EX-13 9 f38267exv13.htm EXHIBIT 13 exv13
 

Exhibit 13

 
Financial Review
             
  34     Overview
       
 
   
  39     Critical Accounting Policies
       
 
   
  43     Earnings Performance
       
 
   
  49     Balance Sheet Analysis
       
 
   
  51     Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
       
 
   
  53     Risk Management
       
 
   
  65     Capital Management
       
 
   
  65     Comparison of 2006 with 2005
       
 
   
  66     Risk Factors
       
 
   
        Controls and Procedures
       
 
   
  72     Disclosure Controls and Procedures
       
 
   
  72     Internal Control over Financial Reporting
       
 
   
  72     Management’s Report on Internal Control over Financial Reporting
       
 
   
  73     Report of Independent Registered Public Accounting Firm
       
 
   
        Financial Statements
       
 
   
  74     Consolidated Statement of Income
       
 
   
  75     Consolidated Balance Sheet
       
 
   
  76     Consolidated Statement of Changes in Stockholders’ Equity and Comprehensive Income
       
 
   
  77     Consolidated Statement of Cash Flows
       
 
   
        Notes to Financial Statements
       
 
   
  78    
1
  Summary of Significant
Accounting Policies
       
 
   
  84    
2
  Business Combinations
 
             
  85    
3
  Cash, Loan and Dividend Restrictions
       
 
   
  85    
4
  Federal Funds Sold, Securities Purchased
       
 
  under Resale Agreements and Other
       
 
  Short-Term Investments
       
 
   
  86    
5
  Securities Available for Sale
       
 
   
  88    
6
  Loans and Allowance
       
 
  for Credit Losses
       
 
   
  91    
7
  Premises, Equipment, Lease
       
 
  Commitments and Other Assets
       
 
   
  92    
8
  Securitizations and Variable
       
 
  Interest Entities
       
 
   
  94    
9
  Mortgage Banking Activities
       
 
   
  95    
10
  Intangible Assets
       
 
   
  96    
11
  Goodwill
       
 
   
  97    
12
  Deposits
       
 
   
  97    
13
  Short-Term Borrowings
       
 
   
  98    
14
  Long-Term Debt
       
 
   
  100    
15
  Guarantees and Legal Actions
       
 
   
  101    
16
  Derivatives
       
 
   
  105    
17
  Fair Values of Assets and Liabilities
       
 
   
  110    
18
  Preferred Stock
       
 
   
  110    
19
  Common Stock and
       
 
  Stock Plans
       
 
   
  114    
20
  Employee Benefits and
       
 
  Other Expenses
       
 
   
  118    
21
  Income Taxes
       
 
   
  119    
22
  Earnings Per Common Share
       
 
   
  120    
23
  Other Comprehensive Income
       
 
   
  121    
24
  Operating Segments
       
 
   
  123    
25
  Condensed Consolidating Financial
       
 
  Statements
       
 
   
  127    
26
  Regulatory and Agency Capital
       
 
  Requirements
       
 
   
  129     Report of Independent Registered Public Accounting Firm
       
 
   
  130     Quarterly Financial Data


(STAGECOACH)

33


 

This Annual Report, including the Financial Review and the Financial Statements and related Notes, has forward-looking statements, which may 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 may differ significantly from our forecasts and expectations due to several factors. Please refer to the “Risk Factors” section of this Report for a discussion of some of the factors that may cause results to differ.
Financial Review
Overview
 

Wells Fargo & Company is a $575 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, 2007. When we refer to “the Company,” “we,” “our” or “us” in this Report, we mean Wells Fargo & Company and Subsidiaries (consolidated). When we refer to “the Parent,” we mean Wells Fargo & Company.
      The financial services industry faced unprecedented challenges in 2007. Home values declined abruptly and sharply, adversely impacting the consumer lending business of many financial service providers; credit spreads widened as the capital markets repriced in many asset classes; price volatility increased and market liquidity decreased in several sectors of the capital markets; and, late in the year, economic growth declined sharply.
      We were not immune to these unprecedented external factors. Our provision for credit losses was $2.7 billion higher in 2007 than in 2006, reflecting $1.3 billion in additional provisions for actual charge-offs that occurred in 2007 and a special $1.4 billion provision to further build reserves for loan losses.
      While the $2.7 billion in additional provisions reduced consolidated net income after tax by 18%, consolidated full-year earnings per share declined only 4% to $2.38 per share, a strong overall result given the external environment and higher credit costs.
      Our results were as strong as they were because we largely avoided or had negligible exposure to many of the problem areas that resulted in significant costs and write-downs at other large financial institutions and because we continued to build our diversified franchise throughout 2007, once again achieving growth rates, operating margins, and returns at or near the top of the financial services industry, while at the same time maintaining strong capital levels and strong liquidity.
      Our vision is to satisfy all our customers’ financial needs, 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 our customers buy from us and to give them 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. Despite the aforementioned challenges, we continued to earn more of our customers’ business in 2007 in both our retail and commercial banking businesses. Our cross-sell set records for the ninth consecutive year—our average retail banking household now has 5.5 products, almost one in five have more than eight, 6.1 for Wholesale Banking customers, and our average middle-market commercial banking customer has almost eight products. Business banking cross-sell reached 3.5 products. Our goal in each customer segment is eight products per customer, which is currently half of our estimate of potential demand.
      Revenue, the sum of net interest income and noninterest income, grew 10.4% to a record $39.4 billion in 2007 from $35.7 billion in 2006. The breadth and depth of our business model resulted in very strong and balanced growth in loans, deposits and fee-based products. Many of our businesses continued to post double-digit, year-over-year revenue growth, including business direct, wealth management, credit and debit card, global remittance services, personal credit management, home mortgage, asset-based lending, asset management, specialized financial services and international.
      Among the many products and services that grew in 2007, we achieved the following results:
  Average loans grew by 12%;
  Average core deposits grew by 13%;
  Assets under management were up 14%;
  Mortgage servicing fees were up 14%;
  Insurance premiums were up 14%; and
  Total noninterest income rose 17%, reflecting the breadth of our cross-sell efforts.
     We continue to maintain leading market positions in deposits in many communities within our banking footprint and to be #1 in many categories of financial services nationally, including small business lending, retail mortgage originations, agricultural lending, internet banking, insurance brokerage among banks, and provider of financial services to middle-market companies in the western U.S.
     We have stated in the past that to consistently grow over the long term, successful companies must invest in their core businesses and maintain strong balance sheets. We continued to make investments in 2007 by opening 87 regional banking stores and converting 42 stores acquired from Placer Sierra Bancshares and National City Bank to our network. We grew our sales and service force by adding 1,755 team members (full-time equivalents) in 2007, including 578 retail


34


 

platform bankers. In fourth quarter 2007, we completed the acquisition of Greater Bay Bancorp, with $7.4 billion in assets, the third largest bank acquisition in our history, adding to our community banking, commercial insurance brokerage, specialty finance and trust businesses. We also recently agreed to acquire the banking operations of United Bancorporation of Wyoming, which will make us the largest bank in our nation’s ninth fastest growing state.
      We believe it is important to maintain a well-controlled environment as we continue to grow our businesses. We manage our credit risk by setting what we believe are sound credit policies for underwriting new business, while monitoring and reviewing the performance of our loan portfolio. We manage the interest rate and market risks inherent in our asset and liability balances within prudent ranges, while ensuring adequate liquidity and funding. We maintain strong capital levels to provide for future growth. Our stockholder value has increased over time due to customer satisfaction, strong financial results, investment in our businesses, consistent execution of our business model and management of our business risks.
      Wells Fargo Bank, N.A. continued to be rated as “Aaa,” the highest possible credit rating issued by Moody’s Investors Service (Moody’s), and was upgraded in February 2007 to “AAA,” the highest possible credit rating issued by Standard & Poor’s Ratings Services (S&P). Of the more than 1,100 financial institutions and 70 national banking systems covered by S&P globally, this upgrade makes our bank one of only two banks worldwide to have S&P’s “AAA” credit rating. Wells Fargo Bank, N.A. is now the only U.S. bank to have the highest possible credit rating from both Moody’s and S&P.
     Our financial results included the following:
     Net income in 2007 was $8.06 billion ($2.38 per share), compared with $8.42 billion ($2.47 per share) in 2006. Results for 2007 included the impact of the previously announced $1.4 billion (pre tax) credit reserve build ($0.27 per share) and $203 million of Visa litigation expenses ($0.04 per share), and for 2006 included $95 million ($0.02 per share) of Visa litigation expenses. Despite the challenging environment in 2007, we had a solid year and achieved both double-digit top line revenue growth and positive operating leverage (revenue growth of 10.4% exceeding expense growth of 9.5%). Return on average total assets (ROA) was 1.55% and return on average stockholders’ equity (ROE) was 17.12% in 2007, compared with 1.73% and 19.52%, respectively, in 2006. Both ROA and ROE were, once again, at or near the top of our large bank peers.
      Net interest income on a taxable-equivalent basis was $21.1 billion in 2007, up from $20.1 billion a year ago, reflecting strong loan growth. Average earning assets grew 7% from 2006. Our net interest margin was 4.74% for 2007, compared with 4.83% in 2006, primarily due to earning assets increasing at a slightly faster rate than core deposits.
      Noninterest income increased 17% to $18.4 billion in 2007 from $15.7 billion in 2006. The increase was across our businesses, with double-digit increases in debit and credit card fees (up 22%), deposit service charges (up 13%), trust
and investment fees (up 15%), and insurance revenue (up 14%). Capital markets and equity investment results were also strong. Mortgage banking noninterest income increased $822 million (36%) from 2006 because net servicing fee income increased due to growth in loans serviced for others.
      During 2007, noninterest income was affected by changes in interest rates, widening credit spreads, and other credit and housing market conditions, including:
  $(803) million – $479 million write-down of the mortgage warehouse/pipeline, and $324 million write-down, primarily due to mortgage loans repurchased and an increase in the repurchase reserve for projected early payment defaults.
  $583 million – Increase in mortgage servicing income reflecting a $571 million reduction in the value of mortgage servicing rights (MSRs) due to the decline in mortgage rates during the year, offset by a $1.15 billion gain on the financial instruments hedging the MSRs. The ratio of MSRs to related loans serviced for others at December 31, 2007, was 1.20%, the lowest ratio in 10 quarters.
     Noninterest expense was $22.8 billion in 2007, up 9.5% from $20.8 billion in 2006, primarily due to continued investments in new stores and additional sales and service-related team members. Despite these investments and the acquisition of Greater Bay Bancorp and related integration expense, our efficiency ratio improved to 57.9% in 2007 from 58.4% in 2006. We obtained concurrence from the staff of the Securities and Exchange Commission (SEC) regarding our accounting for certain transactions related to the restructuring of Visa Inc., and recorded a litigation liability and corresponding expense, included in operating losses, of $203 million for 2007 and $95 million for 2006.
      During 2007, net charge-offs were $3.54 billion (1.03% of average total loans), up $1.3 billion from $2.25 billion (0.73%) during 2006. Commercial and commercial real estate net charge-offs increased $239 million in 2007 from 2006, of which $162 million was from loans originated through our business direct channel. Business direct consists primarily of unsecured lines of credit to small firms and sole proprietors that tend to perform in a manner similar to credit cards. Total wholesale net charge-offs (excluding business direct) were $103 million (0.08% of average loans). The remaining balance of commercial and commercial real estate (other real estate mortgage, real estate construction and lease financing) continued to have low net charge-off rates in 2007.
      National Home Equity Group (Home Equity) portfolio net charge-offs totaled $595 million (0.73% of average loans) in 2007, compared with $110 million (0.14%) in 2006. Because the majority of the Home Equity net charge-offs were concentrated in the indirect or third party origination channels, which have a higher percentage of 90% or greater combined loan-to-value portfolios, we have discontinued third party activities not behind a Wells Fargo first mortgage and segregated these indirect loans into a liquidating portfolio. As previously disclosed, while the $11.9 billion of loans in this liquidating portfolio represented about 3% of total loans outstanding at December 31, 2007, these loans represent


35


 

the highest risk in our $84.2 billion Home Equity portfolio. The loans in the liquidating portfolio were primarily sourced through wholesale (brokers) and correspondents. Additionally, they are largely concentrated in geographic markets that have experienced the most abrupt and steepest declines in housing prices. We will continue to provide home equity financing directly to our customers, but have stopped originating or acquiring new home equity loans through indirect channels unless they are behind a Wells Fargo first mortgage and have a combined loan-to-value ratio lower than 90%. We also experienced increased net charge-offs in our unsecured consumer portfolios, such as credit cards and lines of credit, in part due to growth and in part due to increased economic stress in households.
      Full year 2007 auto portfolio net charge-offs were $1.02 billion (3.45% of average loans), compared with $857 million (3.15%) in 2006. These results were consistent with our expectations and reflected planned lower growth in originations and an improvement in collection activities within this business.
      The provision for credit losses was $4.94 billion in 2007, an increase of $2.74 billion from $2.20 billion in 2006, due to higher net charge-offs and the 2007 credit reserve build of $1.4 billion, primarily for higher net loss content that we estimated in the Home Equity portfolio. Given the weakness in housing and the overall state of the U.S. economy, it is likely that net charge-offs will be higher in 2008. The allowance for credit losses, which consists of the allowance for loan losses and the reserve for unfunded credit commitments, was $5.52 billion (1.44% of total loans) at December 31, 2007, compared with $3.96 billion (1.24%) at December 31, 2006.
      At December 31, 2007, total nonaccrual loans were $2.68 billion (0.70% of total loans) up from $1.67 billion (0.52%) at December 31, 2006. The majority of the increase in nonaccrual loans was concentrated in the first mortgage portfolio ($209 million in Wells Fargo Home Mortgage and $343 million in Wells Fargo Financial) and was due to the national rise in mortgage default rates. We believe there is minimal additional loss content in these loans since they are


                                                                 
Table 1: Six-Year Summary of Selected Financial Data  
(in millions, except   2007     2006 (1)   2005     2004     2003     2002     % Change     Five-year  
per share amounts)                                       2007   compound  
                                        2006     growth rate  
 
                                                               
INCOME STATEMENT
                                                               
Net interest income
  $ 20,974     $ 19,951     $ 18,504     $ 17,150     $ 16,007     $ 14,482       5 %     8 %
Noninterest income
    18,416       15,740       14,445       12,909       12,382       10,767       17       11  
 
                                                   
Revenue
    39,390       35,691       32,949       30,059       28,389       25,249       10       9  
Provision for credit losses
    4,939       2,204       2,383       1,717       1,722       1,684       124       24  
Noninterest expense
    22,824       20,837       19,018       17,573       17,190       14,711       10       9  
 
                                                               
Before effect of change in accounting principle (2)
                                                               
Net income
  $ 8,057     $ 8,420     $ 7,671     $ 7,014     $ 6,202     $ 5,710       (4 )     7  
Earnings per common share
    2.41       2.50       2.27       2.07       1.84       1.68       (4 )     7  
Diluted earnings per common share
    2.38       2.47       2.25       2.05       1.83       1.66       (4 )     7  
 
                                                               
After effect of change in accounting principle
                                                               
Net income
  $ 8,057     $ 8,420     $ 7,671     $ 7,014     $ 6,202     $ 5,434       (4 )     8  
Earnings per common share
    2.41       2.50       2.27       2.07       1.84       1.60       (4 )     9  
Diluted earnings per common share
    2.38       2.47       2.25       2.05       1.83       1.58       (4 )     9  
Dividends declared per common share
    1.18       1.08       1.00       0.93       0.75       0.55       9       16  
 
                                                               
BALANCE SHEET
(at year end)
                                                               
Securities available for sale
  $ 72,951     $ 42,629     $ 41,834     $ 33,717     $ 32,953     $ 27,947       71       21  
Loans
    382,195       319,116       310,837       287,586       253,073       192,478       20       15  
Allowance for loan losses
    5,307       3,764       3,871       3,762       3,891       3,819       41       7  
Goodwill
    13,106       11,275       10,787       10,681       10,371       9,753       16       6  
Assets
    575,442       481,996       481,741       427,849       387,798       349,197       19       11  
Core deposits (3)
    311,731       288,068       253,341       229,703       211,271       198,234       8       9  
Long-term debt
    99,393       87,145       79,668       73,580       63,642       47,320       14       16  
Guaranteed preferred beneficial interests in Company’s subordinated debentures (4)
                                  2,885              
Stockholders’ equity
    47,628       45,814       40,660       37,866       34,469       30,319       4       9  
 
                                                               
 
(1)   Results for 2006 have been revised to reflect $95 million of litigation expenses associated with indemnification obligations arising from the Company’s ownership interest in Visa.
 
(2)   Change in accounting principle is for a transitional goodwill impairment charge recorded in 2002 upon adoption of FAS 142, Goodwill and Other Intangible Assets.
 
(3)   Core deposits are noninterest-bearing deposits, interest-bearing checking, savings certificates, market rate and other savings, and certain foreign deposits (Eurodollar sweep balances).
 
(4)   At December 31, 2003, upon adoption of FIN 46 (revised December 2003), Consolidation of Variable Interest Entities (FIN 46(R)), these balances were reflected in long-term debt. See Note 14 (Long-Term Debt) to Financial Statements for more information.

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adjusted to market value when transferred to nonperforming asset (NPA) status. Total NPAs were $3.87 billion (1.01% of total loans) at December 31, 2007, compared with $2.42 billion (0.76%) at December 31, 2006. Due to illiquid market conditions, we are now holding more foreclosed properties than we have historically. Foreclosed assets were $1.18 billion at December 31, 2007, compared with $745 million at December 31, 2006. Foreclosed assets, a component of total NPAs, included $649 million and $423 million in residential property or auto loans and $535 million and $322 million of foreclosed real estate securing Government National Mortgage Association (GNMA) loans at December 31, 2007 and 2006, respectively, consistent with regulatory reporting requirements. The foreclosed real estate securing GNMA loans of $535 million represented 14 basis points of the ratio of NPAs to loans at December 31, 2007. Both principal and interest for the GNMA loans secured by the foreclosed real estate are collectible because the GNMA loans are insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs.
                         
Table 2: Ratios and Per Common Share Data  
 
    Year ended December 31 ,
    2007     2006     2005  
 
                       
PROFITABILITY RATIOS
                       
Net income to average total assets (ROA)
    1.55 %     1.73 %     1.72 %
Net income to average stockholders’ equity (ROE)
    17.12       19.52       19.59  
 
                       
EFFICIENCY RATIO (1)
    57.9       58.4       57.7  
 
                       
CAPITAL RATIOS
                       
At year end:
                       
Stockholders’ equity to assets
    8.28       9.51       8.44  
Risk-based capital (2)
                       
Tier 1 capital
    7.59       8.93       8.26  
Total capital
    10.68       12.49       11.64  
Tier 1 leverage (2)
    6.83       7.88       6.99  
Average balances:
                       
Stockholders’ equity to assets
    9.04       8.88       8.78  
 
                       
PER COMMON SHARE DATA
                       
Dividend payout (3)
    49.0       43.2       44.1  
Book value
  $ 14.45     $ 13.57     $ 12.12  
Market price (4)
                       
High
  $ 37.99     $ 36.99     $ 32.35  
Low
    29.29       30.31       28.81  
Year end
    30.19       35.56       31.42  
 
   
(1)   The efficiency ratio is noninterest expense divided by total revenue (net interest income and noninterest income).
 
(2)   See Note 26 (Regulatory and Agency Capital Requirements) to Financial Statements for additional information.
 
(3)   Dividends declared per common share as a percentage of earnings per common share.
 
(4)   Based on daily prices reported on the New York Stock Exchange Composite Transaction Reporting System.
      The Company and each of its subsidiary banks remained “well capitalized” under applicable regulatory capital adequacy guidelines. The ratio of stockholders’ equity to total assets was 8.28% at December 31, 2007, compared with 9.51% at December 31, 2006. Our total risk-based capital (RBC) ratio at December 31, 2007, was 10.68% and our Tier 1 RBC ratio was 7.59%, exceeding the minimum
regulatory guidelines of 8% and 4%, respectively, for bank holding companies. Our RBC ratios at December 31, 2006, were 12.49% and 8.93%, respectively. Our Tier 1 leverage ratios were 6.83% and 7.88% at December 31, 2007 and 2006, respectively, exceeding the minimum regulatory guideline of 3% for bank holding companies.
Current Accounting Developments
On January 1, 2007, we adopted the following new accounting pronouncements:
  FIN 48 – Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109;
  FSP 13-2 – FASB Staff Position 13-2, Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction;
  FAS 155 – Statement of Financial Accounting Standards No. 155, Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140;
  FAS 157 – Fair Value Measurements; and
  FAS 159 – The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115.
     The adoption of FIN 48, FAS 155, FAS 157 and FAS 159 did not have any effect on our financial statements at the date of adoption. For additional information, see Note 17 (Fair Values of Assets and Liabilities) and Note 21 (Income Taxes) to Financial Statements.
      Upon adoption of FSP 13-2, we recorded a cumulative effect of change in accounting principle to reduce the beginning balance of 2007 retained earnings by $71 million after tax ($115 million pre tax). This amount will be recognized back into income over the remaining terms of the affected leases.
      On July 1, 2007, we adopted Emerging Issues Task Force (EITF) Topic D-109, Determining the Nature of a Host Contract Related to a Hybrid Financial Instrument Issued in the Form of a Share under FASB Statement No. 133 (Topic D-109), which provides clarifying guidance as to whether certain hybrid financial instruments are more akin to debt or equity, for purposes of evaluating whether the embedded derivative financial instrument requires separate accounting under FAS 133, Accounting for Derivative Instruments and Hedging Activities. In accordance with the transition provisions of Topic D-109, we transferred $1.2 billion of securities, consisting of investments in preferred stock callable by the issuer, from trading assets to securities available for sale. Because the securities were carried at fair value, the adoption of Topic D-109 did not have any effect on our total stockholders’ equity.
      On April 30, 2007, the FASB issued Staff Position FIN 39-1, Amendment of FASB Interpretation No. 39 (FSP FIN 39-1). FSP FIN 39-1 amends Interpretation No. 39 to permit a reporting entity to offset the right to reclaim cash collateral (a receivable), or the obligation to return cash collateral


37


 

(a payable), against derivative instruments executed with the same counterparty under the same master netting arrangement. The provisions of this FSP are effective for the year beginning on January 1, 2008, with early adoption permitted. We adopted FSP FIN 39-1 on January 1, 2008, and it did not have a material effect on our consolidated financial statements.
      On September 20, 2006, the FASB ratified the consensus reached by the EITF at its September 7, 2006, meeting with respect to Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements (EITF 06-4). On March 28, 2007, the FASB ratified the consensus reached by the EITF at its March 15, 2007, meeting with respect to Issue No. 06-10, Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements (EITF 06-10). These pronouncements require that for endorsement split-dollar life insurance arrangements and collateral split-dollar life insurance arrangements where the employee is provided benefits in postretirement periods, the employer should recognize the cost of providing that insurance over the employee’s service period by accruing a liability for the benefit obligation. Additionally, for collateral assignment split-dollar life insurance arrangements, EITF 06-10 requires an employer to recognize and measure an asset based upon the nature and substance of the agreement. EITF 06-4 and EITF 06-10 are effective for the year beginning on January 1, 2008, with early adoption permitted. We adopted EITF 06-4 and EITF 06-10 on January 1, 2008, and reduced beginning retained earnings for 2008 by $20 million (after tax), primarily related to split-dollar life insurance arrangements from the acquisition of Greater Bay Bancorp.
      On November 5, 2007, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value Through Earnings (SAB 109). SAB 109 provides the staff’s views on the accounting for written loan commitments recorded at fair value under U.S. generally accepted accounting principles (GAAP). To make the staff’s views consistent with current authoritative accounting guidance, SAB 109 revises and rescinds portions of SAB 105, Application of Accounting Principles to Loan Commitments. Specifically, SAB 109 states the expected net future cash flows associated with the servicing of a loan should be included in the measurement of all written
loan commitments that are accounted for at fair value through earnings. The provisions of SAB 109, which we adopted on January 1, 2008, are applicable to written loan commitments recorded at fair value that are entered into beginning on or after January 1, 2008.
      On December 4, 2007, the FASB issued FAS 141R, Business Combinations. This statement requires an acquirer to recognize the assets acquired (including loan receivables), the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, to be measured at their fair values as of that date, with limited exceptions. The acquirer is not permitted to recognize a separate valuation allowance as of the acquisition date for loans and other assets acquired in a business combination. The revised statement requires acquisition-related costs to be expensed separately from the acquisition. It also requires restructuring costs that the acquirer expected but was not obligated to incur, to be expensed separately from the business combination. FAS 141R should be applied prospectively to business combinations beginning with the first annual reporting period beginning on or after December 15, 2008. Early adoption is prohibited. We are currently evaluating the impact that FAS 141R may have on our consolidated financial statements.
      On December 4, 2007, the FASB issued FAS 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51. FAS 160 specifies that noncontrolling interests in a subsidiary are to be treated as a separate component of equity and, as such, increases and decreases in the parent’s ownership interest that leave control intact are accounted for as capital transactions. It changes the way the consolidated income statement is presented by requiring that an entity’s consolidated net income include the amounts attributable to both the parent and the noncontrolling interest. FAS 160 requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. This statement should be applied prospectively to all noncontrolling interests, including any that arose before the effective date. The statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Early adoption is prohibited. We are currently evaluating the impact that FAS 160 may have on our consolidated financial statements.


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Critical Accounting Policies
 

Our significant accounting policies (see 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. Five of these policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. These policies govern the allowance for credit losses, the valuation of residential mortgage servicing rights (MSRs) and financial instruments, pension accounting and income taxes. 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 consists of 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
While we attribute portions of the allowance to specific loan categories as part of our analytical process, the entire allowance is used to absorb credit losses inherent in the total loan portfolio.
      A significant portion of the allowance is estimated at a pooled level for consumer loans and some segments of commercial small business loans. We use forecasting models to measure the losses inherent in these portfolios. We validate and update these models periodically to capture recent behavioral characteristics of the portfolios, such as updated credit bureau information, actual changes in underlying economic or market conditions and changes in our loss mitigation strategies.
      The remaining portion of the allowance is for commercial loans, commercial real estate loans and lease financing. We initially estimate this portion of the allowance by applying historical loss factors statistically derived from tracking losses associated with actual portfolio movements over a specified period of time, using a standardized loan grading process. Based on this process, we assign loss factors to each pool of graded loans and a loan equivalent amount for unfunded loan commitments and letters of credit. These estimates are then adjusted or supplemented where necessary from additional
analysis of long-term average loss experience, external loss data or other risks identified from current conditions and trends in selected portfolios, including management’s judgment for imprecision and uncertainty. We assess and account for as impaired certain nonaccrual commercial and commercial real estate loans that are over $3 million and certain consumer, commercial and commercial real estate loans whose terms have been modified in a troubled debt restructuring. We include the impairment on these nonperforming loans in the allowance unless it has already been recognized as a loss.
      Reflected in the two portions of the allowance previously described is an amount for imprecision or uncertainty that incorporates the range of probable outcomes inherent in estimates used for the allowance, which may change from period to period. This amount is the result of our judgment of risks inherent in the portfolios, economic uncertainties, historical loss experience and other subjective factors, including industry trends, calculated to better reflect our view of risk in each loan portfolio.
      The total allowance reflects management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date. To estimate the possible range of allowance required at December 31, 2007, and the related change in provision expense, we assumed the following scenarios of a reasonably possible deterioration or improvement in loan credit quality.
Assumptions for deterioration in loan credit quality were:
  for consumer loans, a 23 basis point increase in estimated loss rates from actual 2007 loss levels, moving closer to longer term average loss rates or more prolonged stress case for home equity loans; and
  for wholesale loans, a 24 basis point increase in estimated loss rates, moving closer to historical averages.
Assumptions for improvement in loan credit quality were:
  for consumer loans, an 18 basis point decrease in estimated loss rates from actual 2007 loss levels, adjusting for the elevated home equity losses and an improving real estate market for consumers; and
  for wholesale loans, nominal change from the 2007 net credit loss performance.
     Under the assumptions for deterioration in loan credit quality, another $804 million in expected losses could occur and under the assumptions for improvement, a $416 million reduction in expected losses could occur.
      Changes in the estimate of the allowance for credit losses and the related provision expense 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 of losses that are highly uncertain and require a high degree of judgment. Given that the majority of our loan portfolio is consumer loans, for which losses tend to emerge within a relatively short, predictable timeframe, and that a significant portion of the allowance for credit losses relates to estimated credit


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losses associated with consumer loans, management believes that the provision for credit losses for consumer loans, absent any significant credit event, severe decrease in collateral values, significant acceleration of losses or significant change in payment behavior, will closely track the level of related net charge-offs. From time to time, events or economic factors may impact the loan portfolio, causing management to provide additional amounts or release balances from the allowance for credit losses. The increase in the allowance for credit losses in excess of net charge-offs in 2007 was primarily due to higher losses in the Home Equity portfolio stemming from the steeper than anticipated decline in national home prices. See Note 6 (Loans and Allowance for Credit Losses) to Financial Statements and “Risk Management – Credit Risk Management Process” for further discussion of our allowance for credit losses.
Valuation of Residential Mortgage Servicing Rights
We recognize as assets the rights to service mortgage loans for others, or mortgage servicing rights (MSRs), whether we purchase the servicing rights, or the servicing rights result from the sale or securitization of loans we originate (asset transfers). We also acquire MSRs under co-issuer agreements that provide for us to service loans that are originated and securitized by third-party correspondents. Effective January 1, 2006, under FAS 156, Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140, we elected to initially measure and carry our MSRs related to residential mortgage loans (residential MSRs) using the fair value measurement method. Under this method, purchased MSRs and MSRs from asset transfers are capitalized and carried at fair value. Prior to the adoption of FAS 156, we capitalized purchased residential MSRs at cost, and MSRs from asset transfers based on the relative fair value of the servicing right and the residential mortgage loan at the time of sale, and carried both purchased MSRs and MSRs from asset transfers at the lower of cost or market value. Effective January 1, 2006, upon the remeasurement of our residential MSRs at fair value, we recorded a cumulative effect adjustment to increase the 2006 beginning balance of retained earnings by $101 million after tax ($158 million pre tax) in stockholders’ equity.
      At the end of each quarter, 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 (including housing price volatility), discount rate, default rates, cost to service (including delinquency and foreclosure costs), escrow account earnings, contractual servicing fee income, ancillary income and late fees. The valuation of MSRs is discussed further in this section and in Note 1 (Summary of Significant Accounting Policies), Note 8 (Securitizations and Variable Interest Entities), Note 9 (Mortgage Banking Activities) and Note 17 (Fair Values of Assets and Liabilities) to Financial Statements.
     To reduce the sensitivity of earnings to interest rate and market value fluctuations, we may use securities available for sale and free-standing derivatives (economic hedges) to hedge the risk of changes in the fair value of MSRs, with the resulting gains or losses reflected in income. Changes in the fair value of the MSRs from changing mortgage interest rates are generally offset by gains or losses in the fair value of the derivatives depending on the amount of MSRs we hedge and the particular instruments chosen to hedge the MSRs. We may choose not to fully hedge MSRs, partly because origination volume tends to act as a “natural hedge.” For example, as interest rates decline, servicing values generally decrease and fees from origination volume tend to increase. Conversely, as interest rates increase, the fair value of the MSRs generally increases, while fees from origination volume tend to decline. See “Mortgage Banking Interest Rate and Market Risk” for discussion of the timing of the effect of changes in mortgage interest rates.
      Net servicing income, a component of mortgage banking noninterest income, includes the changes from period to period in fair value of both our residential MSRs and the free-standing derivatives (economic hedges) used to hedge our residential MSRs. Changes in the fair value of residential MSRs from period to period result from (1) changes in the valuation model inputs or assumptions (principally reflecting changes in discount rates and prepayment speed assumptions, mostly due to changes in interest rates) and (2) other changes, representing changes due to collection/realization of expected cash flows.
      We use a dynamic and sophisticated model to estimate the value of our MSRs. The model is validated by an independent internal model validation group operating in accordance with Company policies. Senior management reviews all significant assumptions quarterly. 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 used to determine the present value of estimated future net servicing income—another key assumption in the model—is the required rate of return investors in the market would expect 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 quarterly as market conditions and interest rates change. For example, an increase in either the prepayment speed or discount rate assumption results in a decrease in the fair value of the MSRs, while a decrease in either assumption would result in an increase in the fair value of the MSRs. In recent years, there have been significant market-driven fluctuations in loan prepayment speeds and the discount rate. These fluctuations can be rapid and may be 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.


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      These key economic assumptions and the sensitivity of the fair value of MSRs to an immediate adverse change in those assumptions are shown in Note 8 (Securitizations and Variable Interest Entities) to Financial Statements.
Fair Valuation of Financial Instruments
We use fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. Trading assets, securities available for sale, derivatives and substantially all mortgages held for sale (MHFS) are financial instruments recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other financial assets on a nonrecurring basis, such as nonprime residential and commercial MHFS, loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets. Further, we include in Notes to Financial Statements information about the extent to which fair value is used to measure assets and liabilities, the valuation methodologies used and its impact to earnings. Additionally, for financial instruments not recorded at fair value we disclose the estimate of their fair value.
      FAS 157, Fair Value Measurements (FAS 157), defines fair value as the price that would be received to sell the financial asset or paid to transfer the financial liability in an orderly transaction between market participants at the measurement date.
      FAS 157 establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect our estimates about market data.
  Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 instruments include securities traded on active exchange markets, such as the New York Stock Exchange, as well as U.S. Treasury, other U.S. government and agency mortgage-backed securities that are traded by dealers or brokers in active over-the-counter markets.
  Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 2 instruments include securities traded in less active dealer or broker markets and MHFS that are valued based on prices for other mortgage whole loans with similar characteristics.
  Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect
    our own estimates of assumptions market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
     In accordance with FAS 157, it is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. When available, we use quoted market prices to measure fair value. If market prices are not available, fair value measurement is based upon models that use primarily market-based or independently-sourced market parameters, including interest rate yield curves, prepayment speeds, option volatilities and currency rates. Substantially all of our financial instruments use either of the foregoing methodologies, collectively Level 1 and Level 2 measurements, to determine fair value adjustments recorded to our financial statements. However, in certain cases, when market observable inputs for model-based valuation techniques may not be readily available, we are required to make judgments about assumptions market participants would use in estimating the fair value of the financial instrument.
      The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not fully available, management judgment is necessary to estimate fair value. In addition, changes in the market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. Therefore, when market data is not available, we would use valuation techniques requiring more management judgment to estimate the appropriate fair value measurement.
      At December 31, 2007, approximately 22% of total assets, or $123.8 billion, consisted of financial instruments recorded at fair value on a recurring basis. Approximately 82% of these financial instruments used valuation methodologies involving market-based or market-derived information, collectively Level 1 and 2 measurements, to measure fair value. Approximately 18% of these financial assets are measured using model-based techniques, or Level 3 measurements. Virtually all of our financial assets valued using Level 3 measurements represented MSRs (previously described) or investments in asset-backed securities where we underwrite the underlying collateral (auto lease receivables). At December 31, 2007, approximately 0.5% of total liabilities, or $2.6 billion, consisted of financial instruments recorded at fair value on a recurring basis.
      See Note 17 (Fair Values of Assets and Liabilities) to Financial Statements for a complete discussion on our use of fair valuation of financial instruments, our related measurement techniques and its impact to our financial statements.


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Pension Accounting
We account for our defined benefit pension plans using an actuarial model required by FAS 87, Employers’ Accounting for Pensions, as amended by FAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and 132(R). FAS 158 was issued on September 29, 2006, and became effective for us on December 31, 2006. FAS 158 requires us to recognize the funded status of our pension and postretirement benefit plans in our balance sheet. Additionally, FAS 158 will require us to use a year-end measurement date beginning in 2008. The adoption of FAS 158 did not change the amount of net periodic benefit expense recognized in our income statement.
      We use four key variables to calculate our annual pension cost: size and characteristics of the employee population, actuarial assumptions, expected long-term rate of return on plan assets, and 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.
ACTUARIAL ASSUMPTIONS
To estimate the projected benefit obligation, actuarial assumptions are required about factors such as the rates of mortality, turnover, retirement, disability and compensation increases for our participant population. These demographic assumptions are reviewed periodically. In general, the range of assumptions is narrow.
EXPECTED LONG-TERM RATE OF RETURN ON PLAN ASSETS
We determine the expected return on plan assets each year based on the composition of assets and the expected long-term rate of return on that portfolio. The expected long-term rate of return assumption is a long-term assumption and is not anticipated to change significantly from year to year.
      To determine if the expected rate of return is reasonable, we consider such factors as (1) long-term historical return experience for major asset class categories (for example, large cap and small cap domestic equities, international equities and domestic fixed income), and (2) forward-looking return expectations for these major asset classes. Our expected rate of return for 2008 is 8.75%, the same rate used for 2007 and 2006. Differences in each year, if any, between expected and actual returns are included in our net actuarial gain or loss amount, which is recognized in other comprehensive income. We generally amortize any net actuarial gain or loss in excess of a 5% corridor (as defined in FAS 87) in net periodic pension expense calculations over the next five years. Our average remaining service period is approximately 11 years. See Note 20 (Employee Benefits and Other Expenses) to Financial Statements for information on funding, changes in the pension benefit obligation, and plan assets (including the investment categories, asset allocation and the fair value).
      We use November 30 as the measurement date for our pension assets and projected benefit obligations. 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 $54 million. In 2008 we will use December 31 as our measurement date as required under FAS 158.
DISCOUNT RATE
We use a discount rate to determine the present value of our future benefit obligations. The discount rate reflects the current rates available on long-term high-quality fixed-income debt instruments, and is reset annually on the measurement date. To determine the discount rate, we review in conjunction with our independent actuary, spot interest rate yield curves based upon yields from a broad population of high-quality bonds, adjusted to match the timing and amounts of the Cash Balance Plan’s expected benefit payments. We used a discount rate of 6.25% in 2007 and 5.75% in 2006.
      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 $6 million. If we were to assume a 1% decrease in the discount rate, and keep other assumptions constant, pension expense would increase by approximately $82 million. The decrease in pension expense due to a 1% increase in discount rate differs from the increase in pension expense due to a 1% decrease in discount rate due to the impact of the 5% gain/loss corridor.
Income Taxes
We are subject to the income tax laws of the U.S., its states and municipalities and those of the foreign jurisdictions in which we operate. We account for income taxes in accordance with FAS 109, Accounting for Income Taxes, as interpreted by FIN 48, Accounting for Uncertainty in Income Taxes. Our income tax expense consists of two components: current and deferred. Current income tax expense approximates taxes to be paid or refunded for the current period and includes income tax expense related to our uncertain tax positions. We determine deferred income taxes 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 recognized enacted changes in tax rates and laws in the period in which they occur. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized subject to management’s judgment that realization is more likely than not. Uncertain tax positions that meet the “more likely than not” recognition threshold are measured to determine the amount of benefit to recognize. An uncertain tax position is measured at the largest amount of benefit that management believes is greater than 50% likely of being realized upon settlement. Foreign taxes paid are generally applied as credits to reduce federal income taxes payable. We account for interest and penalties as a component of income tax expense.


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     The income tax laws of the jurisdictions in which we operate are complex and subject to different interpretations by the taxpayer and the relevant government taxing authorities. In establishing a provision for income tax expense, we must make judgments and interpretations about the application of these inherently complex tax laws. We must also make estimates about when in the future certain items will affect taxable income in the various tax jurisdictions by the government taxing authorities, both domestic and foreign. Our interpretations may be subjected to review during examination by taxing authorities and disputes may arise over the respective tax positions. We attempt to resolve these disputes during the tax examination and audit process and ultimately through the court systems when applicable.
     We monitor relevant tax authorities and revise our estimate of accrued income taxes due to changes in income tax laws and their interpretation by the courts and regulatory authorities on a quarterly basis. Revisions of our estimate of accrued income taxes also may result from our own income tax planning and from the resolution of income tax controversies. Such revisions in our estimates may be material to our operating results for any given quarter.
      See Note 21 (Income Taxes) to Financial Statements for a further description of our provision for income taxes and related income tax assets and liabilities.


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% federal statutory tax rate.
      Net interest income on a taxable-equivalent basis was $21.1 billion in 2007, up 5% from $20.1 billion in 2006. Our net interest margin decreased to 4.74% for 2007 from 4.83% for 2006. Both the increase in net interest income and the decrease in the net interest margin were largely driven by strong growth in earning assets which were up 7% in 2007.
      Average earning assets increased $30.1 billion to $445.9 billion in 2007 from $415.8 billion in 2006. Average loans increased to $344.8 billion in 2007 from $306.9 billion in 2006. Average mortgages held for sale decreased to $33.1 billion in 2007 from $42.9 billion in 2006. Average debt securities available for sale increased to $57.0 billion in 2007 from $53.6 billion in 2006.
      Core deposits are an important contributor to growth in net interest income and the net interest margin, and are
a low-cost source of funding. Core deposits are noninterest-bearing deposits, interest-bearing checking, savings certificates, market rate and other savings, and certain foreign deposits (Eurodollar sweep balances). We have one of the largest bases of core deposits among large U.S. banks. Average core deposits grew 13% to $303.1 billion in 2007 from $268.9 billion in 2006 and funded 88% of average total loans in both years. Total average retail core deposits, which exclude Wholesale Banking core deposits and retail mortgage escrow deposits, for 2007 grew $12.9 billion (6%) from 2006. Average mortgage escrow deposits increased to $21.5 billion in 2007 from $18.2 billion in 2006. Average savings certificates of deposit increased to $40.5 billion in 2007 from $32.4 billion in 2006 and average noninterest-bearing checking accounts and other core deposit categories (interest-bearing checking and market rate and other savings) increased to $241.9 billion in 2007 from $227.7 billion in 2006. Total average interest-bearing deposits increased to $239.2 billion in 2007 from $223.8 billion in 2006, due to a shift in the deposit mix in favor of higher-yielding savings and certificates of deposit relative to lower cost savings and demand deposit accounts.
      Table 3 presents the individual components of net interest income and the net interest margin.


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Table 3: Average Balances, Yields and Rates Paid (Taxable-Equivalent Basis) (1)(2)
 
                                                 
(in millions)   2007     2006  
    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
  $ 4,468       4.99 %   $ 223     $ 5,515       4.80 %   $ 265  
Trading assets
    4,291       4.37       188       4,958       4.95       245  
Debt securities available for sale (3):
                                               
Securities of U.S. Treasury and federal agencies
    848       4.26       36       875       4.36       39  
Securities of U.S. states and political subdivisions
    4,740       7.37       342       3,192       7.98       245  
Mortgage-backed securities:
                                               
Federal agencies
    38,592       6.10       2,328       36,691       6.04       2,206  
Private collateralized mortgage obligations
    6,548       6.12       399       6,640       6.57       430  
 
                                       
Total mortgage-backed securities
    45,140       6.10       2,727       43,331       6.12       2,636  
Other debt securities (4)
    6,295       7.52       477       6,204       7.10       439  
 
                                       
Total debt securities available for sale (4)
    57,023       6.34       3,582       53,602       6.31       3,359  
Mortgages held for sale (5)
    33,066       6.50       2,150       42,855       6.41       2,746  
Loans held for sale (5)
    896       7.76       70       630       7.40       47  
Loans:
                                               
Commercial and commercial real estate:
                                               
Commercial
    77,965       8.17       6,367       65,720       8.13       5,340  
Other real estate mortgage
    32,722       7.38       2,414       29,344       7.32       2,148  
Real estate construction
    16,934       7.80       1,321       14,810       7.94       1,175  
Lease financing
    5,921       5.84       346       5,437       5.72       311  
 
                                       
Total commercial and commercial real estate
    133,542       7.82       10,448       115,311       7.78       8,974  
Consumer:
                                               
Real estate 1-4 family first mortgage
    61,527       7.25       4,463       57,509       7.27       4,182  
Real estate 1-4 family junior lien mortgage
    72,075       8.12       5,851       64,255       7.98       5,126  
Credit card
    15,874       13.58       2,155       12,571       13.29       1,670  
Other revolving credit and installment
    54,436       9.71       5,285       50,922       9.60       4,889  
 
                                       
Total consumer
    203,912       8.71       17,754       185,257       8.57       15,867  
Foreign
    7,321       11.68       855       6,343       12.39       786  
 
                                       
Total loans (5)
    344,775       8.43       29,057       306,911       8.35       25,627  
Other
    1,402       5.07       71       1,357       4.97       68  
 
                                       
Total earning assets
  $ 445,921       7.93       35,341     $ 415,828       7.79       32,357  
 
                                       

FUNDING SOURCES

                                               
Deposits:
                                               
Interest-bearing checking
  $ 5,057       3.16       160     $ 4,302       2.86       123  
Market rate and other savings
    147,939       2.78       4,105       134,248       2.40       3,225  
Savings certificates
    40,484       4.38       1,773       32,355       3.91       1,266  
Other time deposits
    8,937       4.87       435       32,168       4.99       1,607  
Deposits in foreign offices
    36,761       4.57       1,679       20,724       4.60       953  
 
                                       
Total interest-bearing deposits
    239,178       3.41       8,152       223,797       3.21       7,174  
Short-term borrowings
    25,854       4.81       1,245       21,471       4.62       992  
Long-term debt
    93,193       5.18       4,824       84,035       4.91       4,124  
Guaranteed preferred beneficial interests in Company’s subordinated debentures (6)
                                   
 
                                       
Total interest-bearing liabilities
    358,225       3.97       14,221       329,303       3.73       12,290  
Portion of noninterest-bearing funding sources
    87,696                   86,525              
 
                                       
Total funding sources
  $ 445,921       3.19       14,221     $ 415,828       2.96       12,290  
 
                                       

Net interest margin and net interest income on a taxable-equivalent basis (7)

            4.74 %   $ 21,120               4.83 %   $ 20,067  
 
                                       

NONINTEREST-EARNING ASSETS

                                               
Cash and due from banks
  $ 11,806                     $ 12,466                  
Goodwill
    11,957                       11,114                  
Other
    51,068                       46,615                  
 
                                           
Total noninterest-earning assets
  $ 74,831                     $ 70,195                  
 
                                           

NONINTEREST-BEARING FUNDING SOURCES

                                               
Deposits
  $ 88,907                     $ 89,117                  
Other liabilities
    26,557                       24,467                  
Stockholders’ equity
    47,063                       43,136                  
Noninterest-bearing funding sources used to fund earning assets
    (87,696 )                     (86,525 )                
 
                                           
Net noninterest-bearing funding sources
  $ 74,831                     $ 70,195                  
 
                                           
TOTAL ASSETS
  $ 520,752                     $ 486,023                  
 
                                           
 
 
(1)   Our average prime rate was 8.05%, 7.96%, 6.19%, 4.34% and 4.12% for 2007, 2006, 2005, 2004 and 2003, respectively. The average three-month London Interbank Offered Rate (LIBOR) was 5.30%, 5.20%, 3.56%, 1.62% and 1.22% 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.

44


 

 
                                                                         
    2005     2004     2003  
    Average     Yields   Interest     Average     Yields   Interest     Average     Yields   Interest  
    balance     rates     income   balance     rates     income   balance     rates     income
                    expense                     expense                     expense  

 

                                                                       

 
 

  $ 5,448       3.01 %   $ 164     $ 4,254       1.49 %   $ 64     $ 4,174       1.16 %   $ 49  
 
    5,411       3.52       190       5,286       2.75       145       6,110       2.56       156  
 
 
    997       3.81       38       1,161       4.05       46       1,286       4.74       58  
 
    3,395       8.27       266       3,501       8.00       267       2,424       8.62       196  
 
                                                                       
 
    19,768       6.02       1,162       21,404       6.03       1,248       18,283       7.37       1,276  
 
    5,128       5.60       283       3,604       5.16       180       2,001       6.24       120  
 
                                                           
 
    24,896       5.94       1,445       25,008       5.91       1,428       20,284       7.26       1,396  
 
    3,846       7.10       266       3,395       7.72       236       3,302       7.75       240  
 
                                                           
 
    33,134       6.24       2,015       33,065       6.24       1,977       27,296       7.32       1,890  
 
    38,986       5.67       2,213       32,263       5.38       1,737       58,672       5.34       3,136  
 
    2,857       5.10       146       8,201       3.56       292       7,142       3.51       251  
 
                                                                       
 
                                                                       
 
    58,434       6.76       3,951       49,365       5.77       2,848       47,279       6.08       2,876  
 
    29,098       6.31       1,836       28,708       5.35       1,535       25,846       5.44       1,405  
 
    11,086       6.67       740       8,724       5.30       463       7,954       5.11       406  
 
    5,226       5.91       309       5,068       6.23       316       4,453       6.22       277  
 
                                                           
 
    103,844       6.58       6,836       91,865       5.62       5,162       85,532       5.80       4,964  
 
                                                                       
 
    78,170       6.42       5,016       87,700       5.44       4,772       56,252       5.54       3,115  
 
    55,616       6.61       3,679       44,415       5.18       2,300       31,670       5.80       1,836  
 
    10,663       12.33       1,315       8,878       11.80       1,048       7,640       12.06       922  
 
    43,102       8.80       3,794       33,528       9.01       3,022       29,838       9.09       2,713  
 
                                                           
 
    187,551       7.36       13,804       174,521       6.38       11,142       125,400       6.85       8,586  
 
    4,711       13.49       636       3,184       15.30       487       2,200       18.00       396  
 
                                                           
 
    296,106       7.19       21,276       269,570       6.23       16,791       213,132       6.54       13,946  
 
    1,581       4.34       68       1,709       3.81       65       1,626       4.57       74  
 
                                                           
 
  $ 383,523       6.81       26,072     $ 354,348       5.97       21,071     $ 318,152       6.16       19,502  
 
                                                           

 

                                                                       
 
                                                                       
 
  $ 3,607       1.43       51     $ 3,059       0.44       13     $ 2,571       0.27       7  
 
    129,291       1.45       1,874       122,129       0.69       838       106,733       0.66       705  
 
    22,638       2.90       656       18,850       2.26       425       20,927       2.53       529  
 
    27,676       3.29       910       29,750       1.43       427       25,388       1.20       305  
 
    11,432       3.12       357       8,843       1.40       124       6,060       1.11       67  
 
                                                           
 
    194,644       1.98       3,848       182,631       1.00       1,827       161,679       1.00       1,613  
 
    24,074       3.09       744       26,130       1.35       353       29,898       1.08       322  
 
    79,137       3.62       2,866       67,898       2.41       1,637       53,823       2.52       1,355  

 

                                        3,306       3.66       121  
 
                                                           
 
    297,855       2.50       7,458       276,659       1.38       3,817       248,706       1.37       3,411  
 
    85,668                   77,689                   69,446              
 
                                                           
 
  $ 383,523       1.95       7,458     $ 354,348       1.08       3,817     $ 318,152       1.08       3,411  
 
                                                           
 
 
 
            4.86 %   $ 18,614               4.89 %   $ 17,254               5.08 %   $ 16,091  
 
                                                           

 

                                                                       
 
  $ 13,173                     $ 13,055                     $ 13,433                  
 
    10,705                       10,418                       9,905                  
 
    38,389                       32,758                       36,123                  
 
                                                                 
 
  $ 62,267                     $ 56,231                     $ 59,461                  
 
                                                                 
 
 
                                                                       
 
  $ 87,218                     $ 79,321                     $ 76,815                  
 
    21,559                       18,764                       20,030                  
 
    39,158                       35,835                       32,062                  

 

    (85,668 )                     (77,689 )                     (69,446 )                
 
                                                                 
 
  $ 62,267                     $ 56,231                     $ 59,461                  
 
                                                                 
 
  $ 445,790                     $ 410,579                     $ 377,613                  
 
                                                                 
 
(5)   Nonaccrual loans and related income are included in their respective loan categories.
(6)   At December 31, 2003, upon adoption of FIN 46(R), these balances were reflected in long-term debt. See Note 14 (Long-Term Debt) 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.

45


 

     Table 4 allocates the changes in net interest income on a taxable-equivalent basis to changes in either average balances or average rates for both interest-earning assets and interest-bearing liabilities. Because of the numerous simultaneous volume and rate changes during any period, it is not
possible to precisely allocate such changes between volume and rate. For this table, changes that are not solely due to either volume or rate are allocated to these categories in proportion to the percentage changes in average volume and average rate.


Table 4: Analysis of Changes in Net Interest Income
                                                 
(in millions)   Year ended December 31 ,
    2007 over 2006     2006 over 2005  
    Volume     Rate     Total     Volume     Rate     Total  
 
                                               
Increase (decrease) in interest income:
                                               
Federal funds sold, securities purchased under resale agreements and other short-term investments
  $ (52 )   $ 10     $ (42 )   $ 2     $ 99     $ 101  
Trading assets
    (30 )     (27 )     (57 )     (17 )     72       55  
Debt securities available for sale:
                                               
Securities of U.S. Treasury and federal agencies
    (2 )     (1 )     (3 )     (5 )     6       1  
Securities of U.S. states and political subdivisions
    117       (20 )     97       (13 )     (8 )     (21 )
Mortgage-backed securities:
                                               
Federal agencies
    102       20       122       1,040       4       1,044  
Private collateralized mortgage obligations
    (5 )     (26 )     (31 )     93       54       147  
Other debt securities
    8       30       38       173             173  
Mortgages held for sale
    (634 )     38       (596 )     230       303       533  
Loans held for sale
    21       2       23       (146 )     47       (99 )
Loans:
                                               
Commercial and commercial real estate:
                                               
Commercial
    1,001       26       1,027       529       860       1,389  
Other real estate mortgage
    248       18       266       16       296       312  
Real estate construction
    167       (21 )     146       278       157       435  
Lease financing
    28       7       35       12       (10 )     2  
Consumer:
                                               
Real estate 1-4 family first mortgage
    292       (11 )     281       (1,441 )     607       (834 )
Real estate 1-4 family junior lien mortgage
    634       91       725       620       827       1,447  
Credit card
    448       37       485       247       108       355  
Other revolving credit and installment
    339       57       396       730       365       1,095  
Foreign
    116       (47 )     69       205       (55 )     150  
Other
    2       1       3       (10 )     10        
 
                                   
Total increase in interest income
    2,800       184       2,984       2,543       3,742       6,285  
 
                                   

Increase (decrease) in interest expense:

                                               
Deposits:
                                               
Interest-bearing checking
    23       14       37       12       60       72  
Market rate and other savings
    345       535       880       75       1,276       1,351  
Savings certificates
    343       164       507       337       273       610  
Other time deposits
    (1,134 )     (38 )     (1,172 )     167       530       697  
Deposits in foreign offices
    732       (6 )     726       376       220       596  
Short-term borrowings
    211       42       253       (88 )     336       248  
Long-term debt
    465       235       700       186       1,072       1,258  
 
                                   
Total increase in interest expense
    985       946       1,931       1,065       3,767       4,832  
 
                                   

Increase (decrease) in net interest income on a taxable-equivalent basis

  $ 1,815     $ (762 )   $ 1,053     $ 1,478     $ (25 )   $ 1,453  
 
                                   
   

Noninterest Income
We earn trust, investment and IRA fees from managing and administering assets, including mutual funds, corporate trust, personal trust, employee benefit trust and agency assets. At December 31, 2007, these assets totaled $1.12 trillion, up 14% from $983 billion at December 31, 2006. Trust, investment and IRA fees are primarily based on a tiered scale relative to the market value of the assets under management or administration. The 13% increase in these fees in 2007 from 2006 was due to continued strong asset growth across all the trust and investment management businesses.
      We also receive commissions and other fees for providing services to full-service and discount brokerage customers. At December 31, 2007 and 2006, brokerage assets totaled $131
billion and $115 billion, respectively. Generally, these fees include transactional commissions, which are based on the number of transactions executed at the customer’s direction, or asset-based fees, which are based on the market value of the customer’s assets. A significant portion of the 20% increase in these fees in 2007 from a year ago was due to higher securities issuance and investment banking activity.
      Card fees increased 22% to $2,136 million in 2007 from $1,747 million in 2006, primarily due to an increase in the percentage of our customer base using a Wells Fargo credit card and to higher credit and debit card transaction volume. Purchase volume on these cards increased 19% from a year ago and average card balances were up 28%.


46


 

Table 5: Noninterest Income
                                         
(in millions)   Year ended December 31 ,   % Change  
    2007     2006     2005     2007 /   2006 /
                            2006     2005  

Service charges on deposit accounts

  $ 3,050     $ 2,690     $ 2,512       13 %     7 %
Trust and investment fees:
                                       
Trust, investment and IRA fees
    2,305       2,033       1,855       13       10  
Commissions and all other fees
    844       704       581       20       21  
 
                                 
Total trust and investment fees
    3,149       2,737       2,436       15       12  
Card fees
    2,136       1,747       1,458       22       20  
Other fees:
                                       
Cash network fees
    193       184       180       5       2  
Charges and fees on loans
    1,011       976       1,022       4       (5 )
All other fees
    1,088       897       727       21       23  
 
                                 
Total other fees
    2,292       2,057       1,929       11       7  
Mortgage banking:
                                       
Servicing income, net
    1,511       893       987       69       (10 )
Net gains on mortgage loan origination/sales activities
    1,289       1,116       1,085       16       3  
All other
    333       302       350       10       (14 )
 
                                 
Total mortgage banking
    3,133       2,311       2,422       36       (5 )
Operating leases
    703       783       812       (10 )     (4 )
Insurance
    1,530       1,340       1,215       14       10  
Net gains from trading activities
    544       544       571             (5 )
Net gains (losses) on debt securities available for sale
    209       (19 )     (120 )   NM     (84 )
Net gains from equity investments
    734       738       511       (1 )     44  
All other
    936       812       699       15       16  
 
                                 

Total

  $ 18,416     $ 15,740     $ 14,445       17       9  
 
                                 
   
NM – Not meaningful

      Mortgage banking noninterest income was $3,133 million in 2007, compared with $2,311 million in 2006. Servicing fees, included in net servicing income, increased to $4,025 million in 2007 from $3,525 million in 2006, due to growth in loans serviced for others, primarily reflecting the full year effect of the $140 billion servicing portfolio acquired from Washington Mutual, Inc. in July 2006. Our portfolio of loans serviced for others was $1.43 trillion at December 31, 2007, up 12% from $1.28 trillion at December 31, 2006. Servicing income also includes both changes in the fair value of MSRs during the period as well as changes in the value of derivatives (economic hedges) used to hedge the MSRs. Net servicing income for 2007 included a $583 million net MSRs valuation gain that was recorded to earnings ($571 million fair value loss offset by a $1.15 billion economic hedging gain) and for 2006 included a $154 million net MSRs valuation loss ($9 million fair value loss plus a $145 million economic hedging loss). At December 31, 2007, the ratio of MSRs to related loans serviced for others was 1.20%, the lowest ratio in 10 quarters.
      Net gains on mortgage loan origination/sales activities were $1,289 million in 2007, up from $1,116 million in 2006. Gains for 2007 were partly offset by losses of $803 million, which consisted of a $479 million write-down of the mortgage warehouse/pipeline, and a $324 million write-down primarily due to mortgage loans repurchased and an increase in the repurchase reserve for projected early payment defaults. During 2006, we realized losses of $126 million resulting from the sale of low yielding ARMs as part of our balance sheet repositioning strategy. Residential real estate originations totaled $272 billion in 2007, compared
with $294 billion in 2006. Under FAS 159 we elected in 2007 to account for new prime MHFS at fair value. These loans are initially measured at fair value, with subsequent changes in fair value recognized as a component of net gains on mortgage loan origination/sales activities. Prior to the adoption of FAS 159, these fair value gains would have been deferred until the sale of these loans. (For additional detail, see “Asset/Liability and Market Risk Management — Mortgage Banking Interest Rate and Market Risk,” and Note 1 (Summary of Significant Accounting Policies), Note 9 (Mortgage Banking Activities) and Note 17 (Fair Values of Assets and Liabilities) to Financial Statements.) The 1-4 family first mortgage unclosed pipeline was $43 billion at December 31, 2007 and $48 billion at December 31, 2006.
      Insurance revenue was up 14% from 2006, due to higher insurance commissions and increases in crop insurance premiums.
      Income from trading activities was $544 million in both 2007 and 2006. Net gains on debt securities were $209 million for 2007, compared with losses of $19 million for 2006. Net gains from equity investments were $734 million in 2007, compared with $738 million in 2006.
      We routinely review our investment portfolios and recognize impairment write-downs based primarily on fair market value, issuer-specific factors and results, and our intent to hold such securities to recovery. 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 other-than-temporary impairment based on the information available at the time of the assessment, with particular focus on the severity and duration of specific security impairments, but new information or economic developments in the future could result in recognition of additional impairment.
Noninterest Expense
Table 6: Noninterest Expense
                                         
(in millions)   Year ended December 31 ,   % Change  
    2007     2006     2005     2007 /   2006 /
                            2006     2005  

Salaries

  $ 7,762     $ 7,007     $ 6,215       11 %     13 %
Incentive compensation
    3,284       2,885       2,366       14       22  
Employee benefits
    2,322       2,035       1,874       14       9  
Equipment
    1,294       1,252       1,267       3       (1 )
Net occupancy
    1,545       1,405       1,412       10        
Operating leases
    561       630       635       (11 )     (1 )
Outside professional services
    899       942       835       (5 )     13  
Outside data processing
    482       437       449       10       (3 )
Travel and entertainment
    474       542       481       (13 )     13  
Contract services
    448       579       596       (23 )     (3 )
Operating losses
    437       275       194       59       42  
Insurance
    416       257       224       62       15  
Advertising and promotion
    412       456       443       (10 )     3  
Postage
    345       312       281       11       11  
Telecommunications
    321       279       278       15        
Stationery and supplies
    220       223       205       (1 )     9  
Security
    176       179       167       (2 )     7  
Core deposit intangibles
    113       112       123       1       (9 )
All other
    1,313       1,030       973       27       6  
 
                                 
Total
  $ 22,824     $ 20,837     $ 19,018       10       10  
 
                                 
   


47


 

We continued to build our business with investments in additional team members, largely sales and service professionals, and new banking stores in 2007. The 10% increase in noninterest expense to $22.8 billion in 2007 from $20.8 billion in 2006 was due primarily to the increase in salaries, incentive compensation and employee benefits. We grew our sales and service force by adding 1,755 team members (full-time equivalents), including 578 retail platform bankers. In 2007, we opened 87 regional banking stores and converted 42 stores acquired from Placer Sierra Bancshares and National City Bank to our network. The acquisition of Greater Bay Bancorp added $87 million of expenses in 2007. Expenses also included stock option expense of $129 million in 2007, compared with $134 million in 2006. In addition, expenses in 2007 included $433 million in origination costs that, prior to the adoption of FAS 159, would have been deferred and recognized as a reduction of net gains on mortgage loan origination/sales activities at the time of sale.
      Operating losses included $203 million for 2007 and $95 million for 2006 of litigation expenses associated with indemnification obligations arising from our ownership interest in Visa.
      Wells Fargo is a member of the Visa USA network. On October 3, 2007, the Visa organization of affiliated entities completed a series of global restructuring transactions to combine its affiliated operating companies, including Visa USA, under a single holding company, Visa Inc. Visa Inc. intends to issue and sell a majority of its shares to the public in an initial public offering (IPO). We have an approximate 2.8% ownership interest in Visa Inc., which is included in our balance sheet at a nominal amount.
      We obtained concurrence from the staff of the SEC concerning our accounting for the Visa restructuring transactions, including (1) judgment sharing agreements previously executed among the Company, Visa Inc. and its predecessors (collectively Visa) and certain other member banks of the Visa USA network, (2) litigation, and (3) an escrow account that will be established by Visa Inc. at the time of its IPO. The escrow account will be funded from IPO proceeds and will be used to make payments related to Visa litigation. We recorded litigation liabilities associated with indemnification obligations related to agreements entered into during second quarter 2006 and third quarter 2007. Based on our proportionate membership share of Visa USA, we recorded a litigation liability and corresponding expense of $95 million for 2006 and $203 million for 2007. The effect to the second quarter 2006 was estimated based upon our share of an actual settlement reached in November 2007. Management does not believe that the fair value of this obligation if determined in second quarter 2006 would have been materially different given information available at that time. Management has concluded, and the Audit and Examination Committee of our Board of Directors has concurred, that these amounts are immaterial to the periods affected.
      Upon completion of Visa Inc.’s IPO, we will account for the funding of the escrow account by reducing our litigation liability with a corresponding credit to noninterest expense
for our portion of the escrow account, consistent with the method of allocating joint and several liability among potentially responsible parties in American Institute of Certified Public Accountants Statement of Position 96-1, Environmental Remediation Liabilities.
Income Tax Expense
On January 1, 2007, we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). Implementation of FIN 48 did not result in a cumulative effect adjustment to retained earnings. At January 1, 2007, the total amount of unrecognized tax benefits and accrued interest was $3.1 billion, of which $1.7 billion related to tax benefits and interest that, if recognized, would impact the annual effective tax rate. Our effective tax rate for 2007 was 30.7%, compared with 33.4% for 2006. Income tax expense and the related effective tax rate for 2007 included FIN 48 tax benefits of $235 million, as well as the impact of lower pre-tax earnings in relation to the level of tax-exempt income and tax credits. The tax benefits were primarily related to the resolution of certain matters with federal and state taxing authorities and statute expirations, reduced by accruals for uncertain tax positions, in accordance with FIN 48. We expect that FIN 48 will cause more volatility in our effective tax rate from quarter to quarter as we are now required to recognize tax positions in our financial statements based on the probability of ultimately sustaining such positions with the respective taxing authorities, and we are required to reassess those positions each quarter based on our evaluation of new information.
Operating Segment Results
We have three lines of business for management reporting: Community Banking, Wholesale Banking and Wells Fargo Financial. For a more complete description of our operating segments, including additional financial information and the underlying management accounting process, see Note 24 (Operating Segments) to Financial Statements.
      To reflect a change in the allocation of income taxes for management reporting adopted in 2007, results for prior periods have been revised.
COMMUNITY BANKING’S net income decreased 5% to $5.29 billion in 2007 from $5.55 billion in 2006. Strong sales and revenue growth combined with disciplined expense management were offset by higher credit costs, including the $1.4 billion (pre tax) credit reserve build. Revenue increased 11% to $25.54 billion from $23.03 billion in 2006. Net interest income increased 2% to $13.37 billion in 2007 from $13.12 billion in 2006. Although the net interest margin declined 3 basis points to 4.75% (primarily due to lower investment yields), the 3% growth in earning assets more than offset the impact of the lower margin. The growth in earning assets was predominantly driven by loan growth. Average loans were up 9% to $194.0 billion in 2007 from $178.0 billion in 2006. Average core deposits were up 7% to $249.8 billion in 2007 from $233.5 billion a year ago.


48


 

Noninterest income increased 23% to $12.17 billion in 2007 from $9.92 billion in 2006, primarily due to retail banking fee revenue growth in brokerage, deposit service charges, cards and investments. Noninterest income also included higher mortgage banking revenue, which increased $505 million (18%) largely due to higher servicing income. The provision for credit losses for 2007 increased to $3.19 billion in 2007 from $887 million in 2006 including the fourth quarter 2007 $1.4 billion credit reserve build, with over half of the remaining increase in the Home Equity portfolio. Noninterest expense for 2007 increased 8% to $15.00 billion in 2007 from $13.92 billion in 2006, due to growth in personnel expenses.
WHOLESALE BANKING’S net income increased 13% to a record $2.28 billion in 2007 from $2.02 billion in 2006. Revenue increased 15% to a record $8.34 billion from $7.23 billion in 2006. Net interest income increased 16% to $3.38 billion for 2007 from $2.92 billion for 2006 primarily due to higher earning asset volumes and earning asset yields and related fees, partially offset by higher funding costs. Average loans increased 20% to $85.6 billion in 2007 from $71.4 billion in 2006. Average core deposits grew 51% to $53.3 billion primarily due to large corporate and middle-market relationships, international and correspondent banking customers and from higher Eurodollar sweep and liquidity balances from our asset management customers. The increase in provision for credit losses to $69 million in 2007 from $16 million in 2006 was due to higher net charge-offs. Noninterest income increased 15% to $4.96 billion in 2007, due to higher deposit service charges, trust and investment income, foreign exchange
fees, insurance revenue, commercial real estate brokerage fees and capital markets activity. Noninterest expense increased 16% to $4.77 billion in 2007 from $4.11 billion in 2006, due to higher personnel-related costs, expenses related to higher sales volumes, investments in new offices and businesses and acquisitions.
WELLS FARGO FINANCIAL’S net income decreased 44% to $481 million in 2007 from $852 million in 2006 reflecting higher credit losses and our decision in late 2006 to slow the growth in our auto portfolio as well as the divestiture of some of our Latin American operations and a $50 million reversal of Hurricane Katrina-related reserves, both in 2006. Revenue was up 2% to $5.51 billion in 2007 from $5.43 billion in 2006. Net interest income increased 8% to $4.23 billion from $3.91 billion in 2006 due to growth in average loans. Average loans increased 13% to $65.2 billion in 2007 from $57.5 billion in 2006. The provision for credit losses increased $382 million in 2007 from 2006, primarily due to an increase in net charge-offs in the auto lending and credit card portfolios, and lower net charge-offs in early 2006 relating to the bankruptcy law change in October 2005. Noninterest income decreased $231 million in 2007 from 2006 in part, as a result of the Latin American sale. Noninterest expense increased $246 million (9%) in 2007 from 2006, primarily due to higher employee compensation and benefit costs. A significant portion of this increase was due to Wells Fargo Financial’s continued focus on reducing losses and delinquencies in auto lending and credit card portfolios by improving processes and staffing levels in collections.


Balance Sheet Analysis
 

Securities Available for Sale
Our securities available for sale consist of both debt and marketable equity securities. We hold debt securities available for sale primarily for liquidity, interest rate risk management and long-term yield enhancement. Accordingly, this portfolio primarily includes very liquid, high-quality federal agency and privately issued mortgage-backed securities. At December 31, 2007, we held $70.2 billion of debt securities available for sale, with net unrealized gains of $775 million, compared with $41.8 billion at December 31, 2006, with net unrealized gains of $722 million. We also held $2.8 billion of marketable equity securities available for sale at December 31, 2007, and $796 million at December 31, 2006, with net unrealized losses of $95 million and net gains of $204 million for the same periods, respectively. The increase in marketable equity securities was primarily due to our adoption of Topic D-109 effective July 1, 2007, which resulted in the transfer of approximately $1.2 billion of securities, consisting of investments in preferred stock callable by the issuer, from trading assets to securities available for sale.
      The weighted-average expected maturity of debt securities available for sale was 5.9 years at December 31, 2007. Since 78%
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 is shown in Table 7.
                         
Table 7: Mortgage-Backed Securities  
                   
(in billions)   Fair     Net     Remaining  
    value     unrealized     maturity  
          gain (loss )      
 
                       
At December 31, 2007
  $ 55.0       $   0.9     4.0 yrs.
 
                       
At December 31, 2007,
                       
assuming a 200 basis point:
                       
Increase in interest rates
    50.7       (3.4 )   6.4 yrs.
Decrease in interest rates
    56.7       2.6     1.7 yrs.
 
                       
 
     We have approximately $3 billion of investments in securities, primarily municipal bonds, that are guaranteed against loss by bond insurers. These securities are almost exclusively


49


 

investment grade and were generally underwritten in accordance with our own investment standards prior to the determination to purchase, without relying on the bond insurer’s guarantee in making the investment decision. These securities will continue to be monitored as part of our ongoing impairment analysis of our securities available for sale, but are expected to perform, even if the rating agencies reduce the credit rating of the bond insurers.
      See Note 5 (Securities Available for Sale) to Financial Statements for securities available for sale by security type.
Loan Portfolio
A discussion of average loan balances is included in “Earnings Performance – Net Interest Income” on page 43 and 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.
      Total loans at December 31, 2007, were $382.2 billion, up $63.1 billion (20%) from $319.1 billion at December 31, 2006. Consumer loans were $221.9 billion at December 31, 2007, up $31.5 billion (17%) from $190.4 billion a year ago. Commercial and commercial real estate loans of $152.8 billion at December 31, 2007, increased $30.8 billion (25%) from a year ago. Mortgages held for sale decreased to $26.8 billion at December 31, 2007, from $33.1 billion a year ago. Our acquisitions of Greater Bay Bancorp, Placer Sierra Bancshares and the CIT construction business in 2007 added $9.7 billion of total loans, consisting of $8.8 billion of commercial and commercial real estate loans and $866 million of consumer loans at December 31, 2007.
      Table 8 shows contractual loan maturities and interest rate sensitivities for selected loan categories.
                                     
Table 8: Maturities for Selected Loan Categories  
       
(in millions)   December 31, 2007  
    Within   After   After   Total  
    one   one year   five      
    year   through   years      
        five years          
 
                               
Selected loan maturities:
                               
Commercial
  $ 27,381     $ 45,185     $ 17,902     $ 90,468  
Other real estate mortgage
    4,828       12,606       19,313       36,747  
Real estate construction
    9,960       7,713       1,181       18,854  
Foreign
    770       3,897       2,774       7,441  
 
                       
Total selected loans
  $ 42,939     $ 69,401     $ 41,170     $ 153,510  
 
                       
 
                               
Sensitivity of loans due after one year to changes in interest rates:
                               
Loans at fixed interest rates
          $ 12,744     $ 14,727          
Loans at floating/variable interest rates
            56,657       26,443          
 
                           
Total selected loans
          $ 69,401     $ 41,170          
 
                           
 
                               
 
Deposits
Year-end deposit balances are shown in Table 9. Comparative detail of average deposit balances is included in Table 3. Average core deposits increased $34.2 billion to $303.1 billion in 2007 from $268.9 billion in 2006. Average core deposits funded 58.2% and 55.3% of average total assets in 2007 and 2006, respectively. Total average interest-bearing deposits increased to $239.2 billion in 2007 from $223.8 billion in 2006, largely due to growth in market rate and other savings deposits, along with growth in foreign deposits, offset by a decline in other time deposits. Total average noninterest-bearing deposits declined to $88.9 billion in 2007 from $89.1 billion in 2006. Savings certificates increased on average to $40.5 billion in 2007 from $32.4 billion in 2006.
                                 
Table 9: Deposits  
                     
(in millions)   December 31 ,           %  
    2007     2006             Change  
 
                               
Noninterest-bearing
  $ 84,348     $ 89,119               (5 )%
Interest-bearing checking
    5,277       3,540               49  
Market rate and other savings
    153,924       140,283               10  
Savings certificates
    42,708       37,282               15  
Foreign deposits (1)
    25,474       17,844               43  
 
                           
Core deposits
    311,731       288,068               8  
Other time deposits
    3,654       13,819               (74 )
Other foreign deposits
    29,075       8,356               248  
 
                           
Total deposits
  $ 344,460     $ 310,243               11  
 
                           
 
                               
   
(1)   Reflects Eurodollar sweep balances included in core deposits.

50


 

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 variable interest entities in which we are the primary beneficiary. Generally, we use the equity method of accounting if we own at least 20% of an entity and we carry the investment at cost if we own less than 20% of an entity. 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 in the balance sheet, or may be recorded in the balance sheet in amounts that are different from 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 U.S. GAAP.
      We have largely avoided many of the industry issues associated with collateralized debt obligations (CDOs) and structured investment vehicles (SIVs). A CDO is a security backed by pools of assets, which may include debt securities, including bonds (collateralized bond obligations, or CBOs) or loans (collateralized loan obligations, or CLOs). CDOs often can have reinvestment periods in which they can trade assets and/or reinvest asset sales or liquidation proceeds. Like collateralized mortgage obligations, CDOs issue tranches of debt with different maturities and risk characteristics. We typically have not engaged in creating or sponsoring SIVs to hold off-balance sheet assets and we have not made a market in subprime securities.
      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 commercial mortgages. We normally structure loan securitizations as sales, in accordance with FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities – a replacement of FASB Statement No. 125. 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 record a liability related to standard representations and warranties we make to purchasers and issuers 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, 2007, securitization arrangements sponsored by the Company consisted of $224 billion in securitized loan receivables, including $135 billion of home mortgage loans and $89 billion of commercial mortgages. At December 31, 2007, the retained servicing rights and other interests held related to these securitizations were $10.8 billion, consisting of $8.8 billion in securities, $1.5 billion in servicing assets and $413 million in other interests held. Related to our securitizations, we have committed to provide up to $21 million in credit enhancements.
      We have investments in certain special-purpose entities, generally created by other sponsoring organizations, where we hold variable interests greater than 20% but less than 50% (significant variable interests). These special-purpose entities were predominantly formed to invest in affordable housing and sustainable energy projects and to securitize corporate debt and had approximately $5.8 billion in total assets at December 31, 2007, including $960 million related to CDOs. 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 $2.0 billion at December 31, 2007, primarily representing investments in entities formed to invest in affordable housing and sustainable energy projects. However, we expect to recover our investment in these entities over time primarily through realization of federal tax credits. Our investments in CDOs, including those special-purpose entities where we hold significant variable interests, totaled $860 million at December 31, 2007. Table 10 reflects these investments, including the corresponding asset collateral categories and related credit ratings.


                                                                         
Table 10: Investments in Collateralized Debt Obligations  
       
(in millions)   December 31, 2007
                                            Distribution of fair value by rating category  
                                            Investment grade          
    Cost   Gross   Gross   Fair           AAA   AA to   Other   Total  
        unrealized   unrealized   value               BBB -        
        gains   losses (1)                        
 
                                                                       
Corporate credit
  $ 589     $ 1     $ (68 )   $ 522             $ 13     $ 292     $ 217 (2)   $ 522  
Bank or insurance trust preferred
    298       1       (5 )     294               257       37             294  
Commercial mortgage
    49             (5 )     44               24       20             44  
Residential mortgage
                                                       
 
                                                       
Total
  $ 936     $ 2     $ (78 )   $ 860             $ 294     $ 349     $ 217     $ 860  
 
                                                       
 
                                                                       
   
(1)   All unrecognized losses are reviewed for potential impairment on a quarterly basis. At December 31, 2007, there was no deterioration in cash flows for any of the investments reflected above and, therefore, no impairment charge. We have the ability and the intent to hold these investments until maturity or recovery.
 
(2)   Approximately 90% had underlying credit portfolios that were selected by Wells Fargo credit analysts. Included $192 million of non-rated securities.

51


 

     In addition, in securities available for sale, we held approximately $1,735 million in tax-exempt bonds at December 31, 2007, in the form of CDOs, consolidated in our balance sheet with related liabilities, based on the Company’s participation in certain municipal tender option bond programs. The fair value includes a $69 million net unrealized loss due to changes in interest rates which is expected to be recovered over time. Approximately 98% of the bonds are rated investment grade while 2% are not rated. Under the municipal tender option bond programs in which we participate, we place long-term tax-exempt municipal bonds in a trust sponsored by a third party which serves as the collateral for short-term tender option bonds issued by the trust to investors. These tender option bonds can be “put” or tendered by the investor to the trust at par at predetermined times (generally weekly or monthly). We are required to consolidate the trusts in accordance with FIN 46R. We earn a spread between the long-term rate on the municipal bonds and the short-term rate on the corresponding tender option bonds.
      For more information on securitizations, including sales proceeds and cash flows from securitizations, see Note 8 (Securitizations and Variable Interest Entities) to Financial Statements.
      Our money market mutual funds are allowed to hold investments in SIVs in accordance with approved investment parameters for the respective funds and, therefore, may have indirect exposure to CDOs. At December 31, 2007, our money market mutual funds held $106 billion of assets under management including investments in eight SIVs not sponsored by the Company aggregating $1.6 billion, or 1.5% of the funds’ assets. Based on the maturity and paydown of these investments, by February 1, 2008, the funds held three SIVs aggregating $1.0 billion. At February 1, 2008, the remaining assets held by the money market funds were either U.S. government, high-grade municipal, or high-grade corporate securities. At such time, to maintain an investment rating of AAA for certain funds, we elected to enter into a capital support agreement for up to $130 million related to one SIV held by our AAA-rated non-government money market mutual funds. We are generally not responsible for investment losses incurred by our funds, and we do not have a contractual or implicit obligation to indemnify such losses or provide additional support to the funds. Based on our estimate of the guarantee obligation at the time we entered into the agreement, we recorded a liability of $39 million in 2008. While we elected to enter into the capital support agreement for the AAA-rated funds, we are not obligated and may elect not to provide additional support to these funds or other funds in the future.
      Wells Fargo Home Mortgage (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. through an established line of credit and are subject to specified underwriting criteria. At December 31, 2007, the total assets of these mortgage origination joint ventures were approximately $55 million. We provide liquidity to these joint ventures in the form of outstanding lines of credit and, at December 31, 2007, these liquidity commitments totaled $238 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, 2007, total assets of our real estate lending and merchant services joint ventures were approximately $775 million.
      In connection with certain brokerage, asset management, insurance agency and other acquisitions we have made, the terms of the acquisition agreements provide for deferred payments or additional consideration, based on certain performance targets. At December 31, 2007, the amount of additional 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 15 (Guarantees and Legal Actions) 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 related investment cycle, the period over which privately-held companies are funded by investors and ultimately sold or taken public. 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 commitments is used. At December 31, 2007, these commitments were approximately $895 million. Our other investment commitments, principally related to affordable housing, civic and other community development initiatives, were approximately $685 million at December 31, 2007.
      In the ordinary course of business, we enter into indemnification agreements, including underwriting agreements relating to our securities, securities lending, acquisition agreements, and various other business transactions or arrangements. For more information, see Note 15 (Guarantees and Legal Actions) to Financial Statements.


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Contractual Obligations
In addition to the contractual commitments and arrangements previously described, 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 11 summarizes these contractual obligations at December 31, 2007, except obligations for short-term borrowing arrangements and pension and postretirement benefit plans. More information on those obligations is in Note 13 (Short-Term Borrowings) and Note 20 (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 are subject to the income tax laws of the U.S., its states and municipalities, and those of the foreign jurisdictions in which we operate. We have various unrecognized tax obligations related to these operations which may require
future cash tax payments to various taxing authorities. Because of their uncertain nature, the expected timing and amounts of these payments are not reasonably estimable or determinable. See Note 21 (Income Taxes) to Financial Statements for more information.
      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 16 (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. We had no related party transactions required to be reported under FAS 57 for the years ended December 31, 2007, 2006 and 2005.


                                                              
Table 11: Contractual Obligations  
                             
(in millions) Note(s) to   Less than   1-3   3-5   More than   Indeterminate   Total  
  Financial   1 year   years   years   5 years   maturity (1)    
  Statements                          
 
                                                       
Contractual payments by period:
                                                       
Deposits
    12     $ 95,893     $ 3,459     $ 1,205     $ 343     $ 243,560     $ 344,460  
Long-term debt (2)
    7,14       18,397       27,221       22,015       31,760             99,393  
Operating leases
    7       618       976       681       1,408             3,683  
Purchase obligations (3)
            386       539       317       254             1,496  
 
                                           
 
                                                       
Total contractual obligations
          $ 115,294     $ 32,195     $ 24,218     $ 33,765     $ 243,560     $ 449,032  
 
                                           
 
                                                       
   
(1)   Includes interest-bearing and noninterest-bearing checking, and market rate and other savings accounts.
 
(2)   Includes obligations under 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, judgmental or statistical credit underwriting, frequent and detailed risk measurement and modeling, extensive credit training programs and a continual loan review and audit process. In addition, regulatory examiners review and perform detailed tests of our credit underwriting, loan administration and allowance processes. In 2007, the credit policies related to residential real estate lending were updated to reflect the current economic conditions in the industry. Credit policy was tightened as we made decisions to exit certain poorly performing indirect channels.
      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 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 for the consolidated company. We strive to identify problem loans early and have dedicated, specialized collection and work-out units.
      The Chief Credit Officer provides company-wide credit oversight. Each business unit with direct credit risks has a senior 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, credit performance or business requirements. The Chief Credit Officer is a member of the Company’s Management Committee. The Chief Credit Officer provides a quarterly credit review to the Credit Committee of the Board of Directors and meets with them periodically.


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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 in risk asset review and internal audit independently review portfolios with credit risk, monitor performance, sample credits, review and test adherence to credit policy and recommend/require corrective actions as necessary.
      Our primary business focus on middle-market commercial, residential real estate, auto, credit card and small consumer lending, results in portfolio diversification. We assess loan portfolios for geographic, industry or other concentrations and use mitigation strategies, which may include loan sales, syndications or third party insurance, to minimize these concentrations, as we deem appropriate.
      In our commercial loan, commercial real estate loan and lease financing portfolios, larger or more complex loans are individually underwritten and judgmentally risk rated. They are periodically monitored and prompt corrective actions are taken on deteriorating loans. Smaller, more homogeneous commercial small business loans are approved and monitored using statistical techniques.
      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 and approves new model implementation and periodic validation.
      Residential real estate mortgages are one of our core products. We offer a broad spectrum of first mortgage and junior lien loans that we consider mostly prime or near prime. These loans are almost entirely secured by a primary residence for the purpose of purchase money, refinance, debt consolidation, or home equity loans. We do not make or purchase option adjustable-rate mortgage products (option ARMs) or variable-rate mortgage products with fixed payment amounts, commonly referred to within the financial services industry as negative amortizing mortgage loans, as we believe these products rarely provide a benefit to our customers.
      We originate mortgage loans through a variety of sources, including our retail sales force and licensed real estate brokers. We apply consistent credit policies, borrower documentation standards, Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) compliant appraisal requirements, and sound underwriting, regardless of application source. We perform quality control reviews for third party originated loans and actively manage or terminate sources that do not meet our credit standards. Specifically, during 2007 we stopped originating first and junior lien residential mortgages where credit performance had deteriorated beyond our expectations, especially recent vintages of high combined loan-to-value home equity loans sourced through third party channels.
      We believe our underwriting process is well controlled and appropriate for the needs of our customers as well as
investors who purchase the loans or securities collateralized by the loans. We only approve applications and make loans if we believe the customer has the ability to repay the loan or line of credit according to all its terms. A small portion of borrower selected stated income loans originated from third party channels produced unacceptable performance in our Home Equity portfolio. We have tightened our bank-selected reduced documentation requirements as a precautionary measure and substantially reduced third party originations due to the negative trends experienced in these channels. Appraisals are used to support property values.
      In the mortgage industry, it has been common for consumers, lenders, and servicers to purchase mortgage insurance, which can enhance the credit quality of the loan for investors and serves generally to expand the market for home ownership.
      In our servicing portfolio, certain of the loans we service carry mortgage insurance, based largely on the requirements of investors, who bear the ultimate credit risk. Within our $1.5 trillion servicing portfolio, we service approximately $115 billion of loans that carry approximately $25 billion of mortgage insurance coverage purchased from a group of mortgage insurance companies that are rated AA or higher by one or more of the major rating agencies. Should any of these companies experience a downgrade by one or more of the rating agencies, investors may be exposed to a higher level of credit risk. In this event, as servicer, we would work with the investors to determine if it is necessary to obtain replacement coverage with another insurer. Our mortgage servicing portfolio consists of over 90% prime loans and we continue to be among the highest rated loan servicers for residential real estate mortgage loans, based on various servicing criteria. The foreclosure rate in our mortgage servicing portfolio was only 0.88% at year-end 2007.
      Similarly, we obtained approximately $2 billion of mortgage insurance coverage for certain loans that we held for investment or for sale at December 31, 2007. In the event a mortgage insurer is unable to meet its obligations on defaulted loans in accordance with the insurance contract, we might be exposed to higher credit losses if replacement coverage on those loans cannot be obtained. However, approximately one-third of the coverage related to the debt consolidation nonprime real estate 1-4 family mortgage loans held by Wells Fargo Financial, which have had a low level of credit losses (0.31% loss rate (annualized) in fourth quarter 2007 for the entire debt consolidation portfolio). The remaining coverage primarily related to prime real estate 1-4 family mortgage loans, primarily high quality ARMs for our retail and wealth management customers, which also have had very low loss rates.
      Each business unit regularly completes asset quality forecasts to quantify its intermediate-term outlook for loan losses and recoveries, nonperforming loans and market trends. To make sure our overall loss estimates and the 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, stemming from economic conditions or borrower performance.


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     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, geographic locations such as states or Metropolitan Statistical Areas and specific macroeconomic trends.
LOAN PORTFOLIO CONCENTRATIONS
Loan concentrations may exist when there are borrowers engaged in similar activities or types of loans extended to a diverse group of borrowers that could cause those borrowers or portfolios to be similarly impacted by economic or other conditions.
      The concentrations of real estate 1-4 family mortgage loans by state are presented in Table 12. Our real estate 1-4 family mortgage loans to borrowers in the state of California represented approximately 13% of total loans at December 31, 2007, compared with 11% at the end of 2006. These loans are mostly within several metropolitan areas in California, with no single area consisting of more than 3% of total loans. Changes in real estate values and underlying economic or market conditions for these areas are monitored continuously within the credit risk management process. In 2007, the residential real estate markets experienced significant declines in property values, and several markets in California, specifically the Central Valley and several Southern California metropolitan statistical areas, experienced more severe value adjustments.
      Some of our real estate 1-4 family mortgage loans, including first mortgage and home equity products, include an interest-only feature as part of the loan terms. At December 31, 2007, these loans were approximately 20% of total loans, compared with 19% at the end of 2006. Substantially all of these loans are considered to be prime or near prime. We do not make or purchase option ARMs or negative amortizing mortgage loans. We have minimal ARM reset risk across our owned mortgage loan portfolios.
                                 
Table 12: Real Estate 1-4 Family Mortgage Loans by State  
                       
(in millions) December 31, 2007  
  Real estate   Real estate   Total real   % of  
  1-4 family   1-4 family   estate 1-4   total  
  first   junior lien   family   loans  
  mortgage   mortgage   mortgage      
 
                               
California
  $ 20,782     $ 28,234     $ 49,016       13 %
Minnesota
    3,009       4,209       7,218       2  
Arizona
    2,986       3,451       6,437       2  
Florida
    3,127       2,851       5,978       2  
Colorado
    2,612       2,889       5,501       1  
Washington
    2,476       2,938       5,414       1  
Texas
    3,551       1,805       5,356       1  
New York
    2,200       2,275       4,475       1  
Nevada
    1,625       1,642       3,267       *  
Illinois
    1,616       1,444       3,060       *  
Other (1)
    27,431       23,827       51,258       13  
 
                       
 
                               
Total
  $ 71,415     $ 75,565     $ 146,980       38 %
 
                       
 
                               
   
*   Less than 1%.
 
(1)   Consists of 40 states; no state had loans in excess of $2,959 million. Includes $5,029 million in GNMA early pool buyouts.
     The deterioration in specific segments of the National Home Equity Group (Home Equity) portfolio required a targeted approach to managing these assets. A liquidating portfolio, consisting of all home equity loans generated through the wholesale channel not behind a Wells Fargo first mortgage, and all home equity loans acquired through correspondents was identified. While the $11.9 billion of loans in this liquidating portfolio represented about 3% of total loans outstanding at December 31, 2007, these loans represented the highest risk in the $84.2 billion Home Equity portfolio, with a loss rate of 4.80% (December 2007, annualized) compared with 0.86% for the remaining portfolio. The loans in the liquidating portfolio are largely concentrated in geographic markets that have experienced the most abrupt and steepest declines in housing prices. The remaining portfolio consists of $72.3 billion of loans in the Home Equity portfolio at December 31, 2007, of which $70.9 billion were originated through the retail channel, with approximately $11.4 billion of these retail originations in a first lien position. Retail originations in a second lien position included approximately $38.1 billion behind a Wells Fargo first mortgage. Table 13 includes the credit attributes of these two portfolios.
                         
Table 13: National Home Equity Group Portfolio  
               
  December 31, 2007  
  Outstanding             December 2007  
  balance     % 30 days     loss rate  
  (in millions )   past due     (annualized )
 
                       
Liquidating portfolio
                       
California
  $ 4,387       2.94 %     7.34 %
Florida
    582       4.98       7.08  
Arizona
    274       2.67       5.84  
Texas
    221       0.83       0.78  
Minnesota
    141       3.18       4.09  
Other
    6,296       2.00       2.94  
 
                     
Total
  $ 11,901       2.50       4.80  
 
                     
 
                       
Remaining portfolio
                       
California
  $ 25,991       1.63 %     1.27 %
Florida
    2,614       2.92       2.57  
Arizona
    3,821       1.54       0.90  
Texas
    2,842       1.03       0.19  
Minnesota
    4,668       1.08       0.88  
Other
    32,393       1.43       0.44  
 
                     
 
                       
Total
  $ 72,329       1.52       0.86  
 
                     
 
                       
Home Equity Portfolios as of December 31, 2007
 
                       
            Liquidating     Remaining  
($ in billions)           portfolio     portfolio  
 
                       
December 2007 loss rate (annualized)
          4.80 %     0.86 %
 
                       
CLTV > 90% (1)
            55 %     25 %
Average FICO
            725       735  
 
                       
Wells Fargo retail originated
      1 %     98 %
$ in 1st lien
            $  0.4       $  11.4  
$ in 2nd lien behind a Wells Fargo 1st lien
            3.4       38.1  
 
                       
% in California
            38 %     36 %
 
                       
   
(1)   Combined loan-to-value ratio greater than 90% based primarily on automated appraisal updates as of September 30, 2007.
 


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     For purposes of portfolio risk management, we aggregate commercial loans and lease financing according to market segmentation and standard industry codes. Commercial loans and lease financing are presented by industry in Table 14. These groupings contain a highly diverse mix of customer relationships throughout our target markets. Loan types and product offerings are carefully underwritten and monitored. Credit policies incorporate specific industry risks.
                 
Table 14: Commercial Loans and Lease Financing by Industry  
       
(in millions) December 31, 2007  
  Commercial   % of  
  loans and lease   total  
  financing   loans  
 
               
Small business loans
  $ 11,126       3 %
Lessors and other real estate activities (1)
    4,888       1  
Oil and gas
    4,718       1  
Retailers
    4,699       1  
Financial institutions
    4,479       1  
Food and beverage
    4,145       1  
Industrial equipment
    4,123       1  
Securities firms
    3,592       *  
Technology
    3,298       *  
Healthcare
    2,785       *  
Other (2)
    49,387       13  
 
           
 
               
Total
  $ 97,240       25 %
 
           
 
               
   
*   Less than 1%.
 
(1)   Includes loans to lessors, appraisers, property managers, real estate agents and brokers.
 
(2)   No other single category had loans in excess of $2,748 million.
     Other real estate mortgages and real estate construction loans that are diversified in terms of both the state where the property is located and by the type of property securing the loans are presented in Table 15. The composition of these portfolios was stable throughout 2007 and the distribution is consistent with our target markets and focus on customer relationships. Approximately 28% of other real estate and construction loans are loans to owner-occupants where more than 50% of the property is used in the conduct of their business. The largest group of loans in any one state is 5% of total loans and the largest group of loans secured by one type of property is 3% of total loans.
                                   
Table 15: Commercial Real Estate Loans by State and Property Type  
       
(in millions)   December 31, 2007  
    Other real   Real   Total   % of  
    estate   estate   commercial   total  
    mortgage   construction   real estate   loans  
 
                                 
By state:
                                 
California
    $ 13,922     $ 6,050     $ 19,972       5 %
Texas
      2,934       1,135       4,069       1  
Arizona
      1,926       1,262       3,188       *  
Colorado
      1,669       873       2,542       *  
Washington
      1,441       652       2,093       *  
Minnesota
      1,319       382       1,701       *  
Florida
      636       913       1,549       *  
Utah
      719       581       1,300       *  
New York
      331       949       1,280       *  
Oregon
      803       441       1,244       *  
Other (1)
      11,047       5,616       16,663       4  
 
                                 
 
                                 
Total (2)
    $ 36,747     $ 18,854     $ 55,601       15 %
 
                                 
 
                                 
By property type:
                         
Office buildings
    $ 9,435     $ 1,500     $ 10,935       3 %
Industrial/ warehouse
    5,817       789       6,606       2  
Land
      1       5,236       5,237       1  
Retail
      4,183       400       4,583       1  
Apartments
      2,468       1,166       3,634       1  
Shopping center
    2,206       927       3,133       *  
1-4 family land
      1       3,037       3,038       *  
1-4 family structure
  16       3,014       3,030       *  
Hotels/motels
    1,843       830       2,673       *  
Agricultural
      1,620       27       1,647       *  
Other
      9,157       1,928       11,085       3  
 
                                 
 
                                 
Total (2)
    $ 36,747     $ 18,854     $ 55,601       15 %
 
                                 
 
                                 
   
*   Less than 1%.
 
(1)   Consists of 40 states; no state had loans in excess of $1,000 million.
 
(2)   Includes owner-occupied real estate and construction loans of $15,295 million.


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NONACCRUAL LOANS AND OTHER ASSETS
Table 16 shows the five-year trend for nonaccrual loans and other assets. We generally place loans on nonaccrual status when:
  the full and timely collection of interest or principal becomes uncertain;
  they are 90 days (120 days with respect to real estate 1-4 family first and junior lien mortgages and auto loans) past due for interest or principal (unless both well-secured and in the process of collection); or
  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.
      Nonperforming loans increased $1.0 billion in 2007 from 2006, with the majority of the increase in the real estate 1-4 family first mortgage loan portfolio (including $209 million in Home Mortgage and $343 million in Wells Fargo Financial real estate) due to the deteriorating conditions in the residential real estate market and the national rise in mortgage default rates. Additionally, a portion of the increase related to loan growth. The increase in the commercial and commercial real estate portfolios was influenced by
the deterioration of credits related to the residential real estate and construction industries. In addition, due to illiquid market conditions, we are now holding more foreclosed properties than we have historically. As a result, other foreclosed asset balances increased $226 million in 2007 (including $128 million from Home Equity and $52 million in Wells Fargo Financial real estate).
      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 one loan can be affected by external factors, such as economic or market 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 $165 million of interest would have been recorded in 2007, compared with payments of $47 million recorded as interest income.
      Substantially all of the foreclosed assets at December 31, 2007, have been in the portfolio one year or less.


                                         
Table 16: Nonaccrual Loans and Other Assets  
       
(in millions)   December 31 ,
  2007   2006   2005   2004   2003  
 
                                       
Nonaccrual loans:
                                       
Commercial and commercial real estate:
                                       
Commercial
  $ 432     $ 331     $ 286     $ 345     $ 592  
Other real estate mortgage
    128       105       165       229       285  
Real estate construction
    293       78       31       57       56  
Lease financing
    45       29       45       68       73  
 
                             
Total commercial and commercial real estate
    898       543       527       699       1,006  
Consumer:
                                       
Real estate 1-4 family first mortgage (1)
    1,272       688       471       386       274  
Real estate 1-4 family junior lien mortgage
    280       212       144       92       87  
Other revolving credit and installment
    184       180       171       160       88  
 
                             
Total consumer
    1,736       1,080       786       638       449  
Foreign
    45       43       25       21       3  
 
                             
Total nonaccrual loans (2)
    2,679       1,666       1,338       1,358       1,458  
As a percentage of total loans
    0.70 %     0.52 %     0.43 %     0.47 %     0.58 %
 
                                       
Foreclosed assets:
                                       
GNMA loans (3)
    535       322                    
Other
    649       423       191       212       198  
Real estate and other nonaccrual investments (4)
    5       5       2       2       6  
 
                             
Total nonaccrual loans and other assets
  $ 3,868     $ 2,416     $ 1,531     $ 1,572     $ 1,662  
 
                             
As a percentage of total loans
    1.01 %     0.76 %     0.49 %     0.55 %     0.66 %
 
                             
 
                                       
   
(1)   Includes nonaccrual mortgages held for sale.
 
(2)   Includes impaired loans of $469 million, $230 million, $190 million, $309 million and $629 million at December 31, 2007, 2006, 2005, 2004 and 2003, respectively. (See Note 1 (Summary of Significant Accounting Policies) and Note 6 (Loans and Allowance for Credit Losses) to Financial Statements for further discussion of impaired loans.)
 
(3)   Due to a change in regulatory reporting requirements effective January 1, 2006, foreclosed real estate securing GNMA loans has been classified as nonperforming. Both principal and interest for GNMA loans secured by the foreclosed real estate are collectible because the GNMA loans are insured by the FHA or guaranteed by the Department of Veterans Affairs.
 
(4)   Includes real estate investments (contingent interest loans accounted for as investments) that would be classified as nonaccrual if these assets were recorded as loans.

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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 or more past due and still accruing was $6,393 million, $5,073 million, $3,606 million, $2,578 million and $2,337 million at December 31, 2007, 2006, 2005, 2004 and 2003, respectively. The total included $4,834 million, $3,913 million, $2,923 million, $1,820 million and $1,641 million for the same periods, respectively, in advances pursuant to our servicing agreements to GNMA mortgage pools whose repayments are insured by the FHA or guaranteed by the Department of Veterans Affairs. Table 17 reflects loans 90 days or more past due and still accruing excluding the insured/guaranteed GNMA advances.
                                         
Table 17: Loans 90 Days or More Past Due and Still Accruing  
                (Excluding Insured/Guaranteed GNMA Advances)  
       
(in millions)   December 31 ,
    2007     2006     2005     2004     2003  
 
                                       
Commercial and commercial real estate:
                                       
Commercial
  $ 32     $ 15     $ 18     $ 26     $ 87  
Other real estate mortgage
    10       3       13       6       9  
Real estate construction
    24       3       9       6       6  
 
                             
Total commercial and commercial real estate
    66       21       40       38       102  
Consumer:
                                       
Real estate 1-4 family first mortgage (1)
    286       154       103       148       117  
Real estate 1-4 family junior lien mortgage
    201       63       50       40       29  
Credit card
    402       262       159       150       134  
Other revolving credit and installment
    552       616       290       306       271  
 
                             
Total consumer
    1,441       1,095       602       644       551  
Foreign
    52       44       41       76       43  
 
                             
Total
  $ 1,559     $ 1,160     $ 683     $ 758     $ 696  
 
                             
 
                                       
   
(1)   Includes mortgage loans held for sale 90 days or more past due and still accruing.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses, which consists of 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 nonaccrual loans will change at different points in time based on credit performance, loan mix and collateral values. 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, a loan is charged off when clas-
sified as a loss by either internal loan examiners or regulatory examiners. The detail of the changes in the allowance for credit losses, including charge-offs and recoveries by loan category, is in Note 6 (Loans and Allowance for Credit Losses) to Financial Statements.
      At December 31, 2007, the allowance for loan losses was $5.31 billion (1.39% of total loans), compared with $3.76 billion (1.18%), at December 31, 2006. The allowance for credit losses was $5.52 billion (1.44% of total loans) at December 31, 2007, and $3.96 billion (1.24%) at December 31, 2006. These ratios fluctuate from period to period and the increase in the ratios of the allowance for loan losses and the allowance for credit losses to total loans in 2007 was primarily due to the $1.4 billion credit reserve build in 2007. Until 2007 we had historically experienced the lowest charge-offs on our residential real estate secured consumer loan portfolio. In 2007, net charge-offs in the Home Equity portfolio increased due to a severe decline in housing prices in several of our major geographic markets. The increased level of loss content in the Home Equity portfolio was the primary driver of the $1.4 billion increase to the allowance for loan losses. The reserve for unfunded credit commitments was $211 million at December 31, 2007, and $200 million at December 31, 2006.
      The ratio of the allowance for credit losses to total nonaccrual loans was 206% and 238% at December 31, 2007 and 2006, respectively. This ratio may fluctuate significantly from period to period due to such factors as the mix of loan types in the portfolio, borrower credit strength and the value and marketability of collateral. Over half of nonaccrual loans were home mortgages, auto and other consumer loans at December 31, 2007. Nonaccrual loans are generally written down to fair value less cost to sell at the time they are placed on nonaccrual and accounted for on a cost recovery basis.
      The provision for credit losses totaled $4.94 billion in 2007, $2.20 billion in 2006 and $2.38 billion in 2005. In 2007, the provision included $1.4 billion in excess of net charge-offs, which was our estimate of the increase in incurred losses in our loan portfolio at year-end 2007, primarily related to the Home Equity portfolio.
      Net charge-offs in 2007 were 1.03% of average total loans, compared with 0.73% in 2006 and 0.77% in 2005. Net charge-offs for 2007 in the Home Equity portfolio were $595 million (0.73% of average loans), a $485 million increase from $110 million (0.14%) for 2006. The increase was primarily due to loans in geographic markets that have experienced the most abrupt and steepest declines in housing prices. Because the majority of the Home Equity net charge-offs were concentrated in the indirect or third party origination channels, which have a higher percentage of 90% or greater combined loan-to-value portfolios, we have discontinued third party activities not behind a Wells Fargo first mortgage and segregated these loans into a liquidating portfolio. As previously disclosed, while the $11.9 billion of loans in this liquidating portfolio represented about 3% of total loans outstanding at December 31, 2007, these loans represent the highest risk in our $84.2 billion Home Equity portfolio. The loans in the liquidating portfolio were primarily


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sourced through wholesale (brokers) and correspondents. Our real estate 1-4 family first mortgage portfolio continued to perform well, with net charge-offs of $87 million (0.14% of average loans) for 2007, up from $77 million (0.13%) for 2006.
      Because of our responsible lending and risk management practices, we have not faced many of the issues others have in the mortgage industry. We do not make or purchase any negative amortizing mortgages, including option ARMs. We have minimal ARM reset risk across our owned loan portfolios. While our disciplined underwriting standards have resulted in first mortgage delinquencies below industry levels, we continued to tighten our underwriting standards in the last half of 2007. Home Mortgage closed its nonprime wholesale channel early in third quarter, after closing its nonprime correspondent channel in second quarter 2007. Rates were increased for nonconforming mortgage loans during third quarter reflecting the reduced liquidity in the capital markets.
      Credit quality in Wells Fargo Financial’s real estate-secured lending business has not experienced the level of credit degradation that many nonprime lenders have because of our disciplined underwriting practices. Wells Fargo Financial does not use brokers or correspondents in its U.S. debt consolidation business. We endeavor to ensure that there is a tangible benefit to the borrower before we make a loan. The recent guidance issued by the federal financial regulatory agencies in June 2007, Statement on Subprime Mortgage Lending, which addresses issues relating to certain ARM products, will not have a significant impact on Wells Fargo Financial’s operations, since many of those guidelines have long been part of our normal business practices.
      Higher net charge-offs in non-real estate consumer loans (credit card and other revolving credit and installment) were primarily due to increases in the indirect auto portfolio, with auto net charge-offs for 2007 up $164 million from 2006. The increase in all other consumer portfolios, including credit cards, was due to an overall weakening in the economy.
      Credit performance in the commercial and commercial real estate portfolio remained strong, with net charge-offs of $536 million (0.40% of average loans), compared with $297
million (0.26%) in 2006. As is typical, the vast majority of these charge-offs came from loans originated through our business direct channel. Business direct consists primarily of unsecured lines of credit to small firms and properties that tend to perform in a manner similar to credit cards. Because of our Wholesale Banking business model, focused primarily on business customers, we do not actively participate in certain higher-risk activities. Our capital market business was largely not impacted by the credit crunch or market dislocations in 2007, including industry problem areas of CDOs, CLOs and SIVs. On the investment side of this business, we operate within disciplined credit standards and regularly monitor and manage our securities portfolios. From an underwriting standpoint, we have not participated in a significant way in any of the large leveraged buyouts that were “covenant lite” and we have minimal direct exposure to hedge funds. Similarly, we have not made a market in subprime securities. Leveraged-buyout-related outstandings are diversified by business and borrower and totaled less than 2% of total Wells Fargo loans. Our residential real estate development portfolio of approximately $6 billion, or 2% of total loans, continued to perform in a satisfactory manner.
      Table 18 presents the allocation of the allowance for credit losses by type of loans. The $1.55 billion increase in the allowance for credit losses from year-end 2006 to year-end 2007 was due to actions taken in 2007 primarily related to the Home Equity portfolio and approximately $100 million acquired from bank acquisitions. The decrease of $93 million in the allowance for credit losses from year-end 2005 to year-end 2006 was primarily due to the release of the remaining portion of the provision made for Hurricane Katrina in 2005. Changes in the allowance reflect changes in statistically derived loss estimates, historical loss experience, current trends in borrower risk and/or general economic activity on portfolio performance, and management’s estimate for imprecision and uncertainty. Effective December 31, 2006, the entire allowance was assigned to individual portfolio types to better reflect our view of risk in these portfolios. The allowance for credit losses includes a combination of baseline loss estimates and a range of imprecision or uncertainty specific to each portfolio segment previously categorized as unallocated in prior years.


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Table 18: Allocation of the Allowance for Credit Losses  
       
(in millions)   December 31 ,
    2007     2006     2005     2004     2003  
  Loans   Loans   Loans   Loans   Loans  
  as %   as %   as %   as %   as %  
  of total   of total   of total   of total   of total  
  loans   loans   loans   loans   loans  
 
                                                                               
Commercial and commercial real estate:
                                                                               
Commercial
  $ 1,137       24 %   $ 1,051       22 %   $ 926       20 %   $ 940       19 %   $ 917       19 %
Other real estate mortgage
    288       9       225       9       253       9       298       11       444       11  
Real estate construction
    156       5       109       5       115       4       46       3       63       3  
Lease financing
    51       2       40       2       51       2       30       2       40       2  
 
                                                           
Total commercial and commercial real estate
    1,632       40       1,425       38       1,345       35       1,314       35       1,464       35  
Consumer:
                                                                               
Real estate 1-4 family first mortgage
    415       19       186       17       229       25       150       31       176       33  
Real estate 1-4 family junior lien mortgage
    1,329       20       168       21       118       19       104       18       92       15  
Credit card
    834       5       606       5       508       4       466       4       443       3  
Other revolving credit and installment
    1,164       14       1,434       17       1,060       15       889       11       802       13  
 
                                                           
Total consumer
    3,742       58       2,394       60       1,915       63       1,609       64       1,513       64  
Foreign
    144       2       145       2       149       2       139       1       95       1  
 
                                                           
Total allocated
    5,518       100 %     3,964       100 %     3,409       100 %     3,062       100 %     3,072       100 %
 
                                                                     
Unallocated component of allowance
                                648               888               819          
 
                                                                     
Total
  $ 5,518             $ 3,964             $ 4,057             $ 3,950             $ 3,891          
 
                                                                     
 
                                                                               
   

     We consider the allowance for credit losses of $5.52 billion adequate to cover credit losses inherent in the loan portfolio, including unfunded credit commitments, at December 31, 2007. Given that the majority of our loan portfolio is consumer loans, for which losses tend to emerge within a relatively short, predictable timeframe, and that a significant portion of the allowance for credit losses is related to estimated credit losses associated with consumer loans, management believes that the provision for credit losses for consumer loans, absent any significant credit event, severe decrease in collateral values, significant acceleration of losses or significant change in payment behavior, will closely track the level of related net charge-offs. In 2007, due to further deterioration in the outlook for the housing market, we recorded a credit reserve build, primarily for higher loss content that we estimated in the Home Equity portfolio. 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 or market conditions and ongoing internal and external examination processes. Our process for determining the adequacy of the allowance for credit losses is discussed in “Financial Review – Critical Accounting Policies – Allowance for Credit Losses” and 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 has individual asset/liability management committees and processes linked to the Corporate ALCO process.
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 (for example, 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).
      Interest rates may also have a direct or indirect effect on loan demand, credit losses, mortgage origination volume, the fair value of MSRs and other financial instruments, the value of the pension liability and other items affecting earnings.


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     We assess interest rate risk by comparing our most likely earnings plan with various earnings simulations 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, as of December 31, 2007, our most recent simulation indicated estimated earnings at risk of approximately 4% of our most likely earnings plan over the next 12 months using a scenario in which the federal funds rate rises 175 basis points to 6% and the 10-year Constant Maturity Treasury bond yield rises 300 basis points to 7%. 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. Due to timing differences between the quarterly valuation of MSRs and the eventual impact of interest rates on mortgage banking volumes, earnings at risk in any particular quarter could be higher than the average earnings at risk over the 12-month simulation period, depending on the path of interest rates and on our hedging strategies for MSRs. See “Mortgage Banking Interest Rate and Market Risk” below.
      We use exchange-traded and over-the-counter interest rate derivatives to hedge our interest rate exposures. The notional or contractual amount, credit risk amount and estimated net fair value of these derivatives as of December 31, 2007 and 2006, are presented in Note 16 (Derivatives) to Financial Statements. We use derivatives for asset/liability management in three main ways:
  to convert a major portion of our long-term fixed-rate debt, which we issue to finance the Company, from fixed-rate payments to floating-rate payments by entering into receive-fixed swaps;
  to convert the cash flows from selected asset and/or liability instruments/portfolios from fixed-rate payments to floating-rate payments or vice versa; and
  to hedge our mortgage origination pipeline, funded mortgage loans and MSRs using interest rate swaps, swaptions, futures, forwards and options.
MORTGAGE BANKING INTEREST RATE AND MARKET RISK
We originate, fund and service mortgage loans, which subjects us to various risks, including credit, liquidity and interest rate risks. We reduce unwanted credit and liquidity risks by selling or securitizing predominantly all of the long-term fixed-rate mortgage loans we originate and most of the ARMs we originate. From time to time, we hold originated ARMs in our loan portfolio as an investment for our growing base of core deposits. We determine whether the loans will be held for investment or held for sale at the time of commitment. We may subsequently change our intent to hold loans for investment and sell some or all of our ARMs as part of our corporate asset/liability management. We may also acquire and add to our securities available for sale a portion of the securities issued at the time we securitize mortgages held for sale.
      2007 was a challenging year for the financial services industry with the downturn in the national housing market, deterioration in the capital markets, widening credit spreads and increases in market volatility, in addition to changes in
interest rates discussed in the following sections. Notwithstanding the sharp downturn in the housing sector, the widening of nonconforming credit spreads and the lack of liquidity in the nonconforming secondary markets, our mortgage banking revenue grew, reflecting the complementary origination and servicing strengths of the business. The secondary market for agency-conforming mortgages functioned well for most of the year. However, secondary market spreads widened during the second half of 2007. The mortgage warehouse and pipeline, which predominantly consists of prime mortgage loans, was written down by $479 million in 2007 to reflect the unusual widening in nonconforming and conforming agency market spreads. In addition to the write-down associated with the mortgage warehouse and pipeline, we further reduced mortgage origination gains by $324 million primarily to reflect a write-down of mortgage loans repurchased during the year, as well as an increase to the repurchase reserve for projected early payment defaults.
      Interest rate and market risk can be substantial in the mortgage business. Changes in interest rates may potentially impact total origination and servicing fees, the value of our residential MSRs measured at fair value, the value of MHFS and the associated income and loss reflected in mortgage banking noninterest income, the income and expense associated with instruments (economic hedges) used to hedge changes in the fair value of MSRs and MHFS, and the value of derivative loan commitments (interest rate “locks”) extended to mortgage applicants.
      Interest rates impact the amount and timing of origination and servicing fees because consumer demand for new mortgages and the level of refinancing activity are sensitive to changes in mortgage interest rates. Typically, a decline in mortgage interest rates will lead to an increase in mortgage originations and fees and may also lead to an increase in servicing fee income, depending on the level of new loans added to the servicing portfolio and prepayments. Given the time it takes for consumer behavior to fully react to interest rate changes, as well as the time required for processing a new application, providing the commitment, and securitizing and selling the loan, interest rate changes will impact origination and servicing fees with a lag. The amount and timing of the impact on origination and servicing fees will depend on the magnitude, speed and duration of the change in interest rates.
      Under FAS 159, which we adopted January 1, 2007, we elected to measure MHFS at fair value prospectively for new prime MHFS originations for which an active secondary market and readily available market prices currently exist to reliably support fair value pricing models used for these loans. We also elected to measure at fair value certain of our other interests held related to residential loan sales and securitizations. We believe that the election for new prime MHFS and other interests held (which are now hedged with free-standing derivatives (economic hedges) along with our MSRs) will reduce certain timing differences and better match changes in the value of these assets with changes in the value of derivatives used as economic hedges for these assets. Loan origination fees are recorded when earned, and related direct loan origination costs and fees are recognized when incurred.


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     Under FAS 156, which we adopted January 1, 2006, we elected to use the fair value measurement method to initially measure and carry our residential MSRs, which represent substantially all of our MSRs. Under this method, the MSRs are recorded at fair value at the time we sell or securitize the related mortgage loans. The carrying value of MSRs reflects changes in fair value at the end of each quarter and changes are included in net servicing income, a component of mortgage banking noninterest income. If the fair value of the MSRs increases, income is recognized; if the fair value of the MSRs decreases, a loss is recognized. We use a dynamic and sophisticated model to estimate the fair value of our MSRs and periodically benchmark our estimates to independent appraisals. While the valuation of MSRs can be highly subjective and involve complex judgments by management about matters that are inherently unpredictable, changes in interest rates influence a variety of significant assumptions included in the periodic valuation of MSRs. Assumptions affected include prepayment speed, expected returns and potential risks on the servicing asset portfolio, the value of escrow balances and other servicing valuation elements impacted by interest rates.
      A decline in interest rates generally increases the propensity for refinancing, reduces the expected duration of the servicing portfolio and therefore reduces the estimated fair value of MSRs. This reduction in fair value causes a charge to income (net of any gains on free-standing derivatives (economic hedges) used to hedge MSRs). We may choose to not fully hedge all of the potential decline in the value of our MSRs resulting from a decline in interest rates because the potential increase in origination/servicing fees in that scenario provides a partial “natural business hedge.” In 2007, the decrease in the fair value of our MSRs net of the gains on free-standing derivatives used to hedge the MSRs increased income by $583 million.
      Hedging the various sources of interest rate risk in mortgage banking is a complex process that requires sophisticated modeling and constant monitoring. While we attempt to balance these various aspects of the mortgage business, there are several potential risks to earnings:
  MSRs valuation changes associated with interest rate changes are recorded in earnings immediately within the accounting period in which those interest rate changes occur, whereas the impact of those same changes in interest rates on origination and servicing fees occur with a lag and over time. Thus, the mortgage business could be protected from adverse changes in interest rates over a period of time on a cumulative basis but still display large variations in income from one accounting period to the next.
  The degree to which the “natural business hedge” offsets changes in MSRs valuations is imperfect, varies at different points in the interest rate cycle, and depends not just on the direction of interest rates but on the pattern of quarterly interest rate changes.
  Origination volumes, the valuation of MSRs and hedging results and associated costs are also impacted by many factors. Such factors include the mix of new business between ARMs and fixed-rated mortgages, the relation-
    ship between short-term and long-term interest rates, the degree of volatility in interest rates, the relationship between mortgage interest rates and other interest rate markets, and other interest rate factors. Many of these factors are hard to predict and we may not be able to directly or perfectly hedge their effect.
  While our hedging activities are designed to balance our mortgage banking interest rate risks, the financial instruments we use may not perfectly correlate with the values and income being hedged. For example, the change in the value of ARMs production held for sale from changes in mortgage interest rates may or may not be fully offset by Treasury and LIBOR index-based financial instruments used as economic hedges for such ARMs.
      The total carrying value of our residential and commercial MSRs was $17.2 billion at December 31, 2007, and $18.0 billion at December 31, 2006. The weighted-average note rate on the owned servicing portfolio was 6.01% at December 31, 2007, and 5.92% at December 31, 2006. Our total MSRs were 1.20% of mortgage loans serviced for others at December 31, 2007, compared with 1.41% at December 31, 2006.
      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. These derivative loan commitments are recognized at fair value in the balance sheet with changes in their fair values recorded as part of mortgage banking noninterest income. We record no value for the loan commitment at inception. Subsequent to inception, we recognize the 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 not fund within the terms of the commitment (referred to as a fall-out factor). The value of the underlying loan is affected primarily by changes in interest rates and the passage of time.
      Outstanding derivative loan commitments expose us to the risk that the price of the mortgage loans underlying the commitments might decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan. To minimize this risk, we utilize forwards and options, Eurodollar futures, and Treasury futures, forwards and options contracts as economic hedges against the potential decreases in the values of the loans. We expect that these derivative financial instruments will experience changes in fair value that will either fully or partially offset the changes in fair value of the derivative loan commitments. However, changes in investor demand, such as concerns about credit risk, can also cause changes in the spread relationships between underlying loan value and the derivative financial instruments that cannot be hedged.


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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, foreign exchange transactions, commodity transactions and derivatives used in our trading businesses 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, 2007 and 2006, are included in Note 16 (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. VAR measures the worst expected loss over a given time interval and within a given confidence interval. We measure and report daily VAR at a 99% confidence interval based on actual changes in rates and prices over the past 250 trading days. The analysis captures all financial instruments that are considered trading positions. The average one-day VAR throughout 2007 was $18 million, with a lower bound of $9 million and an upper bound of $93 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). The Board’s policy is to review business developments, key risks and historical returns for the private equity investment portfolio 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. Private equity investments totaled $2.02 billion at December 31, 2007, and $1.67 billion at December 31, 2006.
      We also have marketable equity securities in the securities available-for-sale portfolio, including securities relating to 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 other-than-temporary impairment may be periodically recorded when identified. 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 our investment horizon in relationship to an anticipated near-term recovery in the stock price, if any. The fair value of marketable equity securities was $2.78 billion and cost was $2.88 billion at December 31, 2007, and $796 million and $592 million, respectively, at December 31, 2006. The increase in marketable equity securities was primarily due to our adoption of Topic D-109 effective July 1, 2007, which resulted in the transfer of approximately $1.2 billion of securities, consisting of investments in preferred stock callable by the issuer, from trading assets to securities available for sale.
      Changes in equity market prices may also indirectly affect our net income by affecting (1) the value of third party assets under management and, hence, fee income, (2) particular borrowers, whose ability to repay principal and/or interest may be affected by the stock market, or (3) 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 these guidelines for both the consolidated balance sheet and for the Parent 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, securities purchased under resale agreements and other short-term investments. The weighted-average expected remaining maturity of the debt securities within this portfolio was 5.9 years at December 31, 2007. Of the $69.4 billion (cost basis) of debt securities in this portfolio at December 31, 2007, $12.0 billion (17%) is expected to mature or be prepaid in 2008 and an additional $7.8 billion (11%) in 2009. Asset liquidity is further enhanced by our ability to sell or securitize loans in secondary markets through whole-loan sales and securitizations. In 2007, we sold mortgage loans of $224 billion, including home mortgage loans and commercial mortgage loans of $48 billion that we securitized. The amount of mortgage loans, home equity loans and other consumer loans available to be sold or securitized was approximately $160 billion at December 31, 2007.


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     Core customer deposits have historically provided a sizeable source of relatively stable and low-cost funds. Average core deposits funded 58.2% and 55.3% of average total assets in 2007 and 2006, respectively.
      The remaining assets were funded by long-term debt (including trust preferred securities), other foreign deposits, and short-term borrowings (federal funds purchased, securities sold under repurchase agreements, commercial paper and other short-term borrowings). Long-term debt averaged $93.2 billion in 2007 and $84.0 billion in 2006. Short-term borrowings averaged $25.9 billion in 2007 and $21.5 billion in 2006.
      We anticipate making capital expenditures of approximately $1 billion in 2008 for our stores, relocation and remodeling of our facilities, and routine replacement of furniture, equipment and servers. We fund expenditures from various sources, including cash flows from operations 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. 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. Moody’s Investors Service rates Wells Fargo Bank, N.A. as “Aaa,” its highest investment grade, and rates the Company’s senior debt as “Aa1.” In February 2007, Standard & Poor’s Ratings Services raised Wells Fargo Bank, N.A.’s credit rating to “AAA” from “AA+,” and raised the Company’s senior debt rating to “AA+” from “AA.” Wells Fargo Bank, N.A. is now the only U.S. bank to have the highest possible credit rating from both Moody’s and S&P.
      Table 19 provides the credit ratings of the Company and Wells Fargo Bank, N.A. as of December 31, 2007.
                                         
Table 19: Credit Ratings  
 
    Wells Fargo & Company   Wells Fargo Bank, N.A.  
    Senior   Subord - Commer -    Long - Short -
    debt   inated   cial   term   term  
        debt   paper   deposits   borrow -
                    ings  

Moody’s

  Aa1   Aa2       P-1   Aaa     P-1  
S&P
  AA + AA       A-1 + AAA     A-1 +
Fitch, Inc.
  AA   AA -     F1 + AA +   F1 +
Dominion Bond Rating Service
  AA   AA *     R-1 ** AA ***   R-1 ***
 
                                       
   
* low   ** middle   *** high
PARENT. Under SEC rules, the Parent is classified as a “well-known seasoned issuer,” which allows it to file a registration statement that does not have a limit on issuance capacity. “Well-known seasoned issuers” generally include those companies with a public float of common equity of at least $700
million or those companies that have issued at least $1 billion in aggregate principal amount of non-convertible securities, other than common equity, in the last three years. In June 2006, the Parent’s registration statement with the SEC for issuance of senior and subordinated notes, preferred stock and other securities became effective. However, the Parent’s ability to issue debt and other securities under this registration statement is limited by the debt issuance authority granted by the Board. The Parent is currently authorized by the Board to issue $30 billion in outstanding short-term debt and $105 billion in outstanding long-term debt, subject to a total outstanding debt limit of $135 billion. During 2007, the Parent issued a total of $21.6 billion of registered senior notes, including $1.5 billion (denominated in pounds sterling) sold primarily in the United Kingdom. The Parent also issued $1 billion in junior subordinated debt in connection with the issuance of trust preferred securities by a statutory business trust formed by the Parent. Also, in 2007, the Parent issued $413 million in private placements (denominated in Australian dollars) under the Parent’s Australian debt issuance program. We used the proceeds from securities issued in 2007 for general corporate purposes and expect that the proceeds in the future will also be used for general corporate purposes. In January 2008, the Parent issued $5.5 billion of registered senior notes. The Parent also issues commercial paper from time to time, subject to its short-term debt limit.
WELLS FARGO BANK, N.A. Wells Fargo Bank, N.A. is authorized by its board of directors to issue $50 billion in outstanding short-term debt and $50 billion in outstanding long-term debt. In December 2007, Wells Fargo Bank, N.A. established a $100 billion bank note program under which, subject to any other debt outstanding under the limits described above, it may issue $50 billion in outstanding short-term senior notes and $50 billion in long-term senior or subordinated notes. Securities are issued under this program as private placements in accordance with Office of the Comptroller of the Currency (OCC) regulations. During 2007, Wells Fargo Bank, N.A. issued $26.1 billion in short-term senior notes.
WELLS FARGO FINANCIAL. In January 2006, Wells Fargo Financial Canada Corporation (WFFCC), an indirect wholly-owned Canadian subsidiary of the Parent, qualified with the Canadian provincial securities commissions CAD$7.0 billion of medium-term notes for distribution from time to time in Canada. During 2007, WFFCC issued CAD$1.4 billion in senior notes under its 2006 short form base shelf prospectus, which expired in February 2008. In February 2008, WFFCC filed a new short form base shelf prospectus qualifying an additional CAD$7.0 billion of issuance authority and issued CAD$500 million of medium-term notes, leaving CAD$6.5 billion available for future issuance. All medium-term notes issued by WFFCC are unconditionally guaranteed by the Parent.


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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 the costs of doing so are perceived to be low.
      From time to time the Board of Directors authorizes the Company to repurchase shares of our common stock. Although we announce when the 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 Securities Exchange Act of 1934 including a limitation on the daily volume of repurchases. Rule 10b-18 imposes 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 our 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.
      In March, August and November 2007, the Board authorized the repurchase of up to 75 million, 50 million and 75 million additional shares of our outstanding common stock, respectively. During 2007, we repurchased 220 million shares of our common stock. In 2007, we issued approximately 82 million shares of common stock (including shares issued for our ESOP plan) under various employee benefit and director plans and under our dividend reinvestment and direct stock purchase programs and approximately 58 million shares for acquisitions. At December 31, 2007, the total remaining common stock repurchase authority was 42 million shares.
      Our potential sources of capital include retained earnings and issuances of common and preferred stock. In 2007, retained earnings increased $3.8 billion, predominantly as a result of net income of $8.1 billion less dividends of $4.0 billion. In 2007, we issued $2.3 billion of common stock under various employee benefit and director plans and $2.1 billion of common stock for acquisitions.
      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, 2007, the Company and each of our covered subsidiary banks were “well capitalized” under applicable regulatory capital adequacy guidelines. See Note 26 (Regulatory and Agency Capital Requirements) to Financial Statements for additional information.


Comparison of 2006 with 2005
 

Net income in 2006 increased 10% to a record $8.4 billion in 2006 from $7.7 billion in 2005. Diluted earnings per common share increased 10% to a record $2.47 in 2006 from $2.25 in 2005.
      Our 10% growth in earnings per share was driven by revenue growth. Revenue grew 8% to a record $35.7 billion in 2006 from $32.9 billion in 2005. The breadth and depth of our business model resulted in very strong and balanced growth across product sources (net interest income up 8%, noninterest income up 9%) and across businesses (double-digit revenue and/or profit growth in regional banking, business direct, wealth management, credit and debit card, corporate trust, commercial banking, asset-based lending, asset management, real estate brokerage, insurance, international, commercial real estate, corporate banking and specialized financial services).
      We continued to make investments in 2006 by opening 109 regional banking stores and growing our sales and service
force by adding 4,497 team members (full-time equivalents) in 2006, including 1,914 retail platform bankers. In 2006, we continued to be #1 in many categories of financial services nationally, including retail mortgage originations, home equity lending, small business lending, agricultural lending, internet banking, and provider of financial services to middle-market companies in the western U.S.
Our core products grew in 2006 from 2005:
  Average loans grew by 4% (up 14% excluding real estate 1-4 family first mortgages);
  Average core deposits grew by 10%; and
  Assets managed and administered were up 26%.
     Return on average total assets was 1.73% and return on average stockholders’ equity was 19.52% in 2006, compared with 1.72% and 19.59%, respectively, in 2005.
      Net interest income on a taxable-equivalent basis was $20.1 billion in 2006, compared with $18.6 billion a year ago, reflecting solid loan growth (excluding ARMs) and a relatively stable net interest margin. With short-term interest


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rates above 5% at year-end 2006, our cumulative sales of ARMs and debt securities from mid-2004 to mid-2006 had a positive impact on our net interest margin and net interest income. We completed our sales of over $90 billion of ARMs since mid-2004 with the sales of $26 billion of ARMs in second quarter 2006. Average earning assets grew 8% from 2005, or 17% excluding 1-4 family first mortgages (the loan category that includes ARMs). Our net interest margin was 4.83% for 2006, compared with 4.86% in 2005.
      Noninterest income increased 9% to $15.7 billion in 2006 from $14.4 billion in 2005. Growth in noninterest income was driven by growth across our businesses, with particular strength in trust and investment fees (up 12%), card fees (up 20%), insurance fees (up 10%) and gains on equity investments (up 44%).
      Revenue, the sum of net interest income and noninterest income, increased 8% to a record $35.7 billion in 2006 from $32.9 billion in 2005. Home Mortgage revenue decreased $704 million (15%) to $4.2 billion in 2006 from $4.9 billion in 2005. Combined revenue in businesses other than Home Mortgage grew 12% from 2005 to 2006, with double-digit revenue growth in virtually every major business line other than Home Mortgage.
      Noninterest expense was $20.8 billion in 2006, up 10% from $19.0 billion in 2005, primarily due to continued investments in new stores and additional sales and service-related team members. We began expensing stock options on January 1, 2006. Total stock option expense reduced 2006 earnings by approximately $0.025 per share.
      During 2006, net charge-offs were $2.25 billion (0.73% of average total loans), compared with $2.28 billion (0.77%) during 2005. Net charge-offs for auto loans increased $160 million in 2006 partially due to growth and seasoning, but largely due to collection capacity constraints and restrictive payment extension practices that occurred when Wells Fargo
Financial integrated its prime and nonprime auto loan businesses during 2006. Net charge-offs for 2005 included $171 million of incremental fourth quarter bankruptcy losses and increased net charge-offs of $163 million in first quarter 2005 to conform Wells Fargo Financial’s charge-off practices to more stringent Federal Financial Institutions Examination Council guidelines. The provision for credit losses was $2.20 billion in 2006, down $179 million from $2.38 billion in 2005. The 2005 provision for credit losses also included $100 million for estimated charge-offs related to Hurricane Katrina. We subsequently realized approximately $50 million of Katrina-related losses. Because we no longer anticipated further credit losses attributable to Katrina, we released the remaining $50 million reserve in 2006. The allowance for credit losses, which consists of the allowance for loan losses and the reserve for unfunded credit commitments, was $3.96 billion, or 1.24% of total loans, at December 31, 2006, compared with $4.06 billion (1.31%) at December 31, 2005.
     At December 31, 2006, total nonaccrual loans were $1.67 billion (0.52% of total loans), up from $1.34 billion (0.43%) at December 31, 2005. Total nonperforming assets were $2.42 billion (0.76% of total loans) at December 31, 2006, compared with $1.53 billion (0.49%) at December 31, 2005. Foreclosed assets were $745 million at December 31, 2006, compared with $191 million at December 31, 2005. Foreclosed assets, a component of total nonperforming assets, included an additional $322 million of foreclosed real estate securing GNMA loans at December 31, 2006, due to a change in regulatory reporting requirements effective January 1, 2006. The foreclosed real estate securing GNMA loans of $322 million represented 10 basis points of the ratio of non-performing assets to loans at December 31, 2006.


Risk Factors
 

An investment in the Company has risk. We discuss below and elsewhere in this Report and in other documents we file with the SEC various risk factors that could cause our financial results and condition to vary significantly from period to period. We refer you to the Financial Review section and Financial Statements and related Notes in this Report for more information about credit, interest rate and market risks and to the “Regulation and Supervision” section of our 2007 Form 10-K for more information about legislative and regulatory risks. Any factor described below or elsewhere in this Report or in our 2007 Form 10-K could, by itself or together with other factors, have a material negative effect on our financial results and condition and on the value of an investment in Wells Fargo. Refer to our quarterly reports on Form 10-Q that we will file with the SEC in 2008 for material changes to the discussion of risk factors.
     In accordance with the Private Securities Litigation Reform Act of 1995, we caution you that one or more of the factors discussed below, in the Financial Review section of this Report, in the Financial Statements and related Notes included in this Report, in the 2007 Form 10-K, or in other documents we file with the SEC from time to time could cause us to fall short of expectations for our future financial and business performance that we may express in forward-looking statements. We make forward-looking statements when we use words such as “believe,” “expect,” “anticipate,” “estimate,” “will,” “may,” “can” and similar expressions. Do not unduly rely on forward-looking statements. Actual results may differ significantly from expectations. Forward-looking statements speak only as of the date made. We do not undertake to update them to reflect changes or events that occur after that date.


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     In this Report we make forward-looking statements that we expect or believe:
  net charge-offs will be higher in 2008, particularly in the Home Equity portfolio;
  there is minimal additional loss content in nonaccrual loans;
  the provision for credit losses for consumer loans, absent a significant credit event, severe decrease in collateral values, significant acceleration of losses or significant change in payment behavior, will closely track the level of related net charge-offs;
  FIN 48 will cause more volatility in our effective tax rate from quarter to quarter;
  our investments in affordable housing and sustainable energy projects will be recovered over time through realization of federal tax credits;
  the amount of any additional consideration that may be payable in connection with previous acquisitions will not be significant to our financial statements;
  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;
  recent guidance issued by federal financial regulatory agencies for nonprime mortgage lending will not have a significant impact on Wells Fargo Financial’s operations;
  the election to measure at fair value new prime residential MHFS and other interests held will reduce certain timing differences and better match changes in the value of these assets with changes in the value of derivatives used as economic hedges for these assets;
  changes in the fair value of derivative financial instruments used as economic hedges of derivative loan commitments will fully or partially offset changes in the fair value of such commitments to the extent changes in value are due to interest rate changes;
  capital expenditures of approximately $1 billion will be made in 2008 for our stores, relocation and remodeling of our facilities, and routine replacement of furniture, equipment and servers;
  proceeds of securities issued in the future will be used for general corporate purposes;
  the outcome of pending and threatened legal actions will not have a material adverse effect on our results of operations or stockholders’ equity;
  $63 million of net deferred gains on derivatives in other comprehensive income at December 31, 2007, will be reclassified as earnings in the next 12 months;
  $126 million of unrecognized compensation cost related to stock options will be recognized over a weighted-average period of 2.1 years;
  a contribution to the Cash Balance Plan will not be required in 2008; and
  our unrecognized tax benefits could decrease by approximately $100 to $200 million during the next 12 months primarily related to statute expirations.
     This Report also includes various statements about the estimated impact on our earnings from simulated changes in interest rates and on expected losses in our loan portfolio from assumed changes in loan credit quality. As described in more detail below and elsewhere in this Report, changes in the estimate of the allowance for credit losses and the related provision expense could have a material negative effect on net income.
OUR ABILITY TO GROW REVENUE AND EARNINGS WILL SUFFER IF WE ARE UNABLE TO CROSS-SELL MORE PRODUCTS TO CUSTOMERS. Selling more products to our customers—“cross-selling”—is the foundation of our business model and key to our ability to grow revenue and earnings. Many of our competitors also focus on cross-selling, especially in retail banking and mortgage lending.
This can put pressure on us to sell our products at lower prices, reducing our net interest income and revenue from our fee-based products. It could also affect our ability to keep existing customers. New technologies could require us to spend more to modify or adapt our products to attract and retain customers. Increasing our cross-sell ratio—or the average number of products sold to existing customers—may become more challenging, especially given that our cross-sell ratio is already high, and we might not attain our goal of selling an average of eight products to each customer.
AN ECONOMIC RECESSION OR EVEN A MODEST SLOWDOWN COULD REDUCE DEMAND FOR OUR PRODUCTS AND SERVICES AND LEAD TO LOWER REVENUE AND LOWER EARNINGS. We earn revenue from the interest and fees we charge on the loans and other products and services we sell. When the economy slows, the demand for those products and services can fall, reducing our interest and fee income and our earnings. An economic downturn can also hurt the ability of our borrowers to repay their loans, causing us to incur higher credit losses. Several factors could cause the economy to slow down or even recede, including higher energy costs, higher interest rates, reduced consumer or corporate spending, a slowdown in housing, declining home values, natural disasters, terrorist activities, military conflicts, and the normal cyclical nature of the economy.
CHANGES IN STOCK MARKET PRICES COULD REDUCE FEE INCOME FROM OUR BROKERAGE AND ASSET MANAGEMENT BUSINESSES. We earn fee income from managing assets for others and providing brokerage services. Because investment management fees are often based on the value of assets under management, a fall in the market prices of those assets could reduce our fee income. Changes in stock market prices could affect the trading activity of investors, reducing commissions and other fees we earn from our brokerage business.
      For more information, refer to “Risk Management – Asset/Liability and Market Risk Management – Market Risk – Equity Markets” in the Financial Review section of this Report.
CHANGES IN INTEREST RATES COULD REDUCE OUR NET INTEREST INCOME AND EARNINGS. Our net interest income is the interest we earn on loans, debt securities and other assets we hold less the interest we pay on our deposits, long-term and short-term debt, and other liabilities. Net interest income is a measure of both our net interest margin—the difference between the yield we earn on our assets and the interest rate we pay for deposits and our other sources of funding—and the amount of earning assets we hold. As a result, changes in either our net interest margin or the amount of earning assets we hold could affect our net interest income and our earnings.
      Changes in interest rates—up or down—could adversely affect our net interest margin. Although the yield we earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing our net interest margin to expand or contract. Our liabilities tend to be shorter in duration than our assets, so they may adjust faster in response to changes in interest rates. As a result, when interest rates rise, our funding costs may rise faster than the yield we earn on our assets, causing our net interest margin to contract until the yield catches up.
      Changes in the slope of the “yield curve”—or the spread between short-term and long-term interest rates—could also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets.


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     The interest we earn on our loans may be tied to U.S.-denominated interest rates such as the federal funds rate while the interest we pay on our debt may be based on international rates such as LIBOR. If the federal funds rate were to fall without a corresponding decrease in LIBOR, we might earn less on our loans without any offsetting decrease in our funding costs. This could lower our net interest margin and our net interest income.
      We assess our interest rate risk by estimating the effect on our earnings under various scenarios that differ based on assumptions about the direction, magnitude and speed of interest rate changes and the slope of the yield curve. We hedge some of that interest rate risk with interest rate derivatives. We also rely on the “natural hedge” that our loan originations and servicing rights can provide.
      We do not hedge all of our interest rate risk. There is always the risk that changes in interest rates could reduce our net interest income and our earnings in material amounts, especially if actual conditions turn out to be materially different than what we assumed. For example, if interest rates rise or fall faster than we assumed or the slope of the yield curve changes, we may incur significant losses on debt securities we hold as investments. To reduce our interest rate risk, we may rebalance our investment and loan portfolios, refinance our debt and take other strategic actions. We may incur losses or expenses when we take such actions.
      For more information, refer to “Risk Management – Asset/Liability and Market Risk Management – Interest Rate Risk” in the Financial Review section of this Report.
CHANGES IN INTEREST RATES COULD ALSO REDUCE THE VALUE OF OUR MORTGAGE SERVICING RIGHTS AND MORTGAGES HELD FOR SALE, REDUCING OUR EARNINGS. We have a sizeable portfolio of mortgage servicing rights. A mortgage servicing right (MSR) is the right to service a mortgage loan—collect principal, interest, escrow amounts, etc.—for a fee. We acquire MSRs when we keep the servicing rights after we sell or securitize the loans we have originated or when we purchase the servicing rights to mortgage loans originated by other lenders. Effective January 1, 2006, upon adoption of FAS 156, we elected to initially measure and carry our residential MSRs using the fair value measurement method. Fair value is the present value of estimated future net servicing income, calculated based on a number of variables, including assumptions about the likelihood of prepayment by borrowers.
      Changes in interest rates can affect prepayment assumptions and thus fair value. When interest rates fall, borrowers are more likely to prepay their mortgage loans by refinancing them at a lower rate. As the likelihood of prepayment increases, the fair value of our MSRs can decrease. Each quarter we evaluate the fair value of our MSRs, and any decrease in fair value reduces earnings in the period in which the decrease occurs.
      Effective January 1, 2007, we elected to measure at fair value new prime mortgages held for sale (MHFS) for which an active secondary market and readily available market prices exist. We also measure at fair value certain other interests we hold related to residential loan sales and securitizations. Similar to other interest-bearing securities, the value of these MHFS and other interests held may be negatively affected by changes in interest rates. For example, if market interest rates increase relative to the yield on these MHFS and other interests held, their fair value may fall. We may not hedge this risk, and even if we do hedge the risk with derivatives and other instruments we may still incur significant losses from changes in the value of these MHFS and other interests or from changes in the value of the hedging instruments.
      For more information, refer to “Critical Accounting Policies” and “Risk Management – Asset/Liability and Market Risk
Management – Mortgage Banking Interest Rate and Market Risk” in the Financial Review section of this Report.
MARKET ILLIQUIDITY AND INCREASED COMPETITION FOR FUNDING COULD INCREASE OUR FUNDING COSTS. We sell most of the mortgage loans we originate in order to reduce our credit risk and provide funding for additional loans. We rely on Fannie Mae and Freddie Mac to purchase loans that meet their conforming loan requirements and on other capital market investors to purchase loans that do not meet those requirements – referred to as “nonconforming” loans. In 2007, investor demand for nonconforming loans began to fall sharply, increasing credit spreads and reducing the liquidity for those loans. In response to the reduced liquidity in the capital markets, we may retain more nonconforming loans. When we retain a loan not only do we keep the credit risk associated with the loan but we also do not receive any sale proceeds that could be used to generate new loans. Continued lack of liquidity could limit our ability to fund—and thus originate—new mortgage loans, reducing the fees we earn from originating and servicing loans. In addition, we cannot assure that Fannie Mae and Freddie Mac will not materially limit their purchases of conforming loans due to capital requirements, or changes in criteria for conforming loans (e.g., maximum loan amount or borrower eligibility).
      We rely on bank deposits to be a low cost and stable source of funding for the loans we make. We compete with banks and other financial services companies for deposits. If our competitors raise the rates they pay on deposits our funding costs may increase, either because we raise our rates to avoid losing deposits or because we lose deposits and must rely on more expensive sources of funding. Higher funding costs reduce our net interest margin and net interest income.
WE MAY ELECT TO PROVIDE CAPITAL SUPPORT TO OUR MUTUAL FUNDS RELATING TO INVESTMENTS IN STRUCTURED CREDIT PRODUCTS. Our money market mutual funds are allowed to hold investments in structured investment vehicles (SIVs) in accordance with approved investment parameters for the respective funds and, therefore, we may have indirect exposure to collateralized debt obligations (CDOs). Although we generally are not responsible for investment losses incurred by our mutual funds, we may from time to time elect to provide support to a fund even though we are not contractually obligated to do so. For example, in February 2008, to maintain an investment rating of AAA for certain non-government money market mutual funds, we elected to enter into a capital support agreement for up to $130 million related to one SIV held by those funds.
      For more information, refer to “Off-Balance Sheet Arrangements and Aggregate Contractual Obligations – Off-Balance Sheet Arrangements, Variable Interest Entities, Guarantees and Other Commitments” in the Financial Review section of this Report.
HIGHER CREDIT LOSSES COULD REQUIRE US TO INCREASE OUR ALLOWANCE FOR CREDIT LOSSES THROUGH A CHARGE TO EARNINGS. When we loan money or commit to loan money we incur credit risk, or the risk of losses if our borrowers do not repay their loans. We reserve for credit losses by establishing an allowance through a charge to earnings. The amount of this allowance is based on our assessment of credit losses inherent in our loan portfolio (including unfunded credit commitments). The process for determining the amount of the allowance is critical to our financial results and condition. It requires difficult, subjective and complex judgments about the future, including forecasts of economic or market conditions that might impair the ability of our borrowers to repay their loans.


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      We might underestimate the credit losses inherent in our loan portfolio and have credit losses in excess of the amount reserved. We might increase the allowance because of changing economic conditions. For example, in a rising interest rate environment, borrowers with adjustable-rate loans could see their payments increase. There may be a significant increase in the number of borrowers who are unable or unwilling to repay their loans, resulting in our charging off more loans and increasing our allowance. In addition, when home values decline, the potential severity of loss on a real estate-secured loan can increase significantly, especially in the case of loans with high combined loan-to-value ratios. In fourth quarter 2007, we recorded a special provision of $1.4 billion to build credit reserves, primarily for home equity losses incurred at December 31, 2007, expected to be realized in 2008, and incurred higher net charge-offs. We believe that we will incur higher charge-offs in 2008 than in 2007. There is no assurance that our allowance for credit losses at December 31, 2007, will be sufficient to cover future credit losses. We may be required to build reserves in 2008, thus reducing earnings.
      For more information, refer to “Critical Accounting Policies – Allowance for Credit Losses” and “Risk Management – Credit Risk Management Process” in the Financial Review section of this Report.
WE MAY HAVE MORE CREDIT RISK AND HIGHER CREDIT LOSSES TO THE EXTENT OUR LOANS ARE CONCENTRATED BY LOAN TYPE, INDUSTRY SEGMENT, BORROWER TYPE, OR LOCATION OF THE BORROWER OR COLLATERAL. Our credit risk and credit losses can increase if our loans are concentrated to borrowers engaged in the same or similar activities or to borrowers who as a group may be uniquely or disproportionately affected by economic or market conditions. We experienced the effect of concentration risk in 2007 when we incurred greater than expected losses in our Home Equity loan portfolio due to a housing slowdown and greater than expected deterioration in residential real estate values in many markets, including the Central Valley California market and several Southern California metropolitan statistical areas. As California is our largest banking state in terms of loans and deposits, continued deterioration in real estate values and underlying economic conditions in those markets or elsewhere in California could result in materially higher credit losses. In addition, deterioration in housing conditions and real estate values in other areas and generally across the country could result in materially higher credit losses.
      For more information, refer to “Risk Management – Credit Risk Management Process – Loan Portfolio Concentrations” in the Financial Review section of this Report and Note 9 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.
FINANCIAL DIFFICULTIES OR CREDIT DOWNGRADES OF MORTGAGE AND BOND INSURERS MAY NEGATIVELY AFFECT OUR SERVICING AND INVESTMENT PORTFOLIOS. Our servicing portfolio includes certain mortgage loans that carry some level of insurance from one or more mortgage insurance companies. To the extent that any of these companies experience financial difficulties or credit downgrades, we may be required, as servicer of the insured loan on behalf of the investor, to obtain replacement coverage with another provider, possibly at a higher cost than current coverage. We may be responsible for some or all of the incremental cost of the new coverage for certain loans depending on the terms of our servicing agreement with the investor and other circumstances. Similarly, some of the mortgage loans we hold for investment or for sale carry mortgage insurance. If a mortgage insurer is unable to meet its credit obligations with respect to an insured loan, we might incur higher credit losses if replacement coverage is not obtained. We also have investments in municipal bonds that are guaranteed against loss by bond insurers. The value of these bonds and the payment of principal and interest on them may be negatively affected by financial difficulties or credit downgrades experienced by the bond insurers.
     For more information, refer to “Earnings Performance – Balance Sheet Analysis – Securities Available for Sale” and “Risk Management – Credit Risk Management Process” in the Financial Review section of this Report.
OUR MORTGAGE BANKING REVENUE CAN BE VOLATILE FROM QUARTER TO QUARTER. We earn revenue from fees we receive for originating mortgage loans and for servicing mortgage loans. When rates rise, the demand for mortgage loans tends to fall, reducing the revenue we receive from loan originations. At the same time, revenue from our MSRs can increase through increases in fair value. When rates fall, mortgage originations tend to increase and the value of our MSRs tends to decline, also with some offsetting revenue effect. Even though they can act as a “natural hedge,” the hedge is not perfect, either in amount or timing. For example, the negative effect on revenue from a decrease in the fair value of residential MSRs is immediate, but any offsetting revenue benefit from more originations and the MSRs relating to the new loans would accrue over time. It is also possible that, because of a slowing economy and a deterioration of the housing market, even if interest rates were to fall, mortgage originations may also fall or any increase in mortgage originations may not be enough to offset the decrease in the MSR value caused by the lower rates.
      We typically use derivatives and other instruments to hedge our mortgage banking interest rate risk. We generally do not hedge all of our risk, and the fact that we attempt to hedge any of the risk does not mean we will be successful. Hedging is a complex process, requiring sophisticated models and constant monitoring, and is not a perfect science. We may use hedging instruments tied to U.S. Treasury rates, LIBOR or Eurodollars that may not perfectly correlate with the value or income being hedged. We could incur significant losses from our hedging activities. There may be periods where we elect not to use derivatives and other instruments to hedge mortgage banking interest rate risk.
      For more information, refer to “Risk Management – Asset/Liability and Market Risk Management – Mortgage Banking Interest Rate and Market Risk” in the Financial Review section of this Report.
OUR BANK CUSTOMERS COULD TAKE THEIR MONEY OUT OF THE BANK AND PUT IT IN ALTERNATIVE INVESTMENTS, CAUSING US TO LOSE A LOWER COST SOURCE OF FUNDING. Checking and savings account balances and other forms of customer deposits can decrease when customers perceive alternative investments, such as the stock market, as providing a better risk/return tradeoff. When customers move money out of bank deposits and into other investments, we can lose a relatively low cost source of funds, increasing our funding costs and reducing our net interest income.
OUR VENTURE CAPITAL BUSINESS CAN ALSO BE VOLATILE FROM QUARTER TO QUARTER. Earnings from our venture capital investments can be volatile and hard to predict and can have a significant effect on our earnings from period to period. When—and if—we recognize gains can depend on a number of factors, 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. Our venture capital investments could result in significant losses.
      We assess our private and public equity portfolio at least quarterly for other-than-temporary impairment based on a number


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of factors, including the then current market value of each investment compared to its carrying value. Our venture capital investments tend to be in technology and other volatile industries globally, so the value of our public and private equity portfolios can fluctuate widely. If we determine there is other-than-temporary impairment for an investment, we will write-down the carrying value of the investment, resulting in a charge to earnings. The amount of this charge could be significant, especially if under accounting rules we were required previously to write-up the value because of higher market prices.
      For more information, refer to “Risk Management – Asset/Liability and Market Risk Management – Market Risk – Equity Markets” in the Financial Review section of this Report.
WE RELY ON DIVIDENDS FROM OUR SUBSIDIARIES FOR REVENUE, AND FEDERAL AND STATE LAW CAN LIMIT THOSE DIVIDENDS. Wells Fargo & Company, the parent holding company, is a separate and distinct legal entity from its subsidiaries. It receives a significant portion of its revenue from dividends from its subsidiaries. We use these dividends to pay dividends on our common and preferred stock and interest and principal on our debt. Federal and state laws limit the amount of dividends that our bank and some of our nonbank subsidiaries may pay to us. Also, our 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 2007 Form 10-K and to Notes 3 (Cash, Loan and Dividend Restrictions) and 26 (Regulatory and Agency Capital Requirements) to Financial Statements in this Report.
CHANGES IN ACCOUNTING POLICIES OR ACCOUNTING STANDARDS, AND CHANGES IN HOW ACCOUNTING STANDARDS ARE INTERPRETED OR APPLIED, COULD MATERIALLY AFFECT HOW WE REPORT OUR FINANCIAL RESULTS AND CONDITION. Our accounting policies are fundamental to determining and understanding our financial results and condition. Some of these policies require use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Five of our accounting 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. For a description of these policies, refer to “Critical Accounting Policies” in the Financial Review section of this Report.
      From time to time the FASB and the SEC change the financial accounting and reporting standards that govern the preparation of our external financial statements. In addition, accounting standard setters and those who interpret the accounting standards (such as the FASB, SEC, banking regulators and our outside auditors) may change or even reverse their previous interpretations or positions on how these standards should be applied. Changes in financial accounting and reporting standards and changes in current interpretations may be beyond our control, can be hard to predict and could materially impact how we report our financial results and condition. We could be required to apply a new or revised standard retroactively or apply an existing standard differently, also retroactively, in each case resulting in our potentially restating prior period financial statements in material amounts.
ACQUISITIONS COULD REDUCE OUR STOCK PRICE UPON ANNOUNCEMENT AND REDUCE OUR EARNINGS IF WE OVERPAY OR HAVE DIFFICULTY INTEGRATING THEM. We regularly explore opportunities to acquire companies in the financial services industry. We cannot predict the frequency, size or timing of our acquisitions, and we typically do not comment publicly on a possible acquisition until we have signed a definitive agreement. When we do announce an acquisition, our stock price may fall depending on the size of the acquisition, the purchase price and the potential dilution to existing stockholders. It is also possible that an acquisition could dilute earnings per share.
     We generally must receive federal regulatory approval before we can acquire a bank or bank holding company. In deciding 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. Also, 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, branches and/or business units 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 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 harm our ability to retain customers and employees or achieve the anticipated benefits of the acquisition. Time and resources spent on integration may also impair our ability to grow our existing businesses. Also, the negative effect of any divestitures required by regulatory authorities in acquisitions or business combinations may be greater than expected.
FEDERAL AND STATE REGULATIONS CAN RESTRICT OUR BUSINESS, AND NON-COMPLIANCE COULD RESULT IN PENALTIES, LITIGATION AND DAMAGE TO OUR REPUTATION. Our parent company, our subsidiary banks and many of our nonbank subsidiaries are heavily regulated at the federal and/or state levels. This regulation is to protect depositors, federal deposit insurance funds, consumers and the banking system as a whole, not our stockholders. Federal and state regulations can significantly restrict our businesses, and we could be fined or otherwise penalized if we are found to be out of compliance.
      The Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley) limits the types of non-audit services our outside auditors may provide to us in order to preserve their independence from us. If our auditors were found not to be “independent” of us under SEC rules, we could be required to engage new auditors and file new financial statements and audit reports with the SEC. We could be out of compliance with SEC rules until new financial statements and audit reports were filed, limiting our ability to raise capital and resulting in other adverse consequences.
      Sarbanes-Oxley also requires our management to evaluate the Company’s disclosure controls and procedures and its internal control over financial reporting and requires our auditors to issue a report on our internal control over financial reporting. We are required to disclose, in our annual report on Form 10-K filed with the SEC, the existence of any “material weaknesses” in our internal control. We cannot assure that we will not find one or more material weaknesses as of the end of any given year, nor can we predict the effect on our stock price of disclosure of a material weakness.
      The Patriot Act, which was enacted in the wake of the September 2001 terrorist attacks, requires us to implement new or revised policies and procedures relating to anti-money laundering, compliance, suspicious activities, and currency transaction reporting and due diligence on customers. The Patriot Act


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also requires federal bank regulators to evaluate the effectiveness of an applicant in combating money laundering in determining whether to approve a proposed bank acquisition.
      A number of states have recently challenged the position of the OCC as the sole regulator of national banks and their subsidiaries. If these challenges are successful or if Congress acts to give greater effect to state regulation, the impact on us could be significant, not only because of the potential additional restrictions on our businesses but also from having to comply with potentially 50 different sets of regulations.
      From time to time Congress considers legislation that could significantly change our regulatory environment, potentially increasing our cost of doing business, limiting the activities we may pursue or affecting the competitive balance among banks, savings associations, credit unions, and other financial institutions. As an example, our business model depends on sharing information among the family of Wells Fargo businesses to better satisfy our customers’ needs. Laws that restrict the ability of our companies to share information about customers could limit our ability to cross-sell products and services, reducing our revenue and earnings. For example, federal financial regulators have issued regulations under the Fair and Accurate Credit Transactions Act which have the effect of increasing the length of the waiting period, after privacy disclosures are provided to new customers, before information can be shared among Wells Fargo companies for the purpose of cross-selling Wells Fargo’s products and services. This may result in certain cross-sell programs being less effective than they have been in the past. Wells Fargo must comply with these regulations not later than October 1, 2008.
      For more information, refer to “Regulation and Supervision” in our 2007 Form 10-K and to “Report of Independent Registered Public Accounting Firm” in this Report.
WE MAY INCUR FINES, PENALTIES AND OTHER NEGATIVE CONSEQUENCES FROM REGULATORY VIOLATIONS, POSSIBLY EVEN INADVERTENT OR UNINTENTIONAL VIOLATIONS. We maintain systems and procedures designed to ensure that we comply with applicable laws and regulations. However, some legal/regulatory frameworks provide for the imposition of fines or penalties for noncompliance even though the noncompliance was inadvertent or unintentional and even though there was in place at the time systems and procedures designed to ensure compliance. For example, we are subject to regulations issued by the Office of Foreign Assets Control (OFAC) that prohibit financial institutions from participating in the transfer of property belonging to the governments of certain foreign countries and designated nationals of those countries. OFAC may impose penalties for inadvertent or unintentional violations even if reasonable processes are in place to prevent the violations. Therefore, the establishment and maintenance of systems and procedures reasonably designed to ensure compliance cannot guarantee that we will be able to avoid a fine or penalty for noncompliance. For example, in April 2003 and January 2005 OFAC reported settlements with Wells Fargo Bank, N.A. in amounts of $5,500 and $42,833, respectively. These settlements related to transactions involving inadvertent acts or human error alleged to have violated OFAC regulations. There may be other negative consequences resulting from a finding of noncompliance, including restrictions on certain activities. Such a finding may also damage our reputation (see below) and could restrict the ability of institutional investment managers to invest in our securities.
NEGATIVE PUBLICITY COULD DAMAGE OUR REPUTATION. Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract customers and expose us to adverse legal and regulatory consequences. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or inadequate protection of customer information, and from actions taken by government regulators and community organizations in response to that conduct. Because we
conduct most of our businesses under the “Wells Fargo” brand, negative public opinion about one business could affect our other businesses.
WE DEPEND ON THE ACCURACY AND COMPLETENESS OF INFORMATION ABOUT CUSTOMERS AND COUNTERPARTIES. In deciding whether to extend credit or enter into other transactions, we rely on the accuracy and completeness of information about our customers, including financial statements and other financial information and reports of independent auditors. For example, in deciding whether to extend credit, we may assume that a customer’s audited financial statements conform with U.S. 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. If that information is incorrect or incomplete, we may incur credit losses or other charges to earnings.
WE RELY ON OTHERS TO HELP US WITH OUR OPERATIONS. We rely on outside vendors to provide key components of our business operations such as internet connections and network access. Disruptions in communication services provided by a vendor or any failure of a vendor to handle current or higher volumes of use could hurt our ability to deliver products and services to our customers and otherwise to conduct our business. Financial or operational difficulties of an outside vendor could also hurt our operations if those difficulties interfere with the vendor’s ability to serve us.
FEDERAL RESERVE BOARD POLICIES CAN SIGNIFICANTLY IMPACT BUSINESS AND ECONOMIC CONDITIONS AND OUR FINANCIAL RESULTS AND CONDITION. The Federal Reserve Board (FRB) 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 MSRs. Its policies also can affect our borrowers, potentially increasing the risk that they may fail to repay their loans. Changes in FRB policies are beyond our control and can be hard to predict.
OUR STOCK PRICE CAN BE VOLATILE DUE TO OTHER FACTORS. Our stock price can fluctuate widely in response to a variety of factors, in addition to those described above, including:
  general business and economic conditions;
  recommendations by securities analysts;
  new technology used, or services offered, by our competitors;
  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;
  natural disasters; and
  geopolitical conditions such as acts or threats of terrorism or military conflicts.


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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, 2007, 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 chief financial officer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2007.
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 U.S. generally accepted accounting principles (GAAP) 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 GAAP, 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 any quarter in 2007 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, 2007, 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, 2007, 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 the Company’s internal control over financial reporting. KPMG’s audit report appears on the following page.

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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Wells Fargo & Company:
We have audited Wells Fargo & Company and Subsidiaries’ (“the Company”) internal control over financial reporting as of December 31, 2007, 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, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on 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, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included 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, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control – Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of December 31, 2007 and 2006, 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, 2007, and our report dated February 25, 2008, expressed an unqualified opinion on those consolidated financial statements.
(KPMG LLP)
San Francisco, California
February 25, 2008

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Financial Statements
                         
Wells Fargo & Company and Subsidiaries  
Consolidated Statement of Income  
       
(in millions, except per share amounts)   Year ended December 31 ,
    2007     2006     2005  
 
                       
INTEREST INCOME
                       
Trading assets
  $ 173     $ 225     $ 190  
Securities available for sale
    3,451       3,278       1,921  
Mortgages held for sale
    2,150       2,746       2,213  
Loans held for sale
    70       47       146  
Loans
    29,040       25,611       21,260  
Other interest income
    293       332       232  
 
                 
Total interest income
    35,177       32,239       25,962  
 
                 
 
                       
INTEREST EXPENSE
                       
Deposits
    8,152       7,174       3,848  
Short-term borrowings
    1,245       992       744  
Long-term debt
    4,806       4,122       2,866  
 
                 
Total interest expense
    14,203       12,288       7,458  
 
                 
 
                       
NET INTEREST INCOME
    20,974       19,951       18,504  
Provision for credit losses
    4,939       2,204       2,383  
 
                 
Net interest income after provision for credit losses
    16,035       17,747       16,121  
 
                 
 
                       
NONINTEREST INCOME
                       
Service charges on deposit accounts
    3,050       2,690       2,512  
Trust and investment fees
    3,149       2,737       2,436  
Card fees
    2,136       1,747       1,458  
Other fees
    2,292       2,057       1,929  
Mortgage banking
    3,133       2,311       2,422  
Operating leases
    703       783       812  
Insurance
    1,530       1,340       1,215  
Net gains (losses) on debt securities available for sale
    209       (19 )     (120 )
Net gains from equity investments
    734       738       511  
Other
    1,480       1,356       1,270  
 
                 
Total noninterest income
    18,416       15,740       14,445  
 
                 
 
                       
NONINTEREST EXPENSE
                       
Salaries
    7,762       7,007       6,215  
Incentive compensation
    3,284       2,885       2,366  
Employee benefits
    2,322       2,035       1,874  
Equipment
    1,294       1,252       1,267  
Net occupancy
    1,545       1,405       1,412  
Operating leases
    561       630       635  
Other
    6,056       5,623       5,249  
 
                 
Total noninterest expense
    22,824       20,837       19,018  
 
                 
 
                       
INCOME BEFORE INCOME TAX EXPENSE
    11,627       12,650       11,548  
Income tax expense
    3,570       4,230       3,877  
 
                 
 
                       
NET INCOME
  $ 8,057     $ 8,420     $ 7,671  
 
                 
 
                       
EARNINGS PER COMMON SHARE
  $ 2.41     $ 2.50     $ 2.27  
 
                       
DILUTED EARNINGS PER COMMON SHARE
  $ 2.38     $ 2.47     $ 2.25  
 
                       
DIVIDENDS DECLARED PER COMMON SHARE
  $ 1.18     $ 1.08     $ 1.00  
 
                       
Average common shares outstanding
    3,348.5       3,368.3       3,372.5  
Diluted average common shares outstanding
    3,382.8       3,410.1       3,410.9  
 
                       
   
The accompanying notes are an integral part of these statements.

74


 

                 
Wells Fargo & Company and Subsidiaries  
Consolidated Balance Sheet  
       
(in millions, except shares)   December 31 ,
    2007     2006  
 
               
ASSETS
               
Cash and due from banks
  $ 14,757     $ 15,028  
Federal funds sold, securities purchased under
resale agreements and other short-term investments
    2,754       6,078  
Trading assets
    7,727       5,607  
Securities available for sale
    72,951       42,629  
Mortgages held for sale (includes $24,998 carried at fair value at December 31, 2007)
    26,815       33,097  
Loans held for sale
    948       721  
 
               
Loans
    382,195       319,116  
Allowance for loan losses
    (5,307 )     (3,764 )
 
           
Net loans
    376,888       315,352  
 
           
 
               
Mortgage servicing rights:
               
Measured at fair value (residential MSRs)
    16,763       17,591  
Amortized
    466       377  
Premises and equipment, net
    5,122       4,698  
Goodwill
    13,106       11,275  
Other assets
    37,145       29,543  
 
           
 
               
Total assets
  $ 575,442     $ 481,996  
 
           
 
               
LIABILITIES
               
Noninterest-bearing deposits
  $ 84,348     $ 89,119  
Interest-bearing deposits
    260,112       221,124  
 
           
Total deposits
    344,460       310,243  
Short-term borrowings
    53,255       12,829  
Accrued expenses and other liabilities
    30,706       25,965  
Long-term debt
    99,393       87,145  
 
           
 
               
Total liabilities
    527,814       436,182  
 
           
 
               
STOCKHOLDERS’ EQUITY
               
Preferred stock
    450       384  
Common stock – $12/3 par value, authorized 6,000,000,000 shares;
issued 3,472,762,050 shares
    5,788       5,788  
Additional paid-in capital
    8,212       7,739  
Retained earnings
    38,970       35,215  
Cumulative other comprehensive income
    725       302  
Treasury stock – 175,659,842 shares and 95,612,189 shares
    (6,035 )     (3,203 )
Unearned ESOP shares
    (482 )     (411 )
 
           
 
               
Total stockholders’ equity
    47,628       45,814  
 
           
 
               
Total liabilities and stockholders’ equity
  $ 575,442     $ 481,996  
 
           
 
               
   
The accompanying notes are an integral part of these statements.

75


 

                                                                         
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, 2004
    3,389,183,274     $ 270     $ 5,788     $ 6,912     $ 26,482     $ 950     $ (2,247 )   $ (289 )   $ 37,866  
 
                                                       
Comprehensive income:
                                                                       
Net income – 2005
                                    7,671                               7,671  
Other comprehensive income, net of tax:
                                                                       
Translation adjustments
                                            5                       5  
Net unrealized losses on securities available for sale and other interests held
                                            (298 )                     (298 )
Net unrealized gains on derivatives and hedging activities
                                            8                       8  
 
                                                                     
Total comprehensive income
                                                                    7,386  
Common stock issued
    57,528,986                       (52 )     (198 )             1,617               1,367  
Common stock issued for acquisitions
    3,909,004                       12                       110               122  
Common stock repurchased
    (105,597,728 )                                             (3,159 )             (3,159 )
Preferred stock (363,000) issued to ESOP
            362               25                               (387 )      
Preferred stock released to ESOP
                            (21 )                             328       307  
Preferred stock (307,100) converted to common shares
    10,142,528       (307 )             21                       286                
Common stock dividends
                                    (3,375 )                             (3,375 )
Tax benefit upon exercise of stock options
                            143                                       143  
Other, net
                                                    3               3  
 
                                                       
Net change
    (34,017,210 )     55             128       4,098       (285 )     (1,143 )     (59 )     2,794  
 
                                                       
 
                                                                       
BALANCE DECEMBER 31, 2005
    3,355,166,064       325       5,788       7,040       30,580       665       (3,390 )     (348 )     40,660  
 
                                                       
Cumulative effect from adoption of FAS 156
                                    101                               101  
 
                                                                   
BALANCE JANUARY 1, 2006
    3,355,166,064       325       5,788       7,040       30,681       665       (3,390 )     (348 )     40,761  
 
                                                       
Comprehensive income:
                                                                       
Net income – 2006
                                    8,420                               8,420  
Other comprehensive income, net of tax:
                                                                       
Net unrealized losses on securities available for sale and other interests held
                                            (31 )                     (31 )
Net unrealized gains on derivatives and hedging activities
                                            70                       70  
 
                                                                     
Total comprehensive income
                                                                    8,459  
Common stock issued
    70,063,930                       (67 )     (245 )             2,076               1,764  
Common stock repurchased
    (58,534,072 )                                             (1,965 )             (1,965 )
Preferred stock (414,000) issued to ESOP
            414               29                               (443 )      
Preferred stock released to ESOP
                            (25 )                             380       355  
Preferred stock (355,659) converted to common shares
    10,453,939       (355 )             41                       314                
Common stock dividends
                                    (3,641 )                             (3,641 )
Tax benefit upon exercise of stock options
                            229                                       229  
Stock option compensation expense
                            134                                       134  
Net change in deferred compensation and related plans
                            50                       (27 )             23  
Reclassification of share-based plans
                            308                       (211 )             97  
Adoption of FAS 158
                                            (402 )                     (402 )
 
                                                       
Net change
    21,983,797       59             699       4,534       (363 )     187       (63 )     5,053  
 
                                                       
 
                                                                       
BALANCE DECEMBER 31, 2006
    3,377,149,861       384       5,788       7,739       35,215       302       (3,203 )     (411 )     45,814  
 
                                                       
Cumulative effect from adoption of FSP 13-2
                                    (71 )                             (71 )
 
                                                                   
BALANCE JANUARY 1, 2007
    3,377,149,861       384       5,788       7,739       35,144       302       (3,203 )     (411 )     45,743  
 
                                                       
Comprehensive income:
                                                                       
Net income – 2007
                                    8,057                               8,057  
Other comprehensive income, net of tax:
                                                                       
Translation adjustments
                                            23                       23  
Net unrealized losses on securities available for sale and other interests held
                                            (164 )                     (164 )
Net unrealized gains on derivatives and hedging activities
                                            322                       322  
Defined benefit pension plans:
                                                                       
Amortization of net actuarial loss and prior service cost included in net income
                                            242                       242  
 
                                                                     
Total comprehensive income
                                                                    8,480  
Common stock issued
    69,894,448                       (132 )     (276 )             2,284               1,876  
Common stock issued for acquisitions
    58,058,813                       190                       1,935               2,125  
Common stock repurchased
    (220,327,473 )                                             (7,418 )             (7,418 )
Preferred stock (484,000) issued to ESOP
            484               34                               (518 )      
Preferred stock released to ESOP
                            (29 )                             447       418  
Preferred stock (418,000) converted to common shares
    12,326,559       (418 )             13                       405                
Common stock dividends
                                    (3,955 )                             (3,955 )
Tax benefit upon exercise of stock options
                            210                                       210  
Stock option compensation expense
                            129                                       129  
Net change in deferred compensation and related plans
                            58                       (38 )             20  
 
                                                       
Net change
    (80,047,653 )     66             473       3,826       423       (2,832 )     (71 )     1,885  
 
                                                       
 
                                                                       
BALANCE DECEMBER 31, 2007
    3,297,102,208     $ 450     $ 5,788     $ 8,212     $ 38,970     $ 725     $ (6,035 )   $ (482 )   $ 47,628  
 
                                                       
 
                                                                       
   
The accompanying notes are an integral part of these statements.

76


 

                         
Wells Fargo & Company and Subsidiaries  
Consolidated Statement of Cash Flows  
       
(in millions)   Year ended December 31 ,
    2007     2006     2005  
 
                       
Cash flows from operating activities:
                       
Net income
  $ 8,057     $ 8,420     $ 7,671  
Adjustments to reconcile net income to net cash provided (used) by operating activities:
                       
Provision for credit losses
    4,939       2,204       2,383  
Change in fair value of MSRs (residential) and MHFS carried at fair value
    2,611       2,453        
Reversal of provision for MSRs in excess of fair value
                (378 )
Depreciation and amortization
    1,532       3,221       4,161  
Other net gains
    (1,407 )     (1,701 )     (1,200 )
Preferred shares released to ESOP
    418       355       307  
Stock option compensation expense
    129       134        
Excess tax benefits related to stock option payments
    (196 )     (227 )      
Originations of MHFS
    (223,266 )     (237,841 )     (230,897 )
Proceeds from sales of and principal collected on mortgages originated for sale
    216,270       238,800       213,514  
Net change in:
                       
Trading assets
    (3,388 )     5,271       (1,905 )
Loans originated for sale
    (222 )     (109 )     683  
Deferred income taxes
    (31 )     593       813  
Accrued interest receivable
    (407 )     (291 )     (796 )
Accrued interest payable
    (87 )     455       311  
Other assets, net
    (365 )     3,570       (10,237 )
Other accrued expenses and liabilities, net
    4,491       2,669       3,585  
 
                 
Net cash provided (used) by operating activities
    9,078       27,976       (11,985 )
 
                 
 
                       
Cash flows from investing activities:
                       
Net change in:
                       
Federal funds sold, securities purchased under resale agreements
and other short-term investments
    3,331       (717 )     (281 )
Securities available for sale:
                       
Sales proceeds
    47,990       53,304       19,059  
Prepayments and maturities
    8,505       7,321       6,972  
Purchases
    (75,129 )     (62,462 )     (28,634 )
Loans:
                       
Increase in banking subsidiaries’ loan originations, net of collections
    (48,615 )     (37,730 )     (42,309 )
Proceeds from sales (including participations) of loans originated for investment
by banking subsidiaries
    3,369       38,343       42,239  
Purchases (including participations) of loans by banking subsidiaries
    (8,244 )     (5,338 )     (8,853 )
Principal collected on nonbank entities’ loans
    21,476       23,921       22,822  
Loans originated by nonbank entities
    (25,284 )     (26,974 )     (33,675 )
Net cash acquired from (paid for) acquisitions
    (2,811 )     (626 )     66  
Proceeds from sales of foreclosed assets
    1,405       593       444  
Changes in MSRs from purchases and sales
    791       (3,539 )     (1,943 )
Other, net
    (4,099 )     (2,678 )     (3,324 )
 
                 
Net cash used by investing activities
    (77,315 )     (16,582 )     (27,417 )
 
                 
 
                       
Cash flows from financing activities:
                       
Net change in:
                       
Deposits
    27,058       (4,452 )     38,961  
Short-term borrowings
    39,827       (11,156 )     1,878  
Long-term debt:
                       
Proceeds from issuance
    29,360       20,255       26,473  
Repayment
    (18,250 )     (12,609 )     (18,576 )
Common stock:
                       
Proceeds from issuance
    1,876       1,764       1,367  
Repurchased
    (7,418 )     (1,965 )     (3,159 )
Cash dividends paid
    (3,955 )     (3,641 )     (3,375 )
Excess tax benefits related to stock option payments
    196       227        
Other, net
    (728 )     (186 )     (1,673 )
 
                 
Net cash provided (used) by financing activities
    67,966       (11,763 )     41,896  
 
                 
Net change in cash and due from banks
    (271 )     (369 )     2,494  
Cash and due from banks at beginning of year
    15,028       15,397       12,903  
 
                 
 
                       
Cash and due from banks at end of year
  $ 14,757     $ 15,028     $ 15,397  
 
                 
 
                       
Supplemental disclosures of cash flow information:
                       
Cash paid during the year for:
                       
Interest
  $ 14,290     $ 11,833     $ 7,769  
Income taxes
    3,719       3,084       3,584  
Noncash investing and financing activities:
                       
Transfers from trading assets to securities available for sale
  $ 1,268     $     $  
Net transfers from loans held for sale to loans
                7,444  
Transfers from MHFS to securities available for sale
    7,949             5,490  
Transfers from MHFS to loans
    2,133            
Transfers from MHFS to MSRs
    3,720       4,118       2,652  
Transfers from loans to MHFS
        32,383       41,270  
Transfers from loans to foreclosed assets
    2,666       1,918       567  
 
                       
 
The accompanying notes are an integral part of these statements.

77


 

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, when we refer to “the Company,” “we,” “our” or “us” we mean Wells Fargo & Company and Subsidiaries (consolidated). Wells Fargo & Company (the Parent) is a financial holding company and a bank holding company.
      Our accounting and reporting policies conform with U.S. 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 residential mortgage servicing rights (MSRs) (Notes 8 and 9) and financial instruments (Note 17), pension accounting (Note 20) and income taxes (Note 21). Actual results could differ from those estimates.
      In the Financial Statements and related Notes, all common share and per share disclosures reflect a two-for-one stock split in the form of a 100% stock dividend distributed August 11, 2006.
      On January 1, 2007, we adopted the following new accounting pronouncements:
  FIN 48 – Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109;
  FSP 13-2 – FASB Staff Position 13-2, Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction;
  FAS 155 – Statement of Financial Accounting Standards No. 155, Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140;
  FAS 157 – Fair Value Measurements; and
  FAS 159 – The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115.
      The adoption of FIN 48, FAS 155, FAS 157 and FAS 159 did not have any effect on our financial statements at the date of adoption. For additional information, see Note 17 and Note 21.
      FSP 13-2 relates to the accounting for leveraged lease transactions for which there have been cash flow estimate changes based on when income tax benefits are recognized.
Certain of our leveraged lease transactions have been challenged by the Internal Revenue Service (IRS). We have paid the IRS the contested income tax associated with these transactions. However, we are continuing to vigorously defend our initial filing position as to the timing of the tax benefits associated with these transactions. Upon adoption of FSP 13-2, we recorded a cumulative effect of change in accounting principle to reduce the beginning balance of 2007 retained earnings by $71 million after tax ($115 million pre tax). Since this adjustment changes only the timing of income tax cash flows and not the total net income for these leases, this amount will be recognized back into income over the remaining terms of the affected leases.
      On July 1, 2007, we adopted Emerging Issues Task Force (EITF) Topic D-109, Determining the Nature of a Host Contract Related to a Hybrid Financial Instrument Issued in the Form of a Share under FASB Statement No. 133 (Topic D-109), which provides clarifying guidance as to whether certain hybrid financial instruments are more akin to debt or equity, for purposes of evaluating whether the embedded derivative financial instrument requires separate accounting under FAS 133, Accounting for Derivative Instruments and Hedging Activities. In accordance with the transition provisions of Topic D-109, we transferred $1.2 billion of securities, consisting of investments in preferred stock callable by the issuer, from trading assets to securities available for sale. Because the securities were carried at fair value, the adoption of Topic D-109 did not have any effect on our total stockholders’ equity.
IMMATERIAL ADJUSTMENTS
We obtained concurrence from the staff of the Securities and Exchange Commission (the SEC) subsequent to the filing of our third quarter 2007 Form 10-Q concerning our accounting for the Visa restructuring transactions, including judgment sharing agreements previously executed among Wells Fargo, Visa Inc. and its predecessors (collectively Visa) and certain other member banks of the Visa USA network. We recorded an immaterial adjustment to the previously filed 2006 Statement of Income associated with indemnification obligations related to agreements entered into during second quarter 2006. Based on our proportionate membership share of Visa USA, a litigation liability and corresponding expense of $95 million was recorded for second quarter 2006, which was included in Community Banking for management reporting. This adjustment was estimated based upon our share of an actual settlement reached in November 2007. The impact of this adjustment to the 2006 Statement of Income was to reduce net income by $62 million and diluted earnings per share by $0.02.
     In 2006 and 2005, our consolidated statement of cash flows reflected mortgage servicing rights (MSRs) from securitizations and asset transfers, as separately detailed in Note 9, of $4,118 million and $2,652 million, respectively, as an increase to cash flows from operating activities with a corresponding decrease to cash flows from investing activities.


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We have revised our consolidated statement of cash flows to appropriately reflect the proceeds from sales of mortgages held for sale (MHFS) and the related investment in MSRs as noncash transfers from MHFS to MSRs. The impact of the adjustments was to decrease net cash provided by operating activities from $32,094 million to $27,976 million in 2006, increase net cash used by operating activities from $9,333 million to $11,985 million in 2005, decrease net cash used by investing activities from $20,700 million to $16,582 million in 2006, and decrease net cash used by investing activities from $30,069 million to $27,417 million in 2005. These revisions to the historical financial statements were not considered to be material.
      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 entity, we generally account for the investment using the equity method. If we own less than 20% of an entity, 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.
      We are a variable interest holder in certain special-purpose entities in which we 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. Our variable interest arises from contractual, ownership or other monetary interests in the entity, which change with fluctuations in the entity’s net asset value. 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. Noninterest income from trading assets was $544 million in 2007 and 2006, and $571 million in 2005.
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. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.
      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. We conduct other-than-temporary impairment analysis on a quarterly basis. The initial indicator of other-than-temporary impairment for both debt and equity securities is a decline in market value below the amount recorded for an investment, and the severity and
duration of the decline. In determining whether an impairment is other than temporary, we consider the length of time and the extent to which market value has been less than cost, any recent events specific to the issuer and economic conditions of its industry, and our ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery.
      For marketable equity securities, we also consider the issuer’s financial condition, capital strength, and near-term prospects.
For debt securities we also consider:
  the cause of the price decline—general level of interest rates and industry and issuer-specific factors;
  the issuer’s financial condition, near term prospects and current ability to make future payments in a timely manner;
  the issuer’s ability to service debt; and
  any change in agencies’ ratings at evaluation date from acquisition date and any likely imminent action.
     The securities portfolio is an integral part of our asset/liability management process. We manage these investments to provide liquidity, manage interest rate risk and maximize portfolio yield within capital risk limits approved by management and the Board of Directors and monitored by the Corporate Asset/Liability Management Committee (Corporate ALCO). 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


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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 (MHFS) include commercial and residential mortgages originated for sale and securitization in the secondary market, which is our principal market, or for sale as whole loans. Effective January 1, 2007, we elected to measure new prime residential MHFS at fair value.
     Nonprime residential and commercial MHFS continue to be held at the lower of cost or market value. For these loans, 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. The deferred costs and fees are recognized in mortgage banking noninterest income upon sale of the loan.
      At origination, our lines of business are authorized to originate held for investment loans that meet or exceed established loan product profitability criteria, including minimum positive net interest margin spreads in excess of funding costs. When a determination is made at the time of commitment to originate loans as held for investment, it is our intent to hold these loans to maturity or for the “foreseeable future,” subject to periodic review under our corporate asset/liability management process. In determining the “foreseeable future” for these loans, management considers 1) the current economic environment and market conditions, 2) our business strategy and current business plans, 3) the nature and type of the loan receivable, including its expected life, and 4) our current financial condition and liquidity demands. Consistent with our core banking business of managing the spread between the yield on our assets and the cost of our funds, loans are periodically reevaluated to determine if our minimum net interest margin spreads continue to meet our profitability objectives. If subsequent changes in interest rates significantly impact the ongoing profitability of certain loan products, we may subsequently change our intent to hold these loans and we would take actions to sell such loans in response to the Corporate ALCO directives to reposition our balance sheet because of the changes in interest rates. Such Corporate ALCO directives identify both the type of loans (for example 3/1, 5/1, 10/1 and relationship adjustable-rate mortgages (ARMs), as well as specific fixed-rate loans) to be sold and the weighted-average coupon rate of such loans no longer meeting our ongoing investment criteria. Upon the issuance of such directives, we immediately transfer these loans to the MHFS portfolio at the lower of cost or market value.
Loans Held for Sale
Loans held for sale are carried at the lower of 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 noninterest income upon sale of the loan.
Loans
Loans are reported at their outstanding principal balances net of any unearned income, charge-offs, unamortized deferred fees and costs on originated loans and premiums or discounts on purchased loans, except for certain purchased loans, which are recorded at fair value on their purchase date. Unearned income, deferred fees and costs, and discounts and premiums are amortized to income over the contractual life of the loan using the interest method.
      We offer a portfolio product known as relationship ARMs that provides interest rate reductions to reward eligible banking customers who have an existing relationship or establish a new relationship with Wells Fargo. Accordingly, this product offering is generally underwritten to certain Company guidelines rather than secondary market standards
and is typically originated for investment. At December 31, 2007 and 2006, we had $15.4 billion and $3.4 billion, respectively, of relationship ARMs in loans held for investment and $2 million and $163 million, respectively, in mortgages held for sale. Originations, net of collections and proceeds from the sale of these loans are reflected as investing cash flows consistent with their original classification.
      Lease financing assets include aggregate lease rentals, net of related unearned income, which includes deferred investment tax credits, and related nonrecourse debt. Leasing income is recognized as a constant percentage of outstanding lease financing balances over the lease terms.
      Loan commitment fees are generally deferred and amortized into noninterest income on a straight-line basis over the commitment period.
      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 when:
  the full and timely collection of interest or principal becomes uncertain;
  they are 90 days (120 days with respect to real estate 1-4 family first and junior lien mortgages and auto loans) past due for interest or principal (unless both well-secured and in the process of collection); or
  part of the principal balance has been charged off.
     Generally, consumer loans not secured by real estate or autos are placed on nonaccrual status only when part of the principal has been charged off. These loans are charged off or charged down to the net realizable value of the collateral when deemed uncollectible, due to bankruptcy or other factors, 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 when (a) all delinquent interest and principal becomes current under the terms of the


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loan agreement or (b) the loan is both well-secured and in the process of collection and collectibility is no longer doubtful.
IMPAIRED LOANS We consider a loan to be impaired when, based on current information and events, we determine that we will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. We assess and account for as impaired certain nonaccrual commercial and commercial real estate loans that are over $3 million and certain consumer, commercial and commercial real estate loans whose terms have been modified in a troubled debt restructuring.
      When we identify a loan as impaired, we measure the impairment based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral. In these cases we use an observable market price or the current fair value of the collateral, less selling costs when foreclosure is probable, 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 allowance estimate or a charge-off to the allowance.
ALLOWANCE FOR CREDIT LOSSES The allowance for credit losses, which consists of 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.
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. Effective January 1, 2006, upon adoption of FAS 156, Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140, servicing rights resulting from the sale or securitization of loans we originate (asset transfers), are initially measured at fair value at the date of transfer. We recognize the rights to service mortgage loans for others, or mortgage servicing rights (MSRs), as assets whether we purchase the MSRs or the MSRs result from an asset transfer. We determine the fair value of servicing rights at the date of transfer using the present value of estimated future net servicing income, using assumptions that market participants use in their estimates of values. We use quoted market prices when available to determine the value of other interests held. Gain or loss on sale of loans depends on (a) proceeds received and (b) the previous carrying amount of the financial assets transferred and any interests we continue to hold (such as interest-only strips) based on relative fair value at the date of transfer.
      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 (including housing price volatility), discount rate, default rates, cost to service (including delinquency and foreclosure costs), escrow account earnings, contractual servicing fee income, ancillary income and late fees. This model is validated by an independent internal model validation group operating in accordance with a model validation policy approved by Corporate ALCO.
MORTGAGE SERVICING RIGHTS MEASURED AT FAIR VALUE
Effective January 1, 2006, upon adoption of FAS 156, we elected to initially measure and carry our MSRs related to residential mortgage loans (residential MSRs) using the fair value method. Under the fair value method, residential MSRs are carried in the balance sheet at fair value and the changes in fair value, primarily due to changes in valuation inputs and assumptions and to the collection/realization of expected cash flows, are reported in earnings in the period in which the change occurs.
     Effective January 1, 2006, upon the remeasurement of our residential MSRs at fair value, we recorded a cumulative effect adjustment to increase the 2006 beginning balance of retained earnings by $101 million after tax ($158 million pre tax) in stockholders’ equity.
AMORTIZED MORTGAGE SERVICING RIGHTS
Amortized MSRs, which include commercial MSRs and, prior to January 1, 2006, residential MSRs, are carried at the lower of cost or market value. These 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, as well as other factors.
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.
      We primarily 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.
      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.
      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


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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.
Operating Lease Assets
Operating lease rental income for leased assets, generally autos, 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. Leased assets are written down to the fair value of the collateral less cost to sell 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, as amended by FAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and 132(R). 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.
      FAS 158 was issued on September 29, 2006, and became effective for us on December 31, 2006. FAS 158 requires us to recognize the funded status of our pension and postretirement benefit plans on our balance sheet. Additionally, FAS 158 will require us to use a year-end measurement date beginning in 2008. We conformed our pension asset and our pension and postretirement liabilities to FAS 158 and recorded a corresponding reduction of $402 million (after tax) to the December 31, 2006, balance of cumulative other comprehensive income in stockholders’ equity. The adoption of FAS 158 did not change the amount of net periodic benefit expense recognized in our income statement.
      One of the principal components of the net periodic pension expense 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 should closely match 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) long-term historical return experience for major asset class categories (for example, large cap and small cap domestic equities, international equities and domestic fixed income), and (2) forward-looking return expectations for these major asset classes. Differences in each year, if any, between expected and actual returns are included in our net actuarial gain or loss amount, which is recognized in other comprehensive income. We generally amortize any net actuarial gain or loss in excess of a 5% corridor (as defined in FAS 87) in net periodic pension expense 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). In 2008, we will use December 31 as our measurement date as required under FAS 158.
Income Taxes
We file a consolidated federal income tax return and, in certain states, combined state tax returns.
      We account for income taxes in accordance with FAS 109, Accounting for Income Taxes, as interpreted by FIN 48, resulting in two components of income tax expense: current and deferred. Current income tax expense approximates taxes to be paid or refunded for the current period and includes income tax expense related to our uncertain tax positions. We determine deferred income taxes 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 in the period in which they occur. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized subject to management’s judgment that realization is more likely than not. A tax position that meets the “more likely than not” recognition threshold is measured to determine the amount of benefit to recognize. The tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement. Foreign taxes paid are generally applied as credits to reduce federal income taxes payable. Interest and penalties are recognized as a component of income tax expense.
Stock-Based Compensation
We have stock-based employee compensation plans, as more fully discussed in Note 19. Prior to January 1, 2006, we accounted for stock options and stock awards under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations, as permitted by FAS 123, Accounting for Stock-Based Compensation. Under this guidance, no stock option expense was recognized in our income statement for periods prior to January 1, 2006, as all options granted under our plans had an exercise price equal to the market value of the underlying common stock on the


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date of grant. Effective January 1, 2006, we adopted FAS 123(R), Share-Based Payment, using the “modified prospective” transition method. Accordingly, compensation cost recognized in 2006 and 2007 includes (1) compensation cost for share-based payments granted prior to, but not yet vested as of the adoption date of January 1, 2006, based on the grant date fair value estimated in accordance with FAS 123, and (2) compensation cost for all share-based awards granted on or after January 1, 2006. Results for prior periods have not been restated. In calculating the common stock equivalents for purposes of diluted earnings per share, we selected the transition method provided by FASB Staff Position FAS 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.
      As a result of adopting FAS 123(R) on January 1, 2006, income before income taxes of $11.6 billion and net income of $8.1 billion for 2007 was $129 million and $80 million lower, respectively, than if we had continued to account for share-based compensation under APB 25, and, for 2006, income before income taxes of $12.7 billion and net income of $8.4 billion was $134 million and $84 million lower, respectively. Basic and diluted earnings per share for 2007 of $2.41 and $2.38, respectively, were both $0.025 per share lower than if we had not adopted FAS 123(R), and, for 2006, basic and diluted earnings per share of $2.50 and $2.47, respectively, were also both $0.025 per share lower.
      Pro forma net income and earnings per common share information are provided in the following table as if we accounted for employee stock option plans under the fair value method of FAS 123 in 2005.
 
         
(in millions, except per
share amounts)
  Year ended December 31, 2005
 
 
 
       
Net income, as reported
    $7,671  
 
       
Add: Stock-based employee compensation expense included in reported net income, net of tax
    1  
Less: Total stock-based employee compensation expense under the fair value method for all awards, net of tax
    (188 )
 
       
Net income, pro forma
    $7,484  
 
       
 
       
Earnings per common share
       
As reported
    $ 2.27  
Pro forma
    2.22  
Diluted earnings per common share
       
As reported
    $ 2.25  
Pro forma
    2.19  
   
     Stock options granted in each of our February 2005 and February 2004 annual grants, under our Long-Term Incentive Compensation Plan (the Plan), fully vested upon grant, resulting in full recognition of stock-based compensation expense for both grants in the year of the grant under the fair value method in the table above. Stock options granted in our 2003 annual grant under the Plan vest over a three-year period, and expense reflected in the table for this grant 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 in 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, including hedges of foreign currency exposure (“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 asset/liability risk management purposes, including economic hedges not qualifying under FAS 133, Accounting for Derivative Instruments and Hedging Activities (“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 earnings 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, with any ineffectiveness recorded in current period earnings. 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.
      For fair value and cash flow hedges qualifying under FAS 133, we formally document at inception the relationship between hedging instruments and hedged items, our risk management objective, strategy and our evaluation of effectiveness for our hedge transactions. This includes linking all derivatives designated as fair value or cash flow hedges to specific assets and liabilities in the balance sheet or to specific forecasted transactions. Periodically, as required, we also formally assess whether the derivative we designated in each hedging relationship is expected to be and has been highly effective in offsetting changes in fair values or cash flows of the hedged item using the regression analysis method or, in limited cases, the dollar offset method.
      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 de-designated 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.


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      When we discontinue hedge accounting because a derivative no longer qualifies as an effective fair value hedge, we continue to carry the derivative in 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 cash flow hedge accounting because the hedging instrument is sold, terminated, or no longer designated (de-designated), the amount reported in other comprehensive income up to the date of sale, termination or de-designation continues to be reported in other comprehensive income until the forecasted transaction affects earnings.
      When we discontinue cash flow hedge accounting because it is probable that a forecasted transaction will not occur, we continue to carry the derivative in 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.
      In all other situations in which we discontinue hedge accounting, the derivative will be carried at its fair value in 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 not 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 not measured at fair value with changes in fair value reported in earnings, and (3) if a separate instrument with the same terms as the embedded instrument would meet the definition of a derivative. If the embedded derivative meets all of these conditions, we separate it from the host contract by recording the bifurcated derivative at fair value and the remaining host contract at the difference between the basis of the hybrid instrument and the fair value of the bifurcated derivative. The bifurcated derivative is carried as a free-standing derivative at fair value with changes recorded in current period earnings.


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.
     Business combinations completed in 2007, 2006 and 2005 are presented below.
      For information on additional consideration related to acquisitions, which is considered to be a guarantee, see Note 15.


                 
 
(in millions)   Date     Assets  

2007
               
Placer Sierra Bancshares, Sacramento, California
  June 1   $ 2,644  
Certain assets of The CIT Group/Equipment Financing, Inc., Tempe, Arizona
  June 29     2,888  
Greater Bay Bancorp, East Palo Alto, California
  October 1     8,204  
Certain Illinois branches of National City Bank, Cleveland, Ohio
  December 7     61  
Other (1)
  Various     61  
 
             
 
          $ 13,858  
 
             
 
               
2006
               
Secured Capital Corp/Secured Capital LLC, Los Angeles, California
  January 18   $ 132  
Martinius Corporation, Rogers, Minnesota
  March 1     91  
Commerce Funding Corporation, Vienna, Virginia
  April 17     82  
Fremont National Bank of Canon City/Centennial Bank of Pueblo, Canon City and Pueblo, Colorado
  June 7     201  
Certain assets of the Reilly Mortgage Companies, McLean, Virginia
  August 1     303  
Barrington Associates, Los Angeles, California
  October 2     65  
EFC Partners LP (Evergreen Funding), Dallas, Texas
  December 15     93  
Other (2)
  Various     20  
 
             
 
          $ 987  
 
             
 
               
2005
               
Certain branches of PlainsCapital Bank, Amarillo, Texas
  July 22   $ 190  
First Community Capital Corporation, Houston, Texas
  July 31     644  
Other (3)
  Various     40  
 
             
 
          $ 874  
 
             
 
(1)   Consists of six acquisitions of insurance brokerage and third party health care payment processing businesses.
(2)   Consists of seven acquisitions of insurance brokerage businesses.
(3)   Consists of eight acquisitions of insurance brokerage and lockbox processing businesses.

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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 $2.0 billion in 2007 and $1.7 billion in 2006.
      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 $2.2 billion at December 31, 2007, without obtaining prior regulatory approval. Our nonbank subsidiaries are also limited by certain federal and state statutory provisions and regulations covering the amount of dividends that may be paid in any given year. Based on retained earnings at December 31, 2007, our nonbank subsidiaries could have declared additional dividends of $3.7 billion at December 31, 2007, without obtaining prior approval.


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

The table below provides the detail of federal funds sold, securities purchased under resale agreements and other short-term investments.
                 
 
(in millions)   December 31
    2007     2006  

Federal funds sold and securities purchased under resale agreements

  $ 1,700     $ 5,024  
Interest-earning deposits
    460       413  
Other short-term investments
    594       641  
 
           
Total
  $ 2,754     $ 6,078  
 
           
 
For resale agreements, which represent collateralized financing transactions, we hold collateral in the form of securities that we have the right to sell or repledge of $1.1 billion at December 31, 2007, and $1.8 billion at December 31, 2006, of which we sold or repledged $705 million and $1.4 billion, respectively.


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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. The net unrealized gains (losses) are reported on an after-tax basis as a component of cumulative
other comprehensive income. There were no securities classified as held to maturity as of the periods presented.


                                                                 
 
(in millions)   December 31
    2007     2006  
    Cost   Gross   Gross   Fair     Cost   Gross   Gross   Fair  
        unrealized   unrealized     value         unrealized   unrealized     value  
        gains   losses               gains   losses        

Securities of U.S. Treasury and federal agencies

  $ 962     $ 20     $     $ 982     $ 774     $ 2     $ (8 )   $ 768  
Securities of U.S. states and political subdivisions
    6,128       135       (111 )     6,152       3,387       148       (5 )     3,530  
Mortgage-backed securities:
                                                               
Federal agencies
    34,092       898       (3 )     34,987       26,981       497       (15 )     27,463  
Private collateralized mortgage obligations (1)
    20,026       82       (126 )     19,982       3,989       63       (6 )     4,046  
 
                                               
Total mortgage-backed securities
    54,118       980       (129 )     54,969       30,970       560       (21 )     31,509  
Other
    8,185       45       (165 )     8,065       5,980       67       (21 )     6,026