Wells Fargo 2010 Annual Report Download - page 183

LOANS For the carrying value of loans, including PCI loans, see
Note 1 (Summary of Significant Accounting Policies – Loans).
We generally do not record loans at fair value on a recurring
basis. However, from time to time, 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.
The fair value of commercial loans is calculated by
discounting contractual cash flows, adjusted for credit loss
estimates, using discount rates that reflect our current pricing
for loans with similar characteristics and remaining maturity.
For real estate 1-4 family first and junior lien mortgages, fair
value is calculated 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 risk-adjusted
discount rate for loans of similar size, type, remaining maturity
and repricing characteristics.
For credit card loans, the portfolio's yield is equal to our
current pricing and, therefore, the fair value is equal to book
value adjusted for estimates of credit losses inherent in the
portfolio at the balance sheet date.
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 and certain residential 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 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.
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