Wells Fargo 2015 Annual Report Download - page 120

Risk Factors (continued)
on our assets or if the yield we earn on our assets falls faster than
our funding costs, our net interest margin could contract.
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 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 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, 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. When the yield curve flattens, or even inverts, our net
interest margin could decrease if the cost of our short-term
funding increases relative to the yield we can earn on our long-
term 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 generally do 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 reduce our interest rate risk, we may rebalance
our investment and loan portfolios, refinance our debt and take
other strategic actions. We may incur losses when we take such
actions.
We hold securities in our investment securities portfolio,
including U.S. Treasury and federal agency securities and federal
agency MBS, securities of U.S. states and political subdivisions,
residential and commercial MBS, corporate debt securities,
other asset-backed securities and marketable equity securities,
including securities relating to our venture capital activities. We
analyze securities held in our investment securities portfolio for
OTTI on at least a quarterly basis. The process for determining
whether impairment is other than temporary usually requires
difficult, subjective judgments about the future financial
performance of the issuer and any collateral underlying the
security in order to assess the probability of receiving
contractual principal and interest payments on the security.
Because of changing economic and market conditions, as well as
credit ratings, affecting issuers and the performance of the
underlying collateral, we may be required to recognize OTTI in
future periods. In particular, economic difficulties in the oil and
gas industry resulting from prolonged low oil prices may further
impact our energy sector investments and require us to
recognize OTTI in these investments in future periods. Our net
income also is exposed to changes in interest rates, credit
spreads, foreign exchange rates, equity and commodity prices in
connection with our trading activities, which are conducted
primarily to accommodate our customers in the management of
their market price risk, as well as when we take positions based
on market expectations or to benefit from differences between
financial instruments and markets. The securities held in these
activities are carried at fair value with realized and unrealized
gains and losses recorded in noninterest income. As part of our
business to support our customers, we trade public securities
and these securities also are subject to market fluctuations with
gains and losses recognized in net income when realized and
periodically include OTTI charges. Although we have processes
in place to measure and monitor the risks associated with our
trading activities, including stress testing and hedging strategies,
there can be no assurance that our processes and strategies will
be effective in avoiding losses that could have a material adverse
effect on our financial results.
The value of our public and private equity investments can
fluctuate from quarter to quarter. Certain of these investments
are carried under the cost or equity method, while others are
carried at fair value with unrealized gains and losses reflected in
earnings. Earnings from our equity investments may be volatile
and hard to predict, and may have a significant effect on our
earnings from period to period. When, and if, we recognize gains
may depend on a number of factors, including general economic
and market conditions, the prospects of the companies in which
we invest, when a company goes public, the size of our position
relative to the public float, and whether we are subject to any
resale restrictions.
Our venture capital investments could result in significant
OTTI losses for those investments carried under the cost or
equity method. Our assessment for OTTI is based on a number
of factors, including the then current market value of each
investment compared with its carrying value. If we determine
there is OTTI for an investment, we write-down the carrying
value of the investment, resulting in a charge to earnings. The
amount of this charge could be significant.
For more information, refer to the “Risk Management –
Asset/Liability Management – Interest Rate Risk”, “– Market
Risk – Equity Investments”, and “– Market Risk – Trading
Activities” and the “Balance Sheet Analysis – Investment
Securities” sections in this Report and Note 5 (Investment
Securities) to Financial Statements in this Report.
Effective liquidity management, which ensures that we
can meet customer loan requests, customer deposit
maturities/withdrawals and other cash commitments,
including principal and interest payments on our debt,
efficiently under both normal operating conditions and
other unpredictable circumstances of industry or
financial market stress, is essential for the operation of
our business, and our financial results and condition
could be materially adversely affected if we do not
effectively manage our liquidity. Our liquidity is essential
for the operation of our business. We primarily rely on bank
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