Wells Fargo 2012 Annual Report Download - page 82

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 Board’s Finance Committee, 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:
x 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);
x 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);
x 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);
x 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); or
x 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 outcomes under
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. These simulations require assumptions
regarding how changes in interest rates and related market
conditions could influence drivers of earnings and balance sheet
composition such as loan origination demand, prepayment
speeds, deposit balances and mix, as well as pricing strategies.
Our risk measures include both net interest income
sensitivity and interest rate sensitive noninterest income and
expense impacts. We refer to the combination of these exposures
as interest rate sensitive earnings. In general, the Company is
positioned to benefit from higher interest rates. Currently, our
profile is such that net interest income will benefit from higher
interest rates as our assets reprice faster and to a greater degree
than our liabilities, and, in response to lower market rates, our
assets will reprice downward and to a greater degree than our
liabilities. Our interest rate sensitive noninterest income and
expense is largely driven by mortgage activity, and tends to move
in the opposite direction of our net interest income. So, in
response to higher interest rates, mortgage activity, primarily
refinancing activity, generally declines. And in response to lower
rates, mortgage activity generally increases. Mortgage results are
also impacted by the valuation of MSRs and related hedge
positions. See the “Risk Management – Mortgage Banking
Interest Rate and Market Risk” section in this Report for more
information.
The degree to which these sensitivities offset each other is
dependent upon the timing and magnitude of changes in interest
rates, and the slope of the yield curve. During a transition to a
higher interest rate environment, a slowdown in interest
sensitive earnings from the mortgage banking business could
occur quickly, while the benefit from balance sheet repricing
may take more time to develop. For example, our “slightly
strong” scenario measures the impact of such a transition
involving an increase in long-term market rates while short-term
rates remain relatively low. If on the other hand rates decline
further, we would expect a near-term increase in interest
sensitive earnings from mortgage banking activity, while
pressure on net interest income would take place over a longer
period as the balance sheet reprices as described above.
As of December 31, 2012, our most recent simulations
estimate earnings at risk over the next 24 months under a range
of both lower and higher interest rates. The results of the
simulations are summarized in Table 41, indicating cumulative
net income after tax earnings sensitivity relative to the most
likely earnings plan over the 24 month horizon (a positive range
indicates a beneficial earnings sensitivity measurement relative
to the most likely earnings plan).
Table 41: Earnings Sensitivity Over 24 Month Horizon Relative
to Most Likely Earnings Plan
Most Slightly Slightly
likely Weak weak strong Strong
Ending rates:
Fed funds 0.50 % 0 - 0.25 0 - 0.25 0.50 4.00
10-year treasury (1) 2.50 1.45 1.98 3.50 5.10
Earnings relative to
most likely N/A 0 - 5% 0 - 5% -0.9% >5%
(1)
U.S. Constant Maturity Treasury Rate
We use the available-for-sale securities portfolio and
exchange-traded and over-the-counter (OTC) interest rate
derivatives to hedge our interest rate exposures. See the “Balance
Sheet Analysis – Securities Available for Sale” section of this
Report for more information on the use of the available-for-sale
securities portfolio. The notional or contractual amount, credit
risk amount and estimated net fair value of the derivatives used
to hedge our interest rate risk exposures as of December 31, 2012
and 2011, are presented in Note 16 (Derivatives) to Financial
Statements in this Report. We use derivatives for asset/liability
management in three main ways:
x 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;
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