EX-13 9 f06409exv13.htm EXHIBIT 13 exv13
 

       

     
 
  Financial Review
 
   
34
  Overview
 
   
38
  Critical Accounting Policies
 
   
41
  Earnings Performance
41
  Net Interest Income
44
  Noninterest Income
45
  Noninterest Expense
45
  Operating Segment Results
 
   
46
  Balance Sheet Analysis
46
  Securities Available for Sale
(table on page 72)
46
  Loan Portfolio (table on page 74)
46
  Deposits
 
   
47
  Off-Balance Sheet Arrangements and
Aggregate Contractual Obligations
47
  Off-Balance Sheet Arrangements,
Variable Interest Entities, Guarantees
and Other Commitments
48
  Contractual Obligations
48
  Transactions with Related Parties
 
   
48
  Risk Management
48
  Credit Risk Management Process
49
  Nonaccrual Loans and Other Assets
50
  Loans 90 Days or More Past Due
and Still Accruing
50
  Allowance for Credit Losses
(table on page 75)
50
  Asset/Liability and
Market Risk Management
51
  Interest Rate Risk
     
51
  Mortgage Banking Interest Rate Risk
52
  Market Risk - Trading Activities
52
  Market Risk - Equity Markets
53
  Liquidity and Funding
 
   
54
  Capital Management
 
   
54
  Comparison of 2003 with 2002
 
   
55
  Factors That May Affect Future Results
 
   
59
  Additional Information
 
   
60
  Controls and Procedures
 
   
60
  Disclosure Controls and Procedures
 
   
60
  Internal Control over Financial Reporting
 
   
60
  Management’s Report on Internal Control
over Financial Reporting
61
  Report of Independent Registered Public
Accounting Firm
 
   
 
  Financial Statements
 
   
62
  Consolidated Statement of Income
 
   
63
  Consolidated Balance Sheet
 
   
64
  Consolidated Statement of
Changes in Stockholders’ Equity
and Comprehensive Income
 
   
65
  Consolidated Statement of Cash Flows
 
   
66
  Notes to Financial Statements
 
   
112
  Report of Independent Registered
Public Accounting Firm
 
   
113
  Quarterly Financial Data
 
   
115
  Glossary

 

(WELLS FARGO STAGECOACH GRAPHIC)

33


 

      This Annual Report, including the Financial Review and the Financial Statements and related Notes, has forward-looking statements, which include forecasts of our financial results and condition, expectations for our operations and business, and our assumptions for those forecasts and expectations. Do not unduly rely on forward-looking statements. Actual results might differ significantly from our forecasts and expectations. Please refer to “Factors that May Affect Future Results” for a discussion of some factors that may cause results to differ.

Overview

 

Wells Fargo & Company is a $428 billion diversified financial services company providing banking, insurance, investments, mortgage banking and consumer finance through banking stores, the internet and other distribution channels to consumers, businesses and institutions in all 50 states of the U.S. and in other countries. We ranked fifth in assets and fourth in market value of our common stock among U.S. bank holding companies at December 31, 2004. When we refer to “the Company”, “we”, “our” and “us” in this report, we mean Wells Fargo & Company and Subsidiaries (consolidated). When we refer to the Parent, we mean Wells Fargo & Company.

      2004 was another exceptional year for our company, with record diluted earnings per share of $4.09, record net income of $7.0 billion and solid market share growth across our more than 80 businesses. Because these results would not have been possible without the customer focus and dedication of our exceptional team, at the end of 2004 we committed to make a special contribution in shares of Wells Fargo common stock to the 401(k) Plan accounts of eligible team members, equaling 1% of a team member’s pay, up to a maximum contribution of $750, resulting in an additional $44 million in employee benefits expense.
      Our growth in earnings per share was driven by revenue growth, operating leverage (revenue growth in excess of expense growth) and improved credit quality. Our primary sources of earnings are driven by lending and deposit taking activities, which generate net interest income, and providing financial services that generate fee income.
      Revenue grew 6% from 2003. Combined revenue in all of our businesses other than Wells Fargo Home Mortgage (Home Mortgage), which had exceptional revenue in 2003 due to the refinance boom, grew 11% this year. In addition to double-digit growth in earnings per share, we also had double-digit growth in loans and retail core deposits and continued strong credit quality for the year. We have been achieving these results not just for one, two, or even five years, as many companies have done, but for the past 20 years, through many different economic cycles. Our compound annual growth rate over the past 20 years has averaged 13% in revenue, averaged 14% in earnings per share, and our total compound annual stockholder return has been 23% compared with 13% for the S&P 500®. Our total compound annual stockholder return, including reinvestment of dividends, has been about 10 percentage points above the S&P 500 for each of the past five, ten, 15 and 20 year periods.

      (LONG-TERM PERFORMANCE BAR CHART)

      We have a 20-year history of investing in our company, and 2004 was one of our highest investment years ever. Companies must reinvest to consistently grow profits and revenue at double-digit rates over time. We achieved record results in 2004 while making very significant investments throughout the year to benefit future performance, including opening 177 new stores, increasing the number of team members serving our customers by over 5,000, committing to add Wells Fargo stock to every eligible team member’s 401(k) account to thank them for all their efforts, making significant incremental investments in electronic imaging, call centers and other technology projects, integrating acquisitions, and improving future margins by incurring the costs of extinguishing high interest rate debt and selling low yielding assets. We continued to support our communities by taking a $217 million charitable contribution expense in fourth quarter 2004, to be funded by tax-advantaged venture capital gains, helping ensure that the Wells Fargo Foundation remains well funded over the next eight to ten years.
      In 2004, we became one of the nation’s 20 largest mutual fund companies with the acquisition of $29 billion in assets under management from Strong Financial Corporation (Strong Financial). Our stock hit a record high close of $63.25 in December 2004. Our solid financial performance enables us to be one of the top givers to non-profits among all U.S. companies. We continue to be the only “Aaa” rated bank in the U.S., the highest possible credit rating.

 

34


 

      Our corporate vision is to satisfy all the financial needs of our customers, help them succeed financially, be recognized as the premier financial services company in our markets and be one of America’s great companies. Our primary strategy to achieve this vision is to increase the number of products we provide to our customers and to focus on providing each customer with all of the financial products that fulfill their needs. Our cross-sell strategy and diversified business model facilitate growth in strong and weak economic cycles, as we can grow by expanding the number of products our current customers have with us. We estimate that our average banking household now has 4.6 products with us, which we believe is among the highest, if not the highest, in our industry. Our goal is eight products per customer, which is currently half of our estimate of potential demand.

      Our core products grew this year as follows:
    Average loans grew by 26%;
    Average retail core deposits grew by 11% (average core deposits grew by 8%); and
    Assets managed and administered were up 22%.

      We believe it is important to maintain a well-controlled environment as we continue to grow our businesses. We manage our credit risk by maintaining prudent credit policies and continuously examining our credit process. In 2004, nonperforming loans and net charge-offs as a percentage of loans outstanding declined from the prior year. Asset quality improved in 2004 compared with a year ago, with net charge-offs down 3% and nonperforming assets (including nonaccrual loans and foreclosed assets) down 5%. We manage the interest rate and market risks inherent in our asset and liability balances within prudent ranges, while ensuring adequate liquidity and funding. Our stockholder value has increased over time due to customer satisfaction, strong financial results, reinvestment in our businesses and the prudent way we attempt to manage our business risks.

      Our financial results included the following:

      Net income in 2004 increased 13% to $7.0 billion from $6.2 billion in 2003. Diluted earnings per common share increased 12% to $4.09 in 2004 from $3.65 in 2003. In

 

Table 1: Six-Year Summary of Selected Financial Data

                                                                 
   

(in millions, except
                                                  % Change     Five-year  
per share amounts)                                                   2004 /   compound  
    2004     2003     2002     2001     2000     1999     2003     growth rate  
 
                                                               
INCOME STATEMENT
                                                               
Net interest income
  $ 17,150     $ 16,007     $ 14,482     $ 11,976     $ 10,339     $ 9,608       7 %     12 %
Provision for credit losses
    1,717       1,722       1,684       1,727       1,284       1,079             10  
Noninterest income
    12,909       12,382       10,767       9,005       10,360       9,277       4       7  
Noninterest expense
    17,573       17,190       14,711       13,794       12,889       11,483       2       9  
 
                                                               
Before effect of change in accounting principle (1)
                                                               
 
                                                               
Net income
  $ 7,014     $ 6,202     $ 5,710     $ 3,411     $ 4,012     $ 3,995       13       12  
Earnings per common share
    4.15       3.69       3.35       1.99       2.35       2.31       12       12  
Diluted earnings per common share
    4.09       3.65       3.32       1.97       2.32       2.28       12       12  
 
                                                               
After effect of change in accounting principle
                                                               
 
                                                               
Net income
  $ 7,014     $ 6,202     $ 5,434     $ 3,411     $ 4,012     $ 3,995       13       12  
Earnings per common share
    4.15       3.69       3.19       1.99       2.35       2.31       12       12  
Diluted earnings per common share
    4.09       3.65       3.16       1.97       2.32       2.28       12       12  
Dividends declared per common share
    1.86       1.50       1.10       1.00       .90       .785       24       19  
 
                                                               
BALANCE SHEET
                                                               
(at year end)
                                                               
Securities available for sale
  $ 33,717     $ 32,953     $ 27,947     $ 40,308     $ 38,655     $ 43,911       2       (5 )
Loans
    287,586       253,073       192,478       167,096       155,451       126,700       14       18  
Allowance for loan losses
    3,762       3,891       3,819       3,717       3,681       3,312       (3 )     3  
Goodwill
    10,681       10,371       9,753       9,527       9,303       8,046       3       6  
Assets
    427,849       387,798       349,197       307,506       272,382       241,032       10       12  
Core deposits (2)
    229,703       211,271       198,234       182,295       156,710       138,247       9       11  
Long-term debt
    73,580       63,642       47,320       36,095       32,046       26,866       16       22  
Guaranteed preferred beneficial interests in Company’s subordinated debentures (3)
                2,885       2,435       935       935              
Stockholders’ equity
    37,866       34,469       30,319       27,175       26,461       23,858       10       10  
 
                                                               
 
 
(1)   Change in accounting principle is for a transitional goodwill impairment charge recorded in 2002 upon adoption of FAS 142, Goodwill and Other Intangible Assets.
(2)   Core deposits consist of noninterest-bearing deposits, interest-bearing checking, savings certificates and market rate and other savings.
(3)   At December 31, 2003, upon adoption of FIN 46 (revised December 2003), Consolidation of Variable Interest Entities (FIN 46R), these balances were reflected in long-term debt. See Note 13 (Guaranteed Preferred Beneficial Interests in Company’s Subordinated Debentures) to Financial Statements for more information.

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addition to incremental investments in new stores, sales-focused team members and technology, 2004 results included $217 million ($.08 per share) of charitable contribution expense for the Wells Fargo Foundation, $44 million ($.02 per share) for the special 401(k) contribution and $19 million ($.01 per share) in integration expense related to the Strong Financial transaction. We also took significant actions to reposition our balance sheet in 2004 designed to improve earning asset yields and to reduce long-term debt costs. The extinguishment of high interest rate debt reduced earnings by $.06 per share for 2004. Return on average assets was 1.71% and return on average common equity was 19.56% in 2004, up from 1.64% and 19.36%, respectively, for 2003.

      Net interest income on a taxable-equivalent basis was $17.3 billion in 2004, compared with $16.1 billion a year ago. The net interest margin was 4.89% for 2004, compared with 5.08% in 2003.
      Noninterest income was $12.9 billion in 2004, compared with $12.4 billion in 2003, an increase of 4%, driven by growth across our business, with particular strength in trust, investment and IRA fees, credit and debit card fees, loan fees and gains on equity investments.
      Revenue, the sum of net interest income and noninterest income, increased 6% to a record $30.1 billion in 2004 from $28.4 billion in 2003, despite a 37% decrease in mortgage originations as the refinance driven market declined from its exceptional 2003 level. Despite our balance sheet repositioning actions during the year, which reduced revenue growth by approximately 1 percentage point due to the loss on sale of lower yielding assets, and our significant level of investment spending, operating leverage improved during 2004 with revenue growing 6% and noninterest expense up only 2%. For the year, Home Mortgage revenue declined $807 million, or 16%, from $5.2 billion in 2003 to $4.4 billion in 2004.
      Noninterest expense totaled $17.6 billion in 2004, compared with $17.2 billion in 2003, an increase of 2%. In 2005, we expect to incur integration expense of approximately $.02 per share for the balance of the Strong Financial transaction and for the pending acquisition of Houston-based First Community Capital Corporation. We will expense stock options, as required, beginning July 1, 2005, and we estimate the effect of expensing current outstanding options will reduce earnings by $.03 per share for the last half of 2005.
      During 2004, net charge-offs were $1.67 billion, or .62% of average total loans, compared with $1.72 billion, or .81%, during 2003. The provision for credit losses was $1.72 billion in 2004, flat compared with 2003. The allowance for credit losses, which comprises the allowance for loan losses and the reserve for unfunded credit commitments, was $3.95 billion, or 1.37% of total loans, at December 31, 2004, compared with $3.89 billion, or 1.54%, at December 31, 2003.

      At December 31, 2004, total nonaccrual loans were $1.36 billion, or .47% of total loans, down from $1.46 billion, or .58%, at December 31, 2003. Foreclosed assets were $212 million at December 31, 2004, compared with $198 million at December 31, 2003.

      The ratio of stockholders’ equity to total assets was 8.85% at December 31, 2004, compared with 8.89% at December 31, 2003. Our total risk-based capital (RBC) ratio at December 31, 2004 was 12.07% and our Tier 1 RBC ratio was 8.41%, exceeding the minimum regulatory guidelines of 8% and 4%, respectively, for bank holding companies. Our RBC ratios at December 31, 2003 were 12.21% and 8.42%, respectively. Our Tier 1 leverage ratios were 7.08% and 6.93% at December 31, 2004 and 2003, respectively, exceeding the minimum regulatory guideline of 3% for bank holding companies.

Table 2: Ratios and Per Common Share Data

                         
   
   
Year ended December 31
,
    2004     2003     2002  
 
                       
Before effect of change in accounting principle(1)
                       
 
                       
PROFITABILITY RATIOS
                       
Net income to average total assets (ROA)
    1.71 %     1.64 %     1.77 %
Net income applicable to common stock to average common stockholders’ equity (ROE)
    19.56       19.36       19.63  
Net income to average stockholders’ equity
    19.57       19.34       19.61  
 
                       
After effect of change in accounting principle
                       
 
                       
PROFITABILITY RATIOS
                       
ROA
    1.71       1.64       1.69  
ROE
    19.56       19.36       18.68  
Net income to average stockholders’ equity
    19.57       19.34       18.66  
 
                       
EFFICIENCY RATIO (2)
    58.5       60.6       58.3  
 
                       
CAPITAL RATIOS
                       
At year end:
                       
Stockholders’ equity to assets
    8.85       8.89       8.68  
Risk-based capital (3)
                       
Tier 1 capital
    8.41       8.42       7.70  
Total capital
    12.07       12.21       11.44  
Tier 1 leverage (3)
    7.08       6.93       6.57  
Average balances:
                       
Stockholders’ equity to assets
    8.73       8.49       9.05  
 
                       
PER COMMON SHARE DATA
                       
Dividend payout (4)
    44.8       40.7       34.5  
Book value
  $ 22.36     $ 20.31     $ 17.95  
Market prices (5)
                       
High
  $ 64.04     $ 59.18     $ 54.84  
Low
    54.32       43.27       38.10  
Year end
    62.15       58.89       46.87  
 
                       
 
 
(1)   Change in accounting principle is for a transitional goodwill impairment charge recorded in 2002 upon adoption of FAS 142, Goodwill and Other Intangible Assets.
(2)   The efficiency ratio is noninterest expense divided by total revenue (net interest income and noninterest income).
(3)   See Note 26 (Regulatory and Agency Capital Requirements) to Financial Statements for additional information.
(4)   Dividends declared per common share as a percentage of earnings per common share.
(5)   Based on daily prices reported on the New York Stock Exchange Composite Transaction Reporting System.

 

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Recent Accounting Standards
On December 8, 2003, President Bush signed the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act). The Act introduces a prescription drug benefit under Medicare as well as a federal subsidy to plan sponsors that provide a benefit that is at least equivalent to Medicare. Specific authoritative guidance on the accounting for the federal subsidy has been issued through the Financial Accounting Standards Board (FASB) Staff Position 106-2 (FSP 106-2), Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003, which was issued in May 2004. We adopted FSP 106-2 prospectively effective July 1, 2004, and the adoption did not have a material impact on either our accumulated postretirement benefit obligation or our net periodic postretirement benefit cost during 2004.

      On December 12, 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 03-3 (SOP 03-3), Accounting for Certain Loans or Debt Securities Acquired in a Transfer, which addresses the accounting for certain loans acquired in a transfer when it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable. SOP 03-3 is applied prospectively, effective for loans acquired beginning January 1, 2005. SOP 03-3 requires acquired loans with evidence of credit deterioration to be recorded at fair value and prohibits recording any valuation allowance related to such loans at the time of purchase. This SOP limits the yield that may be accreted on such loans to the excess of the investor’s estimated cash flows over its initial investment in the loan. Subsequent increases in cash flows expected to be collected are recognized prospectively through adjustment of the loan’s yield over its remaining life. Decreases in cash flows expected to be collected are recognized as impairment. Mortgage loans held for sale and loans to borrowers in good standing under revolving credit agreements are excluded from the scope of SOP 03-3.
      On July 16, 2004, the FASB ratified the decisions reached by the Emerging Issues Task Force (EITF) with respect to Issue No. 02-14 (EITF 02-14), Whether the Equity Method of Accounting Applies When an Investor Does Not Have an Investment in Voting Stock of an Investee but Exercises Significant Influence through Other Means. The EITF reached a consensus that an investor should apply the equity method of accounting when it has investments in either common stock or “in-substance common stock” of a corporation, provided that the investor has the ability to exercise significant influence over the operating and financial policies of the investee. In-substance common stock, as defined in the consensus, is an investment that has risk and reward

characteristics, among other factors, that are substantially the same as common stock. We adopted the consensus reached in EITF 02-14 during 2004 and the adoption did not have a material effect on our financial statements.

      On October 13, 2004, the FASB ratified the consensus reached by the EITF at its September 29–30 and June 30–July 1 meetings with respect to Issue No. 04-8 (EITF 04-8), The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share. This consensus requires instruments with contingent conversion features that are based on the market price of an entity’s own stock, even though the market price trigger has not been met, to be included in the computation of diluted earnings per share. EITF 04-8 became effective for periods ending after December 15, 2004. However, the determination of the dilutive effect upon adoption of EITF 04-8, if any, is based on the form of the instrument that existed at December 31, 2004.
      In November 2004, we amended the indenture under which the Company’s Floating Rate Convertible Senior Debentures due 2033 (the Debentures) were issued to eliminate a provision in the indenture that prohibited us from paying cash upon conversion of the Debentures if an event of default, as defined in the indenture, exists at the time of conversion. We then made an irrevocable election under the indenture that obligates us to deliver, upon conversion of the Debentures, cash in an amount equal to at least the original principal amount of the converted Debentures and cash or common stock or a combination of cash and common stock for any amount in excess of such original principal amount. As a result of these actions, none of the shares of common stock underlying the Debentures currently would be considered outstanding for the purposes of calculating diluted earnings per share under EITF 04-8.
      On December 16, 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (FAS 123R), which replaces FAS 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. The scope of FAS 123R includes a wide range of stock-based compensation arrangements including stock options, restricted stock plans, performance-based awards, stock appreciation rights, and employee stock purchase plans. FAS 123R requires us to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the grant date. That cost must be recognized in the income statement over the vesting period of the award. Because market prices are generally not available for most employee stock options, the grant-date fair value must be estimated using an option-pricing model. FAS 123R applies to all awards granted after July 1, 2005 and to awards modified, repurchased, or cancelled after July 1, 2005. We will adopt

 

37


 

FAS 123R effective July 1, 2005, as required, and will use the “modified prospective” transition method. Under this method, awards that are granted, modified, or settled after July 1, 2005, will be measured and accounted for in accordance with FAS 123R. In addition, beginning July 1, 2005, expense must be recognized in the income statement for

unvested awards that were granted prior to July 1, 2005. The expense will be based on the fair value determined at grant date under FAS 123. We estimate that our earnings per share in the second half of 2005 will be reduced by $.03 as a result of implementing FAS 123R.

 

Critical Accounting Policies

 

Our significant accounting policies (described in Note 1 (Summary of Significant Accounting Policies) to Financial Statements) are fundamental to understanding our results of operations and financial condition, because some accounting policies require that we use estimates and assumptions that may affect the value of our assets or liabilities and financial results. Three 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, the valuation of mortgage servicing rights and pension accounting. Management has reviewed and approved these critical accounting policies and has discussed these policies with the Audit and Examination Committee.

Allowance for Credit Losses
The allowance for credit losses, which comprises the allowance for loan losses and the reserve for unfunded credit commitments, is management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date. We have an established process, using several analytical tools and benchmarks, to calculate a range of possible outcomes and determine the adequacy of the allowance. No single statistic or measurement determines the adequacy of the allowance. Loan recoveries and the provision for credit losses increase the allowance, while loan charge-offs decrease the allowance.

PROCESS TO DETERMINE THE ADEQUACY OF THE ALLOWANCE FOR CREDIT LOSSES
For analytical purposes only, we allocate a portion of the allowance to specific loan categories (the allocated allowance). The entire allowance (both allocated and unallocated), however, is used to absorb credit losses inherent in the total loan portfolio.

      Approximately two-thirds of the allocated allowance is determined at a pooled level for retail loan portfolios (consumer loans and leases, home mortgage loans and some segments of small business loans). We use forecasting models to measure the losses inherent in these portfolios. We frequently validate and update these models to capture the recent behavioral characteristics of the portfolios, as well as any changes in our loss mitigation or marketing strategies.

      We use a standardized loan grading process for wholesale loan portfolios (commercial loans, commercial real estate and construction loans and leases). Based on this process, we assign a loss factor to each pool of graded loans and a loan equivalent amount of unfunded loan commitments and letters of credit. For graded loans with evidence of credit weakness at the balance sheet date, the loss factors are derived from migration models that track loss content associated with actual portfolio movements between loan grades over a specified period of time. For graded loans without evidence of credit weakness at the balance sheet date, we use a combination of our long-term average loss experience and external loss data. In addition, we individually review nonperforming loans over $3 million for impairment based on cash flows or collateral. We include the impairment on nonperforming loans in the allocated allowance unless it has already been recognized as a loss.

      The allocated allowance is supplemented by the unallocated allowance to adjust for imprecision and to incorporate the range of probable outcomes inherent in estimates used for the allocated allowance. The unallocated allowance is the result of our judgment of risks inherent in the portfolio, economic uncertainties, historical loss experience and other subjective factors, including industry trends, not reflected in the allocated allowance.
      The ratios of the allocated allowance and the unallocated allowance to the total allowance may change from period to period. The total allowance reflects management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date.
      The allowance for credit losses, and the resulting provision, is based on judgments and assumptions, including (1) general economic conditions, (2) loan portfolio composition, (3) loan loss experience, (4) management’s evaluation of the credit risk relating to pools of loans and individual borrowers, (5) sensitivity analysis and expected loss models and (6) observations from our internal auditors, internal loan review staff or our banking regulators.
      To estimate the possible range of allowance required at December 31, 2004, and the related change in provision expense, we assumed the following scenarios of a reasonably possible deterioration or improvement in loan credit quality.

 

38


 

Assumptions for deterioration in loan credit quality were:
    For retail loans, a 15 basis point increase in estimated loss rates from actual 2004 loss levels; and
    For wholesale loans, a 20 basis point increase in estimated loss rates, moving closer to historical averages.

Assumptions for improvement in loan credit quality were:
    For retail loans, a 5 basis point decrease in estimated loss rates from actual 2004 loss levels; and
    For wholesale loans, no improvement in actual 2004 loss levels.

      Under the assumptions for deterioration in loan credit quality, another $470 million in expected losses could occur and under the assumptions for improvement, a $70 million reduction in expected losses could occur.

      Changes in the estimate of the allowance for credit losses can materially affect net income. The example above is only one of a number of reasonably possible scenarios. Determining the allowance for credit losses requires us to make forecasts that are highly uncertain and require a high degree of judgment.

Valuation of Mortgage Servicing Rights
We recognize the rights to service mortgage loans for others, or mortgage servicing rights (MSRs), as assets, whether we purchase the servicing rights, or keep them after the sale or securitization of loans we originated. Purchased MSRs are capitalized at cost. Originated MSRs are recorded based on the relative fair value of the retained servicing right and the mortgage loan on the date the mortgage loan is sold. Both purchased and originated MSRs are carried at the lower of (1) the capitalized amount, net of accumulated amortization and hedge accounting adjustments, or (2) fair value. If MSRs are designated as a hedged item in a fair value hedge, the MSRs’ carrying value is adjusted for changes in fair value resulting from the application of hedge accounting. The adjustment becomes part of the carrying value. The carrying value of these MSRs is subject to a fair value test under FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.

      MSRs are amortized in proportion to and over the period of estimated net servicing income. We analyze the amortization of MSRs monthly and adjust amortization to reflect changes in prepayment speeds and discount rates.
      We determine the fair value of MSRs using a valuation model that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, ancillary income and late fees. The valuation of MSRs is discussed further in this section and in Notes 1 (Summary of Significant Accounting Policies), 21 (Securitizations and Variable Interest Entities) and 22 (Mortgage Banking Activities) to Financial Statements.

      Each quarter, we evaluate MSRs for possible impairment based on the difference between the carrying amount and current estimated fair value under FAS 140. To evaluate and measure impairment we stratify the portfolio based on certain risk characteristics, including loan type and note rate. If temporary impairment exists, we establish a valuation allowance through a charge to net income for any excess of amortized cost over the current fair value, by risk stratification. If we later determine that all or part of the temporary impairment no longer exists for a particular risk stratification, we may reduce the valuation allowance through an increase to net income.

      Under our policy, we also evaluate other-than-temporary impairment of MSRs by considering both historical and projected trends in interest rates, pay-off activity and whether the impairment could be recovered through interest rate increases. We recognize a direct write-down if we determine that the recoverability of a recorded valuation allowance is remote. A direct write-down permanently reduces the carrying value of the MSRs, while a valuation allowance (temporary impairment) can be reversed.
      To reduce the sensitivity of earnings to interest rate and market value fluctuations, we hedge the change in value of MSRs primarily with derivative contracts. Reductions or increases in the value of the MSRs are generally offset by gains or losses in the value of the derivative. If the reduction or increase in the value of the MSRs is not offset, we immediately recognize a gain or loss for the portion of the amount that is not offset (hedge ineffectiveness). We do not fully hedge MSRs because origination volume is a “natural hedge,” (i.e., as interest rates decline, servicing values decrease and fees from origination volume increase). Conversely, as interest rates increase, the value of the MSRs increases, while fees from origination volume tend to decline.
      Servicing fees—net of amortization, provision for impairment and gain or loss on the ineffective portion and the portion of the derivatives excluded from the assessment of hedge effectiveness—are recorded in mortgage banking noninterest income.
      We use a dynamic and sophisticated model to estimate the value of our MSRs. Mortgage loan prepayment speed—a key assumption in the model—is the annual rate at which borrowers are forecasted to repay their mortgage loan principal. The discount rate—another key assumption in the model—is equal to what we believe the required rate of return would be for an asset with similar risk. To determine the discount rate, we consider the risk premium for uncertainties from servicing operations (e.g., possible changes in future servicing costs, ancillary income and earnings on escrow accounts). Both assumptions can and generally will change in quarterly and annual valuations as market conditions and interest rates change. Senior management reviews all assumptions quarterly.

 

39


 

      Our key economic assumptions and the sensitivity of the current fair value of MSRs to an immediate adverse change in those assumptions are shown in Note 21 (Securitizations and Variable Interest Entities) to Financial Statements.
      There have been significant market-driven fluctuations in loan prepayment speeds and the discount rate in recent years. These fluctuations could be rapid and significant in the future. Therefore, estimating prepayment speeds within a range that market participants would use in determining the fair value of MSRs requires significant management judgment.

Pension Accounting
We use four key variables to calculate our annual pension cost; (1) size and characteristics of the employee population, (2) actuarial assumptions, (3) expected long-term rate of return on plan assets, and (4) discount rate. We describe below the effect of each of these variables on our pension expense.

SIZE AND CHARACTERISTICS OF THE EMPLOYEE POPULATION
Pension expense is directly related to the number of employees covered by the plans, and other factors including salary, age and years of employment. The number of our employees eligible for pension benefits has steadily increased over the last few years, causing a proportional growth in pension expense.

ACTUARIAL ASSUMPTIONS
To estimate the projected benefit obligation, actuarial assumptions are required about factors such as mortality rate, turnover rate, retirement rate, disability rate and the rate of compensation increases. These factors don’t tend to change significantly over time, so the range of assumptions, and their impact on pension expense, is generally narrow.

EXPECTED LONG-TERM RATE OF RETURN ON PLAN ASSETS
We calculate the expected return on plan assets each year based on the composition of assets at the beginning of the plan year and the expected long-term rate of return on that portfolio. The expected long-term rate of return is designed to approximate the actual long-term rate of return on the plan assets over time and is not expected to change significantly. Therefore the pattern of income/expense recognition closely matches the stable pattern of services provided by our employees over the life of the pension obligation.

      To determine if the expected rate of return is reasonable, we consider such factors as (1) the actual return earned on plan assets, (2) historical rates of return on the various asset classes in the plan portfolio, (3) projections of returns on various asset classes, and (4) current/prospective capital market conditions and economic forecasts. We have used an expected rate of return of 9% on plan assets for the past eight years. Over the last two decades, the plan assets have actually earned an average annualized rate of return higher than 9%. Differences in each year, if any, between expected and actual returns are included in our unrecognized net actuarial gain or loss amount. We generally amortize any unrecognized net actuarial gain or loss in excess of a 5% corridor (as defined in FAS 87, Employers’ Accounting for Pensions) in net periodic pension calculations over the next five years. Our average remaining service period is approximately 11 years. See Note 16 (Employee Benefits and Other Expenses) to Financial Statements for details on changes in the pension benefit obligation and the fair value of plan assets.

      We use November 30 as a measurement date for our pension asset and projected benefit obligation balances. If we were to assume a 1% increase/decrease in the expected long-term rate of return, holding the discount rate and other actuarial assumptions constant, pension expense would decrease/increase by approximately $44 million.

DISCOUNT RATE
We use the discount rate to determine the present value of our future benefit obligations. It reflects the rates available on long-term high-quality fixed-income debt instruments, reset annually on the measurement date. We lowered our discount rate to 6% in 2004 from 6.5% in 2003 and 7% in 2002, reflecting the decline in market interest rates during these periods.

      If we were to assume a 1% increase in the discount rate, and keep the expected long-term rate of return and other actuarial assumptions constant, pension expense would decrease by approximately $62 million; if we were to assume a 1% decrease in the discount rate, and keep other assumptions constant, pension expense would increase by approximately $90 million. The decrease to pension expense based on a 1% increase in discount rate differs from the increase to pension expense based on a 1% decrease in discount rate due to the 5% corridor.

 

40


 

Earnings Performance

 

Net Interest Income
Net interest income is the interest earned on debt securities, loans (including yield-related loan fees) and other interest-earning assets minus the interest paid for deposits and long-term and short-term debt. The net interest margin is the average yield on earning assets minus the average interest rate paid for deposits and our other sources of funding. Net interest income and the net interest margin are presented on a taxable-equivalent basis to consistently reflect income from taxable and tax-exempt loans and securities based on a 35% marginal tax rate.

      Net interest income on a taxable-equivalent basis was $17.3 billion in 2004, compared with $16.1 billion in 2003, an increase of 7%. The increase was primarily due to strong consumer loan growth, particularly in mortgage products. The benefit of this growth was partially offset by lower loan yields as new volumes were added below the portfolio average.
      The net interest margin for 2004 decreased to 4.89% from 5.08% in 2003. The decrease was primarily due to lower investment portfolio yields following maturities and prepayments of higher yielding mortgage-backed securities, and the addition of new consumer and commercial loans with yields below the existing portfolio average. These factors were partially offset by the benefits of balance sheet repositioning actions taken in 2004.
      Average earning assets increased $36.2 billion in 2004 from 2003 due to increases in average loans and debt securities available for sale, offset by a decline in average mortgages held for sale. Loans averaged $269.6 billion in

2004, compared with $213.1 billion in 2003. The increase was largely due to growth in mortgage and home equity products. Average mortgages held for sale decreased to $32.3 billion in 2004 from $58.7 billion in 2003, due to a 37% decrease in mortgage originations as the refinance driven market declined from its exceptional 2003 level. Debt securities available for sale averaged $33.1 billion in 2004, compared with $27.3 billion in 2003.

      Average core deposits are an important contributor to growth in net interest income and the net interest margin. This low-cost source of funding rose 8% from 2003. Total average retail core deposits, which exclude Wholesale Banking core deposits and mortgage escrow deposits, for 2004 grew $17.8 billion, or 11%, from a year ago. Average mortgage escrow deposits declined to $14.1 billion in 2004 from $18.9 billion in 2003. Average core deposits were $223.4 billion and $207.0 billion and funded 54.4% and 54.8% of average total assets in 2004 and 2003, respectively. While savings certificates of deposits declined on average from $20.9 billion to $18.9 billion, noninterest-bearing checking accounts and other core deposit categories increased on average from $186.1 billion in 2003 to $204.5 billion in 2004 reflecting growth in consumer and business primary account relationships. Total average interest-bearing deposits increased to $182.6 billion in 2004 from $161.7 billion a year ago. Total average noninterest-bearing deposits increased to $79.3 billion in 2004 from $76.8 billion a year ago.
      Table 3 presents the individual components of net interest income and the net interest margin.

 

41


 

Table 3: Average Balances, Yields and Rates Paid (Taxable-Equivalent Basis)(1)(2)

                                                 
   

(in millions)
  2004     2003  
    Average     Yields /   Interest     Average     Yields /   Interest  
    balance     rates     income /   balance     rates     income /
                expense                 expense  
 
                                               
EARNING ASSETS
                                               
Federal funds sold, securities purchased under resale agreements and other short-term investments
  $ 4,254       1.49 %   $ 64     $ 4,174       1.16 %   $ 49  
Trading assets
    5,286       2.75       145       6,110       2.56       156  
Debt securities available for sale (3):
                                               
Securities of U.S. Treasury and federal agencies
    1,161       4.05       46       1,286       4.74       58  
Securities of U.S. states and political subdivisions
    3,501       8.00       267       2,424       8.62       196  
Mortgage-backed securities:
                                               
Federal agencies
    21,404       6.03       1,248       18,283       7.37       1,276  
Private collateralized mortgage obligations
    3,604       5.16       180       2,001       6.24       120  
 
                                       
Total mortgage-backed securities
    25,008       5.91       1,428       20,284       7.26       1,396  
Other debt securities (4)
    3,395       7.72       236       3,302       7.75       240  
 
                                       
Total debt securities available for sale (4)
    33,065       6.24       1,977       27,296       7.32       1,890  
Mortgages held for sale (3)
    32,263       5.38       1,737       58,672       5.34       3,136  
Loans held for sale (3)
    8,201       3.56       292       7,142       3.51       251  
Loans:
                                               
Commercial and commercial real estate:
                                               
Commercial
    49,365       5.77       2,848       47,279       6.08       2,876  
Other real estate mortgage
    28,708       5.35       1,535       25,846       5.44       1,405  
Real estate construction
    8,724       5.30       463       7,954       5.11       406  
Lease financing
    5,068       6.23       316       4,453       6.22       277  
 
                                       
Total commercial and commercial real estate
    91,865       5.62       5,162       85,532       5.80       4,964  
Consumer:
                                               
Real estate 1-4 family first mortgage
    87,700       5.44       4,772       56,252       5.54       3,115  
Real estate 1-4 family junior lien mortgage
    44,415       5.18       2,300       31,670       5.80       1,836  
Credit card
    8,878       11.80       1,048       7,640       12.06       922  
Other revolving credit and installment
    33,528       9.01       3,022       29,838       9.09       2,713  
 
                                       
Total consumer
    174,521       6.38       11,142       125,400       6.85       8,586  
Foreign
    3,184       15.30       487       2,200       18.00       396  
 
                                       
Total loans (5)
    269,570       6.23       16,791       213,132       6.54       13,946  
Other
    1,709       3.81       65       1,626       4.57       74  
 
                                       
Total earning assets
  $ 354,348       5.97       21,071     $ 318,152       6.16       19,502  
 
                                       
 
                                               
FUNDING SOURCES
                                               
Deposits:
                                               
Interest-bearing checking
  $ 3,059       .44       13     $ 2,571       .27       7  
Market rate and other savings
    122,129       .69       838       106,733       .66       705  
Savings certificates
    18,850       2.26       425       20,927       2.53       529  
Other time deposits
    29,750       1.43       427       25,388       1.20       305  
Deposits in foreign offices
    8,843       1.40       124       6,060       1.11       67  
 
                                       
Total interest-bearing deposits
    182,631       1.00       1,827       161,679       1.00       1,613  
Short-term borrowings
    26,130       1.35       353       29,898       1.08       322  
Long-term debt
    67,898       2.41       1,637       53,823       2.52       1,355  
Guaranteed preferred beneficial interests in Company’s subordinated debentures (6)
                      3,306       3.66       121  
 
                                       
Total interest-bearing liabilities
    276,659       1.38       3,817       248,706       1.37       3,411  
Portion of noninterest-bearing funding sources
    77,689                   69,446              
 
                                       
Total funding sources
  $ 354,348       1.08       3,817     $ 318,152       1.08       3,411  
 
                                       
 
                                               
Net interest margin and net interest income on a taxable-equivalent basis (7)
            4.89 %   $ 17,254               5.08 %   $ 16,091  
 
                                       
 
                                               
NONINTEREST-EARNING ASSETS
                                               
Cash and due from banks
  $ 13,055                     $ 13,433                  
Goodwill
    10,418                       9,905                  
Other
    32,758                       36,123                  
 
                                           
Total noninterest-earning assets
  $ 56,231                     $ 59,461                  
 
                                           
 
                                               
NONINTEREST-BEARING FUNDING SOURCES
                                               
Deposits
  $ 79,321                     $ 76,815                  
Other liabilities
    18,764                       20,030                  
Stockholders’ equity
    35,835                       32,062                  
Noninterest-bearing funding sources used to fund earning assets
    (77,689 )                     (69,446 )                
 
                                           
Net noninterest-bearing funding sources
  $ 56,231                     $ 59,461                  
 
                                           
TOTAL ASSETS
  $ 410,579                     $ 377,613                  
 
                                           
 
                                               
 
 
(1)   Our average prime rate was 4.34%, 4.12%, 4.68%, 6.91% and 9.24% for 2004, 2003, 2002, 2001 and 2000, respectively. The average three-month London Interbank Offered Rate (LIBOR) was 1.62%, 1.22%, 1.80%, 3.78% and 6.52% for the same years, respectively.
(2)   Interest rates and amounts include the effects of hedge and risk management activities associated with the respective asset and liability categories.
(3)   Yields are based on amortized cost balances computed on a settlement date basis.
(4)   Includes certain preferred securities.

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2002
    2001     2000  
   
            Interest                     Interest                     Interest  
    Average     Yields /   income /   Average     Yields /   income /   Average     Yields /   income /
    balance     rates     expense     balance     rates     expense     balance     rates     expense  
 
                                               
 
  $ 2,961       1.73 %   $ 51     $ 2,741       3.72 %   $ 102     $ 2,485       6.18 %   $ 153  
 
    4,747       3.58       169       2,580       4.44       115       1,713       5.71       98  
 
                                               
 
    1,770       5.57       95       2,158       6.55       137       3,322       6.16       210  
 
    2,106       8.33       167       2,026       7.98       154       2,080       7.74       162  
 
                                               
 
    26,718       7.23       1,856       27,433       7.19       1,917       26,054       7.22       1,903  
 
    2,341       7.18       163       1,766       8.55       148       2,379       7.61       187  
 
                                                           
 
    29,059       7.22       2,019       29,199       7.27       2,065       28,433       7.25       2,090  
 
    3,029       7.74       232       3,343       7.80       254       5,049       7.93       261  
 
                                                           
 
    35,964       7.25       2,513       36,726       7.32       2,610       38,884       7.24       2,723  
 
    39,858       6.13       2,450       23,677       6.72       1,595       10,725       7.85       849  
 
    5,380       4.69       252       4,820       6.58       317       4,915       8.50       418  
 
                                               
 
    46,520       6.80       3,164       48,648       8.01       3,896       45,352       9.40       4,263  
 
    25,413       6.17       1,568       24,194       7.99       1,934       22,509       8.99       2,023  
 
    7,925       5.69       451       8,073       8.10       654       6,934       10.02       695  
 
    4,079       6.32       258       4,024       6.90       278       4,218       5.35       225  
 
                                                           
 
    83,937       6.48       5,441       84,939       7.96       6,762       79,013       9.12       7,206  
 
                                               
 
    32,669       6.69       2,185       23,359       7.54       1,761       17,190       7.72       1,327  
 
    25,220       7.07       1,783       17,587       9.20       1,619       14,458       10.85       1,569  
 
    6,810       12.27       836       6,270       13.36       838       5,867       14.58       856  
 
    24,072       10.28       2,475       23,459       11.40       2,674       21,824       12.06       2,631  
 
                                                           
 
    88,771       8.20       7,279       70,675       9.75       6,892       59,339       10.76       6,383  
 
    1,774       18.90       335       1,603       20.82       333       1,621       21.15       343  
 
                                                           
 
    174,482       7.48       13,055       157,217       8.90       13,987       139,973       9.95       13,932  
 
    1,436       4.87       72       1,262       5.50       69       1,378       6.56       91  
 
                                                           
 
                                               
 
  $ 264,828       7.04       18,562     $ 229,023       8.24       18,795     $ 200,073       9.18       18,264  
 
                                                           
 
                                               
 
                                               
 
  $ 2,494       .55       14     $ 2,178       1.59       35     $ 3,424       1.88       64  
 
    93,787       .95       893       80,585       2.08       1,675       63,577       2.81       1,786  
 
    24,278       3.21       780       29,850       5.13       1,530       30,101       5.37       1,616  
 
    8,191       1.86       153       1,332       5.04       67       4,438       5.69       253  
 
    5,011       1.58       79       6,209       3.96       246       5,950       6.22       370  
 
                                                           
 
    133,761       1.43       1,919       120,154       2.96       3,553       107,490       3.80       4,089  
 
    33,278       1.61       536       33,885       3.76       1,273       28,222       6.23       1,758  
 
    42,158       3.33       1,404       34,501       5.29       1,826       29,000       6.69       1,939  
 
                                               
 
    2,780       4.23       118       1,394       6.40       89       935       7.92       74  
 
                                                           
 
    211,977       1.88       3,977       189,934       3.55       6,741       165,647       4.75       7,860  
 
    52,851                   39,089                   34,426              
 
                                                           
 
                                               
 
  $ 264,828       1.51       3,977     $ 229,023       2.95       6,741     $ 200,073       3.95       7,860  
 
                                                           
 
                                               
 
                                               
 
            5.53 %   $ 14,585               5.29 %   $ 12,054               5.23 %   $ 10,404  
 
                                                           
 
                                               
 
  $ 13,820                     $ 14,608                     $ 13,103                  
 
    9,737                       9,514                       8,811                  
 
    33,340                       32,222                       28,170                  
 
                                                                 
 
                                               
 
  $ 56,897                     $ 56,344                     $ 50,084                  
 
                                                                 
 
                                               
 
                                               
 
  $ 63,574                     $ 55,333                     $ 48,691                  
 
    17,054                       13,214                       10,949                  
 
    29,120                       26,886                       24,870                  
 
                                               
 
    (52,851 )                     (39,089 )                     (34,426 )                
 
                                                                 
 
  $ 56,897                     $ 56,344                     $ 50,084                  
 
                                                                 
 
  $ 321,725                     $ 285,367                     $ 250,157                  
 
                                                                 
 
                                               
 
                                               
 
 
(5)   Nonaccrual loans and related income are included in their respective loan categories.
(6)   At December 31, 2003, upon adoption of FIN 46 (revised December 2003), Consolidation of Variable Interest Entities (FIN 46R), these balances were reflected in long-term debt. See Note 13 (Guaranteed Preferred Beneficial Interests in Company’s Subordinated Debentures) to Financial Statements for more information.
(7)   Includes taxable-equivalent adjustments primarily related to tax-exempt income on certain loans and securities. The federal statutory tax rate was 35% for all years presented.

43


 

Noninterest Income

Table 4: Noninterest Income

                                         
   

(in millions)
  Year ended December 31 ,   % Change  
    2004     2003     2002     2004 /   2003 /
                      2003     2002  
 
                                       
Service charges on deposit accounts
  $ 2,417     $ 2,297     $ 2,134       5 %     8 %
Trust and investment fees:
                                       
Trust, investment and IRA fees
    1,509       1,345       1,343       12        
Commissions and all other fees
    607       592       532       3       11  
 
                                 
Total trust and investment fees
    2,116       1,937       1,875       9       3  
 
                                       
Card fees
    1,230       1,079       977       14       10  
 
                                       
Other fees:
                                       
Cash network fees
    180       179       183       1       (2 )
Charges and fees on loans
    921       756       616       22       23  
All other
    678       625       573       8       9  
 
                                 
Total other fees
    1,779       1,560       1,372       14       14  
 
                                       
Mortgage banking:
                                       
Servicing fees, net of amortization and provision for impairment
    1,037       (954 )     (737 )           29  
Net gains on mortgage loan origination/sales activities
    539       3,019       2,086       (82 )     45  
All other
    284       447       364       (36 )     23  
 
                                 
Total mortgage banking
    1,860       2,512       1,713       (26 )     47  
 
                                       
Operating leases
    836       937       1,115       (11 )     (16 )
Insurance
    1,193       1,071       997       11       7  
Trading assets
    523       502       321       4       56  
Net gains (losses) on debt securities available for sale
    (15 )     4       293             (99 )
Net gains (losses) from equity investments
    394       55       (327 )     616        
Net gains on sales of loans
    11       28       19       (61 )     47  
Net gains (losses) on dispositions of operations
    (15 )     29       10             190  
All other
    580       371       268       56       38  
 
                                 
Total
  $ 12,909     $ 12,382     $ 10,767       4 %     15 %
 
                             
 
                                       
 

      Service charges on deposit accounts increased 5% to $2,417 million in 2004 from $2,297 million in 2003 due to growth in core deposits and increased activity.

      We earn trust, investment and IRA fees from managing and administering assets, which include mutual funds, corporate trust, personal trust, employee benefit trust and agency assets. Generally, these fees are based on the market value of the assets that are managed, administered, or both. At December 31, 2004, our managed and administered assets totaled approximately $705 billion, up from $576 billion at December 31, 2003. This increase included $24 billion in mutual fund assets and $5 billion in institutional investment accounts acquired from Strong Financial Corporation (Strong Financial) at December 31, 2004. When the merger of the Wells Fargo Funds® and certain Strong Financial funds is completed in second quarter 2005, we will rename our mutual fund family the Wells Fargo Advantage FundsSM. The increase in trust, investment and IRA fees was primarily due to growth in assets, successful efforts to grow businesses, and modest fill-in acquisitions (excluding the year-end Strong Financial transaction).
      Additionally, we receive commission and other fees for providing services for retail and discount brokerage customers.

At December 31, 2004 and 2003, brokerage balances were approximately $86 billion and $78 billion, respectively. Generally, these fees are based on the number of transactions executed at the customer’s direction.

      Card fees increased 14% to $1,230 million in 2004 from $1,079 million in 2003 predominantly due to increases in credit card accounts and credit and debit card transaction volume.
      Other fees increased 14% to $1,779 million in 2004 from $1,560 million in 2003 due to the increase in loan fees as a result of growth in the portfolio.
      Mortgage banking noninterest income was $1,860 million in 2004, compared with $2,512 million in 2003. Net servicing fees reflected income of $1,037 million in 2004 compared with losses of $954 million in 2003. Servicing fees are presented net of amortization and impairment of mortgage servicing rights (MSRs) and gains and losses from hedge ineffectiveness, which are all influenced by both the level and direction of mortgage interest rates. The increase in net servicing fees in 2004, compared with the prior year, reflected a reduction of $934 million in amortization due to an increase in average interest rates and higher gross servicing fees resulting from growth in the servicing portfolio. In addition, to reflect the higher value of our MSRs, we reversed $208 million of the valuation allowance in 2004, compared with an impairment provision of $1,092 million in 2003. Net derivative gains on fair value hedges of our MSRs were $554 million and $1,111 million in 2004 and 2003, respectively. (For further discussion of hedge accounting for MSRs see Note 27 (Derivatives – Fair Value Hedges) to Financial Statements.)
      Net gains on mortgage loan origination/sales activities were $539 million in 2004, compared with $3,019 million for 2003. The lower level of gains in 2004 compared with 2003 reflected lower origination volume and a decrease in margins due primarily to the increase in average interest rates and lower consumer demand. Originations during 2004 declined to $298 billion from $470 billion in 2003.
      Net losses on debt securities were $15 million for 2004, compared with net gains of $4 million for 2003. Net gains from equity investments were $394 million in 2004, compared with gains of $55 million in 2003 due to improved market conditions.
      We routinely review our investment portfolios and recognize impairment write-downs based primarily on issuer-specific factors and results, and our intent to hold such securities. We also consider general economic and market conditions, including industries in which venture capital investments are made, and adverse changes affecting the availability of venture capital. We determine impairment based on all of the information available at the time of the assessment, but new information or economic developments in the future could result in recognition of additional impairment.
      “All other” noninterest income for 2003 was offset by $163 million of losses on the early retirement of $2.6 billion of term debt that was previously issued at higher costs.

 

44


 

Noninterest Expense

Table 5: Noninterest Expense

                                         
   

(in millions)
  Year ended December 31 ,   % Change  
    2004     2003     2002     2004 /   2003 /
                      2003     2002  
 
                                       
Salaries
  $ 5,393     $ 4,832     $ 4,383       12 %     10 %
Incentive compensation
    1,807       2,054       1,706       (12 )     20  
Employee benefits
    1,724       1,560       1,283       11       22  
Equipment
    1,236       1,246       1,014       (1 )     23  
Net occupancy
    1,208       1,177       1,102       3       7  
Operating leases
    633       702       802       (10 )     (12 )
Outside professional services
    669       509       445       31       14  
Contract services
    626       866       546       (28 )     59  
Advertising and promotion
    459       392       327       17       20  
Travel and entertainment
    442       389       337       14       15  
Outside data processing
    418       404       350       3       15  
Telecommunications
    296       343       347       (14 )     (1 )
Postage
    269       336       256       (20 )     31  
Charitable donations
    248       237       39       5       508  
Insurance
    247       197       169       25       17  
Stationery and supplies
    240       241       226             7  
Operating losses
    192       193       163       (1 )     18  
Net losses from debt extinguishment
    174                          
Security
    161       163       159       (1 )     3  
Core deposit intangibles
    134       142       155       (6 )     (8 )
All other
    997       1,207       902       (17 )     34  
 
                                 
Total
  $ 17,573     $ 17,190     $ 14,711       2 %     17 %
 
                             
 
                                       
 

      Noninterest expense in 2004 increased only 2%, including the net losses on extinguishment of debt and additional investments made in new stores, technology and additional sales and service team members, offset by a reduction in Home Mortgage production costs. Employee benefits expense included the $44 million special 401(k) contribution. Noninterest expense for 2004 included a $217 million expense for a charitable contribution to our Foundation, to be funded by tax-advantaged venture capital gains, and 2003 included donations of appreciated public equity securities to our Foundation.

      We expect to incur approximately $65 million of integration expense related to the Strong Financial transaction, of which $19 million (or approximately $.01 per share) was incurred in fourth quarter 2004. In 2005, we expect to incur total integration expense of approximately $.02 per share for the balance of the expenses for the Strong Financial transaction and for the pending acquisition of First Community Capital Corporation.
      We will expense stock options, as required, beginning July 1, 2005, and estimate the effect of expensing current outstanding options will reduce earnings per share by $.03 for the last half of 2005.

Operating Segment Results
Our lines of business for management reporting consist of Community Banking, Wholesale Banking and Wells Fargo Financial.

COMMUNITY BANKING’S net income increased 14% to $5.0 billion in 2004 from $4.4 billion in 2003. Net interest income increased to $12.2 billion in 2004 from $11.5 billion in 2003, or 6%, primarily due to growth in consumer loans and deposits, partially offset by a decrease in average mortgages held for sale. Average loans were $187.0 billion in 2004, up 31% from $143.2 billion in 2003. Retail core deposits, which exclude Wholesale Banking core deposits and mortgage escrow deposits, averaged $183.7 billion in 2004, up 11% over the prior year. Revenue in businesses other than Home Mortgage rose 10% on higher fee revenue, including deposit service charges, trust and investments, debit and credit cards and insurance. Home Mortgage revenue decreased from 2003, a year of record originations from strong refinancing activity. While total Community Banking noninterest expense included additional investments made in technology, store growth and additional team members, total noninterest expense decreased $137 million, or 1%, due to overall expense management, including a reduction in Home Mortgage production costs.

WHOLESALE BANKING’S net income increased 11% to $1.6 billion in 2004 from $1.4 billion in 2003. Average loans increased 7% and average core deposits grew 14% from 2003. The quality of Wholesale Banking’s loan portfolio improved as reflected in a lower level of nonperforming loans and a decrease in net credit losses from the prior year. The provision for credit losses decreased to $62 million in 2004 from $177 million in 2003, due to lower net charge-offs. Noninterest income increased $304 million to $3.1 billion in 2004 compared with 2003, primarily due to higher income in insurance brokerage, trust and investment fees, commissions and capital markets activity. Noninterest expense increased to $2.7 billion in 2004 from $2.6 billion in 2003 primarily due to higher personnel expense, along with integration costs related to the Strong Financial transaction.

WELLS FARGO FINANCIAL’S net income increased 12% to $507 million in 2004 from $451 million in 2003. The 2004 results reflected a strong increase in real estate secured loans and auto lending, as average loans reached $29.5 billion, an increase of 45% over the prior year. Total revenue rose 18% in 2004, reaching $3.2 billion, compared with $2.7 billion in 2003, due to higher net interest income. Net interest income increased $482 million, or 21%, to $2.8 billion in 2004 from $2.3 billion in 2003 due to growth in average loans. The provision for credit losses increased by $174 million from 2003 to 2004 due to the growth in average loans and expected seasoning in the loan portfolio. Noninterest expense increased $247 million, or 18%, in 2004 from 2003, reflecting investments in new consumer finance stores and additional team members.

      For a more complete description of our operating segments, including additional financial information and the underlying management accounting process, see Note 20 (Operating Segments) to Financial Statements.

 

45


 

Balance Sheet Analysis

 

A comparison between the year-end 2004 and 2003 balance sheets is presented below.

Securities Available for Sale
Our securities available for sale portfolio includes both debt and marketable equity securities. We hold debt securities available for sale primarily for liquidity, interest rate risk management and yield enhancement purposes. Accordingly, this portfolio primarily includes very liquid, high-quality federal agency debt securities. At December 31, 2004, we held $33.0 billion of debt securities available for sale, compared with $32.4 billion at December 31, 2003, with a net unrealized gain of $1.2 billion and $1.3 billion for the same periods. In addition, we held $696 million of marketable equity securities available for sale at December 31, 2004, and $582 million at December 31, 2003, with a net unrealized gain of $189 million and $188 million for the same periods.

      The weighted-average expected maturity of debt securities available for sale was 4.3 years at December 31, 2004. Since 76% of this portfolio is mortgage-backed securities, the expected remaining maturity may differ from contractual maturity because borrowers may have the right to prepay obligations before the underlying mortgages mature.
      The estimated effect of a 200 basis point increase or decrease in interest rates on the fair value and the expected remaining maturity of the mortgage-backed securities available for sale portfolio is in Table 6.

Table 6: Mortgage-Backed Securities

                         
   

(in billions)
  Fair     Net unrealized     Remaining  
    value     gain (loss)     maturity  
 
                       
At December 31, 2004
  $ 25.1     $ .9     3.7 yrs.
 
                       
At December 31, 2004,
assuming a 200 basis point:
                       
Increase in interest rates
    23.2       (1.0 )   6.3 yrs.  
Decrease in interest rates
    25.9       1.7     1.6 yrs.  
 
                       
   

      See Note 5 (Securities Available for Sale) to Financial Statements for securities available for sale by security type.

Loan Portfolio
A comparative schedule of average loan balances is included in Table 3; year-end balances are in Note 6 (Loans and Allowance for Credit Losses) to Financial Statements.

      Loans averaged $269.6 billion in 2004, compared with $213.1 billion in 2003, an increase of 26%. Total loans at December 31, 2004, were $287.6 billion, compared with $253.1 billion at year-end 2003, an increase of 14%. Average 1–4 family first mortgages and junior liens increased $31.4 billion, or 56%, and $12.7 billion, or 40%, respectively, in 2004 compared with a year ago. Average commercial and commercial real estate loans increased $6.3 billion in 2004 compared with a year ago. Average mortgages held for sale decreased $26.4 billion, or 45%, to $32.3 billion in 2004 from $58.7 billion in 2003 due to lower origination volume. With lower refinancing demand in 2004, residential mortgage originations of $298 billion were down 37% from the industry record of $470 billion we established in 2003.

Deposits
Year-end deposit balances are in Table 7. Comparative detail of average deposit balances is included in Table 3. Average core deposits funded 54.4% and 54.8% of average total assets in 2004 and 2003, respectively. Total average interest-bearing deposits rose from $161.7 billion in 2003 to $182.6 billion in 2004. Total average noninterest-bearing deposits rose from $76.8 billion in 2003 to $79.3 billion in 2004. Savings certificates declined on average from $20.9 billion in 2003 to $18.9 billion in 2004.

Table 7: Deposits

                         
   

(in millions)
  December 31 ,   %  
    2004     2003     Change  
 
                       
Noninterest-bearing
  $ 81,082     $ 74,387       9 %
Interest-bearing checking
    3,122       2,735       14  
Market rate and other savings
    126,648       114,362       11  
Savings certificates
    18,851       19,787       (5 )
 
                   
Core deposits
    229,703       211,271       9  
Other time deposits
    36,622       27,488       33  
Deposits in foreign offices
    8,533       8,768       (3 )
 
                   
Total deposits
  $ 274,858     $ 247,527       11 %
 
                 
 
                       
 

 

46


 

Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

 

Off-Balance Sheet Arrangements, Variable Interest Entities, Guarantees and Other Commitments
We consolidate our majority-owned subsidiaries and subsidiaries in which we are the primary beneficiary. Generally, we use the equity method of accounting if we own at least 20% of an affiliate and we carry the investment at cost if we own less than 20% of an affiliate. See Note 1 (Summary of Significant Accounting Policies) to Financial Statements for our consolidation policy.

      In the ordinary course of business, we engage in financial transactions that are not recorded on the balance sheet, or may be recorded on the balance sheet in amounts that are different than the full contract or notional amount of the transaction. These transactions are designed to (1) meet the financial needs of customers, (2) manage our credit, market or liquidity risks, (3) diversify our funding sources or (4) optimize capital, and are accounted for in accordance with generally accepted accounting principles (GAAP).
      Almost all of our off-balance sheet arrangements result from securitizations. We routinely securitize home mortgage loans and, from time to time, other financial assets, including student loans, commercial mortgages and automobile receivables. We normally structure loan securitizations as sales, in accordance with FAS 140. This involves the transfer of financial assets to certain qualifying special-purpose entities that we are not required to consolidate. In a securitization, we can convert the assets into cash earlier than if we held the assets to maturity. Special-purpose entities used in these types of securitizations obtain cash to acquire assets by issuing securities to investors. In a securitization, we usually provide representations and warranties for receivables transferred. Also, we generally retain the right to service the transferred receivables and to repurchase those receivables from the special-purpose entity if the outstanding balance of the receivable falls to a level where the cost exceeds the benefits of servicing such receivables.
      At December 31, 2004, securitization arrangements sponsored by the Company consisted of approximately $77 billion in securitized loan receivables, including $45 billion of home mortgage loans. We retained servicing rights and other beneficial interests related to these securitizations of $575 million, consisting of $138 million in securities, $353 million in servicing assets and $84 million in other retained interests. Related to securitizations, we provided $16 million in liquidity commitments in demand notes and reserve fund balances, and committed to provide up to $32 million in credit enhancements.
      Also, we hold variable interests greater than 20% but less than 50% in certain special-purpose entities formed to provide affordable housing and to securitize high-yield corporate debt that had approximately $3 billion in total assets at December 31, 2004. We are not required to consolidate these entities. Our maximum exposure to loss as a result of our involvement with these unconsolidated

variable interest entities was approximately $950 million at December 31, 2004, primarily representing investments in entities formed to invest in affordable housing. We, however, expect to recover our investment over time through realization of federal low-income housing tax credits.

      For more information on securitizations including sales proceeds and cash flows from securitizations, see Note 21 (Securitizations and Variable Interest Entities) to Financial Statements.
      Home Mortgage, in the ordinary course of business, originates a portion of its mortgage loans through unconsolidated joint ventures in which we own an interest of 50% or less. Loans made by these joint ventures are funded by Wells Fargo Bank, N.A., or an affiliated entity, through an established line of credit and are subject to specified underwriting criteria. At December 31, 2004, the total assets of these mortgage origination joint ventures were approximately $80 million. We provide liquidity to these joint ventures in the form of outstanding lines of credit and, at December 31, 2004, these liquidity commitments totaled $350 million.
      We also hold interests in other unconsolidated joint ventures formed with unrelated third parties to provide efficiencies from economies of scale. A third party manages our real estate lending services joint ventures and provides customers title, escrow, appraisal and other real estate related services. Our merchant services joint venture includes credit card processing and related activities. At December 31, 2004, total assets of our real estate lending and merchant services joint ventures were approximately $520 million.
      When we acquire brokerage, asset management and insurance agencies, the terms of the acquisitions may provide for deferred payments or additional consideration, based on certain performance targets. At December 31, 2004, the amount of contingent consideration we expected to pay was not significant to our financial statements.
      As a financial services provider, we routinely commit to extend credit, including loan commitments, standby letters of credit and financial guarantees. A significant portion of commitments to extend credit may expire without being drawn upon. These commitments are subject to the same credit policies and approval process used for our loans. For more information, see Note 6 (Loans and Allowance for Credit Losses) and Note 25 (Guarantees) to Financial Statements.
      In our venture capital and capital markets businesses, we commit to fund equity investments directly to investment funds and to specific private companies. The timing of future cash requirements to fund these commitments generally depends on the venture capital investment cycle, the period over which privately-held companies are funded by venture capital investors and ultimately taken public through an initial offering. This cycle can vary based on market conditions and the industry in which the companies operate. We expect that many of these investments will become public, or otherwise become liquid, before the balance of unfunded equity

 

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commitments is used. At December 31, 2004, these commitments were approximately $685 million. Our other investment commitments, principally affordable housing, civic and other community development initiatives, were approximately $530 million at December 31, 2004. Also, in 2004, we made an irrevocable commitment of $275 million to the Wells Fargo Foundation to fund the Foundation over the next eight to ten years, which resulted in a $217 million charitable contribution expense.

      In the ordinary course of business, we enter into indemnification agreements, including underwriting agreements relating to offers and sales of our securities, acquisition agreements, and various other business transactions or arrangements, such as relationships arising from service as a director or officer of the Company. For more information, see Note 25 (Guarantees) to Financial Statements.

Contractual Obligations
In addition to the contractual commitments and arrangements described above, which, depending on the nature of the obligation, may or may not require use of our resources, we enter into other contractual obligations in the ordinary course of business, including debt issuances for the funding of operations and leases for premises and equipment.

      Table 8 summarizes these contractual obligations at December 31, 2004, except obligations for short-term borrowing arrangements and pension and postretirement benefits plans. More information on these obligations is in Notes 11 (Short-Term Borrowings) and 16 (Employee Benefits and Other Expenses) to Financial Statements. The table also excludes other commitments more fully described under “Off-Balance Sheet Arrangements, Variable Interest Entities, Guarantees and Other Commitments.”

      We enter into derivatives, which create contractual obligations, as part of our interest rate risk management process, for our customers or for other trading activities. See “Asset/Liability and Market Risk Management” in this report and Note 27 (Derivatives) to Financial Statements for more information.

Transactions with Related Parties
FAS 57, Related Party Disclosures, requires disclosure of material related party transactions, other than compensation arrangements, expense allowances and other similar items in the ordinary course of business. The Company had no related party transactions required to be reported under FAS 57 for the years ended December 31, 2004, 2003 and 2002.

 

Table 8: Contractual Obligations

                                                         
   

(in millions)
  Note(s) to     Less than     1-3     3-5     More than     Indeterminate     Total  
    Financial Statements     1 year     years     years     5 years     maturity (1)      
 
                                                       
Contractual payments by period:
                                                       
 
                                                       
Deposits
    10     $ 56,279     $ 5,668     $ 1,557     $ 349     $ 211,005     $ 274,858  
Long-term debt (2)
    7, 12       14,586       22,465       16,785       19,744             73,580  
Operating leases
    7       476       730       487       835             2,528  
Purchase obligations (3)
            2,155       176       43       4             2,378  
 
                                           
Total contractual obligations
          $ 73,496     $ 29,039     $ 18,872     $ 20,932     $ 211,005     $ 353,344  
 
                                           
 
                                                       
 
 
(1)   Represents interest- and noninterest-bearing checking, market rate and other savings accounts.
(2)   Includes capital leases of $20 million.
(3)   Represents agreements to purchase goods or services.

Risk Management

 

Credit Risk Management Process
Our credit risk management process provides for decentralized management and accountability by our lines of business. Our overall credit process includes comprehensive credit policies, frequent and detailed risk measurement and modeling, extensive credit training programs and a continual loan audit review process. In addition, regulatory examiners review and perform detailed tests of our credit underwriting, loan administration and allowance processes.

      Managing credit risk is a company-wide process. We have credit policies for all banking and nonbanking operations incurring credit risk with customers or counterparties that provide a consistent, prudent approach to credit risk management. We use detailed tracking and analysis to measure credit performance and exception rates and we routinely

review and modify credit policies as appropriate. We have corporate data integrity standards to ensure accurate and complete credit performance reporting. We strive to identify problem loans early and have dedicated, specialized collection and work-out units.

      The Chief Credit Officer, who reports directly to the Chief Executive Officer, provides company-wide credit oversight. Each business unit with direct credit risks has a credit officer and has the primary responsibility for managing its own credit risk. The Chief Credit Officer delegates authority, limits and other requirements to the business units. These delegations are routinely reviewed and amended if there are significant changes in personnel or credit performance. The Chief Credit Officer is actively involved in the Corporate Enterprise Risk Management Committee.

 

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      Our business units and the office of the Chief Credit Officer periodically review all credit risk portfolios to ensure that the risk identification processes are functioning properly and that credit standards are followed. Business units conduct quality assurance reviews to ensure that loans meet portfolio or investor credit standards. Our loan examiners and/or internal auditors also independently review portfolios with credit risk.

      Our primary business focus in middle market commercial and residential real estate, auto and small consumer lending, results in portfolio diversification. We ensure that we use appropriate methods to understand and underwrite risk.
      In our wholesale portfolios, loans are individually underwritten and judgmentally risk rated. They are periodically monitored and prompt corrective actions are taken on deteriorating loans.
      Retail loans are typically underwritten with statistical decision-making tools and are managed throughout their life cycle on a portfolio basis. The Chief Credit Officer establishes corporate standards for model development and validation to ensure sound credit decisions and regulatory compliance.
      Each business unit completes quarterly asset quality forecasts to quantify its intermediate-term outlook for loan losses and recoveries, nonperforming loans and market trends. To make sure our overall allowance for credit losses is adequate we conduct periodic stress tests. This includes a portfolio loss simulation model that simulates a range of possible losses for various sub-portfolios assuming various trends in loan quality. We assess loan portfolios for geographic, industry, or other concentrations and develop mitigation strategies, which may include loan sales, syndications or third party insurance, to minimize these concentrations as we deem necessary.
      We routinely review and evaluate risks that are not borrower specific but that may influence the behavior of a particular credit, group of credits or entire sub-portfolios. We also assess risk for particular industries and specific macroeconomic trends.

NONACCRUAL LOANS AND OTHER ASSETS
Table 9 shows the five-year trend for nonaccrual loans and other assets. We generally place loans on nonaccrual status (1) when the full and timely collection of interest or principal becomes uncertain, (2) when they are 90 days (120 days with respect to real estate 1–4 family first and junior lien mortgages) past due for interest or principal (unless both well-secured and in the process of collection) or (3) when part of the principal balance has been charged off. Note 1 (Summary of Significant Accounting Policies) to Financial Statements describes our accounting policy for nonaccrual loans.

      We expect that the amount of nonaccrual loans will change due to portfolio growth, portfolio seasoning, routine problem loan recognition and resolution through collections, sales or charge-offs. The performance of any loan can be affected by external factors, such as economic conditions, or factors particular to a borrower, such as actions of a borrower’s management.
      If interest due on the book balances of all nonaccrual loans (including loans that were but are no longer on nonaccrual at year end) had been accrued under the original terms, approximately $80 million of interest would have been recorded in 2004, compared with payments of $38 million recorded as interest income.
      Substantially all foreclosed assets at December 31, 2004, have been in the portfolio one year or less.

 

Table 9: Nonaccrual Loans and Other Assets

                                         
   

(in millions)
  December 31 ,
    2004     2003     2002     2001     2000  
 
                                       
Nonaccrual loans:
                                       
Commercial and commercial real estate:
                                       
Commercial
  $ 345     $ 592     $ 796     $ 827     $ 739  
Other real estate mortgage
    229       285       192       210       113  
Real estate construction
    57       56       93       145       57  
Lease financing
    68       73       79       163       92  
 
                             
Total commercial and commercial real estate
    699       1,006       1,160       1,345       1,001  
 
                                       
Consumer:
                                       
Real estate 1-4 family first mortgage
    386       274       230       205       128  
Real estate 1-4 family junior lien mortgage
    92       87       49       22       22  
Other revolving credit and installment
    160       88       48       59       36  
 
                             
Total consumer
    638       449       327       286       186  
 
                                       
Foreign
    21       3       5       9       7  
 
                             
Total nonaccrual loans (1)
    1,358       1,458       1,492       1,640       1,194  
As a percentage of total loans
    .47 %     .58 %     .78 %     .98 %     .77 %
 
                                       
Foreclosed assets
    212       198       195       160       120  
Real estate investments (2)
    2       6       4       2       27  
 
                             
 
                                       
Total nonaccrual loans and other assets
  $ 1,572     $ 1,662     $ 1,691     $ 1,802     $ 1,341  
 
                             
As a percentage of total loans
    .55 %     .66 %     .88 %     1.08 %     .86 %
 
                             
 
                                       
 
 
(1)   Includes impaired loans of $309 million, $629 million, $612 million, $823 million and $504 million at December 31, 2004, 2003, 2002, 2001 and 2000, respectively.
(See Notes 1 (Significant Accounting Policies) and 6 (Loans and Allowance for Credit Losses) to Financial Statements for further discussion of impaired loans.)
(2)   Real estate investments (contingent interest loans accounted for as investments) that would be classified as nonaccrual if these assets were recorded as loans.
Real estate investments totaled $4 million, $9 million, $9 million, $24 million and $56 million at December 31, 2004, 2003, 2002, 2001 and 2000, respectively.

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LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING
Loans included in this category are 90 days or more past due as to interest or principal and still accruing, because they are (1) well-secured and in the process of collection or (2) real estate 1-4 family first mortgage loans or consumer loans exempt under regulatory rules from being classified as nonaccrual.

      The total of loans 90 days past due and still accruing was $2,578 million, $2,337 million, $672 million, $698 million and $578 million at December 31, 2004, 2003, 2002, 2001 and 2000, respectively. In 2004 and 2003, the total included $1,820 million and $1,641 million, respectively, in advances pursuant to our servicing agreements to Government National Mortgage Association (GNMA) mortgage pools whose repayments are insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs. Prior to clarifying guidance issued in 2003 as to classification as loans, GNMA advances were included in other assets. Table 10 provides detail by loan category excluding GNMA advances.

Table 10:    Loans 90 Days or More Past Due and Still Accruing (Excluding Insured/Guaranteed GNMA Advances)

                                         
   

(in millions)
  December 31 ,
    2004     2003     2002     2001     2000  
 
                                       
Commercial and commercial real estate:
                                       
Commercial
  $ 26     $ 87     $ 92     $ 60     $ 87  
Other real estate mortgage
    6       9       7       22       24  
Real estate construction
    6       6       11       47       12  
 
                             
Total commercial and commercial real estate
    38       102       110       129       123  
 
                                       
Consumer:
                                       
Real estate 1-4 family first mortgage
    148       117       104       145       74  
Real estate 1-4 family junior lien mortgage
    40       29       18       17       18  
Credit card
    150       134       130       116       95  
Other revolving credit and installment
    306       271       282       268       235  
 
                             
Total consumer
    644       551       534       546       422  
 
                                       
Foreign
    76       43       28       23       33  
 
                             
Total
  $ 758     $ 696     $ 672     $ 698     $ 578  
 
                             
 
                                       
 

ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses, which comprises the allowance for loan losses and the reserve for unfunded credit commitments, is management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date. We assume that our allowance for credit losses as a percentage of charge-offs and nonperforming loans will change at different points in time based on credit performance, loan mix and collateral values. The analysis of the changes in the allowance for credit losses, including charge-offs and recoveries by loan category, is presented in Note 6 (Loans and Allowance for Credit Losses) to Financial Statements.

      At December 31, 2004, the allowance for loan losses was $3.76 billion, or 1.31% of total loans, compared with $3.89 billion, or 1.54%, at December 31, 2003, and $3.82 billion, or 1.98%, at December 31, 2002. The decrease in the ratio of the allowance for loan losses to total loans was primarily due to significant growth in our consumer real estate portfolio, which inherently has lower losses that emerge over a longer time frame compared with other consumer products. We have historically experienced lower losses on our residential real estate secured consumer loan portfolio. The provision for credit losses totaled $1.72 billion in 2004 and 2003 and $1.68 billion in 2002. Net charge-offs in 2004 were .62% of average total loans, compared with .81% in 2003 and .96% in 2002. Any loan with past due principal or interest that is not both well-secured and in the process of collection generally is charged off (to the extent that it exceeds the fair value of any related collateral) based on loan category after a defined period of time. Also, loans are charged off when classified as a loss by either internal loan examiners or regulatory examiners.

      At December 31, 2004, the reserve for unfunded credit commitments was $188 million, less than 5% of the allowance for credit losses, compared with 3% a year ago.
      We consider the allowance for credit losses of $3.95 billion adequate to cover credit losses inherent in the loan portfolio, including unfunded credit commitments, at December 31, 2004. The process for determining the adequacy of the allowance for credit losses is critical to our financial results. It requires difficult, subjective and complex judgments, as a result of the need to make estimates about the effect of matters that are uncertain. (See “Financial Review – Critical Accounting Policies – Allowance for Credit Losses.”) Therefore, we cannot provide assurance that, in any particular period, we will not have sizeable credit losses in relation to the amount reserved. We may need to significantly adjust the allowance for credit losses, considering current factors at the time, including economic conditions and ongoing internal and external examination processes. Our process for determining the adequacy of the allowance for credit losses is discussed in Note 6 (Loans and Allowance for Credit Losses) to Financial Statements.

Asset/Liability and Market Risk Management
Asset/liability management involves the evaluation, monitoring and management of interest rate risk, market risk, liquidity and funding. The Corporate Asset/Liability Management Committee (Corporate ALCO)—which oversees these risks and reports periodically to the Finance Committee of the Board of Directors—consists of senior financial and business executives. Each of our principal business groups—Community Banking (including Mortgage Banking), Wholesale Banking and Wells Fargo Financial—have individual asset/liability management committees and processes linked to the Corporate ALCO process.

 

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INTEREST RATE RISK
Interest rate risk, which potentially can have a significant earnings impact, is an integral part of being a financial intermediary. We are subject to interest rate risk because:
    assets and liabilities may mature or reprice at different times (for example, if assets reprice faster than liabilities and interest rates are generally falling, earnings will initially decline);
    assets and liabilities may reprice at the same time but by different amounts (for example, when the general level of interest rates is falling, we may reduce rates paid on checking and savings deposit accounts by an amount that is less than the general decline in market interest rates);
    short-term and long-term market interest rates may change by different amounts (i.e., the shape of the yield curve may affect new loan yields and funding costs differently); or
    the remaining maturity of various assets or liabilities may shorten or lengthen as interest rates change (for example, if long-term mortgage interest rates decline sharply, mortgage-backed securities held in the securities available for sale portfolio may prepay significantly earlier than anticipated – which could reduce portfolio income). In addition, interest rates may have an indirect impact on loan demand, credit losses, mortgage origination volume, the value of mortgage servicing rights, the value of the pension liability and other sources of earnings.

      We assess interest rate risk by comparing our most likely earnings plan with various earnings models using many interest rate scenarios that differ in the direction of interest rate changes, the degree of change over time, the speed of change and the projected shape of the yield curve. For example, if we assume an increase of 325 basis points in the federal funds rate and an increase of 250 basis points in the 10 year Constant Maturity Treasury Bond yield during the same period, estimated earnings at risk would be approximately 3.0% of our most likely earnings plan for 2005. Simulation estimates depend on, and will change with, the size and mix of our actual and projected balance sheet at the time of each simulation.

      We use exchange-traded and over-the-counter interest rate derivatives to hedge our interest rate exposures. The credit risk amount and estimated net fair values of these derivatives as of December 31, 2004 and 2003 are presented in Note 27 (Derivatives) to Financial Statements. We use derivatives for asset/liability management in three ways:
    to convert most of the long-term fixed-rate debt to floating-rate payments by entering into receive-fixed swaps at issuance;
    to convert the cash flows from selected asset and/or liability instruments/portfolios from fixed to floating payments or vice versa; and
    to hedge the mortgage origination pipeline, funded mortgage loans and mortgage servicing rights using swaptions, futures, forwards and options.

MORTGAGE BANKING INTEREST RATE RISK
We originate, fund and service mortgage loans, which subjects us to a number of risks, including credit, liquidity and interest rate risks. We manage credit and liquidity risk by selling or securitizing most of the mortgage loans we originate. Changes in interest rates, however, may have a significant effect on mortgage banking income in any quarter and over time. Interest rates impact both the value of the mortgage servicing rights (MSRs), which is adjusted to the lower of cost or fair value, and the future earnings of the mortgage business, which are driven by origination volume and the duration of our servicing. We manage both risks by hedging the impact of interest rates on the value of the MSRs using derivatives, combined with the “natural hedge” provided by the origination and servicing components of the mortgage business; however, we do not hedge 100% of these two risks.

      We hedge a significant portion of the value of our MSRs against a change in interest rates with derivatives. The principal source of risk in this hedging process is the risk that changes in the value of the hedging contracts may not match changes in the value of the hedged portion of our MSRs for any given change in long-term interest rates.
      The value of our MSRs is influenced primarily by prepayment speed assumptions affecting the duration of the mortgage loans to which our MSRs relate. Changes in long-term interest rates affect these prepayment speed assumptions. For example, a decrease in long-term rates would accelerate prepayment speed assumptions as borrowers refinance their existing mortgage loans and decrease the value of the MSRs. In contrast, prepayment speed assumptions would tend to slow in a rising interest rate environment and increase the value of the MSRs.
      For a given decline in interest rates, a portion of the potential reduction in the value of our MSRs is offset by estimated increases in origination and servicing fees over time from new mortgage activity or refinancing associated with that decline in interest rates. With much lower long-term interest rates, the decline in the value of our MSRs and the effect on net income would be immediate whereas the additional origination and servicing fee income accrues over time. Under GAAP, impairment of our MSRs, due to a decrease in long-term rates or other reasons, is charged to earnings through an increase to the valuation allowance.
      In scenarios of sustained increases in long-term interest rates, origination fees may decline as refinancing activity slows. In such higher interest rate scenarios, the duration of the servicing portfolio may lengthen. In such circumstances, we may reduce periodic amortization of MSRs, and may recover some or all of the previously established valuation allowance.
      Our MSRs totaled $7.9 billion, net of a valuation allowance of $1.6 billion at December 31, 2004, and $6.9 billion, net of a valuation allowance of $1.9 billion, at December 31, 2003. The weighted-average note rate on the owned servicing portfolio was 5.75% at December 31, 2004, and 5.90% at December 31, 2003. Our MSRs were 1.15% of mortgage loans serviced for others at December 31, 2004 and 2003.

 

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      As part of our mortgage banking activities, we enter into commitments to fund residential mortgage loans at specified times in the future. A mortgage loan commitment is an interest rate lock that binds us to lend funds to a potential borrower at a specified interest rate and within a specified period of time, generally up to 60 days after inception of the rate lock. These loan commitments are derivative loan commitments if the loans that will result from the exercise of the commitments will be held for sale. Under FAS 133, Accounting for Derivative Instruments and Hedging Activities (as amended), these derivative loan commitments are recognized at fair value on the consolidated balance sheet with changes in their fair values recorded as part of income from mortgage banking operations. Consistent with EITF 02-3, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities, and SEC Staff Accounting Bulletin No. 105, Application of Accounting Principles to Loan Commitments, we record no value for the loan commitment at inception. Subsequent to inception, we recognize fair value of the derivative loan commitment based on estimated changes in the fair value of the underlying loan that would result from the exercise of that commitment and on changes in the probability that the loan will fund within the terms of the commitment. The value of that loan is affected primarily by changes in interest rates and the passage of time. We also apply a fall-out factor to the valuation of the derivative loan commitment for the probability that the loan will not fund within the terms of the commitments. The value of the MSRs is recognized only after the servicing asset has been contractually separated from the underlying loan by sale or securitization.

      Outstanding derivative loan commitments expose us to the risk that the price of the 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 utilize options, futures and forwards to economically hedge the potential decreases in the values of the loans that could result from the exercise of the loan commitments. We expect that these derivative financial instruments will experience changes in fair value that will offset the changes in fair value of the derivative loan commitments.

MARKET RISK – TRADING ACTIVITIES
From a market risk perspective, our net income is exposed to changes in interest rates, credit spreads, foreign exchange rates, equity and commodity prices and their implied volatilities. The primary purpose of our trading businesses is to accommodate customers in the management of their market price risks. Also, we take positions based on market expectations or to benefit from price differences between financial instruments and markets, subject to risk limits established and monitored by Corporate ALCO. All securities, loans, foreign exchange transactions, commodity transactions and derivatives—transacted with customers or used to hedge capital market transactions with customers—are carried at fair value.

The Institutional Risk Committee establishes and monitors counterparty risk limits. The notional or contractual amount, credit risk amount and estimated net fair value of all customer accommodation derivatives at December 31, 2004 and 2003 are included in Note 27 (Derivatives) to Financial Statements. Open, “at risk” positions for all trading business are monitored by Corporate ALCO.

      The standardized approach for monitoring and reporting market risk for the trading activities is the value-at-risk (VAR) metrics complemented with factor analysis and stress testing. Value-at-risk measures the worst expected loss over a given time interval and within a given confidence interval. We measure and report daily VAR at 99% confidence interval based on actual changes in rates and prices over the past 250 days. The analysis captures all financial instruments that are considered trading positions. The average one-day VAR throughout 2004 was $19 million, with a lower bound of $12 million and an upper bound of $57 million.

MARKET RISK – EQUITY MARKETS
We are directly and indirectly affected by changes in the equity markets. We make and manage direct equity investments in start-up businesses, emerging growth companies, management buy-outs, acquisitions and corporate recapitalizations. We also invest in non-affiliated funds that make similar private equity investments. These private equity investments are made within capital allocations approved by management and the Board of Directors. The Board reviews business developments, key risks and historical returns for the private equity investments at least annually. Management reviews these investments at least quarterly and assesses them for possible other-than-temporary impairment. For nonmarketable investments, the analysis is based on facts and circumstances of each individual investment and the expectations for that investment’s cash flows and capital needs, the viability of its business model and our exit strategy. At December 31, 2004, private equity investments totaled $1,449 million, compared with $1,714 million at December 31, 2003.

      We also have marketable equity securities in the available for sale investment portfolio, including securities distributed from our venture capital activities. We manage these investments within capital risk limits approved by management and the Board and monitored by Corporate ALCO. Gains and losses on these securities are recognized in net income when realized and, in addition, other-than-temporary impairment may be periodically recorded. The initial indicator of impairment for marketable equity securities is a sustained decline in market price below the amount recorded for that investment. We consider a variety of factors, such as the length of time and the extent to which the market value has been less than cost; the issuer’s financial condition, capital strength, and near-term prospects; any recent events specific to that issuer and economic conditions of its industry; and, to a lesser degree, our investment horizon in relationship to an anticipated near-term recovery in the stock price, if any. At December 31, 2004, the fair value of marketable equity securities was $696 million and cost was $507 million, compared with $582 million and $394 million, respectively, at December 31, 2003.

 

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      Changes in equity market prices may also indirectly affect our net income (1) by affecting the value of third party assets under management and, hence, fee income, (2) by affecting particular borrowers, whose ability to repay principal and/or interest may be affected by the stock market, or (3) by affecting brokerage activity, related commission income and other business activities. Each business line monitors and manages these indirect risks.

LIQUIDITY AND FUNDING
The objective of effective liquidity management is to ensure that we can meet customer loan requests, customer deposit maturities/withdrawals and other cash commitments efficiently under both normal operating conditions and under unpredictable circumstances of industry or market stress. To achieve this objective, Corporate ALCO establishes and monitors liquidity guidelines that require sufficient asset-based liquidity to cover potential funding requirements and to avoid over-dependence on volatile, less reliable funding markets. We set liquidity management guidelines for both the consolidated balance sheet as well as for the Parent specifically to ensure that the Parent is a source of strength for its regulated, deposit-taking banking subsidiaries.

      Debt securities in the securities available for sale portfolio provide asset liquidity, in addition to the immediately liquid resources of cash and due from banks and federal funds sold and securities purchased under resale agreements. The weighted-average expected remaining maturity of the debt securities within this portfolio was 4.3 years at December 31, 2004. Of the $31.8 billion (cost basis) of debt securities in this portfolio at December 31, 2004, $5.1 billion, or 16%, is expected to mature or be prepaid in 2005 and an additional $4.5 billion, or 14%, in 2006. Asset liquidity is further enhanced by our ability to sell or securitize loans in secondary markets through whole-loan sales and securitizations. In 2004, we sold mortgage loans of approximately $230 billion, including securitized home mortgage loans and commercial mortgage loans of approximately $195 billion. The amount of mortgage loans, as well as home equity loans and other consumer loans, available to be sold or securitized totaled approximately $125 billion at December 31, 2004.
      Core customer deposits have historically provided a sizeable source of relatively stable and low-cost funds. Average core deposits and stockholders’ equity funded 63.1% and 63.3% of average total assets in 2004 and 2003, respectively.
      The remaining assets were funded by long-term debt, deposits in foreign offices, short-term borrowings (federal funds purchased, securities sold under repurchase agreements, commercial paper and other short-term borrowings) and trust preferred securities. Short-term borrowings averaged $26.1 billion and $29.9 billion in 2004 and 2003, respectively. Long-term debt, including issuances of trust preferred securities, averaged $67.9 billion and $57.1 billion in 2004 and 2003, respectively.
      We anticipate making capital expenditures of approximately $1.2 billion in 2005 for stores, relocation and remodeling of

Company facilities, and routine replacement of furniture, equipment and servers. We will fund these expenditures from various sources, including retained earnings and borrowings.

      Liquidity is also available through our ability to raise funds in a variety of domestic and international money and capital markets. We access capital markets for long-term funding by issuing registered debt, private placements and asset-backed secured funding. Approximately $80 billion of our debt is rated by Moody’s Investors Service as “Aa1” and Fitch, Inc. as “AA,” among the highest ratings given to a financial services company. In September 2003, Moody’s Investors Service raised Wells Fargo Bank, N.A.’s rating to “Aaa,” its highest investment grade, from “Aa1” and raised the Company’s senior debt rating to “Aa1” from “Aa2.” In October 2003, Standard & Poor’s Ratings Service raised the counterparty ratings on the Company to “AA-minus/A-1-plus” from “A-plus/A-1” and the revised outlook for the Company to stable from positive. Rating agencies base their ratings on many quantitative and qualitative factors, including capital adequacy, liquidity, asset quality, business mix and level and quality of earnings. Material changes in these factors could result in a different debt rating; however, a change in debt rating would not cause us to violate any of our debt covenants.

PARENT. In March 2003, the Parent registered with the Securities and Exchange Commission (SEC) for issuance of $15.3 billion in senior and subordinated notes and preferred and common securities. In April 2004, the Parent filed a registration statement with the SEC for issuance of an additional $20 billion in senior and subordinated notes, preferred stock and other securities. During 2004, the Parent issued a total of $17.1 billion of senior and subordinated notes and trust preferred securities. At December 31, 2004, the Parent’s remaining issuance capacity under effective registration statements was $11.9 billion. We used the proceeds from securities issued in 2004 for general corporate purposes and expect that the proceeds in the future will also be used for general corporate purposes. The Parent also issues commercial paper and has a $1 billion back-up credit facility. In February 2005, the Parent issued $750 million in senior notes.

WELLS FARGO BANK, N.A. In March 2003, Wells Fargo Bank, N.A. established a $50 billion bank note program under which it may issue up to $20 billion in short-term senior notes outstanding at any time and up to a total of $30 billion in long-term senior and subordinated notes. Securities are issued under this program as private placements in accordance with Office of the Comptroller of the Currency (OCC) regulations. During 2004, Wells Fargo Bank, N.A. issued $5.9 billion in senior long-term notes. At December 31, 2004, the remaining issuance authority under the long-term portion was $9.0 billion. In January 2005, Wells Fargo Bank, N.A. issued $225 million in senior long-term notes. In addition, not under the bank note program, in February 2005, Wells Fargo Bank, N.A. issued $1.5 billion in subordinated debt.

 

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WELLS FARGO FINANCIAL. In November 2003, Wells Fargo Financial Canada Corporation (WFFCC), a wholly owned Canadian subsidiary of Wells Fargo Financial, Inc. (WFFI), qualified for distribution with the provincial securities exchanges in Canada $1.5 billion (Canadian) of issuance authority. In December 2004, WFFCC amended its existing shelf registration by adding $2.5 billion (Canadian) of issuance authority. During 2004, WFFCC issued $1.1 billion

(Canadian) in senior notes. At December 31, 2004, the remaining issuance capacity for WFFCC was $2.9 billion (Canadian). During 2004, WFFI issued $400 million (Canadian) and $207 million (U.S.) in senior notes as private placements. In 2004, WFFI also entered into a secured borrowing arrangement for $500 million (U.S.). Under the terms of the arrangement, WFFI pledged auto loans as security for the borrowing.

 

Capital Management

 

We have an active program for managing stockholder capital. We use capital to fund organic growth, acquire banks and other financial services companies, pay dividends and repurchase our shares. Our objective is to produce above market long-term returns by opportunistically using capital when returns are perceived to be high and issuing/accumulating capital when such costs are perceived to be low.

      From time to time our Board of Directors authorizes the Company to repurchase shares of its common stock. Although we announce when our Board authorizes share repurchases, we typically do not give any public notice before we repurchase our shares. Various factors determine the amount and timing of our share repurchases, including our capital requirements, the number of shares we expect to issue for acquisitions and employee benefit plans, market conditions (including the trading price of our stock), and legal considerations. These factors can change at any time, and there can be no assurance as to the number of shares we will repurchase or when we will repurchase them.
      Historically, our policy has been to repurchase shares under the “safe harbor” conditions of Rule 10b-18 of the Exchange Act including a limitation on the daily volume of repurchases. In November 2003, the SEC amended Rule 10b-18 to impose an additional daily volume limitation on share repurchases during a pending merger or acquisition in which shares of our stock will constitute some or all of the consideration. Our management may determine that during a pending stock merger or acquisition when the safe harbor would otherwise be available, it is in the Company’s best interest to repurchase shares in excess of this additional daily volume limitation. In such cases, we intend to repurchase shares in compliance with the other conditions of the safe harbor, including the standing daily volume limitation that applies whether or not there is a pending stock merger or acquisition.

      During 2002, the Board of Directors authorized the repurchase of up to 50 million additional shares of our outstanding common stock. In April 2004, the Board authorized the repurchase of up to 25 million shares of common stock. During 2004, we repurchased approximately 38 million shares of our common stock. At December 31, 2004, the total remaining common stock repurchase authority under the 2004 authorization was approximately 13 million shares. In January 2005, the Board authorized the repurchase of up to an additional 25 million shares of common stock. Effective February 22, 2005, the Board amended the PartnerShares® Stock Option Plan to reduce the number of shares available for awards under the plan by 20,000,000 shares. At December 31, 2004, there were 21,194,286 shares available for awards under the plan. (See Note 15 (Common Stock and Stock Plans) for additional information on our broad-based employee stock option plans.)

      Our potential sources of capital include retained earnings, and issuances of common and preferred stock and subordinated debt. In 2004, retained earnings increased $3.6 billion, predominantly as a result of net income of $7.0 billion less dividends of $3.2 billion. In 2004, we issued $1.7 billion of common stock under various employee benefit and director plans and under our dividend reinvestment program. The Parent issued $1.9 billion in subordinated debt and trust preferred securities in 2004.
      The Company and each of our subsidiary banks are subject to various regulatory capital adequacy requirements administered by the Federal Reserve Board and the OCC. Risk-based capital guidelines establish a risk-adjusted ratio relating capital to different categories of assets and off-balance sheet exposures. At December 31, 2004, the Company and each of our covered subsidiary banks were “well capitalized” under regulatory standards. See Note 26 (Regulatory and Agency Capital Requirements) to Financial Statements for additional information.

 

Comparison of 2003 with 2002

 

Net income in 2003 was $6.2 billion, or $3.65 per share, compared with $5.7 billion, or $3.32 per share, before the effect of the accounting change related to FAS 142, for 2002. On the same basis, return on average assets (ROA) was 1.64% and return on average common equity (ROE) was

19.36% in 2003, compared with 1.77% and 19.63%, respectively, for 2002.

      Net income in 2003 was $6.2 billion, compared with $5.4 billion in 2002. Diluted earnings per common share were $3.65 in 2003, compared with $3.16 in 2002. ROA

 

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was 1.64% and ROE was 19.36% in 2003, compared with 1.69% and 18.68%, respectively, in 2002.

      Net interest income on a taxable-equivalent basis was $16.1 billion in 2003, compared with $14.6 billion in 2002. The 10% increase in net interest income was primarily due to robust loan growth and significantly lower funding costs resulting from strong core deposit growth and lower wholesale funding rates. These factors were partially offset by reduced income from a smaller investment portfolio following the sale, prepayment and maturity of higher yielding mortgage-backed securities. The net interest margin was 5.08% for 2003, compared with 5.53% in 2002. The decrease was primarily due to declining loan yields as new volumes were added to the portfolio at yields below existing loans due to a lower interest rate environment. This was partially offset by significantly reduced funding costs and growth in noninterest-bearing funds.
      Noninterest income was $12.4 billion in 2003, compared with $10.8 billion in 2002. The 15% increase was largely due to higher mortgage banking noninterest income and fee income, including service charges on deposit accounts, credit card fees and charges and fees on loans. Also, the increase reflects net gains from equity investments in 2003, compared with losses in 2002. The increase in noninterest income was partially offset by lower net gains on debt securities in 2003 compared with 2002.
      Mortgage banking noninterest income was $2.5 billion in 2003, compared with $1.7 billion in 2002. Net servicing fees reflected losses of $1.0 billion in 2003, compared with $.7 billion in 2002. The increase in net losses from servicing fees was primarily due to lower average interest rates, which resulted in higher MSRs amortization and an increase to the

valuation allowance. The increase in net losses was partially offset by an increase in gross servicing fees due to an 18% growth in the servicing portfolio. Net gains on mortgage loan origination/sales activities increased to $3.0 billion in 2003 from $2.1 billion in 2002, primarily due to higher mortgage origination volume and gains on loan sales. Originations during 2003 grew to $470 billion from $333 billion in 2002.

      Revenue, the sum of net interest income and noninterest income, increased from $25.2 billion in 2002 to $28.4 billion in 2003, or 12%.
      Noninterest expense totaled $17.2 billion in 2003, compared with $14.7 billion in 2002, an increase of 17%. The increase in noninterest expense, including increases in salaries, employee benefits, incentive compensation, contract services, advertising and promotion and postage, was largely due to the growth in the mortgage banking business, which accounted for approximately 48% of the increase from 2002. The increase was also due to charitable donations, predominantly donations of appreciated public equity securities to the Wells Fargo Foundation.
      The provision for credit losses was $1.72 billion in 2003, compared with $1.68 billion in 2002. During 2003, net charge-offs were .81% of average total loans, compared with .96% during 2002. The allowance for credit losses was $3.89 billion, or 1.54% of total loans, at December 31, 2003, compared with $3.82 billion, or 1.98%, at December 31, 2002.
      At December 31, 2003, total nonaccrual loans were $1.46 billion, or .58% of total loans, compared with $1.49 billion, or .78%, at December 31, 2002. Foreclosed assets were $198 million at December 31, 2003, and $195 million at December 31, 2002.

 

Factors That May Affect Future Results

 

We make forward-looking statements in this report and in other reports and proxy statements we file with the SEC. In addition, our senior management might make forward-looking statements orally to analysts, investors, the media and others.

      Forward-looking statements include:
    projections of our revenues, income, earnings per share, capital expenditures, dividends, capital structure or other financial items;
    descriptions of plans or objectives of our management for future operations, products or services, including pending acquisitions;
    forecasts of our future economic performance; and
    descriptions of assumptions underlying or relating to any of the foregoing.

      In this report, for example, we make forward-looking statements about:
    the projected funding requirements of the Wells Fargo Foundation over the next eight to ten years and the

      expected funding sources for the 2004 commitment to the Foundation;
    the amount of integration expense expected to be incurred in 2005 for the Strong Financial transaction and the pending acquisition of First Community Capital Corporation;
    the estimated impact of expensing stock options on 2005 earnings per share;
    the anticipated amount of capital expenditures in 2005 for stores, relocation and remodeling of facilities, and other items;
    the expected impact of recent accounting standards;
    future credit losses and nonperforming assets; and
    future short-term and long-term interest rate levels and their impact on our net interest margin, net income, liquidity and capital.

      Forward-looking statements discuss matters that are not historical facts. Because they discuss future events or conditions, forward-looking statements often include words such

 

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as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” or similar expressions. Do not unduly rely on forward-looking statements. They give our expectations about the future and are not guarantees. Forward-looking statements speak only as of the date they are made, and we might not update them to reflect changes that occur after the date they are made.

      There are a number of factors—many beyond our control—that could cause results to differ significantly from our expectations. Some of these factors are described below. Other factors, such as credit, market, operational, liquidity, interest rate and other risks, are described elsewhere in this report (see, for example, “Balance Sheet Analysis”). Factors relating to the regulation and supervision are described in our Annual Report on Form 10-K for the year ended December 31, 2004. Any factor described in this report or in our 2004 Form 10-K could by itself, or together with one or more other factors, adversely affect our business, results of operations or financial condition. There are also other factors that we have not described in this report or in our 2004 Form 10-K that could cause results to differ from our expectations.

Industry Factors
AS A FINANCIAL SERVICES COMPANY, OUR EARNINGS ARE SIGNIFICANTLY AFFECTED BY GENERAL BUSINESS AND ECONOMIC CONDITIONS.
Our business and earnings are affected by general business and economic conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, monetary supply, fluctuations in both debt and equity capital markets, and the strength of the U.S. economy and the local economies in which we operate. For example, an economic downturn, an increase in unemployment, or other events that affect household and/or corporate incomes could decrease the demand for loan and non-loan products and services and increase the number of customers who fail to pay interest or principal on their loans.

      Geopolitical conditions can also affect our earnings. Acts or threats of terrorism, actions taken by the U.S. or other governments in response to acts or threats of terrorism and/or military conflicts, could affect business and economic conditions in the U.S. and abroad. The terrorist attacks in 2001, for example, caused an immediate decrease in air travel, which affected the airline industry, lodging, gaming and tourism.
      We discuss other business and economic conditions in more detail elsewhere in this report.

THE FISCAL AND MONETARY POLICIES OF THE FEDERAL GOVERNMENT AND ITS AGENCIES SIGNIFICANTLY AFFECT OUR EARNINGS.
The Board of Governors of the Federal Reserve System regulates the supply of money and credit in the United States. Its policies determine in large part our cost of funds for lending and investing and the return we earn on those loans and investments, both of which affect our net interest margin. They also can materially affect the value of financial instruments we hold, such as debt securities and mortgage servicing rights. Its policies also can affect our borrowers,

potentially increasing the risk that they may fail to repay their loans. Changes in Federal Reserve Board policies are beyond our control and hard to predict.

THE FINANCIAL SERVICES INDUSTRY IS HIGHLY COMPETITIVE.
We operate in a highly competitive industry that could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies now can merge by creating a “financial holding company,” which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Recently, a number of foreign banks have acquired financial services companies in the United States, further increasing competition in the U.S. market. Also, technology has lowered barriers to entry and made it possible for nonbanks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and some have lower cost structures.

WE ARE HEAVILY REGULATED BY FEDERAL AND STATE AGENCIES.
The Parent, our subsidiary banks and many of our nonbank subsidiaries are heavily regulated at the federal and state levels. This regulation is to protect depositors, federal deposit insurance funds and the banking system as a whole, not security holders. Congress and state legislatures and federal and state regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways including limiting the types of financial services and products we may offer and/or increasing the ability of nonbanks to offer competing financial services and products. Also, if we do not comply with laws, regulations or policies, we could receive regulatory sanctions and damage to our reputation. For more information, refer to the “Regulation and Supervision” section of our 2004 Form 10-K and to Notes 3 (Cash, Loan and Dividend Restrictions) and 26 (Regulatory and Agency Capital Requirements) to Financial Statements.

FUTURE LEGISLATION COULD CHANGE OUR COMPETITIVE POSITION.
Legislation is from time to time introduced in the Congress, including proposals to substantially change the financial institution regulatory system and to expand or contract the powers of banking institutions and bank holding companies. This legislation may change banking statutes and our operating environment in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. We cannot predict whether any of this potential legislation will be enacted, and if enacted, the effect that it, or any regulations, would have on our financial condition or results of operations.

 

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WE DEPEND ON THE ACCURACY AND COMPLETENESS OF INFORMATION ABOUT CUSTOMERS AND COUNTERPARTIES.
In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information furnished to us by or on behalf of customers and counterparties, including financial statements and other financial information. We also may rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit, we may assume that a customer’s audited financial statements conform with GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. We also may rely on the audit report covering those financial statements. Our financial condition and results of operations could be negatively affected by relying on financial statements that do not comply with GAAP or that are materially misleading.

CONSUMERS MAY DECIDE NOT TO USE BANKS TO COMPLETE THEIR FINANCIAL TRANSACTIONS.
Technology and other changes now allow parties to complete financial transactions without banks. For example, consumers can pay bills and transfer funds directly without banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits.

Company Factors
MAINTAINING OR INCREASING OUR MARKET SHARE DEPENDS ON MARKET ACCEPTANCE AND REGULATORY APPROVAL OF NEW PRODUCTS AND SERVICES.
Our success depends, in part, on our ability to adapt our products and services to evolving industry standards. There is increasing pressure to provide products and services at lower prices. This can reduce our net interest margin and revenues from our fee-based products and services. In addition, the widespread adoption of new technologies, including internet services, could require us to make substantial expenditures to modify or adapt our existing products and services. We might not be successful in introducing new products and services, achieving market acceptance of our products and services, or developing and maintaining loyal customers.

NEGATIVE PUBLIC OPINION COULD DAMAGE OUR REPUTATION AND ADVERSELY IMPACT OUR EARNINGS.
Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to keep and attract customers and can expose us to litigation and regulatory action. Because virtually all our businesses operate under the “Wells Fargo”

brand, actual or alleged conduct by one business can result in negative public opinion about other Wells Fargo businesses. Although we take steps to minimize reputation risk in dealing with our customers and communities, as a large diversified financial services company with a relatively high industry profile, the risk will always be present in our organization.

THE PARENT RELIES ON DIVIDENDS FROM ITS SUBSIDIARIES FOR MOST OF ITS REVENUE.
The Parent is a separate and distinct legal entity from its subsidiaries. It receives substantially all of its revenue from dividends from its subsidiaries. These dividends are the principal source of funds to pay dividends on the Parent’s common and preferred stock and interest and principal on its debt. Various federal and/or state laws and regulations limit the amount of dividends that our bank and certain of our nonbank subsidiaries may pay to the Parent. Also, the Parent’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. For more information, refer to “Regulation and Supervision – Dividend Restrictions” and “ – Holding Company Structure” in our 2004 Form 10-K.

OUR ACCOUNTING POLICIES AND METHODS ARE KEY TO HOW WE REPORT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS. THEY MAY REQUIRE MANAGEMENT TO MAKE ESTIMATES ABOUT MATTERS THAT ARE UNCERTAIN.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with GAAP and reflect management’s judgment of the most appropriate manner to report our financial condition and results. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in our reporting materially different amounts than would have been reported under a different alternative. Note 1 (Summary of Significant Accounting Policies) to Financial Statements describes our significant accounting policies.

      Three accounting policies are critical to presenting our financial condition and results. They require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions. These critical accounting policies relate to: (1) the allowance for credit losses, (2) the valuation of mortgage servicing rights, and (3) pension accounting. Because of the uncertainty of estimates about these matters, we cannot provide any assurance that we will not:
    significantly increase our allowance for credit losses and/or sustain credit losses that are significantly higher than the reserve provided;
    recognize significant provision for impairment of our mortgage servicing rights; or
    significantly increase our pension liability.

 

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      For more information, refer in this report to “Critical Accounting Policies,” “Balance Sheet Analysis” and “Risk Management.”

CHANGES IN ACCOUNTING STANDARDS COULD MATERIALLY IMPACT OUR FINANCIAL STATEMENTS.
From time to time the Financial Accounting Standards Board (FASB) changes the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements.

WE HAVE BUSINESSES OTHER THAN BANKING.
We are a diversified financial services company. In addition to banking, we provide insurance, investments, mortgages and consumer finance. Although we believe our diversity helps lessen the effect when downturns affect any one segment of our industry, it also means our earnings could be subject to different risks and uncertainties. We discuss some examples below.

MERCHANT BANKING. Our merchant banking business, which includes venture capital investments, has a much greater risk of capital losses than our traditional banking business. Also, it is difficult to predict the timing of any gains from this business. Realization of gains from our venture capital investments depends on a number of factors—many beyond our control—including general economic conditions, the prospects of the companies in which we invest, when these companies go public, the size of our position relative to the public float, and whether we are subject to any resale restrictions. Factors, such as a slowdown in consumer demand or a decline in capital spending, could result in declines in the values of our publicly-traded and private equity securities. If we determine that the declines are other-than-temporary, additional impairment charges would be recognized. Also, we will realize losses to the extent we sell securities at less than book value. For more information, see in this report “Balance Sheet Analysis – Securities Available for Sale.”

MORTGAGE BANKING. The effect of interest rates on our mortgage business can be large and complex. Changes in interest rates can affect loan origination fees and loan servicing fees, which account for a significant portion of mortgage-related revenues. A decline in mortgage rates generally increases the demand for mortgage loans as borrowers refinance, but also generally leads to accelerated payoffs in our mortgage servicing portfolio. Conversely, in a constant or increasing rate environment, we would expect fewer loans to be refinanced and a decline in payoffs in our servicing portfolio. We use dynamic, sophisticated models to assess the effect of interest rates on mortgage fees, amortization of mortgage servicing rights, and the value of mortgage servicing rights.

The estimates of net income and fair value produced by these models, however, depend on assumptions of future loan demand, prepayment speeds and other factors that may overstate or understate actual experience. We use derivatives to hedge the value of our servicing portfolio but they do not cover the full value of the portfolio. We cannot assure that the hedges will offset significant decreases in the value of the portfolio. For more information, see in this report “Critical Accounting Policies – Valuation of Mortgage Servicing Rights” and “Asset /Liability and Market Risk Management.”

WE RELY ON OTHER COMPANIES TO PROVIDE KEY COMPONENTS OF OUR BUSINESS INFRASTRUCTURE.
Third parties provide key components of our business infrastructure such as internet connections and network access. Any disruption in internet, network access or other voice or data communication services provided by these third parties or any failure of these third parties to handle current or higher volumes of use could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Technological or financial difficulties of a third party service provider could adversely affect our business to the extent those difficulties result in the interruption or discontinuation of services provided by that party.

WE HAVE AN ACTIVE ACQUISITION PROGRAM.
We regularly explore opportunities to acquire financial institutions and other financial services providers. We cannot predict the number, size or timing of acquisitions. We typically do not comment publicly on a possible acquisition or business combination until we have signed a definitive agreement.

      We must generally receive federal regulatory approval before we can acquire a bank or bank holding company. In determining whether to approve a proposed bank acquisition, federal bank regulators will consider, among other factors, the effect of the acquisition on competition, financial condition, and future prospects including current and projected capital ratios and levels, the competence, experience, and integrity of management and record of compliance with laws and regulations, the convenience and needs of the communities to be served, including the acquiring institution’s record of compliance under the Community Reinvestment Act, and the effectiveness of the acquiring institution in combating money laundering activities. In addition, we cannot be certain when or if, or on what terms and conditions, any required regulatory approvals will be granted. We might be required to sell banks or branches as a condition to receiving regulatory approval.
      Difficulty in integrating an acquired company may cause us not to realize expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from the acquisition. The integration could result in higher than expected deposit attrition (run-off), loss of key employees, disruption of our business or the business of the acquired company, or otherwise adversely affect our ability to maintain relationships with customers and employees or achieve the anticipated benefits of the acquisition. Also,

 

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the negative effect of any divestitures required by regulatory authorities in acquisitions or business combinations may be greater than expected.

LEGISLATIVE RISK
Our business model depends on sharing information among the family of companies owned by Wells Fargo to better satisfy our customers’ needs. Laws that restrict the ability of our companies to share information about customers could negatively affect our revenue and profit.

OUR BUSINESS COULD SUFFER IF WE FAIL TO ATTRACT AND RETAIN SKILLED PEOPLE.
Our success depends, in large part, on our ability to attract and retain key people. Competition for the best people in most activities we engage in can be intense. We may not be able to hire the best people or to keep them.

OUR STOCK PRICE CAN BE VOLATILE.
Our stock price can fluctuate widely in response to a variety of factors including:
    actual or anticipated variations in our quarterly operating results;

    recommendations by securities analysts;
    new technology used, or services offered, by our competitors;
    significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving us or our competitors;
    failure to integrate our acquisitions or realize anticipated benefits from our acquisitions;
    operating and stock price performance of other companies that investors deem comparable to us;
    news reports relating to trends, concerns and other issues in the financial services industry;
    changes in government regulations; and
    geopolitical conditions such as acts or threats of terrorism or military conflicts.

      General market fluctuations, industry factors and general economic and political conditions and events, such as terrorist attacks, economic slowdowns or recessions, interest rate changes, credit loss trends or currency fluctuations, also could cause our stock price to decrease regardless of our operating results.

 

Additional Information

 

Our common stock is traded on the New York Stock Exchange and the Chicago Stock Exchange. The common stock prices in the graphs below were reported on the New York Stock Exchange Composite Transaction Reporting System. The number of holders of record of our common stock was 94,669 at January 31, 2005.

      Our chief executive officer certified to the New York Stock Exchange (NYSE) that, as of May 14, 2004, he was not aware of any violation by the Company of the NYSE’s corporate governance listing standards. The certifications of our chief

executive officer and chief financial officer required under Section 302 of the Sarbanes-Oxley Act of 2002 were filed as Exhibits 31(a) and 31(b), respectively, to our 2004 Form 10-K.

      Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, are available free of charge on or through our website (www.wellsfargo.com), as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Those reports and amendments are also available free of charge on the SEC’s website (www.sec.gov).

 

       

(PRICE RANGE OF COMMON STOCK - GRAPHS)

(PRICE RANGE OF COMMON STOCK - GRAPHS)

 

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Controls and Procedures

Disclosure Controls and Procedures

 

As required by SEC rules, the Company’s management evaluated the effectiveness, as of December 31, 2004, of the Company’s disclosure controls and procedures. The Company’s chief executive officer and chief financial officer participated in the evaluation. Based on this evaluation, the Company’s chief executive officer and the chief financial officer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2004.

Internal Control over Financial Reporting

 

Internal control over financial reporting is defined in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the company’s principal executive and principal financial officers and effected by the company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
    Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of assets of the company;
    Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
    Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

      Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. No change occurred during fourth quarter 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. Management’s report on internal control over financial reporting is set forth below, and should be read with these limitations in mind.

Management’s Report on Internal Control over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework. Based on this assessment, management concluded that as of December 31, 2004, the Company’s internal control over financial reporting was effective.

      KPMG LLP, the independent registered public accounting firm that audited the Company’s financial statements included in this Annual Report, issued an audit report on management’s assessment of the Company’s internal control over financial reporting. KPMG’s audit report appears on the following page.

60


 

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Wells Fargo & Company:

      We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Wells Fargo & Company and Subsidiaries (“the Company”) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

      We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

      A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

      Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

      In our opinion, management’s assessment that Wells Fargo & Company and Subsidiaries maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, Wells Fargo & Company and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

      We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Wells Fargo & Company and Subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, changes in stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2004, and our report dated February 23, 2005 expressed an unqualified opinion on those consolidated financial statements.

-s- KPMG LLP
San Francisco, California
February 23, 2005

61


 

Wells Fargo & Company and Subsidiaries
Consolidated Statement of Income

                         
   

(in millions, except per share amounts)
  Year ended December 31 ,
    2004     2003     2002  
 
                       
INTEREST INCOME
                       
Trading assets
  $ 145     $ 156     $ 169  
Securities available for sale
    1,883       1,816       2,424  
Mortgages held for sale
    1,737       3,136       2,450  
Loans held for sale
    292       251       252  
Loans
    16,781       13,937       13,045  
Other interest income
    129       122       119  
 
                 
Total interest income
    20,967       19,418       18,459  
 
                 
 
                       
INTEREST EXPENSE
                       
Deposits
    1,827       1,613       1,919  
Short-term borrowings
    353       322       536  
Long-term debt
    1,637       1,355       1,404  
Guaranteed preferred beneficial interests in Company’s subordinated debentures
          121       118  
 
                 
Total interest expense
    3,817       3,411       3,977  
 
                 
 
                       
NET INTEREST INCOME
    17,150       16,007       14,482  
Provision for credit losses
    1,717       1,722       1,684  
 
                 
Net interest income after provision for credit losses
    15,433       14,285       12,798  
 
                 
 
                       
NONINTEREST INCOME
                       
Service charges on deposit accounts
    2,417       2,297       2,134  
Trust and investment fees
    2,116       1,937       1,875  
Card fees
    1,230       1,079       977  
Other fees
    1,779       1,560       1,372  
Mortgage banking
    1,860       2,512       1,713  
Operating leases
    836       937       1,115  
Insurance
    1,193       1,071       997  
Net gains (losses) on debt securities available for sale
    (15 )     4       293  
Net gains (losses) from equity investments
    394       55       (327 )
Other
    1,099       930       618  
 
                 
Total noninterest income
    12,909       12,382       10,767  
 
                 
 
                       
NONINTEREST EXPENSE
                       
Salaries
    5,393       4,832       4,383  
Incentive compensation
    1,807       2,054       1,706  
Employee benefits
    1,724       1,560       1,283  
Equipment
    1,236       1,246       1,014  
Net occupancy
    1,208       1,177       1,102  
Operating leases
    633       702       802  
Other
    5,572       5,619       4,421  
 
                 
Total noninterest expense
    17,573       17,190       14,711  
 
                 
 
                       
INCOME BEFORE INCOME TAX EXPENSE AND EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
    10,769       9,477       8,854  
Income tax expense
    3,755       3,275       3,144  
 
                 
 
                       
NET INCOME BEFORE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
    7,014       6,202       5,710  
Cumulative effect of change in accounting principle
                (276 )
 
                 
 
                       
NET INCOME
  $ 7,014     $ 6,202     $ 5,434  
 
                 
 
                       
EARNINGS PER COMMON SHARE BEFORE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
                       
Earnings per common share
  $ 4.15     $ 3.69     $ 3.35  
Diluted earnings per common share
    4.09       3.65       3.32  
 
                       
EARNINGS PER COMMON SHARE
                       
Earnings per common share
  $ 4.15     $ 3.69     $ 3.19  
Diluted earnings per common share
    4.09       3.65       3.16  
 
                       
DIVIDENDS DECLARED PER COMMON SHARE
  $ 1.86     $ 1.50     $ 1.10  
 
                       
Average common shares outstanding
    1,692.2       1,681.1       1,701.1  
Diluted average common shares outstanding
    1,713.4       1,697.5       1,718.0  
 
                       
 
The accompanying notes are an integral part of these statements.

62


 

Wells Fargo & Company and Subsidiaries
Consolidated Balance Sheet

                 
   

(in millions, except shares)
  December 31 ,
    2004     2003  
 
               
ASSETS
               
Cash and due from banks
  $ 12,903     $ 15,547  
Federal funds sold, securities purchased under resale agreements and other short-term investments
    5,020       3,733  
Trading assets
    9,000       8,919  
Securities available for sale
    33,717       32,953  
Mortgages held for sale
    29,723       29,027  
Loans held for sale
    8,739       7,497  
 
               
Loans
    287,586       253,073  
Allowance for loan losses
    (3,762 )     (3,891 )
 
           
Net loans
    283,824       249,182  
 
           
 
               
Mortgage servicing rights, net
    7,901       6,906  
Premises and equipment, net
    3,850       3,534  
Goodwill
    10,681       10,371  
Other assets
    22,491       20,129  
 
           
Total assets
  $ 427,849     $ 387,798  
 
           
 
               
LIABILITIES
               
Noninterest-bearing deposits
  $ 81,082     $ 74,387  
Interest-bearing deposits
    193,776       173,140  
 
           
Total deposits
    274,858       247,527  
Short-term borrowings
    21,962       24,659  
Accrued expenses and other liabilities
    19,583       17,501  
Long-term debt
    73,580       63,642  
 
           
Total liabilities
    389,983       353,329  
 
           
 
               
STOCKHOLDERS’ EQUITY
               
Preferred stock
    270       214  
Common stock – $12/3 par value, authorized 6,000,000,000 shares; issued 1,736,381,025 shares
    2,894       2,894  
Additional paid-in capital
    9,806       9,643  
Retained earnings
    26,482       22,842  
Cumulative other comprehensive income
    950       938  
Treasury stock – 41,789,388 shares and 38,271,651 shares
    (2,247 )     (1,833 )
Unearned ESOP shares
    (289 )     (229 )
 
           
Total stockholders’ equity
    37,866       34,469  
 
           
Total liabilities and stockholders’ equity
  $ 427,849     $ 387,798  
 
           
 
               
 
The accompanying notes are an integral part of these statements.

63


 

Wells Fargo & Company and Subsidiaries
Consolidated Statement of Changes in Stockholders’ Equity and Comprehensive Income

                                                                         
   

(in millions, except shares)
  Number     Preferred     Common     Additional     Retained     Cumulative     Treasury     Unearned     Total  
    of common     stock     stock     paid-in     earnings     other     stock     ESOP     stock-  
    shares                 capital           comprehensive           shares     holders’  
                                  income                 equity  
 
                                                                       
BALANCE DECEMBER 31, 2001
    1,695,494,997     $ 218     $ 2,894     $ 9,436     $ 15,966     $ 752     $ (1,937 )   $ (154 )   $ 27,175  
 
                                                     
Comprehensive income
                                                                       
Net income – 2002
                                    5,434                               5,434  
Other comprehensive income, net of tax:
                                                                       
Translation adjustments
                                            1                       1  
Minimum pension liability adjustment
                                            42                       42  
Net unrealized gains on securities available for sale and other retained interests
                                            484                       484  
Net unrealized losses on derivatives and hedging activities
                                            (303 )                     (303 )
 
                                                                     
Total comprehensive income
                                                                    5,658  
Common stock issued
    17,345,078                       43       (168 )             777               652  
Common stock issued for acquisitions
    12,017,193                       4                       531               535  
Common stock repurchased
    (43,170,943 )                                             (2,033 )             (2,033 )
Preferred stock (238,000) issued to ESOP
            239               17                               (256 )      
Preferred stock released to ESOP
                            (14 )                             220       206  
Preferred stock (205,727) converted to common shares
    4,220,182       (206 )             12                       194                
Preferred stock dividends
                                    (4 )                             (4 )
Common stock dividends
                                    (1,873 )                             (1,873 )
Change in Rabbi trust assets and similar arrangements (classified as treasury stock)
                                                    3               3  
 
                                                     
Net change
    (9,588,490 )     33             62       3,389       224       (528 )     (36 )     3,144  
 
                                                     
 
                                                                       
BALANCE DECEMBER 31, 2002
    1,685,906,507       251       2,894       9,498       19,355       976       (2,465 )     (190 )     30,319  
 
                                                     
Comprehensive income
                                                                       
Net income – 2003
                                    6,202                               6,202  
Other comprehensive income, net of tax:
                                                                       
Translation adjustments
                                            26                       26  
Net unrealized losses on securities available for sale and other retained interests
                                            (117 )                     (117 )
Net unrealized gains on derivatives and hedging activities
                                            53                       53  
 
                                                                     
Total comprehensive income
                                                                    6,164  
Common stock issued
    26,063,731                       63       (190 )             1,221               1,094  
Common stock issued for acquisitions
    12,399,597                       66                       585               651  
Common stock repurchased
    (30,779,500 )                                             (1,482 )             (1,482 )
Preferred stock (260,200) issued to ESOP
            260               19                               (279 )      
Preferred stock released to ESOP
                            (16 )                             240       224  
Preferred stock (223,660) converted to common shares
    4,519,039       (224 )             13                       211                
Preferred stock (1,460,000) redeemed
            (73 )                                                     (73 )
Preferred stock dividends
                                    (3 )                             (3 )
Common stock dividends
                                    (2,527 )                             (2,527 )
Change in Rabbi trust assets and similar arrangements (classified as treasury stock)
                                                    97               97  
Other, net
                                    5                               5  
 
                                                     
Net change
    12,202,867       (37 )           145       3,487       (38 )     632       (39 )     4,150  
 
                                                     
 
                                                                       
BALANCE DECEMBER 31, 2003
    1,698,109,374       214       2,894       9,643       22,842       938       (1,833 )     (229 )     34,469  
 
                                                     
Comprehensive income
                                                                       
Net income – 2004
                                    7,014                               7,014  
Other comprehensive income, net of tax:
                                                                       
Translation adjustments
                                            12                       12  
Net unrealized losses on securities available for sale and other retained interests
                                            (22 )                     (22 )
Net unrealized gains on derivatives and hedging activities
                                            22                       22  
 
                                                                     
Total comprehensive income
                                                                    7,026  
Common stock issued
    29,969,653                       129       (206 )             1,523               1,446  
Common stock issued for acquisitions
    153,482                       1                       8               9  
Common stock repurchased
    (38,172,556 )                                             (2,188 )             (2,188 )
Preferred stock (321,000) issued to ESOP
            321               23                               (344 )      
Preferred stock released to ESOP
                            (19 )                             284       265  
Preferred stock (265,537) converted to common shares
    4,531,684       (265 )             29                       236                
Common stock dividends
                                    (3,150 )                             (3,150 )
Change in Rabbi trust assets and similar arrangements (classified as treasury stock)
                                                    7               7  
Other, net
                                    (18 )                             (18 )
 
                                                     
Net change
    (3,517,737 )     56             163       3,640       12       (414 )     (60 )     3,397  
 
                                                     
 
                                                                       
BALANCE DECEMBER 31, 2004
    1,694,591,637     $ 270     $ 2,894     $ 9,806     $ 26,482     $ 950     $ (2,247 )   $ (289 )   $ 37,866  
 
                                                     
 
                                                                       
 
The accompanying notes are an integral part of these statements.

64


 

Wells Fargo & Company and Subsidiaries
Consolidated Statement of Cash Flows

                         
   

(in millions)
  Year ended December 31 ,
    2004     2003     2002  
 
                       
Cash flows from operating activities:
                       
Net income
  $ 7,014     $ 6,202     $ 5,434  
Adjustments to reconcile net income to net cash provided (used) by operating activities:
                       
Provision for credit losses
    1,717       1,722       1,684  
Provision (reversal of provision) for mortgage servicing rights in excess of fair value
    (208 )     1,092       2,135  
Depreciation and amortization
    3,449       4,305       4,297  
Net gains on securities available for sale
    (60 )     (62 )     (198 )
Net gains on mortgage loan origination/sales activities
    (539 )     (3,019 )     (2,086 )
Net gains on sales of loans
    (11 )     (28 )     (19 )
Net losses on dispositions of premises and equipment
    5       46       52  
Net losses (gains) on dispositions of operations
    15       (29 )     (10 )
Release of preferred shares to ESOP
    265       224       206  
Net decrease (increase) in trading assets
    (81 )     1,248       (3,859 )
Net increase in deferred income taxes
    432       1,698       305  
Net decrease (increase) in accrued interest receivable
    (196 )     (148 )     145  
Net increase (decrease) in accrued interest payable
    47       (63 )     (53 )
Originations of mortgages held for sale
    (221,978 )     (382,335 )     (285,052 )
Proceeds from sales of mortgages held for sale
    230,355       404,207       263,126  
Principal collected on mortgages held for sale
    1,929       3,136       2,063  
Net increase in loans held for sale
    (1,331 )     (832 )     (1,091 )
Other assets, net
    (2,468 )     (5,099 )     (4,466 )
Other accrued expenses and liabilities, net
    1,732       (1,070 )     1,929  
 
                 
 
                       
Net cash provided (used) by operating activities
    20,088       31,195       (15,458 )
 
                 
 
                       
Cash flows from investing activities:
                       
Securities available for sale:
                       
Proceeds from sales
    6,322       7,357       11,863  
Proceeds from prepayments and maturities
    8,823       13,152       9,684  
Purchases
    (16,583 )     (25,131 )     (7,261 )
Net cash paid for acquisitions
    (331 )     (822 )     (588 )
Increase in banking subsidiaries’ loan originations, net of collections
    (34,320 )     (36,235 )     (18,992 )
Proceeds from sales (including participations) of loans by banking subsidiaries
    1,457       1,590       948  
Purchases (including participations) of loans by banking subsidiaries
    (5,877 )     (15,087 )     (2,818 )
Principal collected on nonbank entities’ loans
    17,996       17,638       11,396  
Loans originated by nonbank entities
    (27,751 )     (21,792 )     (14,621 )
Purchases of loans by nonbank entities
          (3,682 )      
Proceeds from dispositions of operations
    4       34       94  
Proceeds from sales of foreclosed assets
    419       264       473  
Net increase in federal funds sold, securities purchased under resale agreements and other short-term investments
    (1,287 )     (208 )     (789 )
Net increase in mortgage servicing rights
    (1,389 )     (3,875 )     (1,492 )
Other, net
    (520 )     3,818       628  
 
                 
 
                       
Net cash used by investing activities
    (53,037 )     (62,979 )     (11,475 )
 
                 
 
                       
Cash flows from financing activities:
                       
Net increase in deposits
    27,327       28,643       25,050  
Net decrease in short-term borrowings
    (2,697 )     (8,901 )     (5,224 )
Proceeds from issuance of long-term debt
    29,394       29,490       21,711  
Repayment of long-term debt
    (19,639 )     (17,931 )     (10,902 )
Proceeds from issuance of guaranteed preferred beneficial interests in Company’s subordinated debentures
          700       450  
Proceeds from issuance of common stock
    1,271       944       578  
Redemption of preferred stock
          (73 )      
Repurchase of common stock
    (2,188 )     (1,482 )     (2,033 )
Payment of cash dividends on preferred and common stock
    (3,150 )     (2,530 )     (1,877 )
Other, net
    (13 )     651       32  
 
                 
 
                       
Net cash provided by financing activities
    30,305       29,511       27,785  
 
                 
 
                       
Net change in cash and due from banks
    (2,644 )     (2,273 )     852  
 
                       
Cash and due from banks at beginning of year
    15,547       17,820       16,968  
 
                 
 
                       
Cash and due from banks at end of year
  $ 12,903     $ 15,547     $ 17,820  
 
                 
 
                       
Supplemental disclosures of cash flow information:
                       
Cash paid during the year for:
                       
Interest
  $ 3,864     $ 3,348     $ 3,924  
Income taxes
    2,326       2,713       2,789  
Noncash investing and financing activities:
                       
Net transfers from loans to mortgages held for sale
    11,225       368       439  
Net transfers from loans to loans held for sale
                829  
Transfers from loans to foreclosed assets
    603       411       491  
 
                       
 
The accompanying notes are an integral part of these statements.

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Notes to Financial Statements

Note 1:   Summary of Significant Accounting Policies

 

Wells Fargo & Company is a diversified financial services company. We provide banking, insurance, investments, mortgage banking and consumer finance through banking stores, the internet and other distribution channels to consumers, businesses and institutions in all 50 states of the U.S. and in other countries. In this Annual Report, Wells Fargo & Company and Subsidiaries (consolidated) are called the Company. Wells Fargo & Company (the Parent) is a financial holding company and a bank holding company.

      Our accounting and reporting policies conform with generally accepted accounting principles (GAAP) and practices in the financial services industry. To prepare the financial statements in conformity with GAAP, management must make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and income and expenses during the reporting period. Management has made significant estimates in several areas, including the allowance for credit losses (Note 6), valuing mortgage servicing rights (Notes 21 and 22) and pension accounting (Note 16). Actual results could differ from those estimates.
      The following is a description of our significant accounting policies.

Consolidation
Our consolidated financial statements include the accounts of the Parent and our majority-owned subsidiaries and variable interest entities (VIEs) (defined below) in which we are the primary beneficiary. Significant intercompany accounts and transactions are eliminated in consolidation. If we own at least 20% of an affiliate, we generally account for the investment using the equity method. If we own less than 20% of an affiliate, we generally carry the investment at cost, except marketable equity securities, which we carry at fair value with changes in fair value included in other comprehensive income. Assets accounted for under the equity or cost method are included in other assets.

      In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities and, in December 2003, issued Revised Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46R), which replaced FIN 46. This set forth the rules of consolidation for certain entities, VIEs, in which the equity investors do not have a controlling financial interest or do not have enough equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. An enterprise’s variable interest arises from contractual, ownership or other monetary interests in the entity, which change with fluctuations in the entity’s net asset value. Effective for VIEs formed after January 31, 2003, and effective for all existing VIEs on

December 31, 2003, we consolidate a VIE if we are the primary beneficiary because we will absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both.

Trading Assets
Trading assets are primarily securities, including corporate debt, U.S. government agency obligations and other securities that we acquire for short-term appreciation or other trading purposes, and the fair value of derivatives held for customer accommodation purposes or proprietary trading. Trading assets are carried at fair value, with realized and unrealized gains and losses recorded in noninterest income.

Securities
SECURITIES AVAILABLE FOR SALE  Debt securities that we might not hold until maturity and marketable equity securities are classified as securities available for sale and reported at estimated fair value. Unrealized gains and losses, after applicable taxes, are reported in cumulative other comprehensive income. We use current quotations, where available, to estimate the fair value of these securities. Where current quotations are not available, we estimate fair value based on the present value of future cash flows, adjusted for the quality rating of the securities, prepayment assumptions and other factors.

      We reduce the asset value when we consider the declines in the value of debt securities and marketable equity securities to be other-than-temporary and record the estimated loss in noninterest income. The initial indicator of impairment for both debt and marketable equity securities is a sustained decline in market price below the amount recorded for that investment. We consider the length of time and the extent to which market value has been less than cost and any recent events specific to the issuer and economic conditions of its industry.

      For marketable equity securities, we also consider:
    the issuer’s financial condition, capital strength, and near-term prospects; and
    to a lesser degree, our investment horizon in relationship to an anticipated near-term recovery in the stock price, if any.

      For debt securities we also consider:
    the cause of the price decline – general level of interest rates and broad industry factors or issuer-specific;
    the issuer’s financial condition and current ability to make future payments in a timely manner;
    our investment horizon;
    the issuer’s ability to service debt; and
    any change in agencies’ ratings at evaluation date from acquisition date and any likely imminent action.

 

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      We manage these investments within capital risk limits approved by management and the Board and monitored by the Corporate Asset/Liability Management Committee. We recognize realized gains and losses on the sale of these securities in noninterest income using the specific identification method.

      Unamortized premiums and discounts are recognized in interest income over the contractual life of the security using the interest method. As principal repayments are received on securities (i.e. primarily mortgage-backed securities) a pro-rata portion of the unamortized premium or discount is recognized in interest income.

NONMARKETABLE EQUITY SECURITIES Nonmarketable equity securities include venture capital equity securities that are not publicly traded and securities acquired for various purposes, such as to meet regulatory requirements (for example, Federal Reserve Bank and Federal Home Loan Bank stock). We review these assets at least quarterly for possible other-than-temporary impairment. Our review typically includes an analysis of the facts and circumstances of each investment, the expectations for the investment’s cash flows and capital needs, the viability of its business model and our exit strategy. These securities are accounted for under the cost or equity method and are included in other assets. We reduce the asset value when we consider declines in value to be other-than-temporary. We recognize the estimated loss as a loss from equity investments in noninterest income.

Mortgages Held for Sale
Mortgages held for sale are stated at the lower of total cost or market value. Gains and losses on loan sales (sales proceeds minus carrying value) are recorded in noninterest income. Direct loan origination costs and fees are deferred at origination of the loan. These deferred costs and fees are recognized in mortgage banking noninterest income upon sale of the loan.

Loans Held for Sale
Loans held for sale are carried at the lower of cost or market value. Direct loan origination costs and fees are deferred at origination of the loan. Gains and losses on loan sales (sales proceeds minus carrying value) are recorded in noninterest income.

Loans
Loans are reported at the principal amount outstanding, net of unearned income, except for purchased loans, which are recorded at fair value on the purchase date. Unearned income includes deferred fees net of deferred direct incremental loan origination costs. We amortize unearned income to interest income, over periods not exceeding the contractual life of the loan, using the interest method.

      From time to time, we pledge loans, primarily 1-4 family mortgage loans, to secure borrowings from the Federal Home Loan Bank.

NONACCRUAL LOANS We generally place loans on nonaccrual status (1) when the full and timely collection of interest or principal becomes uncertain, (2) when they are 90 days (120 days with respect to real estate 1-4 family first and junior lien mortgages) past due for interest or principal (unless both well-secured and in the process of collection) or (3) when part of the principal balance has been charged off. Generally, consumer loans not secured by real estate are placed on nonaccrual status only when part of the principal has been charged off. These loans are entirely charged off when deemed uncollectible or when they reach a defined number of days past due based on loan product, industry practice, country, terms and other factors.

      When we place a loan on nonaccrual status, we reverse the accrued and unpaid interest receivable against interest income and account for the loan on the cash or cost recovery method, until it qualifies for return to accrual status. Generally, we return a loan to accrual status (a) when all delinquent interest and principal becomes current under the terms of the loan agreement or (b) when the loan is both well-secured and in the process of collection and collectibility is no longer doubtful, after a period of demonstrated performance.

IMPAIRED LOANS We assess, account for and disclose as impaired certain nonaccrual commercial loans and commercial real estate mortgage and construction loans that are over $3 million. We consider a loan to be impaired when, based on current information and events, we will probably not be able to collect all amounts due according to the loan contract, including scheduled interest payments.

      When we identify a loan as impaired, we measure the impairment using discounted cash flows, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral. In these cases we use the current fair value of the collateral, less selling costs, instead of discounted cash flows.
      If we determine that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), we recognize impairment through an allocated reserve or a charge-off to the allowance.

ALLOWANCE FOR CREDIT LOSSES The allowance for credit losses, which comprises the allowance for loan losses and the reserve for unfunded credit commitments, is management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date. Our determination of the allowance, and the resulting provision, is based on judgments and assumptions, including (1) general economic conditions, (2) loan portfolio composition, (3) loan loss experience, (4) management’s evaluation of credit risk relating to pools of loans and individual borrowers, (5) sensitivity analysis and expected loss models and (6) observations from our internal auditors, internal loan review staff or our banking regulators.

 

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Transfers and Servicing of Financial Assets
We account for a transfer of financial assets as a sale when we surrender control of the transferred assets. Servicing rights and other retained interests in the sold assets are recorded by allocating the previously recorded investment between the assets sold and the interest retained based on their relative fair values at the date of transfer. We determine the fair values of servicing rights and other retained interests at the date of transfer using the present value of estimated future cash flows, using assumptions that market participants use in their estimates of values. We use quoted market prices when available to determine the value of other retained interests.

      We recognize the rights to service mortgage loans for others, or mortgage servicing rights (MSRs), as assets whether we purchase the servicing rights or sell or securitize loans we originate and retain servicing rights. MSRs are amortized in proportion to, and over the period of, estimated net servicing income. The amortization of MSRs is analyzed monthly and is adjusted to reflect changes in prepayment speeds.
      To determine the fair value of MSRs, we use a valuation model that calculates the present value of estimated future net servicing income. We use assumptions in the valuation model that market participants use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, ancillary income and late fees.
      Each quarter, we evaluate MSRs for possible impairment based on the difference between the carrying amount and current fair value, in accordance with Statement of Financial Accounting Standards No. 140 (FAS 140), Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. To evaluate and measure impairment we stratify the portfolio based on certain risk characteristics, including loan type and note rate. If temporary impairment exists, we establish a valuation allowance through a charge to net income for any excess of amortized cost over the current fair value, by risk stratification. If we later determine that all or a portion of the temporary impairment no longer exists for a particular risk stratification, we will reduce the valuation allowance through an increase to net income.
      Under our policy, we also evaluate other-than-temporary impairment of MSRs by considering both historical and projected trends in interest rates, pay off activity and whether the impairment could be recovered through interest rate increases. We recognize a direct write-down when we determine that the recoverability of a recorded valuation allowance is remote. A direct write-down permanently reduces the carrying value of the MSRs, while a valuation allowance (temporary impairment) can be reversed.

      Mortgages held for sale include residential mortgages that were originated in accordance with secondary market pricing and underwriting standards and certain mortgages originated initially for investment and not underwritten to secondary market standards. Net gains and losses on mortgage loan origination/sales activities reflect the periodic evaluation of our portfolios, which are carried at the lower of cost or market value.

Premises and Equipment
Premises and equipment are carried at cost less accumulated depreciation and amortization. Capital leases are included in premises and equipment at the capitalized amount less accumulated amortization.

      Primarily we use the straight-line method of depreciation and amortization. Estimated useful lives range up to 40 years for buildings, up to 10 years for furniture and equipment, and the shorter of the estimated useful life or lease term for leasehold improvements. We amortize capitalized leased assets on a straight-line basis over the lives of the respective leases.

Goodwill and Identifiable Intangible Assets
Goodwill is recorded when the purchase price is higher than the fair value of net assets acquired in business combinations under the purchase method of accounting.

      Effective January 1, 2002, we assess goodwill for impairment annually, and more frequently in certain circumstances. We assess goodwill for impairment on a reporting unit level by applying a fair-value-based test using discounted estimated future net cash flows. Impairment exists when the carrying amount of the goodwill exceeds its implied fair value. We recognize impairment losses as a charge to noninterest expense (unless related to discontinued operations) and an adjustment to the carrying value of the goodwill asset. Subsequent reversals of goodwill impairment are prohibited. In 2002, our initial goodwill impairment testing resulted in a $276 million (after tax), $404 million (before tax), transitional impairment charge reported as a cumulative effect of a change in accounting principle.
      We amortize core deposit intangibles on an accelerated basis based on useful lives of 10 to 15 years. We review core deposit intangibles for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. Impairment is indicated if the sum of undiscounted estimated future net cash flows is less than the carrying value of the asset. Impairment is permanently recognized by writing down the asset to the extent that the carrying value exceeds the estimated fair value.

 

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Operating Lease Assets
Operating lease rental income for leased assets, generally automobiles, is recognized in other income on a straight-line basis over the lease term. Related depreciation expense is recorded on a straight-line basis over the life of the lease, taking into account the estimated residual value of the leased asset. On a periodic basis, leased assets are reviewed for impairment. Impairment loss is recognized if the carrying amount of leased assets exceeds fair value and is not recoverable. The carrying amount of leased assets is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the lease payments and the estimated residual value upon the eventual disposition of the equipment. Auto lease receivables are written off when 120 days past due.

Pension Accounting
We account for our defined benefit pension plans using an actuarial model required by FAS 87, Employers’ Accounting for Pensions. This model allocates pension costs over the service period of employees in the plan. The underlying principle is that employees render service ratably over this period and, therefore, the income statement effects of pensions should follow a similar pattern.

      One of the principal components of the net periodic pension calculation is the expected long-term rate of return on plan assets. The use of an expected long-term rate of return on plan assets may cause us to recognize pension income returns that are greater or less than the actual returns of plan assets in any given year.
      The expected long-term rate of return is designed to approximate the actual long-term rate of return over time and is not expected to change significantly. Therefore, the pattern of income/expense recognition closely matches the stable pattern of services provided by our employees over the life of our pension obligation. To determine if the expected rate of return is reasonable, we consider such factors as (1) the actual return earned on plan assets, (2) historical rates of return on the various asset classes in the plan portfolio, (3) projections of returns on various asset classes, and (4) current/prospective capital market conditions and economic forecasts. Differences in each year, if any, between expected and actual returns are included in our unrecognized net actuarial gain or loss amount. We generally amortize any unrecognized net actuarial gain or loss in excess of a 5% corridor (as defined in FAS 87) in net periodic pension calculations over the next five years.
      We use a discount rate to determine the present value of our future benefit obligations. The discount rate reflects the rates available at the measurement date on long-term high-quality fixed-income debt instruments and is reset annually on the measurement date (November 30).

Income Taxes
We file a consolidated federal income tax return and, in certain states, combined state tax returns.

      We determine deferred income tax assets and liabilities using the balance sheet method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and recognizes enacted changes in tax rates and laws. Deferred tax assets are recognized subject to management judgment that realization is more likely than not. Foreign taxes paid are generally applied as credits to reduce federal income taxes payable.

Stock-Based Compensation
We have several stock-based employee compensation plans, which are described more fully in Note 15. As permitted by FAS 123, Accounting for Stock-Based Compensation, we have elected to continue applying the intrinsic value method of Accounting Principles Board Opinion 25, Accounting for Stock Issued to Employees, in accounting for stock-based employee compensation plans. Pro forma net income and earnings per common share information is provided below, as if we accounted for employee stock option plans under the fair value method of FAS 123.

                         
   

(in millions, except per
  Year ended December 31 ,
share amounts)   2004     2003     2002  
 
                       
Net income, as reported
  $ 7,014     $ 6,202     $ 5,434  
 
                       
Add:      Stock-based employee compensation expense included in reported net income, net of tax
    2       3       3  
Less:      Total stock-based employee compensation expense under the fair value method for all awards, net of tax
    (275 )     (198 )     (190 )
 
                 
 
                       
Net income, pro forma
  $ 6,741     $ 6,007     $ 5,247  
 
                 
 
                       
Earnings per common share
                       
As reported
  $ 4.15     $ 3.69     $ 3.19  
Pro forma
    3.99       3.57       3.08  
Diluted earnings per common share
 
As reported
  $ 4.09     $ 3.65     $ 3.16  
Pro forma
    3.93       3.53       3.05  
 
                       
 

 

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      Total stock-based employee compensation was higher under the fair value method in 2004 compared with 2003. Stock options granted in our February 2004 grant, under our Long-Term Incentive Compensation Plan (the Plan), fully vested upon grant, resulting in full recognition of stock-based compensation expense for the 2004 annual grant under the fair value method in the table on the previous page. Stock options granted in our 2003, 2002 and 2001 annual grants under the Plan vest over a three-year period, and expense reflected in the table for these grants is recognized over the vesting period.

Earnings Per Common Share
We present earnings per common share and diluted earnings per common share. We compute earnings per common share by dividing net income (after deducting dividends on preferred stock) by the average number of common shares outstanding during the year. We compute diluted earnings per common share by dividing net income (after deducting dividends on preferred stock) by the average number of common shares outstanding during the year, plus the effect of common stock equivalents (for example, stock options, restricted share rights and convertible debentures) that are dilutive.

Derivatives and Hedging Activities
We recognize all derivatives on the balance sheet at fair value. On the date we enter into a derivative contract, we designate the derivative as (1) a hedge of the fair value of a recognized asset or liability (“fair value” hedge), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow” hedge) or (3) held for trading, customer accommodation or a contract not qualifying for hedge accounting (“free-standing derivative”). For a fair value hedge, we record changes in the fair value of the derivative and, to the extent that it is effective, changes in the fair value of the hedged asset or liability, attributable to the hedged risk, in current period net income in the same financial statement category as the hedged item. For a cash flow hedge, we record changes in the fair value of the derivative to the extent that it is effective in other comprehensive income. We subsequently reclassify these changes in fair value to net income in the same period(s) that the hedged transaction affects net income in the same financial statement category as the hedged item. For free-standing derivatives, we report changes in the fair values in current period noninterest income.

      We formally document the relationship between hedging instruments and hedged items, as well as our risk management objective and strategy for various hedge transactions. This includes linking all derivatives designated as fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific forecasted transactions. We also

formally assess, both at the inception of the hedge and on an ongoing basis, if the derivatives we use are highly effective in offsetting changes in fair values or cash flows of hedged items. If we determine that a derivative is not highly effective as a hedge, we discontinue hedge accounting.

      We discontinue hedge accounting prospectively when (1) a derivative is no longer highly effective in offsetting changes in the fair value or cash flows of a hedged item, (2) a derivative expires or is sold, terminated, or exercised, (3) a derivative is dedesignated as a hedge, because it is unlikely that a forecasted transaction will occur, or (4) we determine that designation of a derivative as a hedge is no longer appropriate.
      When we discontinue hedge accounting because a derivative no longer qualifies as an effective fair value hedge, we continue to carry the derivative on the balance sheet at its fair value with changes in fair value included in earnings, and no longer adjust the previously hedged asset or liability for changes in fair value. Previous adjustments to the hedged item are accounted for in the same manner as other components of the carrying amount of the asset or liability.
      When we discontinue hedge accounting because it is probable that a forecasted transaction will not occur, we continue to carry the derivative on the balance sheet at its fair value with changes in fair value included in earnings, and immediately recognize gains and losses that were accumulated in other comprehensive income in earnings.
      When we discontinue hedge accounting because the hedging instrument is sold, terminated, or no longer designated (dedesignated), the amount reported in other comprehensive income up to the date of sale, termination or dedesignation continues to be reported in other comprehensive income until the forecasted transaction affects earnings.
      In all other situations in which we discontinue hedge accounting, the derivative will be carried at its fair value on the balance sheet, with changes in its fair value recognized in current period earnings.
      We occasionally purchase or originate financial instruments that contain an embedded derivative. At inception of the financial instrument, we assess (1) if the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the financial instrument (host contract), (2) if the financial instrument that embodies both the embedded derivative and the host contract is measured at fair value with changes in fair value reported in earnings, or (3) if a separate instrument with the same terms as the embedded instrument would meet the definition of a derivative. If the embedded derivative does not meet any of these conditions, we separate it from the host contract and carry it at fair value with changes recorded in current period earnings.

 

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Note 2:   Business Combinations

 

We regularly explore opportunities to acquire financial services companies and businesses. Generally, we do not make a public announcement about an acquisition opportunity until a definitive agreement has been signed.

      Effective December 31, 2004, we completed the acquisition of $29 billion in assets under management, comprising $24 billion in mutual fund assets and $5 billion in institutional investment accounts, from Strong Financial Corporation. Other business combinations completed in 2004, 2003 and 2002 were:

      At December 31, 2004, we had two pending business combinations with total assets of approximately $720 million. We expect to complete these transactions by second quarter 2005.

      For information on contingent consideration related to acquisitions, which are considered guarantees, see Note 25.

 

                 
   

(in millions)
  Date   Assets  
 
               
2004
               
Other (1)
  Various   $ 74  
 
             
 
               
2003
               
Certain assets of Telmark, LLC, Syracuse, New York
  February 28   $ 660  
Pacific Northwest Bancorp, Seattle, Washington
  October 31     3,245  
Two Rivers Corporation, Grand Junction, Colorado
  October 31     74  
Other (2)
  Various     136  
 
             
 
          $ 4,115  
 
             
 
               
2002
               
Texas Financial Bancorporation, Inc., Minneapolis, Minnesota
  February 1   $ 2,957  
Five affiliated banks and related entities of Marquette Bancshares, Inc. located in Minnesota, Wisconsin, Illinois, Iowa and South Dakota
  February 1     3,086  
Rediscount business of Washington Mutual Bank, FA, Philadelphia, Pennsylvania
  March 28     281  
Tejas Bancshares, Inc., Amarillo, Texas
  April 26     374  
Other (3)
  Various     94  
 
             
 
          $ 6,792  
 
             
 
               
   
 
(1)   Consists of 13 acquisitions of insurance brokerage and payroll services businesses.
(2)   Consists of 14 acquisitions of asset management, commercial real estate brokerage, bankruptcy and insurance brokerage businesses.
(3)   Consists of 6 acquisitions of asset management, securities brokerage and insurance brokerage businesses.

Note 3:   Cash, Loan and Dividend Restrictions

 

Federal Reserve Board regulations require that each of our subsidiary banks maintain reserve balances on deposits with the Federal Reserve Banks. The average required reserve balance was $1.2 billion and $1.0 billion in 2004 and 2003, respectively.

      Federal law restricts the amount and the terms of both credit and non-credit transactions between a bank and its nonbank affiliates. They may not exceed 10% of the bank’s capital and surplus (which for this purpose represents Tier 1 and Tier 2 capital, as calculated under the risk-based capital guidelines, plus the balance of the allowance for credit losses excluded from Tier 2 capital) with any single nonbank affiliate and 20% of the bank’s capital and surplus with all its nonbank affiliates. Transactions that are extensions of credit may require collateral to be held to provide added security to the bank. (For further discussion of risk-based capital, see Note 26.)

      Dividends paid by our subsidiary banks are subject to various federal and state regulatory limitations. Dividends that may be paid by a national bank without the express approval of the Office of the Comptroller of the Currency (OCC) are limited to that bank’s retained net profits for the preceding two calendar years plus retained net profits up to the date of any dividend declaration in the current calendar year. Retained net profits, as defined by the OCC, consist of net income less dividends declared during the period. We also have state-chartered subsidiary banks that are subject to state regulations that limit dividends. Under those provisions, our national and state-chartered subsidiary banks could have declared additional dividends of $1,154 million and $844 million at December 31, 2004 and 2003, respectively, without obtaining prior regulatory approval. In addition, our nonbank subsidiaries could have declared additional dividends of $1,638 million and $1,682 million at December 31, 2004 and 2003, respectively.

 

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Note 4:    Federal Funds Sold, Securities Purchased Under Resale Agreements and Other Short-Term Investments

 

The table to the right provides the detail of federal funds sold, securities purchased under resale agreements and other short-term investments.

                 
   

(in millions)
  December 31 ,
    2004     2003  
 
               
Federal funds sold and securities purchased under resale agreements
  $ 3,009     $ 2,081  
Interest-earning deposits
    1,397       988  
Other short-term investments
    614       664  
 
           
Total
  $ 5,020     $ 3,733  
 
           
 
               
 

 

Note 5:   Securities Available for Sale

 

The following table provides the cost and fair value for the major categories of securities available for sale carried at fair

value. There were no securities classified as held to maturity at the end of 2004 or 2003.

 

                                                                 
   
 
(in millions)   December 31 ,
  2004     2003  
    Cost     Unrealized     Unrealized     Fair     Cost     Unrealized     Unrealized     Fair  
          gross     gross     value           gross     gross     value  
          gains     losses                 gains     losses        
 
                                                               
Securities of U.S. Treasury and federal agencies
  $ 1,128     $ 16     $ (4 )   $ 1,140     $ 1,252     $ 35     $ (1 )   $ 1,286  
Securities of U.S. states and political subdivisions
    3,429       196       (4 )     3,621       3,175       176       (5 )     3,346  
Mortgage-backed securities:
                                                               
Federal agencies
    20,198       750       (4 )     20,944       20,353       799       (22 )     21,130  
Private collateralized mortgage obligations (1)
    4,082       121       (4 )     4,199       3,056       106       (8 )     3,154  
 
                                               
Total mortgage-backed securities
    24,280       871       (8 )     25,143       23,409       905       (30 )     24,284  
Other
    2,974       157       (14 )     3,117       3,285       198       (28 )     3,455  
 
                                               
Total debt securities
    31,811       1,240       (30 )     33,021       31,121       1,314       (64 )     32,371  
Marketable equity securities
    507       198       (9 )     696       394       188             582  
 
                                               
Total (2)
  $ 32,318     $ 1,438     $ (39 )   $ 33,717     $ 31,515     $ 1,502     $ (64 )   $ 32,953  
 
                                               
 
                                                               
 
 
(1)   A majority of private collateralized mortgage obligations are AAA-rated bonds collateralized by 1–4 family residential first mortgages.
(2)   At December 31, 2004, we held no securities of any single issuer (excluding the U.S.Treasury and federal agencies) with a book value that exceeded 10% of stockholders’ equity.

         The following table shows the unrealized gross losses and fair value of
securities in the securities available for sale portfolio at

December 31, 2004, by length of time that individual securities in each category have been in a continuous loss position.

 

                                                 
   

(in millions)
  December 31, 2004  
    Less than 12 months     12 months or more     Total  
    Unrealized     Fair     Unrealized     Fair     Unrealized     Fair  
    gross     value     gross     value     gross     value  
    losses           losses           losses        
 
                                               
Securities of U.S. Treasury and federal agencies
  $ (4 )   $ 304     $     $     $ (4 )   $ 304  
Securities of U.S. states and political subdivisions
    (1 )     65       (3 )     62       (4 )     127  
Mortgage-backed securities:
                                               
Federal agencies
    (4 )     450                   (4 )     450  
Private collateralized mortgage obligations
    (4 )     981                   (4 )     981  
 
                                   
Total mortgage-backed securities
    (8 )     1,431                   (8 )     1,431  
Other
    (11 )     584       (3 )     56       (14 )     640  
 
                                   
Total debt securities
    (24 )     2,384       (6 )     118       (30 )     2,502  
Marketable equity securities
    (9 )     44                   (9 )     44  
 
                                   
Total
  $ (33 )   $ 2,428     $ (6 )   $ 118     $ (39 )   $ 2,546  
 
                                   
 
                                               
 

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      We had a limited number of debt securities in a continuous loss position for 12 months or more at December 31, 2004, which consisted of asset-backed securities, bonds and notes. Because the declines in fair value were due to changes in market interest rates, not in estimated cash flows, and because we have the intent and ability to retain our investment in the issuer for a period of time to allow for any anticipated recovery in market value, no other-than-temporary impairment was recorded at December 31, 2004.

      Securities pledged where the secured party has the right to sell or repledge totaled $2.3 billion at December 31, 2004, and $3.2 billion at December 31, 2003. Securities pledged where the secured party does not have the right to sell or repledge totaled $19.4 billion at December 31, 2004, and $18.6 billion at December 31, 2003, primarily to secure trust and public deposits and for other purposes as required or permitted by law. We have accepted collateral in the form of securities that we have the right to sell or repledge of $2.5 billion at December 31, 2004, and $2.1 billion at December 31, 2003, of which we sold or repledged $1.7 billion and $1.8 billion, respectively.

      The following table shows the realized net gains on the sales of securities from the securities available for sale portfolio, including marketable equity securities.

                         
   

(in millions)
  Year ended December 31 ,
    2004     2003     2002  
 
                       
Realized gross gains
  $ 168     $ 178     $ 617  
Realized gross losses (1)
    (108 )     (116 )     (419 )
 
                 
Realized net gains
  $ 60     $ 62     $ 198  
 
                 
 
                       
 
 
(1)   Includes other-than-temporary impairment of $9 million, $50 million and $180 million for 2004, 2003 and 2002, respectively.

      The following table shows the remaining contractual principal maturities and contractual yields of debt securities available for sale. The remaining contractual principal maturities for mortgage-backed securities were allocated assuming no prepayments. Remaining expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations before the underlying mortgages mature.

 

                                                                                 
   

(in millions)
  December 31, 2004  
    Total     Weighted -   Remaining contractual principal maturity  
    amount     average                     After one year     After five years        
          yield     Within one year     through five years     through ten years     After ten years  
                Amount     Yield     Amount     Yield     Amount     Yield     Amount     Yield  
 
                                                                               
Securities of U.S. Treasury
and federal agencies
  $ 1,140       3.51 %   $ 278       3.02 %   $ 774       3.47 %   $ 43       4.99 %   $ 45       5.73 %
Securities of U.S. states and
political subdivisions
    3,621       7.20       253       8.10       1,011       7.73       1,020       7.35       1,337       6.51  
Mortgage-backed securities:
                                                                               
Federal agencies
    20,944       5.80       28       2.79       89       5.55       66       5.72       20,761       5.81  
Private collateralized mortgage obligations
    4,199       4.98                   3       6.80       4       3.79       4,192       4.98  
 
                                                                     
Total mortgage-backed securities
    25,143       5.67       28       2.79       92       5.60       70       5.60       24,953       5.67  
Other
    3,117       8.42       207       4.63       1,037       8.46       1,115       8.79       758       8.84  
 
                                                                     
 
                                                                               
ESTIMATED FAIR VALUE OF DEBT SECURITIES (1)
  $ 33,021       6.02 %   $ 766       5.12 %   $ 2,914       6.79 %   $ 2,248       7.97 %   $ 27,093       5.80 %
 
                                                           
 
                                                                               
TOTAL COST OF DEBT SECURITIES
  $ 31,811             $ 645             $ 2,504             $ 2,093             $ 26,569          
 
                                                                     
 
                                                                               
 
 
(1)   The weighted-average yield is computed using the contractual life amortization method.

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Note 6:   Loans and Allowance for Credit Losses

 

A summary of the major categories of loans outstanding is shown in the following table. Outstanding loan balances at December 31, 2004 and 2003, are net of unearned income, including net deferred loan fees, of $3,766 million and $3,430 million, respectively.

      At December 31, 2004 and 2003, we did not have any concentrations greater than 10% of total loans included in

any of the following loan categories: commercial loans by industry; commercial real estate loans by state or property type; real estate 1–4 family first and junior lien mortgages by state, except for California, which represented 18% of total loans at December 31, 2004, and 19% of total loans at December 31, 2003; or other revolving credit and installment loans by product type.

 

                                         
   

(in millions)
  December 31 ,
    2004     2003     2002     2001     2000  
 
                                       
Commercial and commercial real estate:
                                       
Commercial
  $ 54,517     $ 48,729     $ 47,292     $ 47,547     $ 50,518  
Other real estate mortgage
    29,804       27,592       25,312       24,808       23,972  
Real estate construction
    9,025       8,209       7,804       7,806       7,715  
Lease financing
    5,169       4,477       4,085       4,017       4,350  
 
                             
Total commercial and commercial real estate
    98,515       89,007       84,493       84,178       86,555  
 
                                       
Consumer:
                                       
Real estate 1-4 family first mortgage
    87,686       83,535       44,119       29,317       19,321  
Real estate 1-4 family junior lien mortgage
    52,190       36,629       28,147       21,801       17,361  
Credit card
    10,260       8,351       7,455       6,700       6,616  
Other revolving credit and installment
    34,725       33,100       26,353       23,502       23,974  
 
                             
Total consumer
    184,861       161,615       106,074       81,320       67,272  
 
                                       
Foreign
    4,210       2,451       1,911       1,598       1,624  
 
                             
Total loans
  $ 287,586     $ 253,073     $ 192,478     $ 167,096     $ 155,451  
 
                             
 
                                       
 

      In assessing adequate compensation for the credit risk presented by a customer, we may require collateral. We hold various types of collateral, including accounts receivable, inventory, land, buildings, equipment, income-producing commercial properties and residential real estate. Collateral requirements for each customer may vary according to the specific credit underwriting, terms and structure of loans funded immediately or under a commitment to fund at a later date.

      A commitment to extend credit is a legally binding agreement to lend funds to a customer, usually at a stated interest rate and for a specified purpose. These commitments have fixed expiration dates and generally require a fee. When we make such a commitment, we have credit risk. The liquidity requirements or credit risk will be lower than the contractual amount of commitments to extend credit because a significant portion of these commitments are expected to expire without being used. Certain commitments are subject to loan agreements with covenants regarding the financial performance of the customer that must be met before we are required to fund the commitment. We use the same credit policies for commitments to extend credit that we use in making loans. For information on standby letters of credit, see Note 25.

      In addition, we manage the potential risk in credit commitments by limiting the total amount of arrangements, both by individual customer and in total, by monitoring the size and maturity structure of these portfolios and by applying the same credit standards for all of our credit activities.

      The total of our unfunded loan commitments, net of all funds lent and all standby and commercial letters of credit issued under the terms of these commitments, is summarized by loan categories in the following table.
                 
   

(in millions)
  December 31 ,
    2004     2003  
 
               
Commercial and commercial real estate:
               
Commercial
  $ 59,603     $ 52,211  
Other real estate mortgage
    2,788       1,961  
Real estate construction
    7,164       5,644  
 
           
Total commercial and commercial real estate
    69,555       59,816  
 
               
Consumer:
               
Real estate 1-4 family first mortgage
    9,009       6,428  
Real estate 1-4 family junior lien mortgage
    31,396       23,436  
Credit card
    38,200       24,831  
Other revolving credit and installment
    15,427       11,219  
 
           
Total consumer
    94,032       65,914  
 
               
Foreign
    407       238  
 
           
Total loan commitments
  $ 163,994     $ 125,968  
 
           
 
               
 

 

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      The allowance for credit losses comprises the allowance for loan losses and the reserve for unfunded credit commitments.

Changes in the allowance for credit losses were:

 

                                         
   

(in millions)
  Year ended December 31 ,
    2004     2003     2002     2001     2000  
 
                                       
Balance, beginning of year
  $ 3,891     $ 3,819     $ 3,717     $ 3,681     $ 3,312  
 
                                       
Allowances related to business combinations/other
    8       69       93       41       265  
 
                                       
Provision for credit losses
    1,717       1,722       1,684       1,727       1,284  
 
                                       
Loan charge-offs:
                                       
Commercial and commercial real estate:
                                       
Commercial
    (424 )     (597 )     (716 )     (692 )     (429 )
Other real estate mortgage
    (25 )     (33 )     (24 )     (32 )     (32 )
Real estate construction
    (5 )     (11 )     (40 )     (37 )     (8 )
Lease financing
    (62 )     (41 )     (21 )     (22 )      
 
                             
Total commercial and commercial real estate
    (516 )     (682 )     (801 )     (783 )     (469 )
 
                                       
Consumer:
                                       
Real estate 1-4 family first mortgage
    (53 )     (47 )     (39 )     (40 )     (16 )
Real estate 1-4 family junior lien mortgage
    (107 )     (77 )     (55 )     (36 )     (34 )
Credit card
    (463 )     (476 )     (407 )     (421 )     (367 )
Other revolving credit and installment
    (919 )     (827 )     (770 )     (770 )     (623 )
 
                             
Total consumer
    (1,542 )     (1,427 )     (1,271 )     (1,267 )     (1,040 )
 
                                       
Foreign
    (143 )     (105 )     (84 )     (78 )     (86 )
 
                             
Total loan charge-offs
    (2,201 )     (2,214 )     (2,156 )     (2,128 )     (1,595 )
 
                             
 
                                       
Loan recoveries:
                                       
Commercial and commercial real estate:
                                       
Commercial
    150       177       162       96       98  
Other real estate mortgage
    17       11       16       22       13  
Real estate construction
    6       11       19       3       4  
Lease financing
    26       8                    
 
                             
Total commercial and commercial real estate
    199       207       197       121       115  
 
                                       
Consumer:
                                       
Real estate 1-4 family first mortgage
    6       10       8       6       4  
Real estate 1-4 family junior lien mortgage
    24       13       10       8       14  
Credit card
    62       50       47       40       39  
Other revolving credit and installment
    220       196       205       203       213  
 
                             
Total consumer
    312       269       270       257       270  
 
                                       
Foreign
    24       19       14       18       30  
 
                             
Total loan recoveries
    535       495       481       396       415  
 
                             
Net loan charge-offs
    (1,666 )     (1,719 )     (1,675 )     (1,732 )     (1,180 )
 
                             
 
                                       
Balance, end of year
  $ 3,950     $ 3,891     $ 3,819     $ 3,717     $ 3,681  
 
                             
 
                                       
Components:
                                       
Allowance for loan losses
  $ 3,762     $ 3,891     $ 3,819     $ 3,717     $ 3,681  
Reserve for unfunded credit commitments (1)
    188                          
 
                             
Allowance for credit losses
  $ 3,950     $ 3,891     $ 3,819     $ 3,717     $ 3,681  
 
                             
 
                                       
Net loan charge-offs as a percentage of average total loans
    .62 %     .81 %     .96 %     1.10 %     .84 %
 
                                       
Allowance for loan losses as a percentage of total loans
    1.31 %     1.54 %     1.98 %     2.22 %     2.37 %
Allowance for credit losses as a percentage of total loans
    1.37       1.54       1.98       2.22       2.37  
 
                                       
 
 
(1)   Effective September 30, 2004, we transferred the portion of the allowance for loan losses related to commercial lending commitments and letters of credit to other liabilities.

      We have an established process to determine the adequacy of the allowance for credit losses that assesses the risks and losses inherent in our portfolio. This process supports an allowance consisting of two components, allocated and unallocated. For the allocated component, we combine estimates of the allowances needed for loans analyzed on a pooled basis and loans analyzed individually (including impaired loans).

      Approximately two-thirds of the allocated allowance is determined at a pooled level for retail loan portfolios (consumer loans and leases, home mortgage loans, and some segments of small business loans). We use forecasting models to measure inherent loss in these portfolios. We frequently validate and update these models to capture recent behavioral characteristics of the portfolios, as well as any changes in our loss mitigation or marketing strategies.

 

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      We use a standardized loan grading process for wholesale loan portfolios (commercial, commercial real estate, real estate construction and leases) and review larger higher-risk transactions individually. Based on this process, we assign a loss factor to each pool of graded loans. For graded loans with evidence of credit weakness at December 31, 2004, the loss factors are derived from migration models that track loss content associated with actual portfolio movements between loan grades over a specified period of time. For graded loans without evidence of credit weakness at December 31, 2004, we use a combination of our long-term average loss experience and external loss data. In addition, we individually review nonperforming loans over $3 million for impairment based on cash flows or collateral. We include the impairment on nonperforming loans in the allocated allowance unless it has already been recognized as a loss.

      The potential risk from unfunded loan commitments and letters of credit for wholesale loan portfolios is considered along with the loss analysis of loans outstanding. Unfunded commercial loan commitments and letters of credit are converted to a loan equivalent factor as part of the analysis. At December 31, 2004, the reserve for these unfunded credit commitments was $188 million, less than 5% of the allowance for credit losses. At December 31, 2003, 3% of the total allowance for credit losses related to this potential risk.
      The allocated allowance is supplemented by the unallocated allowance to adjust for imprecision and to incorporate the range of probable outcomes inherent in estimates used for the allocated allowance. The unallocated allowance is the result of our judgment of risks inherent in the portfolio, economic uncertainties, historical loss experience and other subjective factors, including industry trends.
      The ratios of the allocated allowance and the unallocated allowance to the total allowance may change from period to period. The total allowance reflects management’s estimate of credit losses inherent in the loan portfolio, including unfunded commitments, at December 31, 2004.
      Like all national banks, our subsidiary national banks continue to be subject to examination by their primary regulator, the Office of the Comptroller of the Currency (OCC), and some have OCC examiners in residence. The OCC examinations occur throughout the year and target various activities of our subsidiary national banks, including both the loan grading system and specific segments of the loan portfolio (for example, commercial real estate and shared national credits). The Parent and its nonbank subsidiaries are examined by the Federal Reserve Board.

      We consider the allowance for credit losses of $3.95 billion adequate to cover credit losses inherent in the loan portfolio, including unfunded commitments, at December 31, 2004.

      Nonaccrual loans were $1,358 million and $1,458 million at December 31, 2004 and 2003, respectively. Loans past due 90 days or more as to interest or principal and still accruing interest were $2,578 million at December 31, 2004 and $2,337 million at December 31, 2003. The 2004 and 2003 balances included $1,820 million and $1,641 million, respectively, in advances pursuant to our servicing agreements to the Government National Mortgage Association (GNMA) mortgage pools whose repayments are insured by the Federal Housing Administration or guaranteed by the Department of Veteran Affairs. Prior to clarifying guidance issued in 2003 as to classification as loans, GNMA advances were included in other assets.
      The recorded investment in impaired loans and the methodology used to measure impairment was:
                 
   

(in millions)
  December 31 ,
    2004     2003  
 
               
Impairment measurement based on:
               
Collateral value method
  $ 183     $ 386  
Discounted cash flow method
    126       243  
 
           
Total (1)
  $ 309     $ 629  
 
           
 
               
 
 
(1)   Includes $107 million and $59 million of impaired loans with a related allowance of $17 million and $8 million at December 31, 2004 and 2003, respectively.

      The average recorded investment in impaired loans during 2004, 2003 and 2002 was $481 million, $668 million and $705 million, respectively.

      All of our impaired loans are on nonaccrual status. When the ultimate collectibility of the total principal of an impaired loan is in doubt, all payments are applied to principal, under the cost recovery method. When the ultimate collectibility of the total principal of an impaired loan is not in doubt, contractual interest is credited to interest income when received, under the cash basis method. Total interest income recognized for impaired loans in 2004, 2003 and 2002 under the cash basis method was not significant.

 

76


 

Note 7: Premises, Equipment, Lease Commitments and Other Assets

 

                 
   

     
(in millions)   December 31 ,
    2004     2003  
 
               
Land
  $ 585     $ 521  
Buildings
    2,974       2,699  
Furniture and equipment
    3,110       3,013  
Leasehold improvements
    1,049       957  
Premises and equipment leased under capital leases
    60       57  
 
           
Total premises and equipment
    7,778       7,247  
Less accumulated depreciation and amortization
    3,928       3,713  
 
           
Net book value, premises and equipment
  $ 3,850     $ 3,534  
 
           
 
               
 

Depreciation and amortization expense for premises and equipment was $654 million, $666 million and $599 million in 2004, 2003 and 2002, respectively.

      Net losses on dispositions of premises and equipment, included in noninterest expense, were $5 million, $46 million and $52 million in 2004, 2003 and 2002, respectively.
      We have obligations under a number of noncancelable operating leases for premises (including vacant premises) and equipment. The terms of these leases, including renewal options, are predominantly up to 15 years, with the longest up to 75 years, and many provide for periodic adjustment of rentals based on changes in various economic indicators. The future minimum payments under noncancelable operating leases and capital leases, net of sublease rentals, with terms greater than one year as of December 31, 2004, were:
                 
   

           
(in millions)   Operating leases     Capital leases  
 
               
Year ended December 31,
               
2005
  $ 476     $ 7  
2006
    398       4  
2007
    332       2  
2008
    268       2  
2009
    219       1  
Thereafter
    835       15  
 
           
Total minimum lease payments
  $ 2,528       31  
 
             
 
               
Executory costs
            (2 )
Amounts representing interest
            (9 )
 
             
Present value of net minimum lease payments
          $ 20  
 
             
 
               
 

       

      Operating lease rental expense (predominantly for premises), net of rental income, was $586 million, $574 million and $535 million in 2004, 2003 and 2002, respectively.
      The components of other assets were:
                 
   

             
(in millions)   December 31 ,
    2004     2003  
 
               
Nonmarketable equity investments:
               
Private equity investments
  $ 1,449     $ 1,714  
Federal bank stock
    1,713       1,765  
All other
    2,067       1,542  
 
           
Total nonmarketable equity investments(1)
    5,229       5,021  
 
               
Operating lease assets
    3,642       3,448  
Accounts receivable
    2,682       2,456  
Interest receivable
    1,483       1,287  
Core deposit intangibles
    603       737  
Foreclosed assets
    212       198  
Due from customers on acceptances
    170       137  
Other
    8,470       6,845  
 
           
Total other assets
  $ 22,491     $ 20,129  
 
           
 
               
 
 
(1)   At December 31, 2004 and 2003, $3.3 billion and $2.8 billion, respectively, of nonmarketable equity investments, including all federal bank stock, were accounted for at cost.

      Income related to nonmarketable equity investments was:

                 
   

     
(in millions)   Year ended December 31 ,
    2004     2003  
 
               
Nonmarketable equity investments:
               
Net gains (losses) from private equity investments
  $ 319     $ (3 )
Net gains from all other nonmarketable equity investments
    33       116  
 
           
Net gains from nonmarketable equity investments
  $ 352     $ 113  
 
           
 
               
 

 

77


 

Note 8: Intangible Assets

 

The gross carrying amount of intangible assets and accumulated amortization was:

                                 
   

     
(in millions)   December 31 ,
    2004     2003  
    Gross     Accumulated     Gross     Accumulated  
    carrying     amortization     carrying     amortization  
    amount           amount        
 
                               
Amortized intangible assets:
                               
Mortgage servicing rights, before valuation
allowance(1)
  $ 18,903     $ 9,437     $ 16,459     $ 7,611  
Core deposit intangibles
    2,426       1,823       2,426       1,689  
Other
    567       296       392       273  
 
                       
Total amortized intangible assets
  $ 21,896     $ 11,556     $ 19,277     $ 9,573  
 
                       
Unamortized intangible asset (trademark)
  $ 14             $ 14          
 
                           
 
                               
 
 
(1)   See Note 22 for additional information on MSRs and the related valuation allowance.

      As of December 31, 2004, the current year and estimated future amortization expense for amortized intangible assets was:

                                 
   

                       
(in millions)   Mortgage     Core     Other     Total  
    servicing     deposit              
    rights     intangibles              
 
                               
Year ended December 31, 2004
  $ 1,826     $ 134     $ 26     $ 1,986  
 
                       
Estimate for year ended December 31,
                   
2005
  $ 1,828     $ 123     $ 51     $ 2,002  
2006
    1,413       110       47       1,570  
2007
    1,115       100       44       1,259  
2008
    930       92       25       1,047  
2009
    762       85       23       870  
 
                               
 

      We based the projections of amortization expense for mortgage servicing rights shown above on existing asset balances and the existing interest rate environment as of December 31, 2004. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates and market conditions. We based the projections of amortization expense for core deposit intangibles shown above on existing asset balances at December 31, 2004. Future amortization expense may vary based on additional core deposit intangibles acquired through business combinations.

 

78


 

Note 9: Goodwill

 

The changes in the carrying amount of goodwill as allocated to our operating segments for goodwill impairment analysis were:

                                 
   

                       
(in millions)   Community     Wholesale     Wells Fargo     Consolidated  
    Banking     Banking     Financial     Company  
 
                               
December 31, 2002
  $ 6,743     $ 2,667     $ 343     $ 9,753  
Goodwill from business combinations
    545       68             613  
Foreign currency translation adjustments
                7       7  
Goodwill written off related to divested businesses
    (2 )                 (2 )
 
                       
 
                               
December 31, 2003
    7,286       2,735       350       10,371  
Goodwill from business combinations
    5       302             307  
Foreign currency translation adjustments
                3       3  
 
                       
December 31, 2004
  $ 7,291     $ 3,037     $ 353     $ 10,681  
 
                       
 
                               
   

      For goodwill impairment testing, enterprise-level goodwill acquired in business combinations is allocated to reporting units based on the relative fair value of assets acquired and recorded in the respective reporting units. Through this allocation, we assigned enterprise-level goodwill to the reporting units that are expected to benefit from the synergies of the combination. We used discounted estimated future net cash flows to evaluate goodwill reported at all reporting units.

      For our goodwill impairment analysis, we allocate all of the goodwill to the individual operating segments. For management reporting we do not allocate all of the goodwill to the individual operating segments: some is allocated at the enterprise level. See Note 20 for further information on management reporting. The balances of goodwill for management reporting were:

 

                                         
   

                             
(in millions)   Community     Wholesale     Wells Fargo     Enterprise     Consolidated  
    Banking     Banking     Financial           Company  
 
                                       
December 31, 2003
  $ 3,439     $ 785     $ 350     $ 5,797     $ 10,371  
 
                             
 
                                       
December 31, 2004
  $ 3,444     $ 1,087     $ 353     $ 5,797     $ 10,681  
 
                             
 
                                       
   

79


 

Note 10: Deposits

 

The total of time certificates of deposit and other time deposits issued by domestic offices was $55,495 million and $47,322 million at December 31, 2004 and 2003, respectively. Substantially all of those deposits were interest bearing. The contractual maturities of those deposits were:

         
   

     
(in millions)   December 31, 2004  
 
       
2005
  $ 47,937  
2006
    3,758  
2007
    1,909  
2008
    953  
2009
    604  
Thereafter
    334  
 
     
Total
  $ 55,495  
 
     
 
       
 

      Of those deposits, the amount of time deposits with a denomination of $100,000 or more was $41,851 million and $33,258 million at December 31, 2004 and 2003, respectively. The contractual maturities of these deposits were:

         
   

     
(in millions)   December 31, 2004  
 
       
Three months or less
  $ 37,990  
After three months through six months
    778  
After six months through twelve months
    1,115  
After twelve months
    1,968  
 
     
Total
  $ 41,851  
 
     
 
       
 

Time certificates of deposit and other time deposits issued by foreign offices with a denomination of $100,000 or more represent the majority of all of our foreign deposit liabilities of $8,533 million and $8,768 million at December 31, 2004 and 2003, respectively.

      Demand deposit overdrafts of $470 million and $655 million were included as loan balances at December 31, 2004 and 2003, respectively.

 

Note 11: Short-Term Borrowings

 

The table below shows selected information for short-term borrowings, which generally mature in less than 30 days.

      At December 31, 2004, we had $1.09 billion available in lines of credit. These financing arrangements require the

maintenance of compensating balances or payment of fees, which were not material.

 

                                                 
   

                 
(in millions)   2004     2003     2002  
    Amount     Rate     Amount     Rate     Amount     Rate  
 
                                               
As of December 31,
                                               
Commercial paper and other short-term borrowings
  $ 6,225       2.40 %   $ 6,709       1.26 %   $ 11,109       1.57 %
 
               
Federal funds purchased and securities sold under agreements to repurchase
    15,737       2.04       17,950       .84       22,337       1.08  
 
                                         
Total
  $ 21,962       2.14     $ 24,659       .95     $ 33,446       1.24  
 
                                         
 
               
 
                                               
Year ended December 31,
                                               
Average daily balance
                                               
Commercial paper and other short-term borrowings
  $ 10,010       1.56 %   $ 11,506       1.22 %   $ 13,048       1.84 %
 
               
Federal funds purchased and securities sold under agreements to repurchase
    16,120       1.22       18,392       .99       20,230       1.47  
 
                                         
Total
  $ 26,130       1.35     $ 29,898       1.08     $ 33,278       1.61  
 
                                         
 
               
Maximum month-end balance
                                               
Commercial paper and other short-term borrowings (1)
  $ 16,492       N/A     $ 14,462       N/A     $ 17,323       N/A  
 
               
Federal funds purchased and securities sold under agreements to repurchase (2)
    22,117       N/A       24,132       N/A       33,647       N/A  
 
                                               
 
 
N/A – Not applicable.
(1)   Highest month-end balance in each of the last three years was in July 2004, January 2003 and January 2002.
(2)   Highest month-end balance in each of the last three years was in June 2004, April 2003 and January 2002.

80


 

Note 12: Long-Term Debt

 

Following is a summary of long-term debt, based on original maturity, (reflecting unamortized debt discounts and premiums, where applicable) owed by the Parent and its subsidiaries:

                         
 

             
(in millions)           December 31 ,
    Maturity   Stated   2004     2003  
    date(s)   interest            
        rate(s)            
 
                       
Wells Fargo & Company (Parent only)
                       
 
                     
Senior
                       
Global Notes(1)
  2005-2027   2.20-7.65%   $ 12,970     $ 9,497  
Floating-Rate Notes
  2005-2009   Varies     20,155       12,905  
Extendable Notes(2)
  2005-2009   Varies     5,500       2,999  
Equity Linked Notes(3)
  2006-2014   Varies     472       297  
Convertible Debenture(4)
  2033   Varies     3,000       3,000  
 
                   
Total senior debt – Parent
            42,097       28,698  
 
                   
 
                     
Subordinated
                       
Fixed-Rate Notes(1)
  2011-2023   4.625-6.65%     4,502       3,280  
FixFloat Notes
  2012   4.00% through 2006, varies     299       299  
 
                   
Total subordinated debt – Parent
            4,801       3,579  
 
                   
 
                     
Junior Subordinated
                       
Fixed-Rate Notes(1)(5)
  2031-2034   5.625-7.00%     3,248       2,732  
 
                   
Total junior subordinated debt – Parent
            3,248       2,732  
 
                   
Total long-term debt – Parent
            50,146       35,009  
 
                   
 
                       
Wells Fargo Bank, N.A. and its subsidiaries (WFB, N.A.)
                       
 
                     
Senior
                       
Fixed-Rate Bank Notes(1)
  2006-2007   1.50-2.75%     165       210  
Floating-Rate Notes
  2005-2034   Varies     7,604       9,035  
Floating-Rate Federal Home Loan Bank (FHLB) Advances
  2005-2011   Varies     1,400       1,075  
FHLB Notes and Advances(1)
  2012   5.20%     200       3,310  
Equity Linked Notes(3)
  2005-2014   2.08-5.13%     40        
Notes payable by subsidiaries
  2005-2024   3.132-21.08%     79       79  
Other notes and debentures
  2005-2013   1.14-3.83%     53        
Other notes and debentures
  2005-2011   Varies     11       11  
Obligations of subsidiaries under capital leases (Note 7)
            19       7  
 
                   
Total senior debt – WFB, N.A.
            9,571       13,727  
 
                   
 
                     
Subordinated
                       
Fixed-Rate Bank Notes(1)
  2011-2013   7.73-9.39%             16  
FixFloat Notes(1)
  2010   Varies     998       998  
Floating-Rate Notes
  2011-2013   Varies           43  
Notes
  2010-2011   6.45-7.55%     2,821       2,867  
Other notes and debentures
  2008-2013   6.00-12.00%     11        
 
                   
Total subordinated debt – WFB, N.A.
            3,830       3,924  
 
                   
Total long-term debt – WFB, N.A.
            13,401       17,651  
 
                   
 
                       
Wells Fargo Financial, Inc., and its subsidiaries (WFFI)
                       
 
                     
Senior
                       
Fixed-Rate Notes
  2005-2012   1.47-7.60%     5,343       6,969  
Floating-Rate Notes
  2005-2034   Varies     1,303       1,292  
 
                   
Total long-term debt – WFFI
          $ 6,646     $ 8,261  
 
                   
 
                       
 
 
(1)   We entered into interest rate swap agreements for a major portion of these notes, whereby we receive fixed-rate interest payments approximately equal to interest on the notes and make interest payments based on an average three-month or six-month London Interbank Offered Rate (LIBOR).
(2)   The extendable notes are floating-rate securities with an initial maturity of 13 months, which can be extended on a rolling monthly basis, at the investor’s option, to a final maturity of 5 years.
(3)   These notes are linked to baskets of equities, commodities or equity indices.
(4)   On April 15, 2003, we issued $3 billion of convertible senior debentures as a private placement. In November 2004, we amended the indenture under which the debentures were issued to eliminate a provision in the indenture that prohibited us from paying cash upon conversion of the debentures if an event of default as defined in the indenture exists at the time of conversion. We then made an irrevocable election under the indenture on December 15, 2004, that upon conversion of the debentures, we must satisfy the accreted value of the obligation (the amount accrued to the benefit of the holder exclusive of the conversion spread) in cash and may satisfy the conversion spread (the excess conversion value over the accreted value) in either cash or stock. We can also redeem all or some of the convertible debt securities for cash at any time on or after May 5, 2008, at their principal amount plus accrued interest, if any.
(5)   See Note 13 (Guaranteed Preferred Beneficial Interests in Company’s Subordinated Debentures).

(continued on following page)

81


 

                         
(continued from previous page)  

(in millions)
          December 31 ,
    Maturity   Stated   2004     2003  
    date(s)   interest            
        rate(s)            
 
                       
Other consolidated subsidiaries
                       
 
                       
Senior
                       
Fixed-Rate Notes
  2005-2031   1.50-6.97%   $ 93     $ 150  
Floating-Rate FHLB Advances
  2008-2009   Varies     500        
Other notes and debentures – Floating-Rate
  2011   Varies     10       10  
Other notes and debentures
  2005-2016   1.16-3.50%     471       41  
Other notes and debentures
  2007   Varies     1       5  
Obligations of subsidiaries under capital leases (Note 7)
            1       18  
 
                   
Total senior debt – Other consolidated subsidiaries
            1,076       224  
 
                   
 
                       
Subordinated
                       
Notes
  2008   6.25%     222       228  
Notes (1)
  2005-2006   6.875-7.31%     889       1,091  
Other notes and debentures – Floating-Rate
  2005   7.55%     85       85  
Other notes and debentures
  2005-2008   1.23-11.88%     83       57  
 
                   
Total subordinated debt – Other consolidated subsidiaries
            1,279       1,461  
 
                   
 
                       
Junior Subordinated
                       
Fixed-Rate Notes (5)
  2026-2029   7.73-9.875%     865       868  
Floating-Rate Notes (5)
  2027-2032   Varies     167       168  
 
                   
Total junior subordinated debt – Other consolidated subsidiaries
            1,032       1,036  
 
                   
Total long-term debt – Other consolidated subsidiaries
            3,387       2,721  
 
                   
Total long-term debt
          $ 73,580     $ 63,642  
 
                   
 
                       
 

      At December 31, 2004, the principal payments, including sinking fund payments, on long-term debt are due as noted:
                 
   

(in millions)
  Parent     Company  
 
               
2005 
  $ 8,149     $ 14,586  
2006 
    7,358       9,113  
2007 
    10,592       13,352  
2008 
    6,666       9,831  
2009 
    5,928       6,954  
Thereafter
    11,453       19,744  
 
           
Total
  $ 50,146     $ 73,580  
 
           
 
               
 
      The interest rates on floating-rate notes are determined periodically by formulas based on certain money market rates, subject, on certain notes, to minimum or maximum interest rates.
      As part of our long-term and short-term borrowing arrangements, we are subject to various financial and operational covenants. Some of the agreements under which debt has been issued have provisions that may limit the merger or sale of certain subsidiary banks and the issuance of capital stock or convertible securities by certain subsidiary banks. At December 31, 2004, we were in compliance with all the covenants.

 

Note 13: Guaranteed Preferred Beneficial Interests in Company’s Subordinated Debentures

 

Effective December 31, 2003, as a result of the adoption of FIN 46R we deconsolidated certain wholly-owned trusts formed for the sole purpose of issuing trust preferred securities (the Trusts). With respect to those Trusts that would otherwise be subject to reporting obligations under SEC rules and regulations, the Parent has provided a full and unconditional guarantee of the trust preferred securities, and the Trusts have no operating histories or independent operations and are not engaged in and do not propose to engage in any other activity.

      Information with respect to the Trusts is summarized in the table to the right and information with respect to the Parent is included in Note 23 (Condensed Consolidating Financial Statements). The trust preferred securities qualified as Tier 1 capital. See Note 26 (Regulatory and Agency Capital Requirements). The junior subordinated debentures
held by the Trusts are included in the Company’s long-term debt. See Note 12 (Long-Term Debt). Prior to December 31, 2003, the Trusts were consolidated subsidiaries and the trust preferred securities were included in liabilities in the consolidated balance sheet, as “Guaranteed preferred beneficial interests in Company’s subordinated debentures.”
                 
   

($ in millions)
  December 31 ,
    2004     2003  
 
               
Company’s junior subordinated debentures
  $ 4,280     $ 3,768  
 
           
 
               
Trust common securities
  $ 129     $ 113  
Trust preferred securities
    4,151       3,655  
 
           
 
  $ 4,280     $ 3,768  
 
           
 
               
Number of Trusts
    14       13  
 
           
 
               
 

 

82


 

Note 14: Preferred Stock

 

We are authorized to issue 20 million shares of preferred stock and 4 million shares of preference stock, both without par value. Preferred shares outstanding rank senior to common shares both as to dividends and liquidation preference but have no general voting rights. We have not issued any preference shares under this authorization.

      On November 15, 2003, all shares of the Adjustable-Rate Cumulative, Series B, preferred stock were redeemed. Preferred dividends of $3 million and $4 million were declared in 2003 and 2002, respectively.

ESOP CUMULATIVE CONVERTIBLE PREFERRED STOCK

All shares of our ESOP Cumulative Convertible Preferred Stock (ESOP Preferred Stock) were issued to a trustee acting on behalf of the Wells Fargo & Company 401(k) Plan.
Dividends on the ESOP Preferred Stock are cumulative from the date of initial issuance and are payable quarterly at annual rates ranging from 8.50% to 12.50%, depending upon the year of issuance. Each share of ESOP Preferred Stock released from the unallocated reserve of the 401(k) Plan is converted into shares of our common stock based on the stated value of the ESOP Preferred Stock and the then current market price of our common stock. The ESOP Preferred Stock is also convertible at the option of the holder at any time, unless previously redeemed. We have the option to redeem the ESOP Preferred Stock at any time, in whole or in part, at a redemption price per share equal to the higher of (a) $1,000 per share plus accrued and unpaid dividends or (b) the fair market value, as defined in the Certificates of Designation of the ESOP Preferred Stock.

 

                                                 
   
   
Shares issued
    Carrying amount        
    and outstanding     (in millions)     Adjustable  
    December 31 ,   December 31 ,   dividend rate  
    2004     2003     2004     2003     Minimum     Maximum  
 
                                               
ESOP Preferred Stock (1):
                                               
2004
    89,420           $ 90     $       8.50 %     9.50 %
2003
    60,513       68,238       61       68       8.50       9.50  
2002
    46,694       53,641       47       54       10.50       11.50  
2001
    34,279       40,206       34       40       10.50       11.50  
2000
    24,362       29,492       24       30       11.50       12.50  
1999
    8,722       11,032       9       11       10.30       11.30  
1998
    2,985       4,075       3       4       10.75       11.75  
1997
    2,206       4,081       2       4       9.50       10.50  
1996
    382       2,927             3       8.50       9.50  
1995
          408                   10.00       10.00