Wells Fargo & Company is a $1.2 trillion diversified financial services company providing banking, insurance, trust and investments, mortgage banking, investment banking, retail banking, brokerage and consumer finance through banking stores, the internet and other distribution channels to individuals, businesses and institutions in all 50 states, the District of Columbia (D.C.) and in other countries. We ranked fourth in assets and second in the market value of our common stock among our large bank peers at March 31, 2011. When we refer to “Wells Fargo,” “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. When we refer to “legacy Wells Fargo,” we mean Wells Fargo excluding Wachovia Corporation (Wachovia).

Our Vision and Strategy

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 offer them all of the financial products that fulfill their needs. Our cross-sell strategy, diversified business model and the breadth of our geographic reach facilitate growth in both strong and weak economic cycles, as we can grow by expanding the number of products our current customers have with us, gain new customers in our extended markets, and increase market share in many businesses.

     Our combined company retail bank household cross-sell was 5.79 products per household in first quarter 2011, up from 5.60 a year ago. We believe there is more opportunity for cross-sell as we continue to earn more business from our Wachovia customers. Our goal is eight products per customer, which is approximately half of our estimate of potential demand for an average U.S. household. One of every four of our retail banking households has eight or more products. Business banking cross-sell offers another potential opportunity for growth, with cross-sell of 4.09 products in our Western footprint (including legacy Wells Fargo and converted Wachovia customers), up from 4.04 in fourth quarter 2010.

     Our pursuit of growth and earnings performance is influenced by our belief that it is important to maintain a well controlled operating environment as we complete the integration of the Wachovia businesses and grow the combined company. We manage our credit risk by establishing 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 established ranges, while ensuring adequate liquidity and funding. We maintain strong capital levels to facilitate future growth.

Financial Performance

     Wells Fargo net income was a record $3.8 billion in first quarter 2011, up 48% from a year ago, and diluted earnings per common share were $0.67, up 49%. Our results included contributions from each of our three business segments: Community Banking; Wholesale Banking; and Wealth, Brokerage and Retirement. In first quarter 2011, credit quality improved, capital ratios increased and cross-selling reached new highs. Reflecting the significant improvement in our credit portfolios, the provision for credit losses was $1.0 billion less than net charge-offs for first quarter 2011. Revenue was down 5% from a year ago, reflecting a decline in mortgage banking income and lower service charges on deposits due to regulatory changes, as well as a decline in average loans as we continued to reduce our non-strategic and liquidating loan portfolios. Noninterest expense was up 5% primarily due to higher commission and incentive compensation.

     Our average core deposits grew 5% from a year ago to $796.8 billion at March 31, 2011. Average core deposits were 106% of total average loans in first quarter 2011, up from 95% a year ago. We continued to attract high quality core deposits in the form of checking and savings deposits, which grew 9% to $722.5 billion at March 31, 2011, from $664.4 billion a year ago, as we added new customers and deepened our relationships with existing customers.

     Wells Fargo remained one of the largest providers of credit to the U.S. economy. We continued to lend to creditworthy customers and made $151 billion in new loan commitments to consumer, small business and commercial customers, including

$84 billion of residential mortgage originations in first quarter 2011, up from a total of $128 billion a year ago. We are an industry leader in loan modifications for homeowners. As of March 31, 2011, approximately 665,000 Wells Fargo mortgage customers were in active trial or had completed loan modifications since the beginning of 2009.

Credit Quality

We experienced significant improvement in our credit portfolio with lower net charge-offs, lower nonperforming assets and improved delinquency trends. The improvement in our credit portfolio was due in part to the continued decline in our non-strategic and liquidating loan portfolios (primarily from the Wachovia acquisition), which decreased $6.5 billion in first quarter 2011, and $65.0 billion in total since the Wachovia acquisition, to $126.8 billion at March 31, 2011.

     Reflecting the improved performance in our loan portfolios, the provision for credit losses was $1.0 billion less than net charge-offs for first quarter 2011. Absent significant deterioration in the economy, we expect future reductions in the allowance for credit losses. First quarter 2011 marked the fifth consecutive quarter of declining loan losses and the second consecutive quarter of reduced nonperforming assets. Net charge-offs decreased significantly to $3.2 billion in first quarter 2011 from $3.8 billion in fourth quarter 2010, and $5.3 billion a year ago. Nonperforming assets decreased to $30.6 billion at March 31, 2011, from $32.4 billion at December 31, 2010, and $31.5 billion a year ago. Loans 90 days or more past due and still accruing (excluding government insured/guaranteed loans) decreased to $2.4 billion at March 31, 2011, from $2.6 billion at December 31, 2010, and $4.9 billion a year ago. In addition, the portfolio of purchased credit-impaired (PCI) loans acquired in the Wachovia merger has performed better than originally expected.

Capital

We continued to build capital in first quarter 2011, with total shareholders’ equity up $7.1 billion from year-end 2010. In first quarter 2011, our Tier 1 common equity ratio grew more than 60 basis points to 8.93% of risk-weighted assets under Basel I, reflecting strong internal capital generation. Under our interpretation of current Basel III capital proposals, we estimate that our Tier 1 common equity ratio grew to 7.2% in first quarter 2011. Our other regulatory capital ratios also continued to grow with the Tier 1 capital ratio reaching 11.50% and Tier 1 leverage ratio reaching 9.27% at March 31, 2011. See the “Capital Management” section in this Report for more information regarding our capital, including Tier 1 common equity.

     We took several capital actions in first quarter 2011. Reflecting our strong capital position, we returned more capital to shareholders in first quarter 2011, with an increase in our quarterly common stock dividend to $0.12 per share. We also increased our share repurchase authority by 200 million shares. In addition, we issued notice to call $3.2 billion of high-cost trust preferred securities and expect to call additional trust preferred securities.

Wachovia Merger Integration

On December 31, 2008, Wells Fargo acquired Wachovia, one of the nation’s largest diversified financial services companies. At the beginning of our third year of the Wachovia integration, our progress to date is on track and on schedule, and business and revenue synergies have exceeded our expectations at the time the merger was announced. First quarter 2011 marked further milestones in our integration of legacy Wells Fargo and Wachovia: we completed our conversion to one common retail brokerage platform and we converted retail banking stores in several eastern states, including Connecticut, Delaware, New Jersey, and New York. With our April conversion of the Pennsylvania retail banking stores, 74% of our banking customers are now on a single deposit system. The Wachovia merger has already proven to be a financial success, with substantially all of the originally expected savings already realized and growing revenue synergies reflecting market share gains in many businesses, including mortgage, auto dealer services and investment banking.

     As a result of PCI accounting for loans acquired in the Wachovia merger, ratios of the Company, including the growth rate in nonperforming assets (NPAs) since December 31, 2008, may not be directly comparable with periods prior to the merger or with credit-related ratios of other financial institutions. In particular:

•		Wachovia’s high risk loans were written down pursuant to PCI accounting at the time of merger. Therefore, the allowance for credit losses is lower than otherwise would have been required without PCI loan accounting; and
•		Because we virtually eliminated Wachovia’s nonaccrual loans at December 31, 2008, the quarterly growth rate in our nonaccrual loans following the merger was higher than it would have been without PCI loan accounting. Similarly, our net charge-offs rate was lower than it otherwise would have been.

Market and Industry Developments

The Board of Governors of the Federal Reserve System (FRB) and the Office of the Comptroller of the Currency (OCC) recently issued consent orders that will require us to promptly correct deficiencies in our residential mortgage loan servicing and foreclosure practices that were identified by federal banking regulators in their review conducted in fourth quarter 2010. The consent orders also require that we improve our servicing and foreclosure practices. We are committed to compliance with the consent orders and support the development of national servicing standards that will provide greater clarity for servicers, investors and customers. We continue to be committed to modifying mortgages for at-risk customers. We have been working with our regulators for an extended period to improve our processes and have already begun making some of the operational changes that will result from the expanded servicing responsibilities outlined in the consent orders.

     In 2009, the FRB announced regulatory changes to debit card and ATM overdraft practices, which have reduced our service charges on deposit accounts. The Dodd-Frank Act, among other things, authorizes the FRB to issue regulations

governing debit card interchange fees, which are expected to be implemented in 2011. We continue to refine our estimate of the potential impact on our income of these regulations, if implemented in 2011. Based on the current FRB proposals, we

currently expect that our quarterly income would be reduced by approximately $325 million (after tax), before the impact of any offsetting actions.

Net income for first quarter 2011 was $3.8 billion ($0.67 diluted per share) with $3.6 billion applicable to common stock, compared with net income of $2.5 billion ($0.45 diluted per share) with $2.4 billion applicable to common stock for first quarter 2010. Our first quarter 2011 earnings reflected the benefit of continued improvements in credit quality, partially offset by a decrease in total loans and elevated balances of lower yielding earning assets.

     Revenue, the sum of net interest income and noninterest income, was $20.3 billion in first quarter 2011 compared with $21.4 billion in first quarter 2010. The decline in revenue was predominantly due to lower net interest income and lower mortgage banking revenue. However, many businesses generated year over year revenue growth, including corporate banking, commercial mortgage servicing, fixed income and equity sales and trading, global remittance, real estate capital markets, retail brokerage, auto dealer services and wealth management. Net interest income of $10.7 billion in first quarter 2011 declined 4% from a year ago compared with a 5% decline in average loans. The decline in average loans reflected continued reductions in the non-strategic/liquidating portfolios and soft consumer loan demand.

     Noninterest expense was $12.7 billion (63% of revenue) in first quarter 2011, compared with $12.1 billion (56% of revenue) a year ago. First quarter 2011 included $440 million of merger integration costs (up from $380 million a year ago), $472 million of operating losses (up from $208 million a year ago) substantially all from additional litigation accruals for foreclosure-related matters, and higher incentive compensation expenses caused by sales increases in commission-based business units as well as other earnings-based incentives. Certain expenses remained elevated year over year, including loan resolution costs and merger costs. As we conclude the integration process, and as the economy continues to recover, we expect these expenses to decline.

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, short-term borrowings and long-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 in Table 1 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 $10.8 billion in first quarter 2011, compared with $11.3 billion a year ago. The net interest margin was 4.05% in first quarter 2011,

down 22 basis points from 4.27% in first quarter 2010. Net interest margin was compressed relative to first quarter 2010 as lower-yielding cash and short-term investments increased as loan balances declined. The impact of these factors was somewhat mitigated by continued disciplined deposit pricing and reduced long-term debt.

     The mix of earning assets and their yields are important drivers of net interest income. Soft consumer loan demand and the impact of liquidating certain loan portfolios reduced average loans in first quarter 2011 to 70% of average earning assets from 74% in first quarter 2010. Average short-term investments and trading account assets increased to 11% of earning assets in first quarter 2011, up from 6% of earning assets in first quarter 2010.

     Core deposits are a low-cost source of funding and thus an important contributor to both net interest income and the net interest margin. Core deposits include noninterest-bearing deposits, interest-bearing checking, savings certificates, certain market rate and other savings, and certain foreign deposits (Eurodollar sweep balances). Average core deposits rose to $796.8 billion in first quarter 2011 from $759.2 billion in first quarter 2010 and funded 106% and 95% of average loans, respectively. Average core deposits increased to 74% of average earning assets in first quarter 2011, up from 71% a year ago, yet the cost of these deposits declined significantly as the mix shifted from higher cost certificates of deposit to checking and savings products, which were also at lower yields relative to first quarter 2010. About 90% of our core deposits are now in checking and savings deposits, one of the highest percentages in the industry.

NM - Not meaningful

Noninterest income was $9.7 billion for first quarter 2011, compared with $10.3 billion for first quarter 2010, representing 48% of revenue for both periods. The decrease from March 31, 2010 was due largely to lower mortgage banking net servicing income and lower service charges on deposit accounts.

     Our service charges on deposit accounts decreased in first quarter by $320 million from a year ago. This decrease was primarily the result of changes to Regulation E and related overdraft policy changes.

     We earn trust, investment and IRA (Individual Retirement Account) fees from managing and administering assets, including mutual funds, corporate trust, personal trust, employee benefit trust and agency assets. At March 31, 2011, these assets totaled $2.2 trillion, up 10% from $2.0 trillion at March 31, 2010. Trust, investment and IRA fees are largely based on a tiered scale relative to the market value of the assets under management or administration. These fees were $1.1 billion in first quarter 2011, up 1% from a year ago.

     We receive commissions and other fees for providing services to full-service and discount brokerage customers as well as from investment banking activities including equity and bond underwriting. These fees increased to $1.9 billion in first quarter 2011 from $1.6 billion a year ago. These fees include transactional commissions, which are based on the number of

transactions executed at the customer’s direction, and asset-based fees, which are based on the market value of the customer’s assets. Brokerage client assets totaled $1.2 trillion at March 31, 2011, up from $1.1 trillion a year ago.

     Card fees increased to $957 million in first quarter 2011, from $865 million a year ago, mainly due to growth in purchase volume and new accounts growth driven by improvements in the economy.

     Mortgage banking noninterest income consists of net servicing income and net gains on loan origination/sales activities and totaled $2.0 billion in first quarter 2011, compared with $2.5 billion a year ago. The reduction year over year in mortgage banking noninterest income was primarily driven by a decline in net servicing income.

     Net servicing income includes both changes in the fair value of mortgage servicing rights (MSRs) during the period as well as changes in the value of derivatives (economic hedges) used to hedge the MSRs. Net servicing income for first quarter 2011 included a $379 million net MSR valuation gain that was recorded to earnings ($499 million increase in the fair value of the MSRs offset by a $120 million hedge loss) and for first quarter 2010 included a $989 million net MSR valuation gain ($777 million decrease in the fair value of MSRs offset by a $1.8 billion hedge gain). The valuation of our MSRs at the end of first quarter 2011 reflected our assessment of changes in servicing and foreclosure costs, including the estimated impact from regulatory consent orders. See the “Risk Management – Credit Risk Management – Risks Relating to Servicing Activities” section and Note 11 (Legal Actions) to Financial Statements in this Report for information on the regulatory consent orders. The $610 million decline in net MSR valuation gain results for first quarter 2011 compared with first quarter 2010 was primarily due to a decline in hedge carry income. See the “Risk Management – Mortgage Banking Interest Rate and Market Risk” section of this Report for a detailed discussion of our MSRs risks and hedging approach. Our portfolio of loans serviced for others was $1.86 trillion at March 31, 2011, and $1.84 trillion at December 31, 2010. At March 31, 2011, the ratio of MSRs to related loans serviced for others was 0.92%, compared with 0.86% at December 31, 2010.

     Income from loan origination/sale activities was $1.2 billion in first quarter 2011 compared with $1.1 billion a year ago. The slight increase in first quarter 2011 was driven by lower provision for loan repurchase losses and higher loan origination volume, offset by lower margins on loan originations.

     Net gains on mortgage loan origination/sales activities include the cost of any additions to the mortgage repurchase liability. Mortgage loans are repurchased from third parties based on standard representations and warranties and early payment default clauses in mortgage sale contracts. Additions to the mortgage repurchase liability that were charged against net gains on mortgage loan origination/sales activities during first quarter 2011 totaled $249 million (compared with $402 million for first quarter 2010), of which $214 million ($358 million for first quarter 2010) was for subsequent increases in estimated losses on prior year’s loan sales because of the current economic environment. For additional information about mortgage loan

repurchases, see the “Risk Management – Credit Risk Management – Liability for Mortgage Loan Repurchase Losses” section in this Report.

     Residential real estate originations were $84 billion in first quarter 2011 compared with $76 billion a year ago and mortgage applications were $102 billion in first quarter 2011 compared with $125 billion a year ago. The 1-4 family first mortgage unclosed pipeline was $45 billion at March 31, 2011, and $59 billion at March 31, 2010. For additional detail, see the “Risk Management – Mortgage Banking Interest Rate and Market Risk” section and Note 8 (Mortgage Banking Activities) and Note 13 (Fair Values of Assets and Liabilities) to Financial Statements in this Report.

     Net gains on debt and equity securities totaled $187 million for first quarter 2011 and $71 million for first quarter 2010, after other-than-temporary impairment (OTTI) write-downs of $121 million for first quarter 2011 and $197 million a year ago.

Noninterest expense was $12.7 billion in first quarter 2011, up 5% from $12.1 billion in first quarter 2010, mostly due to performance-based compensation in brokerage and mortgage, as well as higher operating losses. Commission and incentive compensation expense increased proportionately more than salaries due to higher revenues generated by businesses with revenue-based compensation including the brokerage and mortgage businesses. Volume-related mortgage personnel expense reductions initiated in first quarter 2011 were not fully realized in the first quarter as team member displacement notification periods can lag volume declines. Operating losses of $472 million were substantially all from litigation accruals for foreclosure-related matters.

     Merger integration costs totaled $440 million and $380 million in first quarter 2011 and 2010, respectively. Integration expense drove the majority of the increase in outside professional services. First quarter 2011 marked further milestones in our integration of legacy Wells Fargo and Wachovia: we completed our conversion to one common retail brokerage platform and we converted retail banking stores in several eastern states, including Connecticut, Delaware, New Jersey, and New York. With our April conversion of the Pennsylvania retail banking stores, 74% of our banking customers are now on a single deposit system.

Income Tax Expense

Our effective tax rate was 29.5% for first quarter 2011, which included the benefit associated with the realization for tax purposes of a previously written-down investment. Our current estimate of the effective tax rate for the full year 2011 is 32%.

Operating Segment Results

We define our operating segments by product and customer. In fourth quarter 2010, we aligned certain lending businesses into Wholesale Banking from Community Banking to reflect our previously announced restructuring of Wells Fargo Financial. In first quarter 2011, we realigned a private equity business into Wholesale Banking from Community Banking. Prior periods

have been revised to reflect these changes. Table 4 and the following discussion present our results by operating segment. For a more complete description of our operating segments, including additional financial information and the underlying management accounting process, see Note 17 (Operating Segments) to Financial Statements in this Report.

Community Banking offers a complete line of diversified financial products and services for consumers and small businesses including investment, insurance and trust services in 39 states and D.C., and mortgage and home equity loans in all 50 states and D.C. through its Regional Banking and Wells Fargo Home Mortgage business units.

     Community Banking reported net income of $2.2 billion and revenue of $12.6 billion in first quarter 2011. Revenue declined $1.4 billion from first quarter 2010 driven primarily by a decrease in mortgage banking income due to a decrease in servicing income, lower deposit service charges due to Regulation E and related overdraft policy changes, and lower net interest income from the planned reduction in certain liquidating loan portfolios. Average core deposits increased $16.6 billion, or 3%, as growth in liquid deposits more than offset planned certificates of deposit run-off. We generated strong growth in the number of consumer and business checking accounts (up 7.4% and 5.3%, respectively, from March 31, 2010). Noninterest expense increased from first quarter 2010 due primarily to higher operating losses due to litigation-related accruals and volume driven mortgage-related expenses. The provision for credit losses decreased $2.5 billion from first quarter 2010 and credit quality indicators in most of our consumer and business loan portfolios generally continued to improve. Net credit losses declined in almost all portfolios and we released $850 million in reserves in first quarter 2011, compared with no reserve release a year ago.

Wholesale Banking provides financial solutions across the U.S. and globally to middle market and large corporate customers with annual revenue generally in excess of $20 million. Products and businesses include commercial banking, investment banking and capital markets, securities investment, government and institutional banking, corporate banking, commercial real estate, treasury management, capital finance, international, insurance, real estate capital markets, commercial mortgage servicing, corporate trust, equipment finance, asset backed finance, and asset management.

     Wholesale Banking reported net income of $1.7 billion, up $415 million, or 34%, from first quarter 2010. Revenue increased $37 million, or 1%, from the prior year, driven by growth in net interest income due to stronger earning assets, solid deposit growth and higher loan portfolio yields. Noninterest income declined $164 million, or 6%, from prior year as growth in investment banking and capital markets, corporate banking, foreign exchange and real estate capital markets was more than offset by reduced levels of PCI portfolio recoveries, crop insurance gains and trading portfolio income. Noninterest expense increased $115 million, or 4%, from prior year related to higher personnel expenses. Total provision for credit losses of $134 million declined $676 million, or 83%, from first quarter 2010. The decrease included a $150 million allowance release along with a $526 million improvement in credit losses, compared with no allowance release a year ago.

Wealth, Brokerage and Retirement provides a full range of financial advisory services to clients using a planning approach to meet each client’s needs. Wealth Management provides affluent and high net worth clients with a complete range of wealth management solutions including financial planning, private banking, credit, investment management and trust. Family Wealth meets the unique needs of the ultra high net worth customers. Brokerage serves customers’ advisory, brokerage and financial needs as part of one of the largest full-service brokerage firms in the United States. Retirement is a national leader in providing institutional retirement and trust services (including 401(k) and pension plan record keeping) for businesses, retail retirement solutions for individuals, and reinsurance services for the life insurance industry.

     Wealth, Brokerage and Retirement earned net income of $339 million in first quarter 2011. Revenue of $3.2 billion included a mix of brokerage commissions, asset-based fees and net interest income. Net interest income was up $32 million compared with first quarter 2010 as higher investment income was driven by solid deposits growth. Noninterest income was up $208 million, or 9%, as higher asset-based fees were partially

offset by lower brokerage transaction revenue and miscellaneous fees. Noninterest expense was up $169 million, or 7%, from first

quarter 2010, primarily due to increased broker commissions from increased production levels.

 

During first quarter 2011, our total assets, loans and core deposits each declined slightly from December 31, 2010, but the strength of our business model produced record earnings and high rates of internal capital generation as reflected in our improved capital ratios. Tier 1 capital increased to 11.50% as a percentage of total risk-weighted assets, total capital to 15.30%, Tier 1 leverage to 9.27% and Tier 1 common equity to 8.93% at March 31, 2011, up from 11.16%, 15.01%, 9.19% and 8.30%, respectively, at December 31, 2010. At March 31, 2011, core

deposits funded 106% of the loan portfolio, and we have significant capacity to add loans and higher yielding long-term MBS to generate future revenue and earnings growth.

     The following discussion provides additional information about the major components of our balance sheet. Information about changes in our asset mix and about our capital is included in the “Earnings Performance – Net Interest Income” and “Capital Management” sections of this Report.

     Table 5 presents a summary of our securities available-for-sale portfolio. Securities available for sale consist of both debt and marketable equity securities. We hold debt securities available for sale primarily for liquidity, interest rate risk management and long-term yield enhancement. Accordingly, this portfolio consists primarily of very liquid, high quality federal agency debt and privately issued MBS. The total net unrealized gains on securities available for sale were $8.9 billion at March 31, 2011, up from net unrealized gains of $8.3 billion at December 31, 2010, primarily due to narrowing of credit spreads.

     We analyze securities for OTTI quarterly or more often if a potential loss-triggering event occurs. Of the $121 million OTTI write-downs in first quarter 2011, $80 million related to debt securities. There were no OTTI write-downs for marketable equity securities and there were $41 million in OTTI write-downs related to nonmarketable equity securities. For a discussion of our OTTI accounting policies and underlying considerations and analysis see Note 1 (Summary of Significant Accounting Policies – Securities) in our 2010 Form 10-K and Note 4 (Securities Available for Sale) to Financial Statements in this Report.

     At March 31, 2011, debt securities available for sale included $21 billion of municipal bonds, of which 84% were rated “A-” or better, based on external, and in some cases internal, ratings. Additionally, some of these bonds are guaranteed against loss by bond insurers. These bonds are predominantly investment grade and were generally underwritten in accordance with our own investment standards prior to the determination to

 

     A discussion of average loan balances and a comparative detail of average loan balances is included in Table 1 under “Earnings Performance – Net Interest Income” earlier in this Report. Year-end balances and other loan related information

are in Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.

Deposits

Deposits totaled $837.7 billion at March 31, 2011, compared with $847.9 billion at December 31, 2010. Table 8 provides additional detail regarding deposits. Comparative detail of average deposit balances is provided in Table 1 under “Earnings Performance – Net Interest Income” earlier in this Report. Total core deposits were $795.0 billion at March 31, 2011, down $3.2 billion from $798.2 billion at December 31, 2010.

 

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. See our 2010 Form 10-K for a description of our critical accounting policy related to fair valuation of financial instruments.

     We may use independent pricing services and brokers to obtain fair values based on quoted prices. We determine the most appropriate and relevant pricing service for each security class and generally obtain one quoted price for each security. For certain securities, we may use internal traders to obtain quoted prices. Quoted prices are subject to our internal price verification procedures. We validate prices received using a variety of methods, including, but not limited to, comparison to 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.

     Table 9 presents the summary of the fair value of financial instruments recorded at fair value on a recurring basis, and the amounts measured using significant Level 3 inputs (before derivative netting adjustments). The fair value of the remaining assets and liabilities were measured using valuation methodologies involving market-based or market-derived information, collectively Level 1 and 2 measurements.

Table 9: Fair Value Level 3 Summary

     See Note 13 (Fair Values of Assets and Liabilities) to Financial Statements in this Report for a complete discussion on our use of fair valuation of financial instruments, our related measurement techniques and the impact to our financial statements.

 

In the ordinary course of business, we engage in financial transactions that are not recorded in the balance sheet, or may be recorded in the balance sheet in amounts that are different from the full contract or notional amount of the transaction. These transactions are designed to (1) meet the financial needs of customers, (2) manage our credit, market or liquidity risks, (3) diversify our funding sources, and/or (4) optimize capital.

Off-Balance Sheet Transactions with Unconsolidated Entities

We routinely enter into various types of on- and off-balance sheet transactions with special purpose entities (SPEs), which are corporations, trusts or partnerships that are established for a limited purpose. Historically, the majority of SPEs were formed in connection with securitization transactions. For more information on securitizations, including sales proceeds and cash flows from securitizations, see Note 7 (Securitizations and Variable Interest Entities) to Financial Statements in this Report.

 

All financial institutions must manage and control a variety of business risks that can significantly affect their financial performance. Key among those are credit, asset/liability and market risk.

     For more information about how we manage these risks, see the “Risk Management” section in our 2010 Form 10-K. The discussion that follows is intended to provide an update on these risks.

Credit Risk Management

Table 10: Total Loans Outstanding by Portfolio Segment and Class of Financing Receivable

Our credit risk management process is governed centrally, but provides for decentralized management and accountability by our lines of business. Our overall credit process includes comprehensive credit policies, judgmental or statistical credit underwriting, frequent and detailed risk measurement and modeling, extensive credit training programs, and a continual loan review and audit process. In addition, banking regulatory examiners review and perform detailed tests of our credit underwriting, loan administration and allowance processes.

     A key to our credit risk management is adhering to a well controlled underwriting process, which we believe is appropriate for the needs of our customers as well as investors who purchase the loans or securities collateralized by the loans. We approve applications and make loans only if we believe the customer has the ability to repay the loan or line of credit according to all its terms. Our underwriting of loans collateralized by residential real property includes appraisals or automated valuation models (AVMs) to support property values. AVMs are computer-based tools used to estimate the market value of homes. AVMs are a lower-cost alternative to

appraisals and support valuations of large numbers of properties in a short period of time. AVMs estimate property values based on processing large volumes of market data including market comparables and price trends for local market areas. The primary risk associated with the use of AVMs is that the value of an individual property may vary significantly from the average for the market area. We have processes to periodically validate AVMs and specific risk management guidelines addressing the circumstances when AVMs may be used. Generally AVMs are used in underwriting to support property values on loan originations only where the loan amount is under $250,000. For underwriting residential property loans of $250,000 or more, we generally require property visitation appraisals by qualified independent appraisers.

Non-Strategic and Liquidating Portfolios We continually evaluate and modify our credit policies to address appropriate levels of risk. Accordingly, from time to time, we designate certain portfolios and loan products as non-strategic or high risk to limit or cease their continued origination as we actively work to limit losses and reduce our exposures.

     Table 11 identifies our non-strategic and liquidating loan portfolios. These portfolios have decreased 34% since the merger with Wachovia at December 31, 2008, and decreased 5% from the end of 2010. They consist primarily of the Pick-a-Pay mortgage portfolio and non Pick-a-Pay PCI loans acquired in our acquisition of Wachovia as well as some portfolios from legacy Wells Fargo home equity and Wells Fargo Financial. Effective first quarter 2011, we added our education finance government guaranteed loan portfolio to the non-strategic and liquidating portfolios as there is no longer a U.S. Government guaranteed student loan program available to private financial institutions pursuant to legislation in 2010.

     The legacy Wells Fargo Financial debt consolidation portfolio included $1.2 billion of loans at March 31, 2011, and December 31, 2010, that were considered prime based on secondary market standards. The remainder is non-prime but was originated with standards to reduce credit risk.

     Analysis of the Pick-a-Pay and the commercial and industrial and CRE domestic PCI portfolios is presented below in the Significant Credit Concentrations and Portfolios Reviews section.