EX-13 4 f17867exv13.htm EXHIBIT 13 exv13
 

Exhibit 13

     
 
  Financial Review
34
  Overview
38
  Critical Accounting Policies
41
  Earnings Performance
41
  Net Interest Income
44
  Noninterest Income
45
  Noninterest Expense
45
  Income Tax Expense
45
  Operating Segment Results

   
46
  Balance Sheet Analysis
46
  Securities Available for Sale
(table on page 71)
46
  Loan Portfolio (table on page 73)
46
  Deposits

   
47
  Off-Balance Sheet Arrangements and
Aggregate Contractual Obligations
47
  Off-Balance Sheet Arrangements,
Variable Interest Entities, Guarantees
and Other Commitments
48
  Contractual Obligations
48
  Transactions with Related Parties

   
49
  Risk Management
49
  Credit Risk Management Process
49
  Nonaccrual Loans and Other Assets
50
  Loans 90 Days or More Past Due
and Still Accruing
51
  Allowance for Credit Losses
(table on page 75)
52
  Asset/Liability and
Market Risk Management
     
52
  Interest Rate Risk
52
  Mortgage Banking Interest Rate Risk
54
  Market Risk – Trading Activities
54
  Market Risk – Equity Markets
54
  Liquidity and Funding

   
56
  Capital Management
57
  Comparison of 2004 with 2003

   
 
  Controls and Procedures

   
58
  Disclosure Controls and Procedures
58
  Internal Control over Financial Reporting
58
  Management’s Report on Internal Control
over Financial Reporting
59
  Report of Independent Registered Public
Accounting Firm

   
 
  Financial Statements

   
60
  Consolidated Statement of Income
61
  Consolidated Balance Sheet
62
  Consolidated Statement of Changes in Stockholders’
Equity and Comprehensive Income
63
  Consolidated Statement of Cash Flows
64
  Notes to Financial Statements

   
112
  Report of Independent Registered Public Accounting Firm

   
113
  Quarterly Financial Data

   


 


 

     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 might differ significantly from our forecasts and expectations due to several factors. Some of these factors are described in the Financial Review and in the Financial Statements and related Notes. For a discussion of other factors, refer to the “Risk Factors” and “Regulation and Supervision” sections of our Annual Report on Form 10-K for the year ended December 31, 2005, filed with the Securities and Exchange Commission (SEC) and available on the SEC’s website at www.sec.gov.
Financial Review
Overview
 

Wells Fargo & Company is a $482 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, 2005. When we refer to “the Company,” “we,” “our” and “us” in this Report, we mean Wells Fargo & Company and Subsidiaries (consolidated). When we refer to “the Parent,” we mean Wells Fargo & Company.
     We had another exceptional year in 2005, with record diluted earnings per share of $4.50, record net income of $7.7 billion and solid market share growth across our more than 80 businesses. Our earnings growth from a year ago was broad based, with nearly every consumer and commercial business line achieving double-digit profit growth, including regional banking, private client services, corporate trust, business direct, asset-based lending, student lending, consumer credit, commercial real estate and international trade services. Both net interest income and noninterest income for 2005 grew solidly from last year and virtually all of our fee-based products had double-digit revenue growth. We took significant actions to reposition our balance sheet in 2005 designed to improve yields on earning assets, including the sale of $48 billion of our lowest-yielding adjustable rate mortgages (ARMs), resulting in $119 million of sales-related losses, and the sale of $17 billion of debt securities, including low-yielding fixed-income securities, resulting in $120 million of losses.
     Our growth in earnings per share was driven by revenue growth, operating leverage (revenue growth in excess of expense growth) and credit quality, which remained solid despite the following credit-related events:
    $171 million of net charge-offs from incremental consumer bankruptcy filings nationwide due to a change in bankruptcy law in October 2005;
    $163 million first quarter 2005 initial implementation of conforming to more stringent Federal Financial Institutions Examination Council (FFIEC) charge-off rules at Wells Fargo Financial; and
    $100 million provision for credit losses for our assessment of the effect of Hurricane Katrina.
     Our primary sources of earnings are driven by lending and deposit taking activities, which generate net interest income, and providing financial services that generate fee income.
     Revenue grew 10% from 2004. In addition to double-digit growth in earnings per share, we also had double-digit growth in average loans. We have been achieving these results not just for one year, but for the past five, 10, 15 and 20 years. Our total shareholder return the past five years was 10 times that of the S&P 500®, and almost double the S&P 500 including the past 10, 15 and 20 years. These periods included almost every economic cycle and economic condition a financial institution can experience, including high and low interest rates, high and low unemployment, bubbles and recessions and all types of yield curves — steep, flat and inverted. For us to achieve double-digit growth through different economic cycles, our primary strategy, consistent for 20 years, is to satisfy all our customers’ financial needs, help them succeed financially and, through cross-selling, gain market share, wallet share and earn 100% of their business.
     We have stated in the past that to consistently grow over the long term, successful companies must invest in their core businesses and in maintaining strong balance sheets. We continued to make investments in 2005 by opening 92 banking stores, seven commercial banking offices, 47 mortgage stores and 20 consumer finance stores. We continued to be #1 nationally in retail mortgage originations, home equity lending, small business lending, agricultural lending, consumer internet banking, and providing financial services to middle-market companies in the western U.S.
(BAR CHART)


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     Our solid financial performance enables us to be one of the top givers to non-profits among all U.S. companies. We continued to have the only “Aaa” rated bank in the U.S., the highest possible credit rating issued by Moody’s Investors Service.
     Our vision is to satisfy all the financial needs of our customers, help them succeed financially, be recognized as the premier financial services company in our markets and be one of America’s great companies. Our primary strategy to achieve this vision is to increase the number of products our customers buy from us and to give them all 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. At year-end 2005, our average cross-sell set new records for the Company — our average retail banking household now has 4.8 products with us, up from 4.6 a year ago and our average Wholesale Banking customer now has a record 5.7 products. Our goal is eight products per customer, which is currently half of our estimate of potential demand.
     Our core products grew this year:
    Average loans grew by 10%;
    Average retail core deposits grew by 10% (average core deposits grew by 9%); and
    Assets managed and administered were up 11%.
     We believe it is important to maintain a well controlled environment as we continue to grow our businesses. We manage our credit risk by maintaining prudent credit policies for underwriting with effective procedures for monitoring and review. We have a well diversified loan portfolio, measured by industry, geography and product type. We manage the interest rate and market risks inherent in our asset and liability balances within prudent ranges, while ensuring adequate liquidity and funding. Our stockholder value has increased over time due to customer satisfaction, strong financial results, investment in our businesses and the prudent way we attempt to manage our business risks.
     Our financial results included the following:
     Net income in 2005 increased 9% to $7.7 billion from $7.0 billion in 2004. Diluted earnings per common share increased 10% to $4.50 in 2005 from $4.09 in 2004. Return on average total assets was 1.72% and return on average common equity was 19.57% in 2005, and 1.71% and 19.56%, respectively, in 2004.
     Net interest income on a taxable-equivalent basis was $18.6 billion in 2005, compared with $17.3 billion a year ago, reflecting solid loan growth (other than ARMs) and a relatively flat net interest margin. Average earning assets grew 8% from a year ago, or 15% excluding 1-4 family first mortgages. Our net interest margin was 4.86% for 2005, compared with 4.89% in 2004. Given the prospect of higher short-term interest rates and a flatter yield curve, beginning in second quarter 2004, as part of our asset/liability management
strategy, we sold the lowest-yielding ARMs on our balance sheet, replacing some of these loans with higher-yielding ARMs. At the end of 2005, new ARMs being held for investment within real estate 1-4 family mortgage loans had yields more than 1% higher than the average yield on the ARMs sold since second quarter 2004.
     Noninterest income increased 12% to $14.4 billion in 2005 from $12.9 billion in 2004. Double-digit growth in noninterest income was driven by growth across our businesses, with particular strength in trust, investment and IRA fees, card fees, loan fees, mortgage banking income and gains on equity investments.
     Revenue, the sum of net interest income and noninterest income, increased 10% to a record $32.9 billion in 2005 from $30.1 billion in 2004 despite balance sheet repositioning actions, including losses from the sales of low-yielding ARMs and debt securities. For the year, Wells Fargo Home Mortgage (Home Mortgage) revenue increased $455 million, or 10%, from $4.4 billion in 2004 to $4.9 billion in 2005. Operating leverage improved during 2005 with revenue growing 10% and noninterest expense up only 8%.
     Noninterest expense was $19.0 billion in 2005, up 8% from $17.6 billion in 2004, primarily due to increased mortgage production and continued investments in new stores and additional sales-related team members. Noninterest expense also included a $117 million expense to adjust the estimated lives for certain depreciable assets, primarily building improvements, $62 million of airline lease write-downs, $56 million of integration expense and $25 million for the adoption of FIN 47. We began expensing stock options, as required, on January 1, 2006. Taking into account our February 2006 option grant, we anticipate that total stock option expense will reduce earnings by approximately $.06 per share for 2006.
     During 2005, net charge-offs were $2.28 billion, or .77% of average total loans, compared with $1.67 billion, or .62%, during 2004. Credit losses for 2005 included $171 million of incremental fourth quarter bankruptcy losses and increased losses of $163 million for first quarter 2005 initial implementation of conforming to more stringent FFIEC charge-off timing rules at Wells Fargo Financial. The provision for credit losses was $2.38 billion in 2005, up $666 million from $1.72 billion in 2004. The 2005 provision for credit losses also included $100 million for estimated credit losses related to Hurricane Katrina. The allowance for credit losses, which consists of the allowance for loan losses and the reserve for unfunded credit commitments, was $4.06 billion, or 1.31% of total loans, at December 31, 2005, compared with $3.95 billion, or 1.37%, at December 31, 2004.
     At December 31, 2005, total nonaccrual loans were $1.34 billion, or .43% of total loans, down from $1.36 billion, or .47%, at December 31, 2004. Foreclosed assets were $191 million at December 31, 2005, compared with $212 million at December 31, 2004.


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     The ratio of stockholders’ equity to total assets was 8.44% at December 31, 2005, compared with 8.85% at December 31, 2004. Our total risk-based capital (RBC) ratio at December 31, 2005, was 11.64% and our Tier 1 RBC ratio was 8.26%, exceeding the minimum regulatory guidelines of 8% and 4%, respectively, for bank holding companies. Our RBC ratios at December 31, 2004, were 12.07% and 8.41%, respectively. Our Tier 1 leverage ratios were 6.99% and 7.08% at December 31, 2005 and 2004, respectively, exceeding the minimum regulatory guideline of 3% for bank holding companies.
Table 1: Ratios and Per Common Share Data
                         
   
    Year ended December 31 ,
    2005     2004     2003  

PROFITABILITY RATIOS

                       
Net income to average total assets (ROA)
    1.72 %     1.71 %     1.64 %
Net income applicable to common stock to average common stockholders’ equity (ROE)
    19.57       19.56       19.36  
Net income to average stockholders’ equity
    19.59       19.57       19.34  

EFFICIENCY RATIO(1)

    57.7       58.5       60.6  

CAPITAL RATIOS

                       
At year end:
                       
Stockholders’ equity to assets
    8.44       8.85       8.89  
Risk-based capital(2)
                       
Tier 1 capital
    8.26       8.41       8.42  
Total capital
    11.64       12.07       12.21  
Tier 1 leverage(2)
    6.99       7.08       6.93  
Average balances:
                       
Stockholders’ equity to assets
    8.78       8.73       8.49  

PER COMMON SHARE DATA

                       
Dividend payout(3)
    44.0       44.8       40.7  
Book value
  $ 24.25     $ 22.36     $ 20.31  
Market price(4)
                       
High
  $ 64.70     $ 64.04     $ 59.18  
Low
    57.62       54.32       43.27  
Year end
    62.83       62.15       58.89  
   
(1)   The efficiency ratio is noninterest expense divided by total revenue (net interest income and noninterest income).
 
(2)   See Note 25 (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.
Current Accounting Developments
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004),
Share-Based Payment (FAS 123R), which replaced FAS 123, Accounting for Stock-Based Compensation, and superceded Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. We adopted FAS 123R on January 1, 2006, using the “modified prospective” transition method. The scope of FAS 123R includes a wide range of stock-based compensation arrangements including stock options, restricted stock plans, performance-based awards, stock appreciation rights, and employee stock purchase plans. FAS 123R requires that we measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the grant date. That cost must be recognized in the income statement over the vesting period of the award. Under the “modified prospective” transition method, awards that are granted, modified or settled beginning at the date of adoption will be measured and accounted for in accordance with FAS 123R. In addition, expense must be recognized in the income statement for unvested awards that were granted prior to the date of adoption. The expense will be based on the fair value determined at the grant date. Taking into account our February 2006 option grant, we anticipate that total stock option expense will reduce 2006 earnings by approximately $.06 per share.
     On March 30, 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations – An Interpretation of FASB Statement No. 143 (FIN 47). FIN 47 was issued to address diverse accounting practices that developed with respect to the timing of liability recognition for legal obligations associated with the retirement of tangible long-lived assets, such as building and leasehold improvements, when the timing and/or method of settlement of the obligations are conditional on a future event. FIN 47 requires companies to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. We adopted FIN 47 in 2005 and recorded a $25 million charge to noninterest expense.
     We continuously monitor emerging accounting issues, including proposed standards issued by the FASB, for any impact on our financial statements. We are currently aware of a proposed FASB Staff Position (FSP) related 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 leveraged lease transactions have been challenged by the Internal Revenue Service (IRS). While we have not made investments in a broad class of transactions that the IRS commonly refers to as “Lease-In, Lease-Out” (LILO) transactions, we have previously invested in certain leveraged lease transactions that the IRS labels as “Sale-In, Lease-Out” (SILO) transactions. We have paid the IRS the income tax associated with our SILO transactions. However, we are continuing to vigorously defend our initial filing position as to the timing of the tax benefits associated with these transactions. If the draft FSP had been effective at December 31, 2005, we would have been required to record a pre-tax charge of approximately $125 million as a cumulative effect of change in accounting principle. However, subsequent deliberations by the FASB could significantly change the draft FSP, which, in turn, could affect our estimate and the method of adoption. We will continue to monitor the FASB’s deliberations regarding this proposal.


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     On August 11, 2005, the FASB issued for public comment an Exposure Draft that would amend FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This Exposure Draft, Accounting for Servicing of Financial Assets – An Amendment of FASB Statement No. 140, would require that all separately recognized servicing rights be initially measured at fair value, if practicable. For each class of separately recognized servicing assets and liabilities, this proposed standard would permit an entity to choose from two subsequent measurement methods. Specifically, an entity could amortize servicing assets and
liabilities in proportion to and over the period of estimated net servicing income or servicing loss (effectively the existing requirement in FAS 140) or an entity could report servicing assets or liabilities at fair value at each reporting date with any changes reported currently in operations. We expect this guidance to be finalized and issued in early 2006. Based on the guidance in the current Exposure Draft, it is likely that we will adopt the fair value alternative upon issuance of the standard. We will continue to monitor this emerging guidance in order to finalize our decision and determine the impact on our financial statements.


Table 2: Six-Year Summary of Selected Financial Data
                                                                 
   
(in millions, except                                                   % Change     Five-year  
per share amounts)                                                   2005/     compound  
    2005     2004     2003     2002     2001     2000     2004     growth rate  

INCOME STATEMENT

                                                               
Net interest income
  $ 18,504     $ 17,150     $ 16,007     $ 14,482     $ 11,976     $ 10,339       8 %     12 %
Noninterest income
    14,445       12,909       12,382       10,767       9,005       10,360       12       7  
 
                                                   
Revenue
    32,949       30,059       28,389       25,249       20,981       20,699       10       10  
Provision for credit losses
    2,383       1,717       1,722       1,684       1,727       1,284       39       13  
Noninterest expense
    19,018       17,573       17,190       14,711       13,794       12,889       8       8  

Before effect of change in
accounting principle
(1)

Net income

  $ 7,671     $ 7,014     $ 6,202     $ 5,710     $ 3,411     $ 4,012       9       14  
Earnings per common share
    4.55       4.15       3.69       3.35       1.99       2.35       10       14  
Diluted earnings per common share
    4.50       4.09       3.65       3.32       1.97       2.32       10       14  

After effect of change in accounting principle

Net income

  $ 7,671     $ 7,014     $ 6,202     $ 5,434     $ 3,411     $ 4,012       9       14  
Earnings per common share
    4.55       4.15       3.69       3.19       1.99       2.35       10       14  
Diluted earnings per common share
    4.50       4.09       3.65       3.16       1.97       2.32       10       14  
Dividends declared per common share
    2.00       1.86       1.50       1.10       1.00       .90       8       17  

BALANCE SHEET
(at year end)

                                                               
Securities available for sale
  $ 41,834     $ 33,717     $ 32,953     $ 27,947     $ 40,308     $ 38,655       24       2  
Loans
    310,837       287,586       253,073       192,478       167,096       155,451       8       15  
Allowance for loan losses
    3,871       3,762       3,891       3,819       3,717       3,681       3       1  
Goodwill
    10,787       10,681       10,371       9,753       9,527       9,303       1       3  
Assets
    481,741       427,849       387,798       349,197       307,506       272,382       13       12  
Core deposits (2)
    253,341       229,703       211,271       198,234       182,295       156,710       10       10  
Long-term debt
    79,668       73,580       63,642       47,320       36,095       32,046       8       20  
Guaranteed preferred beneficial interests in Company’s subordinated debentures(3)
                      2,885       2,435       935              
Stockholders’ equity
    40,660       37,866       34,469       30,319       27,175       26,461       7       9  
   
(1)   Change in accounting principle is for a transitional goodwill impairment charge recorded in 2002 upon adoption of FAS 142, Goodwill and Other Intangible Assets.
 
(2)   Core deposits consist of noninterest-bearing deposits, interest-bearing checking, savings certificates and market rate and other savings.
 
(3)   At December 31, 2003, upon adoption of FIN 46 (revised December 2003), Consolidation of Variable Interest Entities (FIN 46R), these balances were reflected in long-term debt. See Note 12 (Long-Term Debt) to Financial Statements for more information.

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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. Three of these policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. These policies govern the allowance for credit losses, the valuation of mortgage servicing rights and pension accounting. Management has reviewed and approved these critical accounting policies and has discussed these policies with the Audit and Examination Committee.
Allowance for Credit Losses
The allowance for credit losses, which 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 allocate a portion of the allowance to specific loan categories (the allocated allowance), the entire allowance (both allocated and unallocated) is used to absorb credit losses inherent in the total loan portfolio.
     Approximately two-thirds of the allocated allowance is determined at a pooled level for consumer loans and some segments of commercial small business loans. We use forecasting models to measure the losses inherent in these portfolios. We frequently validate and update these models to capture recent behavioral characteristics of the portfolios, as well as changes in our loss mitigation or marketing strategies.
     The remaining allocated allowance is for commercial loans, commercial real estate loans and lease financing. We initially estimate this portion of the allocated allowance by applying historical loss factors statistically derived from tracking loss content 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. Also, we individually review nonperforming loans over $3 million for impairment based on cash flows or collateral. We include impairment on these nonperforming loans in the allocated allowance unless it has already been recognized as a loss.
     The allocated allowance is supplemented by the unallocated allowance to adjust for imprecision and to incorporate the range of probable outcomes inherent in estimates used for the allocated allowance. The unallocated allowance is the result of our judgment of risks inherent in the portfolio, economic uncertainties, historical loss experience and other subjective factors, including industry trends, not reflected in the allocated allowance.
     The ratios of the allocated allowance and the unallocated allowance to the total allowance may change from period to period. The total allowance reflects management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date.
     The allowance for credit losses, and the resulting provision, is based on judgments and assumptions, including:
    general economic conditions;
    loan portfolio composition;
    loan loss experience;
    management’s evaluation of the credit risk relating to pools of loans and individual borrowers;
    sensitivity analysis and expected loss models; and
    observations from our internal auditors, internal loan review staff or banking regulators.
     To estimate the possible range of allowance required at December 31, 2005, and the related change in provision expense, we assumed the following scenarios of a reasonably possible deterioration or improvement in loan credit quality.


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Assumptions for deterioration in loan credit quality were:
    for retail loans, a 12 basis point increase in estimated loss rates from actual 2005 loss levels, moving closer to longer term average loss rates; and
    for wholesale loans, a 30 basis point increase in estimated loss rates, moving closer to historical averages.
Assumptions for improvement in loan credit quality were:
    for retail loans, an 8 basis point decrease in estimated loss rates from actual 2005 loss levels, adjusting for incremental consumer bankruptcy losses; and
    for wholesale loans, no change from the essentially zero 2005 net loss performance.
     Under the assumptions for deterioration in loan credit quality, another $550 million in expected losses could occur and under the assumptions for improvement, a $170 million reduction in expected losses could occur.
     Changes in the estimate of the allowance for credit losses can materially affect net income. The example above is only one of a number of reasonably possible scenarios. Determining the allowance for credit losses requires us to make forecasts that are highly uncertain and require a high degree of judgment.
Valuation of Mortgage Servicing Rights
We recognize as assets the rights to service mortgage loans for others, or mortgage servicing rights (MSRs), whether we purchase the servicing rights, or keep them after the sale or securitization of loans we originate. Purchased MSRs are capitalized at cost. Originated MSRs are recorded based on the relative fair value of the retained servicing right and the mortgage loan on the date the mortgage loan is sold. Both purchased and originated MSRs are carried at the lower of (1) the capitalized amount, net of accumulated amortization and hedge accounting adjustments, or (2) fair value. If MSRs are designated as a hedged item in a fair value hedge, the MSRs’ carrying value is adjusted for changes in fair value resulting from the application of hedge accounting. The carrying value of these MSRs is subject to a fair value test under FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.
     MSRs are amortized in proportion to and over the period of estimated net servicing income. We analyze the amortization of MSRs monthly and adjust amortization to reflect changes in prepayment speeds, discount rates and other factors that affect estimated net servicing income.
     We determine the fair value of MSRs using a valuation model that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, ancillary income and late fees. The valuation of MSRs is discussed further in this section and in
Note 1 (Summary of Significant Accounting Policies), Note 20 (Securitizations and Variable Interest Entities) and Note 21 (Mortgage Banking Activities) to Financial Statements.
     At the end of each quarter, we evaluate MSRs for possible impairment based on the difference between the carrying amount and current estimated fair value. To evaluate and measure impairment, we stratify the portfolio based on certain risk characteristics, including loan type and note rate. If temporary impairment exists, we establish a valuation allowance through a charge to income for those risk stratifications with an excess of amortized cost over the current fair value. If we later determine that all or part of the temporary impairment no longer exists for a particular risk stratification, we may reduce the valuation allowance through an increase to income.
     Under our policy, we also evaluate other-than-temporary impairment of MSRs by considering both historical and projected trends in interest rates, pay-off activity and whether the impairment could be recovered through interest rate increases. We recognize a direct write-down if we determine that the recoverability of a recorded valuation allowance is remote. A direct write-down permanently reduces the carrying value of the MSRs, while a valuation allowance (temporary impairment) can be reversed.
     To reduce the sensitivity of earnings to interest rate and market value fluctuations, we hedge the change in value of MSRs primarily with derivative contracts. Reductions or increases in the value of the MSRs are generally offset by gains or losses in the value of the derivatives. We immediately recognize a gain or loss for the amount of change in the value of MSRs that is not offset by the change in value of the hedge instrument (i.e., hedge ineffectiveness). 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 decrease and fees from origination volume increase). Conversely, as interest rates increase, the value of the MSRs increases, while fees from origination volume tend to decline.
     Servicing income—net of amortization, provision for impairment and net derivative gains and losses—is recorded in mortgage banking noninterest income.
     We use a dynamic and sophisticated model to estimate the value of our MSRs. Mortgage loan prepayment speed—a key assumption in the model—is the annual rate at which borrowers are forecasted to repay their mortgage loan principal. The discount rate—another key assumption in the model—is the required rate of return 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 and annual valuations as market conditions and interest rates change. Senior management reviews all assumptions quarterly.


39


 

     Our key economic assumptions and the sensitivity of the current fair value of MSRs to an immediate adverse change in those assumptions are shown in Note 20 (Securitizations and Variable Interest Entities) to Financial Statements.
     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.
Pension Accounting
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) the actual return earned on plan assets, (2) historical rates of return on the various asset classes in the plan portfolio, (3) projections of returns on various asset classes, and (4) current/prospective capital market conditions and economic forecasts. Including 2005, we have used an expected rate of return of 9% on plan assets for the past nine years. In light of the market conditions in recent years, including a marked increase in volatility, we
reduced the expected long-term rate of return on plan assets to 8.75% for 2006. Differences in each year, if any, between expected and actual returns are included in our unrecognized net actuarial gain or loss amount. We generally amortize any unrecognized net actuarial gain or loss in excess of a 5% corridor (as defined in FAS 87, Employers’ Accounting for Pensions) in net periodic pension expense calculations over the next five years. Our average remaining service period is approximately 11 years. See Note 15 (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 $50 million.
DISCOUNT RATE
We use the discount rate to determine the present value of our future benefit obligations. It reflects the rates available on long-term high-quality fixed-income debt instruments, and is reset annually on the measurement date. As the basis for determining our discount rate, we review the Moody’s Aa Corporate Bond Index, on an annualized basis, and the rate of a hypothetical portfolio using the Hewitt Yield Curve (HYC) methodology, which was developed by our independent actuary. The instruments used in both the Moody’s Aa Corporate Bond Index and the HYC consist of high quality bonds for which the timing and amount of cash outflows approximates the estimated payouts of our Cash Balance Plan. We lowered our discount rate to 5.75% in 2005 from 6% in 2004 and 6.5% in 2003, reflecting the decline in market interest rates during these periods.
     If we were to assume a 1% increase in the discount rate, and keep the expected long-term rate of return and other actuarial assumptions constant, pension expense would decrease by approximately $59 million. If we were to assume a 1% decrease in the discount rate, and keep other assumptions constant, pension expense would increase by approximately $104 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.


40


 

Earnings Performance
 

Net Interest Income
Net interest income is the interest earned on debt securities, loans (including yield-related loan fees) and other interest-earning assets minus the interest paid for deposits and long-term and short-term debt. The net interest margin is the average yield on earning assets minus the average interest rate paid for deposits and our other sources of funding. Net interest income and the net interest margin are presented on a taxable-equivalent basis to consistently reflect income from taxable and tax-exempt loans and securities based on a 35% marginal tax rate.
     Net interest income on a taxable-equivalent basis was $18.6 billion in 2005, compared with $17.3 billion in 2004, an increase of 8%, reflecting solid loan growth (other than ARMs) and a relatively flat net interest margin.
     Our net interest margin was 4.86% for 2005 and 4.89% for 2004. During a year in which the Federal Reserve raised rates eight times and the yield curve flattened, our net interest margin remained essentially flat compared with a year ago. Given the prospect of higher short-term interest rates and a flatter yield curve, beginning in second quarter 2004, as part of our asset/liability management strategy, we sold the lowest-yielding ARMs on our balance sheet, replacing some of these loans with higher-yielding ARMs. Over the last seven quarters, we sold $65 billion in ARMs at an average yield of 4.28%. As a result, the average yield on our 1-4 family first mortgage portfolio—which includes ARMs—increased from 5.19% on an average balance of $89.4 billion in second quarter 2004 to 6.75% on an average balance of $76.2 billion in fourth quarter 2005. At year-end 2005, yields on new ARMs being held for investment within real estate 1-4 family mortgage loans were more than 1% higher
than the average yield on the ARMs sold since second quarter 2004. Our net interest margin has performed better than our peers’ due to our balance sheet repositioning actions and our ability to grow transaction and savings deposits while maintaining our deposit pricing discipline.
     Average earning assets increased $29.2 billion to $383.5 billion in 2005 from $354.3 billion in 2004. Loans averaged $296.1 billion in 2005, compared with $269.6 billion in 2004. Average mortgages held for sale were $39.0 billion in 2005 and $32.3 billion in 2004. Debt securities available for sale averaged $33.1 billion in both 2005 and 2004.
     Average core deposits are an important contributor to growth in net interest income and the net interest margin. This low-cost source of funding rose 9% from 2004. Average core deposits were $242.8 billion and $223.4 billion and funded 54.5% and 54.4% of average total assets in 2005 and 2004, respectively. Total average retail core deposits, which exclude Wholesale Banking core deposits and retail mortgage escrow deposits, for 2005 grew $18.2 billion, or 10%, from a year ago. Average mortgage escrow deposits were $16.7 billion in 2005 and $14.1 billion in 2004. Savings certificates of deposits increased on average from $18.9 billion in 2004 to $22.6 billion in 2005 and noninterest-bearing checking accounts and other core deposit categories increased on average from $204.5 billion in 2004 to $220.1 billion in 2005. Total average interest-bearing deposits increased to $194.6 billion in 2005 from $182.6 billion a year ago. Total average noninterest-bearing deposits increased to $87.2 billion in 2005 from $79.3 billion a year ago.
     Table 3 presents the individual components of net interest income and the net interest margin.


41


 

Table 3: Average Balances, Yields and Rates Paid (Taxable-Equivalent Basis) (1)(2)
                                                 
   
(in millions)   2005     2004  
    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
  $ 5,448       3.01 %   $ 164     $ 4,254       1.49 %   $ 64  
Trading assets
    5,411       3.52       190       5,286       2.75       145  
Debt securities available for sale (3):
                                               
Securities of U.S. Treasury and federal agencies
    997       3.81       38       1,161       4.05       46  
Securities of U.S. states and political subdivisions
    3,395       8.27       266       3,501       8.00       267  
Mortgage-backed securities:
                                               
Federal agencies
    19,768       6.02       1,162       21,404       6.03       1,248  
Private collateralized mortgage obligations
    5,128       5.60       283       3,604       5.16       180  
 
                                       
Total mortgage-backed securities
    24,896       5.94       1,445       25,008       5.91       1,428  
Other debt securities (4)
    3,846       7.10       266       3,395       7.72       236  
 
                                       
Total debt securities available for sale (4)
    33,134       6.24       2,015       33,065       6.24       1,977  
Mortgages held for sale (3)
    38,986       5.67       2,213       32,263       5.38       1,737  
Loans held for sale (3)
    2,857       5.10       146       8,201       3.56       292  
Loans:
                                               
Commercial and commercial real estate:
                                               
Commercial
    58,434       6.76       3,951       49,365       5.77       2,848  
Other real estate mortgage
    29,098       6.31       1,836       28,708       5.35       1,535  
Real estate construction
    11,086       6.67       740       8,724       5.30       463  
Lease financing
    5,226       5.91       309       5,068       6.23       316  
 
                                       
Total commercial and commercial real estate
    103,844       6.58       6,836       91,865       5.62       5,162  
Consumer:
                                               
Real estate 1-4 family first mortgage
    78,170       6.42       5,016       87,700       5.44       4,772  
Real estate 1-4 family junior lien mortgage
    55,616       6.61       3,679       44,415       5.18       2,300  
Credit card
    10,663       12.33       1,315       8,878       11.80       1,048  
Other revolving credit and installment
    43,102       8.80       3,794       33,528       9.01       3,022  
 
                                       
Total consumer
    187,551       7.36       13,804       174,521       6.38       11,142  
Foreign
    4,711       13.49       636       3,184       15.30       487  
 
                                       
Total loans (5)
    296,106       7.19       21,276       269,570       6.23       16,791  
Other
    1,581       4.34       68       1,709       3.81       65  
 
                                       
Total earning assets
  $ 383,523       6.81       26,072     $ 354,348       5.97       21,071  
 
                                       

FUNDING SOURCES

                                               

Deposits:

                                               
Interest-bearing checking
  $ 3,607       1.43       51     $ 3,059       .44       13  
Market rate and other savings
    129,291       1.45       1,874       122,129       .69       838  
Savings certificates
    22,638       2.90       656       18,850       2.26       425  
Other time deposits
    27,676       3.29       910       29,750       1.43       427  
Deposits in foreign offices
    11,432       3.12       357       8,843       1.40       124  
 
                                       
Total interest-bearing deposits
    194,644       1.98       3,848       182,631       1.00       1,827  
Short-term borrowings
    24,074       3.09       744       26,130       1.35       353  
Long-term debt
    79,137       3.62       2,866       67,898       2.41       1,637  
Guaranteed preferred beneficial interests in Company’s subordinated debentures (6)
                                   
 
                                       
Total interest-bearing liabilities
    297,855       2.50       7,458       276,659       1.38       3,817  
Portion of noninterest-bearing funding sources
    85,668                   77,689              
 
                                       
Total funding sources
  $ 383,523       1.95       7,458     $ 354,348       1.08       3,817  
 
                                       
Net interest margin and net interest income on a taxable-
equivalent basis 
(7)
            4.86 %   $ 18,614               4.89 %   $ 17,254  
 
                                       
NONINTEREST-EARNING ASSETS
Cash and due from banks
  $ 13,173                     $ 13,055                  
Goodwill
    10,705                       10,418                  
Other
    38,389                       32,758                  
 
                                           
Total noninterest-earning assets
  $ 62,267                     $ 56,231                  
 
                                           
NONINTEREST-BEARING FUNDING SOURCES
Deposits
  $ 87,218                     $ 79,321                  
Other liabilities
    21,559                       18,764                  
Stockholders’ equity
    39,158                       35,835                  
Noninterest-bearing funding sources used to fund earning assets
    (85,668 )                     (77,689 )                
 
                                           
Net noninterest-bearing funding sources
  $ 62,267                     $ 56,231                  
 
                                           
TOTAL ASSETS
  $ 445,790                     $ 410,579                  
 
                                           
 
(1)   Our average prime rate was 6.19%, 4.34%, 4.12%, 4.68% and 6.91% for 2005, 2004, 2003, 2002 and 2001, respectively. The average three-month London Interbank Offered Rate (LIBOR) was 3.56%, 1.62%, 1.22%, 1.80% and 3.78% 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.

42


 

  
                                                                       
 
    2003     2002     2001  
  Average   Yields/   Interest   Average   Yields/   Interest   Average   Yields/   Interest  
  balance   rates   income/   balance   rates   income/   balance   rates   income/  
                expense                   expense                   expense  
 

                                                                   
 
 
  $
4,174
              1.16 %                $ 49          $ 2,961             1.73 %      $ 51          $ 2,741             3.72 %           $ 102    
 
   
6,110
      2.56       156       4,747       3.58       169       2,580       4.44       115  
 

                                                                   
 
   
1,286
      4.74       58       1,770       5.57       95       2,158       6.55       137  
 
   
2,424
      8.62       196       2,106       8.33       167       2,026       7.98       154  
 

                                                                   
   
18,283
      7.37       1,276       26,718       7.23       1,856       27,433       7.19       1,917  
 
   
2,001
      6.24       120       2,341       7.18       163       1,766       8.55       148  
   
 
                                                       
   
20,284
      7.26       1,396       29,059       7.22       2,019       29,199       7.27       2,065  
   
3,302
      7.75       240       3,029       7.74       232       3,343       7.80       254  
   
 
                                                       
 
   
27,296
      7.32       1,890       35,964       7.25       2,513       36,726       7.32       2,610  
   
58,672
      5.34       3,136       39,858       6.13       2,450       23,677       6.72       1,595  
   
7,142
      3.51       251       5,380       4.69       252       4,820       6.58       317  
 

                                                                   
 
 
   
47,279
      6.08       2,876       46,520       6.80       3,164       48,648       8.01       3,896  
   
25,846
      5.44       1,405       25,413       6.17       1,568       24,194       7.99       1,934  
   
7,954
      5.11       406       7,925       5.69       451       8,073       8.10       654  
   
4,453
      6.22       277       4,079       6.32       258       4,024       6.90       278  
   
 
                                                       
 
   
85,532
      5.80       4,964       83,937       6.48       5,441       84,939       7.96       6,762  
 

                                                                   
 
   
56,252
      5.54       3,115       32,669       6.69       2,185       23,359       7.54       1,761  
 
   
31,670
      5.80       1,836       25,220       7.07       1,783       17,587       9.20       1,619  
   
7,640
      12.06       922       6,810       12.27       836       6,270       13.36       838  
 
   
29,838
      9.09       2,713       24,072       10.28       2,475       23,459       11.40       2,674  
   
 
                                                       
   
125,400
      6.85       8,586       88,771       8.20       7,279       70,675       9.75       6,892  
   
2,200
      18.00       396       1,774       18.90       335       1,603       20.82       333  
   
 
                                                       
   
213,132
      6.54       13,946       174,482       7.48       13,055       157,217       8.90       13,987  
   
1,626
      4.57       74       1,436       4.87       72       1,262       5.50       69  
   
 
                                                       
  $
318,152
      6.16       19,502     $ 264,828       7.04       18,562     $ 229,023       8.24       18,795  
   
 
                                                       
 
 

                                                                   
 
 
  $
2,571
      .27       7     $ 2,494       .55       14     $ 2,178       1.59       35  
   
106,733
      .66       705       93,787       .95       893       80,585       2.08       1,675  
   
20,927
      2.53       529       24,278       3.21       780       29,850       5.13       1,530  
   
25,388
      1.20       305       8,191       1.86       153       1,332       5.04       67  
   
6,060
      1.11       67       5,011       1.58       79       6,209       3.96       246  
   
 
                                                       
   
161,679
      1.00       1,613       133,761       1.43       1,919       120,154       2.96       3,553  
   
29,898
      1.08       322       33,278       1.61       536       33,885       3.76       1,273  
   
53,823
      2.52       1,355       42,158       3.33       1,404       34,501       5.29       1,826  
 
 
   
3,306
      3.66       121       2,780       4.23       118       1,394       6.40       89  
   
 
                                                       
   
248,706
      1.37       3,411       211,977       1.88       3,977       189,934       3.55       6,741  
 
   
69,446
                  52,851                   39,089              
   
 
                                                       
  $
318,152
      1.08       3,411     $ 264,828       1.51       3,977     $ 229,023       2.95       6,741  
   
 
                                                       
 
 
 
 
        5.08 %   $ 16,091               5.53 %   $ 14,585               5.29 %   $ 12,054  
 
 
                                                     
 

                                                                   
  $
13,433
                    $ 13,820                     $ 14,608                  
   
9,905
                      9,737                       9,514                  
   
36,123
                      33,340                       32,222                  
   
 
                                                             
 
  $
$59,461
                    $ 56,897                     $ 56,344                  
   
 
                                                             
 

                                                                   
  $
76,815
                    $ 63,574                     $ 55,333                  
   
20,030
                      17,054                       13,214                  
   
32,062
                      29,120                       26,886                  
   

(69,446

)                     (52,851 )                     (39,089 )                
   
 
                                                             
 
  $
59,461
                    $ 56,897                     $ 56,344                  
   
 
                                                             
  $
377,613
                    $ 321,725                     $ 285,367                  
   
 
                                                             
 
(5)   Nonaccrual loans and related income are included in their respective loan categories.
 
(6)   At December 31, 2003, upon adoption of FIN 46 (revised December 2003), Consolidation of Variable Interest Entities (FIN 46R), these balances were reflected in long-term debt. See Note 12 (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.

43


 

Noninterest Income
Table 4: Noninterest Income
                                         
   
(in millions)   Year ended December 31,     % Change  
    2005     2004     2003     2005/     2004/  
                            2004     2003  

Service charges on deposit accounts

  $ 2,512     $ 2,417     $ 2,297       4 %     5 %
Trust and investment fees:
                                       
Trust, investment and IRA fees
    1,855       1,509       1,345       23       12  
Commissions and all other fees
    581       607       592       (4 )     3  
 
                                 
Total trust and investment fees
    2,436       2,116       1,937       15       9  

Card fees

    1,458       1,230       1,079       19       14  

Other fees:

                                       
Cash network fees
    180       180       179             1  
Charges and fees on loans
    1,022       921       756       11       22  
All other
    727       678       625       7       8  
 
                                 
Total other fees
    1,929       1,779       1,560       8       14  

Mortgage banking:

                                       
Servicing income, net of amortization and provision for impairment
    987       1,037       (954 )     (5 )      
Net gains on mortgage loan origination/sales activities
    1,085       539       3,019       101       (82 )
All other
    350       284       447       23       (36 )
 
                                 
Total mortgage banking
    2,422       1,860       2,512       30       (26 )

Operating leases

    812       836       937       (3 )     (11 )
Insurance
    1,215       1,193       1,071       2       11  
Trading assets
    571       523       502       9       4  
Net gains (losses) on debt securities available for sale
    (120 )     (15 )     4       700        
Net gains from equity investments
    511       394       55       30       616  
Net gains on sales of loans
    5       11       28       (55 )     (61 )
Net gains (losses) on dispositions of operations
    14       (15 )     29              
All other
    680       580       371       17       56  
 
                                 
Total
  $ 14,445     $ 12,909     $ 12,382       12       4  
 
                                 
   
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, 2005, these assets totaled $783 billion, up 11% from $705 billion at December 31, 2004. At December 31, 2004, we acquired $24 billion in mutual fund assets and $5 billion in institutional investment accounts from Strong Financial Corporation (Strong Financial). When the Wells Fargo Funds® and certain Strong Financial funds merged in April 2005, we renamed our mutual fund family the Wells Fargo Advantage FundsSM.
Generally, trust, investment and IRA fees are based on the market value of the assets that are managed, administered, or both. The increase in these fees was due to additional revenue from the December 31, 2004, acquisition of assets from the Strong Financial transaction and our successful efforts to grow our investment businesses.
     Also, we receive commissions and other fees for providing services for retail and discount brokerage customers. At December 31, 2005 and 2004, brokerage balances were $97 billion and $86 billion, respectively. Generally, these fees are based on the number of transactions executed at the customer’s direction.
     Card fees increased 19% to $1,458 million in 2005 from $1,230 million in 2004, predominantly due to increases in credit card accounts and credit and debit card transaction volume.
     Mortgage banking noninterest income increased to $2,422 million in 2005 from $1,860 million in 2004, due to an increase in net gains on mortgage loan origination/sales activities partly offset by the decline in net servicing income.
     Net gains on mortgage loan origination/sales activities were $1,085 million in 2005, up from $539 million in 2004, primarily due to higher origination volume. Originations were $366 billion in 2005 and $298 billion in 2004. The 1-4 family first mortgage unclosed pipeline was $50 billion at both year-end 2005 and 2004.
     Net servicing income was $987 million in 2005 compared with $1,037 million in 2004. Servicing income includes net derivative gains and losses and is net of amortization and impairment of MSRs, which are all influenced by both the level and direction of mortgage interest rates. The Company’s portfolio of loans serviced for others was $871 billion at December 31, 2005, up 27% from $688 billion at year-end 2004. Given a larger servicing portfolio year over year, the increase in servicing income was partly offset by higher amortization of MSRs. Servicing fees increased to $2,457 million in 2005 from $2,101 million in 2004 and amortization of MSRs increased to $1,991 million in 2005 from $1,826 million in 2004. Servicing income in 2005 also included a higher MSRs valuation allowance release of $378 million in 2005 compared with $208 million in 2004, due to higher long-term interest rates in certain quarters of 2005. The increase in fee revenue and the higher MSRs valuation allowance release were mostly offset by the decrease in net derivative gains to $143 million in 2005 from $554 million in 2004.
     Net losses on debt securities were $120 million for 2005, compared with $15 million for 2004. Net gains from equity investments were $511 million in 2005, compared with $394 million in 2004, primarily reflecting the continued strong performance of our venture capital business.
     We routinely review our investment portfolios and recognize impairment write-downs based primarily on issuer-specific factors and results, and our intent to hold such securities. We also consider general economic and market conditions, including industries in which venture capital investments are made, and adverse changes affecting the availability of venture capital. We determine impairment based on all of the information available at the time of the assessment, but new information or economic developments in the future could result in recognition of additional impairment.


44


 

Noninterest Expense
Table 5: Noninterest Expense
                                         
   
(in millions)   Year ended December 31,     % Change  
    2005     2004     2003     2005/     2004/  
                            2004     2003  

Salaries

  $ 6,215     $ 5,393     $ 4,832       15 %     12 %
Incentive compensation
    2,366       1,807       2,054       31       (12 )
Employee benefits
    1,874       1,724       1,560       9       11  
Equipment
    1,267       1,236       1,246       3       (1 )
Net occupancy
    1,412       1,208       1,177       17       3  
Operating leases
    635       633       702             (10 )
Outside professional services
    835       669       509       25       31  
Contract services
    596       626       866       (5 )     (28 )
Travel and entertainment
    481       442       389       9       14  
Outside data processing
    449       418       404       7       3  
Advertising and promotion
    443       459       392       (3 )     17  
Postage
    281       269       336       4       (20 )
Telecommunications
    278       296       343       (6 )     (14 )
Insurance
    224       247       197       (9 )     25  
Stationery and supplies
    205       240       241       (15 )      
Operating losses
    194       192       193       1       (1 )
Security
    167       161       163       4       (1 )
Core deposit intangibles
    123       134       142       (8 )     (6 )
Charitable donations
    61       248       237       (75 )     5  
Net losses from debt
extinguishment
    11       174             (94 )      
All other
    901       997       1,207       (10 )     (17 )
 
                                 
Total
  $ 19,018     $ 17,573     $ 17,190       8       2  
 
                                 
   
Noninterest expense in 2005 increased 8% to $19.0 billion from $17.6 billion in 2004, primarily due to increased mortgage production and continued investments in new stores and additional sales-related team members. Noninterest expense in 2005 included a $117 million expense to adjust the estimated lives for certain depreciable assets, primarily building improvements, $62 million of airline lease write-downs, $56 million of integration expense and $25 million for the adoption of FIN 47, which relates to recognition of obligations associated with the retirement of long-lived assets, such as building and leasehold improvements. Home Mortgage expenses increased $426 million from 2004, reflecting higher production costs from an increase in loan origination volume. For 2004, employee benefits included a $44 million special 401(k) contribution and charitable donations included a $217 million contribution to the Wells Fargo Foundation.
     See “Current Accounting Developments” for information on accounting for share-based awards, such as stock option grants. On January 1, 2006, we adopted FAS 123R, which requires that we include the cost of such grants in our income statement over the vesting period of the award.
Income Tax Expense
Our effective income tax rate for 2005 decreased to 33.57% from 34.87% for 2004, due primarily to higher tax-exempt income and income tax credits, and the tax benefit associated with our donation of appreciated securities.
Operating Segment Results
Our lines of business for management reporting are 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 19 (Operating Segments) to Financial Statements.
COMMUNITY BANKING’S net income increased 13% to $5.5 billion in 2005 from $4.9 billion in 2004. Total revenue for 2005 increased 9%, driven by loan and deposit growth and higher mortgage origination volumes. The provision for credit losses for 2005 increased $108 million, or 14%, reflecting incremental consumer bankruptcy filings before the mid-October legislative reform. Noninterest expense for 2005 increased $982 million, or 8%, driven by mortgage production, growth in other businesses, and investments in new stores, sales staff and technology. Average loans were $187.0 billion in 2005, up 5% from $178.9 billion in 2004.
WHOLESALE BANKING’S net income was a record $1.73 billion in 2005, up 8% from $1.60 billion in 2004, driven largely by a 15% increase in earning assets, as well as very low loan losses. Average loans increased 17% to $62.2 billion in 2005 from $53.1 billion in 2004, with double-digit increases across wholesale lending businesses. The provision for credit losses decreased to $1 million in 2005 from $62 million in 2004, with loan charge-offs at very low levels throughout 2005. Noninterest income increased 13% to $3.4 billion in 2005 from $3.0 billion in 2004, largely due to the Strong Financial acquisition completed at the end of 2004. Noninterest expense increased 16% to $3.17 billion in 2005 from $2.73 billion in 2004, due to the Strong Financial acquisition and airline lease writedowns.
WELLS FARGO FINANCIAL’S net income decreased 34% to $409 million in 2005 from $617 million in 2004. Net income was reduced by incremental bankruptcies related to the change in bankruptcy law and the $163 million first quarter 2005 initial implementation of conforming to more stringent FFIEC charge-off timing rules. Also, a $100 million provision for credit losses was taken in third quarter 2005 for estimated losses from Hurricane Katrina. Total revenue rose 12% in 2005, reaching $4.7 billion, compared with $4.2 billion in 2004, due to higher net interest income. Noninterest expense increased $202 million, or 9%, in 2005 from 2004, reflecting investments in new consumer finance stores and additional team members.
     Segment results for prior periods have been revised due to the realignment of our automobile financing businesses into Wells Fargo Financial in 2005, designed to leverage the expertise, systems and resources of the existing businesses.


45


 

Balance Sheet Analysis
 

Securities Available for Sale
Our securities available for sale portfolio consists of both debt and marketable equity securities. We hold debt securities available for sale primarily for liquidity, interest rate risk management and yield enhancement. Accordingly, this portfolio primarily includes very liquid, high-quality federal agency debt securities. At December 31, 2005, we held $40.9 billion of debt securities available for sale, compared with $33.0 billion at December 31, 2004, with a net unrealized gain of $591 million and $1.2 billion for the same periods, respectively. We also held $900 million of marketable equity securities available for sale at December 31, 2005, and $696 million at December 31, 2004, with a net unrealized gain of $342 million and $189 million for the same periods, respectively.
     The weighted-average expected maturity of debt securities available for sale was 5.9 years at December 31, 2005. Since 79% of this portfolio is mortgage-backed securities, the expected remaining maturity may differ from contractual maturity because borrowers may have the right to prepay obligations before the underlying mortgages mature.
     The estimated effect of a 200 basis point increase or decrease in interest rates on the fair value and the expected remaining maturity of the mortgage-backed securities available for sale portfolio is shown in Table 6.
Table 6: Mortgage-Backed Securities
                         
   
(in billions)   Fair     Net unrealized     Remaining  
    value     gain (loss)     maturity  
At December 31, 2005
  $ 32.4     $ .4     5.3 yrs.

At December 31, 2005,
assuming a 200 basis point:

                       
Increase in interest rates
    29.9       (2.1 )   7.5 yrs.
Decrease in interest rates
    33.5       1.5     2.0 yrs.
   
     See Note 5 (Securities Available for Sale) to Financial Statements for securities available for sale by security type.
Loan Portfolio
A comparative schedule of average loan balances is included in Table 3; year-end balances are in Note 6 (Loans and Allowance for Credit Losses) to Financial Statements.
     Loans averaged $296.1 billion in 2005, compared with $269.6 billion in 2004, an increase of 10%. Total loans at December 31, 2005, were $310.8 billion, compared with $287.6 billion at year-end 2004, an increase of 8%. Average 1-4 family first mortgages decreased $9.5 billion, or 11%, and average junior liens increased $11.2 billion, or 25%, in 2005 compared with a year ago. Average commercial and commercial real estate loans increased $12.0 billion, or 13%, in 2005 compared with a year ago. Average mortgages held for sale increased $6.7 billion, or 21%, to $39.0 billion in
2005 from $32.3 billion in 2004, due to higher origination volume. Residential mortgage originations of $366 billion were up 23% from $298 billion in 2004. Loans held for sale decreased to $612 million at December 31, 2005, from $8.7 billion a year ago, due to the transfer of student loans held for sale to the held for investment portfolio. Our decision to hold these loans for investment was based on present yields and our intent and ability to hold this portfolio for the foreseeable future.
     Table 7 shows contractual loan maturities and interest rate sensitivities for selected loan categories.
Table 7: Maturities for Selected Loan Categories
                                 
   
(in millions)   December 31, 2005  
    Within     After     After     Total  
    one     one year     five          
    year     through     years          
            five years                  

Selected loan maturities:

                               
Commercial
  $ 18,748     $ 31,627     $ 11,177     $ 61,552  
Other real estate mortgage
    3,763       11,777       13,005       28,545  
Real estate construction
    5,081       6,887       1,438       13,406  
Foreign
    525       3,995       1,032       5,552  
 
                     
Total selected loans
  $ 28,117     $ 54,286     $ 26,652     $ 109,055  
 
                     
Sensitivity of loans due after one year to changes in interest rates:
                               
Loans at fixed interest rates
          $ 11,145     $ 7,453          
Loans at floating/variable interest rates
            43,141       19,199          
 
                         
Total selected loans
          $ 54,286     $ 26,652          
 
                         
   
Deposits
Year-end deposit balances are in Table 8. Comparative detail of average deposit balances is included in Table 3. Average core deposits funded 54.5% and 54.4% of average total assets in 2005 and 2004, respectively. Total average interest-bearing deposits rose from $182.6 billion in 2004 to $194.6 billion in 2005. Total average noninterest-bearing deposits rose from $79.3 billion in 2004 to $87.2 billion in 2005. Savings certificates increased on average from $18.9 billion in 2004 to $22.6 billion in 2005.
Table 8: Deposits
                         
   
(in millions)   December 31,     %  
    2005     2004     Change  
Noninterest-bearing
  $ 87,712     $ 81,082       8 %
Interest-bearing checking
    3,324       3,122       6  
Market rate and
other savings
    134,811       126,648       6  
Savings certificates
    27,494       18,851       46  
 
                   
Core deposits
    253,341       229,703       10  
Other time deposits
    46,488       36,622       27  
Deposits in foreign offices
    14,621       8,533       71  
 
                   
Total deposits
  $ 314,450     $ 274,858       14  
 
                   
   


46


 

Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
 

Off-Balance Sheet Arrangements, Variable Interest
Entities, Guarantees and Other Commitments
We consolidate our majority-owned subsidiaries and subsidiaries in which we are the primary beneficiary. Generally, we use the equity method of accounting if we own at least 20% of an 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 on the balance sheet, or may be recorded on the balance sheet in amounts that are different than the full contract or notional amount of the transaction. These transactions are designed to (1) meet the financial needs of customers, (2) manage our credit, market or liquidity risks, (3) diversify our funding sources or (4) optimize capital, and are accounted for in accordance with U.S. generally accepted accounting principles (GAAP).
     Almost all of our off-balance sheet arrangements result from securitizations. We routinely securitize home mortgage loans and, from time to time, other financial assets, including student loans, commercial mortgages and automobile receivables. We normally structure loan securitizations as sales, in accordance with FAS 140. This involves the transfer of financial assets to certain qualifying special-purpose entities that we are not required to consolidate. In a securitization, we can convert the assets into cash earlier than if we held the assets to maturity. Special-purpose entities used in these types of securitizations obtain cash to acquire assets by issuing securities to investors. In a securitization, we 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, 2005, securitization arrangements sponsored by the Company consisted of $121 billion in securitized loan receivables, including $75 billion of home mortgage loans. At December 31, 2005, the retained servicing rights and other beneficial interests related to these securitizations were $4,426 million, consisting of $3,501 million in securities, $784 million in servicing assets and $141 million in other retained interests. Related to our securitizations, we have committed to provide up to $40 million in credit enhancements.
     We also hold variable interests greater than 20% but less than 50% in certain special-purpose entities formed to provide affordable housing and to securitize corporate debt that had approximately $3 billion in total assets at December 31, 2005. 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 $870 million at December 31, 2005, predominantly representing investments in entities formed to invest in affordable housing. We, however, expect to recover our investment over time primarily through realization of federal low-income housing tax credits.
     For more information on securitizations including sales proceeds and cash flows from securitizations, see Note 20 (Securitizations and Variable Interest Entities) to Financial Statements.
     Home Mortgage, in the ordinary course of business, originates a portion of its mortgage loans through unconsolidated joint ventures in which we own an interest of 50% or less. Loans made by these joint ventures are funded by Wells Fargo Bank, N.A., or an affiliated entity, through an established line of credit and are subject to specified underwriting criteria. At December 31, 2005, 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, 2005, these liquidity commitments totaled $358 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, 2005, total assets of our real estate lending and merchant services joint ventures were approximately $715 million.
     When we acquire brokerage, asset management and insurance agencies, the terms of the acquisitions may provide for deferred payments or additional consideration, based on certain performance targets. At December 31, 2005, the amount of contingent consideration we expected to pay was not significant to our financial statements.
     As a financial services provider, we routinely commit to extend credit, including loan commitments, standby letters of credit and financial guarantees. A significant portion of commitments to extend credit may expire without being drawn upon. These commitments are subject to the same credit policies and approval process used for our loans. For more information, see Note 6 (Loans and Allowance for Credit Losses) and Note 24 (Guarantees) to Financial Statements.
     In our venture capital and capital markets businesses, we commit to fund equity investments directly to investment funds and to specific private companies. The timing of future cash requirements to fund these commitments generally depends on the venture capital investment cycle, the period over which privately-held companies are funded by venture capital investors and ultimately sold or taken public. This


47


 

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, 2005, these commitments were approximately $650 million. Our other investment commitments, principally related to affordable housing, civic and other community development initiatives, were approximately $465 million at December 31, 2005.
     In the ordinary course of business, we enter into indemnification agreements, including underwriting agreements relating to offers and sales of our securities, acquisition agreements, and various other business transactions or arrangements, such as relationships arising from service as a director or officer of the Company. For more information, see Note 24 (Guarantees) to Financial Statements.
Contractual Obligations
In addition to the contractual commitments and arrangements described above, which, depending on the nature of the obligation, may or may not require use of our resources, we enter into other contractual obligations in the ordinary course of business, including debt issuances for the funding of operations and leases for premises and equipment.
     Table 9 summarizes these contractual obligations at December 31, 2005, except obligations for short-term borrowing arrangements and pension and postretirement benefit plans. More information on these obligations is in Note 11 (Short-Term Borrowings) and Note 15 (Employee Benefits and Other Expenses) to Financial Statements. The table also excludes other commitments more fully described under “Off-Balance Sheet Arrangements, Variable Interest Entities, Guarantees and Other Commitments.”
     We enter into derivatives, which create contractual obligations, as part of our interest rate risk management process, for our customers or for other trading activities. See “Asset/Liability and Market Risk Management” in this report and Note 26 (Derivatives) to Financial Statements for more information.
Transactions with Related Parties
FAS 57, Related Party Disclosures, requires disclosure of material related party transactions, other than compensation arrangements, expense allowances and other similar items in the ordinary course of business. The Company had no related party transactions required to be reported under FAS 57 for the years ended December 31, 2005, 2004 and 2003.


Table 9: Contractual Obligations
                                                         
   
(in millions)   Note(s) to     Less than     1-3     3-5     More than     Indeterminate     Total  
    Financial Statements     1 year     years     years     5 years     maturity(1)          

Contractual payments by period:

                                                       

Deposits

    10     $ 80,461     $ 5,785     $ 1,307     $ 231     $ 226,666     $ 314,450  
Long-term debt(2)
    7, 12       11,124       27,704       15,869       24,971             79,668  
Operating leases
    7       514       786       535       898             2,733  
Purchase obligations(3)
            548       244       28                   820  
 
                                           
Total contractual obligations
          $ 92,647     $ 34,519     $ 17,739     $ 26,100     $ 226,666     $ 397,671  
 
                                           
   
(1)   Represents interest-bearing and noninterest-bearing checking, market rate and other savings accounts.
(2)   Includes capital leases of $14 million.
(3)   Represents agreements to purchase goods or services.

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Risk Management
 

Credit Risk Management Process
Our credit risk management process provides for decentralized management and accountability by our lines of business. Our overall credit process includes comprehensive credit policies, frequent and detailed risk measurement and modeling, extensive credit training programs and a continual loan audit review process. In addition, regulatory examiners review and perform detailed tests of our credit underwriting, loan administration and allowance processes.
     Managing credit risk is a company-wide process. We have credit policies for all banking and nonbanking operations incurring credit risk with customers or counterparties that provide a consistent, prudent approach to credit risk management. We use detailed tracking and analysis to measure credit performance and exception rates and we routinely review and modify credit policies as appropriate. We have corporate data integrity standards to ensure accurate and complete credit performance reporting. We strive to identify problem loans early and have dedicated, specialized collection and work-out units.
     The Chief Credit Officer, who reports directly to the Chief Executive Officer, provides company-wide credit oversight. Each business unit with direct credit risks has a credit officer and has the primary responsibility for managing its own credit risk. The Chief Credit Officer delegates authority, limits and other requirements to the business units. These delegations are routinely reviewed and amended if there are significant changes in personnel, credit performance, or business requirements. The Chief Credit Officer is a member of the Company’s Management Committee.
     Our business units and the office of the Chief Credit Officer periodically review all credit risk portfolios to ensure that the risk identification processes are functioning properly and that credit standards are followed. Business units conduct quality assurance reviews to ensure that loans meet portfolio or investor credit standards. Our loan examiners and internal auditors also independently review portfolios with credit risk.
     Our primary business focus in middle-market commercial and residential real estate, auto and small consumer lending, results in portfolio diversification. We ensure that we use appropriate methods to understand and underwrite risk.
     In our wholesale portfolios, 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 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.
     Each business unit completes quarterly asset quality forecasts to quantify its intermediate-term outlook for loan losses and recoveries, nonperforming loans and market trends. To make sure our overall allowance for credit losses is adequate we conduct periodic stress tests. This includes a portfolio loss simulation model that simulates a range of possible losses for various sub-portfolios assuming various trends in loan quality. We assess loan portfolios for geographic, industry, or other concentrations and use mitigation strategies, which may include loan sales, syndications or third party insurance, to minimize these concentrations, as we deem necessary.
     We routinely review and evaluate risks that are not borrower specific but that may influence the behavior of a particular credit, group of credits or entire sub-portfolios. We also assess risk for particular industries, geographic locations such as states or Metropolitan Statistical Areas (MSAs) and specific macroeconomic trends.
NONACCRUAL LOANS AND OTHER ASSETS
Table 10 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) 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.
     The decrease in nonaccrual loans was primarily due to payoffs of commercial and commercial real estate nonaccrual loans.
     We expect that the amount of nonaccrual loans will change due to portfolio growth, portfolio seasoning, routine problem loan recognition and resolution through collections, sales or charge-offs. The performance of any one loan can be affected by external factors, such as economic conditions, or factors particular to a borrower, such as actions of a borrower’s management.
     If interest due on the book balances of all nonaccrual loans (including loans that were but are no longer on nonaccrual at year end) had been accrued under the original terms, approximately $85 million of interest would have been recorded in 2005, compared with payments of $35 million recorded as interest income.
     Most of the foreclosed assets at December 31, 2005, have been in the portfolio one year or less.


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Table 10:   Nonaccrual Loans and Other Assets
                                         
   
(in millions)   December 31 ,
    2005     2004     2003     2002     2001  

Nonaccrual loans:

                                       
Commercial and commercial real estate:
                                       
Commercial
  $ 286     $ 345     $ 592     $ 796     $ 827  
Other real estate mortgage
    165       229       285       192       210  
Real estate construction
    31       57       56       93       145  
Lease financing
    45       68       73       79       163  
 
                             
Total commercial and commercial real estate
    527       699       1,006       1,160       1,345  
Consumer:
                                       
Real estate 1-4 family first mortgage
    471       386       274       230       205  
Real estate 1-4 family junior lien mortgage
    144       92       87       49       22  
Other revolving credit and installment
    171       160       88       48       59  
 
                             
Total consumer
    786       638       449       327       286  
Foreign
    25       21       3       5       9  
 
                             
Total nonaccrual loans (1)
    1,338       1,358       1,458       1,492       1,640  
As a percentage of total loans
    .43 %     .47 %     .58 %     .78 %     .98 %

Foreclosed assets

    191       212       198       195       160  
Real estate investments (2)
    2       2       6       4       2  
 
                             
Total nonaccrual loans and other assets
  $ 1,531     $ 1,572     $ 1,662     $ 1,691     $ 1,802  
 
                             
As a percentage of total loans
    .49 %     .55 %     .66 %     .88 %     1.08 %
 
                             
   
(1)   Includes impaired loans of $190 million, $309 million, $629 million, $612 million and $823 million at December 31, 2005, 2004, 2003, 2002 and 2001, 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.)
 
(2)   Real estate investments (contingent interest loans accounted for as investments) that would be classified as nonaccrual if these assets were recorded as loans.
Real estate investments totaled $84 million, $4 million, $9 million, $9 million and $24 million at December 31, 2005, 2004, 2003, 2002 and 2001, respectively.

LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING
Loans 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 $3,606 million, $2,578 million, $2,337 million, $672 million and $698 million at December 31, 2005, 2004, 2003, 2002 and 2001, respectively. At December 31, 2005, 2004, and 2003, the total included $2,923 million, $1,820 million and $1,641 million, respectively, in advances pursuant to our servicing agreements to Government National Mortgage Association (GNMA) mortgage pools whose repayments are insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs. Before clarifying guidance issued in 2003 as to classification as loans, GNMA advances were included in other assets. Table 11 provides detail by loan category excluding GNMA advances.
 
Table 11:   Loans 90 Days or More Past Due and Still Accruing (Excluding Insured/Guaranteed GNMA Advances)
                                         
   
(in millions)   December 31 ,
    2005     2004     2003     2002     2001  

Commercial and commercial real estate:

                                       
Commercial
  $ 18     $ 26     $ 87     $ 92     $ 60  
Other real estate mortgage
    13       6       9       7       22  
Real estate construction
    9       6       6       11       47  
 
                             
Total commercial and commercial real estate
    40       38       102       110       129  

Consumer:

                                       
Real estate
1-4 family
first mortgage
    103       148       117       104       145  
Real estate
1-4 family
junior lien mortgage
    50       40       29       18       17  
Credit card
    159       150       134       130       116  
Other revolving credit and installment
    290       306       271       282       268  
 
                             
Total consumer
    602       644       551       534       546  
Foreign
    41       76       43       28       23  
 
                             
Total
  $ 683     $ 758     $ 696     $ 672     $ 698  
 
                             
   


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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 classified 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, 2005, the allowance for loan losses was $3.87 billion, or 1.25% of total loans, compared with $3.76 billion, or 1.31%, at December 31, 2004, and $3.89 billion, or 1.54%, at December 31, 2003. The decrease in the ratio of the allowance for loan losses to total loans was primarily due to a continued shift toward a higher percentage of consumer loans in our portfolio, including consumer loans and some small business loans, which have shorter loss emergence periods, and home mortgage loans, which have inherently lower losses that emerge over a longer time frame compared to other consumer products. We have historically experienced lower losses on our residential real estate secured consumer loan portfolio.
     The allowance for credit losses was $4.06 billion at December 31, 2005, and $3.95 billion at December 31, 2004. The ratio of the allowance for credit losses to net charge-offs was 178% and 237% at December 31, 2005 and 2004, respectively. This ratio fluctuates from period to period and the decrease in 2005 reflects increased loss rates within the various consumer and small business portfolios impacted by higher consumer bankruptcies in fourth quarter 2005.
     The ratio of the allowance for credit losses to total nonaccrual loans was 303% and 291% at December 31, 2005 and 2004, 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 and other consumer loans at December 31, 2005. Nonaccrual loans are generally written down to a net realizable value at the time they are placed on nonaccrual and accounted for on a cost recovery basis.
     The provision for credit losses totaled $2.38 billion in 2005, and $1.72 billion in both 2004 and 2003. In 2005, the provision included $100 million in excess of net charge-offs,
which was our estimate of probable credit losses related to Hurricane Katrina. We continue to work with customers under various payment moratoriums and forbearance programs to re-evaluate and refine our estimates as more information becomes available and can be confirmed in subsequent quarters.
     Net charge-offs in 2005 were .77% of average total loans, compared with .62% in 2004 and .81% in 2003. Higher net charge-offs in 2005 included the additional credit losses from the change in bankruptcy laws and conforming Wells Fargo Financial to FFIEC charge-off rules. A portion of these bankruptcy charge-offs represent an acceleration of charge-offs that would have likely occurred in 2006. The increase in consumer bankruptcies primarily impacted our credit card, unsecured consumer loans and lines, auto and small business portfolios.
     The reserve for unfunded credit commitments was $186 million at December 31, 2005, and $188 million at December 31, 2004, less than 5% of the total allowance for credit losses related to this potential risk for both years.
     The allocated component of the allowance for credit losses was $3.41 billion at December 31, 2005, and $3.06 billion at December 31, 2004, an increase of $347 million year over year. Changes in the allocated allowance reflect changes in statistically derived loss estimates, historical loss experience, and current trends in borrower risk and/or general economic activity on portfolio performance. The unallocated allowance decreased to $648 million, or 16% of the allowance for credit losses, at December 31, 2005, from $888 million, or 22%, at December 31, 2004.
     We consider the allowance for credit losses of $4.06 billion adequate to cover credit losses inherent in the loan portfolio, including unfunded credit commitments, at December 31, 2005. The process for determining the adequacy of the allowance for credit losses is critical to our financial results. It requires difficult, subjective and complex judgments, as a result of the need to make estimates about the effect of matters that are uncertain. (See “Financial Review — Critical Accounting Policies — Allowance for Credit Losses.”) Therefore, we cannot provide assurance that, in any particular period, we will not have sizeable credit losses in relation to the amount reserved. We may need to significantly adjust the allowance for credit losses, considering current factors at the time, including economic conditions and ongoing internal and external examination processes. Our process for determining the adequacy of the allowance for credit losses is discussed in Note 6 (Loans and Allowance for Credit Losses) to Financial Statements.


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Asset/Liability and Market Risk Management
Asset/liability management involves the evaluation, monitoring and management of interest rate risk, market risk, liquidity and funding. The Corporate Asset/Liability Management Committee (Corporate ALCO)—which oversees these risks and reports periodically to the Finance Committee of the Board of Directors—consists of senior financial and business executives. Each of our principal business groups—Community Banking (including Mortgage Banking), Wholesale Banking and Wells Fargo Financial—have individual asset/liability management committees and processes linked to the Corporate ALCO process.
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 value of MSRs, the value of the pension liability and other sources of earnings.
     We assess interest rate risk by comparing our most likely earnings plan with various earnings 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, 2005, our most recent simulation indicated estimated earnings at risk of less than 1% of our most likely earnings plan over the next 12 months using a scenario in which the federal funds rate dropped 200 basis points to 2.25% and the 10-year Constant Maturity Treasury bond yield dropped 125 basis points to 3.25% over the same period. 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 twelve month simulation period, depending on the path of interest rates and on our MSRs hedging strategies. See “Mortgage Banking Interest Rate 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 values of these derivatives as of December 31, 2005 and 2004, are presented in Note 26 (Derivatives) to Financial Statements. We use derivatives for asset/liability management in three 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 RISK
We originate, fund and service mortgage loans, which subjects us to various risks, including credit, liquidity and interest rate risks. We avoid unwanted credit and liquidity risks by selling or securitizing virtually 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 portfolio as an investment for our growing base of core deposits, and we may subsequently sell some or all of these ARMs as part of our corporate asset/liability management.
     While credit and liquidity risks are relatively low for mortgage banking activities, interest rate risk can be substantial. Changes in interest rates may potentially impact origination and servicing fees, the value of our MSRs, the income and expense associated with instruments used to hedge changes in the value of MSRs, and the value of derivative loan commitments 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, depending on our ability to retain market share, may also lead to an increase in servicing fees. 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


52


 

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 GAAP, MSRs are adjusted at the end of each quarter to the lower of cost or market. 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 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 increases the propensity for refinancing, reduces the expected duration of the servicing portfolio and therefore reduces the estimated value of MSRs. This reduction in value causes a charge to income as a result of increasing the valuation allowance for potential MSRs impairment (net of any gains on derivatives used to hedge MSRs). We typically do not fully hedge with financial instruments (derivatives or securities) all of the potential decline in the value of our MSRs to a decline in interest rates because the potential increase in origination/servicing fees in that scenario provides a partial “natural business hedge.” In a rising rate period, when the MSRs valuation is not fully hedged with derivatives, the amount of valuation allowance that can be recaptured into income will typically—although not always—exceed the losses on any derivatives hedging the MSRs.
     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 in any accounting period.
    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. For example, given the relatively high level of refinancing activity in recent years and the increase in interest rates in 2005, any significant increase in refinancing activity would likely occur only if rates drop substantially from year-end 2005 levels.
    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 relationship 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, including mortgage, U.S. Treasury, and LIBOR-based futures, forwards, swaps and options, may not perfectly correlate with the values and income being hedged.
     Our MSRs totaled $12.5 billion, net of a valuation allowance of $1.2 billion at December 31, 2005, and $7.9 billion, net of a valuation allowance of $1.6 billion, at December 31, 2004. The weighted-average note rate of our owned servicing portfolio was 5.72% at December 31, 2005, and 5.75% at December 31, 2004. Our MSRs were 1.44% of mortgage loans serviced for others at December 31, 2005, and 1.15% at December 31, 2004.
     As part of our mortgage banking activities, we enter into commitments to fund residential mortgage loans at specified times in the future. A mortgage loan commitment is an interest rate lock that binds us to lend funds to a potential borrower at a specified interest rate and within a specified period of time, generally up to 60 days after inception of the rate lock. These loan commitments are derivative loan commitments if the loans that will result from the exercise of the commitments will be held for sale. Under FAS 133, Accounting for Derivative Instruments and Hedging Activities (as amended), these derivative loan commitments are recognized at fair value on the consolidated balance sheet with changes in their fair values recorded as part of income from mortgage banking operations. Consistent with EITF 02-3, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities, and SEC Staff Accounting Bulletin No. 105, Application of Accounting Principles to Loan Commitments, we record no value for the loan commitment at inception. Subsequent to inception, we recognize fair value of the derivative loan commitment based on estimated changes in the fair value of the underlying loan that would result from the exercise of that commitment and on changes in the probability that the loan will fund within the terms of the commitment. The value of that loan is affected primarily by changes in interest rates and the passage of time. We also apply a fall-out factor to the valuation of the derivative loan commitment for the probability that the loan will not fund within the terms of the commitments. The value of the MSRs is recognized only after the servicing asset has been contractually separated from the underlying loan by sale or securitization.


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     Outstanding derivative loan commitments expose us to the risk that the price of the loans underlying the commitments might decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan. To minimize this risk, we utilize options, futures and forwards to economically hedge the potential decreases in the values of the loans that could result from the exercise of the loan commitments. We expect that these derivative financial instruments will experience changes in fair value that will either fully or partially offset the changes in fair value of the derivative loan commitments.
MARKET RISK – TRADING ACTIVITIES
From a market risk perspective, our net income is exposed to changes in interest rates, credit spreads, foreign exchange rates, equity and commodity prices and their implied volatilities. The primary purpose of our trading businesses is to accommodate customers in the management of their market price risks. Also, we take positions based on market expectations or to benefit from price differences between financial instruments and markets, subject to risk limits established and monitored by Corporate ALCO. All securities, foreign exchange transactions, commodity transactions and derivatives—transacted with customers or used to hedge capital market transactions with customers—are carried at fair value. The Institutional Risk Committee establishes and monitors counterparty risk limits. The notional or contractual amount, credit risk amount and estimated net fair value of all customer accommodation derivatives at December 31, 2005 and 2004, are included in Note 26 (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 99% confidence interval based on actual changes in rates and prices over the past 250 days. The analysis captures all financial instruments that are considered trading positions. The average one-day VAR throughout 2005 was $18 million, with a lower bound of $11 million and an upper bound of $24 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 reviews business developments, key risks and historical returns for the private equity investments at least annually. Management reviews these investments at least quarterly and assesses them for possible other-than-temporary impairment. For nonmarketable investments, the analysis is based on facts and circumstances of each 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 $1,537 million at December 31, 2005, and $1,449 million at December 31, 2004.
     We also have marketable equity securities in the available for sale investment 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, to a lesser degree, 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 $900 million and cost was $558 million at December 31, 2005, and $696 million and $507 million, respectively, at December 31, 2004.
     Changes in equity market prices may also indirectly affect our net income (1) by affecting the value of third party assets under management and, hence, fee income, (2) by affecting particular borrowers, whose ability to repay principal and/or interest may be affected by the stock market, or (3) by affecting brokerage activity, related commission income and other business activities. Each business line monitors and manages these indirect risks.
LIQUIDITY AND FUNDING
The objective of effective liquidity management is to ensure that we can meet customer loan requests, customer deposit maturities/withdrawals and other cash commitments efficiently under both normal operating conditions and under unpredictable circumstances of industry or market stress. To achieve this objective, Corporate ALCO establishes and monitors liquidity guidelines that require sufficient asset-based liquidity to cover potential funding requirements and to avoid over-dependence on volatile, less reliable funding markets. We set 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.


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     Debt securities in the securities available for sale portfolio provide asset liquidity, in addition to the immediately liquid resources of cash and due from banks and federal funds sold and securities purchased under resale agreements. The weighted-average expected remaining maturity of the debt securities within this portfolio was 5.9 years at December 31, 2005. Of the $40.3 billion (cost basis) of debt securities in this portfolio at December 31, 2005, $5.1 billion, or 13%, is expected to mature or be prepaid in 2006 and an additional $5.5 billion, or 14%, in 2007. Asset liquidity is further enhanced by our ability to sell or securitize loans in secondary markets through whole-loan sales and securitizations. In 2005, we sold mortgage loans of approximately $435 billion, including securitized home mortgage loans and commercial mortgage loans of approximately $190 billion. The amount of mortgage loans, home equity loans and other consumer loans available to be sold or securitized was approximately $150 billion at December 31, 2005.
     Core customer deposits have historically provided a sizeable source of relatively stable and low-cost funds. Average core deposits and stockholders’ equity funded 63.2% and 63.1% of average total assets in 2005 and 2004, respectively.
     The remaining assets were funded by long-term debt, deposits in foreign offices, short-term borrowings (federal funds purchased, securities sold under repurchase agreements, commercial paper and other short-term borrowings) and trust preferred securities. Short-term borrowings averaged $24.1 billion in 2005 and $26.1 billion in 2004. Long-term debt averaged $79.1 billion in 2005 and $67.9 billion in 2004.
     We anticipate making capital expenditures of approximately $900 million in 2006 for our stores, relocation and remodeling of Company facilities, and routine replacement of furniture, equipment and servers. We fund expenditures from various sources, including cash flows from operations, retained earnings and borrowings.
     Liquidity is also available through our ability to raise funds in a variety of domestic and international money and capital markets. We access capital markets for long-term funding by issuing registered debt, private placements and asset-backed secured funding. 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. In September 2003, Moody’s Investors Service rated Wells Fargo Bank, N.A. as “Aaa,” its highest investment grade, and rated the Company’s senior debt rating as “Aa1.” In July 2005, Dominion Bond Rating Service raised the Company’s senior debt rating to “AA” from “AA(low).”
     Table 12 provides the credit ratings of the Company and Wells Fargo Bank, N.A. as of December 31, 2005.
Table 12:   Credit Ratings
                     
 
    Wells Fargo & Company   Wells Fargo Bank, N.A.
    Senior   Subordinated   Commercial   Long-term   Short-term
    debt   debt   paper   deposits   borrowings
 

Moody’s

  Aa1   Aa2   P-1   Aaa   P-1
Standard & Poor’s
  AA-   A+   A-1+   AA   A-1+
Fitch, Inc.
  AA   AA-   F1+   AA+   F1+
Dominion Bond Rating Service
  AA   AA(low)   R-1(middle)   AA(high)   R-1(high)
 
     On June 29, 2005, the SEC adopted amendments to its rules with respect to the registration, communications and offerings processes under the Securities Act of 1933. The rules, which became effective December 1, 2005, facilitate access to the capital markets by well-established public companies, modernize the existing restrictions on corporate communications during a securities offering and further integrate disclosures under the Securities Act of 1933 and the Securities Exchange Act of 1934. The amended rules provide the most flexibility to “well-known seasoned issuers” (Seasoned Issuers), including the option of automatic effectiveness upon filing of shelf registration statements and relief under the less restrictive communications rules. 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. Based on each of these criteria calculated as of December 1, 2005, the Company met the eligibility requirements to qualify as a Seasoned Issuer.
PARENT. In July 2005, the Parent’s registration statement with the SEC for issuance of $30 billion in senior and subordinated notes, preferred stock and other securities became effective. During 2005, the Parent issued a total of $16.0 billion of senior notes, including approximately $1.3 billion (denominated in pounds sterling) sold primarily in the United Kingdom. Also, in 2005, the Parent issued $1.5 billion (denominated in Australian dollars) in senior notes under the Parent’s Australian debt issuance program. At December 31, 2005, the Parent’s remaining authorized issuance capacity under its effective registration statements was $24.8 billion. We used the proceeds from securities issued in 2005 for general corporate purposes and expect that the proceeds in the future will also be used for general corporate purposes. In January and February 2006, the Parent issued a total of $3.6 billion in senior notes, including approximately $900 million denominated in pounds sterling. The Parent also issues commercial paper from time to time.


55


 

WELLS FARGO BANK, N.A. In March 2003, Wells Fargo Bank, N.A. established a $50 billion bank note program under which it may issue up to $20 billion in short-term senior notes outstanding at any time and up to a total of $30 billion in long-term senior notes. Securities are issued under this program as private placements in accordance with Office of the Comptroller of the Currency (OCC) regulations. During 2005, Wells Fargo Bank, N.A. issued $2.3 billion in long-term senior notes. At December 31, 2005, the remaining long-term issuance authority was $6.7 billion. Wells Fargo Bank, N.A. also issued $1.5 billion in subordinated debt in 2005.
WELLS FARGO FINANCIAL. In November 2003, Wells Fargo Financial Canada Corporation (WFFCC), a wholly-owned Canadian subsidiary of Wells Fargo Financial, Inc. (WFFI), qualified for distribution with the provincial securities exchanges in Canada $1.5 billion (Canadian) of issuance authority. In December 2004, WFFCC amended its existing shelf registration by adding $2.5 billion (Canadian) of issuance authority. During 2005, WFFCC issued $2.2 billion (Canadian) in senior notes. The remaining issuance capacity for WFFCC of $700 million (Canadian) expired in December 2005. In January 2006, a $7.0 billion (Canadian) shelf registration became effective. In 2005, WFFI entered into a secured borrowing arrangement for $1 billion (U.S.). Under the terms of the arrangement, WFFI pledged auto loans as security for the borrowing.


Capital Management
 

We have an active program for managing stockholder capital. We use capital to fund organic growth, acquire banks and other financial services companies, pay dividends and repurchase our shares. Our objective is to produce above-market long-term returns by opportunistically using capital when returns are perceived to be high and issuing/accumulating capital when such costs are perceived to be low.
     From time to time our Board of Directors authorizes the Company to repurchase shares of our common stock. Although we announce when our Board authorizes share repurchases, we typically do not give any public notice before we repurchase our shares. Various factors determine the amount and timing of our share repurchases, including our capital requirements, the number of shares we expect to issue for acquisitions and employee benefit plans, market conditions (including the trading price of our stock), and legal considerations. These factors can change at any time, and there can be no assurance as to the number of shares we will repurchase or when we will repurchase them.
     Historically, our policy has been to repurchase shares under the “safe harbor” conditions of Rule 10b-18 of the Exchange Act including a limitation on the daily volume of repurchases. 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 the Company’s best interest to repurchase shares in excess of
this additional daily volume limitation. In such cases, we intend to repurchase shares in compliance with the other conditions of the safe harbor, including the standing daily volume limitation that applies whether or not there is a pending stock merger or acquisition.
     In 2005, the Board of Directors authorized the repurchase of up to 75 million additional shares of our outstanding common stock. During 2005, we repurchased approximately 53 million shares of our common stock. At December 31, 2005, the total remaining common stock repurchase authority was approximately 35 million shares.
     Our potential sources of capital include retained earnings, and issuances of common and preferred stock and subordinated debt. In 2005, retained earnings increased $4.1 billion, predominantly as a result of net income of $7.7 billion less dividends of $3.4 billion. In 2005, we issued $1.9 billion of common stock under various employee benefit and director plans and under our dividend reinvestment and direct stock purchase programs.
     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, 2005, the Company and each of our covered subsidiary banks were “well capitalized” under applicable regulatory capital adequacy guidelines. See Note 25 (Regulatory and Agency Capital Requirements) to Financial Statements for additional information.


56


 

Comparison of 2004 with 2003
 

Net income in 2004 increased 13% to $7.0 billion from $6.2 billion in 2003. Diluted earnings per common share increased 12% to $4.09 in 2004 from $3.65 in 2003. In addition to incremental investments in new stores, sales-focused team members and technology, 2004 results included $217 million ($.08 per share) of charitable contribution expense for the Wells Fargo Foundation, $44 million ($.02 per share) for a special 401(k) contribution and $19 million ($.01 per share) in integration expense related to the Strong Financial transaction. We also took significant actions to reposition our balance sheet in 2004 designed to improve earning asset yields and to reduce long-term debt costs. The extinguishment of high interest rate debt reduced earnings by $174 million ($.06 per share) for 2004. Return on average assets was 1.71% and return on average common equity was 19.56% in 2004, up from 1.64% and 19.36%, respectively, for 2003.
     Net interest income on a taxable-equivalent basis was $17.3 billion in 2004, compared with $16.1 billion in 2003, an increase of 7%. The increase was primarily due to strong consumer loan growth, especially in mortgage products. The benefit of this growth was partially offset by lower loan yields as new volumes were added below the portfolio average.
     The net interest margin for 2004 decreased to 4.89% from 5.08% in 2003. The decrease was primarily due to lower investment portfolio yields following maturities and prepayments of higher yielding mortgage-backed securities, and the addition of new consumer and commercial loans with yields below the existing portfolio average. These factors were partially offset by the benefits of balance sheet repositioning actions taken in 2004.
     Noninterest income was $12.9 billion in 2004, compared with $12.4 billion in 2003, an increase of 4%, driven by growth across our business, with particular strength in trust, investment and IRA fees, card fees, loan fees and gains on equity investments.
     Mortgage banking noninterest income was $1,860 million in 2004, compared with $2,512 million in 2003. Net servicing income was $1,037 million in 2004, compared with losses of $954 million in 2003. The increase in net servicing income in 2004, compared with 2003, reflected a reduction of $934 million in amortization due to an increase in average
interest rates and higher gross servicing fees resulting from growth in the servicing portfolio. In addition, to reflect the higher value of our MSRs, we reversed $208 million of the valuation allowance in 2004, compared with an impairment provision of $1,092 million in 2003. Net derivative gains on fair value hedges of our MSRs were $554 million and $1,111 million in 2004 and 2003, respectively.
     Net gains on mortgage loan origination/sales activities were $539 million in 2004, compared with $3,019 million for 2003. Lower gains in 2004 compared with 2003 reflected lower origination volume and a decrease in margins, due primarily to the increase in average interest rates and lower consumer demand. Originations during 2004 declined to $298 billion from $470 billion in 2003.
     Revenue, the sum of net interest income and noninterest income, increased 6% to a record $30.1 billion in 2004 from $28.4 billion in 2003, despite a 37% decrease in mortgage originations as the refinance driven market declined from its exceptional 2003 level. Despite our balance sheet repositioning actions in 2004, which reduced 2004 revenue growth by approximately 1 percentage point due to the loss on sale of lower yielding assets, and our significant level of investment spending, operating leverage improved during 2004 with revenue growing 6% and noninterest expense up only 2%. For the year, Home Mortgage revenue declined $807 million, or 16%, from $5.2 billion in 2003 to $4.4 billion in 2004.
     Noninterest expense was $17.6 billion in 2004, compared with $17.2 billion in 2003, an increase of 2%.
     During 2004, net charge-offs were $1.67 billion, or .62% of average total loans, compared with $1.72 billion, or .81%, during 2003. The provision for credit losses was $1.72 billion in 2004, flat compared with 2003. The allowance for credit losses, which consists of the allowance for loan losses and the reserve for unfunded credit commitments, was $3.95 billion, or 1.37% of total loans, at December 31, 2004, and $3.89 billion, or 1.54%, at December 31, 2003.
     At December 31, 2004, total nonaccrual loans were $1.36 billion, or .47% of total loans, down from $1.46 billion, or .58%, at December 31, 2003. Foreclosed assets were $212 million at December 31, 2004, compared with $198 million at December 31, 2003.


57


 

Controls and Procedures
Disclosure Controls and Procedures
 
As required by SEC rules, the Company’s management evaluated the effectiveness, as of December 31, 2005, of the Company’s disclosure controls and procedures. The Company’s chief executive officer and chief financial officer participated in the evaluation. Based on this evaluation, the Company’s chief executive officer and the chief financial officer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2005.
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 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 fourth quarter 2005 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, 2005, 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, 2005, the Company’s internal control over financial reporting was effective.
     KPMG LLP, the independent registered public accounting firm that audited the Company’s financial statements included in this Annual Report, issued an audit report on management’s assessment of the Company’s internal control over financial reporting. KPMG’s audit report appears on the following page.

58


 

Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Wells Fargo & Company:
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Wells Fargo & Company and Subsidiaries (“the Company”) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control —Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by COSO. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, 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, 2005 and 2004, 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, 2005, and our report dated February 21, 2006, expressed an unqualified opinion on those consolidated financial statements.
(KPMG LLP)
San Francisco, California
February 21, 2006

59


 

Financial Statements
Wells Fargo & Company and Subsidiaries
Consolidated Statement of Income
                         
   
(in millions, except per share amounts)   Year ended December 31 ,
                   
    2005     2004     2003  

INTEREST INCOME

                       
Trading assets
  $ 190     $ 145     $ 156  
Securities available for sale
    1,921       1,883       1,816  
Mortgages held for sale
    2,213       1,737       3,136  
Loans held for sale
    146       292       251  
Loans
    21,260       16,781       13,937  
Other interest income
    232       129       122  
 
                 
Total interest income
    25,962       20,967       19,418  
 
                 

INTEREST EXPENSE

                       
Deposits
    3,848       1,827       1,613  
Short-term borrowings
    744       353       322  
Long-term debt
    2,866       1,637       1,355  
Guaranteed preferred beneficial interests in Company’s subordinated debentures
                121  
 
                 
Total interest expense
    7,458       3,817       3,411  
 
                 

NET INTEREST INCOME

    18,504       17,150       16,007  
Provision for credit losses
    2,383       1,717       1,722  
 
                 
Net interest income after provision for credit losses
    16,121       15,433       14,285  
 
                 

NONINTEREST INCOME

                       
Service charges on deposit accounts
    2,512       2,417       2,297  
Trust and investment fees
    2,436       2,116       1,937  
Card fees
    1,458       1,230       1,079  
Other fees
    1,929       1,779       1,560  
Mortgage banking
    2,422       1,860       2,512  
Operating leases
    812       836       937  
Insurance
    1,215       1,193       1,071  
Net gains (losses) on debt securities available for sale
    (120 )     (15 )     4  
Net gains from equity investments
    511       394       55  
Other
    1,270       1,099       930  
 
                 
Total noninterest income
    14,445       12,909       12,382  
 
                 

NONINTEREST EXPENSE

                       
Salaries
    6,215       5,393       4,832  
Incentive compensation
    2,366       1,807       2,054  
Employee benefits
    1,874       1,724       1,560  
Equipment
    1,267       1,236       1,246  
Net occupancy
    1,412       1,208       1,177  
Operating leases
    635       633       702  
Other
    5,249       5,572       5,619  
 
                 
Total noninterest expense
    19,018       17,573       17,190  
 
                 

INCOME BEFORE INCOME TAX EXPENSE

    11,548       10,769       9,477  
Income tax expense
    3,877       3,755       3,275  
 
                 

NET INCOME

  $ 7,671     $ 7,014     $ 6,202  
 
                 

EARNINGS PER COMMON SHARE

  $ 4.55     $ 4.15     $ 3.69  

DILUTED EARNINGS PER COMMON SHARE

  $ 4.50     $ 4.09     $ 3.65  

DIVIDENDS DECLARED PER COMMON SHARE

  $ 2.00     $ 1.86     $ 1.50  

Average common shares outstanding

    1,686.3       1,692.2       1,681.1  

Diluted average common shares outstanding

    1,705.5       1,713.4       1,697.5  
   
The accompanying notes are an integral part of these statements.

60


 

Wells Fargo & Company and Subsidiaries
Consolidated Balance Sheet
                 
   
(in millions, except shares)   December 31 ,
             
    2005     2004  

ASSETS

               
Cash and due from banks
  $ 15,397     $ 12,903  
Federal funds sold, securities purchased under resale agreements and other short-term investments
    5,306       5,020  
Trading assets
    10,905       9,000  
Securities available for sale
    41,834       33,717  
Mortgages held for sale
    40,534       29,723  
Loans held for sale
    612       8,739  

Loans

    310,837       287,586  
Allowance for loan losses
    (3,871 )     (3,762 )
 
           
Net loans
    306,966       283,824  
 
           

Mortgage servicing rights, net

    12,511       7,901  
Premises and equipment, net
    4,417       3,850  
Goodwill
    10,787       10,681  
Other assets
    32,472       22,491  
 
           
Total assets
  $ 481,741     $ 427,849  
 
           

LIABILITIES

               
Noninterest-bearing deposits
  $ 87,712     $ 81,082  
Interest-bearing deposits
    226,738       193,776  
 
           
Total deposits
    314,450       274,858  
Short-term borrowings
    23,892       21,962  
Accrued expenses and other liabilities
    23,071       19,583  
Long-term debt
    79,668       73,580  
 
           
Total liabilities
    441,081       389,983  
 
           

STOCKHOLDERS’ EQUITY

               
Preferred stock
    325       270  
Common stock — $12/3 par value, authorized 6,000,000,000 shares; issued 1,736,381,025 shares
    2,894       2,894  
Additional paid-in capital
    9,934       9,806  
Retained earnings
    30,580       26,482  
Cumulative other comprehensive income
    665       950  
Treasury stock — 58,797,993 shares and 41,789,388 shares
    (3,390 )     (2,247 )
Unearned ESOP shares
    (348 )     (289 )
 
           
Total stockholders’ equity
    40,660       37,866  
 
           
Total liabilities and stockholders’ equity
  $ 481,741     $ 427,849  
 
           
   
The accompanying notes are an integral part of these statements.

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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, 2002

    1,685,906,507     $ 251     $ 2,894     $ 9,498     $ 19,355     $ 976     $ (2,465 )   $ (190 )   $ 30,319  
 
                                                     
Comprehensive income
                                                                       
Net income — 2003
                                    6,202                               6,202  
Other comprehensive income, net of tax:
                                                                       
Translation adjustments
                                            26                       26  
Net unrealized losses on securities available for sale and other retained interests
                                            (117 )                     (117 )
Net unrealized gains on derivatives and hedging activities
                                            53                       53  
 
                                                                     
Total comprehensive income
                                                                    6,164  
Common stock issued
    26,063,731                       63       (190 )             1,221               1,094  
Common stock issued for acquisitions
    12,399,597                       66                       585               651  
Common stock repurchased
    (30,779,500 )                                             (1,482 )             (1,482 )
Preferred stock (260,200) issued to ESOP
            260               19                               (279 )      
Preferred stock released to ESOP
                            (16 )                             240       224  
Preferred stock (223,660) converted to common shares
    4,519,039       (224 )             13                       211                
Preferred stock (1,460,000) redeemed
            (73 )                                                     (73 )
Preferred stock dividends
                                    (3 )                             (3 )
Common stock dividends
                                    (2,527 )                             (2,527 )
Change in Rabbi trust assets and similar arrangements (classified as treasury stock)
                                                    97               97  
Other, net
                                    5                               5  
 
                                                     
Net change
    12,202,867       (37 )           145       3,487       (38 )     632       (39 )     4,150  
 
                                                     

BALANCE DECEMBER 31, 2003

    1,698,109,374       214       2,894       9,643       22,842       938       (1,833 )     (229 )     34,469  
 
                                                     
Comprehensive income
                                                                       
Net income — 2004
                                    7,014                               7,014  
Other comprehensive income, net of tax:
                                                                       
Translation adjustments
                                            12                       12  
Net unrealized losses on securities available for sale and other retained interests
                                            (22 )                     (22 )
Net unrealized gains on derivatives and hedging activities
                                            22                       22  
 
                                                                     
Total comprehensive income
                                                                    7,026  
Common stock issued
    29,969,653                       129       (206 )             1,523               1,446  
Common stock issued for acquisitions
    153,482                       1                       8               9  
Common stock repurchased
    (38,172,556 )                                             (2,188 )             (2,188 )
Preferred stock (321,000) issued to ESOP
            321               23                               (344 )      
Preferred stock released to ESOP
                            (19 )                             284       265  
Preferred stock (265,537) converted to common shares
    4,531,684       (265 )             29                       236                
Common stock dividends
                                    (3,150 )                             (3,150 )
Change in Rabbi trust assets and similar arrangements (classified as treasury stock)
                                                    7               7  
Other, net
                                    (18 )                             (18 )
 
                                                     
Net change
    (3,517,737 )     56             163       3,640       12       (414 )     (60 )     3,397  
 
                                                     

BALANCE DECEMBER 31, 2004

    1,694,591,637       270       2,894       9,806       26,482       950       (2,247 )     (289 )     37,866  
 
                                                     
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 retained interests
                                            (298 )                     (298 )
Net unrealized gains on derivatives and hedging activities
                                            8                       8  
 
                                                                     
Total comprehensive income
                                                                    7,386  
Common stock issued
    28,764,493                       91       (198 )             1,617               1,510  
Common stock issued for acquisitions
    1,954,502                       12                       110               122  
Common stock repurchased
    (52,798,864 )                                             (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
    5,071,264       (307 )             21                       286               --  
Common stock dividends
                                    (3,375 )                             (3,375 )
Other, net
                                                    3               3  
 
                                                     
Net change
    (17,008,605 )     55             128       4,098       (285 )     (1,143 )     (59 )     2,794  
 
                                                     

BALANCE DECEMBER 31, 2005

    1,677,583,032     $ 325     $ 2,894     $ 9,934     $ 30,580     $ 665     $ (3,390 )   $ (348 )   $ 40,660  
 
                                                     
   
The accompanying notes are an integral part of these statements.

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Wells Fargo & Company and Subsidiaries
Consolidated Statement of Cash Flows
                         
   
(in millions)   Year ended December 31 ,
    2005     2004     2003  

Cash flows from operating activities:

                       
Net income
  $ 7,671     $ 7,014     $ 6,202  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Provision for credit losses
    2,383       1,717       1,722  
Provision (reversal of provision) for mortgage servicing rights in excess of fair value
    (378 )     (208 )     1,092  
Depreciation and amortization
    4,161       3,449       4,305  
Net gains on securities available for sale
    (40 )     (60 )     (62 )
Net gains on mortgage loan origination/sales activities
    (1,085 )     (539 )     (3,019 )
Other net losses (gains)
    (75 )     9       (11 )
Preferred shares released to ESOP
    307       265       224  
Net decrease (increase) in trading assets
    (1,905 )     (81 )     1,248  
Net increase in deferred income taxes
    813       432       1,698  
Net increase in accrued interest receivable
    (796 )     (196 )     (148 )
Net increase (decrease) in accrued interest payable
    311       47       (63 )
Originations of mortgages held for sale
    (230,897 )     (221,978 )     (382,335 )
Proceeds from sales of mortgages originated for sale
    214,740       217,272       404,207  
Principal collected on mortgages originated for sale
    1,426       1,409       3,136  
Net decrease (increase) in loans originated for sale
    683       (1,331 )     (832 )
Other assets, net
    (10,237 )     (2,468 )     (5,099 )
Other accrued expenses and liabilities, net
    3,585       1,732       (1,070 )
 
                 

Net cash provided (used) by operating activities

    (9,333 )     6,485       31,195  
 
                 

Cash flows from investing activities:

                       
Securities available for sale:
                       
Sales proceeds
    19,059       6,322       7,357  
Prepayments and maturities
    6,972       8,823       13,152  
Purchases
    (28,634 )     (16,583 )     (25,131 )
Net cash acquired from (paid for) acquisitions
    66       (331 )     (822 )
Increase in banking subsidiaries’ loan originations, net of collections
    (42,309 )     (33,800 )     (36,235 )
Proceeds from sales (including participations) of loans by banking subsidiaries
    42,239       14,540       1,590  
Purchases (including participations) of loans by banking subsidiaries
    (8,853 )     (5,877 )     (15,087 )
Principal collected on nonbank entities’ loans
    22,822       17,996       17,638  
Loans originated by nonbank entities
    (33,675 )     (27,751 )     (21,792 )
Purchases of loans by nonbank entities
                (3,682 )
Proceeds from sales of foreclosed assets
    444       419       264  
Net increase in federal funds sold, securities purchased under resale agreements and other short-term investments
    (281 )     (1,287 )     (208 )
Net increase in mortgage servicing rights
    (4,595 )     (1,389 )     (3,875 )
Other, net
    (3,324 )     (516 )     3,852  
 
                 

Net cash used by investing activities

    (30,069 )     (39,434 )     (62,979 )
 
                 

Cash flows from financing activities:

                       
Net increase in deposits
    38,961       27,327       28,643  
Net increase (decrease) in short-term borrowings
    1,878       (2,697 )     (8,901 )
Proceeds from issuance of long-term debt
    26,473       29,394       29,490  
Long-term debt repayment
    (18,576 )     (19,639 )     (17,931 )
Proceeds from issuance of guaranteed preferred beneficial interests in Company’s subordinated debentures
                700  
Proceeds from issuance of common stock
    1,367       1,271       944  
Preferred stock redeemed
                (73 )
Common stock repurchased
    (3,159 )     (2,188 )     (1,482 )
Cash dividends paid on preferred and common stock
    (3,375 )     (3,150 )     (2,530 )
Other, net
    (1,673 )     (13 )     651  
 
                 

Net cash provided by financing activities

    41,896       30,305       29,511  
 
                 

Net change in cash and due from banks

    2,494       (2,644 )     (2,273 )

Cash and due from banks at beginning of year

    12,903       15,547       17,820  
 
                 

Cash and due from banks at end of year

  $ 15,397     $ 12,903     $ 15,547  
 
                 

Supplemental disclosures of cash flow information:

                       
Cash paid during the year for:
                       
Interest
  $ 7,769     $ 3,864     $ 3,348  
Income taxes
    3,584       2,326       2,713  
Noncash investing and financing activities:
                       
Net transfers from loans to mortgages held for sale
    41,270       11,225       368  
Net transfers from loans held for sale to loans
    7,444              
Transfers from loans to foreclosed assets
    567       603       411  
Transfers from mortgages held for sale to securities available for sale
    5,490              
   
The accompanying notes are an integral part of these statements.

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Notes to Financial Statements
Note 1: Summary of Significant Accounting Policies
 

Wells Fargo & Company is a diversified financial services company. We provide banking, insurance, investments, mortgage banking and consumer finance through banking stores, the internet and other distribution channels to consumers, businesses and institutions in all 50 states of the U.S. and in other countries. In this Annual Report, Wells Fargo & Company and Subsidiaries (consolidated) are called the Company. Wells Fargo & Company (the Parent) is a financial holding company and a bank holding company.
     Our accounting and reporting policies conform with 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 mortgage servicing rights (Notes 20 and 21) and pension accounting (Note 15). Actual results could differ from those estimates.
     The following is a description of our significant accounting policies.
Consolidation
Our consolidated financial statements include the accounts of the Parent and our majority-owned subsidiaries and variable interest entities (VIEs) (defined below) in which we are the primary beneficiary. Significant intercompany accounts and transactions are eliminated in consolidation. If we own at least 20% of an 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.
Securities
SECURITIES AVAILABLE FOR SALE Debt securities that we might not hold until maturity and marketable equity securities are classified as securities available for sale and reported at estimated fair value. Unrealized gains and losses, after applicable taxes, are reported in cumulative other comprehensive income. We use current quotations, where available, to estimate the fair value of these securities. Where current quotations are not available, we estimate fair value based on the present value of future cash flows, adjusted for the credit rating of the securities, prepayment assumptions and other factors.
     We reduce the asset value when we consider the declines in the value of debt securities and marketable equity securities to be other-than-temporary and record the estimated loss in noninterest income. The initial indicator of impairment for both debt and marketable equity securities is a sustained decline in market price below the amount recorded for that investment. We consider the length of time and the extent to which market value has been less than cost, any recent events specific to the issuer and economic conditions of its industry and our investment horizon in relationship to an anticipated near-term recovery in the stock or bond price, if any.
     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.


64


 

     We manage these investments within capital risk limits approved by management and the Board of Directors and monitored by the Corporate Asset/Liability Management Committee. We recognize realized gains and losses on the sale of these securities in noninterest income using the specific identification method.
     Unamortized premiums and discounts are recognized in interest income over the contractual life of the security using the interest method. As principal repayments are received on securities (i.e., primarily mortgage-backed securities) a pro-rata portion of the unamortized premium or discount is recognized in interest income.
NONMARKETABLE EQUITY SECURITIES Nonmarketable equity securities include venture capital equity securities that are not publicly traded and securities acquired for various purposes, such as to meet regulatory requirements (for example, Federal Reserve Bank and Federal Home Loan Bank stock). We review these assets at least quarterly for possible other-than-temporary impairment. Our review typically includes an analysis of the facts and circumstances of each investment, the expectations for the investment’s cash flows and capital needs, the viability of its business model and our exit strategy. These securities are accounted for under the cost or equity method and are included in other assets. We reduce the asset value when we consider declines in value to be other-than-temporary. We recognize the estimated loss as a loss from equity investments in noninterest income.
Mortgages Held for Sale
Mortgages held for sale include residential mortgages that were originated in accordance with secondary market pricing and underwriting standards and certain mortgages originated initially for investment and not underwritten to secondary market standards, and are stated 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 mortgage banking noninterest income upon sale of the loan.
Loans Held for Sale
Loans held for sale are carried at the lower of cost or market value. 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 the 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.
     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) 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 are placed on nonaccrual status only when part of the principal has been charged off. These loans are entirely charged off when deemed uncollectible or when they reach a defined number of days past due based on loan product, industry practice, country, terms and other factors.
     When we place a loan on nonaccrual status, we reverse the accrued and unpaid interest receivable against interest income and account for the loan on the cash or cost recovery method, until it qualifies for return to accrual status. Generally, we return a loan to accrual status when (a) all delinquent interest and principal becomes current under the terms of the loan agreement or (b) the loan is both well-secured and in the process of collection and collectibility is no longer doubtful, after a period of demonstrated performance.
IMPAIRED LOANS We assess, account for and disclose as impaired certain nonaccrual commercial and commercial real estate loans that are over $3 million. We consider a loan to be impaired when, based on current information and events, we will probably not be able to collect all amounts due according to the loan contract, including scheduled interest payments.
     When we identify a loan as impaired, we measure the impairment 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, instead of discounted cash flows.
     If we determine that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), we recognize impairment through an allocated reserve or a charge-off to the allowance.


65


 

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. Our determination of the allowance, and the resulting provision, is based on judgments and assumptions, including:
    general economic conditions;
    loan portfolio composition;
    loan loss experience;
    management’s evaluation of credit risk relating to pools of loans and individual borrowers;
    sensitivity analysis and expected loss models; and
    observations from our internal auditors, internal loan review staff or banking regulators.
Transfers and Servicing of Financial Assets
We account for a transfer of financial assets as a sale when we surrender control of the transferred assets. Servicing rights and other retained interests in the sold assets are recorded by allocating the previously recorded investment between the assets sold and the interest retained based on their relative fair values at the date of transfer. We determine the fair values of servicing rights and other retained interests at the date of transfer using the present value of estimated future cash flows, using assumptions that market participants use in their estimates of values. We use quoted market prices when available to determine the value of other retained interests.
     We recognize the rights to service mortgage loans for others, or mortgage servicing rights (MSRs), as assets whether we purchase the servicing rights or sell or securitize loans we originate and retain servicing rights. MSRs are amortized in proportion to, and over the period of, estimated net servicing income. The amortization of MSRs is analyzed monthly and is adjusted to reflect changes in prepayment speeds, as well as other factors.
     To determine the fair value of MSRs, we use a valuation model that calculates the present value of estimated future net servicing income. We use assumptions in the valuation model that market participants use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, ancillary income and late fees.
     At the end of each quarter, we evaluate MSRs for possible impairment based on the difference between the carrying amount and current fair value, in accordance with Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS 140). To evaluate and measure impairment we stratify the portfolio based on certain risk characteristics, including loan type and note rate. If temporary impairment
exists, we establish a valuation allowance through a charge to income for those risk stratifications with an excess of amortized cost over the current fair value. If we later determine that all or a portion of the temporary impairment no longer exists for a particular risk stratification, we will reduce the valuation allowance through an increase to income.
     Under our policy, we evaluate other-than-temporary impairment of MSRs by considering both historical and projected trends in interest rates, pay off activity and whether the impairment could be recovered through interest rate increases. We recognize a direct write-down when we determine that the recoverability of a recorded valuation allowance is remote. A direct write-down permanently reduces the carrying value of the MSRs, while a valuation allowance (temporary impairment) can be reversed.
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 or changes in circumstances indicate that their carrying amounts may not be recoverable. Impairment is indicated if the sum of undiscounted estimated future net cash flows is less than the carrying value of the asset. Impairment is permanently recognized by writing down the asset to the extent that the carrying value exceeds the estimated fair value.


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Operating Lease Assets
Operating lease rental income for leased assets, generally automobiles, is recognized in other income on a straight-line basis over the lease term. Related depreciation expense is recorded on a straight-line basis over the life of the lease, taking into account the estimated residual value of the leased asset. On a periodic basis, leased assets are reviewed for impairment. Impairment loss is recognized if the carrying amount of leased assets exceeds fair value and is not recoverable. The carrying amount of leased assets is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the lease payments and the estimated residual value upon the eventual disposition of the equipment. Auto lease receivables are written off when 120 days past due.
Pension Accounting
We account for our defined benefit pension plans using an actuarial model required by FAS 87, Employers’ Accounting for Pensions. This model allocates pension costs over the service period of employees in the plan. The underlying principle is that employees render service ratably over this period and, therefore, the income statement effects of pensions should follow a similar pattern.
     One of the principal components of the net periodic pension calculation is the expected long-term rate of return on plan assets. The use of an expected long-term rate of return on plan assets may cause us to recognize pension income returns that are greater or less than the actual returns of plan assets in any given year.
     The expected long-term rate of return is designed to approximate the actual long-term rate of return over time and is not expected to change significantly. Therefore, the pattern of income/expense recognition 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) the actual return earned on plan assets, (2) historical rates of return on the various asset classes in the plan portfolio, (3) projections of returns on various asset classes, and (4) current/prospective capital market conditions and economic forecasts. Differences in each year, if any, between expected and actual returns are included in our unrecognized net actuarial gain or loss amount. We generally amortize any unrecognized net actuarial gain or loss in excess of a 5% corridor (as defined in FAS 87) in net periodic pension calculations over the next five years.
     We use a discount rate to determine the present value of our future benefit obligations. The discount rate reflects the rates available at the measurement date on long-term high-quality fixed-income debt instruments and is reset annually on the measurement date (November 30).
Income Taxes
We file a consolidated federal income tax return and, in certain states, combined state tax returns.
     We determine deferred income tax assets and liabilities using the balance sheet method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and recognizes enacted changes in tax rates and laws. Deferred tax assets are recognized subject to management judgment that realization is more likely than not. Foreign taxes paid are generally applied as credits to reduce federal income taxes payable.
Stock-Based Compensation
We have several stock-based employee compensation plans, which are described more fully in Note 14. As permitted by FAS 123, Accounting for Stock-Based Compensation, we have elected to apply the intrinsic value method of Accounting Principles Board Opinion 25, Accounting for Stock Issued to Employees (APB 25), in accounting for stock-based employee compensation plans through December 31, 2005. Pro forma net income and earnings per common share information is provided below, as if we accounted for employee stock option plans under the fair value method of FAS 123.
     On December 16, 2004, the FASB issued FAS 123 (revised 2004), Share-Based Payment (FAS 123R), which replaced FAS 123 and superceded APB 25. We adopted FAS 123R on January 1, 2006, which requires us to measure the cost of employee services received in exchange for an award of equity instruments, such as stock options or restricted stock, based on the fair value of the award on the grant date. This cost must be recognized in the income statement over the vesting period of the award.
                         
 
(in millions, except per   Year ended December 31 ,
share amounts)   2005     2004     2003  

Net income, as reported

  $ 7,671     $ 7,014     $ 6,202  

Add: Stock-based employee compensation expense included in reported net income, net of tax

    1       2       3  
Less: Total stock-based employee compensation expense under the fair value method for all awards, net of tax
    (188 )     (275 )     (198 )
 
                 
Net income, pro forma
  $ 7,484     $ 6,741     $ 6,007  
 
                 

Earnings per common share

                       
As reported
  $ 4.55     $ 4.15     $ 3.69  
Pro forma
    4.44       3.99       3.57  
Diluted earnings per common share
                       
As reported
  $ 4.50     $ 4.09     $ 3.65  
Pro forma
    4.38       3.93       3.53  
 


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     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 on the previous page. Stock options granted in our 2003, 2002 and 2001 annual grants under the Plan vest over a three-year period, and expense reflected in the table for these grants is recognized over the vesting period.
Earnings Per Common Share
We present earnings per common share and diluted earnings per common share. We compute earnings per common share by dividing net income (after deducting dividends on preferred stock) by the average number of common shares outstanding during the year. We compute diluted earnings per common share by dividing net income (after deducting dividends on preferred stock) by the average number of common shares outstanding during the year, plus the effect of common stock equivalents (for example, stock options, restricted share rights and convertible debentures) that are dilutive.
Derivatives and Hedging Activities
We recognize all derivatives on the balance sheet at fair value. On the date we enter into a derivative contract, we designate the derivative as (1) a hedge of the fair value of a recognized asset or liability (“fair value” hedge), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow” hedge) or (3) held for trading, customer accommodation or for risk management not qualifying for hedge accounting (“free-standing derivative”). For a fair value hedge, we record changes in the fair value of the derivative and, to the extent that it is effective, changes in the fair value of the hedged asset or liability attributable to the hedged risk, in current period 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. We subsequently reclassify these changes in fair value to net income in the same period(s) that the hedged transaction affects net income in the same financial statement category as the hedged item. For free-standing derivatives, we report changes in the fair values in current period noninterest income.
     We formally document 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 on 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 either the dollar offset or the regression analysis method. If we determine that a derivative is not highly effective as a hedge, we discontinue hedge accounting.
     We discontinue hedge accounting prospectively when (1) a derivative is no longer highly effective in offsetting changes in the fair value or cash flows of a hedged item, (2) a derivative expires or is sold, terminated, or exercised, (3) a derivative is dedesignated as a hedge, because it is unlikely that a forecasted transaction will occur, or (4) we determine that designation of a derivative as a hedge is no longer appropriate.
     When we discontinue hedge accounting because a derivative no longer qualifies as an effective fair value hedge, we continue to carry the derivative on the balance sheet at its fair value with changes in fair value included in earnings, and no longer adjust the previously hedged asset or liability for changes in fair value. Previous adjustments to the hedged item are accounted for in the same manner as other components of the carrying amount of the asset or liability.
     When we discontinue hedge accounting because it is probable that a forecasted transaction will not occur, we continue to carry the derivative on the balance sheet at its fair value with changes in fair value included in earnings, and immediately recognize gains and losses that were accumulated in other comprehensive income in earnings.
     When we discontinue hedge accounting because the hedging instrument is sold, terminated, or no longer designated (dedesignated), the amount reported in other comprehensive income up to the date of sale, termination or dedesignation continues to be reported in other comprehensive income until the forecasted transaction affects earnings.
     In all other situations in which we discontinue hedge accounting, the derivative will be carried at its fair value on the balance sheet, with changes in its fair value recognized in current period earnings.
     We occasionally purchase or originate financial instruments that contain an embedded derivative. At inception of the financial instrument, we assess (1) if the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the financial instrument (host contract), (2) if the financial instrument that embodies both the embedded derivative and the host contract is measured at fair value with changes in fair value reported in earnings, or (3) if a separate instrument with the same terms as the embedded instrument would meet the definition of a derivative. If the embedded derivative does not meet any of these conditions, we separate it from the host contract and carry it at fair value with changes recorded in current period earnings.


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Note 2: Business Combinations
 

We regularly explore opportunities to acquire financial services companies and businesses. Generally, we do not make a public announcement about an acquisition opportunity until a definitive agreement has been signed.
     Effective December 31, 2004, we completed the acquisition of $29 billion in assets under management, consisting of $24 billion in mutual fund assets and $5 billion in institutional investment accounts, from Strong Financial Corporation. Other business combinations completed in 2005, 2004 and 2003 are presented below.
     At December 31, 2005, we had three pending business combinations with total assets of approximately $278 million. We expect to complete these transactions by second quarter 2006.
     For information on contingent consideration related to acquisitions, which is considered to be a guarantee, see Note 24.


                 
 
(in millions)     Date   Assets  

2005

               
Certain branches of PlainsCapital Bank, Amarillo, Texas
  July 22   $ 190  
First Community Capital Corporation, Houston, Texas
  July 31     644  
Other (1)
  Various     40  
 
             
 
          $ 874  
 
             

2004

               
Other (2)
  Various   $ 74  
 
             

2003

               
Certain assets of Telmark, LLC, Syracuse, New York
  February 28   $ 660  
Pacific Northwest Bancorp, Seattle, Washington
  October 31     3,245  
Two Rivers Corporation, Grand Junction, Colorado
  October 31     74  
Other (3)
  Various     136  
 
             
 
          $ 4,115  
 
             
 
(1)   Consists of 8 acquisitions of insurance brokerage and lockbox processing businesses.
(2)   Consists of 13 acquisitions of insurance brokerage and payroll services businesses.
(3)   Consists of 14 acquisitions of asset management, commercial real estate brokerage, bankruptcy and insurance brokerage 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 $1.4 billion in 2005 and $1.2 billion in 2004.
     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 25.)
     Dividends paid by our subsidiary banks are subject to various federal and state regulatory limitations. Dividends that may be paid by a national bank without the express
approval of the Office of the Comptroller of the Currency (OCC) are limited to that bank’s retained net profits for the preceding two calendar years plus retained net profits up to the date of any dividend declaration in the current calendar year. Retained net profits, as defined by the OCC, consist of net income less dividends declared during the period. We also have state-chartered subsidiary banks that are subject to state regulations that limit dividends. Under those provisions, our national and state-chartered subsidiary banks could have declared additional dividends of $1,185 million at December 31, 2005, 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 year-end 2005, our nonbank subsidiaries could have declared additional dividends of $2,411 million at December 31, 2005, without obtaining prior approval.


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

The table to the right provides the detail of federal funds sold, securities purchased under resale agreements and other short-term investments.
                 
 
(in millions)   December 31 ,
    2005     2004  

Federal funds sold and securities purchased under resale agreements

  $ 3,789     $ 3,009  
Interest-earning deposits
    847       1,397  
Other short-term investments
    670       614  
 
           
Total
  $ 5,306     $ 5,020  
 
           
 


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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. There were no securities classified as held to maturity as of the periods presented.


                                                                 
 
(in millions)   December 31 ,
    2005     2004  
    Cost     Unrealized     Unrealized     Fair     Cost     Unrealized     Unrealized     Fair  
          gross     gross     value           gross     gross     value  
          gains     losses                 gains     losses        

Securities of U.S. Treasury and federal agencies

  $ 845     $ 4     $ (10 )   $ 839     $ 1,128     $ 16     $ (4 )   $ 1,140  
Securities of U.S. states and political subdivisions
    3,048       149       (6 )     3,191       3,429       196       (4 )     3,621  
Mortgage-backed securities:
                                                               
Federal agencies
    25,304       336       (24 )     25,616       20,198       750       (4 )     20,944  
Private collateralized mortgage obligations (1)
    6,628       128       (6 )     6,750       4,082       121       (4 )     4,199  
 
                                               
Total mortgage-backed securities
    31,932       464       (30 )     32,366       24,280       871       (8 )     25,143  
Other
    4,518       75       (55 )     4,538       2,974       157       (14 )     3,117  
 
                                               
Total debt securities
    40,343       692       (101 )     40,934       31,811       1,240       (30 )     33,021  
Marketable equity securities
    558       349       (7 )     900       507       198       (9 )     696  
 
                                               
Total (2)
  $ 40,901     $ 1,041     $ (108 )   $ 41,834     $ 32,318     $ 1,438     $ (39 )   $ 33,717  
 
                                               
 
(1)   Substantially all of the private collateralized mortgage obligations are AAA-rated bonds collateralized by 1-4 family residential first mortgages.
(2)   At December 31, 2005, we held no securities of any single issuer (excluding the U.S. Treasury and federal agencies) with a book value that exceeded 10% of stockholders’ equity.

     The following table shows the unrealized gross losses and fair value of securities in the securities available for sale portfolio at December 31, 2005 and 2004, by length of time that individual securities in each category had been in a continuous loss position.
     The decline in fair value for the debt securities that had been in a continuous loss position for 12 months or more at December 31, 2005, was primarily due to changes in market
interest rates and not due to the credit quality of the securities. We believe that the principal and interest on these securities are fully collectible and we have the intent and ability to retain our investment for a period of time to allow for any anticipated recovery in market value. We have reviewed these securities in accordance with our policy and do not consider them to be other-than-temporarily impaired.


                                                 
 
(in millions)   Less than 12 months     12 months or more     Total  
    Unrealized     Fair     Unrealized     Fair     Unrealized     Fair  
    gross     value     gross     value     gross     value  
    losses           losses           losses        

December 31, 2005

                                               

Securities of U.S. Treasury and federal agencies

  $ (6 )   $ 341     $ (4 )   $ 142     $ (10 )   $ 483  
Securities of U.S. states and political subdivisions
    (3 )     204       (3 )     57       (6 )     261  
Mortgage-backed securities:
                                               
Federal agencies
    (22 )     2,213       (2 )     89       (24 )     2,302  
Private collateralized mortgage obligations
    (6 )     1,494                   (6 )     1,494  
 
                                   
Total mortgage-backed securities
    (28 )     3,707       (2 )     89       (30 )     3,796  
Other
    (38 )     890       (17 )     338       (55 )     1,228  
 
                                   
Total debt securities
    (75 )     5,142       (26 )     626       (101 )     5,768  
Marketable equity securities
    (7 )     185                   (7 )     185  
 
                                   
Total
  $ (82 )   $ 5,327     $ (26 )   $ 626     $ (108 )   $ 5,953  
 
                                   

December 31, 2004

                                               

Securities of U.S. Treasury and federal agencies

  $ (4 )   $ 304     $     $     $ (4 )   $ 304  
Securities of U.S. states and political subdivisions
    (1 )     65       (3 )     62       (4 )     127  
Mortgage-backed securities:
                                               
Federal agencies
    (4 )     450                   (4 )     450  
Private collateralized mortgage obligations
    (4 )     981                   (4 )     981  
 
                                   
Total mortgage-backed securities
    (8 )     1,431                   (8 )     1,431  
Other
    (11 )     584       (3 )     56       (14 )     640  
 
                                   
Total debt securities
    (24 )     2,384       (6 )     118       (30 )     2,502  
Marketable equity securities
    (9 )     44                   (9 )     44  
 
                                   
Total
  $ (33 )   $ 2,428     $ (6 )   $ 118     $ (39 )   $ 2,546  
 
                                   
 

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     Securities pledged where the secured party has the right to sell or repledge totaled $5.3 billion at December 31, 2005, and $2.3 billion at December 31, 2004. Securities pledged where the secured party does not have the right to sell or repledge totaled $24.3 billion at December 31, 2005, and $19.4 billion at December 31, 2004, primarily to secure trust and public deposits and for other purposes as required or permitted by law. We have accepted collateral in the form of securities that we have the right to sell or repledge of $3.4 billion at December 31, 2005, and $2.5 billion at December 31, 2004, of which we sold or repledged $2.3 billion and $1.7 billion, respectively.
     The following table shows the realized net gains on the sales of securities from the securities available for sale portfolio, including marketable equity securities.
                         
 
(in millions)   Year ended December 31 ,
    2005     2004     2003  

Realized gross gains

  $ 355     $ 168     $ 178  
Realized gross losses (1)
    (315 )     (108 )     (116 )
 
                 
Realized net gains
  $ 40     $ 60     $ 62  
 
                 
 
(1)   Includes other-than-temporary impairment of $45 million, $9 million and $50 million for 2005, 2004 and 2003, respectively.
     The following table shows the remaining contractual principal maturities and contractual yields of debt securities available for sale. The remaining contractual principal maturities for mortgage-backed securities were allocated assuming no prepayments. Remaining expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations before the underlying mortgages mature.


                                                                                 
 
(in millions)   December 31, 2005  
    Total     Weighted-     Remaining contractual principal maturity  
    amount     average                     After one year     After five years        
          yield     Within one year     through five years     through ten years     After ten years  
                Amount     Yield     Amount     Yield     Amount     Yield     Amount     Yield  

Securities of U.S. Treasury and federal agencies

  $ 839       4.38 %   $ 50       5.11 %   $ 677       4.21 %   $ 93       4.69 %   $ 19       6.88 %
Securities of U.S. states and political subdivisions
    3,191       7.57       86       6.63       281       6.06       560       7.25       2,264       7.87  
Mortgage-backed securities:
                                                                               
Federal agencies
    25,616       5.68       33       6.02       49       6.51       69       5.91       25,465       5.68  
Private collateralized mortgage obligations
    6,750       5.40                               42       6.45       6,708       5.40  
 
                                                                     
Total mortgage-backed securities
    32,366       5.62       33       6.02       49       6.51       111       6.12       32,173       5.62  
Other
    4,538       6.11       225       5.80       2,773       5.70       953       7.13       587       6.53  
 
                                                                     
Total debt securities at fair value (1)
  $ 40,934       5.80 %   $ 394       5.91 %   $ 3,780       5.47 %   $ 1,717       6.97 %   $ 35,043       5.78 %
 
                                                           
 
(1)   The weighted-average yield is computed using the contractual life amortization method.

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Note 6: Loans and Allowance for Credit Losses
 

A summary of the major categories of loans outstanding is shown in the following table. Outstanding loan balances reflect unearned income, net deferred loan fees, and unamortized discount and premium totaling $3,918 million and $3,766 million at December 31, 2005 and 2004, respectively.
     Loan concentrations may exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities or similar types of loans extended to a diverse group of borrowers that would cause them to be similarly impacted by economic or other conditions. At December 31, 2005 and 2004, we did not have concentrations representing 10% or more of our total loan portfolio in commercial loans (by industry); commercial real estate loans (other real estate mortgage and real estate construction) (by state or property type); or other revolving credit and installment loans (by product type). Our real estate 1-4 family mortgage loans to borrowers in the state of California represented approximately
14% of total loans at December 31, 2005, compared with 18% at the end of 2004. These loans are mostly within the larger metropolitan areas in California, with no single area consisting of more than 3% of our total loans. Changes in real estate values and underlying economic conditions for these areas are monitored continuously within our credit risk management process.
     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, 2005, such loans were approximately 26% of total loans, compared with 28% at the end of 2004. Substantially all of these loans are considered to be prime or near prime. We do not offer option adjustable-rate mortgage products, nor do we offer variable-rate mortgage products with fixed payment amounts, commonly referred to within the financial services industry as negative amortizing mortgage loans.


                                         
 
(in millions)   December 31 ,
    2005     2004     2003     2002     2001  

Commercial and commercial real estate:

                                       
Commercial
  $ 61,552     $ 54,517     $ 48,729     $ 47,292     $ 47,547  
Other real estate mortgage
    28,545       29,804       27,592       25,312       24,808  
Real estate construction
    13,406       9,025       8,209       7,804       7,806  
Lease financing
    5,400       5,169       4,477       4,085       4,017  
 
                             
Total commercial and commercial real estate
    108,903       98,515       89,007       84,493       84,178  
Consumer:
                                       
Real estate 1-4 family first mortgage
    77,768       87,686       83,535       44,119       29,317  
Real estate 1-4 family junior lien mortgage
    59,143       52,190       36,629       28,147       21,801  
Credit card
    12,009       10,260       8,351       7,455       6,700  
Other revolving credit and installment
    47,462       34,725       33,100       26,353       23,502  
 
                             
Total consumer
    196,382       184,861       161,615       106,074       81,320  
Foreign
    5,552       4,210       2,451       1,911       1,598  
 
                             
Total loans
  $ 310,837     $ 287,586     $ 253,073     $ 192,478     $ 167,096  
 
                             
 

     For certain extensions of credit, we may require collateral, based on our assessment of a customer’s credit risk. We hold various types of collateral, including accounts receivable, inventory, land, buildings, equipment, automobiles, financial instruments, income-producing commercial properties and residential real estate. Collateral requirements for each customer may vary according to the specific credit underwriting, terms and structure of loans funded immediately or under a commitment to fund at a later date.
     A commitment to extend credit is a legally binding agreement to lend funds to a customer, usually at a stated interest rate and for a specified purpose. These commitments have
fixed expiration dates and generally require a fee. When we make such a commitment, we have credit risk. The liquidity requirements or credit risk will be lower than the contractual amount of commitments to extend credit because a significant portion of these commitments are expected to expire without being used. Certain commitments are subject to loan agreements with covenants regarding the financial performance of the customer that must be met before we are required to fund the commitment. We use the same credit policies in extending credit for unfunded commitments and letters of credit that we use in making loans. For information on standby letters of credit, see Note 24.


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     In addition, we manage the potential risk in credit commitments by limiting the total amount of arrangements, both by individual customer and in total, by monitoring the size and maturity structure of these portfolios and by applying the same credit standards for all of our credit activities.
     The total of our unfunded loan commitments, net of all funds lent and all standby and commercial letters of credit issued under the terms of these commitments, is summarized by loan category in the following table:
                 
 
(in millions)   December 31 ,
    2005     2004  

Commercial and commercial real estate:

               
Commercial
  $ 71,548     $ 59,603  
Other real estate mortgage
    2,398       2,788  
Real estate construction
    9,369       7,164  
 
           
Total commercial and commercial real estate
    83,315       69,555  
Consumer:
               
Real estate 1-4 family first mortgage
    10,229       9,009  
Real estate 1-4 family junior lien mortgage
    37,909       31,396  
Credit card
    45,270       38,200  
Other revolving credit and installment
    13,957       15,427  
 
           
Total consumer
    107,365       94,032  
Foreign
    675       407  
 
           
Total unfunded loan commitments
  $ 191,355     $ 163,994  
 
           
 
     We have an established process to determine the adequacy of the allowance for credit losses that assesses the risks and losses inherent in our portfolio. This process supports an allowance consisting of two components, allocated and unallocated. For the allocated component, we combine estimates of the allowances needed for loans analyzed on a pooled basis and loans analyzed individually (including impaired loans).
     Approximately two-thirds of the allocated allowance is determined at a pooled level for consumer loans and some segments of commercial small business loans. We use forecasting models to measure inherent loss in these portfolios. We frequently validate and update these models to capture recent behavioral characteristics of the portfolios, as well as changes in our loss mitigation or marketing strategies.
     The remaining allocated allowance is for commercial loans, commercial real estate loans and lease financing. We initially estimate this portion of the allocated allowance by applying historical loss factors statistically derived from tracking loss content 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. Also, we individually review nonperforming loans over $3 million for impairment based on cash flows or collateral. We include the impairment on these nonperforming loans in the allocated allowance unless it has already been recognized as a loss.
     The potential risk from unfunded loan commitments and letters of credit for wholesale loan portfolios is considered along with the loss analysis of loans outstanding. Unfunded commercial loan commitments and letters of credit are converted to a loan equivalent factor as part of the analysis. The reserve for unfunded credit commitments was $186 million at December 31, 2005, and $188 million at December 31, 2004, both representing less than 5% of the total allowance for credit losses.
     The allocated allowance is supplemented by the unallocated allowance to adjust for imprecision and to incorporate the range of probable outcomes inherent in estimates used for the allocated allowance. The unallocated allowance is the result of our judgment of risks inherent in the portfolio, economic uncertainties, historical loss experience and other subjective factors, including industry trends.
     No material changes in estimation methodology for the allowance for credit losses were made in 2005.
     The ratios of the allocated allowance and the unallocated allowance to the total allowance may change from period to period. The total allowance reflects management’s estimate of credit losses inherent in the loan portfolio, including unfunded credit commitments, at December 31, 2005.
     Like all national banks, our subsidiary national banks continue to be subject to examination by their primary regulator, the Office of the Comptroller of the Currency (OCC), and some have OCC examiners in residence. The OCC examinations occur throughout the year and target various activities of our subsidiary national banks, including both the loan grading system and specific segments of the loan portfolio (for example, commercial real estate and shared national credits). The Parent and its nonbank subsidiaries are examined by the Federal Reserve Board.
     We consider the allowance for credit losses of $4.06 billion adequate to cover credit losses inherent in the loan portfolio, including unfunded credit commitments, at December 31, 2005.


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     The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded credit commitments. Changes in the allowance for credit losses were:
                                         
 
(in millions)   Year ended December 31 ,
    2005     2004     2003     2002     2001  

Balance, beginning of year

  $ 3,950     $ 3,891     $ 3,819     $ 3,717     $ 3,681  

Provision for credit losses

    2,383       1,717       1,722       1,684       1,727  

Loan charge-offs:

                                       
Commercial and commercial real estate:
                                       
Commercial
    (406 )     (424 )     (597 )     (716 )     (692 )
Other real estate mortgage
    (7 )     (25 )     (33 )     (24 )     (32 )
Real estate construction
    (6 )     (5 )     (11 )     (40 )     (37 )
Lease financing
    (35 )     (62 )     (41 )     (21 )     (22 )
 
                             
Total commercial and commercial real estate
    (454 )     (516 )     (682 )     (801 )     (783 )
Consumer:
                                       
Real estate 1-4 family first mortgage
    (111 )     (53 )     (47 )     (39 )     (40 )
Real estate 1-4 family junior lien mortgage
    (136 )     (107 )     (77 )     (55 )     (36 )
Credit card
    (553 )     (463 )     (476 )     (407 )     (421 )
Other revolving credit and installment
    (1,480 )     (919 )     (827 )     (770 )     (770 )
 
                             
Total consumer
    (2,280 )     (1,542 )     (1,427 )     (1,271 )     (1,267 )
Foreign
    (298 )     (143 )     (105 )     (84 )     (78 )
 
                             
Total loan charge-offs
    (3,032 )     (2,201 )     (2,214 )     (2,156 )     (2,128 )
 
                             
Loan recoveries:
                                       
Commercial and commercial real estate:
                                       
Commercial
    133       150       177       162       96  
Other real estate mortgage
    16       17       11       16       22  
Real estate construction
    13       6       11       19       3  
Lease financing
    21       26       8              
 
                             
Total commercial and commercial real estate
    183       199       207       197       121  
Consumer:
                                       
Real estate 1-4 family first mortgage
    21       6       10       8       6  
Real estate 1-4 family junior lien mortgage
    31       24       13       10       8  
Credit card
    86       62       50       47       40  
Other revolving credit and installment
    365       220       196       205       203  
 
                             
Total consumer
    503       312       269       270       257  
Foreign
    63       24       19       14       18  
 
                             
Total loan recoveries
    749       535       495       481       396  
 
                             
Net loan charge-offs
    (2,283 )     (1,666 )     (1,719 )     (1,675 )     (1,732 )
 
                             

Other

    7       8       69       93       41  
 
                             

Balance, end of year

  $ 4,057     $ 3,950     $ 3,891     $ 3,819     $ 3,717  
 
                             

Components:

                                       
Allowance for loan losses
  $ 3,871     $ 3,762     $ 3,891     $ 3,819     $ 3,717  
Reserve for unfunded credit commitments (1)
    186       188                    
 
                             
Allowance for credit losses
  $ 4,057     $ 3,950     $ 3,891     $ 3,819     $ 3,717  
 
                             

Net loan charge-offs as a percentage of average total loans

    .77 %     .62 %     .81 %     .96 %     1.10 %

Allowance for loan losses as a percentage of total loans

    1.25 %     1.31 %     1.54 %     1.98 %     2.22 %
Allowance for credit losses as a percentage of total loans
    1.31       1.37       1.54       1.98       2.22  
 
(1)   Effective September 30, 2004, we transferred the portion of the allowance for loan losses related to commercial lending commitments and letters of credit to other liabilities.

75


 

     Nonaccrual loans were $1,338 million and $1,358 million at December 31, 2005 and 2004, respectively. Loans past due 90 days or more as to interest or principal and still accruing interest were $3,606 million at December 31, 2005, and $2,578 million at December 31, 2004. The 2005 and 2004 balances included $2,923 million and $1,820 million, respectively, in advances pursuant to our servicing agreements to the Government National Mortgage Association mortgage pools whose repayments are insured by the Federal Housing Administration or guaranteed by the Department of Veteran Affairs.
     The recorded investment in impaired loans and the methodology used to measure impairment was:
                 
 
(in millions)   December 31 ,
    2005     2004  

Impairment measurement based on:

               
Collateral value method
  $ 115     $ 183  
Discounted cash flow method
    75       126  
 
           
Total (1)
  $ 190     $ 309  
 
           
 
(1)   Includes $56 million and $107 million of impaired loans with a related allowance of $10 million and $17 million at December 31, 2005 and 2004, respectively.
     The average recorded investment in impaired loans during 2005, 2004 and 2003 was $260 million, $481 million and $668 million, respectively.
     All of our impaired loans are on nonaccrual status. When the ultimate collectibility of the total principal of an impaired loan is in doubt, all payments are applied to principal, under the cost recovery method. When the ultimate collectibility of the total principal of an impaired loan is not in doubt, contractual interest is credited to interest income when received, under the cash basis method. Total interest income recognized for impaired loans in 2005, 2004 and 2003 under the cash basis method was not significant.


76


 

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

                 
 
(in millions)   December 31 ,
    2005     2004  

Land

  $ 649     $ 585  
Buildings
    3,617       2,974  
Furniture and equipment
    3,425       3,110  
Leasehold improvements
    1,115       1,049  
Premises and equipment leased under capital leases
    60       60  
 
           
Total premises and equipment
    8,866       7,778  
Less: Accumulated depreciation and amortization
    4,449       3,928  
 
           
Net book value, premises and equipment
  $ 4,417     $ 3,850  
 
           
 
Depreciation and amortization expense for premises and equipment was $810 million, $654 million and $666 million in 2005, 2004 and 2003, respectively.
     Net gains (losses) on dispositions of premises and equipment, included in noninterest expense, were $56 million, $(5) million and $(46) million in 2005, 2004 and 2003, respectively.
     We have obligations under a number of noncancelable operating leases for premises (including vacant premises) and equipment. The terms of these leases, including renewal options, are predominantly up to 15 years, with the longest up to 72 years, and many provide for periodic adjustment of rentals based on changes in various economic indicators. The future minimum payments under noncancelable operating leases and capital leases, net of sublease rentals, with terms greater than one year as of December 31, 2005, were:
                 
 
(in millions)   Operating leases     Capital leases  

Year ended December 31,

               
2006
  $ 514     $ 4  
2007
    426       2  
2008
    360       2  
2009
    298       1  
2010
    237       1  
Thereafter
    898       14  
 
           
Total minimum lease payments
  $ 2,733       24  
 
             

Executory costs

            (2 )
Amounts representing interest
            (8 )
 
             

Present value of net minimum lease payments

          $ 14  
 
             
 
     Operating lease rental expense (predominantly for premises), net of rental income, was $583 million, $586 million and $574 million in 2005, 2004 and 2003, respectively.
     The components of other assets were:
                 
 
(in millions)   December 31 ,
    2005     2004  

Nonmarketable equity investments:

               
Private equity investments
  $ 1,537     $ 1,449  
Federal bank stock
    1,402       1,713  
All other
    2,151       2,067  
 
           
Total nonmarketable equity investments (1)
    5,090       5,229  

Operating lease assets

    3,414       3,642  
Accounts receivable
    11,606       2,682  
Interest receivable
    2,279       1,483  
Core deposit intangibles
    489       603  
Foreclosed assets
    191       212  
Due from customers on acceptances
    104       170  
Other
    9,299       8,470  
 
           
Total other assets
  $ 32,472     $ 22,491  
 
           
 
(1)   At December 31, 2005 and 2004, $3.1 billion and $3.3 billion, respectively, of nonmarketable equity investments, including all federal bank stock, were accounted for at cost.
     Income related to nonmarketable equity investments was:
                         
 
(in millions)   Year ended December 31 ,
    2005     2004     2003  

Net gains (losses) from private equity investments

  $ 351     $ 319     $ (3 )
Net gains from all other nonmarketable equity investments
    43       33       116  
 
                 
Net gains from nonmarketable equity investments
  $ 394     $ 352     $ 113  
 
                 
 


77


 

Note 8: Intangible Assets
 

The gross carrying amount of intangible assets and accumulated amortization was:
                                 
   
(in millions)   December 31 ,
    2005     2004  
    Gross     Accumulated     Gross     Accumulated  
    carrying     amortization     carrying     amortization  
    amount           amount        

Amortized intangible assets:

                               
Mortgage servicing rights, before valuation allowance (1)
  $ 25,126     $ 11,428     $ 18,903     $ 9,437  
Core deposit intangibles
    2,432       1,943       2,426       1,823  
Other
    567       312       567       296  
 
                       
Total amortized intangible assets
  $ 28,125     $ 13,683     $ 21,896     $ 11,556  
 
                       
Unamortized intangible asset (trademark)
  $ 14             $ 14          
 
                           
 
(1)   See Note 21 for additional information on MSRs and the related valuation allowance.
     As of December 31, 2005, the current year and estimated future amortization expense for amortized intangible assets was:
                                 
   
(in millions)   Mortgage     Core     Other     Total  
    servicing     deposit              
    rights     intangibles              

Year ended December 31, 2005

  $ 1,991     $ 123     $ 55     $ 2,169  
 
                       

Estimate for year ended December 31,

                               
2006
  $ 1,959     $ 111     $ 48     $ 2,118  
2007
    1,659       101       46       1,806  
2008
    1,426       93       30       1,549  
2009
    1,246       85       25       1,356  
2010
    1,068       77       23       1,168  
 
     We based the projections of amortization expense for mortgage servicing rights shown above on existing asset balances and the existing interest rate environment as of December 31, 2005. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates and market conditions. We based the projections of amortization expense for core deposit intangibles shown above on existing asset balances at December 31, 2005. Future amortization expense may vary based on additional core deposit intangibles acquired through business combinations.


78


 

Note 9: Goodwill
 
The changes in the carrying amount of goodwill as allocated to our operating segments for goodwill impairment analysis were:
                                 
   
(in millions)   Community     Wholesale     Wells Fargo     Consolidated  
    Banking     Banking     Financial     Company  

December 31, 2003

  $ 7,286     $ 2,735     $ 350     $ 10,371  
Goodwill from business combinations
    5       302             307  
Foreign currency translation adjustments
                3       3  
 
                       

December 31, 2004

    7,291       3,037       353       10,681  
Reduction in goodwill related to divested businesses
    (31 )     (3 )           (34 )
Goodwill from business combinations
    125       13             138  
Realignment of automobile financing business
    (11 )           11        
Foreign currency translation adjustments
                2       2  
 
                       
December 31, 2005
  $ 7,374     $ 3,047     $ 366     $ 10,787  
 
                       
 

     For goodwill impairment testing, enterprise-level goodwill acquired in business combinations is allocated to reporting units based on the relative fair value of assets acquired and recorded in the respective reporting units. Through this allocation, we assigned enterprise-level goodwill to the reporting units that are expected to benefit from the synergies of the combination. We used discounted estimated future net cash flows to evaluate goodwill reported at all reporting units.
     For our goodwill impairment analysis, we allocate all of the goodwill to the individual operating segments. For management reporting we do not allocate all of the goodwill to the individual operating segments: some is allocated at the enterprise level. See Note 19 for further information on management reporting. The balances of goodwill for management reporting were:


                                         
   
(in millions)   Community     Wholesale     Wells Fargo     Enterprise     Consolidated  
    Banking     Banking     Financial           Company  

December 31, 2004

  $ 3,433     $ 1,087     $ 364     $ 5,797     $ 10,681  
 
                             

December 31, 2005

  $ 3,527     $ 1,097     $ 366     $ 5,797     $ 10,787  
 
                             
 

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Note 10: Deposits
 

The total of time certificates of deposit and other time deposits issued by domestic offices was $74,023 million and $55,495 million at December 31, 2005 and 2004, respectively. Substantially all of those deposits were interest bearing. The contractual maturities of those deposits were:
         
   
(in millions)   December 31, 2005  

2006

  $ 66,700  
2007
    3,886  
2008
    1,899  
2009
    769  
2010
    538  
Thereafter
    231  
 
     
Total
  $ 74,023  
 
     
 
     Of those deposits, the amount of time deposits with a denomination of $100,000 or more was $56,123 million and $41,851 million at December 31, 2005 and 2004, respectively. The contractual maturities of these deposits were:
         
   
(in millions)   December 31, 2005  

Three months or less

  $ 45,763  
After three months through six months
    2,154  
After six months through twelve months
    5,867  
After twelve months
    2,339  
 
     
Total
  $ 56,123  
 
     
 
     Time certificates of deposit and other time deposits issued by foreign offices with a denomination of $100,000 or more represent the majority of all of our foreign deposit liabilities of $14,621 million and $8,533 million at December 31, 2005 and 2004, respectively.
     Demand deposit overdrafts of $618 million and $470 million were included as loan balances at December 31, 2005 and 2004, respectively.


Note 11: Short-Term Borrowings
 
The table below shows selected information for short-term borrowings, which generally mature in less than 30 days.
                                                 
 
(in millions)   2005     2004     2003
    Amount     Rate     Amount     Rate     Amount     Rate

As of December 31,

                                               
Commercial paper and other short-term borrowings
  $ 3,958       3.80 %   $ 6,225       2.40 %   $ 6,709       1.26 %

Federal funds purchased and securities sold under agreements to repurchase

    19,934       3.99       15,737       2.04       17,950       .84  
 
                                         
Total
  $ 23,892       3.96     $ 21,962       2.14     $ 24,659       .95  
 
                                         

Year ended December 31,

                                               
Average daily balance
                                               
Commercial paper and other short-term borrowings
  $ 9,548       3.09 %   $ 10,010       1.56 %   $ 11,506       1.22 %

Federal funds purchased and securities sold under agreements to repurchase

    14,526       3.09       16,120       1.22       18,392       .99  
 
                                         
Total
  $ 24,074       3.09     $ 26,130       1.35     $ 29,898       1.08  
 
                                         

Maximum month-end balance

                                               
Commercial paper and other short-term borrowings (1)
  $ 15,075       N/A     $ 16,492       N/A     $ 14,462       N/A  

Federal funds purchased and securities sold under agreements to repurchase (2)

    22,315       N/A       22,117       N/A       24,132       N/A  
 
N/A — Not applicable.
 
(1)   Highest month-end balance in each of the last three years was in January 2005, July 2004 and January 2003.
 
(2)   Highest month-end balance in each of the last three years was in August 2005, June 2004 and April 2003.

80


 

Note 12: Long-Term Debt
 
Following is a summary of our long-term debt based on original maturity (reflecting unamortized debt discounts and premiums, where applicable):
                                 
   
(in millions)                   December 31 ,
      Maturity     Stated   2005     2004  
      date(s)     interest            
            rate(s)            

Wells Fargo & Company (Parent only)

                               

Senior

                               
Fixed-Rate Notes (1)
    2006-2035       2.20-6.875%   $ 16,081     $ 12,970  
Floating-Rate Notes
    2006-2015       Varies     21,711       20,155  
Extendable Notes (2)
    2008-2015       Varies     10,000       5,500  
Equity-Linked Notes (3)
    2006-2014       Varies     444       472  
Convertible Debenture (4)
    2033       Varies     3,000       3,000  
 
                           
Total senior debt — Parent
                    51,236       42,097  
 
                           

Subordinated

                               
Fixed-Rate Notes (1)
    2011-2023       4.625-6.65%     4,558       4,502  
FixFloat Notes
    2012       4.00% through
2006, varies
    300       299  
 
                           
Total subordinated debt — Parent
                    4,858       4,801  
 
                           

Junior Subordinated

                               
Fixed-Rate Notes (1)(5)
    2031-2034       5.625-7.00%     3,247       3,248  
 
                           
Total junior subordinated debt — Parent
                    3,247       3,248  
 
                           
Total long-term debt — Parent
                    59,341       50,146  
 
                           

Wells Fargo Bank, N.A. and its subsidiaries (WFB, N.A.)

                               

Senior

                               
Fixed-Rate Notes (1)
    2006-2019       1.16-4.24%     256       218  
Floating-Rate Notes
    2006-2034       Varies     3,138       7,615  
Floating-Rate Federal Home Loan Bank (FHLB) Advances (6)
                      1,400  
FHLB Notes and Advances
    2012       5.20%     203       200  
Equity-Linked Notes (3)
    2006-2014       Varies     229       40  
Notes payable by subsidiaries
                      79  
Obligations of subsidiaries under capital leases (Note 7)
                    14       19  
 
                           
Total senior debt — WFB, N.A.
                    3,840       9,571  
 
                           

Subordinated

                               
FixFloat Notes (7)
                      998  
Fixed-Rate Notes (1)
    2010-2015       4.07-7.55%     4,330       2,821  
Other notes and debentures
    2006-2013       4.50-12.00%     13       11  
 
                           
Total subordinated debt — WFB, N.A.
                    4,343       3,830  
 
                           
Total long-term debt — WFB, N.A.
                    8,183       13,401  
 
                           

Wells Fargo Financial, Inc., and its subsidiaries (WFFI)

                               

Senior

                               
Fixed-Rate Notes
    2006-2034       2.06-7.47%     7,159       5,343  
Floating-Rate Notes
    2007-2010       Varies     1,714       1,303  
 
                           
Total long-term debt — WFFI
                  $ 8,873     $ 6,646  
 
                           
 
(1)   We entered into interest rate swap agreements for a major portion of these notes, whereby we receive fixed-rate interest payments approximately equal to interest on the notes and make interest payments based on an average one-month, three-month or six-month London Interbank Offered Rate (LIBOR).
 
(2)   The extendable notes are floating-rate securities with an initial maturity of 13 months or 2 years, which can be extended, respectively, on a rolling monthly basis, to a final maturity of 5 or 6 years, or, on a 6 month rolling basis, to a final maturity of 10 years, at the investor’s option.
 
(3)   These notes are linked to baskets of equities, commodities or equity indices.
 
(4)   On April 15, 2003, we issued $3 billion of convertible senior debentures as a private placement. In November 2004, we amended the indenture under which the debentures were issued to eliminate a provision in the indenture that prohibited us from paying cash upon conversion of the debentures if an event of default as defined in the indenture exists at the time of conversion. We then made an irrevocable election under the indenture on December 15, 2004, that upon conversion of the debentures, we must satisfy the accreted value of the obligation (the amount accrued to the benefit of the holder exclusive of the conversion spread) in cash and may satisfy the conversion spread (the excess conversion value over the accreted value) in either cash or stock. We can also redeem all or some of the convertible debt securities for cash at any time on or after May 5, 2008, at their principal amount plus accrued interest, if any.
 
(5)   Effective December 31, 2003, as a result of the adoption of FIN 46R we deconsolidated certain wholly-owned trusts formed for the sole purpose of issuing trust preferred securities (the Trusts). The junior subordinated debentures held by the Trusts are included in the Company’s long-term debt.
 
(6)   During 2005, the FHLB exercised their put options on all outstanding floating-rate advances.
 
(7)   Note was called in June 2005.
(continued on following page)

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(continued from previous page)
                                 
   
(in millions)                   December 31 ,
      Maturity     Stated   2005     2004  
      date(s)     interest            
            rate(s)            

Other consolidated subsidiaries

                               

Senior

                               
Fixed-Rate Notes
    2006-2045       1.50-6.90%   $ 502     $ 564  
Floating-Rate FHLB Advances
    2008-2009       Varies     500       500  
Other notes and debentures — Floating-Rate
    2012       Varies     14       1  
Obligations of subsidiaries under capital leases (Note 7)
                          1  
 
                           
Total senior debt — Other consolidated subsidiaries
                    1,016       1,066  
 
                           

Subordinated

                               
Fixed-Rate Notes (1)
    2006-2009       1.00-13.87%     1,138       1,194  
Other notes and debentures — Floating-Rate
    2011-2015       Varies     66       95  
 
                           
Total subordinated debt — Other consolidated subsidiaries
                    1,204       1,289  
 
                           

Junior Subordinated

                               
Fixed-Rate Notes (5)
    2026-2031       7.73-10.18%     869       865  
Floating-Rate Notes (5)
    2027-2034       Varies     182       167  
 
                           
Total junior subordinated debt — Other consolidated subsidiaries
                    1,051       1,032  
 
                           
Total long-term debt — Other consolidated subsidiaries
                    3,271       3,387  
 
                           
Total long-term debt
                  $ 79,668     $ 73,580  
 
                           
 

     At December 31, 2005, aggregate annual maturities of long-term debt obligations (based on final maturity dates) were as follows:
                 
   
(in millions)   Parent     Company  

2006

  $ 7,309     $ 11,124  
2007
    10,557       13,962  
2008
    11,648       13,742  
2009
    5,904       6,926  
2010
    6,911       8,943  
Thereafter
    17,012       24,971  
 
           
Total
  $ 59,341     $ 79,668  
 
           
 
     The interest rates on floating-rate notes are determined periodically by formulas based on certain money market rates, subject, on certain notes, to minimum or maximum interest rates.
     As part of our long-term and short-term borrowing arrangements, we are subject to various financial and operational covenants. Some of the agreements under which debt has been issued have provisions that may limit the merger or sale of certain subsidiary banks and the issuance of capital stock or convertible securities by certain subsidiary banks. At December 31, 2005, we were in compliance with all the covenants.


82


 

Note 13: Preferred Stock
 

We are authorized to issue 20 million shares of preferred stock and 4 million shares of preference stock, both without par value. Preferred shares outstanding rank senior to common shares both as to dividends and liquidation preference but have no general voting rights. We have not issued any preference shares under this authorization.
ESOP CUMULATIVE CONVERTIBLE PREFERRED STOCK
All shares of our ESOP (Employee Stock Ownership Plan) Cumulative Convertible Preferred Stock (ESOP Preferred Stock) were issued to a trustee acting on behalf of the Wells Fargo & Company 401(k) Plan (the 401(k) Plan). Dividends on the ESOP Preferred Stock are cumulative from the date of initial issuance and are payable quarterly
at annual rates ranging from 8.50% to 12.50%, depending upon the year of issuance. Each share of ESOP Preferred Stock released from the unallocated reserve of the 401(k) Plan is converted into shares of our common stock based on the stated value of the ESOP Preferred Stock and the then current market price of our common stock. The ESOP Preferred Stock is also convertible at the option of the holder at any time, unless previously redeemed. We have the option to redeem the ESOP Preferred Stock at any time, in whole or in part, at a redemption price per share equal to the higher of (a) $1,000 per share plus accrued and unpaid dividends or (b) the fair market value, as defined in the Certificates of Designation for the ESOP Preferred Stock.


                                                 
 
    Shares issued     Carrying amount        
    and outstanding     (in millions)     Adjustable  
    December 31 ,   December 31 ,   dividend rate  
    2005     2004     2005     2004     Minimum     Maximum  

ESOP Preferred Stock (1):

                                               
2005
    102,184           $ 102     $       9.75 %     10.75 %
2004
    74,880       89,420       75       90       8.50       9.50  
2003
    52,643       60,513       53       61       8.50       9.50  
2002
    39,754       46,694       40       47       10.50       11.50  
2001
    28,263       34,279       28       34       10.50       11.50  
2000
    19,282       24,362       19       24       11.50       12.50  
1999
    6,368       8,722       6       9       10.30       11.30  
1998
    1,953       2,985       2       3       10.75       11.75  
1997
    136       2,206             2       9.50       10.50  
1996
          382                   8.50       9.50  
 
                                       
Total ESOP Preferred Stock
    325,463       269,563     $ 325     $ 270                  
 
                                       
Unearned ESOP shares (2)
                  $ (348 )   $ (289 )                
 
                                           
 
(1)   Liquidation preference $1,000.
   
(2)   In accordance with the American Institute of Certified Public Accountants (AICPA) Statement of Position 93-6, Employers’ Accounting for Employee Stock Ownership Plans, we recorded a corresponding charge to unearned ESOP shares in connection with the issuance of the ESOP Preferred Stock. The unearned ESOP shares are reduced as shares of the ESOP Preferred Stock are committed to be released. For information on dividends paid, see Note 14.

83


 

Note 14: Common Stock and Stock Plans
 

Common Stock
Our reserved, issued and authorized shares of common stock at December 31, 2005, were:
         
   
    Number of shares  

Dividend reinvestment and common stock purchase plans

    3,088,307  
Director plans
    651,102  
Stock plans (1)
    307,357,126  
 
     
Total shares reserved
    311,096,535  
Shares issued
    1,736,381,025  
Shares not reserved
    3,952,522,440  
 
     
Total shares authorized
    6,000,000,000  
 
     
 
(1)   Includes employee option, restricted shares and restricted share rights,
401(k), profit sharing and compensation deferral plans.
Dividend Reinvestment and Common Stock Purchase Plans
Participants in our dividend reinvestment and common stock direct purchase plans may purchase shares of our common stock at fair market value by reinvesting dividends and/or making optional cash payments, under the plan’s terms.
Director Plans
We provide a stock award to non-employee directors as part of their annual retainer under our director plans. We also provide annual grants of options to purchase common stock to each non-employee director elected or re-elected at the annual meeting of stockholders. The options can be exercised after six months and through the tenth anniversary of the grant date.
Employee Stock Plans
LONG-TERM INCENTIVE PLANS
Our stock incentive plans provide for awards of incentive and nonqualified stock options, stock appreciation rights, restricted shares, restricted share rights, performance awards and stock awards without restrictions. Options must have an exercise price at or above fair market value (as defined in the plan) of the stock at the date of grant (except for substitute or replacement options granted in connection with mergers or other acquisitions) and a term of no more than 10 years. Options granted in 2003 and prior generally become exercisable over three years from the date of grant. Options granted in 2004 and the beginning of 2005 generally were fully vested upon grant. Effective April 26, 2005, options granted under our plan generally cannot fully vest in less than one year. Options granted generally have a contractual term of 10 years. Except as otherwise permitted under the plan, if employment is ended for reasons other than retirement, permanent disability or death, the option period is reduced or the options are canceled.
     Options also may include the right to acquire a “reload” stock option. If an option contains the reload feature and if a participant pays all or part of the exercise price of the option with shares of stock purchased in the market or held by the participant for at least six months, upon exercise of the option, the participant is granted a new option to purchase, at the fair market value of the stock as of the date of the reload, the number of shares of stock equal to the sum of the number of shares used in payment of the exercise price and a number of shares with respect to related statutory minimum withholding taxes. Options granted after 2003 did not include a reload feature.
     We did not record any compensation expense for the options granted under the plans during 2005, 2004 and 2003, as the exercise price was equal to the quoted market price of the stock at the date of grant. The total number of shares of common stock available for grant under the plans at December 31, 2005, was 116,604,733.
     Holders of restricted shares and restricted share rights are entitled to the related shares of common stock at no cost generally over three to five years after the restricted shares or restricted share rights were granted. Holders of restricted shares generally are entitled to receive cash dividends paid on the shares. Holders of restricted share rights generally are entitled to receive cash payments equal to the cash dividends that would have been paid had the restricted share rights been issued and outstanding shares of common stock. Except in limited circumstances, restricted shares and restricted share rights are canceled when employment ends.
     In 2005, 26,400 restricted shares and restricted share rights were granted with a weighted-average grant-date per share fair value of $61.59. In 2004, no restricted shares or restricted share rights were granted. In 2003, 61,740 restricted shares and restricted share rights were granted with a weighted-average grant-date per share fair value of $56.05. At December 31, 2005, 2004 and 2003, there were 353,022, 448,150 and 577,722 restricted shares and restricted share rights outstanding, respectively. The compensation expense for the restricted shares and restricted share rights equals the quoted market price of the related stock at the date of grant and is accrued over the vesting period. We recognized total compensation expense for the restricted shares and restricted share rights of $2 million in 2005, $3 million in 2004 and $4 million in 2003.
     For various acquisitions and mergers since 1992, we converted employee and director stock options of acquired or merged companies into stock options to purchase our common stock based on the terms of the original stock option plan and the agreed-upon exchange ratio.


84


 

BROAD-BASED PLANS In 1996, we adopted the PartnerShares® Stock Option Plan, a broad-based employee stock option plan. It covers full- and part-time employees who were generally not included in the long-term incentive plans described on the preceding page. The total number of shares of common stock authorized for issuance under the plan since inception through December 31, 2005, was 54,000,000, including 3,669,903 shares available for grant. No options have been granted under the PartnerShares Plan since 2002. The exercise date of options granted under the PartnerShares Plan is the earlier of (1) five years after the
date of grant, or (2) when the quoted market price of the stock reaches a predetermined price. These options generally expire 10 years after the date of grant. Because the exercise price of each PartnerShares grant has been equal to or higher than the quoted market price of our common stock at the date of grant, we have not recognized any compensation expense in 2005 and prior years.
     The following table summarizes stock option activity and related information for the three years ended December 31, 2005.


                                                 
   
    Director Plans     Long-Term Incentive Plans     Broad-Based Plans  
    Number     Weighted-average     Number     Weighted-average     Number     Weighted-average  
          exercise price           exercise price           exercise price  

Options outstanding as of December 31, 2002

    349,108     $ 36.78       93,379,737     $ 40.35       50,088,196     $ 43.25  
 
                                         
2003:
                                               
Granted
    62,346       47.22       23,052,384 (1)     46.04              
Canceled
                (1,529,868 )     46.76       (4,293,930 )     46.85  
Exercised
    (59,707 )     26.90       (13,884,561 )     31.96       (6,408,797 )     34.09  
Acquisitions
    4,769       31.42       889,842       25.89              
 
                                         
Options outstanding as of December 31, 2003
    356,516       40.19       101,907,534       42.56       39,385,469       44.35  
 
                                         
2004:
                                               
Granted
    50,960       56.39       21,983,690 (1)     57.41              
Canceled
                (1,241,637 )     48.06       (2,895,200 )     48.26  
Exercised
    (21,427 )     18.81       (18,574,660 )     37.89       (3,792,605 )     34.84  
 
                                         
Options outstanding as of December 31, 2004
    386,049       43.51       104,074,927       46.46       32,697,664       45.10  
2005:
                                               
Granted
    64,252       59.33       21,601,697 (1)     60.12              
Canceled
    (3,594 )     19.93       (623,384 )     51.80       (2,475,617 )     47.51  
Exercised
    (57,193 )     27.66       (14,514,952 )     42.20       (5,729,286 )     42.78  
Acquisitions
                52,824       27.35              
 
                                         
Options outstanding as of December 31, 2005
    389,514     $ 48.67       110,591,112     $ 49.65       24,492,761     $ 45.51  
 
                                     

Outstanding options exercisable as of:

                                               
December 31, 2003
    353,131     $ 40.08       63,257,541     $ 40.33       12,063,244     $ 35.21  
December 31, 2004
    386,049       43.51       84,702,073       46.64       8,590,539       35.99  
December 31, 2005
    389,514       48.67       103,053,320       49.80       14,444,786       42.10  
 
(1)   Includes 4,014,597, 4,909,864 and 2,311,824 reload grants in 2005, 2004 and 2003, respectively.

     The following table presents the weighted-average per share fair value of options granted estimated using a Black-Scholes option-pricing model and the weighted-average assumptions used.
                         
   
    2005     2004     2003  

Per share fair value of options granted:

                       
Director Plans
  $ 6.27     $ 9.34     $ 9.59  
Long-Term Incentive Plans
    7.50       9.32       9.48  
Expected life (years)
    4.4       4.4       4.3  
Expected volatility
    16.1 %     23.8 %     29.2 %
Risk-free interest rate
    4.0       2.9       2.5  
Expected annual dividend yield
    3.4       3.4       2.9  
 
      


85


 

     This table is a summary of our stock option plans described on the preceding page.
                                         
   
    December 31, 2005  
    Options outstanding     Options exercisable  
Range of exercise prices   Number     Weighted-average     Weighted-average     Number     Weighted-average  
          exercise price     remaining contractual           exercise price  
                life (in yrs.)              

Director Plans

                                       
$13.49-$16.00
    2,530     $ 13.49       1.01       2,530     $ 13.49  
$16.01-$25.04
    17,010       24.09       .49       17,010       24.09  
$25.05-$38.29
    34,620       33.09       1.88       34,620       33.09  
$38.30-$51.00
    197,942       46.51       5.60       197,942       46.51  
$51.01-$69.01
    137,412       59.38       7.69       137,412       59.38  

Long-Term Incentive Plans

                                       
$3.37-$5.06
    29,012     $ 4.23       6.50       29,012     $ 4.23  
$5.07-$7.60
    4,366       5.84       20.02       4,366       5.84  
$11.42-$17.13
    101,430       16.53       .60       101,430       16.53  
$17.14-$25.71
    57,574       23.33       3.53       57,574       23.33  
$25.72-$38.58
    16,442,280       34.24       2.98       16,277,280       34.22  
$38.59-$71.30
    93,956,450       52.41       5.99       86,583,658       52.80  

Broad-Based Plans

                                       
$16.56
    287,403     $ 16.56       .56       287,403     $ 16.56  
$24.85-$37.81
    5,107,673       35.35       2.42       5,107,673       35.35  
$37.82-$46.50
    8,661,248       46.44       4.86       8,540,348       46.50  
$46.51-$51.15
    10,436,437       50.50       6.22       509,362       50.50  
 

EMPLOYEE STOCK OWNERSHIP PLAN Under the Wells Fargo & Company 401(k) Plan (the 401(k) Plan), a defined contribution ESOP, the 401(k) Plan may borrow money to purchase our common or preferred stock. Since 1994, we have loaned money to the 401(k) Plan to purchase shares of our ESOP Preferred Stock. As we release and convert ESOP Preferred Stock into common shares, we record compensation expense equal to the current market price of the common shares. Dividends on the common shares allocated as a result of the release and conversion of the ESOP Preferred Stock reduce retained earnings and the shares are considered outstanding
for computing earnings per share. Dividends on the unallocated ESOP Preferred Stock do not reduce retained earnings, and the shares are not considered to be common stock equivalents for computing earnings per share. Loan principal and interest payments are made from our contributions to the 401(k) Plan, along with dividends paid on the ESOP Preferred Stock. With each principal and interest payment, a portion of the ESOP Preferred Stock is released and, after conversion of the ESOP Preferred Stock into common shares, allocated to the 401(k) Plan participants.


     The balance of ESOP shares, the dividends on allocated shares of common stock and unreleased preferred shares paid to the 401(k) Plan and the fair value of unearned ESOP shares were:
                                                 
   
(in millions, except shares)   Shares outstanding     Dividends paid  
    December 31 ,   Year ended December 31 ,
    2005     2004     2003     2005     2004     2003  

Allocated shares (common)

    36,917,501       33,921,758       31,927,982     $ 71     $ 61     $ 46
Unreleased shares (preferred)
    325,463       269,563       214,100       39       32       26  

Fair value of unearned ESOP shares

  $ 325     $ 270     $ 214                        
 

Deferred Compensation Plan for Independent Sales Agents
WF Deferred Compensation Holdings, Inc. is a wholly owned subsidiary of the Parent formed solely to sponsor a deferred compensation plan for independent sales agents who provide investment, financial and other qualifying services for or with respect to participating affiliates.
The plan, which became effective January 1, 2002, allows participants to defer all or part of their eligible compensation payable to them by a participating affiliate. The Parent has fully and unconditionally guaranteed the deferred compensation obligations of WF Deferred Compensation Holdings, Inc. under the plan.


86


 

Note 15: Employee Benefits and Other Expenses
 

Employee Benefits
We sponsor noncontributory qualified defined benefit retirement plans including the Cash Balance Plan. The Cash Balance Plan is an active plan that covers eligible employees (except employees of certain subsidiaries).
     Under the Cash Balance Plan, eligible employees’ Cash Balance Plan accounts are allocated a compensation credit based on a percentage of their certified compensation. The compensation credit percentage is based on age and years of credited service. In addition, investment credits are allocated to participants quarterly based on their accumulated balances. Employees become vested in their Cash Balance Plan accounts after completing five years of vesting service or reaching age 65, if earlier.
     Although we were not required to make a contribution in 2005 for our Cash Balance Plan, we funded the maximum amount deductible under the Internal Revenue Code, or $288 million. The total amount contributed for our pension plans was $340 million. We expect that we will not be required to make a contribution in 2006 for the Cash Balance Plan. The maximum we can contribute in 2006 for the Cash Balance Plan depends on several factors, including the finalization of participant data. Our decision on how much to contribute, if any, depends on other factors, including the actual investment performance of plan assets. Given these uncertainties, we cannot at this time reliably estimate the maximum deductible contribution or the amount that we will contribute in 2006 to the Cash
Balance Plan. For the unfunded nonqualified pension plans and postretirement benefit plans, we will contribute the minimum required amount in 2006, which equals the benefits paid under the plans. In 2005, we paid $78 million in benefits for the postretirement plans, which included $29 million in retiree contributions, and $13 million for the unfunded pension plans.
     We sponsor defined contribution retirement plans including the 401(k) Plan. Under the 401(k) Plan, after one month of service, eligible employees may contribute up to 25% of their pretax certified compensation, although there may be a lower limit for certain highly compensated employees in order to maintain the qualified status of the 401(k) Plan. Eligible employees who complete one year of service are eligible for matching company contributions, which are generally a 100% match up to 6% of an employee’s certified compensation. The matching contributions generally vest over four years.
     Expenses for defined contribution retirement plans were $370 million, $356 million and $257 million in 2005, 2004 and 2003, respectively.
     We provide health care and life insurance benefits for certain retired employees and reserve the right to terminate or amend any of the benefits at any time.
     The information set forth in the following tables is based on current actuarial reports using the measurement date of November 30 for our pension and postretirement benefit plans.


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     The changes in the projected benefit obligation during 2005 and 2004 and the amounts included in the Consolidated Balance Sheet at December 31, 2005 and 2004, were:
                                                 
 
(in millions)   December 31 ,
    2005     2004  
    Pension benefits             Pension benefits        
            Non-     Other             Non-     Other  
    Qualified     qualified     benefits     Qualified     qualified     benefits  

Projected benefit obligation at beginning of year

  $ 3,777     $ 228     $ 751     $ 3,387     $ 202     $ 698  
Service cost
    208       21       21       170       23       17  
Interest cost
    220       14       41       215       13       43  
Plan participants’ contributions
                29                   26  
Amendments
    37             (44 )     (54 )     (12 )     (1 )
Actuarial gain (loss)
    43       27       (12 )     296       27       37  
Benefits paid
    (242 )     (13 )     (78 )     (240 )     (25 )     (70 )
Foreign exchange impact
    2             1       3             1  
 
                                   
Projected benefit obligation at end of year
  $ 4,045     $ 277     $ 709     $ 3,777     $ 228     $ 751  
 
                                   
 

     The weighted-average assumptions used to determine the projected benefit obligation were: