Wells Fargo 2010 Annual Report Download - page 96

Risk Factors (continued)
mortgage loan terms could make bankruptcy a more attractive
option for troubled borrowers, leading to increased bankruptcy
filings and accelerated defaults.
RISKS RELATING TO THE WACHOVIA MERGER
Our financial results and condition could be adversely
affected if we fail to realize all of the expected benefits
of the Wachovia merger or it takes longer than expected
to realize those benefits. The merger with Wachovia requires
the integration of the businesses of Wachovia and Wells Fargo.
The integration process may result in the loss of key employees,
the disruption of ongoing businesses and the loss of customers
and their business and deposits. It may also divert management
attention and resources from other operations and limit the
Company’s ability to pursue other acquisitions. There is no
assurance that we will realize all of the cost savings and other
financial benefits of the merger when and in the amounts
expected.
We may incur losses on loans, securities and other
acquired assets of Wachovia that are materially greater
than reflected in our preliminary fair value
adjustments. We accounted for the Wachovia merger under
the purchase method of accounting, recording the acquired
assets and liabilities of Wachovia at fair value based on
preliminary purchase accounting adjustments. Under purchase
accounting, we had until one year after the merger date to
finalize the fair value adjustments, meaning we could adjust the
preliminary fair value estimates of Wachovia’s assets and
liabilities based on new or updated information that provided a
better estimate of the fair value at merger date.
We recorded at fair value all PCI loans acquired in the merger
based on the present value of their expected cash flows. We
estimated cash flows using internal credit, interest rate and
prepayment risk models using assumptions about matters that
are inherently uncertain. We may not realize the estimated cash
flows or fair value of these loans. In addition, although the
difference between the pre-merger carrying value of the credit-
impaired loans and their expected cash flows – the
“nonaccretable difference” – is available to absorb future charge-
offs, we may be required to increase our allowance for credit
losses and related provision expense because of subsequent
additional credit deterioration in these loans.
For more information, refer to the “Overview” and “Critical
Accounting Policies – Purchased Credit-Impaired Loans”
sections in this Report.
GENERAL RISKS RELATING TO OUR BUSINESS
Higher charge-offs and worsening credit conditions
could require us to increase our allowance for credit
losses through a charge to earnings. When we loan money
or commit to loan money we incur credit risk, or the risk of
losses if our borrowers do not repay their loans. We reserve for
credit losses by establishing an allowance through a charge to
earnings. The amount of this allowance is based on our
assessment of credit losses inherent in our loan portfolio
(including unfunded credit commitments). The process for
determining the amount of the allowance is critical to our
financial results and condition. It requires difficult, subjective
and complex judgments about the future, including forecasts of
economic or market conditions that might impair the ability of
our borrowers to repay their loans.
We might underestimate the credit losses inherent in our loan
portfolio and have credit losses in excess of the amount reserved.
We might increase the allowance because of changing economic
conditions, including falling home prices and higher
unemployment, or other factors such as changes in borrower
behavior. As an example, borrowers may be less likely to
continue making payments on their real estate-secured loans if
the value of the real estate is less than what they owe, even if they
are still financially able to make the payments.
While we believe that our allowance for credit losses was
adequate at December 31, 2010, there is no assurance that it will
be sufficient to cover future credit losses, especially if housing
and employment conditions worsen. We may be required to
build reserves in 2011, thus reducing earnings.
For more information, refer to the “Risk Management –
Credit Risk Management” and “Critical Accounting Policies –
Allowance for Credit Losses” sections in this Report.
We may have more credit risk and higher credit losses
to the extent our loans are concentrated by loan type,
industry segment, borrower type, or location of the
borrower or collateral. Our credit risk and credit losses can
increase if our loans are concentrated to borrowers engaged in
the same or similar activities or to borrowers who as a group may
be uniquely or disproportionately affected by economic or
market conditions. We experienced the effect of concentration
risk in 2009 and 2010 when we incurred greater than expected
losses in our Home Equity loan portfolio due to a housing
slowdown and greater than expected deterioration in residential
real estate values in many markets, including the Central Valley
California market and several Southern California metropolitan
statistical areas. As California is our largest banking state in
terms of loans and deposits, continued deterioration in real
estate values and underlying economic conditions in those
markets or elsewhere in California could result in materially
higher credit losses. As a result of the Wachovia merger, we have
increased our exposure to California, as well as to Arizona and
Florida, two states that have also suffered significant declines in
home values. Continued deterioration in housing conditions and
real estate values in these states and generally across the country
could result in materially higher credit losses.
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