10-Q 1 d404366d10q.htm QUARTERLY REPORT ON FORM 10-Q Quarterly Report on Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012

Commission file number 001-2979

WELLS FARGO & COMPANY

(Exact name of registrant as specified in its charter)

 

Delaware   No. 41-0449260
(State of incorporation)   (I.R.S. Employer Identification No.)

420 Montgomery Street, San Francisco, California 94163

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: 1-866-249-3302

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ            No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes þ            No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   þ    Accelerated filer ¨  
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company ¨  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨            No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

    

Shares Outstanding

October 31, 2012

    
Common stock, $1-2/3 par value    5,264,273,367   


Table of Contents

FORM 10-Q

CROSS-REFERENCE INDEX

 

PART I

 

Financial Information

  

Item 1.

 

Financial Statements

     Page   
 

Consolidated Statement of Income

     57   
 

Consolidated Statement of Comprehensive Income

     58   
 

Consolidated Balance Sheet

     59   
 

Consolidated Statement of Changes in Equity

     60   
 

Consolidated Statement of Cash Flows

     62   
 

Notes to Financial Statements

  
 

  1  -  Summary of Significant Accounting Policies

     63   
 

  2  -  Business Combinations

     65   
 

  3  -   Federal Funds Sold, Securities Purchased under Resale Agreements and Other Short-Term Investments

     65   
 

  4  -  Securities Available for Sale

     66   
 

  5  -  Loans and Allowance for Credit Losses

     74   
 

  6  -  Other Assets

     93   
 

  7  -  Securitizations and Variable Interest Entities

     94   
 

  8  -  Mortgage Banking Activities

     105   
 

  9  -  Intangible Assets

     108   
 

10  -  Guarantees, Pledged Assets and Collateral

     109   
 

11  -  Legal Actions

     111   
 

12  -  Derivatives

     113   
 

13  -  Fair Values of Assets and Liabilities

     120   
 

14  -  Preferred Stock

     145   
 

15  -  Employee Benefits

     147   
 

16  -  Earnings Per Common Share

     148   
 

17  -  Other Comprehensive Income

     149   
 

18  -  Operating Segments

     151   
 

19  -  Regulatory and Agency Capital Requirements

     153   

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Financial Review)

  
 

Summary Financial Data

     2   
 

Overview

     3   
 

Earnings Performance

     5   
 

Balance Sheet Analysis

     14   
 

Off-Balance Sheet Arrangements

     18   
 

Risk Management

     19   
 

Capital Management

     50   
 

Regulatory Reform

     53   
 

Critical Accounting Policies

     53   
 

Current Accounting Developments

     54   
 

Forward-Looking Statements

     54   
 

Risk Factors

     55   
 

Glossary of Acronyms

     154   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     46   

Item 4.

 

Controls and Procedures

     56   

PART II

 

Other Information

  

Item 1.

 

Legal Proceedings

     155   

Item 1A.

 

Risk Factors

     155   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     155   

Item 6.

 

Exhibits

     156   

Signature

       156   

Exhibit Index

       157   

 

 

 

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Table of Contents

PART I - FINANCIAL INFORMATION

FINANCIAL REVIEW

Summary Financial Data

 

 

     Quarter ended      % Change
Sept. 30, 2012 from
    Nine months ended         
($ in millions, except per share amounts)    Sept. 30,
2012
    June 30,
2012
     Sept. 30,
2011
     June 30,
2012
    Sept. 30,
2011
    Sept. 30,
2012
     Sept. 30,
2011
    

%

Change

 

 

 

For the Period

                    

Wells Fargo net income

   $             4,937       4,622        4,055        7  %      22       13,807        11,762        17  % 

Wells Fargo net income applicable to common stock

     4,717       4,403        3,839        7       23       13,142        11,137        18  

Diluted earnings per common share

     0.88       0.82        0.72        7       22       2.45        2.09        17  

Profitability ratios (annualized):

                    

Wells Fargo net income to average assets (ROA)

     1.45  %      1.41        1.26        3       15       1.39        1.25        11  

Wells Fargo net income applicable to common stock to average Wells Fargo common stockholders’ equity (ROE)

     13.38       12.86        11.86        4       13       12.81        11.92        7  

Efficiency ratio (1)

     57.1       58.2        59.5        (2     (4     58.5        61.1        (4

Total revenue

   $ 21,213       21,289        19,628        -        8       64,138        60,343        6  

Pre-tax pre-provision profit (PTPP) (2)

     9,101       8,892        7,951        2       14       26,636        23,458        14  

Dividends declared per common share

     0.22       0.22        0.12        -        83       0.66        0.36        83  

Average common shares outstanding

     5,288.1       5,306.9        5,275.5        -        -        5,292.7        5,280.2        -   

Diluted average common shares outstanding

     5,355.6       5,369.9        5,319.2        -        1       5,355.7        5,325.6        1  

Average loans

   $ 776,734       768,223        754,544        1       3       771,200        753,293        2  

Average assets

     1,354,340       1,321,584        1,281,369        2       6       1,326,384        1,257,977        5  

Average core deposits (3)

     895,374       880,636        836,845        2       7       882,224        813,865        8  

Average retail core deposits (4)

     630,053       624,329        599,227        1       5       623,671        592,156        5  

Net interest margin

     3.66  %      3.91        3.84        (6     (5     3.82        3.96        (4

At Period End

                    

Securities available for sale

   $ 229,350       226,846        207,176        1       11       229,350        207,176        11  

Loans

     782,630       775,199        760,106        1       3       782,630        760,106        3  

Allowance for loan losses

     17,385       18,320        20,039        (5     (13     17,385        20,039        (13

Goodwill

     25,637       25,406        25,038        1       2       25,637        25,038        2  

Assets

     1,374,715       1,336,204        1,304,945        3       5       1,374,715        1,304,945        5  

Core deposits (3)

     901,075       882,137        849,632        2       6       901,075        849,632        6  

Wells Fargo stockholders’ equity

     154,679       148,070        137,768        4       12       154,679        137,768        12  

Total equity

     156,059       149,437        139,244        4       12       156,059        139,244        12  

Tier 1 capital (5)

     122,741       117,856        110,749        4       11       122,741        110,749        11  

Total capital (5)

     154,888       149,813        146,147        3       6       154,888        146,147        6  

Capital ratios:

                    

Total equity to assets

     11.35  %      11.18        10.67        2       6       11.35        10.67        6  

Risk-based capital (5):

                    

Tier 1 capital

     11.50       11.69        11.26        (2     2       11.50        11.26        2  

Total capital

     14.51       14.85        14.86        (2     (2     14.51        14.86        (2

Tier 1 leverage (5)

     9.40       9.25        8.97        2       5       9.40        8.97        5  

Tier 1 common equity (6)

     9.92       10.08        9.34        (2     6       9.92        9.34        6  

Common shares outstanding

     5,289.6       5,275.7        5,272.2        -        -        5,289.6        5,272.2        -   

Book value per common share

   $ 27.10       26.06        24.13        4       12       27.10        24.13        12  

Common stock price:

                    

High

     36.60       34.59        29.63        6       24       36.60        34.25        7  

Low

     32.62       29.80        22.58        9       44       27.94        22.58        24  

Period end

     34.53       33.44        24.12        3       43       34.53        24.12        43  

Team members (active, full-time equivalent)

     267,000       264,400        263,800        1       1       267,000        263,800        1  

 

 

 

(1) The efficiency ratio is noninterest expense divided by total revenue (net interest income and noninterest income).
(2) Pre-tax pre-provision profit (PTPP) is total revenue less noninterest expense. Management believes that PTPP is a useful financial measure because it enables investors and others to assess the Company’s ability to generate capital to cover credit losses through a credit cycle.
(3) Core deposits are noninterest-bearing deposits, interest-bearing checking, savings certificates, certain market rate and other savings, and certain foreign deposits (Eurodollar sweep balances).
(4) Retail core deposits are total core deposits excluding Wholesale Banking core deposits and retail mortgage escrow deposits.
(5) See Note 19 (Regulatory and Agency Capital Requirements) to Financial Statements in this Report for additional information.
(6) See the “Capital Management” section in this Report for additional information.

 

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This Quarterly Report, including the Financial Review and the Financial Statements and related Notes, contains forward-looking statements, which may include forecasts of our financial results and condition, expectations for our operations and business, and our assumptions for those forecasts and expectations. Do not unduly rely on forward-looking statements. Actual results may differ materially from our forward-looking statements due to several factors. Factors that could cause our actual results to differ materially from our forward-looking statements are described in this Report, including in the “Forward-Looking Statements” section, and the “Risk Factors” and “Regulation and Supervision” sections of our Annual Report on Form 10-K for the year ended December 31, 2011 (2011 Form 10-K).

When we refer to “Wells Fargo,” “the Company,” “we,” “our” or “us” in this Report, we mean Wells Fargo & Company and Subsidiaries (consolidated). When we refer to the “Parent,” we mean Wells Fargo & Company. When we refer to “legacy Wells Fargo,” we mean Wells Fargo excluding Wachovia Corporation (Wachovia). See the Glossary of Acronyms at the end of this Report for terms used throughout this Report.

Financial Review

Overview

 

 

Wells Fargo & Company is a nationwide, diversified, community-based financial services company with $1.4 trillion in assets. Founded in 1852 and headquartered in San Francisco, we provide banking, insurance, investments, mortgage, and consumer and commercial finance through more than 9,000 stores, 12,000 ATMs and the Internet (wellsfargo.com), and we have offices in more than 35 countries to support our customers who conduct business in the global economy. With approximately 265,000 active, full-time equivalent team members, we serve one in three households in the United States and ranked No. 26 on Fortune’s 2012 rankings of America’s largest corporations. We ranked fourth in assets and first in the market value of our common stock among all U.S. banks at September 30, 2012.

Our vision is to satisfy all our customers’ financial needs, help them succeed financially, be recognized as the premier financial services company in our markets and be one of America’s great companies. Our primary strategy to achieve this vision is to increase the number of our products our customers utilize and to offer them all of the financial products that fulfill their needs. Our cross-sell strategy, diversified business model and the breadth of our geographic reach facilitate growth in both strong and weak economic cycles, as we can grow by expanding the number of products our current customers have with us, gain new customers in our extended markets, and increase market share in many businesses.

Our pursuit of growth and earnings performance is influenced by our belief that it is important to maintain a well controlled operating environment. We manage our credit risk by establishing what we believe are sound credit policies for underwriting new business, while monitoring and reviewing the performance of our loan portfolio. We manage the interest rate and market risks inherent in our asset and liability balances within established ranges, while ensuring adequate liquidity and funding. We maintain strong capital levels to facilitate future growth.

Financial Performance

We reported strong financial results in third quarter 2012 including year over year increased net income and revenue,

continued loan and deposit growth, an improved efficiency ratio and continued improvement in underlying credit quality. Our return on assets of 1.45% was up 19 basis points from a year ago, the highest it has been in five years, and our return on equity increased to 13.38%, up 152 basis points from a year ago.

Wells Fargo net income was $4.9 billion and diluted earnings per common share were $0.88 in third quarter 2012, each up 22% from the prior year. Third quarter 2012 was our eleventh consecutive quarter of earnings per share growth. Our increase in net income from third quarter 2011 was driven by higher total revenue resulting primarily from increased noninterest income.

Our total revenue was $21.2 billion in third quarter 2012, up $1.6 billion, or 8%, from the prior year. The 8% year-over-year increase predominantly reflected $974 million in increased mortgage banking income and $971 million in increased net gains from trading activities. The increased mortgage banking income was due to higher net gains on higher mortgage loan origination/sales activities reflecting a lower interest rate environment compared with a year ago. Our unclosed mortgage loan pipeline at September 30, 2012, was a strong $97 billion, up 15% from $84 billion a year ago and down slightly from $102 billion at June 30, 2012, which was the second largest in our history.

Noninterest expense of $12.1 billion in third quarter 2012 increased from $11.7 billion in third quarter 2011. The increase in noninterest expense was primarily driven by increased mortgage banking volume. As announced in second quarter 2011, we have a current company-wide expense management initiative, which is focused on removing unnecessary complexity and eliminating duplication as a way to improve our customers’ experience and the work process of our team members. Our expenses, however, are driven in part by our revenue opportunities. Accordingly, we believe our efficiency ratio, which measures our noninterest expense as a percentage of total revenue, is an appropriate measure of our expense management efforts. Our efficiency ratio of 57.1% in third quarter 2012 improved by 240 basis points from a year ago as a result of higher mortgage banking noninterest income and our continued focus on expenses. We have targeted an efficiency ratio of 55 to 59%, and our efficiency ratio of 57.1% in third quarter 2012 was

 

 

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within this target range and was at its lowest level in 10 quarters. We expect to remain in our targeted range in fourth quarter 2012.

We had strong balance sheet growth in third quarter 2012 with growth in short-term investments, securities available for sale, total loans and average core deposits. Short-term investment balances increased $25.8 billion from second quarter 2012, driven by strong deposit growth, and securities available for sale increased $2.5 billion primarily due to an increase in their fair value as new investments were largely offset by the continued run-off of higher yielding securities. Our non-strategic/liquidating loan portfolios decreased $4.5 billion during the quarter and, excluding the planned runoff of these loans, our core loan portfolios increased $11.9 billion from the prior quarter, driven primarily by retention of $9.8 billion of 1-4 family conforming first mortgage production on the balance sheet. We also plan to retain some of our fourth quarter 2012 production of 1-4 family conforming first mortgage loans. In addition there was growth during the quarter in auto, credit card, private student lending, and commercial and industrial loan balances. Our average core deposits were up $14.7 billion from second quarter 2012 and up $58.5 billion, or 7%, from a year ago. We have grown deposits while reducing our deposit costs for eight consecutive quarters. Our costs on average deposits in third quarter 2012 were 18 basis points, down 7 basis points from the same quarter a year ago. Our average core deposits were 115% of average loans in third quarter 2012, up from 111% a year ago.

Credit Quality

Our credit quality continued to improve during third quarter 2012, as the overall financial condition of businesses and consumers strengthened and the housing market in many areas of the nation improved. Our reported credit metrics in third quarter 2012 were affected by implementation of the guidance in the Office of the Comptroller of the Currency (OCC) update to the Bank Accounting Advisory Series (OCC guidance) issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be written down to net realizable collateral value and classified as nonaccrual troubled debt restructurings (TDRs), regardless of their delinquency status. As of September 30, 2012, only 8% of the performing loans placed on nonaccrual status as a result of the OCC guidance were 30 days or more past due. Implementation of the OCC guidance in third quarter 2012 resulted in the following:

   

$1.4 billion reclassification of performing consumer loans to nonaccrual status;

   

$567 million increase in loan charge-offs; and

   

$4.3 billion of loans classified as TDRs.

Net charge-offs of $2.4 billion during third quarter 2012 were 1.21% (annualized) of average loans, down 16 basis points from 1.37% a year ago. Excluding $567 million in charge-offs resulting from implementation of the OCC guidance, net charge-offs were $1.8 billion or 0.92% (annualized) of average loans.

Nonperforming assets, including the $1.4 billion increase resulting from implementation of the OCC guidance, were $25.3 billion at September 30, 2012. These assets totaled

$26.0 billion at December 31, 2011. The year-to-date decrease in nonperforming assets also included the offsetting impact of our $1.7 billion reclassification of real estate 1-4 family junior lien mortgages to nonaccrual status in first quarter 2012 in accordance with junior lien mortgage industry guidance issued by bank regulators during that quarter.

Loans 90 days or more past due and still accruing (excluding government insured/guaranteed loans) totaled $1.5 billion at September 30, 2012, compared with $2.0 billion at December 31, 2011.

The improvement in our credit portfolio was due in part to the continued decline in balances in our non-strategic/liquidating loan portfolios, which decreased $4.5 billion during the quarter, and $92.1 billion in total since the beginning of 2009, to $98.7 billion at September 30, 2012.

Our $1.6 billion provision for credit losses in third quarter 2012 was $220 million less than a year ago, reflecting continued credit performance improvement in our portfolios. The provision for third quarter 2012 was $767 million lower than net loan charge-offs due to two factors:

   

$567 million increase in net loan charge offs charged directly against the allowance for loan losses from implementation of the OCC guidance; and

   

$200 million allowance for loan losses release due to continued strong underlying credit performance, compared with $400 million in the prior quarter and $800 million a year ago.

See the “Risk Management – Credit Risk Management” section in this Report for more information regarding implementation of the OCC guidance and its effect on our third quarter 2012 credit metrics.

During the last week of October 2012, Hurricane Sandy and related storms caused destruction along the East Coast, including in Connecticut, New Jersey, New York, Pennsylvania, Delaware, Maryland, Virginia and Washington D.C., and resulted in, among other things, property damage for our customers and the closing of many businesses and financial markets. We are currently assessing the impact to our customers and our business as a result of Hurricane Sandy. The financial impact to us is expected to primarily relate to our consumer and commercial real estate loan portfolios and will depend on a number of factors, including, as to our consumer and commercial loan portfolios, the types of loans most affected by the storms, the extent of damage to our collateral, the extent of available insurance coverage, the availability of government assistance for our borrowers, and whether our borrowers’ ability to repay their loans has been diminished. We are actively reviewing our exposure but are currently unable to reasonably estimate the extent of losses we may incur as a result of these storms. Absent significant deterioration in the economy or significant impact of Hurricane Sandy on our loan portfolios, we continue to expect future allowance releases.

Capital

Our capital position remained strong in third quarter 2012, as total equity increased $6.6 billion from second quarter 2012 to $156.1 billion and our Tier I common equity totaled

 

 

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$105.8 billion under Basel I, or 9.92% of risk-weighted assets. Our other capital ratios also remained strong with a Tier 1 capital ratio of 11.50%, total capital ratio of 14.51% and Tier 1 leverage ratio of 9.40% at September 30, 2012, compared with 11.69%, 14.85% and 9.25%, respectively, at June 30, 2012. The third quarter 2012 Tier 1 and total risk-based capital ratios, and Tier 1 common equity ratio reflected refinements to the risk weighting of certain unused lending commitments that provide for the ability to issue standby letters of credit and commitments to issue standby letters of credit under syndication arrangements where we have an obligation to issue in a lead agent or similar capacity beyond our contractual

participation level. While these refinements reduced our Tier 1 common equity ratio under Basel I, they did not affect our estimated Tier 1 common equity ratio under current Basel III capital proposals, which rose to 8.02% at September 30, 2012.

See the “Capital Management” section in this Report for more information regarding our capital, including Tier 1 common equity.

In third quarter 2012 we repurchased approximately 17 million shares of common stock and entered into a forward repurchase contract to repurchase approximately 9 million shares that settled in October 2012. We also paid a quarterly common stock dividend of $0.22 per share.

 

 

Earnings Performance

 

 

Wells Fargo net income for third quarter 2012 was $4.9 billion ($0.88 diluted earnings per common share) compared with $4.1 billion ($0.72 diluted earnings per common share) for third quarter 2011. Net income for the first nine months of 2012 was $13.8 billion, compared with $11.8 billion for the same period a year ago. Our September 30, 2012, quarterly and nine-month earnings reflected strong execution of our business strategy and growth in many of our businesses. The key drivers of our financial performance in third quarter 2012 were balanced net interest and fee income, diversified sources of fee income, a diversified loan portfolio and strong underlying credit performance.

Revenue, the sum of net interest income and noninterest income, was $21.2 billion in third quarter 2012, compared with $19.6 billion in third quarter 2011. Revenue for the first nine months of 2012 was $64.1 billion, up 6% from a year ago. The increase in revenue for the third quarter and first nine months of 2012 was due to strong growth in noninterest income, predominantly from mortgage banking, and modest growth in net interest income. Mortgage banking revenue in third quarter 2012 increased 53% from a year ago due to higher net gains on higher mortgage loan origination/sales activities reflecting a lower interest rate environment. Mortgage originations were $139 billion in third quarter 2012, a 56% increase from a year ago. The unclosed mortgage pipeline at September 30, 2012, was strong at $97 billion, up from $84 billion a year ago. In addition to mortgage banking, businesses generating double-digit year-over-year revenue growth in third quarter 2012 included capital markets, commercial real estate, corporate trust, asset backed finance, merchant services, mortgage and retail sales finance. Net interest income was $10.7 billion in third quarter 2012, representing 50% of revenue, compared with $10.5 billion (54%) in third quarter 2011. Continued success in generating low-cost deposits enabled us to grow assets by funding loans and securities growth while reducing higher cost long-term debt.

Noninterest income was $10.6 billion in third quarter 2012, representing 50% of revenue, compared with $9.1 billion (46%) in third quarter 2011. Noninterest income was $31.6 billion for the first nine months of 2012 compared with $28.5 billion for the same period a year ago. The increase in noninterest income for the third quarter and first nine months of 2012 was driven primarily by an increase in net gains on higher mortgage loan origination/sales activities.

Noninterest expense was $12.1 billion in third quarter 2012, compared with $11.7 billion in third quarter 2011. Noninterest expense was $37.5 billion for the first nine months of 2012, compared with $36.9 billion for the same period a year ago. The increase in noninterest expense in third quarter 2012 from third quarter 2011 was predominantly due to higher revenue-based commissions and incentive compensation. Our efficiency ratio was 57.1% in third quarter 2012 compared with 59.5% in third quarter 2011, reflecting our expense management efforts and revenue growth.

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 on deposits, short-term borrowings and long-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 in Table 1 to consistently reflect income from taxable and tax-exempt loans and securities based on a 35% federal statutory tax rate.

While the Company believes that it has the ability to increase net interest income over time, net interest income and the net interest margin in any one period can be significantly affected by a variety of factors including the mix and overall size of our earning asset portfolio and the cost of funding those assets. In addition, some sources of interest income, such as resolutions from purchased credit-impaired (PCI) loans, loan prepayment fees and collection of interest on nonaccrual loans, can vary from period to period.

Net interest income on a taxable-equivalent basis was $10.8 billion and $33.1 billion in the third quarter and first nine months of 2012, up from $10.7 billion and $32.4 billion for the same periods a year ago. The net interest margin was 3.66% and 3.82% for the third quarter and first nine months of 2012, down from 3.84% and 3.96% for the same periods a year ago. The increase in net interest income for both the third quarter and first nine months of 2012, compared with the same periods a year ago, was largely driven by growth in loans and available-for-sale securities, disciplined deposit pricing, debt maturities and redemptions of higher yielding trust preferred securities, which partially offset the impact of higher yielding loan and investment

 

 

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securities runoff. The decline in net interest margin in the third quarter and first nine months of 2012, compared with the same periods a year ago, was largely driven by continued runoff of higher yielding assets. In addition, our third quarter and first nine months of 2012 net interest margin experienced pressure as short-term investment balances remained elevated because of robust deposit growth. We expect continued pressure on our net interest margin as the balance sheet continues to reprice in the current low interest rate environment.

Average earning assets increased $66.2 billion and $64.1 billion in the third quarter and first nine months of 2012 from a year ago, as average securities available for sale increased $32.8 billion and $48.6 billion, and average mortgages held for sale increased $17.5 billion and $14.9 billion for the same periods, respectively. In addition, the increase in commercial and industrial loans contributed to $22.2 billion and $17.9 billion higher average loans in the third quarter and first nine months of 2012, respectively, compared with a year ago. These increases in average securities available for sale, mortgages held for sale and average loans were predominantly offset by a $7.3 billion and $20.7 billion decline in average short-term investments from the third quarter and first nine months of 2011.

Core deposits are an important low-cost source of funding and affect both net interest income and the net interest margin. Core deposits include noninterest-bearing deposits, interest-bearing checking, savings certificates, market rate and other savings, and certain foreign deposits (Eurodollar sweep balances). Average core deposits rose to $895.4 billion in third quarter 2012 ($882.2 billion in the first nine months of 2012) compared with $836.8 billion in third quarter 2011 ($813.9 billion in the first nine months of 2011) and funded 115% of average loans in third quarter 2012 (114% in the first nine months of 2012) compared with 111% a year ago (108% for the first nine months of 2011). Average core deposits increased to 76% of average earning assets in both the third quarter and first nine months of 2012, compared with 75% for the same periods a year ago. The cost of these deposits has continued to decline due to a sustained low interest rate environment and a shift in our deposit mix from higher cost certificates of deposit to lower yielding checking and savings products. About 94% of our average core deposits are in checking and savings deposits, one of the highest industry percentages.

 

 

 

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Earnings Performance (continued)

 

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

 

 

     Quarter ended September 30,  
     2012      2011  
(in millions)    Average
balance
     Yields/
rates
    Interest
income/
expense
     Average
balance
     Yields/
rates
    Interest
income/
expense
 

 

 

Earning assets

               

Federal funds sold, securities purchased under resale agreements and other short-term investments

   $ 91,561         0.44  %    $ 101         98,909         0.42  %    $ 105   

Trading assets

     39,441         3.08       304         37,939         3.67       348   

Securities available for sale (3):

               

Securities of U.S. Treasury and federal agencies

     1,390         1.05              9,578         1.02       24   

Securities of U.S. states and political subdivisions

     35,925         4.36       392         25,593         4.93       315   

Mortgage-backed securities:

               

Federal agencies

     94,324         2.88       679         72,887         4.41       804   

Residential and commercial

     33,124         6.67       553         32,625         7.46       609   

 

      

 

 

    

 

 

      

 

 

 

Total mortgage-backed securities

     127,448         3.87       1,232         105,512         5.36       1,413   

Other debt and equity securities

     47,647         4.07       486         38,888         4.69       457   

 

      

 

 

    

 

 

      

 

 

 

Total securities available for sale

     212,410         3.98       2,114         179,571         4.92       2,209   

Mortgages held for sale (4)

     52,128         3.65       476         34,634         4.49       389   

Loans held for sale (4)

     932         7.38       17         968         5.21       13   

Loans:

               

Commercial:

               

Commercial and industrial

     177,500         3.84       1,711         159,625         4.22       1,697   

Real estate mortgage

     105,148         4.05       1,070         102,428         3.93       1,015   

Real estate construction

     17,687         5.21       232         20,537         6.12       317   

Lease financing

     12,608         6.60       208         12,964         7.21       234   

Foreign

     39,663         2.46       245         38,175         2.42       233   

 

      

 

 

    

 

 

      

 

 

 

Total commercial

     352,606         3.91       3,466         333,729         4.16       3,496   

 

      

 

 

    

 

 

      

 

 

 

Consumer:

               

Real estate 1-4 family first mortgage

     234,020         4.51       2,638         223,765         4.83       2,704   

Real estate 1-4 family junior lien mortgage

     79,718         4.26       854         89,065         4.37       980   

Credit card

     23,040         12.64       732         21,452         12.96       695   

Other revolving credit and installment

     87,350         6.08       1,334         86,533         6.25       1,364   

 

      

 

 

    

 

 

      

 

 

 

Total consumer

     424,128         5.23       5,558         420,815         5.44       5,743   

 

      

 

 

    

 

 

      

 

 

 

Total loans (4)

     776,734         4.63       9,024         754,544         4.87       9,239   

Other

     4,386         4.62       50         4,831         4.18       50   

 

      

 

 

    

 

 

      

 

 

 

Total earning assets

   $         1,177,592         4.09  %    $         12,086                 1,111,396         4.43  %    $ 12,353   

 

      

 

 

    

 

 

      

 

 

 

Funding sources

               

Deposits:

               

Interest-bearing checking

   $ 28,815         0.06  %    $        43,986         0.07  %    $  

Market rate and other savings

     506,138         0.12       152         473,409         0.17       198   

Savings certificates

     58,206         1.29       188         67,633         1.47       251   

Other time deposits

     14,373         1.49       54         12,809         2.02       65   

Deposits in foreign offices

     71,791         0.16       30         63,548         0.23       37   

 

      

 

 

    

 

 

      

 

 

 

Total interest-bearing deposits

     679,323         0.25       428         661,385         0.34       559   

Short-term borrowings

     51,857         0.17       22         50,373         0.18       23   

Long-term debt

     127,486         2.37       756         139,542         2.81       980   

Other liabilities

     9,945         2.40       60         11,170         2.75       77   

 

      

 

 

    

 

 

      

 

 

 

Total interest-bearing liabilities

     868,611         0.58       1,266         862,470         0.76       1,639   

Portion of noninterest-bearing funding sources

     308,981         -                248,926         -          

 

      

 

 

    

 

 

      

 

 

 

Total funding sources

   $ 1,177,592         0.43       1,266         1,111,396         0.59       1,639   

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Net interest margin and net interest income on a taxable-equivalent basis (5)

        3.66  %    $ 10,820            3.84  %    $         10,714   
     

 

 

       

 

 

 

Noninterest-earning assets

               

Cash and due from banks

   $ 15,682              17,101        

Goodwill

     25,566              25,008        

Other

     135,500              127,864        

 

         

 

 

      

Total noninterest-earning assets

   $ 176,748              169,973        

 

         

 

 

      

Noninterest-bearing funding sources

               

Deposits

   $ 267,184              221,182        

Other liabilities

     66,116              57,464        

Total equity

     152,429              140,253        

Noninterest-bearing funding sources used to fund earning assets

     (308,981)              (248,926)        

 

         

 

 

      

Net noninterest-bearing funding sources

   $ 176,748              169,973        

 

         

 

 

      

Total assets

   $ 1,354,340              1,281,369        

 

         

 

 

      

 

 

 

(1) Our average prime rate was 3.25% for the quarters ended September 30, 2012 and 2011, and 3.25% for the first nine months of both 2012 and 2011. The average three-month London Interbank Offered Rate (LIBOR) was 0.43% and 0.30% for the quarters ended September 30, 2012 and 2011, respectively, and 0.47% and 0.29%, respectively, for the first nine months of 2012 and 2011.
(2) Yield/rates and amounts include the effects of hedge and risk management activities associated with the respective asset and liability categories.
(3) Yields and rates are based on interest income/expense amounts for the period, annualized based on the accrual basis for the respective accounts. The average balance amounts represent amortized cost for the periods presented.
(4) Nonaccrual loans and related income are included in their respective loan categories.
(5) Includes taxable-equivalent adjustments of $158 million and $172 million for the quarters ended September 30, 2012 and 2011, respectively, and $504 million and $505 million for the first nine months of 2012 and 2011, respectively, primarily related to tax-exempt income on certain loans and securities. The federal statutory tax rate utilized was 35% for the periods presented.

 

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     Nine months ended September 30,  
     2012      2011  
(in millions)    Average
balance
     Yields/
rates
    Interest
income/
expense
     Average
balance
     Yields/
rates
    Interest
income/
expense
 

 

 

Earning assets

               

Federal funds sold, securities purchased under resale agreements and other short-term investments

   $ 73,011         0.47  %    $ 257         93,661         0.37  %    $ 257   

Trading assets

     41,931         3.29       1,035         37,788         3.73       1,056   

Securities available for sale (3):

               

Securities of U.S. Treasury and federal agencies

     3,041         1.12       25         4,423         1.43       47   

Securities of U.S. states and political subdivisions

     34,366         4.42       1,139         22,694         5.21       887   

Mortgage-backed securities:

               

Federal agencies

     93,555         3.24       2,277         71,408         4.63       2,480   

Residential and commercial

     33,839         6.82       1,731         30,954         8.64       2,005   

 

      

 

 

    

 

 

      

 

 

 

Total mortgage-backed securities

     127,394         4.19       4,008         102,362         5.84       4,485   

Other debt and equity securities

     48,983         4.09       1,501         35,709         5.32       1,423   

 

      

 

 

    

 

 

      

 

 

 

Total securities available for sale

     213,784         4.16       6,673         165,188         5.52       6,842   

Mortgages held for sale (4)

     49,531         3.80       1,412         34,668         4.57       1,188   

Loans held for sale (4)

     838         6.07       38         1,100         5.05       42   

Loans:

               

Commercial:

               

Commercial and industrial

     172,039         4.07       5,245         154,469         4.48       5,181   

Real estate mortgage

     105,548         4.24       3,350         101,230         4.00       3,033   

Real estate construction

     18,118         4.98       676         22,255         4.96       826   

Lease financing

     12,875         7.47       721         12,961         7.59       737   

Foreign

     39,915         2.52       753         36,103         2.62       708   

 

      

 

 

    

 

 

      

 

 

 

Total commercial

     348,495         4.12       10,745         327,018         4.28       10,485   

 

      

 

 

    

 

 

      

 

 

 

Consumer:

               

Real estate 1-4 family first mortgage

     231,256         4.60       7,984         226,048         4.93       8,363   

Real estate 1-4 family junior lien mortgage

     82,161         4.28       2,631         91,881         4.32       2,973   

Credit card

     22,414         12.75       2,140         21,305         13.04       2,084   

Other revolving credit and installment

     86,874         6.12       3,980         87,041         6.31       4,107   

 

      

 

 

    

 

 

      

 

 

 

Total consumer

     422,705         5.28       16,735         426,275         5.49       17,527   

 

      

 

 

    

 

 

      

 

 

 

Total loans (4)

     771,200         4.76       27,480         753,293         4.97       28,012   

Other

     4,492         4.53       153         5,017         4.06       153   

 

      

 

 

    

 

 

      

 

 

 

Total earning assets

   $         1,154,787         4.28  %    $         37,048                 1,090,715         4.59  %    $ 37,550   

 

      

 

 

    

 

 

      

 

 

 

Funding sources

               

Deposits:

               

Interest-bearing checking

   $ 30,465         0.06  %    $ 14         51,891         0.09  %    $ 34   

Market rate and other savings

     500,850         0.12       457         457,483         0.19       661   

Savings certificates

     60,404         1.33       601         71,343         1.43       762   

Other time deposits

     13,280         1.74       173         13,212         2.10       208   

Deposits in foreign offices

     67,424         0.16       83         59,662         0.23       103   

 

      

 

 

    

 

 

      

 

 

 

Total interest-bearing deposits

     672,423         0.26       1,328         653,591         0.36       1,768   

Short-term borrowings

     50,650         0.17       65         52,805         0.19       77   

Long-term debt

     127,561         2.48       2,375         145,000         2.85       3,093   

Other liabilities

     10,052         2.50       189         10,547         2.99       236   

 

      

 

 

    

 

 

      

 

 

 

Total interest-bearing liabilities

     860,686         0.61       3,957         861,943         0.80       5,174   

Portion of noninterest-bearing funding sources

     294,101         -                228,772         -          

 

      

 

 

    

 

 

      

 

 

 

Total funding sources

   $ 1,154,787         0.46       3,957         1,090,715         0.63       5,174  

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Net interest margin and net interest income on a taxable-equivalent basis (5)

        3.82  %    $ 33,091            3.96  %    $         32,376   
     

 

 

       

 

 

 

Noninterest-earning assets

               

Cash and due from banks

   $ 16,283              17,277        

Goodwill

     25,343              24,853        

Other

     129,971              125,132        

 

         

 

 

      

Total noninterest-earning assets

   $ 171,597              167,262        

 

         

 

 

      

Noninterest-bearing funding sources

               

Deposits

   $ 256,120              204,643        

Other liabilities

     60,606              55,324        

Total equity

     148,972              136,067        

Noninterest-bearing funding sources used to fund earning assets

     (294,101)              (228,772)        

 

         

 

 

      

Net noninterest-bearing funding sources

   $ 171,597              167,262        

 

         

 

 

      

Total assets

   $ 1,326,384              1,257,977        

 

         

 

 

      

 

 

 

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Table of Contents

Earnings Performance (continued)

 

Noninterest Income

Table 2: Noninterest Income

 

 

     Quarter ended Sept. 30,      %     Nine months ended Sept. 30,      %  
(in millions)    2012      2011      Change     2012      2011      Change  

 

 

Service charges on deposit accounts

   $ 1,210        1,103         10   $ 3,433        3,189         8

Trust and investment fees:

                

Trust, investment and IRA fees

     1,062        1,019         4       3,127        3,099         1  

Commissions and all other fees

     1,892        1,767         7       5,564        5,547         -   

 

      

 

 

    

Total trust and investment fees

     2,954        2,786         6       8,691        8,646         1  

 

      

 

 

    

Card fees

     744        1,013         (27)        2,102        2,973         (29)   

Other fees:

                

Cash network fees

     121        105         15       359        280         28  

Charges and fees on loans

     426        438         (3)        1,298        1,239         5  

Processing and all other fees

     550        542         1       1,669        1,578         6  

 

      

 

 

    

Total other fees

     1,097        1,085         1       3,326        3,097         7  

 

      

 

 

    

Mortgage banking:

                

Servicing income, net

     197        1,030         (81)        1,128        2,773         (59)   

Net gains on mortgage loan origination/sales activities

     2,610        803         225       7,442        2,695         176  

 

      

 

 

    

Total mortgage banking

     2,807        1,833         53       8,570        5,468         57  

 

      

 

 

    

Insurance

     414        423         (2)        1,455        1,494         (3)   

Net gains (losses) from trading activities

     529        (442)         NM        1,432        584         145  

Net gains (losses) on debt securities available for sale

     3        300         (99)        (65)                NM   

Net gains from equity investments

     164        344         (52)        770        1,421         (46)   

Operating leases

     218        284         (23)        397        464         (14)   

All other

     411        357         15       1,440        1,130         27  

 

      

 

 

    

Total

   $           10,551        9,086         16     $           31,551        28,472         11  

 

 

NM - Not meaningful

 

Noninterest income was $10.6 billion and $9.1 billion for third quarter 2012 and 2011, respectively, and $31.6 billion and $28.5 billion for the first nine months of 2012 and 2011, respectively. Noninterest income represented 50% of revenue in third quarter 2012 and 49% in the first nine months of 2012. The increase in total noninterest income in the third quarter and first nine months of 2012 from the same periods a year ago was primarily due to higher net gains on higher mortgage loan origination/sales activities reflecting a lower interest rate environment.

Our service charges on deposit accounts increased 10% in the third quarter and 8% in the first nine months of 2012 from the same periods a year ago. This increase was predominantly due to product and account changes including changes to service charges and fewer fee waivers, continued customer adoption of overdraft services and customer account growth.

We earn trust, investment and IRA (Individual Retirement Account) fees from managing and administering assets, including mutual funds, corporate trust, personal trust, employee benefit trust and agency assets. At September 30, 2012, these assets totaled $2.2 trillion, up 6% from a year ago. Trust, investment and IRA fees are largely based on a tiered scale relative to the market value of the assets under management or administration. These fees increased to $1.1 billion in third quarter 2012 compared with $1.0 billion a year ago, and were essentially flat at $3.1 billion in the first nine months of 2012 compared with the same period a year ago.

We receive commissions and other fees for providing services to full-service and discount brokerage customers as well as from investment banking activities including equity and bond underwriting. These fees were $1.9 billion in the third quarter of 2012, up 7% from the same period a year ago, and essentially flat at $5.6 billion for the first nine months of 2012 compared with the same period a year ago. Commissions and other fees include transactional commissions based on the number of transactions executed at the customer’s direction, and asset-based fees, which are based on the market value of the customer’s assets. Brokerage client assets totaled $1.2 trillion at September 30, 2012, an 11% increase from a year ago.

Card fees decreased to $744 million in third quarter 2012, from $1.0 billion in third quarter 2011. For the first nine months of 2012, card fees decreased to $2.1 billion from $3.0 billion a year ago. Card fees decreased because of lower debit card interchange rates resulting from the final FRB rules implementing the Durbin Amendment to the Dodd-Frank Act, which became effective in fourth quarter 2011. The reduction in debit card interchange income was partially offset by growth in purchase volume and new accounts.

Mortgage banking noninterest income, consisting of net servicing income and net gains on loan origination/sales activities, totaled $2.8 billion in third quarter 2012, compared with $1.8 billion a year ago, and totaled $8.6 billion for the first nine months of 2012 compared with $5.5 billion for the same period a year ago. The year over year increase in mortgage

 

 

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banking noninterest income for both time periods was driven by an increase in net gains on higher mortgage loan origination/sales activities, partially offset by a decrease in servicing income.

Net mortgage loan servicing income includes amortization of commercial mortgage servicing rights (MSRs), changes in the fair value of residential MSRs during the period, and changes in the value of derivatives (economic hedges) used to hedge the residential MSRs. Net servicing income for third quarter 2012 included a $142 million net MSR valuation gain ($1.43 billion decrease in the fair value of the MSRs offset by a $1.57 billion hedge gain) and for third quarter 2011 included a $607 million net MSR valuation gain ($2.64 billion decrease in the fair value of MSRs offset by a $3.25 billion hedge gain). For the first nine months of 2012, net servicing income included a $461 million net MSR valuation gain ($3.22 billion decrease in the fair value of MSRs offset by a $3.68 billion hedge gain) and for the same period of 2011, included a $1.36 billion net MSR valuation gain ($3.22 billion decrease in the fair value of MSRs offset by a $4.58 billion hedge gain). The $465 million decline in net MSR valuation gain results for third quarter 2012 compared with the same period last year was primarily due to a reduction in the fair value of our residential MSRs to reflect servicing and foreclosure cost updates. The third quarter 2012 MSRs valuation included a $350 million reduction reflecting the additional costs associated with implementation of the servicing standards developed in connection with our settlement with the Department of Justice (DOJ) and other state and federal agencies relating to our mortgage servicing and foreclosure practices, as well as higher foreclosure costs. The $899 million decline in net MSR valuation gain results for the first nine months of 2012 compared with the same period last year also included a $344 million reduction in the fair value of our residential MSRs, reflecting a discount rate increase driven by increased capital return requirements from market participants. The valuation of our MSRs at the end of third quarter 2012 and 2011 reflected our assessment of expected future amounts of servicing and foreclosure costs. Our portfolio of loans serviced for others was $1.91 trillion at September 30, 2012, and $1.85 trillion at December 31, 2011. At September 30, 2012, the ratio of MSRs to related loans serviced for others was 0.63%, compared with 0.76% at December 31, 2011. See the “Risk Management – Mortgage Banking Interest Rate and Market Risk” section of this Report for additional information regarding our MSRs risks and hedging approach and the “Risk Management – Credit Risk Management – Risks Relating to Servicing Activities” section in this Report for information on the DOJ settlement and the regulatory consent orders that we entered into relating to our mortgages servicing and foreclosure practices.

Net gains on loan origination/sale activities were $2.6 billion and $7.4 billion in the third quarter and nine months ended September 30, 2012, respectively, up from $803 million and $2.7 billion for the same periods a year ago. The year over year increases were driven by higher loan origination volume and margins. Residential real estate originations were $139 billion and $399 billion in third quarter and nine months ended September 30, 2012 compared with $89 billion and $237 billion for the same periods a year ago, respectively. During third

quarter 2012 we retained for investment 1-4 family conforming first mortgage loans, forgoing approximately $200 million of fee revenue that could have been generated had the loans been originated for sale along with other agency loan originations. While retaining these mortgage loans on our balance sheet reduced mortgage revenue this quarter, we expect to generate spread income in future quarters from mortgage loans with higher yields than mortgage backed securities we could have purchased in the market. We have a large enough mortgage business and strong capital to make these choices that should benefit long-term results. We currently expect to retain additional conforming mortgages in fourth quarter 2012. Mortgage applications were $188 billion and $584 billion in the third quarter and nine months ended September 30, 2012, compared with $169 billion and $380 billion for the same periods a year ago, respectively. The 1-4 family first mortgage unclosed pipeline was $97 billion at September 30, 2012, and $84 billion a year ago. For additional information about our mortgage banking activities and results, see the “Risk Management – Mortgage Banking Interest Rate and Market Risk” section and Note 8 (Mortgage Banking Activities) and Note 13 (Fair Values of Assets and Liabilities) to Financial Statements in this Report.

Net gains on mortgage loan origination/sales activities include the cost of additions to the mortgage repurchase liability. Mortgage loans are repurchased from third parties based on standard representations and warranties, and early payment default clauses in mortgage sale contracts. Additions to the mortgage repurchase liability that were charged against net gains on mortgage loan origination/sales activities during third quarter 2012 totaled $462 million (compared with $390 million for third quarter 2011), of which $387 million ($371 million for third quarter 2011) was for subsequent increases in estimated losses on prior period loan sales. Additions to the mortgage repurchase liability for the nine months ended September 30, 2012, and 2011 were $1.6 billion and $881 million, respectively, of which $1.4 billion and $807 million, respectively, were for subsequent increases in estimated losses on prior period loan sales. For additional information about mortgage loan repurchases, see the “Risk Management – Credit Risk Management – Liability for Mortgage Loan Repurchase Losses” section and Note 8 (Mortgage Banking Activities) to Financial Statements in this Report.

Net gains (losses) from trading activities, which reflect unrealized changes in fair value of our trading positions and realized gains and losses, were $529 million and $1.4 billion in the third quarter and first nine months of 2012, respectively, compared with $(442) million and $584 million for the same periods a year ago. The year-over-year increase for the third quarter and first nine months of 2012 was driven by gains on customer accommodation trading activities and economic hedging gains, which included higher gains on deferred compensation plan investments. Net gains (losses) from trading activities do not include interest income and other fees earned from related activities. Those amounts are reported within interest income from trading assets and other noninterest income, respectively. Net gains (losses) from trading activities are primarily from trading conducted on behalf of or driven by the needs of our customers (customer accommodation trading)

 

 

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Earnings Performance (continued)

 

and also include the results of certain economic hedging and proprietary trading activity. Proprietary trading had $2 million and $16 million of net gains in the third quarter and first nine months of 2012, compared with net losses of $9 million and $18 million, respectively, for the same periods a year ago. Proprietary trading results also included interest and fees reported in their corresponding income statement line items. Proprietary trading activities are not significant to our client-focused business model. Our trading activities, customer accommodation, economic hedging and proprietary trading are further discussed in the “Asset/Liability Management – Market Risk – Trading Activities” section in this Report.

Net gains on debt and equity securities totaled $167 million for third quarter 2012 and $644 million for third quarter 2011 ($705 million and $1.4 billion for the first nine months of 2012 and 2011, respectively), after other-than-temporary impairment (OTTI) write-downs of $72 million and $144 million in third quarter 2012 and 2011, respectively, and $257 million and $470 million for the first nine months of 2012 and 2011, respectively.

 

 

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Noninterest Expense

Table 3: Noninterest Expense

 

 

     Quarter ended Sept. 30,      %     Nine months
ended Sept. 30,
     %  
(in millions)    2012      2011      Change     2012      2011      Change  

 

 

Salaries

   $ 3,648        3,718        (2 )%    $ 10,954        10,756        2

Commission and incentive compensation

     2,368        2,088        13       7,139        6,606        8  

Employee benefits

     1,063        780        36       3,720        3,336        12  

Equipment

     510        516        (1     1,526        1,676        (9

Net occupancy

     727        751        (3     2,129        2,252        (5

Core deposit and other intangibles

     419        466        (10     1,256        1,413        (11

FDIC and other deposit assessments

     359        332        8       1,049        952        10  

Outside professional services

     733        640        15       1,985        1,879        6  

Contract services

     237        341        (30     776        1,051        (26

Foreclosed assets

     247        271        (9     840        984        (15

Operating losses

     281        198        42       1,282        1,098        17  

Postage, stationery and supplies

     196        240        (18     607        711        (15

Outside data processing

     234        226        4       683        678        1  

Travel and entertainment

     208        198        5       628        609        3  

Advertising and promotion

     170        159        7       436        441        (1

Telecommunications

     127        128        (1     378        394        (4

Insurance

     51        94        (46     391        428        (9

Operating leases

     27        29        (7     82        84        (2

All other

     507        502        1       1,641        1,537        7  

 

      

 

 

    

Total

   $     12,112        11,677        4     $     37,502        36,885        2  

 

 

Noninterest expense was $12.1 billion in third quarter 2012, up 4% from $11.7 billion a year ago, predominantly due to higher personnel expenses ($7.1 billion, up from $6.6 billion a year ago), partially offset by lower merger costs resulting from the completion of Wachovia merger integration activities in first quarter 2012 ($376 million in third quarter 2011). For the first nine months of 2012, noninterest expense was up 2% from the same period a year ago.

Personnel expenses were up $493 million, or 7%, in third quarter 2012 compared with the same quarter last year, due to higher revenues generated by businesses with revenue-based compensation, such as capital markets and mortgage, and a $283 million increase in employee benefits due primarily to higher deferred compensation expense which was offset in trading income. Personnel expenses were up $1.1 billion, or 5%, for the first nine months of 2012 compared with the same period in 2011, mostly due to higher revenue-related compensation, higher deferred compensation expense which was offset in trading income, and annual salary increases and related salary taxes.

Outside professional services were up $93 million, or 15%, in third quarter 2012 compared with the same quarter last year and up $106 million, or 6%, in the first nine months of 2012 compared with the same period a year ago. Substantially all of the increase for both periods was due to expenses associated with our mortgage servicing regulatory consent orders.

Operating losses were up $83 million, or 42%, in third quarter 2012 and up $184 million, or 17%, in the first nine months of 2012, compared with the same periods in 2011, predominantly due to higher litigation charges.

The completion of Wachovia integration activities in the first quarter 2012 significantly contributed to year-over-year

reductions, for both the third quarter and first nine months of 2012, in equipment, occupancy, contract services, postage, stationery and supplies, and advertising and promotion expenses.

We remain focused on expense management and improving our expense efficiency ratio. In turn, we will not forgo attractive revenue opportunities in order to meet specific noninterest expense targets.

Income Tax Expense

Our effective tax rate was 33.4% in third quarter 2012, up from 33.0% in third quarter 2011. Our effective tax rate was 34.2% in the first nine months of 2012, up from 32.1% in the first nine months of 2011. The lower tax rate in 2011 reflected a tax benefit from the realization for tax purposes of a previously written down investment as well as tax benefits related to charitable donations of appreciated securities.

 

 

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Earnings Performance (continued)

 

Operating Segment Results

We are organized for management reporting purposes into three operating segments: Community Banking; Wholesale Banking; and Wealth, Brokerage and Retirement. These segments are defined by product type and customer segment and their results are based on our management accounting process, for which there is no comprehensive, authoritative financial accounting guidance equivalent to generally accepted accounting principles

(GAAP). In first quarter 2012, we modified internal funds transfer rates and the allocation of funding. The prior periods have been revised to reflect these changes. Table 4 and the following discussion present our results by operating segment. For a more complete description of our operating segments, including additional financial information and the underlying management accounting process, see Note 18 (Operating Segments) to Financial Statements in this Report.

 

 

Table 4: Operating Segment Results – Highlights

 

 

     Community Banking      Wholesale Banking      Wealth, Brokerage
and Retirement
 
(in billions)    2012      2011       2012      2011       2012      2011  

Quarter ended September 30,

                 

Revenue

   $ 13.1        12.5         5.9        5.1         3.0        2.9  

Net income

     2.7        2.3         2.0        1.8         0.3        0.3  

Average loans

     485.3        489.7         277.1        253.4         42.5        43.1  

Average core deposits

     594.5        556.4         225.4        209.3         136.7        133.3  

Nine months ended September 30,

                 

Revenue

   $           39.6        37.8         18.1        16.2         9.1        9.1  

Net income

     7.6        6.6         5.7        5.4         1.0        1.0  

Average loans

     485.1        498.3         272.0        243.7         42.5        43.1  

Average core deposits

     585.3        552.3         222.4        195.0         135.5        128.2  

 

 

Community Banking offers a complete line of diversified financial products and services for consumers and small businesses. These products include investment, insurance and trust services in 39 states and D.C., and mortgage and home equity loans in all 50 states and D.C. through its Regional Banking and Wells Fargo Home Lending business units. Cross-sell of our products is an important part of our strategy to achieve our vision to satisfy all our customers’ financial needs. Our retail bank household cross-sell has increased each quarter since the beginning of 2011, and in August 2012 our cross-sell was 6.04 products per household, up from 5.90 a year ago. We believe there is more opportunity for cross-sell as we continue to earn more business from our customers. Our goal is eight products per customer, which is approximately half of our estimate of potential demand for an average U.S. household. As of August 2012, one of every four of our retail banking households had eight or more of our products.

Community Banking had net income of $2.7 billion, up $416 million, or 18%, from third quarter 2011, and $7.6 billion for the first nine months of 2012, up $999 million, or 15%, compared with the same period a year ago. Revenue of $13.1 billion increased $600 million, or 5%, from third quarter 2011 and was $39.6 billion for the first nine months of 2012, an increase of $1.9 billion, or 5%, compared with the same period a year ago. Revenue increased in both periods as a result of higher volume-related mortgage banking income and growth in deposit service charges, partially offset by higher equity gains in the prior year, planned runoff of non-strategic loan balances and lower debit card revenue due to regulatory changes enacted in October 2011. Noninterest income increased $2.2 billion, or 14%, for the first nine months of 2012 compared with the same period a year ago, mostly due to higher volume-related mortgage banking income. Average core deposits increased $38.1 billion,

or 7%, from third quarter 2011 and $33 billion, or 6%, from the first nine months of 2011. Noninterest expense increased 7% from third quarter 2011, and 4% from the first nine months of 2011, largely due to higher mortgage volume-related expenses and increased severance expense associated with our efficiency and cost save initiatives. The provision for credit losses was $347 million, or 18%, lower than third quarter 2011 and $873 million, or 15%, lower than the first nine months of 2011, due to improved portfolio performance.

Wholesale Banking provides financial solutions to businesses across the United States and globally with annual sales generally in excess of $20 million. Products and business segments include Middle Market Commercial Banking, Government and Institutional Banking, Corporate Banking, Commercial Real Estate, Treasury Management, Wells Fargo Capital Finance, Insurance, International, Real Estate Capital Markets, Commercial Mortgage Servicing, Corporate Trust, Equipment Finance, Wells Fargo Securities, Principal Investments, Asset Backed Finance, and Asset Management.

Wholesale Banking had record net income of $2.0 billion in third quarter 2012, up $190 million, or 11%, from third quarter 2011. Net income increased to $5.7 billion for the first nine months of 2012 from $5.4 billion a year ago. Results for the first nine months of 2012 benefited from strong revenue growth partially offset by increased noninterest expense and a higher provision for loan losses. Revenue in third quarter 2012 increased $814 million, or 16%, from third quarter 2011 and revenue in the first nine months of 2012 increased $1.9 billion, or 12%, from the first nine months of 2011 driven by broad-based business growth as well as growth from acquisitions. Average loans of $277.1 billion in third quarter 2012 increased 9% from third quarter 2011 driven by acquisitions and strong

 

 

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borrowing demand with many lending areas experiencing double digit growth including asset backed finance, capital finance, commercial banking, commercial real estate, corporate banking, and real estate capital markets. Average core deposits of $225.4 billion in third quarter 2012 increased 8% from third quarter 2011, reflecting continued strong customer liquidity. Noninterest expense in third quarter and for the first nine months of 2012 increased 8% and 10%, respectively, from the comparable periods last year, on higher personnel expenses related to revenue growth and higher non-personnel expenses related to growth initiatives and compliance and regulatory requirements as well as increased operating losses. The provision for credit losses increased $121 million from third quarter 2011, and included a $110 million loan loss allowance release, compared with a $350 million release a year ago. The provision for credit losses increased $367 million for the first nine months of 2012, compared with the same period a year ago, primarily due to a lower allowance release.

Wealth, Brokerage and Retirement provides a full range of financial advisory services to clients using a planning approach to meet each client’s needs. Wealth Management provides affluent and high net worth clients with a complete range of wealth management solutions, including financial planning, private banking, credit, investment management and trust. Abbot Downing, a Wells Fargo business, provides comprehensive wealth management services to ultra high net worth families and individuals as well as their endowments and foundations. Brokerage serves customers’ advisory, brokerage and financial needs as part of one of the largest full-service

brokerage firms in the United States. Retirement is a national leader in providing institutional retirement and trust services (including 401(k) and pension plan record keeping) for businesses, retail retirement solutions for individuals, and reinsurance services for the life insurance industry.

Wealth, Brokerage and Retirement had net income of $338 million in third quarter 2012, up $48 million, or 17%, from third quarter 2011. Net income for the first nine months of 2012 was $977 million, up $7 million, or 1%, compared with the same period a year ago. The prior year results include the H.D. Vest Financial Services business that was divested in fourth quarter 2011. Revenue was $3.0 billion in third quarter 2012, up $145 million, or 5%, from third quarter 2011, due to $45 million in gains on deferred compensation plan investments (offset in expense), compared with $128 million in losses in third quarter 2011. Excluding deferred compensation, revenue was down 1% primarily due to lower net interest income and reduced securities gains in the brokerage business, partially offset by growth in managed account fee revenue. Revenue was down 1% from the first nine months of 2011 due to lower brokerage transaction revenue and reduced securities gains in the brokerage business, partially offset by an increase in gains on deferred compensation. Total provision for credit losses decreased $18 million from third quarter 2011 and $40 million compared with the first nine months of 2011. Noninterest expense was up 4% from third quarter 2011, driven by higher deferred compensation plan expense. Noninterest expense was flat for the first nine months of 2012 compared to the same period of 2011.

 

 

Balance Sheet Analysis

 

 

At September 30, 2012, our total assets, core deposits and total loans were up from December 31, 2011. Core deposits totaled 115% of the loan portfolio at September 30, 2012, and we have the capacity to add higher yielding earning assets to generate future revenue and earnings growth. The strength of our business model produced record earnings and continued internal capital generation as reflected in our capital ratios, substantially all of which improved from December 31, 2011. Tier 1 capital as a percentage of total risk-weighted assets increased to 11.50%, total capital decreased to 14.51%, Tier 1 leverage

increased to 9.40%, and Tier 1 common equity increased to 9.92% at September 30, 2012, compared with 11.33%, 14.76%, 9.03%, and 9.46%, respectively, at December 31, 2011.

The following discussion provides additional information about the major components of our balance sheet. Information regarding our capital and changes in our asset mix is included in the “Earnings Performance – Net Interest Income” and “Capital Management” sections and Note 19 (Regulatory and Agency Capital Requirements) to Financial Statements in this Report.

 

 

Securities Available for Sale

Table 5: Securities Available for Sale – Summary

 

 

     September 30, 2012      December 31, 2011  
(in millions)    Cost     

Net

unrealized

gain

    

Fair

value

     Cost     

Net

unrealized

gain

    

Fair

value

 

Debt securities available for sale

   $         214,674         11,924         226,598         212,642         6,554         219,196   

Marketable equity securities

     2,327         425         2,752         2,929         488         3,417   

Total securities available for sale

   $ 217,001         12,349         229,350         215,571         7,042         222,613   

 

 

Table 5 presents a summary of our securities available-for-sale portfolio, which consists of both debt and marketable equity securities. We hold debt securities available

for sale primarily for liquidity, interest rate risk management and long-term yield

 

 

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Balance Sheet Analysis (continued)

 

enhancement. Accordingly, this portfolio consists primarily of liquid, high quality federal agency debt and privately issued mortgage-backed securities (MBS). The total net unrealized gains on securities available for sale were $12.3 billion at September 30, 2012, up from net unrealized gains of $7.0 billion at December 31, 2011, due to a decline in long-term yields and tightening of credit spreads.

We analyze securities for OTTI quarterly or more often if a potential loss-triggering event occurs. Of the $257 million OTTI write-downs recognized in the first nine months of 2012, $163 million related to debt securities. There was $9 million in OTTI write-downs for marketable equity securities and $85 million in OTTI write-downs related to nonmarketable equity securities. For a discussion of our OTTI accounting policies and underlying considerations and analysis see Note 1 (Summary of Significant Accounting Policies – Securities) in our 2011 Form 10-K and Note 4 (Securities Available for Sale) to Financial Statements in this Report.

At September 30, 2012, debt securities available for sale included $37.9 billion of municipal bonds, of which 81% were rated “A-” or better based on external and, in some cases, internal ratings. Additionally, some of the securities in our total municipal bond portfolio are guaranteed against loss by bond insurers. These guaranteed bonds are predominantly investment grade and were generally underwritten in accordance with our own investment standards prior to the determination to purchase, without relying on the bond insurer’s guarantee in making the investment decision. Our municipal bond holdings are monitored as part of our ongoing impairment analysis of our securities available for sale.

The weighted-average expected maturity of debt securities available for sale was 5.0 years at September 30, 2012. Because 61% of this portfolio is MBS, the expected remaining maturity may differ from contractual maturity because borrowers generally 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 MBS available for sale are shown in Table 6.

Table 6: Mortgage-Backed Securities

 

 

(in billions)    Fair
value
     Net
unrealized
gain (loss)
     Expected
remaining
maturity
(in years)
 

At September 30, 2012

        

Actual

   $     138.8         8.5         3.2   

Assuming a 200 basis point:

        

Increase in interest rates

     130.3         -         4.6   

Decrease in interest rates

     141.1         10.8         2.7   

 

See Note 4 (Securities Available for Sale) to Financial Statements in this Report for securities available for sale by security type.

 

 

 

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Loan Portfolio

Total loans were $782.6 billion at September 30, 2012, up $13.0 billion from December 31, 2011. Table 7 provides a summary of total outstanding loans for our commercial and consumer loan portfolios. Excluding the runoff in the non-strategic/liquidating portfolios of $13.7 billion, loans in the core portfolio grew $26.7 billion in the first nine months of 2012. Our core loan growth in 2012 included:

   

an $8.9 billion increase in commercial loans, which included:

   

$6.9 billion acquired during our second quarter 2012 acquisitions of BNP Paribas’ North American energy lending business and WestLB’s subscription finance loan portfolio; and

   

$858 million of commercial asset-based loans acquired with the acquisition of Burdale Financial Holdings Limited (Burdale) and the portfolio of Burdale Capital Finance Inc. in first quarter 2012; and

   

a $17.7 billion increase in consumer loans with growth in first mortgage (including the retention of $9.8 billion of 1-4 family conforming first mortgages), auto, credit card and private student lending.

Additional information on the non-strategic and liquidating loan portfolios is included in Table 11 in the “Credit Risk Management” section of this Report.

 

 

Table 7: Loan Portfolios – Summary

 

 

     September 30, 2012      December 31, 2011  
(in millions)    Core      Liquidating      Total      Core      Liquidating      Total  

Commercial

   $   348,696          3,836          352,532          339,755          5,695          345,450    

Consumer

     335,278          94,820          430,098          317,550          106,631          424,181    

Total loans

   $ 683,974          98,656          782,630          657,305          112,326          769,631    

 

A discussion of the impact on net interest income and a comparative detail of average loan balances is included in “Earnings Performance – Net Interest Income” and Table 1 in this Report. Additional information on total loans outstanding by portfolio segment and class of financing receivable is included in the “Credit Risk Management” section in this Report. Period-end balances and other loan related information are in Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.

Deposits

Deposits totaled $952.2 billion at September 30, 2012, compared with $920.1 billion at December 31, 2011. Table 8 provides additional information regarding deposits. Information regarding the impact of deposits on net interest income and a comparison of average deposit balances is provided in “Earnings Performance – Net Interest Income” and Table 1 earlier in this Report. Total core deposits were $901.1 billion at September 30, 2012, up $28.5 billion from $872.6 billion at December 31, 2011.

 

 

Table 8: Deposits

 

 

($ in millions)    Sept. 30,
2012
     % of
total
deposits
    Dec. 31,
2011
     % of
total
deposits
    %
Change
 

 

 

Noninterest-bearing

   $ 268,969         28  %    $ 243,961         26  %      10   

Interest-bearing checking

     29,427         3        37,027         4        (21

Market rate and other savings

     502,482         53        485,534         53        3   

Savings certificates

     57,547         6        63,617         7        (10

Foreign deposits (1)

     42,650         5        42,490         5        -   

 

   

Core deposits

     901,075         95        872,629         95        3   

Other time and savings deposits

     21,636         2        20,745         2        4   

Other foreign deposits

     29,528         3        26,696         3        11   

 

   

Total deposits

   $ 952,239         100  %    $ 920,070         100  %      3   

 

 

(1) Reflects Eurodollar sweep balances included in core deposits.

 

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Balance Sheet Analysis (continued)

 

Fair Valuation of Financial Instruments

We use fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. See our 2011 Form 10-K for a description of our critical accounting policy related to fair valuation of financial instruments.

We may use independent pricing services and brokers (collectively, pricing vendors) to obtain fair values (vendor prices) which are used to either record the price of an instrument or to corroborate internally developed prices. For certain securities, we may use internal traders to price instruments. Where vendor prices are used for recording the price of an instrument, we determine the most appropriate and relevant pricing vendor for each security class and obtain a price from that particular pricing vendor for each security.

Determination of the fair value of financial instruments using either vendor prices or internally developed prices are both subject to our internal price validation procedures, which include, but are not limited to, one or a combination of the following procedures:

   

comparison to pricing vendors (for internally developed prices) or to other pricing vendors (for vendor developed prices);

   

variance analysis of prices;

   

corroboration of pricing by reference to other independent market data such as secondary broker quotes and relevant benchmark indices;

   

review of pricing by Company personnel familiar with market liquidity and other market-related conditions; and

   

investigation of prices on a specific instrument-by-instrument basis.

For instruments where we use vendor prices to record the price of an instrument, we perform additional procedures. We evaluate pricing vendors by comparing prices from one vendor to prices of other vendors for identical or similar instruments and evaluate the consistency of prices to known market

transactions when determining the level of reliance to be placed on a particular pricing vendor. Methodologies employed and inputs used by third party pricing vendors are subject to additional review when such services are provided. This review may consist of, in part, obtaining and evaluating control reports issued and pricing methodology materials distributed.

Table 9 presents the summary of the fair value of financial instruments recorded at fair value on a recurring basis, and the amounts measured using significant Level 3 inputs (before derivative netting adjustments). The fair value of the remaining assets and liabilities were measured using valuation methodologies involving market-based or market-derived information (collectively Level 1 and 2 measurements).

Table 9: Fair Value Level 3 Summary

 

 

     September 30, 2012     December 31, 2011  
($ in billions)    Total
balance
    Level 3 (1)     Total
balance
     Level
3 (1)
 

Assets carried at fair value

   $     364.0         49.8        373.0         53.3   

As a percentage of total assets

     26      4        28         4   

Liabilities carried at fair value

   $ 27.3         4.1        26.4         4.6   

As a percentage of total liabilities

         *        2         *   

 

* Less than 1%.
(1) Before derivative netting adjustments.

See Note 13 (Fair Values of Assets and Liabilities) to Financial Statements in this Report for additional information regarding our use of fair valuation of financial instruments, our related measurement techniques and the impact to our financial statements.

 

 

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Off-Balance Sheet Arrangements

 

 

In the ordinary course of business, we engage in financial transactions that are not recorded in the balance sheet, or may be recorded in the balance sheet in amounts that are different from the full contract or notional amount of the transaction. These transactions are designed to (1) meet the financial needs of customers, (2) manage our credit, market or liquidity risks, (3) diversify our funding sources, and/or (4) optimize capital.

Off-Balance Sheet Transactions with Unconsolidated Entities

We routinely enter into various types of on- and off-balance sheet transactions with special purpose entities (SPEs), which are corporations, trusts or partnerships that are established for a limited purpose. Historically, the majority of SPEs were formed in connection with securitization transactions. For more information on securitizations, including sales proceeds and cash flows from securitizations, see Note 7 (Securitizations and Variable Interest Entities) to Financial Statements in this Report.

 

 

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Risk Management

 

 

All financial institutions must manage and control a variety of business risks that can significantly affect their financial performance. Key among those are credit, asset/liability and market risk. Effective management of operational risks, which include risks relating to management information systems, security systems, and information security, also is an important focus for financial institutions such as Wells Fargo. Recently, Wells Fargo and reportedly other financial institutions have been the target of various denial-of-service or other cyber attacks as part of what appears to be a coordinated effort to disrupt the operations of financial institutions. Although to date Wells Fargo has not experienced any material losses relating to these or other cyber attacks, cyber security and the continued development and enhancement of our controls, processes and systems to protect our networks, computers, software, and data from attack, damage or unauthorized access remain a priority for Wells Fargo. See the “Risk Factors” section in our 2011 Form 10-K for additional information regarding the risks associated with a failure or breach of our operational or security systems or infrastructure, including as a result of cyber attacks.

For more information about how we manage credit, asset/liability and market risk, see the “Risk Management” section in our 2011 Form 10-K. The discussion that follows provides an update regarding these risks.

Credit Risk Management

Loans represent the largest component of assets on our balance sheet and their related credit risk is among the most significant risks we manage. We define credit risk as the risk of loss associated with a borrower or counterparty default (failure to meet obligations in accordance with agreed upon terms). Table 10 presents our total loans outstanding by portfolio segment and class of financing receivable.

Table 10: Total Loans Outstanding by Portfolio Segment and Class of Financing Receivable

 

 

(in millions)    Sept. 30,
2012
     Dec. 31,
2011
 

Commercial:

     

Commercial and industrial

   $ 178,191         167,216   

Real estate mortgage

     104,611         105,975   

Real estate construction

     17,710         19,382   

Lease financing

     12,279         13,117   

Foreign (1)

     39,741         39,760   

Total commercial

     352,532         345,450   

Consumer:

     

Real estate 1-4 family first mortgage

     240,554         228,894   

Real estate 1-4 family junior lien mortgage

     78,091         85,991   

Credit card

     23,692         22,836   

Other revolving credit and installment

     87,761         86,460   

Total consumer

     430,098         424,181   

Total loans

   $       782,630         769,631   

 

 

(1) Substantially all of our foreign loan portfolio is commercial loans. Loans are classified as foreign if the borrower’s primary address is outside of the United States.
 

 

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Risk Management – Credit Risk Management (continued)

 

Non-Strategic and Liquidating Loan Portfolios We continually evaluate and modify our credit policies to address appropriate levels of risk. We may designate certain portfolios and loan products as non-strategic or liquidating to cease their continued origination as we actively work to limit losses and reduce our exposures.

Table 11 identifies our non-strategic and liquidating loan portfolios. They consist primarily of the Pick-a-Pay mortgage portfolio and PCI loans acquired from Wachovia, some portfolios from legacy Wells Fargo Home Equity and Wells

Fargo Financial, and our education finance government guaranteed loan portfolio. The total of outstanding balances of our non-strategic and liquidating loan portfolios has decreased 48% since the merger with Wachovia at December 31, 2008, and decreased 12% from the end of 2011.

The home equity portfolio of loans generated through third party channels was designated as liquidating in fourth quarter 2007. Additional information regarding this portfolio, as well as the liquidating PCI and Pick-a-Pay loan portfolios, is provided in the discussion of loan portfolios that follows.

 

 

Table 11: Non-Strategic and Liquidating Loan Portfolios

 

 

     Outstanding balance  
(in millions)    Sept. 30,
2012
     Dec. 31,
2011
     Dec. 31,
2010
     Dec. 31,
2009
     Dec. 31,
2008
 

Commercial:

              

Legacy Wachovia commercial and industrial, CRE and foreign PCI loans (1)

   $ 3,836         5,695         7,935         12,988         18,704   

Total commercial

     3,836         5,695         7,935         12,988         18,704   

Consumer:

              

Pick-a-Pay mortgage (1)

     60,080         65,652         74,815         85,238         95,315   

Liquidating home equity

     4,951         5,710         6,904         8,429         10,309   

Legacy Wells Fargo Financial indirect auto

     1,104         2,455         6,002         11,253         18,221   

Legacy Wells Fargo Financial debt consolidation

     15,002         16,542         19,020         22,364         25,299   

Education Finance - government guaranteed

     12,951         15,376         17,510         21,150         20,465   

Legacy Wachovia other PCI loans (1)

     732         896         1,118         1,688         2,478   

Total consumer

     94,820         106,631         125,369         150,122         172,087   

Total non-strategic and liquidating loan portfolios

   $         98,656         112,326         133,304         163,110         190,791   

 

 

(1) Net of purchase accounting adjustments related to PCI loans.

 

PURCHASED CREDIT-IMPAIRED (PCI) LOANS Loans acquired with evidence of credit deterioration since their origination and where it is probable that we will not collect all contractually required principal and interest payments are accounted for using the measurement provisions for PCI loans. PCI loans are recorded at fair value at the date of acquisition, and the historical allowance for credit losses related to these loans is not carried over. Such loans are considered to be accruing due to the existence of the accretable yield and not based on consideration given to contractual interest payments. Substantially all of our PCI loans were acquired in the Wachovia acquisition on December 31, 2008. For additional information on PCI loans, see the “Risk Management – Credit Risk Management – Purchased Credit-Impaired Loans” section in our 2011 Form 10-K.

During the first nine months of 2012, we recognized as income $80 million released from the nonaccretable difference related to commercial PCI loans due to payoffs and other resolutions. We also transferred $1.0 billion from the nonaccretable difference to the accretable yield for PCI loans with improving credit-related cash flows and absorbed $2.0 billion of losses in the nonaccretable difference from loan resolutions and write-downs. Our cash flows expected to be collected have been favorably affected by lower expected defaults and losses as a result of observed strengthening in housing prices and loan modifications that are expected to keep borrowers in their homes longer. These factors led to the reduction in expected losses on PCI loans, primarily Pick-a-Pay, which resulted in a reclassification from nonaccretable difference to accretable yield. Table 12 provides an analysis of changes in the nonaccretable difference.

 

 

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Table 12: Changes in Nonaccretable Difference for PCI Loans

 

 

(in millions)        Commercial     Pick-a-Pay     Other
consumer
    Total  

Balance, December 31, 2008

   $ 10,410        26,485        4,069        40,964   

Addition of nonaccretable difference due to acquisitions

     188        -        -        188   

Release of nonaccretable difference due to:

        

Loans resolved by settlement with borrower (1)

     (1,345     -        -        (1,345

Loans resolved by sales to third parties (2)

     (299     -        (85     (384

Reclassification to accretable yield for loans with improving credit-related cash flows (3)

     (1,216     (2,383     (614     (4,213

Use of nonaccretable difference due to:

        

Losses from loan resolutions and write-downs (4)

     (6,809     (14,976     (2,718     (24,503

 

 

Balance, December 31, 2011

     929        9,126        652        10,707   

Addition of nonaccretable difference due to acquisitions

     -        -        -        -   

Release of nonaccretable difference due to:

        

Loans resolved by settlement with borrower (1)

     (76     -        -        (76

Loans resolved by sales to third parties (2)

     (4     -        -        (4

Reclassification to accretable yield for loans with improving credit-related cash flows (3)

     (188     (648     (170     (1,006

Use of nonaccretable difference due to:

        

Losses from loan resolutions and write-downs (4)(5)

     (104     (1,799     (112     (2,015

 

 

Balance, September 30, 2012

   $ 557        6,679        370        7,606   

 

 

 

 

Balance, June 30, 2012

   $ 658        8,128        440        9,226   

Addition of nonaccretable difference due to acquisitions

     -        -        -        -   

Release of nonaccretable difference due to:

        

Loans resolved by settlement with borrower (1)

     (24     -        -        (24

Loans resolved by sales to third parties (2)

     (4     -        -        (4

Reclassification to accretable yield for loans with improving credit-related cash flows (3)

     (41     (603     (43     (687

Use of nonaccretable difference due to:

        

Losses from loan resolutions and write-downs (4)(5)

     (32     (846     (27     (905

 

 

Balance, September 30, 2012

   $ 557        6,679        370        7,606   

 

 

 

(1) Release of the nonaccretable difference for settlement with borrower, on individually accounted PCI loans, increases interest income in the period of settlement. Pick-a-Pay and Other consumer PCI loans do not reflect nonaccretable difference releases for settlements with borrowers due to pool accounting for those loans, which assumes that the amount received approximates the pool performance expectations.
(2) Release of the nonaccretable difference as a result of sales to third parties increases noninterest income in the period of the sale.
(3) Reclassification of nonaccretable difference to accretable yield for loans with increased cash flow estimates will result in increased interest income as a prospective yield adjustment over the remaining life of the loan or pool of loans.
(4) Write-downs to net realizable value of PCI loans are absorbed by the nonaccretable difference when severe delinquency (normally 180 days) or other indications of severe borrower financial stress exist that indicate there will be a loss of contractually due amounts upon final resolution of the loan.
(5) Quarter and nine months ended September 30, 2012, include $376 million resulting from the implementation of OCC guidance issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be written down to net realizable collateral value, regardless of their delinquency status.

 

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Risk Management – Credit Risk Management (continued)

 

Since December 31, 2008, we have released $7.0 billion in nonaccretable difference, including $5.2 billion transferred from the nonaccretable difference to the accretable yield and $1.8 billion released to income through loan resolutions. Also, we have provided $1.8 billion for losses on certain PCI loans or pools of PCI loans that have had credit-related decreases to cash flows expected to be collected. The net result is a $5.2 billion reduction from December 31, 2008, through September 30, 2012, in our initial projected losses on all PCI loans.

At September 30, 2012, the allowance for credit losses on certain PCI loans was $160 million. The allowance is necessary to absorb credit-related decreases in cash flows expected to be collected and primarily relates to individual PCI loans. Table 13 analyzes the actual and projected loss results on PCI loans since acquisition through September 30, 2012.

For additional information on PCI loans, see Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.

 

 

Table 13: Actual and Projected Loss Results on PCI Loans Since Acquisition of Wachovia

 

 

(in millions)    Commercial     Pick-a-Pay      Other
consumer
    Total  

Release of nonaccretable difference due to:

         

Loans resolved by settlement with borrower (1)

   $ 1,421        -         -        1,421   

Loans resolved by sales to third parties (2)

     303        -         85        388   

Reclassification to accretable yield for loans with improving credit-related cash flows (3)

     1,404        3,031         784        5,219   

 

 

Total releases of nonaccretable difference due to better than expected losses

     3,128        3,031         869        7,028   

Provision for losses due to credit deterioration (4)

     (1,679     -         (125     (1,804

 

 

Actual and projected losses on PCI loans less than originally expected

   $ 1,449        3,031         744        5,224   

 

 

 

(1) Release of the nonaccretable difference for settlement with borrower, on individually accounted PCI loans, increases interest income in the period of settlement. Pick-a-Pay and Other consumer PCI loans do not reflect nonaccretable difference releases for settlements with borrowers due to pool accounting for those loans, which assumes that the amount received approximates the pool performance expectations.
(2) Release of the nonaccretable difference as a result of sales to third parties increases noninterest income in the period of the sale.
(3) Reclassification of nonaccretable difference to accretable yield for loans with increased cash flow estimates will result in increased interest income as a prospective yield adjustment over the remaining life of the loan or pool of loans.
(4) Provision for additional losses is recorded as a charge to income when it is estimated that the cash flows expected to be collected for a PCI loan or pool of loans may not support full realization of the carrying value.

 

Significant Portfolio Reviews Measuring and monitoring our credit risk is an ongoing process that tracks delinquencies, collateral values, FICO scores, economic trends by geographic areas, loan-level risk grading for certain portfolios (typically commercial) and other indications of credit risk. Our credit risk monitoring process is designed to enable early identification of developing risk and to support our determination of an appropriate allowance for credit losses. The following discussion provides additional characteristics and analysis of our significant portfolios. See Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report for more analysis and credit metric information.

COMMERCIAL AND INDUSTRIAL LOANS AND LEASE FINANCING For purposes of portfolio risk management, we aggregate commercial and industrial loans and lease financing according to market segmentation and standard industry codes. Table 14 summarizes commercial and industrial loans and lease financing by industry with the related nonaccrual totals. We generally subject commercial and industrial loans and lease financing to individual risk assessment using our internal borrower and collateral quality ratings. Our ratings are aligned to pass and criticized categories with our criticized categories aligned to special mention, substandard and doubtful categories as defined by bank regulatory agencies.

Across our non-PCI commercial loans and leases, the commercial and industrial loans and lease financing portfolio generally experienced credit improvement in third quarter 2012. Of the total commercial and industrial loans and lease financing non-PCI portfolio, 0.03% was 90 days or more past due and still accruing at September 30, 2012, compared with 0.09% at

December 31, 2011, 0.76% (1.22% at December 31, 2011) was nonaccruing and 11.04% (12.5% at December 31, 2011) was criticized. The net charge-off rate for this portfolio declined to 0.28% in third quarter 2012 from 0.54% in second quarter 2012 and 0.70% for the full year of 2011.

A majority of our commercial and industrial loans and lease financing portfolio is secured by short-term assets, such as accounts receivable, inventory and securities, as well as long-lived assets, such as equipment and other business assets. Generally, the collateral securing this portfolio represents a secondary source of repayment. See Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report for additional credit metric information.

During second quarter 2012, we acquired $6.9 billion of commercial loans in connection with our acquisitions of BNP Paribas’ North American energy lending business and WestLB’s subscription finance loan portfolio, of which an aggregate of $5.4 billion was added to the commercial and industrial loan portfolio. In first quarter 2012, we also added $858 million to this portfolio when we acquired commercial asset-based loans from the Bank of Ireland in the Burdale acquisition.

 

 

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Table 14: Commercial and Industrial Loans and Lease Financing by Industry

 

 

      September 30, 2012  
(in millions)    Nonaccrual
loans
     Total
portfolio (1)
    % of
total
loans
 

 

 

PCI loans (1):

       

Healthcare

   $ -         41      

Technology

     -         39       *   

Aerospace and defense

     -         34       *   

Steel and metal products

     -         22       *   

Home furnishings

     -         22       *   

Cyclical retailers

     -         22       *   

Other

     -         66  (2)      *   

 

 

Total PCI loans

   $ -         246      

 

 

All other loans:

       

Oil and gas

   $ 49        13,991      

Investors

     2        13,216       2  

Cyclical retailers

     30        11,339       1  

Food and beverage

     49        10,702       1  

Financial institutions

     95        10,080       1  

Industrial equipment

     34        9,492       1  

Healthcare

     41        8,906       1  

Real estate lessor

     34        7,064       *   

Technology

     20        6,795       *   

Transportation

     9        6,471       *   

Business services

     29        5,816       *   

Securities firms

     23        5,248       *   

Other

     1,038        81,104  (3)      10  

 

 

Total all other loans

   $ 1,453        190,224       24 

 

 

Total

   $ 1,453        190,470       24 

 

 

 

* Less than 1%.
(1) For PCI loans, amounts represent carrying value. PCI loans are considered to be accruing due to the existence of the accretable yield and not based on consideration given to contractual interest payments.
(2) No other single category had loans in excess of $14 million.
(3) No other single category had loans in excess of $4.4 billion.

 

COMMERCIAL REAL ESTATE (CRE) The CRE portfolio, consisting of both CRE mortgage loans and CRE construction loans, totaled $122.3 billion, or 16%, of total loans at September 30, 2012. CRE construction loans totaled $17.7 billion at September 30, 2012, and CRE mortgage loans totaled $104.6 billion at September 30, 2012. Table 15 summarizes CRE loans by state and property type with the related nonaccrual totals. CRE nonaccrual loans totaled 4% of the non-PCI CRE outstanding balance at September 30, 2012. The portfolio is diversified both geographically and by property type. At September 30, 2012, we had $18.3 billion of criticized non-PCI CRE mortgage loans, a decrease of 18% from December 31, 2011, and $4.5 billion of criticized non-PCI CRE construction loans, a decrease of 34% from December 31, 2011. See Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report for additional information on criticized loans. The largest geographic concentrations of combined CRE loans are in California and Florida, which represented 26% and 9% of the total CRE portfolio, respectively. By property type, the largest concentrations are office buildings at 26% and industrial/warehouse at 10% of the portfolio.

At September 30, 2012, the recorded investment in PCI CRE loans totaled $3.5 billion, down from $12.3 billion when they were acquired at December 31, 2008, reflecting the reduction resulting from principal payments, loan resolutions and write-downs.

 

 

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Risk Management – Credit Risk Management (continued)

 

Table 15: CRE Loans by State and Property Type

 

 

     September 30, 2012  
     Real estate mortgage      Real estate construction      Total     % of  
     Nonaccrual      Total      Nonaccrual      Total      Nonaccrual      Total     total  
(in millions)    loans      portfolio (1)      loans      portfolio (1)      loans      portfolio (1)     loans  

 

 

By state:

                   

PCI loans (1):

                   

New York

   $ -         518         -         148        -         666       *

Florida

     -         325        -         168        -         493       *   

California

     -         384        -         63        -         447       *   

Pennsylvania

     -         116        -         116        -         232       *   

Texas

     -         129        -         83        -         212       *   

Other

     -         878        -         586        -         1,464  (2)      *   

 

 

Total PCI loans

   $ -         2,350        -         1,164        -         3,514       *

 

 

All other loans:

                   

California

   $ 903        27,909        231        3,286        1,134        31,195      

Florida

     401        8,941        150        1,418        551        10,359       1  

Texas

     308        7,647        33        1,393        341        9,040       1  

New York

     35        5,887        4        1,049        39        6,936       *   

North Carolina

     246        4,040        155        978        401        5,018       *   

Arizona

     153        4,253        31        431        184        4,684       *   

Virginia

     85        2,874        20        1,174        105        4,048       *   

Georgia

     226        3,264        122        466        348        3,730       *   

Washington

     31        3,080        19        477        50        3,557       *   

Colorado

     111        2,927        17        401        128        3,328       *   

Other

     1,100        31,439        471        5,473        1,571        36,912  (3)      5  

 

 

Total all other loans

   $ 3,599        102,261        1,253        16,546        4,852        118,807       15 

 

 

Total

   $ 3,599        104,611        1,253        17,710        4,852        122,321       16 

 

 

By property:

                   

PCI loans (1):

                   

Office buildings

   $ -         848        -         121        -         969       *

Apartments

     -         463        -         162        -         625       *   

Retail (excluding shopping center)

     -         382        -         6        -         388       *   

Shopping center

     -         254        -         110        -         364       *   

1-4 family land

     -         -         -         313        -         313       *   

Other

     -         403        -         452        -         855       *   

 

 

Total PCI loans

   $ -         2,350        -         1,164        -         3,514       *

 

 

All other loans:

                   

Office buildings

   $ 821        29,135        86        1,545        907        30,680      

Industrial/warehouse

     515        12,373        22        412        537        12,785       2  

Apartments

     197        9,664        25        1,799        222        11,463       1  

Retail (excluding shopping center)

     487        10,609        43        301        530        10,910       1  

Real estate - other

     354        10,082        55        344        409        10,426       1  

Shopping center

     357        9,631        38        741        395        10,372       1  

Hotel/motel

     184        8,361        31        708        215        9,069       1  

Land (excluding 1-4 family)

     6        69        362        6,972        368        7,041       *   

Institutional

     103        2,783        -         312        103        3,095       *   

Agriculture

     162        2,518        -         15        162        2,533       *   

Other

     413        7,036        591        3,397        1,004        10,433       1  

 

 

Total all other loans

   $ 3,599        102,261        1,253        16,546        4,852        118,807       15 

 

 

Total

   $ 3,599        104,611        1,253        17,710        4,852        122,321       16 

 

 

 

* Less than 1%.
(1) For PCI loans, amounts represent carrying value. PCI loans are considered to be accruing due to the existence of the accretable yield and not based on consideration given to contractual interest payments.
(2) Includes 32 states; no state had loans in excess of $196 million.
(3) Includes 40 states; no state had loans in excess of $2.8 billion.

 

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FOREIGN LOANS AND EUROPEAN EXPOSURE We classify loans as foreign if the borrower’s primary address is outside of the United States. At September 30, 2012, foreign loans represented approximately 5% of our total consolidated loans outstanding and approximately 3% of our total assets.

Our foreign country risk monitoring process incorporates frequent dialogue with our foreign financial institution customers, counterparties and with regulatory agencies, enhanced by centralized monitoring of macroeconomic and capital markets conditions. We establish exposure limits for each country through a centralized oversight process based on the needs of our customers, and in consideration of relevant economic, political, social, legal, and transfer risks. We monitor exposures closely and adjust our limits in response to changing conditions.

We evaluate our individual country risk exposure on an ultimate risk basis which is normally based on the country of residence of the guarantor or collateral location. Our largest foreign country exposure on an ultimate risk basis was the United Kingdom, which amounted to approximately $14.5 billion, or 1% of our total assets, and included $2.1 billion of sovereign claims. Our United Kingdom sovereign claims arise primarily from deposits we have placed with the Bank of England pursuant to regulatory requirements in support of our London branch.

At September 30, 2012, our Eurozone exposure, including cross-border claims on an ultimate risk basis, and foreign exchange and derivative products, aggregated approximately $10.9 billion, including $214 million of sovereign claims, compared with approximately $11.4 billion at December 31, 2011, which included $364 million of sovereign claims. Our Eurozone exposure is relatively small compared to our overall credit risk exposure and is diverse by country, type, and counterparty.

We conduct periodic stress tests of our significant country risk exposures, analyzing the direct and indirect impacts on the risk of loss from various macroeconomic and capital markets scenarios. We do not have significant exposure to foreign country risks because our foreign portfolio is relatively small. However, we have identified exposure to increased loss from U.S. borrowers associated with the potential indirect impact of a European downturn on the U.S. economy. We mitigate these potential impacts through our normal risk management processes which include active monitoring and, if necessary, the application of aggressive loss mitigation strategies.

Table 16 provides information regarding our exposures to European sovereign entities and institutions located within such countries, including cross-border claims on an ultimate risk basis, and foreign exchange and derivative products.

 

 

Table 16: European Exposure

 

 

    Lending (1)(2)     Securities (3)     Derivatives and other (4)     Total exposure  
(in millions)   Sovereign     Non-
sovereign
    Sovereign     Non-
sovereign
    Sovereign     Non-
sovereign
    Sovereign     Non-
sovereign (5)
    Total  

 

 

September 30, 2012

                 

Eurozone

                 

Netherlands

  $ -        2,363        -        394        -        528        -        3,285        3,285   

Germany

    60        1,582        -        414        -        55        60        2,051        2,111   

Luxembourg

    -        835        -        161        -        5        -        1,001        1,001   

Ireland

    -        767        -        197        -        38        -        1,002        1,002   

France

    52        1,029        -        391        -        56        52        1,476        1,528   

Spain

    -        717        -        57        -        3        -        777        777   

Italy

    -        264        -        105        -        1        -        370        370   

Austria

    102        251        -        3        -        -        102        254        356   

Belgium

    -        175        -        40        -        62        -        277        277   

Other (6)

    -        113        -        35        -        1        -        149        149   

Total Eurozone exposure

    214        8,096        -        1,797        -        749        214        10,642        10,856   

United Kingdom

    2,098        5,395        -        6,525        -        484        2,098        12,404        14,502   

Other European countries

    -        3,939        4        365        -        523        4        4,827        4,831   

Total European exposure

  $ 2,312        17,430        4        8,687        -        1,756        2,316        27,873        30,189   

 

(1) Lending exposure includes funded loans and unfunded commitments, leveraged leases, and money market placements presented on a gross basis prior to the deduction of impairment allowance and collateral received under the terms of the credit agreements.
(2) Includes $1.3 billion in PCI loans, largely to customers in Germany and United Kingdom territories, and $2.4 billion in defeased leases secured predominantly by U.S. Treasury and government agency securities, or government guaranteed.
(3) Represents issuer exposure on cross-border debt and equity securities, held in trading or available-for-sale portfolio, at fair value.
(4) Represents counterparty exposure on foreign exchange and derivative contracts, and securities resale and lending agreements. This exposure is presented net of counterparty netting adjustments and reduced by the amount of cash collateral. It includes credit default swaps (CDS) predominantly used to manage our U.S. and London-based cash credit trading businesses, which sometimes results in selling and purchasing protection on the identical reference entity. Generally, we do not use market instruments such as CDS to hedge the credit risk of our investment or loan positions, although we do use them to manage risk in our trading businesses. At September 30, 2012, the gross notional amount of our CDS sold that reference assets domiciled in Europe was $7.6 billion, which was offset by the notional amount of CDS purchased of $7.7 billion. We did not have any CDS purchased or sold where the reference asset was solely the sovereign debt of a European country. Certain CDS purchased or sold reference pools of assets that contain sovereign debt, however the amount of referenced sovereign European debt was insignificant at September 30, 2012.
(5) Total non-sovereign exposure comprises $11.9 billion exposure to financial institutions and $16.0 billion to non-financial corporations at September 30, 2012.
(6) Includes non-sovereign exposure to Greece and Portugal in the amount of $7 million and $27 million, respectively. We had no sovereign debt exposure to these countries at September 30, 2012.

 

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Risk Management – Credit Risk Management (continued)

 

 

REAL ESTATE 1-4 FAMILY FIRST AND JUNIOR LIEN MORTGAGE LOANS Our real estate 1-4 family first and junior lien mortgage loans primarily include loans we have made to customers and retained as part of our asset liability management strategy. These loans also include the Pick-a-Pay portfolio acquired from Wachovia and the home equity portfolio, which are discussed later in this Report. In addition, these loans include other purchased loans and loans included on our balance sheet due to the adoption of consolidation accounting guidance related to variable interest entities (VIEs).

Our underwriting and periodic review of loans collateralized by residential real property includes appraisals or estimates from automated valuation models (AVMs). Additional information about AVMs and our policy for their use can be found in the “Risk Management – Credit Risk Management – Real Estate 1-4 Family Mortgage Loans” section in our 2011 Form 10-K.

Some of our real estate 1-4 family first and junior lien mortgage loans include an interest-only feature as part of the loan terms. These interest-only loans were approximately 19% of total loans at September 30, 2012, compared with 21% at December 31, 2011.

We believe we have manageable adjustable-rate mortgage (ARM) reset risk across our owned mortgage loan portfolios. We do not offer option ARM 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. Our liquidating option ARM portfolio was acquired from Wachovia.

We continue to modify real estate 1-4 family mortgage loans to assist homeowners and other borrowers in the current difficult economic cycle. As announced in February 2012, we reached a settlement regarding our mortgage servicing and foreclosure practices with the DOJ and other federal and state government entities, which became effective on April 5, 2012, where we committed to provide relief to borrowers with real estate 1-4 family first and junior lien mortgage loans. See the “Risk Management – Credit Risk Management – Risks Relating to Servicing Activities” section in this report and in our 2011 Form 10-K for more details. In addition, as announced in October 2010, we entered into agreements with certain state attorneys general whereby we agreed to offer loan modifications to eligible Pick-a-Pay customers through June 2013. These Pick-a-Pay specific agreements cover the majority of our option payment loan portfolio and require that we offer modifications (both HAMP and proprietary) to eligible customers with the option payment loan product.

For more information on our modification programs, see the “Risk Management – Credit Risk Management – Real Estate 1-4 Family Mortgage Loans” section in our 2011 Form 10-K.

Real estate 1-4 family first and junior lien mortgage loans by state are presented in Table 17. Our real estate 1-4 family mortgage loans to borrowers in California represented approximately 13% of total loans (2% of this amount were PCI loans from Wachovia) at September 30, 2012, located mostly within the larger metropolitan areas, with no single California metropolitan area consisting of more than 3% of total loans. We monitor changes in real estate values and underlying economic

or market conditions for all geographic areas of our real estate 1-4 family mortgage portfolio as part of our credit risk management process.

Part of our credit monitoring includes tracking delinquency, FICO scores and collateral values (LTV/CLTV) on the entire real estate 1-4 family mortgage loan portfolio. These credit risk indicators continued to improve in third quarter 2012 on the non-PCI mortgage portfolio. Loans 30 days or more delinquent at September 30, 2012, totaled $15.9 billion, or 5%, of total non-PCI mortgages, compared with $18.4 billion, or 6%, at December 31, 2011. Loans with FICO scores lower than 640 totaled $38.7 billion at September 30, 2012, or 13% of total non-PCI mortgages, compared with $44.1 billion, or 15%, at December 31, 2011. Mortgages with a LTV/CLTV greater than 100% totaled $63.2 billion at September 30, 2012, or 22% of total non-PCI mortgages, compared with $74.2 billion, or 26%, at December 31, 2011. Information regarding credit risk indicators can be found in Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.

We monitor the credit performance of our junior lien mortgage portfolio for trends and factors that influence the frequency and severity of loss. In first quarter 2012, in accordance with Interagency Supervisory Guidance on Allowance for Loan and Lease Losses Estimation Practices for Loans and Lines of Credit Secured by Junior Liens on 1-4 Family Residential Properties issued by bank regulators on January 31, 2012 (Interagency Guidance), we aligned our nonaccrual reporting so that a junior lien is reported as a nonaccrual loan if the related first lien is 120 days past due or is in the process of foreclosure regardless of the junior lien delinquency status. This action increased our nonperforming assets by $1.7 billion, but otherwise had minimal financial impact as the expected loss content of these loans was already considered in the allowance for loan losses.

Credit metrics for third quarter 2012 real estate 1-4 family mortgage loans were affected by the implementation of OCC guidance, which requires consumer loans discharged in bankruptcy to be written down to net realizable collateral value and classified as nonaccrual TDRs, regardless of their delinquency status. Loans impacted were predominantly real estate 1-4 family mortgage loans. As of September 30, 2012, only 8% of the performing loans placed on nonaccrual status as a result of the OCC guidance were 30 days or more past due. Implementation of the OCC guidance in third quarter 2012 resulted in the following:

 

 

$1.4 billion reclassification of performing loans to nonaccrual status;

 

 

$567 million increase in loan charge-offs; and

 

 

$4.3 billion of loans classified as TDRs.

See the “Risk Management – Credit Risk Management – Nonperforming Assets” section in this Report for more information.

 

 

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Table of Contents

Table 17: Real Estate 1-4 Family First and Junior Lien Mortgage Loans by State

 

     September 30, 2012  

(in millions)

 

Real estate

1-4 family

first

mortgage

   

Real estate

1-4 family

junior lien

mortgage

   

Total real

estate 1-4

family

mortgage

   

% of

total

loans

 

 

 

PCI loans:

       

California

  $ 17,872        36        17,908       

Florida

    2,457        33        2,490        *   

New Jersey

    1,259        22        1,281        *   

Other (1)

    5,947        90        6,037        *   

 

 

Total PCI loans

  $ 27,535        181        27,716       

 

 

All other loans:

       

California

  $ 61,166        21,776        82,942        11 

Florida

    15,601        6,974        22,575        3   

New Jersey

    9,325        5,790        15,115        2   

New York

    10,724        3,303        14,027        2   

Virginia

    6,301        4,076        10,377        1   

Pennsylvania

    5,822        3,626        9,448        1   

North Carolina

    5,779        3,292        9,071        1   

Texas

    7,106        1,168        8,274        1   

Georgia

    4,756        3,068        7,824        1   

Other (2)

    57,899        24,837        82,736        10   

Government insured/guaranteed loans (3)

    28,540        -        28,540        4   

 

 

Total all other loans

  $ 213,019        77,910        290,929        37 

 

 

Total

  $ 240,554        78,091        318,645        41 

 

 

 

* Less than 1%.
(1) Consists of 45 states; no state had loans in excess of $711 million.
(2) Consists of 41 states; no state had loans in excess of $6.7 billion.
(3) Represents loans whose repayments are insured by the FHA or guaranteed by the VA.
 

 

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Table of Contents

Risk Management – Credit Risk Management (continued)

 

Pick-a-Pay Portfolio The Pick-a-Pay portfolio was one of the consumer residential first mortgage portfolios we acquired from Wachovia and a majority of the portfolio was identified as PCI loans.

The Pick-a-Pay portfolio includes loans that offer payment options (Pick-a-Pay option payment loans), and also includes loans that were originated without the option payment feature, loans that no longer offer the option feature as a result of our modification efforts since the acquisition, and loans where the customer voluntarily converted to a fixed-rate product. The Pick-

a-Pay portfolio is included in the consumer real estate 1-4 family first mortgage class of loans throughout this Report. Real estate 1-4 family junior lien mortgages and lines of credit associated with Pick-a-Pay loans are reported in the home equity portfolio. Table 18 provides balances by types of loans as of September 30, 2012, as a result of modification efforts, compared to the types of loans included in the portfolio at December 31, 2011, and at acquisition.

 

 

Table 18: Pick-a-Pay Portfolio - Comparison to Acquisition Date

 

 

            December 31,  
      September 30, 2012 (1)     2011     2008  
(in millions)    Adjusted
unpaid
principal
balance (2)
     % of  
total  
    Adjusted
unpaid
principal
balance (2)
     % of
total
    Adjusted
unpaid
principal
balance (2)
     % of
total
 

 

 

Option payment loans

   $ 33,364         50  %    $ 39,164         53  %    $ 99,937         86  % 

Non-option payment adjustable-rate and fixed-rate loans (3)

     8,974         14        9,986         14        15,763         14   

Full-term loan modifications

     23,736         36        24,207         33        -         -   

 

 

Total adjusted unpaid principal balance (3)

   $ 66,074         100  %    $ 73,357         100  %    $ 115,700         100  % 

 

 

Total carrying value

   $ 60,080           65,652           95,315      

 

 

 

(1) Reflects $413 million in write-downs resulting from the implementation of OCC guidance issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be written down to net realizable collateral value, regardless of their delinquency status.

 

(2) Adjusted unpaid principal balance includes write-downs taken on loans where severe delinquency (normally 180 days) or other indications of severe borrower financial stress exist that indicate there will be a loss of contractually due amounts upon final resolution of the loan.

 

(3) Includes loans refinanced under the Consumer Relief Refinance Program.

 

Pick-a-Pay loans may have fixed or adjustable rates with payment options that include a minimum payment, an interest-only payment or fully amortizing payment (both 15 and 30 year options). Total interest deferred due to negative amortization on Pick-a-Pay loans was $1.5 billion at September 30, 2012, and $2.0 billion at December 31, 2011. Approximately 88% of the Pick-a-Pay customers making a minimum payment in September 2012 did not defer interest, compared with 83% in December 2011.

Deferral of interest on a Pick-a-Pay loan may continue as long as the loan balance remains below a pre-defined principal cap, which is based on the percentage that the current loan balance represents to the original loan balance. Substantially all the Pick-a-Pay portfolio has a cap of 125% of the original loan balance. Most of the Pick-a-Pay loans on which there is a deferred interest balance re-amortize (the monthly payment amount is reset or “recast”) on the earlier of the date when the loan balance reaches its principal cap, or the 10-year anniversary of the loan. After a recast, the customers’ new payment terms are reset to the amount necessary to repay the balance over the rest of the original loan term.

Due to the terms of the Pick-a-Pay portfolio, there is little recast risk in the near term. Based on assumptions of a flat rate environment, if all eligible customers elect the minimum payment option 100% of the time and no balances prepay, we would expect the following balances of loans to recast based on reaching the principal cap: $5 million for the remainder of 2012, $18 million in 2013, and $59 million in 2014. In addition, in a

flat rate environment, we would expect the following balances of loans to start fully amortizing due to reaching their recast anniversary date: $9 million for the remainder of 2012, $99 million in 2013, and $333 million in 2014. In third quarter 2012, $1 million was recast based on these events.

Table 19 reflects the geographic distribution of the Pick-a-Pay portfolio broken out between PCI loans and all other loans. The LTV ratio is a useful metric in predicting future real estate 1-4 family first mortgage loan performance, including potential charge-offs. Because PCI loans were initially recorded at fair value, including write-downs for expected credit losses, the ratio of the carrying value to the current collateral value will be lower compared with the LTV based on the adjusted unpaid principal balance. For informational purposes, we have included both ratios for PCI loans in the following table.

 

 

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Table of Contents

Table 19: Pick-a-Pay Portfolio (1)

 

 

      September 30, 2012  
      PCI loans     All other loans  
(in millions)    Adjusted
unpaid
principal
balance (2)
    

Current

LTV

ratio (3)

   

Carrying

value (4)

    

Ratio of

carrying

value to

current

value (5)

   

Carrying

value (4)

    

Ratio of

carrying

value to

current

value (5)

 

 

 

California

   $ 22,401         116  %    $ 17,833         92  %    $ 16,162         84  % 

Florida

     2,941         114        2,322         86        3,376         95   

New Jersey

     1,243         91        1,205         86        2,118         79   

New York

     710         91        679         84        941         80   

Texas

     310         79        288         73        1,336         64   

Other states

     5,502         105        4,657         87        9,163         85   

 

      

 

 

      

 

 

    

Total Pick-a-Pay loans

   $ 33,107         $     26,984         $     33,096      

 

      

 

 

      

 

 

    

 

 

 

(1) The individual states shown in this table represent the top five states based on the total net carrying value of the Pick-a-Pay loans at the beginning of 2012.

 

(2) Adjusted unpaid principal balance includes write-downs taken on loans where severe delinquency (normally 180 days) or other indications of severe borrower financial stress exist that indicate there will be a loss of contractually due amounts upon final resolution of the loan.

 

(3) The current LTV ratio is calculated as the adjusted unpaid principal balance divided by the collateral value. Collateral values are generally determined using automated valuation models (AVM) and are updated quarterly. AVMs are computer-based tools used to estimate market values of homes based on processing large volumes of market data including market comparables and price trends for local market areas.

 

(4) Carrying value, which does not reflect the allowance for loan losses, includes remaining purchase accounting adjustments, which, for PCI loans may include the nonaccretable difference and the accretable yield and, for all other loans, an adjustment to mark the loans to a market yield at date of merger less any subsequent charge-offs.

 

(5) The ratio of carrying value to current value is calculated as the carrying value divided by the collateral value.

 

To maximize return and allow flexibility for customers to avoid foreclosure, we have in place several loss mitigation strategies for our Pick-a-Pay loan portfolio. We contact customers who are experiencing financial difficulty and may in certain cases modify the terms of a loan based on a customer’s documented income and other circumstances.

We also have taken steps to work with customers to refinance or restructure their Pick-a-Pay loans into other loan products. For customers at risk, we offer combinations of term extensions of up to 40 years (from 30 years), interest rate reductions, forbearance of principal, and, in geographies with substantial property value declines, we may offer permanent principal forgiveness.

In third quarter 2012, we completed more than 3,100 proprietary and HAMP Pick-a-Pay loan modifications and have completed more than 109,000 modifications since the Wachovia acquisition, resulting in $4.6 billion of principal forgiveness to our Pick-a-Pay customers as well as an additional $401 million of conditional forgiveness that can be earned by borrowers through performance over the next three years.

Due to better than expected performance observed on the Pick-a-Pay PCI portfolio compared with the original acquisition estimates, we have reclassified $3.0 billion from the nonaccretable difference to the accretable yield since acquisition including $603 million in third quarter 2012. This better than originally expected performance is primarily attributable to significant loan modification efforts, the portfolio’s delinquency stabilization, an improved housing market forecast and credit outlook, and observed strengthening in housing prices. These factors are expected to reduce the frequency and severity of defaults and keep these loans performing for a longer period, thus increasing future principal and interest cash flows. The resulting increase in the accretable yield will be realized over the remaining life of the portfolio, which is estimated to have a

weighted-average remaining life of approximately 12.7 years at September 30, 2012. The weighted-average remaining life increased 1.3 years during third quarter 2012 due to estimated lower loan defaults, which extended the average life of the portfolio. The accretable yield percentage at September 30, 2012, was 4.21%, down from 4.45% at the end of 2011. Fluctuations in the accretable yield are driven by changes in interest rate indices for variable rate PCI loans, prepayment assumptions, and expected principal and interest payments over the estimated life of the portfolio, which will be affected by the pace and degree of improvements in the U.S. economy and housing markets and projected lifetime performance resulting from loan modification activity. Changes in the projected timing of cash flow events, including loan liquidations, modifications and short sales, can also affect the accretable yield percentage and the estimated weighted-average life of the portfolio.

The Pick-a-Pay portfolio is a significant portion of our PCI loans. For further information on the judgment involved in estimating expected cash flows for PCI loans, please see “Critical Accounting Policies – Purchased Credit-Impaired Loans” in our 2011 Form 10-K.

 

 

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Table of Contents

Risk Management – Credit Risk Management (continued)

 

HOME EQUITY PORTFOLIOS Our home equity portfolios consist of real estate 1-4 family junior lien mortgages and first and junior lines of credit secured by real estate. Our first lien lines of credit represent 20% of our home equity portfolio and are included in real estate 1-4 family first mortgages. The majority of our junior lien loan products are amortizing payment loans with fixed interest rates and repayment periods between 5 to 30 years. Junior lien loans with balloon payments at the end of the repayment term represent a small portion of our junior lien loans.

Our first and junior lien lines of credit products generally have a draw period of 10 years with variable interest rates and payment options during the draw period of (1) interest only or (2) 1.5% of total outstanding balance. During the draw period, the borrower has the option of converting all or a portion of the line from a variable interest rate to a fixed rate with terms

including interest-only payments for a fixed period between three to seven years or a fully amortizing payment with a fixed period between five to 30 years. At the end of the draw period, a line of credit generally converts to an amortizing payment loan with repayment terms of up to 30 years based on the balance at time of conversion. Substantially all of our lines of credit will remain in their draw period through 2014 and a majority through 2017.

Table 20 summarizes delinquency and loss rates by the holder of the lien. For additional information regarding current junior liens behind delinquent first lien loans, see the “Risk Management – Credit Risk Management – Home Equity Portfolios” section in our 2011 Form 10-K and the “Risk Management – Credit Risk Management – Real Estate 1-4 Family First and Junior Lien Mortgage Loans” section in this Report.

 

 

Table 20: Home Equity Portfolios Performance by Holder of 1st Lien (1)(2)

 

 

     Outstanding balance      % of loans
two payments
or more past due
     Loss rate
(annualized)
quarter ended
 
(in millions)    Sept. 30,
2012
     Dec. 31,
2011
     Sept. 30,
2012
    Dec. 31,
2011
     Sept. 30,
2012 (3)
     June 30,
2012
     Mar. 31,
2012
     Dec. 31,
2011
     Sept. 30,
2011
 

 

 

First lien lines

   $ 20,002         20,786         3.25  %      3.10         0.95         0.88         1.35         0.95         0.91   

Junior lien mortgages and lines behind:

                         

Wells Fargo owned or serviced first lien

     39,331         42,810         2.77        2.91         4.96         3.34         3.54         3.48         3.43   

Third party first lien

     38,597         42,996         2.99        3.59         5.40         3.44         3.72         3.83         4.11   

 

                     

Total

   $     97,930         106,592         2.95        3.22         4.32         2.89         3.18         3.13         3.22   

 

 

 

(1) Excludes PCI loans and real estate 1-4 family first lien line reverse mortgages added to the consumer portfolio in fourth quarter 2011 as a result of consolidating reverse mortgage loans previously sold. These reverse mortgage loans are insured by the FHA.

 

(2) Includes $1.4 billion and $1.5 billion at September 30, 2012, and December 31, 2011, respectively, associated with the Pick-a-Pay portfolio.

 

(3) Reflects the implementation of OCC guidance issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be written down to net realizable collateral value, regardless of their delinquency status.

 

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Table of Contents

We monitor the number of borrowers paying the minimum amount due on a monthly basis. In September 2012, approximately 45% of our borrowers with a home equity outstanding balance paid only the minimum amount due; 93% paid the minimum or more.

The home equity liquidating portfolio includes home equity loans generated through third party channels, including correspondent loans. This liquidating portfolio represents less than 1% of our total loans outstanding at September 30, 2012, and contains some of the highest risk in our home equity portfolio, with a loss rate of 11.60% compared with 3.93% for the core (non-liquidating) home equity portfolio at September 30, 2012. Table 21 shows the credit attributes of the core and liquidating home equity portfolios and lists the top five states by

outstanding balance. California loans represent the largest state concentration in each of these portfolios. The decrease in outstanding balances primarily reflects loan paydowns and charge-offs. As of September 30, 2012, 35% of the outstanding balance of the core home equity portfolio was associated with loans that had a combined loan to value (CLTV) ratio in excess of 100%. CLTV means the ratio of the total loan balance of first mortgages and junior lien mortgages (including unused line amounts for credit line products) to property collateral value. The unsecured portion of the outstanding balances of these loans (the outstanding amount that was in excess of the most recent property collateral value) totaled 16% of the core home equity portfolio at September 30, 2012.

 

 

Table 21: Home Equity Portfolios (1)

 

 

     Outstanding balance      % of loans
two payments
or more past due
     Loss rate
(annualized)
quarter ended
 
     Sept. 30,      Dec. 31,      Sept. 30,     Dec. 31,      Sept. 30,      June 30,      Mar. 31,      Dec. 31,      Sept. 30,  
(in millions)    2012      2011      2012     2011      2012 (2)      2012      2011      2011      2011  

 

 

Core portfolio (3)

                         

California

   $ 23,665         25,555         2.62  %      3.03         4.77         3.13         3.56         3.42         3.41   

Florida

     9,946         10,870         4.49        4.99         4.75         3.76         4.79         4.30         4.42   

New Jersey

     7,474         7,973         3.58        3.73         3.22         2.02         2.46         2.22         2.17   

Virginia

     4,839         5,248         2.06        2.15         2.54         1.60         1.42         1.31         1.67   

Pennsylvania

     4,738         5,071         2.73        2.82         2.15         1.45         1.49         1.41         1.38   

Other

     42,317         46,165         2.67        2.79         3.75         2.37         2.50         2.50         2.64   

 

                     

Total

     92,979         100,882         2.90        3.13         3.93         2.60         2.91         2.79         2.88   

 

                     

Liquidating portfolio

                         

California

     1,747         2,024         4.56        5.50         14.57         10.98         10.80         11.93         12.62   

Florida

     234         265         5.66        7.02         8.25         7.92         9.84         9.71         11.06   

Arizona

     101         116         4.12        6.64         13.07         11.89         15.08         17.54         18.30   

Texas

     83         97         1.31        0.93         4.95         2.01         2.43         1.57         3.07   

Minnesota

     68         75         2.96        2.83         12.24         10.10         5.07         8.13         6.11   

Other

     2,718         3,133         3.66        4.13         10.10         6.35         6.23         7.12         6.20   

 

                     

Total

     4,951         5,710         4.03        4.73         11.60         8.14         8.11         9.09         8.97   

 

                     

Total core and liquidating portfolios

   $      97,930         106,592         2.95        3.22         4.32         2.89         3.18         3.13         3.22   

 

                     

 

 

 

(1) Consists predominantly of real estate 1-4 family junior lien mortgages and first and junior lines of credit secured by real estate, but excludes PCI loans because their losses are generally covered by PCI accounting adjustment at the date of acquisition, and excludes real estate 1-4 family first lien open-ended line reverse mortgages because they do not have scheduled payments. These reverse mortgage loans are insured by the FHA.

 

(2) Reflects the implementation of OCC guidance issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be written down to net realizable collateral value, regardless of their delinquency status. Excluding the impact of OCC guidance, total core and liquidating portfolio loss rate for third quarter 2012 was 2.59%. We believe that the presentation of certain information in this Report excluding the impact of the OCC guidance provides useful disclosure regarding the underlying credit quality of the Company’s loan portfolio.

 

(3) Includes $1.4 billion and $1.5 billion at September 30, 2012, and December 31, 2011, respectively, associated with the Pick-a-Pay portfolio.

 

CREDIT CARDS Our credit card portfolio totaled $23.7 billion at September 30, 2012, which represented 3% of our total outstanding loans. The quarterly net charge-off rate (annualized) for our credit card loans was 3.67% for third quarter 2012, compared with 4.90% for third quarter 2011.

OTHER REVOLVING CREDIT AND INSTALLMENT Other revolving credit and installment loans totaled $87.8 billion at September 30, 2012, and predominantly include automobile, student and security-based margin loans. The quarterly loss rate (annualized) for other revolving credit and installment loans was 1.00% for third quarter 2012, compared with 1.19% for third quarter 2011. Excluding government guaranteed student loans, the loss rates were 1.14% and 1.42% for third quarter 2012 and 2011, respectively. Our automobile portfolio, predominately composed of indirect loans, totalled $46.0 billion at September 30, 2012 and had a third quarter loss rate (annualized) of 0.66% and 0.86% in 2012 and 2011, respectively.

 

 

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Risk Management – Credit Risk Management (continued)

 

NONPERFORMING ASSETS (NONACCRUAL LOANS AND FORECLOSED ASSETS) Table 22 summarizes nonperforming assets (NPAs) for each of the last four quarters. We generally place loans on nonaccrual status when:

   

the full and timely collection of interest or principal becomes uncertain (generally based on an assessment of the borrower’s financial condition and the adequacy of collateral, if any);

   

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;

   

part of the principal balance has been charged off; or

   

effective first quarter 2012, for junior lien mortgages, we have evidence that the related first lien mortgage may be 120 days past due or in the process of foreclosure regardless of the junior lien delinquency status.

In first quarter 2012, the implementation of Interagency Guidance, which requires us to place junior liens on nonaccrual status if the related first lien is nonaccruing, increased our nonperforming assets by $1.7 billion.

In third quarter 2012, the implementation of OCC guidance, which requires consumer loans discharged in bankruptcy to be placed on nonaccrual status and written down to net realizable collateral value, regardless of their delinquency status, increased our nonperforming assets by $1.4 billion. We charged off $567 million for these loans and they had the following characteristics:

   

loans affected were predominantly single family residential mortgages;

   

92% of the loans were current or less than 30 days past due;

   

approximately 50% had been making payments for at least two years since bankruptcy, and approximately 75% for at least one year; and

   

customers had an average current FICO of 673 and an average current CLTV of 89%.

 

 

Table 22: Nonperforming Assets (Nonaccrual Loans and Foreclosed Assets)

 

 

      September 30, 2012     June 30, 2012     March 31, 2011     December 31, 2011  
                                                    
($ in millions)    Balance      % of
total
loans
    Balance     % of
total
loans
    Balance      % of
total
loans
    Balance     % of
total
loans
 

 

 

Nonaccrual loans:

                  

Commercial:

                  

Commercial and industrial

   $ 1,404         0.79  %    $ 1,549        0.87  %    $ 1,726         1.02  %    $ 2,142        1.28  % 

Real estate mortgage

     3,599         3.44        3,832        3.63        4,081         3.85        4,085        3.85   

Real estate construction

     1,253         7.08        1,421        8.08        1,709         9.21        1,890        9.75   

Lease financing

     49         0.40        43        0.34        45         0.34        53        0.40   

Foreign

     66         0.17        79        0.20        38         0.10        47        0.12   

 

      

 

 

     

 

 

      

 

 

   

Total commercial (1)

     6,371         1.81        6,924        1.96        7,599         2.20        8,217        2.38   

 

      

 

 

     

 

 

      

 

 

   

Consumer:

                  

Real estate 1-4 family first mortgage (2)

     11,195         4.65        10,368        4.50        10,683         4.67        10,913        4.77   

Real estate 1-4 family junior lien mortgage (3)

     3,140         4.02        3,091        3.82        3,558         4.28        1,975        2.30   

Other revolving credit and installment

     338         0.39        195        0.22        186         0.21        199        0.23   

 

      

 

 

     

 

 

      

 

 

   

Total consumer (4)

     14,673         3.41        13,654        3.24        14,427         3.43        13,087        3.09   

 

      

 

 

     

 

 

      

 

 

   

Total nonaccrual loans (4)(5)(6)(7)

     21,044         2.69        20,578        2.65        22,026         2.87        21,304        2.77   

 

      

 

 

     

 

 

      

 

 

   

Foreclosed assets:

                  

Government insured/guaranteed (8)

     1,479           1,465          1,352           1,319     

Non-government insured/guaranteed

     2,730           2,842          3,265           3,342     

 

      

 

 

     

 

 

      

 

 

   

Total foreclosed assets

     4,209           4,307          4,617           4,661     

 

      

 

 

     

 

 

      

 

 

   

Total nonperforming assets

   $ 25,253         3.23  %    $      24,885        3.21  %    $      26,643         3.48  %    $ 25,965        3.37  % 

 

      

 

 

     

 

 

      

 

 

   

Change in NPAs from prior quarter

   $ 368           (1,758       678           (879  

 

 

 

(1) Includes LHFS of $22 million, $17 million, $9 million and $25 million at September 30, June 30 and March 31, 2012, and December 31, 2011, respectively.

 

(2) Includes MHFS of $338 million, $310 million, $287 million and $301 million at September 30, June 30 and March 31, 2012, and December 31, 2011, respectively.

 

(3) Includes $1.7 billion at March 31, 2012, resulting from implementation of the Interagency Guidance issued on January 31, 2012. This guidance accelerated the timing of placing these loans on nonaccrual to coincide with the timing of placing the related real estate 1-4 family first mortgage loans on nonaccrual.

 

(4) Includes $1.4 billion of performing loans at September 30, 2012, consisting of $1.0 billion of first mortgages, $262 million of junior liens and $155 million of auto loans, resulting from the implementation of OCC guidance issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be placed on nonaccrual status and written down to net realizable collateral value, regardless of their delinquency status.

 

(5) Excludes PCI loans because they continue to earn interest income from accretable yield, independent of performance in accordance with their contractual terms.

 

(6) Real estate 1-4 family mortgage loans insured by the FHA or guaranteed by the VA and student loans predominantly guaranteed by agencies on behalf of the U.S. Department of Education under the Federal Family Education Loan Program are not placed on nonaccrual status because they are insured or guaranteed.

 

(7) See Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report for further information on impaired loans.

 

(8) Consistent with regulatory reporting requirements, foreclosed real estate securing government insured/guaranteed loans are classified as nonperforming. Both principal and interest for government insured/guaranteed loans secured by the foreclosed real estate are collectible because the loans are insured by the FHA or guaranteed by the VA.

 

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Total NPAs were $25.3 billion (3.23% of total loans) at September 30, 2012, and included $21.1 billion of nonaccrual loans and $4.2 billion of foreclosed assets. Nonaccrual loans increased $466 million in third quarter 2012; however, apart

from implementing the OCC guidance, total commercial and consumer nonaccrual loans declined in the quarter by $975 million. Table 23 provides an analysis of the changes in nonaccrual loans.

 

 

Table 23: Analysis of Changes in Nonaccrual Loans

 

 

      Quarter ended  
     Sept. 30,     June 30,     Mar. 31,     Dec. 31,     Sept. 30,  
(in millions)    2012     2012     2012     2011     2011  

Commercial nonaccrual loans

          

Balance, beginning of quarter

   $ 6,924        7,599        8,217        8,611        9,265   

Inflows

     976        952        1,138        1,329        1,148   

Outflows:

          

Returned to accruing

     (90     (242     (188     (185     (275

Foreclosures

     (151     (92     (119     (161     (156

Charge-offs

     (364     (402     (347     (382     (397

Payments, sales and other (1)

     (924     (891     (1,102     (995     (974

Total outflows

     (1,529     (1,627     (1,756     (1,723     (1,802

Balance, end of quarter

     6,371        6,924        7,599        8,217        8,611   

Consumer nonaccrual loans

          

Balance, beginning of quarter

     13,654        14,427        13,087        13,289        13,780   

Inflows (2)

     4,111        2,750        4,765        3,465        3,544   

Outflows:

          

Returned to accruing

     (1,039     (1,344     (943     (1,277     (1,411

Foreclosures

     (182     (186     (226     (209     (286

Charge-offs

     (987     (1,137     (1,364     (1,404     (1,385

Payments, sales and other (1)

     (884     (856     (892     (777     (953

Total outflows

     (3,092     (3,523     (3,425     (3,667     (4,035

Balance, end of quarter

     14,673        13,654        14,427        13,087        13,289   

Total nonaccrual loans

   $     21,044        20,578        22,026        21,304        21,900   

 

(1) Other outflows include the effects of VIE deconsolidations and adjustments for loans carried at fair value.
(2) Quarter ended September 30, 2012, includes $1.4 billion of performing loans moved to nonaccrual status as a result of the implementation of OCC guidance issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be placed on nonaccrual status and written down to net realizable collateral value, regardless of their delinquency status. The quarter ended March 31, 2012, includes $1.7 billion moved to nonaccrual status as a result of implementing Interagency Guidance issued January 31, 2012.

 

Typically, changes to nonaccrual loans period-over-period represent inflows for loans that are placed on nonaccrual status in accordance with our policy, offset by reductions for loans that are charged off, sold, transferred to foreclosed properties, or are no longer classified as nonaccrual as a result of continued performance and an improvement in the borrower’s financial condition and loan repayment capabilities.

While nonaccrual loans are not free of loss content, we believe exposure to loss is significantly mitigated by four factors. First, 99% of the $14.7 billion of consumer nonaccrual loans and 96% of the $6.4 billion of commercial nonaccrual loans are secured at September 30, 2012. Of the consumer nonaccrual loans, 98% are secured by real estate and 40% have a combined LTV (CLTV) ratio of 80% or below. Second, losses of $4.6 billion and $1.9 billion have already been recognized on 51% of consumer nonaccrual loans and 40% of commercial nonaccrual loans, respectively. Generally, when a consumer real estate loan is 120 days past due, we transfer it to nonaccrual status. When the loan reaches 180 days past due it is our policy to write these loans down to net realizable value (fair value of collateral less estimated costs to sell), except for modifications in their trial period that are not written down as long as trial payments are made on time. Thereafter, we

revalue each loan regularly and recognize additional write-downs if needed. Third, as of September 30, 2012, 61% of commercial nonaccrual loans were current on interest. Fourth, the risk of loss for all nonaccruals has been considered and we believe is appropriately covered by the allowance for loan losses.

Under both our proprietary modification programs and the MHA programs, customers may be required to provide updated documentation, and some programs require completion of trial payment periods to demonstrate sustained performance before the loan can be removed from nonaccrual status. In addition, for loans in foreclosure, many states, including California, Florida and New Jersey, have enacted legislation that significantly increases the time to complete the foreclosure process, meaning that loans will remain in nonaccrual status for longer periods.

Table 24 provides a summary of foreclosed assets and an analysis of changes in foreclosed assets.

 

 

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Risk Management – Credit Risk Management (continued)

 

 

Table 24: Foreclosed Assets  
          
     Sept. 30,     June 30,     Mar. 31,     Dec. 31,     Sept. 30,  
(in millions)    2012     2012     2012     2011     2011  

Government insured/guaranteed (1)

   $         1,479        1,465        1,352        1,319        1,336   

PCI loans:

          

Commercial

     707        777        875        840        1,079   

Consumer

     263        321        431        465        530   

Total PCI loans

     970        1,098        1,306        1,305        1,609   

All other loans:

          

Commercial

     1,175        1,147        1,289        1,379        1,322   

Consumer

     585        597        670        658        677   

Total all other loans

     1,760        1,744        1,959        2,037        1,999   

Total foreclosed assets

   $ 4,209        4,307        4,617        4,661        4,944   

Analysis of changes in foreclosed assets

          

Balance, beginning of quarter

   $ 4,307        4,617        4,661        4,944        4,861   

Net change in government insured/guaranteed (2)

     14        113        33        (17     16   

Additions to foreclosed assets (3)

     692        664        926        934        1,440   

Reductions:

          

Sales

     (750     (1,003     (896     (1,123     (1,260

Write-downs and loss on sales

     (54     (84     (107     (77     (113

Total reductions

     (804     (1,087     (1,003     (1,200     (1,373

Balance, end of quarter

   $ 4,209        4,307        4,617        4,661        4,944   

 

(1) Consistent with regulatory reporting requirements, foreclosed real estate securing government insured/guaranteed loans are classified as nonperforming. Both principal and interest for government insured/guaranteed loans secured by the foreclosed real estate are collectible because the loans are insured by the FHA or guaranteed by the VA.
(2) Foreclosed government insured/guaranteed loans are temporarily transferred to and held by us as servicer, until reimbursement is received from FHA or VA. The net change in government insured/guaranteed foreclosed assets is made up of inflows from mortgages held for investment and MHFS, and outflows when we are reimbursed by FHA/VA.
(3) Predominantly include loans moved into foreclosure from non-accrual status, PCI loans transitioned directly to foreclosed assets and repossessed automobiles.

 

Foreclosed assets at September 30, 2012, included $1.5 billion of foreclosed real estate that is FHA insured or VA guaranteed and expected to have little to no loss content. The remaining balance of $2.7 billion of foreclosed assets has been written down to estimated net realizable value. Foreclosed assets were down $452 million, or 10%, at September 30, 2012, compared with December 31, 2011. At September 30, 2012, 69% of our foreclosed assets of $4.2 billion have been in the foreclosed assets portfolio one year or less. Given our real estate-secured loan concentrations and current economic conditions, we anticipate we will continue to hold an elevated level of NPAs on our balance sheet.

 

 

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TROUBLED DEBT RESTRUCTURINGS (TDRs)

Table 25: Troubled Debt Restructurings (TDRs) (1)

 

 

     Sept. 30,      June 30,      Mar. 31,      Dec. 31,      Sept. 30,  
(in millions)    2012      2012      2012      2011      2011  

Commercial TDRs

              

Commercial and industrial

   $         1,877         1,937         1,967         2,026         2,192   

Real estate mortgage

     2,498         2,457         2,485         2,262         1,752   

Real estate construction

     949         980         1,048         1,008         795   

Lease financing

     26         27         29         33         51   

Foreign

     28         28         19         20         9   

Total commercial TDRs

     5,378         5,429         5,548         5,349         4,799   

Consumer TDRs

              

Real estate 1-4 family first mortgage

     17,861         13,919         13,870         13,799         13,512   

Real estate 1-4 family junior lien mortgage

     2,437         1,975         1,981         1,986         1,975   

Other revolving credit and installment

     981         856         873         872         875   

Trial modifications (1)

     733         745         723         651         668   

Total consumer TDRs (2)

     22,012         17,495         17,447         17,308         17,030   

Total TDRs

   $ 27,390         22,924         22,995         22,657         21,829   

TDRs on nonaccrual status

   $ 9,990         6,900         7,136         6,811         6,758   

TDRs on accrual status

     17,400         16,024         15,859         15,846         15,071   

Total TDRs

   $ 27,390         22,924         22,995         22,657         21,829   

 

(1) Based on clarifying guidance from the Securities and Exchange Commission (SEC) received in December 2011, we classify trial modifications as TDRs at the beginning of the trial period. For many of our consumer real estate modification programs, we may require a borrower to make trial payments generally for a period of three to four months. Prior to the SEC clarification, we classified trial modifications as TDRs once a borrower successfully completed the trial period in accordance with the terms.
(2) September 30, 2012, includes $4.3 billion of loans, consisting of $3.7 billion of first mortgages, $452 million of junior liens and $160 million of auto loans, resulting from the implementation of OCC guidance issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be classified as TDRs.

 

Table 25 provides information regarding the recorded investment of loans modified in TDRs. The allowance for loan losses for TDRs was $5.1 billion and $5.2 billion at September 30, 2012, and December 31, 2011, respectively. See Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report for additional information regarding TDRs. Those loans discharged in bankruptcy and reported as TDRs this quarter have been written down to net realizable collateral value.

In those situations where principal is forgiven, the entire amount of such principal forgiveness is immediately charged off to the extent not done so prior to the modification. We sometimes delay the timing on the repayment of a portion of principal (principal forbearance) and charge off the amount of forbearance if that amount is not considered fully collectible.

 

 

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Table of Contents

Risk Management – Credit Risk Management (continued)

 

Table 26 provides an analysis of the changes in TDRs.

Table 26: Analysis of Changes in TDRs

 

 

                          Quarter ended  
     Sept. 30,     June 30,     Mar. 31,     Dec. 31,     Sept. 30,  
(in millions)    2012     2012     2012     2011     2011  

Commercial TDRs

          

Balance, beginning of quarter

   $         5,429        5,548        5,349        4,799        4,053   

Inflows

     620        687        710        1,271        1,321   

Outflows

          

Charge-offs

     (84     (112     (119     (84     (68

Foreclosure

     (20     (24     (2     (16     (23

Payments, sales and other (1)

     (567     (670     (390     (621     (484

Balance, end of quarter

     5,378        5,429        5,548        5,349        4,799   

Consumer TDRs

          

Balance, beginning of quarter

     17,495        17,447        17,308        17,030        16,628   

Inflows (2)

     5,212        762        829        904        1,455   

Outflows

          

Charge-offs

     (244     (319     (295     (261     (290

Foreclosure

     (35     (25     (33     (33     (39

Payments, sales and other (1)

     (404     (392     (434     (315     (450

Net change in trial modifications (3)

     (12     22        72        (17     (274

Balance, end of quarter

     22,012        17,495        17,447        17,308        17,030   

Total TDRs

   $ 27,390        22,924        22,995        22,657        21,829   

 

(1) Other outflows include normal amortization/accretion of loan basis adjustments and loans transferred to held-for-sale.
(2) Quarter ended September 30, 2012, includes $4.3 billion of loans, resulting from the implementation of OCC guidance issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be classified as TDRs.
(3) Net change in trial modifications includes: inflows of new TDRs entering the trial payment period, net of outflows for modifications that either (i) successfully perform and enter into a permanent modification, or (ii) did not successfully perform according to the terms of the trial period plan and are subsequently charged-off, foreclosed upon or otherwise resolved. Our recent experience is that most of the mortgages that enter a trial payment period program are successful in completing the program requirements.

 

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Table of Contents

LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING Loans 90 days or more past due as to interest or principal are still accruing if they are (1) well-secured and in the process of collection or (2) real estate 1-4 family mortgage loans or consumer loans exempt under regulatory rules from being classified as nonaccrual until later delinquency, usually 120 days past due. PCI loans of $6.2 billion, $6.6 billion, $7.1 billion, $8.7 billion, and $8.9 billion at September 30, June 30 and March 31, 2012, and December 31, and September 30, 2011, respectively, are not included in these past due and still accruing loans even though they are 90 days or more contractually past due. These PCI loans are considered to be accruing due to the existence of the accretable yield and not based on consideration given to contractual interest payments.

Excluding insured/guaranteed loans, loans 90 days or more past due and still accruing at September 30, 2012, were down $556 million, or 27%, from December 31, 2011, due to loss

mitigation activities including modifications, seasonality, decline in non-strategic and liquidating portfolios, and credit stabilization. Loans 90 days or more past due and still accruing whose repayments are insured by the Federal Housing Administration (FHA) or predominantly guaranteed by the Department of Veterans Affairs (VA) for mortgages and the U.S. Department of Education for student loans under the Federal Family Education Loan Program (FFELP) were $21.4 billion at September 30, 2012, up from $20.5 billion at December 31, 2011.

Table 27 reflects non-PCI loans 90 days or more past due and still accruing by class for loans not government insured/guaranteed. For additional information on delinquencies by loan class, see Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.

 

 

Table 27: Loans 90 Days or More Past Due and Still Accruing

 

 

     Sept. 30,      June 30,      Mar. 31,      Dec. 31,      Sept. 30,  
(in millions)    2012      2012      2012      2011      2011  

Loans 90 days or more past due and still accruing:

              

Total (excluding PCI):

   $     22,894         22,872         22,555         22,569         19,639   

Less: FHA insured/guaranteed by the VA (1)(2)

     20,320         20,368         19,681         19,240         16,498   

Less: Student loans guaranteed under the FFELP (3)

     1,082         1,144         1,238         1,281         1,212   

Total, not government insured/guaranteed

   $ 1,492         1,360         1,636         2,048         1,929   

By segment and class, not government insured/guaranteed:

              

Commercial:

              

Commercial and industrial

   $ 49         44         104         153         108   

Real estate mortgage

     206         184         289         256         207   

Real estate construction

     41         25         25         89         57   

Foreign

     2         3         7         6         11   

Total commercial

     298         256         425         504         383   

Consumer:

              

Real estate 1-4 family first mortgage (2)

     627         561         616         781         819   

Real estate 1-4 family junior lien mortgage (2)(4)

     151         159         156         279         255   

Credit card

     288         274         319         346         328   

Other revolving credit and installment

     128         110         120         138         144   

Total consumer

     1,194         1,104         1,211         1,544         1,546   

Total, not government insured/guaranteed

   $ 1,492         1,360         1,636         2,048         1,929   

 

(1) Represents loans whose repayments are insured by the FHA or guaranteed by the VA.
(2) Includes mortgages held for sale 90 days or more past due and still accruing.
(3) Represents loans whose repayments are predominantly guaranteed by agencies on behalf of the U.S. Department of Education under the FFELP.
(4) During first quarter 2012, $43 million of 1-4 family junior lien mortgages were transferred to nonaccrual upon implementation of the Interagency Guidance issued on January 31, 2012.

 

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NET CHARGE-OFFS

Table 28: Net Charge-offs

 

 

     Quarter ended  
     September 30, 2012     June 30, 2012     March 31, 2012     December 31, 2011     September 30, 2011  
($ in millions)    Net loan
charge-
offs
    

As a

% of
avg.
loans(1)

    Net loan
charge-
offs
    

As a

% of
avg.
loans (1)

    Net loan
charge-
offs
    

As a

% of
avg.
loans (1)

    Net loan
charge-
offs
   

As a

% of
avg.
loans (1)

    Net loan
charge-
offs
    

As a

% of
avg.
loans (1)

 

Commercial:

                        

Commercial and industrial

   $ 131         0.29  %    $ 249         0.58  %    $ 256         0.62  %    $ 310        0.74  %    $ 261         0.65  % 

Real estate mortgage

     54         0.21        81         0.31        46         0.17        117        0.44        96         0.37   

Real estate construction

     1         0.03        17         0.40        67         1.43        (5     (0.09     55         1.06   

Lease financing

     1         0.03        -         -        2         0.06        4        0.13        3         0.11   

Foreign

     30         0.29        11         0.11        14         0.14        45        0.45        8         0.08   

Total commercial

     217         0.24        358         0.42        385         0.45        471        0.54        423         0.50   

Consumer:

                        

Real estate 1-4 family first mortgage

     673         1.15        743         1.30        791         1.39        844        1.46        821         1.46   

Real estate 1-4 family junior lien mortgage

     1,036         5.17        689         3.38        763         3.62        800        3.64        842         3.75   

Credit card

     212         3.67        240         4.37        242         4.40        256        4.63        266         4.90   

Other revolving credit and installment

     220         1.00        170         0.79        214         0.99        269        1.24        259         1.19   

Total consumer (2)

     2,141         2.01        1,842         1.76        2,010         1.91        2,169        2.02        2,188         2.06   

Total

   $ 2,358         1.21  %    $ 2,200         1.15  %    $ 2,395         1.25  %    $ 2,640        1.36  %    $ 2,611         1.37  % 
                                                                                      

 

(1) Quarterly net charge-offs as a percentage of average respective loans are annualized.
(2) Quarter ended September 30, 2012, includes $567 million resulting from the implementation of OCC guidance issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be placed on nonaccrual status and written down to net realizable collateral value, regardless of their delinquency status. Excluding this impact, net charge offs were $1.8 billion (0.92% of average total loans outstanding). We believe that the presentation of certain information in this Report excluding the impact of the OCC guidance provides useful disclosure regarding the underlying credit quality of the Company’s loan portfolios.

 

Table 28 presents net charge-offs for third quarter 2012 and the previous four quarters. Net charge-offs in third quarter 2012 were $2.4 billion (1.21% of average total loans outstanding) compared with $2.6 billion (1.37%) in third quarter 2011. Third quarter 2012 included $567 million of net charge-offs resulting from the implementation of OCC guidance issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be placed on nonaccrual status and written down to net realizable collateral value, regardless of their delinquency status. Excluding the impact of this guidance, net charge-offs were $1.8 billion (0.92% of average total loans outstanding), and net charge-offs as a percentage of average loans declined for nearly all categories of loans in third quarter 2012, compared with third quarter 2011, as we saw signs of stabilization in the housing market although the economic recovery remained uneven.

 

 

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ALLOWANCE FOR CREDIT LOSSES The allowance for credit losses, which consists of the allowance for loan losses and the allowance for unfunded credit commitments, is management’s estimate of credit losses inherent in the loan portfolio and unfunded credit commitments at the balance sheet date, excluding loans carried at fair value. The detail of the changes in the allowance for credit losses by portfolio segment (including charge-offs and recoveries by loan class) is in Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report. Table 29 provides a summary of our allowance for credit losses.

We employ a disciplined process and methodology to establish our allowance for credit losses each quarter. This process takes into consideration many factors, including historical and forecasted loss trends, loan-level credit quality ratings and loan grade-specific loss factors. The process involves subjective and complex judgments. In addition, we review a variety of credit metrics and trends. These credit metrics and trends, however, do not solely determine the amount of the allowance as we use several analytical tools. For additional information on our allowance for credit losses, see the “Critical Accounting Policies – Allowance for Credit Losses” section in our 2011 Form 10-K and Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.

 

 

Table 29: Allowance for Credit Losses

 

 

     Sept. 30,     June 30,      Mar. 31,      Dec. 31,      Sept. 30,  
(in millions)    2012     2012      2012      2011      2011  

Components:

             

Allowance for loan losses

   $         17,385        18,320         18,852         19,372         20,039   

Allowance for unfunded credit commitments

     418        326         277         296         333   

Allowance for credit losses

   $ 17,803        18,646         19,129         19,668         20,372   

Allowance for loan losses as a percentage of total loans

     2.22      2.36         2.46         2.52         2.64   

Allowance for loan losses as a percentage of annualized net charge-offs

     185        207         196         185         193   

Allowance for credit losses as a percentage of total loans

     2.27        2.41         2.50         2.56         2.68   

Allowance for credit losses as a percentage of total nonaccrual loans

     85        91         87         92         93   

 

In addition to the allowance for credit losses, there was $7.6 billion at September 30, 2012, and $10.7 billion at December 31, 2011, of nonaccretable difference to absorb losses for PCI loans. The allowance for credit losses is lower than otherwise would have been required without PCI loan accounting. As a result of PCI loans, certain ratios of the Company may not be directly comparable with prior periods. For additional information on PCI loans, see the “Risk Management – Credit Risk Management – Purchased Credit-Impaired Loans” section and Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.

The ratio of the allowance for credit losses to total nonaccrual loans 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 at September 30, 2012 were home mortgages.

The decline in the allowance for loan losses in third quarter 2012 reflected continued improvement in consumer delinquency trends and improved portfolio performance. The reduction in the allowance included $567 million of net charge-offs resulting from the implementation of OCC guidance issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be placed on nonaccrual status and written down to net realizable collateral value, regardless of their delinquency status. While the impact of the OCC guidance accelerated charge-offs of performing consumer loans discharged in bankruptcy in the third quarter, the allowance had full coverage for these charge-offs. The reduction also included a $200 million allowance release due to strong underlying credit. Total provision for credit losses was $1.6 billion in third quarter 2012, compared with $1.8 billion a year ago. Excluding the impact of the OCC guidance, the third

quarter 2012 provision was $200 million less than net charge-offs, compared with a provision that was $400 million, $400 million, $600 million and $800 million less than net charge-offs in the second and first quarters of 2012 and fourth and third quarters of 2011, respectively.

In determining the appropriate allowance attributable to our residential real estate portfolios, our process considers the associated credit cost, including re-defaults of modified loans and projected loss severity for loan modifications that occur or are probable to occur. In addition, our process incorporates the estimated allowance associated with recent events including our settlement announced in first quarter 2012 with federal and state government entities relating to our mortgage servicing and foreclosure practices and high risk portfolios defined in the Interagency Guidance relating to junior lien mortgages.

Changes in the allowance reflect changes in statistically derived loss estimates, historical loss experience, current trends in borrower risk and/or general economic activity on portfolio performance, and management’s estimate for imprecision and uncertainty.

We believe the allowance for credit losses of $17.8 billion was appropriate to cover credit losses inherent in the loan portfolio, including unfunded credit commitments, at September 30, 2012. The allowance for credit losses is subject to change and reflects existing factors at the time of determination, including economic or market conditions and ongoing internal and external examination processes. Due to the sensitivity of the allowance for credit losses to changes in the economy and business environment, it is possible that we will incur incremental credit losses not anticipated as of the balance sheet date. Absent significant deterioration in the economy or significant impact of Hurricane Sandy on our loan portfolios, we continue to expect

 

 

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Risk Management – Credit Risk Management (continued)

 

future allowance releases. Our process for determining the allowance for credit losses is discussed in the “Critical Accounting Policies – Allowance for Credit Losses” section in our 2011 Form 10-K and Note 5 (Loans and Allowance for Credit Losses) to the Financial Statements in this Report.

LIABILITY FOR MORTGAGE LOAN REPURCHASE LOSSES We sell residential mortgage loans to various parties, including (1) government-sponsored entities Freddie Mac and Fannie Mae (GSEs) who include the mortgage loans in GSE-guaranteed mortgage securitizations, (2) SPEs that issue private label MBS, and (3) other financial institutions that purchase mortgage loans for investment or private label securitization. In addition, we pool FHA-insured and VA-guaranteed mortgage loans that back securities guaranteed by GNMA. We may be required to repurchase these mortgage loans, indemnify the securitization trust, investor or insurer, or reimburse the securitization trust, investor or insurer for credit losses incurred on loans (collectively, repurchase) in the event of a breach of contractual representations or warranties that is not remedied within a period (usually 90 days or less) after we receive notice of the breach.

We have established a mortgage repurchase liability related to various representations and warranties that reflect management’s estimate of probable losses for loans for which we have a repurchase obligation, whether or not we currently service those loans, based on a combination of factors. Our mortgage repurchase liability estimation process also incorporates a forecast of repurchase demands associated with mortgage insurance rescission activity. Repurchase demands have primarily related to 2006 through 2008 vintages and to GSE-guaranteed MBS.

During third quarter 2012, we continued to experience elevated levels of repurchase activity measured by the number of investor repurchase demands. We repurchased or reimbursed investors for incurred losses on mortgage loans with original balances of $474 million in third quarter 2012, compared with $788 million a year ago. We incurred net losses on repurchased loans and investor reimbursements totalling $193 million in third quarter 2012 compared with $384 million a year ago.

Table 30 provides the number of unresolved repurchase demands and mortgage insurance rescissions. We do not typically receive repurchase requests from GNMA, FHA/HUD or VA. As an originator of an FHA insured or VA guaranteed loan, we are responsible for obtaining the insurance with FHA or the guarantee with the VA. To the extent we are not able to obtain the insurance or the guarantee we must request to repurchase the loan from the GNMA pool. Such repurchases from GNMA pools typically represent a self-initiated process upon discovery of the uninsurable loan (usually within 180 days from funding of the loan). Alternatively, in lieu of repurchasing loans from GNMA pools, we may be asked by the FHA/HUD or the VA to indemnify them (as applicable) for defects found in the Post Endorsement Technical Review process or audits performed by FHA/HUD or the VA. Our liability for mortgage loan repurchase losses incorporates probable losses associated with such indemnification.

 

 

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Table 30: Unresolved Repurchase Demands and Mortgage Insurance Rescissions

 

 

     Government
sponsored entities (1)
     Private      Mortgage insurance
rescissions with no demand (2)
     Total  
($ in millions)    Number of
loans
     Original loan
balance (3)
     Number of
loans
     Original loan
balance (3)
     Number of
loans
     Original loan
balance (3)
     Number of
loans
     Original loan
balance (3)
 

2012

                       

September 30,

     6,525       $             1,489         1,513       $             331         817       $             183         8,855       $             2,003   

June 30,

     5,687         1,265         913         213         840         188         7,440         1,666   

March 31,

     6,333         1,398         857         241         970         217         8,160         1,856   

2011

                       

December 31,

     7,066         1,575         470         167         1,178         268         8,714         2,010   

September 30,

     6,577         1,500         582         208         1,508         314         8,667         2,022   

June 30,

     6,876         1,565         695         230         2,019         444         9,590         2,239   

March 31,

     6,210         1,395         1,973         424         2,885         674         11,068         2,493   

 

(1) Includes repurchase demands of 534 and $111 million, 526 and $103 million, 694 and $131 million, 861 and $161 million, 878 and $173 million, 892 and $179 million and 685 and $132 million for September 30, June 30 and March 31, 2012, and December 31, September 30, June 30 and March 31, 2011, respectively, received from investors on mortgage servicing rights acquired from other originators. We generally have the right of recourse against the seller and may be able to recover losses related to such repurchase demands subject to counterparty risk associated with the seller. The number of repurchase demands from GSEs that are from mortgage loans originated in 2006 through 2008 totaled 80% at September 30, 2012.
(2) As part of our representations and warranties in our loan sales contracts, we typically represent to GSEs and private investors that certain loans have mortgage insurance to the extent there are loans that have loan to value ratios in excess of 80% that require mortgage insurance. To the extent the mortgage insurance is rescinded by the mortgage insurer due to a claim of breach of a contractual representation or warranty, the lack of insurance may result in a repurchase demand from an investor. Similar to repurchase demands, we evaluate mortgage insurance rescission notices for validity and appeal for reinstatement if the rescission was not based on a contractual breach. When investor demands are received due to lack of mortgage insurance, they are reported as unresolved repurchase demands based on the applicable investor category for the loan (GSE or private). Over the last year, approximately 20% of our repurchase demands from GSEs had mortgage insurance rescission as one of the reasons for the repurchase demand. Of all the mortgage insurance rescissions notices received in 2011, approximately 80% have resulted in repurchase demands through September 2012. Not all mortgage insurance rescissions received in 2011 have been completed through the appeals process with the mortgage insurer and, upon successful appeal, we work with the investor to rescind the repurchase demand.
(3) While the original loan balances related to these demands are presented above, the establishment of the repurchase liability is based on a combination of factors, such as our appeals success rates, reimbursement by correspondent and other third party originators, and projected loss severity, which is driven by the difference between the current loan balance and the estimated collateral value less costs to sell the property.

 

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The overall level of unresolved repurchase demands and mortgage insurance rescissions outstanding at September 30, 2012, was flat from a year ago in both number of outstanding loans and in total dollar balances as we continued to work through the new demands and mortgage insurance rescissions. Customary with industry practice, we have the right of recourse against correspondent lenders from whom we have purchased loans with respect to representations and warranties. Of total repurchase demands and mortgage insurance recissions outstanding as of September 30, 2012, presented in Table 30, approximately 25% relate to loans purchased from correspondent lenders. Due primarily to the financial difficulties of some correspondent lenders, we are currently recovering on average approximately 45% of losses from these lenders. Historical recovery rates as well as projected lender performance are incorporated in the establishment of our mortgage repurchase liability.

We believe we have a high quality residential mortgage loan servicing portfolio. Of the $1.9 trillion in the residential mortgage loan servicing portfolio at September 30, 2012, 93% was current, less than 2% was subprime at origination, and less than 1% was home equity securitizations. Our combined delinquency and foreclosure rate on this portfolio was 7.32% at September 30, 2012, compared with 7.96% at December 31, 2011. Four percent of this portfolio are private label securitizations where we originated the loans and therefore have some repurchase risk. We believe the risk of repurchase in our private label securitizations is substantially reduced, relative to other private label securitizations, because approximately half of this portfolio of private label securitizations do not contain

representations and warranties regarding borrower or other third party misrepresentations related to the mortgage loan, general compliance with underwriting guidelines, or property valuation, which are commonly asserted bases for repurchase. For this 4% private label securitization segment of our residential mortgage loan servicing portfolio (weighted average age of 83 months), 58% are loans from 2005 vintages or earlier; 78% were prime at origination; and approximately 64% are jumbo loans. The weighted-average LTV as of September 30, 2012 for this private securitization segment was 74%. We believe the highest risk segment of these private label securitizations is the subprime loans originated in 2006 and 2007. These subprime loans have seller representations and warranties and currently have LTVs close to or exceeding 100%, and represent 9% of the private label securitization portion of the residential mortgage servicing portfolio. We had only $26 million of repurchases related to private label securitizations in the third quarter 2012.

Of the servicing portfolio, 4% is non-agency acquired servicing and 1% is private whole loan sales. We did not underwrite and securitize the non-agency acquired servicing and therefore we have no obligation on that portion of our servicing portfolio to the investor for any repurchase demands arising from origination practices. For the private whole loan segment, while we do have repurchase risk on these loans, less than 2% were subprime at origination and loans that were sold and subsequently securitized are included in the private label securitization segment discussed above.

Table 31 summarizes the changes in our mortgage repurchase liability.

 

 

Table 31: Changes in Mortgage Repurchase Liability

 

 

     Quarter ended  
     Sept. 30,     June 30,     Mar. 31,     Dec. 31,     Sept. 30,  
(in millions)    2012     2012     2012     2011     2011  

Balance, beginning of period

    $             1,764        1,444        1,326        1,194        1,188   

Provision for repurchase losses:

          

Loan sales

     75        72        62        27        19   

Change in estimate (1)

     387        597        368        377        371   

 

 

Total additions

     462        669        430        404        390   

Losses

     (193     (349     (312     (272     (384

 

 

Balance, end of period

    $ 2,033        1,764        1,444        1,326        1,194   

 

 

 

(1) Results from changes in investor demand and mortgage insurer practices, credit deterioration and changes in the financial stability of correspondent lenders.

 

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The mortgage repurchase liability of $2.0 billion at September 30, 2012 represents our best estimate of the probable loss that we expect to incur for various representations and warranties in the contractual provisions of our sales of mortgage loans. The mortgage repurchase liability estimation process requires management to make difficult, subjective and complex judgments about matters that are inherently uncertain, including demand expectations, economic factors, and the specific characteristics of the loans subject to repurchase. Our evaluation considers the collective actions of the GSEs and their regulator, the Federal Housing Finance Agency (FHFA), mortgage insurers and our correspondent lenders. We maintain regular contact with the GSEs, the FHFA, and other significant investors to monitor their repurchase demand practices and issues as part of our process to update our repurchase liability estimate as new information becomes available.

Our liability for mortgage repurchases, included in “Accrued expenses and other liabilities” in our consolidated balance sheet, was $2.0 billion at September 30, 2012 and $1.3 billion at December 31, 2011. In the quarter ended September 30, 2012, we provided $462 million, which reduced net gains on mortgage loan origination/sales activities, compared with a provision of $390 million a year ago. Our provision in third quarter 2012 reflected an increase in projections of future GSE repurchase demands, net of appeals, for the 2006 through 2008 vintages to incorporate the impact of recent trends in repurchase demand activity (comprising approximately 58% of the third quarter 2012 provision), an increase in probable loss estimates for non-agency risk (approximately 26%), and new loan sales (approximately 16%). The increase in projected future GSE repurchase demands in the quarter was predominately a result of an increase in the expected demand rate on audited loans based on our most recent experience with the GSEs.

Because of the uncertainty in the various estimates underlying the mortgage repurchase liability, there is a range of losses in excess of the recorded mortgage repurchase liability that are reasonably possible. The estimate of the range of possible loss for representations and warranties does not represent a probable loss, and is based on currently available information, significant judgment, and a number of assumptions that are subject to change. The high end of this range of reasonably possible losses in excess of our recorded liability was $2.5 billion at September 30, 2012, and was determined based upon modifying the assumptions utilized in our best estimate of probable loss to reflect what we believe to be the high end of reasonably possible adverse assumptions. For additional information on our repurchase liability, see the “Critical Accounting Policies – Liability for Mortgage Loan Repurchase Losses” section in our 2011 Form 10-K and Note 8 (Mortgage Banking Activities) to Financial Statements in this Report.

To the extent that economic conditions and the housing market do not improve or future investor repurchase demands and appeals success rates differ from past experience, we could continue to have increased demands and increased loss severity on repurchases, causing future additions to the repurchase liability. However, some of the underwriting standards that were permitted by the GSEs for conforming loans in the 2006 through 2008 vintages, which significantly contributed to recent levels of

repurchase demands, were tightened starting in mid to late 2008. Accordingly, we do not expect, and have not experienced, a similar rate of repurchase requests from the 2009 and later vintages, absent unanticipated deterioration in economic conditions or changes in investor behavior.

RISKS RELATING TO SERVICING ACTIVITIES In addition to servicing loans in our portfolio, we act as servicer and/or master servicer of residential mortgage loans included in GSE-guaranteed mortgage securitizations, GNMA-guaranteed mortgage securitizations of FHA/VA-guaranteed mortgages and private label mortgage securitizations, as well as for unsecuritized loans owned by institutional investors. For additional information regarding risks relating to our servicing activities, see pages 73-77 in our 2011 Form 10-K.

In April 2011, the Federal Reserve Board (FRB) and the OCC issued consent orders that require us to correct deficiencies in our residential mortgage loan servicing and foreclosure practices that were identified by federal banking regulators in their fourth quarter 2010 review. The consent orders also require that we improve our servicing and foreclosure practices. We have implemented nearly all of the operational changes that resulted from the expanded servicing responsibilities outlined in the consent orders.

On February 9, 2012, a federal/state settlement was announced among the DOJ, the Department of Housing and Urban Development (HUD), the Department of the Treasury, the Department of Veterans Affairs, the Federal Trade Commission (FTC), the Executive Office of the U.S. Trustee, the Consumer Financial Protection Bureau, a task force of Attorneys General representing 49 states, Wells Fargo, and four other servicers related to investigations of mortgage industry servicing and foreclosure practices. While Oklahoma did not participate in the larger settlement, it settled separately with the five servicers under a simplified agreement. Under the terms of the larger settlement, which became effective April 5, 2012, upon approval of a consent judgment by a federal court in Washington, DC and which will remain in effect for three and a half years (subject to a trailing review period), we have agreed to the following programmatic commitments, consisting of three components totaling approximately $5.3 billion:

 

   

Consumer Relief Program commitment of $3.4 billion

 

   

Refinance Program commitment of $900 million

 

   

Foreclosure Assistance Program of $1 billion

Additionally and simultaneously, the OCC and FRB announced the imposition of civil money penalties of $83 million and $87 million, respectively, pursuant to the consent orders. While still subject to FRB and OCC confirmation, Wells Fargo believes the civil money obligations were satisfied through payments made under the Foreclosure Assistance Program to the federal government and participating states for their use to address the impact of foreclosure challenges as they determine and which may include direct payments to consumers.

We began conducting creditable activities towards satisfaction of the requirements of the Consumer Relief Program on March 1, 2012. We can also receive an additional 25% credit

 

 

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Risk Management – Credit Risk Management (continued)

 

for first or second lien principal reduction taken within one year from March 1, 2012. Because we will not receive dollar-for-dollar credit for the relief provided in some circumstances, the actual relief we provide to borrowers will likely exceed our commitment. The terms also require that we satisfy 75% of the commitments under the Consumer Relief Program within two years from March 1, 2012. If we do not meet this two-year requirement and also do not meet the entire commitment within three years, we are required to pay an amount equal to 140% of the unmet commitment amount. If we meet the two-year commitment target, but do not meet the entire commitment amount within the three years, we are required to pay an amount equal to 125% of the unmet commitment amount. We expect that we will be able to meet our commitment (and state-level sub-commitments) on the Consumer Relief Program within the required timeframes. We expect to be able to meet our Consumer Relief Program commitment primarily through our first and second lien modification and short sale and other deficiency balance waiver programs. Given the types of relief provided, we consider these loan modifications to be TDRs. We have evaluated our commitment along with the menu of credits and believe that fulfilling our commitment under the Consumer Relief Program has been appropriately considered in our estimation for the allowance for loan losses as well as our cash flow projections to evaluate the nonaccretable difference for our PCI portfolios at September 30, 2012.

We will receive credit under the Refinance Program for activities taken on or after March 1, 2012. The Refinance Program allows for an additional 25% credit (additional credit) for all refinance credits earned in the first 12 months of the program. We expect that we will be able to complete the number of refinances necessary to satisfy the entire credit in the first 12 months of offering the Refinance Program, which will provide an additional credit of $350 million to $390 million. If successful in this regard, the estimated total earned credit for the Refinance Program will be approximately $1.7 billion to $2.0 billion.

We expect that we will refinance approximately 33,000 to 36,000 borrowers with an unpaid principal balance of approximately $6.7 billion to $7.4 billion under the Refinance Program. Based on the mix of loans we anticipate will be refinanced, we estimate their weighted average note rate will be reduced by approximately 270 basis points and that their weighted average estimated remaining life will be approximately 10 years. These estimates will be affected by the actual number of eligible borrowers that accept a refinance offer, their existing and new note rates and the remaining term of the actual loans refinanced. The impact of fulfilling our commitment under the Refinance Program will be recognized over a period of years in the form of lower interest income as qualified borrowers benefit from reduced interest rates on loans refinanced under the Refinance Program. Based on our expectation that we will fulfill the credit needs for the Refinance Program within the first 12 months, we expect the future reduction in interest income to be approximately $1.8 billion to $2.0 billion or $181 million to $201 million annually. As a result of refinancings under the Refinance Program, we will be forgoing interest that we may not otherwise have agreed to forgo. No loss was recognized in our financial statements for this

estimated forgone interest income as the impact will be recognized over a period of years in the form of lower interest income as qualified borrowers benefit from reduced interest rates on loans refinanced under the Refinance Program. The impact of this forgone interest income on our future net interest margin is anticipated to be modestly adverse and will be influenced by the overall mortgage interest rate environment, which products are accepted by the eligible borrowers, and the pace of the execution of the program. The Refinance Program will also affect our fair value for these loans. The estimated reduction of the fair value of our loans for the Refinance Program is approximately $1.4 billion to $1.6 billion and will be affected by our actual execution of the program and borrower acceptance rates.

The expectations discussed above about the volume of loans that we may refinance, the resulting reduction in our lifetime and annual interest income, and the reductions in fair value of loans for the Refinance Program exceed the amounts that would result from just meeting our minimum commitments under the Program due to the significantly higher than expected response we have received from our customers through the third quarter 2012, which is partially driven by product changes and our decision to hold interest rates consistent with the prevailing market environment.

Although the Refinance Program relates to borrowers in good standing as to their payment history who are not experiencing financial difficulty, we will evaluate each borrower to confirm their ability to repay their mortgage obligation. This evaluation will include reviewing key credit and underwriting policy metrics to validate that these borrowers are not experiencing financial difficulty and therefore, actions taken under the Refinance Program will not generally be considered a TDR. To the extent we determine that an eligible borrower is experiencing financial difficulty, we generally will consider alternative modification programs that are intended for loans that may be classified and accounted for as a TDR.

We expect that we will be able to meet the obligations of our commitment for the Refinance Program (and any state-level sub-commitments) and will not be required to pay for not meeting our commitment.

We are in the process of successfully executing activities under both the Consumer Relief and the Refinance Programs and have successfully implemented the settlement’s servicing standards in accordance with the terms of our commitments. We will be providing a report of progress against our commitments to the Monitor of the National Mortgage Settlement on November 14, 2012. As announced on August 20, 2012, we are making good progress towards our commitments.

Other Mortgage Matters On July 12, 2012, we entered into a settlement agreement with the DOJ resolving the DOJ’s claims that some of our mortgages may have had a disparate impact on some African-American and Hispanic borrowers. The DOJ claims were based on a statistical survey of Wells Fargo Home Mortgage (WFHM) loans between 2004 and 2009, and the claims primarily related to mortgages priced and sold to consumers by independent mortgage brokers. In the settlement, we denied the claims, but agreed to pay $125 million to

 

 

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borrowers that the DOJ believes were adversely affected by mortgages priced and sold by independent mortgage brokers through the wholesale division of WFHM. The settlement also resolved pending litigation filed in 2009 by the State of Illinois and an investigative complaint filed by the Pennsylvania Human Relations Commission. As part of the settlement, we also agreed to pay $50 million to fund a community support program in approximately eight cities or metropolitan statistical areas, as to be agreed upon between the DOJ and Wells Fargo, and agreed to undertake an internal lending compliance review of a small percentage of subprime mortgages delivered through our retail channel during the period of 2004 to 2008 and will rebate borrowers as appropriate. The $175 million was paid during third quarter 2012. While not part of the settlement, Wells Fargo also announced that as of July 13, 2012, it voluntarily discontinued the funding of mortgages that are originated, priced and sold by independent mortgage brokers through the WFHM wholesale division. Mortgages sold by independent mortgage brokers in this manner represented approximately 6% of Wells Fargo’s home mortgage funded volume in third quarter 2012. For additional information on this and other legal matters related to our mortgage origination and servicing activities, see pages 73-77 in our 2011 Form 10-K and Note 11 (Legal Actions) to Financial Statements in this Report.

 

 

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Asset/Liability Management

Asset/liability management involves evaluating, monitoring and managing of interest rate risk, market risk, liquidity and funding. The Corporate Asset/Liability Management Committee (Corporate ALCO), which oversees these risks and reports periodically to the Finance Committee of the Board of Directors, consists of senior financial and business executives. Each of our principal business groups has its own asset/liability management committee and process 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 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 September 30, 2012, our most recent simulation indicated estimated earnings at risk of less than 1% of our most likely earnings plan over the next 12 months under a range of both lower and higher interest rates, including a scenario in which the federal funds rate remains unchanged and the 10-year Constant Maturity Treasury bond yield averages below 1.20%, and a scenario in which the federal funds rate rises to 3.75% and the 10-year Constant Maturity Treasury bond yield increases to 5.10%. Simulation estimates depend on, and will change with, the size and mix of our actual and projected balance sheet at the time of each simulation. Due to timing differences between the quarterly valuation of MSRs and the eventual impact of interest rates on mortgage banking volumes, earnings at risk in any particular quarter could be higher than the average earnings at risk over the 12-month simulation period, depending on the path of interest rates and on our hedging strategies for MSRs. See the “Risk Management – Mortgage Banking Interest Rate and Market Risk” below for more information.

We use exchange-traded and over-the-counter (OTC) interest rate derivatives to hedge our interest rate exposures. The notional or contractual amount, credit risk amount and estimated net fair value of these derivatives as of September 30, 2012, and December 31, 2011, are presented in Note 12 (Derivatives) to Financial Statements in this Report.

For additional information regarding interest rate risk, see page 78 of our 2011 Form 10-K.

MORTGAGE BANKING INTEREST RATE AND MARKET RISK We originate, fund and service mortgage loans, which subjects us to various risks, including credit, liquidity and interest rate risks. For a discussion of mortgage banking interest rate and market risk, see pages 78-80 of our 2011 Form 10-K.

While our hedging activities are designed to balance our mortgage banking interest rate risks, the financial instruments we use may not perfectly correlate with the values and income being hedged. For example, the change in the value of ARM production held for sale from changes in mortgage interest rates may or may not be fully offset by Treasury and LIBOR index-based financial instruments used as economic hedges for such ARMs. Additionally, hedge-carry income on our economic

hedges for the MSRs may not continue if the spread between short-term and long-term rates decreases, we shift composition of the hedge to more interest rate swaps, or there are other changes in the market for mortgage forwards that affect the implied carry.

The total carrying value of our residential and commercial MSRs was $12.1 billion at September 30, 2012, and $14.0 billion at December 31, 2011. The weighted-average note rate on our portfolio of loans serviced for others was 4.87% at September 30, 2012, and 5.14% at December 31, 2011. The carrying value of our total MSRs represented 0.63% of mortgage loans serviced for others at September 30, 2012, and 0.76% at December 31, 2011.

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 our Corporate ALCO. All securities, foreign exchange transactions, commodity transactions and derivatives used in our trading businesses are carried at fair value. Our Market and Institutional Risk Committee, which provides governance and oversight over market risk-taking activities across the Company, establishes and monitors counterparty risk limits. The credit risk amount and estimated net fair value of all customer accommodation derivatives at September 30, 2012, and December 31, 2011, are included in Note 12 (Derivatives) to Financial Statements in this Report. Open “at risk” positions for all trading businesses are monitored by Corporate ALCO. Table 32 presents net gains (losses) from trading activities attributable to the following types of activity:

Table 32: Trading Activities

 

 

     Quarter ended Sept. 30,     Nine months ended Sept. 30,  
(in millions)   2012     2011     2012     2011  

 

 

Customer accommodation

  $ 393        82        1,083        769   

Economic hedging

    134        (515     333        (167

Proprietary

    2        (9     16        (18

 

 

Total net trading gains (losses)

  $ 529        (442     1,432        584   

 

 

The amounts reflected in the table above capture only gains (losses) due to changes in fair value of our trading positions and are reported within net gains (losses) on trading activities within the noninterest income line item of the income statement. These amounts do not include interest income and other fees earned from related activities, which are reported within interest income from trading assets and other fees within noninterest income line items of the income statement. Categorization of net gains (losses) from trading activities in the previous table is based on our own definition of those categories because uniform industry definitions do not currently exist.

 

 

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Customer accommodation trading consists of security or derivative transactions conducted in an effort to help customers manage their market price risks and is done on their behalf or driven by their investment needs. For the majority of our customer accommodation trading, we serve as intermediary between buyer and seller. For example, we may enter into financial instruments with customers who use the instruments for risk management purposes and offset our exposure on such contracts by entering into separate instruments. Customer accommodation trading also includes net gains related to market-making activities in which we take positions to facilitate expected customer order flow.

Economic hedges consist primarily of cash or derivative positions used to facilitate certain of our balance sheet risk management activities that did not qualify for hedge accounting or were not designated in a hedge accounting relationship. Economic hedges may also include securities that we elected to carry at fair value with changes in fair value recorded to earnings in order to mitigate accounting measurement mismatches or avoid embedded derivative accounting complexities.

Proprietary trading consists of security or derivative positions executed for our own account based on market expectations or to benefit from price differences between financial instruments and markets. Proprietary trading activity is expected to be restricted by the Dodd-Frank Act prohibitions known as the “Volcker Rule,” which has not yet been finalized. On October 11, 2011, federal banking agencies and the SEC issued proposed regulations to implement the Volcker Rule. We believe our definition of proprietary trading is consistent with the proposed regulations. However, given that final rule-making is required by various governmental regulatory agencies to define proprietary trading within the context of the final Volcker Rule, our definition of proprietary trading may change. We have reduced or exited certain business activities in anticipation of the final Volcker Rule. As discussed within the noninterest income section of our financial results, proprietary trading activity is not significant to our financial results. See the “Regulatory Reform” sections in our 2011 Form 10-K and in our 2012 First Quarter Form 10-Q for additional information on the Volcker Rule.

The fair value of our trading derivatives is reported in Notes 12 (Derivatives) and 13 (Fair Values of Assets and Liabilities) to Financial Statements in this Report. The fair value of our trading securities is reported in Note 13 (Fair Values of Assets and Liabilities) to Financial Statements in this Report.

The standardized approach for monitoring and reporting market risk for the trading activities consists of value-at-risk (VaR) metrics complemented with sensitivity analysis and stress testing. VaR measures the worst expected loss over a given time interval and within a given confidence interval. We measure and report daily VaR at a 99% confidence interval based on actual changes in rates and prices over the previous 250 trading days. The analysis captures all financial instruments that are considered trading positions. The average one-day VaR throughout third quarter 2012 was $19 million, with a lower bound of $12 million and an upper bound of $32 million.

MARKET RISK – EQUITY MARKETS We are directly and indirectly affected by changes in the equity markets. For

additional information regarding market risk related to equity markets, see page 81 of our 2011 Form 10-K.

Table 33 provides information regarding our marketable and nonmarketable equity investments.

Table 33: Nonmarketable and Marketable Equity Investments

 

 

     Sept. 30,      Dec. 31,  
(in millions)    2012      2011  

 

 

Nonmarketable equity investments:

     

Cost method:

     

Private equity investments

   $ 3,718         3,444   

Federal bank stock

     4,343         4,617   

 

 

Total cost method

     8,061         8,061   

 

 

Equity method:

     

LIHTC investments (1)

     4,464         4,077   

Private equity and other

     4,983         4,670   

 

 

Total equity method

     9,447         8,747   

 

 

Total nonmarketable equity investments (2)

   $             17,508         16,808   

 

 

Marketable equity securities:

     

Cost

   $ 2,327         2,929   

Net unrealized gains

     425         488   

 

 

Total marketable equity securities (3)

   $ 2,752         3,417   

 

 

 

(1) Represents low income housing tax credit investments
(2) Included in other assets on the balance sheet. See Note 6 (Other Assets) to Financial Statements in this Report for additional information.
(3) Included in securities available for sale. See Note 4 (Securities Available for Sale) to Financial Statements in this Report for additional information.
 

 

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Risk Management – Asset/Liability Management (continued)

 

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, the 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.

Unencumbered debt and equity securities in the securities available-for-sale portfolio provide asset liquidity, in addition to

the immediately liquid resources of cash and due from banks and federal funds sold, securities purchased under resale agreements and other short-term investments. Asset liquidity is further enhanced by our ability to sell or securitize loans in secondary markets and to pledge loans to access secured borrowing facilities through the Federal Home Loan Banks (FHLB) and the FRB.

Core customer deposits have historically provided a sizeable source of relatively stable and low-cost funds. At September 30, 2012, core deposits were 115% of total loans, compared with 112% a year ago. Additional funding is provided by long-term debt, other foreign deposits, and short-term borrowings.

Table 34 shows selected information for short-term borrowings, which generally mature in less than 30 days.

 

 

Table 34: Short-Term Borrowings

 

 

      Quarter ended  
     Sept. 30,      June 30,      Mar. 31,      Dec. 31,      Sept. 30,  
(in millions)    2012      2012      2012      2011      2011  

 

 

Balance, period end

              

Commercial paper and other short-term borrowings

   $ 20,474         19,695         17,759         18,053         17,444   

Federal funds purchased and securities sold under agreements to repurchase

     31,483         36,328         33,205         31,038         33,331   

 

 

Total

   $ 51,957         56,023         50,964         49,091         50,775   

 

 

Average daily balance for period

              

Commercial paper and other short-term borrowings

   $ 19,675         18,072         18,038         17,301         17,040   

Federal funds purchased and securities sold under agreements to repurchase

     32,182         33,626         30,344         31,441         33,333   

 

 

Total

   $ 51,857         51,698         48,382         48,742         50,373   

 

 

Maximum month-end balance for period

              

Commercial paper and other short-term borrowings (1)

   $ 20,474         19,695         18,323         18,053         17,569   

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

     32,766         36,328         33,205         32,354         33,331   

 

 

 

(1) Highest month-end balance in each of the last five quarters was in September, June and January 2012, and December and July 2011.
(2) Highest month-end balance in each of the last five quarters was in July, June and March 2012, and October and September 2011.

 

        We access domestic and international capital markets for long-term funding through issuances of registered debt securities, private placements and asset-backed secured funding. Investors in the long-term capital markets, as well as other market participants, generally will consider, among other factors, a company’s debt rating in making investment decisions. Rating agencies base their ratings on many quantitative and qualitative factors, including capital adequacy, liquidity, asset quality, business mix, the level and quality of earnings, and rating agency assumptions regarding the probability and extent of Federal financial assistance or support for certain large financial institutions. Adverse changes in these factors could result in a reduction of our credit rating; however, a reduction in credit rating would not cause us to violate any of our debt covenants. Generally, rating agencies review a firm’s ratings at least annually. During third quarter 2012, our ratings were reviewed and affirmed by both Standard & Poor’s and Fitch Ratings. Dominion Bond Rating Service reviewed and affirmed our ratings in second quarter 2012. There were no changes to our credit ratings in third quarter 2012. See the “Risk Management – Asset/Liability Management” and “Risk Factors” sections in our 2011 Form 10-K for additional information regarding our credit ratings as of December 31, 2011, and the

potential impact a credit rating downgrade would have on our liquidity and operations, as well as Note 12 (Derivatives) to Financial Statements in this Report for information regarding additional collateral and funding obligations required for certain derivative instruments in the event our credit ratings were to fall below investment grade.

On December 20, 2011, the FRB proposed enhanced liquidity risk management rules. The proposed rules would require modifications to our existing liquidity risk management processes. This includes increased frequency of liquidity reporting and stress testing along with additional corporate governance. We will continue to analyze the proposed rules and other regulatory proposals that may affect liquidity risk management, including Basel III, to determine the level of operational or compliance impact to Wells Fargo. For additional information see the “Capital Management” and “Regulatory Reform” sections in this Report and in our 2011 Form 10-K.

Parent Under SEC rules, our Parent is classified as a “well-known seasoned issuer,” which allows it to file a registration statement that does not have a limit on issuance capacity. In April 2012, the Parent filed a registration statement with the SEC for the issuance of senior and subordinated notes, preferred

 

 

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stock and other securities. The Parent’s ability to issue debt and other securities under this registration statement is limited by the debt issuance authority granted by the Board. The Parent is currently authorized by the Board to issue $60 billion in outstanding short-term debt and $170 billion in outstanding long-term debt. During the first nine months of 2012, the Parent issued $15.3 billion of senior notes, of which $10.6 billion were registered with the SEC.

The Parent’s proceeds from securities issued in the first nine months of 2012 were used for general corporate purposes, and, unless otherwise specified in the applicable prospectus or prospectus supplement, we expect the proceeds from securities issued in the future will be used for the same purposes. Depending on market conditions, we may purchase our outstanding debt securities from time to time in privately negotiated or open market transactions, by tender offer, or otherwise.

Table 35 provides information regarding the Parent’s medium-term note (MTN) programs. The Parent may issue senior and subordinated debt securities under Series L & M, and the European and Australian programmes. Under Series K, the Parent may issue senior debt securities linked to one or more indices or bearing interest at a fixed or floating rate.

Table 35: Medium-Term Note (MTN) Programs

 

 

                 September 30, 2012  
(in billions)   Date
established
          Debt
issuance
authority
    Available
for
issuance
 

 

 

MTN program:

       

Series L & M (1)

    May 2012        $ 25.0        22.3   

Series K (1) (3)

    April 2010          25.0        23.4   

European (2) (3)

    December 2009          25.0        20.9   

Australian (2) (4)

    June 2005        AUD        10.0        6.7   
       

 

 

 

(1) SEC registered.
(2) Not registered with the SEC. May not be offered in the United States without applicable exemptions from registration.
(3) As amended in April 2012.
(4) As amended in October 2005 and March 2010.

Wells Fargo Bank, N.A. Wells Fargo Bank, N.A. is authorized by its board of directors to issue $100 billion in outstanding short-term debt and $125 billion in outstanding long-term debt. At September 30, 2012, Wells Fargo Bank, N.A. had available $100 billion in short-term debt issuance authority and $102.2 billion in long-term debt issuance authority. In March 2012, Wells Fargo Bank, N.A. established a $100 billion bank note program under which, subject to any other debt outstanding under the limits described above, it may issue $50 billion in outstanding short-term senior notes and $50 billion in outstanding long-term senior or subordinated notes. During the first nine months of 2012, Wells Fargo Bank, N.A. issued $4.6 billion of senior notes. At September 30, 2012, Wells Fargo Bank, N.A. had remaining issuance capacity under the bank note program of $50 billion in short-term senior notes and $45.4 billion in long-term senior or subordinated notes.

Wells Fargo Canada Corporation In January 2012, Wells Fargo Canada Corporation (WFCC, formerly known as Wells Fargo Financial Canada Corporation), an indirect wholly owned Canadian subsidiary of the Parent, qualified with the Canadian provincial securities commissions a base shelf prospectus for the distribution from time to time in Canada of up to CAD $7.0 billion in medium-term notes. During the first nine months of 2012, WFCC issued CAD $3.0 billion in medium-term notes. At September 30, 2012, CAD $4.0 billion remained available for future issuance.

FEDERAL HOME LOAN BANK MEMBERSHIP We are a member of the Federal Home Loan Banks based in Dallas, Des Moines and San Francisco (collectively, the FHLBs). Each member of the FHLBs is required to maintain a minimum investment in capital stock of the applicable FHLB. The board of directors of each FHLB can increase the minimum investment requirements in the event it has concluded that additional capital is required to allow it to meet its own regulatory capital requirements. Any increase in the minimum investment requirements outside of specified ranges requires the approval of the Federal Housing Finance Board. Because the extent of any obligation to increase our investment in any of the FHLBs depends entirely upon the occurrence of a future event, potential future payments to the FHLBs are not determinable.

The FHLBs are a group of cooperatives that lending institutions use to finance housing and economic development in local communities. About 80% of U.S. lending institutions, including Wells Fargo, rely on the FHLBs for low-cost funds. We use the funds to support home mortgage lending and other community investments.

 

 

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Capital Management

 

 

We have an active program for managing stockholders’ equity and regulatory capital, and maintain a comprehensive process for assessing the Company’s overall capital adequacy. We generate capital primarily through the retention of earnings net of dividends. Our objective is to maintain capital at an amount commensurate with our risk profile and risk tolerance objectives, and to meet both regulatory and market expectations. Our potential sources of stockholders’ equity include retained earnings and issuances of common and preferred stock. Retained earnings increased $9.6 billion from December 31, 2011, predominantly from Wells Fargo net income of $13.8 billion, less common and preferred stock dividends of $4.2 billion. During third quarter 2012, we issued approximately 31 million shares of common stock (approximately 105 million for the first nine months of 2012), substantially all of which related to employee benefit plans. We also issued 30 million Depositary Shares, each representing a 1/1,000th interest in a share of the Company’s newly issued Non-Cumulative Perpetual Class A Preferred Stock, Series N, for an aggregate public offering price of $750 million. During third quarter 2012, we repurchased approximately 6 million shares of common stock in open market transactions and from employee benefit plans, at a net cost of $195 million, and approximately 11 million shares through the settlement in September 2012 of a $350 million forward purchase contract entered into in June 2012. In addition, the Company entered into a forward purchase contract in September 2012 at a net cost of $300 million and settled in October 2012 for approximately 9 million shares. For additional information about our forward repurchase agreements see Note 1 (Summary of Significant Accounting Policies) to Financial Statements in this Report. During the first nine months of 2012 we repurchased a total of approximately 50 million shares of common stock at a net cost of $1.6 billion in open market transactions and from employee plans, as well as approximately 27 million shares of common stock at a net cost of $850 million from the settlement of forward purchase contracts.

Regulatory Capital Guidelines

The Company and each of our subsidiary banks are subject to various regulatory capital adequacy requirements administered by the FRB and the OCC. Risk-based capital (RBC) guidelines establish a risk-adjusted ratio relating capital to different categories of assets and off-balance sheet exposures. At September 30, 2012, the Company and each of our subsidiary banks were “well-capitalized” under applicable regulatory capital adequacy guidelines. See Note 19 (Regulatory and Agency Capital Requirements) to Financial Statements in this Report for additional information.

Current regulatory RBC rules are based primarily on broad credit-risk considerations and limited market-related risks, but do not take into account other types of risk facing a financial services company. Our capital adequacy assessment process contemplates a wide range of risks that the Company is exposed to and also takes into consideration our performance under a variety of stressed economic conditions, as well as regulatory expectations and guidance, rating agency viewpoints and the view of capital markets participants.

In 2007, U.S. bank regulators approved a final rule adopting international guidelines for determining regulatory capital known as “Basel II.” Basel II incorporates three pillars that address (a) capital adequacy, (b) supervisory review, which relates to the computation of capital and internal assessment processes, and (c) market discipline, through increased disclosure requirements. We entered the “parallel run phase” of Basel II in July 2012. During the “parallel run phase,” banks must successfully complete at least a four quarter evaluation period under supervision from regulatory agencies in order to be compliant with the Basel II final rule.

In December 2010, the Basel Committee on Bank Supervision (BCBS) finalized a set of international guidelines for determining regulatory capital known as “Basel III.” These guidelines were developed in response to the financial crisis of 2008 and 2009 and address many of the weaknesses identified in the banking sector as contributing to the crisis including excessive leverage, inadequate and low quality capital and insufficient liquidity buffers. The guidelines, among other things, increase minimum capital requirements and when fully phased in require bank holding companies to maintain a minimum ratio of Tier 1 common equity to risk-weighted assets of at least 7.0% consisting of a minimum ratio of 4.5% plus a 2.5% capital conservation buffer.

The BCBS also proposed additional Tier 1 common equity surcharge requirements for global systemically important banks (G-SIBs). The surcharge ranges from 1.0% to 3.5% of risk-weighed assets depending on the bank’s systemic importance to be determined under an indicator-based approach that would consider five broad categories: cross-jurisdictional activity; size; inter-connectedness; substitutability/financial institution infrastructure and complexity. These additional capital requirements, which would be phased in beginning in January 2016 and become fully effective on January 1, 2019, would be in addition to the Basel III 7.0% Tier 1 common equity requirement. The Financial Stability Board (FSB), in an updated list published in November 2012 based on year-end 2011 data, has identified the Company as one of 28 G-SIBs and provisionally determined that the Company’s surcharge would be 1%. The FSB may revise the list of G-SIBs and their required surcharges prior to implementation based on additional or future data.

U.S. regulatory authorities have been considering the BCBS capital guidelines and proposals, and in June 2012, the U.S. banking regulators jointly issued three notices of proposed rulemaking that are essentially intended to implement the BCBS capital guidelines for U.S. banks. Together these notices of proposed rulemaking would, among other things:

 

   

implement in the United States the Basel III regulatory capital reforms including those that revise the definition of capital, increase minimum capital ratios, and introduce a minimum Tier 1 common equity ratio of 4.5% and a capital conservation buffer of 2.5% (for a total minimum Tier 1 common equity ratio of 7.0%) and a potential countercyclical buffer of up to 2.5%, which would be imposed by regulators at their discretion if it is determined that a period of excessive credit growth is contributing to an increase in systemic risk;

 

 

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revise “Basel I” rules for calculating risk-weighted assets to enhance risk sensitivity;

 

   

modify the existing Basel II advanced approaches rules for calculating risk-weighted assets to implement Basel III; and

 

   

comply with the Dodd-Frank Act provision prohibiting the reliance on external credit ratings.

The U.S. banking regulators also approved a final rule to implement changes to the market risk capital rule, which requires banking organizations with significant trading activities to adjust their capital requirements to better account for the market risks of those activities. The notices of proposed rulemaking did not address the BCBS capital surcharge proposals for G-SIBs or the proposed Basel III liquidity standards. U.S. regulatory authorities have indicated that these proposals will be addressed at a later date.

Although uncertainty exists regarding final capital rules, we evaluate the impact of Basel III on our capital ratios based on our interpretation of the proposed capital requirements and we estimate that our Tier 1 common equity ratio under the Basel III capital proposals exceeded the fully phased-in minimum of 7.0% by 102 basis points at September 30, 2012. The proposed Basel III capital rules and interpretations and assumptions used in estimating our Basel III calculations are subject to change depending on final promulgation of Basel III capital rulemaking.

In October 2012, the FRB and OCC issued final rules regarding stress testing as required under the Dodd-Frank Act provision imposing enhanced prudential standards on large bank holding companies (BHCs) such as Wells Fargo. The final stress test rules, which become effective on November 15, 2012, set forth the timing and type of stress test activities as well as rules governing controls, oversight and disclosure.

Table 36 and Table 37, which appear at the end of this Capital Management section, provide information regarding our Tier 1 common equity calculations under Basel I and as estimated under Basel III, respectively.

Capital Planning

In late 2011, the FRB finalized rules to require large BHCs to submit capital plans annually and to obtain regulatory approval before making capital distributions. The rule requires updates to capital plans in the event of material changes in a BHC’s risk profile, including as a result of any significant acquisitions.

Under the FRB’s new capital plan rule, our 2012 Comprehensive Capital Analysis and Review (CCAR) included a comprehensive capital plan supported by an assessment of expected uses and sources of capital over a given planning horizon under a range of expected and stress scenarios, similar to the process the FRB used to conduct a CCAR in 2011. As part of the 2012 CCAR, the FRB also generated a supervisory stress test driven by a sharp decline in the economy and significant decline in asset pricing using the information provided by the Company to estimate performance.

On March 13, 2012, the FRB notified us that it did not object to our 2012 capital plan included in the 2012 CCAR. Since the FRB notification, the Company took several capital actions,

including increasing its quarterly common stock dividend rate to $0.22 a share, redeeming a total of $2.7 billion of trust preferred securities that will no longer count as Tier 1 capital under the Dodd-Frank Act and the proposed Basel III capital standards, and purchasing an aggregate of $2.2 billion of our subordinated debt with an effective yield of 2.02% in tender offers for such securities.

Securities Repurchases

From time to time the Board authorizes the Company to repurchase shares of our common stock. Although we announce when the Board authorizes share repurchases, we typically do not give any public notice before we repurchase our shares. Future stock repurchases may be private or open-market repurchases, including block transactions, accelerated or delayed block transactions, forward transactions, and similar transactions. Additionally, we may enter into plans to purchase stock that satisfy the conditions of Rule 10b5-1 of the Securities Exchange Act of 1934. Various factors determine the amount and timing of our share repurchases, including our capital requirements, the number of shares we expect to issue for employee benefit plans and acquisitions, market conditions (including the trading price of our stock), and regulatory and legal considerations, including the FRB’s response to our capital plan and to changes in our risk profile.

In first quarter 2011, the Board authorized the repurchase of 200 million shares of our common stock. At September 30, 2012, we had remaining authority under this authorization to purchase approximately 40 million shares. In October 2012, the Board authorized the repurchase of an additional 200 million shares. For more information about share repurchases during 2012, see Part II, Item 2 of this Report.

Historically, our policy has been to repurchase shares under the “safe harbor” conditions of Rule 10b-18 of the Securities Exchange Act of 1934 including a limitation on the daily volume of repurchases. Rule 10b-18 imposes an additional daily volume limitation on share repurchases during a pending merger or acquisition in which shares of our stock will constitute some or all of the consideration. Our management may determine that during a pending stock merger or acquisition when the safe harbor would otherwise be available, it is in our best interest to repurchase shares in excess of this additional daily volume limitation. In such cases, we intend to repurchase shares in compliance with the other conditions of the safe harbor, including the standing daily volume limitation that applies whether or not there is a pending stock merger or acquisition.

In connection with our participation in the Capital Purchase Program (CPP), a part of the Troubled Asset Relief Program (TARP), we issued to the U.S. Treasury Department warrants to purchase 110,261,688 shares of our common stock with an exercise price of $34.01 per share expiring on October 28, 2018. The Board authorized the repurchase by the Company of up to $1 billion of the warrants. On May 26, 2010, in an auction by the U.S. Treasury, we purchased 70,165,963 of the warrants at a price of $7.70 per warrant. We have purchased an additional 951,426 warrants since the U.S. Treasury auction. At September 30, 2012, there were 39,144,299 warrants outstanding and exercisable and $452 million of unused warrant repurchase authority. Depending on market conditions, we may purchase from time to time additional warrants in privately negotiated or open market transactions, by tender offer or otherwise.

 

 

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Capital Management (continued)

 

Table 36: Tier 1 Common Equity Under Basel I (1)

 

 
          Sept. 30,     Dec. 31,  
(in billions)         2012     2011  

 

 

Total equity

      $             156.1        141.7   

Noncontrolling interests

        (1.4     (1.5

 

 

Total Wells Fargo stockholders’ equity

        154.7        140.2   

 

 

Adjustments:

       

Preferred equity

        (11.3     (10.6

Goodwill and intangible assets (other than MSRs)

        (33.4     (34.0

Applicable deferred taxes

        3.3        3.8   

MSRs over specified limitations

        (0.7     (0.8

Cumulative other comprehensive income

        (6.4     (3.1

Other

        (0.4     (0.4

 

 

Tier 1 common equity

   (A)    $ 105.8        95.1   

 

 

Total risk-weighted assets (2)

   (B)    $ 1,067.1        1,005.6   

 

 

Tier 1 common equity to total risk-weighted assets (2)

   (A)/(B)      9.92     9.46   

 

 

 

(1) Tier 1 common equity is a non-GAAP financial measure that is used by investors, analysts and bank regulatory agencies to assess the capital position of financial services companies. Management reviews Tier 1 common equity along with other measures of capital as part of its financial analyses and has included this non-GAAP financial information, and the corresponding reconciliation to total equity, because of current interest in such information on the part of market participants.
(2) Under the regulatory guidelines for risk-based capital, on-balance sheet assets and credit equivalent amounts of derivatives and off-balance sheet items are assigned to one of several broad risk categories according to the obligor or, if relevant, the guarantor or the nature of any collateral. The aggregate dollar amount in each risk category is then multiplied by the risk weight associated with that category. The resulting weighted values from each of the risk categories are aggregated for determining total risk-weighted assets. The September 30, 2012, risk-weighted assets and resulting Tier 1 common equity to total risk-weighted assets reflect the Company’s refinement to its determination of risk weighting of certain unused lending commitments that provide for the ability to issue standby letters of credit and commitments to issue standby letters of credit under syndication arrangements where we have an obligation to issue in a lead agent or similar capacity beyond our contractual participation level.

Table 37: Tier 1 Common Equity Under Basel III (Estimated) (1)(2)

 

 
(in billions)        September 30, 
2012 
 

 

 

Tier 1 common equity under Basel I

     $ 105.8    

 

 

Adjustments from Basel I to Basel III (3) (5):

    

Cumulative other comprehensive income related to AFS securities and defined benefit pension plans

       6.0    

Other

       0.3    

 

 

Total adjustments from Basel I to Basel III

       6.3    

Threshold deductions, as defined under Basel III (4) (5)

       (0.7

 

 

Tier 1 common equity anticipated under Basel III

   (C)   $ 111.4    

 

 

Total risk-weighted assets anticipated under Basel III (6)

   (D)   $         1,388.3    

 

 

Tier 1 common equity to total risk-weighted assets anticipated under Basel III

   (C)/(D)     8.02

 

 

 

(1) Tier 1 common equity is a non-GAAP financial measure that is used by investors, analysts and bank regulatory agencies to assess the capital position of financial services companies. Management reviews Tier 1 common equity along with other measures of capital as part of its financial analyses and has included this non-GAAP financial information, and the corresponding reconciliation to total equity, because of current interest in such information on the part of market participants.
(2) The Basel III Tier 1 common equity and risk-weighted assets are calculated based on management’s current interpretation of the Basel III capital rules proposed by federal banking agencies in notices of proposed rulemaking announced in June 2012. The proposed rules and interpretations and assumptions used in estimating Basel III calculations are subject to change depending on final promulgations of Basel III capital rules.
(3) Adjustments from Basel I to Basel III represent reconciling adjustments, primarily certain components of cumulative other comprehensive income deducted for Basel I purposes, to derive Tier 1 common equity under Basel III.
(4) Threshold deductions, as defined under Basel III, include individual and aggregate limitations, as a percentage of Tier 1 common equity, with respect to MSRs, deferred tax assets and investments in unconsolidated financial companies.
(5) Volatility in interest rates can have a significant impact on the valuation of cumulative other comprehensive income and MSRs and therefore, may impact adjustments from Basel I to Basel III, and MSRs subject to threshold deductions, as defined under Basel III, in future reporting periods.
(6) Under current Basel proposals, risk-weighted assets incorporate different classifications of assets, with certain risk weights based on a borrower’s credit rating or Wells Fargo’s own risk models, along with adjustments to address a combination of credit/counterparty, operational and market risks, and other Basel III elements. The amount of risk-weighted assets anticipated under Basel III is preliminary and subject to change depending on final promulgation of Basel III capital rulemaking and interpretations thereof by regulatory authorities.

 

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Regulatory Reform

 

 

The past two years have witnessed a significant increase in regulation and regulatory oversight initiatives that may substantially change how most U.S. financial services companies conduct business. Regulation mandated by the Dodd-Frank Act is the source of most current U.S. regulatory reform, and many aspects of the Dodd-Frank Act remain subject to final rulemaking, guidance, and interpretation by regulatory authorities.

The following supplements our discussion of the significant regulations and regulatory oversight initiatives that have affected or may affect our business contained in the “Regulatory Reform” and “Risk Factors” sections of our 2011 Form 10-K and the “Regulatory Reform” section of our 2012 First and Second Quarter Reports on Form 10-Q.

STRESS TESTING REQUIREMENTS In October 2012, the FRB and OCC issued final rules regarding stress testing as required under the Dodd-Frank Act provision, imposing enhanced prudential standards on large BHCs such as Wells Fargo. The final stress test rules will become effective on November 15, 2012. For additional information, see the “Capital Management” section of this Report.

REGULATION OF CONSUMER FINANCIAL PRODUCTS BY THE CONSUMER FINANCIAL PROTECTION BUREAU (CFPB) The CFPB, which has now been in operation for over a year, has indicated that it expects to concentrate much of its rulemaking efforts in upcoming months on a variety of mortgage-related topics required under the Dodd-Frank Act, including mortgage origination disclosures, minimum underwriting standards and ability to repay, high-cost mortgage lending, and servicing practices. In addition, the CFPB has also gathered data concerning other consumer products, including private student lending, prepaid cards and overdraft practices.

REGULATION OF SWAPS AND OTHER DERIVATIVES ACTIVITIES In July 2012, the Commodity Futures Trading Commission and the SEC finalized definitions for terms such as “swap” and “security-based swap” and delineated the jurisdiction of “mixed swaps” between the Commissions. Finalization of these terms established the compliance dates for many of the Commissions’ rules implementing the new regulatory framework for swaps, including registration requirements for swap dealers. Wells Fargo Bank, N.A. must provisionally register as a swap dealer with the National Futures Association on December 31, 2012.

 

 

Critical Accounting Policies

 

 

Our significant accounting policies (see Note 1 (Summary of Significant Accounting Policies) to Financial Statements in our 2011 Form 10-K) are fundamental to understanding our results of operations and financial condition because they require that we use estimates and assumptions that may affect the value of our assets or liabilities and financial results. Six of these policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. These policies govern:

 

 

the allowance for credit losses;

 

 

PCI loans;

 

 

the valuation of residential MSRs;

 

 

liability for mortgage loan repurchase losses;

 

 

the fair valuation of financial instruments; and

 

 

income taxes.

Management has reviewed and approved these critical accounting policies and has discussed these policies with the Board’s Audit and Examination Committee. These policies are described further in the “Financial Review – Critical Accounting Policies” section and Note 1 (Summary of Significant Accounting Policies) to Financial Statements in our 2011 Form 10-K.

 

 

 

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Current Accounting Developments

 

 

The following accounting pronouncement has been issued by the FASB but is not yet effective:

 

 

Accounting Standards Update (ASU or Update) 2011-11, Disclosures about Offsetting Assets and Liabilities.

ASU 2011-11 expands the disclosure requirements for certain financial instruments and derivatives that are subject to enforceable master netting agreements or similar arrangements. The disclosures are required regardless of whether the instruments have been offset (or netted) in the statement of

financial position. Under ASU 2011-11, companies must describe the nature of offsetting arrangements and provide quantitative information about those agreements, including the gross and net amounts of financial instruments that are recognized in the statement of financial position. These changes are effective for us in first quarter 2013 with retrospective application. This Update will not affect our consolidated financial results since it amends only the disclosure requirements for offsetting financial instruments.

 

 

Forward-Looking Statements

 

 

This Report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as “anticipates,” “intends,” “plans,” “seeks,” “believes,” “estimates,” “expects,” “target,” “projects,” “outlook,” “forecast,” “will,” “may,” “could,” “should,” “can” and similar references to future periods. Examples of forward-looking statements in this Report include, but are not limited to, statements we make about: (i) future results of the Company; (ii) our noninterest expense, including our expectations regarding operating within our targeted efficiency ratio range of 55 to 59% in fourth quarter 2012, as part of our expense management initiatives; (iii) future credit quality and expectations regarding future loan losses in our loan portfolios; our foreign loan exposure; the level and loss content of NPAs and nonaccrual loans; the appropriateness of the allowance for credit losses, including our current expectation of future allowance releases; the recast risk in our Pick-a-Pay portfolio; and the reduction or mitigation of risk in our loan portfolios and the effects of loan modification programs; (iv) our net interest income and net interest margin, including our expectation that we expect continued pressure on our net interest margin; (v) our plans to retain on our balance sheet some of our 1-4 family conforming first mortgage loans and the expected benefits associated with the retention of such mortgage loans; (vi) future capital levels and our estimate regarding our Tier 1 common equity ratio as of September 30, 2012 under the latest Basel III capital proposals contained in the notices of proposed rulemaking announced by federal banking agencies in June 2012; (vii) the quality of our residential mortgage loan servicing portfolio, our mortgage repurchase exposure and exposure relating to our mortgage foreclosure practices; (viii) our expectations regarding the satisfaction of our obligations under our settlement with the DOJ and other federal and state government entities related to our mortgage servicing and foreclosure practices, including our estimates of the impact of the settlement on our future financial results; (ix) the expected outcome and impact of legal, regulatory and legislative developments, including the Dodd-Frank Act; and (x) the Company’s plans, objectives and strategies, including our belief that we have more opportunity to increase cross-sell of our products.

Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future,

they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. Our actual results may differ materially from those contemplated by the forward-looking statements. We caution you, therefore, against relying on any of these forward-looking statements. They are neither statements of historical fact nor guarantees or assurances of future performance. While there is no assurance that any list of risks and uncertainties or risk factors is complete, important factors that could cause actual results to differ materially from those in the forward-looking statements include the following, without limitation:

 

 

current and future economic and market conditions, including the effects of further declines in housing prices and high unemployment rates, U. S. fiscal debt, budget and tax matters, the sovereign debt crisis and economic difficulties in Europe, and the overall slowdown in global economic growth;

 

losses relating to Hurricane Sandy and related storms, including as a result of, among other things, the loss of business due to the extensive damage to communities and the closing of some of our retail stores and facilities in the affected areas and, as to our consumer and commercial loan portfolios, the extent of damage or loss to our collateral for loans in our portfolios or the unavailability of adequate insurance coverage or government assistance for our borrowers;

 

 

our capital and liquidity requirements (including under regulatory capital standards, such as the latest Basel III capital proposals, as determined and interpreted by applicable regulatory authorities) and our ability to generate capital internally or raise capital on favorable terms;

 

 

financial services reform and other current, pending or future legislation or regulation that could have a negative effect on our revenue and businesses, including the Dodd-Frank Act and legislation and regulation relating to overdraft fees (and changes to our overdraft practices as a result thereof), debit card interchange fees, credit cards, and other bank services, as well as the extent of our ability to mitigate the loss of revenue and income from financial services reform and other legislation and regulation;

 

 

the extent of our success in our loan modification efforts, as well as the effects of regulatory requirements or guidance

 

 

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regarding loan modifications or changes in such requirements or guidance;

 

 

the amount of mortgage loan repurchase demands that we receive and our ability to satisfy any such demands without having to repurchase loans related thereto or otherwise indemnify or reimburse third parties, and the credit quality of or losses on such repurchased mortgage loans;

 

 

negative effects relating to our mortgage servicing and foreclosure practices, including our ability to meet our obligations under the settlement with the DOJ and other federal and state government entities, as well as changes in our procedures or practices and/or industry standards or practices, regulatory or judicial requirements, penalties or fines, increased servicing and other costs or obligations, including loan modification requirements, or delays or moratoriums on foreclosures;

 

 

our ability to realize our efficiency ratio target as part of our expense management initiatives when and in the range targeted, including as a result of business and economic cyclicality, seasonality, changes in our business composition and operating environment, growth in our businesses and/or acquisitions, and unexpected expenses relating to, among other things, litigation and regulatory matters;

 

 

the effect of the current low interest rate environment or changes in interest rates on our net interest income, net interest margin and our mortgage originations, MSRs and MHFS;

 

 

hedging gains or losses;

 

 

a recurrence of significant turbulence or disruption in the capital or financial markets, which could result in, among other things, reduced investor demand for mortgage loans, a reduction in the availability of funding or increased funding costs, and declines in asset values and/or recognition of OTTI on securities held in our available-for-sale portfolio due to volatility or changes in interest rates, foreign exchange rates and/or debt, equity and commodity prices;

 

 

our ability to sell more products to our existing customers through our cross-selling efforts;

 

the effect of a fall in stock market prices on our investment banking business and our fee income from our brokerage, asset and wealth management businesses;

 

 

changes in the value of our venture capital investments;

 

changes in our accounting policies or in accounting standards or in how accounting standards are to be applied or interpreted;

 

 

mergers, acquisitions and divestitures;

 

 

changes in the Company’s credit ratings and changes in the credit quality of the Company’s customers or counterparties;

 

 

reputational damage from negative publicity, protests, fines, penalties and other negative consequences from regulatory violations and legal actions;

 

 

a failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers, including as a result of cyber attacks;

 

 

the loss of checking and savings account deposits to other investments such as the stock market, and the resulting increase in our funding costs and impact on our net interest margin;

 

 

fiscal and monetary policies of the FRB; and

 

 

the other risk factors and uncertainties described under “Risk Factors” in our 2011 Form 10-K.

In addition to the above factors, we also caution that there is no assurance that our allowance for credit losses will be appropriate to cover future credit losses, especially if housing prices decline, unemployment worsens or losses from Hurricane Sandy are significant. Increases in loan charge-offs or in the allowance for credit losses and related provision expense could materially adversely affect our financial results and condition.

Any forward-looking statement made by us in this Report speaks only as of the date on which it is made. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

 

 

Risk Factors

 

 

An investment in the Company involves risk, including the possibility that the value of the investment could fall substantially and that dividends or other distributions on the investment could be reduced or eliminated. We discuss previously under “Forward-Looking Statements” and elsewhere in this Report, as well as in other documents we file with the SEC, risk factors that could adversely affect our financial results and condition and the value of, and return on, an investment in the Company. For a discussion of risk factors, we refer you to the “Risk Factors” section of our 2011 Form 10-K, as well as to the Financial Review section and Financial Statements (and related Notes) in this Report for more information about credit, interest rate, market, and litigation risks and to the “Regulation and Supervision” section in our 2011 Form 10-K for more information about legislative and regulatory risks. Any factor described in this Report or in our 2011 Form 10-K could by itself, or together with other factors, adversely affect our financial results and condition, or the value of an investment in the Company. There are factors not discussed in this Report or in our 2011 Form 10-K that could adversely affect our financial results and condition.

    

 
  

 

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Controls and Procedures

Disclosure Controls and Procedures

 

As required by SEC rules, the Company’s management evaluated the effectiveness, as of September 30, 2012, of the Company’s disclosure controls and procedures. The Company’s chief executive officer and chief financial officer participated in the evaluation. Based on this evaluation, the Company’s chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2012.

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, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles (GAAP) and includes those policies and procedures that:

 

 

pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of assets of the Company;

 

 

provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

 

 

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. No change occurred during third quarter 2012 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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Wells Fargo & Company and Subsidiaries

Consolidated Statement of Income (Unaudited)

 

 
     Quarter ended Sept. 30,     Nine months ended Sept. 30,  
(in millions, except per share amounts)    2012      2011     2012     2011  

 

 

Interest income

         

Trading assets

   $ 299         343        1,019        1,040   

Securities available for sale

     1,966         2,053        6,201        6,383   

Mortgages held for sale

     476         389        1,412        1,188   

Loans held for sale

     17         13        38        42   

Loans

     9,016         9,224        27,455        27,972   

Other interest income

     151         156        409        409   

 

 

Total interest income

     11,925         12,178        36,534        37,034   

 

 

Interest expense

         

Deposits

     428         559        1,328        1,768   

Short-term borrowings

     19         20        55        66   

Long-term debt

     756         980        2,375        3,093   

Other interest expense

     60         77        189        236   

 

 

Total interest expense

     1,263         1,636        3,947        5,163   

 

 

Net interest income

     10,662         10,542        32,587        31,871   

Provision for credit losses

     1,591         1,811        5,386        5,859   

 

 

Net interest income after provision for credit losses

     9,071         8,731        27,201        26,012   

 

 

Noninterest income

         

Service charges on deposit accounts

     1,210         1,103        3,433        3,189   

Trust and investment fees

     2,954         2,786        8,691        8,646   

Card fees

     744         1,013        2,102        2,973   

Other fees

     1,097         1,085        3,326        3,097   

Mortgage banking

     2,807         1,833        8,570        5,468   

Insurance

     414         423        1,455        1,494   

Net gains (losses) from trading activities

     529         (442     1,432        584   

Net gains (losses) on debt securities available for sale (1)

     3         300        (65     6   

Net gains from equity investments (2)

     164         344        770        1,421   

Operating leases

     218         284        397        464   

Other

     411         357        1,440        1,130   

 

 

Total noninterest income

     10,551         9,086        31,551        28,472   

 

 

Noninterest expense

         

Salaries

     3,648         3,718        10,954        10,756   

Commission and incentive compensation

     2,368         2,088        7,139        6,606   

Employee benefits

     1,063         780        3,720        3,336   

Equipment

     510         516        1,526        1,676   

Net occupancy

     727         751        2,129        2,252   

Core deposit and other intangibles

     419         466        1,256        1,413   

FDIC and other deposit assessments

     359         332        1,049        952   

Other

     3,018         3,026        9,729        9,894   

 

 

Total noninterest expense

     12,112         11,677        37,502        36,885   

 

 

Income before income tax expense

     7,510         6,140        21,250        17,599   

Income tax expense

     2,480         1,998        7,179        5,571   

 

 

Net income before noncontrolling interests

     5,030         4,142        14,071        12,028   

Less: Net income from noncontrolling interests

     93         87        264        266   

 

 

Wells Fargo net income

   $                 4,937         4,055        13,807        11,762   

 

 

Less: Preferred stock dividends and other

     220         216        665        625   

 

 

Wells Fargo net income applicable to common stock

   $ 4,717         3,839        13,142        11,137   

 

 

Per share information

         

Earnings per common share

   $ 0.89         0.73        2.48        2.11   

Diluted earnings per common share

     0.88         0.72        2.45        2.09   

Dividends declared per common share

     0.22         0.12        0.66        0.36   

Average common shares outstanding

     5,288.1         5,275.5        5,292.7        5,280.2   

Diluted average common shares outstanding

     5,355.6         5,319.2        5,355.7        5,325.6   

 

 

 

(1) Total other-than-temporary impairment (OTTI) losses (gains) were $(101) million and $136 million for third quarter 2012 and 2011, respectively. Of total OTTI, losses of $36 million and $96 million were recognized in earnings, and losses (gains) of $(137) million and $40 million were recognized as non-credit-related OTTI in other comprehensive income for third quarter 2012 and 2011, respectively. Total other-than-temporary impairment (OTTI) losses (gains) were $(19) million and $189 million for the nine months ended September 30, 2012 and 2011, respectively. Of total OTTI, losses of $163 million and $365 million were recognized in earnings, and gains of $(182) million and $(176) million were recognized as non-credit-related OTTI in other comprehensive income for the nine months ended September 30, 2012 and 2011, respectively.
(2) Includes OTTI losses of $36 million and $48 million for third quarter 2012 and 2011, respectively, and $94 million and $105 million for the nine months ended September 30, 2012 and 2011, respectively.

The accompanying notes are an integral part of these statements.

 

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Wells Fargo & Company and Subsidiaries

Consolidated Statement of Comprehensive Income (Unaudited)

 

 
     Quarter ended Sept. 30,     Nine months ended Sept. 30,  
(in millions)    2012     2011     2012     2011  

 

 

Wells Fargo net income

   $ 4,937        4,055        13,807        11,762   

 

 

Other comprehensive income, before tax:

        

Foreign currency translation adjustments:

        

Net unrealized gains (losses) arising during the period

     45        (58     (1     (29

Reclassification of net gains included in net income

     -        -        (10     -   

Securities available for sale:

        

Net unrealized gains (losses) arising during the period

     2,892        (2,007     5,597        (878

Reclassification of net gains included in net income

     (41     (431     (290     (614

Derivatives and hedging activities:

        

Net unrealized gains arising during the period

     24        68        63        205   

Reclassification of net gains on cash flow hedges included in net income

     (89     (141     (295     (454

Defined benefit plans adjustment:

        

Net actuarial gains (losses) arising during the period

     (1     1        (18     (2

Amortization of net actuarial loss and prior service cost included in net income

     35        23        111        71   

 

 

Other comprehensive income (loss), before tax

     2,865        (2,545     5,157        (1,701

Income tax (expense) benefit related to OCI

     (1,057     945        (1,923     781   

 

 

Other comprehensive income (loss), net of tax

     1,808        (1,600     3,234        (920

Less: Other comprehensive income (loss) from noncontrolling interests

     2        (6     6        (10

 

 

Wells Fargo other comprehensive income (loss), net of tax

     1,806        (1,594     3,228        (910

 

 

Wells Fargo comprehensive income

     6,743        2,461        17,035        10,852   

Comprehensive income from noncontrolling interests

     95        81        270        256   

 

 

Total comprehensive income

   $             6,838        2,542        17,305        11,108   

 

 

The accompanying notes are an integral part of these statements.

 

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Wells Fargo & Company and Subsidiaries

Consolidated Balance Sheet (Unaudited)

 

 
     Sept. 30,     Dec. 31,  
(in millions, except shares)    2012     2011  

 

 

Assets

    

Cash and due from banks

   $ 16,986        19,440   

Federal funds sold, securities purchased under resale agreements and other short-term investments

     100,442        44,367   

Trading assets

     60,592        77,814   

Securities available for sale

     229,350        222,613   

Mortgages held for sale (includes $46,575 and $44,791 carried at fair value)

     50,337        48,357   

Loans held for sale (includes $172 and $1,176 carried at fair value)

     298        1,338   

Loans (includes $6,188 and $5,916 carried at fair value)

     782,630        769,631   

Allowance for loan losses

     (17,385     (19,372

 

 

Net loans

     765,245        750,259   

 

 

Mortgage servicing rights:

    

Measured at fair value

     10,956        12,603   

Amortized

     1,144        1,408   

Premises and equipment, net

     9,165        9,531   

Goodwill

     25,637        25,115   

Other assets

     104,563        101,022   

 

 

Total assets (1)

   $ 1,374,715        1,313,867   

 

 

Liabilities

    

Noninterest-bearing deposits

   $ 268,991        244,003   

Interest-bearing deposits

     683,248        676,067   

 

 

Total deposits

     952,239        920,070   

Short-term borrowings

     51,957        49,091   

Accrued expenses and other liabilities

     83,659        77,665   

Long-term debt (includes $218 and $0 carried at fair value)

     130,801        125,354   

 

 

Total liabilities (2)

     1,218,656        1,172,180   

 

 

Equity

    

Wells Fargo stockholders’ equity:

    

Preferred stock

     12,283        11,431   

Common stock – $1-2/3 par value, authorized 9,000,000,000 shares;
issued 5,463,056,853 shares and 5,358,522,061 shares

     9,105        8,931   

Additional paid-in capital

     59,089        55,957   

Retained earnings

     73,994        64,385   

Cumulative other comprehensive income

     6,435        3,207   

Treasury stock – 173,431,978 shares and 95,910,425 shares

     (5,186     (2,744

Unearned ESOP shares

     (1,041     (926

 

 

Total Wells Fargo stockholders’ equity

     154,679        140,241   

Noncontrolling interests

     1,380        1,446   

 

 

Total equity

     156,059        141,687   

 

 

Total liabilities and equity

   $         1,374,715        1,313,867   

 

 

 

(1) Our consolidated assets at September 30, 2012, and December 31, 2011, include the following assets of certain variable interest entities (VIEs) that can only be used to settle the liabilities of those VIEs: Cash and due from banks, $264 million and $321 million; Trading assets, $520 million and $293 million; Securities available for sale, $2.7 billion and $3.3 billion; Mortgages held for sale, $602 million and $444 million; Net loans, $10.8 billion and $12.0 billion; Other assets, $502 million and $1.9 billion, and Total assets, $15.5 billion and $18.2 billion, respectively.
(2) Our consolidated liabilities at September 30, 2012, and December 31, 2011, include the following VIE liabilities for which the VIE creditors do not have recourse to Wells Fargo: Short-term borrowings, $0 and $24 million; Accrued expenses and other liabilities, $128 million and $175 million; Long-term debt, $3.9 billion and $4.9 billion; and Total liabilities, $4.0 billion and $5.1 billion, respectively.

The accompanying notes are an integral part of these statements.

 

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Wells Fargo & Company and Subsidiaries

Consolidated Statement of Changes in Equity (Unaudited)

 

 

    

 

 
               
     Preferred stock      Common stock  
(in millions, except shares)    Shares      Amount      Shares      Amount  

Balance January 1, 2011

     10,185,303         $ 8,689           5,262,283,228         $ 8,787     

Net income

                                   

Other comprehensive loss, net of tax

                                   

Noncontrolling interests

                                   

Common stock issued

                       40,877,396           68     

Common stock repurchased

                       (59,201,762)              

Preferred stock issued to ESOP

     1,200,000           1,200                       

Preferred stock released by ESOP

                                   

Preferred stock converted to common shares

     (824,411)           (824)           28,261,663           47     

Common stock warrants repurchased

                                   

Preferred stock issued

     25,010           2,501                       

Common stock dividends

                                   

Preferred stock dividends

                                   

Tax benefit upon exercise of stock options

                                   

Stock incentive compensation expense

                                   

Net change in deferred compensation and related plans

                                   

Net change

     400,599           2,877           9,937,297           115     

Balance September 30, 2011

     10,585,902         $ 11,566           5,272,220,525         $ 8,902     

Balance December 31, 2011

     10,450,690         $ 11,431           5,262,611,636         $ 8,931     

Cumulative effect of fair value election for certain
residential mortgage servicing rights

                                   

Balance January 1, 2012

     10,450,690           11,431           5,262,611,636           8,931     

Net income

                                   

Other comprehensive income, net of tax

                                   

Noncontrolling interests

                                   

Common stock issued

                       80,013,209           133     

Common stock repurchased (1)

                       (77,521,553)              

Preferred stock issued to ESOP

     940,000           940                       

Preferred stock released by ESOP

                                   

Preferred stock converted to common shares

     (837,591)           (838)           24,521,583           41     

Preferred stock issued

     30,000           750                       

Common stock dividends

                                   

Preferred stock dividends

                                   

Tax benefit upon exercise of stock options

                                   

Stock incentive compensation expense

                                   

Net change in deferred compensation and related plans

                                   

Net change

     132,409           852           27,013,239           174     

Balance September 30, 2012

     10,583,099         $     12,283           5,289,624,875         $     9,105     

 

(1) For the nine months ended September 30, 2012, includes $300 million related to a private forward repurchase transaction entered into in third quarter 2012 that settled in October 2012 for approximately 9 million shares of common stock. See Note 1 (Summary of Significant Accounting Policies) for additional information.

The accompanying notes are an integral part of these statements.

 

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Wells Fargo stockholders’ equity        

Additional

paid-in

capital

   

Retained

earnings

 

Cumulative

other
comprehensive
income

 

Treasury

stock

 

Unearned

ESOP

shares

 

Total

Wells Fargo
stockholders’

equity

  Noncontrolling
interests
 

Total

equity

  53,426      51,918   4,738   (487)   (663)   126,408   1,481   127,889
        11,762               11,762   266   12,028
            (910)           (910)   (10)   (920)
  (39                   (39)   (261)   (300)
  946                      1,014       1,014
  (150           (1,612)       (1,762)       (1,762)
  102                  (1,302)   -       -
  (70               894   824       824
  777                      -       -
  (1                   (1)       (1)
                        2,501       2,501
  16      (1,921)               (1,905)       (1,905)
        (624)               (624)       (624)
  69                      69       69
  454                      454       454
  (35           12       (23)       (23)
  2,069      9,217   (910)   (1,600)   (408)   11,360   (5)   11,355
  55,495      61,135   3,828   (2,087)   (1,071)   137,768   1,476   139,244
  55,957      64,385   3,207   (2,744)   (926)   140,241   1,446   141,687
        2               2       2
  55,957      64,387   3,207   (2,744)   (926)   140,243   1,446   141,689
        13,807               13,807   264   14,071
            3,228           3,228   6   3,234
  (6                   (6)   (336)   (342)
  1,867                      2,000       2,000
  (150           (2,447)       (2,597)       (2,597)
  88                  (1,028)   -       -
  (75               913   838       838
  797                      -       -
  (8                   742       742
  41      (3,541)               (3,500)       (3,500)
        (659)               (659)       (659)
  198                      198       198
  465                      465       465
  (85           5       (80)       (80)
  3,132      9,607   3,228   (2,442)   (115)   14,436   (66)   14,370
  59,089      73,994   6,435   (5,186)   (1,041)   154,679   1,380   156,059

 

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Wells Fargo & Company and Subsidiaries

Consolidated Statement of Cash Flows (Unaudited)

 

 

     Nine months ended Sept. 30,  
(in millions)    2012     2011  

Cash flows from operating activities:

    

Net income before noncontrolling interests

   $ 14,071        12,028   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Provision for credit losses

     5,386        5,859   

Changes in fair value of MSRs, MHFS and LHFS carried at fair value

     (1,496     713   

Depreciation and amortization

     2,083        1,483   

Other net losses

     724        3,094   

Preferred stock released by ESOP

     838        824   

Stock incentive compensation expense

     465        454   

Excess tax benefits related to stock option payments

     (193     (70

Originations of MHFS

     (372,204     (229,382

Proceeds from sales of and principal collected on mortgages originated for sale

     317,386        224,464   

Originations of LHFS

     (10     -   

Proceeds from sales of and principal collected on LHFS

     8,792        8,077   

Purchases of LHFS

     (7,221     (7,010

Net change in:

    

Trading assets

     86,127        16,815   

Deferred income taxes

     202        1,830   

Accrued interest receivable

     (3     (277

Accrued interest payable

     81        (125

Other assets, net

     (4,499     (8,603

Other accrued expenses and liabilities, net

     (340     7,615   

Net cash provided by operating activities

     50,189        37,789   

Cash flows from investing activities:

    

Net change in:

    

Federal funds sold, securities purchased under resale agreements and other short-term investments

     (56,075     (9,167

Securities available for sale:

    

Sales proceeds

     4,969        21,374   

Prepayments and maturities

     44,592        34,114   

Purchases

     (49,703     (84,157

Loans:

    

Loans originated by banking subsidiaries, net of principal collected

     (29,308     (25,542

Proceeds from sales (including participations) of loans originated for investment by banking subsidiaries

     4,601        5,310   

Purchases (including participations) of loans by banking subsidiaries

     (7,431     (5,514

Principal collected on nonbank entities’ loans

     17,719        7,688   

Loans originated by nonbank entities

     (16,122     (5,668

Net cash paid for acquisitions

     (4,319     (245

Proceeds from sales of foreclosed assets

     7,427        8,089   

Changes in MSRs from purchases and sales

     159        (102

Other, net

     (2,285     2,051   

Net cash used by investing activities

     (85,776     (51,769

Cash flows from financing activities:

    

Net change in:

    

Deposits

     32,166        47,486   

Short-term borrowings

     2,481        (4,547

Long-term debt:

    

Proceeds from issuance

     24,999        7,779   

Repayment

     (22,273     (33,436

Preferred stock:

    

Proceeds from issuance

     742        2,501   

Cash dividends paid

     (726     (691

Common stock:

    

Proceeds from issuance

     2,000        1,014   

Repurchased

     (2,597     (1,762

Cash dividends paid

     (3,500     (1,905

Common stock warrants repurchased

     -        (1

Excess tax benefits related to stock option payments

     193        70   

Net change in noncontrolling interests

     (352     (258

Net cash provided by financing activities

     33,133        16,250   

Net change in cash and due from banks

     (2,454     2,270   

Cash and due from banks at beginning of period

     19,440        16,044   

Cash and due from banks at end of period

   $ 16,986        18,314   

Supplemental cash flow disclosures:

    

Cash paid for interest

   $ 3,866        5,288   

Cash paid for income taxes

     4,701        2,898   

The accompanying notes are an integral part of these statements. See Note 1 for noncash activities.

 

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See the Glossary of Acronyms at the end of this Report for terms used throughout the Financial Statements and related Notes of this Form 10-Q.

Note 1: Summary of Significant Accounting Policies

 

 

Wells Fargo & Company is a diversified financial services company. We provide banking, insurance, trust and investments, mortgage banking, investment banking, retail banking, brokerage, and consumer and commercial finance through banking stores, the internet and other distribution channels to consumers, businesses and institutions in all 50 states, the District of Columbia, and in other countries. When we refer to “Wells Fargo,” “the Company,” “we,” “our” or “us,” we mean Wells Fargo & Company and Subsidiaries (consolidated). Wells Fargo & Company (the Parent) is a financial holding company and a bank holding company. We also hold a majority interest in a real estate investment trust, which has publicly traded preferred stock outstanding.

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 based on assumptions about future economic and market conditions (for example, unemployment, market liquidity, real estate prices, etc.) that affect the reported amounts of assets and liabilities at the date of the financial statements and income and expenses during the reporting period and the related disclosures. Although our estimates contemplate current conditions and how we expect them to change in the future, it is reasonably possible that actual conditions could be worse than anticipated in those estimates, which could materially affect our results of operations and financial condition. Management has made significant estimates in several areas, including allowance for credit losses and purchased credit-impaired (PCI) loans (Note 5), valuations of residential mortgage servicing rights (MSRs) (Notes 7 and 8) and financial instruments (Note 13), liability for mortgage loan repurchase losses (Note 8) and income taxes. Actual results could differ from those estimates.

These unaudited interim financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the periods presented. These adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q. The results of operations in the interim financial statements do not necessarily indicate the results that may be expected for the full year. The interim financial information should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2011 (2011 Form 10-K).

Accounting Standards Adopted in 2012

In third quarter 2012, we early adopted Accounting Standards Update (ASU or Update) 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment.

ASU 2012-02 provides entities with the option to perform a qualitative assessment of indefinite-lived intangible assets to test for impairment. If, based on qualitative reviews, a company concludes it is more likely than not that the fair value of an

indefinite-lived intangible asset is less than its carrying amount, then the company must complete quantitative steps to determine if the asset is impaired. If a company concludes otherwise, quantitative tests are not required. Our adoption of this Update did not affect our consolidated financial statements.

In first quarter 2012, we adopted the following new accounting guidance:

   

ASU 2011-05, Presentation of Comprehensive Income;

   

ASU 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05;

   

ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs; and

   

ASU 2011-03, Reconsideration of Effective Control for Repurchase Agreements.

ASU 2011-05 eliminates the option for companies to include the components of other comprehensive income in the statement of changes in stockholders’ equity. This Update requires entities to present the components of comprehensive income in either a single statement or in two separate statements, with the statement of other comprehensive income (OCI) immediately following the statement of income. This Update also requires companies to present amounts reclassified out of OCI and into net income on the face of the statement of income. In December 2011, the FASB issued ASU 2011-12, which defers indefinitely the requirement to present reclassification adjustments on the statement of income. We adopted the remaining provisions in first quarter 2012 with retrospective application. This Update did not affect our consolidated financial results as it amends only the presentation of comprehensive income.

ASU 2011-04 modifies accounting guidance and expands existing disclosure requirements for fair value measurements. This Update clarifies how fair values should be measured for instruments classified in stockholders’ equity and under what circumstances premiums and discounts should be applied in fair value measurements. This Update also permits entities to measure fair value on a net basis for financial instruments that are managed based on net exposure to market risks and/or counterparty credit risk. ASU 2011-04 requires new disclosures for financial instruments classified as Level 3, including: 1) quantitative information about unobservable inputs used in measuring fair value, 2) qualitative discussion of the sensitivity of fair value measurements to changes in unobservable inputs, and 3) a description of valuation processes used. This Update also requires disclosure of fair value levels for financial instruments that are not recorded at fair value but for which fair value is required to be disclosed. We adopted this guidance in first quarter 2012 with prospective application, resulting in

 

 

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Note 1: Summary of Significant Accounting Policies (continued)

 

expanded fair value disclosures. The measurement clarifications of this Update did not have a material effect on our consolidated financial statements.

ASU 2011-03 amends the criteria companies use to determine if repurchase and similar agreements should be accounted for as sales or financings. Specifically, this Update removes the criterion for transferors to have the ability to meet contractual obligations through collateral maintenance provisions, even if transferees fail to return transferred assets pursuant to the agreements. We adopted this guidance in first quarter 2012 with prospective application to new transactions and existing transactions modified on or after January 1, 2012. This Update did not have a material effect on our consolidated financial statements.

Accounting Standards with Retrospective Application

The following accounting pronouncement has been issued by the FASB but is not yet effective:

 

 

   

Accounting Standards Update (ASU or Update) 2011-11, Disclosures about Offsetting Assets and Liabilities.

ASU 2011-11 expands the disclosure requirements for certain financial instruments and derivatives that are subject to enforceable master netting agreements or similar arrangements. The disclosures are required regardless of whether the instruments have been offset (or netted) in the statement of financial position. Under ASU 2011-11, companies must describe the nature of offsetting arrangements and provide quantitative information about those agreements, including the gross and net amounts of financial instruments that are recognized in the statement of financial position. These changes are effective for us in first quarter 2013 with retrospective application. This Update will not affect our consolidated financial results since it amends only the disclosure requirements for offsetting financial instruments.

Significant Accounting Policy Update

In first quarter 2012, we implemented the Interagency Supervisory Guidance on Allowance for Loan and Lease Losses Estimation Practices for Loans and Lines of Credit Secured by Junior Liens on 1-4 Family Residential Properties (Interagency Guidance), which was issued on January 31, 2012. As a result, we aligned our nonaccrual accounting policy with this guidance to accelerate the timing of placing junior lien loans on nonaccrual to coincide with the timing of placing the related real estate 1-4 family first mortgage loans on nonaccrual.

We implemented the guidance in the Office of the Comptroller of the Currency (OCC) update to Bank Accounting Advisory Series (OCC guidance) issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be written down to net realizable collateral value and classified as nonaccrual troubled debt restructurings (TDRs), regardless of their delinquency status.

Our updated nonaccrual policy is as follows:

 

We generally place loans on nonaccrual status when:

 

   

the full and timely collection of interest or principal becomes uncertain (generally based on an assessment of the borrower’s financial condition and the adequacy of collateral, if any);

 

   

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;

 

   

part of the principal balance has been charged off; or

 

   

effective first quarter 2012, for junior lien mortgages, we have evidence that the related first lien mortgage may be 120 days past due or in the process of foreclosure regardless of the junior lien delinquency status.

 

There have been no other material changes to our significant accounting policies, as discussed in Note 1 in our 2011 Form 10-K.

Private Share Repurchases

In June 2012, we entered into a private forward repurchase contract with an unrelated third party. This contract settled in third quarter 2012 for approximately 11 million shares of our common stock. We entered into this transaction to complement our open-market common stock repurchase strategies, to allow us to manage our share repurchases in a manner consistent with our capital plan submitted under the 2012 Comprehensive Capital Analysis and Review (CCAR), and to provide an economic benefit to the Company. In connection with this contract, we paid $350 million to the counterparty, which was recorded in permanent equity in the quarter paid and was not subject to re-measurement. The classification of the up-front payment as permanent equity assured that we would have appropriate repurchase timing consistent with our 2012 capital plan, which contemplated a fixed dollar amount available per quarter for share repurchases pursuant to Federal Reserve Board (FRB) supervisory guidance. In return, the counterparty agreed to deliver a variable number of shares based on a per share discount to the volume-weighted average stock price over the contract period. The counterparty had the right to accelerate settlement with delivery of shares prior to the contractual settlement. There were no scenarios where the contracts would not either physically settle in shares or allow us to choose the settlement method.

In September 2012, we entered into a similar private forward repurchase contract and paid $300 million to an unrelated third party. This contract settled in October 2012 for approximately 9 million shares of our common stock. The amount we paid to the counterparty meets accounting requirements to be treated as a permanent equity reduction.

 

 

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SUPPLEMENTAL CASH FLOW INFORMATION  Noncash activities are presented below, including information on transfers affecting MHFS, LHFS, and MSRs.

 

   
     Nine months ended Sept. 30,  
(in millions)    2012     2011  

Transfers from loans to securities available for sale

   $ 921        -   

Trading assets retained from securitization of MHFS

     68,905        23,205   

Capitalization of MSRs from sale of MHFS

     3,860        2,852   

Transfers from MHFS to foreclosed assets

     172        169   

Transfers from loans to MHFS

     5,523        5,490   

Transfers from loans to LHFS

     118        170   

Transfers from loans to foreclosed assets

     6,938        7,057   

Changes in consolidations (deconsolidations) of variable interest entities:

    

Securities available for sale

     (40     6   

Loans

     (295     (693

Long-term debt

     (338     674   
                  

 

SUBSEQUENT EVENTS  We have evaluated the effects of subsequent events that have occurred subsequent to period end September 30, 2012, and there have been no material events that would require recognition in our third quarter 2012 consolidated financial statements or disclosure in the Notes to the financial statements. During the last week of October 2012, Hurricane Sandy and related storms caused destruction along the East Coast, including in Connecticut, New Jersey, New York, Pennsylvania, Delaware, Maryland, Virginia and Washington D.C., and resulted in, among other things, property damage for our customers and the closing of many businesses and financial markets. We are currently assessing the impact to our customers and our business as a result of

Hurricane Sandy. The financial impact to us is expected to primarily relate to our consumer and commercial real estate loan portfolios and will depend on a number of factors, including, as to our consumer and commercial loan portfolios, the types of loans most affected by the storms, the extent of damage to our collateral, the extent of available insurance coverage, the availability of government assistance for our borrowers, and whether our borrowers’ ability to repay their loans has been diminished. We are actively reviewing our exposure but are currently unable to reasonably estimate the extent of losses we may incur as a result of these storms.

 

 

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. For information on additional contingent consideration related to acquisitions, which is considered to be a guarantee, see Note 10.

In the first nine months of 2012, we completed four acquisitions with combined total assets of $4.8 billion consisting

of an energy lending business with total assets of $3.6 billion, an asset-based lending business with total assets of $874 million, a prime brokerage and technology provider with total assets of $281 million and a global investments business with total assets of $7 million. At September 30, 2012, we had no pending business combinations.

 

 

Note 3: Federal Funds Sold, Securities Purchased under Resale Agreements and Other Short-Term Investments

 

 

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

 

     
     Sept. 30,      Dec. 31,  
(in millions)    2012      2011  

Federal funds sold and securities
purchased under resale agreements

   $ 30,517         24,255   

Interest-earning deposits

     68,336         18,917   

Other short-term investments

     1,589         1,195   

Total

   $   100,442         44,367   

We receive collateral from other entities under resale agreements and securities borrowings. For additional information, see the “Pledged Assets and Collateral” section of Note 10.

 

 

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Note 4: Securities Available for Sale

 

 

The following table provides the cost and fair value for the major categories of securities available for sale carried at fair value. The net unrealized gains (losses) are reported on an after-tax basis as a component of cumulative OCI. There were no securities classified as held to maturity as of the periods presented.

 

 

(in millions)    Cost      Gross
unrealized
gains
    

Gross

unrealized
losses

   

Fair

value

 

September 30, 2012

          

Securities of U.S. Treasury and federal agencies

   $ 1,829         40         -        1,869   

Securities of U.S. states and political subdivisions

     36,417         1,994         (486     37,925   

Mortgage-backed securities:

          

Federal agencies

     97,342         5,381         (10     102,713   

Residential

     14,754         1,845         (61     16,538   

Commercial

     18,213         1,743         (396     19,560   

Total mortgage-backed securities

     130,309         8,969         (467     138,811   

Corporate debt securities

     19,101         1,254         (92     20,263   

Collateralized debt obligations (1)

     9,890         475         (140     10,225   

Other (2)

     17,128         491         (114     17,505   

Total debt securities

     214,674         13,223         (1,299     226,598   

Marketable equity securities:

          

Perpetual preferred securities

     1,924         240         (47     2,117   

Other marketable equity securities

     403         239         (7     635   

Total marketable equity securities

     2,327         479         (54     2,752   

Total

   $ 217,001         13,702         (1,353     229,350   

December 31, 2011

          

Securities of U.S. Treasury and federal agencies

   $ 6,920         59         (11     6,968   

Securities of U.S. states and political subdivisions

     32,307         1,169         (883     32,593   

Mortgage-backed securities:

          

Federal agencies

     92,279         4,485         (10     96,754   

Residential

     16,997         1,253         (414     17,836   

Commercial

     17,829         1,249         (928     18,150   

Total mortgage-backed securities

     127,105         6,987         (1,352     132,740   

Corporate debt securities

     17,921         769         (286     18,404   

Collateralized debt obligations (1)

     8,650         298         (349     8,599   

Other (2)

     19,739         378         (225     19,892   

Total debt securities

     212,642         9,660         (3,106     219,196   

Marketable equity securities:

          

Perpetual preferred securities

     2,396         185         (54     2,527   

Other marketable equity securities

     533         366         (9     890   

Total marketable equity securities

     2,929         551         (63     3,417   

Total

   $ 215,571         10,211         (3,169     222,613   

 

(1) Includes collateralized loan obligations with a cost basis and fair value of $9.4 billion and $9.7 billion, respectively, at September 30, 2012, and $8.1 billion for both cost basis and fair value, at December 31, 2011.
(2) Included in the “Other” category are asset-backed securities collateralized by auto leases or loans and cash reserves with a cost basis and fair value of $5.4 billion and $5.5 billion, respectively, at September 30, 2012, and $6.7 billion and $6.7 billion, respectively, at December 31, 2011. Also included in the “Other” category are asset-backed securities collateralized by home equity loans with a cost basis and fair value of $713 million and $880 million, respectively, at September 30, 2012, and $846 million and $932 million, respectively, at December 31, 2011. The remaining balances primarily include asset-backed securities collateralized by credit cards and student loans.

 

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Gross Unrealized Losses and Fair Value

The following table shows the gross unrealized losses and fair value of securities in the securities available-for-sale portfolio by length of time that individual securities in each category had been in a continuous loss position. Debt securities on which we

have taken credit-related OTTI write-downs are categorized as being “less than 12 months” or “12 months or more” in a continuous loss position based on the point in time that the fair value declined to below the cost basis and not the period of time since the credit-related OTTI write-down.

 

 

       
     Less than 12 months      12 months or more      Total  
(in millions)   

 

Gross
unrealized
losses

    Fair
value
     Gross
unrealized
losses
    Fair
value
     Gross
unrealized
losses
    Fair
value
 

September 30, 2012

              

Securities of U.S. Treasury and federal agencies

   $ -        -         -        -         -        -   

Securities of U.S. states and political subdivisions

     (33     1,623         (453     5,129         (486     6,752   

Mortgage-backed securities:

              

Federal agencies

     (10     3,619         -        -         (10     3,619   

Residential

     (3     126         (58     2,073         (61     2,199   

Commercial

     (6     353         (390     3,902         (396     4,255   

Total mortgage-backed securities

     (19     4,098         (448     5,975         (467     10,073   

Corporate debt securities

     (15     417         (77     596         (92     1,013   

Collateralized debt obligations

     (6     685         (134     1,429         (140     2,114   

Other

     (15     2,164         (99     888         (114     3,052   

Total debt securities

     (88     8,987         (1,211     14,017         (1,299     23,004   

Marketable equity securities:

              

Perpetual preferred securities

     (8     173         (39     515         (47     688   

Other marketable equity securities

     (7     26         -        -         (7     26   

Total marketable equity securities

     (15     199         (39     515         (54     714   

Total

   $ (103     9,186         (1,250     14,532         (1,353     23,718   

December 31, 2011

              

Securities of U.S. Treasury and federal agencies

   $ (11     5,473         -        -         (11     5,473   

Securities of U.S. states and political subdivisions

     (229     8,501         (654     4,348         (883     12,849   

Mortgage-backed securities:

              

Federal agencies

     (7     2,392         (3     627         (10     3,019   

Residential

     (80     3,780         (334     3,440         (414     7,220   

Commercial

     (157     3,183         (771     3,964         (928     7,147   

Total mortgage-backed securities

     (244     9,355         (1,108     8,031         (1,352     17,386   

Corporate debt securities

     (205     8,107         (81     167         (286     8,274   

Collateralized debt obligations

     (150     4,268         (199     613         (349     4,881   

Other

     (55     3,002         (170     841         (225     3,843   

Total debt securities

     (894     38,706         (2,212     14,000         (3,106     52,706   

Marketable equity securities:

              

Perpetual preferred securities

     (13     316         (41     530         (54     846   

Other marketable equity securities

     (9     61         -        -         (9     61   

Total marketable equity securities

     (22     377         (41     530         (63     907   

Total

   $ (916     39,083         (2,253     14,530         (3,169     53,613   

 

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Note 4: Securities Available for Sale (continued)

 

We do not have the intent to sell any securities included in the previous table. For debt securities included in the table, we have concluded it is more likely than not that we will not be required to sell prior to recovery of the amortized cost basis. We have assessed each security with gross unrealized losses for credit impairment. For debt securities, we evaluate, where necessary, whether credit impairment exists by comparing the present value of the expected cash flows to the securities’ amortized cost basis. For equity securities, we consider numerous factors in determining whether impairment exists, including our intent and ability to hold the securities for a period of time sufficient to recover the cost basis of the securities.

For complete descriptions of the factors we consider when analyzing debt securities for impairment, see Note 5 in our 2011 Form 10-K. There have been no material changes to our methodologies for assessing impairment in the first nine months of 2012.

SECURITIES OF U.S. TREASURY AND FEDERAL AGENCIES AND FEDERAL AGENCY MORTGAGE-BACKED SECURITIES (MBS) The unrealized losses associated with U.S. Treasury and federal agency securities and federal agency MBS are primarily driven by changes in interest rates and not due to credit losses given the explicit or implicit guarantees provided by the U.S. government.

SECURITIES OF U.S. STATES AND POLITICAL SUBDIVISIONS The unrealized losses associated with securities of U.S. states and political subdivisions are primarily driven by changes in the relationship between municipal and term funding credit curves rather than by changes to the credit quality of the underlying securities. Substantially all of these investments are investment grade. The securities were generally underwritten in accordance with our own investment standards prior to the decision to purchase. Some of these securities are guaranteed by a bond insurer, but we did not rely on this guarantee in making our investment decision. These investments will continue to be monitored as part of our ongoing impairment analysis, but are expected to perform, even if the rating agencies reduce the credit rating of the bond insurers. As a result, we expect to recover the entire amortized cost basis of these securities.

RESIDENTIAL AND COMMERCIAL MBS The unrealized losses associated with private residential MBS and commercial MBS are primarily driven by changes in projected collateral losses, credit spreads and interest rates. We assess for credit impairment by estimating the present value of expected cash flows. The key assumptions for determining expected cash flows include default rates, loss severities and/or prepayment rates. We estimate losses to a security by forecasting the underlying mortgage loans in each transaction. We use forecasted loan performance to project cash flows to the various tranches in the structure. We also consider cash flow forecasts and, as applicable, independent industry analyst reports and forecasts, sector credit ratings, and other independent market data. Based upon our assessment of the expected credit losses and the credit enhancement level of the securities, we expect to recover the entire amortized cost basis of these securities.

CORPORATE DEBT SECURITIES The unrealized losses associated with corporate debt securities are primarily related to unsecured debt obligations issued by various corporations. We evaluate the financial performance of each issuer on a quarterly basis to determine that the issuer can make all contractual principal and interest payments. Based upon this assessment, we expect to recover the entire amortized cost basis of these securities.

COLLATERALIZED DEBT OBLIGATIONS (CDOs) The unrealized losses associated with CDOs relate to securities primarily backed by commercial, residential or other consumer collateral. The unrealized losses are primarily driven by changes in projected collateral losses, credit spreads and interest rates. We assess for credit impairment by estimating the present value of expected cash flows. The key assumptions for determining expected cash flows include default rates, loss severities and prepayment rates. We also consider cash flow forecasts and, as applicable, independent industry analyst reports and forecasts, sector credit ratings, and other independent market data. Based upon our assessment of the expected credit losses and the credit enhancement level of the securities, we expect to recover the entire amortized cost basis of these securities.

OTHER DEBT SECURITIES The unrealized losses associated with other debt securities primarily relate to other asset-backed securities. The losses are primarily driven by changes in projected collateral losses, credit spreads and interest rates. We assess for credit impairment by estimating the present value of expected cash flows. The key assumptions for determining expected cash flows include default rates, loss severities and prepayment rates. Based upon our assessment of the expected credit losses and the credit enhancement level of the securities, we expect to recover the entire amortized cost basis of these securities.

MARKETABLE EQUITY SECURITIES Our marketable equity securities include investments in perpetual preferred securities, which provide attractive tax-equivalent yields. We evaluated these hybrid financial instruments with investment-grade ratings for impairment using an evaluation methodology similar to that used for debt securities. Perpetual preferred securities are not considered to be other-than-temporarily impaired if there is no evidence of credit deterioration or investment rating downgrades of any issuers to below investment grade, and we expect to continue to receive full contractual payments. We will continue to evaluate the prospects for these securities for recovery in their market value in accordance with our policy for estimating OTTI. We have recorded impairment write-downs on perpetual preferred securities where there was evidence of credit deterioration.

 

 

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OTHER SECURITIES AVAILABLE FOR SALE MATTERS The fair values of our investment securities could decline in the future if the underlying performance of the collateral for the residential and commercial MBS or other securities deteriorate and our credit enhancement levels do not provide sufficient protection to our contractual principal and interest. As a result, there is a risk that significant OTTI may occur in the future.

The following table shows the gross unrealized losses and fair value of debt and perpetual preferred securities available for sale by those rated investment grade and those rated less than investment grade, according to their lowest credit rating by Standard & Poor’s Rating Services (S&P) or Moody’s Investors Service (Moody’s). Credit ratings express opinions about the credit quality of a security. Securities rated investment grade, that is those rated BBB- or higher by S&P or Baa3 or higher by

Moody’s, are generally considered by the rating agencies and market participants to be low credit risk. Conversely, securities rated below investment grade, labeled as “speculative grade” by the rating agencies, are considered to be distinctively higher credit risk than investment grade securities. We have also included securities not rated by S&P or Moody’s in the table below based on the internal credit grade of the securities (used for credit risk management purposes) equivalent to the credit rating assigned by major credit agencies. The unrealized losses and fair value of unrated securities categorized as investment grade based on internal credit grades were $16 million and $1.9 billion, respectively, at September 30, 2012, and $207 million and $6.2 billion, respectively, at December 31, 2011. If an internal credit grade was not assigned, we categorized the security as non-investment grade.

 

 

 

 

     Investment grade      Non-investment grade  
     Gross            Gross        
     unrealized     Fair      unrealized     Fair  
(in millions)    losses     value      losses     value  

 

 

September 30, 2012

         

Securities of U.S. Treasury and federal agencies

   $ -        -         -        -   

Securities of U.S. states and political subdivisions

     (414     6,259         (72     493   

Mortgage-backed securities:

         

Federal agencies

     (10     3,619         -        -   

Residential

     (2     256         (59     1,943   

Commercial

     (114     3,343         (282     912   

 

 

Total mortgage-backed securities

     (126     7,218         (341     2,855   

 

 

Corporate debt securities

     (15     593         (77     420   

Collateralized debt obligations

     (52     1,825         (88     289   

Other

     (100     2,955         (14     97   

 

 

Total debt securities

     (707     18,850         (592     4,154   

Perpetual preferred securities

     (47     688         -        -   

 

 

Total

   $ (754     19,538         (592     4,154   

 

 

December 31, 2011

         

Securities of U.S. Treasury and federal agencies

   $ (11     5,473         -        -   

Securities of U.S. states and political subdivisions

     (781     12,093         (102     756   

Mortgage-backed securities:

         

Federal agencies

     (10     3,019         -        -   

Residential

     (39     2,503         (375     4,717   

Commercial

     (429     6,273         (499     874   

 

 

Total mortgage-backed securities

     (478     11,795         (874     5,591   

 

 

Corporate debt securities

     (165     7,156         (121     1,118   

Collateralized debt obligations

     (185     4,597         (164     284   

Other

     (186     3,458         (39     385   

 

 

Total debt securities

     (1,806     44,572         (1,300     8,134   

Perpetual preferred securities

     (53     833         (1     13   

 

 

Total

   $ (1,859     45,405         (1,301     8,147   

 

 

 

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Note 4: Securities Available for Sale (continued)

 

Contractual Maturities

The following table shows the remaining contractual maturities and contractual yields of debt securities available for sale. The remaining contractual principal maturities for MBS do not consider prepayments. Remaining expected maturities will differ

from contractual maturities because borrowers may have the right to prepay obligations before the underlying mortgages mature.

 

 

             Remaining contractual maturity  
     Total      Weighted-
average
    Within one year     After one year
through five years
    After five years
through ten years
    After ten years  
       

 

 

   

 

 

   

 

 

   

 

 

 
(in millions)    amount      yield     Amount      Yield     Amount      Yield     Amount      Yield     Amount      Yield  

 

 

September 30, 2012

                         

Securities of U.S. Treasury and federal agencies

   $ 1,869         1.28    $ 215          0.55    $ 866          1.03    $ 787          1.75    $         2.93 

Securities of U.S. states and political subdivisions

     37,925         4.60         2,184          2.59         11,861          2.13         3,326          4.99         20,554          6.18    

Mortgage-backed securities:

                         

Federal agencies

     102,713         3.91                 5.05         153          4.56         1,142          3.15         101,417          3.92    

Residential

     16,538         4.46                                       611          2.12         15,927          4.55    

Commercial

     19,560         5.43                        31          4.17         117          3.45         19,412          5.44    

 

      

 

 

      

 

 

      

 

 

      

 

 

    

Total mortgage-backed securities

     138,811         4.19                 5.05         184          4.49         1,870          2.83         136,756          4.21    

 

      

 

 

      

 

 

      

 

 

      

 

 

    

Corporate debt securities

     20,263         4.37         987          4.13         12,137          3.27         5,648          6.36         1,491          5.94    

Collateralized debt obligations

     10,225         1.20         43          3.46         758          0.89         7,808          1.05         1,616          2.04    

Other

     17,505         1.88         700          1.01         10,887          1.67         2,584          2.24         3,334          2.47    

 

      

 

 

      

 

 

      

 

 

      

 

 

    

Total debt securities at fair value

   $ 226,598         3.94    $ 4,130          2.60    $ 36,693          2.33    $ 22,023          3.32    $ 163,752          4.41 

 

 

December 31, 2011

                         

Securities of U.S. Treasury and federal agencies

   $ 6,968         0.91    $ 57          0.48    $ 6,659          0.84    $ 194          2.73    $ 58          3.81 

Securities of U.S. states and political subdivisions

     32,593         4.94         520          3.02         11,679          2.90         2,692          5.31         17,702          6.28    

Mortgage-backed securities:

                         

Federal agencies

     96,754         4.39                 6.47         442          4.02         1,399          3.07         94,912          4.42    

Residential

     17,836         4.51                                       640          1.88         17,196          4.61    

Commercial

     18,150         5.40                                       87          3.33         18,063          5.41    

 

      

 

 

      

 

 

      

 

 

      

 

 

    

Total mortgage-backed securities

     132,740         4.55                 6.47         442          4.02         2,126          2.72         130,171          4.58    

 

      

 

 

      

 

 

      

 

 

      

 

 

    

Corporate debt securities

     18,404         4.64         815          5.57         11,022          3.40         4,691          6.67         1,876          6.38    

Collateralized debt obligations

     8,599         1.10                        540          1.61         6,813          1.00         1,246          1.42    

Other

     19,892         1.89         506          2.29         12,963          1.75         3,149          2.04         3,274          2.29    

 

      

 

 

      

 

 

      

 

 

      

 

 

    

Total debt securities at fair value

   $ 219,196         4.12    $ 1,899          3.85    $ 43,305          2.36    $ 19,665          3.31    $ 154,327          4.72 

 

 

 

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Realized Gains and Losses

The following table shows the gross realized gains and losses on sales and OTTI write-downs related to the securities available-

for-sale portfolio, which includes marketable equity securities, as well as net realized gains and losses on nonmarketable equity securities (see Note 6 – Other Assets).

 

 

     
     Quarter ended Sept. 30,     Nine months ended Sept. 30,  
(in millions)    2012     2011     2012     2011  

Gross realized gains

   $ 110        544        527        1,044   

Gross realized losses

     (29            (65     (49

OTTI write-downs

     (39     (112     (172     (381

Net realized gains from securities available for sale

     42        432        290        614   

Net realized gains from private equity investments

     125        212        415        813   

Net realized gains from debt securities and equity investments

   $ 167        644        705        1,427   

 

Other-Than-Temporary Impairment

The following table shows the detail of total OTTI write-downs included in earnings for debt securities and marketable and nonmarketable equity securities.

 

 

 

 

     Quarter ended Sept. 30,      Nine months ended Sept. 30,  
(in millions)    2012      2011      2012      2011  

 

 

OTTI write-downs included in earnings

           

Debt securities:

           

U.S. states and political subdivisions

   $         -         -         9           

Mortgage-backed securities:

           

Residential

     17         35         65         241    

Commercial

     8         52         41         75    

Corporate debt securities

     5         -         9           

Collateralized debt obligations

     -         1         1           

Other debt securities

     6         8         38         46    

 

 

Total debt securities

     36         96         163         365    

 

 

Equity securities:

           

Marketable equity securities:

           

Perpetual preferred securities

     2         -         8           

Other marketable equity securities

     1         16         1         16    

 

 

Total marketable equity securities

     3         16         9         16    

 

 

Total securities available for sale

     39         112         172         381    

Nonmarketable equity securities

     33         32         85         89    

 

 

Total OTTI write-downs included in earnings

   $ 72         144         257         470    

 

 

 

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Note 4: Securities Available for Sale (continued)

 

Other-Than-Temporarily Impaired Debt Securities

The following table shows the detail of OTTI write-downs on debt securities available for sale included in earnings and the related changes in OCI for the same securities.

 

 

 

 

     Quarter ended Sept. 30,      Nine months ended Sept. 30,  
(in millions)    2012       2011       2012       2011   

 

 

OTTI on debt securities

           

Recorded as part of gross realized losses:

           

Credit-related OTTI

   $         36          96          160          364    

Intent-to-sell OTTI

                               

 

 

Total recorded as part of gross realized losses

     36          96          163          365    

 

 

Recorded directly to OCI for non-credit-related impairment:

           

U.S. states and political subdivisions

                     (7)         (1)   

Residential mortgage-backed securities

     (85)         (13)         (148)         (181)   

Commercial mortgage-backed securities

     (56)         51          (62)         15    

Corporate debt securities

                               

Collateralized debt obligations

     (1)                           

Other debt securities

     (1)         (2)         30          (13)   

 

 

Total recorded directly to OCI for increase (decrease) in non-credit-related impairment (1)

     (137)         40          (182)         (176)   

 

 

Total OTTI losses (gains) recorded on debt securities

   $ (101)         136          (19)         189    

 

 

 

(1) Represents amounts recorded to OCI on debt securities in periods OTTI write-downs have occurred. Changes in fair value in subsequent periods on such securities, to the extent additional credit-related OTTI did not occur, are not reflected in this total. Increases represent OTTI write-downs recorded to OCI on debt securities in the periods non-credit related impairment has occurred. Decreases represent partial recoveries in the fair value of securities due to factors other than credit, where the increase in fair value was not sufficient to recover the full amount of the unrealized loss on such securities.

 

The following table presents a rollforward of the credit loss component recognized in earnings for debt securities we still own (referred to as “credit-impaired” debt securities). The credit loss component of the amortized cost represents the difference between the present value of expected future cash flows discounted using the security’s current effective interest rate and the amortized cost basis of the security prior to considering credit losses. OTTI recognized in earnings for credit-impaired debt securities is presented as additions and is classified into one of two components based upon whether the current period is the first time the debt security was credit-impaired (initial credit

impairment) or if the debt security was previously credit-impaired (subsequent credit impairments). The credit loss component is reduced if we sell, intend to sell or believe we will be required to sell previously credit-impaired debt securities. Additionally, the credit loss component is reduced if we receive or expect to receive cash flows in excess of what we previously expected to receive over the remaining life of the credit-impaired debt security, the security matures or is fully written down.

Changes in the credit loss component of credit-impaired debt securities that were recognized in earnings and related to securities that we do not intend to sell were:

 

 

 

 

     Quarter ended Sept. 30,      Nine months ended Sept. 30,  
(in millions)    2012     2011       2012     2011   

 

 

Credit loss component, beginning of period

   $         1,314        1,251          1,272        1,043    

Additions:

         

Initial credit impairments

     14        31          50        73    

Subsequent credit impairments

     22        65          110        291    

 

 

Total additions

     36        96          160        364    

 

 

Reductions:

         

For securities sold

     (100     (104)         (170     (142)   

For securities derecognized due to changes in consolidation status of variable interest entities

     -        (2)         -        (2)   

For recoveries of previous credit impairments (1)

     (5     (5)         (17     (27)   

 

 

Total reductions

     (105     (111)         (187     (171)   

 

 

Credit loss component, end of period

   $ 1,245        1,236          1,245        1,236    

 

 

 

(1) Recoveries of previous credit impairments result from increases in expected cash flows subsequent to credit loss recognition. Such recoveries are reflected prospectively as interest yield adjustments using the effective interest method.

 

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To determine credit impairment losses for asset-backed securities (e.g., residential MBS), we estimate expected future cash flows of the security by estimating the expected future cash flows of the underlying collateral and applying those collateral cash flows, together with any credit enhancements such as subordinated interests owned by third parties, to the security. The expected future cash flows of the underlying collateral are determined using the remaining contractual cash flows adjusted for future expected credit losses (which consider current delinquencies and nonperforming assets (NPAs), future

expected default rates and collateral value by vintage and geographic region) and prepayments. The expected cash flows of the security are then discounted at the security’s current effective interest rate to arrive at a present value amount. Total credit impairment losses on residential MBS that we do not intend to sell are shown in the table below. The table also presents a summary of the significant inputs considered in determining the measurement of the credit loss component recognized in earnings for residential MBS.

 

 

 

 

     Quarter ended Sept. 30,      Nine months ended Sept. 30,  
  

 

 

    

 

 

 
($ in millions)    2012     2011      2012      2011  

 

 

Credit impairment losses on residential MBS

  

  

Investment grade

   $         -                -           

Non-investment grade

     17        35          65         236    

 

 

Total credit impairment losses on residential MBS

   $ 17        35          65         241    

 

 

Significant inputs (non-agency – non-investment grade MBS)

          

Expected remaining life of loan losses (1):

          

Range (2)

     3-36      0-48          1-44         0-48    

Credit impairment distribution (3):

          

0 - 10% range

     95        28          71         42    

10 - 20% range

     5        30          13         19    

20 - 30% range

     -        20          6         29    

Greater than 30%

     -        22          10         10    

Weighted average (4)

     7        14          9         11    

Current subordination levels (5):

          

Range (2)

     0-9        0-25          0-57         0-25    

Weighted average (4)

     3                2           

Prepayment speed (annual CPR (6)):

          

Range (2)

     9-23        3-19          5-29         3-19    

Weighted average (4)

     16        14          15         11    

 

 

 

(1) Represents future expected credit losses on underlying pool of loans expressed as a percentage of total current outstanding loan balance.
(2) Represents the range of inputs/assumptions based upon the individual securities within each category.
(3) Represents distribution of credit impairment losses recognized in earnings categorized based on range of expected remaining life of loan losses. For example 95% of credit impairment losses recognized in earnings for the quarter ended September 30, 2012, had expected remaining life of loan loss assumptions of 0 to 10%.
(4) Calculated by weighting the relevant input/assumption for each individual security by current outstanding amortized cost basis of the security.
(5) Represents current level of credit protection (subordination) for the securities, expressed as a percentage of total current underlying loan balance.
(6) Constant prepayment rate.

 

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Note 5: Loans and Allowance for Credit Losses

 

 

The following table presents total loans outstanding by portfolio segment and class of financing receivable. Outstanding balances include a total net reduction of $8.0 billion and $9.3 billion at September 30, 2012 and December 31, 2011, respectively, for unearned income, net deferred loan fees, and unamortized

discounts and premiums. Outstanding balances also include PCI loans net of any remaining purchase accounting adjustments. Information about PCI loans is presented separately in the “Purchased Credit-Impaired Loans” section of this Note.

 

 

 

 

(in millions)    Sept. 30,
2012
     Dec. 31,
2011 
 

 

 

Commercial:

     

Commercial and industrial

   $     178,191         167,216    

Real estate mortgage

     104,611         105,975    

Real estate construction

     17,710         19,382    

Lease financing

     12,279         13,117    

Foreign (1)

     39,741         39,760    

 

 

Total commercial

     352,532         345,450    

 

 

Consumer:

     

Real estate 1-4 family first mortgage

     240,554         228,894    

Real estate 1-4 family junior lien mortgage

     78,091         85,991    

Credit card

     23,692         22,836    

Other revolving credit and installment

     87,761         86,460    

 

 

Total consumer

     430,098         424,181    

 

 

Total loans

   $     782,630         769,631    

 

 

 

(1) Substantially all of our foreign loan portfolio is commercial loans. Loans are classified as foreign if the borrower’s primary address is outside of the United States.

 

The following table summarizes the proceeds paid or received for purchases and sales of loans and transfers from loans held for investment to mortgages/loans held for sale at lower of cost or market. This loan activity primarily includes purchases or sales of commercial loan participation interests, whereby we

receive or transfer a portion of a loan after origination. The table excludes PCI loans and loans recorded at fair value, including loans originated for sale because their loan activity normally does not impact the allowance for credit losses.

 

 

 

 

     2012     2011  
(in millions)    Commercial     Consumer     Total     Commercial     Consumer     Total  

 

 

Quarter ended September 30,

            

Loans - held for investment:

            

Purchases (1)

   $         1,021        -        1,021        2,575        283        2,858   

Sales

     (796     (164         (960     (1,648     (379         (2,027

Transfers to MHFS/LHFS (1)

     (41     (5     (46     (35     (19     (54

 

 
            

 

 

Nine months ended September 30,

            

Loans - held for investment:

            

Purchases (1)

   $         10,196                167        10,363        4,681        283        4,964   

Sales

     (3,731     (487     (4,218             (4,114     (693     (4,807

Transfers to MHFS/LHFS (1)

     (59     (10     (69     (205     (69     (274

 

 

 

(1) The “Purchases” and “Transfers to MHFS/LHFS” categories exclude activity in government insured/guaranteed loans. As servicer, we are able to buy delinquent insured/guaranteed loans out of the Government National Mortgage Association (GNMA) pools. These loans have different risk characteristics from the rest of our consumer portfolio, whereby this activity does not impact the allowance for loan losses in the same manner because the loans are insured by the Federal Housing Administration (FHA) or are guaranteed by the Department of Veterans Affairs (VA). On a net basis, this activity was $1.5 billion and $2.7 billion for the third quarter 2012 and 2011, respectively, and $7.0 billion and $5.7 billion for the first nine months ended September 30, 2012 and September 30, 2011, respectively.

 

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Allowance for Credit Losses (ACL)

The ACL is management’s estimate of credit losses inherent in the loan portfolio, including unfunded credit commitments, at the balance sheet date. We have an established process to determine the adequacy of the allowance for credit losses that assesses the losses inherent in our portfolio and related unfunded credit commitments. While we attribute portions of the allowance to specific portfolio segments, the entire allowance is available to absorb credit losses inherent in the total loan portfolio and unfunded credit commitments.

Our process involves procedures to appropriately consider the unique risk characteristics of our commercial and consumer loan portfolio segments. For each portfolio segment, losses are estimated collectively for groups of loans with similar characteristics, individually or pooled for impaired loans or, for PCI loans, based on the changes in cash flows expected to be collected.

Our allowance levels are influenced by loan volumes, loan grade migration or delinquency status, historic loss experience influencing loss factors, and other conditions influencing loss expectations, such as economic conditions.

COMMERCIAL PORTFOLIO SEGMENT ACL METHODOLOGY Generally, commercial loans are assessed for estimated losses by grading each loan using various risk factors as identified through periodic reviews. We apply historic grade-specific loss factors to the aggregation of each funded grade pool. These historic loss factors are also used to estimate losses for unfunded credit commitments. In the development of our statistically derived loan grade loss factors, we observe historical losses over a relevant period for each loan grade. These loss estimates are adjusted as appropriate based on additional analysis of long-term average loss experience compared to previously forecasted losses, external loss data or other risks identified from current economic conditions and credit quality trends.

The allowance also includes an amount for the estimated impairment on nonaccrual commercial loans and commercial loans modified in a TDR, whether on accrual or nonaccrual status.

CONSUMER PORTFOLIO SEGMENT ACL METHODOLOGY For consumer loans, not identified as a TDR, we determine the allowance predominantly on a collective basis utilizing forecasted losses to represent our best estimate of inherent loss. We pool loans, generally by product types with similar risk characteristics, such as residential real estate mortgages and credit cards. As appropriate and to achieve greater accuracy, we may further stratify selected portfolios by sub-product, origination channel, vintage, loss type, geographic location and other predictive characteristics. Models designed for each pool are utilized to develop the loss estimates. We use assumptions for these pools in our forecast models, such as historic delinquency and default, loss severity, home price trends, unemployment trends, and other key economic variables that may influence the frequency and severity of losses in the pool.

In determining the appropriate allowance attributable to our residential mortgage portfolio, we incorporate the default rates and high severity of loss for junior lien mortgages behind

delinquent first lien mortgages into our loss forecasting calculations. In addition, the loss rates we use in determining our allowance include the impact of our established loan modification programs. When modifications occur or are probable to occur, our allowance considers the impact of these modifications, taking into consideration the associated credit cost, including re-defaults of modified loans and projected loss severity. Accordingly, the loss content associated with the effects of existing and probable loan modifications and junior lien mortgages behind delinquent first lien mortgages has been captured in our allowance methodology.

We separately estimate impairment for consumer loans that have been modified in a TDR (including trial modifications), whether on accrual or nonaccrual status.

OTHER ACL MATTERS The allowance for credit losses for both portfolio segments includes an amount for imprecision or uncertainty that may change from period to period. This amount represents management’s judgment of risks inherent in the processes and assumptions used in establishing the allowance. This imprecision considers economic environmental factors, modeling assumptions and performance, process risk, and other subjective factors, including industry trends.

Impaired loans, which predominantly include nonaccrual commercial loans and any loans that have been modified in a TDR, have an estimated allowance calculated as the difference, if any, between the impaired value of the loan and the recorded investment in the loan. The impaired value of the loan is generally calculated as the present value of expected future cash flows from principal and interest which incorporates expected lifetime losses, discounted at the loan’s effective interest rate. The allowance for an impaired loan that was modified in a TDR may be lower than the previously established allowance for that loan due to benefits received through modification, such as lower probability of default and/or severity of loss, and the impact of prior charge-offs or charge-offs at the time of the modification that may reduce or eliminate the need for an allowance.

Commercial and consumer PCI loans may require an allowance subsequent to their acquisition. This allowance requirement is due to decreases in expected principal and interest cash flows (other than due to decreases in interest rate indices and changes in prepayment assumptions).

 

 

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Note 5: Loans and Allowance for Credit Losses (continued)

 

The allowance for credit losses consists of the allowance for loan losses and the allowance for unfunded credit commitments. Changes in the allowance for credit losses were:

 

     
     Quarter ended Sept. 30,     Nine months ended Sept. 30,  
(in millions)    2012     2011      2012     2011   

Balance, beginning of period

   $ 18,646        21,262        19,668        23,463   

Provision for credit losses

     1,591        1,811        5,386        5,859   

Interest income on certain impaired loans (1)

     (76     (84     (245     (246

Loan charge-offs:

        

Commercial:

        

Commercial and industrial

     (285     (349     (1,004     (1,182

Real estate mortgage

     (100     (119     (296     (483

Real estate construction

     (41     (98     (181     (316

Lease financing

     (5     (10     (18     (30

Foreign

     (35     (25     (81     (121

 

 

Total commercial

     (466     (601     (1,580     (2,132

 

 

Consumer:

        

Real estate 1-4 family first mortgage

     (719     (900     (2,319     (2,979

Real estate 1-4 family junior lien mortgage

     (1,095     (893     (2,672     (2,907

Credit card

     (255     (320     (842     (1,146

Other revolving credit and installment

     (336     (421     (1,027     (1,312

 

 

Total consumer (2)

     (2,405     (2,534     (6,860     (8,344

 

 

Total loan charge-offs

     (2,871     (3,135     (8,440     (10,476

 

 

Loan recoveries:

        

Commercial:

        

Commercial and industrial

     154        88        368        313   

Real estate mortgage

     46        23        115        107   

Real estate construction

     40        43        96        106   

Lease financing

     4        7        15        20   

Foreign

     5        17        26        38   

 

 

Total commercial

     249        178        620        584   

 

 

Consumer:

        

Real estate 1-4 family first mortgage

     46        79        112        345   

Real estate 1-4 family junior lien mortgage

     59        51        184        162   

Credit card

     43        54        148        204   

Other revolving credit and installment

     116        162        423        522   

 

 

Total consumer

     264        346        867        1,233   

 

 

Total loan recoveries

     513        524        1,487        1,817   

 

 

Net loan charge-offs (3)

     (2,358     (2,611     (6,953     (8,659

 

 

Allowances related to business combinations/other

     -        (6     (53     (45

 

 

Balance, end of period

   $ 17,803        20,372        17,803        20,372   

 

 

Components:

        

Allowance for loan losses

   $ 17,385        20,039        17,385        20,039   

Allowance for unfunded credit commitments

     418        333        418        333   

 

 

Allowance for credit losses (4)

   $ 17,803        20,372        17,803        20,372   

 

 

Net loan charge-offs (annualized) as a percentage of average total loans (3)

     1.21  %      1.37        1.20        1.54   

Allowance for loan losses as a percentage of total loans (4)

     2.22        2.64        2.22        2.64   

Allowance for credit losses as a percentage of total loans (4)

     2.27        2.68        2.27        2.68   

 

 

 

(1) Certain impaired loans with an allowance calculated by discounting expected cash flows using the loan’s effective interest rate over the remaining life of the loan recognize reductions in the allowance as interest income.
(2) Quarter and nine months ended September 30, 2012, include $567 million resulting from the implementation of OCC guidance issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be placed on nonaccrual status and written down to net realizable collateral value, regardless of their delinquency status.
(3) For PCI loans, charge-offs are only recorded to the extent that losses exceed the purchase accounting estimates.
(4) The allowance for credit losses includes $160 million and $302 million at September 30, 2012 and 2011, respectively, related to PCI loans acquired from Wachovia. Loans acquired from Wachovia are included in total loans net of related purchase accounting net write-downs.

 

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The following table summarizes the activity in the allowance for credit losses by our commercial and consumer portfolio segments.

 

      2012     2011  
(in millions)            Commercial     Consumer     Total     Commercial     Consumer     Total  

 

   

 

 

 

Quarter ended September 30,

            

Balance, beginning of period

   $ 6,159        12,487        18,646        7,413        13,849        21,262   

Provision for credit losses

     (108     1,699        1,591        (242     2,053        1,811   

Interest income on certain impaired loans

     (22     (54     (76     (39     (45     (84

Loan charge-offs

     (466     (2,405     (2,871     (601     (2,534     (3,135

Loan recoveries

     249        264        513        178        346        524   

 

   

 

 

 

Net loan charge-offs

     (217     (2,141     (2,358     (423     (2,188     (2,611

 

   

 

 

 

Allowance related to business combinations/other

     -        -        -        (6     -        (6

 

   

 

 

 

Balance, end of period

   $ 5,812        11,991        17,803        6,703        13,669        20,372   

 

   

 

 

 
            

 

 

Nine months ended September 30,

            

Balance, beginning of period

   $ 6,358        13,310        19,668        8,169        15,294        23,463   

Provision for credit losses

     490        4,896        5,386        203        5,656        5,859   

Interest income on certain impaired loans

     (76     (169     (245     (123     (123     (246

Loan charge-offs

     (1,580     (6,860     (8,440     (2,132     (8,344     (10,476

Loan recoveries

     620        867        1,487        584        1,233        1,817   

 

   

 

 

 

Net loan charge-offs

     (960     (5,993     (6,953     (1,548     (7,111     (8,659

 

   

 

 

 

Allowance related to business combinations/other

     -        (53     (53     2        (47     (45

 

   

 

 

 

Balance, end of period

   $ 5,812        11,991        17,803        6,703        13,669        20,372   

 

   

 

 

 

The following table disaggregates our allowance for credit losses and recorded investment in loans by impairment methodology.

 

     
     Allowance for credit losses      Recorded investment in loans  
(in millions)            Commercial      Consumer      Total      Commercial      Consumer      Total  

 

 

September 30, 2012

                 

Collectively evaluated (1)

   $ 3,984         7,608         11,592         338,804         380,171         718,975   

Individually evaluated (2)

     1,730         4,321         6,051         8,931         22,211         31,142   

PCI (3)

     98         62         160         4,797         27,716         32,513   

 

 

Total

   $ 5,812         11,991         17,803         352,532         430,098         782,630   

 

 

December 31, 2011

                 

Collectively evaluated (1)

   $ 4,060         8,699         12,759         328,117         376,785         704,902   

Individually evaluated (2)

     2,133         4,545         6,678         10,566         17,444         28,010   

PCI (3)

     165         66         231         6,767         29,952         36,719   

 

 

Total

   $ 6,358         13,310         19,668         345,450         424,181         769,631   

 

 

 

(1) Represents loans collectively evaluated for impairment in accordance with Accounting Standards Codification (ASC) 450-20, Loss Contingencies (formerly FAS 5), and pursuant to amendments by ASU 2010-20 regarding allowance for non-impaired loans.
(2) Represents loans individually evaluated for impairment in accordance with ASC 310-10, Receivables (formerly FAS 114), and pursuant to amendments by ASU 2010-20 regarding allowance for impaired loans.
(3) Represents the allowance and related loan carrying value determined in accordance with ASC 310-30, Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality (formerly SOP 03-3) and pursuant to amendments by ASU 2010-20 regarding allowance for PCI loans.

 

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Note 5: Loans and Allowance for Credit Losses (continued)

 

Credit Quality

We monitor credit quality as indicated by evaluating various attributes and utilize such information in our evaluation of the adequacy of the allowance for credit losses. The following sections provide the credit quality indicators we most closely monitor. See the “Purchased Credit-Impaired Loans” section of this Note for credit quality information on our PCI portfolio.

The majority of credit quality indicators are based on September 30, 2012 information, with the exception of updated FICO and updated loan-to-value (LTV)/combined LTV (CLTV), which are obtained at least quarterly. Generally, these indicators are updated in the second month of each quarter, with updates no older than June 30, 2012.

COMMERCIAL CREDIT QUALITY INDICATORS In addition to monitoring commercial loan concentration risk, we manage a consistent process for assessing commercial loan credit quality. Generally, commercial loans are subject to individual risk assessment using our internal borrower and collateral quality ratings. Our ratings are aligned to Pass and Criticized categories. The Criticized category includes Special Mention, Substandard, and Doubtful categories which are defined by bank regulatory agencies.

The following table provides a breakdown of outstanding commercial loans by risk category. Of the $22.8 billion in criticized commercial real estate (CRE) loans, $4.9 billion has been placed on nonaccrual status and written down to net realizable collateral value. CRE loans have a high level of monitoring in place to manage these assets and mitigate any loss exposure.

 

 

 

 
(in millions)    Commercial
and
industrial
     Real
estate
mortgage
    

Real

estate
construction

     Lease
financing
     Foreign      Total  

 

 

September 30, 2012

                 

By risk category:

                 

Pass

   $ 157,586         83,912         12,056         11,629         36,476         301,659   

Criticized

     20,359         18,349         4,490         650         2,228         46,076   

 

 

Total commercial loans (excluding PCI)

     177,945         102,261         16,546         12,279         38,704         347,735   

Total commercial PCI loans (carrying value)

     246         2,350         1,164         -         1,037         4,797   

 

 

Total commercial loans

   $ 178,191         104,611         17,710         12,279         39,741         352,532   

 

 

December 31, 2011

                 

By risk category:

                 

Pass

   $ 144,980         80,215         10,865         12,455         36,567         285,082   

Criticized

     21,837         22,490         6,772         662         1,840         53,601   

 

 

Total commercial loans (excluding PCI)

     166,817         102,705         17,637         13,117         38,407         338,683   

Total commercial PCI loans (carrying value)

     399         3,270         1,745         -         1,353         6,767   

 

 

Total commercial loans

   $ 167,216         105,975         19,382         13,117         39,760         345,450   

 

 

 

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The following table provides past due information for commercial loans, which we monitor as part of our credit risk management practices.

 

 

 

 
(in millions)    Commercial
and
industrial
     Real
estate
mortgage
    

Real

estate
construction

     Lease
financing
     Foreign      Total      

 

 

September 30, 2012

                 

By delinquency status:

                 

Current-29 DPD and still accruing

   $ 175,900         97,293         15,153         12,180         38,600         339,126       

30-89 DPD and still accruing

     592         1,163         99         50         36         1,940       

90+ DPD and still accruing

     49         206         41         -         2         298       

Nonaccrual loans

     1,404         3,599         1,253         49         66         6,371       

 

 

Total commercial loans (excluding PCI)

     177,945         102,261         16,546         12,279         38,704         347,735       

Total commercial PCI loans (carrying value)

     246         2,350         1,164         -         1,037         4,797       

 

 

Total commercial loans

   $ 178,191         104,611         17,710         12,279         39,741         352,532       

 

 

December 31, 2011

                 

By delinquency status:

                 

Current-29 DPD and still accruing

   $ 163,583         97,410         15,471         12,934         38,122         327,520       

30-89 DPD and still accruing

     939         954         187         130         232         2,442       

90+ DPD and still accruing

     153         256         89         -         6         504       

Nonaccrual loans

     2,142         4,085         1,890         53         47         8,217       

 

 

Total commercial loans (excluding PCI)

     166,817         102,705         17,637         13,117         38,407         338,683       

Total commercial PCI loans (carrying value)

     399         3,270         1,745         -         1,353         6,767       

 

 

Total commercial loans

   $ 167,216         105,975         19,382         13,117         39,760         345,450       

 

 

 

CONSUMER CREDIT QUALITY INDICATORS We have various classes of consumer loans that present respective unique risks. Loan delinquency, FICO credit scores and LTV for loan types are common credit quality indicators that we monitor and utilize in our evaluation of the adequacy of the allowance for credit losses for the consumer portfolio segment.

The majority of our loss estimation techniques used for the allowance for credit losses rely on delinquency matrix models or delinquency roll rate models. Therefore, delinquency is an important indicator of credit quality and the establishment of our allowance for credit losses.

 

 

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Note 5: Loans and Allowance for Credit Losses (continued)

 

The following table provides the outstanding balances of our consumer portfolio by delinquency status.

 

 

 

(in millions)    Real estate
1-4 family
first
mortgage
     Real estate
1-4 family
junior lien
mortgage
     Credit
card
     Other
revolving
credit and
installment
     Total  

September 30, 2012

              

By delinquency status:

              

Current-29 DPD

   $ 170,799         75,694         23,082         73,594         343,169   

30-59 DPD

     3,621         666         191         814         5,292   

60-89 DPD

     1,636         375         131         264         2,406   

90-119 DPD

     904         284         113         128         1,429   

120-179 DPD

     1,173         378         175         27         1,753   

180+ DPD

     6,346         513         -         3         6,862   

Government insured/guaranteed loans (1)

     28,540         -         -         12,931         41,471   

Total consumer loans (excluding PCI)

     213,019         77,910         23,692         87,761         402,382   

Total consumer PCI loans (carrying value)

     27,535         181         -         -         27,716   

Total consumer loans

   $ 240,554         78,091         23,692         87,761         430,098   

December 31, 2011

              

By delinquency status:

              

Current-29 DPD

   $ 156,985         83,033         22,125         69,712         331,855   

30-59 DPD

     4,075         786         211         963         6,035   

60-89 DPD

     2,012         501         154         275         2,942   

90-119 DPD

     1,152         382         135         127         1,796   

120-179 DPD

     1,704         537         211         33         2,485   

180+ DPD

     6,665         546         -         4         7,215   

Government insured/guaranteed loans (1)

     26,555         -         -         15,346         41,901   

Total consumer loans (excluding PCI)

     199,148         85,785         22,836         86,460         394,229   

Total consumer PCI loans (carrying value)

     29,746         206         -         -         29,952   

Total consumer loans

   $ 228,894         85,991         22,836         86,460         424,181   

 

(1) Represents loans whose repayments are insured by the FHA or guaranteed by the VA and student loans whose repayments are predominantly guaranteed by agencies on behalf of the U.S. Department of Education under the Federal Family Education Loan Program (FFELP). Loans insured/guaranteed by the FHA/VA and 90+ DPD totaled $20.3 billion at September 30, 2012, compared with $19.2 billion at December 31, 2011. Student loans 90+ DPD totaled $1.1 billion at September 30, 2012, compared with $1.3 billion at December 31, 2011.

 

Of the $10.0 billion of loans not government insured/guaranteed that are 90 days or more past due at September 30, 2012, $1.2 billion was accruing, compared with $11.5 billion past due and $1.5 billion accruing at December 31, 2011.

Real estate 1-4 family first mortgage loans 180 days or more past due totaled $6.3 billion, or 3.0% of total first mortgages (excluding PCI), at September 30, 2012, compared with $6.7 billion, or 3.3%, at December 31, 2011.

The following table provides a breakdown of our consumer portfolio by updated FICO. We obtain FICO scores at loan origination and the scores are updated at least quarterly. The majority of our portfolio is underwritten with a FICO score of 680 and above. FICO is not available for certain loan types and may not be obtained if we deem it unnecessary due to strong collateral and other borrower attributes, primarily securities-based margin loans of $4.7 billion at September 30, 2012, and $5.0 billion at December 31, 2011.

 

 

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(in millions)   

Real estate
1-4 family
first

mortgage

     Real estate
1-4 family
junior lien
mortgage
     Credit
card
     Other
revolving
credit and
installment
     Total  

September 30, 2012

              

By updated FICO:

              

< 600

   $ 18,114         6,303         2,321         8,980         35,718   

600-639

     10,488         3,747         1,899         6,388         22,522   

640-679

     15,796         6,785         3,595         10,088         36,264   

680-719

     24,102         11,635         4,766         11,586         52,089   

720-759

     30,248         16,557         4,837         10,697         62,339   

760-799

     58,494         22,779         3,841         12,253         97,367   

800+

     23,770         8,763         1,935         6,344         40,812   

No FICO available

     3,467         1,341         498         3,752         9,058   

FICO not required

     -         -         -         4,742         4,742   

Government insured/guaranteed loans (1)

     28,540         -         -         12,931         41,471   

Total consumer loans (excluding PCI)

     213,019         77,910         23,692         87,761         402,382   

Total consumer PCI loans (carrying value)

     27,535         181         -         -         27,716   

Total consumer loans

   $ 240,554         78,091         23,692         87,761         430,098   

December 31, 2011

              

By updated FICO:

              

< 600

   $ 21,604         7,428         2,323         8,921         40,276   

600-639

     10,978         4,086         1,787         6,222         23,073   

640-679

     15,563         7,187         3,383         9,350         35,483   

680-719

     23,622         12,497         4,697         10,465         51,281   

720-759

     27,417         17,574         4,760         9,936         59,687   

760-799

     47,337         24,979         3,517         11,163         86,996   

800+

     21,381         10,247         1,969         5,674         39,271   

No FICO available

     4,691         1,787         400         4,393         11,271   

FICO not required

     -         -         -         4,990         4,990   

Government insured/guaranteed loans (1)

     26,555         -         -         15,346         41,901   

Total consumer loans (excluding PCI)

     199,148         85,785         22,836         86,460         394,229   

Total consumer PCI loans (carrying value)

     29,746         206         -         -         29,952   

Total consumer loans

   $         228,894         85,991         22,836         86,460         424,181   

 

(1) Represents loans whose repayments are insured by the FHA or guaranteed by the VA and student loans whose repayments are predominantly guaranteed by agencies on behalf of the U.S. Department of Education under FFELP.

 

LTV refers to the ratio comparing the loan’s unpaid principal balance to the property’s collateral value. CLTV refers to the combination of first mortgage and junior lien mortgage (including unused line amounts for credit line products) ratios. LTVs and CLTVs are updated quarterly using a cascade approach which first uses values provided by automated valuation models (AVMs) for the property. If an AVM is not available, then the value is estimated using the original appraised value adjusted by the change in Home Price Index (HPI) for the property location. If an HPI is not available, the original appraised value is used. The HPI value is normally the only method considered for high value properties as the AVM values have proven less accurate for these properties.

The following table shows the most updated LTV and CLTV distribution of the real estate 1-4 family first and junior lien mortgage loan portfolios. In recent years, the residential real estate markets have experienced significant declines in property values and several markets, particularly California and Florida have experienced more significant declines than the national decline. These trends are considered in the way that we monitor credit risk and establish our allowance for credit losses. LTV

does not necessarily reflect the likelihood of performance of a given loan, but does provide an indication of collateral value. In the event of a default, any loss should be limited to the portion of the loan amount in excess of the net realizable value of the underlying real estate collateral value. Certain loans do not have an LTV or CLTV primarily due to industry data availability and portfolios acquired from or serviced by other institutions.

 

 

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Note 5: Loans and Allowance for Credit Losses (continued)

 

     
     September 30, 2012      December 31, 2011  
(in millions)    Real estate
1-4 family
first
mortgage
by LTV
     Real estate
1-4 family
junior lien
mortgage
by CLTV
     Total      Real estate
1-4 family
first
mortgage
by LTV
     Real estate
1-4 family
junior lien
mortgage
by CLTV
     Total  

By LTV/CLTV:

                 

0-60%

   $         51,929         12,298         64,227         46,476         12,694         59,170   

60.01-80%

     60,534         15,414         75,948         46,831         15,722         62,553   

80.01-100%

     36,474         18,677         55,151         36,764         20,290         57,054   

100.01-120% (1)

     18,389         14,063         32,452         21,116         15,829         36,945   

> 120% (1)

     14,975         15,722         30,697         18,608         18,626         37,234   

No LTV/CLTV available

     2,178         1,736         3,914         2,798         2,624         5,422   

Government insured/guaranteed loans (2)

     28,540         -         28,540         26,555         -         26,555   

Total consumer loans (excluding PCI)

     213,019         77,910         290,929         199,148         85,785         284,933   

Total consumer PCI loans (carrying value)

     27,535         181         27,716         29,746         206         29,952   

Total consumer loans

   $ 240,554         78,091         318,645         228,894         85,991         314,885   

 

(1) Reflects total loan balances with LTV/CLTV amounts in excess of 100%. In the event of default, the loss content would generally be limited to only the amount in excess of 100% LTV/CLTV.
(2) Represents loans whose repayments are insured by the FHA or guaranteed by the VA.

 

NONACCRUAL LOANS The following table provides loans on nonaccrual status. PCI loans are excluded from this table due to the existence of the accretable yield.

 

 

 

     Sept. 30,      Dec. 31,  
(in millions)    2012      2011  

Commercial:

     

Commercial and industrial

   $ 1,404         2,142   

Real estate mortgage

     3,599         4,085   

Real estate construction

     1,253         1,890   

Lease financing

     49         53   

Foreign

     66         47   

Total commercial (1)

     6,371         8,217   

Consumer:

     

Real estate 1-4 family first mortgage (2)

     11,195         10,913   

Real estate 1-4 family junior lien mortgage (3)

     3,140         1,975   

Other revolving credit and installment

     338         199   

Total consumer (4)

     14,673         13,087   

Total nonaccrual loans (excluding PCI)

   $         21,044         21,304   

 

(1) Includes LHFS of $22 million at September 30, 2012, and $25 million at December 31, 2011.
(2) Includes MHFS of $338 million at September 30, 2012, and $301 million at December 31, 2011.
(3) The balance at September 30, 2012 includes the impact from the transfer of 1-4 family junior lien mortgages to nonaccrual loans in accordance with the Interagency Guidance issued on January 31, 2012.
(4) Includes $1.4 billion of performing loans at September 30, 2012, consisting of $1.0 billion of first mortgages, $262 million of junior liens and $155 million of auto loans, resulting from the implementation of OCC guidance issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be placed on nonaccrual status and written down to net realizable collateral value, regardless of their delinquency status.
 

 

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LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING Certain loans 90 days or more past due as to interest or principal are still accruing, because they are (1) well-secured and in the process of collection or (2) real estate 1-4 family mortgage loans or consumer loans exempt under regulatory rules from being classified as nonaccrual until later delinquency, usually 120 days past due. PCI loans of $6.2 billion at September 30, 2012, and $8.7 billion at December 31, 2011, are not included in these past due and still accruing loans even though they are 90 days or more contractually past due. These PCI loans are considered to be accruing due to the existence of the accretable yield and not based on consideration given to contractual interest payments. Loans 90 days or more past due and still accruing whose repayments are insured by the FHA or predominantly guaranteed by the VA for mortgages and the U.S. Department of Education for student loans under the FFELP were $21.4 billion at September 30, 2012, up from $20.5 billion at December 31, 2011.

The following table shows non-PCI loans 90 days or more past due and still accruing by class for loans not government insured/guaranteed.

 

 

 

             Sept. 30,      Dec. 31,  
(in millions)    2012      2011  

Loan 90 days or more past due and still accruing:

     

Total (excluding PCI):

   $ 22,894         22,569   

Less: FHA insured/guaranteed by the VA (1)(2)

     20,320         19,240   

Less: Student loans guaranteed under the FFELP (3)

     1,082         1,281   

Total, not government insured/guaranteed

   $ 1,492         2,048   

By segment and class, not government insured/guaranteed:

     

Commercial:

     

Commercial and industrial

   $ 49         153   

Real estate mortgage

     206         256   

Real estate construction

     41         89   

Foreign

     2         6   

Total commercial

     298         504   

Consumer:

     

Real estate 1-4 family first mortgage (2)

     627         781   

Real estate 1-4 family junior lien mortgage (2)(4)

     151         279   

Credit card

     288         346   

Other revolving credit and installment

     128         138   

Total consumer

     1,194         1,544   

Total, not government insured/guaranteed

   $ 1,492         2,048   

 

(1) Represents loans whose repayments are insured by the FHA or guaranteed by the VA.
(2) Includes mortgage loans held for sale 90 days or more past due and still accruing.
(3) Represents loans whose repayments are predominantly guaranteed by agencies on behalf of the U.S. Department of Education under the FFELP.
(4) The balance at September 30, 2012, includes the impact from the transfer of 1-4 family junior lien mortgages to nonaccrual loans in accordance with the Interagency Guidance issued on January 31, 2012.
 

 

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Note 5: Loans and Allowance for Credit Losses (continued)

 

IMPAIRED LOANS The table below summarizes key information for impaired loans. Our impaired loans predominately include loans on nonaccrual status in the commercial portfolio segment and loans modified in a TDR, whether on accrual or nonaccrual status. These impaired loans generally have estimated losses which are included in the allowance for credit losses. Impaired

loans exclude PCI loans. Based on clarifying guidance from the Securities and Exchange Commission (SEC) received in December 2011, we now classify trial modifications as TDRs at the beginning of the trial period. The table below includes trial modifications that totaled $733 million at September 30, 2012, and $651 million at December 31, 2011.

 

 

 

 

            Recorded investment         
(in millions)    Unpaid
principal
balance
     Impaired
loans (2)
     Impaired loans
with related
allowance for
credit losses
     Related
allowance for
credit losses
 

September 30, 2012

           

Commercial:

           

Commercial and industrial

   $         3,624         2,339         2,169         355   

Real estate mortgage

     6,000         4,774         4,774         1,051   

Real estate construction

     2,252         1,602         1,602         295   

Lease financing

     78         64         61         17   

Foreign

     128         57         52         12   

Total commercial (1)

     12,082         8,836         8,658         1,730   

Consumer:

           

Real estate 1-4 family first mortgage

     21,333         18,559         15,151         3,144   

Real estate 1-4 family junior lien mortgage

     3,258         2,531         1,992         889   

Credit card

     557         557         557         255   

Other revolving credit and installment

     432         431         206         33   

Total consumer

     25,580         22,078         17,906         4,321   

Total impaired loans (excluding PCI)

   $ 37,662         30,914         26,564         6,051   

December 31, 2011

           

Commercial:

           

Commercial and industrial

   $ 7,191         3,072         3,018         501   

Real estate mortgage

     7,490         5,114         4,637         1,133   

Real estate construction

     4,733         2,281         2,281         470   

Lease financing

     127         68         68         21   

Foreign

     185         31         31         8   

Total commercial (1)

     19,726         10,566         10,035         2,133   

Consumer:

           

Real estate 1-4 family first mortgage

     16,494         14,486         13,909         3,380   

Real estate 1-4 family junior lien mortgage

     2,232         2,079         2,079         784   

Credit card

     593         593         593         339   

Other revolving credit and installment

     287         286         274         42   

Total consumer

     19,606         17,444         16,855         4,545   

Total impaired loans (excluding PCI)

   $ 39,332         28,010         26,890         6,678   

 

(1) The unpaid principal balance for commercial loans at December 31, 2011 includes $5.6 billion ($2.5 billion – commercial and industrial, $1.1 billion – real estate mortgage, $1.8 billion – real estate construction and $157 million – lease financing and foreign) for commercial loans that have been fully charged off and therefore have no recorded investment. The unpaid principal balance for loans with no recorded investment has been excluded from the amounts disclosed at September 30, 2012.
(2) The recorded investment of impaired loans balance at September 30, 2012, includes $4.3 billion of consumer loans, consisting of $3.7 billion of first mortgages, $452 million of junior liens and $160 million of auto loans, resulting from the implementation of OCC guidance issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be written down to net realizable collateral value and classified as TDRs.

 

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Commitments to lend additional funds on loans whose terms have been modified in a TDR amounted to $592 million at September 30, 2012, and $3.8 billion at December 31, 2011.

The following table provides the average recorded investment in impaired loans and the amount of interest income recognized on impaired loans by portfolio segment and class.

 

 

 

 

      Quarter ended September 30,      Nine months ended September 30,  
     2012      2011      2012      2011  
(in millions)    Average
recorded
investment
     Recognized
interest
income
     Average
recorded
investment
     Recognized
interest
income
     Average
recorded
investment
     Recognized
interest
income
     Average
recorded
investment
     Recognized
interest
income
 

Commercial:

                       

Commercial and industrial

   $ 2,488         19         3,379         35         2,493         91         3,668         80   

Real estate mortgage

     5,147         37         5,093         24         4,826         87         5,429         54   

Real estate construction

     1,831         15         2,331         11         1,897         42         2,523         36   

Lease financing

     61         1         150         -         62         1         169         -   

Foreign

     63         1         21         -         34         1         19         -   

Total commercial

     9,590         73         10,974         70         9,312         222         11,808         170   

Consumer:

                       

Real estate 1-4 family first mortgage

     14,768         183         13,241         179         14,631         562         12,548         484   

Real estate 1-4 family junior lien mortgage

     2,102         20         1,928         17         2,078         64         1,831         51   

Credit card

     566         17         602         3         580         48         593         15   

Other revolving credit and installment

     316         8         272         6         315         34         257         19   

Total consumer

     17,752         228         16,043         205         17,604         708         15,229         569   

Total impaired loans (excluding PCI)

   $         27,342         301         27,017         275         26,916         930         27,037         739   

Interest income:

                       

Cash basis of accounting

      $ 72            35            198            120   

Other (1)

              229                  240                  732                  619   

Total interest income

            $             301                  275                  930                  739   

 

(1) Includes interest recognized on accruing TDRs, interest recognized related to certain impaired loans which have an allowance calculated using discounting, and amortization of purchase accounting adjustments related to certain impaired loans. See footnote 1 to the table of changes in the allowance for credit losses.

 

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Note 5: Loans and Allowance for Credit Losses (continued)

 

TROUBLED DEBT RESTRUCTURINGS (TDRs) When, for economic or legal reasons related to a borrower’s financial difficulties, we grant a concession for other than an insignificant period of time to a borrower that we would not otherwise consider, the related loan is classified as a TDR. We do not consider any loans modified through a loan resolution such as foreclosure or short sale to be a TDR.

We may require some borrowers experiencing financial difficulty to make trial payments generally for a period of three to four months, according to the terms of a planned permanent modification, to determine if they can perform according to those terms. Based on clarifying guidance from the SEC in December 2011, these arrangements represent trial modifications, which we classify and account for as TDRs. While loans are in trial payment programs, their original terms are not considered modified and they continue to advance through delinquency status and accrue interest according to their original terms. The planned modifications for these arrangements predominantly involve interest rate reductions or other interest rate concessions, however, the exact concession type and resulting financial effect are usually not finalized and do not take effect until the loan is permanently modified. The trial period terms are developed in accordance with our proprietary programs or the U.S. Treasury’s Making Homes Affordable programs for real estate 1-4 family first lien (i.e. Home Affordable Modification Program – HAMP) and junior lien (i.e. Second Lien Modification Program – 2MP) mortgage loans.

At September 30, 2012, the loans in trial modification period were $407 million under HAMP, $51 million under 2MP and $275 million under proprietary programs, compared with $421 million, $46 million and $184 million at December 31, 2011, respectively. Trial modifications with a recorded investment of $295 million at September 30, 2012, and $310 million at December 31, 2011, were accruing loans and $438 million and $341 million, respectively, were nonaccruing loans. Our recent experience is that most of the mortgages that enter a trial payment period program are successful in completing the program requirements and are then permanently modified at the end of the trial period. As previously discussed, our allowance process considers the impact of those modifications that are probable to occur including the associated credit cost and related re-default risk.

The following table summarizes our TDR modifications for the periods presented by primary modification type and includes the financial effects of these modifications.

 

 

     
     Primary modification type (1)      Financial effects of modifications  
(in millions)    Principal (2)      Interest
rate
reduction
    

Other

interest

rate
concessions (3)

     Total      Charge-
offs (4)
     Weighted
average
interest
rate
reduction
    Recorded
investment
related to
interest rate
reduction (5)
 

Quarter ended September 30, 2012

                   

Commercial:

                   

Commercial and industrial

   $ -         5         364         369         2         1.15  %    $ 5   

Real estate mortgage

     2         40         405         447         2         1.48        42   

Real estate construction

     12         1         111         124         1         2.26        2   

Lease financing

     -         -         1         1         -         -        -   

Foreign

     -         -         14         14         -         -        -   

Total commercial

     14         46         895         955         5         1.47        49   

Consumer:

                   

Real estate 1-4 family first mortgage

     379         390         3,822         4,591         221         3.04        686   

Real estate 1-4 family junior lien mortgage

     17         57         489         563         445         3.66        73   

Credit card

     -         58         -         58         -         10.85        58   

Other revolving credit and installment

     1         15         187         203         7         5.43        15   

Trial modifications (6)

     -         -         7         7         -         -        -   

Total consumer

     397         520         4,505         5,422         673         3.68        832   

Total

   $ 411         566         5,400         6,377         678         3.56  %    $ 881   

Quarter ended September 30, 2011 (7)

                   

Commercial:

                   

Commercial and industrial

   $ 36         2         685         723         14         0.70  %    $ 2   

Real estate mortgage

     13         34         419         466         14         1.18        35   

Real estate construction

     -         35         67         102         3         0.38        34   

Lease financing

     -         -         30         30         -         -        -   

Foreign

     -         -         -         -         -         -        -   

Total commercial

     49         71         1,201         1,321         31         0.78        71   

Consumer:

                   

Real estate 1-4 family first mortgage

     453         504         198         1,155         90         3.23        882   

Real estate 1-4 family junior lien mortgage

     19         109         48         176         4         4.50        125   

Credit card

     -         76         -         76         1         10.69        54   

Other revolving credit and installment

     19         28         1         48         4         -        43   

Total consumer

     491         717         247         1,455         99         3.88        1,104   

Total

   $         540         788         1,448         2,776         130         3.69  %    $ 1,175   

(continued on following page)

 

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(continued from previous page)

 

     
     Primary modification type (1)      Financial effects of modifications  
(in millions)    Principal (2)      Interest
rate
reduction
    

Other

interest

rate
concessions (3)

     Total      Charge-
offs (4)
     Weighted
average
interest
rate
reduction
    Recorded
investment
related to
interest rate
reduction (5)
 

Nine months ended September 30, 2012

                   

Commercial:

                   

Commercial and industrial

   $ 11         27         1,113         1,151         22         1.53  %    $ 28   

Real estate mortgage

     13         160         1,341         1,514         9         1.47        164   

Real estate construction

     12         8         395         415         10         2.49        8   

Lease financing

     -         -         3         3         -         -        -   

Foreign

     -         -         16         16         -         -        -   

Total commercial

     36         195         2,868         3,099         41         1.52        200   

Consumer:

                   

Real estate 1-4 family first mortgage

     1,033         894         4,194         6,121         354         2.96        1,728   

Real estate 1-4 family junior lien mortgage

     50         194         558         802         461         3.79        238   

Credit card

     -         191         -         191         -         10.83        191   

Other revolving credit and installment

     5         48         245         298         27         6.87        50   

Trial modifications (6)

     -         -         678         678         -         -        -   

Total consumer

     1,088         1,327         5,675         8,090         842         3.82        2,207   

Total

   $ 1,124         1,522         8,543         11,189         883         3.63  %    $ 2,407   

Nine months ended September 30, 2011 (7)

                   

Commercial:

                   

Commercial and industrial

   $ 123         59         2,040         2,222         47         3.27  %    $ 64   

Real estate mortgage

     56         114         1,274         1,444         21         1.46        128   

Real estate construction

     29         55         296         380         26         0.63        66   

Lease financing

     -         -         57         57         -         -        -   

Foreign

     -         -         5         5         -         -        -   

Total commercial

     208         228         3,672         4,108         94         1.70        258   

Consumer:

                   

Real estate 1-4 family first mortgage

     1,324         1,560         745         3,629         223         3.32        2,705   

Real estate 1-4 family junior lien mortgage

     81         480         163         724         21         4.33        557   

Credit card

     -         263         -         263         2         10.77        187   

Other revolving credit and installment

     57         92         4         153         18         6.37        145   

Total consumer

     1,462         2,395         912         4,769         264         3.99        3,594   

Total

   $         1,670         2,623         4,584         8,877         358         3.83  %    $ 3,852   

 

(1) Amounts represent the recorded investment in loans after recognizing the effects of the TDR, if any. TDRs with multiple types of concessions are presented only once in the table in the first category type based on the order presented.
(2) Principal modifications include principal forgiveness at the time of the modification, contingent principal forgiveness granted over the life of the loan based on borrower performance, and principal that has been legally separated and deferred to the end of the loan, with a zero percent contractual interest rate.
(3) Other interest rate concessions include loans modified to an interest rate that is not commensurate with the credit risk, even though the rate may have been increased. These modifications would include renewals, term extensions and other interest adjustments, but exclude modifications that also forgive principal and/or reduce the interest rate. Quarter and nine months ended September 30, 2012, include $4.3 billion of loans, consisting of $3.7 billion of first mortgages, $452 million of junior liens and $160 million of auto loans, resulting from the implementation of OCC guidance issued in third quarter 2012, which requires consumer loans discharged in bankruptcy to be classified as TDRs.
(4) Charge-offs include write-downs of the investment in the loan in the period it is contractually modified. The amount of charge off will differ from the modification terms if the loan has been charged down prior to the modification based on our policies. In addition, there may be cases where we have a charge-off/down with no legal principal modification. Modifications resulted in legally forgiving principal (actual, contingent or deferred) of $141 million and $134 million for third quarter of 2012 and 2011 and $362 million and $407 million for the first nine months of 2012 and 2011. Quarter and nine months ended September 30, 2012, include $567 million in charge-offs on consumer loans resulting from the implementation of OCC guidance discussed above.
(5) Reflects the effect of reduced interest rates to loans with principal or interest rate reduction primary modification type.
(6) Trial modifications are granted a delay in payments due under the original terms during the trial payment period. However, these loans continue to advance through delinquency status and accrue interest according to their original terms. Any subsequent permanent modification generally includes interest rate related concessions; however, the exact concession type and resulting financial effect are usually not known until the loan is permanently modified. Trial modifications for the period are presented net of any trial modifications that successfully complete the program requirements. Such successful modifications are included as an addition to the appropriate loan category in the period they successfully complete the program requirements.
(7) Based on clarifying guidance from the Securities and Exchange Commission (SEC) received in December 2011, we classify trial modifications as TDRs at the beginning of the trial period. Prior to the SEC clarification, we classified trial modifications as TDRs once a borrower successfully completed the trial period in accordance with the terms.

 

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Note 5: Loans and Allowance for Credit Losses (continued)

 

The table below summarizes permanent modification TDRs that have defaulted in the current period within 12 months of their permanent modification date. We are reporting these

defaulted TDRs based on a payment default definition of 90 days past due for the commercial portfolio segment and 60 days past due for the consumer portfolio segment.

 

 

 

 

     Recorded investment of defaults  
     Quarter ended Sept. 30,      Nine months ended Sept. 30,  
(in millions)    2012      2011      2012      2011  

Commercial:

           

Commercial and industrial

   $ 119         31         269         148   

Real estate mortgage

     124         105         473         260   

Real estate construction

     23         9         252         41   

Total commercial

     266         145         994         449   

Consumer:

           

Real estate 1-4 family first mortgage

     150         277         447         867   

Real estate 1-4 family junior lien mortgage

     12         35         48         98   

Credit card

     22         29         73         131   

Other revolving credit and installment

     18         35         46         85   

Total consumer

     202         376         614         1,181   

Total

   $         468         521         1,608         1,630   

 

Purchased Credit-Impaired Loans

Substantially all of our PCI loans were acquired from Wachovia on December 31, 2008. The following table presents PCI loans net of any remaining purchase accounting adjustments.

 

 

 

 

(in millions)    Sept. 30,
2012
     Dec. 31,
2011
 

Commercial:

     

Commercial and industrial

   $ 246         399   

Real estate mortgage

     2,350         3,270   

Real estate construction

     1,164         1,745   

Foreign

     1,037         1,353   

Total commercial

     4,797         6,767   

Consumer:

     

Real estate 1-4 family first mortgage

     27,535         29,746   

Real estate 1-4 family junior lien mortgage

     181         206   

Total consumer

     27,716         29,952   

Total PCI loans (carrying value)

   $ 32,513         36,719   

Total PCI loans (unpaid principal balance)

   $         47,846         55,312   

 

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ACCRETABLE YIELD The excess of cash flows expected to be collected over the carrying value of PCI loans is referred to as the accretable yield and is recognized in interest income using an effective yield method over the remaining life of the loan, or pools of loans. The accretable yield is affected by:

 

Changes in interest rate indices for variable rate PCI loans – Expected future cash flows are based on the variable rates in effect at the time of the regular evaluations of cash flows expected to be collected;

 

Changes in prepayment assumptions – Prepayments affect the estimated life of PCI loans which may change the amount of interest income, and possibly principal, expected to be collected; and

 

Changes in the expected principal and interest payments over the estimated life – Updates to expected cash flows are driven by the credit outlook and actions taken with borrowers. Changes in expected future cash flows from loan modifications are included in the regular evaluations of cash flows expected to be collected.

In third quarter 2012, our expectation of cash flows was favorably impacted by lower expected defaults and losses as a result of observed strengthening in housing prices and the impact of modifications that are expected to keep borrowers in their homes longer. These factors favorably impacted probability of default and loss severity, reducing our expected loss on PCI loans, primarily Pick-a-Pay, and increasing the estimated weighted-average remaining life of the PCI portfolios and resulting expected interest to be collected. Accordingly, we increased accretable yield for $687 million of transfers out of nonaccretable difference for the increase in principal expected to be collected, and by $3.6 billion for the increase in interest income expected to be collected.

The change in the accretable yield related to PCI loans is presented in the following table.

 

 

 

 

(in millions)        

Balance, December 31, 2008

   $ 10,447   

Addition of accretable yield due to acquisitions

     128   

Accretion into interest income (1)

     (7,199

Accretion into noninterest income due to sales (2)

     (237

Reclassification from nonaccretable difference for loans with improving credit-related cash flows

     4,213   

Changes in expected cash flows that do not affect nonaccretable difference (3)

     8,609   

Balance, December 31, 2011

     15,961   

Addition of accretable yield due to acquisitions

     -   

Accretion into interest income (1)

     (1,639

Accretion into noninterest income due to sales (2)

     (5

Reclassification from nonaccretable difference for loans with improving credit-related cash flows

     1,006   

Changes in expected cash flows that do not affect nonaccretable difference (3)

     3,589   

Balance, September 30, 2012

   $ 18,912   
  
          

Balance, June 30, 2012

   $ 15,153   

Addition of accretable yield due to acquisitions

     -   

Accretion into interest income (1)

     (495

Accretion into noninterest income due to sales (2)

     -   

Reclassification from nonaccretable difference for loans with improving credit-related cash flows

     687   

Changes in expected cash flows that do not affect nonaccretable difference (3)

     3,567   

Balance, September 30, 2012

   $         18,912   

 

(1) Includes accretable yield released as a result of settlements with borrowers, which is included in interest income.
(2) Includes accretable yield released as a result of sales to third parties, which is included in noninterest income.
(3) Represents changes in cash flows expected to be collected due to changes in interest rates on variable rate PCI loans, changes in prepayment assumptions and the impact of modifications.

 

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Note 5: Loans and Allowance for Credit Losses (continued)

 

PCI ALLOWANCE Based on our regular evaluation of estimates of cash flows expected to be collected, we may establish an allowance for a PCI loan or pool of loans, with a charge to

income though the provision for losses. The following table summarizes the changes in allowance for PCI loan losses.

 

 

 

 

(in millions)    Commercial     Pick-a-Pay      Other
consumer
    Total  

Balance, December 31, 2008

   $ -        -         -        -   

Provision for losses due to credit deterioration

     1,668        -         116        1,784   

Charge-offs

     (1,503     -         (50     (1,553

Balance, December 31, 2011

     165        -         66        231   

Provision for losses due to credit deterioration

     11        -         9        20   

Charge-offs

     (78     -         (13     (91

Balance, September 30, 2012

   $ 98        -         62        160   
         
                                   

Balance, June 30, 2012

   $ 145        -         67        212   

Reversal of provision for losses

     (7     -         -        (7

Charge-offs

     (40     -         (5     (45

Balance, September 30, 2012

   $ 98        -         62        160   

COMMERCIAL PCI CREDIT QUALITY INDICATORS The following table provides a breakdown of commercial PCI loans by risk category.

 

 

 

(in millions)    Commercial
and
industrial
     Real
estate
mortgage
    

Real

estate
construction

     Foreign      Total  

September 30, 2012

              

By risk category:

              

Pass

   $ 93         448         279         192         1,012   

Criticized

     153         1,902         885         845         3,785   

Total commercial PCI loans

   $ 246         2,350         1,164         1,037         4,797   

December 31, 2011

              

By risk category:

              

Pass

   $ 191         640         321         -         1,152   

Criticized

     208         2,630         1,424         1,353         5,615   

Total commercial PCI loans

   $         399         3,270         1,745         1,353         6,767   

 

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Table of Contents

The following table provides past due information for commercial PCI loans.

 

 

 

(in millions)    Commercial
and
industrial
     Real
estate
mortgage
    

Real

estate
construction

     Foreign      Total  

September 30, 2012

              

By delinquency status:

              

Current-29 DPD and still accruing

   $ 221         2,171         941         894         4,227   

30-89 DPD and still accruing

     1         18         23         -         42   

90+ DPD and still accruing

     24         161         200         143         528   

Total commercial PCI loans

   $ 246         2,350         1,164         1,037         4,797   

December 31, 2011

              

By delinquency status:

              

Current-29 DPD and still accruing

   $ 359         2,867         1,206         1,178         5,610   

30-89 DPD and still accruing

     22         178         72         -         272   

90+ DPD and still accruing

     18         225         467         175         885   

Total commercial PCI loans

   $         399         3,270         1,745         1,353         6,767   

 

CONSUMER PCI CREDIT QUALITY INDICATORS Our consumer PCI loans were aggregated into several pools of loans at acquisition. Below, we have provided credit quality indicators based on the unpaid principal balance (adjusted for write-downs)

of the individual loans included in the pool, but we have not allocated the remaining purchase accounting adjustments, which were established at a pool level. The following table provides the delinquency status of consumer PCI loans.

 

 

 

 

     September 30, 2012      December 31, 2011  
(in millions)   

Real estate

1-4 family
first
mortgage

     Real estate
1-4 family
junior lien
mortgage
     Total      Real estate
1-4 family
first
mortgage
     Real estate
1-4 family
junior lien
mortgage
     Total  

By delinquency status:

                 

Current-29 DPD

   $ 23,006         246         23,252         25,693         268         25,961   

30-59 DPD

     2,878         17         2,895         3,272         20         3,292   

60-89 DPD

     1,423         8         1,431         1,433         9         1,442   

90-119 DPD

     673         6         679         791         8         799   

120-179 DPD

     771         7         778         1,169         10         1,179   

180+ DPD

     5,479         132         5,611         5,921         150         6,071   

Total consumer PCI loans (adjusted unpaid principal balance)

   $ 34,230         416         34,646         38,279         465         38,744   

Total consumer PCI loans (carrying value)

   $             27,535         181         27,716         29,746         206         29,952   

 

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Table of Contents

Note 5: Loans and Allowance for Credit Losses (continued)

 

The following table provides FICO scores for consumer PCI loans.

 

 

 

     September 30, 2012      December 31, 2011  
(in millions)   

Real estate

1-4 family

first

mortgage

     Real estate
1-4 family
junior lien
mortgage
     Total      Real estate
1-4 family
first
mortgage
     Real estate
1-4 family
junior lien
mortgage
     Total  

By FICO:

                 

< 600

   $ 13,781         166         13,947         17,169         210         17,379   

600-639

     6,996         79         7,075         7,489         83         7,572   

640-679

     6,731         87         6,818         6,646         89         6,735   

680-719

     3,698         49         3,747         3,698         47         3,745   

720-759

     1,777         15         1,792         1,875         14         1,889   

760-799

     886         7         893         903         6         909   

800+

     200         1         201         215         2         217   

No FICO available

     161         12         173         284         14         298   

Total consumer PCI loans (adjusted unpaid principal balance)

   $ 34,230         416         34,646         38,279         465         38,744   

Total consumer PCI loans (carrying value)

   $               27,535         181         27,716         29,746         206         29,952   

The following table shows the distribution of consumer PCI loans by LTV for real estate 1-4 family first mortgages and by CLTV for real estate 1-4 family junior lien mortgages.

                                                  
                                           
     September 30, 2012      December 31, 2011  
(in millions)   

Real estate

1-4 family

first

mortgage

by LTV

     Real estate
1-4 family
junior lien
mortgage
by CLTV
     Total      Real estate
1-4 family
first
mortgage
by LTV
     Real estate
1-4 family
junior lien
mortgage
by CLTV
     Total  

By LTV/CLTV:

                 

0-60%

   $ 1,306         16         1,322         1,243         25         1,268   

60.01-80%

     3,821         28         3,849         3,806         49         3,855   

80.01-100%

     9,675         51         9,726         9,341         63         9,404   

100.01-120% (1)

     8,165         81         8,246         9,471         79         9,550   

> 120% (1)

     11,254         238         11,492         14,318         246         14,564   

No LTV/CLTV available

     9         2         11         100         3         103   

Total consumer PCI loans (adjusted unpaid principal balance)

   $ 34,230         416         34,646         38,279         465         38,744   

Total consumer PCI loans (carrying value)

   $               27,535         181         27,716         29,746         206         29,952   

 

(1) Reflects total loan balances with LTV/CLTV amounts in excess of 100%. In the event of default, the loss content would generally be limited to only the amount in excess of 100% LTV/CLTV.

 

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Note 6: Other Assets

 

The components of other assets were:

 

(in millions)    Sept. 30,
2012
    

 

Dec. 31,
2011

 

Nonmarketable equity investments:

     

Cost method:

     

Private equity investments

   $ 3,718         3,444   

Federal bank stock

     4,343         4,617   

Total cost method

     8,061         8,061   

Equity method:

     

LIHTC investments (1)

     4,464         4,077   

Private equity and other

     4,983         4,670   

Total equity method

     9,447         8,747   

Total nonmarketable equity investments

     17,508         16,808   

Corporate/bank-owned life insurance

     20,347         20,146   

Accounts receivable

     29,058         25,939   

Interest receivable

     5,302         5,296   

Core deposit intangibles

     6,264         7,311   

Customer relationship and other amortized intangibles

     1,450         1,639   

Foreclosed assets:

     

GNMA (2)

     1,479         1,319   

Other

     2,730         3,342   

Operating lease assets

     1,955         1,825   

Due from customers on acceptances

     399         225   

Other

     18,071         17,172   

Total other assets

   $     104,563             101,022   

 

(1) Represents low income housing tax credit investments.
(2) These are foreclosed real estate securing GNMA loans. Both principal and interest for government insured/guaranteed loans secured by the foreclosed real estate are collectible because the loans are insured by the FHA or guaranteed by the VA.
 

 

Income related to nonmarketable equity investments was:

 

 

 

     Quarter ended Sept. 30,     Nine months ended Sept. 30,  
(in millions)    2012     2011     2012     2011  

Net realized gains from private equity investments

   $             125        212        415        813   

All other

     (27     (19     (51     (200

Total

   $ 98        193        364        613   

 

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Note 7: Securitizations and Variable Interest Entities

 

 

Involvement with SPEs

In the normal course of business, we enter into various types of on- and off-balance sheet transactions with special purpose entities (SPEs), which are corporations, trusts or partnerships that are established for a limited purpose. Historically, the majority of SPEs were formed in connection with securitization transactions. In a securitization transaction, assets from our balance sheet are transferred to an SPE, which then issues to investors various forms of interests in those assets and may also enter into derivative transactions. In a securitization transaction, we typically receive cash and/or other interests in an SPE as proceeds for the assets we transfer. Also, in certain transactions, we may retain the right to service the transferred receivables and to repurchase those receivables from the SPE if the outstanding balance of the receivables falls to a level where the cost exceeds the benefits of servicing such receivables. In addition, we may purchase the right to service loans in an SPE that were transferred to the SPE by a third party.

In connection with our securitization activities, we have various forms of ongoing involvement with SPEs, which may include:

 

underwriting securities issued by SPEs and subsequently making markets in those securities;

 

providing liquidity facilities to support short-term obligations of SPEs issued to third party investors;

 

providing credit enhancement on securities issued by SPEs or market value guarantees of assets held by SPEs through the use of letters of credit, financial guarantees, credit default swaps and total return swaps;

 

entering into other derivative contracts with SPEs;

 

holding senior or subordinated interests in SPEs;

 

acting as servicer or investment manager for SPEs; and

 

providing administrative or trustee services to SPEs.

SPEs are generally considered variable interest entities (VIEs). A VIE is an entity that has either a total equity investment that is insufficient to finance its activities without additional subordinated financial support or whose equity investors lack the ability to control the entity’s activities. A VIE is consolidated by its primary beneficiary, the party that has both the power to direct the activities that most significantly impact the VIE and a variable interest that could potentially be significant to the VIE. A variable interest is a contractual, ownership or other interest that changes with changes in the fair value of the VIE’s net assets. To determine whether or not a variable interest we hold could potentially be significant to the VIE, we consider both qualitative and quantitative factors regarding the nature, size and form of our involvement with the VIE. We assess whether or not we are the primary beneficiary of a VIE on an on-going basis.

We have segregated our involvement with VIEs between those VIEs which we consolidate, those which we do not consolidate and transfers of financial assets that are accounted for as secured borrowings. Secured borrowings are transactions involving transfers of our financial assets to third parties that are accounted for as financings with the assets pledged as collateral. Accordingly, the transferred assets remain recognized on our balance sheet. Subsequent tables within this Note further segregate these transactions by structure type.

 

 

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The classifications of assets and liabilities in our balance sheet associated with our transactions with VIEs follow:

 

(in millions)   

VIEs that we

do not
consolidate

    

VIEs

that we
consolidate

   

 

Transfers that

we account

for as secured

borrowings

     Total  

 

 

September 30, 2012

          

Cash

   $ -         264        104         368   

Trading assets

     2,288         520        229         3,037   

Securities available for sale (1)

     20,287         2,747        13,952         36,986   

Mortgages held for sale

     -         602        -         602   

Loans

     9,641         10,846        7,189         27,676   

Mortgage servicing rights

     10,424         -        -         10,424   

Other assets

     4,841         502        163         5,506   

 

 

Total assets

     47,481         15,481        21,637         84,599   

 

 

Short-term borrowings

     -         2,190   (2)      12,221         14,411   

Accrued expenses and other liabilities

     3,638         850   (2)      148         4,636   

Long-term debt

     -         3,900   (2)      6,665         10,565   

 

 

Total liabilities

     3,638         6,940        19,034         29,612   

 

 

Noncontrolling interests

     -         52        -         52   

 

 

Net assets

   $ 43,843         8,489        2,603         54,935   

 

 

December 31, 2011

          

Cash

   $ -         321        11         332   

Trading assets

     3,723         293        30         4,046   

Securities available for sale (1)

     21,708         3,332        11,671         36,711   

Mortgages held for sale

     -         444        -         444   

Loans

     11,404         11,967        7,181         30,552   

Mortgage servicing rights

     12,080         -        -         12,080   

Other assets

     4,494         1,858        137         6,489   

 

 

Total assets

     53,409         18,215        19,030         90,654   

 

 

Short-term borrowings

     -         3,450   (2)      10,682         14,132   

Accrued expenses and other liabilities

     3,350         1,138   (2)      121         4,609   

Long-term debt

     -         4,932   (2)      6,686         11,618   

 

 

Total liabilities

     3,350         9,520        17,489         30,359   

 

 

Noncontrolling interests

     -         61        -         61   

 

 

Net assets

   $ 50,059         8,634        1,541         60,234   

 

 

 

(1) Excludes certain debt securities related to loans serviced for the Federal National Mortgage Association (FNMA), Federal Home Loan Mortgage Corporation (FHLMC) and GNMA.
(2) Includes the following VIE liabilities at September 30, 2012, and December 31, 2011, respectively, with recourse to the general credit of Wells Fargo: Short-term borrowings, $2.2 billion and $3.4 billion; Accrued expenses and other liabilities, $722 million and $963 million; and Long-term debt, $29 million and $30 million.

 

Transactions with Unconsolidated VIEs

Our transactions with VIEs include securitizations of residential mortgage loans, CRE loans, student loans and auto loans and leases; investment and financing activities involving CDOs backed by asset-backed and CRE securities, collateralized loan obligations (CLOs) backed by corporate loans, and other types of structured financing. We have various forms of involvement with VIEs, including holding senior or subordinated interests, entering into liquidity arrangements, credit default swaps and other derivative contracts. Involvements with these unconsolidated VIEs are recorded on our balance sheet primarily in trading assets, securities available for sale, loans, MSRs, other assets and other liabilities, as appropriate.

The following tables provide a summary of unconsolidated VIEs with which we have significant continuing involvement, but we are not the primary beneficiary. We do not consider our continuing involvement in an unconsolidated VIE to be significant when it relates to third-party sponsored VIEs for which we were not the transferor or if we were the sponsor but do not have any other significant continuing involvement.

Significant continuing involvement includes transactions where we were the sponsor or transferor and have other significant forms of involvement. Sponsorship includes transactions with unconsolidated VIEs where we solely or materially participated in the initial design or structuring of the entity or marketing of the transaction to investors. When we transfer assets to a VIE and account for the transfer as a sale, we are considered the transferor. We consider investments in securities held outside of trading, loans, guarantees, liquidity

 

 

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Note 7: Securitizations and Variable Interest Entities (continued)

 

agreements, written options and servicing of collateral to be other forms of involvement that may be significant. We have excluded certain transactions with unconsolidated VIEs from the balances presented in the table below where we have determined

that our continuing involvement is not significant due to the temporary nature and size of our variable interests, because we were not the transferor or because we were not involved in the design or operations of the unconsolidated VIEs.

 

 

 

 
(in millions)    Total
VIE
assets
     Debt and
equity
interests (1)
     Servicing
assets
     Derivatives     Other
commitments
and
guarantees
    Net
assets
 

 

 

September 30, 2012

               
        Carrying value - asset (liability)   
     

 

 

 

Residential mortgage loan securitizations:

               

Conforming

   $         1,264,447         3,658         9,640         -        (1,533     11,765   

Other/nonconforming

     52,710         2,330         303         1        (54     2,580   

Commercial mortgage securitizations

     171,208         7,398         452         408        -        8,258   

Collateralized debt obligations:

               

Debt securities

     7,975         400         -         406        144        950   

Loans (2)

     8,177         7,972         -         -        -        7,972   

Asset-based finance structures

     9,866         6,651         -         (108     -        6,543   

Tax credit structures

     19,250         4,500         -         -        (1,636     2,864   

Collateralized loan obligations

     8,166         1,629         -         6        -        1,635   

Investment funds

     4,578         50         -         -        -        50   

Other (3)

     16,858         1,270         29         8        (81     1,226   

 

 

Total

   $ 1,563,235         35,858         10,424         721        (3,160     43,843   

 

 
        Maximum exposure to loss   
     

 

 

 

Residential mortgage loan securitizations:

               

Conforming

      $ 3,658         9,640         -        4,955        18,253   

Other/nonconforming

        2,330         303         1        350        2,984   

Commercial mortgage securitizations

        7,398         452         574        -        8,424   

Collateralized debt obligations:

               

Debt securities

        400         -         759        144        1,303   

Loans (2)

        7,972         -         -        -        7,972   

Asset-based finance structures

        6,651         -         108        1,960        8,719   

Tax credit structures

        4,500         -         -        -        4,500   

Collateralized loan obligations

        1,629         -         6        322        1,957   

Investment funds

        50         -         -        36        86   

Other (3)

        1,270         29         347        150        1,796   

 

 

Total

      $         35,858         10,424         1,795        7,917        55,994   

 

 

(continued on following page)

 

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(continued from previous page)

 

(in millions)    Total
VIE
assets
     Debt and
equity
interests (1)
     Servicing
assets
     Derivatives     Other
commitments
and
guarantees
    Net
assets
 

 

 

December 31, 2011

               
        Carrying value - asset (liability)   
     

 

 

 

Residential mortgage loan securitizations:

               

Conforming

   $ 1,135,629         4,682         11,070         -        (975     14,777   

Other/nonconforming

     61,461         2,460         353         1        (48     2,766   

Commercial mortgage securitizations

     179,007         7,063         623         349        -        8,035   

Collateralized debt obligations:

               

Debt securities

     11,240         1,107         -         193        -        1,300   

Loans (2)

     9,757         9,511         -         -        -        9,511   

Asset-based finance structures

     9,606         6,942         -         (130     -        6,812   

Tax credit structures

     19,257         4,119         -         -        (1,439     2,680   

Collateralized loan obligations

     12,191         2,019         -         40        -        2,059   

Investment funds

     6,318         -         -         -        -        -   

Other (3)

     18,717         1,896         34         190        (1     2,119   

 

 

Total

   $         1,463,183         39,799         12,080         643        (2,463     50,059   

 

 
        Maximum exposure to loss   
     

 

 

 

Residential mortgage loan securitizations:

               

Conforming

      $ 4,682         11,070         -        3,657        19,409   

Other/nonconforming

        2,460         353         1        295        3,109   

Commercial mortgage securitizations

        7,063         623         538        -        8,224   

Collateralized debt obligations:

               

Debt securities

        1,107         -         874        -        1,981   

Loans (2)

        9,511         -         -        -        9,511   

Asset-based finance structures

        6,942         -         130        1,504        8,576   

Tax credit structures

        4,119         -         -        -        4,119   

Collateralized loan obligations

        2,019         -         41        523        2,583   

Investment funds

        -         -         -        41        41   

Other (3)

        1,896         34         903        150        2,983   

 

 

Total

      $         39,799         12,080         2,487        6,170        60,536   

 

 

 

(1) Includes total equity interests of $497 million and $460 million at September 30, 2012, and December 31, 2011, respectively. Also includes debt interests in the form of both loans and securities. Excludes certain debt securities held related to loans serviced for FNMA, FHLMC and GNMA.
(2) Represents senior loans to trusts that are collateralized by asset-backed securities. The trusts invest primarily in senior tranches from a diversified pool of primarily U.S. asset securitizations, of which all are current, and over 83% were rated as investment grade by the primary rating agencies at September 30, 2012. These senior loans are accounted for at amortized cost and are subject to the Company’s allowance and credit charge-off policies.
(3) Includes structured financing, student loan securitizations, auto loan and lease securitizations and credit-linked note structures. Also contains investments in auction rate securities (ARS) issued by VIEs that we do not sponsor and, accordingly, are unable to obtain the total assets of the entity.

 

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Note 7: Securitizations and Variable Interest Entities (continued)

 

In the two preceding tables, “Total VIE assets” represents the remaining principal balance of assets held by unconsolidated VIEs using the most current information available. For VIEs that obtain exposure to assets synthetically through derivative instruments, the remaining notional amount of the derivative is included in the asset balance. “Carrying value” is the amount in our consolidated balance sheet related to our involvement with the unconsolidated VIEs. “Maximum exposure to loss” from our involvement with off-balance sheet entities, which is a required disclosure under GAAP, is determined as the carrying value of our involvement with off-balance sheet (unconsolidated) VIEs plus the remaining undrawn liquidity and lending commitments, the notional amount of net written derivative contracts, and generally the notional amount of, or stressed loss estimate for, other commitments and guarantees. It represents estimated loss that would be incurred under severe, hypothetical circumstances, for which we believe the possibility is extremely remote, such as where the value of our interests and any associated collateral declines to zero, without any consideration of recovery or offset from any economic hedges. Accordingly, this required disclosure is not an indication of expected loss.

RESIDENTIAL MORTGAGE LOANS Residential mortgage loan securitizations are financed through the issuance of fixed- or floating-rate-asset-backed-securities, which are collateralized by the loans transferred to a VIE. We typically transfer loans we originated to these VIEs, account for the transfers as sales, retain the right to service the loans and may hold other beneficial interests issued by the VIEs. We also may be exposed to limited liability related to recourse agreements and repurchase agreements we make to our issuers and purchasers, which are included in other commitments and guarantees. In certain instances, we may service residential mortgage loan securitizations structured by third parties whose loans we did not originate or transfer. Our residential mortgage loan securitizations consist of conforming and nonconforming securitizations.

Conforming residential mortgage loan securitizations are those that are guaranteed by GSEs, including GNMA. We do not consolidate our conforming residential mortgage loan securitizations because we do not have power over the VIEs.

The loans sold to the VIEs in nonconforming residential mortgage loan securitizations are those that do not qualify for a GSE guarantee. We may hold variable interests issued by the VIEs, primarily in the form of senior securities. We do not consolidate the nonconforming residential mortgage loan securitizations included in the table because we either do not hold any variable interests, hold variable interests that we do not consider potentially significant or are not the primary servicer for a majority of the VIE assets.

Other commitments and guarantees include amounts related to loans sold that we may be required to repurchase, or otherwise indemnify or reimburse the investor or insurer for losses incurred, due to material breach of contractual representations and warranties. The maximum exposure to loss for material breach of contractual representations and warranties represents a stressed case estimate we utilize for

determining stressed case regulatory capital needs and is considered to be a remote scenario.

COMMERCIAL MORTGAGE LOAN SECURITIZATIONS Commercial mortgage loan securitizations are financed through the issuance of fixed- or floating-rate-asset-backed-securities, which are collateralized by the loans transferred to the VIE. In a typical securitization, we may transfer loans we originate to these VIEs, account for the transfers as sales, retain the right to service the loans and may hold other beneficial interests issued by the VIEs. In certain instances, we may service commercial mortgage loan securitizations structured by third parties whose loans we did not originate or transfer. We typically serve as primary or master servicer of these VIEs. The primary or master servicer in a commercial mortgage loan securitization typically cannot make the most significant decisions impacting the performance of the VIE and therefore does not have power over the VIE. We do not consolidate the commercial mortgage loan securitizations included in the disclosure because we either do not have power or do not have a variable interest that could potentially be significant to the VIE.

COLLATERALIZED DEBT OBLIGATIONS (CDOs) A CDO is a securitization where an SPE purchases a pool of assets consisting of asset-backed securities and issues multiple tranches of equity or notes to investors. In some transactions, a portion of the assets are obtained synthetically through the use of derivatives such as credit default swaps or total return swaps.

Prior to 2008, we engaged in the structuring of CDOs on behalf of third party asset managers who would select and manage the assets for the CDO. Typically, the asset manager has some discretion to manage the sale of assets of, or derivatives used by the CDO, which generally gives the asset manager the power over the CDO. We have not structured these types of transactions since the credit market disruption began in late 2007.

In addition to our role as arranger we may have other forms of involvement with these transactions, including transactions established prior to 2008. Such involvement may include acting as liquidity provider, derivative counterparty, secondary market maker or investor. For certain transactions, we may also act as the collateral manager or servicer. We receive fees in connection with our role as collateral manager or servicer.

We assess whether we are the primary beneficiary of CDOs based on our role in the transaction in combination with the variable interests we hold. Subsequently, we monitor our ongoing involvement in these transactions to determine if the nature of our involvement has changed. We are not the primary beneficiary of these transactions in most cases because we do not act as the collateral manager or servicer, which generally denotes power. In cases where we are the collateral manager or servicer, we are not the primary beneficiary because we do not hold interests that could potentially be significant to the VIE.

COLLATERALIZED LOAN OBLIGATIONS (CLOs) A CLO is a securitization where an SPE purchases a pool of assets consisting of loans and issues multiple tranches of equity or notes to investors. Generally, CLOs are structured on behalf of a third

 

 

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party asset manager that typically selects and manages the assets for the term of the CLO. Typically, the asset manager has the power over the significant decisions of the VIE through its discretion to manage the assets of the CLO. We assess whether we are the primary beneficiary of CLOs based on our role in the transaction and the variable interests we hold. In most cases, we are not the primary beneficiary of these transactions because we do not have the power to manage the collateral in the VIE.

In addition to our role as arranger, we may have other forms of involvement with these transactions. Such involvement may include acting as underwriter, derivative counterparty, secondary market maker or investor. For certain transactions, we may also act as the servicer, for which we receive fees in connection with that role. We also earn fees for arranging these transactions and distributing the securities.

ASSET-BASED FINANCE STRUCTURES We engage in various forms of structured finance arrangements with VIEs that are collateralized by various asset classes including energy contracts, auto and other transportation leases, intellectual property, equipment and general corporate credit. We typically provide senior financing, and may act as an interest rate swap or commodity derivative counterparty when necessary. In most cases, we are not the primary beneficiary of these structures because we do not have power over the significant activities of the VIEs involved in these transactions.

For example, we have investments in asset-backed securities that are collateralized by auto leases or loans and cash reserves. These fixed-rate and variable-rate securities have been structured as single-tranche, fully amortizing, unrated bonds that are equivalent to investment-grade securities due to their significant overcollateralization. The securities are issued by VIEs that have been formed by third party auto financing institutions primarily because they require a source of liquidity to fund ongoing vehicle sales operations. The third party auto financing institutions manage the collateral in the VIEs, which is indicative of power in these transactions and we therefore do not consolidate these VIEs.

TAX CREDIT STRUCTURES We co-sponsor and make investments in affordable housing and sustainable energy projects that are designed to generate a return primarily through the realization of federal tax credits. In some instances, our investments in these structures may require that we fund future capital commitments at the discretion of the project sponsors. While the size of our investment in a single entity may at times exceed 50% of the outstanding equity interests, we do not consolidate these structures due to the project sponsor’s ability to manage the projects, which is indicative of power in these transactions.

INVESTMENT FUNDS We do not consolidate the investment funds because we do not absorb the majority of the expected future variability associated with the funds’ assets, including variability associated with credit, interest rate and liquidity risks.

OTHER TRANSACTIONS WITH VIEs In 2008, legacy Wachovia reached an agreement to purchase at par auction rate securities (ARS) that were sold to third-party investors by certain of its subsidiaries. ARS are debt instruments with long-term maturities, but which re-price more frequently, and preferred equities with no maturity. We purchased all outstanding ARS that were issued by VIEs and subject to the agreement. At September 30, 2012, we held in our securities available-for-sale portfolio $406 million of ARS issued by VIEs redeemed pursuant to this agreement, compared with $643 million at December 31, 2011.

In 2009, we reached agreements to purchase additional ARS from eligible investors who bought ARS through one of our broker-dealer subsidiaries. We purchased all outstanding ARS that were issued by VIEs and subject to the agreement. As of September 30, 2012, we held in our securities available-for-sale portfolio $345 million of ARS issued by VIEs redeemed pursuant to this agreement, compared with $624 million at December 31, 2011.

We do not consolidate the VIEs that issued the ARS because we do not have power over the activities of the VIEs.

TRUST PREFERRED SECURITIES In addition to the involvements disclosed in the preceding table, through the issuance of trust preferred securities we had junior subordinated debt financing with a carrying value of $5.0 billion at September 30, 2012, and $7.6 billion at December 31, 2011 and $2.5 billion of preferred stock at both September 30, 2012, and December 31, 2011. In these transactions, VIEs that we wholly own issue debt securities or preferred equity to third party investors. All of the proceeds of the issuance are invested in debt securities or preferred equity that we issue to the VIEs. The VIEs’ operations and cash flows relate only to the issuance, administration and repayment of the securities held by third parties. We do not consolidate these VIEs because the sole assets of the VIEs are receivables from us. This is the case even though we own all of the voting equity shares of the VIEs, have fully guaranteed the obligations of the VIEs and may have the right to redeem the third party securities under certain circumstances. We report the debt securities issued to the VIEs as long-term junior subordinated debt and the preferred equity securities issued to the VIEs as preferred stock in our consolidated balance sheet.

In the first nine months of 2012, we redeemed $2.7 billion of trust preferred securities that will no longer count as Tier 1 capital under the Dodd-Frank Act and the Basel Committee recommendations known as the Basel III standards.

Securitization Activity Related to Unconsolidated VIEs

We use VIEs to securitize consumer and CRE loans and other types of financial assets, including student loans and auto loans. We typically retain the servicing rights from these sales and may continue to hold other beneficial interests in the VIEs. We may also provide liquidity to investors in the beneficial interests and credit enhancements in the form of standby letters of credit. Through these securitizations we may be exposed to liability under limited amounts of recourse as well as standard representations and warranties we make to purchasers and issuers.

 

 

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Note 7: Securitizations and Variable Interest Entities (continued)

 

We recognized net gains of $97 million and $161 million from transfers accounted for as sales of financial assets in securitizations in the third quarter and nine months ended

September 30, 2012, respectively, and net gains of $39 million and $105 million, respectively, in the same periods of 2011. Additionally, we had the following cash flows with our securitization trusts that were involved in transfers accounted for as sales.

 

 

 

 

     2012      2011  
(in millions)    Mortgage
loans
     Other
financial
assets
     Mortgage
loans
     Other
financial
assets
 

Quarter ended September 30,

           

Sales proceeds from securitizations (1)

   $       135,596           -           76,730           -     

Servicing fees

     1,088           3           1,104           3     

Other interests held

     466           20           390           73     

Purchases of delinquent assets

     2           -           3           -     

Net servicing advances

     25           -           29           -     
                                     

Nine months ended September 30,

           

Sales proceeds from securitizations (1)

   $ 412,465           -           247,944           -     

Servicing fees

     3,312           8           3,297           9     

Other interests held

     1,333           114           1,406           213     

Purchases of delinquent assets

     54           -           8           -     

Net servicing advances

     151           -           9           -     
                                     

 

(1) Represents cash flow data for all loans securitized in the period presented.

 

Sales with continuing involvement during the third quarter and first nine months of 2012 and 2011 predominantly related to conforming residential mortgage securitizations. During the third quarter and first nine months of 2012 we transferred $129.3 billion and $398.4 billion, respectively, in fair value of conforming residential mortgages to unconsolidated VIEs and recorded the transfers as sales, compared with $73.1 billion and $245.4 billion, respectively, in the same periods of 2011. These transfers did not result in a gain or loss because the loans are already carried at fair value. In connection with these transfers, in the first nine months of 2012 we recorded a $3.8 billion servicing asset, measured at fair value using a Level 3 measurement technique, and a $209 million liability for probable repurchase losses. In the first nine months of 2011, we recorded a $2.7 billion servicing asset and a $74 million liability.

We used the following key weighted-average assumptions to measure mortgage servicing assets at the date of securitization:

 

     

 

Residential mortgage
servicing rights

 
              2012             2011  
Quarter ended September 30,             

Prepayment speed (1)

     13.9     13.6   

Discount rate

     7.3        7.7   

Cost to service ($ per loan) (2)

   $ 169        167   
                  
Nine months ended September 30,             

Prepayment speed (1)

     13.4     12.5   

Discount rate

     7.3        7.9   

Cost to service ($ per loan) (2)

   $ 143        158   
                  

 

(1) The prepayment speed assumption for residential mortgage servicing rights includes a blend of prepayment speeds and default rates. Prepayment speed assumptions are influenced by mortgage interest rate inputs as well as our estimation of drivers of borrower behavior.
(2) Includes costs to service and unreimbursed foreclosure costs.
 

 

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The following table provides key economic assumptions and the sensitivity of the current fair value of residential mortgage servicing rights and other retained interests to immediate adverse changes in those assumptions. “Other interests held” relate predominantly to residential and commercial mortgage loan securitizations. Residential mortgage-backed securities retained in securitizations issued through GSEs, such as FNMA, FHLMC and GNMA, are excluded from the table because these securities have a remote risk of credit loss due to the GSE

guarantee. These securities also have economic characteristics similar to GSE mortgage-backed securities that we purchase, which are not included in the table. Subordinated interests include only those bonds whose credit rating was below AAA by a major rating agency at issuance. Senior interests include only those bonds whose credit rating was AAA by a major rating agency at issuance. The information presented excludes trading positions held in inventory.

 

 

     
           Other interests held  
     Residential            Consumer      Commercial (2)  
($ in millions, except cost to service amounts)   

mortgage

servicing
rights (1)

   

Interest-

only
strips

     Subordinated
bonds
    Senior
bonds
     Subordinated
bonds
     Senior
bonds
 

Fair value of interests held at September 30, 2012

   $     10,956          201           44          -           247           870     

Expected weighted-average life (in years)

     4.5          4.1           6.0          -           5.0           5.0     

Key economic assumptions:

               

Prepayment speed assumption (3)

     17.2       10.7           6.8          -           

Decrease in fair value from:

               

10% adverse change

   $ 853          5           -          -           

25% adverse change

     1,994          12           -          -           

Discount rate assumption

     7.2       16.6           8.7          -           4.6           2.4     

Decrease in fair value from:

               

100 basis point increase

   $ 513          5           2          -           10           36     

200 basis point increase

     981          9           4          -           19           70     

Cost to service assumption ($ per loan)

     219                  

Decrease in fair value from:

               

10% adverse change

     589                  

25% adverse change

     1,472                  

Credit loss assumption

          0.4       -           10.9           -     

Decrease in fair value from:

               

10% higher losses

        $ -          -           10           -     

25% higher losses

          -          -           18           -     
                                                     

Fair value of interests held at December 31, 2011

   $ 12,918          230           45          321           240           852     

Expected weighted-average life (in years)

     5.1          4.6           6.1          5.6           5.3           4.4     

Key economic assumptions:

               

Prepayment speed assumption (3)

     14.8       10.7           6.9          13.9           

Decrease in fair value from:

               

10% adverse change

   $ 895          6           -          2           

25% adverse change

     2,105          15           1          4           

Discount rate assumption

     7.1       15.6           11.9          7.1           3.8           2.4     

Decrease in fair value from:

               

100 basis point increase

   $ 566          6           2          12           9           31     

200 basis point increase

     1,081          12           4          24           18           59     

Cost to service assumption ($ per loan)

     218                  

Decrease in fair value from:

               

10% adverse change

     582                  

25% adverse change

     1,457                  

Credit loss assumption

          0.5       4.5           10.7           -     

Decrease in fair value from:

               

10% higher losses

        $ -          1           8           -     

25% higher losses

          -          2           18           -     
                                                     

 

(1) December 31, 2011, has been revised to report only the sensitivities for residential mortgage servicing rights. See narrative following this table for a discussion of commercial mortgage servicing rights.
(2) “Other interests held” has been expanded to include retained interests from commercial securitizations.
(3) The prepayment speed assumption for residential mortgage servicing rights includes a blend of prepayment speeds and default rates. Prepayment speed assumptions are influenced by mortgage interest rate inputs as well as our estimation of drivers of borrower behavior.

 

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Note 7: Securitizations and Variable Interest Entities (continued)

 

In addition to residential mortgage servicing rights (MSRs) included in the previous table, we have a small portfolio of commercial MSRs with a fair value of $1.4 billion at September 30, 2012, and December 31, 2011. The nature of our commercial MSRs, which are carried at LOCOM, is different from our residential MSRs. Prepayment activity on serviced loans does not significantly impact the value of commercial MSRs because, unlike residential mortgages, commercial mortgages experience significantly lower prepayments due to certain contractual restrictions, impacting the borrower’s ability to prepay the mortgage. Additionally, for our commercial MSR portfolio, we are typically master/primary servicer, but not the special servicer, who is separately responsible for the servicing and workout of delinquent and foreclosed loans. It is the special servicer, similar to our role as servicer of residential mortgage loans, who is affected by higher servicing and foreclosure costs due to an increase in delinquent and foreclosed loans. Accordingly, prepayment speeds and costs to service are not key assumptions for commercial MSRs as they do not significantly impact the valuation. The primary economic driver impacting the fair value of our commercial MSRs is forward interest rates, which are derived from market observable yield curves used to price capital markets instruments. Market interest rates most significantly affect interest earned on custodial deposit balances. The sensitivity of the current fair value to an immediate adverse 25% change in the assumption about interest earned on deposit balances at September 30, 2012, and December 31, 2011, results in a decrease in fair value of $147 million and $219 million,

respectively. See Note 8 for further information on our commercial MSRs.

The sensitivities in the preceding paragraph and table are hypothetical and caution should be exercised when relying on this data. Changes in value based on variations in assumptions generally cannot be extrapolated because the relationship of the change in the assumption to the change in value may not be linear. Also, the effect of a variation in a particular assumption on the value of the other interests held is calculated independently without changing any other assumptions. In reality, changes in one factor may result in changes in others (for example, changes in prepayment speed estimates could result in changes in the credit losses), which might magnify or counteract the sensitivities.

The following table presents information about the principal balances of off-balance sheet securitized loans, including residential mortgages sold to FNMA, FHLMC, GNMA and securitizations where servicing is our only form of continuing involvement. Delinquent loans include loans 90 days or more past due and still accruing interest as well as nonaccrual loans. In securitizations where servicing is our only form of continuing involvement, we would only experience a loss if required to repurchase a delinquent loan due to a breach in representations and warranties associated with our loan sale or servicing contracts. Net charge-offs exclude loans sold to FNMA, FHLMC and GNMA as we do not service or manage the underlying real estate upon foreclosure and, as such, do not have access to net charge-off information.

 

 

                                      Net charge-offs  
     Total loans      Delinquent loans      Nine months  
     Sept. 30,      Dec. 31,      Sept. 30,      Dec. 31,      ended September 30,  
(in millions)    2012      2011      2012      2011              2012          2011  

Commercial:

                 

Real estate mortgage

     $     131,640           137,121           13,091           11,142           323           307     

Total commercial

     131,640           137,121           13,091           11,142           323           307     

Consumer:

                 

Real estate 1-4 family first mortgage

     1,283,700           1,171,666           22,263           24,235           876           1,216     

Real estate 1-4 family junior lien mortgage

     1           2           -           -           -           16     

Other revolving credit and installment

     2,082           2,271           114           131           -           -     

Total consumer

     1,285,783           1,173,939           22,377           24,366           876           1,232     

Total off-balance sheet securitized loans

     $     1,417,423           1,311,060           35,468           35,508               1,199           1,539     

 

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Transactions with Consolidated VIEs and Secured Borrowings

The following table presents a summary of transfers of financial assets accounted for as secured borrowings and involvements with consolidated VIEs. “Consolidated assets” are presented using GAAP measurement methods, which may include fair value, credit impairment or other adjustments, and therefore in

some instances will differ from “Total VIE assets.” For VIEs that obtain exposure synthetically through derivative instruments, the remaining notional amount of the derivative is included in “Total VIE assets.” On the consolidated balance sheet, we separately disclose the consolidated assets of certain VIEs that can only be used to settle the liabilities of those VIEs.

 

 

              Carrying value  
(in millions)   

Total

VIE

assets

     Consolidated
assets
     Third
party
liabilities
    Noncontrolling
interests
    Net
assets
 

 

 

September 30, 2012

            

Secured borrowings:

            

Municipal tender option bond securitizations

   $ 15,902         14,247         (12,369     -        1,878   

Commercial real estate loans

     1,059         1,059         (773     -        286   

Residential mortgage securitizations

     5,831         6,331         (5,892     -        439   

Total secured borrowings

     22,792         21,637         (19,034     -        2,603   

Consolidated VIEs:

            

Nonconforming residential mortgage loan securitizations

     9,091         8,098         (3,176     -        4,922   

Multi-seller commercial paper conduit

     2,142         2,142         (2,175     -        (33

Auto loan securitizations

     -         -         -        -        -   

Structured asset finance

     84         84         (17     -        67   

Investment funds

     1,861         1,861         (1     -        1,860   

Other

     4,033         3,296         (1,571     (52     1,673   

Total consolidated VIEs

     17,211         15,481         (6,940     (52     8,489   

Total secured borrowings and consolidated VIEs

   $ 40,003         37,118         (25,974     (52     11,092   

December 31, 2011

            

Secured borrowings:

            

Municipal tender option bond securitizations

   $ 14,168         11,748         (10,689     -        1,059   

Commercial real estate loans

     1,168         1,168         (1,041     -        127   

Residential mortgage securitizations

     5,705         6,114         (5,759     -        355   

Total secured borrowings

     21,041         19,030         (17,489     -        1,541   

Consolidated VIEs:

            

Nonconforming residential mortgage loan securitizations

     11,375         10,244         (4,514     -        5,730   

Multi-seller commercial paper conduit

     2,860         2,860         (2,935     -        (75

Auto loan securitizations

     163         163         (143     -        20   

Structured asset finance

     124         124         (16     -        108   

Investment funds

     2,012         2,012         (22     -        1,990   

Other

     3,432         2,812         (1,890     (61     861   

Total consolidated VIEs

     19,966         18,215         (9,520     (61     8,634   

Total secured borrowings and consolidated VIEs

   $             41,007         37,245         (27,009     (61     10,175   

 

In addition to the transactions included in the previous table, at both September 30, 2012, and December 31, 2011, we had approximately $6.0 billion of private placement debt financing issued through a consolidated VIE. The issuance is classified as long-term debt in our consolidated financial statements. At September 30, 2012, and December 31, 2011, respectively, we pledged approximately $6.5 billion and $6.2 billion in loans (principal and interest eligible to be capitalized), $271 million and $316 million in securities available for sale, and $180 million and $154 million in cash and cash equivalents to collateralize the VIE’s borrowings. These assets were not

transferred to the VIE, and accordingly we have excluded the VIE from the previous table.

We have raised financing through the securitization of certain financial assets in transactions with VIEs accounted for as secured borrowings. We also consolidate VIEs where we are the primary beneficiary. In certain transactions other than the multi-seller commercial paper conduit, we provide contractual support in the form of limited recourse and liquidity to facilitate the remarketing of short-term securities issued to third party investors. Other than this limited contractual support, the assets of the VIEs are the sole source of repayment of the securities held by third parties. The liquidity support we provide to the

 

 

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Note 7: Securitizations and Variable Interest Entities (continued)

 

multi-seller commercial paper conduit ensures timely repayment of commercial paper issued by the conduit and is described further below.

MUNICIPAL TENDER OPTION BOND SECURITIZATIONS As part of our normal portfolio investment activities, we consolidate municipal bond trusts that hold highly rated, long-term, fixed-rate municipal bonds, the majority of which are rated AA or better. Our residual interests in these trusts generally allow us to capture the economics of owning the securities outright, and constructively make decisions that significantly impact the economic performance of the municipal bond vehicle, primarily by directing the sale of the municipal bonds owned by the vehicle. In addition, the residual interest owners have the right to receive benefits and bear losses that are proportional to owning the underlying municipal bonds in the trusts. The trusts obtain financing by issuing floating-rate trust certificates that reprice on a weekly or other basis to third-party investors. We may serve as remarketing agent and/or liquidity provider for the trusts. The floating-rate investors have the right to tender the certificates at specified dates, often with as little as seven days’ notice. Should we be unable to remarket the tendered certificates, we are generally obligated to purchase them at par under standby liquidity facilities unless the bond’s credit rating has declined below investment grade or there has been an event of default or bankruptcy of the issuer and insurer.

NONCONFORMING RESIDENTIAL MORTGAGE LOAN SECURITIZATIONS We have consolidated certain of our nonconforming residential mortgage loan securitizations in accordance with consolidation accounting guidance. We have determined we are the primary beneficiary of these securitizations because we have the power to direct the most significant activities of the entity through our role as primary servicer and also hold variable interests that we have determined to be significant. The nature of our variable interests in these entities may include beneficial interests issued by the VIE, mortgage servicing rights and recourse or repurchase reserve liabilities. The beneficial interests issued by the VIE that we hold include either subordinate or senior securities held in an amount that we consider potentially significant.

MULTI-SELLER COMMERCIAL PAPER CONDUIT We administer a multi-seller asset-based commercial paper conduit that finances certain client transactions. This conduit is a bankruptcy remote entity that makes loans to, or purchases certificated interests, generally from SPEs, established by our clients (sellers) and which are secured by pools of financial assets. The conduit funds itself through the issuance of highly rated commercial paper to third party investors. The primary source of repayment of the commercial paper is the cash flows from the conduit’s assets or the re-issuance of commercial paper upon maturity. The conduit’s assets are structured with deal-specific credit enhancements generally in the form of overcollateralization provided by the seller, but may also include subordinated interests, cash reserve accounts, third party credit support facilities and excess spread capture. The timely repayment of the commercial paper is further supported by

asset-specific liquidity facilities in the form of liquidity asset purchase agreements that we provide. Each facility is equal to 102% of the conduit’s funding commitment to a client. The aggregate amount of liquidity must be equal to or greater than all the commercial paper issued by the conduit. At the discretion of the administrator, we may be required to purchase assets from the conduit at par value plus accrued interest or discount on the related commercial paper, including situations where the conduit is unable to issue commercial paper. Par value may be different from fair value.

We receive fees in connection with our role as administrator and liquidity provider. We may also receive fees related to the structuring of the conduit’s transactions. We are the primary beneficiary of the conduit because we have power over the significant activities of the conduit and have a significant variable interest due to our liquidity arrangement.

INVESTMENT FUNDS We have consolidated certain of our investment funds where we manage the assets of the fund and our interests absorb a majority of the funds’ variability. We consolidate these VIEs because we have discretion over the management of the assets and are the sole investor in these funds.

 

 

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Note 8: Mortgage Banking Activities

 

 

Mortgage banking activities, included in the Community Banking and Wholesale Banking operating segments, consist of residential and commercial mortgage originations, sale activity and servicing.

We apply the amortization method to all commercial MSRs and apply the fair value method to only residential MSRs. The changes in MSRs measured using the fair value method were:

 

 

 

 
     Quarter ended Sept. 30,     Nine months ended Sept. 30,  

(in millions)

     2012        2011        2012        2011   

 

 

Fair value, beginning of period

   $ 12,081        14,778        12,603        14,467   

Servicing from securitizations or asset transfers (1)

     1,173        744        4,088        2,746   

Sales

     -        -        (293     -   

 

 

Net additions

     1,173        744        3,795        2,746   

 

 

Changes in fair value:

        

Due to changes in valuation model inputs or assumptions:

        

Mortgage interest rates (2)

     (1,131     (2,867     (2,480     (3,266

Servicing and foreclosure costs (3)

     (350     (33     (550     (692

Discount rates (4)

     -        -        (344     (150

Prepayment estimates and other (5)

     54        260        158        892   

 

 

Net changes in valuation model inputs or assumptions

     (1,427     (2,640     (3,216     (3,216

 

 

Other changes in fair value (6)

     (871     (510     (2,226     (1,625

 

 

Total changes in fair value

     (2,298     (3,150     (5,442     (4,841

 

 

Fair value, end of period

   $         10,956        12,372        10,956        12,372   

 

 

 

(1) Nine months ended September 30, 2012, includes $315 million residential MSRs transferred from amortized MSRs that we elected to carry at fair value effective January 1, 2012.
(2) Primarily represents prepayment speed changes due to changes in mortgage interest rates, but also includes other valuation changes due to changes in mortgage interest rates (such as changes in estimated interest earned on custodial deposit balances).
(3) Includes costs to service and unreimbursed foreclosure costs.
(4) Reflects discount rate assumption change, excluding portion attributable to changes in mortgage interest rates; the nine months ended September 30, 2012, change reflects increased capital return requirements from market participants.
(5) Represents changes driven by other valuation model inputs or assumptions including prepayment speed estimation changes and other assumption updates. Prepayment speed estimation changes are influenced by observed changes in borrower behavior.
(6) Represents changes due to collection/realization of expected cash flows over time.

The changes in amortized MSRs were:

 

 

 
     Quarter ended Sept. 30,     Nine months ended Sept. 30,  

(in millions)

     2012        2011        2012        2011   

 

 

Balance, beginning of period

   $         1,130        1,432        1,445        1,422   

Purchases

     42        21        134        102   

Servicing from securitizations or asset transfers (1)

     30        50        (263     106   

Amortization (2)

     (58     (66     (172     (193

 

 

Balance, end of period (2)

     1,144        1,437        1,144        1,437   

 

 

Valuation allowance:

        

Balance, beginning of period

     -        (10     (37     (3

Reversal of provision (provision) for MSRs in excess of fair value (1)

     -        (30     37        (37

 

 

Balance, end of period (3)

     -        (40     -        (40

 

 

Amortized MSRs, net

   $ 1,144        1,397        1,144        1,397   

 

 

Fair value of amortized MSRs:

        

Beginning of period

   $ 1,450        1,805        1,756        1,812   

End of period (4)

     1,399        1,759        1,399        1,759   
        

 

 

 

(1) Nine months ended September 30, 2012, is net of $350 million ($313 million after valuation allowance) of residential MSRs that we elected to carry at fair value effective January 1, 2012. A cumulative adjustment of $2 million to fair value was recorded in retained earnings at January 1, 2012.
(2) Includes $367 million in residential amortized MSRs at September 30, 2011. For the third quarter and first nine months of 2011, the residential MSR amortization was $(13) million and $(34) million, respectively.
(3) Commercial amortized MSRs are evaluated for impairment purposes by the following risk strata: agency (GSEs) and non-agency. There was no valuation allowance recorded for the periods presented on the commercial amortized MSRs. Residential amortized MSRs are evaluated for impairment purposes by the following risk strata: mortgages sold to GSEs (FHLMC and FNMA) and mortgages sold to GNMA, each by interest rate stratifications. A valuation allowance of $40 million was recorded on the residential amortized MSRs at September 30, 2011. For nine months ended September 30, 2012, valuation allowance of $37 million for residential MSRs was reversed upon election to carry at fair value.
(4) Includes fair value of $330 million in residential amortized MSRs and $1,429 million in commercial amortized MSRs at September 30, 2011. The September 30, 2012, balance is all commercial amortized MSRs.

 

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Note 8: Mortgage Banking Activities (continued)

 

We present the components of our managed servicing portfolio in the following table at unpaid principal balance for

loans serviced and subserviced for others and at book value for owned loans serviced.

 

 

 

 
(in billions)    Sept. 30,
2012
    Dec. 31,
2011
 

 

 

Residential mortgage servicing:

    

Serviced for others

   $             1,508        1,456   

Owned loans serviced

     364        358   

Subservicing

     7        8   

 

 

Total residential servicing

     1,879        1,822   

 

 

Commercial mortgage servicing:

    

Serviced for others

     405        398   

Owned loans serviced

     105        106   

Subservicing

     13        14   

 

 

Total commercial servicing

     523        518   

 

 

Total managed servicing portfolio

   $ 2,402        2,340   

 

 

Total serviced for others

   $ 1,913        1,854   

Ratio of MSRs to related loans serviced for others

     0.63     0.76   
    

 

 

The components of mortgage banking noninterest income were:

 

 

 
     Quarter ended Sept. 30,     Nine months ended Sept. 30,  
(in millions)    2012     2011     2012     2011  

 

 

Servicing income, net:

        

Servicing fees:

        

Contractually specified servicing fees

   $             1,136        1,153        3,448        3,473   

Late charges

     66        64        195        233   

Ancillary fees

     89        104        229        267   

Unreimbursed direct servicing costs (1)

     (307     (292     (807     (705

 

 

Net servicing fees

     984        1,029        3,065        3,268   

 

 

Changes in fair value of MSRs carried at fair value:

        

Due to changes in valuation model inputs or assumptions (2)

     (1,427     (2,640     (3,216     (3,216

Other changes in fair value (3)

     (871     (510     (2,226     (1,625

 

 

Total changes in fair value of MSRs carried at fair value

     (2,298     (3,150     (5,442     (4,841

Amortization

     (58     (66     (172     (193

Provision for MSRs in excess of fair value

     -        (30     -        (37

Net derivative gains from economic hedges (4)

     1,569        3,247        3,677        4,576   

 

 

Total servicing income, net

     197        1,030        1,128        2,773   

Net gains on mortgage loan origination/sales activities

     2,610        803        7,442        2,695   

 

 

Total mortgage banking noninterest income

   $ 2,807        1,833        8,570        5,468   

 

 

Market-related valuation changes to MSRs, net of hedge results (2) + (4)

   $ 142        607        461        1,360   
        

 

 

 

(1) Primarily associated with foreclosure expenses and other interest costs.
(2) Refer to the changes in fair value of MSRs table in this Note for more detail.
(3) Represents changes due to collection/realization of expected cash flows over time.
(4) Represents results from free-standing derivatives (economic hedges) used to hedge the risk of changes in fair value of MSRs. See Note 12 – Free-Standing Derivatives for additional discussion and detail.

 

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The table below summarizes the changes in our liability for mortgage loan repurchase losses. This liability is in “Accrued expenses and other liabilities” in our consolidated financial statements and the provision for repurchase losses reduces net gains on mortgage loan origination/sales activities. Because the level of mortgage loan repurchase losses depends upon economic factors, investor demand strategies and other external conditions that may change over the life of the underlying loans, the level of the liability for mortgage loan repurchase losses is difficult to estimate and requires considerable management judgment. We maintain regular contact with the GSEs, the Federal Housing Finance Agency (FHFA), and other significant investors to monitor their repurchase demand practices and issues as part of our process to update our repurchase liability estimate as new information becomes available. Because of the uncertainty in the various estimates underlying the mortgage repurchase liability, there is a range of losses in excess of the recorded mortgage repurchase liability that are reasonably possible. The estimate of the range of possible loss for representations and warranties does not represent a probable loss, and is based on currently available information, significant judgment, and a number of assumptions that are subject to change. The high end of this range of reasonably possible losses in excess of our recorded liability was $2.5 billion at September 30, 2012, and was determined based upon modifying the assumptions utilized in our best estimate of probable loss to reflect what we believe to be the high end of reasonably possible adverse assumptions.

 

 

 
     Quarter
ended Sept. 30,
    Nine months
ended Sept. 30,
 
(in millions)    2012     2011     2012     2011  

 

 

Balance, beginning of period

   $         1,764        1,188                1,326        1,289   

Provision for repurchase losses:

        

Loan sales

     75        19        209        74   

Change in estimate (1)

     387        371        1,352        807   

 

 

Total additions

     462        390        1,561        881   

Losses

     (193     (384     (854     (976

 

 

Balance, end of period

   $ 2,033        1,194        2,033        1,194   

 

 

 

(1) Results from changes in investor demand and mortgage insurer practices, credit deterioration, and changes in the financial stability of correspondent lenders.
 

 

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Note 9: Intangible Assets

 

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

 

 

 
     September 30, 2012      December 31, 2011  
(in millions)   

Gross

carrying

value

    

Accumulated

amortization

   

Net

carrying

value

    

Gross

carrying

value

    

Accumulated

amortization

   

Net

carrying

value

 

 

 

Amortized intangible assets (1):

               

MSRs (2)

   $ 2,240         (1,096     1,144         2,383         (975     1,408   

Core deposit intangibles

     12,836         (6,572     6,264         15,079         (7,768     7,311   

Customer relationship and other intangibles

     3,184         (1,734     1,450         3,158         (1,519     1,639   

 

 

Total amortized intangible assets

   $ 18,260         (9,402     8,858         20,620         (10,262     10,358   

 

 

Unamortized intangible assets:

               

MSRs (carried at fair value) (2)

   $         10,956              12,603        

Goodwill

     25,637              25,115        

Trademark

     14              14        
               

 

 

 

  (1) Excludes fully amortized intangible assets.
  (2) See Note 8 for additional information on MSRs.

We based our projections of amortization expense shown below on existing asset balances at September 30, 2012. Future amortization expense may vary from these projections.

The following table provides the current year and estimated future amortization expense for amortized intangible assets.

 

 

 
(in millions)   

Amortized

MSRs

    

Core

deposit

intangibles

    

Customer

relationship

and other
intangibles

     Total  

 

 

Nine months ended September 30, 2012 (actual)

   $ 172         1,047         215         1,434   

 

 

Estimate for the remainder of 2012

   $             62         348         72         482   

Estimate for year ended December 31,

           

2013

     230         1,241         267         1,738   

2014

     199         1,113         250         1,562   

2015

     174         1,022         227         1,423   

2016

     139         919         212         1,270   

2017

     94         851         195         1,140   
           

 

 

 

For our goodwill impairment analysis, we allocate all of the goodwill to the individual operating segments. We identify reporting units that are one level below an operating segment (referred to as a component), and distinguish these reporting units based on how the segments and components are managed, taking into consideration the economic characteristics, nature of

the products and customers of the components. We allocate goodwill to reporting units based on relative fair value, using certain performance metrics. See Note 18 for further information on management reporting.

The following table shows the allocation of goodwill to our operating segments for purposes of goodwill impairment testing.

 

 

 

 
(in millions)   

Community

Banking

   

Wholesale

Banking

   

Wealth,

Brokerage and

Retirement

    

Consolidated

Company

 

 

 

December 31, 2010

   $ 17,922        6,475        373         24,770   

Reduction in goodwill related to divested businesses

     -        (6     -         (6

Goodwill from business combinations

     -        274        -         274   

 

 

September 30, 2011

   $ 17,922        6,743        373         25,038   

 

 

December 31, 2011

   $ 17,924        6,820        371         25,115   

Goodwill from business combinations, net

     (2     524        -         522   

 

 

September 30, 2012

   $ 17,922        7,344        371         25,637   

 

 

 

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Note 10:  Guarantees, Pledged Assets and Collateral

 

 

Guarantees are contracts that contingently require us to make payments to a guaranteed party based on an event or a change in an underlying asset, liability, rate or index. Guarantees are generally in the form of standby letters of credit, securities lending and other indemnifications, liquidity agreements,

written put options, recourse obligations, residual value guarantees, and contingent consideration. The following table shows carrying value, maximum exposure to loss on our guarantees and the related non-investment grade amounts.

 

 

     
     September 30, 2012      December 31, 2011  
            Maximum exposure to loss             Maximum exposure to loss  
(in millions)   

Carrying

value

     Total     

Non-

investment

grade

    

Carrying

value

     Total     

Non-

investment

grade

 

 

 

Standby letters of credit (1)

   $ 2         40,824         21,659         85         41,171         22,259   

Securities lending and other indemnifications

     -         2,858         166         -         669         62   

Liquidity agreements (2)

     -         3         3         -         2         2   

Written put options (2) (3)

     1,463         11,851         4,153         1,469         8,224         2,466   

Loans and MHFS sold with recourse

     100         5,925         3,957         102         5,784         3,850   

Residual value guarantees

     8         197         -         8         197         -   

Contingent consideration

     21         96         95         31         98         97   

Other guarantees

     6         1,460         4         6         552         4   

 

 

Total guarantees

   $ 1,600         63,214         30,037         1,701         56,697         28,740   

 

 

(1) Total maximum exposure to loss includes direct pay letters of credit (DPLCs) of $19.4 billion and $19.7 billion at September 30, 2012, and December 31, 2011, respectively. We issue DPLCs to provide credit enhancements for certain bond issuances. Beneficiaries (bond trustees) may draw upon these instruments to make scheduled principal and interest payments, redeem all outstanding bonds because a default event has occurred, or for other reasons as permitted by the agreement. We also originate multipurpose lending commitments under which borrowers have the option to draw on the facility in one of several forms, including as a standby letter of credit. Total maximum exposure to loss includes the portion of these facilities for which the borrower has drawn on the commitment in the form of a standby letter of credit.

(2) Certain of these agreements included in this table are related to off-balance sheet entities and, accordingly, are also disclosed in Note 7.

(3) Written put options, which are in the form of derivatives, are also included in the derivative disclosures in Note 12.

 

“Maximum exposure to loss” and “Non-investment grade” are required disclosures under GAAP. Non-investment grade represents those guarantees on which we have a higher risk of being required to perform under the terms of the guarantee. If the underlying assets under the guarantee are non-investment grade (that is, an external rating that is below investment grade or an internal credit default grade that is equivalent to a below investment grade external rating), we consider the risk of performance to be high. Internal credit default grades are determined based upon the same credit policies that we use to evaluate the risk of payment or performance when making loans and other extensions of credit. These credit policies are further described in Note 5.

Maximum exposure to loss represents the estimated loss that would be incurred under an assumed hypothetical circumstance, despite what we believe is its extremely remote possibility, where the value of our interests and any associated collateral declines to zero. Maximum exposure to loss estimates in the table above do not reflect economic hedges or collateral we could use to offset or recover losses we may incur under our guarantee arrangements. Accordingly, this required disclosure is not an indication of expected loss. We believe the carrying value, which is either fair value for derivative related products or the allowance for lending related commitments, is more representative of our exposure to loss than maximum exposure to loss.

STANDBY LETTERS OF CREDIT We issue standby letters of credit, which include performance and financial guarantees, for customers in connection with contracts between our customers and third parties. Standby letters of credit are agreements where we are obligated to make payment to a third party on behalf of a

customer in the event the customer fails to meet their contractual obligations. We consider the credit risk in standby letters of credit and commercial and similar letters of credit in determining the allowance for credit losses.

SECURITIES LENDING AND OTHER INDEMNIFICATIONS As a securities lending agent, we lend securities from participating institutional clients’ portfolios to third-party borrowers. We indemnify our clients against default by the borrower in returning these lent securities. This indemnity is supported by collateral received from the borrowers. Collateral is generally in the form of cash or highly liquid securities that are marked to market daily. There was $473 million at September 30, 2012, and $687 million at December 31, 2011, in collateral supporting loaned securities with values of $458 million and $669 million, respectively.

Commencing third quarter 2012, we began using certain third party clearing agents to clear and settle transactions on behalf of some of our institutional brokerage customers. We indemnify the clearing agents against loss that could occur for non-performance by our customers on transactions that are not sufficiently collateralized. Transactions subject to the indemnifications may include customer obligations related to the settlement of margin accounts and short positions, such as written call options and securities borrowing transactions. Outstanding customer obligations and related collateral were $616 million and $3.1 billion, respectively, as of September 30, 2012. Our estimate of maximum exposure to loss, which requires judgment regarding the range and likelihood of future events, was $2.4 billion as of September 30, 2012.

 

 

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Note 10: Guarantees, Pledged Assets and Collateral (continued)

 

We enter into other types of indemnification agreements in the ordinary course of business under which we agree to indemnify third parties against any damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with us. These relationships or transactions include those arising from service as a director or officer of the Company, underwriting agreements relating to our securities, acquisition agreements and various other business transactions or arrangements. Because the extent of our obligations under these agreements depends entirely upon the occurrence of future events, we are unable to determine our potential future liability under these agreements. We do, however, record a liability for residential mortgage loans that we may have to repurchase pursuant to various representations and warranties. See Note 8 for additional information on the liability for mortgage loan repurchase losses.

LIQUIDITY AGREEMENTS We provide liquidity facilities on all commercial paper issued by the conduit we administer. We also provide liquidity to certain off-balance sheet entities that hold securitized fixed-rate municipal bonds and consumer or commercial assets that are partially funded with the issuance of money market and other short-term notes. See Note 7 for additional information on these arrangements.

WRITTEN PUT OPTIONS Written put options are contracts that give the counterparty the right to sell to us an underlying instrument held by the counterparty at a specified price, and include options, floors, caps and credit default swaps. These written put option contracts generally permit net settlement. While these derivative transactions expose us to risk in the event the option is exercised, we manage this risk by entering into offsetting trades or by taking short positions in the underlying instrument. We offset substantially all put options written to customers with purchased options. Additionally, for certain of these contracts, we require the counterparty to pledge the underlying instrument as collateral for the transaction. Our ultimate obligation under written put options is based on future market conditions and is only quantifiable at settlement. See Note 7 for additional information regarding transactions with VIEs and Note 12 for additional information regarding written derivative contracts.

LOANS AND MHFS SOLD WITH RECOURSE In certain loan sales or securitizations, we provide recourse to the buyer whereby we are required to indemnify the buyer for any loss on the loan up to par value plus accrued interest. We provide recourse, predominantly to the GSEs, on loans sold under various programs and arrangements. Primarily all of these programs and arrangements require that we share in the loans’ credit exposure for their remaining life by providing recourse to the GSE, up to 33.33% of actual losses incurred on a pro-rata basis, in the event of borrower default. Under the remaining recourse programs and arrangements, if certain events occur within a specified period of time from transfer date, we have to provide limited recourse to the buyer to indemnify them for

losses incurred for the remaining life of the loans. The maximum exposure to loss reported in the accompanying table represents the outstanding principal balance of the loans sold or securitized that are subject to recourse provisions or the maximum losses per the contractual agreements. However, we believe the likelihood of loss of the entire balance due to these recourse agreements is remote and amounts paid can be recovered in whole or in part from the sale of collateral. In third quarter 2012, we repurchased $21 million of loans associated with these agreements. We also provide representation and warranty guarantees on loans sold under the various recourse programs and arrangements. Our loss exposure relative to these guarantees is separately considered and provided for, as necessary, in determination of our liability for loan repurchases due to breaches of representation and warranties. See Note 8 for additional information on the liability for mortgage loan repurchase losses.

RESIDUAL VALUE GUARANTEES We have provided residual value guarantees as part of certain leasing transactions of corporate assets. At September 30, 2012, the only remaining residual value guarantee is related to a leasing transaction on certain corporate buildings. The lessors in these leases are generally large financial institutions or their leasing subsidiaries. These guarantees protect the lessor from loss on sale of the related asset at the end of the lease term. To the extent that a sale of the leased assets results in proceeds less than a stated percent (generally 80% to 89%) of the asset’s cost, we would be required to reimburse the lessor under our guarantee.

CONTINGENT CONSIDERATION In connection with certain brokerage, asset management, insurance agency and other acquisitions we have made, the terms of the acquisition agreements provide for deferred payments or additional consideration, based on certain performance targets.

OTHER GUARANTEES We are members of exchanges and clearing houses that we use to clear our trades and those of our customers. It is common that all members in these organizations are required to collectively guarantee the performance of other members. Our obligations under the guarantees are based on either a fixed amount or a multiple of the collateral we are required to maintain with these organizations. We have not recorded a liability for these arrangements as of the dates presented in the previous table because we believe the likelihood of loss is remote.

We also have contingent performance arrangements related to various customer relationships and lease transactions. We are required to pay the counterparties to these agreements if third parties default on certain obligations.

PARENT GUARANTEE OF SUBSIDIARY DEBT In third quarter 2012, the remaining outstanding debt issued by Wells Fargo Financial, Inc. (WFFI) was paid off. This debt had been guaranteed by the Parent. The Parent continues to guarantee all outstanding term debt securities of Wells Fargo Canada Corporation, WFFI’s Canadian subsidiary.

 

 

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Pledged Assets and Collateral

As part of our liquidity management strategy, we pledge assets to secure trust and public deposits, borrowings from the FHLB and FRB and for other purposes as required or permitted by law. The following table provides pledged loans and securities available for sale where the secured party does not have the right to sell or repledge the collateral. At September 30, 2012, and December 31, 2011, we did not pledge any loans or securities available for sale where the secured party has the right to sell or repledge the collateral. The table excludes pledged assets related to VIEs, which can only be used to settle the liabilities of those entities. See Note 7 for additional information on consolidated VIE assets.

 

     
(in millions)   

Sept. 30,

2012

    

Dec. 31,

2011

 

Securities available for sale

   $ 69,609         80,540   

Loans

     348,615         317,742   

Total

   $       418,224         398,282   

 

We also pledge certain financial instruments that we own to collateralize repurchase agreements and other securities financings. The types of collateral we pledge include securities issued by federal agencies, government-sponsored entities (GSEs), and domestic and foreign companies. We pledged $24.6 billion at September 30, 2012, and $20.8 billion at December 31, 2011, under agreements that permit the secured parties to sell or repledge the collateral. Pledged collateral where the secured party cannot sell or repledge was $807 million and $2.8 billion at the same period ends, respectively.

We receive collateral from other entities under resale agreements and securities borrowings. We received $26.5 billion at September 30, 2012, and $17.8 billion at December 31, 2011, for which we have the right to sell or repledge the collateral. These amounts include securities we have sold or repledged to others with a fair value of $25.0 billion at September 30, 2012, and $16.7 billion at December 31, 2011.

 

 

Note 11: Legal Actions

 

 

The following supplements our discussion of certain matters previously reported in Part I, Item 3 (Legal Proceedings) of our 2011 Form 10-K, and Part II, Item 1 (Legal Proceedings) of our 2012 first and second quarter Quarterly Reports on Form 10-Q for events occurring in third quarter 2012.

FHA INSURANCE LITIGATION On October 9, 2012, the United States filed a complaint, captioned United States of America v. Wells Fargo Bank, N.A., in the U.S. District Court for the Southern District of New York. The complaint makes claims with respect to Wells Fargo’s FHA lending program for the period 2001 to 2010. The complaint alleges, among other allegations, that Wells Fargo improperly certified certain FHA mortgage loans for FHA insurance that did not qualify for the program, and therefore Wells Fargo should not have received insurance proceeds from FHA when some of the loans later defaulted. The complaint further alleges Wells Fargo knew some of the mortgages did not qualify for insurance, and did not disclose the deficiencies to FHA before making insurance claims.

MORTGAGE FORECLOSURE DOCUMENT LITIGATION As previously disclosed, eight purported class actions and several individual borrower actions related to foreclosure document practices were filed in late 2010 and in early 2011 against Wells Fargo Bank, N.A. in its status as mortgage servicer or corporate trustee of mortgage trusts. Five of those cases had been previously dismissed or otherwise resolved. Two of the three remaining purported class actions were dismissed or otherwise resolved on October 3 and October 25, 2012. As a result, seven of the eight purported class actions have now been dismissed or otherwise resolved.

MORTGAGE RELATED REGULATORY INVESTIGATIONS Government agencies and authorities continue investigations or examinations of certain mortgage

related practices of Wells Fargo. The current investigations primarily relate to: (1) whether Wells Fargo complied with applicable laws, regulations and documentation requirements relating to mortgage origination and securitizations, including those at the former Wachovia Corporation; and (2) whether Wells Fargo properly disclosed in offering documents for its residential mortgage-backed securities the facts and risks associated with those securities. As previously disclosed, on July 12, 2012, the DOJ filed a complaint captioned United States of America v. Wells Fargo Bank, N.A. in the U.S. District Court for the District of Columbia. The complaint alleged violations of the Fair Housing Act and the Equal Credit Opportunity Act (ECOA) with respect to Wells Fargo’s residential mortgage lending operations during the period 2004 – 2008. Simultaneously with the filing of the complaint, a Consent Decree executed between the DOJ and Wells Fargo was filed providing for a consensual resolution of the complaint. In the Consent Decree, Wells Fargo denied that it had violated the Fair Housing Act or ECOA, but agreed to resolve the matter by paying $125 million in connection with pricing and product placement allegations primarily relating to mortgages priced and sold to consumers by third party brokers through the Wholesale Division of Wells Fargo Home Mortgage. In addition, Wells Fargo agreed to pay $50 million to fund a community support program in approximately eight cities or metropolitan statistical areas, with details yet to be agreed upon between the DOJ and Wells Fargo. Wells Fargo also agreed to undertake an internal lending compliance review of a small percentage of subprime mortgages delivered through its Retail channel during the period 2004 – 2008 and will rebate to borrowers as appropriate. Of the $125 million, $8 million and $2 million are specifically allocated to Illinois and Pennsylvania, respectively, to resolve matters in those states. On September 20, 2012, the Court entered a Memorandum Opinion and Order approving and entering the Consent Order.

 

 

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Note 11: Legal Actions (continued)

 

ORDER OF POSTING LITIGATION As previously disclosed, a series of putative class actions have been filed against Wachovia Bank, N.A. and Wells Fargo Bank, N.A., as well as many other banks, challenging the high to low order in which the Banks posted debit card transactions to consumer deposit accounts. There remain several such cases pending against Wells Fargo Bank (including the Wachovia Bank cases to which Wells Fargo succeeded), most of which have been consolidated in multi-district litigation proceedings in the U.S. District Court for the Southern District of Florida. The bank defendants moved to compel these cases to arbitration under recent Supreme Court authority. On November 22, 2011, the Judge denied the motion. On October 26, 2012, the U.S. Court of Appeals for the Eleventh Circuit affirmed the District Court’s denial of the motion to compel arbitration.

WACHOVIA EQUITY SECURITIES AND BONDS/NOTES LITIGATION As previously disclosed, a securities class action, now captioned In re Wachovia Equity Securities Litigation, had been pending under various names since July 7, 2008, in the U.S. District Court for the Southern District of New York alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. Among other allegations, plaintiffs alleged Wachovia’s common stock price was artificially inflated as a result of allegedly misleading disclosures relating to the Golden West Financial Corp. mortgage portfolio, Wachovia’s exposure to other mortgage related products such as CDOs, control issues and auction rate securities. There were four additional cases (not class actions) containing allegations similar to the allegations in the In re Wachovia Equity Securities Litigation captioned Stichting Pensioenfonds ABP v. Wachovia Corp. et al., FC Holdings AB, et al. v. Wachovia Corp., et al., Deka Investment GmbH v. Wachovia Corp. et al. and Forsta AP-Fonden v. Wachovia Corp., et al., respectively, which were filed in the U.S. District Court for the Southern District of New York. On March 31, 2011, the U.S. District Court for the Southern District of New York entered a Decision and Order granting Wachovia’s motions to dismiss the In re Wachovia Equity Securities Litigation and the Stichting Pensioenfonds ABP, FC Holdings AB, Deka Investment GmbH and Forsta AP-Fonden cases and all of those cases have subsequently been resolved. Plaintiffs and Wells Fargo agreed to settle the Equity Securities Litigation for $75 million and on January 27, 2012, the Court entered an order preliminarily approving the settlement. On June 12, 2012, an Order finally approving the class action settlement was filed.

There were four previously disclosed individual actions, containing allegations similar to the main In re Wachovia Equity Securities Litigation matter, filed in state courts in North Carolina and South Carolina. All four of those cases have now been finally dismissed.

OUTLOOK When establishing a liability for contingent litigation losses, the Company determines a range of potential losses for each matter that is both probable and estimable, and records the amount it considers to be the best estimate within the range. The high end of the range of reasonably possible potential litigation losses in excess of the Company’s liability for probable and estimable losses was $1.2 billion as of September 30, 2012. For these matters and others where an unfavorable outcome is reasonably possible but not probable, there may be a range of possible losses in excess of the established liability that cannot be estimated. Based on information currently available, advice of counsel, available insurance coverage and established reserves, Wells Fargo believes that the eventual outcome of the actions against Wells Fargo and/or its subsidiaries, including the matters described above, will not, individually or in the aggregate, have a material adverse effect on Wells Fargo’s consolidated financial position. However, in the event of unexpected future developments, it is possible that the ultimate resolution of those matters, if unfavorable, may be material to Wells Fargo’s results of operations for any particular period.

 

 

 

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Note 12: Derivatives

 

 

We primarily use derivatives to manage exposure to market risk, interest rate risk, credit risk and foreign currency risk, and to assist customers with their risk management objectives. Derivative transactions are measured in terms of the notional amount, but this amount is not recorded on the balance sheet and is not, when viewed in isolation, a meaningful measure of the risk profile of the instruments. The notional amount is generally not exchanged, but is used only as the basis on which interest and other payments are determined.

Our asset/liability management approach to interest rate, foreign currency and certain other risks includes the use of derivatives. Such derivatives are typically designated as fair value or cash flow hedges, or economic hedge derivatives for those that do not qualify for hedge accounting. This helps minimize significant, unplanned fluctuations in earnings, fair values of assets and liabilities, and cash flows caused by interest rate, foreign currency and other market value volatility. This approach involves modifying the repricing characteristics of certain assets and liabilities so that changes in interest rates, foreign currency and other exposures do not have a significantly adverse effect on the net interest margin, cash flows and earnings. As a result of fluctuations in these exposures, hedged assets and liabilities will gain or lose market value. In a fair value or economic hedge, the effect of this unrealized gain or loss will generally be offset by the gain or loss on the derivatives linked to the hedged assets and liabilities. In a cash flow hedge, where we manage the variability of cash payments due to interest rate fluctuations by the effective use of derivatives linked to hedged assets and liabilities, the unrealized gain or loss on the derivatives or the hedged asset or liability is generally not reflected in earnings.

We also offer various derivatives, including interest rate, commodity, equity, credit and foreign exchange contracts, to our customers but usually offset our exposure from such contracts by purchasing other financial contracts. The customer accommodations and any offsetting financial contracts are treated as free-standing derivatives. Free-standing derivatives also include derivatives we enter into for risk management that do not otherwise qualify for hedge accounting, including economic hedge derivatives. To a lesser extent, we take positions based on market expectations or to benefit from price differentials between financial instruments and markets. Additionally, free-standing derivatives include embedded derivatives that are required to be accounted for separately from their host contracts.

The following table presents the total notional or contractual amounts and fair values for derivatives designated as qualifying hedge contracts, which are used as asset/liability management hedges, and free-standing derivatives (economic hedges) not designated as hedging instruments that are recorded on the balance sheet in other assets or other liabilities. Customer accommodation, trading and other free-standing derivatives are recorded on the balance sheet at fair value in trading assets or other liabilities.

 

 

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Note 12: Derivatives (continued)

 

 

 

     September 30, 2012     December 31, 2011  
    

Notional or

contractual

amount

     Fair value    

Notional or

contractual

amount

     Fair value  
       

Asset

derivatives

   

Liability

derivatives

      

Asset

derivatives

   

Liability

derivatives

 
(in millions)               
   

Derivatives designated as hedging instruments

              

Interest rate contracts (1)

   $ 91,830         7,869        2,884        87,537         8,423        2,769   

Foreign exchange contracts

     26,617         1,761        177        22,269         1,523        572   

Total derivatives designated as qualifying hedging instruments

        9,630        3,061           9,946        3,341   

Derivatives not designated as hedging instruments

              

Free-standing derivatives (economic hedges):

              

Interest rate contracts (2)

     374,049         2,119        2,702        377,497         2,318        2,011   

Equity contracts

     75         -        50        -         -        -   

Foreign exchange contracts

     1,882         7        136        5,833         250        3   

Credit contracts - protection purchased

     33         -        -        125         3        -   

Other derivatives

     2,327         -        91        2,367         -        117   

Subtotal

        2,126        2,979           2,571        2,131   

Customer accommodation, trading and other free-standing derivatives:

              

Interest rate contracts

     2,799,763         70,312        71,397        2,425,144         81,336        83,834   

Commodity contracts

     91,159         3,627        3,823        77,985         4,351        4,234   

Equity contracts

     73,746         4,161        4,211        68,778         3,768        3,661   

Foreign exchange contracts

     184,871         2,707        2,274        140,704         3,151        2,803   

Credit contracts - protection sold

     28,255         321        3,257        38,403         319        5,178   

Credit contracts - protection purchased

     30,835         1,899        340        36,156         3,254        276   

Subtotal

        83,027        85,302           96,179        99,986   

Total derivatives not designated as hedging instruments

        85,153        88,281           98,750        102,117   

Total derivatives before netting

        94,783        91,342           108,696        105,458   

Netting (3)

        (64,706     (73,966        (81,143     (89,990

Total

            $ 30,077        17,376                 27,553        15,468   

 

(1) Notional amounts presented exclude $5.2 billion at September 30, 2012, and $15.5 billion at December 31, 2011, of basis swaps that are combined with receive fixed-rate/pay floating-rate swaps and designated as one hedging instrument.
(2) Includes free-standing derivatives (economic hedges) used to hedge the risk of changes in the fair value of residential MSRs, MHFS and other interests held.
(3) Represents netting of derivative asset and liability balances, and related cash collateral, with the same counterparty subject to master netting arrangements. The amount of cash collateral netted against derivative assets and liabilities was $6.6 billion and $16.4 billion, respectively, at September 30, 2012, and $6.6 billion and $15.4 billion, respectively, at December 31, 2011.

 

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Fair Value Hedges

We use interest rate swaps to convert certain of our fixed-rate long-term debt and CDs to floating rates to hedge our exposure to interest rate risk. We also enter into cross-currency swaps, cross-currency interest rate swaps and forward contracts to hedge our exposure to foreign currency risk and interest rate risk associated with the issuance of non-U.S. dollar denominated long-term debt. In addition, we use interest rate swaps, cross-currency swaps, cross-currency interest rate swaps and forward contracts to hedge against changes in fair value of certain investments in available-for-sale debt securities due to changes in interest rates, foreign currency rates, or both. We also use interest rate swaps to hedge against changes in fair value for certain mortgages held for sale. The entire derivative gain or loss is included in the assessment of hedge effectiveness for all fair value hedge relationships, except for those involving foreign-currency denominated securities available for sale and long-term

debt hedged with foreign currency forward derivatives for which the component of the derivative gain or loss related to the changes in the difference between the spot and forward price is excluded from the assessment of hedge effectiveness.

We use statistical regression analysis to assess hedge effectiveness, both at inception of the hedging relationship and on an ongoing basis. The regression analysis involves regressing the periodic change in fair value of the hedging instrument against the periodic changes in fair value of the asset or liability being hedged due to changes in the hedged risk(s). The assessment includes an evaluation of the quantitative measures of the regression results used to validate the conclusion of high effectiveness.

The following table shows the net gains (losses) recognized in the income statement related to derivatives in fair value hedging relationships.

 

 

 

     Interest rate
contracts hedging:
    Foreign exchange
contracts hedging:
    Total net
gains
 
(in millions)    Securities
available
for sale
    Mortgages
held for
sale
    Long-term
debt
    Securities
available
for sale
    Long-term
debt
    (losses)
on fair
value
hedges
 

Quarter ended September 30, 2012

            

Gains (losses) recorded in net interest income

   $ (115     -        415        -        55        355   

Gains (losses) recorded in noninterest income

            

Recognized on derivatives

     (19     (7     (67     (115     502        294   

Recognized on hedged item

     24        4        26        130        (515     (331

Recognized on fair value hedges (ineffective portion) (1)

   $ 5        (3     (41     15        (13     (37

Quarter ended September 30, 2011

            

Gains (losses) recorded in net interest income

   $ (123     -        413        (4     104        390   

Gains (losses) recorded in noninterest income

            

Recognized on derivatives

     (1,163     (20     2,651        44        (1,118     394   

Recognized on hedged item

     1,166        17        (2,477     (45     1,151        (188

Recognized on fair value hedges (ineffective portion) (1)

   $ 3        (3     174        (1     33        206   

Nine months ended September 30, 2012

            

Gains (losses) recorded in net interest income

   $ (340     1        1,281        (4     186        1,124   

Gains (losses) recorded in noninterest income

            

Recognized on derivatives

     (229     (13     267        71        351        447   

Recognized on hedged item

     222        6        (186     (32     (393     (383

Recognized on fair value hedges (ineffective portion) (1)

   $ (7     (7     81        39        (42     64   

Nine months ended September 30, 2011

            

Gains (losses) recorded in net interest income

   $ (336     -        1,264        (8     299        1,219   

Gains (losses) recorded in noninterest income

            

Recognized on derivatives

     (1,274     (20     2,742        90        477        2,015   

Recognized on hedged item

     1,208        17        (2,564     (96     (478     (1,913

Recognized on fair value hedges (ineffective portion) (1)

   $ (66     (3     178        (6     (1     102   

 

(1) The third quarter and first nine months of 2012 included $(3) million and $(5) million, respectively, and the third quarter and first nine months of 2011 included $20 million and $50 million, respectively, of gains (losses) on forward derivatives hedging foreign currency securities available for sale and long-term debt, representing the portion of derivative gains (losses) excluded from the assessment of hedge effectiveness (time value).

 

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Note 12: Derivatives (continued)

 

Cash Flow Hedges

We hedge floating-rate debt against future interest rate increases by using interest rate swaps, caps, floors and futures to limit variability of cash flows due to changes in the benchmark interest rate. We also use interest rate swaps and floors to hedge the variability in interest payments received on certain floating-rate commercial loans, due to changes in the benchmark interest rate. Gains and losses on derivatives that are reclassified from OCI to interest income and interest expense in the current period are included in the line item in which the hedged item’s effect on earnings is recorded. All parts of gain or loss on these derivatives are included in the assessment of hedge effectiveness. We assess hedge effectiveness using regression analysis, both at inception of the hedging relationship and on an ongoing basis. The regression analysis involves regressing the periodic changes in cash flows of the hedging instrument against the periodic

changes in cash flows of the forecasted transaction being hedged due to changes in the hedged risk(s). The assessment includes an evaluation of the quantitative measures of the regression results used to validate the conclusion of high effectiveness.

Based upon current interest rates, we estimate that $381 million (pre tax) of deferred net gains on derivatives in OCI at September 30, 2012, will be reclassified into interest income and interest expense during the next twelve months. Future changes to interest rates may significantly change actual amounts reclassified to earnings. We are hedging our exposure to the variability of future cash flows for all forecasted transactions for a maximum of 6 years for both hedges of floating-rate debt and floating-rate commercial loans.

The following table shows the net gains (losses) recognized related to derivatives in cash flow hedging relationships.

 

 

 

 

 

 
    Quarter ended September 30,     Nine months ended September 30,  
(in millions)             2012               2011               2012               2011  

Gains (pre tax) recognized in OCI on derivatives

  $ 24        68        63        205   

Gains (pre tax) reclassified from cumulative OCI into net interest income

    89        141        295        454   

Losses (pre tax) recognized in noninterest income on derivatives (1)

    (1     (4     (2     (6

 

 

 

(1) None of the change in value of the derivatives was excluded from the assessment of hedge effectiveness.

 

Free-Standing Derivatives

We use free-standing derivatives (economic hedges), in addition to debt securities available for sale, to hedge the risk of changes in the fair value of certain residential MHFS, certain loans held for investment, residential MSRs measured at fair value, derivative loan commitments and other interests held. The resulting gain or loss on these economic hedges is reflected in mortgage banking noninterest income and other noninterest income. Changes in fair value of debt securities available for sale (unrealized gains and losses) are not included in servicing income, but are reported in cumulative OCI (net of tax) or, upon sale, are reported in net gains (losses) on debt securities available for sale.

The derivatives used to hedge MSRs measured at fair value, which include swaps, swaptions, constant maturity mortgages, forwards, Eurodollar and Treasury futures and options contracts, resulted in net derivative gains of $1.6 billion and $3.7 billion, respectively, in the third quarter and first nine months of 2012 and net derivative gains of $3.2 billion and $4.6 billion, respectively, in the same periods of 2011, which are included in mortgage banking noninterest income. The aggregate fair value of these derivatives was a net asset of $1.1 billion at September 30, 2012, and a net asset of $1.4 billion at December 31, 2011. The change in fair value of these derivatives for each period end is due to changes in the underlying market indices and interest rates as well as the purchase and sale of derivative financial instruments throughout the period as part of our dynamic MSR risk management process.

Interest rate lock commitments for residential mortgage loans that we intend to sell are considered free-standing derivatives. Our interest rate exposure on these derivative loan commitments, as well as substantially all residential MHFS, is

hedged with free-standing derivatives (economic hedges) such as swaps, forwards and options, Eurodollar futures and options, and Treasury futures, forwards and options contracts. The commitments, free-standing derivatives and residential MHFS are carried at fair value with changes in fair value included in mortgage banking noninterest income. For the fair value measurement of interest rate lock commitments we include, at inception and during the life of the loan commitment, the expected net future cash flows related to the associated servicing of the loan. Fair value changes subsequent to inception are based on changes in fair value of the underlying loan resulting from the exercise of the commitment and changes in the probability that the loan will not fund within the terms of the commitment (referred to as a fall-out factor). The value of the underlying loan is affected primarily by changes in interest rates and the passage of time. However, changes in investor demand can also cause changes in the value of the underlying loan value that cannot be hedged. The aggregate fair value of derivative loan commitments in the balance sheet was a net asset of $1.2 billion at September 30, 2012, and a net asset of $478 million at December 31, 2011, and is included in the caption “Interest rate contracts” under “Customer accommodation, trading and other free-standing derivatives” in the first table in this Note.

We also enter into various derivatives primarily to provide derivative products to customers. To a lesser extent, we take positions based on market expectations or to benefit from price differentials between financial instruments and markets. These derivatives are not linked to specific assets and liabilities in the balance sheet or to forecasted transactions in an accounting hedge relationship and, therefore, do not qualify for hedge accounting. We also enter into free-standing derivatives for risk management that do not otherwise qualify for hedge accounting. They are carried at fair value with changes in fair value recorded as other noninterest income.

 

 

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Free-standing derivatives also include embedded derivatives that are required to be accounted for separately from their host contract. We periodically issue hybrid long-term notes and CDs where the performance of the hybrid instrument notes is linked to an equity, commodity or currency index, or basket of such indices. These notes contain explicit terms that affect some or all of the cash flows or the value of the note in a manner similar to a derivative instrument and therefore are considered to contain an “embedded” derivative instrument. The indices on which the performance of the hybrid instrument is calculated are not

clearly and closely related to the host debt instrument. The “embedded” derivative is separated from the host contract and accounted for as a free-standing derivative. Additionally, we may invest in hybrid instruments that contain embedded derivatives, such as credit derivatives, that are not clearly and closely related to the host contract. In such instances, we either elect fair value option for the hybrid instrument or separate the embedded derivative from the host contract and account for the host contract and derivative separately.

The following table shows the net gains recognized in the income statement related to derivatives not designated as hedging instruments.

 

 

     
     Quarter ended Sept. 30,     Nine months ended Sept. 30,  
(in millions)    2012     2011     2012     2011  

Net gains (losses) recognized on free-standing derivatives (economic hedges):

        

Interest rate contracts

        

Recognized in noninterest income:

        

Mortgage banking (1)

   $ (1,356     277        (2,182     528   

Other (2)

     (7     (133     (40     (153

Equity contracts (2)

     -        -        1        (5

Foreign exchange contracts (2)

     (37     267        (38     (102

Credit contracts (2)

     (3     (5     (13     (13

Subtotal

     (1,403     406        (2,272     255   

Net gains (losses) recognized on customer accommodation, trading and other free-standing derivatives:

        

Interest rate contracts

        

Recognized in noninterest income:

        

Mortgage banking (3)

     2,794        1,645        6,336        2,804   

Other (4)

     136        (95     466        195   

Commodity contracts (4)

     (72     (25     (116     76   

Equity contracts (4)

     99        378        20        855   

Foreign exchange contracts (4)

     131        219        380        526   

Credit contracts (4)

     (29     (382     (18     (338

Other (4)

     -        (4     -        (5

Subtotal

     3,059        1,736        7,068        4,113   

Net gains recognized related to derivatives not designated as hedging instruments

   $ 1,656        2,142        4,796        4,368   

 

(1) Predominantly mortgage banking noninterest income including gains (losses) on the derivatives used as economic hedges of MSRs measured at fair value, interest rate lock commitments and mortgages held for sale.
(2) Predominantly included in other noninterest income.
(3) Predominantly mortgage banking noninterest income including gains (losses) on interest rate lock commitments.
(4) Predominantly included in net gains from trading activities in noninterest income.

 

Credit Derivatives

We use credit derivatives primarily to assist customers with their risk management objectives. We may also use credit derivatives in structured product transactions or liquidity agreements written to special purpose vehicles. The maximum exposure of sold credit derivatives is managed through posted collateral, purchased credit derivatives and similar products in order to achieve our desired credit risk profile. This credit risk management provides an ability to recover a significant portion of any amounts that would be paid under the sold credit derivatives. We would be required to perform under the noted credit derivatives in the event of default by the referenced obligors. Events of default include events such as bankruptcy, capital restructuring or lack of principal and/or interest payment. In certain cases, other triggers may exist, such as the

credit downgrade of the referenced obligors or the inability of the special purpose vehicle for which we have provided liquidity to obtain funding.

 

 

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Note 12: Derivatives (continued)

 

The following table provides details of sold and purchased credit derivatives.

 

   
             Notional amount         
(in millions)    Fair value
liability
     Protection
sold (A)
    

Protection
sold -

non-
investment
grade

    

Protection
purchased

with

identical
underlyings (B)

     Net
protection
sold
(A) - (B)
     Other
protection
purchased
     Range of
maturities
 

September 30, 2012

                    

Credit default swaps on:

                    

Corporate bonds

   $ 303         17,020         9,242         10,662         6,358         8,459         2012-2021   

Structured products

     2,300         3,252         2,869         1,282         1,970         740         2016-2056   

Credit protection on:

                    

Default swap index

     20         3,219         663         2,967         252         629         2012-2017   

Commercial mortgage-backed securities index

     569         1,173         360         688         485         704         2049-2052   

Asset-backed securities index

     61         67         67         6         61         133         2037-2046   

Other

     4         3,524         3,524         143         3,381         4,271         2012-2056   

Total credit derivatives

   $       3,257         28,255         16,725         15,748         12,507         14,936            

December 31, 2011

                    

Credit default swaps on:

                    

Corporate bonds

   $ 1,002         24,634         14,043         13,329         11,305         9,404         2012-2021   

Structured products

     3,308         4,691         4,300         2,194         2,497         1,335         2016-2056   

Credit protection on:

                    

Default swap index

     68         3,006         843         2,341         665         912         2012-2017   

Commercial mortgage-backed securities index

     713         1,357         458         19         1,338         1,403         2049-2052   

Asset-backed securities index

     76         83         83         8         75         116         2037-2046   

Other

     11         4,632         4,090         481         4,151         4,673         2012-2056   

Total credit derivatives

   $ 5,178         38,403         23,817         18,372         20,031         17,843            

 

Protection sold represents the estimated maximum exposure to loss that would be incurred under an assumed hypothetical circumstance, where the value of our interests and any associated collateral declines to zero, without any consideration of recovery or offset from any economic hedges. We believe this hypothetical circumstance to be an extremely remote possibility and accordingly, this required disclosure is not an indication of expected loss. The amounts under non-investment grade represent the notional amounts of those credit derivatives on which we have a higher risk of being required to perform under the terms of the credit derivative and are a function of the underlying assets.

We consider the risk of performance to be high if the underlying assets under the credit derivative have an external rating that is below investment grade or an internal credit default grade that is equivalent thereto. We believe the net protection sold, which is representative of the net notional amount of protection sold and purchased with identical underlyings, in combination with other protection purchased, is more representative of our exposure to loss than either non-investment grade or protection sold. Other protection purchased represents additional protection, which may offset the exposure to loss for protection sold, that was not purchased with an identical underlying of the protection sold.

 

 

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Credit-Risk Contingent Features

Certain of our derivative contracts contain provisions whereby if the credit rating of our debt were to be downgraded by certain major credit rating agencies, the counterparty could demand additional collateral or require termination or replacement of derivative instruments in a net liability position. The aggregate fair value of all derivative instruments with such credit-risk-related contingent features that are in a net liability position was $17.6 billion at September 30, 2012, and $17.1 billion at December 31, 2011, respectively, for which we posted $15.7 billion and $15.0 billion, respectively, in collateral in the normal course of business. If the credit rating of our debt had been downgraded below investment grade, which is the credit-risk-related contingent feature that if triggered requires the maximum amount of collateral to be posted, on September 30, 2012, or December 31, 2011, we would have been required to post additional collateral of $1.9 billion or $2.1 billion, respectively, or potentially settle the contract in an amount equal to its fair value.

Counterparty Credit Risk

By using derivatives, we are exposed to counterparty credit risk if counterparties to the derivative contracts do not perform as expected. If a counterparty fails to perform, our counterparty credit risk is equal to the amount reported as a derivative asset on our balance sheet. The amounts reported as a derivative asset are derivative contracts in a gain position, and to the extent subject to master netting arrangements, net of derivatives in a loss position with the same counterparty and cash collateral received. We minimize counterparty credit risk through credit approvals, limits, monitoring procedures, executing master netting arrangements and obtaining collateral, where appropriate. To the extent the master netting arrangements and other criteria meet the applicable requirements, derivatives balances and related cash collateral amounts are shown net in the balance sheet. Counterparty credit risk related to derivatives is considered in determining fair value and our assessment of hedge effectiveness.

 

 

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Note 13: Fair Values of Assets and Liabilities

 

 

We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Trading assets, securities available for sale, derivatives, substantially all residential MHFS, certain commercial LHFS, certain loans held for investment, fair value MSRs and securities sold but not yet purchased (short sale liabilities) are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets on a nonrecurring basis, such as certain residential and commercial MHFS, certain LHFS, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets.

Fair Value Hierarchy

We group our assets and liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

 

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

 

Level 3 – Valuation is generated from techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

In the determination of the classification of financial instruments in Level 2 or Level 3 of the fair value hierarchy, we consider all available information, including observable market data, indications of market liquidity and orderliness, and our understanding of the valuation techniques and significant inputs used. For securities in inactive markets, we use a predetermined percentage to evaluate the impact of fair value adjustments derived from weighting both external and internal indications of value to determine if the instrument is classified as Level 2 or Level 3. Based upon the specific facts and circumstances of each instrument or instrument category, we make judgments regarding the significance of the Level 3 inputs to the instruments’ fair value measurement in its entirety. If Level 3 inputs are considered significant, the instrument is classified as Level 3.

Determination of Fair Value

We base our fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We maximize the use of observable inputs and minimize

the use of unobservable inputs when developing fair value measurements.

In instances where there is limited or no observable market data, fair value measurements for assets and liabilities are based primarily upon our own estimates or combination of our own estimates and independent vendor or broker pricing, and the measurements are often calculated based on current pricing for products we offer or issue, the economic and competitive environment, the characteristics of the asset or liability and other such factors. As with any valuation technique used to estimate fair value, changes in underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values. Accordingly, these fair value estimates may not be realized in an actual sale or immediate settlement of the asset or liability.

We incorporate lack of liquidity into our fair value measurement based on the type of asset or liability measured and the valuation methodology used. For example, for certain residential MHFS and certain securities where the significant inputs have become unobservable due to illiquid markets and vendor or broker pricing is not used, we use a discounted cash flow technique to measure fair value. This technique incorporates forecasting of expected cash flows (adjusted for credit loss assumptions and estimated prepayment speeds) discounted at an appropriate market discount rate to reflect the lack of liquidity in the market that a market participant would consider. For other securities where vendor or broker pricing is used, we use either unadjusted broker quotes or vendor prices or vendor or broker prices adjusted by weighting them with internal discounted cash flow techniques to measure fair value. These unadjusted vendor or broker prices inherently reflect any lack of liquidity in the market as the fair value measurement represents an exit price from a market participant viewpoint.

Where markets are inactive and transactions are not orderly, transaction or quoted prices for assets or liabilities in inactive markets may require adjustment due to the uncertainty of whether the underlying transactions are orderly. For items that use price quotes in inactive markets, such as certain security classes within securities available for sale, we analyze the degree of market inactivity and distressed transactions to determine the appropriate adjustment to the price quotes.

The methodology used to adjust the quotes involves weighting the price quotes and results of internal pricing techniques such as the net present value of future expected cash flows (with observable inputs, where available) discounted at a rate of return market participants require. The significant inputs utilized in the internal pricing techniques, which are estimated by type of underlying collateral, include credit loss assumptions, estimated prepayment speeds and discount rates.

The more active and orderly markets for particular security classes are determined to be, the more weighting is assigned to price quotes. The less active and orderly markets are determined to be, the less weighting is assigned to price quotes. We continually assess the level and volume of market activity in our investment security classes in determining adjustments, if any, to price quotes. Given market conditions can change over time,

 

 

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our determination of which securities markets are considered active or inactive can change. If we determine a market to be inactive, the degree to which price quotes require adjustment, can also change.

Following are descriptions of the valuation methodologies used for assets and liabilities recorded at fair value on a recurring or nonrecurring basis and for estimating fair value for financial instruments not recorded at fair value.

Assets

SHORT-TERM FINANCIAL ASSETS Short-term financial assets include cash and due from banks, federal funds sold and securities purchased under resale agreements and due from customers on acceptances. These assets are carried at historical cost. The carrying amount is a reasonable estimate of fair value because of the relatively short time between the origination of the instrument and its expected realization.

TRADING ASSETS (EXCLUDING DERIVATIVES) AND SECURITIES AVAILABLE FOR SALE Trading assets and securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon various sources of market pricing. We use quoted prices in active markets, where available and classify such instruments within Level 1 of the fair value hierarchy. Examples include exchange-traded equity securities and some highly liquid government securities such as U.S. Treasuries. When instruments are traded in secondary markets and quoted market prices do not exist for such securities, we generally rely on internal valuation techniques or on prices obtained from independent pricing services or brokers (collectively, vendors) or combination thereof, and accordingly, we classify these instruments as Level 2 or 3.

Trading securities are mostly valued using trader prices that are subject to price verification procedures performed by separate internal personnel. The majority of fair values derived using internal valuation techniques are verified against multiple pricing sources, including prices obtained from independent vendors. Vendors compile prices from various sources and often apply matrix pricing for similar securities when no price is observable. We review pricing methodologies provided by the vendors in order to determine if observable market information is being used, versus unobservable inputs. When evaluating the appropriateness of an internal trader price compared with vendor prices, considerations include the range and quality of vendor prices. Vendor prices are used to ensure the reasonableness of a trader price; however valuing financial instruments involves judgments acquired from knowledge of a particular market and is not perfunctory. If a trader asserts that a vendor price is not reflective of market value, justification for using the trader price, including recent sales activity where possible, must be provided to and approved by the appropriate levels of management.

Similarly, while securities available for sale traded in secondary markets are typically valued using unadjusted vendor prices or vendor prices adjusted by weighting them with internal discounted cash flow techniques, these prices are reviewed and, if deemed inappropriate by a trader who has the most knowledge

of a particular market, can be adjusted. Securities measured with these internal valuation techniques are generally classified as Level 2 of the hierarchy and often involve using quoted market prices for similar securities, pricing models, discounted cash flow analyses using significant inputs observable in the market where available or combination of multiple valuation techniques. Examples include certain residential and commercial MBS, municipal bonds, U.S. government and agency MBS, and corporate debt securities.

Security fair value measurements using significant inputs that are unobservable in the market due to limited activity or a less liquid market are classified as Level 3 in the fair value hierarchy. Such measurements include securities valued using internal models or a combination of multiple valuation techniques such as weighting of internal models and vendor or broker pricing, where the unobservable inputs are significant to the overall fair value measurement. Securities classified as Level 3 include certain residential and commercial MBS, asset-backed securities collateralized by auto leases or loans and cash reserves, CDOs and CLOs, and certain residual and retained interests in residential mortgage loan securitizations. We value CDOs using the prices of similar instruments, the pricing of completed or pending third party transactions or the pricing of the underlying collateral within the CDO. Where vendor or broker prices are not readily available, we use management’s best estimate.

MORTGAGES HELD FOR SALE (MHFS) We carry substantially all of our residential MHFS portfolio at fair value. Fair value is based on independent quoted market prices, where available, or the prices for other mortgage whole loans with similar characteristics. As necessary, these prices are adjusted for typical securitization activities, including servicing value, portfolio composition, market conditions and liquidity. Most of our MHFS are classified as Level 2. For the portion where market pricing data is not available, we use a discounted cash flow model to estimate fair value and, accordingly, classify as Level 3.

LOANS HELD FOR SALE (LHFS) LHFS are carried at the lower of cost or market value, or at fair value. The fair value of LHFS is based on what secondary markets are currently offering for loans with similar characteristics. As such, we classify those loans subjected to nonrecurring fair value adjustments as Level 2.

LOANS For information on how we report the carrying value of loans, including PCI loans, see Note 1 in our 2011 Form 10-K. Although most loans are not recorded at fair value on a recurring basis, reverse mortgages are held at fair value on a recurring basis. In addition, we record nonrecurring fair value adjustments to loans to reflect partial write-downs that are based on the observable market price of the loan or current appraised value of the collateral.

We provide fair value estimates in this disclosure for loans that are not recorded at fair value on a recurring or nonrecurring basis. Those estimates differentiate loans based on their financial characteristics, such as product classification, loan category, pricing features and remaining maturity. Prepayment and credit loss estimates are evaluated by product and loan rate.

 

 

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The fair value of commercial loans is calculated by discounting contractual cash flows, adjusted for credit loss estimates, using discount rates that are appropriate for loans with similar characteristics and remaining maturity.

For real estate 1-4 family first and junior lien mortgages, we calculate fair value by discounting contractual cash flows, adjusted for prepayment and credit loss estimates, using discount rates based on current industry pricing (where readily available) or our own estimate of an appropriate discount rate for loans of similar size, type, remaining maturity and repricing characteristics.

The carrying value of credit card loans, which is adjusted for estimates of credit losses inherent in the portfolio at the balance sheet date, is reported as a reasonable estimate of fair value.

For all other consumer loans, the fair value is generally calculated by discounting the contractual cash flows, adjusted for prepayment and credit loss estimates, based on the current rates we offer for loans with similar characteristics.

Loan commitments, standby letters of credit and commercial and similar letters of credit generate ongoing fees at our current pricing levels, which are recognized over the term of the commitment period. In situations where the credit quality of the counterparty to a commitment has declined, we record an allowance. A reasonable estimate of the fair value of these instruments is the carrying value of deferred fees plus the related allowance. Certain letters of credit that are hedged with derivative instruments are carried at fair value in trading assets or liabilities. For those letters of credit, fair value is calculated based on readily quotable credit default spreads, using a market risk credit default swap model.

DERIVATIVES Quoted market prices are available and used for our exchange-traded derivatives, such as certain interest rate futures and option contracts, which we classify as Level 1. However, substantially all of our derivatives are traded in over-the-counter (OTC) markets where quoted market prices are not always readily available. Therefore we value most OTC derivatives using internal valuation techniques. Valuation techniques and inputs to internally-developed models depend on the type of derivative and nature of the underlying rate, price or index upon which the derivative’s value is based. Key inputs can include yield curves, credit curves, foreign-exchange rates, prepayment rates, volatility measurements and correlation of such inputs. Where model inputs can be observed in a liquid market and the model does not require significant judgment, such derivatives are typically classified as Level 2 of the fair value hierarchy. Examples of derivatives classified as Level 2 include generic interest rate swaps, foreign currency swaps, commodity swaps, and certain option and forward contracts. When instruments are traded in less liquid markets and significant inputs are unobservable, such derivatives are classified as Level 3. Examples of derivatives classified as Level 3 include complex and highly structured derivatives, certain credit default swaps, interest rate lock commitments written for our residential mortgage loans that we intend to sell and long dated equity options where volatility is not observable. Additionally, significant judgments are required when classifying financial

instruments within the fair value hierarchy, particularly between Level 2 and 3, as is the case for certain derivatives.

MORTGAGE SERVICING RIGHTS (MSRs) AND CERTAIN OTHER INTERESTS HELD IN SECURITIZATIONS MSRs and certain other interests held in securitizations (e.g., interest-only strips) do not trade in an active market with readily observable prices. Accordingly, we determine the fair value of MSRs using a valuation model that calculates the present value of estimated future net servicing income cash flows. The model incorporates assumptions that market participants use in estimating future net servicing income cash flows, including estimates of prepayment speeds (including housing price volatility), discount rate, default rates, cost to service (including delinquency and foreclosure costs), escrow account earnings, contractual servicing fee income, ancillary income and late fees. Commercial MSRs are carried at lower of cost or market value, and therefore can be subject to fair value measurements on a nonrecurring basis. Changes in the fair value of MSRs occur primarily due to the collection/realization of expected cash flows, as well as changes in valuation inputs and assumptions. For other interests held in securitizations (such as interest-only strips) we use a valuation model that calculates the present value of estimated future cash flows. The model incorporates our own estimates of assumptions market participants use in determining the fair value, including estimates of prepayment speeds, discount rates, defaults and contractual fee income. Interest-only strips are recorded as trading assets. Our valuation approach is validated by our internal valuation model validation group. Fair value measurements of our MSRs and interest-only strips use significant unobservable inputs and, accordingly, we classify them as Level 3.

FORECLOSED ASSETS Foreclosed assets are carried at net realizable value, which represents fair value less costs to sell. Fair value is generally based upon independent market prices or appraised values of the collateral and, accordingly, we classify foreclosed assets as Level 2.

NONMARKETABLE EQUITY INVESTMENTS Nonmarketable equity investments are generally recorded under the cost or equity method of accounting. There are generally restrictions on the sale and/or liquidation of these investments, including federal bank stock. Federal bank stock carrying value approximates fair value. We use facts and circumstances available to estimate the fair value of our nonmarketable equity investments. We typically consider our access to and need for capital (including recent or projected financing activity), qualitative assessments of the viability of the investee, evaluation of the financial statements of the investee and prospects for its future. Public equity investments are valued using quoted market prices and discounts are only applied when there are trading restrictions that are an attribute of the investment. We estimate the fair value of investments in non-public securities using metrics such as security prices of comparable public companies, acquisition prices for similar companies and original investment purchase price multiples, while also incorporating a portfolio company’s financial performance and specific factors.

 

 

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For investments in private equity funds, we use the NAV provided by the fund sponsor as an appropriate measure of fair value. In some cases, such NAVs require adjustments based on certain unobservable inputs.

Liabilities

DEPOSIT LIABILITIES Deposit liabilities are carried at historical cost. The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, interest-bearing checking, and market rate and other savings, is equal to the amount payable on demand at the measurement date. The fair value of other time deposits is calculated based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for like wholesale deposits with similar remaining maturities.

SHORT-TERM FINANCIAL LIABILITIES Short-term financial liabilities are carried at historical cost and include federal funds purchased and securities sold under repurchase agreements, commercial paper and other short-term borrowings. The carrying amount is a reasonable estimate of fair value because of the relatively short time between the origination of the instrument and its expected realization.

OTHER LIABILITIES Other liabilities recorded at fair value on a recurring basis, excluding derivative liabilities (see the “Derivatives” section for derivative liabilities), includes primarily short sale liabilities. Short sale liabilities are predominantly classified as either Level 1 or Level 2, generally dependent upon whether the underlying securities have readily obtainable quoted prices in active exchange markets.

LONG-TERM DEBT Long-term debt is generally carried at amortized cost. For disclosure, we are required to estimate the fair value of long-term debt. Generally, the discounted cash flow method is used to estimate the fair value of our long-term debt. Contractual cash flows are discounted using rates currently offered for new notes with similar remaining maturities and, as such, these discount rates include our current spread levels.

Level 3 Asset and Liability Valuation Processes

We generally determine fair value of our Level 3 assets and liabilities by using internally developed models and, to a lesser extent, prices obtained from independent pricing services or brokers (collectively, vendors). Our valuation processes vary depending on which approach is utilized.

INTERNAL MODEL VALUATIONS Our internally developed models primarily consist of discounted cash flow techniques. Use of such techniques requires determining relevant inputs, some of which are unobservable. Unobservable inputs are generally derived from historic performance of similar assets or determined from previous market trades in similar instruments. These unobservable inputs usually consist of discount rates, default rates, loss severity upon default, volatilities, correlations and prepayment rates, which are inherent within our Level 3 instruments. Such inputs can be correlated to similar portfolios with known historic experience or recent trades where particular

unobservable inputs may be implied; but due to the nature of various inputs being reflected within a particular trade, the value of each input is considered unobservable. We attempt to correlate each unobservable input to historic experience and other third party data where available.

Internal valuation models are subject to review prescribed within our model risk management policies and procedures which includes model validation. The purpose of model validation includes ensuring the model is appropriate for its intended use and the appropriate controls exist to help mitigate risk of invalid valuations. Model validation assesses the adequacy and appropriateness of the model, including reviewing its key components such as inputs, processing components, logic or theory, output results and supporting model documentation. Validation also includes ensuring significant unobservable model inputs are appropriate given observable market transactions or other market data within the same or similar asset classes. This ensures modeled approaches are appropriate given similar product valuation techniques and are in line with their intended purpose.

We have ongoing monitoring procedures in place for our Level 3 assets and liabilities that use such internal valuation models. These procedures, which are designed to provide reasonable assurance that models continue to perform as expected after approved, include:

   

ongoing analysis and benchmarking to market transactions and other independent market data (including pricing vendors, if available);

   

back-testing of modeled fair values to actual realized transactions; and

   

review of modeled valuation results against expectations, including review of significant or unusual value fluctuations.

We update model inputs and methodologies periodically to reflect these monitoring procedures. Additionally, procedures and controls are in place to ensure existing models are subject to periodic reviews, and we perform full model revalidations as necessary.

All internal valuation models are subject to ongoing review by business-unit-level management. More complex models are subject to additional oversight by a corporate-level risk management department. Corporate oversight responsibilities include evaluating adequacy of business unit risk management programs, maintaining company-wide model validation policies and standards and reporting the results of these activities to management and our Enterprise Risk Management Committee (ERMC). The ERMC, which consists of senior executive management and reports on top risks to the Company’s Board of Directors, monitors all company-wide risks, including credit risk, market risk, and reputational risk.

VENDOR-DEVELOPED VALUATIONS In certain limited circumstances we obtain pricing from third party vendors for the value of our Level 3 assets or liabilities. We have processes in place to approve such vendors to ensure information obtained and valuation techniques used are appropriate. Once these vendors are approved to provide pricing information, we

 

 

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monitor and review the results to ensure the fair values are reasonable and in line with market experience in similar asset classes. While the input amounts used by the pricing vendor in determining fair value are not provided, and therefore unavailable for our review, we do perform one or more of the following procedures to validate the prices received:

   

comparison to other pricing vendors (if available);

   

variance analysis of prices;

   

corroboration of pricing by reference to other independent market data such as market transactions and relevant benchmark indices;

   

review of pricing by Company personnel familiar with market liquidity and other market-related conditions; and

   

investigation of prices on a specific instrument-by-instrument basis.

Fair Value Measurements from Independent Brokers or Independent Third Party Pricing Services For certain assets and liabilities, we obtain fair value measurements from independent brokers or independent third party pricing services and record the unadjusted fair value in our financial statements. The detail by level is shown in the table below. Fair value measurements obtained from independent brokers or independent third party pricing services that we have adjusted to determine the fair value recorded in our financial statements are not included in the following table.

 

 

      Independent brokers      Third party pricing services  
(in millions)    Level 1      Level 2      Level 3      Level 1      Level 2      Level 3  

September 30, 2012

                 

Trading assets (excluding derivatives)

   $ -         469         8         1,289         1,053         -   

Securities available for sale:

                 

Securities of U.S. Treasury and federal agencies

     -         -         -         957         911         -   

Securities of U.S. states and political subdivisions

     -         -         -         -         33,582         -   

Mortgage-backed securities

     -         335         2         -         131,514         177   

Other debt securities

     -         2,421         9,674         -         25,797         285   

Total debt securities

     -         2,756         9,676         957         191,804         462   

Total marketable equity securities

     -         -         -         31         663         -   

Total securities available for sale

     -         2,756         9,676         988         192,467         462   

Derivatives (trading and other assets)

     -         8         -         -         634         1   

Loans held for sale

     -         -         -         -         1         -   

Derivatives (liabilities)

     -         34         -         -         627         -   

Other liabilities

     -         92         -         -         184         -   
                                                       

December 31, 2011

                 

Trading assets (excluding derivatives)

   $ -         446         7         1,086         1,564         -   

Securities available for sale:

                 

Securities of U.S. Treasury and federal agencies

     -         -         -         868         5,748         -   

Securities of U.S. states and political subdivisions

     -         16         -         -         21,014         -   

Mortgage-backed securities

     -         2,342         43         -         118,107         186   

Other debt securities

     -         1,091         8,163         -         26,222         145   

Total debt securities

     -         3,449         8,206         868         171,091         331   

Total marketable equity securities

     -         -         -         33         665         3   

Total securities available for sale

     -         3,449         8,206         901         171,756         334   

Derivatives (trading and other assets)

     -         17         44         -         834         -   

Loans held for sale

     -         -         -         -         1         -   

Derivatives (liabilities)

     -         11         43         -         850         -   

Other liabilities

     -         22         -         6         249         -   
                                                       

 

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Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The following two tables present the balances of assets and liabilities measured at fair value on a recurring basis.

 

 

           
(in millions)    Level 1     Level 2     Level 3     Netting     Total  

September 30, 2012

          

Trading assets (excluding derivatives)

          

Securities of U.S. Treasury and federal agencies

   $ 5,127        3,904        -        -        9,031   

Securities of U.S. states and political subdivisions

     -        2,671        61        -        2,732   

Collateralized debt obligations (1)

     -        -        1,075        -        1,075   

Corporate debt securities

     15        6,169        42        -        6,226   

Mortgage-backed securities

     -        13,883        44        -        13,927   

Asset-backed securities

     -        517        172        -        689   

Equity securities

     3,905        227        3        -        4,135   

Total trading securities

     9,047        27,371        1,397        -        37,815   

Other trading assets

     2,114        341        82        -        2,537   

Total trading assets (excluding derivatives)

     11,161        27,712        1,479        -        40,352   

Securities of U.S. Treasury and federal agencies

     957        912        -        -        1,869   

Securities of U.S. states and political subdivisions

     -        33,713        4,212  (2)      -        37,925   

Mortgage-backed securities:

          

Federal agencies

     -        102,713        -        -        102,713   

Residential

     -        16,536        2        -        16,538   

Commercial

     -        19,381        179        -        19,560   

Total mortgage-backed securities

     -        138,630        181        -        138,811   

Corporate debt securities

     126        19,916        221        -        20,263   

Collateralized debt obligations (3)

     -        -        10,225  (2)      -        10,225   

Asset-backed securities:

          

Auto loans and leases

     -        7        5,487  (2)      -        5,494   

Home equity loans

     -        783        97        -        880   

Other asset-backed securities

     -        7,175        2,923  (2)      -        10,098   

Total asset-backed securities

     -        7,965        8,507        -        16,472   

Other debt securities

     -        1,033        -        -        1,033   

Total debt securities

     1,083        202,169        23,346        -        226,598   

Marketable equity securities:

          

Perpetual preferred securities (4)

     631        637        849  (2)      -        2,117   

Other marketable equity securities

     578        57        -        -        635   

Total marketable equity securities

     1,209        694        849        -        2,752   

Total securities available for sale

     2,292        202,863        24,195        -        229,350   

Mortgages held for sale

     -        43,268        3,307        -        46,575   

Loans held for sale

     -        172        -        -        172   

Loans

     -        175        6,013        -        6,188   

Mortgage servicing rights (residential)

     -        -        10,956        -        10,956   

Derivative assets:

          

Interest rate contracts

     -        78,490        1,810        -        80,300   

Commodity contracts

     -        3,539        88        -        3,627   

Equity contracts

     634        2,763        764        -        4,161   

Foreign exchange contracts

     41        4,409        25        -        4,475   

Credit contracts

     -        1,291        929        -        2,220   

Other derivative contracts

     -        -        -        -        -   

Netting

     -        -        -        (64,706 (5)      (64,706

Total derivative assets (6)

     675        90,492        3,616        (64,706     30,077   

Other assets

     87        54        193        -        334   

Total assets recorded at fair value

   $     14,215        364,736        49,759        (64,706     364,004   

Derivative liabilities:

          

Interest rate contracts

   $ (3     (76,563     (417     -        (76,983

Commodity contracts

     -        (3,763     (60     -        (3,823

Equity contracts

     (239     (3,066     (956     -        (4,261

Foreign exchange contracts

     (47     (2,537     (3     -        (2,587

Credit contracts

     -        (1,287     (2,310     -        (3,597

Other derivative contracts

     -        -        (91     -        (91

Netting

     -        -        -        73,966  (5)      73,966   

Total derivative liabilities (6)

     (289     (87,216     (3,837     73,966        (17,376

Short sale liabilities:

          

Securities of U.S. Treasury and federal agencies

     (3,088     (943     -        -        (4,031

Securities of U.S. states and political subdivisions

     -        (16     -        -        (16

Corporate debt securities

     (58     (4,205     -        -        (4,263

Equity securities

     (1,255     -        -        -        (1,255

Other securities

     -        (70     -        -        (70

Total short sale liabilities

     (4,401     (5,234     -        -        (9,635

Other liabilities

     -        (34     (253     -        (287

Total liabilities recorded at fair value

   $ (4,690     (92,484     (4,090     73,966        (27,298

 

(1) Includes collateralized loan obligations of $666 million that are classified as trading assets.
(2) Balances consist of securities that are predominantly investment grade based on ratings received from the ratings agencies or internal credit grades categorized as investment grade if external ratings are not available. The securities are classified as Level 3 due to limited market activity.
(3) Includes collateralized loan obligations of $9.7 billion that are classified as securities available for sale.
(4) Perpetual preferred securities include ARS and corporate preferred securities. See Note 7 for additional information.
(5) Derivatives are reported net of cash collateral received and paid and, to the extent that the criteria of the accounting guidance covering the offsetting of amounts related to certain contracts are met, positions with the same counterparty are netted as part of a legally enforceable master netting agreement.
(6) Derivative assets and derivative liabilities include contracts qualifying for hedge accounting, economic hedges, and derivatives included in trading assets and trading liabilities, respectively.

(continued on following page)

 

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(continued from previous page)

 

(in millions)    Level 1     Level 2     Level 3     Netting     Total  

December 31, 2011

          

Trading assets (excluding derivatives)

          

Securities of U.S. Treasury and federal agencies

   $ 3,342        3,638        -        -        6,980   

Securities of U.S. states and political subdivisions

     -        2,438        53        -        2,491   

Collateralized debt obligations (1)

     -        -        1,582        -        1,582   

Corporate debt securities

     -        6,479        97        -        6,576   

Mortgage-backed securities

     -        34,959        108        -        35,067   

Asset-backed securities

     -        1,093        190        -        1,283   

Equity securities

     1,682        172        4        -        1,858   

Total trading securities

     5,024        48,779        2,034        -        55,837   

Other trading assets

     1,847        68        115        -        2,030   

Total trading assets (excluding derivatives)

     6,871        48,847        2,149        -        57,867   

Securities of U.S. Treasury and federal agencies

     869        6,099        -        -        6,968   

Securities of U.S. states and political subdivisions

     -        21,077        11,516  (2)      -        32,593   

Mortgage-backed securities:

          

Federal agencies

     -        96,754        -        -        96,754   

Residential

     -        17,775        61        -        17,836   

Commercial

     -        17,918        232        -        18,150   

Total mortgage-backed securities

     -        132,447        293        -        132,740   

Corporate debt securities

     317        17,792        295        -        18,404   

Collateralized debt obligations (3)

     -        -        8,599  (2)      -        8,599   

Asset-backed securities:

          

Auto loans and leases

     -        86        6,641  (2)      -        6,727   

Home equity loans

     -        650        282        -        932   

Other asset-backed securities

     -        8,326        2,863  (2)      -        11,189   

Total asset-backed securities

     -        9,062        9,786        -        18,848   

Other debt securities

     -        1,044        -        -        1,044   

Total debt securities

     1,186        187,521        30,489        -        219,196   

Marketable equity securities:

          

Perpetual preferred securities (4)

     552        631        1,344  (2)      -        2,527   

Other marketable equity securities

     814        53        23        -        890   

Total marketable equity securities

     1,366        684        1,367        -        3,417   

Total securities available for sale

     2,552        188,205        31,856        -        222,613   

Mortgages held for sale

     -        41,381        3,410        -        44,791   

Loans held for sale

     -        1,176        -        -        1,176   

Loans

     -        5,893        23        -        5,916   

Mortgage servicing rights (residential)

     -        -        12,603        -        12,603   

Derivative assets:

          

Interest rate contracts

     -        91,022        1,055        -        92,077   

Commodity contracts

     -        4,351        -        -        4,351   

Equity contracts

     471        2,737        560        -        3,768   

Foreign exchange contracts

     35        4,873        16        -        4,924   

Credit contracts

     -        2,219        1,357        -        3,576   

Other derivative contracts

     -        -        -        -        -   

Netting

     -        -        -        (81,143 ) (5)      (81,143

Total derivative assets (6)

     506        105,202        2,988        (81,143     27,553   

Other assets

     88        135        244        -        467   

Total assets recorded at fair value

   $     10,017        390,839        53,273        (81,143     372,986   

Derivative liabilities:

          

Interest rate contracts

   $ (4     (88,164     (446     -        (88,614

Commodity contracts

     -        (4,234     -        -        (4,234

Equity contracts

     (229     (2,797     (635     -        (3,661

Foreign exchange contracts

     (31     (3,324     (23     -        (3,378

Credit contracts

     -        (2,099     (3,355     -        (5,454

Other derivative contracts

     -        -        (117     -        (117

Netting

     -        -        -        89,990  (5)      89,990   

Total derivative liabilities (6)

     (264     (100,618     (4,576     89,990        (15,468

Short sale liabilities:

          

Securities of U.S. Treasury and federal agencies

     (3,820     (919     -        -        (4,739

Securities of U.S. states and political subdivisions

     -        (2     -        -        (2

Corporate debt securities

     -        (4,112     -        -        (4,112

Equity securities

     (944     (298     -        -        (1,242

Other securities

     -        (737     -        -        (737

Total short sale liabilities

     (4,764     (6,068     -        -        (10,832

Other liabilities

     -        (98     (44     -        (142

Total liabilities recorded at fair value

   $ (5,028     (106,784     (4,620     89,990        (26,442

 

(1) Includes collateralized loan obligations of $583 million that are classified as trading assets.
(2) Balances consist of securities that are predominantly investment grade based on ratings received from the ratings agencies or internal credit grades categorized as investment grade if external ratings are not available. The securities are classified as Level 3 due to limited market activity.
(3) Includes collateralized loan obligations of $8.1 billion that are classified as securities available for sale.
(4) Perpetual preferred securities include ARS and corporate preferred securities. See Note 7 for additional information.
(5) Derivatives are reported net of cash collateral received and paid and, to the extent that the criteria of the accounting guidance covering the offsetting of amounts related to certain contracts are met, positions with the same counterparty are netted as part of a legally enforceable master netting agreement.
(6) Derivative assets and derivative liabilities include contracts qualifying for hedge accounting, economic hedges, and derivatives included in trading assets and trading liabilities, respectively.

 

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Changes in Fair Value Levels

We monitor the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy and transfer between Level 1, Level 2, and Level 3 accordingly. Observable market data includes but is not limited to quoted prices and market transactions. Changes in economic conditions or market liquidity generally will drive changes in availability of observable market data. Changes in

availability of observable market data, which also may result in changing the valuation technique used, are generally the cause of transfers between Level 1, 2 or 3.

All current period transfers into and out of Level 1, Level 2, and Level 3 are provided within the below table. The amounts reported as transfers represent the fair value as of the beginning of the quarter in which the transfer occurred.

 

 

      Transfers Between Fair Value Levels  
     Level 1      Level 2     Level 3 (1)        

(in millions)

     In        Out         In         Out        In        Out        Total   

Quarter ended September 30, 2012

                

Trading securities

   $ 23        -         6         (23     -        (6     -   

Securities available for sale (2)

     -        -         5,417         (16     16        (5,417     -   

Mortgages held for sale

     -        -         79         (127     127        (79     -   

Loans (3)

     -        -         -         (5,851     5,851        -        -   

Net derivative assets and liabilities

     -        -         84         -        -        (84     -   

Short sale liabilities

     (29     -         -         29        -        -        -   

Total transfers

   $ (6     -         5,586         (5,988     5,994        (5,586     -   

Nine months ended September 30, 2012

                

Trading securities

   $     23        -         16         (37     14        (16     -   

Securities available for sale (2)

     -        -         9,453         (73     73        (9,453     -   

Mortgages held for sale

     -        -         229         (298     298        (229     -   

Loans (3)

     -        -         -         (5,851     5,851        -        -   

Net derivative assets and liabilities

     -        -         97         8        (8     (97     -   

Short sale liabilities

     (29     -         -         29        -        -        -   

Total transfers

   $ (6     -         9,795         (6,222     6,228        (9,795     -   

 

(1) All transfers in and out of Level 3 are disclosed within the recurring level 3 rollforward table in this Note.
(2) Includes $5.2 billion and $9.1 billion of securities of U.S. states and political subdivisions that we transferred from Level 3 to Level 2 in the third quarter and first nine months of 2012, respectively, as a result of increased observable market data in the valuation of such instruments. This transfer was done in conjunction with a change in our valuation technique from an internal model based upon unobservable inputs to third party vendor pricing based upon market observable data.
(3) Consists of reverse mortgage loans securitized with GNMA which were accounted for as secured borrowing transactions. We transferred the loans from Level 2 to Level 3 in third quarter 2012 due to decreased market activity and visibility to significant trades of the same or similar products. As a result, we changed our valuation technique from an internal model based on market observable data to an internal discounted cash flow model based on unobservable inputs.

 

For the first nine months of 2011, there were no significant transfers between Levels 1 and 2. We transferred $612 million of debt securities available for sale from Level 3 to Level 2 due to an increase in the volume of trading activity for certain securities, which resulted in increased occurrences of observable market prices. We also transferred $434 million of securities available for sale from Level 2 to Level 3 primarily due to a decrease in liquidity for certain asset-backed securities.

 

 

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Note 13: Fair Values of Assets and Liabilities (continued)

 

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the quarter ended September 30, 2012, are summarized as follows:

 

           

Total net gains

(losses) included in

   

Purchases,
sales,

                         Net unrealized
gains (losses)
included in
 
(in millions)   Balance,
beginning
of period
    Net
income
    Other
compre-
hensive
income
   

issuances
and

settlements,

net (1)

    Transfers
into
Level 3
    Transfers
out of
Level 3
    Balance,
end of
period
    income related
to assets and
liabilities held
at period end  (2)
 

Quarter ended September 30, 2012

               

Trading assets

               

(excluding derivatives):

               

Securities of U.S. states and
political subdivisions

  $ 58        2        -        1        -        -        61        -   

Collateralized debt obligations

    1,273        (224     -        26        -        -        1,075        (246

Corporate debt securities

    56        -        -        (14     -        -        42        (2

Mortgage-backed securities

    93        -        -        (59     -        10        44        -   

Asset-backed securities

    179        18        -        (9     -        (16     172        13   

Equity securities

    3        -        -        -        -        -        3        -   

Total trading securities

    1,662        (204     -        (55     -        (6     1,397        (235

Other trading assets

    91        (9     -        -        -        -        82        (7

Total trading assets
(excluding derivatives)

    1,753        (213     -        (55     -        (6     1,479        (242 )(3) 

Securities available for sale:

               

Securities of U.S. states and political subdivisions

    9,505        13        (6     (136     14        (5,178     4,212        -   

Mortgage-backed securities:

               

Residential

    15        -        -        -        -        (13     2        -   

Commercial

    189        (3     (2     (5     -        -        179        (3

Total mortgage-backed securities

    204        (3     (2     (5     -        (13     181        (3

Corporate debt securities

    286        14        -        (38     -        (41     221        -   

Collateralized debt obligations

    9,147        27        210        841        -        -        10,225        -   

Asset-backed securities:

               

Auto loans and leases

    6,206        -        (2     (717     -        -        5,487        -   

Home equity loans

    257        3        (3     -        2        (162     97        -   

Other asset-backed securities

    3,074        (5     34        (157     -        (23     2,923        (6

Total asset-backed securities

    9,537        (2     29        (874     2        (185     8,507        (6

Total debt securities

    28,679        49        231        (212     16        (5,417     23,346        (9 )(4) 

Marketable equity securities:

               

Perpetual preferred securities

    927        14        (4     (88     -        -        849        -   

Other marketable equity securities

    2        1        -        (3     -        -        -        -   

Total marketable equity securities

    929        15        (4     (91     -        -        849        - (5) 

Total securities available for sale

    29,608        64        227        (303     16        (5,417     24,195        (9

Mortgages held for sale

    3,328        38        -        (107     127        (79     3,307        37 (6) 

Loans

    24        59        -        79        5,851        -        6,013        59 (6) 

Mortgage servicing rights

    12,081        (2,298     -        1,173        -        -        10,956        (1,427 )(6) 

Net derivative assets and liabilities:

               

Interest rate contracts

    906        2,879        -        (2,392     -        -        1,393        1,248   

Commodity contracts

    4        48        -        (21     -        (3     28        21   

Equity contracts

    (269     25        -        133        -        (81     (192     1   

Foreign exchange contracts

    1        19        -        2        -        -        22        21   

Credit contracts

    (1,657     (15     -        291        -        -        (1,381     (2

Other derivative contracts

    (106     15        -        -        -        -        (91     -   

Total derivative contracts

    (1,121     2,971        -        (1,987     -        (84     (221     1,289 (7) 

Other assets

    225        (10     -        (22     -        -        193        (8 )(3) 

Short sale liabilities

    (9     -        -        9        -        -        -        - (3) 

Other liabilities (excluding derivatives)

    (245     (17     -        9        -        -        (253     - (6) 

 

 

(1) See next page for detail.
(2) Represents only net gains (losses) that are due to changes in economic conditions and management’s estimates of fair value and excludes changes due to the collection/realization of cash flows over time.
(3) Included in trading activities and other noninterest income in the income statement.
(4) Included in debt securities available for sale in the income statement.
(5) Included in equity investments in the income statement.
(6) Included in mortgage banking and other noninterest income in the income statement.
(7) Included in mortgage banking, trading activities and other noninterest income in the income statement.

 

(continued on following page)

 

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(continued from previous page)

 

The following table presents gross purchases, sales, issuances and settlements related to the changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the quarter ended September 30, 2012.

 

           
(in millions)    Purchases     Sales     Issuances     Settlements     Net  

Quarter ended September 30, 2012

          

Trading assets

          

(excluding derivatives):

          

Securities of U.S. states and political subdivisions

   $ 5        (4     -        -        1   

Collateralized debt obligations

     271        (245     -        -        26   

Corporate debt securities

     -        (14     -        -        (14

Mortgage-backed securities

     -        (59     -        -        (59

Asset-backed securities

     6        (3     -        (12     (9

Equity securities

     -        -        -        -        -   

Total trading securities

     282        (325     -        (12     (55

Other trading assets

     -        -        -        -        -   

Total trading assets

          

    (excluding derivatives)

     282        (325     -        (12     (55

Securities available for sale:

          

Securities of U.S. states and

     199        (35     65        (365     (136

political subdivisions

          

Mortgage-backed securities:

          

Residential

     -        -        -        -        -   

Commercial

     -        -        -        (5     (5

Total mortgage-backed securities

     -        -        -        (5     (5

Corporate debt securities

     -        (37     -        (1     (38

Collateralized debt obligations

     1,188        -        -        (347     841   

Asset-backed securities:

          

Auto loans and leases

     -        -        180        (897     (717

Home equity loans

     -        -        -        -        -   

Other asset-backed securities

     94        (38     270        (483     (157

Total asset-backed securities

     94        (38     450        (1,380     (874

Total debt securities

     1,481        (110     515        (2,098     (212

Marketable equity securities:

          

Perpetual preferred securities

     -        -        -        (88     (88

Other marketable equity securities

     -        (3     -        -        (3

Total marketable equity securities

     -        (3     -        (88     (91

  Total securities available for sale

     1,481        (113     515        (2,186     (303

Mortgages held for sale

     100        -        -        (207     (107

Loans

     -        -        129        (50     79   

Mortgage servicing rights

     -        -        1,173        -        1,173   

Net derivative assets and liabilities:

          

 Interest rate contracts

     28        (22     -        (2,398     (2,392

 Commodity contracts

     22        (8     -        (35     (21

 Equity contracts

     13        49        1        70        133   

 Foreign exchange contracts

     -        -        -        2        2   

 Credit contracts

     -        -        -        291        291   

 Other derivative contracts

     -        -        -        -        -   

Total derivative contracts

     63        19        1        (2,070     (1,987

Other assets

     -        (5     -        (17     (22

Short sale liabilities

     9        -        -        -        9   

Other liabilities (excluding derivatives)

     (2     1        (8     18        9   

 

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Note 13: Fair Values of Assets and Liabilities (continued)

 

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the quarter ended September 30, 2011, are summarized as follows:

 

             Total net gains
(losses) included in
    Purchases,
sales,
                         Net unrealized
gains (losses)
included in
 
(in millions)    Balance,
beginning
of period
    Net
income
    Other
compre-
hensive
income
    issuances
and
settlements,
net (1)
    Transfers
into
Level 3
    Transfers
out of
Level 3
    Balance,
end of
period
    income related
to assets and
liabilities held
at period end (2)
 

Quarter ended September 30, 2011

                

Trading assets

                

(excluding derivatives):

                

Securities of U.S. states and political subdivisions

   $ 135        1        -        45        -        -        181        -   

Collateralized debt obligations

     1,801        (16     -        (168     -        -        1,617        (41

Corporate debt securities

     103        3        -        (10     -        -        96        1   

Mortgage-backed securities

     223        1        -        (100     -        -        124        (2

Asset-backed securities

     181        35        -        (18     -        -        198        29   

Equity securities

     4        (3     -        3        -        -        4        (2

Total trading securities

     2,447        21        -        (248     -        -        2,220        (15

Other trading assets

     144        (16     -        -        -        (2     126        (9

Total trading assets
(excluding derivatives)

     2,591        5        -        (248     -        (2     2,346        (24 )(3) 

Securities available for sale:

                

Securities of U.S. states and political subdivisions

     6,695        3        28        752        -        -        7,478        1   

Mortgage-backed securities:

                

Residential

     6        (4     (1     (3     80        (2     76        (5

Commercial

     282        (20     (8     (11     -        -        243        (15

Total mortgage-backed
securities

     288        (24     (9     (14     80        (2     319        (20

Corporate debt securities

     517        110        (140     (175     35        (1     346        -   

Collateralized debt obligations

     7,232        81        (310     1,318        -        -        8,321        -   

Asset-backed securities:

                

Auto loans and leases

     3,900        1        19        2,670        -        -        6,590        -   

Home equity loans

     76        -        (5     (1     160        -        230        (7

Other asset-backed securities

     2,629        7        (61     231        48        -        2,854        -   

Total asset-backed securities

     6,605        8        (47     2,900        208        -        9,674        (7

Total debt securities

     21,337        178        (478     4,781        323        (3     26,138        (26 )(4) 

Marketable equity securities:

                

Perpetual preferred securities

     1,545        25        (21     (179     2        -        1,372        -   

Other marketable equity securities

     36        -        (2     (2     -        -        32        -   

Total marketable
equity securities

     1,581        25        (23     (181     2        -        1,404        - (5) 

Total securities
available for sale

     22,918        203        (501     4,600        325        (3     27,542        (26

Mortgages held for sale

     3,360        68        -        (74     139        (77     3,416        68 (6) 

Loans

     -        -        -        -        -        -        -        - (6) 

Mortgage servicing rights

     14,778        (3,150     -        744        -        -        12,372        (2,640 )(6) 

Net derivative assets and liabilities:

                

Interest rate contracts

     240        1,764        -        (1,448     -        -        556        268   

Commodity contracts

     (2     2        -        (10     -        -        (10     1   

Equity contracts

     (186     159        -        (2     (2     2        (29     93   

Foreign exchange contracts

     25        (23     -        5        1        -        8        (4

Credit contracts

     (1,105     (479     -        (40     -        -        (1,624     (524

Other derivative contracts

     (33     (96     -        (1     -        -        (130     -   

Total derivative contracts

     (1,061     1,327        -        (1,496     (1     2        (1,229     (166 )(7) 

Other assets

     300        4        -        (30     -        -        274        (16 )(3) 

Short sale liabilities

                

(corporate debt securities)

     -        (1     -        (7     -        -        (8     - (3) 

Other liabilities (excluding derivatives)

     (37     -        -        (7     -        -        (44     - (6) 

 

(1) See next page for detail.
(2) Represents only net gains (losses) that are due to changes in economic conditions and management’s estimates of fair value and excludes changes due to the collection/realization of cash flows over time.
(3) Included in trading activities and other noninterest income in the income statement.
(4) Included in debt securities available for sale in the income statement.
(5) Included in equity investments in the income statement.
(6) Included in mortgage banking and other noninterest income in the income statement.
(7) Included in mortgage banking, trading activities and other noninterest income in the income statement.

 

(continued on following page)

 

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(continued from previous page)

 

The following table presents gross purchases, sales, issuances and settlements related to the changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the quarter ended September 30, 2011.

 

(in millions)    Purchases     Sales     Issuances      Settlements     Net  

Quarter ended September 30, 2011

           

Trading assets

           

(excluding derivatives):

           

Securities of U.S. states and
political subdivisions

   $ 124        (79     -         -        45   

Collateralized debt obligations

     409        (577     -         -        (168

Corporate debt securities

     30        (38     -         (2     (10

Mortgage-backed securities

     87        (186     -         (1     (100

Asset-backed securities

     121        (110     -         (29     (18

Equity securities

     3        -        -         -        3   

Total trading securities

     774        (990     -         (32     (248

Other trading assets

     -        -        -         -        -   

Total trading assets

           

    (excluding derivatives)

     774        (990     -         (32     (248

Securities available for sale:

           

Securities of U.S. states and
political subdivisions

     1,325        (5     462         (1,030     752   

Mortgage-backed securities:

           

Residential

     -        -        -         (3     (3

Commercial

     -        -        -         (11     (11

Total mortgage-backed
    securities

     -        -        -         (14     (14

Corporate debt securities

     1        (167     -         (9     (175

Collateralized debt obligations

     1,588        -        -         (270     1,318   

Asset-backed securities:

           

Auto loans and leases

     3,610        -        107         (1,047     2,670   

Home equity loans

     -        -        -         (1     (1

Other asset-backed securities

     392        (230     435         (366     231   

Total asset-backed securities

     4,002        (230     542         (1,414     2,900   

Total debt securities

     6,916        (402     1,004         (2,737     4,781   

Marketable equity securities:

           

Perpetual preferred securities

     -        (13     -         (166     (179

Other marketable equity securities

     -        -        -         (2     (2

Total marketable
    equity securities

     -        (13     -         (168     (181

Total securities
    available for sale

     6,916        (415     1,004         (2,905     4,600   

Mortgages held for sale

     106        -        -         (180     (74

Loans

     -        -        -         -        -   

Mortgage servicing rights

     -        -        744         -        744   

Net derivative assets and liabilities:

           

Interest rate contracts

     -        -        -         (1,448     (1,448

Commodity contracts

     7        (17     -         -        (10

Equity contracts

     12        (4     -         (10     (2

Foreign exchange contracts

     1        (1     -         5        5   

Credit contracts

     1        -        -         (41     (40

Other derivative contracts

     -        -        -         (1     (1

Total derivative contracts

     21        (22     -         (1,495     (1,496

Other assets

     19        (5     -         (44     (30

Short sale liabilities

           

(corporate debt securities)

     (9     1        -         1        (7

Other liabilities (excluding derivatives)

 

     (8     1        -         -        (7

 

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Note 13: Fair Values of Assets and Liabilities (continued)

 

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the nine months ended September 30, 2012, are summarized as follows:

 

            Total net gains
(losses) included in
    Purchases,
sales,
                         Net unrealized
gains (losses)
included in
 
(in millions)   Balance,
beginning
of period
    Net
income
    Other
compre-
hensive
income
    issuances
and
settlements,
net (1)
    Transfers
into
Level 3
    Transfers
out of
Level 3
    Balance,
end of
period
    income related
to assets and
liabilities held
at period end  (2)
 

Nine months ended September 30, 2012

               

Trading assets

               

(excluding derivatives):

               

Securities of U.S. states and political subdivisions

  $ 53        2        -        6        -        -        61        (1

Collateralized debt obligations

    1,582        (206     -        (301     -        -        1,075        (261

Corporate debt securities

    97        (2     -        (53     -        -        42        (4

Mortgage-backed securities

    108        3        -        (67     -        -        44        (2

Asset-backed securities

    190        46        -        (62     14        (16     172        35   

Equity securities

    4        1        -        (2     -        -        3        -   

Total trading securities

    2,034        (156     -        (479     14        (16     1,397        (233

Other trading assets

    115        (33     -        -        -        -        82        (18

Total trading assets (excluding derivatives)

    2,149        (189     -        (479     14        (16     1,479        (251 )(3) 

Securities available for sale:

               

Securities of U.S. states and political subdivisions

    11,516        8        188        1,565        14        (9,079     4,212        -   

Mortgage-backed securities:

               

Residential

    61        11        11        (35     28        (74     2        (1

Commercial

    232        (17     19        (55     -        -        179        (20

Total mortgage-backed securities

    293        (6     30        (90     28        (74     181        (21

Corporate debt securities

    295        17        (5     (46     1        (41     221        -   

Collateralized debt obligations

    8,599        112        387        1,127        -        -        10,225        -   

Asset-backed securities:

               

Auto loans and leases

    6,641        3        5        (1,162     -        -        5,487        -   

Home equity loans

    282        14        11        (3     29        (236     97        (4

Other asset-backed securities

    2,863        (28     96        14        1        (23     2,923        (26

Total asset-backed securities

    9,786        (11     112        (1,151     30        (259     8,507        (30

Total debt securities

    30,489        120        712        1,405        73        (9,453     23,346        (51 )(4) 

Marketable equity securities:

               

Perpetual preferred securities

    1,344        85        (28     (552     -        -        849        -   

Other marketable equity securities

    23        2        (15     (10     -        -        -        -   

Total marketable equity securities

    1,367        87        (43     (562     -        -        849        - (5) 

Total securities available for sale

    31,856        207        669        843        73        (9,453     24,195        (51

Mortgages held for sale

    3,410        4        -        (176     298        (229     3,307        16 (6) 

Loans

    23        59        -        80        5,851        -        6,013        59 (6) 

Mortgage servicing rights

    12,603        (5,442     -        3,795        -        -        10,956        (3,216 )(6) 

Net derivative assets and liabilities:

               

Interest rate contracts

    609        6,565        -        (5,781     -        -        1,393        1,292   

Commodity contracts

    -        71        -        (32     (8     (3     28        36   

Equity contracts

    (75     (19     -        (4     -        (94     (192     (18

Foreign exchange contracts

    (7     21        -        8        -        -        22        29   

Credit contracts

    (1,998     96        -        521        -        -        (1,381     37   

Other derivative contracts

    (117     26        -        -        -        -        (91     -   

Total derivative contracts

    (1,588     6,760        -        (5,288     (8     (97     (221     1,376 (7) 

Other assets

    244        (6     -        (45     -        -        193        (11 )(3) 

Short sale liabilities

    -        -        -        -        -        -        -        - (3) 

Other liabilities (excluding derivatives)

    (44     (19     -        (190     -        -        (253     - (6) 

 

(1) See next page for detail.
(2) Represents only net gains (losses) that are due to changes in economic conditions and management’s estimates of fair value and excludes changes due to the collection/realization of cash flows over time.
(3) Included in trading activities and other noninterest income in the income statement.
(4) Included in debt securities available for sale in the income statement.
(5) Included in equity investments in the income statement.
(6) Included in mortgage banking and other noninterest income in the income statement.
(7) Included in mortgage banking, trading activities and other noninterest income in the income statement.

 

(continued on following page)

 

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(continued from previous page)

 

The following table presents gross purchases, sales, issuances and settlements related to the changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the nine months ended September 30, 2012.

 

           
(in millions)    Purchases     Sales     Issuances     Settlements     Net  

Nine months ended September 30, 2012

          

Trading assets

          

(excluding derivatives):

          

Securities of U.S. states and political subdivisions

   $ 73        (67     -        -        6   

Collateralized debt obligations

     642        (943     -        -        (301

Corporate debt securities

     151        (204     -        -        (53

Mortgage-backed securities

     44        (111     -        -        (67

Asset-backed securities

     104        (130     -        (36     (62

Equity securities

     1        (3     -        -        (2

Total trading securities

     1,015        (1,458     -        (36     (479

Other trading assets

     -        -        -        -        -   

Total trading assets

          

    (excluding derivatives)

     1,015        (1,458     -        (36     (479

Securities available for sale:

          

Securities of U.S. states and

     1,759        (37     965        (1,122     1,565   

political subdivisions

          

Mortgage-backed securities:

          

Residential

     1        (34     -        (2     (35

Commercial

     10        -        -        (65     (55

Total mortgage-backed securities

     11        (34     -        (67     (90

Corporate debt securities

     -        (37     -        (9     (46

Collateralized debt obligations

     2,403        (185     -        (1,091     1,127   

Asset-backed securities:

          

Auto loans and leases

     2,040        -        490        (3,692     (1,162

Home equity loans

     -        (2     -        (1     (3

Other asset-backed securities

     996        (132     1,030        (1,880     14   

Total asset-backed securities

     3,036        (134     1,520        (5,573     (1,151

Total debt securities

     7,209        (427     2,485        (7,862     1,405   

Marketable equity securities:

          

Perpetual preferred securities

     -        -        -        (552     (552

Other marketable equity securities

     -        (8     -        (2     (10

Total marketable equity securities

     -        (8     -        (554     (562

 Total securities available for sale

     7,209        (435     2,485        (8,416     843   

Mortgages held for sale

     355        -        -        (531     (176

Loans

     2        -        129        (51     80   

Mortgage servicing rights

     -        (293     4,088        -        3,795   

Net derivative assets and liabilities:

          

 Interest rate contracts

     28        (22     -        (5,787     (5,781

 Commodity contracts

     22        (8     -        (46     (32

 Equity contracts

     117        (133     1        11        (4

 Foreign exchange contracts

     -        -        -        8        8   

 Credit contracts

     (5     2        -        524        521   

 Other derivative contracts

     -        -        -        -        -   

Total derivative contracts

     162        (161     1        (5,290     (5,288

Other assets

     17        (5     -        (57     (45

Short sale liabilities

     9        (9     -        -        -   

Other liabilities (excluding derivatives)

     (3     11        (216     18        (190
                                      

 

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Note 13: Fair Values of Assets and Liabilities (continued)

 

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the nine months ended September 30, 2011, are summarized as follows:

 

            Total net gains
(losses) included in
    Purchases,
sales,
                         Net unrealized
gains (losses)
included in
 
(in millions)   Balance,
beginning
of period
    Net
income
    Other
compre-
hensive
income
    issuances
and
settlements,
net (1)
    Transfers
into
Level 3
    Transfers
out of
Level 3
    Balance,
end of
period
    income related
to assets and
liabilities held
at period end (2)
 

Nine months ended September 30, 2011

               

Trading assets

               

(excluding derivatives):

               

Securities of U.S. states and political subdivisions

  $ 5        6        -        132        38        -        181        -   

Collateralized debt obligations

    1,915        (13     -        (273     -        (12     1,617        (78

Corporate debt securities

    166        2        -        (72     -        -        96        3   

Mortgage-backed securities

    117        6        -        1        7        (7     124        (2

Asset-backed securities

    366        71        -        (118     -        (121     198        68   

Equity securities

    34        (3     -        (28     1        -        4        (5

Total trading securities

    2,603        69        -        (358     46        (140     2,220        (14

Other trading assets

    136        (9     -        1        -        (2     126        18   

Total trading assets
(excluding derivatives)

    2,739        60        -        (357     46        (142     2,346        4 (3) 

Securities available for sale:

               

Securities of U.S. states and political subdivisions

    4,564        8        77        2,829        -        -        7,478        (5

Mortgage-backed securities:

               

Residential

    20        (7     -        (2     87        (22     76        (10

Commercial

    217        (24     50        4        -        (4     243        (17

Total mortgage-backed
securities

    237        (31     50        2        87        (26     319        (27

Corporate debt securities

    433        149        (102     (174     41        (1     346        -   

Collateralized debt obligations

    4,778        218        (169     3,486        8        -        8,321        -   

Asset-backed securities:

               

Auto loans and leases

    6,133        3        (16     470        -        -        6,590        -   

Home equity loans

    112        (3     (9     (3     199        (66     230        (17

Other asset-backed securities

    3,150        5        (13     134        97        (519     2,854        -   

Total asset-backed securities

    9,395        5        (38     601        296        (585     9,674        (17

Other debt securities

    85        -        -        (85     -        -        -        -   

Total debt securities

    19,492        349        (182     6,659        432        (612     26,138        (49 )(4) 

Marketable equity securities:

               

Perpetual preferred securities

    2,434        164        (23     (1,205     2        -        1,372        -   

Other marketable equity securities

    32        -        (1     1        -        -        32        -   

Total marketable
equity securities

    2,466        164        (24     (1,204     2        -        1,404        - (5) 

Total securities
available for sale

    21,958        513        (206     5,455        434        (612     27,542        (49

Mortgages held for sale

    3,305        77        -        (28     288        (226     3,416        80 (6) 

Loans

    309        13        -        (322     -        -        -        - (6) 

Mortgage servicing rights

    14,467        (4,841     -        2,746        -        -        12,372        (3,216 )(6) 

Net derivative assets and liabilities:

               

Interest rate contracts

    77        3,054        -        (2,577     1        1        556        110   

Commodity contracts

    (1     2        -        (9     (3     1        (10     1   

Equity contracts

    (225     205        -        9        (6     (12     (29     136   

Foreign exchange contracts

    9        4        -        (6     1        -        8        (6

Credit contracts

    (1,017     (437     -        (168     -        (2     (1,624     (533

Other derivative contracts

    (35     (95     -        -        -        -        (130     -   

Total derivative contracts

    (1,192     2,733        -        (2,751     (7     (12     (1,229     (292 )(7) 

Other assets

    314        12        -        (52     -        -        274        (6 )(3) 

Short sale liabilities

               

(corporate debt securities)

    -        -        -        (8     -        -        (8     1 (3) 

Other liabilities (excluding derivatives)

    (344     (9     -        309        -        -        (44     - (6) 

 

(1) See next page for detail.
(2) Represents only net gains (losses) that are due to changes in economic conditions and management’s estimates of fair value and excludes changes due to the collection/realization of cash flows over time.
(3) Included in trading activities and other noninterest income in the income statement.
(4) Included in debt securities available for sale in the income statement.
(5) Included in equity investments in the income statement.
(6) Included in mortgage banking and other noninterest income in the income statement.
(7) Included in mortgage banking, trading activities and other noninterest income in the income statement.

 

(continued on following page)

 

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(continued from previous page)

 

The following table presents gross purchases, sales, issuances and settlements related to the changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the nine months ended September 30, 2011.

 

(in millions)    Purchases     Sales     Issuances      Settlements     Net  

Nine months ended September 30, 2011

           

Trading assets

           

(excluding derivatives):

           

Securities of U.S. states and
political subdivisions

   $ 310        (177     -         (1     132   

Collateralized debt obligations

     933        (1,165     -         (41     (273

Corporate debt securities

     61        (134     -         1        (72

Mortgage-backed securities

     656        (650     -         (5     1   

Asset-backed securities

     493        (571     -         (40     (118

Equity securities

     9        (25     -         (12     (28

Total trading securities

     2,462        (2,722     -         (98     (358

Other trading assets

     2        -        -         (1     1   

Total trading assets

           

    (excluding derivatives)

     2,464        (2,722     -         (99     (357

Securities available for sale:

           

Securities of U.S. states and
political subdivisions

     2,958        (4     1,339         (1,464     2,829   

Mortgage-backed securities:

           

Residential

     4        -        -         (6     (2

Commercial

     21        -        -         (17     4   

Total mortgage-backed
securities

     25        -        -         (23     2   

Corporate debt securities

     97        (202     -         (69     (174

Collateralized debt obligations

     4,323        (20     -         (817     3,486   

Asset-backed securities:

           

Auto loans and leases

     4,599        -        270         (4,399     470   

Home equity loans

     -        -        -         (3     (3

Other asset-backed securities

     1,360        (384     807         (1,649     134   

Total asset-backed securities

     5,959        (384     1,077         (6,051     601   

Other debt securities

     -        (85     -         -        (85

Total debt securities

     13,362        (695     2,416         (8,424     6,659   

Marketable equity securities:

           

Perpetual preferred securities

     1        (13     -         (1,193     (1,205

Other marketable equity securities

     3        -        -         (2     1   

Total marketable
equity securities

     4        (13     -         (1,195     (1,204

Total securities
available for sale

     13,366        (708     2,416         (9,619     5,455   

Mortgages held for sale

     472        -        -         (500     (28

Loans

     -        (309     -         (13     (322

Mortgage servicing rights

     -        -        2,746         -        2,746   

Net derivative assets and liabilities:

           

Interest rate contracts

     6        -        -         (2,583     (2,577

Commodity contracts

     7        (17     -         1        (9

Equity contracts

     82        (178     -         105        9   

Foreign exchange contracts

     4        (4     -         (6     (6

Credit contracts

     4        (2     -         (170     (168

Other derivative contracts

     -        -        -         -        -   

Total derivative contracts

     103        (201     -         (2,653     (2,751

Other assets

     8        (5     -         (55     (52

Short sale liabilities

           

(corporate debt securities)

     (124     115        -         1        (8

Other liabilities (excluding derivatives)

 

     (9     1        -         317        309   

 

The following table provides quantitative information about the valuation techniques and significant unobservable inputs used in the valuation of substantially all of our Level 3 assets and liabilities measured at fair value on a recurring basis for which we use an internal model.

The significant unobservable inputs for Level 3 assets and liabilities that are valued using fair values obtained from third party vendors are not included in the table as the specific inputs applied are not provided by the vendor (see discussion regarding vendor-developed valuations within the “Level 3 Asset and Liabilities Valuation Processes” section previously within this Note). In addition, the table excludes the valuation techniques and significant unobservable inputs for certain classes of Level 3

assets and liabilities measured using an internal model that we consider, both individually and in the aggregate, insignificant relative to our overall Level 3 assets and liabilities. We made this determination based upon an evaluation of each class which considered the magnitude of the positions, nature of the unobservable inputs and potential for significant changes in fair value due to changes in those inputs.

 

 

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Note 13: Fair Values of Assets and Liabilities (continued)

 

 

($ in millions, except cost to service amounts)    Fair Value
Level 3
    Valuation Technique(s)      Significant
Unobservable Input
   

Range of

Inputs

    Weighted
Average (1)
 

September 30, 2012

           

Trading and available for sale securities:

           

Securities of U.S. states and political subdivisions:

           

Government, healthcare and other revenue bonds

   $ 3,659        Discounted cash flow         Discount rate        0.5  -  4.1  %      1.6   

Auction rate securities

     614        Discounted cash flow         Discount rate        1.1  -  9.2        4.1   
                Weighted average life        3.0  -  9.0  yrs      3.6   

Collateralized debt obligations (2)

     1,639        Market comparable pricing         Comparability adjustment        (24.8)  -   26.6  %      1.3   
     9,661        Vendor priced                            

Asset-backed securities:

           

Auto loans and leases

     5,487        Discounted cash flow         Default rate        2.1  -  10.2        3.4   
          Discount rate        0.8  -  1.7        1.2   
          Loss severity        50.0  -  66.7        52.2   
                Prepayment rate        0.6  -  0.9        0.7   

Other asset-backed securities:

           

Dealer floor plan

     1,098        Discounted cash flow         Discount rate        0.6  -  2.2        1.9   

Other commercial and consumer

     1,739 (3)      Discounted cash flow         Discount rate        2.7  -  11.3        4.8   
          Weighted average life        0.1  -  7.8 yrs      2.9   
     258        Vendor priced                            

Marketable equity securities: perpetual preferred

     849 (4)      Discounted cash flow         Discount rate        4.2  -  9.2     6.2   
                Weighted average life        1.0  -  10.0  yrs      5.2   

Mortgages held for sale (residential)

     3,307        Discounted cash flow         Default rate        0.6  -  14.7     6.5   
          Discount rate        3.3  -  6.8        5.2   
          Loss severity        1.1  -  37.9        27.7   
                Prepayment rate        1.0  -  12.6        6.0   

Loans

     6,013 (5)      Discounted cash flow         Discount rate        2.4  -  2.8        2.7   
          Prepayment rate        1.7  -  46.5        11.4   
                Utilization rate        0.0  -  2.0        0.8   

Mortgage servicing rights (residential)

     10,956        Discounted cash flow         Cost to service per loan  (6)    $ 91  -  870        219   
          Discount rate        6.3  -  10.5  %      7.2   
                Prepayment rate (7)      7.7  -  24.7        17.2   

Net derivative assets and (liabilities):

           

Interest rate contracts

     183        Discounted cash flow         Default rate        0.0  -  20.0        5.0   
          Loss severity        34.2  -  73.7        51.3   
                Prepayment rate        7.7  -  24.1        15.0   

Interest rate contracts: derivative loan commitments

     1,210        Discounted cash flow         Fall-out factor        1.0  -  99.0        26.0   
                Initial-value servicing        (11.2)  -  129.6  bps      70.2   

Equity contracts

     (192     Option model         Correlation factor        (43.6)  -  94.5  %      69.8   
                Volatility factor        17.1  -  73.4        35.3   

Credit contracts

     (1,390     Market comparable pricing         Comparability adjustment        (34.9)  -  49.3        (0.4
     9        Option model         Credit spread        0.0  -  14.0        2.1   
                Loss severity        16.5  -  87.5        47.9   

Insignificant Level 3 assets, net of liabilities

     569  (8)          

Total level 3 assets, net of liabilities

   $ 45,669  (9)                                  

 

(1) Weighted averages are calculated using outstanding unpaid principal balance for cash instruments such as loans and securities, and notional amounts for derivative instruments.
(2) Includes $10.4 billion of collateralized loan obligations.
(3) Consists primarily of investments in asset-backed securities that are revolving in nature, in which the timing of advances and repayments of principal are uncertain.
(4) Consists of auction rate preferred equity securities with no maturity date that are callable by the issuer.
(5) Consists of reverse mortgage loans securitized with GNMA which were accounted for as secured borrowing transactions.
(6) The high end of the range of inputs is for servicing modified loans. For non-modified loans the range is $91—$379.
(7) Includes a blend of prepayment speeds and expected defaults. Prepayment speeds are influenced by mortgage interest rates as well as our estimation of drivers of borrower behavior.
(8) Represents the aggregate amount of Level 3 assets and liabilities measured at fair value on a recurring basis that are individually and in the aggregate insignificant. The amount includes corporate debt securities, mortgage-backed securities, asset-backed securities backed by home equity loans, other marketable equity securities, loans, other assets, other liabilities and certain net derivative assets and liabilities, such as commodity contracts, foreign exchange contracts and other derivative contracts.
(9) Consists of total Level 3 assets of $49.8 billion and total Level 3 liabilities of $4.1 billion, before netting of derivative balances.

 

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The valuation techniques used for our Level 3 assets and liabilities, as presented in the previous table, are described as follows:

 

Discounted cash flow – Discounted cash flow valuation techniques generally consist of developing an estimate of future cash flows that are expected to occur over the life of an instrument and then discounting those cash flows at a rate of return that results in the fair value amount.

 

Option model – Option model valuation techniques are generally used for instruments in which the holder has a contingent right or obligation based on the occurrence of a future event, such as the price of a referenced asset going above or below a predetermined strike price. Option models estimate the likelihood of the specified event occurring by incorporating assumptions such as volatility estimates, price of the underlying instrument and expected rate of return.

 

Market comparable pricing – Market comparable pricing valuation techniques are used to determine the fair value of certain instruments by incorporating known inputs such as recent transaction prices, pending transactions, or prices of other similar investments which require significant adjustment to reflect differences in instrument characteristics.

 

Vendor-priced – Prices obtained from third party pricing vendors or brokers that are used to record the fair value of the asset or liability, of which the related valuation technique and significant unobservable inputs are not provided.

 Significant unobservable inputs presented in the previous table are those we consider significant to the fair value of the Level 3 asset or liability. We consider unobservable inputs to be significant, if by their exclusion, the fair value of the Level 3 asset or liability would be impacted by a predetermined percentage change or based on qualitative factors such as nature of the instrument, type of valuation technique used, and the significance of the unobservable inputs relative to other inputs used within the valuation. Following is a description of the significant unobservable inputs provided in the table.

 

 

Comparability adjustment – is an adjustment made to observed market data such as a transaction price in order to reflect dissimilarities in underlying collateral, issuer, rating, or other factors used within a market valuation approach, expressed as a percentage of an observed price.

 

Correlation factor – is the likelihood of one instrument changing in price relative to another based on an established relationship expressed as a percentage of relative change in price over a period over time.

 

Cost to service – is the expected cost per loan of servicing a portfolio of loans which includes estimates for unreimbursed expenses (including delinquency and foreclosure costs) that may occur as a result of servicing such loan portfolios.

 

Credit spread – is the portion of the interest rate in excess of a benchmark interest rate, such as LIBOR or U.S. Treasury rates, that when applied to an investment captures changes in the obligor’s creditworthiness.

 

Default rate – is an estimate of the likelihood of not collecting contractual amounts owed expressed as a constant default rate (CDR).

 

Discount rate – is a rate of return used to present value the future expected cash flow to arrive at the fair value of an instrument. The discount rate consists of a benchmark rate component and a risk premium component. The benchmark rate component, for example, LIBOR or U.S. Treasury rates, is generally observable within the market and is necessary to appropriately reflect the time value of money. The risk premium component reflects the amount of compensation market participants require due to the uncertainty inherent in the instruments’ cash flows resulting from risks such as credit and liquidity.

 

Fall-out factor – is the expected percentage of loans associated with our interest rate lock commitment portfolio that are likely of not funding.

 

Initial-value servicing – is the estimated value of the underlying loan, including the value attributable to the embedded servicing right, expressed in basis points of outstanding unpaid principal balance.

 

Loss severity – is the percentage of contractual cash flows lost in the event of a default.

 

Prepayment rate – is the estimated rate at which forecasted prepayments of principal of the related loan or debt instrument are expected to occur, expressed as a constant prepayment rate (CPR).

 

Utilization rate – is the estimated rate in which incremental portions of existing reverse mortgage credit lines are expected to be drawn by borrowers, expressed as an annualized rate.

 

Volatility factor – is the extent of change in price an item is estimated to fluctuate over a specified period of time expressed as a percentage of relative change in price over a period over time.

 

Weighted average life – is the weighted average number of years an investment is expected to remain outstanding, based on its expected cash flows reflecting the estimated date the issuer will call or extend the maturity of the instrument or otherwise reflecting an estimate of the timing of an instrument’s cash flows whose timing is not contractually fixed.

Significant Recurring Level 3 Fair Value Asset and Liability Input Sensitivity

We generally use discounted cash flow or similar internal modeling techniques to determine the fair value of our Level 3 assets and liabilities. Use of these techniques requires determination of relevant inputs and assumptions, some of which represent significant unobservable inputs as indicated in the preceding table. Accordingly, changes in these unobservable inputs may have a significant impact on fair value.

Certain of these unobservable inputs will (in isolation) have a directionally consistent impact on the fair value of the instrument for a given change in that input. Alternatively, the fair value of the instrument may move in an opposite direction for a given change in another input. Where multiple inputs are used within the valuation technique of an asset or liability, a

 

 

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Note 13: Fair Values of Assets and Liabilities (continued)

 

change in one input in a certain direction may be offset by an opposite change in another input having a potentially muted impact to the overall fair value of that particular instrument. Additionally, a change in one unobservable input may result in a change to another unobservable input (that is, changes in certain inputs are interrelated to one another), which may counteract or magnify the fair value impact.

SECURITIES, LOANS and MORTGAGES HELD FOR SALE The fair values of predominantly all Level 3 trading securities, mortgages held for sale, loans and securities available for sale have consistent inputs, valuation techniques and correlation to changes in underlying inputs. The internal models used to determine fair value for these Level 3 instruments use certain significant unobservable inputs within a discounted cash flow or market comparable pricing valuation technique. Such inputs include discount rate, prepayment rate, default rate, loss severity, utilization rate and weighted average life.

These Level 3 assets would decrease (increase) in value based upon an increase (decrease) in discount rate, default rate, loss severity, or weighted average life inputs. Conversely, the fair value of these Level 3 assets would generally increase (decrease) in value if the prepayment rate input were to increase (decrease) or if the utilization rate input were to increase (decrease).

Generally, a change in the assumption used for default rate is accompanied by a directionally similar change in the risk premium component of the discount rate (specifically, the portion related to credit risk) and a directionally opposite change in the assumption used for prepayment rates. Unobservable inputs for loss severity, utilization rate and weighted average life do not increase or decrease based on movements in the other significant unobservable inputs for these Level 3 assets.

DERIVATIVE INSTRUMENTS Level 3 derivative instruments are valued using market comparable pricing, option pricing and discounted cash flow valuation techniques. We utilize certain unobservable inputs within these techniques to determine the fair value of the Level 3 derivative instruments. The significant unobservable inputs consist of credit spread, a comparability adjustment, prepayment rate, default rate, loss severity, initial value servicing, fall-out factor, volatility factor, and correlation factor.

Level 3 derivative assets (liabilities) would decrease (increase) in value upon an increase (decrease) in default rate, fall-out factor, credit spread or loss severity inputs. Conversely, Level 3 derivative assets (liabilities) would increase (decrease) in value upon an increase (decrease) in prepayment rate, initial-value servicing or volatility factor inputs. The correlation factor and comparability adjustment inputs may have a positive or negative impact on the fair value of these derivative instruments depending on the change in value of the item the correlation factor and comparability adjustment is referencing. The correlation factor and comparability adjustment is considered independent from movements in other significant unobservable inputs for derivative instruments.

Generally, for derivative instruments for which we are subject to changes in the value of the underlying referenced instrument, change in the assumption used for default rate is accompanied

by directionally similar change in the risk premium component of the discount rate (specifically, the portion related to credit risk) and a directionally opposite change in the assumption used for prepayment rates. Unobservable inputs for loss severity, fall-out factor, initial-value servicing, and volatility do not increase or decrease based on movements in other significant unobservable inputs for these Level 3 instruments.

MORTGAGE SERVICING RIGHTS We use a discounted cash flow valuation technique to determine the fair value of Level 3 mortgage servicing rights. These models utilize certain significant unobservable inputs including prepayment rate, discount rate and costs to service. An increase in any of these unobservable inputs will reduce the fair value of the mortgage servicing rights and alternatively, a decrease in any one of these inputs would result in the mortgage servicing rights increasing in value. Generally, a change in the assumption used for the default rate is accompanied by a directionally similar change in the assumption used for cost to service and a directionally opposite change in the assumption used for prepayment. The sensitivity of our residential MSRs is discussed further in Note 7.

 

 

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Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of LOCOM accounting or write-downs of individual

assets. For assets measured at fair value on a nonrecurring basis in the first nine months of 2012, and year ended December 31, 2011, that were still held in the balance sheet at each respective period end, the following table provides the fair value hierarchy and the carrying value of the related individual assets or portfolios at period end.

 

 

       
     September 30, 2012           December 31, 2011  
(in millions)    Level 1      Level 2      Level 3      Total           Level 1      Level 2      Level 3      Total  

Mortgages held for sale (LOCOM) (1)

   $ —           1,724         1,075         2,799            —           1,019         1,166         2,185   

Loans held for sale

     —           15         —           15            —           86         —           86   

Loans:

                          

Commercial

     —           1,495         15         1,510            —           1,501         13         1,514   

Consumer

     —           2,512         3         2,515            —           4,163         4         4,167   

Total loans (2)

     —           4,007         18         4,025            —           5,664         17         5,681   

Mortgage servicing rights (amortized)

     —           —           —           —              —           —           293         293   

Other assets (3)

     —           864         101         965              —           537         67         604   

 

(1) Predominantly real estate 1-4 family first mortgage loans.
(2) Represents carrying value of loans for which adjustments are based on the appraised value of the collateral.
(3) Includes the fair value of foreclosed real estate and other collateral owned that were measured at fair value subsequent to their initial classification as foreclosed assets.

 

The following table presents the increase (decrease) in value of certain assets that are measured at fair value on a nonrecurring basis for which a fair value adjustment has been included in the income statement.

 

   
    Nine months ended September 30,  
(in millions)   2012     2011  

Mortgages held for sale (LOCOM)

  $ 45        55   

Loans held for sale

    1        (1)   

Loans:

   

Commercial

    (788)        (874)   

Consumer (1)

    (2,813)        (3,934)   

Total loans

    (3,601)        (4,808)   

Mortgage servicing rights (amortized)

    —          (37)   

Other assets (2)

    (320)        (209)   

Total

  $ (3,875)        (5,000)   

 

(1) Represents write-downs of loans based on the appraised value of the collateral.
(2) Includes the losses on foreclosed real estate and other collateral owned that were measured at fair value subsequent to their initial classification as foreclosed assets.
 

 

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Note 13: Fair Values of Assets and Liabilities (continued)

 

The table below provides quantitative information about the valuation techniques and significant unobservable inputs used in the valuation of substantially all of our Level 3 assets and liabilities measured at fair value on a nonrecurring basis for which we use an internal model.

We have excluded from the table classes of Level 3 assets and liabilities measured using an internal model that we consider,

both individually and in the aggregate, insignificant relative to our overall Level 3 nonrecurring measurements. We made this determination based upon an evaluation of each class which considered the magnitude of the positions, nature of the unobservable inputs and potential for significant changes in fair value due to changes in those inputs.

 

 

($ in millions)    Fair Value
Level 3
    Valuation Technique(s) (1)      Significant
Unobservable Inputs (1)
    Range of inputs    Weighted
Average (2)
 

September 30, 2012

            

Residential mortgages
held for sale
    (LOCOM)

   $ 1,075 (3)      Discounted cash flow         Default rate (4)       3.0    -    20.2%        9.5
          Discount rate      4.0    -    11.7        10.6   
          Loss severity      3.0    -    45.7        6.4   
          Prepayment rate (5)    1.0    -  100.0        67.3   

Insignificant level 3 assets

     119                

Total

     1,194                                      

 

(1) Refer to the narrative following the recurring quantitative Level 3 table of this Note for a definition of the valuation technique(s) and significant unobservable inputs.
(2) Weighted averages are calculated using outstanding unpaid principal balance of the loans.
(3) Consists of approximately $966 million government insured/guaranteed loans purchased from GNMA-guaranteed mortgage securitization and $109 million of other mortgage loans which are not government insured/guaranteed.
(4) Applies only to non-government insured/guaranteed loans.
(5) Includes the impact on prepayment rate of expected defaults for the government insured/guaranteed loans, which impacts the frequency and timing of early resolution of loans.

 

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Alternative Investments

The following table summarizes our investments in various types of funds, which are included in trading assets, securities available for sale and other assets. We use the funds’ net asset

values (NAVs) per share as a practical expedient to measure fair value on recurring and nonrecurring bases. The fair values presented in the table are based upon the funds’ NAVs or an equivalent measure.

 

 

         
(in millions)    Fair
value
    

Unfunded

commitments

     Redemption
frequency
     Redemption
notice
period
 

September 30, 2012

           

Offshore funds

   $ 391         -         Daily -Annually         1 -180 days   

Funds of funds

     1         -         Quarterly         90 days   

Hedge funds

     4         -         Daily -Annually         5 - 95 days   

Private equity funds

     854         212         N/A         N/A   

Venture capital funds

     83         22         N/A         N/A   

Total

   $ 1,333         234         
   

December 31, 2011

           

Offshore funds

   $ 352         -         Daily - Annually         1 -180 days   

Funds of funds

     1         -         Quarterly         90 days   

Hedge funds

     22         -         Daily - Annually         5 - 95 days   

Private equity funds

     976         240         N/A         N/A   

Venture capital funds

     83         28         N/A         N/A   

Total

   $ 1,434         268         
   

N/A - Not applicable

 

Offshore funds primarily invest in investment grade European fixed-income securities. Redemption restrictions are in place for these investments with a fair value of $184 million and $200 million at September 30, 2012 and December 31, 2011, respectively, due to lock-up provisions that will remain in effect until October 2015.

Private equity funds invest in equity and debt securities issued by private and publicly-held companies in connection with leveraged buyouts, recapitalizations and expansion opportunities. Substantially all of these investments do not allow redemptions. Alternatively, we receive distributions as the underlying assets of the funds liquidate, which we expect to occur over the next nine years.

Venture capital funds invest in domestic and foreign companies in a variety of industries, including information technology, financial services and healthcare. These investments can never be redeemed with the funds. Instead, we receive distributions as the underlying assets of the fund liquidate, which we expect to occur over the next six years.

 

 

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Note 13: Fair Values of Assets and Liabilities (continued)

 

Fair Value Option

We measure MHFS at fair value for prime MHFS originations for which an active secondary market and readily available market prices exist to reliably support fair value pricing models used for these loans. Loan origination fees on these loans are recorded when earned, and related direct loan origination costs are recognized when incurred. We also measure at fair value certain of our other interests held related to residential loan sales and securitizations. We believe fair value measurement for prime MHFS and other interests held, which we hedge with free-standing derivatives (economic hedges) along with our MSRs measured at fair value, reduces certain timing differences and better matches changes in the value of these assets with changes in the value of derivatives used as economic hedges for these assets.

We elected to measure certain LHFS portfolios at fair value in conjunction with customer accommodation activities, to better align the measurement basis of the assets held with our management objectives given the trading nature of these portfolios. In addition, we elected to measure at fair value certain letters of credit that are hedged with derivative instruments to better reflect the economics of the transactions.

These letters of credit are included in trading account assets or liabilities.

Loans that we measure at fair value consist of reverse mortgage loans previously transferred under a GNMA reverse mortgage securitization program accounted for as a secured borrowing. Before the transfer, they were classified as MHFS measured at fair value and, as such, remain carried on our balance sheet under the fair value option.

Similarly, we may elect fair value option for the assets and liabilities of certain consolidated VIEs. This option is generally elected for newly consolidated VIEs for which predominantly all of our interests, prior to consolidation, are carried at fair value with changes in fair value recorded to earnings. Accordingly, such an election allows us to continue fair value accounting through earnings for those interests and eliminate income statement mismatch otherwise caused by differences in the measurement basis of the consolidated VIEs assets and liabilities.

The following table reflects the differences between fair value carrying amount of certain assets and liabilities for which we have elected the fair value option and the contractual aggregate unpaid principal amount at maturity.

 

 

 

 
     September 30, 2012     December 31, 2011  

(in millions)

    
 
 
Fair value
carrying
amount
  
  
  
   
 
 
Aggregate
unpaid
principal
  
  
  
   
 
 
 
 
 
 
Fair value
carrying
amount
less
aggregate
unpaid
principal
  
  
  
  
  
  
  
   
 
 
Fair value
carrying
amount
  
  
  
    
 
 
Aggregate
unpaid
principal
  
  
  
    
 
 
 
 
 
 
Fair value
carrying
amount
less
aggregate
unpaid
principal
  
  
  
  
  
  
  

 

 

Mortgages held for sale:

              

Total loans

   $ 46,575        44,671        1,904  (1)      44,791         43,687         1,104 (1) 

Nonaccrual loans

     299        651        (352     265         584         (319

Loans 90 days or more past due and still accruing

     49        63        (14     44         56         (12

Loans held for sale:

              

Total loans

     172        185        (13     1,176         1,216         (40

Nonaccrual loans

     6        12        (6     25         39         (14

Loans:

              

Total loans

     6,188        5,633        555        5,916         5,441         475   

Nonaccrual loans

     79        78        1        32         32         -   

Long-term debt

     (218     (1,679     1,461  (2)      -         -         -   

 

 

 

(1) The difference between fair value carrying amount and aggregate unpaid principal includes changes in fair value recorded at and subsequent to funding, gains and losses on the related loan commitment prior to funding, and premiums on acquired loans.
(2) Represents collateralized, non-recourse debt securities issued by certain of our consolidated securitization VIEs that are held by third party investors. To the extent cash flows from the underlying collateral are not sufficient to pay the unpaid principal amount of the debt, those third party investors absorb losses.

 

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The assets and liabilities accounted for under the fair value option are initially measured at fair value. Gains and losses from initial measurement and subsequent changes in fair value are recognized in earnings. The changes in fair value related to

initial measurement and subsequent changes in fair value included in earnings for these assets and liabilities measured at fair value are shown, by income statement line item, below.

 

 

      2012     2011  
(in millions)    Mortgage banking
noninterest income
     Net gains
(losses)
from
trading
activities
    Other
noninterest
income
    Mortgage
banking
noninterest
income
    Net gains
(losses)
from
trading
activities
     Other
noninterest
income
 

Quarter ended Sept. 30,

              

Mortgages held for sale

   $ 2,594         -        -        2,252        -         -   

Loans held for sale

     -         -        4        -        -         (2

Loans

     -         -        54        -        -         -   

Long-term debt

     -         -        (19     -        -         -   

Other interests held

     -         (12     18        -        -         (49
   

Nine months ended Sept. 30,

              

Mortgages held for sale

   $ 6,915         -        1        4,109        -         -   

Loans held for sale

     -         -        23        -        -         19   

Loans

     -         -        81        13        -         -   

Long-term debt

     -         -        (23     (11     -         -   

Other interests held

     -         (36     33        -        -         (25
   

 

For performing loans, instrument-specific credit risk gains or losses were derived principally by determining the change in fair value of the loans due to changes in the observable or implied credit spread. Credit spread is the market yield on the loans less the relevant risk-free benchmark interest rate. In recent years spreads have been significantly affected by the lack of liquidity in the secondary market for mortgage loans. For nonperforming loans, we attribute all changes in fair value to instrument-specific credit risk. The following table shows the estimated gains and losses from earnings attributable to instrument-specific credit risk related to assets accounted for under the fair value option.

 

 

      Quarter ended Sept. 30,     Nine months ended Sept. 30,  
(in millions)    2012     2011     2012     2011  

Gains (losses) attributable to instrument-specific credit risk:

        

Mortgages held for sale

   $ (8     (37     (99     (108

Loans held for sale

     4        (2     23        19   
         

Total

   $ (4     (39     (76     (89

 

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Note 13: Fair Values of Assets and Liabilities (continued)

 

Disclosures about Fair Value of Financial Instruments

The table below is a summary of fair value estimates for financial instruments, excluding financial instruments recorded at fair value on a recurring basis as they are included within the Assets and Liabilities Recorded at Fair Value on a Recurring Basis table included earlier in this Note. The carrying amounts in the following table are recorded in the balance sheet under the indicated captions.

 

We have not included assets and liabilities that are not financial instruments in our disclosure, such as the value of the long-term relationships with our deposit, credit card and trust customers, amortized MSRs, premises and equipment, goodwill and other intangibles, deferred taxes and other liabilities. The total of the fair value calculations presented does not represent, and should not be construed to represent, the underlying value of the Company.

 

 

      September 30, 2012      December 31, 2011  
            Estimated fair value                

(in millions)

   Carrying
amount
     Level 1      Level 2      Level 3      Total      Carrying
amount
     Estimated
fair value
 

Financial assets

                    

Cash and due from banks (1)

   $ 16,986         16,986         -         -         16,986         19,440         19,440   

Federal funds sold, securities purchased under resale agreements and other short-term investments (1)

     100,442         3,887         96,555         -         100,442         44,367         44,367   

Mortgages held for sale (2)

     3,762         -         2,751         1,075         3,826         3,566         3,566   

Loans held for sale (2)

     126         -         103         29         132         162         176   

Loans, net (3)

     746,868         -         56,334         698,830         755,164         731,308         723,867   

Nonmarketable equity investments (cost method)

     8,061         -         4         9,395         9,399         8,061         8,490   

Financial liabilities

                    

Deposits

     952,239         -         889,179         64,367         953,546         920,070         921,803   

Short-term borrowings (1)

     51,957         -         51,957         -         51,957         49,091         49,091   

Long-term debt (4)

     130,506         -         122,085         11,461         133,546         125,238         126,484   

 

 

 

(1) Amounts consist of financial instruments in which carrying value approximates fair value.
(2) Balance reflects MHFS and LHFS, as applicable, other than those MHFS and LHFS for which election of the fair value option was made.
(3) Loans exclude balances for which the fair value option was elected. Loans exclude lease financing with a carrying amount of $12.3 billion and $13.1 billion at September 30, 2012 and December 31, 2011, respectively.
(4) The carrying amount and fair value exclude balances for which the fair value option was elected and obligations under capital leases of $77 million and $116 million at September 30, 2012 and December 31, 2011, respectively.

 

Loan commitments, standby letters of credit and commercial and similar letters of credit are not included in the table above. A reasonable estimate of the fair value of these instruments is the carrying value of deferred fees plus the related allowance. This amounted to $537 million and $495 million at September 30, 2012 and December 31, 2011, respectively.

 

 

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Note 14: Preferred Stock

 

 

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

preferred stock includes Dividend Equalization Preferred (DEP) shares and Series I, J, K, L and N which are presented in the following two tables, and Employee Stock Ownership Plan (ESOP) Cumulative Convertible Preferred Stock, which is presented in the table on the following page.

 

 

     
     September 30, 2012      December 31, 2011  
      Liquidation
preference
per share
    

Shares
authorized

and designated

     Liquidation
preference
per share
     Shares
authorized
and designated
 

DEP Shares

           

Dividend Equalization Preferred Shares

   $ 10         97,000       $ 10         97,000   

Series G

           

7.25% Class A Preferred Stock

     15,000         50,000         15,000         50,000   

Series H

           

Floating Class A Preferred Stock

     20,000         50,000         20,000         50,000   

Series I

           

Floating Class A Preferred Stock

     100,000         25,010         100,000         25,010   

Series J

           

8.00% Non-Cumulative Perpetual Class A Preferred Stock

     1,000         2,300,000         1,000         2,300,000   

Series K

           

7.98% Fixed-to-Floating Non-Cumulative Perpetual Class A Preferred Stock

     1,000         3,500,000         1,000         3,500,000   

Series L

           

7.50% Non-Cumulative Perpetual Convertible Class A Preferred Stock

     1,000         4,025,000         1,000         4,025,000   

Series N

           

5.20% Non-Cumulative Perpetual Class A Preferred Stock

     25,000         30,000         -         -   

Total

              10,077,010                  10,047,010   

 

 

 
  

 

September 30, 2012

  

  

 

December 31, 2011

  

(in millions, except shares)    Shares
issued and
outstanding
     Par value     

Carrying

value

     Discount     

Shares

issued and
outstanding

     Par value     

Carrying

value

     Discount  

 

 

DEP Shares

                       

Dividend Equalization Preferred Shares

     96,546       $ -         -                 96,546       $ -         -           

Series I (1)

                       

Floating Class A Preferred Stock

     25,010         2,501         2,501                 25,010         2,501         2,501           

Series J (1)

                       

8.00% Non-Cumulative Perpetual Class A Preferred Stock

     2,150,375         2,150         1,995         155          2,150,375         2,150         1,995         155    

Series K (1)

                       

7.98% Fixed-to-Floating Non-Cumulative Perpetual Class A Preferred Stock

     3,352,000         3,352         2,876         476          3,352,000         3,352         2,876         476    

Series L (1)

                       

7.50% Non-Cumulative Perpetual Convertible Class A Preferred Stock

     3,968,000         3,968         3,200         768          3,968,000         3,968         3,200         768    

Series N (1)

                       

5.20% Non-Cumulative Perpetual Class A Preferred Stock

     30,000         750         750                 -         -         -           

 

 

Total

     9,621,931       $ 12,721         11,322         1,399          9,591,931       $ 11,971         10,572         1,399    

 

 

 

(1) Preferred shares qualify as Tier 1 capital.

 

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Note 14: Preferred Stock (continued)

 

 

 

In August 2012, we issued 30 million Depositary Shares, each representing a 1/1,000th interest in a share of the Non-Cumulative Perpetual Class A Preferred Stock, Series N, for an aggregate public offering price of $750 million.

In the first nine months of 2012, we redeemed $2.7 billion of trust preferred securities. See Note 7 for additional information on our trust preferred securities. We do not have a commitment to issue Series G or H preferred stock.

ESOP CUMULATIVE CONVERTIBLE PREFERRED STOCK   All shares of our ESOP Cumulative Convertible Preferred Stock (ESOP Preferred Stock) were issued to a trustee acting on behalf of the Wells Fargo & Company 401(k) Plan (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 based 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 and outstanding         Carrying value     

 

Adjustable

  

     Sept. 30,         Dec. 31,         Sept. 30,        Dec. 31,        dividend rate   

(in millions, except shares)

     2012         2011         2012        2011        Minimum        Maximum   

ESOP Preferred Stock

              

$1,000 liquidation preference per share

              

2012

     288,563         -       $ 288        -        10.00     11.00   

2011

     279,963         370,280         280        370        9.00        10.00   

2010

     201,061         231,361         201        232        9.50        10.50   

2008

     74,134         89,154         74        89        10.50        11.50   

2007

     54,818         68,414         55        69        10.75        11.75   

2006

     34,734         46,112         35        46        10.75        11.75   

2005

     18,882         30,092         19        30        9.75        10.75   

2004

     9,013         17,115         9        17        8.50        9.50   

2003

     -         6,231         -        6        8.50        9.50   

Total ESOP Preferred Stock (1)

     961,168         858,759       $ 961        859       

Unearned ESOP shares (2)

  

      $ (1,041     (926    
                                             

 

(1) At September 30, 2012, and December 31, 2011, additional paid-in capital included $80 million and $67 million, respectively, related to preferred stock.
(2) 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.

 

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Note 15: Employee Benefits

 

We sponsor a noncontributory qualified defined benefit retirement plan, the Wells Fargo & Company Cash Balance Plan (Cash Balance Plan), which covers eligible employees of

Wells Fargo; the benefits earned under the Cash Balance Plan were frozen effective July 1, 2009.

The net periodic benefit cost was:

 

 

 

     2012     2011  
     Pension benefits            Pension benefits         
(in millions)    Qualified     Non-
qualified
     Other
benefits
    Qualified     Non-
qualified
     Other
benefits
 

Quarter ended September 30,

    

Service cost

   $ -        1         3        1        -         3   

Interest cost

     128        8         15        130        9         18   

Expected return on plan assets

     (162     -         (9     (190     -         (10

Amortization of net actuarial loss

     33        2         -        21        1         -   

Amortization of prior service credit

     -        -         (1     -        -         -   

Settlement

     1        -         (2     1        -         -   

Net periodic benefit cost (income)

   $ -        11         6        (37     10         11   

Nine months ended September 30,

    

Service cost

   $ 1        1         9        4        -         10   

Interest cost

     384        24         45        390        26         54   

Expected return on plan assets

     (487     -         (26     (569     -         (31

Amortization of net actuarial loss

     99        7         -        64        5         -   

Amortization of prior service credit

     -        -         (2     -        -         (2

Settlement

     2        5         (3     4        -         -   

Net periodic benefit cost (income)

   $ (1     37         23        (107     31         31   

 

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Note 16: Earnings Per Common Share

 

 

The table below shows earnings per common share and diluted earnings per common share and reconciles the numerator and denominator of both earnings per common share calculations.

 

 

     
     Quarter ended September 30,      Nine months ended September 30,  
(in millions, except per share amounts)    2012      2011      2012      2011  

Wells Fargo net income

   $ 4,937         4,055         13,807         11,762   

Less:    Preferred stock dividends and other (1)

     220         216         665         625   

Wells Fargo net income applicable to common stock (numerator)

   $ 4,717         3,839         13,142         11,137   

Earnings per common share

           

Average common shares outstanding (denominator)

     5,288.1         5,275.5         5,292.7         5,280.2   

Per share

   $ 0.89         0.73         2.48         2.11   

Diluted earnings per common share

           

Average common shares outstanding

     5,288.1         5,275.5         5,292.7         5,280.2   

Add:    Stock options

     28.7         20.9         28.3         25.6   

             Restricted share rights

     38.6         22.8         34.7         19.8   

             Warrants

     0.2         -         -         -   

Diluted average common shares outstanding (denominator)

     5,355.6         5,319.2         5,355.7         5,325.6   

Per share

   $ 0.88         0.72         2.45         2.09   

 

(1) Includes preferred stock dividends of $220 million for both third quarter 2012 and 2011, respectively, and $659 million and $624 million for the first nine months of 2012 and 2011, respectively.

 

The following table presents the outstanding options and warrants to purchase shares of common stock that were anti-dilutive (the exercise price was higher than the weighted-average market price), and therefore not included in the calculation of diluted earnings per common share.

 

 

   
     Weighted-average shares  
     Quarter ended September 30,      Nine months ended September 30,  
(in millions)    2012      2011      2012      2011  

Options

     53.5         197.0         57.2         175.6   

Warrants

     -         39.4         39.2         39.4   

 

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Note 17: Other Comprehensive Income

 

The components of other comprehensive income (OCI) and the related tax effects were:

 

     
     Quarter ended September 30,     Nine months ended September 30,  
     2012     2011     2012     2011  
(in millions)    Before
tax
    Tax
effect
    Net of
tax
    Before
tax
    Tax
effect
    Net of
tax
    Before
tax
    Tax
effect
    Net of
tax
    Before
tax
    Tax
effect
    Net of
tax
 

 

   

 

 

   

 

 

   

 

 

 

Foreign currency translation adjustments:

                        

Net unrealized gains (losses) arising during the period

   $ 45        (17     28        (58     21        (37     (1     -        (1     (29     10        (19

Reclassification of net gains included in net income

     -        -        -        -        -        -        (10     4        (6     -        -        -   

 

   

 

 

   

 

 

   

 

 

 

Net unrealized gains (losses) arising during the period

     45        (17     28        (58     21        (37     (11     4        (7     (29     10        (19

 

   

 

 

   

 

 

   

 

 

 

Securities available for sale:

                        

Net unrealized gains (losses) arising during the period

     2,892        (1,077     1,815        (2,007     744        (1,263     5,597        (2,097     3,500        (878     473        (405

Reclassification of net gains included in net income

     (41     15        (26     (431     162        (269     (290     109        (181     (614     231        (383

 

   

 

 

   

 

 

   

 

 

 

Net unrealized gains (losses) arising during the period

     2,851        (1,062     1,789        (2,438     906        (1,532     5,307        (1,988     3,319        (1,492     704        (788

 

   

 

 

   

 

 

   

 

 

 

Derivatives and hedging activities:

                        

Net unrealized gains arising during the period

     24        (3     21        68        (30     38        63        (19     44        205        (81     124   

Reclassification of net gains on cash flow hedges included in net income

     (89     38        (51     (141     57        (84     (295     115        (180     (454     174        (280 ) (1) 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized losses arising during the period

     (65     35        (30     (73     27        (46     (232     96        (136     (249     93        (156

 

   

 

 

   

 

 

   

 

 

 

Defined benefit plans adjustment:

                        

Net actuarial gains (losses) arising during the period

     (1     -        (1     1        -        1        (18     7        (11     (2     1        (1

Amortization of net actuarial loss and prior service cost included in net income

     35        (13     22        23        (9     14        111        (42     69        71        (27     44   

 

   

 

 

   

 

 

   

 

 

 

Net gains arising during the period

     34        (13     21        24        (9     15        93        (35     58        69        (26     43   

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss)

   $   2,865        (1,057     1,808        (2,545     945        (1,600     5,157        (1,923     3,234        (1,701     781        (920

Less:    Other comprehensive income (loss) from noncontrolling interests, net of tax

         2            (6         6            (10

 

   

 

 

   

 

 

   

 

 

 

Wells Fargo other comprehensive income (loss), net of tax

       $   1,806            (1,594         3,228            (910

 

 

 

(1) Prior period has been revised to correct previously reported amount.

 

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Table of Contents

Cumulative OCI balances were:

 

           
(in millions)    Translation
adjustments
    Securities
available
for sale
    Derivatives
and
hedging
activities
    Defined
benefit
pension
plans
    Cumulative
other
comprehensive
income
 

Quarter ended September 30, 2012

          

Balance, beginning of period

   $ 55        5,939        384        (1,749     4,629   

Net change

     28        1,789        (30     21        1,808   

Less:    Other comprehensive income (loss) from noncontrolling interests

     (1     3        -        -        2   

Balance, end of period

   $ 84        7,725        354        (1,728     6,435   

Quarter ended September 30, 2011

          

Balance, beginning of period

   $ 130        5,814        629        (1,151     5,422   

Net change

     (37     (1,532     (46     15        (1,600

Less:    Other comprehensive income (loss) from noncontrolling interests

     (1     (5     -        -        (6

Balance, end of period

   $ 94        4,287        583        (1,136     3,828   

Nine months ended September 30, 2012

          

Balance, beginning of period

   $ 90        4,413        490        (1,786     3,207   

Net change

     (7     3,319        (136     58        3,234   

Less:    Other comprehensive income (loss) from noncontrolling interests

     (1     7        -        -        6   

Balance, end of period

   $ 84        7,725        354        (1,728     6,435   

Nine months ended September 30, 2011

          

Balance, beginning of period

   $ 112        5,066        739        (1,179     4,738   

Net change

     (19     (788     (156     43        (920

Less:    Other comprehensive income (loss) from noncontrolling interests

     (1     (9     -        -        (10

Balance, end of period

   $ 94        4,287        583        (1,136     3,828   

 

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Note 18: Operating Segments

 

 

We have three operating segments for management reporting: Community Banking; Wholesale Banking; and Wealth, Brokerage and Retirement. The results for these operating segments are based on our management accounting process, for which there is no comprehensive, authoritative guidance equivalent to GAAP for financial accounting. The management accounting process measures the performance of the operating segments based on our management structure and is not necessarily comparable with similar information for other financial services companies. We define our operating segments by product type and customer segment. If the management structure and/or the allocation process changes, allocations, transfers and assignments may change. In first quarter 2012, we modified internal funds transfer rates and the allocation of funding. The prior periods have been revised to reflect these changes.

Community Banking offers a complete line of diversified financial products and services to consumers and small businesses with annual sales generally up to $20 million in which the owner generally is the financial decision maker. Community Banking also offers investment management and other services to retail customers and securities brokerage through affiliates. These products and services include the Wells Fargo Advantage FundsSM, a family of mutual funds. Loan products include lines of credit, auto floor plan lines, equity lines and loans, equipment and transportation loans, education loans, origination and purchase of residential mortgage loans and servicing of mortgage loans and credit cards. Other credit products and financial services available to small businesses and their owners include equipment leases, real estate and other commercial financing, Small Business Administration financing, venture capital financing, cash management, payroll services, retirement plans, Health Savings Accounts, credit cards, and merchant payment processing. Community Banking also offers private label financing solutions for retail merchants across the United States and purchases retail installment contracts from auto dealers in the United States and Puerto Rico. Consumer and business deposit products include checking accounts, savings deposits, market rate accounts, Individual Retirement Accounts, time deposits, global remittance and debit cards.

Community Banking serves customers through a complete range of channels, including traditional banking stores, in-store banking centers, business centers, ATMs, Online and Mobile Banking, and Wells Fargo Customer Connection, a 24-hours a day, seven days a week telephone service.

Wholesale Banking provides financial solutions to businesses across the United States with annual sales generally in excess of $20 million and to financial institutions globally. Wholesale Banking provides a complete line of commercial, corporate, capital markets, cash management and real estate banking products and services. These include traditional commercial loans and lines of credit, letters of credit, asset-based lending, equipment leasing, international trade facilities, trade financing, collection services, foreign exchange services, treasury

management, investment management, institutional fixed-income sales, interest rate, commodity and equity risk management, online/electronic products such as the Commercial Electronic Office® (CEO®) portal, insurance, corporate trust fiduciary and agency services, and investment banking services. Wholesale Banking manages customer investments through institutional separate accounts and mutual funds, including the Wells Fargo Advantage Funds and Wells Capital Management. Wholesale Banking also supports the CRE market with products and services such as construction loans for commercial and residential development, land acquisition and development loans, secured and unsecured lines of credit, interim financing arrangements for completed structures, rehabilitation loans, affordable housing loans and letters of credit, permanent loans for securitization, CRE loan servicing and real estate and mortgage brokerage services.

Wealth, Brokerage and Retirement provides a full range of financial advisory services to clients using a planning approach to meet each client’s needs. Wealth Management provides affluent and high net worth clients with a complete range of wealth management solutions, including financial planning, private banking, credit, investment management and trust. Abbot Downing, a Wells Fargo business, provides comprehensive wealth management services to ultra high net worth families and individuals as well as their endowments and foundations. Brokerage serves customers’ advisory, brokerage and financial needs as part of one of the largest full-service brokerage firms in the United States. Retirement is a national leader in providing institutional retirement and trust services (including 401(k) and pension plan record keeping) for businesses, retail retirement solutions for individuals, and reinsurance services for the life insurance industry.

Other includes corporate items (such as integration expenses related to the Wachovia merger) not specific to a business segment and elimination of certain items that are included in more than one business segment.

 

 

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Note 18: Operating Segments (continued)

 

 

 

 

(income/expense in millions,

 

  

Community

Banking

    

Wholesale

Banking

   

Wealth,
Brokerage

and

Retirement

     Other (1)    

Consolidated

Company

 
average balances in billions)    2012      2011      2012     2011     2012      2011      2012     2011     2012      2011  

Quarter ended September 30,

                         

Net interest income (2)

   $ 7,247         7,272         3,028        2,897        680         716         (293     (343     10,662         10,542   

Provision (reversal of provision)

                         

for credit losses

     1,627         1,974         (57     (178     30         48         (9     (33     1,591         1,811   

Noninterest income

     5,863         5,238         2,921        2,238        2,353         2,172         (586     (562     10,551         9,086   

Noninterest expense

     7,402         6,905         2,908        2,689        2,457         2,371         (655     (288     12,112         11,677   

Income (loss) before income

                         

tax expense (benefit)

     4,081         3,631         3,098        2,624        546         469         (215     (584     7,510         6,140   

Income tax expense (benefit)

     1,250         1,220         1,103        822        208         178         (81     (222     2,480         1,998   

Net income (loss) before

                         

noncontrolling interests

     2,831         2,411         1,995        1,802        338         291         (134     (362     5,030         4,142   

Less: Net income (loss) from

                         

noncontrolling interests

     91         87         2        (1     -         1         -        -        93         87   

Net income (loss) (3)

   $ 2,740         2,324         1,993        1,803        338         290         (134     (362     4,937         4,055   

Average loans

   $ 485.3         489.7         277.1        253.4        42.5         43.1         (28.2     (31.7     776.7         754.5   

Average assets

     765.1         751.8         490.7        437.1        163.8         158.4         (65.3     (65.9     1,354.3         1,281.4   

Average core deposits

     594.5         556.4         225.4        209.3        136.7         133.3         (61.2     (62.2     895.4         836.8   

Nine months ended September 30,

                         

Net interest income (2)

   $ 21,879         22,237         9,556        8,545        2,079         2,113         (927     (1,024     32,587         31,871   

Provision (reversal of provision)

                         

for credit losses

     5,078         5,951         226        (141     110         150         (28     (101     5,386         5,859   

Noninterest income

     17,744         15,535         8,543        7,607        6,987         7,022         (1,723     (1,692     31,551         28,472   

Noninterest expense

     22,807         21,939         9,075        8,239        7,380         7,414         (1,760     (707     37,502         36,885   

Income (loss) before income

                         

tax expense (benefit)

     11,738         9,882         8,798        8,054        1,576         1,571         (862     (1,908     21,250         17,599   

Income tax expense (benefit)

     3,856         3,020         3,051        2,682        599         594         (327     (725     7,179         5,571   

Net income (loss) before

                         

noncontrolling interests

     7,882         6,862         5,747        5,372        977         977         (535     (1,183     14,071         12,028   

Less: Net income from

                         

noncontrolling interests

     259         238         5        21        -         7         -        -        264         266   

Net income (loss) (3)

   $ 7,623         6,624         5,742        5,351        977         970         (535     (1,183     13,807         11,762   

Average loans

   $ 485.1         498.3         272.0        243.7        42.5         43.1         (28.4     (31.8     771.2         753.3   

Average assets

     750.1         752.0         479.0        417.9        162.2         153.3         (64.9     (65.2     1,326.4         1,258.0   

Average core deposits

     585.3         552.3         222.4        195.0        135.5         128.2         (61.0     (61.6     882.2         813.9   

 

(1) Includes Wachovia integration expenses and the elimination of items that are included in both Community Banking and Wealth, Brokerage and Retirement, largely representing services and products for wealth management customers provided in Community Banking stores.
(2) Net interest income is the difference between interest earned on assets and the cost of liabilities to fund those assets. Interest earned includes actual interest earned on segment assets and, if the segment has excess liabilities, interest credits for providing funding to other segments. The cost of liabilities includes interest expense on segment liabilities and, if the segment does not have enough liabilities to fund its assets, a funding charge based on the cost of excess liabilities from another segment.
(3) Represents segment net income (loss) for Community Banking; Wholesale Banking; and Wealth, Brokerage and Retirement segments and Wells Fargo net income for the consolidated company.

 

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Note 19: Regulatory and Agency Capital Requirements

 

 

The Company and each of its subsidiary banks are subject to regulatory capital adequacy requirements promulgated by federal regulatory agencies. The Federal Reserve establishes capital requirements, including well capitalized standards, for the consolidated financial holding company, and the OCC has similar requirements for the Company’s national banks, including Wells Fargo Bank, N.A.

We do not consolidate our wholly-owned trust (the Trust) formed solely to issue trust preferred and preferred purchase securities (the Securities). Securities issued by the Trust includable in Tier 1 capital were $4.8 billion at September 30, 2012. Since December 31, 2011, we have redeemed $2.7 billion of trust preferred securities. Under applicable regulatory capital guidelines issued by bank regulatory agencies, upon notice of redemption, the redeemed trust preferred securities no longer qualify as Tier 1 Capital for the Company. This redemption is

consistent with the Capital Plan the Company submitted to the Federal Reserve Board and the actions the Company previously announced on March 13, 2012.

Certain subsidiaries of the Company are approved seller/servicers, and are therefore required to maintain minimum levels of shareholders’ equity, as specified by various agencies, including the United States Department of Housing and Urban Development, GNMA, FHLMC and FNMA. At September 30, 2012, each seller/servicer met these requirements. Certain broker-dealer subsidiaries of the Company are subject to SEC Rule 15c3-1 (the Net Capital Rule), which requires that we maintain minimum levels of net capital, as defined. At September 30, 2012, each of these subsidiaries met these requirements.

The following table presents regulatory capital information for Wells Fargo & Company and Wells Fargo Bank, N.A.

 

 

 

 

 

     Wells Fargo & Company      Wells Fargo Bank, N.A.      Well-      Minimum  
(in billions, except ratios)    Sept. 30,
2012
    Dec. 31,
2011
     Sept. 30,
2012
     Dec. 31,
2011
     capitalized
ratios (1)
     capital
ratios (1)
 

 

 

Regulatory capital:

                

Tier 1

   $ 122.7        114.0         95.5         92.6         

Total

     154.9        148.5         119.3         117.9         

Assets:

                

Risk-weighted

   $ 1,067.1        1,005.6         986.5         923.2         

Adjusted average (2)

     1,305.4        1,262.6         1,162.5         1,115.4         

Capital ratios:

                

Tier 1 capital (3)

     11.50     11.33         9.68         10.03         6.00         4.00   

Total capital (3)

     14.51        14.76         12.09         12.77         10.00         8.00   

Tier 1 leverage (2)

     9.40        9.03         8.21         8.30         5.00         4.00   

 

 

 

(1) As defined by the regulations issued by the Federal Reserve, OCC and FDIC.
(2) The leverage ratio consists of Tier 1 capital divided by quarterly average total assets, excluding goodwill and certain other items. The minimum leverage ratio guideline is 3% for banking organizations that do not anticipate significant growth and that have well-diversified risk, excellent asset quality, high liquidity, good earnings, effective management and monitoring of market risk and, in general, are considered top-rated, strong banking organizations.
(3) The September 30, 2012, capital ratios reflect the Company’s refinement to its determination of risk weighting of certain unused lending commitments that provide for the ability to issue standby letters of credit and commitments to issue standby letters of credit under syndication arrangements where we have an obligation to issue in a lead agent or similar capacity beyond our contractual participation level.

 

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Glossary of Acronyms

 

 

ACL

   Allowance for credit losses

ALCO

   Asset/Liability Management Committee

ARM

   Adjustable-rate mortgage

ARS

   Auction rate security

ASC

   Accounting Standards Codification

ASU

   Accounting Standards Update

AVM

   Automated valuation model

BCBS

   Basel Committee on Bank Supervision

BHC

   Bank holding company

CCAR

   Comprehensive Capital Analysis and Review

CD

   Certificate of deposit

CDO

   Collateralized debt obligation

CLO

   Collateralized loan obligation

CLTV

   Combined loan-to-value

CPP

   Capital Purchase Program

CPR

   Constant prepayment rate

CRE

   Commercial real estate

DOJ

   United States Department of Justice

DPD

   Days past due

ESOP

   Employee Stock Ownership Plan

FAS

   Statement of Financial Accounting Standards

FASB

   Financial Accounting Standards Board

FDIC

   Federal Deposit Insurance Corporation

FFELP

   Federal Family Education Loan Program

FHA

   Federal Housing Administration

FHFA

   Federal Housing Finance Agency

FHLB

   Federal Home Loan Bank

FHLMC

   Federal Home Loan Mortgage Corporation

FICO

   Fair Isaac Corporation (credit rating)

FNMA

   Federal National Mortgage Association

FRB

   Board of Governors of the Federal Reserve System

GAAP

   Generally accepted accounting principles

GNMA

   Government National Mortgage Association

GSE

   Government-sponsored entity

G-SIB

   Globally systemic important bank

HAMP

   Home Affordability Modification Program

HPI

   Home Price Index

HUD

   Department of Housing and Urban Development

IFRS

   International Financial Reporting Standards

LHFS

   Loans held for sale

LIBOR

   London Interbank Offered Rate

LOCOM

   Lower of cost or market value

LTV

   Loan-to-value

MBS

   Mortgage-backed security

MHA

   Making Home Affordable programs

MHFS

   Mortgages held for sale

MSR

   Mortgage servicing right

MTN

   Medium-term note

NAV

   Net asset value

NPA

   Nonperforming asset

OCC

   Office of the Comptroller of the Currency

OCI

   Other comprehensive income

OTC

   Over-the-counter

OTTI

   Other-than-temporary impairment

PCI Loans

   Purchased credit-impaired loans

PTPP

   Pre-tax pre-provision profit

RBC

   Risk-based capital

ROA

   Wells Fargo net income to average total assets

ROE

   Wells Fargo net income applicable to common stock to average Wells Fargo common stockholders’ equity

SEC

   Securities and Exchange Commission

S&P

   Standard & Poor’s

SPE

   Special purpose entity

TARP

   Troubled Asset Relief Program

TDR

   Troubled debt restructuring

VA

   Department of Veterans Affairs

VaR

   Value-at-risk

VIE

   Variable interest entity

WFCC

   Wells Fargo Canada Corporation
 

 

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Table of Contents

PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

Information in response to this item can be found in Note 11 (Legal Actions) to Financial Statements in this Report which information is incorporated by reference into this item.

 

Item 1A. Risk Factors

Information in response to this item can be found under the “Financial Review – Risk Factors” section in this Report which information is incorporated by reference into this item.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table shows Company repurchases of its common stock for each calendar month in the quarter ended September 30, 2012.

 

Calendar month    Total number
of shares
repurchased (1)
     Weighted-average
price paid per share
     Maximum number of
shares that may yet
be purchased under
the authorizations
 

July

     694,776       $             33.90         55,616,751   

August

     2,031,116         33.76         53,585,635   

September (2)

     13,813,965         32.81         39,771,670   

Total

     16,539,857         

 

 

 

(1) All shares were repurchased under an authorization covering up to 200 million shares of common stock approved by the Board of Directors and publicly announced by the Company on March 18, 2011. Unless modified or revoked by the Board, this authorization does not expire.
(2) Includes 10,774,535 shares at a weighted-average price paid per share of $32.48 repurchased in a private transaction.

The following table shows Company repurchases of the warrants for each calendar month in the quarter ended September 30, 2012.

 

       
Calendar month    Total number
of warrants
repurchased (1)
     Average price
paid per warrant
    

Maximum dollar value
of warrants that

may yet be purchased

 

July

     -       $                 -         452,254,979   

August

     -         -         452,254,979   

September

     -         -         452,254,979   

Total

     -         

 

 

 

(1) Warrants are purchased under the authorization covering up to $1 billion in warrants approved by the Board of Directors (ratified and approved on June 22, 2010). Unless modified or revoked by the Board, authorization does not expire.

 

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Table of Contents
Item 6. Exhibits

A list of exhibits to this Form 10-Q is set forth on the Exhibit Index immediately preceding such exhibits and is incorporated herein by reference.

The Company’s SEC file number is 001-2979. On and before November 2, 1998, the Company filed documents with the SEC under the name Norwest Corporation. The former Wells Fargo & Company filed documents under SEC file number 001-6214.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Dated: November 6, 2012     WELLS FARGO & COMPANY
    By:   /s/ RICHARD D. LEVY
      Richard D. Levy
     

Executive Vice President and Controller

(Principal Accounting Officer)

 

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Table of Contents

EXHIBIT INDEX

 

Exhibit

Number

  

Description

  

Location

3(a)    Restated Certificate of Incorporation, as amended and in effect on the date hereof.    Filed herewith.
3(b)    By-Laws.    Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed January 28, 2011.
4(a)    See Exhibits 3(a) and 3(b).   
4(b)    The Company agrees to furnish upon request to the Commission a copy of each instrument defining the rights of holders of senior and subordinated debt of the Company.   
12(a)    Computation of Ratios of Earnings to Fixed Charges:    Filed herewith.

 

         Quarter ended
Sept. 30,
         Nine months ended
Sept. 30,
           
 

 

      

 

 

       
         2012      2011          2012      2011            
 

 

       
  Including interest on deposits      6.50         4.51           5.99         4.19         
 

 

Excluding interest on deposits

     9.05         6.20           8.29         5.73         
 

 

       

 

12(b)        

   Computation of Ratios of Earnings to Fixed Charges and Preferred Dividends:    Filed herewith.

 

         Quarter ended
Sept. 30,
         Nine months ended
Sept. 30,
           
 

 

      

 

 

       
         2012      2011          2012      2011            
 

 

       
  Including interest on deposits      5.22         3.80           4.83         3.58         
 

 

Excluding interest on deposits

     6.66         4.85           6.13         4.58         
 

 

       

 

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Table of Contents

Exhibit

Number

 

Description

  

Location

    
31(a)   Certification of principal executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.    Filed herewith.   
31(b)   Certification of principal financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.    Filed herewith.   
32(a)   Certification of Periodic Financial Report by Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. § 1350.    Furnished herewith.   
32(b)   Certification of Periodic Financial Report by Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. § 1350.    Furnished herewith.   
101   XBRL Instance Document    Filed herewith.   
101   XBRL Taxonomy Extension Schema Document    Filed herewith.   
101   XBRL Taxonomy Extension Calculation Linkbase Document    Filed herewith.   
101   XBRL Taxonomy Extension Label Linkbase Document    Filed herewith.   
101   XBRL Taxonomy Extension Presentation Linkbase Document    Filed herewith.   
101   XBRL Taxonomy Extension Definitions Linkbase Document    Filed herewith.   

 

158