Wells Fargo 2008 Annual Report Download - page 139

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Note 17: Fair Values of Assets and Liabilities
We use fair value measurements to record fair value
adjustments to certain assets and liabilities and to determine
fair value disclosures. Trading assets, securities available
for sale, derivatives, prime residential mortgages held for
sale (MHFS), certain commercial loans held for sale (LHFS),
residential MSRs, principal investments and securities sold
but not yet purchased (short sale liabilities) are recorded at
fair value on a recurring basis. Additionally, from time to
time, we may be required to record at fair value other assets
on a nonrecurring basis, such as nonprime residential and
commercial MHFS, certain LHFS, loans held for investment
and certain other assets. These nonrecurring fair value
adjustments typically involve application of lower-of-cost-or-
market accounting or write-downs of individual assets.
Under FAS 159, we elected to measure MHFS at fair value
prospectively for new prime residential MHFS originations,
for which an active secondary market and readily available
market prices existed to reliably support fair value pricing
models used for these loans. On December 31, 2008, we elected
to measure at fair value prime residential MHFS acquired
from Wachovia. We also elected to remeasure at fair value
certain of our other interests held related to residential loan
sales and securitizations. We believe the election for MHFS
and other interests held (which are now hedged with free-
standing derivatives (economic hedges) along with our
MSRs) reduces certain timing differences and better matches
changes in the value of these assets with changes in the value
of derivatives used as economic hedges for these assets.
There was no transition adjustment required upon adoption
of FAS 159 for MHFS because we continued to account for
MHFS originated prior to 2007 at the lower of cost or market
value. At December 31, 2006, the book value of other interests
held was equal to fair value and, therefore, a transition
adjustment was not required.
Upon the acquisition of Wachovia, we elected to measure
at fair value certain portfolios of LHFS that we intend to hold
for trading purposes and that may be economically hedged
with derivative instruments. In addition, we elected to mea-
sure at fair value certain letters of credit that are hedged with
derivative instruments to better reflect the economics of the
transactions. These letters of credit are included in trading
account assets or liabilities.
Under FAS 159, we were also required to adopt FAS 157,
Fair Value Measurements (FAS 157). FAS 157 defines fair
value, establishes a consistent framework for measuring fair
value and expands disclosure requirements for fair value
measurements. Additionally, FAS 157 amended FAS 107,
Disclosure about Fair Value of Financial Instruments
(FAS 107), and, as such, we follow FAS 157 in determination
of FAS 107 fair value disclosure amounts. The disclosures
required under FAS 159, FAS 157 and FAS 107 are included
in this Note.
Fair Value Hierarchy
Under FAS 157, we group our assets and liabilities at fair
value in three levels, based on the markets in which the
assets and liabilities are traded and the reliability of the
assumptions used to determine fair value. These levels are:
• Level 1 – Valuation is based upon quoted prices for
identical instruments traded in active markets.
• Level 2 – Valuation is based upon quoted prices for similar
instruments in active markets, quoted prices for identical
or similar instruments in markets that are not active, and
model-based valuation techniques for which all significant
assumptions are observable in the market.
• Level 3 – Valuation is generated from model-based
techniques that use significant assumptions not observable
in the market. These unobservable assumptions reflect
estimates of assumptions that market participants would
use in pricing the asset or liability. Valuation techniques
include use of option pricing models, discounted cash
flow models and similar techniques.
Determination of Fair Value
Under FAS 157, we base our fair values on the price that
would be received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants at the
measurement date. It is our policy to maximize the use of
observable inputs and minimize the use of unobservable
inputs when developing fair value measurements, in
accordance with the fair value hierarchy in FAS 157.
Fair value measurements for assets and liabilities
where there exists limited or no observable market data
and, therefore, are based primarily upon our own estimates,
are often calculated based on current pricing policy, the
economic and competitive environment, the characteristics
of the asset or liability and other such factors. Therefore,
the results cannot be determined with precision and may
not be realized in an actual sale or immediate settlement
of the asset or liability. Additionally, there may be inherent
weaknesses in any calculation technique, and changes in
the underlying assumptions used, including discount rates
and estimates of future cash flows, that could significantly
affect the results of current or future values.
We incorporate lack of liquidity into our fair value
measurement based on the type of asset measured and the
valuation methodology used. For example, for residential
mortgage loans held for sale and certain securities where
the significant inputs have become unobservable due to the
illiquid markets, we use a discounted cash flow technique to
measure fair value. This technique incorporates forecasting
of expected cash flows discounted at an appropriate market
discount rate to reflect the lack of liquidity in the market that
a market participant would consider. For other securities,
we use unadjusted broker quotes or vendor prices to measure