Wells Fargo 2011 Annual Report Download - page 100

Risk Factors (continued)
commercial loan portfolios by making loans to creditworthy
borrowers at attractive yields. Although we have significant
capacity to add loans to our balance sheet and there have been
some early signs of increased borrower activity, loan demand,
especially consumer loan demand, has been soft resulting in our
retaining a much higher amount of lower yielding liquid assets
on our balance sheet. If economic conditions do not continue to
improve or if the economy worsens and unemployment rises,
which also would likely result in a decrease in consumer and
business confidence and spending, the demand for our credit
products, including our mortgages, may fall, reducing our
interest and fee income and our earnings.
A deterioration in business and economic conditions, which
may erode consumer and investor confidence levels, and/or
increased volatility of financial markets, also could adversely
affect financial results for our fee-based businesses, including
our investment advisory, mutual fund, securities brokerage,
wealth management, and investment banking businesses. As a
result of the Wachovia merger, a greater percentage of our
revenue depends on our fee income from these businesses. We
earn fee income from managing assets for others and providing
brokerage and other investment advisory and wealth
management services. Because investment management fees are
often based on the value of assets under management, a fall in
the market prices of those assets could reduce our fee income.
Changes in stock market prices could affect the trading activity of
investors, reducing commissions and other fees we earn from our
brokerage business. Poor economic conditions and volatile or
unstable financial markets also can negatively affect our debt and
equity underwriting and advisory businesses, as well as our
trading and venture capital businesses. Extreme market volatility
also could cause us to elect to provide capital support to our
money market funds, which would reduce our earnings. Our
acquisition of Wachovia expanded our international businesses,
particularly our global financial institution and correspondent
banking services, and any deterioration in global financial
markets and economies, including as a result of Europe’s
sovereign debt crisis or any international political unrest or
disturbances, may adversely affect the revenues and earnings of
these and other businesses.
For more information, refer to the “Risk Management –
Asset/Liability Management” and “– Credit Risk Management”
sections in this Report.
Changes in interest rates and financial market values
could reduce our net interest income and earnings,
including as a result of recognizing losses or OTTI on
the securities that we hold in our portfolio or trade for
our customers. Our net interest income is the interest we earn
on loans, debt securities and other assets we hold less the
interest we pay on our deposits, long-term and short-term debt,
and other liabilities. Net interest income is a measure of both our
net interest margin – the difference between the yield we earn on
our assets and the interest rate we pay for deposits and our other
sources of funding – and the amount of earning assets we hold.
Changes in either our net interest margin or the amount or mix
of earning assets we hold could affect our net interest income
and our earnings. Changes in interest rates can affect our net
interest margin. Although the yield we earn on our assets and
our funding costs tend to move in the same direction in response
to changes in interest rates, one can rise or fall faster than the
other, causing our net interest margin to expand or contract. Our
liabilities tend to be shorter in duration than our assets, so they
may adjust faster in response to changes in interest rates. When
interest rates rise, our funding costs may rise faster than the
yield we earn on our assets, causing our net interest margin to
contract until the asset yield increases.
The amount and type of earning assets we hold can affect our
yield and net interest margin. We hold earning assets in the form
of loans and investment securities, among other assets. As noted
above, if the economy remains weak or worsens we may see
lower demand for loans by creditworthy customers, reducing our
net interest income and yield. In addition, our net interest
income and net interest margin can be negatively affected by a
prolonged low interest rate environment, which as noted below is
currently being experienced as a result of economic conditions
and FRB monetary policies, as it may result in us holding lower
yielding loans and securities on our balance sheet, particularly if
we are unable to replace the maturing higher yielding assets on
our balance sheet, including the loans in our non-strategic and
liquidating loan portfolio, with similar higher yielding assets.
Increases in interest rates, however, may negatively affect loan
demand and could result in higher credit losses as borrowers
may have more difficulty making higher interest payments. As
described below, changes in interest rates also affect our
mortgage business, including the value of our MSRs.
Changes in the slope of the “yield curve” – or the spread
between short-term and long-term interest rates – could also
reduce our net interest margin. Normally, the yield curve is
upward sloping, meaning short-term rates are lower than long-
term rates. Because our liabilities tend to be shorter in duration
than our assets, when the yield curve flattens, as is the case in the
current interest rate environment, or even inverts, our net
interest margin could decrease as our cost of funds increases
relative to the yield we can earn on our assets.
The interest we earn on our loans may be tied to U.S.-
denominated interest rates such as the federal funds rate while
the interest we pay on our debt may be based on international
rates such as LIBOR. If the federal funds rate were to fall without
a corresponding decrease in LIBOR, we might earn less on our
loans without any offsetting decrease in our funding costs. This
could lower our net interest margin and our net interest income.
We assess our interest rate risk by estimating the effect on our
earnings under various scenarios that differ based on
assumptions about the direction, magnitude and speed of
interest rate changes and the slope of the yield curve. We hedge
some of that interest rate risk with interest rate derivatives. We
also rely on the “natural hedge” that our mortgage loan
originations and servicing rights can provide.
We may not hedge all of our interest rate risk. There is always
the risk that changes in interest rates could reduce our net
interest income and our earnings in material amounts, especially
if actual conditions turn out to be materially different than what
we assumed. For example, if interest rates rise or fall faster than
we assumed or the slope of the yield curve changes, we may incur
significant losses on debt securities we hold as investments. To
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