Wells Fargo 2011 Annual Report Download - page 128

Note 1: Summary of Significant Accounting Policies (continued)
TROUBLED DEBT RESTRUCTURINGS (TDRs)
In situations where,
for economic or legal reasons related to a borrower’s financial
difficulties, we grant a concession for other than an insignificant
period of time to the borrower that we would not otherwise
consider, the related loan is classified as a TDR. We strive to
identify borrowers in financial difficulty early and work with
them to modify their loan to more affordable terms before it
reaches nonaccrual status. These modified terms may include
rate reductions, principal forgiveness, term extensions, payment
forbearance and other actions intended to minimize our
economic loss and to avoid foreclosure or repossession of the
collateral. For modifications where we forgive principal, the
entire amount of such principal forgiveness is immediately
charged off. Loans classified as TDRs, including loans in trial
payment periods (trial modifications), are considered impaired
loans.
PURCHASED CREDIT-IMPAIRED (PCI) LOANS Loans acquired
with evidence of credit deterioration since their origination and
where it is probable that we will not collect all contractually
required principal and interest payments are accounted for using
the measurement provision for PCI loans. PCI loans are recorded
at fair value at the date of acquisition, and the historical
allowance for credit losses related to these loans is not carried
over. Some loans that otherwise meet the definition as credit-
impaired are specifically excluded from the PCI loan portfolios,
such as revolving loans where the borrower still has revolving
privileges.
Evidence of credit quality deterioration as of the purchase
date may include statistics such as past due and nonaccrual
status, commercial risk ratings, recent borrower credit scores
and recent loan-to-value percentages. Generally, acquired loans
that meet our definition for nonaccrual status are considered to
be credit-impaired.
Substantially all commercial and industrial, CRE and foreign
PCI loans are accounted for as individual loans. Conversely,
Pick-a-Pay and other consumer PCI loans have been aggregated
into several pools based on common risk characteristics. Each
pool is accounted for as a single asset with a single composite
interest rate and an aggregate expectation of cash flows.
Accounting for PCI loans involves estimating fair value, at
acquisition, using the principal and interest cash flows expected
to be collected discounted at the prevailing market rate of
interest. The excess of cash flows expected to be collected over
the carrying value (estimated fair value at acquisition date) is
referred to as the accretable yield and is recognized in interest
income using an effective yield method over the remaining life of
the loan, or pool of loans, in situations where there is a
reasonable expectation about the timing and amount of cash
flows to be collected. The difference between contractually
required payments and the cash flows expected to be collected at
acquisition, considering the impact of prepayments, is referred
to as the nonaccretable difference.
Subsequent to acquisition, we regularly evaluate our
estimates of cash flows expected to be collected. If we have
probable decreases in cash flows expected to be collected (other
than due to decreases in interest rate indices and changes in
prepayment assumptions), we charge the provision for credit
losses, resulting in an increase to the allowance for loan losses. If
we have probable and significant increases in cash flows
expected to be collected, we first reverse any previously
established allowance for loan losses and then increase interest
income as a prospective yield adjustment over the remaining life
of the loan, or pool of loans. Estimates of cash flows are
impacted by changes in interest rate indices for variable rate
loans and prepayment assumptions, both of which are treated as
prospective yield adjustments included in interest income.
Resolutions of loans may include sales of loans to third
parties, receipt of payments in settlement with the borrower, or
foreclosure of the collateral. For individual PCI loans, gains or
losses on sales to third parties are included in noninterest
income, and gains or losses as a result of a settlement with the
borrower are included in interest income. Our policy is to
remove an individual loan from a pool based on comparing the
amount received from its resolution with its contractual amount.
Any difference between these amounts is absorbed by the
nonaccretable difference for the entire pool. This removal
method assumes that the amount received from resolution
approximates pool performance expectations. The remaining
accretable yield balance is unaffected and any material change in
remaining effective yield caused by this removal method is
addressed by our quarterly cash flow evaluation process for each
pool. For loans that are resolved by payment in full, there is no
release of the nonaccretable difference for the pool because there
is no difference between the amount received at resolution and
the contractual amount of the loan. Modified PCI loans are not
removed from a pool even if those loans would otherwise be
deemed TDRs. Modified PCI loans that are accounted for
individually are considered TDRs, and removed from PCI
accounting if there has been a concession granted in excess of
the original nonaccretable difference. We include these TDRs in
our impaired loans.
FORECLOSED ASSETS Foreclosed assets obtained through our
lending activities primarily include real estate. Generally, loans
have been written down to their net realizable value prior to
foreclosure. Any further reduction to their net realizable value is
recorded with a charge to the allowance for credit losses at
foreclosure. We allow up to 90 days after foreclosure to finalize
determination of net realizable value. Thereafter, changes in net
realizable value are recorded to noninterest expense. The net
realizable value of these assets is reviewed and updated
periodically depending on the type of property.
ALLOWANCE FOR CREDIT LOSSES The allowance for credit
losses (allowance), which consists of the allowance for loan
losses and the allowance for unfunded credit commitments, is
management’s estimate of credit losses inherent in the loan
portfolio and unfunded credit commitments at the balance sheet
date, excluding loans carried at fair value. It considers both
unimpaired and impaired loans and is developed and
documented at the loan portfolio segment level – commercial
and consumer.
Unimpaired loans are generally evaluated on a collective
basis by utilizing risk grades for the commercial loan portfolio
segment and loss estimates for pools of loans with similar risk
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