Wells Fargo 2013 Annual Report Download - page 119

management services. Because investment management fees are
often based on the value of assets under management, a fall in
the market prices of those assets could reduce our fee income.
Changes in stock market prices could affect the trading activity of
investors, reducing commissions and other fees we earn from our
brokerage business. The U.S. stock market experienced all-time
highs in 2013 and there is no guarantee that those price levels
will continue. Poor economic conditions and volatile or unstable
financial markets also can negatively affect our debt and equity
underwriting and advisory businesses, as well as our trading and
venture capital businesses. Any deterioration in global financial
markets and economies, including as a result of any international
political unrest or disturbances, may adversely affect the
revenues and earnings of our international operations,
particularly our global financial institution and correspondent
banking services.
For more information, refer to the “Risk Management –
Asset/Liability Management” and “– Credit Risk Management”
sections in this Report.
Changes in interest rates and financial market values
could reduce our net interest income and earnings,
including as a result of recognizing losses or OTTI on
the securities that we hold in our portfolio or trade for
our customers. Our net interest income is the interest we earn
on loans, debt securities and other assets we hold less the
interest we pay on our deposits, long-term and short-term debt,
and other liabilities. Net interest income is a measure of both our
net interest margin – the difference between the yield we earn on
our assets and the interest rate we pay for deposits and our other
sources of funding – and the amount of earning assets we hold.
Changes in either our net interest margin or the amount or mix
of earning assets we hold could affect our net interest income
and our earnings. Changes in interest rates can affect our net
interest margin. Although the yield we earn on our assets and
our funding costs tend to move in the same direction in response
to changes in interest rates, one can rise or fall faster than the
other, causing our net interest margin to expand or contract. Our
liabilities tend to be shorter in duration than our assets, so they
may adjust faster in response to changes in interest rates. When
interest rates rise, our funding costs may rise faster than the
yield we earn on our assets, causing our net interest margin to
contract until the asset yield increases.
The amount and type of earning assets we hold can affect our
yield and net interest margin. We hold earning assets in the form
of loans and investment securities, among other assets. As noted
above, if the economy worsens we may see lower demand for
loans by creditworthy customers, reducing our net interest
income and yield. In addition, our net interest income and net
interest margin can be negatively affected by a prolonged low
interest rate environment, which as noted below is currently
being experienced as a result of economic conditions and FRB
monetary policies, as it may result in us holding short-term lower
yielding loans and securities on our balance sheet, particularly if
we are unable to replace the maturing higher yielding assets,
including the loans in our non-strategic and liquidating loan
portfolio, with similar higher yielding assets. Increases in
interest rates, however, may negatively affect loan demand and
could result in higher credit losses as borrowers may have more
difficulty making higher interest payments. As described below,
changes in interest rates also affect our mortgage business,
including the value of our MSRs.
Changes in the slope of the “yield curve” – or the spread
between short-term and long-term interest rates – could also
reduce our net interest margin. Normally, the yield curve is
upward sloping, meaning short-term rates are lower than long-
term rates. Because our liabilities tend to be shorter in duration
than our assets, when the yield curve flattens, as is the case in the
current interest rate environment, or even inverts, our net
interest margin could decrease as our cost of funds increases
relative to the yield we can earn on our assets.
The interest we earn on our loans may be tied to U.S.-
denominated interest rates such as the federal funds rate while
the interest we pay on our debt may be based on international
rates such as LIBOR. If the federal funds rate were to fall without
a corresponding decrease in LIBOR, we might earn less on our
loans without any offsetting decrease in our funding costs. This
could lower our net interest margin and our net interest income.
We assess our interest rate risk by estimating the effect on
our earnings under various scenarios that differ based on
assumptions about the direction, magnitude and speed of
interest rate changes and the slope of the yield curve. We hedge
some of that interest rate risk with interest rate derivatives. We
also rely on the “natural hedge” that our mortgage loan
originations and servicing rights can provide.
We generally do not hedge all of our interest rate risk. There
is always the risk that changes in interest rates could reduce our
net interest income and our earnings in material amounts,
especially if actual conditions turn out to be materially different
than what we assumed. For example, if interest rates rise or fall
faster than we assumed or the slope of the yield curve changes,
we may incur significant losses on debt securities we hold as
investments. To reduce our interest rate risk, we may rebalance
our investment and loan portfolios, refinance our debt and take
other strategic actions. We may incur losses when we take such
actions.
We hold securities in our investment securities portfolio,
including U.S. Treasury and federal agency securities and federal
agency MBS, securities of U.S. states and political subdivisions,
residential and commercial MBS, corporate debt securities, other
asset-backed securities and marketable equity securities,
including securities relating to our venture capital activities. We
analyze securities held in our investment securities portfolio for
OTTI on at least a quarterly basis. The process for determining
whether impairment is other than temporary usually requires
difficult, subjective judgments about the future financial
performance of the issuer and any collateral underlying the
security in order to assess the probability of receiving contractual
principal and interest payments on the security. Because of
changing economic and market conditions, as well as credit
ratings, affecting issuers and the performance of the underlying
collateral, we may be required to recognize OTTI in future
periods. Our net income also is exposed to changes in interest
rates, credit spreads, foreign exchange rates, equity and
commodity prices in connection with our trading activities,
which are conducted primarily to accommodate our customers in
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