Wells Fargo 2010 Annual Report Download - page 78

Risk Management –Asset/Liability Management (continued)
However, in order to foreclose on the mortgage loan, it may be
necessary for an assignment of the mortgage to be completed by
MERS to the trust, in order to comply with state law
requirements governing foreclosure. A delay by a servicer in
processing any related assignment of mortgage to the trust could
delay foreclosure, with adverse effects to security holders and
potential for servicer liability. Our practice is to obtain
assignments of mortgages from MERS during the foreclosure
process.
The FRB and OCC have completed a joint interagency
horizontal examination of foreclosure processing at large
mortgage servicers, including Wells Fargo, to evaluate the
adequacy of their controls and governance over bank foreclosure
processes, including compliance with applicable federal and
state law. The OCC and other federal banking regulators are
finalizing actions that will incorporate remedial requirements
and sanctions with respect to servicers within their relevant
jurisdictions for identified deficiencies.
Asset/Liability Management
Asset/liability management involves the evaluation, monitoring
and management of interest rate risk, market risk, liquidity and
funding. The Corporate Asset/Liability Management Committee
(Corporate ALCO), which oversees these risks and reports
periodically to the Finance Committee of the Board of Directors
(Board), 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 are subject to interest rate risk
because:
• assets and liabilities may mature or reprice at different
times (for example, if assets reprice faster than liabilities
and interest rates are generally falling, earnings will initially
decline);
• assets and liabilities may reprice at the same time but by
different amounts (for example, when the general level of
interest rates is falling, we may reduce rates paid on
checking and savings deposit accounts by an amount that is
less than the general decline in market interest rates);
• short-term and long-term market interest rates may change
by different amounts (for example, the shape of the yield
curve may affect new loan yields and funding costs
differently); or
• the remaining maturity of various assets or liabilities may
shorten or lengthen as interest rates change (for example, if
long-term mortgage interest rates decline sharply, MBS held
in the securities available-for-sale portfolio may prepay
significantly earlier than anticipated, which could reduce
portfolio income).
Interest rates may also have a direct or indirect effect on loan
demand, credit losses, mortgage origination volume, the fair
value of MSRs and other financial instruments, the value of the
pension liability and other items affecting earnings.
We assess interest rate risk by comparing our most likely
earnings plan with various earnings simulations using many
interest rate scenarios that differ in the direction of interest rate
changes, the degree of change over time, the speed of change and
the projected shape of the yield curve. For example, as of
December 31, 2010, our most recent simulation indicated
estimated earnings at risk of approximately 5% of our most likely
earnings plan over the next 12 months using a scenario in which
the federal funds rate rises to 4.25% and the 10-year Constant
Maturity Treasury bond yield rises 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” section in this Report 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
December 31, 2010 and 2009, are presented in Note 15
(Derivatives) to Financial Statements in this Report. We use
derivatives for asset/liability management in three main ways:
• to convert a major portion of our long-term fixed-rate debt,
which we issue to finance the Company, from fixed-rate
payments to floating-rate payments by entering into
receive-fixed swaps;
• to convert the cash flows from selected asset and/or liability
instruments/portfolios from fixed-rate payments to
floating-rate payments or vice versa; and
• to hedge our mortgage origination pipeline, funded
mortgage loans and MSRs using interest rate swaps,
swaptions, futures, forwards and options.
MORTGAGE BANKING INTEREST RATE AND MARKET RISK We
originate, fund and service mortgage loans, which subjects us to
various risks, including credit, liquidity and interest rate risks.
Based on market conditions and other factors, we reduce credit
and liquidity risks by selling or securitizing some or all of the
long-term fixed-rate mortgage loans we originate and most of
the ARMs we originate. On the other hand, we may hold
originated ARMs and fixed-rate mortgage loans in our loan
portfolio as an investment for our growing base of core deposits.
We determine whether the loans will be held for investment or
held for sale at the time of commitment. We may subsequently
change our intent to hold loans for investment and sell some or
all of our ARMs or fixed-rate mortgages as part of our corporate
asset/liability management. We may also acquire and add to our
securities available for sale a portion of the securities issued at
the time we securitize MHFS.
Notwithstanding the continued downturn in the housing
sector, and the continued lack of liquidity in the nonconforming
secondary markets, our mortgage banking revenue remained
strong, reflecting the complementary origination and servicing
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