Wells Fargo 2012 Annual Report Download - page 85

flows related to the associated servicing of the loan as part of the
fair value measurement of derivative loan commitments.
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 probability that the loan will not
fund within the terms of the commitment, referred to as a fall-
out factor. The value of the underlying loan commitment 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 employ forwards and options,
Eurodollar futures and 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 experience changes in fair
value that will either fully or partially offset the changes in fair
value of the derivative loan commitments. However, changes in
investor demand, such as concerns about credit risk, can also
cause changes in the spread relationships between underlying
loan value and the derivative financial instruments that cannot
be hedged.
MARKET RISK – TRADING ACTIVITIES We engage in trading
activities primarily to accommodate the investment and risk
management activities of our customers, execute economic
hedging to manage certain of our balance sheet risks and for a
very limited amount of proprietary trading for our own account.
These activities primarily occur within our trading businesses
and include entering into transactions with our customers that
are recorded as trading assets and liabilities on our balance
sheet. All of our trading assets and liabilities, including
securities, foreign exchange transactions, commodity
transactions and derivatives are carried at fair value. Income
earned related to these trading activities include net interest
income and changes in fair value related to trading assets and
liabilities. Net interest income earned on trading assets and
liabilities is reflected in the interest income and interest expense
components of our income statement. Changes in fair value of
trading assets and liabilities are reflected in net gains (losses) on
trading activities, a component of noninterest income in our
income statement.
From a market risk perspective, our net income is exposed to
changes in the fair value of trading assets and liabilities due to
changes in interest rates, credit spreads, foreign exchange rates,
equity and commodity prices. Our Market Risk Committee,
which is a sub-committee of Corporate ALCO, provides
governance and oversight over market risk-taking activities
across the Company and establishes and monitors risk limits.
Table 42 presents total revenue from trading activities.
Table 42: Income from Trading Activities
Year ended December 31,
(in millions) 2012 2011 2010
Interest income (1) $ 1,358 1,440 1,098
Less: Interest expense (2) 245 316 227
Net interest income 1,113 1,124 871
Noninterest income:
Net gains (losses) from
trading activities (3):
Customer accommodation 1,347 1,029 1,448
Economic hedging and other 345 (1) 178
Proprietary trading 15 (14) 22
Total net trading gains 1,707 1,014 1,648
Total trading-related net interest
and noninterest income $ 2,820 2,138 2,519
(1) Represents interest and dividend income earned on trading securities.
(2) Represents interest and dividend expense incurred on trading securities we have
sold but have not yet purchased.
(3) Represents realized gains (losses) from our trading activity and unrealized gains
(losses) due to changes in fair value of our trading positions, attributable to the
type of business activity.
For further information regarding the fair value of our
trading assets and liabilities, refer to Note 16 (Derivatives) and
Note 17 (Fair Values of Assets and Liabilities) to Financial
Statements in this Report.
Customer accommodation Customer accommodation activities
are conducted to help customers manage their investment needs
and risk management and hedging activities. We engage in
market-making activities or act as an intermediary to purchase
or sell financial instruments in anticipation or in response to
customer needs. This category also includes positions we use to
manage our exposure to such transactions.
For the majority of our customer accommodation trading, we
serve as intermediary between buyer and seller. For example, we
may purchase or sell a derivative to a customer who wants to
manage interest rate risk exposure. We typically enter into
offsetting derivative(s) or security positions with a separate
counterparty or exchange to manage our exposure to the
derivative with our customer. We earn income on this activity
based on the transaction price difference between the customer
and offsetting derivative or security positions, which is reflected
in the fair value changes of the positions recorded in net gains
(losses) on trading activities.
Customer accommodation trading also includes net gains
related to market-making activities in which we take positions to
facilitate customer order flow. For example, we may own
securities recorded as trading assets (long positions) or sold
securities we have not yet purchased, recorded as trading
liabilities (short positions), typically on a short-term basis, to
facilitate anticipated buying and selling demand from our
customers. As market-maker in these securities, we earn income
due (1) to the difference between the price paid or received for
the purchase and sale of the security (bid-ask spread) and (2) the
net interest income and change in fair value of the long or short
positions during the short-term period held on our balance
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