Wells Fargo 2006 Annual Report Download - page 76

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ALLOWANCE FOR CREDIT LOSSES The allowance for credit losses,
which consists of the allowance for loan losses and the
reserve for unfunded credit commitments, is management’s
estimate of credit losses inherent in the loan portfolio at the
balance sheet date.
Transfers and Servicing of Financial Assets
We account for a transfer of financial assets as a sale when
we surrender control of the transferred assets. Effective
January 1, 2006, upon adoption of Statement of Financial
Accounting Standards No. 156, Accounting for Servicing of
Financial Assets – an amendment of FASB Statement No. 140
(FAS 156), servicing rights resulting from the sale or securiti-
zation of loans we originate (asset transfers), are initially
measured at fair value at the date of transfer. We recognize
the rights to service mortgage loans for others, or mortgage
servicing rights (MSRs), as assets whether we purchase the
MSRs or the MSRs result from an asset transfer. We also
acquire MSRs under co-issuer agreements that provide for us
to service loans that are originated and securitized by third-
party correspondents. We determine the fair value of servic-
ing rights at the date of transfer using the present value of
estimated future net servicing income, using assumptions
that market participants use in their estimates of values. We
use quoted market prices when available to determine the
value of other interests held. Gain or loss on sale of loans
depends on (a) proceeds received and (b) the previous carry-
ing amount of the financial assets transferred and any inter-
ests we continue to hold (such as interest-only strips) based
on relative fair value at the date of transfer.
To determine the fair value of MSRs, we use a valuation
model that calculates the present value of estimated future
net servicing income. We use assumptions in the valuation
model that market participants use in estimating future net
servicing income, including estimates of prepayment speeds,
discount rate, cost to service, escrow account earnings, con-
tractual servicing fee income, ancillary income and late fees.
This model is validated by an independent internal model
validation group operating in accordance with a model vali-
dation policy approved by the Corporate Asset/Liability
Management Committee.
MORTGAGE SERVICING RIGHTS MEASURED AT FAIR VALUE
Effective January 1, 2006, upon adoption of FAS 156, we
elected to initially measure and carry our MSRs related to
residential mortgage loans (residential MSRs) using the fair
value method. Under the fair value method, residential MSRs
are carried in the balance sheet at fair value and the changes
in fair value, primarily due to changes in valuation inputs
and assumptions and to the collection/realization of expected
cash flows, are reported in earnings in the period in which
the change occurs.
Effective January 1, 2006, upon the remeasurement of
our residential MSRs at fair value, we recorded a cumulative
effect adjustment to increase the 2006 beginning balance of
retained earnings by $101 million after tax ($158 million
pre tax) in stockholders’ equity.
AMORTIZED MORTGAGE SERVICING RIGHTS
Amortized MSRs, which include commercial MSRs and,
prior to January 1, 2006, residential MSRs, are carried at
the lower of cost or market. These MSRs are amortized in
proportion to, and over the period of, estimated net servicing
income. The amortization of MSRs is analyzed monthly and
is adjusted to reflect changes in prepayment speeds, as well
as other factors.
Premises and Equipment
Premises and equipment are carried at cost less accumulated
depreciation and amortization. Capital leases are included in
premises and equipment at the capitalized amount less accu-
mulated amortization.
We primarily use the straight-line method of depreciation
and amortization. Estimated useful lives range up to 40 years
for buildings, up to 10 years for furniture and equipment,
and the shorter of the estimated useful life or lease term for
leasehold improvements. We amortize capitalized leased assets
on a straight-line basis over the lives of the respective leases.
Goodwill and Identifiable Intangible Assets
Goodwill is recorded when the purchase price is higher than
the fair value of net assets acquired in business combinations
under the purchase method of accounting.
We assess goodwill for impairment annually, and more
frequently in certain circumstances. We assess goodwill for
impairment on a reporting unit level by applying a fair-
value-based test using discounted estimated future net cash
flows. Impairment exists when the carrying amount of the
goodwill exceeds its implied fair value. We recognize impair-
ment losses as a charge to noninterest expense (unless related
to discontinued operations) and an adjustment to the carry-
ing value of the goodwill asset. Subsequent reversals of
goodwill impairment are prohibited.
We amortize core deposit intangibles on an accelerated
basis based on useful lives of 10 to 15 years. We review
core deposit intangibles for impairment whenever events
or changes in circumstances indicate that their carrying
amounts may not be recoverable. Impairment is indicated if
the sum of undiscounted estimated future net cash flows is
less than the carrying value of the asset. Impairment is per-
manently recognized by writing down the asset to the extent
that the carrying value exceeds the estimated fair value.
Operating Lease Assets
Operating lease rental income for leased assets, generally
autos, is recognized in other income on a straight-line basis
over the lease term. Related depreciation expense is recorded
on a straight-line basis over the life of the lease, taking into
account the estimated residual value of the leased asset. On
a periodic basis, leased assets are reviewed for impairment.
Impairment loss is recognized if the carrying amount of
leased assets exceeds fair value and is not recoverable. The
carrying amount of leased assets is not recoverable if it
exceeds the sum of the undiscounted cash flows expected to
result from the lease payments and the estimated residual