Wells Fargo 2008 Annual Report Download - page 73

As part of our mortgage banking activities, we enter into
commitments to fund residential mortgage loans at specified
times in the future. A mortgage loan commitment is an inter-
est rate lock that binds us to lend funds to a potential borrower
at a specified interest rate and within a specified period of
time, generally up to 60 days after inception of the rate lock.
These loan commitments are derivative loan commitments if
the loans that will result from the exercise of the commit-
ments will be held for sale. These derivative loan commit-
ments are recognized at fair value in the balance sheet with
changes in their fair values recorded as part of mortgage
banking noninterest income. For interest rate lock commit-
ments issued prior to January 1, 2008, we recorded a zero fair
value for the derivative loan commitment at inception consis-
tent with SAB 105. Effective January 1, 2008, we were
required by SAB 109 to include, at inception and during the
life of the loan commitment, the expected net future cash
flows related to the associated servicing of the loan as part of
the fair value measurement of derivative loan commitments.
The implementation of SAB 109 did not have a material
impact on our results or the valuation of our loan commit-
ments. Changes subsequent to inception are based on
changes in fair value of the underlying loan resulting from
the exercise of the commitment and changes in the probabili-
ty that the loan will not fund within the terms of the commit-
ment (referred to as a fall-out factor). The value of the under-
lying loan is affected primarily by changes in interest rates
and the passage of time.
Outstanding derivative loan commitments expose us to
the risk that the price of the mortgage loans underlying the
commitments might decline due to increases in mortgage
interest rates from inception of the rate lock to the funding
of the loan. To minimize this risk, we utilize forwards and
options, Eurodollar futures, Eurodollar options, and Treasury
futures, forwards and options contracts as economic hedges
against the potential decreases in the values of the loans. We
expect that these derivative financial instruments will experi-
ence changes in fair value that will either fully or partially
offset the changes in fair value of the derivative loan commit-
ments. However, changes in investor demand, such as con-
cerns about credit risk, can also cause changes in the spread
relationships between underlying loan value and the deriva-
tive financial instruments that cannot be hedged.
MARKET RISK – TRADING ACTIVITIES From a market risk per-
spective, our net income is exposed to changes in interest
rates, credit spreads, foreign exchange rates, equity and com-
modity prices and their implied volatilities. The primary pur-
pose of our trading businesses is to accommodate customers
in the management of their market price risks. Also, we take
positions based on market expectations or to benefit from
price differences between financial instruments and markets,
subject to risk limits established and monitored by Corporate
ALCO. All securities, foreign exchange transactions, com-
modity transactions and derivatives used in our trading
businesses are carried at fair value. The Institutional Risk
Committee establishes and monitors counterparty risk limits.
The notional or contractual amount, credit risk amount and
estimated net fair value of all customer accommodation
derivatives at December 31, 2008 and 2007, are included in
Note 16 (Derivatives) to Financial Statements. Open, “at risk”
positions for all trading businesses are monitored by
Corporate ALCO.
The standardized approach for monitoring and reporting
market risk for the trading activities is the value-at-risk
(VAR) metrics complemented with factor analysis and stress
testing. VAR measures the worst expected loss over a given
time interval and within a given confidence interval. We mea-
sure and report daily VAR at a 99% confidence interval based
on actual changes in rates and prices over the past 250 trad-
ing days. The analysis captures all financial instruments that
are considered trading positions. The average one-day VAR
throughout 2008 was $19 million, with a lower bound of
$10 million and an upper bound of $52 million. We acquired
from Wachovia a capital markets business. Generally, these
activities have a more significant VAR exposure.
MARKET RISK – EQUITY MARKETS We are directly and indirect-
ly affected by changes in the equity markets. We make and
manage direct equity investments in start-up businesses,
emerging growth companies, management buy-outs, acquisi-
tions and corporate recapitalizations. We also invest in non-
affiliated funds that make similar private equity investments.
These private equity investments are made within capital
allocations approved by management and the Board of
Directors (the Board). The Board’s policy is to review busi-
ness developments, key risks and historical returns for the
private equity investment portfolio at least annually.
Management reviews the valuations of these investments at
least quarterly and assesses them for possible other-than-
temporary impairment. For nonmarketable investments, the
analysis is based on facts and circumstances of each individ-
ual investment and the expectations for that investment’s
cash flows and capital needs, the viability of its business
model and our exit strategy. Nonmarketable investments
included private equity investments of $2.71 billion at
December 31, 2008, and $2.02 billion at December 31, 2007,
and principal investments of $1.28 billion at December 31,
2008. Private equity investments are carried at cost subject to
other-than-temporary impairment. Principal investments are
carried at fair value with net unrealized gains and losses
reported in noninterest income.
We also have marketable equity securities in the securi-
ties available-for-sale portfolio, including securities relating
to our venture capital activities. We manage these invest-
ments within capital risk limits approved by management
and the Board and monitored by Corporate ALCO. Gains and
losses on these securities are recognized in net income when
realized and periodically include other-than-temporary
impairment charges, which are recorded when determined.
The fair value of marketable equity securities was $6.14 billion
and cost was $6.30 billion at December 31, 2008, and $2.78 billion
and $2.88 billion, respectively, at December 31, 2007.
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