Wells Fargo 2008 Annual Report Download - page 140

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Examples include private CMOs, municipal bonds, U.S.
government and agency mortgage-backed securities, and
corporate debt securities.
Where significant inputs are unobservable in the market
due to limited activity or a less liquid market, securities valued
using models with such inputs are classified as Level 3 of the
fair value hierarchy. Securities classified as Level 3 include pri-
vate placement asset-backed securities, collateralized by auto
leases and cash reserves, private CMOs, collateralized debt
obligations (CDOs) and collateralized loan obligations
(CLOs), and certain residual and retained interests in
residential mortgage loan securitizations. CDOs are valued
using the prices of similar instruments, the pricing of
completed or pending third party transactions or the pricing
of the underlying collateral within the CDO. Where prices
are not readily available, management’s best estimate is used.
MORTGAGES HELD FOR SALE (MHFS) Under FAS 159, we elected
to carry our new prime residential MHFS portfolio at fair
value. The remaining MHFS are carried at the lower of cost
or market value. Fair value is based on independent quoted
market prices, where available, or the prices for other
mortgage whole loans with similar characteristics. As
necessary, these prices are adjusted for typical securitization
activities, including servicing value, portfolio composition,
market conditions and liquidity. Most of our MHFS are
classified as Level 2. For the portion where market pricing
data is not available, we use a discounted cash flow model
to estimate fair value and, accordingly, classify as Level 3.
LOANS HELD FOR SALE (LHFS) Loans held for sale are carried at
the lower of cost or market value, or at fair value for certain
portfolios that we intend to hold for trading purposes. The
fair value of LHFS is based on what secondary markets are
currently offering for portfolios with similar characteristics.
As such, we classify those loans subjected to nonrecurring
fair value adjustments as Level 2.
LOANS For the carrying value of loans, including loans
accounted for under SOP 03-3, see Note 1 – Loans. We do
not record loans at fair value on a recurring basis. As such,
valuation techniques discussed herein for loans are primarily
for estimating fair value for FAS 107 disclosure purposes.
However, from time to time, we record nonrecurring fair
value adjustments to loans to reflect (1) partial write-downs
that are based on the observable market price or current
appraised value of the collateral, or (2) the full charge-off
of the loan carrying value.
The fair value estimates for FAS 107 purposes differentiate
loans based on their financial characteristics, such as product
classification, loan category, pricing features and remaining
maturity. Prepayment and credit loss estimates are evaluated
by product and loan rate.
The fair value of commercial and commercial real estate
loans is calculated by discounting contractual cash flows,
adjusted for credit loss estimates, using discount rates that
reflect our current pricing for loans with similar characteristics
and remaining maturity.
fair value, which inherently reflect any lack of liquidity in the
market as the fair value measurement represents an exit
price from a market participant viewpoint.
Following is a description of valuation methodologies
used for assets and liabilities recorded at fair value and for
estimating fair value for financial instruments not recorded
at fair value (FAS 107 disclosures).
Assets
SHORT-TERM FINANCIAL ASSETS Short-term financial assets
include cash and due from banks, federal funds sold and
securities purchased under resale agreements and due from
customers on acceptances. These assets are carried at historical
cost. The carrying amount is a reasonable estimate of fair
value because of the relatively short time between the
origination of the instrument and its expected realization.
TRADING ASSETS AND SECURITIES AVAILABLE FOR SALE Trading
assets and securities available for sale are recorded at fair
value on a recurring basis. Fair value measurement is based
upon quoted prices, if available. Such instruments are classified
within Level 1 of the fair value hierarchy. Examples include
exchange-traded equity securities and some highly liquid
government securities such as U.S. Treasuries.
When instruments are traded in secondary markets and
quoted market prices do not exist for such securities, we
generally rely on internal valuation techniques or on prices
obtained from independent pricing services or brokers
(collectively, vendors). Trading assets and liabilities are
typically valued using trader prices that are subject to
independent price verification procedures. The majority of
fair values derived using internal valuation techniques are
verified against multiple pricing sources, including prices
obtained from independent vendors. Vendors compile prices
from various sources and often apply matrix pricing for similar
securities when no price is observable. We review pricing
methodologies provided by the vendors in order to determine
if observable market information is being used, versus
unobservable inputs. When evaluating the appropriateness
of an internal trader price compared to vendor prices,
considerations include the range and quality of vendor
prices. Vendor prices are used to ensure the reasonableness
of a trader price; however valuing financial instruments
involves judgments acquired from knowledge of a particular
market and is not perfunctory. If a trader asserts that a vendor
price is not reflective of market value, justification for using
the trader price, including recent sales activity where possible,
must be provided to and approved by the appropriate levels
of management. Similarly, while securities available for sale
traded in secondary markets are typically valued using a vendor
price, these prices are reviewed and, if deemed inappropriate
by a trader who has the most knowledge of a particular market,
can be adjusted. Securities measured with these internal
valuation techniques are generally classified as Level 2 of
the hierarchy and often involve using quoted market prices
for similar securities, pricing models or discounted cash flow
analyses using inputs observable in the market where available.