Financial Review
34		Overview
41		Critical Accounting Policies
47		Earnings Performance
53		Balance Sheet Analysis
55		Off-Balance Sheet Arrangements
58		Risk Management
73		Capital Management
74		Comparison of 2007 with 2006
76		Risk Factors
		Controls and Procedures
84		Disclosure Controls and Procedures
84		Internal Control over Financial Reporting
84		Management’s Report on Internal Control over Financial Reporting
85		Report of Independent Registered Public Accounting Firm
		Financial Statements
86		Consolidated Statement of Income
87		Consolidated Balance Sheet
88		Consolidated Statement of Changes In Stockholders’ Equity and Comprehensive Income
90		Consolidated Statement of Cash Flows
		Notes to Financial Statements
91		1		Summary of Significant Accounting Policies
100		2		Business Combinations

103			3			Cash, Loan and Dividend Restrictions
103			4			Federal Funds Sold, Securities Purchased under Resale Agreements and Other Short-Term Investments
104			5			Securities Available for Sale
106			6			Loans and Allowance for Credit Losses
110			7			Premises, Equipment, Lease Commitments and Other Assets
111			8			Securitizations and Variable Interest Entities
119			9			Mortgage Banking Activities
120			10			Intangible Assets
121			11			Goodwill
122			12			Deposits
122			13			Short-Term Borrowings
123			14			Long-Term Debt
126			15			Guarantees and Legal Actions
132			16			Derivatives
137			17			Fair Values of Assets and Liabilities
144			18			Preferred Stock
146			19			Common Stock and Stock Plans
149			20			Employee Benefits and Other Expenses
153			21			Income Taxes
155			22			Earnings Per Common Share
155			23			Other Comprehensive Income
156			24			Operating Segments
158			25			Condensed Consolidating Financial Statements
162			26			Regulatory and Agency Capital Requirements
164			Report of Independent Registered Public Accounting Firm
165			Quarterly Financial Data

 

Wells Fargo & Company is a $1.3 trillion diversified financial services company providing banking, insurance, investments, mortgage banking, investment banking, retail banking, brokerage and consumer finance through banking stores, the internet and other distribution channels to consumers, businesses and institutions in all 50 states and in other countries. We ranked fourth in assets and first in market value of our common stock among our peers at December 31, 2008. When we refer to “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.

     We reported diluted earnings per common share of $0.70 for 2008 compared with $2.38 for 2007. Net income was $2.66 billion for 2008 compared with $8.06 billion for 2007. Net income for 2008 included an $8.14 billion (pre tax) credit reserve build, $2.01 billion (pre tax) of other-than-temporary impairment and $124 million (pre tax) of merger-related expenses.

     On December 31, 2008, Wells Fargo acquired Wachovia Corporation (Wachovia). Because the acquisition was completed at the end of 2008, Wachovia’s results are not included in the income statement, average balances or related metrics for 2008. Wachovia’s assets and liabilities are included in the consolidated balance sheet at December 31, 2008, at their respective acquisition date fair values.

     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 products our customers buy from us and to give them all of the financial products that fulfill their needs. Our cross-sell strategy and diversified business model facilitate growth in strong and weak economic cycles, as we can grow by expanding the number of products our current customers have with us. We continued to earn more of our customers’ business in 2008 in both our retail and commercial banking businesses.

     Despite the unprecedented contraction in the credit markets, we continued to lend to credit-worthy customers. We made $106 billion in new loan commitments during 2008 to consumer, small business and commercial customers and originated $230 billion of residential mortgages. The fundamentals of our time-tested business model are as sound as ever. During fourth quarter 2008, our average core deposits grew an impressive 31% (annualized) over the prior quarter. Our cross-sell set records for the 10th consecutive year–our

average retail banking household now has 5.73 products, one of every four has eight or more products, 6.4 products for Wholesale Banking customers, and our average middle-market commercial banking customer has almost eight products. Business banking cross-sell reached 3.61 products. Our goal is eight products per customer, which is currently half of our estimate of potential demand. We were able to increase our lending to creditworthy customers because we were building capital and shrinking our balance sheet in 2005 and 2006, when credit spreads were unrealistically low and were not priced for their underlying risk. We did make some mistakes, but for the most part, we maintained our credit discipline. We understand our customers’ financial needs. As a result, our company at year-end 2008 was one of the world’s strongest financial institutions. At February 23, 2009, Wells Fargo Bank, N.A. has the highest credit rating currently given to U.S. banks by Moody’s Investors Service, “Aa1,” and Standard & Poor’s Ratings Services, “AA+.”

WACHOVIA MERGER On December 31, 2008, Wachovia merged into Wells Fargo & Company with Wells Fargo surviving the merger. Wachovia, based in Charlotte, North Carolina, was one of the nation’s largest diversified financial services companies, providing a broad range of retail banking and brokerage, asset and wealth management, and corporate and investment banking products and services to customers through 3,300 financial centers in 21 states from Connecticut to Florida and west to Texas and California, and nationwide retail brokerage, mortgage lending and auto finance businesses. In the merger, Wells Fargo exchanged 0.1991 shares of its common stock for each outstanding share of Wachovia common stock, issuing a total of 422.7 million shares of Wells Fargo common stock with a December 31, 2008, value of $12.5 billion to Wachovia shareholders. Shares of each outstanding series of Wachovia preferred stock were converted into shares (or fractional shares) of a corresponding series of Wells Fargo preferred stock having substantially the same rights and preferences. Wachovia’s assets and liabilities are included in the consolidated balance sheet at their respective acquisition date fair values. Wachovia’s year-end assets at fair value totaled $707 billion. Because the acquisition was completed at the end of 2008, Wachovia’s results of operations are not included in our income statement. Based on the purchase price of $23.1 billion and the fair value of net assets acquired of $14.3 billion, the transaction resulted in goodwill of $8.8 billion, which will change as acquisition date fair values

are refined over a period of up to one year following the acquisition. Because the transaction closed on the last day of the annual reporting period, certain fair value purchase accounting adjustments were based on data as of an interim period with estimates through year end. Accordingly, we will be re-validating and, where necessary, refining our purchase accounting adjustments. We expect that the refinements will focus largely on loans with evidence of credit deterioration. The impact of any changes will be recorded as an adjustment to goodwill.

     The more significant fair value adjustments in our purchase accounting for the Wachovia acquisition were to loans. Certain of the loans acquired from Wachovia have evidence of credit deterioration since origination and it is probable that we will not collect all contractually required principal and interest payments. Such loans are accounted for under American Institute of Certified Public Accountants (AICPA) Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (SOP 03-3). SOP 03-3 requires that acquired credit-impaired loans be recorded at fair value and prohibits carryover of the related allowance for loan losses.

     Loans within the scope of SOP 03-3 are initially recorded at fair value. The application of the SOP, and accordingly the process of estimating fair value, involves estimating the principal and interest cash flows expected to be collected on the credit-impaired loans and discounting those cash flows at a market rate of interest.

     Under SOP 03-3, the excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life of the loan, or pool of loans, in situations where there is a reasonable expectation about the timing and amount of cash flows expected to be collected. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition, considering the impact of prepayments, is referred to as the nonaccretable difference. Subsequent decreases to the expected cash flows will generally result in a charge to the provision for credit losses resulting in an increase to the allowance for loan losses. Subsequent increases in cash flows result in reversal of any nonaccretable difference (or allowance for loan losses to the extent any has been recorded) with a positive impact on interest income. Disposals of loans, which may include sales of loans, receipt of payments in full by the borrower, foreclosure or troubled debt restructurings (TDRs) result in removal of the loan from the SOP 03-3 portfolio at its carrying amount.

     Of the $446.1 billion of loans acquired in the Wachovia merger, $93.9 billion were determined to be credit-impaired and therefore subject to SOP 03-3. Generally, loans on nonaccrual status were considered to be credit-impaired for purposes of applying the SOP. The fair value of these loans was $58.8 billion at December 31, 2008. Wachovia’s allowance for loan losses related to the loans was $12.0 billion and such allowance was not carried forward to the Wells Fargo allowance, rather it

was reversed with an offset to goodwill. The allowance for loan losses of $7.5 billion (excluding the impact of conforming adjustments) associated with loans not within the scope of SOP 03-3 was carried over and is included in the consolidated allowance for loan losses.

     Loans subject to SOP 03-3 are written down to an amount estimated to be collectible. Accordingly, such loans are no longer classified as nonaccrual even though they may be contractually past due. We expect to fully collect the new carrying values of such loans (that is, the new cost basis arising out of our purchase accounting). Of Wachovia’s pre-acquisition nonaccrual loans, $20.0 billion are no longer considered to be nonaccrual because of the application of SOP 03-3 and $97 million continue to be reported as nonaccrual because they are outside the scope of the SOP. Loans subject to SOP 03-3 are also excluded from the disclosure of loans 90 days or more past due and still accruing interest even though substantially all of them are 90 days or more contractually past due and they are considered to be accruing because the interest income on these loans relates to the establishment of an accretable yield in accordance with SOP 03-3.

     As a result of the application of SOP 03-3 to Wachovia’s loans, certain ratios of the combined company cannot be used to compare a portfolio that includes acquired credit-impaired loans accounted for under SOP 03-3 against one that does not, for example, in comparing peer companies, and cannot be used to compare ratios across years such as comparing 2008 ratios, which include the Wachovia acquisition, against prior periods, which do not. The ratios particularly affected by the accounting under SOP 03-3 include the allowance for loan losses as a percentage of loans, nonaccrual loans, and nonperforming assets, and nonaccrual loans and nonperforming assets as a percentage of total loans.
     Loans not subject to SOP 03-3 are recorded net of an adjustment to reflect market interest rates. The allowance for loan losses related to these loans of $7.5 billion was carried over and included in the consolidated allowance for loan losses.

SUMMARY RESULTS Revenue, the sum of net interest income and noninterest income, grew 6% to a record $41.9 billion in 2008 from $39.4 billion in 2007. The breadth and depth of our business model resulted in very strong and balanced growth in loans, deposits and fee-based products. We achieved positive operating leverage (revenue growth of 6%; expense decline of 1%), the best among large bank peers. Net income for 2008 of $2.66 billion included an $8.14 billion (pre tax) credit reserve build, $2.01 billion (pre tax) of other-than-temporary impairment and $124 million (pre tax) of merger-related expenses. Diluted earnings per share of $0.70 included credit reserve build ($1.51 per share) and other-than-temporary impairment ($0.37 per share). Industry-leading annual results included the highest growth in pre-tax pre-provision earnings (up 16%), highest net interest margin (4.83%), return on average common stockholders’ equity (ROE), return on average total assets (ROA) and highest total shareholder return among large bank peers (up 2%).

     We are among the banking industry’s leaders in increasing loans and assets and remained “open for business” in providing credit to consumers, small businesses and commercial customers. Average earning assets, primarily loans and securities, were up $119 billion, or 28%, since the start of the credit crisis in mid-2007. We have made $187 billion of new loan commitments to consumer and commercial customers since mid-2007. We have originated $354 billion of residential real estate loans since mid-2007, including $50 billion in fourth quarter 2008. We have continued to help homeowners remain in their homes. We delivered over 498,000 solutions to customers in 2008, including 143,000 in the fourth quarter alone, through repayment plans, modifications and other loss mitigation options and are working with government agencies, HOPE NOW and others. Wells Fargo has led the industry in development of programs for at-risk customers to avoid foreclosure.

     Among the many products and services that grew in 2008, we achieved the following results:

•		Average loans grew 16%;
•		Average core deposits grew 7%; and
•		Assets under management were up 45%, including $510 billion from Wachovia.

     We have significantly strengthened the balance sheet and future earnings stream of the new Wells Fargo. This included the following actions:

•		$37.2 billion of credit write-downs taken at December 31, 2008, through purchase accounting adjustments on $93.9 billion of high-risk loans in Wachovia’s loan portfolio
•		Reduced the cost basis of the Wachovia securities portfolio by $9.6 billion, reflecting $2.4 billion of recognized losses in the fourth quarter and write-off of $7.2 billion of unrealized losses previously reflected in negative cumulative other comprehensive income
•		Additional net $2.9 billion of Wachovia negative cumulative other comprehensive income written off, primarily related to pension obligations
•		Wachovia period-end loans, securities, trading assets and loans held for sale reduced by $115.2 billion, or 17%, from June 30, 2008
•		$8.1 billion credit reserve build, including $3.9 billion of provision to conform to the most conservative methodology from each company within Federal Financial Institutions Examination Council (FFIEC) guidelines

	-	$2.7 billion for Wells Fargo’s consumer portfolios
	-	$1.2 billion for Wachovia’s commercial and Pick-a-Pay portfolios

•

Wells Fargo securities portfolio written down by $2.0 billion for other-than-temporary impairment

     Our combined allowance for credit losses was $21.7 billion at December 31, 2008, which represents 3.2 times coverage of nonaccrual loans. At December 31, 2008, our combined allowance covered 12 months of estimated losses for all consumer portfolios and at least 24 months for all commercial and commercial real estate portfolios. As described on page 35, our nonaccrual loans excluded $20.0 billion of SOP 03-3 loans that were previously reflected as nonaccrual by Wachovia.

     With the acquisition of Wachovia, we have leading market positions in deposits in many communities in our expanded banking footprint, including #1 market share in 18 of our 39 combined community banking states and the District of Columbia. In addition, we are the #1 lender in the following markets: middle-market companies, commercial real estate, small business and agriculture, and the #1 commercial real estate broker and bank-owned insurance broker.
     We have stated in the past that to consistently grow over the long term, successful companies must invest in their core businesses and maintain strong balance sheets. In addition to the Wachovia acquisition, we continued to make investments in 2008 by opening 58 regional banking stores and converting 32 stores acquired from Greater Bay Bancorp, Farmers State Bank and United Bancorporation of Wyoming, Inc. to our network.
     We believe it is important to maintain a well-controlled environment as we continue to grow our businesses. We manage our credit risk by setting 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 prudent ranges, while ensuring adequate liquidity and funding. We maintain strong capital levels to provide for future growth.
     At December 31, 2008, consolidated Tier 1 regulatory capital was $86.4 billion, after the impact of purchase accounting for credit impairments of loans and write-down of negative cumulative other comprehensive income at Wachovia, which, in the aggregate, reduced the Tier 1 capital ratio by approximately 230 basis points to 7.8% at year end, well above regulatory minimums for a well-capitalized bank.
     The Board of Directors declared a common stock dividend of $0.34 per share for first quarter 2009.

     Our financial results included the following:

     Net income in 2008 was $2.66 billion ($0.70 per share), compared with $8.06 billion ($2.38 per share) in 2007. Results for 2008 included the impact of our $8.1 billion (pre tax) credit reserve build, which included a $3.9 billion (pre tax) provision to conform both Wells Fargo’s and Wachovia’s credit reserve practices to the more conservative of each company. Results for 2007 included the impact of our $1.4 billion (pre tax) credit reserve build ($0.27 per share) and $203 million of Visa litigation expenses ($0.04 per share). Despite the challenging environment in 2008, we achieved both top line revenue growth and positive operating leverage (revenue growth of 6%; expense decline of 1%). ROA was 0.44% and ROE was 4.79% in 2008, compared with 1.55% and 17.12%, respectively, in 2007. Both ROA and ROE were at or near the top of our large bank peers.
     Net interest income on a taxable-equivalent basis was $25.4 billion in 2008, up from $21.1 billion a year ago, reflecting strong loan growth, disciplined deposit pricing and lower market funding costs. Average earning assets grew 17% from 2007. Our net interest margin was 4.83% for 2008, up from 4.74% in 2007, primarily due to the benefit of lower funding costs as market rates declined.

     Noninterest income decreased 9% to $16.8 billion in 2008 from $18.4 billion in 2007. Card fees were up 9% from a year ago, due to continued growth in new accounts and higher credit and debit card transaction volume. Insurance revenue was up 20%, due to customer growth, higher crop insurance revenue and the fourth quarter 2007 acquisition of ABD Insurance. However, trust and investment fees decreased 7% and other fees decreased 9%, due to depressed market conditions. Operating lease income decreased 39% from a year ago, due to continued softening in the auto market, reflecting tightened credit standards. Noninterest income included $300 million in net gains on debt and equity securities, including $2.01 billion of other-than-temporary impairment write-downs.
     During 2008, noninterest income was affected by changes in interest rates, widening credit spreads, and other credit and housing market conditions, including:

•		($2.01) billion of other-than-temporary impairment
•		($847) million in write-downs of loans in the mortgage warehouse due to changes in liquidity and other spreads, and additions to the mortgage repurchase reserve
•		($242) million mortgage servicing rights (MSRs) mark to market, net of hedge gain
•		($228) million of other changes in the mortgage pipeline/warehouse value including a decline in servicing value, net of pipeline/warehouse hedge results

     Noninterest expense was $22.7 billion in 2008, down 1% from $22.8 billion in 2007. We continued to invest in new stores and additional sales and service-related team members.
      In 2008, net charge-offs were $7.84 billion (1.97% of average total loans), up $4.3 billion from $3.54 billion (1.03%) in 2007. Commercial and commercial real estate net charge-offs increased $1.25 billion in 2008 from 2007, of which $379 million

was from loans originated through our Business Direct channel. Business Direct consists primarily of unsecured lines of credit to small firms and sole proprietors that tend to perform in a manner similar to credit cards. Total wholesale net charge-offs (excluding Business Direct) were $967 million (0.11% of average loans). The remaining balance of commercial and commercial real estate loans (other real estate mortgage, real estate construction and lease financing) experienced some deterioration from 2007 with loss levels increasing, reflecting the credit environment in 2008.
     Home Equity net charge-offs were $2.21 billion (2.59% of average Home Equity loans) in 2008, compared with $595 million (0.73%) in 2007. Since our loss experience through third party channels was significantly worse than other retail channels, in 2007 we segregated these indirect loans into a liquidating portfolio. While the $10.3 billion of loans in this liquidating portfolio represented about 1% of total loans outstanding at December 31, 2008, these loans represent some of the highest risk in our $129.5 billion Home Equity portfolios. The loans in the liquidating portfolio were primarily sourced through wholesale channels (brokers) and correspondents. Additionally, they are largely concentrated in geographic markets that have experienced the most abrupt and steepest declines in housing prices. We continue to provide home equity financing directly to our customers, but have stopped originating or acquiring new home equity loans through indirect channels unless they are behind a Wells Fargo first mortgage and have a combined loan-to-value ratio lower than 85%. We also experienced increased net charge-offs in our unsecured consumer portfolios, such as credit cards and lines of credit, in part due to growth and in part due to increased economic stress in households.

 

     Auto portfolio net charge-offs for 2008 were $1.23 billion (4.50% of average auto loans), compared with $1.02 billion (3.45%) in 2007. While we have continued to reduce the size of this portfolio and limited additional growth, the economic environment has adversely affected portfolio results. We have remained focused on our loss mitigation strategies, however, credit performance has deteriorated as a result of increased unemployment and depressed used car values, resulting in higher than expected losses for the year.
     The provision for credit losses was $15.98 billion in 2008, an increase of $11.04 billion from $4.94 billion in 2007, due to higher net charge-offs and the 2008 credit reserve build of $8.14 billion, including $3.9 billion to conform estimated loss emergence coverage periods to the most conservative of each company within FFIEC guidelines ($2.7 billion for Wells Fargo consumer loans and $1.2 billion for Wachovia commercial and Pick-a-Pay loans). The balance of the reserve build was attributed to higher projected loss rates across the majority of the consumer credit business, and some credit deterioration and growth in the wholesale portfolios. The allowance for credit losses, which consists of the allowance for loan losses and the reserve for unfunded credit commitments, was $21.7 billion (2.51% of total loans) at December 31, 2008, compared with $5.52 billion (1.44%) at December 31, 2007.
     At December 31, 2008, total nonaccrual loans were $6.80 billion (0.79% of total loans) up from $2.68 billion (0.70%) at December 31, 2007. Total nonaccrual loans at December 31, 2008, excluded $20.0 billion of SOP 03-3 loans that were previously reflected as nonaccrual by Wachovia. The majority of the $4.1 billion increase in nonaccrual loans was in the real estate 1-4 family first mortgage portfolio, including $742 million in Wells Fargo Financial real estate and $424 million in Wells Fargo Home Mortgage, and was due to the national rise in mortgage default rates. Total nonperforming assets (NPAs) were $9.01 billion (1.04% of total loans) at December 31, 2008, compared with $3.87 billion (1.01%) at December 31, 2007. Total NPAs at December 31, 2008, excluded $20.0 billion of SOP 03-3 loans that were previously reflected as nonperforming by Wachovia. Foreclosed assets were $2.19 billion at December 31, 2008, including $885 million from Wachovia, compared with $1.18 billion at December 31, 2007. Foreclosed assets, a component of total NPAs, included $1.53 billion and $649 million in residential property and auto loans and $667 million and $535 million of foreclosed real estate securing Government National Mortgage Association (GNMA) loans at December 31, 2008 and 2007, respectively, consistent with regulatory reporting requirements. The foreclosed real estate securing GNMA loans of $667 million represented eight basis points of the ratio of NPAs to loans at December 31, 2008. Both principal and interest for the GNMA loans secured by the foreclosed real estate are collectible because the GNMA loans are insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs.
     The Company and each of its subsidiary banks remained “well capitalized” under applicable regulatory capital adequacy guidelines. The ratio of common stockholders’ equity to total

assets was 5.21% at December 31, 2008, compared with 8.28% at December 31, 2007. Our total risk-based capital (RBC) ratio at December 31, 2008, was 11.83% and our Tier 1 RBC ratio was 7.84%, exceeding the minimum regulatory guidelines of 8% and 4%, respectively, for bank holding companies. Our RBC ratios at December 31, 2007, were 10.68% and 7.59%, respectively. Our Tier 1 leverage ratios were 14.52% and 6.83% at December 31, 2008 and 2007, respectively, exceeding the minimum regulatory guideline of 3% for bank holding companies.

Table 2: Ratios and Per Common Share Data
		Year ended December 31,
		2008				2007				2006
PROFITABILITY RATIOS
Net income to average total assets (ROA)			0.44	%			1.55	%			1.73	%
Net income applicable to common stock to average common stockholders’ equity (ROE)			4.79				17.12				19.52
EFFICIENCY RATIO (1)			54.1				57.9				58.4
CAPITAL RATIOS
At year end:
Common stockholders’ equity to assets			5.21				8.28				9.51
Risk-based capital (2)
Tier 1 capital			7.84				7.59				8.93
Total capital			11.83				10.68				12.49
Tier 1 leverage (2)(3)			14.52				6.83				7.88
Average balances:
Common stockholders’ equity to assets			8.18				9.04				8.88
PER COMMON SHARE DATA
Dividend payout (4)			185.7				49.0				43.2
Book value		$	16.15			$	14.45			$	13.57
Market price (5)
High		$	44.68			$	37.99			$	36.99
Low			19.89				29.29				30.31
Year end			29.48				30.19				35.56

Current Accounting Developments
On January 1, 2008, we adopted the following new accounting pronouncements:

•		FSP FIN 39-1 – Financial Accounting Standards Board (FASB) Staff Position on Interpretation No. 39, Amendment of FASB Interpretation No. 39;
•		EITF 06-4 – Emerging Issues Task Force (EITF) Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements;
•		EITF 06-10 – EITF Issue No. 06-10, Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements; and
•		SAB 109 – Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value Through Earnings.

     On July 1, 2008, we adopted the following new accounting pronouncement:

•

FSP FAS 157-3 – FASB Staff Position No. FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.

     We adopted the following new accounting pronouncements, which were effective for year-end 2008 reporting:

•		FSP FAS 140-4 and FIN 46(R)-8 – FASB Staff Position No. 140-4 and FIN 46(R)-8, Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities;
•		FSP FAS 133-1 and FIN 45-4 – FASB Staff Position No. 133-1 and FIN 45-4, Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161; and
•		FSP EITF 99-20-1 – FASB Staff Position No. EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 99-20.

     On April 30, 2007, the FASB issued FSP FIN 39-1, which amends Interpretation No. 39 to permit a reporting entity to offset the right to reclaim cash collateral (a receivable), or the obligation to return cash collateral (a payable), against derivative instruments executed with the same counterparty under the same master netting arrangement. The provisions of this FSP are effective for the year beginning on January 1, 2008, with early adoption permitted. We adopted FSP FIN 39-1 on January 1, 2008, and it did not have a material effect on our consolidated financial statements.

     On September 20, 2006, the FASB ratified the consensus reached by the EITF at its September 7, 2006, meeting with respect to EITF 06-4. On March 28, 2007, the FASB ratified the consensus reached by the EITF at its March 15, 2007, meeting with respect to EITF 06-10. These pronouncements require that for endorsement split-dollar life insurance arrangements and collateral split-dollar life insurance arrangements where the employee is provided benefits in postretirement periods, the employer should recognize the cost of providing that insurance over the employee’s service period by accruing a liability for the benefit obligation. Additionally, for collateral assignment split-dollar life insurance arrangements, an employer is required to recognize and measure an asset based upon the nature and substance of the agreement. EITF 06-4 and EITF 06-10 are effective for the year beginning on January 1, 2008, with early adoption permitted. We adopted EITF 06-4 and EITF 06-10 on January 1, 2008, and reduced beginning retained earnings for 2008 by $20 million (after tax), primarily related to split-dollar life insurance arrangements from the acquisition of Greater Bay Bancorp.

     On November 5, 2007, the Securities and Exchange Commission (SEC) issued SAB 109, which provides the staff’s views on the accounting for written loan commitments recorded at fair value under U.S. generally accepted accounting principles (GAAP). To make the staff’s views consistent with current authoritative accounting guidance, SAB 109 revises and rescinds portions of SAB 105, Application of

Accounting Principles to Loan Commitments. Specifically, SAB 109 states that the expected net future cash flows associated with the servicing of a loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. The provisions of SAB 109, which we adopted on January 1, 2008, are applicable to written loan commitments recorded at fair value that are entered into beginning on or after January 1, 2008. The implementation of SAB 109 did not have a material impact on our first quarter 2008 results or the valuation of our loan commitments.

     On October 10, 2008, the FASB issued FSP FAS 157-3, which clarifies the application of FAS 157, Fair Value Measurements, in an inactive market and illustrates how an entity would determine fair value when the market for a financial asset is not active. The FSP states that an entity should not automatically conclude that a particular transaction price is determinative of fair value. In a dislocated market, judgment is required to evaluate whether individual transactions are forced liquidations or distressed sales. When relevant observable market information is not available, a valuation approach that incorporates management’s judgments about the assumptions that market participants would use in pricing the asset in a current sale transaction is acceptable. The FSP also indicates that quotes from brokers or pricing services may be relevant inputs when measuring fair value, but are not necessarily determinative in the absence of an active market for the asset. In weighing a broker quote as an input to a fair value measurement, an entity should place less reliance on quotes that do not reflect the result of market transactions. Further, the nature of the quote (for example, whether the quote is an indicative price or a binding offer) should be considered when weighing the available evidence. The FSP was effective immediately and applied to prior periods for which financial statements have not been issued, including interim or annual periods ending on or before September 30, 2008. We adopted the FSP prospectively, beginning July 1, 2008. The adoption of the FSP did not have a material impact on our consolidated financial results or fair value determinations.

     On December 11, 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8. This FSP is intended to improve disclosures about transfers of financial assets and continuing involvement with both qualifying special purpose entities (QSPEs) and variable interest entities (VIEs). The FSP requires qualitative and quantitative disclosures surrounding the nature of a company’s continuing involvement with QSPEs and VIEs, the carrying amount and classification of related assets and liabilities, including the nature of any restrictions on those assets and liabilities; contractual or non-contractual support provided to either QSPEs or VIEs; and a company’s maximum exposure to loss related to these activities. This FSP amends FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities – a replacement of FASB Statement No. 125, and FIN 46(R), Consolidation of Variable Interest Entities (revised December 2003) – an interpretation of ARB No. 51. The FSP is effective for reporting periods (annual or interim) ending after December 15, 2008.

Because the FSP amends only the disclosure requirements, the adoption of the FSP did not affect our consolidated financial results. For additional information, see Note 8 (Securitizations and Variable Interest Entities).

     On September 12, 2008, the FASB issued FSP FAS 133-1 and FIN 45-4. This FSP is intended to improve disclosures about credit derivatives by requiring more information about the potential adverse effects of changes in credit risk on the financial position, financial performance and cash flows of the sellers of credit derivatives. It amends FAS 133, Accounting for Derivative Instruments and Hedging Activities, to require disclosures by sellers of credit derivatives, including credit derivatives embedded in hybrid instruments. The FSP also amends FIN 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others – an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34, to require an additional disclosure about the current status of the payment/performance risk of a guarantee. The provisions of the FSP that amend FAS 133 and FIN 45 are effective for reporting periods (annual or interim) ending after November 15, 2008. Because the FSP amends only the disclosure requirements for credit derivatives and certain guarantees, the adoption of the FSP did not affect our consolidated financial results.

     On October 14, 2008, the SEC’s Office of the Chief Accountant (OCA) clarified its views on the application of other-than-temporary impairment guidance in FAS 115, Accounting for Certain Investments in Debt and Equity Securities, to certain perpetual preferred securities. The OCA concluded that it would not object to a registrant applying an other-than-temporary impairment model to investments in perpetual preferred securities that possess significant debt-like characteristics that is similar to the impairment model applied to debt securities, provided there has been no evidence of deterioration in credit of the issuer. An entity is permitted to apply the OCA’s views in its financial statements included in filings subsequent to the date of the letter. Accordingly, in third quarter 2008, we began applying this OCA guidance and have subsequently recorded other-than-temporary impairment on certain investment grade perpetual preferred securities where we believe credit events of the issuers have occurred.

     On January 12, 2009, the FASB issued FSP EITF 99-20-1, which amends EITF 99-20, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets (EITF 99-20), to achieve more consistent determinations of whether other-than-temporary impairments of available-for-sale or held-to-maturity debt securities have occurred. The provisions of the FSP are to be applied prospectively and are considered effective for reporting periods (annual or interim) ending after December 15, 2008. Beginning with our fourth quarter 2008 results, based on this FSP guidance, we recorded no other-than-temporary impairment for certain EITF 99-20 securities that otherwise may have been considered impaired.

     On December 4, 2007, the FASB issued FAS 141 (revised 2007), Business Combinations (FAS 141R). This statement requires an acquirer to recognize the assets acquired (including loan receivables), the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, to be measured at their fair values as of that date, with limited exceptions. The acquirer is not permitted to recognize a separate valuation allowance as of the acquisition date for loans and other assets acquired in a business combination. The revised statement requires acquisition-related costs to be expensed separately from the acquisition. It also requires restructuring costs that the acquirer expected but was not obligated to incur, to be expensed separately from the business combination. FAS 141R is applicable prospectively to business combinations completed on or after January 1, 2009. Early adoption is not permitted.

     In December 2008, the FASB issued FAS 160, Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51 (FAS 160). FAS 160 requires that noncontrolling interests (referred to as minority interests) be reported as a component of stockholders’ equity in the balance sheet. Prior to adoption of FAS 160 they are classified in liabilities or between liabilities and stockholders’ equity. This new standard also changes the way a minority interest is presented in the income statement such that a parent’s consolidated income statement includes amounts attributable to both the parent’s interest and the noncontrolling interest. FAS 160 requires that a parent recognize a gain or loss when a subsidiary is deconsolidated. The remaining interest is initially recorded at fair value. Other changes in ownership interest where the parent continues to have a majority ownership interest in the subsidiary are accounted for as capital transactions.

     FAS 160 is effective for fiscal years and interim periods within fiscal years, beginning on or after December 15, 2008. Early adoption is not permitted. Adoption is applied prospectively to all noncontrolling interests including those that arose prior to the adoption of FAS 160, with retrospective adoption required for disclosure of noncontrolling interests held as of the adoption date.

     We hold a controlling interest in a joint venture with Prudential Financial, Inc. (Prudential) as described in more detail on page 57. Prudential’s noncontrolling interest of 23% is included in other liabilities in the balance sheet, and amounted to $824 million at December 31, 2008. Under the terms of the original agreement under which the joint venture was established between Wachovia and Prudential, each party has certain rights such that changes in our ownership interest can occur. Prudential has stated its intention to exercise its option to put its noncontrolling interest to us at a date in the future.

     As a result of the issuance of FAS 160 and related interpretive guidance, along with this stated intention, in the first quarter of 2009, the carrying value of Prudential’s noncontrolling interest in the joint venture will be increased from its December 31, 2008, carrying value to the estimated maximum redemption amount, with the offset recorded to additional paid-in capital.

     On February 20, 2008, the FASB issued FSP FAS No. 140-3, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FSP FAS 140-3). FSP FAS 140-3 requires that, if an entity transfers a loan to, and then subsequently executes a repurchase financing with the transferor collateralized by that loan, then the transferor would not be permitted to treat the initial transfer as a sale unless certain criteria are met, including that the transferred asset must be readily obtainable in the marketplace. The provisions of this FSP are effective beginning January 1, 2009, and shall be applied prospectively to initial transfers and repurchase financings for which the initial transfer is executed on or after this date. Early application is not permitted. FSP FAS 140-3 is not expected to have a material effect on our consolidated financial results.

     On March 19, 2008, the FASB issued FAS 161, Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133 (FAS 161). FAS 161 changes the disclosure requirements for derivative instruments and hedging activities. It requires enhanced disclosures about how and why an entity uses derivatives, how derivatives and related hedged items are accounted for, and how derivatives and hedged items affect an entity’s financial position, performance and cash flows. The provisions of FAS 161 are effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early adoption encouraged. Because FAS 161 amends only the disclosure requirements for derivative instruments and hedged items, the adoption of FAS 161 will not affect our consolidated financial results.

 

Our significant accounting policies (see Note 1 (Summary of Significant Accounting Policies) to Financial Statements) 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;
•		acquired loans accounted for under SOP 03-3;
•		the valuation of residential mortgage servicing rights (MSRs);
•		the fair valuation of financial instruments;
•		pension accounting; and
•		income taxes.

     Management has reviewed and approved these critical accounting policies and has discussed these policies with the Audit and Examination Committee of the Company’s Board of Directors.

Allowance for Credit Losses
The allowance for credit losses, which consists of the allowance for loan losses and the reserve for unfunded credit commitments, is management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date. We have an established process, using several analytical tools and benchmarks, to calculate a range of possible outcomes and determine the adequacy of the allowance. The allowance carried over from Wachovia was generally subject to the same methodology described above. No single statistic or measurement determines the adequacy of the allowance. Loan recoveries and the provision for credit losses increase the allowance, while loan charge-offs decrease the allowance.

PROCESS TO DETERMINE THE ADEQUACY OF THE ALLOWANCE FOR CREDIT LOSSES While we attribute portions of the allowance to specific loan categories as part of our analytical process, the entire allowance is used to absorb credit losses inherent in the total loan portfolio.

     At December 31, 2008, the portion of the allowance for credit losses estimated at a pooled level for consumer loans and some segments of commercial small business loans was $16.4 billion. For purposes of determining the allowance for credit losses, we pool certain loans in our portfolio by product type, primarily for the auto, credit card and real estate mortgage portfolios. To achieve greater accuracy, we further segment selected portfolios. As appropriate, the business groups may attempt to achieve greater accuracy through segmentation by sub-product, origination channel, vintage, loss type, geography and other predictive characteristics. For example, credit cards are segmented by origination channel and the Home Equity portfolios are further segmented between liquidating and nonliquidating. In the case of residential mortgages, we segment the liquidating Pick-a-Pay portfolio, and further segment this portfolio based on origination channel.

     To measure losses inherent in consumer loans and some commercial small business loans, we use loss models and other quantitative, mathematical techniques to forecast losses. Each business group forecasts losses for loans as of the balance sheet date over the estimated loss emergence period.

     Each business group determines the model type and/or segmentation method that fits the loss characteristics of its portfolios and provides the greatest level of forecasting accuracy. We use both internally developed and vendor supplied roll rate/net cash flow models. Roll rate/net cash flow models, vintage base-models and behavior score models are often used for near-term loss projections as well as time series/statistical trend models for longer term projections. Models are independently validated and are reviewed by corporate credit personnel to ensure that the theory, assumptions, data,

computational processes, reporting and end-user controls of the models are appropriate and well documented. In addition, regulatory examiners review and perform detailed tests of our allowance processes.

     Forecasted losses are compared with actual losses and this information is used by management in order to develop an allowance that management believes adequate to cover losses inherent in the loan portfolio as of the reporting date.

     The portion of the allowance for commercial loans, commercial real estate loans and lease financing was $4.5 billion at December 31, 2008. We initially estimate this portion of the allowance by applying historical loss factors statistically derived from tracking losses associated with actual portfolio movements over a specified period of time, for each specific loan grade. Based on this process, we assign loss factors to each pool of graded loans and a loan equivalent amount for unfunded loan commitments and letters of credit. These estimates are then adjusted or supplemented where necessary from additional analysis of long-term average loss experience, external loss data or other risks identified from current conditions and trends in selected portfolios, including management’s judgment for imprecision and uncertainty.

     We also assess and account for certain nonaccrual commercial and commercial real estate loans that are over $5 million and certain consumer, commercial and commercial real estate loans whose terms have been modified in a troubled debt restructuring as impaired. We include the impairment on these nonperforming loans in the allowance unless it has already been recognized as a loss. At December 31, 2008, we included $816 million in the allowance related to impaired loans.

     Reflected in the portions of the allowance previously described is an amount for imprecision or uncertainty that incorporates the range of probable outcomes inherent in estimates used for the allowance, which may change from period to period. This amount is the result of our judgment of risks inherent in the portfolios, economic uncertainties, historical loss experience and other subjective factors, including industry trends, calculated to better reflect our view of risk in each loan portfolio.

     In addition, the allowance for credit losses included a reserve for unfunded credit commitments of $698 million at December 31, 2008.

     The total allowance reflects management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date. To estimate the possible range of allowance required at December 31, 2008, and the related change in provision expense, we assumed the following scenarios of a reasonably possible deterioration or improvement in loan credit quality.

Assumptions for deterioration in loan credit quality were:

•		for consumer loans, a 55 basis point increase in estimated loss rates from actual 2008 loss levels, prolonged residential real estate value deterioration, continued increase in unemployment levels and higher bankruptcy levels; and
•		for wholesale loans, a 17 basis point increase in estimated loss rates from actual 2008 loss levels, an increase in corporate bankruptcies and continued deterioration in the homebuilder environment.

Assumptions for improvement in loan credit quality were:

•		for consumer loans, a 24 basis point decrease in estimated loss rates from actual 2008 loss levels, adjusting for residential real estate value stabilization and real estate sales market improvement; and
•		for wholesale loans, a 14 basis point decrease in estimated loss rates, large unexpected losses not realized and an improved home builder environment.

     Under these assumptions for deterioration in loan credit quality, another $3.2 billion in expected losses could occur and under the assumptions for improvement, a $1.6 billion reduction in expected losses could occur.

     Changes in the estimate of the allowance for credit losses and the related provision expense can materially affect net income. The example above is only one of a number of reasonably possible scenarios. Determining the allowance for credit losses requires us to make forecasts of losses that are highly uncertain and require a high degree of judgment. The increase in the allowance for credit losses in excess of net charge-offs in 2008 was primarily due to adjustments to conform to the most conservative methodology from Wells Fargo and Wachovia, general deterioration in most of our portfolios given the current economic environment, especially in the Home Equity portfolios stemming from the steeper than anticipated decline in national home prices and a lengthening in the loss emergence timing for consumer credit portfolios. See Note 6 (Loans and Allowance for Credit Losses) to Financial Statements and “Risk Management — Credit Risk Management Process” for further discussion of our allowance for credit losses.

Acquired Loans Accounted for under SOP 03-3

Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase date may include statistics such as past due and nonaccrual status, recent borrower credit scores and recent loan to value percentages. Purchased credit-impaired loans are accounted for under SOP 03-3 and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for credit losses related to these loans is not carried over and recorded at the acquisition date. We estimate the cash flows expected to be collected at acquisition using our internal credit risk, interest rate risk and prepayment risk models, which incorporate our best estimate of current key assumptions, such as default rates, loss severity and prepayment speeds.

     Under SOP 03-3, the excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life of the loan, or pool of loans, in situations where there is a reasonable expectation about the timing and amount of cash flows expected to be collected. The difference between the contractually required payments at acquisition and the cash flows expected to be collected at acquisition,

considering the impact of prepayments, is referred to as the nonaccretable difference. Subsequent decreases to the expected cash flows will generally result in a charge to the provision for credit losses resulting in an increase to the allowance for loan losses. Subsequent increases in cash flows result in reversal of any nonaccretable difference (or allowance for loan losses to the extent any has been recorded) with a positive impact on interest income. Disposals of loans, which may include sales of loans, receipt of payments in full by the borrower, foreclosure or TDRs, result in removal of the loan from the SOP 03-3 portfolio at its carrying amount.

     In connection with the Wachovia acquisition, we acquired certain loans that were deemed to be credit impaired under SOP 03-3. SOP 03-3 allows purchasers to aggregate credit-impaired loans acquired in the same fiscal quarter into one or more pools, provided that the loans have common risk characteristics. A pool is then accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. With respect to the Wachovia acquisition, we aggregated all of the consumer loans and wholesale loans with balances of $3 million or less into pools with common risk characteristics. We accounted for wholesale loans with balances in excess of $3 million individually.

     To estimate the possible impact on the accounting for the SOP 03-3 loans as of December 31, 2008, we assumed the following scenarios of a reasonable possible improvement or deterioration in loan credit quality.

     Assumptions for deterioration in loan credit quality for SOP 03-3 loans were:

•		for Pick-a-Pay loans, a 10% increase in expected life of loan loss rates from December 31, 2008, purchase accounting estimates, based on increased loss severity due to prolonged residential real estate value deterioration, continued increase in unemployment levels and higher bankruptcy levels; and
•		for commercial real estate loans, a 10% increase in expected life of loan loss rates from December 31, 2008, purchase accounting estimates due to continued deterioration in the homebuilder and income property sectors.

     Assumptions for improvement in loan credit quality for SOP 03-3 were:

•		for Pick-a-Pay loans, a 10% decrease in expected life of loan loss rates from December 31, 2008, purchase accounting estimates, based on decreased loss severity due to residential real estate value stabilization; and
•		for commercial real estate loans, a 10% decrease in expected life of loan loss rates from December 31, 2008, purchase accounting estimates due to an improvement in the home-builder and income property sectors.

     Had the expected life of loan loss rates we used to determine the nonaccretable difference at December 31, 2008, for these two portfolios reflected the 10% increase or decrease in life of loan loss rates as described above, the nonaccretable difference would have changed by approximately $2.4 billion for Pick-a-Pay loans and $680 million for commercial real estate.

     In accordance with SOP 03-3, loans that were classified as nonperforming loans by Wachovia are no longer classified as nonperforming because, at acquisition, we believe we will fully collect the new carrying value of these loans. It is important to note that judgment is required in reclassifying loans subject to SOP 03-3 to performing status, and is dependent on having a reasonable expectation about the timing and amount of cash flows expected to be collected, even if the loan is contractually past due.

Valuation of Residential Mortgage Servicing Rights

We recognize as assets the rights to service mortgage loans for others, or mortgage servicing rights (MSRs), whether we purchase the servicing rights, or the servicing rights result from the sale or securitization of loans we originate (asset transfers). We also acquire MSRs under co-issuer agreements that provide for us to service loans that are originated and securitized by third-party correspondents. We initially measure and carry our MSRs related to residential mortgage loans (residential MSRs) using the fair value measurement method, under which purchased MSRs and MSRs from asset transfers are capitalized and carried at fair value.

     At the end of each quarter, we determine the fair value of MSRs using a valuation model that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, 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. The valuation of MSRs is discussed further in this section and in Note 1 (Summary of Significant Accounting Policies), Note 8 (Securitizations and Variable Interest Entities), Note 9 (Mortgage Banking Activities) and Note 17 (Fair Values of Assets and Liabilities) to Financial Statements.

     To reduce the sensitivity of earnings to interest rate and market value fluctuations, we may use securities available for sale and free-standing derivatives (economic hedges) to hedge the risk of changes in the fair value of MSRs, with the resulting gains or losses reflected in income. Changes in the fair value of the MSRs from changing mortgage interest rates are generally offset by gains or losses in the fair value of the derivatives depending on the amount of MSRs we hedge and the particular instruments used to hedge the MSRs. We may choose not to fully hedge MSRs, partly because origination volume tends to act as a “natural hedge.” For example, as interest rates decline, servicing values generally decrease and fees from origination volume tend to increase. Conversely, as interest rates increase, the fair value of the MSRs generally increases, while fees from origination volume tend to decline. See “Mortgage Banking Interest Rate and Market Risk” for discussion of the timing of the effect of changes in mortgage interest rates.

     Net servicing income, a component of mortgage banking noninterest income, includes the changes from period to period in fair value of both our residential MSRs and the free-standing derivatives (economic hedges) used to hedge our residential MSRs. Changes in the fair value of residential MSRs from period to period result from (1) changes in the valuation model inputs or assumptions (principally reflecting changes in discount rates and prepayment speed assumptions, mostly due to changes in interest rates) and (2) other changes, representing changes due to collection/realization of expected cash flows.

     We use a dynamic and sophisticated model to estimate the value of our MSRs. The model is validated by an independent internal model validation group operating in accordance with Company policies. Senior management reviews all significant assumptions quarterly. Mortgage loan prepayment speed–a key assumption in the model–is the annual rate at which borrowers are forecasted to repay their mortgage loan principal. The discount rate used to determine the present value of estimated future net servicing income–another key assumption in the model–is the required rate of return investors in the market would expect for an asset with similar risk. To determine the discount rate, we consider the risk premium for uncertainties from servicing operations (e.g., possible changes in future servicing costs, ancillary income and earnings on escrow accounts). Both assumptions can, and generally will, change quarterly as market conditions and interest rates change. For example, an increase in either the prepayment speed or discount rate assumption results in a decrease in the fair value of the MSRs, while a decrease in either assumption would result in an increase in the fair value of the MSRs. In recent years, there have been significant market-driven fluctuations in loan prepayment speeds and the discount rate. These fluctuations can be rapid and may be significant in the future. Therefore, estimating prepayment speeds within a range that market participants would use in determining the fair value of MSRs requires significant management judgment.

     These key economic assumptions and the sensitivity of the fair value of MSRs to an immediate adverse change in those assumptions are shown in Note 8 (Securitizations and Variable Interest Entities) to Financial Statements.

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. Trading assets, securities available for sale, derivatives, prime residential mortgages held for sale (MHFS), certain commercial loans held for sale (LHFS), principal investments 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 nonprime 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. Further, we include in Notes to Financial Statements information about the extent to which fair value is used to measure assets and liabilities, the valuation methodologies used and its impact to earnings. Additionally, for financial instruments not recorded at fair value we disclose the estimate of their fair value.

     FAS 157, Fair Value Measurements (FAS 157), defines fair value as the price that would be received to sell the financial asset or paid to transfer the financial liability in an orderly transaction between market participants at the measurement date.

     FAS 157 establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect our estimates about market data.

•		Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 instruments include securities traded on active exchange markets, such as the New York Stock Exchange, as well as U.S. Treasury and other U.S. government securities that are traded by dealers or brokers in active over-the-counter 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, such as matrix pricing, for which all significant assumptions are observable in the market. Level 2 instruments include securities traded in less active dealer or broker markets and MHFS that are valued based on prices for other mortgage whole loans with similar characteristics.
•		Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect our own estimates of assumptions 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 accordance with FAS 157, it is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. When available, we use quoted market prices to measure fair value. If market prices are not available, fair value measurement is based upon models that use primarily market-based or independently-sourced market parameters, including interest rate yield curves, prepayment speeds, option volatilities and currency rates. Most of our financial instruments use either of the foregoing methodologies, collectively Level 1 and Level 2 measurements, to determine fair value adjustments recorded to our financial statements. However, in certain cases, when market observable inputs for model-based valuation techniques may not be readily available, we are required to make judgments about assumptions market participants would use in estimating the fair value of the financial instrument.

     The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not fully available, management judgment is necessary to estimate fair value. In addition, changes in the market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. When significant adjustments are required to available observable inputs, it may be appropriate to utilize an estimate based primarily on unobservable inputs. When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable.

     Approximately 19% of total assets ($247.5 billion) at December 31, 2008, and 22% of total assets ($123.8 billion) at December 31, 2007, consisted of financial instruments recorded at fair value on a recurring basis. Assets for which fair values were measured using significant Level 3 inputs represented approximately 19% of these financial instruments (4% of total assets) at December 31, 2008, and approximately 18% (4% of total assets) at December 31, 2007. The fair value of the remaining assets were measured using valuation methodologies involving market-based or market-derived information, collectively Level 1 and 2 measurements.

     Our financial assets valued using Level 3 measurements consisted of certain asset-backed securities, including those collateralized by auto leases and cash reserves, private collateralized mortgage obligations (CMOs), collateralized debt obligations (CDOs), collateralized loan obligations (CLOs), auction-rate securities, certain derivative contracts such as credit default swaps related to CMO, CDO and CLO exposures and certain MHFS and MSRs. While MSR valuations generally require use of significant unobservable inputs and therefore are classified as Level 3, significant judgment may be required to determine whether certain other assets measured at fair value are included in Level 2 or Level 3. For example, we closely monitor market conditions involving assets that have become less actively traded, such as MHFS, private CMOs, and certain other debt securities, including CDOs and CLOs. See Note 8 (Securitizations and Variable Interest Entities) to Financial Statements for a detailed discussion of the key assumptions used to determine the fair value of our MSRs and the related sensitivity analysis. If fair value measurement is based upon recent observable market activity of such assets or comparable assets (other than forced or distressed transactions) that occur in sufficient volume and do not require significant adjustment using unobservable inputs, those assets are classified as Level 2; if not, they are classified as Level 3. Making this assessment requires significant judgment. In 2008, $4.3 billion of fair

value option MHFS and $1.9 billion of debt securities available for sale were transferred from Level 2 to Level 3 because significant inputs to the valuation became unobservable, largely due to reduced levels of market liquidity.

     We use prices from independent pricing services and to a lesser extent, indicative (non-binding) quotes from independent brokers, to measure fair value of our investment securities. See Note 17 (Fair Values of Assets and Liabilities) to Financial Statements for the amount and fair value hierarchy classification of those securities measured at fair value using an independent pricing service and those measured at fair value using broker quotes. We utilize multiple independent pricing services and brokers to obtain fair values, however, we generally obtain one price/quote for each individual security. For securities priced by independent pricing services, we determine the most appropriate and relevant pricing service for each security class and have that vendor provide the price for each security in the class. We record the unadjusted value provided by the independent pricing service/broker in our financial statements, subject to our internal price verification procedures. We validate prices received from pricing services or brokers using a variety of methods, including, but not limited to, comparison to secondary pricing services, corroboration of pricing by reference to other independent market data such as secondary broker quotes and relevant benchmark indices, and review of pricing by Company personnel familiar with market liquidity and other market-related conditions. Based upon our internal price verification procedures and review of fair value methodology documentation provided by independent pricing services, we have concluded that the fair values for our investment securities at year end were consistent with the guidance in FAS 157.

     Approximately 2% of total liabilities ($18.8 billion) at December 31, 2008, and 0.5% ($2.6 billion) at December 31, 2007, consisted of financial instruments recorded at fair value on a recurring basis. Liabilities valued using Level 3 measurements were $638 million and $280 million at December 31, 2008 and 2007, respectively.

     See Note 17 (Fair Values of Assets and Liabilities) to Financial Statements for a complete discussion on our use of fair valuation of financial instruments, our related measurement techniques and its impact to our financial statements.

Pension Accounting

We account for our defined benefit pension plans using an actuarial model required by FAS 87, Employers’ Accounting for Pensions, as amended by FAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R). FAS 158 was issued on September 29, 2006, and became effective for us on December 31, 2006. FAS 158 requires us to recognize the funded status of our pension and postretirement benefit plans in our balance sheet. Additionally, FAS 158 required us to use a year-end measurement date beginning in 2008. The adoption of FAS 158 did not change the amount of net periodic benefit expense recognized in our income statement.

     We use four key variables to calculate our annual pension cost: size and characteristics of the employee population, actuarial assumptions, expected long-term rate of return on plan assets, and discount rate. We describe below the effect of each of these variables on our pension expense.

SIZE AND CHARACTERISTICS OF THE EMPLOYEE POPULATION Pension expense is directly related to the number of employees covered by the plans, and other factors including salary, age and years of employment.

ACTUARIAL ASSUMPTIONS To estimate the projected benefit obligation, actuarial assumptions are required about factors such as the rates of mortality, turnover, retirement, disability and compensation increases for our participant population. These demographic assumptions are reviewed periodically. In general, the range of assumptions is narrow.

EXPECTED LONG-TERM RATE OF RETURN ON PLAN ASSETS We determine the expected return on plan assets each year based on the composition of assets and the expected long-term rate of return on that portfolio. The expected long-term rate of return assumption is a long-term assumption and is not anticipated to change significantly from year to year.

     To determine if the expected rate of return is reasonable, we consider such factors as (1) long-term historical return experience for major asset class categories (for example, large cap and small cap domestic equities, international equities and domestic fixed income), and (2) forward-looking return expectations for these major asset classes. Our expected rate of return for 2009 is 8.75%, the same rate used for 2008 and 2007. Differences in each year, if any, between expected and actual returns are included in our net actuarial gain or loss amount, which is recognized in other comprehensive income. We generally amortize any net actuarial gain or loss in excess of a 5% corridor (as defined in FAS 87) in net periodic pension expense calculations over the next five years. Due to the dramatic downturn in market conditions during 2008, our actual rate of return for 2008 was negative, and was therefore significantly less than our long-term expected rate of return of 8.75%. This difference will increase our 2009 pension expense by approximately $600 million due to higher actuarial loss amortization combined with a lower rate of return component of pension expense, as compared to our 2008 pension expense. Although our plan assets experienced a negative return in 2008, our plan assets have earned an average annualized rate of return of about 9% over the last 25 years. Our average remaining service period is approximately 10 years. See Note 20 (Employee Benefits and Other Expenses) to Financial Statements for information on funding, changes in the pension benefit obligation, and plan assets (including the investment categories, asset allocation and the fair value).

     If we were to assume a 1% increase/decrease in the expected long-term rate of return, holding the discount rate and other actuarial assumptions constant, 2009 pension expense would decrease/increase by approximately $74 million.

DISCOUNT RATE We use a discount rate to determine the present value of our future benefit obligations. The discount rate reflects the current rates available on long-term high-quality fixed-income debt instruments, and is reset annually on the measurement date. To determine the discount rate, we review, with our independent actuary, spot interest rate yield curves based upon yields from a broad population of high-quality bonds, adjusted to match the timing and amounts of the Cash Balance Plan’s expected benefit payments. We used a discount rate of 6.75% in 2008 and 6.25% in 2007.

     If we were to assume a 1% increase in the discount rate, and keep the expected long-term rate of return and other actuarial assumptions constant, pension expense would decrease by approximately $72 million. If we were to assume a 1% decrease in the discount rate, and keep other assumptions constant, 2009 pension expense would increase by approximately $70 million. The decrease in pension expense due to a 1% increase in discount rate differs slightly from the increase in pension expense due to a 1% decrease in discount rate due to the impact of the 5% gain/loss corridor.

Income Taxes

We are subject to the income tax laws of the U.S., its states and municipalities and those of the foreign jurisdictions in which we operate. We account for income taxes in accordance with FAS 109, Accounting for Income Taxes, as interpreted by FIN 48, Accounting for Uncertainty in Income Taxes. Our income tax expense consists of two components: current and deferred. Current income tax expense approximates taxes to be paid or refunded for the current period and includes income tax expense related to our uncertain tax positions. We determine deferred income taxes using the balance sheet method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and recognized enacted changes in tax rates and laws in the period in which they occur. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized subject to management’s judgment that realization is “more likely than not.” Uncertain tax positions that meet the more likely than not recognition threshold are measured to determine the amount of benefit to recognize. An uncertain tax position is measured at the largest amount of benefit that management believes is greater than 50% likely of being realized upon settlement. Foreign taxes paid are generally applied as credits to reduce federal income taxes payable. We account for interest and penalties as a component of income tax expense.

     The income tax laws of the jurisdictions in which we operate are complex and subject to different interpretations by the taxpayer and the relevant government taxing authorities. In establishing a provision for income tax expense, we must make judgments and interpretations about the application of these inherently complex tax laws. We must also make estimates about when in the future certain items will affect taxable income in the various tax jurisdictions by the govern-

ment taxing authorities, both domestic and foreign. Our interpretations may be subjected to review during examination by taxing authorities and disputes may arise over the respective tax positions. We attempt to resolve these disputes during the tax examination and audit process and ultimately through the court systems when applicable.

     We monitor relevant tax authorities and revise our estimate of accrued income taxes due to changes in income tax laws and their interpretation by the courts and regulatory

authorities on a quarterly basis. Revisions of our estimate of accrued income taxes also may result from our own income tax planning and from the resolution of income tax controversies. Such revisions in our estimates may be material to our operating results for any given quarter.

     See Note 21 (Income Taxes) to Financial Statements for a further description of our provision for income taxes and related income tax assets and liabilities.

 

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

     Net interest income on a taxable-equivalent basis was $25.4 billion in 2008, up 20% from $21.1 billion in 2007. Our net interest margin increased to 4.83% for 2008 from 4.74% for 2007. Both the increase in net interest income and the increase in the net interest margin were largely driven by disciplined deposit pricing and lower market funding costs.

     Average earning assets increased $77.6 billion to $523.5 billion in 2008 from $445.9 billion in 2007. Average loans increased to $398.5 billion in 2008 from $344.8 billion in 2007. Average mortgages held for sale decreased to $25.7 billion in 2008 from $33.1 billion in 2007. Average debt securities available for sale increased to $86.3 billion in 2008 from $57.0 billion in 2007.

     The purchase accounting adjustments that we recorded on Wachovia’s interest-earning assets and interest-bearing liabilities to reflect market rates of interest for each instrument or pool of instruments will affect net interest income beginning in first quarter 2009. The more significant of these adjustments include an $8.2 billion net increase to loans where amortization will decrease net interest income, a $4.4 billion net increase to deposits, specifically certificates of deposit, and a $190 million increase to long-term debt, where amortization for both will increase net interest income.

     Core deposits are an important contributor to growth in net interest income and the net interest margin, and are a low-cost source of funding. Core deposits are noninterest-bearing deposits, interest-bearing checking, savings certificates, market rate and other savings, and certain foreign deposits (Eurodollar sweep balances). We have one of the largest bases of core deposits among large U.S. banks. Average core deposits grew 7% to $325.2 billion in 2008 from $303.1 billion in 2007 and funded 82% and 88% of average total loans in 2008 and 2007, respectively. Total average retail core deposits, which exclude Wholesale Banking core deposits and retail mortgage escrow deposits, for 2008 grew $13.1 billion (6%) from 2007. Average mortgage escrow deposits decreased to $21.0 billion in 2008 from $21.5 billion in 2007. Average savings certificates of deposit decreased to $39.5 billion in 2008 from $40.5 billion in 2007 and average noninterest-bearing checking accounts and other core deposit categories (interest-bearing checking and market rate and other savings) increased to $260.2 billion in 2008 from $241.9 billion in 2007. Total average interest-bearing deposits increased to $266.1 billion in 2008 from $239.2 billion in 2007, predominantly due to growth in market rate and other savings, along with growth in foreign deposits, offset by a decline in other time deposits.

     Table 3 presents the individual components of net interest income and the net interest margin.