk during the period between issuing a loan commitment and the sale of the loan into the secondary market. All fair value hedges are considered highly effective for the year ended December 31, 2003. The change in fair value attributed to hedge ineffectiveness was a loss of $6.8 million, related to the Company’s mortgage loans held for sale and its 2003 production volume of $29.9 billion. Other Asset and Liability Management Derivative Positions The Company has derivative positions that are used for interest rate risk and other risk management purposes but are not designated as cash flow hedges or fair value hedges in accordance with the provisions of Statement of Financial Accounting Standards No. 133, ‘‘Accounting for Derivative Instruments and Hedge Activities.’’ At December 31, 2003, the Company had $1.0 billion of forward commitments to sell residential mortgage loans to hedge the Company’s interest rate risk related to $1.0 billion of unfunded residential loan commitments. Gains and losses on mortgage banking derivatives and the unfunded loan commitments are included in mortgage banking revenue on the income statement. CUSTOMER-RELATED POSITIONS The Company acts as a seller and buyer of interest rate contracts and foreign exchange rate contracts on behalf of customers. At December 31, 2003, the Company had $16.6 billion of aggregate customer derivative positions, including $12.6 billion of interest rate swaps, caps, and ﬂoors and $4.0 billion of foreign exchange rate contracts. The Company minimizes its market and liquidity risks by taking similar offsetting positions. Gains or losses on customer-related transactions were not signiﬁcant for the year ended December 31, 2003. Note 22 Fair Values of Financial Instruments Due to the nature of its business and its customers’ needs, the Company offers a large number of financial instruments, most of which are not actively traded. When market quotes are unavailable, valuation techniques including discounted cash flow calculations and pricing models or services are used. The Company also uses various aggregation methods and assumptions, such as the discount rate and cash flow timing and amounts. As a result, the fair value estimates can neither be substantiated by independent market comparisons, nor realized by the immediate sale or settlement of the financial instrument. Also, the estimates reflect a point in time and could change significantly based on changes in economic factors, such as interest rates. Furthermore, the disclosure of certain financial and nonfinancial assets and liabilities are not required. Finally, the fair value disclosure is not intended to estimate a market value of the Company as a whole. A summary of the Company’s valuation techniques and assumptions follows. Cash and Cash Equivalents The carrying value of cash, amounts due from banks, federal funds sold and securities purchased under resale agreements was assumed to approximate fair value. Securities Investment securities were valued using available market quotes. In some instances, for securities that are not widely traded, market quotes for comparable securities were used. Loans The loan portfolio consists of both ﬂoating and ﬁxed-rate loans, the fair value of which was estimated using discounted cash ﬂow analyses and other valuation techniques. To calculate discounted cash ﬂows, the loans were aggregated into pools of similar types and expected repayment terms. The expected cash ﬂows of loans considered historical prepayment experiences and estimated credit losses for nonperforming loans and were discounted using current rates offered to borrowers of similar credit characteristics. U.S. Bancorp 97 Deposit Liabilities The fair value of demand deposits, savings accounts and certain money market deposits is equal to the amount payable on demand at year-end. The fair value of ﬁxed-rate certiﬁcates of deposit was estimated by discounting the contractual cash ﬂow using the discount rates implied by the high-grade corporate bond yield curve. Short-term Borrowings Federal funds purchased, securities sold under agreements to repurchase and other short-term funds borrowed are at ﬂoating rates or have short-term maturities. Their carrying value is assumed to approximate their fair value. Long-term Debt and Company-obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts Holding Solely the Junior Subordinated Debentures of the Parent Company The estimated fair value of medium-term notes, bank notes, Federal Home Loan Bank Advances, capital lease obligations and mortgage note obligations was determined using a discounted cash ﬂow analysis based on current market rates of similar maturity debt securities to discount cash ﬂows. Other long-term debt instruments and company-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely the junior subordinated debentures of the parent company were valued using available market quotes. Interest Rate Swaps, Basis Swaps and Options The interest rate options and swap cash ﬂows were estimated using a third-party pricing model and discounted based on appropriate LIBOR, eurodollar futures, swap and treasury note yield curves. Loan Commitments, Letters of Credit and Guarantees The fair value of commitments, letters of credit and guarantees represents the estimated costs to terminate or otherwise settle the obligations with a third-party. Residential mortgage commitments are actively traded and the fair value is estimated using available market quotes. Other loan commitments, letters of credit and guarantees are not actively traded. Substantially all loan commitments have ﬂoating rates and do not expose the Company to interest rate risk assuming no premium or discount was ascribed to loan commitments because funding could occur at market rates. The Company estimates the fair value of loan commitments, letters of credit and guarantees based on the related amount of unamortized deferred commitment fees adjusted for the probable losses for these arrangements. The estimated fair values of the Company’s ﬁnancial instruments at December 31 are shown in the following table: December 31 (Dollars in Millions) Financial Assets 2003 2002 Carrying Amount Fair Value Carrying Amount Fair Value Cash and cash equivalents ******************************************* Investment securities ************************************************* Loans held for sale ************************************************** Loans ************************************************************** $ 8,782 43,334 1,433 115,866 $ 8,782 43,343 1,433 116,874 $ 11,192 28,488 4,159 113,829 $ 11,192 28,495 4,159 115,341 Total ﬁnancial assets ********************************************** 169,415 $170,432 157,668 $159,187 Nonﬁnancial assets ******************************************** 19,871 Total assets *********************************************** $189,286 Financial Liabilities Deposits ************************************************************ Short-term borrowings************************************************ Long-term debt ****************************************************** Company-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely the junior subordinated debentures of the parent company*********************************************** 22,359 $180,027 $115,534 7,806 28,588 $116,039 7,806 29,161 $119,052 10,850 31,215 $119,120 10,850 31,725 2,601 2,700 2,994 3,055 Total ﬁnancial liabilities ******************************************** 163,718 $164,395 154,922 $156,061 Nonﬁnancial liabilities ****************************************** Shareholders’ equity ******************************************* 6,326 19,242 Total liabilities and shareholders’ equity *********************** $189,286 6,669 18,436 $180,027 Derivative Positions Asset and liability management positions Interest rate swaps ******************************************** Forward commitments to sell residential mortgages *************** $ Customer-related positions Interest rate contracts****************************************** Foreign exchange contracts ************************************ 631 — 31 2 $ 631 — 31 2 $ 1,438 (80) $ 1,438 (80) 22 1 22 1 98 U.S. Bancorp The fair value of unfunded commitments, standby letters of credit and other guarantees is approximately equal to their carrying value. The carrying value of unfunded commitments and standby letters of credit was $192 million. The carrying value of other guarantees was $132 million. Note 23 Guarantees and Contingent Liabilities COMMITMENTS TO EXTEND CREDIT Commitments to extend credit are legally binding and generally have ﬁxed expiration dates or other termination clauses. The contractual amount represents the Company’s exposure to credit loss, in the event of default by the borrower. The Company manages this credit risk by using the same credit policies it applies to loans. Collateral is obtained to secure commitments based on management’s credit assessment of the borrower. The collateral may include marketable securities, receivables, inventory, equipment and real estate. Since the Company expects many of the commitments to expire without being drawn, total commitment amounts do not necessarily represent the Company’s future liquidity requirements. In addition, the commitments include consumer credit lines that are cancelable upon notiﬁcation to the consumer. LETTERS OF CREDIT Standby letters of credit are conditional commitments the Company issues to guarantee the performance of a customer to a third-party. The guarantees frequently support public and private borrowing arrangements, including commercial paper issuances, bond financings and other similar transactions. The Company issues commercial letters of credit on behalf of customers to ensure payment or collection in connection with trade transactions. In the event of a customer’s nonperformance, the Company’s credit loss exposure is the same as in any extension of credit, up to the letter’s contractual amount. Management assesses the borrower’s credit to determine the necessary collateral, which may include marketable securities, real estate, accounts receivable and inventory. Since the conditions requiring the Company to fund letters of credit may not occur, the Company expects its liquidity requirements to be less than the total outstanding commitments. The maximum potential future payments guaranteed by the Company under standby letter of credit arrangements at December 31, 2003, were approximately $9.7 billion with a weighted average term of approximately 24 months. The estimated fair value of standby letters of credit was approximately $84.6 million at December 31, 2003. The contract or notional amounts of commitments to extend credit and letters of credit at December 31, 2003, were as follows: (Dollars in Millions) Commitments to extend credit Commercial************** Corporate and purchasing cards ***************** Consumer credit cards **** Other consumer ********** Letters of credit Standby ***************** Commercial************** LEASE COMMITMENTS Less Than One Year After One Year Total $17,240 $30,902 $48,142 12,525 22,349 1,900 4,667 370 — — 9,690 5,073 40 12,525 22,349 11,590 9,740 410 Rental expense for operating leases amounted to $151.4 million in 2003, $148.0 million in 2002 and $165.2 million in 2001. Future minimum payments, net of sublease rentals, under capitalized leases and noncancelable operating leases with initial or remaining terms of one year or more, consisted of the following at December 31, 2003: (Dollars in Millions) 2004 **************************** 2005 **************************** 2006 **************************** 2007 **************************** 2008 **************************** Thereafter *********************** Total minimum lease payments ***** Less amount representing interest ** Present value of net minimum lease payments *************** GUARANTEES Operating Leases $ 181.9 161.7 146.2 131.3 110.9 516.1 $1,248.1 Capitalized Leases $ 8.9 7.9 7.0 6.6 6.2 38.7 75.3 28.5 $46.8 Guarantees are contingent commitments issued by the Company to customers or other third-parties. The Company’s guarantees primarily include parent guarantees related to subsidiaries’ third-party borrowing arrangements; third-party performance guarantees inherent in the Company’s business operations such as indemniﬁed securities lending programs and merchant charge-back guarantees; indemniﬁcation or buy-back provisions related to certain asset sales; and contingent consideration arrangements related to acquisitions. For certain guarantees, the Company has recorded a liability related to the potential obligation, or has access to collateral to support U.S. Bancorp 99 the guarantee or through the exercise of other recourse provisions can offset some or all of the maximum potential future payments made under these guarantees. The estimated fair value of guarantees, other than standby letters of credit, was approximately $132 million at December 31, 2003. Third-Party Borrowing Arrangements The Company provides guarantees to third-parties as a part of certain subsidiaries’ borrowing arrangements, primarily representing guaranteed operating or capital lease payments or other debt obligations with maturity dates extending through 2014. The maximum potential future payments guaranteed by the Company under these arrangements was approximately $1.5 billion at December 31, 2003. The Company’s recorded liabilities as of December 31, 2003, included $40.7 million representing outstanding amounts owed to these third-parties and required to be recorded on balance sheet in accordance with generally accepted accounting principles. The guaranteed operating lease payments are also included in the disclosed minimum lease obligations. Commitments from Securities Lending The Company participates in securities lending activities by acting as the customer’s agent involving the loan or sale of securities. The Company indemniﬁes customers for the difference between the market value of the securities lent and the market value of the collateral received. Cash collateralizes these transactions. The maximum potential future payments guaranteed by the Company under these arrangements was approximately $13.2 billion at December 31, 2003, and represented the market value of the securities lent to third- parties. At December 31, 2003, the Company held assets with a market value of $13.6 billion as collateral for these arrangements. Asset Sales The Company has provided guarantees to certain third-parties in connection with the sale of certain assets, primarily loan portfolios and low-income housing tax credits. These guarantees are generally in the form of asset buy-back or make-whole provisions that are triggered upon a credit event or a change in the tax-qualifying status of the related projects, as applicable, and remain in effect until the loans are collected or ﬁnal tax credits are realized, respectively. The maximum potential future payments guaranteed by the Company under these arrangements were approximately $784.9 million at December 31, 2003, and represented the total proceeds received from the buyer in these transactions where the buy-back or make-whole provisions have not yet expired. Recourse available to the Company includes guarantees from the Small Business Administration (for SBA loans sold), recourse against the correspondent that originated the loan or to the private mortgage issuer, the right to collect payments from the 100 U.S. Bancorp debtors, and/or the right to liquidate the underlying collateral, if any, and retain the proceeds. Based on its established loan-to-value guidelines, the Company believes the recourse available is sufﬁcient to recover future payments, if any, under the loan buy-back guarantees. Merchant Processing The Company, through its subsidiary NOVA Information Systems, Inc., provides merchant processing services. Under the rules of credit card associations, a merchant processor retains a contingent liability for credit card transactions processed. This contingent liability arises in the event of a billing dispute between the merchant and a cardholder that is ultimately resolved in the cardholder’s favor. In this situation, the transaction is ‘‘charged back’’ to the merchant and the disputed amount is credited or otherwise refunded to the cardholder. If the Company is unable to collect this amount from the merchant, it bears the loss for the amount of the refund paid to the cardholder. A cardholder, through its issuing bank, generally has until the latter of up to four months after the date the transaction is processed or the receipt of the product or service to present a charge-back to the Company as the merchant processor. The absolute maximum potential liability is estimated to be the total volume of credit card transactions that meet the associations’ requirements to be valid charge-back transactions at any given time. Management estimates that the maximum potential exposure for charge-backs would approximate the total amount of merchant transactions processed through the credit card associations for the last four months. For the last four months of 2003, this amount totaled approximately $36.8 billion. In most cases, this contingent liability is unlikely to arise, as most products and services are delivered when purchased and amounts are refunded when items are returned to merchants. However, where the product or service is not provided until a future date (‘‘future delivery’’), the potential for this contingent liability increases. To mitigate this risk, the Company may require the merchant to make an escrow deposit, may place maximum volume limitations on future delivery transactions processed by the merchant at any point in time, or may require various credit policy enhancements (including letters of credit and bank guarantees). Also, merchant processing contracts may include event triggers to provide the Company more ﬁnancial and operational control in the event of ﬁnancial deterioration of the merchant. At December 31, 2003, the Company held $28.6 million of merchant escrow deposits as collateral. The Company currently processes card transactions for several of the largest airlines in the United States. In the event of liquidation of these airlines, the Company could become ﬁnancially liable for refunding tickets purchased through the credit card associations under the charge-back provisions. Charge-back risk related to an airline is evaluated in a manner similar to credit risk assessments and merchant processing contracts consider the potential risk of default. At December 31, 2003, the value of future delivery airline tickets purchased was approximately $1.4 billion, and the Company held collateral of $188.7 million in escrow deposits and lines of credit related to airline customer transactions. In the normal course of business, the Company has unresolved charge-backs that are in process of resolution. The Company assesses the likelihood of its potential liability based on the extent and nature of unresolved charge-backs and its historical loss experience. At December 31, 2003, the Company recorded a liability for potential losses of $22.7 million. Contingent Consideration Arrangements The Company has contingent payment obligations related to certain business combination transactions. Payments are guaranteed as long as certain post-acquisition performance-based criteria are met or customer relationships are maintained. At December 31, 2003, the maximum potential future payments required to be made by the Company under these arrangements was approximately $75.5 million and primarily represented contingent payments related to the acquisition of the State Street Corporate Trust business on December 31, 2002. If required, these contingent payments would be payable within the next six months. Other Guarantees The Company provides liquidity and credit enhancement facilities to a Company-sponsored conduit, as more fully described in the ‘‘Off-Balance Sheet Arrangements’’ section within Management’s Discussion and Analysis. Although management believes a draw against these facilities is remote, the maximum potential future payments guaranteed by the Company under these arrangements was approximately $7.3 billion at December 31, 2003. The recorded fair value of the Company’s liability for the credit enhancement recourse obligation and liquidity facilities was $47.3 million at December 31, 2003, and was included in other liabilities. The Company guarantees payments to certain certiﬁcate holders of Company-sponsored investment trusts with varying termination dates extending through September 2004. The maximum potential future payments guaranteed by the Company under these arrangements was approximately $49.1 million at December 31, 2003. At December 31, 2003, the Company had a recorded liability of $44.1 million, held $15.0 million in cash collateral and has other contractual sources of recourse available to it including guarantees from third-parties and the underlying assets held by the investment trusts. OTHER CONTINGENT LIABILITIES In connection with the spin-off of Piper Jaffray Companies, the Company has agreed to indemnify Piper Jaffray Companies against losses that may result from third-party claims relating to certain speciﬁed matters. The Company’s indemniﬁcation obligation related to these speciﬁed matters is capped at $17.5 million and can be terminated by the Company if there is a change in control event for Piper Jaffray Companies. The Company is subject to various other litigation, investigations and legal and administrative cases and proceedings that arise in the ordinary course of its businesses. Due to their complex nature, it may be years before some matters are resolved. While it is impossible to ascertain the ultimate resolution or range of ﬁnancial liability with respect to these contingent matters, the Company believes that the aggregate amount of such liabilities will not have a material adverse effect on the ﬁnancial condition, results of operations or cash ﬂows of the Company. U.S. Bancorp 101 Note 24 U.S. Bancorp (Parent Company) Condensed Balance Sheet December 31 (Dollars in Millions) Assets Deposits with subsidiary banks, principally interest-bearing ************************************************** Available-for-sale securities ****************************************************************************** Investments in Bank and bank holding company subsidiaries*********************************************************** Nonbank subsidiaries (a) ***************************************************************************** Advances to Bank and bank holding company subsidiaries*********************************************************** Nonbank subsidiaries (a) ***************************************************************************** Other assets ******************************************************************************************* Total assets************************************************************************************** 2003 2002 $ 4,726 127 22,628 605 — 16 676 $ 5,869 118 17,479 1,501 575 363 2,663 $28,778 $28,568 Liabilities and Shareholders’ Equity Short-term funds borrowed******************************************************************************* Advances from subsidiaries ****************************************************************************** Long-term debt ***************************************************************************************** Junior subordinated debentures issued to subsidiary trusts ************************************************** Other liabilities ***************************************************************************************** Shareholders’ equity ************************************************************************************ Total liabilities and shareholders’ equity ************************************************************* $ 699 — 5,200 2,629 1,008 19,242 $28,778 $ 380 117 5,695 2,990 950 18,436 $28,568 (a) December 31, 2002, included approximately $610 million of investment in and $316 million of advances to Piper Jaffray Companies. Condensed Statement of Income Year Ended December 31 (Dollars in Millions) Income Dividends from bank and bank holding company subsidiaries ******************************* Dividends from nonbank subsidiaries ***************************************************** Interest from subsidiaries *************************************************************** Service and management fees from subsidiaries******************************************* Other income ************************************************************************** Total income ******************************************************************** Expense Interest on short-term funds borrowed **************************************************** Interest on long-term debt *************************************************************** Interest on junior subordinated debentures issued to subsidiary trusts ************************ Merger and restructuring-related charges ************************************************* Other expense ************************************************************************* Total expense ******************************************************************* Income (loss) before income taxes and equity in undistributed income of subsidiaries ********** Income tax credit*********************************************************************** Income (loss) of parent company ******************************************************** Equity in undistributed income of subsidiaries ********************************************* Net income ********************************************************************* $ 2003 27.0 5.8 69.1 24.2 37.9 164.0 8.0 78.2 192.6 2.9 86.5 368.2 (204.2) (37.1) (167.1) 3,899.7 2002 2001 $3,140.0 15.2 96.9 38.5 16.0 3,306.6 8.9 126.8 214.1 6.7 76.0 432.5 2,874.1 (84.6) 2,958.7 209.4 $1,300.1 10.1 272.8 221.8 21.0 1,825.8 18.5 318.5 141.7 63.2 335.1 877.0 948.8 (112.0) 1,060.8 418.0 $3,732.6 $3,168.1 $1,478.8 102 U.S. Bancorp Condensed Statement of Cash Flows Year Ended December 31 (Dollars in Millions) Operating Activities Net income****************************************************************************** Adjustments to reconcile net income to net cash provided by operating activities 2003 2002 2001 $ 3,732.6 $ 3,168.1 $ 1,478.8 Equity in undistributed income of subsidiaries ******************************************** Other, net**************************************************************************** (3,899.7) 172.2 (209.4) 43.8 (418.0) 88.4 Net cash provided by (used in) operating activities ************************************ 5.1 3,002.5 1,149.2 Investing Activities Proceeds from sales and maturities of investment securities ********************************** Purchases of investment securities ******************************************************** Investments in subsidiaries *************************************************************** Equity distributions from subsidiaries ******************************************************* Net (increase) decrease in short-term advances to subsidiaries ******************************* Long-term advances to subsidiaries ******************************************************** Principal collected on long-term advances to subsidiaries ************************************ Other, net ******************************************************************************* Net cash provided by (used in) investing activities************************************* Financing Activities Net increase (decrease) in short-term advances from subsidiaries ***************************** Net increase (decrease) in short-term borrowings ******************************************* Principal payments on long-term debt ****************************************************** Proceeds from issuance of long-term debt ************************************************** Proceeds from issuance of junior subordinated debentures to subsidiary trusts ***************** Redemption of junior subordinated debentures from subsidiary trusts ************************** Proceeds from issuance of common stock ************************************************** Repurchase of common stock ************************************************************* Cash dividends paid ********************************************************************* 20.9 (73.0) (283.9) 536.5 35.5 — 572.6 130.7 939.3 (117.2) 318.5 (1,593.5) 1,150.0 — (360.8) 398.4 (326.3) (1,556.8) 113.1 (52.9) (536.4) 1,200.0 415.1 (410.0) 1,770.0 44.5 2,543.4 48.4 (72.3) (2,537.5) 2,075.0 — — 147.0 (1,040.4) (1,480.7) 254.9 (73.5) (1,941.0) 600.0 190.4 (1,144.0) 2,713.2 34.7 634.7 (10.6) 228.9 (1,612.8) 1,100.0 1,546.4 — 136.4 (467.9) (1,235.1) Net cash provided by (used in) ﬁnancing activities************************************* (2,087.7) (2,860.5) (314.7) Change in cash and cash equivalents *********************************************** Cash and cash equivalents at beginning of year ********************************************* (1,143.3) 5,869.0 2,685.4 3,183.6 1,469.2 1,714.4 Cash and cash equivalents at end of year******************************************** $ 4,725.7 $ 5,869.0 $ 3,183.6 Transfer of funds (dividends, loans or advances) from bank subsidiaries to the Company is restricted. Federal law prohibits loans unless they are secured and generally limits any loan to the Company or individual afﬁliate to 10 percent of the bank’s equity. In aggregate, loans to the Company and all afﬁliates cannot exceed 20 percent of the bank’s equity. Dividend payments to the Company by its subsidiary banks are subject to regulatory review and statutory limitations and, in some instances, regulatory approval. The approval of the Comptroller of the Currency is required if total dividends by a national bank in any calendar year exceed the bank’s net income for that year combined with its retained net income for the preceding two calendar years or if the bank’s retained earnings are less than zero. Furthermore, dividends are restricted by the Comptroller of the Currency’s minimum capital constraints for all national banks. Within these guidelines, all bank subsidiaries have the ability to pay dividends without prior regulatory approval. The amount of dividends available to the parent company from the bank subsidiaries at December 31, 2003, was approximately $828.5 million. U.S. Bancorp 103 Note 25 Supplemental Disclosures to the Consolidated Financial Statements Consolidated Statement of Cash Flows Listed below are supplemental disclosures to the Consolidated Statement of Cash Flows: Year Ended December 31 (Dollars in Millions) 2003 2002 2001 Income taxes paid********************************************************************** Interest paid *************************************************************************** Net noncash transfers to foreclosed property ********************************************** Acquisitions and divestitures Assets acquired********************************************************************* Liabilities assumed ****************************************************************** Net***************************************************************************** $1,257.8 2,077.0 110.0 $ $ — — — $ 1,129.5 2,890.1 89.5 $ 658.1 5,092.2 59.9 $ 2,068.9 (3,821.9) $1,150.8 (509.0) $(1,753.0) $ 641.8 Money Market Investments Money market investments are included with cash and due from banks as part of cash and cash equivalents. Money market investments consisted of the following at December 31: (Dollars in Millions) Interest-bearing deposits **************************************************************************************** Federal funds sold ********************************************************************************************** Securities purchased under agreements to resell ******************************************************************* Total money market investments**************************************************************************** 2003 $ 4 109 39 $152 2002 $102 61 271 $434 Regulatory Capital The measures used to assess capital include the capital ratios established by bank regulatory agencies, including the speciﬁc ratios for the ‘‘well capitalized’’ designation. For a description of the regulatory capital requirements and the actual ratios as of December 31, 2003 and 2002, for the Company and its bank subsidiaries, see Table 20 included in Management’s Discussion and Analysis which is incorporated by reference into these Notes to Consolidated Financial Statements. Net Gains on the Sale of Loans Included in noninterest income, primarily in mortgage banking revenue, for the years ended December 31, 2003, 2002 and 2001, the Company had net gains on the sale of loans of $162.9 million, $243.4 million and $164.2 million, respectively. 104 U.S. Bancorp Report of Independent Auditors Report of Independent Accountants To the Shareholders and Board of Directors of U.S. Bancorp: To the Shareholders and Board of Directors of U.S. Bancorp: We have audited the accompanying consolidated balance sheet of U.S. Bancorp as of December 31, 2003, and the related consolidated statements of income, shareholders’ equity, and cash ﬂows for the year then ended. These ﬁnancial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these ﬁnancial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the ﬁnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the ﬁnancial statements. An audit also includes assessing the accounting principles used and signiﬁcant estimates made by management, as well as evaluating the overall ﬁnancial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the ﬁnancial statements referred to above present fairly, in all material respects, the consolidated ﬁnancial position of U.S. Bancorp at December 31, 2003, and the consolidated results of their operations and their cash ﬂows for the year then ended, in conformity with accounting principles generally accepted in the United States. As discussed in Note 2 of the Notes to Consolidated Financial Statements, in 2003 the Company changed its method of accounting for stock-based employee compensation. In our opinion, the accompanying consolidated balance sheet as of December 31, 2002 and the related consolidated statements of income, shareholders’ equity and cash ﬂows for each of the two years in the period ended December 31, 2002 present fairly, in all material respects, the ﬁnancial position of U.S. Bancorp and its subsidiaries at December 31, 2002, and the results of their operations and their cash ﬂows for each of the two years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. These ﬁnancial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these ﬁnancial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the ﬁnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the ﬁnancial statements, assessing the accounting principles used and signiﬁcant estimates made by management, and evaluating the overall ﬁnancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 12 of the Notes to Consolidated Financial Statements, in 2002 the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, ‘‘Goodwill and Other Intangible Assets.’’ Minneapolis, Minnesota January 20, 2004 Minneapolis, Minnesota January 21, 2003, except for the effects of the adoption of the fair value provisions under Statement of Financial Accounting Standards No. 123, ‘‘Accounting for Stock- Based Compensation,’’ as discussed in Note 2 of the Notes to Consolidated Financial Statements, and the effects of presenting discontinued operations, as discussed in Note 4 of the Notes to Consolidated Financial Statements, as to which the date of each is December 31, 2003. U.S. Bancorp 105 U.S. Bancorp Consolidated Balance Sheet — Five-Year Summary December 31 (Dollars in Millions) 2003 2002 2001 2000 1999 Assets Cash and due from banks ************************************ Held-to-maturity securities************************************* Available-for-sale securities************************************ Loans held for sale******************************************* Loans******************************************************* Less allowance for credit losses **************************** $ 8,630 152 43,182 1,433 118,235 (2,369) $ 10,758 233 28,255 4,159 116,251 (2,422) $ 9,120 299 26,309 2,820 114,405 (2,457) $ 8,475 252 17,390 764 122,365 (1,787) $ 7,324 194 17,255 670 113,229 (1,710) Net loans ************************************************ Other assets ************************************************ 115,866 20,023 113,829 22,793 111,948 20,894 120,578 17,462 111,519 17,356 % Change 2003 v 2002 (19.8)% (34.8) 52.8 (65.5) 1.7 (2.2) 1.8 (12.2) Total assets ******************************************* $189,286 $180,027 $171,390 $164,921 $154,318 5.1% Liabilities and Shareholders’ Equity Deposits Noninterest-bearing *************************************** Interest-bearing ******************************************* $ 32,470 86,582 $ 35,106 80,428 $ 31,212 74,007 $ 26,633 82,902 $ 26,350 77,067 Total deposits ***************************************** Short-term borrowings **************************************** Long-term debt ********************************************** Company-obligated mandatorily redeemable preferred securities ** Other liabilities *********************************************** Total liabilities ***************************************** Shareholders’ equity****************************************** 119,052 10,850 31,215 2,601 6,326 170,044 19,242 115,534 7,806 28,588 2,994 6,669 161,591 18,436 105,219 14,670 25,716 2,826 6,214 154,645 16,745 109,535 11,833 21,876 1,400 4,944 149,588 15,333 103,417 10,558 21,027 1,400 3,865 140,267 14,051 Total liabilities and shareholders’ equity ****************** $189,286 $180,027 $171,390 $164,921 $154,318 (7.5)% 7.7 3.0 39.0 9.2 (13.1) (5.1) 5.2 4.4 5.1% 106 U.S. Bancorp U.S. Bancorp Consolidated Statement of Income — Five-Year Summary Year Ended December 31 (Dollars in Millions) 2003 2002 2001 2000 1999 % Change 2003 v 2002 Interest Income Loans ******************************************************* Loans held for sale ******************************************* Investment securities Taxable ************************************************** Non-taxable*********************************************** Other interest income ***************************************** Total interest income************************************ Interest Expense Deposits ***************************************************** Short-term borrowings **************************************** Long-term debt *********************************************** Company-obligated mandatorily redeemable preferred securities *** Total interest expense ********************************** Net interest income ******************************************* Provision for credit losses ************************************* Net interest income after provision for credit losses *************** Noninterest Income Credit and debit card revenue ********************************** Corporate payment products revenue *************************** ATM processing services ************************************** Merchant processing services ********************************** Credit card and payment processing revenue ******************** Trust and investment management fees ************************* Deposit service charges *************************************** Treasury management fees ************************************ Commercial products revenue********************************** Mortgage banking revenue************************************* Investment products fees and commissions ********************** Securities gains, net ****************************************** Merger and restructuring-related gains ************************** Other******************************************************** Total noninterest income ******************************** Noninterest Expense Compensation************************************************ Employee beneﬁts ******************************************** Net occupancy and equipment ********************************* Professional services ***************************************** Marketing and business development *************************** Technology and communications ******************************* Postage, printing and supplies ********************************* Goodwill ***************************************************** Other intangibles ********************************************* Merger and restructuring-related charges************************ Other******************************************************** Total noninterest expense ******************************* Income from continuing operations before income taxes*********** Applicable income taxes *************************************** Income from continuing operations ***************************** Income (loss) from discontinued operations (after-tax) ********* Cumulative effect of accounting change (after-tax) ************ Net income ************************************************** $7,272.0 202.2 $7,743.0 170.6 $ 9,413.7 146.9 $10,519.3 102.1 $ 9,078.0 103.9 (6.1)% 18.5 1,654.6 29.4 99.8 1,438.2 46.1 96.0 1,206.1 89.5 90.2 1,008.3 140.6 114.8 1,047.1 150.1 131.5 9,258.0 9,493.9 10,946.4 11,885.1 10,510.6 1,096.6 166.8 702.2 103.1 1,485.3 222.9 834.8 136.6 2,828.1 475.6 1,164.2 127.8 3,618.8 682.2 1,483.0 110.7 2,970.0 538.6 1,109.5 111.0 2,068.7 2,679.6 4,595.7 5,894.7 4,729.1 7,189.3 1,254.0 6,814.3 1,349.0 6,350.7 2,528.8 5,990.4 828.0 5,781.5 646.0 5,935.3 5,465.3 3,821.9 5,162.4 5,135.5 560.7 361.3 165.9 561.4 * 953.9 715.8 466.3 400.5 367.1 144.9 244.8 — 370.4 517.0 325.7 160.6 567.3 * 892.1 690.3 416.9 479.2 330.2 132.7 299.9 — 398.8 465.9 297.7 153.0 308.9 * 887.8 644.9 347.3 437.4 234.0 130.8 329.1 62.2 370.4 431.0 299.2 141.9 120.0 * 920.6 555.6 292.4 350.0 189.9 66.4 8.1 — 591.9 * * * * 837.8 883.1 501.1 280.6 260.7 190.4 91.1 13.2 — 457.1 5,313.0 5,210.7 4,669.4 3,967.0 3,515.1 2,176.8 328.4 643.7 143.4 180.3 417.4 245.6 — 682.4 46.2 732.7 2,167.5 317.5 658.7 129.7 171.4 392.1 243.2 — 553.0 321.2 786.2 2,036.6 285.5 666.6 116.4 178.0 353.9 241.9 236.7 278.4 1,044.8 710.2 1,993.9 303.7 653.0 102.2 188.0 362.1 241.6 219.9 157.3 327.9 433.3 2,086.7 332.0 627.7 90.1 181.8 299.0 244.4 164.0 154.0 524.5 427.6 5,596.9 5,740.5 6,149.0 4,982.9 5,131.8 5,651.4 1,941.3 3,710.1 22.5 — 4,935.5 1,707.5 3,228.0 (22.7) (37.2) 2,342.3 818.3 1,524.0 (45.2) — 4,146.5 1,422.0 2,724.5 27.6 — 3,518.8 1,296.3 2,222.5 17.9 — 15.0 (36.2) 4.0 (2.5) (26.2) (25.2) (15.9) (24.5) (22.8) 5.5 (7.0) 8.6 8.5 10.9 3.3 (1.0) ** 6.9 3.7 11.8 (16.4) 11.2 9.2 (18.4) — (7.1) 2.0 .4 3.4 (2.3) 10.6 5.2 6.5 1.0 — 23.4 (85.6) (6.8) (2.5) 14.5 13.7 14.9 ** ** $3,732.6 $3,168.1 $ 1,478.8 $ 2,752.1 $ 2,240.4 17.8% * Information for 1999 was classiﬁed as credit card and payment processing revenue. The current classiﬁcations are not available. ** Not meaningful U.S. Bancorp 107 U.S. Bancorp Quarterly Consolidated Financial Data (Dollars in Millions, Except Per Share Data) Interest Income Loans ************************************* Loans held for sale************************** Investment securities Taxable ********************************* Non-taxable ***************************** Other interest income *********************** Total interest income ****************** Interest Expense Deposits *********************************** Short-term borrowings *********************** Long-term debt ***************************** Company-obligated mandatorily redeemable preferred securities ********************** Total interest expense ***************** Net interest income ************************* Provision for credit losses ******************** Net interest income after provision for credit losses ********************************** Noninterest Income Credit and debit card revenue **************** Corporate payment products revenue ********* ATM processing services ******************** Merchant processing services **************** Trust and investment management fees ******* Deposit service charges ********************* Treasury management fees ****************** Commercial products revenue **************** Mortgage banking revenue ******************* Investment products fees and commissions **** Securities gains (losses), net ***************** Other ************************************** Total noninterest income*************** Noninterest Expense Compensation ****************************** Employee beneﬁts ************************** Net occupancy and equipment *************** Professional services ************************ Marketing and business development ********* Technology and communications************** Postage, printing and supplies**************** Other intangibles**************************** Merger and restructuring-related charges ****** Other ************************************** Total noninterest expense ************* Income from continuing operations before income taxes **************************** Applicable income taxes ********************* Income from continuing operations ************ Income (loss) from discontinued operations (after-tax) **************************** Cumulative effect of accounting change (after-tax) **************************** Net income********************************* Earnings per share************************** Diluted earnings per share ******************* 2003 2002 First Quarter Second Quarter Third Quarter Fourth Quarter First Quarter Second Quarter Third Quarter Fourth Quarter $1,836.7 59.6 $1,821.0 51.8 $1,818.3 59.5 $1,796.0 31.3 $1,931.0 39.2 $1,936.8 36.6 $1,961.6 37.3 $1,913.6 57.5 396.1 8.9 29.9 422.4 7.5 25.1 403.6 6.7 23.2 432.5 6.3 21.6 347.8 13.2 16.7 346.1 11.7 29.6 372.2 10.9 21.8 372.1 10.3 27.9 2,331.2 2,327.8 2,311.3 2,287.7 2,347.9 2,360.8 2,403.8 2,381.4 306.6 39.5 184.3 31.4 561.8 288.5 38.9 184.0 24.5 535.9 256.4 44.9 167.9 23.6 492.8 245.1 43.5 166.0 23.6 478.2 395.5 72.9 189.9 34.8 693.1 375.8 57.3 214.5 33.9 681.5 370.3 51.1 225.1 34.7 681.2 343.7 41.6 205.3 33.2 623.8 1,769.4 335.0 1,791.9 323.0 1,818.5 310.0 1,809.5 286.0 1,654.8 335.0 1,679.3 335.0 1,722.6 330.0 1,757.6 349.0 1,434.4 1,468.9 1,508.5 1,523.5 1,319.8 1,344.3 1,392.6 1,408.6 127.4 86.0 42.4 127.3 228.6 163.2 112.0 104.2 95.4 35.1 140.7 103.8 142.3 90.9 41.9 141.8 238.9 179.0 111.8 100.0 90.3 38.1 213.1 84.8 137.6 95.7 41.3 146.3 239.8 187.0 126.2 97.8 89.5 35.5 (108.9) 89.6 153.4 88.7 40.3 146.0 246.6 186.6 116.3 98.5 91.9 36.2 (.1) 92.2 109.3 75.2 36.3 133.6 222.7 150.3 104.2 122.2 52.0 34.0 44.1 76.9 131.2 82.5 39.7 144.4 232.9 167.1 104.3 123.7 78.0 30.9 30.6 87.2 132.8 87.6 42.9 147.3 222.9 186.5 105.8 125.0 111.8 32.8 119.0 97.3 143.7 80.4 41.7 142.0 213.6 186.4 102.6 108.3 88.4 35.0 106.2 137.4 1,366.1 1,472.9 1,177.4 1,296.6 1,160.8 1,252.5 1,411.7 1,385.7 546.0 91.7 161.3 26.4 29.8 104.9 60.4 235.1 17.6 181.4 547.6 79.6 159.5 32.9 51.1 104.1 61.8 312.3 10.8 186.9 543.8 75.8 161.3 39.9 48.6 102.1 61.6 10.8 10.2 199.2 539.4 81.3 161.6 44.2 50.8 106.3 61.8 124.2 7.6 165.2 532.4 78.5 162.6 25.4 34.5 95.6 63.5 80.2 71.7 182.3 537.2 72.9 163.8 33.1 41.6 95.8 59.0 104.7 72.4 210.5 552.8 83.1 164.6 36.3 45.7 99.6 60.8 211.4 69.8 212.1 545.1 83.0 167.7 34.9 49.6 101.1 59.9 156.7 107.3 181.3 1,454.6 1,546.6 1,253.3 1,342.4 1,326.7 1,391.0 1,536.2 1,486.6 1,345.9 461.8 1,395.2 480.2 1,432.6 491.9 1,477.7 507.4 1,153.9 400.1 1,205.8 418.2 1,268.1 440.1 1,307.7 449.1 884.1 915.0 940.7 970.3 753.8 787.6 828.0 858.6 .7 — 4.9 — 10.2 — 6.7 — 9.8 (37.2) 4.8 — 1.6 — (38.9) — $ 884.8 $ 919.9 $ 950.9 $ 977.0 $ 726.4 $ 792.4 $ 829.6 $ 819.7 $ $ .46 .46 $ $ .48 .48 $ $ .49 .49 $ $ .51 .50 $ $ .38 .38 $ $ .41 .41 $ $ .43 .43 $ $ .43 .43 108 U.S. Bancorp U.S. Bancorp Supplemental Financial Data Earnings Per Share Summary Earnings per share from continuing operations******************** Discontinued operations **************************************** Cumulative effect of accounting change ************************** Earnings per share ******************************************** Diluted earnings per share from continuing operations ************* Discontinued operations **************************************** Cumulative effect of accounting change ************************** Diluted earnings per share ************************************* Ratios 2003 $1.93 .01 — $1.94 $1.92 .01 — $1.93 2002 $1.68 (.01) (.02) $1.65 $1.68 (.01) (.02) $1.65 2001 $ .79 (.02) — $ .77 $ .79 (.03) — $ .76 2000 $1.43 .01 — $1.44 $1.42 .01 — $1.43 1999 $1.16 .01 — $1.17 $1.15 .01 — $1.16 Return on average assets ************************************** Return on average equity*************************************** Average total equity to average assets *************************** Dividends per share to net income per share ********************* 1.99% 19.2 10.3 44.1 1.84% 18.3 10.0 47.3 .89% 9.0 9.9 97.4 1.74% 19.0 9.1 45.1 1.49% 16.9 8.8 39.3 Other Statistics (Dollars and Shares in Millions) Common shares outstanding (a) ******************************** Average common shares outstanding and common stock equivalents 1,922.9 1,917.0 1,951.7 1,902.1 1,928.5 Earnings per share ************************************** Diluted earnings per share ******************************* Number of shareholders (b)************************************* Common dividends declared ************************************ 1,923.7 1,936.2 74,341 $1,645 1,916.0 1,924.8 74,805 $1,488 1,927.9 1,940.3 76,395 $1,447 1,906.0 1,918.5 46,052 $1,267 1,907.8 1,930.0 45,966 $1,091 (a) Deﬁned as total common shares less common stock held in treasury at December 31. (b) Based on number of common stock shareholders of record at December 31. Stock Price Range and Dividends First quarter ***************************** Second quarter ************************** Third quarter **************************** Fourth quarter *************************** 2003 Sales Price 2002 Sales Price High Low $23.47 24.99 25.82 30.00 $18.56 18.96 22.93 24.04 Closing Price $18.98 24.50 23.99 29.78 Dividends Declared $.205 .205 .205 .240 High Low $23.07 24.50 23.29 22.38 $19.02 22.08 17.09 16.05 Closing Price $22.57 23.35 18.58 21.22 Dividends Declared $.195 .195 .195 .195 The common stock of U.S. Bancorp is traded on the New York Stock Exchange, under the ticker symbol ‘‘USB.’’ Reconciliation of Quarterly Consolidated Financial Data (Dollars in Millions and After-tax) Income before cumulative effect of accounting change, as previously reported *********************************** Less First Quarter 2003 Second Quarter Third Quarter First Quarter Second Quarter Third Quarter Fourth Quarter 2002 $911.2 $953.6 $984.9 $793.2 $823.1 $860.3 $849.8 Discontinued operations of Piper Jaffray Companies (a)*** Adoption of SFAS 123 for stock options (a) ************** .7 26.4 4.9 33.7 10.2 34.0 9.8 29.6 4.8 30.7 1.6 30.7 (38.9) 30.1 Income from continuing operations *********************** $884.1 $915.0 $940.7 $753.8 $787.6 $828.0 $858.6 (a) The Company’s quarterly ﬁnancial results previously ﬁled on Form 10-Q with the Securities and Exchange Commission have been retroactively restated to give effect to the spin- off of Piper Jaffray Companies on December 31, 2003, and the adoption of the fair value method of accounting for stock-based compensation. The accounting change was adopted using the retroactive restatement method. U.S. Bancorp 109 U.S. Bancorp Consolidated Daily Average Balance Sheet and Related Yields Year Ended December 31 2003 2002 (Dollars in Millions) Average Balances Interest Yields and Rates Average Balances Interest Yields and Rates $ 36,647 601 3,616 $1,654.6 42.1 202.2 4.51% 7.01 5.59 $ 27,892 937 2,644 $1,438.2 65.3 170.6 5.16% 6.97 6.45 Assets Taxable securities ****************************************** Non-taxable securities ************************************** Loans held for sale ***************************************** Loans (b) Commercial********************************************* Commercial real estate ********************************** Residential mortgages *********************************** Retail ************************************************** Total loans *************************************** Other earning assets**************************************** Total earning assets ******************************* Allowance for credit losses ********************************** Unrealized gain (loss) on available-for-sale securities *********** Other assets (c) ******************************************** 41,326 27,142 11,696 38,198 118,362 1,582 160,808 (2,467) 120 29,169 Total assets ************************************** $187,630 Liabilities and Shareholders’ Equity Noninterest-bearing deposits********************************* Interest-bearing deposits Interest checking **************************************** Money market accounts ********************************** Savings accounts *************************************** Time certiﬁcates of deposit less than $100,000 ************* Time deposits greater than $100,000 ********************** Total interest-bearing deposits ********************** Short-term borrowings ************************************** Long-term debt********************************************* Company-obligated mandatorily redeemable preferred securities **** $ 31,715 19,104 32,310 5,612 15,493 12,319 84,838 10,503 30,965 2,698 Total interest-bearing liabilities ********************** Other liabilities (d) ****************************************** Shareholders’ equity **************************************** 129,004 7,518 19,393 Total liabilities and shareholders’ equity************** $187,630 2,315.4 1,584.6 713.4 2,673.8 7,287.2 100.1 9,286.2 84.3 317.7 21.2 450.9 222.5 1,096.6 166.8 702.2 103.1 2,068.7 5.60 5.84 6.10 7.00 6.16 6.32 5.77 .44 .98 .38 2.91 1.81 1.29 1.59 2.27 3.82 1.60 2,622.2 1,636.3 595.3 2,902.8 7,756.6 96.1 9,526.8 102.3 312.8 25.1 743.4 301.7 1,485.3 222.9 834.8 136.6 2,679.6 43,817 25,723 8,412 36,501 114,453 1,484 147,410 (2,542) 409 26,671 $171,948 $ 28,715 15,631 25,237 4,928 19,283 11,330 76,409 10,116 29,268 2,904 118,697 7,263 17,273 $171,948 Net interest income ***************************************** $7,217.5 $6,847.2 Gross interest margin *************************************** Gross interest margin without taxable-equivalent increments***** Percent of Earning Assets Interest income********************************************* Interest expense******************************************** Net interest margin ***************************************** Net interest margin without taxable-equivalent increments ******* 4.17% 4.15 5.77% 1.28 4.49 4.47% (a) (b) (c) (d) Interest and rates are presented on a fully taxable-equivalent basis under a tax rate of 35 percent. Interest income and rates on loans include loan fees. Nonaccrual loans are included in average loan balances. Includes approximately $1,427 million, $1,733 million, $1,664 million, $1,970 million and $1,072 million of assets from discontinued operations in 2003, 2002, 2001, 2000 and 1999, respectively. Includes approximately $1,034 million, $1,524 million, $1,776 million, $2,072 million and $1,199 million of liabilities from discontinued operations in 2003, 2002, 2001, 2000 and 1999, respectively. 110 U.S. Bancorp 5.98 6.36 7.08 7.95 6.78 6.48 6.46 .65 1.24 .51 3.86 2.66 1.94 2.20 2.85 4.70 2.26 4.20% 4.18 6.46% 1.81 4.65 4.63% and Rates (a) 2001 2000 1999 Average Balances Interest Yields and Rates Average Balances Interest Yields and Rates Average Balances Interest Yields and Rates 2003 v 2002 % Change Average Balances $ 20,129 1,787 1,911 $ 1,206.1 128.9 146.9 5.99% 7.21 7.69 $ 14,567 2,744 1,303 $ 1,008.3 203.1 102.1 6.92% 7.40 7.84 $ 16,301 2,970 1,450 $ 1,047.1 220.6 103.9 6.42% 7.43 7.17 3,609.3 2,002.7 658.2 3,158.2 9,428.4 90.6 11,000.9 203.6 711.0 42.5 1,241.4 629.6 2,828.1 475.6 1,164.2 127.8 4,595.7 50,072 26,081 8,576 33,448 118,177 1,497 143,501 (1,979) 165 24,257 $165,944 $ 25,109 13,962 24,932 4,571 23,328 13,054 79,847 11,679 24,133 1,955 117,614 6,795 16,426 $165,944 7.21 7.68 7.67 9.44 7.98 6.05 7.67 1.46 2.85 .93 5.32 4.82 3.54 4.07 4.82 6.54 3.91 4,222.6 2,296.9 863.7 3,155.1 10,538.3 115.3 11,967.1 8.43 8.82 7.71 10.18 8.91 6.76 8.63 270.4 1,000.0 74.0 1,458.3 816.1 3,618.8 682.1 1,483.1 110.7 5,894.7 2.07 4.39 1.47 5.64 6.32 4.55 6.20 6.77 7.91 5.17 50,062 26,040 11,207 31,008 118,317 1,705 138,636 (1,781) (247) 21,873 $158,481 $ 23,820 13,035 22,774 5,027 25,861 12,909 79,606 11,008 21,916 1,400 113,930 6,232 14,499 $158,481 3,261.1 1,922.8 1,056.3 2,860.8 9,101.0 132.2 10,604.8 231.0 842.2 111.9 1,322.6 462.3 2,970.0 538.6 1,109.5 111.0 4,729.1 43,328 23,076 13,890 29,344 109,638 2,326 132,685 (1,709) 54 19,137 $150,167 $ 23,556 12,898 22,534 5,961 26,296 8,675 76,364 10,883 19,873 1,400 108,520 4,818 13,273 $150,167 $ 6,405.2 $ 6,072.4 $ 5,875.7 3.76% 3.72 7.67% 3.21 4.46 4.43% 3.46% 3.40 8.63% 4.25 4.38 4.32% 7.53 8.33 7.60 9.75 8.30 5.68 7.99 1.79 3.74 1.88 5.03 5.33 3.89 4.95 5.58 7.93 4.36 3.63% 3.56 7.99% 3.56 4.43 4.36% 31.4% (35.9) 36.8 (5.7) 5.5 39.0 4.6 3.4 6.6 9.1 (3.0) (70.7) 9.4 9.1 10.4 22.2 28.0 13.9 (19.7) 8.7 11.0 3.8 5.8 (7.1) 8.7 3.5 12.3 9.1% U.S. Bancorp 111 Annual Report on Form 10-K Securities and Exchange Commission Washington, D.C. 20549 The registrant is an accelerated ﬁler (as deﬁned in Exchange Act Rule 12b-2). Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the ﬁscal year ended December 31, 2003 Commission File Number 1-6880 U.S. Bancorp Incorporated in the State of Delaware IRS Employer Identiﬁcation #41-0255900 Address: 800 Nicollet Mall Minneapolis, Minnesota 55402-7014 Telephone: (651) 466-3000 Securities registered pursuant to Section 12(b) of the Act (and listed on the New York Stock Exchange): Common Stock, par value $.01. Securities registered pursuant to section 12(g) of the Act: None. U.S. Bancorp (1) has ﬁled all reports required to be ﬁled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such ﬁling requirements for the past 90 days. Disclosure of delinquent ﬁlers pursuant to Item 405 of Regulation S-K is not contained in this Form 10-K, and will not be contained, to the best of the registrant’s knowledge, in the registrant’s deﬁnitive proxy statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. As of January 31, 2004, U.S. Bancorp had 1,927,407,105 shares of common stock outstanding and 74,249 registered holders of its common stock. The aggregate market value of common stock held by non- afﬁliates as of June 30, 2003, was approximately $47.1 billion. This report incorporates into a single document the requirements of the Securities and Exchange Commission with respect to annual reports on Form 10-K and annual reports to shareholders. Only those sections of this report referenced in the following cross-reference index and the information under the caption ‘‘Forward-Looking Statements’’ are incorporated in the Form 10-K. Index Part I Item 1 Item 2 Item 3 Item 4 Part II Item 5 Item 6 Item 7 Page Business General Business Description ************ 20-21, 113-114 Line of Business Financial Performance *********** 54-59 Website Access to SEC Reports ******************** 115 Properties **************************************** 114 Legal Proceedings ******************************* none Submission of Matters to a Vote of Security Holders ****************************** none Market Price and Dividends for the Registrant’s Common Equity and Related Stockholder Matters ***** 3, 51-52, 64, 87-89, 94-95, 109, 112 Selected Financial Data***************************** 19 Management’s Discussion and Analysis of Financial Condition and Results of Operations*** 18-61 Item 7A Quantitative and Qualitative Disclosures About Market Risk ********************************* 44-51 Financial Statements and Supplementary Data **** 62-111 Changes in and Disagreements with Accountants on Item 8 Item 9 Accounting and Financial Disclosure ************* 115 Item 9A Disclosure Controls and Procedures****************** 61 Part III Item 10 Directors and Executive Ofﬁcers of the Registrant ************************ 5, 122-123* Item 11 Executive Compensation ****************************** * Item 12 Security Ownership of Certain Beneﬁcial Owners and Management and Related Stockholder Matters ********************************** 114-115* Item 13 Certain Relationships and Related Transactions ********* * Item 14 Principal Accountant Fees and Services **************** * Part IV Item 15 Exhibits, Financial Statement Schedules and Reports on Form 8-K *********************** 115-117 Signatures************************************************* 118 Certiﬁcations********************************************* 119-121 *U.S. Bancorp’s deﬁnitive proxy statement for the 2004 Annual Meeting of Shareholders is incorporated herein by reference, other than the sections entitled ‘‘Report of the Compensation Committee’’ and ‘‘Stock Performance Chart.’’ 112 U.S. Bancorp General Business Description U.S. Bancorp is a multi-state ﬁnancial services holding company headquartered in Minneapolis, Minnesota. U.S. Bancorp was incorporated in Delaware in 1929 and operates as a ﬁnancial holding company and a bank holding company under the Bank Holding Company Act of 1956. U.S. Bancorp provides a full range of ﬁnancial services, including lending and depository services, cash management, foreign exchange and trust and investment management services. It also engages in credit card services, merchant and automated teller machine (‘‘ATM’’) processing, mortgage banking, insurance, brokerage, leasing and investment banking. U.S. Bancorp’s banking subsidiaries are engaged in the general banking business, principally in domestic markets. The subsidiaries range in size from $26 million to $128 billion in deposits and provide a wide range of products and services to individuals, businesses, institutional organizations, governmental entities and other ﬁnancial institutions. Commercial and consumer lending services are principally offered to customers within the Company’s domestic markets, to domestic customers with foreign operations and within certain niche national venues. Lending services include traditional credit products as well as credit card services, ﬁnancing and import/export trade, asset-backed lending, agricultural ﬁnance and other products. Leasing products are offered through bank leasing subsidiaries. Depository services include checking accounts, savings accounts and time certiﬁcate contracts. Ancillary services such as foreign exchange, treasury management and receivable lock-box collection are provided to corporate customers. U.S. Bancorp’s bank and trust subsidiaries provide a full range of asset management and ﬁduciary services for individuals, estates, foundations, business corporations and charitable organizations. U.S. Bancorp’s non-banking subsidiaries primarily offer investment and insurance products to the Company’s customers principally within its markets and mutual fund processing services to a broad range of mutual funds. Banking and investment services are provided through a network of 2,243 banking ofﬁces principally operating in 24 states in the Midwest and West. The Company operates a network of 4,425 branded ATMs and provides 24-hour, seven day a week telephone customer service. Mortgage banking services are provided through banking ofﬁces and loan production ofﬁces throughout the Company’s markets. Consumer lending products may be originated through banking ofﬁces, indirect correspondents, brokers or other lending sources, and a consumer ﬁnance division. The Company is also one of the largest providers of Visa˛ corporate and purchasing card services and corporate trust services in the United States. A wholly-owned subsidiary, NOVA Information Systems, Inc., provides merchant processing services directly to merchants and through a network of banking afﬁliations. On a full-time equivalent basis, employment during 2003 averaged a total of 51,377 employees. Competition The commercial banking business is highly competitive. Subsidiary banks compete with other commercial banks and with other ﬁnancial institutions, including savings and loan associations, mutual savings banks, ﬁnance companies, mortgage banking companies, credit unions and investment companies. In recent years, competition has increased from institutions not subject to the same regulatory restrictions as domestic banks and bank holding companies. Government Policies The operations of the Company’s various operating units are affected by state and federal legislative changes and by policies of various regulatory authorities, including those of the numerous states in which they operate, the United States and foreign governments. These policies include, for example, statutory maximum legal lending rates, domestic monetary policies of the Board of Governors of the Federal Reserve System, United States ﬁscal policy, international currency regulations and monetary policies, U.S. Patriot Act and capital adequacy and liquidity constraints imposed by bank regulatory agencies. Supervision and Regulation As a registered bank holding company and ﬁnancial holding company under the Bank Holding Company Act, U.S. Bancorp is subject to the supervision of, and regulation by, the Board of Governors of the Federal Reserve System. Under the Bank Holding Company Act, a ﬁnancial holding company may engage in banking, managing or controlling banks, furnishing or performing services for banks it controls, and conducting other ﬁnancial activities. U.S. Bancorp must obtain the prior approval of the Federal Reserve Board before acquiring more than 5 percent of the outstanding shares of another bank or bank holding company, and must provide notice to, and in some situations obtain the prior approval of, the Federal Reserve Board in connection with engaging in, or acquiring more than 5 percent of the outstanding shares of a company engaged in, a new ﬁnancial activity. Under the Bank Holding Company Act, U.S. Bancorp may acquire banks throughout the United States, subject only to state or federal deposit caps and state minimum age requirements. National banks are subject to the supervision of, and are examined by, the Comptroller of the Currency. All subsidiary banks of the Company are members of the Federal Deposit Insurance Corporation and are subject to U.S. Bancorp 113 examination by the FDIC. In practice, the primary federal regulator makes regular examinations of each subsidiary bank subject to its regulatory review or participates in joint examinations with other federal regulators. Areas subject to regulation by federal authorities include the allowance for credit losses, investments, loans, mergers, issuance of securities, payment of dividends, establishment of branches and other aspects of operations. Properties U.S. Bancorp and its signiﬁcant subsidiaries occupy headquarter ofﬁces under a long-term lease in Minneapolis, Minnesota. The Company also leases eight freestanding operations centers in St. Paul, Portland, Milwaukee and Denver. The Company owns six principal operations centers in Cincinnati, St. Louis, Fargo, Milwaukee and St. Paul. At December 31, 2003, the Company’s subsidiaries owned and operated a total of 1,449 facilities and leased an additional 1,361 facilities, all of which are well maintained. The Company believes its current facilities are adequate to meet its needs. Additional information with respect to premises and equipment is presented in Notes 10 and 23 of the Notes to Consolidated Financial Statements. Equity Compensation Plan Information The following table summarizes information regarding equity compensation plans in effect as of December 31, 2003. Plan Category Equity compensation plans approved by security holders (b) **************** Equity compensation plans not approved by security holders (c) ***** Total************************** Number of securities to be issued upon exercise of outstanding options, warrants and rights Weighted-average exercise price of outstanding options, warrants and rights Number of securities remaining available for future issuance under equity compensation plans (excluding securities reﬂected in the ﬁrst column) (a) 91,603,009 12,259,923 103,862,932 $20.63 $22.45 $20.72 41,825,251 — 41,825,251 (a) No shares are available for the granting of future awards under the U.S. Bancorp 1998 Executive Stock Incentive Plan or the U.S. Bancorp 1991 Executive Stock Incentive plan. The 41,825,251 shares available under the U.S. Bancorp 2001 Stock Incentive Plan may become the subject of future awards in the form of stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards or other stock-based awards, except that only 8,772,531 of these shares are available for future grants of awards other than stock options or stock appreciation rights. Includes shares underlying stock options and restricted stock units (convertible into shares of the Company’s common stock on a one-for-one basis) under the U.S. Bancorp 2001 Stock Incentive Plan, the U.S. Bancorp 1998 Executive Stock Incentive Plan and the U.S. Bancorp 1991 Executive Stock Incentive Plan. Excludes 62,277,981 shares underlying outstanding stock options and warrants assumed by U.S. Bancorp in connection with acquisitions by U.S. Bancorp. Of the excluded shares, 54,776,567 underlie stock options granted under equity compensation plans of the former U.S. Bancorp that were approved by the shareholders of the former U.S. Bancorp. (b) (c) All of the identiﬁed shares underlie stock options granted to a broad-based employee population pursuant to the U.S. Bancorp 2001 Employee Stock Incentive plan, the Firstar Corporation 1999 Employee Stock Incentive Plan, the Firstar Corporation 1998 Employee Stock Incentive Plan and the Star Banc Corporation 1996 Starshare Stock Incentive Plan for Employees. Under the U.S. Bancorp 2001 Employee Stock Incentive Plan (‘‘2001 Plan’’), 11,678,800 shares are authorized for issuance pursuant to the grant of nonqualiﬁed stock options to any full-time or part-time employee actively employed by U.S. Bancorp on the grant date, other than individuals eligible to participate in any of the Company’s executive stock incentive plans or in U.S. Bancorp Piper Jaffray Inc.’s annual option plan. As of December 31, 2003, options to purchase an aggregate of 6,238,529 shares were outstanding under the plan. All options under the plan were granted on February 27, 2001. As of December 31, 2003, options to purchase an aggregate of 2,331,475 shares of the Company’s common stock were outstanding under the Firstar Corporation 1999 Employee Stock Incentive Plan (‘‘1999 Plan’’). Under this plan, stock options were granted to each full-time or part- time employee actively employed by Firstar Corporation on the grant date, other than managers who participated in an executive stock incentive plan. As of December 31, 2003, options to purchase an aggregate of 3,278,230 shares of the Company’s common stock were outstanding under the Firstar Corporation 1998 Employee Stock Incentive Plan (‘‘1998 Plan’’). Under this plan, stock options were granted to each full-time or part- time employee actively employed by Firstar Corporation on the grant date, other than managers who participated in an executive stock incentive plan. As of December 31, 2003, options to purchase an aggregate of 411,689 shares of the Company’s common stock were outstanding under the Star Banc Corporation 1996 Starshare Stock Incentive Plan for Employees (‘‘1996 Plan’’). Under the plan, stock options were granted to each employee of Star Banc Corporation, a predecessor company, other than managers who participated in an executive stock incentive plan. No further options will be granted under any of these plans. Under all of the plans, the exercise price of the options equals the fair market value of the underlying common stock on the grant date. All options granted under the plan have a term of 10 years from the grant date and become exercisable over a period of time set forth in the plan or determined by the committee administering the plan. Options granted under the plan are nontransferable and, during the optionee’s lifetime, are exercisable only by the optionee. 114 U.S. Bancorp If an optionee is terminated as a result of his or her gross misconduct or offense, all options terminate immediately, whether or not vested. Under the 2001 Plan, the 1999 Plan and the 1998 Plan, in the event an optionee is terminated immediately following a change in control (as deﬁned in the plans) of U.S. Bancorp, and the termination is due to business needs resulting from the change in control and not as a result of the optionee’s performance or conduct, all of the optionee’s outstanding options will become immediately vested and exercisable as of the date of such termination. Under the 1996 Plan, all outstanding options vest and become exercisable immediately following a change in control. If the outstanding shares of common stock of U.S. Bancorp are changed into or exchanged for a different number or kind of shares of stock or other securities as a result of a reorganization, recapitalization, stock dividend, stock split, combination of shares, reclassiﬁcation, merger, consolidation or similar event, the number of shares underlying outstanding options also may be adjusted. The number of shares underlying the options shown in the table have been adjusted to maintain the economic value of the options following the special dividend paid to effect the spin-off of our Piper Jaffray subsidiary. The plans may be terminated, amended or modiﬁed by the Board of Directors at any time. Change in Certifying Accountants In response to the Sarbanes-Oxley Act of 2002, the Audit Committee determined on November 8, 2002, to segregate the internal and external auditing functions performed for U.S. Bancorp by PricewaterhouseCoopers LLP and appointed Ernst & Young LLP to become the Company’s external auditors following the ﬁling of the Company’s 2002 Annual Report on Form 10-K during the ﬁrst quarter of 2003. No report of PricewaterhouseCoopers LLP on the ﬁnancial statements of U.S. Bancorp for the years ended December 31, 2002 and 2001 contained an adverse opinion or a disclaimer of opinion, or was qualiﬁed or modiﬁed as to uncertainty, audit scope or accounting principles. During the two years ended December 31, 2002 and 2001, there were no disagreements with PricewaterhouseCoopers LLP on any matter of accounting principles or practices, ﬁnancial statement disclosure or auditing scope or procedure which, if not resolved to the satisfaction of PricewaterhouseCoopers LLP, would have caused it to make reference to the subject matter of the disagreement in connection with its reports on the ﬁnancial statements for such years. U.S. Bancorp believes that during the two years ended December 31, 2002 and 2001, there were no ‘‘reportable events,’’ as deﬁned in Item 304(a)(1)(v) of Regulation S-K of the Securities and Exchange Commission. During the two years ended December 31, 2002 and 2001, the Company did not consult with Ernst & Young LLP on any items regarding the application of accounting principles, the type of audit opinion that might be rendered on the Company’s ﬁnancial statements, or the subject matter of a disagreement or reportable event (as described in Regulation S-K Item 304(a)(2)). U.S. Bancorp reported the change in accountants on a Form 8-K ﬁled on November 14, 2002. The Form 8-K contained a letter from PricewaterhouseCoopers LLP, addressed to the Securities and Exchange Commission, stating that it agreed with the statements concerning PricewaterhouseCoopers LLP in such Form 8-K. Website Access to SEC Reports U.S. Bancorp’s internet website can be found at usbank.com. U.S. Bancorp makes available free of charge on its website its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports ﬁled or furnished pursuant to Section 13 or 15(d) of the Exchange Act, as well as all other reports ﬁled by U.S. Bancorp with the SEC, as soon as reasonably practicable after electronically ﬁled with, or furnished to, the SEC. Governance Documents Our Corporate Governance Guidelines, Code of Ethics and Business Conduct and Board of Directors committee charters are available free of charge on our web site at usbank.com, by clicking on ‘‘About U.S. Bancorp,’’ then ‘‘Investor/Shareholder Information.’’ Shareholders may request a free printed copy of any of these documents from our investor relations department by contacting them at Corporaterelations@usbank.com or calling (612) 303-0799. Exhibits Financial Statements Filed U.S. Bancorp and Subsidiaries Consolidated Financial Statements ****************** Notes to Consolidated Financial Statements ************* Reports of Independent Auditors and Accountants ******* Page 62-65 66-104 105 Schedules to the consolidated ﬁnancial statements required by Regulation S-X are omitted since the required information is included in the footnotes or is not applicable. During the three months ended December 31, 2003, and through the date of this report, the Company ﬁled the following Current Reports on Form 8-K: ) Form 8-K dated October 21, 2003, relating to third quarter 2003 earnings; ) Form 8-K dated October 23, 2003, relating to the announcement by the former U.S. Bancorp Piper Jaffray of the composition of its Board of Directors; U.S. Bancorp 115 ) Form 8-K dated December 15, 2003, announcing the declaration of the special dividend paid in order to effect the spin-off of Piper Jaffray Companies; (1)(2)10.4 ) Form 8-K dated December 19, 2003, announcing the effectiveness of the Form 10 registration statement of Piper Jaffray Companies; ) Form 8-K dated December 31, 2003, announcing the completion of the spin-off of Piper Jaffray Companies; ) Form 8-K dated January 9, 2004, announcing the Company’s adoption of the ‘‘fair value’’ method of accounting for stock-based compensation; and ) Form 8-K dated January 20, 2004, relating to fourth quarter 2003 earnings. The following Exhibit Index lists the Exhibits to the Annual Report on Form 10-K. (1)3.1 Restated Certiﬁcate of Incorporation, as amended. Filed as Exhibit 3.1 to Form 10-K for the year ended December 31, 2000. (1)3.2 Restated bylaws, as amended. Filed as 4.1 Exhibit 3.2 to Form 10-K for the year ended December 31, 2001. [Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, copies of instruments deﬁning the rights of holders of long-term debt are not ﬁled. U.S. Bancorp agrees to furnish a copy thereof to the Securities and Exchange Commission upon request.] (1)4.2 Warrant Agreement, dated as of October 2, Summary of U.S. Bancorp 1991 Executive Stock Incentive Plan. Filed as Exhibit 10.4 to Form 10-K for the year ended December 31, 2002. (1)(2)10.5 U.S. Bancorp 2001 Employee Stock Incentive Plan. Filed as Exhibit 10.5 to Form 10-K for the year ended December 31, 2002. (1)(2)10.6 (1)(2)10.7 (1)(2)10.8 Firstar Corporation 1999 Employee Stock Incentive Plan. Filed as Exhibit 10.6 to Form 10-K for the year ended December 31, 2002. Firstar Corporation 1998 Employee Stock Incentive Plan. Filed as Exhibit 10.7 to Form 10-K for the year ended December 31, 2002. Star Banc Corporation 1996 Starshare Stock Incentive Plan for Employees. Filed as Exhibit 10.8 to Form 10-K for the year ended December 31, 2002. (1)(2)10.9 U.S. Bancorp Executive Incentive Plan. Filed as Exhibit 10.2 to Form 10-K for the year ended December 31, 2001. (1)(2)10.10 U.S. Bancorp Executive Deferral Plan, as amended. Filed as Exhibit 10.7 to Form 10-K for the year ended December 31, 1999. (1)(2)10.11 Summary of Nonqualiﬁed Supplemental Executive Retirement Plan, as amended, of the former U.S. Bancorp. Filed as Exhibit 10.4 to Form 10-K for the year ended December 31, 2001. 1995, between U.S. Bancorp and First Chicago Trust Company of New York, as Warrant Agent and Form of Warrant. Filed as Exhibits 4.18 and 4.19 to Registration Statement on Form S-3, File No. 33-61667. (1)(2)10.12 1991 Performance and Equity Incentive Plan of the former U.S. Bancorp. Filed as Exhibit 10.13 to Form 10-K for the year ended December 31, 1997. (1)(2)10.13 Form of Director Indemniﬁcation Agreement (1)4.3 Amended and Restated Rights Agreement, dated as of December 31, 2002, between U.S. Bancorp and Mellon Investor Services LLC. Filed as Exhibit 4.2 to Amendment No. 1 to Registration Statement on Form 8-A (File No. 001-06880) on December 31, 2002. (1)(2)10.1 U.S. Bancorp 2001 Stock Incentive Plan. Filed as Exhibit 10.1 to Form 10-K for the year ended December 31, 2001. (1)(2)10.2 Amendment No. 1 to U.S. Bancorp 2001 Stock Incentive Plan. Filed as Exhibit 10.2 to Form 10-K for the year ended December 31, 2002. (1)(2)10.3 U.S. Bancorp 1998 Executive Stock Incentive Plan. Filed as Exhibit 10.3 to Form 10-K for the year ended December 31, 2002. entered into with former directors of the former U.S. Bancorp. Filed as Exhibit 10.15 to Form 10-K for the year ended December 31, 1997. (1)(2)10.14 U.S. Bancorp Independent Director Retirement and Death Beneﬁt Plan, as amended. Filed as Exhibit 10.17 to Form 10-K for the year ended December 31, 1999. (1)(2)10.15 U.S. Bancorp Deferred Compensation Plan for Directors, as amended. Filed as Exhibit 10.18 to Form 10-K for the year ended December 31, 1999. (1)(2)10.16 U.S. Bancorp Non Qualiﬁed Executive Retirement Plan. Filed as Exhibit 10.16 to Form 10-K for the year ended December 31, 2002. (2)10.17 Amendments No. 1, 2 and 3 to U.S. Bancorp Non-Qualiﬁed Executive Retirement Plan. 116 U.S. Bancorp (2)10.18 U.S. Bancorp Executive Employees Deferred Compensation Plan. (2)10.19 U.S. Bancorp Outside Directors Deferred Compensation Plan. (1)(2)10.20 Form of Change in Control Agreement, effective November 16, 2001, between U.S. Bancorp and certain executive ofﬁcers of U.S. Bancorp. Filed as Exhibit 10.12 to Form 10-K for the year ended December 31, 2001. (1)(2)10.21 Employment Agreement with Jerry A. Grundhofer. Filed as Exhibit 10.13 to Form 10-K for the year ended December 31, 2001. (1)(2)10.22 Employment Agreement with Edward Grzedzinski. Filed as Exhibit 10.22 to Form 10-K for the year ended December 31, 2002. 12 Statement re: Computation of Ratio of Earnings to Fixed Charges. 21 Subsidiaries of the Registrant. 23.1 Consent of Ernst & Young LLP. 23.2 Consent of PricewaterhouseCoopers LLP. 31.1 Certiﬁcation of Chief Executive Ofﬁcer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934. 31.2 Certiﬁcation of Chief Financial Ofﬁcer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934. 32 Certiﬁcation of Chief Executive Ofﬁcer and Chief Financial Ofﬁcer pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002. (1) Exhibit has previously been ﬁled with the Securities and Exchange Commission and is incorporated herein as an exhibit by reference to the prior ﬁling. (2) Management contracts or compensatory plans or arrangements. U.S. Bancorp 117 Signatures Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on February 27, 2004, on its behalf by the undersigned, thereunto duly authorized. U.S. Bancorp By: Jerry A. Grundhofer Chairman, President and Chief Executive Ofﬁcer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on February 27, 2004, by the following persons on behalf of the registrant and in the capacities indicated. Jerry A. Grundhofer Chairman, President and Chief Executive Ofﬁcer (principal executive ofﬁcer) David M. Moffett Vice Chairman and Chief Financial Ofﬁcer (principal ﬁnancial ofﬁcer) Terrance R. Dolan Executive Vice President and Controller (principal accounting ofﬁcer) Linda L. Ahlers Director Victoria Buyniski Gluckman Director Arthur D. Collins, Jr. Director Peter H. Coors Director John C. Dannemiller Director John F. Grundhofer Director Delbert W. Johnson Director Joel W. Johnson Director Jerry W. Levin Director David B. O’Maley Director O’dell M. Owens, M.D., M.P.H. Director Thomas E. Petry Director Richard G. Reiten Director Craig D. Schnuck Director Warren R. Staley Director Patrick T. Stokes Director John J. Stollenwerk Director 118 U.S. Bancorp EXHIBIT 31.1 CERTIFICATION PURSUANT TO RULE 13a-14(a) UNDER THE SECURITIES EXCHANGE ACT OF 1934 I, Jerry A. Grundhofer, Chief Executive Ofﬁcer of U.S. Bancorp, a Delaware corporation, certify that: (1) I have reviewed this annual report on Form 10-K of U.S. Bancorp; (2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; (3) Based on my knowledge, the ﬁnancial statements, and other ﬁnancial information included in this report, fairly present in all material respects the ﬁnancial condition, results of operations and cash ﬂows of the registrant as of, and for, the periods presented in this report; (4) The registrant’s other certifying ofﬁcers and I are responsible for establishing and maintaining disclosure controls and procedures (as deﬁned in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; (c) disclosed in this report any change in the registrant’s internal control over ﬁnancial reporting that occurred during the registrant’s most recent ﬁscal quarter (the registrant’s fourth ﬁscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over ﬁnancial reporting; and (5) The registrant’s other certifying ofﬁcers and I have disclosed, based on our most recent evaluation of internal control over ﬁnancial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons fulﬁlling the equivalent functions): (a) all signiﬁcant deﬁciencies and material weaknesses in the design or operation of internal control over ﬁnancial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report ﬁnancial information; and (b) any fraud, whether or not material, that involves management or other employees who have a signiﬁcant role in the registrant’s internal control over ﬁnancial reporting. Dated: February 27, 2004 /s / JERRY A. GRUNDHOFER Jerry A. Grundhofer Chairman, President and Chief Executive Ofﬁcer U.S. Bancorp 119 EXHIBIT 31.2 CERTIFICATION PURSUANT TO RULE 13a-14(a) UNDER THE SECURITIES EXCHANGE ACT OF 1934 I, David M. Moffett, Chief Financial Ofﬁcer of U.S. Bancorp, a Delaware corporation, certify that: (1) I have reviewed this annual report on Form 10-K of U.S. Bancorp; (2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; (3) Based on my knowledge, the ﬁnancial statements, and other ﬁnancial information included in this report, fairly present in all material respects the ﬁnancial condition, results of operations and cash ﬂows of the registrant as of, and for, the periods presented in this report; (4) The registrant’s other certifying ofﬁcers and I are responsible for establishing and maintaining disclosure controls and procedures (as deﬁned in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; (c) disclosed in this report any change in the registrant’s internal control over ﬁnancial reporting that occurred during the registrant’s most recent ﬁscal quarter (the registrant’s fourth ﬁscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over ﬁnancial reporting; and (5) The registrant’s other certifying ofﬁcers and I have disclosed, based on our most recent evaluation of internal control over ﬁnancial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons fulﬁlling the equivalent functions): (a) all signiﬁcant deﬁciencies and material weaknesses in the design or operation of internal control over ﬁnancial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report ﬁnancial information; and (b) any fraud, whether or not material, that involves management or other employees who have a signiﬁcant role in the registrant’s internal control over ﬁnancial reporting. Dated: February 27, 2004 /s / DAVID M. MOFFETT David M. Moffett Chief Financial Ofﬁcer 120 U.S. Bancorp EXHIBIT 32 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, Chief Executive Ofﬁcer and Chief Financial Ofﬁcer of U.S. Bancorp, a Delaware corporation (the ‘‘Company’’), do hereby certify that: (1) The Annual Report on Form 10-K for the year ended December 31, 2003 (the ‘‘Form 10-K’’) of the Company fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Form 10-K fairly presents, in all material respects, the ﬁnancial condition and results of operations of the Company. /s/ JERRY A. GRUNDHOFER Jerry A. Grundhofer Chief Executive Ofﬁcer Dated: February 27, 2004 /s / DAVID M. MOFFETT David M. Moffett Chief Financial Ofﬁcer U.S. Bancorp 121 Executive Officers Jerry A. Grundhofer William L. Chenevich Edward Grzedzinski Mr. Grundhofer is Chairman, President and Mr. Chenevich is Vice Chairman of U.S. Mr. Grzedzinski is Vice Chairman of U.S. Chief Executive Ofﬁcer of U.S. Bancorp. Bancorp. Mr. Chenevich, 60, has served as Bancorp. Mr. Grzedzinski, 48, has served as Mr. Grundhofer, 59, has served as Vice Chairman of U.S. Bancorp since the Vice Chairman of U.S. Bancorp since July President and Chief Executive Ofﬁcer of merger of Firstar Corporation and 2001. He is Chief Executive Officer of NOVA U.S. Bancorp and Chairman, President and U.S. Bancorp in February 2001, when he Information Systems, Inc., which he co- Chief Executive Ofﬁcer of U.S. Bank assumed responsibility for Technology and founded in 1991 and which became a wholly- National Association since the merger of Operations Services. Previously, he served owned subsidiary of U.S. Bancorp in Firstar Corporation and U.S. Bancorp in as Vice Chairman of Technology and connection with the acquisition of NOVA February 2001. Mr. Grundhofer assumed Operations Services of Firstar Corporation Corporation in July 2001. Mr. Grzedzinski the additional title of Chairman of from 1999 to 2001. Prior to joining Firstar assumed additional responsibility for U.S. Bancorp on December 30, 2002. Prior he was Group Executive Vice President at Transaction Services in 2003. Mr. Grzedzinski to the merger, Mr. Grundhofer was Visa International from 1994 to 1999. served as Chairman of NOVA Corporation President and Chief Executive Ofﬁcer of Firstar Corporation, having served as Chairman, President and Chief Executive Ofﬁcer of Star Banc Corporation from 1993 until its merger with Firstar Corporation in 1998. Jennie P. Carlson Richard K. Davis from 1995 until July 2001. Mr. Davis is Vice Chairman of U.S. Joseph E. Hasten Bancorp. Mr. Davis, 46, has served as Vice Mr. Hasten is Vice Chairman of U.S. Chairman of U.S. Bancorp since the merger Bancorp. Mr. Hasten, 52, has served as of Firstar Corporation and U.S. Bancorp in Vice Chairman of U.S. Bancorp since the February 2001, when he assumed merger of Firstar Corporation and responsibility for Consumer Banking, U.S. Bancorp in February 2001, when he Ms. Carlson is Executive Vice President of including Retail Payment Solutions (card assumed responsibility for Corporate U.S. Bancorp. Ms. Carlson, 43, has served services). Mr. Davis assumed additional Banking. Mr. Hasten assumed additional as Executive Vice President, Human responsibility for Commercial Banking in responsibility for Corporate Payment Resources since January 2002. Until that 2003. Previously, he had been Vice Systems in 2003. Previously, he had been time, she served as Executive Vice Chairman of Consumer Banking of Firstar Vice Chairman of Wholesale Banking of President, Deputy General Counsel and Corporation from 1998 until 2001 and Firstar Corporation, after joining Corporate Secretary of U.S. Bancorp since Executive Vice President, Consumer Mercantile Bancorporation, a predecessor the merger of Firstar Corporation and Banking of Star Banc Corporation from company, as President of its St. Louis bank U.S. Bancorp in February 2001. From 1995 1993 until its merger with Firstar and of Corporate Banking in 1995. until the merger, she was General Counsel Corporation in 1998. Lee R. Mitau and Secretary of Firstar Corporation and Star Banc Corporation, a predecessor company, as well as Senior Vice President from 1994 to 1999 and Executive Vice President from 1999 to 2001. Michael J. Doyle Mr. Mitau is Executive Vice President and Mr. Doyle is Executive Vice President and General Counsel of U.S. Bancorp. Chief Credit Ofﬁcer of U.S. Bancorp. Mr. Mitau, 55, has served in these Mr. Doyle, 47, has served in these positions positions since 1995. Mr. Mitau also serves since January 2003. Until that time, he as Corporate Secretary. Prior to 1995 he Andrew Cecere served as Executive Vice President and was a partner at the law ﬁrm of Dorsey & Mr. Cecere is Vice Chairman of U.S. Senior Credit Ofﬁcer of U.S. Bancorp since Whitney LLP. Bancorp. Mr. Cecere, 43, has served as Vice the merger of Firstar Corporation and Chairman of U.S. Bancorp since the merger U.S. Bancorp in February 2001. From 1999 of Firstar Corporation and U.S. Bancorp in until the merger, he was Executive Vice February 2001. He assumed responsibility President and Chief Approval Ofﬁcer of for Private Client and Trust Services in Firstar Corporation, and had served as February 2001 and U.S. Bancorp Asset Senior Vice President of Firstar Corporation Management in November 2001. and Star Banc Corporation, a predecessor Previously, he had served as Chief Financial company, since 1994. Ofﬁcer of U.S. Bancorp from May 2000 through February 2001. Additionally, he served as Vice Chairman of U.S. Bank with responsibility for Commercial Services from 1999 to 2001, having been a Senior Vice President of Finance since 1992. 122 U.S. Bancorp David M. Moffett Mr. Moffett is Vice Chairman and Chief Financial Ofﬁcer of U.S. Bancorp. Mr. Moffett, 52, has served in these positions since the merger of Firstar Corporation and U.S. Bancorp in February 2001. Prior to the merger, he was Vice Chairman and Chief Financial Ofﬁcer of Firstar Corporation, and had served as Chief Financial Ofﬁcer of Star Banc Corporation from 1993 until its merger with Firstar Corporation in 1998. United Medical Resources, Inc. Chairman and Chief Executive Ofﬁcer Directors Jerry A. Grundhofer1,6 Chairman, President and Chief Executive Ofﬁcer U.S. Bancorp Linda L. Ahlers1,2,3 President Marshall Field’s Minneapolis, Minnesota Victoria Buyniski Gluckman3,4 Chairman, President and Chief Executive Ofﬁcer Cincinnati, Ohio Arthur D. Collins, Jr.1,5,6 Chairman and Chief Executive Ofﬁcer Medtronic, Inc. Minneapolis, Minnesota Peter H. Coors2,4 Chairman Coors Brewing Company Golden, Colorado John C. Dannemiller4,5 Retired Chairman Applied Industrial Technologies Cleveland, Ohio 1. Executive Committee 2. Compensation Committee 3. Audit Committee 4. Community Outreach and Fair Lending Committee 5. Governance Committee 6. Credit and Finance Committee John F. Grundhofer1,6 Chairman Emeritus U.S. Bancorp Delbert W. Johnson1,3,6 Vice President Safeguard Scientiﬁcs, Inc. Wayne, Pennsylvania Joel W. Johnson4,5 Chairman, President and Chief Executive Ofﬁcer Thomas E. Petry1,2,3 Retired Chairman and Chief Executive Ofﬁcer Eagle-Picher Industries, Inc. Cincinnati, Ohio Richard G. Reiten1,3,6 Chairman Northwest Natural Gas Company Portland, Oregon Craig D. Schnuck3,4 Hormel Foods Corporation Chairman and Chief Executive Ofﬁcer Austin, Minnesota Jerry W. Levin5,6 American Household, Inc. Boca Raton, Florida David B. O’Maley1,2,5 Chairman, President and Chief Executive Ofﬁcer Schnuck Markets, Inc. St. Louis, Missouri Warren R. Staley1,3,6 Chairman and Chief Executive Ofﬁcer Cargill, Incorporated Minneapolis, Minnesota Patrick T. Stokes1,2,5 President and Chief Executive Ofﬁcer Ohio National Financial Services, Inc. Anheuser-Busch Companies, Inc. Cincinnati, Ohio St. Louis, Missouri O’dell M. Owens, M.D., M.P.H.4,6 John J. Stollenwerk2,3 Healthcare Consultant Cincinnati, Ohio President and Chief Executive Ofﬁcer Allen-Edmonds Shoe Corporation Port Washington, Wisconsin U.S. Bancorp 123 c o r p o r a t e i n f o r m a t i o n Executive Offices U.S. Bancorp 800 Nicollet Mall Minneapolis, MN 55402 Common Stock Transfer Agent and Registrar Mellon Investor Services acts as our transfer agent and registrar, dividend paying agent and dividend reinvestment plan administrator, and maintains all shareholder records for the corporation. Inquiries related to shareholder records, stock transfers, changes of ownership, lost stock certificates, changes of address and dividend payment should be directed to the transfer agent at: Mellon Investor Services P.O. Box 3315 South Hackensack, NJ 07606-1915 Phone: 888-778-1311 or 201-329-8660 Internet: melloninvestor.com For Registered or Certified Mail: Mellon Investor Services 85 Challenger Road Ridgefield Park, NJ 07660-2104 Telephone representatives are available weekdays from 8:00 a.m. to 6:00 p.m. Central Time, and automated support is available 24 hours a day, 7 days a week. Specific information about your account is available on Mellon’s Internet site by clicking on the Investor ServiceDirect® link. Independent Auditors Ernst & Young LLP serves as the independent auditors for U.S. Bancorp’s financial statements. Common Stock Listing and Trading U.S. Bancorp common stock is listed and traded on the New York Stock Exchange under the ticker symbol USB. Dividends and Reinvestment Plan U.S. Bancorp currently pays quarterly dividends on our common stock on or about the 15th day of January, April, July and October, subject to prior approval by our Board of Directors. U.S. Bancorp shareholders can choose to participate in a plan that provides automatic reinvestment of dividends and/or optional cash purchase of additional shares of U.S. Bancorp common stock. For more information, please contact our transfer agent, Mellon Investor Services. See above. Investor Relations Contacts Howell D. McCullough Senior Vice President, Investor Relations howell.mccullough@usbank.com Phone: 612-303-0786 Judith T. Murphy Vice President, Investor Relations judith.murphy@usbank.com Phone: 612-303-0783 or 866-775-9668 Financial Information U.S. Bancorp news and financial results are available through our web site and by mail. Web site. For information about U.S. Bancorp, including news, financial results, annual reports and other documents filed with the Securities and Exchange Commission, access our home page on the Internet site at usbank.com and click on Investor/Shareholder Information. Mail. At your request, we will mail to you our quarterly earnings, news releases, quarterly financial data reported on Form 10-Q and additional copies of our annual reports. Please contact: U.S. Bancorp Investor Relations 800 Nicollet Mall Minneapolis, MN 55402 corporaterelations@usbank.com Phone: 612-303-0799 or 866-775-9668 Media Requests Steven W. Dale Senior Vice President, Media Relations steve.dale@usbank.com Phone: 612-303-0784 Privacy U.S. Bancorp is committed to respecting the privacy of our customers and safeguarding the financial and personal information provided to us. To learn more about the U.S. Bancorp commitment to protecting privacy, visit usbank.com and click on Privacy Pledge. Code of Ethics U.S. Bancorp places the highest importance on honesty and integrity. Each year, every U.S. Bancorp employee certifies compliance with the letter and spirit of our Code of Ethics and Business Conduct, the guiding ethical standards of our organization. For details about our Code of Ethics and Business Conduct, visit usbank.com and click on Ethics at U.S. Bank. Diversity U.S. Bancorp and our subsidiaries are committed to developing and maintaining a workplace that reflects the diversity of the communities we serve. We support a work environment where individual differences are valued and respected and where each individual who shares the fundamental values of the company has an opportunity to contribute and grow based on individual merit. Equal Employment Opportunity/ Affirmative Action U.S. Bancorp and our subsidiaries are committed to providing Equal Employment Opportunity to all employees and applicants for employment. In keeping with this commitment, employment decisions are made based upon performance, skill and abilities, not race, color, religion, national origin or ancestry, gender, age, disability, veteran status, sexual orientation or any other factors protected by law. The corporation complies with municipal, state and federal fair employment laws, including regulations applying to federal contractors. U.S. Bancorp, including each of our subsidiaries, is an Equal Opportunity Employer committed to creating a diverse workforce. re r r n e n re e a er n a n n a m n m m er en n mer a e. U.S. Bank Member FDIC U.S. Bancorp 800 Nicollet Mall Minneapolis, MN 55402 usbank.com

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