Wells Fargo 2014 Annual Report Download - page 110

Regulatory Reform (continued)
can be accomplished in a reasonable period of time and in a
manner that mitigates the risk that failure would have serious
adverse effects on the financial stability of the United States.
Wells Fargo submitted its second annual resolution plan under
these rules on June 26, 2014. On November 25, 2014, the FRB
and FDIC announced that our 2014 resolution plan submission
provided a basis for a resolution strategy that could facilitate an
orderly resolution under bankruptcy; however, they identified
specific shortcomings in the 2014 resolution plan that would
need to be addressed in the 2015 resolution plan. If the FRB and
FDIC determine that our resolution plan is deficient, the Dodd-
Frank Act authorizes the FRB and FDIC to impose more
stringent capital, leverage or liquidity requirements on us or
restrict our growth or activities until we submit a plan
remedying the deficiencies. If the FRB and FDIC ultimately
determine that we have been unable to remedy the deficiencies,
they could order us to divest assets or operations in order to
facilitate our orderly resolution in the event of our material
distress or failure. Our national bank subsidiary, Wells Fargo
Bank, N.A., is also required to prepare a resolution plan for the
Critical Accounting Policies
FDIC under separate regulatory authority and submitted its
second annual resolution plan on June 26, 2014.
The Dodd-Frank Act also establishes an orderly liquidation
process which allows for the appointment of the FDIC as a
receiver of a systemically important financial institution that is
in default or in danger of default. The FDIC has issued rules to
implement its orderly liquidation authority and released a notice
and request for comment regarding a proposed resolution
strategy, known as “single point of entry,” designed to resolve a
large financial institution in a manner that holds management
responsible for its failure, maintains market stability, and
imposes losses on shareholders and creditors in accordance with
statutory priorities, without imposing a cost on U.S. taxpayers.
Implementation of the strategy would require that institutions
maintain a sufficient amount of available equity and unsecured
debt to absorb losses and recapitalize operating subsidiaries. The
FDIC has not issued any final statements on the single point of
entry resolution strategy.
Our significant accounting policies (see Note 1 (Summary of
Significant Accounting Policies) to Financial Statements in this
Report) are fundamental to understanding our results of
operations and financial condition because they require that we
use estimates and assumptions that may affect the value of our
assets or liabilities and financial results. Five of these policies are
critical because they require management to make difficult,
subjective and complex judgments about matters that are
inherently uncertain and because it is likely that materially
different amounts would be reported under different conditions
or using different assumptions. These policies govern:
• the allowance for credit losses;
• PCI loans;
• the valuation of residential MSRs;
• the fair valuation of financial instruments; and
• income taxes.
Management and the Board's Audit and Examination
committee have reviewed and approved these critical accounting
policies.
Allowance for Credit Losses
We maintain an allowance for credit losses, which consists of the
allowance for loan losses and the allowance for unfunded credit
commitments, which is management’s estimate of credit losses
inherent in the loan portfolio, including unfunded credit
commitments, at the balance sheet date, excluding loans carried
at fair value. For a description of our related accounting policies,
see Note 1 (Summary of Significant Accounting Policies) to
Financial Statements in this Report.
Changes in the allowance for credit losses and, therefore, in
the related provision for credit losses can materially affect net
income. In applying the review and judgment required to
determine the allowance for credit losses, management
considers changes in economic conditions, customer behavior,
and collateral value, among other influences. From time to time,
economic factors or business decisions, such as the addition or
liquidation of a loan product or business unit, may affect the
loan portfolio, causing management to provide or release
amounts from the allowance for credit losses. While our
methodology attributes portions of the allowance to specific
portfolio segments (commercial and consumer), the entire
allowance for credit losses is available to absorb credit losses
inherent in the total loan portfolio and unfunded credit
commitments.
Judgment is specifically applied in:
• Credit risk ratings applied to individual commercial loans
and unfunded credit commitments. We estimate the
probability of default in accordance with the borrower’s
financial strength using a borrower quality rating and the
severity of loss in the event of default using a collateral
quality rating. Collectively, these ratings are referred to as
credit risk ratings and are assigned to our commercial loans.
Probability of default and severity at the time of default are
statistically derived through historical observations of
defaults and losses after default within each credit risk
rating. Commercial loan risk ratings are evaluated based on
each situation by experienced senior credit officers and are
subject to periodic review by an internal team of credit
specialists.
• Economic assumptions applied to pools of consumer loans
(statistically modeled). Losses are estimated using
economic variables to represent our best estimate of
inherent loss. Our forecasted losses are modeled using a
range of economic scenarios.
• Selection of a credit loss estimation model that fits the
credit risk characteristics of its portfolio. We use both
internally developed and vendor supplied models in this
process. We often use expected loss, roll rate, net flow,
vintage maturation, behavior score, and time series or
statistical trend models, most with economic correlations.
Management must use judgment in establishing additional
input metrics for the modeling processes, considering
further stratification into reference data time series, sub-
product, origination channel, vintage, loss type, geographic
location and other predictive characteristics. The models
used to determine the allowance are validated by an internal
model validation group operating in accordance with
Company policies.
• Assessment of limitations to credit loss estimation models.
We apply our judgment to adjust or supplement our
modeled estimates to reflect other risks that may be
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